Speech by SEC Chairman:
Remarks at the National Conference of the Society of Corporate Secretaries and Governance Professionals
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
July 9, 2010
Good morning. It's a pleasure to be in Chicago, surrounded by people dedicated to excellence in corporate governance and committed to the principles of responsibility and transparency.
The Society has long been a force for positive change. In fact, your members have played an important role in ensuring that attitudes and practices change as the business and economic environments evolve—a role that may be as important today as it has been at any point in your history.
Your importance within the corporate structure speaks to my reason for coming today. I'm here to talk about change—to remind you why we need it, to tell you how the SEC has embraced it, and to ask for your input as we embark upon new changes going forward.
The events of the last two years have transformed our world. Your companies, the SEC, the markets and our nation, all changed in significant ways, and on short notice, as each of us strove to react to the most significant economic crisis of our lifetimes.
Like the economic earthquake it was, the financial crisis did tremendous immediate damage and then generated aftershocks that are still being felt. Even as the after-effects continue, it's important to reflect on the events of the recent past.
So let's pause for a moment, and think back to the summer of 2008.
That July, against the backdrop of the growing subprime crisis, the federal government seized control of what was then the second-largest bank to fail in United States history. Unemployment was only 5.5 percent, but oil prices were surging towards a new high of $147 a barrel and the Dow was plunging, down 20 percent year-over-year and headed much lower.
Everyone knew the situation was precarious, but very few seemed to understand the seismic shift that was already underway. Merrill Lynch was still independent, AIG was still solvent, and Lehman Brothers was still trading.
We were only seeing the tip of the iceberg, however. In the coming months, the Reserve Primary Money Market Fund would break the buck. Wachovia and WaMu's banking operations would be sold off. The SEC would issue a series of emergency orders prohibiting short-selling of securities of financial institutions. And the financial sector would deliver the biggest bankruptcies and bailouts in American history.
The only rational response to events of this magnitude is a clear-headed examination of root causes and a willingness to make significant changes in the way we understand and address the complexities of the financial markets. And so, like your companies, the markets, and our country, the SEC began to change as well. Since I returned, nearly 18 months ago, we have refocused on our core mission while bringing new tools and a more comprehensive approach to our effort. Looking ahead, the next 18 months will likely bring further, rapid change if, as expected, financial reform legislation passes and we embrace the responsibilities it assigns us.
I know that our work at the Commission is very important to the work you do, and that your jobs require that you anticipate and react to the positions we take. So, I'd like to share with you some of the changes already in place, let you know what we see immediately ahead, and bring you into a discussion about how the SEC should operate in an environment dramatically different from the one we inhabited just two years ago.
Meeting Change with Change
At the SEC, our goal is to become a more nimble and informed regulator, strengthening investor confidence and keeping capital markets stable with a comprehensive strategy that includes modernizing the agency's structure and approach; a broad, investor-focused regulatory agenda; and, potentially, new mandates and resources contained in the financial reform bill.
When I returned to the SEC a year ago January, my first priority was to create a new structure and culture. After all, it is critical for the SEC to be as dynamic as the changing markets which we regulate. So we brought in new senior leadership across the board. We are breaking down the silos that inhibit communication and effective oversight of dynamic markets. .
We are investing both in much-needed IT upgrades and in human capital. We hired academics and industry professionals who are bringing unique perspectives and insights to the agency. We created a new Division of Risk, Strategy, and Financial Innovation to identify new trends and emerging risks in the financial markets. And we're investing in training, working to keep our staff current as the markets become faster and more sophisticated.
Improving the performance of our Enforcement Division became a top priority. Enforcement has just finished a top-to-bottom reorganization that put talented staff back on the front lines and created new specialized units to deal with areas demanding particularly sophisticated approaches. One such unit, the Structured and New Products Unit, focuses on financial innovations and related abuses.
Another new unit—which may be of particular interest—focuses on enforcement of the Foreign Corrupt Practices Act. Corrupt business practices hurt companies, developing markets and ultimately investors. Companies and executives that adhere to anti-bribery laws should not be outmaneuvered by those seeking unfair advantage through bribery and deceit. Just two days ago, the Department of Justice and the SEC reached a $365 million settlement with Italian and Dutch companies which together funneled more than $180 million in bribes to Nigerian government officials.
The SEC and Justice Department are sending a clear message that those who engage in corrupt activities face a strong and united front around the world.
