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Speech by SEC Chairman:
Opening Remarks at SEC Roundtable on Modernizing the Securities and Exchange Commission’s Disclosure System


Chairman Christopher Cox

U.S. Securities and Exchange Commission

Washington, D.C.
October 8, 2008

Good morning. It is a pleasure to welcome you to the SEC. And it is a particular honor to have such distinguished panelists and guests joining us today.

When the SEC was founded nearly 75 years ago, a fundamental purpose was to restore investor confidence in our capital markets by providing investors and the markets with more reliable information. Today, we are continuing to build on that essential premise: that investors have a right to know the truth — and the risks — about the securities that trade in our public markets. Never in this agency's history has this fundamental mission been more relevant, and more urgent. The current credit crisis has shown the importance of transparency to a healthy marketplace — and how costly hidden risk can be.

The SEC's 21st Century Disclosure Initiative is making a rigorous and disciplined examination of how we can better fulfill our mission and help investors understand the detailed financial reports and complex financial instruments of today's markets.

It will not only evaluate how well we are using our current system, but also guide our planning in addressing the insufficient transparency that is at the heart of today's market problems.

The panelists today will delve deeply into these topics. But to help put today's discussion into perspective, I'd like to describe some of the most important recent actions the Commission has taken to maintain orderly markets and to protect investors, as well as some of the most significant new challenges that we will face in the days ahead.

If I could, I'd like to acknowledge by name every one of the SEC's nearly 4,000 staff who are fighting to protect investors. What I can do is ask every member of SEC staff in this room to please stand. To you, and to all of our colleagues here in Washington and across the country — please accept our appreciation for your dedication, your patriotism, and your public service. [Applause]

Above all in the current turmoil, the markets and investors need transparency. From the moment that the collapse of lending standards created billions in worthless mortgage paper — and billions more in hidden risk — market participants have had enormous difficulty discovering and pricing that risk. Illiquid instruments that were not long ago rated AAA for credit quality were hidden in off-balance sheet vehicles and elaborately structured securities.

We have worked on a number of fronts to improve transparency, including using our new authority under the Credit Rating Agency Reform Act to expose weaknesses in the ratings process and develop strong new rules. We have broadened disclosure by financial institutions, particularly with respect to hard-to-value assets. We have worked closely with the Financial Accounting Standards Board to deal with such issues as consolidation of off-balance sheet liabilities, the application of fair value standards to inactive markets, and the accounting treatment of bank support for money market funds. And we have initiated examinations of the effectiveness of broker-dealers' controls on preventing the spread of false information. The Commission has also required new disclosures of short positions to the SEC, complementing the existing requirements for reporting of long positions.

But beyond all of these actions to increase transparency, the SEC is first and foremost a law enforcement agency. During the market turmoil of the last several months, the professional men and women of the SEC have been working around the clock, seven days a week, to bring accountability to the marketplace and to see to it that the rules against fraud and unfair dealing are rigorously enforced.

In the fiscal year just ended, the SEC's Enforcement Division brought the second-highest number of cases in the agency's history. For the second year in a row, the Commission returned approximately $1 billion to injured investors. And the preliminary settlements in principle that have been reached with major sellers of auction rate securities will allow investors to receive over $28 billion. When they are finalized, these will be by far the largest settlements in the history of the SEC.

The agency has been especially aggressive at combating fraud that has contributed to the subprime crisis and the loss of confidence in our markets. We have over 50 pending law enforcement investigations in the subprime area. Just this week the Commission charged five California brokers with securities fraud for pushing homeowners into risky and unsustainable subprime mortgages, and then fraudulently selling them securities that were paid for with the mortgage proceeds.

In recent weeks, the Division of Enforcement has undertaken a nationwide investigation of potential fraud by issuers of securities in financial institutions, and manipulation of those securities through means including abusive short selling and the intentional spreading of false information. As part of this aggressive law enforcement, on September 19 the Commission approved orders under the Securities Exchange Act requiring certain hedge funds, broker-dealers and institutional investors to file statements under oath regarding trading and market activity in the securities of financial firms.

The sworn responses to the Commission's orders were due on Monday. The orders cover not only equities but also credit default swaps.

To assist in analyzing this information, the SEC's Office of Information Technology is working with the Enforcement Division to create a common database of trading information, of audit trail data, and of credit default swaps clearing data. Our Office of Economic Analysis is also supporting this effort by helping to analyze the data across markets for possible manipulative patterns in both equity securities and derivatives.

The reason for this aggressive enforcement investigation into credit default swaps is the significant opportunity that exists for manipulation in the $58 trillion credit default swaps market. It is a market that is completely lacking in transparency, and virtually unregulated.

