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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Address to the National Italian-American Foundation


Chairman Christopher Cox

U.S. Securities and Exchange Commission

New York City
May 31, 2007

Good afternoon, and thank you, Giovanni [Prezioso], for the kind introduction. Giovanni, as you know, was the General Counsel of the SEC for four years, and it was my opportunity to work with him on issues ranging from foreign issuer deregistration, to improvements to the tender offer rules, to our initiative to allow investors to have access to proxy materials on the Internet. He counseled me, and the Commission, on hundreds of enforcement matters — and helped us place fear in the hearts of would-be fraudsters everywhere. There is nowhere a more dedicated son of Italy who has contributed more to the integrity and security of America's capital markets. He's truly l'avvocato migliore. [Applause] And, Giovanni, it's a pleasure to see you again today.

I very much appreciate the opportunity to share with you in this celebration of the many contributions of the Italian-American community to our nation's economy and to our society. And where better to do that than right here at the center of our great market system? Standing this close, it seems as if you can actually feel the inner workings of NASDAQ's Market Site — the "good vibrations," as we call them in California. [Laughter]

I'd like to thank Joe Del Raso, your Executive Vice President, for his leadership in putting this program together. And it's especially welcoming to find two of my former colleagues in Congress, Frank Guarini and now-Judge Bill Martini, at this truly impressive gathering of so many of America's great leaders from the public and private sectors.

Italy's contributions to our politics are many and well known. They include 29 current members of the House and Senate — among them, most notably, the Speaker of the House. But without the contributions that the Italian language has made to American English, we wouldn't even have our vocabulary of political terms, including "partisans" and "ballots" — and of course there would be no "politicos." In the world of finance, we wouldn't have "banks" — or, for that matter, "bankrupts." There would be no "cash" in those banks, either. And the banks could extend no "credit" … no "credito" … or at least not our current word to describe it.

The Italian-American community has contributed to the rich fabric of our lives in countless ways. No one better than the members of the National Italian American Foundation understands the multi-generational experience of leaving an ancestral homeland, rich with history and culture, in order to seize the unprecedented opportunities of a new world and a vast new continent. As the spiritual descendants of Leonardo, you know the importance of the freedoms here in America to the fulfillment of a truly creative society.

Whenever freedom and genius mix, society is guaranteed a wealth of new discoveries, new improvements to the human condition, and new reasons to celebrate. These days, not least among our reasons to celebrate is the recent news that De Niro and Pacino will soon join their talents for another cinematic masterstroke. [Laughter]

Other great nations and peoples — from every corner of the earth — have also braved the most difficult and trying circumstances to reach this continental nation named for Amerigo Vespucci. And the contribution they've made has created the world's most dynamic and enriching society. We can't see it or touch it, but the endless opportunity that's the soul of America gives texture nonetheless to Leonardo's pursuit of the infinite.

For half a millennium, America has been an immigrant nation. And the challenges both to our country and to the new arrivals have always been daunting. But always, the earlier immigrants have offered wisdom and guidance to newcomers that have helped them to join in the constant nation building reflected in our motto, E Pluribus Unum. The stories and the examples are legion of Italian Americans mentoring immigrants from old and new Europe, from Africa, Asia, and Latin America. And that support has been the bedrock of our success as a nation.

One very practical problem that faces a new immigrant is having to confront a new language. The passage of so many Italian words into American English is reflective of the linguistic leveling that inevitably occurs as people from different cultures interact and engage in commerce with one another. In trade and in business especially, there's a demand for plain language that eliminates ambiguity and assures that the necessary aspects of life can go on.

In much the same way as a new immigrant faces the challenge of learning a foreign language, ordinary investors whose first language is English too often have to contend with the difficult and obscure language of "Legalese." At the SEC, we recognize that America is not only an immigrant nation, but an investor nation — and we're determined to make plain language the order of the day for retail customers facing difficult financial choices.

