Speech by SEC Chairman:
Remarks at CEO Quarterly Meeting of The Business Roundtable
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
June 8, 2010
Good morning, it is a pleasure to be here today, among leaders of so many dynamic American companies. I am here today because I think that it's vital that the SEC maintain an open dialogue with you—so that you appreciate the actions we are taking and, more importantly, why.
While we will surely have different views on many issues at any given time, I believe we share a vision of an America in which businesses and individuals have the resources, infrastructure and incentives they need to prosper through hard work, fair competition and bold ideas.
And, I believe that a dialogue between government and private business helps us strike an appropriate balance between necessary regulation and unrestricted enterprise, a balance that helps us move towards a vision of opportunity and growth.
So with that in mind, I wanted to provide some insight about our efforts at the SEC to protect the investors on whose capital you rely to fuel that growth, and to ensure that the markets through which it flows are stable and fair. Of course, I also want to hear about what you are seeing in the market that can inform the way we operate as a regulator.
I don't have to tell you how devastating the financial crisis of the past two years has been. President Obama talks about the "lost decade," in which average workers spent ten years treading water financially. But, as you know, Corporate America is halfway to its own Lost Decade. In real terms, after-tax profits in 2009 were below those of 2004, the worst such slump in many years.
Although we are seeing signs of an economic recovery, it's critical that we take steps to prevent another crisis of this depth and duration. One of the most important things that the SEC can do to help the economy towards sustainable growth, is to be the most effective market regulator, protecting investors while also encouraging capital formation and investment.
We know that the SEC's efforts are only part of a larger effort to rebuild our national economy. And our effort is, in turn, made up of many smaller initiatives, whose worth is not always immediately obvious. Assembled, and seen from a distance, however, they become important tiles in a larger mosaic: a portrait of a financial marketplace where confident investors provide businesses the capital they need to grow and to create jobs.
Whatever the final portrait, not everyone will find it ideal. No craftsman is perfect, no critic ever wholly satisfied.
But I believe that the American economy, driven by private sector expansion, will fully recover its strength and dynamism. And that when we get to that point, we will look back on this moment as a productive period of effective regulation. We will see that these efforts helped build a solid framework needed for steady growth and broad prosperity.
Re-energizing the SEC
Sixteen months ago, when I arrived in the wake of the financial collapse, it was clear that the SEC could do better. So, the first step in making our mosaic was preparing the surface: re-energizing the SEC, and giving it a 21st Century outlook and infrastructure upon which we could fulfill our regulatory mission.
We started at the top, bringing in new directors known for their energy and creativity to run the agency's four largest operating units and to take over other key positions. As a group, they've refocused their teams on practical results—on stabilizing markets and protecting investors—rather than on process. They have launched significant re-organizations to build more effective structures.
With their help, we're building a culture of collaboration in the agency-of sharing information and ideas across office boundaries and over institutional barriers. We've established a number of cross-functional teams to focus on specific issues and projects.
Effective oversight of our markets isn't a series of discrete tasks; it's a continuum of responsibilities, so it's vital that the people at every step of the process be in touch with one another.
We created the Division of Risk, Strategy and Financial Innovation, which is dedicated to keeping up with innovation in the financial markets. Risk Fin, as we call it, will help us to understand the systemic and individual risks involved in new investment products and strategies—and to do so before these new products and practices cause harm to our markets.
We're also lifting the level of our staff's expertise, hiring experts with extraordinary industry and academic credentials, creating specialized units to monitor and track complex firms, products and behaviors, and making sure that employees throughout the agency receive timely and relevant training.
It's a better structure, and a better attitude, and it's already paying off in a lot of ways.
The greatest number of tiles in our mosaic comes from our efforts to determine appropriate ways to adjust the structure of our securities markets in the face of significant changes over the last few years.
These changes were brought into sharp focus by the market disruption of May 6th—an event which led to trades based on flawed price discovery signals. During the course of an extensive and ongoing review, we are focused on the extent that this sudden volatility likely was exacerbated by disparate trading rules and conventions across the various exchanges, coupled with the sudden withdrawal of liquidity by market participants.