In addition, the Enforcement Division created the Office of Market Intelligence that will use a new electronic management system to coordinate and respond to the multitude of tips and complaints that we receive each year.
At the same time we were reorganizing internally, we set out on an ambitious rulemaking agenda. The SEC has a three-pronged mission: protecting investors; maintaining fair, orderly and efficient markets; and facilitating capital formation. Obviously, each of these mandates is intertwined with the others—investors are better protected when markets are fair and orderly; markets are more orderly and efficient when investors have access to honest brokers and accurate information; and capital formation is more efficient when markets are functioning smoothly and investors are confident.
But if there were to be a conflict between, for example, investor protection and efficient markets, the debate would be settled by asking the question I have posted on the door to my office: "How does it help investors?" And so, investors are the focus of our agenda.
One of the fundamental requirements for rational investing and efficient capital formation is the availability of high quality information. One of our core functions is collecting and making publicly available financial and other relevant information from public companies. Although this is one of the 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.
Already, our staff is reviewing existing disclosure requirements that have not been updated recently. They are reviewing recommendations made by previous advisory committees such as CIFiR, by academics and by other experts. And they are asking individuals who 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 also will likely 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.
In this disclosure vein, we also have adopted rules to create a stronger and more robust regulatory regime around credit rating agencies, to foster competition and address conflicts of interest. We proposed an entirely new regulatory regime for asset backed securities whose foundation is comprehensive and accessible disclosure for each asset. And, we have enhanced disclosure in the municipal securities markets and with regard to the holdings of money market funds.
Level Playing Field
These are all important measures because accurate and unbiased information is a vital tool for investors of all sizes. But its value is limited if the markets themselves are biased in favor of a small group of elite participants.
Today, the U.S. equity market structure is highly fragmented, with ten exchanges, approximately 37 alternative trading systems, Electronic Communications Networks, and more than 200 broker-dealers that execute orders internally. These trading venues are accessed electronically, through highly automated trading systems, many of which can respond to orders with executions in less than a millisecond. To further complicate matters, some trading venues, such as dark pools, do not make their orders accessible to the public.
This complexity presents both logistical and fairness challenges.
The world got a glimpse of how complicated the markets are on May 6, when the Dow dropped 573 points in five minutes—and then, moments later, recovered 543 points in just 90 seconds. For a brief period, the shares of some great 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 to explain this extraordinary volatility—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 potentially significant imbalances between buyers and sellers that may have been exacerbated by the withdrawal of liquidity usually provided by a variety of market participants. These investigations involve understanding the extent to which hedging, shorting, arbitrage, market orders, and stop-loss orders contributed to selling pressure and liquidity mismatches.
Though our investigation continues, we are already taking steps to minimize the chances of something like this happening again.
Within minutes of the May 6 disruptions, we were talking to exchanges and to market makers; within days we were meeting with exchanges and SROs to craft a response; and not long after, exchanges were putting in place a pilot uniform circuit breaker program for S&P 500 stocks that halts trading if their prices move 10 percent in a five-minute period.
As has been noted in the press, three stocks have tripped their circuit-breakers in the past few weeks. In each case circuit-breakers functioned as expected—trading was paused to prevent a cascade of further erroneous executions, market participants had time to react in an orderly fashion, and normal trading resumed at the end of the pause.
And work is underway to expand the program. Last week we published for public comment a proposal to further expand the uniform circuit breaker program to include all stocks in the Russell 1000 Index and many exchange traded funds.
We also published for comment last month proposed rule amendments drafted by 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 percent or more away from their price at 2:40 p.m. That 60 percent benchmark was set after the fact, causing uncertainty and concern on the part of market participants. If adopted, the proposed amendments would address that uncertainty by ensuring that more transparent rules are in place before any future disruption occurs.
But we remain concerned about our markets' fairness, as well as their functioning. So we are continuing to examine the effects of relatively new trading venues, strategies and tools—including high-frequency trading and issues around undisplayed liquidity—on markets, capital formation and investors.
And we've proposed rules that would prohibit flash orders, increase the transparency of dark pools of liquidity, and bar broker-dealers from providing unfiltered access to exchanges by their customers.
We are working to ensure that accelerating technology and evolving trading strategies are not creating a two-tiered marketplace that leaves many investors at a significant disadvantage. And we are committed to supporting exchanges that improve capital access for the companies who trade there.
