Speech by SEC Commissioner:
Remarks at The SEC Speaks in 2011
Commissioner Troy A. Paredes
U.S. Securities and Exchange Commission
February 4, 2011
The snow kept me from attending last year’s SEC Speaks, so I am especially pleased to join you this afternoon at “The SEC Speaks in 2011.” As you know, the Commission has been exceptionally busy, with every division and office dedicating itself to a range of challenging matters. Front and center, of course, has been the agency’s commitment to fulfilling our extensive rulemaking responsibilities under the Dodd-Frank Act. How the Commission exercises our discretion in fashioning the regulatory regime will shape the legislation’s practical contours and Dodd-Frank’s ultimate impact. Accordingly, I want to thank the Commission staff for their hard work and dedication during this highly demanding and important time in the SEC’s history. I greatly appreciate your tremendous effort and professionalism.
Before I say more, I must tell you that the views I express here today are my own and do not necessarily reflect those of the Securities and Exchange Commission or my fellow Commissioners.
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Perhaps the best-known quotation in the field of securities regulation comes from William O. Douglas. On September 21, 1937, it was announced that Douglas would succeed James Landis as Chairman of the SEC, making Douglas the third Chairman in the agency’s then-short history — a position he held before going on to become a Supreme Court Justice. In his first press conference upon being named Chairman, Douglas pronounced his view of the SEC’s purpose. He declared, “We are the investor’s advocate.”
Given the rapid pace of activity at the Commission and the significance of the rulemakings on the SEC’s agenda, now is a good time to step back from Chairman Douglas’s vision for the agency to raise a question that his words beg but do not answer. The question is this: What exactly do investors want the Commission, as their advocate, to be advocating for?
A great deal could be said in response; for to ask “What do investors want?” is to interrogate the intellectual basis that grounds the federal securities laws. Unfortunately, I do not have time today to take up this task in great detail. Still, I would like to introduce some general thoughts in the brief time I do have, leaving more to be said for another day.
My thoughts start with this: Investor protection is not limited to shielding investors from fraud and manipulation or other abusive behavior. Without question, investors stand to benefit from a regulatory regime that empowers them with information and takes other steps to mitigate the risk that investors will be abused. Indeed, for our capital markets to function properly, investors need to be confident that they are adequately informed about their investments, and they need to be secure that their investments will be protected from others’ wrongdoing.
A conception of investor protection that stops there, however, is incomplete. Even as investors frequently — although not always — welcome more disclosure, and even as investors may encourage the Commission to regulate abuses and root out malfeasance, investor protection is about advancing a considerably broader set of investor interests.
Consider capital formation. Promoting capital formation is one of the SEC’s fundamental purposes. An overarching objective engrained into and animating the federal securities laws is to encourage investment so that businesses can raise the capital they need to drive economic growth.
In policy discussions about particular regulatory initiatives, it seems as if the goal of capital formation is often pitted against the goal of investor protection — as if to take a regulatory step to ensure that the regulatory regime is sufficiently flexible to promote capital formation is somehow to compromise investor protection. I see it differently: To me, capital formation itself advances core investor goals.
Investors primarily invest so that they can earn income and accumulate gains. This means that investors need opportunities to invest. More to the point, it means that investors are better served when they are offered more investment choices. This is made abundantly clear when one stops to recognize that investors are themselves so diverse: there are retail investors who have invested for many years and those who have just started to invest; high net worth individuals and those of more modest means; investors who are conservative and those who are willing to take more risk; hedge funds, private equity funds, and venture capital funds; mutual funds and pension funds; buy-and-hold investors and active traders.
In ways that are straightforward to see, small and large businesses alike benefit when enterprises can more efficiently raise the funds they need to finance their current operations and their anticipated growth. However, the other side of the capital formation coin — where we find investors — can get overlooked. If the regulatory regime stifles capital formation by making it more difficult and more costly for businesses to raise funds, investors enjoy fewer investment options and firms investors do invest in may be disadvantaged by a higher cost of capital or, in more extreme circumstances, an inability to raise needed funds. Furthermore, to the extent the flow of capital is hindered, investors may earn lower returns or suffer losses because overall economic growth is not what it could be.
There is thus a coincidence of interests between issuers and investors: Issuers demand capital while investors look to provide it. When companies are frustrated in attempting to raise capital, the risk is that investors end up with an inferior mix of choices for putting their money to work. In other words, capital formation is part and parcel of a more expansive conception of investor protection that credits the full range of investor interests, including investors’ desire to commit their financial resources to productive opportunities.