So, we worked quickly to help develop a uniform set of circuit breakers that will apply across trading venues. These circuit breakers will suspend trading in certain individual stocks if their price moves 10 percent or more in a five-minute period. While initially applying to S&P 500 stocks, it is my hope to rapidly expand the program to thousands of additional publicly traded companies.
Additionally, we are continuing to look at the use of certain types of orders, such as market orders and automated stop-loss orders, the obligations—or lack thereof—of market makers to maintain fair and orderly markets and, the currently flawed process of breaking erroneous trades.
But our interest in market structure reform began long before May 6th. In January, the SEC issued a Market Structure Concept Release through which we solicited public comments on the impact of different trading venues, strategies and tools— including high-frequency trading—on our markets, capital formation and investors.
These comments helped shape a Market Structure Roundtable we held last week. At the roundtable, three separate panels brought together experts and experienced industry hands to discuss:
Equity price performance and volatility, including how well current structures establish prices and bring efficiency to the markets, both in normal and in stressed trading condition;
The growth of high-frequency trading, its effects on liquidity and spreads and its impact on various categories of market participants; and
Issues around undisplayed liquidity, including access, and limitations on access, to different types of dark pools.
By bringing together a variety of viewpoints on critical issues, the Concept Release and Roundtable are helping us shape measured and effective responses to developments that may affect the ability of capital markets to function efficiently for the businesses which rely on them.
Even earlier, the Commission had launched a series of initiatives designed to strengthen the U.S. securities markets and to protect investors. We proposed rules that would prohibit flash orders, increase the transparency of dark pools of liquidity, and prohibit broker-dealers from providing unfiltered access to exchanges by their customers.
We also proposed two rules that will provide us with much faster and more complete information about trading activity. These will allow us to better reconstruct market activity, analyze data and investigate unusual or potentially abusive or illegal trading activity.
We applaud the technology and changes that make markets more efficient, reduce costs, and increase liquidity. But when these changes have the potential to destabilize markets without significantly contributing to key market functions, we believe they deserve a second look. I would ask of you—the companies for whom the markets perform a vital capital formation function- to please weigh in on these issues. We care deeply about how the markets are working for you.
As we look again at our mosaic, one tile would be clear glass rather than brightly colored. This tile, which represents transparency, allows investors to judge risk against potential return. It fosters effective price discovery, and allows regulators to better spot large systemic risks as well as individual frauds and schemes.
I am pleased that the Financial Reform Bill will likely bring a measure of much needed daylight to the over-the-counter-derivatives market. We understand the concerns of the BRT's membership, that the legislation will restrict your ability to hedge effectively. Our interest is ensuring that the bill does not, in accommodating your needs, create a loophole large enough for others to avoid needed regulation.
In furtherance of transparency, we've proposed rules that would revise the disclosure and reporting process in the asset-backed securities market, giving investors more detailed and current information about these securities, as well as more time to make their investment decisions. Under the proposal, ABS issuers would be required to provide detailed data for each loan in the asset pool, both at the time of securitization and on an ongoing basis.
ABS issuers would also be required to file on the SEC website, a computer program that allows investors to analyze information about specific loans within the pool of assets. This computer program would show the effect of the so-called "waterfall." This way, investors will be able to see how the borrowers' loan payments are distributed to investors in the ABS, how losses or non- payment will be divided, and when administrative expenses, such as loan servicing fees, are paid to service providers.
Good information is the basis for rational investment decisions. Ensuring that it is available to all investors, rather than a handful of traders or rating agencies, is fundamental to creating a more stable and fair market. And, I call upon you as business leaders to ensure your industries are doing all they can to provide investors with the information they need.
Some of the tiles for our mosaic involve a topic of key concern to you: corporate governance. I know that, at times, what constitutes "good" or "bad" governance can be a contentious issue, as can the issue of how—or whether—governance should be regulated. So let me share with you my thoughts.
