Speech by SEC Chairman:
Keynote Address to the Columbia Law and Business Schools
Cross Border Securities Market Mergers Conference
Chairman Christopher Cox
New York, New York
U.S. Securities and Exchange Commission
New York, New York
December 19, 2007
Thank you, Dean [David] Schizer, for that kind introduction — and thanks to both the Law School and the Business School for jointly sponsoring this conference. As a long-time enthusiast for joint business and law training, I'm delighted to participate in such a practical demonstration of the complementarity of these two disciplines. And it's a pleasure to see so many of Columbia's luminaries here — including Professor Harvey Goldschmid, who preceded me on the Securities and Exchange Commission and whose gracious personal invitation is the reason I'm here today.
It's especially nice to see my immediate predecessor as Chairman and now good friend, Bill Donaldson, as well as Mike Eisenberg, who was both Bill's and my Director of the Division of Investment Management. Chester Spatt, who served under Bill as Chief Economist at the SEC and whom I reappointed, is also here, as is Giovani Prezioso, my first General Counsel who was originally appointed by Chairman Donaldson. Both Rick Ketchum and Brandon Becker, who are also here, served as Director of the SEC's Division of Market Regulation.
The current SEC is here in force as well, with my colleague on the Commission and former Director of the Division of Market Regulation Annette Nazareth, Trading and Markets Director Erik Sirri, and International Affairs Director Ethiopis Tafara all here this afternoon. And Kathy Kinney is of course with us. Kathy's work as President of the NYSE is very much at the center of what this conference, and indeed my own remarks, are all about.
Above all, it's a special honor to be introduced by the scholar whose name inevitably comes up when the topic is the impact of taxation on investment.
That topic holds infinite interest, not only because I spent nearly two decades in Washington working on tax policy in the White House and Congress before joining the SEC, but also because it brings back memories of my own time in the classroom as a teacher. A quarter century ago, I taught a course called "Tax Factors in Business Decisions" to second year MBA students at Harvard.
I particularly remember the experience of grading the students' final exams. There were two cases on the final — two business situations nefariously constructed to contain every known tax problem. The exam lasted four hours. Naturally, each of the students filled up multiple blue books. All, that is, except one.
I can't tell you how excited I was when I picked up this student's single blue book. I was intrigued to find out what this model of concision could possibly look like. And then, when I opened the cover, I discovered that he'd written on just the first page of the one blue book. Here is what he wrote:
"Dear Professor Cox: What I have learned in your course is that federal income tax is extraordinarily complicated. And when I go into business, I'll be sure to hire someone who knows what he's doing in this area."
I'm reasonably certain that this fellow ended up with a career in improv, rather than tax accounting.
Yet another reason I'm so pleased to be at Columbia is your unparalleled focus on securities issues, on corporate governance, and the important current leadership challenges exemplified by this very conference.
The great intellectual Jacques Barzun, whose name one automatically associates with Columbia, just 20 days ago celebrated his 100th birthday. He once said about gatherings such as this: "In any assembly, the simplest way to stop the transacting of business and split the ranks is to appeal to a principle."
That was more than tongue-in-cheek cynicism, of course, because Barzun was eyewitness to a period in history in which ideologies had become brutally coercive. He'd seen how the a priori designs for human arrangements represented by Nazism, Fascism, and Communism had turned nations against each other in the bloodiest possible manner. Those systems, commanded by their own self-referential principles, did split the ranks of humankind. And they did stop the transacting of business.
It is the great good fortune of all of us who live in the wake of those horrible experiences that what the nations of the world have for the most part set out to do since then is to gather the ranks around the practicality, if not the principle, of people everywhere being able to transact business. So at this point in the 21st Century we can say, despite the scourge of terrorism and the tragedy of regional wars, that this planet — which has endured two world wars in the span of a single generation — has seen nothing like that level of conflict for more than 60 years. The wealth of the world's nations has increased to record levels. And continued improvements in modern technology are spreading knowledge and inventions around the world faster than ever before.
Central to that still-tentative achievement has been the growing consensus that markets play a pivotal role in allocating scarce resources in rational ways. It's more than ironic that the nations which embraced the three great totalitarian systems of the 20th century are today all embracing markets, wiith only such holdouts as Cuba and North Korea surviving as tragic reminders of the poverty and misery that outlawing markets engenders. Today, over 100 countries have thriving stock exchanges, and more than a billion people invest in securities. The growth in the investor class has spread throughout the developed and the developing world.
