Speech by SEC Staff:
Shared Responsibilities In Global Capital Markets
Director, Office of International Affairs
U.S. Securities and Exchange Commission
BritishAmerican Business Inc.'s Financial Services Forum
May 8, 2007
Thank you, Alan.
Before I begin my talk, I should start with the SEC's, by now famous, disclaimer: The SEC as a matter of policy disclaims responsibility for any private remarks made by SEC commissioners or staff. These remarks constitute my own opinions and do not necessarily reflect the views of the Commission, the individual Commissioners, or other members of the Commission staff.
With that out of the way, I thought say a few words about "shared responsibilities" and the global financial community.
Shared Responsibilities among Regulators
We all know the importance of community. Indeed, without community, there is no civilization. Aristotle tells us that man is by nature a "political" animal - and by that he meant political not in the sense of political parties, but in the sense that we cooperate and coordinate our activities, and consciously share responsibilities and values together in a way that even other social animals do not. Aristotle adds that anyone who has no community is either subhuman or superhuman - and that it is the sharing of common values that forms what the Greeks called the polis, and which makes us human and not animals or gods.
In a very real sense, securities regulators are themselves a community - and, in today's global marketplace, a securities regulator who is not part of this global community is, again in Aristotle's words, like an isolated piece in a game of checkers. I'm often amazed in discussions with representatives from the financial industry about how little is known about the depth and frequency with which securities regulators cooperate and coordinate with each other.
Remarkable challenges and opportunities lie ahead of this community of regulators. But in facing challenges and embracing these opportunities, we should - as caretakers and custodians of our individual markets - heed the counsel of Hippocrates: "Declare the past, diagnose the present, foretell the future." But before that, we should "first, do no harm."
Declaring the Past, Diagnosing the Present, Foretelling the Future
Today, when we look across the Atlantic at each others' markets, we realize that the bonds between our markets are stronger than they ever have been. The New York Stock Exchange and Euronext have merged into a transatlantic company that operates six different exchanges catering to different types of issuers. The International Accounting Standards Board and the US Financial Accounting Standards Board have made great strides in converging International Financial Reporting Standards with US Generally Accepted Accounting Principles. This has, in turn, led the SEC to look at eliminating its reconciliation requirement. Each day, issuers and investors alike, from around the world, are increasingly looking beyond their home markets when making investments or seeking capital.
Today, investors - from the largest financial institution that invests on behalf of thousands, to the child that holds a government savings bond - provide the fuel that drives our economies. The capital they provide to entrepreneurs and businesses creates jobs, spurs economic growth, and raises standards of living. And the returns these investors hope to make on their investments hold out for them the promise of secure retirements and good educations for their children.
But markets differ, just as the issuers, investors, and the countries that host them differ. We all know of the regulatory differences. The recent debate about these differences has begun to seem like a debate about industrial policy, in which market participants argue about who is subject to the most rigorous regulatory standards, or most enlightened regulatory approach. Many like to depict growing markets in developing countries as a "threat" to more developed markets in the United States and Europe - as if the rising tide lifting all our boats is a menace because more boats are now being lifted.
I was here in London two weeks ago with Chairman Cox and we received a great number of questions about mutual recognition and substituted compliance and the future of SEC policy in this area. And I'm sure you have such questions yourself, as recent comments made by Chairman Cox and others and my article in the Harvard International Law Journal appear to constitute something of a change in thinking. But these ideas should be viewed in context - in the context of an evolution in the regulatory community and the fact that our markets are everyday growing more and more integrated.
Some believe the idea of mutual recognition is unfolding too slowly, and does not go far enough. To these critics, I say that as the custodians of capital markets, we regulators have an obligation to get it right, and to "do no harm." Getting it right necessarily requires that we move carefully and deliberately, and to be sure that we understand fully the problems we are attempting to solve and the consequences of the solutions we propose.
And others believe that this idea goes too far. To these critics, I say that the press of globalization gives us no choice. Regulation is neither the force that drives globalization nor the brake that slows it. AND we would be foolish to think that, as regulators, we can ignore the markets outside our borders. We must realize that what happens in our markets affects our neighbors, just as what happens in theirs affects ours. In the face of globalization, our task must be to secure its benefits for our investors, while continuing to provide them with the appropriate level of regulatory protection.
