Speech by SEC Chairman:
Remarks at the Stanford University Law School Directors College
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
June 20, 2010
Good evening. It's a pleasure to be here at the Stanford Director's College. As some of you may have experienced, it's difficult to say "no" to my friend and former colleague, Joe Grundfest.
Having served on boards, I know how challenging the role of director is. But I also know what an important job it is - perhaps more so today than ever. We have learned again and again over the last several years that active, informed and independent boards are often the difference between companies that successfully emerge from economic downturns, and those that are unable to do so.
Of course, I gave up my two corporate board seats when I accepted my current job, but I can sincerely say that board service is one of the things I miss most.
Fortunately, since I arrived at the SEC 17 months ago, there hasn't been much time to look back.
If you have ever done any hiking in the mountains, you're probably familiar with the feeling you get when you've struggled up the side of an impressive ridge and paused to enjoy your achievement...only to look around and discover that there is another hill ahead, another ascent to undertake.
That's how I feel nearly every day.
For the past year my colleagues at the Commission and I have been cresting a lot of ridges. Unfortunately, we haven't had much time to enjoy any one, single achievement as we would have liked, because there's always been so much more to do.
Right now, the final touches on financial reform legislation are being made, and we're about to complete a truly historic ascent. This legislation will transform the terrain upon which much of the regulation of our country's businesses and markets takes place.
While the SEC has been actively engaged in the legislative effort affecting the securities markets, we are already climbing the next hill, working to effect much-needed change outside of the legislative arena.
The experiences of the last decade have shown the importance of an effective securities markets regulator to our financial system and to our economy as a whole. I am extremely proud of the men and women who work at the SEC — agency veterans and newcomers alike — who are implementing one of the most significant investor-focused agendas in our history. This evening, I'd like to talk about three key components of that agenda.
First — we're adapting our regulatory approach to meet the challenges of the current structure of the financial markets;
Second — we're protecting the interests of investors in transparent, secure markets;
And third — we're reconciling our rules to support the evolving dialogue between corporate boards, managers, and their shareholders concerning corporate governance.
Perhaps our steepest climb is ensuring that the structure of today's financial markets works for today's investors and for companies seeking to raise capital — in short, ensuring that the markets are fair and efficient.
It's a task that we've been focused on for a great portion of my time as Chairman — and a task whose importance became even more apparent during the market disruption of May 6th. On that day, the Dow declined 573 points in five minutes — and then, moments later, recovered 543 points in just ninety seconds. For a brief period, the shares of some great American companies traded at absurdly low prices — some for as little as a penny — as prices lost all connection to intrinsic value.
We are focused on several working hypotheses and findings — such as a possible link between the sudden and severe price decline in index products on the one hand, and simultaneous and subsequent waves of selling in individual securities on the other.
We're also looking at significant imbalances between buyers and sellers that may have been exacerbated by the withdrawal of liquidity usually provided by a variety of market participants. Part of these investigations involve understanding the extent to which hedging, shorting, arbitrage, market orders, and limit orders contributed to selling pressure and liquidity mismatches.
And of course, all of the markets involved — equities, options, equity indices, and futures — are closely joined by a complex web of cross-market trading strategies, market participants, and even traders themselves. The result is that changes in prices within one market or venue often directly impact prices on another. Similar products trading in different forms, at different speeds, and under different market conventions, add further complexity and linkages.
We are already taking steps to minimize the chances of something like this happening again, however.
Within minutes of the May 6th disruptions, we were talking to exchanges and to market makers; within a couple of days we were meeting with exchanges and SROs to craft a response; and in less than two weeks we had posted for comment proposed rules that would halt trading for certain individual stocks if their price moved 10 percent in a five minute period.
Barely more than six weeks after the event, exchanges began putting in place a pilot uniform circuit breaker program for S&P 500 stocks — a program which will grow to include thousands of equities, helping to restore investor confidence and to ensure that markets can effectively carry out their critical price-discovery functions.
Advising us in this effort is a newly-formed Advisory Committee, comprised of two Nobel Prize winning economists, three former CFTC or SEC Chairmen and other distinguished experts.