Even in the United States, the home of capital markets that are larger by far than those of any other nation, the ranks of investors have been swelling as a share of the population. Just a few generations ago Joe Kennedy, my predecessor as the first chairman of the SEC, could marvel that "one in every 10 Americans owns stocks." But today, fully one-half of all households own securities. And the same technology that is increasing productivity in every corner of the economy is fundamentally changing the way that exchanges themselves operate.
As a result of technological advances over the past decade or so, investors in today's markets enjoy lower costs and more efficient access to liquidity. At the operational level, the operation of today's markets couldn't be more different than just a few years ago. Historically, exchanges were structured as mutual, not-for-profit organizations owned mostly by broker-dealers. But member-controlled, non-profit exchanges suffered from their inability to respond quickly to competition, and from a limited range of capital raising opportunities.
A few years ago, it became clear that more flexible shareholder-owned electronic markets could use new capital to invest in technology that would offer customers faster, more efficient, and lower-cost trading. In response to competitive pressures, over the past several years most U.S. exchanges have moved to that more nimble demutualized structure — and the result has been truly dramatic changes in the way securities are traded in America and throughout the world.
When we think of a traditional floor-based market, we envision the New York Stock Exchange — a bustling floor with specialists and floor brokers frantically working their orders. But while the NYSE is one of the oldest exchanges in our country — going all the way back to 1792, when two dozen stockbrokers and merchants signed the Buttonwood Agreement — today technology has virtually eliminated the need for face-to-face trading on the NYSE and everywhere else. It isn't just the Buttonwood tree and the curb that are no more, but the trading floor itself is becoming obsolete.
The NYSE began its dramatic makeover less than two years ago, in March 2006, when it merged with Archipelago. Not only was this a combination with an all-electronic stock exchange, but as part of the transaction the NYSE demutualized. Now equity ownership in the NYSE was separated from trading privileges.
When the NYSE became a public company, it unleashed powerful forces of change. For the NYSE itself, it meant the exchange now had the ability to split from its traditional floor-based model, and completely redesign its market. The first big step toward electronic trading was its Hybrid Market, which we approved at the SEC early in 2006. It allowed customers to choose an auction on the floor, or the much faster execution of automated trading. The significance of this break with history and tradition at this 200-year old, floor-based market is difficult to overstate.
And that monumental change was just the start — because as its market share has fallen in this newly competitive world, the NYSE has announced a new plan to continue the redesign of its market model, with designated market makers in place of specialists.
Of course the NYSE is hardly the only securities exchange to be undergoing an extreme makeover. While it was the biggest market to demutualize, it was neither the first nor the only U.S. market to go public. Back in 2002, the then 31-year-old Nasdaq Stock Market went public in a spin-off from the NASD. Since that time, Nasdaq has acquired the Brut ECN and the INET ECN, which has significantly deepened Nasdaq's liquidity pool.
Brut and INET also provided Nasdaq the ability to route orders via an internal broker-dealer to multiple liquidity pools. And the INET transaction in particular allowed the combination of both the Nasdaq Market Center and Brut onto INET's lower-cost and faster platform.
There've been many other exchanges that have demutualized over the past few years as well, including the Philadelphia Stock Exchange, the International Securities Exchange, the National Stock Exchange, and the Chicago Stock Exchange. And the century-old Chicago Mercantile Exchange went public in 2002, as did the Chicago Board of Trade in 2005, 157 years after it first opened for business. Taken together, these are breathtaking changes in market structure in just a very short period of time.
The combination of new technology and new legal structures has been the springboard, first, for dramatic changes in the U.S. capital markets, and, simultaneously, for the new globalization of markets that so clearly characterizes the new century. That's because, in addition to allowing innovation, demutualization has also allowed rapid combinations of exchanges, both internationally and domestically.
So here in America you have the Chicago Board of Trade and the Chicago Mercantile Exchange combining just this year. Two months ago, on October 2, Nasdaq agreed to purchase the Boston Stock Exchange. Just last month, Nasdaq agreed to a stock acquisition of the Philadelphia Stock Exchange. Both of these transactions are subject to Commission approval.
The capital infusions from public offerings of exchanges can also be used, of course, to acquire exchanges or ECNs outside the United States. And that's exactly what is happening, as our major markets expand their presence on a global scale.
