U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks Before FINRA’s Market Regulation Annual Staff Meeting


Commissioner Paul S. Atkins

U.S. Securities and Exchange Commission

Washington, D.C.
May 16, 2008

Thank you for that kind introduction. I appreciate the opportunity to be here as part of your Annual Staff Meeting. Being part of this event, I feel almost like a member of the FINRA staff. Of course, SEC ethics rules would prohibit any such thing. Our ethics rules also require me to give the following disclaimer: the views that I express here are my own and not necessarily those of the Securities and Exchange Commission or my fellow Commissioners.

I will not be bound by those rules for long, since, as you may have heard, I have announced my intention to leave the SEC, and the President has nominated my successor. After six years at the SEC, leaving will certainly be a change. In fact, I have logged nearly a decade at the SEC now, between my time as a commissioner and my time on the staffs of former Chairmen Breeden and Levitt.

You all certainly know what change entails. Less than one year ago, FINRA was formed through a combination of the National Association of Securities Dealers and the New York Stock Exchange’s member regulation function. Integration of two such institutions is not an overnight event and — as the continuing work on FINRA’s consolidated rulebook illustrates — is still in progress.

As difficult as it is, the development of the consolidated rulebook is a very healthy process. It provides an opportunity for FINRA to conduct a thorough examination of its predecessor organizations’ rules and to discard those that are no longer needed and modernize the remaining rules. It is rare that an organization is able to undertake a thorough review of this sort with a real ability to make changes. The SEC, which also has a rulebook that has become thick through decades of additions, would do well to embark on a similar comprehensive review. If the plans of some in Washington, D.C. come to pass, the SEC may face a merger one day that will open up just such an opportunity.

SEC merger plans were part of a blueprint for regulatory reform that the Treasury issued earlier this spring. The Blueprint recommended that the SEC merge with the Commodity Futures Trading Commission. In Treasury’s words, SEC-CFTC jurisdictional “ambiguity has spawned a history of jurisdictional disputes, which critics claim have hindered innovation, limited investor choice, harmed investor protection, and encouraged product innovators and their consumers to seek out other, more integrated international markets, engage in regulatory arbitrage, or evade regulatory oversight altogether.”1 Merging the two agencies might be one way to end the jurisdictional disputes, although, even within the SEC, there are sometimes inter-divisional tensions. Ultimately, whether the two agencies should merge is a question for Congress. The SEC should consider the Blueprint’s recommendation that, in the meantime, the SEC follow the CFTC’s lead to adopt a more principles-based regulatory approach. FINRA is setting good precedent for us. As FINRA consolidates its rulebook, one of its goals is looking at the extent to which a principles-based approach can be used.2

Another recommendation in the Treasury’s Blueprint was harmonization between broker-dealer and investment advisor regulation. This recommendation was based in part on the findings of the RAND Study, a study commissioned by the SEC in conjunction with the SEC’s regulatory attempts to draw lines between investment advisory and broker-dealer activity. The SEC’s rule was overturned by the D.C. Circuit Court of Appeals shortly after the rule was adopted. This has forced us back to the drawing board.

Back at the drawing board, the RAND study is an important piece in our consideration of the issues.3 Not surprisingly, RAND’s investor testing found widespread uncertainty about the differences between investment advisors and broker-dealers. Also not surprising, investors are unlikely to read disclosures that explain what their broker or investment advisor does. On the other hand, most of the investors surveyed said that they were satisfied with their own investment professionals and their firms. Investors who had worked with their investment professional for more than ten years were even more likely to be satisfied. The survey suggested that accessibility and attentiveness were the most important attributes of a financial professional, with cost a distant second. However the regulatory issues in this area are ultimately resolved, we must not unnecessarily disrupt advisor or broker relationships that are working effectively. A diverse body of financial service providers is best able to meet the wide-ranging investment needs of a varied population of retail investors.

Treasury’s Blueprint set forth a new regulatory model that would allocate regulatory responsibility by objective. So, for example, the Federal Reserve would be the market stability regulator. A newly created Prudential Financial Regulatory Agency would oversee capital adequacy, impose investment and activity limits, and supervise risk management at institutions that enjoy government guarantees. Finally, business conduct regulation, including most current SEC and CFTC functions, would be carried out by another new entity, the Conduct of Business Regulatory Agency.