The second step of our response has been to publish — this past week — proposed rules sought from the exchanges and designed to bring order and transparency to the process of breaking "clearly erroneous" trades. On May 6, nearly 20,000 trades were invalidated — but only for those stocks that traded 60% or more away from their price at 2:40 PM. That benchmark was set after the fact; we will now have consistent rules in place before any future disruption occurs.
But our interest in market structure reform began long before May 6th. Our US equity market structure is highly fragmented. There are ten exchanges, approximately 37 alternative trading systems — including dark pools — Electronic Communications Networks, and more than 200 broker-dealers that execute orders internally. Today, the New York Stock Exchange only trades about 25% of the shares of NYSE listed stocks.
These trading venues are accessed electronically through highly automated trading systems, many of which can respond to orders with executions in less than one millisecond. This speed has spawned the development of high frequency traders who account for 50% or more of daily trading volume and can enter thousands of orders per second. To further complicate matters, some trading venues, such as dark pools, do not make their orders accessible to the public.
The advent of high frequency trading, in combination with our fragmented market structure, present enormous challenges to investors and to regulators alike. Our efforts to address comprehensively our concerns about fairness and accessibility of our markets, led us to issue a release seeking broad input on the impact of different trading venues, strategies and tools — including high-frequency trading — on markets, capital formation and investors.
This concept release led to a roundtable earlier this month where academics and industry experts discussed stock price performance and volatility, the growth of high-frequency trading, and issues around undisplayed liquidity.
We also proposed two rules that will provide us with much faster and more complete information about trading activity, by requiring registration of large traders and creating a consolidated audit trail. If adopted, these rules will allow us to better reconstruct market activity, analyze data and investigate unusual or potentially abusive or illegal trading activity.
We appreciate the technological 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. And, that process is well underway.
A second focus is better safeguarding the interests of investors, both large and small. Not surprisingly, we believe that a cornerstone of that protection is ensuring that investors get the timely and accurate information they need to analyze a company's operating results, financial position and risk, and thus make informed investment decisions.
An important part of that is our commitment to a single set of high-quality, globally-accepted accounting standards — standards which will benefit U.S. investors and all others who make capital allocation decisions. We continue to encourage the convergence of U.S. GAAP and International Financial Reporting Standards, or "IFRS" and expect that their differences will become fewer and narrower, over time.
Bringing the two systems together has proven a challenging process. But we believe that it's important to provide for adequate due process and commentary on new standards, in order to ensure the informational value, integrity and political independence of the final outcome. And, while we are committed to global standards, a key priority is and must be protecting investors in American markets. We are executing a comprehensive work plan, dedicating significant resources to it and providing periodic progress reports. And we believe that the accounting scandals and financial crisis of the last decade underscore the importance of quality global accounting standards.
The importance of accurate information has always been the impulse behind one of the SEC's original, core functions: collecting and making publicly available financial and other relevant information from public companies. Our staff seeks to enhance the quality of that information by asking companies questions about their disclosures and asking them to make changes where it appears that the disclosures may not be accurate or as complete as they should be. Although this is one of the original functions that the SEC has been performing for 76 years, we believe we can still do it better.
So we are reevaluating all of our corporate filing forms and disclosure requirements, asking ourselves whether the information that is being sought is still relevant, or whether another type of information or a different form of presentation would be more meaningful to investors and to the markets.
This is a major undertaking and, given the demands that financial regulatory reform legislation will likely impose on our rulemaking agenda, it may be a while before a proposal is presented to the Commission. Our staff is already reviewing existing disclosure requirements that have not been updated recently, however; reviewing recommendations made by previous advisory committees such as CIFiR, by academics and by other experts; and asking individuals who prepare and review disclosures day-in and day-out what rule-changes they think would elicit better information.
After this review, I expect the staff will present individual recommendations that we can act on quickly — such as revising the risk disclosure requirements. They will also present more sweeping recommendations that will take more time — such as possibly changing filing formats so that basic information can be more easily digested by investors and updated by companies.
And one key task will be tackling the problem of needless repetition in company filings. If you have suggestions for improving our disclosure requirements, we would love to hear from you.
Just as technology is changing the way we understand and regulate trading mechanics, it's also changing the way investors and companies interact. At the SEC, we see these changes as offering an opportunity to enhance the dialogue between boards and investors, strengthening best practices in corporate governance.