Regulation is not the fuel that drives our markets, but it is the oil that greases the wheels. Too little regulation, and investors demand a premium for their money, to compensate them for the greater risks they face in an under-regulated market. Too much regulation, and the costs outweigh the benefits and market efficiency suffers. Regulators must strike a balance between under-regulation, which carries with it the risk of contagion in the form of fraud, and over-regulation, which saps the vitality of otherwise vibrant markets. A balance must be achieved, and different markets strike this balance in different ways. This isn't just a matter of regulatory competition or even regulatory arbitrage. Different markets have different concerns - concerns that arise, in many cases, from unique circumstances.
It is easy for us to forget these differences in our increasingly globalized world. Capital flows across borders easily and businesses operate on a worldwide basis. Nonetheless, these differences remain and may well continue for some time to come.
Respecting Differences as We Build on Common Ground
But recognizing these differences does not require us to concede that convergence cannot be achieved, or that mutual recognition is not possible. But it does mean that we regulators must look closely at our regulatory systems. We have to ask ourselves, on an ongoing basis, why we do what we do. We will find that some regulations are necessary, tailored to our markets to address very real problems. We will also find that some of our regulations are the result of legislative mandates from our governments, which cannot be changed by the regulator. But we may also find some regulations to be redundant, or to be the result of problems that have long been resolved. When this is the case, it behooves us all to eliminate these redundancies and legacies that have ceased to serve their purposes. Doing so will reduce costs to the benefit of investors and businesses alike.
As our markets evolve and globalize, we find that we now have more things in common than we have in the past. As the SEC works with its counterparts overseas, we often find that our regulatory objectives are the same. In fact, we have now reached the point where we can ask, given that our regulatory objectives are the same, shouldn't our regulations be the same as well? That we can ask the question at all is a testament to just how much more closely our markets are linked, and a tribute to the efforts that regulators around the world have made in seeking common ground. But there is a siren's call here - the idea that a universal set of regulations would allow businesses, financial firms, and investors to operate in a borderless world.
We ultimately should be comfortable with giving investors choices. The idea that informed investors are in the best position to judge for themselves how to allocate their capital is the bedrock upon which US securities laws are built. The trick, of course, is ensuring that both retail and institutional investors are properly informed. For the SEC, this task is the crux of investor protection.
Building a Global Framework
In short, what we have today are global markets with global market participants. But regulation is necessarily national. Since we do not have, nor are we likely to have, a truly global regulator, for international markets to work efficiently, we need national regulators with a global vision. And this necessarily entails cooperation, coordination and shared responsibilities in order to promote investor protection and market integrity.
This cooperation and coordination has grown to such an extent that not a day goes by - indeed, sometimes not an hour - where members of the SEC's Office of International Affairs are not engaged in some kind of direct contact with their counterparts abroad. Our efforts touch on practically every aspect of market oversight.
Here I am obliged to "declare the past" and note that this international infrastructure includes a web of long-standing bilateral and multilateral ties. Bilaterally, we have not just the personal relations between individual government officials, but more formal arrangements such as Memoranda of Understanding which are underpinned by the appropriate statutory authority. For example, the SEC and the UK have had an enforcement information-sharing MOU since before the FSA was created. Serious insider trading, market manipulation and financial fraud cases, in both the United States and the UK, have been prosecuted successfully based on coordinated investigations and information-sharing between the SEC and FSA. Increasingly, these are investigations, where not just evidence but even remedies and sanctions were coordinated.
The importance of this enforcement information-sharing is so widely recognized by the international regulatory community that it has become a keystone of multilateral cooperation. In 2002, the International Organization of Securities Commissions created a multilateral information-sharing MOU under which all signatories pledge not just to share enforcement information with each other and cooperate with the others' investigations, but also demonstrate to the organization that they have the legal authority to live up to the MOU's provisions. This IOSCO Multilateral MOU has proven enormously successful - so much so that this past year IOSCO agreed to make being able to sign the Multilateral MOU a condition of membership by 2010.
Enforcement, though, is only one area where securities regulators cooperate. Historically, our enforcement MOUs have monopolized the spotlight, but recently the SEC has entered into a number of supervisory MOUs relating to globally-active firms and cross-border exchange affiliations, and has finalized a model protocol for conferral between the SEC and the Committee of European Securities Regulators - or CESR - members about the financial statements of dually-listed companies. These supervisory arrangements and protocols call for cooperation in advance of a potential violation of law or rule and contemplate ongoing and regular consultation about regulated entities that operate across our borders.
