Remarks at “Live from the SEC 2008”
Commissioner Troy A. Paredes
U.S. Securities and Exchange Commission
International Law Section of the American Bar Association
October 23, 2008
Thank you for the kind introduction. It is a pleasure to speak to you today. Before I begin, I must tell you that the views I express today are my own and not necessarily those of the U.S. Securities and Exchange Commission or my fellow Commissioners.
Since I joined the Commission in August of this year, the SEC has had to confront serious difficulties. We have not been alone. Nations around the globe have witnessed unprecedented events and have been forced to make difficult decisions in the interest of investors and other securities market participants. We all have worked tirelessly in responding to the current crisis, and I pause to recognize the cooperative spirit with which policymakers around the globe have committed themselves to remedying the troubles burdening financial markets. Given the capabilities and dedication of the individuals entrusted to remedy these problems, I am confident that we will weather the storm.
The U.S. has long played a leading role in the world of finance. In response, countries around the globe have taken noticeable steps to present competing venues for raising capital. As securities markets in the rest of the world continue to change, and as transactions increasingly occur across borders, the U.S. must continually reevaluate its securities laws to ensure that they account for globalization.
My remarks today share some of my views concerning the international reach of U.S. securities law. The Commission’s rules in this area — as in all areas — should be nimble and dynamic to keep pace with the latest market developments. The U.S. has to accommodate the reality of international capital markets in which parties can transact virtually anywhere. U.S. securities regulation must anticipate and respond to the opportunities and challenges of an expanding marketplace in which capital moves freely without regard to geographic boundaries. In doing so, the SEC must be vigilant to ensure that our rules effectively advance the interests of U.S. investors and issuers.
Investors demand a regulatory regime that empowers them with information and protects them against fraud and manipulation; yet they also want access to a range of investment opportunities, including efficient access to the securities of foreign issuers. Issuers, on the other hand, generally want low-cost access to capital and predictable and transparent enforcement regimes. Given recent events, all market participants presumably want a regulatory structure that provides some assurances of liquidity and guards against systemic risk
A desire for low-cost access to capital does not necessarily mean that issuers prefer a lax regulatory regime to a more stringent one. Indeed, issuers may welcome a regime with robust investor protection that can drive down the cost of capital as investors, secure that their investments will be protected, are more willing to invest. That said, there is a tipping point at which a regulatory regime becomes too onerous from the perspective of issuers, as well as investors. Even in the aftermath of the present financial crisis, it is possible that regulation can go too far. When the threshold has been crossed, issuers have reason to gravitate toward a different market where capital will meet them. This may translate into capital leaving one country in favor of another. This dynamic reflects the potential of regulatory competition, with jurisdictions competing to find the right level of regulation. Implicit in this characterization of events is the view that investors are able to evaluate competing regulatory regimes and corporate governance structures, just as they are able to evaluate a company’s business model and financial performance — a view of investor behavior that some resist.
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For years, the reach of the federal securities laws has been scaled to accommodate globalization, thereby encouraging international commerce. However, the nature of the accommodation has changed, especially in recent years as the rate of globalization has accelerated.
Let me turn now to some of the ways that U.S. federal securities regulation has accommodated the internationalization of securities markets, starting with Regulation S.1
It is accepted that the U.S. federal securities laws generally apply to all securities transactions effected in the United States from outside the U.S. The Securities Act of 1933, for example, reaches conduct involving the use of the U.S. mails or instrumentalities of U.S. interstate commerce. A rationale for extending the U.S. federal securities laws to offerings into the U.S. from a foreign country is that one cannot conduct a securities transaction in the United States, even from outside the U.S., without using some means of “interstate commerce,” given that term’s broad definition.
What about offerings into a foreign country from the United States? Such a transaction that uses the U.S. mails or other means of interstate commerce would seem to trigger section 5 of the 1933 Securities Act, which prohibits the offer or sell of a security, unless the offer or sale is registered with the SEC or is exempt from registration.
With Regulation S, adopted in 1990, the Commission codified the agency’s historical position granting relief from compliance with Securities Act registration requirements for an offering made offshore, so long as there were reasonable procedures in place to prevent distributions of the offered securities in the United States.
Regulation S can be viewed as a jurisdictional limitation on the reach of the Securities Act, based on the premise that transactions occurring offshore do not warrant SEC registration when safeguards exist to protect against the flowback of the underlying securities into the U.S.
Regulation S provides issuers with important predictability so they can more effectively structure their capital-raising activities. The Regulation S safe harbors give issuers a means to test whether their offshore offerings are subject to U.S. registration and permit companies to access offshore capital markets more efficiently without incurring the delay and expense of Securities Act registration.