The SEC's "Plain English" initiative is designed to make markets accessible to every American. We're beginning to see some real successes in translating what for too long have been impenetrable disclosures into understandable language, conveniently organized so that investors can really use the information. For the still-formidable amount of investment information that hasn't been made available in plain English, the SEC's Web site features an indispensable glossary of investment terms, and steers people to advice on how to avoid fraud and other deceptive practices.

But this work is far from complete. As a government agency, we inevitably throw some jargon around ourselves. Nonetheless, we're making the elimination of needlessly technical language a priority in our own rules and regulations, as well as in the private sector.

Plain language isn't just important to save investors time, or to make proxy statements and annual reports more aesthetically pleasing to Madison Avenue copy writers and high school English teachers. Stripping away Legalese and technical jargon is important to insure that the investors who trust their dollars to someone else truly understand the bargain they're making and the choices they have. It's part and parcel of everything we do at the SEC to build and maintain investor confidence in our markets.

When our capital markets were smaller and more quaint, face-to-face trading was the norm. Market confidence was based on looking someone directly in the eye and judging that they could be trusted. It's no surprise that private entrepreneurs have long understood this — or that Italian-American entrepreneurs were at the forefront of establishing business practices based on integrity and fair dealing.

Every Californian like me knows the story of the powerful earthquake that shook San Francisco to its core in 1906. One of the many people who faced terror that early spring morning in the Bay area was the son of Genoese immigrants. His parents worked in the produce business, but for the last two years, he'd struck out on his own as an entrepreneurial small banker. Like so many immigrant families, he'd witnessed the big bankers' practice of lending to only the wealthiest patrons. So he became a neighborhood banker, and he named his startup, auspiciously, the Bank of Italy.

But this morning, even his modest quarters were no more — and with the site of his Bank of Italy now lying in rubble, a horse-drawn produce wagon became his place of business. He hid the bank's holdings in the wagon bed, and camouflaged it with vegetables. And then, on a wharf near San Francisco's North Beach, young Amadeo spread a wooden plank across two barrels for a makeshift desk, and started lending again to the homeless victims of this modern Vesuvius. Many of his loans were made on the basis of a handshake alone. The rebuilding of San Francisco got underway in no small part because the young banker trusted people of integrity who invested their own sweat in the local economy.

Of course, you all know that A. P. Giannini grew his neighborhood Bank of Italy into the Bank of America, eventually helping to bankroll California's fledgling wine and film industries, and even the construction of the Golden Gate Bridge.

You might not know, however, how committed he was to serving the needs of others instead of himself. "Serving the needs of others," he would say, "is the only legitimate business today." And more tellingly, he said: "I don't want to become too rich — because not one rich person controls that richness, but rather is controlled by it." He lived by his words. Even though when he died he was the titan of American banking, his estate was only $500,000 — far less than he could have amassed at the end of such a successful career.

So as we find ourselves today somewhere near the arena in which the mythical Gordon Gekko operated — you know, the Michael Douglas character who in Oliver Stone's movie "Wall Street" infamously announced that "greed is good" — we'd all do well to recall the example of the antithesis of Gordon Gekko, A.P. Giannini, whose life and career were so obviously grounded in his belief in the ennobling potential of our capital markets.

Of course, today it's impossible to conduct most business on the basis of a handshake. Life is just too complicated. But we can never allow the ethos of the simple handshake, and the sense of sincerity and good faith that it represents, to disappear from our everyday transactions, even in today's sophisticated financial markets.

Indeed, the very technology that separates today's global capital markets from Giannini's time offers us ways to help insure that ordinary investors fully understand the products they buy and the choices they face.

A private sector effort underway in over 100 countries has developed a way for financial information to come alive for any investor with a home computer — not to mention sophisticated analysts who'll be able to do far more with SEC-mandated disclosures than ever before, and make the results of their analysis available to retail customers. It's called interactive data, and already companies are beginning to file their SEC reports in this new format that offers tremendous power to users of the information.

