Speech by SEC Chairman:
Address to Conference on "The Future of Global Finance"
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
Georgetown University's McDonough School of Business
Sept. 18, 2009
Thank you, and thank you Reena [Aggarwal] for chairing this very informative and I'm sure successful conference. It's a pleasure to be back at Georgetown University, where I am honored to know so many of the faculty and administrators.
And, thank you to the McDonough School of Business for hosting this wonderful event.
Congratulations as well to all of you on your new home - I am sure it will help to further strengthen the already great reputation that this institution holds - not just here in our nation's capital or in the United States, but truly around the world.
And so, congratulations to you Dean Daly and to the entire faculty who help each day to educate our future business leaders.
Information Makes For Good Decisions
I wanted to start today by highlighting a sentence that your business school actually uses to describe itself. This business school, it reads: "is committed to developing leaders capable of making complex business decisions in a global environment."
Of course, what stood out for me was that nowhere does it say these leaders will be capable of making 'good' business decisions. Just complex ones.
But of course, I realize there really is no way to guarantee good decisions. That's because a business decision is only as good as the information upon which it is based.
And, if a business leader does not have - or cannot get - sufficient information, then even the training and education you get at a first-class school like Georgetown will not guarantee that good decisions will be made.
Think about an oil company CEO who decides to drill off the coast of Asia. It's likely to be a good decision only if he has experts opining that there is probably oil there. And, it's even better if he can see and appreciate how the experts arrived at their view - and how much it'll cost to find out. Without that information, the decision to drill may end up being good for the company, but it doesn't necessarily mean it was a well-made decision.
And, think about the CEO of a real estate company who wants to acquire and remodel an aging building on the outskirts of town. Once again, it's only a good decision if that CEO has a top-notch appraiser and an architect who has a good set of blueprints. Without that information, the decision is no better than buying a high-priced lottery ticket.
In short, decisions in business are based on information - and that means the most successful companies are often the ones that have the best access to that information.
Take for instance, a retail store that knows what their customers buy, how much they need, and when they need it. That store is going to have the right items on inventory at the right time. And, sales will be robust.
But more information doesn't necessarily mean better information. Too much, and you don't know what is important. Too much, and you might not even get through it all.
Instead, it's the right information that matters. And, it's the right information that leads to good decisions.
Information in the Securities Arena
In the world of securities - it's really no different.
Investors need information, so they too can make good decisions. But, if the information is obscured, if it's vague, if it's too plentiful or misleading, or if it's just false, investors make bad decisions and they suffer profoundly for it.
The recent economic crisis is a case in point. As you know, in the early part of the decade, many homes were sold to homeowners who ultimately could not afford to pay their mortgages. Many of those mortgages were underwritten using lower underwriting standards, where home buyers didn't even need proof of income.
Why? Because the mortgage companies knew that there was a way to push off the risk to someone else. They could package these mortgages together and sell them to Wall Street, which could in turn repackage them as investments vehicles, or securities.
But, most investors didn't know what really was inside each package of mortgage-backed securities. And, they didn't know how risky the financial product really was.
It's possible some information was out there, perhaps included among a dizzying array of potentially important data, or perhaps made available in too short a time before an investment decision had to be made. But, it's also just as likely that some investors simply decided to rely on experts who are paid to assess risks and rate a product. Of course, as we now know, many of those ratings were inflated, to say the least. And, investor decisions that were based on that wrong information, turned out to be anything but right.
At the Securities and Exchange Commission, we're focused every day on making sure companies and those who issue securities are disclosing the information that will help inform investors. That's what we're about.
We don't always have the authority to change conduct. We cannot tell a rating agency to upgrade or downgrade their rating. We cannot tell a retail chain to cap the pay of its executives. And we certainly cannot tell an oil company where to drill.
What we can do - among many other things - is mandate full and honest disclosure. And that disclosure, that transparency, we believe, leads to better decisions. The SEC's role as a disclosure agency is well understood in the traditional sense. We are all well versed in the requirements for annual and quarterly filings by public companies where they report business and financial results and discuss their risks and prospects. This information is the lifeblood of the capital markets as it is this information that allows investors to make capital allocation decisions.