The regulatory black hole for credit default swaps is one of the most significant issues we are confronting in the current credit crisis, and it requires immediate legislative action.

The over-the-counter market in credit default swaps has experienced explosive growth in recent years. One reason is that the total amount of credit default swaps outstanding far exceeds the total value of what the swaps are meant to insure. So when entire asset classes fall in value, the exponentially larger losses on credit default swaps can work to amplify the risk to the financial system.

To put into context this $58 trillion of value that credit default swaps insure: $58 trillion is more than the gross domestic product of every country on earth, combined.

The market for CDS is barely 10 years old. It has doubled in size since just two years ago. It has grown between the gaps and seams of the current regulatory system, where neither the Commission nor any other government agency can reach it. No one has regulatory authority over credit default swaps — not even to require basic reporting or disclosure.

The over-the-counter credit default swaps market has drawn the world's major financial institutions and others into a tangled web of interconnections where the failure of any one institution might jeopardize the entire financial system. This is an unacceptable situation for a free market economy.

These complex interconnections pose risk to the financial system precisely because of the complete lack of information about who is exposed to whom. They have created a situation that is ripe not only for rumor and misinformation, but potentially fraud. This is of even greater concern because the over-the-counter market for credit default swaps has given rise to a new phenomenon: the rise or fall of prices in the swaps market has begun to serve as a signal to the markets about the pricing of the underlying debt and equity securities.

In recent days we have witnessed how the rise and fall of the costs of credit default swaps on the debt of a financial institution appears to correlate with changes in its stock price. Manipulation in this completely unregulated and hidden space can drive prices in the regulated market for securities. That is why I believe it is important for Congress to act now to provide for regulatory oversight of the credit default swaps market.

Credit default swaps serve important purposes. They can't be trivialized as inherently good or evil. They are simply contracts that have grown in a very short span of time to such size that they matter enormously to the overall economy. But in today's market conditions, where uncertainty is the enemy, their invisibility undermines investor confidence. Transparency is a powerful antidote for what ails our capital markets. When investors have clear and accurate information, and when they can make informed decisions about where to put their resources, money and credit will begin to flow again. That's why what all of you are working on here today is so important.

But today, the Commission's only authority with respect to over-the-counter credit default swaps is limited to enforcing the antifraud laws, such as those against insider trading. In fact, federal securities law specifically prohibits the Commission from regulation of credit default swaps — even as a preventative measure against fraud. That state of affairs simply cannot remain. We have seen the costs of other regulatory gaps in the last few months. There is no longer any excuse for failing to act.

Legislation is needed to require trade and position reporting by dealers in over-the-counter credit default swaps. Public reports of over-the-counter transactions would provide transparency and ensure better pricing.

Position reporting for over-the-counter credit default swaps could be required from market participants with significant positions. This would provide regulators with the information they need to uncover manipulation and monitor risk.

Basic recordkeeping is also necessary for over-the-counter credit default swaps transactions. It would be a valuable tool in enforcing antifraud requirements.

Both the SEC and the CFTC should be given authority to issue anti-fraud rules. This authority could be used to prevent fraudulent, deceptive, or manipulative acts and practices.

Because of the truly global nature of the over-the-counter derivatives market, we will have to work closely with governments and parliaments in other major market centers. The climate for such cooperation is good, because the cross-border impacts of the current market problems are quickly becoming obvious to all.

Notwithstanding the significant limitations on any regulator's authority over credit default swaps, the Commission is doing what it can under its existing statutory authorities to address concerns in this market. We are working with the Federal Reserve, the CFTC, and industry participants to create one or more central counterparties for the credit default swaps market. This is an important step toward preventing the failure of a single market participant from having a disproportionate effect on the overall market. We are also working toward the establishment of one or more organized markets for credit default swaps, such as one or more electronic trading systems.

But under almost any circumstances, despite the potential for an organized and regulated credit default swaps market, the over-the-counter market will continue to be substantial. And for that reason, the lack of regulation in the over-the-counter market will continue to be a growing cause for concern. The solution is to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.

I hope these highlights of some of the issues facing investors and the Commission helps put today's discussion into perspective. And I hope that these are some of the issues that all of you today will have uppermost in mind as you thoroughly scrub today's disclosure system, and search for better ways for investors to unwind the complexity and hidden risk in our markets. I know how committed each of you is to improving disclosure and transparency, and I thank you for it.

So now it is time for our panelists to take center stage. Thank you once again for being here today, and thank you for your work in behalf of America's investors.



Modified: 10/08/2008