Beyond these practical consequences of Regulation S, the rules reflect more fundamental considerations for assessing how to regulate securities markets in a global environment. As the SEC explained in the Regulation S adoption release:
The Regulation adopted today is based on a territorial approach to Section 5 of the Securities Act. The registration of securities is intended to protect the U.S. capital markets and investors purchasing in the U.S. market, whether U.S. or foreign nationals. Principles of comity and the reasonable expectations of participants in the global markets justify reliance on laws applicable in jurisdictions outside the United States to define requirements for transactions effected offshore. The territorial approach recognizes the primacy of the laws in which a market is located. As investors choose their markets, they choose the laws and regulations applicable in such markets.2
Cross-border business combinations and rights offerings are another area where federal securities regulation has accommodated globalization. Before the Commission adopted a series of exemptions in 1999,3 inconsistencies between U.S. and foreign law led to the unfortunate outcome that cross-border business combinations and rights offerings routinely excluded U.S. holders of a foreign issuer. The 1999 cross-border exemptions represented a Commission effort to facilitate the inclusion of U.S. security holders in foreign transactions in a manner consistent with investor protection. The SEC succinctly summarized the impetus motivating the cross-border rules:
When bidders exclude U.S. security holders from tender or exchange offers, they deny U.S. security holders the opportunity to receive a premium for their securities and to participate in an investment opportunity. Similarly, when issuers exclude U.S. security holders from participation in rights offerings, U.S. security holders lose the opportunity to purchase shares at a possible discount from market price.4
Underpinning the regulatory scheme governing cross-border business combinations and rights offerings is the premise that, within bounds, it is prudent to scale back the reach of the U.S. federal securities laws to allow U.S. investors enhanced opportunities to participate in cross-border transactions. To extend the full measure of the federal securities laws to such transactions is to deny U.S. investors valuable investment opportunities.
The cross-border exemptions are structured as a tiered system, where the two tiers are determined by the percentage of securities of a foreign private issuer held by U.S. investors. In “Tier I,” where U.S. holders own no more than 10 percent of the subject securities, a qualifying cross-border transaction is exempt from most filing, dissemination, and procedural requirements of the U.S. tender offer and going private rules. Further, a securities offering that is part of the transaction is exempt from the registration requirements of the Securities Act, as are certain cross-border rights offerings where this 10 percent U.S. ownership threshold is met.
While not as far-ranging as the Tier I exemption, the “Tier II” exemption provides relief from some U.S. tender offer rules for issuers and third-party bidders where U.S. security holders own more than 10 percent, but no more than 40 percent, of the target class.
Although the originally-adopted cross-border exemptions were successful in addressing many areas of conflict between U.S. and foreign law, the Commission has recognized that in some instances the exemptions were not operating as well as they could. Accordingly, this past August we voted to adopt a series of revisions that address concerns that inhibited broader use of the then-existing cross-border exemptions.5 For example, in response to concerns that the original method of measuring the 10 percent and 40 percent thresholds was too burdensome, we revised the rules to provide a more workable method of testing U.S. ownership, although we stopped short of increasing the thresholds themselves.
The 2008 cross-border release makes important strides toward expanding U.S. investors’ access to a wide variety of transnational business combinations and rights offerings, when in the past the predecessor rules often had the practical effect of excluding U.S. investors from these transactions. The 2008 revisions will not eliminate all conflicts in law or practice presented by such cross-border transactions. But the new rules demonstrate the Commission’s flexibility, as we updated the regulatory scheme to reflect evolving market trends and a decade’s worth of experience with the prior rules.
This past summer the SEC took additional steps to ensure that our rules do not place U.S. investors at a disadvantage in the world’s marketplace. The Commission adopted rule changes concerning Exchange Act Rule 12g3-2(b)6 and the so-called Foreign Issuer Reporting Enhancements (FIRE).7 Revised Rule 12g3-2(b) expands the ability of a foreign private issuer to have its equity securities traded on a limited basis in the U.S. over-the-counter market without the need to register under the Exchange Act, while at the same time ensuring that home country disclosure documents remain readily accessible to U.S. investors. The FIRE release enhances the quality of information about foreign private issuers that is available to U.S. investors. These rule changes further improve access to our public markets for foreign issuers, thus enhancing investment opportunities for U.S. investors.
The SEC also has proposed amendments to update Exchange Act Rule 15a-6,8 which provides regulatory relief for foreign broker-dealers engaging in certain conduct in the U.S. I look forward to reading the comments and hearing from interested parties on this topic.
