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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks at Money Smart Week: A Financial Literacy and Education Summit


Lori J. Schock

Director, Office of Investor Education and Advocacy
U.S. Securities and Exchange Commission

Charleston, West Virginia
October 19, 2010

Thank you for the opportunity to speak with you today. It's a pleasure to be in Charleston, which has been home to amazing array of talent, including actress Jennifer Garner. For fans of "Alias," which Garner starred in, let me assure you that I am not a double agent here on a dangerous, clandestine operation. And before we get underway, I need to give the standard disclaimer that the views expressed here are my own, not those of the agency, by which I mean the Securities and Exchange Commission.1

I'd like to spend most of our time together talking about the financial reform bill that Congress passed this summer, and finish with a quick discussion of what the Commission is doing in addition to work required by the financial reform legislation which was signed into law by President Obama in July. And I'll leave a few minutes for questions, if there are any.

As you may know, the financial reform bill was put together under the leadership of Senate Banking Committee Chairman Chris Dodd and House Financial Services Committee Chairman Barney Frank, and in Washington shorthand, it's referred to as the "Dodd-Frank" bill. You probably also know that the bill is large — very, very large. The printed version is about as big as the Washington, D.C. phone book. The law has 16 sections, and requires regulators to issue more than 20 studies and more than 100 rules. These requirements are split among banking regulators, the SEC and the Commodity Futures Trading Commission, but the lion's share of the work will fall to the SEC. So we're going to be very, very busy complying with the requirements of the new law.

Just giving an overview of all the provisions of the new law could take us to dinnertime so I'm not even going to try. Instead, I plan focus on just three of the studies that the SEC is required to complete under the law. Two are due within six months; we have more time for the third study, which is due in two years. So what is it that we're studying and what is it that the studies will do?

The first study, which could lead eventually to Commission rulemaking, involves an issue that has been looked at repeatedly in recent years, but which remains unresolved. I'm talking about the different obligations for brokers and investment advisers and what that means for investors.

At present, brokers are regulated under one federal law, adopted in 1934, while advisers are regulated under another, adopted in 1940. Brokers must follow one set of rules, advisers another. Brokers have to seek the best possible execution of their customers' trades and if they recommend an investment for customers, that investment has to be suitable for the customer, considering things such as the customer's age, risk tolerance and financial goals. Brokers are permitted to give advice without being treated as advisers provided the advice they give is incidental to their work as brokers.

Advisers are held to a fiduciary standard, meaning everything they do for a customer has to be in the best interest of the customer. This system worked pretty well when brokers were brokers and advisers were advisers and everyone stayed within the boundaries set in 1934 and 1940. But in the last decade or so, the lines between brokers and advisers have gotten blurred, raising concerns about investor confusion and investor protection. Some critics of the current system say anyone advising clients about investments should be held to the same fiduciary standard, putting brokers and advisers on a level playing field.

The SEC has studied this issue before. A 2008 study done for the SEC by the RAND Corporation found that investors do not understand the differences between brokers and advisers and don't realize that they play by different rules. The study also found that investors were pretty happy with their financial professional, regardless of whether that professional was a broker or an adviser.

Now, Congress is asking us to revisit the matter and consider whether there are regulatory "gaps" or "shortcomings" in this system of regulation — that's their language, not mine — and if so, whether that should be addressed by new rules or laws. If the Commission decides that brokers should be subject to a fiduciary duty when they provide personalized investment advice to customers, the new law gives the Commission the authority to do so.

As we conduct the study, there are a number of things Congress wants us to take into account, including investors' access to personalized investment advice and how much they pay for it. Congress specified that we have to examine whether increased regulation might result in investors paying more for the personalized advice they get, or might lower the profits that financial professionals make on such business.

So as you can see, there's a lot of ground to cover in a very short time; on the other hand, we have the benefit of having traveled this ground before and are familiar with the issues. We are seeking public input on this and other Dodd-Frank studies and rulemakings, so if you have any interest in weighing in, you can do so online, at www.sec.gov. The SEC typically seeks public comment after it has proposed rules, but given the short deadlines and the amount of work we're facing under Dodd-Frank, we began seeking public input almost as soon as the bill became law.

The second study we're doing is also due in six months, and involves investors who want to check out their broker or adviser online. This information is available free of charge and allows investors to find out if their financial professional has any disciplinary record, for instance. We encourage investors to take advantage of this data. For brokers and brokerage firms, the information is available through BrokerCheck, which is owned and operated by FINRA, the Financial Industry Regulatory Authority, the self-regulatory organization for broker-dealers. For investment advisers and advisory firms, the information is available online through the Investment Adviser Public Disclosure system, or IAPD, which FINRA operates on behalf of the Commission. We have two separate databases, reflecting the fact that brokers and advisers are subject to different laws and are registered separately.

Of course, there are some dually registered firms that appear in both BrokerCheck and IAPD, but they are the exception rather than the rule. Most brokers, advisers and firms are either in one system or the other, but not both. At present, there is no crossover or link between the two systems, so investors have to know where to start — with BrokerCheck for brokers and brokerage firms, or with IAPD for advisers and advisory firms. And as the RAND study found, distinguishing between brokers and advisers is not second nature to investors. While the current system works fine for regulatory purposes, it may not be as user-friendly as it could be, which is why Congress has asked us to consider ways to make the systems more accessible and useful. So stay tuned on that.

