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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Reversing Course — Putting Investors First in Regulatory Reform


Commissioner Luis A. Aguilar

U.S. Securities and Exchange Commission

Compliance Week Annual Conference
Washington, D.C.
June 3, 2009

Thank you for that kind introduction. I am honored to be speaking to a room full of people who spend their days building a culture of compliance. As a former general counsel of a large global asset manager, I have a deep appreciation for the challenges that Compliance Officers face. These challenges are particularly great today. In these times of drastic cost cutting and shrinking revenues, compliance personnel face incredible pressure to do more with less resources and fewer personnel.

Against this backdrop, there is a debate on regulatory reform that deeply affects all of us. Changes to the financial regulatory system will have a significant impact on who regulates the entities you represent and the relationship between the regulator and your employer.

As I consider what is being said about these issues, it has struck me that the regulatory discussion is not being properly oriented. There is a need to shift the dialogue from the discussion of how best to preserve financial institutions to what is best for investors. I firmly believe that the SEC needs to be a strong voice in that discussion, and to vigorously advocate for its mission to protect investors, facilitate capital formation, and maintain fair and orderly markets. The SEC has the right orientation and has the right values to be one of the leaders in the discussion of regulatory reform. The SEC's job is to fight for Main Street even if that means Wall Street will have to reform. That is why it is so important that the SEC be reinvigorated by Congress and that it strongly reasserts itself into our national policy discussions. Investors need the SEC now more than ever.

Investors around the country are feeling the pain of this economic crisis — in their retirement nest eggs, their college savings plans and in their brokerage accounts. Any credible effort at regulatory reform has to work for investors, so that they can feel confident in our markets. My objective is to ensure that prioritizing investors is the primary goal of any regulatory reform.

To that end, I want to concentrate my remarks today on how to structure a regulatory reform proposal that enhances, rather than undercuts, investor protection. And I want to make clear that the thoughts I express are my own, and they do not necessarily reflect the views of the other Commissioners or the staff of the Commission.

In pursuing regulatory reform, I believe the following must happen:

  • First, there must be a searching inquiry into the causes of the crisis;

  • Second, there must be a reversal of the philosophy that resulted in the affirmative decisions that forced gaps in, and otherwise undercut, regulatory protections in order to favor the industry;

  • Third, there needs to be an assessment of whether the current regulatory reform proposals will protect investors and promote market integrity;

  • And I will end with an outline of some reforms I support because they would enhance investor protection.

Searching Inquiry into the Causes of the Economic Crisis

The focus on regulatory reform must start with a searching inquiry into the causes of our economic crisis. Automatically blaming the regulatory structure is not a satisfactory answer. In fact, it reveals a striking blind spot. The staggering amount of taxpayer funds that have been mobilized to try to manage this crisis are being paid to prop up companies who made serious mistakes. The only way to make sure that our regulatory structure is responsive and well-built is to understand what went wrong, and what continues to go wrong.

It is a concern that the chorus of those calling for fundamental, comprehensive reform of our financial regulatory structure may distract from a searching look at the causes of the crisis. Others, such as former SEC Chairman Richard Breeden, have argued that, in general, we had a reasonable regulatory structure during this crisis, and that the real problem is that we didn't have anyone willing to exercise existing authority to look deeply into questionable industry practices — and to "just say no" when needed. Instead we seemed to have had decision makers that weakened regulators, and otherwise fostered "unregulated" markets. Additionally, we often had regulators who failed to pursue their mandates or, at the very least, turned a blind eye to risky practices.

While it is clear that regulators can be more effective — and I have been very vocal as to how to strengthen the SEC — we need to be careful about blindly concluding that the regulatory structure is the reason that investors have lost confidence. The focus on systemic risk may be hiding the fact that we had institutions that were playing fast and loose with other people's money, and a deregulatory philosophy that let people get away with it.

There are many reasons why investors lost confidence, and they go beyond concerns about the regulatory structure. Investors have lost confidence in the integrity of the markets and in the market participants because there have been real questions raised as to whether the people on Wall Street can be trusted, and whether investor interests are protected. Investors have noticed that the financial industry's behavior has, in many cases, put the institutions' interests before their own. Too many on Wall Street may have succumbed to the temptation to obtain another transaction fee, and operated under a compensation system that let Wall Street employees keep the upside and the wins on good bets — milk the bubble, so to speak — but pass on the losses when the bubble burst.