But there are many other ways that the SEC can and does facilitate the decision making of investors through the provision of information. So as we have set about to change the SEC's approach to protecting investors and ensuring market integrity, disclosure is playing a central role.
* * *
In the seven months since I've been at the Commission, we've been doing a great deal to reform how the agency does business. We're streamlining our enforcement procedures, hiring new skill sets, revamping how we handle the hundreds of thousands of tips we get each year, bolstering our training programs. And so much more.
Information Through Disclosure
But, we're also focusing on the rules we adopt - rules that guide the way businesses and Wall Street operate. And, many of the proposed changes we are making to those rules involve one basic goal: Getting more of the right information into the hands of investors.
From who's on corporate boards to what's behind a company's salary philosophy.
From who's paying for a credit rating to data about the successes and failures of those doing the rating.
From how risks are being rewarded in a company to what's the real price the market is willing to pay.
In all these areas, and many more, we want investors to be better informed so their decisions are as well.
Just yesterday, for instance, my fellow commissioners and I discussed a host of rules regarding credit rating agencies.
One such rule seems pretty obvious. It said "let us know how good you credit rating agencies really are" because right now they don't provide enough data about their rating actions to let investors determine their track record.
Instead, what happens is the ratings agency rates a financial product, a company touts it when selling its securities, and investors rely on it without having any understanding of how this Rating agency's ratings have performed in the past.
Investors don't know if the rating firm is really good at rating that type of product. So, when an investor sees that a firm just issued a triple "A" rating - he or she has no idea if that triple "A" should really be a triple "B."
That's why we're requiring that ratings agencies registered with the SEC as nationally recognized, disclose their history of ratings - on a delayed basis. How often, for instance, did they change their ratings, and when did they upgrade or downgrade them?
That little bit of information could go a long way in helping an investor decide how much relative weight to give to these ratings.
Also yesterday, we proposed a rule that would highlight something called ratings shopping. For those students in the audience, I liken it to being able to choose your professor at the beginning of the school year based on who would promise to give you the best grade. Chances are you'd probably take the one who promised you an A.
Oddly, this is what has been happening in some parts of the credit rating arena - where sponsors of financial products can actually shop around for a rating before buying the one they want. And, when the company that issues the financial product tells the world that it just got a triple "A", no one knows that it was the third grade it received.
That's why we hope to shed some light on this practice by requiring companies to disclose not just the final rating from a particular rating agency, but all preliminary ratings they received from others as well.
Once again, that little bit of information could go a long way in helping an investor decide if the final rating is all it's purported to be.
But our new rule proposals stretch well beyond credit ratings.
Earlier in the year, we proposed a series of rules related to proxy materials that investors receive when they're being asked to vote for a Board of Directors.
Boards, as you know, can be made up of friends of the CEO or very cool people like rock stars and athletes. And, there may be nothing wrong with that.
But, the job of being a corporate director is a serious one, as we must all rely on the vigilance, expertise and integrity of Boards to oversee America's corporations. The reality is that today, I think, companies offer insufficient information about a Board candidate's actual qualifications for the job.
So, we are asking for better disclosure about each candidate's particular experience, qualifications, attributes or skills that qualify that person to be a board member, or to sit on a particular Board committee like a risk committee.
Once again, that additional information could go a long way for the shareholder who owns a piece of the company - and who must make decisions about who will, through Board service, oversee the management.
Likewise, investors can gain valuable insight if they can understand how a company rewards risks.
We all know that compensation drives behavior. Last year, the Counterparty Risk Management Policy Group identified compensation schemes as one of five primary driving forces of the economic turmoil.
And, earlier this year, the Financial Stability Forum composed of governments around the world issued a report agreeing with this assessment, and suggesting three principles for "sound compensation practices."
These principles call for effective governance of compensation; effective alignment of compensation with prudent risk taking; and effective supervisory oversight and engagement by stakeholders.
The Commission has proposed a package of new proxy disclosure rules that are in keeping with these principles - in particular, empowering stakeholders with the information necessary for effective engagement.
We might not be able - nor would we want - to ban risk taking, but we can expose it. And, it's again, more information that will help shareholders make good decisions.
Just yesterday as well, we took steps that would ban a trading practice called flash orders.