This year, investors are also getting the benefit of vastly improved disclosure about how much company executives are paid, another SEC initiative to insure that the ordinary Americans who own our public companies have the information they need, in a form they can use. All forms of compensation are totaled into one number that's comparable from company to company, and from industry to industry. And beginning next month, on the SEC's website, all of this executive compensation information will be available in interactive data format for the companies that make up the S&P 500.

Ultimately, the widespread adoption of interactive data will fuel an explosion in new research about public companies, because the analysts who provide investment research will be able to be far more productive. They'll spend far less time tracking down information, and far more time doing comparisons and analyses, and understanding what the mountains of data that are now available really mean.

In an era when far more information is available on most companies than can reasonably be digested — not to mention that it's fueled by the Internet and available in real time — it's shameful that data from essential SEC filings have to be re-typed in order to be analyzed in a spreadsheet or software program. Interactive data will help analysts — from large brokerage firms to boutique niche researchers — to keep pace with the growth and changes in our markets.

There's another way that the research business needs to keep pace with change. Some of our most important rules concerning investment research date back over 30 years, to 1975, when most stock research was in the form of paper reports. In that year, to help make the adjustment from fixed commissions to the new era of competition, Congress allowed investment advisers to pay higher than market rates for brokerage commissions as a way to cover the cost of research.

That was a very long time ago. Today, the market considerations that gave rise to so-called "soft dollars" are as out of date as the Betamax, leisure suits, and "Welcome Back Kotter" — all vintage 1975 as well.

In a "soft dollar" transaction, an investment adviser's customer pays one price — say five cents a share — that covers both the cost of the trade and other research products and services as well. But while investors pay these costs, most investors are unaware of them. That's because for all intents and purposes, these fees are hidden.

And it isn't just retail investors, but even large sophisticated customers of money managers who have difficulty figuring out exactly what their money is buying. Soft dollars make life extremely difficult for investors of all kinds who are trying to understand where their money is going. Soft dollars need to see the light of day.

The fact that soft dollars are hidden from view means their use isn't subject to the same robust scrutiny and oversight that investors apply to the costs that investors can see. And this lack of transparency has led to abuses. We've seen examples of money managers using their clients' soft dollars to pay for office rent, furniture and equipment, lavish trips, theater tickets, and fancy meals. In fact, the most common abuse of soft dollars appears to be advisers using their clients' money to pay others for referring new clients to the adviser. That's not exactly the kind of "research" that will help investors' portfolios.

Even aside from abuses, the lack of transparency may be contributing to higher costs. These higher costs are borne directly by investors in mutual funds, pension funds, and 401(k) plans. Today, when so many American investors are saving for retirement, these extra costs can shave off critical returns that amount to big money in the long run.

There are also inherent conflicts of interest in the use of soft dollars that offer perverse incentives to investment advisers to use them in ways that aren't beneficial to investors. That's because soft dollars offer the opportunity for money managers to use the client's money to pay for expenses the money manager normally would pay itself. Using the client's money may also remove the adviser's incentive to keep its own costs down. And to generate soft dollars, the adviser has an incentive to trade even when it's not in the client's best interest.

Soft dollars can also create incentives to use one client's commissions to pay for another client's research. Beyond ill serving investors, all of this is unfair to money managers. Money managers should never be put in the position where they have an incentive not to put the client first.

As if all of this were not enough, we now have a whole cottage industry of lawyers who give advice on what is "soft dollarable," and what's not. The legal tests are complicated. The SEC's staff spends a considerable amount of time answering questions about how to interpret our guidance.

Let me give you an example of the complexity: The Commission's soft dollar interpretation allows a particular product to be considered both "research" and "not research" at the same time. These are so-called "mixed use" products, which can be paid partially in soft dollars and partially in real, hard dollars. The money manager has to allocate the costs, and disclose them separately. This is unnecessary complexity, which leads to unnecessary costs. And as always, it's the investor who ends up footing the bill.

This witch's brew of hidden fees, conflicts of interest, and complexity in application is at odds with investors' best interests. We all know we can do better. That's why I've asked Congress to consider legislation to repeal or at least substantially revise the 1975 law that provides a "safe harbor" for soft dollars.