The Commission's approach to corporate governance is not to mandate outcomes. We don't believe that there is a single structure that ensures accountability in all circumstances. We believe that it is the role of market participants to determine what represents "good" governance, either in terms of best practices or as applied on a company-by-company basis. It is the role of the SEC, as the federal government's primary institution charged with looking out for investors, to ensure that our disclosure rules support these determinations by requiring clear communication with investors about how the company is governed.
I agree with the BRT's Principles of Corporate Governance, which says: "[I]t is the responsibility of the corporation to engage with long-term shareholders in a meaningful way on issues and concerns that are of widespread interest to long-term shareholders, with appropriate involvement from the board of directors and management."
But meaningful engagement means the spectrum of viewpoints is represented, and all of the company's owners have access to the information they need to persuade or to be persuaded.
The SEC's recent rule changes do not dictate whether your company's governance structure should include an independent chair, a non-independent but non-executive chair, or a combined CEO/chair. We do believe, however, that the company's investors should know why a particular board structure has been selected.
Similarly, they should have detailed information about directors' and nominees' qualifications; about compensation consultants' fees and conflicts; and about the relationship between a company's overall compensation policies and its risk profile.
I know you are also interested in one of the tiles that we call proxy access. Unfortunately, I can speak only generally about the proposal, since we are still studying public comment. But I can confirm that I am committed to bringing a proposal back to the Commission to consider final adoption, within a timeframe that would put the rules into effect for the 2011 proxy season.
I recognize that—like some of the market structures that I've just mentioned—the mechanics of the proxy process have not kept pace with current market conditions or trading practices. For this reason, the Commission will soon consider publishing a Concept Release soliciting detailed ideas about how to modernize this voting infrastructure.
We would like to hear about everything from whether the system of OBO/NOBO ownership should be changed, to whether proxy advisory firms should be subject to greater oversight (and if so, what that oversight should look like).
I know that you and your companies will have important insights on these issues, and I look forward to your participation in this review.
A final tile for our mosaic is better safeguarding investors from frauds, an effort that is taking place on a number of levels across the SEC. For example, we have improved the training of our examiners, brought in outside experts to help sharpen our risk-based targeting strategies, reorganized our Enforcement Division and are revamping our system of gathering and analyzing the hundreds of thousands tips and complaints that we receive each year.
Right now, our resources only allow us to examine less than 10 percent of all registered investment advisers each year. So, in addition to doing a better job of determining which advisers to examine, we also adopted new rules that broaden our reach by bringing in third-party auditors for annual surprise examinations of advisers with custody of their clients' assets.
But investors—and often, companies—are affected by practices other than fraud and manipulation. That is why we took a long, hard look at short selling—including potentially abusive or manipulative short selling—that could be used as a tool to drive down a stock's price or could put retail investors at a disadvantage. This year we instituted a circuit breaker rule that will trigger a restriction on the price at which a security can be sold short, if a stock drops 10 percent or more during the day.
At that point, short selling is only allowed at a price above the current national best bid. In addition, we have significantly restricted "naked" short selling by requiring that failures to deliver resulting from short sales be closed out by no later than the beginning of trading on the day after the fail occurs. This rule has been instrumental in a broader effort that has reduced equities fails by two-thirds.
We are eager to lift the confidence of investors, in the fairness of our markets. A third of all the equities held in the United States are held by households—which equate to millions of investors. Protecting their interests is critical to both their economic security, and to our nation's economic health. It won't benefit anyone if nervous households end up taking the trillions of dollars they've invested in corporate securities out of the capital markets.
The SEC's efforts are, and will always be, a work in progress. We will continually refocus our energies as circumstances warrant, as new ideas are offered and considered, as we consider your opinions and suggestions. But the outlines are emerging, the colors are being filled in, and I am hopeful that a portrait of a financial marketplace more stable and efficient than the one we saw in 2008 is beginning to emerge. As business leaders, you can help to make that portrait come to life.
I look forward to working with you as we continue our work to protect and encourage the investors who fund our economic growth.
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