From your perspective as employees of an SRO, perhaps the most interesting new entrant on Treasury’s model regulatory landscape would be an SRO for advisors. This recommendation grew out of Treasury’s recognition that SROs can play a valuable role. An SRO’s role is different and perhaps more aspirational than the role of government regulators. Plus, SROs can often carry out their responsibilities more quickly and at less cost than a government regulator could. The Blueprint explained: “SROs may adopt rules and aspire to standards that extend beyond statutory or regulatory requirements while at the same time maintaining a flexibility that can help to better protect investors and encourage innovation in the offering of financial services and products.”4

Although FINRA is new in form, it boasts a long history of self-regulatory experience that illustrates Treasury’s point. Overseeing more than 5,000 broker-dealers and 677,000 registered securities representatives is no small task. Add to this other functions such as FINRA’s market regulation functions for NASDAQ, the American Stock Exchange, the International Securities Exchange and the Chicago Climate Exchange; its trade reporting functions; and its operation of the CRD and the IARD. In other words, the “self” in FINRA’s “self-regulation” is quite broad. Overseeing such a substantial portion of the securities markets means that what FINRA does – and, by extension, what you do – matters tremendously. Investors, the SEC, and industry rely on FINRA to perform this task well.

The SEC, as a governmental agency, is automatically subject to the constraints of the Administrative Procedure Act, which Congress adopted to provide sunshine and due process to the actions of the SEC. Before imposing regulatory requirements, we must seek comment from the public, and then duly consider and respond to those comments. Hence, the government’s decision-making process is transparent. Notice-and-comment enables us to hear from the people who will be affected by our rules so that we can better assess what the costs of our rules are likely to be, and what some of the unintended consequences might be.

Likewise, in proceeding against individuals and firms whom we believe to have violated the securities laws, the SEC is obliged to afford due process. We should respond as quickly as possible to the calls by Senators Grassley and Specter to review our enforcement policies and procedures and publish an enforcement policies and procedures manual that is open to the public. One of the most important protections is the opportunity for a person to defend himself in a Wells submission against charges that the SEC staff plans to recommend against him. These transparency and due process requirements are a constant reminder of the stakes; the actions that we take can affect the lives of individuals and the business prospects of firms in dramatic ways. Due process and transparency protections are equally important at FINRA. Its status as a non-governmental regulator does not lessen the effects that its actions can have on those it regulates.

As with regulatory and enforcement actions, protections are necessary for compliance examinations. Importantly, at the SEC there has been a push for greater transparency in the area of inspections. Our Office of Compliance Inspections and Analysis is working to standardize the request letters that it sends to firms and the deficiency language that it uses. OCIE is also letting people know in advance the types of problems for which it is looking. The purpose is to help firms comply with the law rather than engage in a meaningless game of “gotcha.” It is in the best interest of investors that firms comply with the securities laws. Bolstering our own enforcement statistics by finding violations should not be our objective. Granted, where there are serious violations, enforcement action is necessary, but the goal should be to work with firms to build their internal compliance program. The SEC – even aided as it is by the efforts of FINRA – cannot be everywhere all of the time.

FINRA, as an SRO, ought to be even more geared towards fostering compliance programs at member firms rather than relying on its own limited oversight resources to catch every violation that occurs. To quote from what Mary Schapiro told firm compliance officers at a joint SEC-FINRA compliance seminar in March:

We regulators can write rules, conduct examinations, and bring cases, but it's you, in the firms, on the ground, who carry the lion's share of the regulation of the industry. You see what goes on day to day and can spot small problems before they become large ones. You're the ones who develop specific practices and policies from our rules and guidance, to make regulation work in concert with your business, not against it.5

One area in which examiners, whether they be from FINRA or from the SEC, must proceed with tremendous care is inspections with respect to Regulation NMS compliance. As you may know, I opposed Reg NMS from the beginning. The trade-through rule set out to solve a problem that simply did not exist. My opposition has only grown as I have observed the burdensome implementation of Reg NMS. I credit the SEC staff for recognizing the need to grant delays and exemptions upon exemptions upon exemptions. But, the very fact that all of these delays and extensions were needed illustrates just how flawed the rule was in the first place. By adopting such a rule, the SEC required the securities industry to divert billions of dollars into developing the technology to enable it to comply with the rule. Certainly, those technological developments have yielded incidental benefits such as greater connectivity between markets. I would argue that these would have come about anyway through normal development of the market (they had begun, after all with Lava and other cross-market systems). Would it not have been better to allow the industry to pour resources into developing technological solutions to real problems that the market had identified?