For our part, we'll continue to monitor the abuses in order to bring hidden soft dollar expenditures to light — and to ensure that to the maximum extent possible, soft dollars are used only for research. Here again, our goal is to help investors to get the information they need, in a form they can really use and understand.

There's another area where ordinary investors need help in cutting through the fog and getting better information, and it's something that affects nearly everyone in this room. Many, if not most, of you probably have a 401(k) retirement plan, or something like it. We hope to make it far easier for you and for every busy American to understand the returns you're getting and the expenses you're being charged.

Of the more than $3 trillion that Americans have invested in 401(k) plans and other defined contribution plans, nearly half is in mutual funds. But an important factor in determining an investor's mutual fund return in the long run is hopelessly obscured by a quarter-century old provision in the SEC's own rules.

How many of you here can say you understand the 12b-1 fees in your mutual fund investments? [Three hands raised] How many of you know what 12b-1 is? [About a dozen hands raised] I assure you it's not like A-1, or Heinz 57, that you can put on your steak. It's the number of a rule that the SEC adopted in 1980, that permits mutual funds to use investors' funds for expenses such as subsidizing the sale of fund shares to other investors.

The premise was that these subsidies would be relatively short-lived, because they'd be used to solve specific distribution problems as they arose — at a time when the mutual fund industry was struggling in its infancy. The Commission's purpose in adopting the rule was nurturing mutual fund growth at a time of net redemptions. There was a very real concern that if funds weren't permitted to use at least a small portion of their assets to facilitate distribution, many of them might not survive.

Very quickly, however, 12b-1 plans came to be used for other reasons. Most notably, instead of paying for distribution, they became a substitute for front-end loads. In this way, more substantial sales loads could be collected — while the fund could still advertise itself to investors as "no load." The transformation of the 12b-1 fee from a distribution subsidy to a hidden sales load is now so nearly complete that the primary purpose to which the $11 billion in 12b-1 fees last year were put was to compensate brokers.

Back in 1980, the Commission noted in our adopting release that we and our staff would monitor the rule's operation closely, and if experience suggested that the rule's restrictions on the use of fund assets were insufficiently strict, we made it clear we would be prepared to act to remedy the situation. Now, with nearly three decades of experience under our belts — and with today's uses of 12b-1 fees barely recognizable in light of the rule's original purpose — it is high time for a thorough re-evaluation. Today the mutual fund industry is no longer at risk of suffering crib death, as was the case years ago when rule 12b-1 was adopted. At more than $10 trillion and counting, the survival of the mutual fund industry is plainly no longer at issue.

With all of this in mind, the SEC will hold a roundtable discussion of 12b-1 fees on June 19. We'll discuss the historical circumstances that led to the fees, their intended purposes, the changes in their uses, the rule's current role in fund distribution practices, the costs and benefits of the current system, and the options for reform or repeal. During this discussion we'll keep in mind that the investor's interest isn't just in the fees being collected from them in the current year, but in the effect of those collections over time on the potential for compounded returns. That's vitally important to investors who save for retirement, and for other long-term goals such as higher education.

I've spoken thus far of the importance of getting investors clear information about their investments, in language they can understand. That's vitally important because continued investor confidence in our markets depends upon a strong sense of fair play and honest dealings that can only come from truthful and straightforward disclosure. There's one other key role that the SEC plays in maintaining investor confidenceand that's our enforcement function.

First and foremost, the SEC is a law enforcement agency. And letting every American investor know the cop is on the beat is an essential underpinning of the integrity of our markets. That's why the SEC did the spadework first to uncover the egregious practice of stock options backdating, and then to launch the many investigations across the country that are now underway. Surely nothing so completely assaults the spirit of the handshake as this illegal practice. While our investigative work in well over 100 backdating cases is ongoing, we've already announced actions against several companies.

Today we're announcing the first of what you can expect will be several significant sanctions against companies and individuals involved in stock options backdating. Last year, the SEC filed suit against Brocade Communications Systems, charging that the culture at the company was one in which former executives repeatedly granted backdated stock options, and concealed the conduct by falsifying documents in order to avoid reporting to investors hundreds of millions of dollars in compensation expenses.