A third study involves financial literacy among retail investors. This one is near and dear to my heart because the SEC's Office of Investor Education and Advocacy, which I head, has been assigned responsibility for it. It's got a lot of moving parts. Congress wants us to assess financial literacy among retail investors and subgroups of retail investors. It wants us to look for ways to improve the disclosure investors get before they hire a financial professional or buy a financial product. We've also been asked to consider ways to make expenses and conflicts of interest more transparent to investors. And, Congress wants us and to develop a strategy to raise financial literacy among investors and bring about a quote "positive change in investor behavior" unquote. This "positive change" wasn't defined in the law, but we think it should involve factors that are tangible and measurable, so that we can track them and see if we're on the right track.

Now, financial literacy surveys have been done in the past, including a national survey last year by FINRA's Investor Education Foundation. That survey focused on the financial capability of American adults, and it looked at financial attitudes and behaviors as well as literacy. Our study will have a slightly different focus and we expect it to be the first truly comprehensive, nationwide assessment of financial literacy among U.S. retail investors.

We expect to learn a lot from the study. You may recall that former Defense Secretary Donald Rumsfeld liked to talk about the "known unknowns" which are the things we know we don't know. The level of financial literacy is one of those "known unknowns," and this study should help to fill in the gaps of what we know — and what we know we don't know — about investor literacy.

You may be surprised to hear that financial literacy among investors is still largely unchartered territory. But not so surprisingly, one reason this kind of study hasn't been done in the past is the expense involved in such an effort. It's a little bit like "orphan crops" that get scant attention from agricultural researchers. One of those "orphan crops" made the news recently, when scientists announced a breakthrough in mapping the DNA of the cacao tree. Cacao, which is the source for the basic ingredient in chocolate, doesn't grow in the U.S., but the U.S. is a major chocolate consumer and one of the biggest

producers, Mars Inc., funded the DNA project. Mars makes Snickers, M&Ms, Milky Way, Dove bars, and so on, so it has a huge interest in cacao.

Cracking the DNA code of the cacao tree is a breakthrough that can help producers to modify the plant to make it more robust, increase yields, and boost its resistance to drought, disease and pests. The project took two years and Mars footed the bill, which came to $10 million.

Now, we're not going to spend $10 million to map the DNA of investors. But we expect that our two-year study will help us to make our own breakthroughs in understanding investors' financial literacy, and how to boost it to make investors more resistant to investment fraud and pests. Unlike Mars, we won't be able to use gene-sequencing machines. Our study likely will entail a mix of telephone surveys and focus groups, followed by an analysis of the findings and the development of a strategy to bring about that "positive change" in behavior. Look for all of this to be laid out in the report, which is due in July 2012. It won't be easy, but investors deserve no less and we are committed to helping them, because that's part of our DNA: at the SEC, we are the investors' advocate.

So those are just three of the items on our "to-do" list, thanks to the Dodd-Frank Act. There are many, many others involving everything from oversight of hedge fund advisers and credit rating agencies to new rules regulating the swaps market, an item that we are working on in conjunction with the CFTC.

All this work is in addition to the other business that was underway before Dodd-Frank and which hasn't gone away. I'd like to touch on just a few. In the mutual fund area, you may be aware that we recently proposed rules targeting the fees that fund investors may pay for marketing and distribution expenses, sometimes known as 12b-1 fees. The proposal would modify the existing rules that allow such fees and replace them with new limits on fees and clear disclosure. Comments on the plan are due by November 5.

Also in the mutual fund area, the comment period closed in August on proposed changes to advertising of target date funds, which are designed for investors looking to retire by a particular target date, such as 2020 or 2030. Target date funds are increasingly popular and it's easy to see the appeal — they're marketed as a way to "set it and forget it." But not all target date funds are managed the same way. In general, they typically hold more bonds than stocks as they approach the target date, but the mix of assets can be very different, depending on the fund. Funds with the same target date might be 70% invested in bonds or 70% invested in stocks. The SEC rule proposal is aimed at reducing unpleasant surprises for investors in target date funds — the idea is that investors in such funds need to know what they're buying, and can't rely on a "set it and forget it" approach.

Lastly, I'd like to switch gears and talk about what the SEC has done since the market turmoil on May 6, which the press has dubbed the "flash crash." It was a real roller coaster of a day: U.S. financial markets fell more than 5% in a matter of minutes and recovered a short while later. Soon after, the SEC allowed new circuit breakers to be put in place to try to prevent a recurrence. In June, the Commission approved a six-month experiment with circuit breakers for individual stocks whose price moves 10% or more within five minutes. If the circuit breaker is tripped, it triggers a uniform, market-wide pause in trading in that stock for at least five minutes. The experiment initially was limited to stocks in the Standard & Poor's 500 Index, but was extended in September to stocks in the Russell 1000 Index and to several hundred exchange-traded products.

These experiments supplement the market-wide circuit breakers that were in place before May 6, which are triggered by declines of 10% or more in the Dow Jones Industrial Average. That's a high threshold by design: tripping these circuit breakers halts trading market-wide for a minimum of 30 minutes, and can result in a total market shutdown for the rest of the trading day, depending on the extent of the decline and the time of day that it occurs. It's the financial market equivalent of dropping the big one — it's to be used sparingly, if at all.

The circuit breaker approach is easy to understand — you have them in your house, and we have them in our markets for much the same reason, so that when things get overheated, there's an automatic shutdown and cooling off. But you don't want to sit in the dark longer than you have to, or shut down more circuits than you need to. So the Commission is evaluating market-wide and individual stock circuit breakers, and has said there may be more modifications in the months to come.

I should point out that the Commission's focus on these issues pre-dates the events of May 6. The SEC sought comment in January on issues such as high frequency trading and "dark" pools where trading occurs in a less transparent way than on traditional exchanges. Those are just a few more of the issues on what promises to be an action-packed agenda.

I hope I've given you a little insight into what the SEC has been doing and will be doing in the months ahead. And now I'd be happy to take your questions.



Modified: 10/20/2010