I applaud Congress and President Obama for providing for an independent, bi-partisan Financial Crisis Inquiry Commission to investigate the domestic and global causes of the current crisis. By investigating and analyzing what happened, we can, in turn, assess whether the regulatory reform proposals are being driven by the right concerns.

Reverse the Philosophy Resulting in Affirmative Decisions that Undercut Regulation

Over and over again, the philosophy behind deregulatory decisions seems to have been how industry would benefit, rather than how best to benefit investors and the general public. In 1999, the Gramm-Leach-Bliley Act formally repealed Glass-Steagall and authorized banks, securities firms, and insurance companies to combine under one corporate umbrella. This Act was the culmination of years of decisions weakening the protections against the development of large banking conglomerates, without a clear articulation of how investors would be protected against the intrinsic risks and conflicts created by these giant entities. At the time, Senator Phil Gramm said "Glass-Steagall, in the midst of the Great Depression, thought government was the answer. In this period of economic growth and prosperity, we believe freedom is the answer."1 Clearly, this freedom from restrictions on risk and conflicts benefitted industry, but it is hard to tell how it benefitted the average investor.

The Gramm-Leach-Bliley Act is part of a pattern of regulatory decisions over the past decade that were designed to directly benefit the financial services industry, without a clear understanding of how these decisions would directly benefit investors. As another example, there is the Commodity Futures Modernization Act, which excluded derivatives and swaps from most SEC regulation. It was another affirmative decision and prohibited expert regulators and public servants from exercising their judgment as to products such as credit default swaps.

The recent turmoil in the markets and our economy illustrate that Gramm-Leach-Bliley (also known as the Financial Services Modernization Act) and other laws such as the Commodity Futures Modernization Act, did not prioritize investors and average Americans. I have concerns about reform proposals that hide behind the excuse of "modernization" to disguise proposed regulatory changes that benefit the financial services industry, but may be to the detriment of investors. We must ensure that "modernization" means regulatory changes that put investors first.

Assessment of Regulatory Reform Proposals

To that end, it is essential that any regulatory reform prioritizes the needs of investors and the maintenance of America's pre-eminent capital markets. The SEC, a capital markets regulator that puts investors first, is integral to a modern regulatory system that pays attention to overarching systemic risk. The SEC is the only regulator entrusted with advocating for investors and charged with overseeing the integrity of the capital markets. In these times, the SEC is needed more than ever. If the SEC didn't exist, it would need to be invented.

Congress, the administration, and other interested parties have to remember that financial services exist to serve investors and a focus on investors is absolutely essential to any credible regulatory restructuring.

With that as my touchstone, I will discuss my views on some of the recent proposals for reform that are being debated in public. Specifically,

  • Systemic risk regulation;
  • The possibility of a consumer financial products safety commission; and
  • The possible integration of all US financial regulators into a single consolidated regulator, a so-called US Financial Services Authority.

Systemic Risk Regulation

There are many views about the need for a systemic risk regulator. Some have argued we already have existing regulators charged with looking at systemic risk and others say that the creation of such an entity will weaken the overall financial regulatory structure. And, of course, many say it is a necessity.

I think we need to have some clarity in our thinking about what are systemic risks — because how you define systemic risk directly influences your ideas about how the financial regulatory system should be structured. Many think that the regulation of systemic risk should be primarily focused on preserving the viability of institutions that are "too big to fail." But this view of systemic risk can result in a financial regulatory model that focuses too much on specific institutions, not investors, and positions a government regulator to pick winners and losers among companies at the expense of investors and at the expense of market certainty.

Instead, systemic risk regulation should recognize that the various market functions exist to serve investors and other users — and that the focus needs to be on ensuring the continuation of systemically important market functions, not institutions, and should have a clear focus on investor protections. This orientation toward investors and away from a "too big too fail" philosophy would involve identifying the systemically important market functions that an entity provides, and working to isolate these functions within the entity. The objective would be to ensure that the functions would be heavily reinforced against failure, and could be separately maintained should other parts of the entity weaken. The regulation could also provide for cross-entity relationships, or standardized market systems, to allow one or more other entities that provide similar market functions to step in and continue the functions seamlessly. For example, if the NYSE-Arca systems were to fail, the SEC has designed our market system so that NASDAQ would quickly pick up the important market functions.

Let's turn from the objectives of a systemic risk regulator to how the systemic regulator would be organized.