At its core, this too fits into the disclosure regime, because it's about letting all investors have equal access to information.
It is a little esoteric, but it is important as it goes to the integrity of the markets. Currently, I can place an order to sell some shares of my favorite company. If the exchange where my order is routed doesn't have a buyer, it routes my order to another exchange where a buyer is waiting.
But, if my exchange doesn't want to lose that transaction, it can instead decide to flash my sell order to just a select group of market participants within its fiefdom. And, for a fraction of a second those favored folks will have a quick peek and a head-start to decide if they want to execute my trade.
This puts the buyer who is publicly indicating that he is ready, willing and able to match that order at a disadvantage. That's because the select group of participants can cut in line to buy the shares, using the information that is made publicly available by this buyer, without ever having to publicly display a quote.
In addition, those favored few that get a quick peek at the order will also have a better sense of where the market is headed based on information that others won't have.
Such a practice has flourished because of a long-lasting exception to our rules that we have proposed to eliminate.
By doing so, we can prevent a two-tiered market - that is, one market for those who can access information about the best available prices. And, one market for those who cannot.
In the area of municipal securities, we're also moving to improve the information that is available to investors.
As you know, these are securities issued by governments to raise funds for a variety of projects, like building roads and schools. Even though municipal securities are subject to our anti-fraud standards, they are actually exempt from the detailed disclosure requirements of the federal securities laws.
These markets are the foundation of state and local funding initiatives, and on the other hand municipal securities are hugely popular with retail investors. And, because of that, the Commission has managed to create a disclosure regime by placing disclosure obligations not on the local government issuers, but rather on the intermediaries who buy and sell these securities for investors.
Our recent SEC proposals require disclosure concerning variable rate demand obligations and more generally about ratings downgrades, and other events in the life of a muni security. And, with those disclosures, we are very close to exhausting our statutory authority in this area.
We will work with Congress to promote a more robust disclosure and information regime for the future.
Again, it's a little bit of information for investors who just want to make an informed decision.
And finally, we're trying to open a window into the world of short selling.
Just this summer, the SEC set out to increase the public availability of short sale-related information.
As part of this initiative, the Self Regulatory Organizations are publishing the aggregate volume of short sales that occurred on a given day for a given security and they'll be publishing - on a delayed basis the raw data on individual short sale transactions as they occurred in real-time.
This too is a little bit of information that could help inform investors as they consider what stocks to buy or sell.
* * *
The Byproducts of Disclosure
In each of the cases involving corporate disclosure, you can see that we're not necessarily dictating how a firm should act.
But, I believe that when corporate disclosure is mandated, corporate actors may think twice. It's simply a byproduct of disclosure.
So … we might not be able to force the credit rating agency to make good ratings, but we should end up encouraging them to be more rigorous in how they rate and avoid conflicts of interest.
We might not be able to force investors to minimize their reliance on ratings but by disclosing ratings shopping, we may cause them to think about the true value of the rating.
We might not be able to get companies to only nominate Warren Buffets to their Boards, but we could end up encouraging them to reconsider nominating someone with little qualification.
And if that's what happens - it's not a bad thing.
Information for Regulators
Of course, it's not just the investors who need information to make good decisions. It's the regulators who need it too. And the entire regulatory reform effort is in part about just that -- gathering more information.
Many of the proposals will help regulators to answer key questions - such as:
How stable are the hedge funds that aren't even regulated right now but are an enormous presence in our markets?
What types of risks exist as a result of credit default swaps and other derivatives?
What are the systemic risks that are emerging across the entire financial spectrum?
However Congress decides to monitor systemic risk - be it through a single entity or a council of regulators - or a hybrid approach -- they'll have to understand these risks, take steps to minimize them before a crisis develops and be ready to act fast. They'll have to be able to make good decisions. And, they'll need good information to make the right ones.
In this interconnected global financial system, those decisions could have a world-wide impact.
* * *
So that's why we're all about disclosure and transparency.
And, that's why it's at the core of what we do.
For those of you here who are students, training to become that future business leader, I say this: Gather good information. Get the right information. Understand that information.
And, then no matter how complex the decision, you'll be likely to make a better one.
But, in the process, please don't forget that investors deserve good information as well.
Thank you. And good luck to you all.