Let me be clear: the SEC's job is not to define for the market what constitutes "good" or "bad" governance, in a one-size-fits-all approach. Rather, the Commission's job is to ensure that our rules support effective communication and accountability among the triad of governance participants: shareholders, as the owners of the company; directors, whom the owners elect to oversee management; and executives, who manage the company day-to-day.
But meaningful communication 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.
Applying these principles to our proxy disclosure rules, the SEC isn't going to decide for you 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, investors 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. As you probably know, the Commission recently revised its rules to require enhanced disclosure in each of these areas. Before coming here tonight, I asked our staff to give me a sampling of how these amended rules are being implemented.
First, the new rules require more than the bare outline of a board candidate's qualifications, they also require the "specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director
in light of the [company's] business and structure."
I particularly like descriptions like this one, drawn from an actual proxy filing but shortened and changed just a bit, in case the director in question is here today:
"Ms. Gray — of course, not her real name — says the filing — has spent her career in consumer businesses and brings key financial and operations experience to the Company….[she] possesses broad expertise in strategic planning, branding and marketing, business development, retail goods and sales and distribution on a global scale. Ms. Gray's positions as chief financial officer and her service on the audit committees of other companies…also impart significant expertise to the Board…Through her most recent experience… including with on-line selling, Ms. Gray provides the Company with valuable insight and guidance."
Descriptions like this not only reveal the depth of the candidate's experience, they explain why those particular attributes are particularly important to that particular board.
Contrast that with another example — again, changed slightly from the original filing. In this one, each candidate presents only the bare-bones biography that has been required for decades. Then, the filing merely adds a sentence at the end of the section that essentially says: "our directors each have integrity, sound business judgment and honesty, which are important characteristics of a good board member."
We have seen the same divergence of approaches when it comes to disclosure of risk. I believe investors are informed and reassured by a proxy statement that begins with — as one recently did — a thorough discussion of the risk-related responsibilities of the board and its various committees. It then adds a detailed narrative that touches on the company's reporting to the Board and its committees about credit and liquidity risks, risk-focused auditing strategies, and the impact on risk of compensation policies.
Contrast this with a risk oversight disclosure statement that reads: "The board has risk oversight responsibility for Company X and administers this responsibility both directly and with assistance from its committees." Period. Investors might find this type of statement informative — but perhaps not quite in the way that the company intended.
Let me also touch upon another project that some of you may have heard about. Externally, it's called our "voting infrastructure" project. Internally, we refer to is as "proxy plumbing." Specifically, the Commission will soon consider publishing a concept release soliciting detailed ideas about how to modernize the voting infrastructure through which, I am told, over 600 billion shares are voted every year at more than 10,000 public company shareholder meetings.
For example, we'd like to know if proxy advisory firms should be subject to greater Commission oversight and if so, what should that oversight look like?
Proxy advisers play an increasingly important role, particularly with regard to investors who may not have the specialized expertise to weigh in on particular questions. Should there be checks on the accuracy of the information provided by proxy advisers?
Are advisers who provide services to both corporations and investors managing and disclosing the resulting conflicts of interest appropriately? Are SROs appropriately overseeing proxy distribution fees? And, in an area very near to my heart, how can we increase voter participation by retail investors?
These are only a sampling of the questions that we cannot answer alone. Just as the back-and-forth between boards and shareholders yields better decisions, the back-and-forth between regulators and stakeholders improves the process, as well. I hope that you and your companies actively participate in this concept release, because we really do need to hear from you.
When I returned to the SEC early last year, I knew that we would be faced with some steep hills to climb. I also know that whenever we crest a hill, there's going to be another in the distance; there's no finite peak that will represent that last of our challenges.
But the higher we go, the more I understand that the goal isn't this particular regulation or that particular procedure. Rather, it's a financial marketplace where confident investors contribute capital to dynamic companies in a growing economy. I also understand that this isn't a journey we at the SEC are making alone. We are informed at every step by the contributions of your companies to the regulatory dialogue. And if our paths at times diverge, we are ultimately both travelling in the same direction, towards a capital market that will have the support of confident investors.