A recent experience is illustrative. Until Dodd-Frank rescinded the rule last year, Securities Act Rule 436(g) had exempted credit rating agencies from so-called “expert liability” under Section 11 of the ’33 Act. Dodd-Frank’s rescission of Rule 436(g) had two effects. First, rating agencies would be subjected to Section 11 liability. Second, if Regulation AB required an ABS issuer to include a public offering’s rating in the registration statement, the rating agency would have to consent to being named as an “expert.”
Credit rating agencies responded as one might expect. They refused to consent to being named as experts because of worries about additional legal liability. This refusal threatened to halt public offerings of asset-backed securities because an ABS issuer’s registration statement could not include the issuance’s rating and identify the rating agency if the rating agency was unwilling to be named as an expert. After a period of great uncertainty for the ABS market, the threat to such public offerings was alleviated, with the SEC’s Division of Corporation Finance providing no-action relief to ABS issuers that exclude the rating from the registration statement, even though Regulation AB otherwise calls for it.
I recount this short history not to make a point about the ABS market or public offerings more generally, but rather because it sharply evidences how easing a regulatory burden and mitigating the risk of liability can promote capital formation to the benefit of investors. In my view, investors would have been worse off if, as a result of extending Section 11 liability to rating agencies, the public market for securitizations had seized and investors were denied the chance to invest in registered ABS offerings.
Regulation D offers a second illustration. The registration and prospectus delivery requirements of Section 5 of the ‘33 Act are the centerpiece of that Act. Nonetheless, the full measure of Section 5 does not apply to issuers that satisfy Regulation D’s safe harbor requirements. By allowing an issuer that comports with the requirements of Regulation D to forego a statutory prospectus and registration statement, our rules facilitate capital formation and in doing so, permit firms to raise capital more efficiently while expanding the range of investment opportunities investors enjoy as they seek to invest in the most profitable ways.
Because a vibrant private placement market helps drive our economy and redounds to the benefit of both issuers and investors, perhaps it is time to afford issuers more flexibility to engage in private offerings under Regulation D.
Although I have emphasized capital formation, I believe investors want the Commission to advocate for a host of additional interests on their behalf. For example, investors stand to benefit from being able to choose from among a range of diverse trading venues where trades can be executed. Investors stand to gain when securities are priced more efficiently, when markets are more liquid, when execution costs decline, and when investors’ trading strategies cannot be detected by others. Investors stand to be better off when they can select from a diverse mix of broker-dealers and investment advisers based on the nature and quality of the service or advice that is offered and the price that is charged. Investors stand to benefit when investment companies offer innovative new products that permit each investor to diversify and tailor his or her portfolio to fit his or her personal preferences. And investors stand to make better decisions when they are not inundated with volumes of information that overload them, suggesting that less mandatory disclosure sometimes can be better than more.
Many of these investor goals are best achieved if the administration and enforcement of the federal securities laws do not unduly impede market entry and innovation. We need to be mindful, in other words, that notwithstanding the goals that may argue in favor of certain regulatory demands, regulatory obligations and mandates that erect barriers to entry and impede competition can prove to be too costly for investors, working against their best interests. We also need to be mindful that the regulatory regime must be predictable so that legal uncertainty does not frustrate business investment and commercial enterprise in ways that we do not welcome. We all are worse off if businesses struggle to raise the capital they need to undertake cutting-edge research and development, to commercialize new technologies, to expand their capacity, and to create jobs.
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As we consider William O. Douglas’s vision for the SEC, we must appreciate the multitude of interests that the Commission should be advocating for on investors’ behalf. Because there is no one thing that investors want to the exclusion of all else, it means that there are no perfect solutions to whatever challenges may be identified, including from the perspective of investors. Just as there are costs and benefits of a more heavy-handed approach to regulation, there are costs and benefits of an approach that defers more to private-sector decision making and the disciplining effects of competition. Our obligation as regulators is to spot the range of consequences at the end of each regulatory path so that we can balance competing considerations in calibrating the regulatory regime.
The SEC is better equipped to make such decisions when we receive input from those on the ground who are impacted by our choices. With input from you and other interested parties — be it through the notice-and-comment process or otherwise — we can evaluate more critically the practical impacts and tradeoffs of choosing one regulatory course over another. The detailed input we receive allows the Commission to refine our regulations, tailoring the regulatory regime to fit the different cost-benefit analyses that attach to different facts and circumstances.
I appreciate that the pace and volume of rulemaking right now is a challenge for commenters. That is why I want to encourage your active engagement in the process by underscoring how key it is. Personally, I benefit from hearing your ideas and perspectives, and I look forward to your constructive input going forward.
Thank you and enjoy the rest of the program.