If systemic risk regulation is truly focusing on the overarching risk concerns, the systemic risk regulator should be viewed as a supplement to — rather than a replacement for — the primary regulator, such as the SEC. Currently, there are two main models for a potential systemic risk regulator: they are, first, a monolithic risk regulator, and second, a council of regulators. While there are advantages and disadvantages to both of these approaches, the council of regulators seems to offer a comprehensive and effective option.

Some of the advantages of a council of regulators approach are: first, it reflects the main objective of a systemic risk regulator, which is to identify accumulation of risks. In short, the systemic risk regulator needs to spot issues. Bringing together different regulators with different techniques and expertise will provide for a diversity of perspectives that could make it more likely that a risk will be spotted. Just as a wise leader does not guard the fortress with a single sentry, but has several vigilantly scanning the horizon, so too should Congress and the administration require the appropriate regulators to form a council to monitor for systemic risk.

In addition, a council of regulators would inherently ensure that any issues and proposed solutions would be subject to scrutiny in a consultative process by regulators having different mandates, information and expertise. This diversity of perspectives would make for better decisions.

Lastly, and most significantly, a council of regulators would avoid the inherent tensions and conflicts that could arise where one regulator has combined responsibility over monetary policy, a vested interest in the safety and soundness of particular institutions, and plenary powers to address systemic risk. Any organization with a narrow focus on a particular industry and very broad powers is likely to favor that sector to the possible detriment of others.

Moving forward with a "council of regulators model" would present a number of issues to be worked through and would require input from the regulators who would come together to oversee systemic risks. I have spoken previously about some of the key issues that would need to be considered; particularly, what authority the council should have and the need for procedural protections on how the council's powers would be exercised. Regardless of how those issues are resolved, such a council must allow for the free flow of information among regulators. And, to maintain a high level of accountability, it should be required to provide Congress with reports on its activities, at least semi-annually.

Clearly the primary regulator of the capital markets — whether the SEC or a new Integrated Capital Markets Regulator, as I'll soon discuss — would be a vital participant in such a council.

Regardless of the eventual model adopted for regulatory reform, it must be one that prioritizes the needs of investors and markets rather than one that diminishes their value.

Financial Products Safety Commission May Undercut Investor Protection Regime

In addition to a systemic risk regulator proposal, some are also calling for the creation of a Financial Products Safety Commission. Currently, there are two Congressional bills pending that propose to set up a Commission that exclusively looks at non-investment financial products like car loans, mortgages, and credit cards. There has been some talk that such a Commission might also include investment financial products, particularly mutual funds, but fortunately that has recently died down. To the extent this proposal resurfaces, I would have serious concerns that the differences between investment products, like mutual funds, and non-investment financial products, such as mortgages, have not been seriously discussed.

Investment Products Such as Securities Are Fundamentally Different From Other Non-Investment Financial Products

The concern driving the support for the Financial Products Safety Commission is best stated by Elizabeth Warren, a leading proponent of the idea.

As she has often been quoted as saying,

It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance your home with a mortgage that has the same one-in-five chance of putting your family out on the street . . . Why are consumers safe when they purchase tangible products with cash, but left at the mercy of their creditors when they sign up for routine financial products like mortgages and credit cards?2

This is a good question. However, the dialogue around this proposed commission has ignored the difference between investment products and non-investment financial products. Most non-investment financial products are goods or services whose value is fixed at the time of purchase. Take a credit card, for example. The card is a tool used by consumers to buy products and services now and pay later. The fees and interest paid by a consumer for a credit card are, in essence, the price that the consumer is paying for the credit. While the terms to using a credit card can be more clearly written, generally the terms are set at the time the card is issued to the consumer.

Compare that to investment products which are generally bundles of rights with respect to operating entities, investment companies, or other pools of assets. The value of these rights is generally determined by active trading markets — and can fluctuate daily, if not constantly — something not typically expected with a mortgage or with credit card fees. The benefits of a particular investment are expected to be realized over time by the buyer — either by selling it in the secondary market, by holding the instrument in accordance with its terms until expiration, or by trading the instrument for something else. Moreover, when you make an equity investment, although you clearly would like to make a profit, it is understood that the investment may lose value, and in fact may become worthless. For the capital markets to function, investors have to be able to take the risk that they may suffer a loss.

