Speech by SEC Commissioner:
American Society and the SEC's Mission
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
The Center of Excellence
Waseda University Institute for Corporation Law and Society
October 15, 2007
Thank you, Professor [Tatsuo] Uemura, for that kind introduction. It is an honor and privilege to be a part of Waseda University's 125th anniversary celebration. I understand that 125 years is of special significance to the founder of this university, Shigenobu Ohkuma, a proponent of the theory that humans can live to the age of 125 if they take proper care of themselves. Mr. Ohkuma will manage to live far beyond 125 years through the legacy that he left in this university. The forward-thinking, outward-looking vision that motivated him in founding Waseda University continues to drive its global focus today.
I am particularly pleased to address the Waseda Institute for Corporation Law and Society. The Institute was formed to study corporations and the capital markets in light of the significant economic damage — that continues even today — from the collapse of Japan's bubble economy of the 1980s. In carrying out its mission, the Institute has engaged in comparative research of Western legal systems in order to develop sound legal and economic rules for Japan and Asia.
By engaging in its research and teaching students to think globally, the Institute is helping to shape future generations of business leaders, academics, and government officials. As a U.S. government official, I can attest to the fact that international considerations are extremely important. So in this spirit of comparative research, I hope to share with you today some thoughts about securities regulation in the United States — the things that we do well and the things that might be improved. The remarks are my personal views and do not necessarily represent those of the Securities and Exchange Commission or my fellow commissioners.
A good place to start examining the relationship between the SEC and American society is the writings of Milton Friedman, a Nobel Prize-winning economist who died last year. Dr. Friedman was interested in people and what motivated them. This interest led him to profound insights about the economy and society. In his book Capitalism and Freedom, Dr. Friedman wrote that there are only two ways to coordinate the economic activities of millions of people. The first way is through central planning by using coercion and the techniques of the modern totalitarian state. The second way is through the voluntary cooperation of individuals, which he described as the "free private enterprise exchange economy."1 A free market, Dr. Friedman noted, is dependent on the proposition that the parties mutually benefit from a transaction and that the transaction is entered on a voluntary and informed basis.2
Dr. Friedman helped shape my views of the market and government's role in the market. To the maximum extent possible, government must avoid using coercive techniques to coordinate economic behavior. Instead it should defer to the marketplace, which is comprised of willing buyers and sellers who are keenly aware of their own needs. Individual decision-making through free choice is the best reflection of what people want and need. In fact, that is how economists think of prices — as the accumulation of millions and millions of independent decisions, as each side of a transaction weighs how much he wants to part with something versus how much the other party wants it. This is where communist and socialist regimes ultimately lost. Government can only guess about who has needs, what he needs or wants, and who is best equipped to meet those needs or wants. However, government can play a role in establishing and maintaining a fair and open marketplace in which buyers and sellers know the terms of the transactions.
The general approach of the U.S. federal securities laws reflects the free market model. These laws generally require that all material facts be disclosed and that investors be free to choose whether to purchase a security. An alternative approach would be to have government officials review each securities offering and determine whether the offering had sufficient merit before allowing the public to purchase those securities. Fortunately, the federal securities laws did not adopt the merit-based approach, but followed the free-market model instead.
Let me provide you with a little background about the Securities and Exchange Commission, or "SEC," as it is commonly known in Washington. The SEC was created in 1934. Its mission is to protect investors and to promote efficiency, competition and capital formation. The SEC is headquartered in Washington, D.C., but has offices throughout the country.
The SEC is made up of five commissioners, of which I am one. There are only four commissioners at the moment since one departed the SEC last month. His replacement has not yet been selected. The replacement process can take time, because commissioners are appointed by the President and confirmed by the Senate. We serve five year terms, with one commissioner's term expiring each year. As a matter of law, there cannot be more than three commissioners from any one political party. The President designates one of the commissioners to be chairman, who is responsible for carrying out the day-to-day executive functions of the SEC.