Effective Corporate Governance
Finally, we believe investors' interests are served when they can participate productively in the governance of the companies they own.
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.
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. Rules requiring greater disclosure resulted—with some exceptions—in filings that were significantly more informative this year. They gave investors not only greater insight into the qualifications of board candidates, but a better understanding of how candidates' skills and experience suit the needs of their companies.
Disclosure of risk oversight has improved as well, with a number of companies offering detailed disclosures of their boards' and executives risk-related responsibilities and functions.
As you may know, the SEC is also on the verge of another important proxy initiative. Externally, it's called our "voting infrastructure" project. Internally, we refer to it as "proxy plumbing." Next week, the Commission will 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 13,000 shareholder meetings.
It has been many years since we conducted a broad review of the proxy voting system. And we are well aware of corporate and investor interest in promoting greater efficiency and transparency in the system. We are also aware of the opportunity our review presents to enhance the accuracy and integrity of the shareholder vote.
The SEC's Deputy Chief of Staff, Kayla Gillan, will be discussing this issue in depth in a panel later this morning, but we will be looking at ways to improve the voting process; we will be looking at communications and shareholder participation; and we will be looking at the role of proxy advisors, among other subjects.
Good information, fair markets, effective governance and strong inspection and enforcement—the scope of our efforts is broad. But, at the bottom of each area of oversight, and the base of the pyramid upon which our financial markets rest, are the investors who must remain the SEC's top priority.
So, what is the future?
Accountability Going Forward
I am committed to finalizing the many rules that the Commission has proposed over the past 18 months—and to continuing to strengthen our agency's operations across all divisions and offices. During the next 18 months, though, much of our focus could be implementing the important legislation pending before the Senate. That is because the Dodd-Frank Wall Street Reform and Consumer Protection Act would significantly expand the Commission's authority in many key areas, close regulatory gaps, and give us important tools that we need to better protect investors.
First—to highlight just a few—passage of the legislation would bring essential oversight to the over-the-counter derivatives market. Working with the CFTC, we would be writing rules that address, among other issues, capital and margin requirements; mandatory clearing; the operation of execution facilities and data repositories; and reporting and recordkeeping obligations.
Second, the bill calls on the SEC to study the effectiveness of existing standards of care for broker-dealers and investment advisers. We would be seeking public input and identifying legal and regulatory gaps, shortcomings or overlaps in these standards. The legislation also gives the SEC authority to promulgate rules that would impose a harmonized fiduciary standard on broker-dealers and investment advisers who provide personalized investment advice to retail or other customers. I have long advocated such a uniform fiduciary standard and I am pleased the legislation would provide us with the rulemaking authority necessary to implement it.
Third, the legislation would require many advisers to hedge funds and other private funds to register with the SEC. We would be adopting rules governing recordkeeping and reporting, and following these up with a newly-designed examination program.
Fourth, the legislation contains many provisions that would strengthen the ability of our enforcement program to protect investors, including the authority to issue subpoenas on a nationwide basis in civil actions and clarifying an important component of our "aiding and abetting" authority.
Finally, among other things, the bill would require us to adopt many rules enhancing corporate disclosures, particularly with respect to executive compensation. These are areas that we recognize are quite complex, and we expect to be well-served by public comments, so I hope you will be generous in offering your insights.
We are prepared for the broad scope and intense pace of the studies and rulemakings charged to the Commission—and ready to manage these processes diligently. But you, too, should fulfill your role in the process—providing input and suggesting improvements to the rules we propose.
I know that during these discussions and debates, we won't always agree. But we will always listen
and our decisions will ultimately be better with your input.
Two years ago this month we were looking at an economic disruption that still felt as though it could be ridden out like a normal recession, or addressed with modest change around the edges.
The months since then have shown us that this was not the case—that our thinking must change as dramatically as circumstances have changed, and that new thinking must drive actions that are as momentous and comprehensive as the situation they address.
We now recognize that our financial system, that runs at the speed of light and networks the entire globe, is fundamentally different from the system we regulated not too many years ago. And so we are moving to shape a comprehensive response; to re-commit ourselves to protect investors in more effective ways; and to answer these imperatives quickly, in concert with other agencies, and in consultation with committed leaders of the private sector.
That process is well underway, and we're not slowing down. Our goal is to be as nimble and efficient, as comprehensive and effective as the financial markets which we are charged with regulating. Investors, the markets in which they trade, and the companies who turn to them for capital, deserve nothing less.