I do recognize that some products, such as stable value money market funds have traditionally been very safe and are not often thought of as having the potential to lose value. And while the SEC's Rule 2a-7 does set forth a number of requirements to guard against a fund "breaking the buck", and more safeguards are planned, we need to remember that money market funds do have market risk. A fact disclosed in their prospectuses — although, perhaps the funds should enhance their disclosures around this fact.

Let's look at the differences between investor protection and consumer protection. Although there may be some overlap between the concepts of investor protection and consumer protection, they are not the same. Consumer protection typically refers to regulation of the retail interactions between individuals who buy things and the people from whom they buy them — for example, between the person that gets a mortgage and the mortgage holder. By contrast, because of the nature of the products involved, investor protection includes the retail transaction — for example, the relationship between a customer and a broker-dealer — but extends significantly beyond it to reach a number of other market participants. The SEC understands that to effectively protect investors, it must have a holistic understanding of the overall system. This means that the regulatory regime includes regulation of the inter-connected chain of market participants, such as:

  • The issuers of securities;

  • intermediaries such as broker-dealers and underwriters;

  • the accounting standard setters who create standards for reporting financial information;

  • the stock exchanges; and

  • the clearing and settlement systems.

The SEC's overriding goals are to maintain the integrity of the system and its usefulness to investors. Thus, to remove any portion of investment products from this regime would be to risk regulatory arbitrage and seriously undermine investor protection. If a Financial Products Safety Commission did start to regulate some investment products, it would have to re-create this extensive investor protection regime to adequately protect investors. For example, if this Financial Products Safety Commission were to regulate mutual funds, it would also need to consider establishing a regime for regulating the fund's investment adviser, its underwriters, its transfer agents and other service providers otherwise already regulated by the SEC. Clearly, this proposal would require a great deal of thought before going forward.

A Single Consolidated Financial Regulator Could Undercut Investor Protection

Another proposal being mentioned is to create a single consolidated regulator that would combine banking, securities, and insurance regulators. I would be very concerned that having a single regulator could result in the investor protection mandate being completely undermined in the regulator's pursuit of other mandates.

Let's consider the functions we would ask a consolidated regulator to perform. A consolidated financial regulator would be charged with regulating to provide safety and soundness of financial institutions, promote market integrity, and protect investors. In concrete terms, it would mean that the same regulator that is asked to prevent financial institutions from failing would be asked to bring aggressive cases against those institutions on behalf of investors. This regulator would also have conflicts in mandating full disclosure to investors, even when that information might show that a financial institution is weak.

These differences in mandates can result in real differences in aggressive enforcement and transparency. Combining into a single regulator the functions of supervising financial institutions for safety and soundness, while also seeking to provide for efficient markets and investor protection seems destined to require that one of these mandates be subordinated. If you look at the level of enforcement actions by consolidated supervisors around the world, and compare that with the vigor of SEC enforcement, even in the recent years where the SEC's enforcement program has been criticized, you will notice a stark difference. That should serve as a warning sign to investors and the rest of the public about too much regulatory consolidation.

Moreover, as former SEC Chairman Breeden recently testified, a consolidated regulator

. . . can create systemic risk because if the regulatory 'czar' proves wrong, every part of the system will be vulnerable to damage. Some regulators prove more effective than others, so a system with only one pair of eyes watching for risk is weaker than a system in which lots of people are watching. What counts is that somebody rings an alarm when problems are small enough to fix, not who pushes the button.3

Chairman Breeden's concerns resonate with me. I could not support any regulatory proposals that threaten to undermine investor protection.

Integrated Capital Markets Regulator Enhances Investor Protection and Promotes Market Integrity

The reform proposal that I believe best serves investors and would promote market integrity is to create an Integrated Capital Markets Regulator. This regulator would combine the functions of the SEC, the Commodity Futures Trading Commission (CFTC), and the functions of the Department of Labor's Employee Benefits Security Administration (EBSA). I would envision this Integrated Capital Markets Regulator as having the comprehensive investor protection mandate for all investment products such as securities, derivatives, and interests in retirement funds, among others. However, I would not object if a separate CFTC retained oversight of agricultural commodity derivatives.