From your perspective, cooperation among regulators allows for smoother, more consistent, and more rational cross-border oversight. For example, as a result of the SEC's recent protocol with the UK's Financial Reporting Council, we know that if we have a question about a cross-listed UK issuer's accounting, there is someone at the FRC we can call to discuss the matter. By sharing our views and opinions, we can alert each other to ideas and issues that we might not have thought of otherwise.
Cleaving to Hippocrates' counsel, and having declared the past, it might be worthwhile to take a moment to diagnose the present.
IFRS and Elimination of the Reconciliation Requirement
I am sure you all know that in April 2005 SEC staff laid out a "Roadmap" charting a path to a time when issuers that file their financial statements using International Financial Reporting Standards - or IFRS - as issued by the International Accounting Standards Board, would no longer be required to reconcile to US Generally Accepted Accounting Principles. So how far along the road have we come? We have traveled far. The SEC has been gaining its first insights into how IFRS works in practice. Last summer, our staff began reviewing the filings that we received from those foreign private issuers that adopted IFRS in 2005. Meanwhile, our staff is cooperating with CESR pursuant to a joint work plan that was announced just last summer. We also recently hosted a Roundtable on the Roadmap and the effect of IFRS on the investors and issuers in US capital markets. The feedback was extremely positive.
One of the long-held aspirations of those seeking to realize the benefits of global capital markets has been the promise embodied in the International Financial Reporting Standards. The dream has been that a single, global set of standards would ease the burden of issuers who would otherwise have to reconcile their financial statements to the accounting standards of particular jurisdictions. Not only would such a set of standards lift a heavy burden borne by issuers, investors around the world would benefit because these standards would eliminate one of the barriers to foreign private issuers contemplating raising capital outside their borders.
IFRS promises to integrate our markets. But that promise is jeopardized if IFRS is not applied faithfully and consistently across jurisdictions. We must be careful that our faith in that promise does not inadvertently create the conditions for cacophony and confusion. The danger is that filings made in accordance with particularized versions of IFRS will plunge us back into a Babel of national GAAPs, each with its own idiosyncrasies. Regulators must beware the impulse to develop nationally-tailored versions of IFRS, and we must cooperate with one another in implementing a set of standards that is faithfully and consistently applied.
As the SEC staff reviews the filings of foreign private issuers that have adopted IFRS, it will be looking at whether IFRS filers are adhering to IFRS standards. Let me be clear: this is not an effort to dictate how IFRS ought to be applied. And this is not an effort to divert IFRS from principles-based accounting standards to rule-based standards. Rather our staff is looking at whether IFRS filings are complete and adhere to IFRS standards.
Investors and issuers alike will realize the promise inherent in IFRS only if these standards deliver a clear and accurate picture upon which sound investment decisions can be based. We are well down the path charted in the "Roadmap," and on track to consider eliminating the reconciliation requirement by 2009, if not earlier.
The SEC has also been mindful of the ways in which US laws and regulations affect foreign issuers in US markets. In particular, we have noted the concerns raised by foreign private issuers about the application of Section 404 of the Sarbanes-Oxley Act, which requires issuers to include in their annual reports an assessment by management of the effectiveness of the issuer's internal controls as well as an attestation by the independent auditor on the effectiveness of those controls. We have acted to address those concerns. We have twice extended the compliance deadline with provisions of Section 404 for certain foreign private issuers. We have, I think, tried to be sensitive to the particular needs of foreign private issuers, and we have worked to minimize the burdens that 404 may impose on them. I also want to point out that the new deregistration rule takes effect early this summer, allowing foreign private issuers that have a relatively small U.S. trading volume to withdraw their registration and end their US reporting obligations. In short, foreign private issuers can withdraw rather than comply with 404, if they qualify and so desire.
But many of the concerns raised by foreign private issuers are not unique to them alone. During the first few years of 404's implementation, the SEC learned a great deal from both the companies and the auditors charged with implementing section 404. The SEC has listened at roundtables, studied comment letters, and paid close attention to the academic and private sector studies on the costs of implementing 404. The picture that has emerged is that many believe that the costs of implementing section 404 have been too high.