Backdating isn't just a way for insiders to distort how much they're really paying themselves and others in the company — it also involves issuing stock at cheaper prices than what would be paid if the rules had been followed. For that reason, it threatens a company's shareholders in a very direct way. In recent months, the Commission obtained from Brocade important new factual information about the way that the backdated grants were made, and the options were exercised, in order to help analyze both the illegitimate benefit that the company received, and the actual and potential dilution that the shareholders suffered.

With the help of this information, the Commission concluded that not only did the intended beneficiaries of the secret backdating benefit, but on balance, so too did Brocade — and for that reason, in addition to a permanent injunction against future violations, a significant penalty was warranted against the company itself.

The resolution of these significant conceptual issues surrounding backdating was reached by a unanimous vote of the Commission and will form the basis for decision in the many other recent cases that we have filed, and those that we are still investigating.

As part of the sanctions that we are announcing today, Brocade has agreed to pay a penalty of $7 million to settle the SEC's fraud charges. We believe this is a fair outcome for Brocade's investors, and also for their employees and their customers. But most importantly, we believe it's the fairest possible outcome for every participant in America's capital markets. Results like these are important because they reaffirm the rule of law on our exchanges and in our boardrooms. They uphold the integrity of the marketplace and the fundamental trust on which every investor relies when they decide to put their hard-earned savings into stocks, bonds, mutual funds, and other securities.

Back when A.P. Giannini was helping ordinary Californians put their lives back together after the San Francisco earthquake, he did it on a handshake because there was no other choice. You can imagine him, standing behind that makeshift desk constructed from a wooden plank across two barrels, with rubble all around, looking directly into the eyes of a desperate immigrant laborer who'd lost everything, and whose financial future was in his hands.

Today, with America's sophisticated trading techniques, analysis tools, and exotic financial instruments, we might never see the person with whom we're dealing.

But those same bonds of trust are as essential today as when Giannini extended his hand to make a loan. And it's the job of the SEC to make sure that when it comes to your savings and investments, you and every American can rely on the fundamental security of the deepest, broadest, and most liquid capital markets the world has ever known.

America's reputation for honest business, well policed markets, vigorous enforcement, and investor-friendly policies owes much to the work of Italian Americans like A.P. Gianini and Giovanni Prezioso. They're but two in a centuries-long procession of leaders that began with a man from Genoa and included Italian regiments that fought in the Revolutionary War; Italian Americans who signed our Declaration of Independence; and Italian artists and artisans who were responsible for so much of the beauty of Washington, D.C. — from the enormous sculpture of Abraham Lincoln in the Lincoln Memorial, to the elegant statuary in the National Cathedral, to the beautiful paintings on the dome of the Capitol and throughout that famous building where Frank and Bill and I used to work.

More than 15 million Americans claim Italian heritage, and there's not a single profession or field of endeavor in which the leadership and ingenuity of Italian-Americans isn't showing the way forward. The dedication to integrity and the fundamental values of honesty, hard work, and commitment to others that have for so long been the hallmark of Italian-American leaders are the same strengths that have made America — and not least of all our capital markets — unrivalled anywhere on earth.

So as we celebrate the splendid achievements of Italian-Americans here at NASDAQ's Market Site, which so well symbolizes the vitality of free enterprise in this bustling, 21st-century world, let's also take the opportunity to rededicate ourselves to the simple virtues of trust, honesty, and plain speaking exemplified by that humble Italian-American banker more than one hundred years ago. And let's never forget that when it comes to the success and stability of the financial markets upon which our jobs, our economy, and our retirements depend, nothing is more important than the preservation of the investors' confidence in the integrity of our securities exchanges and the business that's transacted there.

To the hundreds of you in this audience who work in our markets here in the nation's financial capital, thank you for what you do each day to preserve that trust. All of us at the SEC are proud to be your partners.


Modified: 06/02/2007