For example, in February of this year, NYSE Group merged with Euronext, a company organized under the laws of the Netherlands and itself the owner of five European exchanges. Today, NYSE Group and Euronext are both subsidiaries of a new publicly-traded holding company, NYSE Euronext. Shares of NYSE Euronext are now listed on the NYSE in U.S. dollars, and on the Euronext Paris in Euros. The U.S. headquarters of NYSE Euronext are here in New York, while its international headquarters are in Paris and Amsterdam. The combined company operates seven exchanges in six countries.
For its part, Nasdaq has recently announced an agreement with Borse Dubai to acquire the Nordic and Baltic stock exchange operator OMX. The Borse Dubai and Nasdaq have in fact agreed to a series of transactions that are intended to create a global financial marketplace in the U.S., Europe, and the Middle East — as well as in strategic emerging markets. Borse Dubai would become a 19.99 percent shareholder in Nasdaq (with voting rights capped at five percent). Nasdaq would acquire all of the OMX shares to be purchased by Borse Dubai in its offer for OMX. And Nasdaq would become a strategic shareholder and the principal commercial partner of Dubai International Financial Exchange. A trust held for the beneficial interest of Borse Dubai would purchase an additional 18 million shares of Nasdaq.
In April, the Deutsche Boerse's Eurex and the International Stock Exchange announced plans for Eurex to acquire the ISE. If that transaction takes place, it will consolidate two of the largest derivatives marketplaces in the world. And there's every reason to expect it will, because Eurex and the ISE have signed a definitive agreement under which Eurex will acquire ISE Holdings and its wholly owned subsidiary, ISE LLC, before year's end. And just a few days ago, on December 13, the Commission approved the rule changes that are necessary for this transaction to occur.
These developments are all manifestations of the growing competition that exchanges in the U.S. and around the world now face as markets have become more sophisticated and more nimble, and as overseas trading markets have become much more readily accessible to investors through recent advances in technology. As a result, it's now a struggle for American markets just to retain, much less increase, their market share. And so they've got to adapt quickly.
The global competition that these transactions represent has already been a great benefit for U.S. investors. The innovation in trading systems has made markets more response to customers. And improving the efficiency of trading has driven down costs, including the fees charged by the markets.
At the same time, these developments have created regulatory challenges for the SEC. Today there are new risks and new strains on the self-regulatory system. The most obvious of these is the inherent tension between an SRO's role as a business, on the one hand, and as a regulator, on the other. A for-profit shareholder-owned SRO will always be tempted to fund the business side of its operations at the expense of regulation.
The SEC focuses on two key aspects of exchange structure to assure the integrity of the self-regulatory function. The first is the question of who controls the exchange. And the second is the governance approach to dealing with the conflicts of interest.
Among other things, the Commission imposes requirements and limitations on those who control the exchange. In this regard, we've paid particular attention to the risks of a member controlling an exchange, given that the exchange has an obligation to provide regulatory oversight of that member. In addition, the SEC has supported the functional separation of exchange regulation from the exchange's business activities. That's been done in part through the creation of independent regulatory operations within the exchange — and, with respect to member regulation, through the consolidation within FINRA of the regulatory functions of the NASD and the NYSE.
Global exchange alliances and mergers require the Commission to focus not only on these key areas, but just as importantly, on cooperation and coordination with the regulators of other nations. The Commission has done all that we can to facilitate the global integration of markets, whether the combinations originate from within the U.S. or abroad. And that's necessitated closer working relationships with our counterparts overseas than the SEC has ever maintained before.
In analyzing and approving the NYSE Euronext combination, for example, the Commission needed to take care that the NYSE Euronext corporate documents included provisions designed to maintain the independence of both the NYSE's, and NYSE Arca's, self-regulatory functions. We were especially focused on ensuring they'd be able to meet their regulatory and oversight obligations under the Exchange Act. So working with our counterpart regulators, we obtained acknowledgments from each of NYSE Euronext, NYSE Group, the NYSE, and NYSE Market that it would be responsible for referring possible rule violations to NYSE Regulation. In addition, they each explicitly agreed to provide adequate funding for NYSE Regulation.
The NYSE Euronext Certificate of Incorporation contains ownership and voting limitations that are designed to prevent any shareholder, or group of shareholders, from exercising control over the operations of either the NYSE or NYSE Arca. These limitations are also meant to ensure that the NYSE, NYSE Arca, and the Commission are each able to carry out our regulatory obligations under the Exchange Act.