The SEC is an "independent agency," which means that it performs a mix of legislative, judicial, and executive functions. First, the SEC has the power to write rules that are consistent with the authority that Congress has given to us by statute. Second, the SEC acts like an appellate court in reviewing appeals from sanctions that the stock exchanges and the professional organization of brokers levy against their members. Finally, the SEC has civil enforcement powers against people who violate the securities laws and our rules. The SEC does not have the authority to prosecute criminal cases. The Department of Justice prosecutes criminal violations of the federal securities laws.
The SEC is one of several independent regulatory agencies established by Congress to handle matters that are too technical to address through laws. Congress sets the general policy by enacting laws and then relies on the agencies to implement the policy within their area of expertise. Decisions that regulatory agencies make affect the products and services that people can buy and sell and the manner in which they can be bought and sold. Regulatory agencies have been granted a wide sphere of influence because they take decisions away from the political process. The rationale is that experts — in contrast to politicians — can think about complex problems through the lens of their experience and devise appropriate solutions. The complexities of securities law, for example, lend themselves well to expert deliberation.
Although it has been beneficial to address highly technical issues through rulemaking by regulatory agencies, this decentralized, non-political approach to government decision-making also has its drawbacks. Among the disadvantages of this approach are a potential for isolation, lack of accountability, and possible lack of transparency in decision-making. Because the day-to-day regulatory work is not done by politicians, decision-makers are not accountable to the public in the way that politicians are to their electorate. Regulatory agencies may not feel the need to correct poor decisions or explain how they arrived at those decisions. People affected by regulatory actions can — and often do — sue agencies in court for those actions. A court will rule against a regulatory agency if it finds that the agency has acted outside of the authority that Congress has given it.
Without accountability, decision-makers do not have a strong incentive to consider the full ramifications of a decision before they make it. Decisions undertaken for a particular purpose in one area can have unintended effects in another area. A lack of accountability combined with a lack of transparency can be particularly problematic because different constituencies often have conflicting interests in influencing regulation. An industry or a firm within an industry might seek to use the regulatory process to gain a competitive edge by avoiding regulatory obligations or encouraging the imposition of regulatory obligations on competitors.
One way in which these concerns are addressed in the U.S. is through our tradition of hiring government employees from the private sector in a process that is sometimes called the "revolving door." Think of a revolving door in an office building with people constantly entering and exiting. The term refers to the tendency of people to spend part of their career in government service and part working outside government. I am a case in point — I spent time at the SEC in the 1990s after working at a private law firm, then I returned to the private sector, and now I am back at the SEC.
People in the U.S. often criticize the "revolving door" — in fact, the term started out, and is often used, as a pejorative description of the process. But upon a closer look, we can see that it has quite positive implications. As long as there are adequate ethics rules, the revolving door enables regulatory agencies to carry out their missions more effectively. People who come to government from outside bring to policy-making a knowledge of how things are really done and what the potential collateral effects of a particular regulatory approach would be. They also tend to have an appreciation for the possibilities of non-governmental solutions. Having experienced the dynamic marketplace, they see innovation in products, services, and technology as something to be welcomed rather than feared and regulated against. Those who have been in the industry might also have a better sense of areas of impending trouble. Regulation and enforcement tend to lag behind trends in the market, but people from the outside can help to speed the regulatory response to problems in the marketplace.
Equally important, people who leave government to return to industry can help to instill a proper sense of the importance of complying with legal obligations. Having seen regulatory failures, they can spread the word of what good behavior is and intervene to stop bad conduct before it happens. They can assist those in industry to understand their legal obligations and bring insights about how best to comply with those obligations. As when people enter government, strong ethics rules guard against potential conflicts of interest when people leave the government for the private sector.