Now that Reg NMS is in full operation, we must focus our efforts on ensuring that examinations for compliance with the rule do not turn it into a trap for well-intentioned firms. In monitoring compliance with Reg NMS, inspectors should not be asking firms for trade-by-trade proof of compliance, but rather should be looking more broadly to determine whether firms have the proper procedures in place to ensure compliance with the trade-through rule. To do otherwise could make compliance with Reg NMS even more costly than it already has been.

The broad lesson to be drawn from the Reg NMS experience is that regulators are no substitute for the market. Regulators have a critical role to play in ensuring the integrity of the marketplace. The entire economy works less efficiently when investors do not have confidence in the markets and in the firms that they deal with. Regulators are removed by necessity from the markets – they cannot and should not substitute themselves as decision-makers for the market participants who know their own needs.

Smart regulation takes into account costs and benefits. Investors, ultimately, suffer the costs of regulatory ineffectiveness and inefficiency. They pay higher prices, but they also have fewer investment opportunities, because higher regulatory costs drive out competitors and innovators – ultimately limiting their opportunities for diversification and better investment performance. Just last night at a reception in New York, I met a woman who closed down her investment management business running college endowment money because of the spate of new regulatory requirements that fell on her small business over the past few years. Investors also bear the cost if there is duplicative regulation. Given the overlapping nature of our roles, the SEC and FINRA must take steps to avoid duplication. We should each concentrate our resources where they will be most effective.

This is an important principle for all regulators – government regulators and self-regulators – to remember during volatile economic times like this when the pressure for more regulation regardless of its merit can be most intense. The markets have certainly undergone some painful changes in the past year or so. As you all know, starting in the summer of 2007, the number of defaults by home owners with subprime mortgages – especially those with an adjustable rate mechanism, started to rise markedly. At the end of 2007, more than twenty percent of adjustable rate subprime mortgages were delinquent as compared with eight percent of subprime fixed mortgages. The number of foreclosures initiated in 2007 – more than 1.7 million – was fifty-three percent higher than the number initiated in 2006. Even more foreclosures are expected in 2008.

The problems did not confine themselves to the subprime market, but spilled over dramatically into the rest of the financial market. Subprime defaults matter to the broader markets because of the fact that most mortgages now are combined with other mortgages and securitized. In fact, since the 1990s, more than half of all home mortgages have been securitized. The resulting mortgage-backed securities, in turn, often become the underlying assets for more complex financial products, such as collateralized debt obligations and structured investment vehicles. These are then sold to investors throughout the marketplace. Unfortunately, the transfer of risk away from the mortgage originators means that they do not have much of an incentive to ensure that borrowers repay their loans.

Spreading the risk in this manner, rather than leaving it entirely with the local mortgage provider, is, in many respects, a good thing. Securitization has played an important role in expanding liquidity in the mortgage markets and making it possible for many Americans, for whom credit would otherwise not have been available, to own their own homes. As Treasury Secretary Paulson explained, “securitization of credit is one example of an innovation that has made more, more flexible and lower-cost capital available to consumers and companies, and stimulated competition.”6 Securitization of mortgages also means, however, that the effects of widespread delinquencies in the mortgage market, such as we are now experiencing, are felt throughout the market.

We saw significant deterioration of overall credit and liquidity conditions, both here and abroad. The drop in liquidity and the accompanying lack of market prices, in turn, affected valuation. Market participants began to question the value of certain complex financial products. As it became more difficult to value these products, liquidity fell further, which only further complicated valuation. In many cases, mark to market accounting rules resulted in the recognition of large losses by financial institutions and other market participants. Investors became increasingly concerned about their level of risk exposure to securities and other financial instruments that were tied to subprime mortgages. Yields on mortgage-backed securities, and to a lesser extent, corporate debt securities rose sharply as investor demand for these securities fell. Conversely, as part of the “flight to safety,” demand for U.S. Treasury securities increased significantly, — evidence that market participants had become more risk averse.

Since the onset of the current market conditions, the market for mortgage-backed securities and other securitized instruments has all but evaporated. In the first quarter of 2008, $61 billion in mortgage-backed securities were issued, compared with approximately $279 billion in the first quarter of 2007. Secondary trading markets in these types of securities also have dramatically decreased.

The most well-known casualty of the risk aversion in the market place was, of course, Bear Stearns. What happened to Bear Stearns last month was unprecedented. The large, well-capitalized, eighty-five year-old investment bank experienced a crisis of confidence that denied it not only unsecured financing, but even short-term financing over-collateralized by high-quality agency securities. Counterparties would not provide securities lending services, and clearing services and prime brokerage customers moved their cash balances elsewhere. These actions fanned fear and concern, prompting other market participants to also reduce their exposure to Bear Stearns creating, in essence, a run on the bank.