Similarly, in the Nasdaq–Borse Dubai agreement, there are voting limitations in Nasdaq's Certificate of Incorporation that limit Borse Dubai to voting only five percent of Nasdaq's shares without board approval. That limitation, by the way, was not requested as part of the transaction — it was a term of the deal as proposed. The Borse Dubai would also have the right to recommend two directors to Nasdaq's 16 person board, and to have a seat on certain Board committees. The Commission staff are reviewing this proposed combination to ensure that it fits within the framework we developed in connection with other cross-border transactions involving self-regulatory organizations. In particular, we're focused on Nasdaq's ability to meet its obligations as a self-regulatory organization, and on ensuring that the Commission has the tools we need to effectively oversee Nasdaq.
Separately from all of this, the Committee on Foreign Investment in the United States (CFIUS) is reviewing the deal.
In the Eurex–ISE transaction, the Swiss and the German owners of Eurex have agreed to adopt resolutions ensuring the independence of ISE's self-regulatory functions. And beyond that, the German and Swiss entities have adopted binding corporate resolutions that commit them to making all of their books and records that are related to the activities of ISE subject at all times to inspection and copying by both the Commission and by ISE.
Consistent with the practices of U.S. exchanges, the German and Swiss entities have filed governing documents with the Commission that make it clear any change in control will require approval by the Commission. In this regard, an independent trust was designed under Delaware law to help ensure that no one acquires control of ISE without Commission approval — and that the Commission can in fact obtain books and records when we request them. If something were to go wrong with these assurances, that would trigger a transfer of majority control of ISE to the trust.
These are new and often complex solutions to very practical problems, which every investor should care about. The fact we've been able to come up with answers that work is a credit to the extraordinary levels of cooperation that have developed among the SEC and our counterpart regulators.
International regulatory cooperation isn't brand new to the SEC; we started using information-sharing MOUs in the late 1980s to help in enforcement matters. And five years ago the International Organization of Securities Commissions, IOSCO, developed a multilateral MOU that recently has grown to include more than 40 national regulators. But the quickening pace of global integration since 2005 has transformed the nature of our work at the SEC, and made my role as Chairman much more international than the responsibilities of any of my predecessors required — so much so that in Tokyo earlier this year, at the international conference of the IOSCO Technical Committee, I took on the role of Vice Chairman. And following the meeting in May, with the assent of the other members, I will become the Chairman.
The urgency of increased international cooperation became particularly clear with the advent of the NYSE Euronext transaction, when the SEC and the College of Euronext Regulators were impelled to move very quickly to negotiate a special and much broader MOU that covered consultation, cooperation, and the exchange of the significant amounts of information that would be necessary for the ongoing oversight of NYSE Euronext.
Despite the fact that the College consists of five distinct European securities authorities, the leadership and staff of the College worked seamlessly and quickly with the SEC to develop a next-generation MOU. It was concluded in January of this year, and it establishes a framework that will help the SEC and the College to work together as the markets consider and implement future integration. The process involved meetings, at the chairmen and staff level, on both sides of the Atlantic. And it afforded me the opportunity to develop solid relationships with leaders in the international regulatory community such as Michel Prada, the Chairman of the French AMF and the IOSCO Technical Committee, as well as Arthur Docters Van Leeuwen, Eddy Wymeersch and Carlos Tavares, the Chairmen of the Dutch, Belgian and Portuguese Commissions.
Because of the relationships we built, we were able to move quickly to quell European public and political perceptions that the NYSE Euronext combination would result in an exportation of US law. In particular, the Sarbanes-Oxley Act was a great concern on the other side of the Atlantic. The SEC issued a very clear and authoritative staff statement that common ownership of markets alone would not trigger SEC registration or the application of the U.S. federal securities laws.
We also worked with the U.S. Treasury to clarify the scope of application of not only current, but future U.S. laws to Euronext and to its companies. That clarification was sought by the Dutch Ministry of Finance — and providing it was very important, because their approval of the merger was necessary given that the holding company of Euronext was Dutch. (The Dutch concern, I expect, was also shared by the other relevant EU Ministries.)