Another way in which concerns about accountability and transparency are addressed is through a statute called the Administrative Procedure Act, or APA. The APA addresses these concerns by imposing certain requirements on decision-making by government agencies. Under the APA, regulatory agencies generally cannot adopt a rule without asking the public what they think about the rule. The APA requires us to consider these comments. Rules are often modified in response to issues that commenters raise. Speaking as a regulator, it is very helpful to hear the perspectives of the full range of people whom the rule would affect.
Because SEC rules often have global implications, we receive letters from people all over the world. The letters we receive from outside of the United States are often especially important because they point us to potential issues that are unique to investors or companies in a particular country. For example, earlier this year, we adopted a rule on credit rating agencies. Two Japanese firms submitted comments during the comment process and were among the seven credit rating agencies that registered with the SEC last month. With respect to another proposed rule, the Keidenren wrote to us last month in response to a question regarding shortening the filing period for foreign private issuers.3 The letter asked us to be mindful of the fact that Japanese companies "engage in double the amount of disclosure and audit preparatory work -- first in connection with their Japanese annual reports that are required to be prepared and filed with the Japanese regulatory authorities within three months of their fiscal year end in accordance with Japan's Financial Instruments and Exchange Law, and second in connection with their annual reports" that are filed in the U.S.4
Because the APA requires public comment, it takes more time to react to a problem for which a regulatory solution is believed to be necessary. This seeming disadvantage is outweighed, however, by the assistance that agencies get from public comment. A good regulation that is the product of deliberation is better than an unworkable one that is the product of haste.
I am very much of a believer in the notice-and-comment requirements of the APA. In fact, this practice has helped the SEC avoid many mistakes over the years. For example, in 2002, Congress passed the Sarbanes-Oxley Act, some of the provisions of which required more disclosure or changes to listing requirements regarding corporate governance issues of SEC-registered companies. Congress gave the SEC a relatively short time to promulgate rules. There was not enough time to do exhaustive research into the corporate governance laws of 150 or so countries. So, in the interest of time, the rules that we proposed generally stuck fairly closely to the statutory provisions, even though Congress in many cases gave us latitude to make the final rules different. It turned out, for example, that because of conflicts with other countries' laws, the strict definition of "independent director" would not have worked for German and Dutch companies, because they have worker representation on their supervisory boards. Also, many companies in Europe and Asia would not have been able to comply with our proposals' requirements that the board appoint the auditors — that is reserved to shareholders in many countries. Because of the notice-and-comment process, we were able to become aware of all of these issues and work them into our rules so that no company was put in the untenable position of having to choose which law to break.
Generally, the five Commissioners vote on official decisions of the SEC. Although we rely on a staff of over 3,500 employees to develop recommendations for formulating and implementing SEC policy, we make the final policy decisions with respect to regulatory and enforcement issues. Aside from specific areas in which the Commission has delegated authority to the staff, the staff is not empowered to make decisions for the Commission.
Given the size and complexity of the securities industry, many matters are not considered by the Commissioners. Staff members provide informal guidance in a number of ways, including in response to telephone inquiries and letters, in connection with compliance inspections, at conferences, and in comments on filings that companies make. A particular company might seek guidance that is specific to its circumstances on how to comply with a regulation. Staff is able to respond to these types of inquiries quickly, to the benefit of both business and investors.
There is, however, also a certain temptation to allow policy decisions to be made by the staff without Commission approval, particularly when matters are highly technical. However, the Commission must be careful not to allow the staff to set policy without appropriate oversight. Although we have a highly-skilled staff, giving them policy-making authority means that SEC decisions are made outside of the formalized public process that the APA requires and without Commission accountability. The Commission, therefore, must monitor closely the actions of the staff in order to ensure that the staff is not inadvertently making policy. The policy decision-making process must remain open and retain the level of accountability that Congress intended.