While ceasing to transact with Bear Stearns in the face of a growing flurry of rumors may have been rational and, for those with fiduciary responsibilities to their own client, prudent, the effect on Bear Stearns was ultimately devastating to its ability to stay in business. Its liquidity position rapidly worsened because of this sudden and unprecedented inability to obtain secured funding. Bear Stearns’ counterparties, clearing services, and secured lending sources included some of the biggest names on Wall Street. The actions of these regulated entities with which Bear Stearns did business ultimately delivered the final blow to the bank.

In light of the current problems in the U.S. markets, some people have suggested that we turn our attention inwards and put on hold efforts to improve the integration of the international marketplace. Unplugging the U.S. economy from the international one is not a way to solve our problems, but rather to exacerbate them. We ought instead to forge ahead with our cooperative efforts with other nations. In addition to the SEC’s cooperative work with SROs like FINRA, the SEC has established strong relationships with foreign regulators. We have a shared commitment to free capital flows, investor protection, and investor choice. To date, our efforts have included the reaching of memoranda of understanding regarding enforcement cooperation, technical assistance, and investigatory collaboration with more than 30 foreign jurisdictions.

We are now also taking tangible steps towards mutual recognition. We will be working with foreign jurisdictions to conduct comparability assessments of one another’s regulatory regimes. I laud the push to reduce or eliminate unnecessary barriers between our capital markets. I am concerned, however, that this comparability undertaking might become an unworkable cycle of rule-by-rule comparison followed by a cumbersome series of individual firm-by-firm exemptions. I hope that instead the Commission can formalize a focused, transparent process that will recognize the merits of alternative regulatory structures. Just as the SEC allows SROs to develop their own approaches to regulation, within certain acceptable bounds, the SEC ought to recognize that foreign regulators might employ different types of rules to effect the same regulatory objectives.

The SEC’s mutual recognition plans include long-overdue amendments to Rule 15a-6 in order to make it easier for certain sophisticated U.S. investors to deal directly with foreign broker-dealers and thereby trade foreign securities. The impracticalities of the chaperoning requirement, which is a central feature of current Rule 15a-6, makes it time for a change, and the change should serve investors well.

Cooperation with foreign regulators is more important now than ever before. Not only has technology brought international markets closer together, but the markets have brought themselves closer together through exchange mergers. The emergence of Nasdaq OMX, NYSE Euronext, Eurex and ISE, and London and Borsa Italiana have demonstrated the ease with which markets overcome national borders. To be effective, regulators with oversight responsibilities over multi-national exchanges will have to work with each other. As these exchange mergers continue, regulators will continue to think about how to allocate regulatory responsibilities wisely.

Exchange mergers are a byproduct of another trend – the trend toward demutualization and for-profit exchanges. This in turn has called for changes in the organization of SROs. For-profit exchanges can and should, as their name suggests, cater to their investors by delivering to them a return on their investments. These incentives are not particularly conducive to the proper functioning of an SRO. Thus, the creation of FINRA was a necessary development in the world of for-profit exchanges. There is still a role for the SEC, though, in overseeing FINRA’s work. I and my colleagues at the SEC look forward to working with you on our shared effort to protect investors and the integrity of the markets in which they trade.

So I wish you all the best as you continue your efforts amidst all of the changes. Thank you for your attention. I would be happy to take some questions. We can talk about any of the issues that I have discussed or anything else that is on your minds.

1 Treasury Blueprint at 107 (available at: http://www.treas.gov/press/releases/reports/Blueprint.pdf).

2 FINRA, Information Notice: Rulebook Consolidation Process, at 2 (Mar. 12, 2008) (available at: http://www.finra.org/web/groups/rules_regs/

3 RAND Center for Corporate Ethics, Law, and Governance, Technical Report: Investor and Industry Perspectives on Investment Advisers and Broker-Dealers (2008) (available at: http://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf).

4 Treasury Blueprint at 122.

5 Remarks by Mary L. Schapiro, Chief Executive Officer, FINRA (Mar. 7, 2008) (available at: http://www.finra.org/PressRoom/SpeechesTestimony/MaryL.Schapiro/P038108).

6 Remarks by Secretary Henry M. Paulson, Jr. on Recommendations from the President’s Working Group on Financial Markets (Mar. 13, 2008) available at http://www.treas.gov/press/releases/hp872.htm.



Modified: 08/04/2008