Last December, the Commission formally proposed new interpretive guidance to assist management in developing a process for evaluating their internal controls over financial reporting. The proposed guidance would allow management to focus on areas presenting the greatest risk of material misstatements. These are the areas that all investors care about, and these are obviously the areas that matter most in capital markets that are becoming increasingly global. The proposed guidance would permit companies to exercise significant judgment in designing an evaluation tailored to its individual circumstances. By proposing to issuers that they focus on these areas, we expect to strike an appropriate balance between protecting investors - wherever they may be - and making our markets hospitable to issuers - from wherever they may come.
The Shared Responsibilities of Industry
I have so far declared the past and I have tried to diagnose the present. As for foretelling the future, I must be more cautious. But I think I can safely say that our markets will grow increasingly interconnected in the years ahead, whatever the world's regulators do. It is my hope that by acting wisely, we can make that process go more smoothly. I think that we can eliminate needless regulatory redundancies, making it easier for investors and issuers to meet in whatever part of the world they choose as capital flows more freely across borders and around the world.
Industry, however, also shares in the responsibility in creating a truly global capital market. Markets, as everyone knows, require trust. Whether it is the Bubble Act of 1720 or the Sarbanes-Oxley Act of 2002, capital markets regulation historically has followed when there has been a breach of this trust. The problem that arises in a world of global capital markets is that when abuses occur today, national regulators may respond but they may respond in different ways.
Not always, but in many cases the problems that spark regulation can be identified beforehand by those in industry itself. After all, no one knows better than those in industry what problems are possible and what risks can be avoided. For example, firms are usually in the best position to recognize conflicts of interest before they become problems. They are also in the best position to know what types of risks their industry faces, and to develop ways to alleviate these risks, before they become regulatory concerns.
By adopting the best possible compliance standards and internal controls, regardless of what is actually mandated by regulation, firms can do as much as regulators to guard the public trust in our markets. As a practical matter, this may also do more to foster the development of a global market than anything an alliance of securities regulators can do.
Clearly, any chain is only as strong as its weakest link, and any market, no matter how honest, can be tainted by just a handful of bad actors. And when a handful of bad actors sow distrust among investors, honest firms can lose as much as the investors who lose money to scam artists and market manipulators.
But regulators rarely draft new regulations to address problems created by a handful of bad actors. Fraud is as old as history itself, and the laws and regulations already on the books usually are sufficient to deal with the occasional crook. The real fear of regulators, the one that keeps us up at night, are the systemic problems. Not the random bad apple, but the rotten barrels.
Perhaps this sounds unfair, but it is a problem that has occurred several times in the past - and usually results in a new set of laws and regulations. When you think about it, you can see how such systemic problems arise. Someone cheats and doesn't get caught. The cheating, either false accounting figures or artificially inflated returns, are perceived by the market, or the firm, as legitimate. This raises expectations for other market participants or firm employees. These expectations, because they are based on a lie, are very difficult to meet. And this, in turn, creates enormous pressures on others to cheat as well - particularly if they are aware that others are cheating.
The cycle continues until the whole house of cards collapses.
In perhaps a simpler time, this type of collective action problem would have been solved by gentlemen's understandings and a sense of professionalism. Today, however, the type of professionalism called for is of a different kind. We still need the sense of individual professionalism - the individual sense of honor, self-esteem and morality to resist the call to take the easy road, if that road is unethical or illegal. But we also need a sense of institutional professionalism - that is, inculcating a sense of compliance, checks and internal controls throughout the firm. A sense that the compliance function is as vitally important to the firm as is quality control. Because the truth is that we can expect individual failures, but individual failure need not be catastrophic - or contagious - if controls are in place to anticipate them and limit their damage.
Further, this sense of institutional professionalism needs to be adopted industry wide, around the globe. This is not a call to bring back the old medieval guilds. But it is a call for industry to foster a sense of professionalism not just at the individual level - which, after all, most firms try to do - but at the systems level. In other words, I believe that the best tool we all have to bring about the benefits of a truly global capital market rests not with regulators, but with industry adopting as much pride in its compliance function and internal controls as it might with a zero-defect quality control system. When this happens, we regulators may find ourselves less occupied.
Thank you for your time, and I am happy to answer any questions you may have.