Determining whether to regulate — and if so, how — can be difficult. One helpful tool in making those determinations is economic analysis. Economic analysis enables us to weigh the costs and benefits of regulation. In other words, it enables us to assess whether a regulation will cost society more than it will benefit society. Resources are scarce and need to be allocated to their highest and best use. A regulation that has a worthy objective might nevertheless not be worth adopting if its costs are so high that regulated entities have to give up other even more worthy objectives. In considering costs, it is important to look not only at the direct costs that the regulation imposes, but also on the indirect costs such as harm to competition and reductions in consumer choice. These indirect costs are important considerations at the SEC, because our mission, in part, is to keep the markets working efficiently and to facilitate capital formation. Indirect costs of regulatory actions can impede market efficiency and distort capital formation.
In the past several years, the SEC has renewed its commitment to undertake better economic analysis. This renewed commitment was not entirely voluntary. It was driven in part by a court ruling that faulted the SEC for failing to consider the costs of one of its rules. The new commitment to economic analysis also is driven by heightened scrutiny on the competitiveness of the U.S. capital markets and the SEC's role in helping or hindering the competitiveness. A group organized by the U.S. Chamber of Commerce, for example, recommended that the SEC do thorough cost-benefit analyses before — and a year or two after — taking regulatory action.5 Last November, another group, the Committee on Capital Markets Regulation, similarly recommended that the SEC "systematically implement … a carefully applied cost-benefit analysis of its proposed rules and regulations" both prior to adoption and periodically thereafter.6
The SEC remains primarily an agency of lawyers so it will take a great deal of effort to give economic analysis the role that it should have in rulemaking. We must involve our economists early in the process so that they can participate in generating policy recommendations, not merely in analyzing policy recommendations that the lawyers devised. We must also enlist the economists to assist after a rule is adopted to assess whether it is having the intended effect and what its costs are.
In addition to periodically assessing our rules, we must periodically assess how we are enforcing them. As an initial matter, we must not try to enforce "rules" that are not in the rule book. Unfortunately, sometimes we try to use the inspection or enforcement process to create new regulatory obligations. As a government agency, the SEC has tremendous power. It is critically important that we appreciate the magnitude of that power, particularly as compared to the vulnerability of the subjects of our investigations. We must respect the rights of those whom we are investigating. We must resist attempts to undermine those rights in order to make it easier for us to investigate cases.
The SEC's resources are limited, so investors play a significant role in their own protection. Americans, in growing numbers, are investing in the capital markets. There are, for example, more than 95 million mutual fund investors in the United States. Approximately 50 percent of our equities are held directly by individuals. In just about every other country, this percentage is not above 20 percent.
The SEC helps these investors in several ways. First, the federal securities laws require that the SEC devote considerable resources to ensuring that investors have adequate disclosure. Investors use this disclosure to make informed decisions about investing. In imposing disclosure requirements, we try to keep in mind that more disclosure is not always better since the things that are important to investors can get lost if we require firms to disclose too much trivial information. The SEC can also help to equip investors through investor education. We do this by reaching out to investors directly and by standing ready to answer their telephone and email inquiries. In this mission, we are greatly aided by other governmental and private investor education initiatives.
As you can see, the relationship between the SEC and American society is a complicated one. It is defined as much by what the agency does not do as by what it does do. We do not — although some people would like us to — protect Americans from making poor investment decisions or attempt to eliminate their investment risk. We do not regulate financial products and services based on their merits. Our role is much more modest — seeing that investors get the information that they need to make informed decisions about financial products and services, overseeing compliance by market participants with our rules, and pursuing those who defraud investors.
Although modest, the SEC's role is not an easy one. We must work with the markets without preventing the markets from working. I am hopeful that, over time, we will get the balance right. The SEC is not even seventy-five years old yet, which is young in comparison with Mr. Ohkuma's milestone 125 years. So I hope that we still have time to learn to do our job better. Thank you all for your attention. I would be happy to answer any questions. If, in the future, you find yourselves in Washington, D.C., please feel free to stop by and visit.
Goseicho arigato gozaimashita.