By combining these entities, you create a financial regulatory structure that truly has oversight over the entire capital markets. After all, the markets for securities and the markets for derivatives that can substitute for securities tend to blend into one market. Today's markets are so interconnected that centralized market oversight by a single independent regulator makes sense. The characteristics that differentiated these separate regulatory entities and justified their separate existence have largely disappeared. As CFTC regulation has expanded from agricultural commodities to include some financial derivatives separate from SEC jurisdiction over security derivatives, the need to provide consistent capital markets oversight has increased. Additionally, as EBSA increasingly regulates participant-directed defined contribution plans, rather than employer-sponsored pension plans, EBSA is regulating plans in which investors fund, manage, and bear the decision-making responsibility and risk for their investment decisions. By including EBSA within the Integrated Capital Markets Regulator, Congress would be enhancing the protections for all investors by providing a regulatory regime with a comprehensive investor protection mandate.

Of course a SEC-CFTC-EBSA merger only answers the question of "who" regulates the capital markets. It doesn't address "how" they are regulated. I support the SEC's mission and model of regulation and both should transfer to the Integrated Capital Markets Regulator. The Integrated Capital Markets Regulator should be an independent agency with a clear mission to protect investors, maintain market integrity, and promote capital formation.

In addition, the model of regulation should be one that provides for strong and broad regulatory authority and vigorous enforcement, coupled with flexible exemptive power to permit dynamic regulation where needed. Our securities markets remain strong in large part because of SEC regulation, which provides for fairness, efficiency and transparency — which, in turn, supports investor confidence, low market transaction costs and efficient public capital raising.

If an Integrated Capital Markets Regulator is created, it must be done in a way that puts investors first. An empowered Integrated Capital Markets Regulator, appropriately funded and authorized by Congress, would be a key participant to establishing a level playing field for investors and market participants alike.

Integrated Capital Markets Regulator Needs Authority Over the Shadow Markets

Congress will need to ensure that the Integrated Capital Markets Regulator has appropriate authority by linking its powers to the market it oversees. There are enormous areas of the securities markets that lack appropriate regulation, including over-the-counter derivatives, hedge funds, and municipal securities. As I have said time and again — these gaps need to be closed.

Integrated Capital Markets Regulator Needs Sustainable Funding Mechanism

In order to be a robust regulator, the Integrated Capital Markets Regulator must also have a sustainable funding mechanism. What does that mean? It means that it must be able to self-fund its operations. This way the Regulator will be able to set multi-year plans and budgets, and have the resources to be able to promptly respond to drastically changing markets. In fact, many financial regulators are already self-funded and have the ability to respond quickly and plan strategically.

One can look to the SEC over the last several years as an example of the harm that can result to a regulatory watchdog if it does not have the ability to appropriately fund and plan its operations — particularly at a time of market expansion. Currently, the SEC does not have the ability to self-fund and this has harmed the agency's ability to perform its mission in terms of long-range planning, developing necessary technology and maintaining appropriate staffing levels. In fact, the SEC has had to freeze needed hiring as the budget allocations failed to keep pace with year-to-year expense increases for existing staff.

Accordingly, it is important that the Integrated Capital Markets Regulator have a sustainable funding mechanism, much the same as financial regulators such as the Federal Deposit Insurance Corporation, Office of Thrift Supervision, Office of the Comptroller of the Currency, and the Federal Reserve, to name a few. The Integrated Capital Markets Regulator should be in the same position as these other financial regulators.


Too often in the past, decision-makers have deregulated financial services and hoped that the public interest and investor protection would occur indirectly, by giving them more choice or through greater competition. In other words, there was a reliance on enlightened self-interest to result in the public good. One thing that I don't think anyone can have much faith in after this economic crisis is enlightened self-interest. We ought to have learned that lesson in the 1930s. We certainly know it now. The desire to earn a profit — or, as some would call it "greed" — is a fantastic motivator and an engine for growth. But it doesn't check itself or act in the public interest. In fact, it must be marshaled in the public interest. As compliance officers, you see this struggle play out every day.

The same struggle you see is one that the SEC staff must police. The SEC has incredibly dedicated line staff — the men and women who have chosen to serve the public interest at the SEC are hardworking, earnest, and fair in their work and interactions. I worry that the reputation of the staff is becoming unfairly tarnished in the press and that the true story of their dedication and hard work is not reaching the public. We should all remember their service, thank them for their effort, and encourage them to continue their hard work.

I'll end my remarks where I started them — by expressing an appreciation for the challenges and efforts of Compliance Officers. I hope your employers appreciate all that you do.

Thank you.



Modified: 06/03/2009