Today, we've made progress in moving past these national concerns, and we've turned our attention instead to how regulators can work collaboratively to oversee global markets. And the SEC-College of Euronext MOU has established a framework for exactly that kind of collaboration. For example, it ensures that now regulators will coordinate when we're presented with market changes that require decisions by more than one regulator. And through the MOU, we've made a commitment to identify the steps necessary for further integration, at an early stage — and to work together in the event that markets pursue them. Finally, at both the Chairman and the staff level, the SEC and the Euronext College are committed to meeting regularly face-to-face, which we have already done several times.
This is a very sound partnership model, and the SEC is implementing it with other counterparts as well — including very recently the German and Swiss authorities, in light of Eurex's Acquisition of ISE. That transaction, by the way, I expect will be officially announced as completed tomorrow. We also have begun discussions with the OMX regulators in view of the proposed Nasdaq–OMX combination.
The experience that the SEC has gained through this and other recent international transactions has convinced us that now it's time for us and our counterpart regulators to take our collaboration to the next level — from information-sharing that's traditionally been focused on enforcement, to supervisory matters as well.
Enforcement, of course, will remain the bread and butter of international securities regulatory cooperation, because the seas of global finance are even more shark-infested than anyone's relatively placid safe harbors at home. Increasingly, not just two or three but a half dozen or more countries can be involved in a securities fraud. Many of our international cases start out as messy as a CSI crime scene. But as Gil Grissom might say, "It's our job to know stuff." And each of us knows that we can't get the job done without the other's help.
That's why instead of competitors, we've got to see one another as partners, working together to ensure the sound regulation of efficient global markets. There is much that we can do to better serve investors, by reducing duplicative and overlapping regulation and ensuring that regulators have access to the information they need — whether it's located domestically or abroad — in order to effectively regulate and enforce cross-border market operations.
Today, as markets such as NYSE Euronext, ISE Eurex, and Nasdaq OMX are embarking on new global business relationships, the SEC and our counterpart regulators can say confidently that we have negotiated our domestic regulatory hurdles and managed an international regulatory integration that extends to both ownership and governance. But each of us knows that this is but the beginning of a much longer, and undoubtedly more interesting, journey. After all, these global exchanges today remain essentially local markets overseen by their local regulators. One can easily look to the future and see endless and dramatic possibilities for a much wider spectrum of integration. Here is where cooperation among the world's securities authorities will be ever more critical.
There will probably never be a global securities regulator, and we probably wouldn't want one. But strong national regulators working closely together is an exceptionally positive development. It will require relationship building, and a willingness as national regulators to take a different look at common issues and to be open to considering the approaches of others. All of us have got to recognize that there is not just one way to effectively regulate markets. So long as our commitment to protecting investors and maintaining the integrity of markets remains strong, then new regulatory partnerships will undoubtedly continue to flourish, to the everlasting benefit of investors all around the world.
The continued integration of the world's capital markets isn't just an interesting development for brokers, bankers, and investors, or the lawyers and accountants who help make it all work. It is bringing the world's nations together like no other development in history, and building wealth for billions of people for whom, during our own lifetimes, a seemingly endless poverty was the only certainty.
There have been many great leaders here at Columbia, some who rose from the student ranks, and others who joined the Columbia family from many different walks of life. One of this university's greatest was a soldier who stood athwart the anti-market ideologies of the 20th century, and who later became Columbia's president. A half century ago, he saw clearly the great opportunity the world could seize with the advent of, in his words, "a common market in which all internal barriers to trade would be completely eliminated, just as they are within the United States." He said that if people are "given freedom from war," then they "can use the new knowledge of modern science and its new tools, to build a prosperity unparalleled in our history." And most presciently of all, President Eisenhower stated that the growing economic strength of other free nations is essential to our own security. "That we've had a part in bringing it to pass," he concluded, "makes this economic progress even more gratifying."
Every one of you here this afternoon who works to build stronger markets, to better protect investors, and to promote the international integration of securities trading has had a part in bringing to pass the global economic strength that is so essential to peace and freedom in our own century. The growth and improvement in markets here and around the world is indeed fueling the spread of modern technology, and building a prosperity unparalleled in the world's history.
We face threats and risks to this work-in-progress every day. It's not easy, and there is no guarantee of success. But there is no undertaking, no vocation more important than the work you are doing. So on behalf of the thousands of men and women of the SEC whose daily work it is to promote healthy markets, thank you for what you do. We're proud to be your partners.