Let me turn to mutual recognition — a means of accommodating globalization that turns less on the granular tailoring of a home country’s securities law to encourage particular transactions and instead leverages a foreign country’s high-quality regulatory regime more generally. Mutual recognition can take many forms, the details of which are left for another day. Instead, I offer a basic observation. Mutual recognition builds on a home country’s determination that a foreign jurisdiction’s regulatory system is of sufficient quality so as to obviate the need for the home country to enforce the full measure of its laws against foreign interests doing business there, thus expanding investment opportunities for home country investors. A key challenge, then, is to evaluate a foreign jurisdiction’s regulatory regime and practices.
Given the complexities of crafting a securities law regime, no two countries’ regulatory systems will be mirror images. In fact, one would expect diverse countries with unique economies, political structures, and histories to approach securities regulation differently. In other words, there is no one-size-fits-all approach to protect investors and ensure market integrity. Different countries may achieve investor protection and market integrity differently. Accordingly, we should resist a detailed cataloging that looks to match up jurisdictions statute-by-statute, rule-by-rule, case law-by-case law, and regulator-by-regulator.
We have taken first steps toward achieving mutual recognition with nations. In August 2008, for example, the Commission entered into a mutual recognition arrangement with the Australian government and the Australian Securities and Investments Commission.9 The U.S.–Australia mutual recognition arrangement provides for the consideration of exemptions that if granted would allow certain U.S. and Australian stock exchanges and broker-dealers to operate in both the U.S. and Australia without facing complete regulation in both jurisdictions. In essence, U.S. stock exchanges and broker-dealers subject to SEC regulation might be allowed to do business in Australia, while receiving relief from Australian securities regulation. Similarly, Australian stock exchanges and broker-dealers subject to Australian securities regulation might be allowed to do business in the U.S., while receiving relief from SEC regulation. I look forward to reading public comments we might receive on any applications for exemption.
Of course, one cannot discuss globalization without discussing the concept of a global accounting standard, such as International Financial Reporting Standards (IFRS). In August 2008, the Commission voted to publish for comment a proposed “Roadmap” that could result in U.S. registrants filing financial statements using IFRS instead of U.S. GAAP.10 The proposed Roadmap follows the SEC’s earlier accommodation to accept financial statements prepared by foreign private issuers in accordance with IFRS without having to reconcile their financial statements to U.S. GAAP.
These developments reflect that IFRS increasingly is used throughout the world. They also reflect that progress toward a single set of high-quality global accounting standards is a significant development in the efficient operation of global capital markets. If U.S. capital markets are to remain at the forefront of capital formation, we must take steps to ensure that our accounting system evolves to address the demands and needs of issuers and investors, while ensuring that we maintain the high-quality controls and standards that we have demanded for so many years.
The path to a global accounting standard is not without risk. Indeed, any large-scale transition will have its attendant costs. But the existence of transition costs is not necessarily a reason to resist change. Rather, transition and other costs must be balanced against the long-term benefits of change. I voted in favor of publishing the Roadmap, and I look forward to reading the comments and hearing from all the constituents on this important issue as we assess these tradeoffs and other aspects of the proposal.
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Many lessons will be learned from the financial crisis that we have been weathering. One lesson already is stark: the world is extremely interconnected, perhaps to a degree and in ways that were not fully appreciated. The existence of global capital markets with global consequences recommends enhanced global regulatory cooperation, particularly to guard against systemic risk. How to achieve effective cooperation in practice given the differences that persist among countries is a topic for another day.
A corollary to cooperation is the recognition that we in the United States do not have a monopoly on good ideas. As the SEC wrestles with complex questions, we must not turn a blind eye to the views of our fellow securities regulators abroad who may have grappled with similar issues and adopted approaches from which we can learn. There is value in looking to other jurisdictions to assess their responses to shared regulatory challenges and opportunities. The Commission should be open to a range of ideas as we work to achieve the optimal regulatory result. Of course, as regulators cooperate and learn from each other, it must be stressed that even if something works for country A it may not work for country B.
For the U.S. regulatory system to remain state-of-the-art, it must be flexible when circumstances warrant. Over the years, the SEC has been willing and able to tailor the reach of the U.S. securities laws to accommodate globalization in advancing the best interests of investors and issuers. Such flexibility promotes investor protection and facilitates capital formation — mutually-reinforcing goals of the U.S. federal securities laws.
I appreciate your interest, and I thank you for being such an attentive audience.