Speech by SEC Commissioner:
An Inflection Point: The SEC and the Current Financial Reform Landscape
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
Social Investment Forum 2011 Conference
June 10, 2011
Thank you. It is my pleasure to be here with you at the Social Investment Forum 2011 Conference focusing on Responsible Investing: Impact and Innovation. This Forum, sponsored by US SIF: The Forum for Sustainable and Responsible Investment, is coming at a critically important time. As I start my remarks, I first should issue the standard disclaimer that the views I express today are my own, and do not necessarily reflect the views of the Securities and Exchange Commission, my fellow Commissioners, or members of the staff.
Today, I would like to discuss some of the SEC’s new responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act), and some of the challenges I see going forward.
Commission Action Required By The Dodd-Frank Act
First, I would like to discuss how the SEC has been impacted by the Dodd-Frank Act. The legislation closed various gaps in regulation and significantly expanded the Commission’s jurisdiction and workload. In the near term, the Dodd-Frank Act requires the SEC to promulgate over 100 new regulations, create five new offices, and undertake about 20 studies. To say this is a significant undertaking is a massive understatement. The SEC is currently right in the middle of this process.
The Dodd-Frank Act will also have a long-term and permanent impact on the SEC. For example, the Dodd-Frank Act charges the Commission with on-going oversight responsibilities on the previously unregulated over-the-counter derivatives market. The Commission’s new responsibilities include direct regulation of participants such as security-based swaps dealers, venues such as swap execution facilities, warehouses such as swap data repositories, and clearing agencies set up as central counterparties. In addition to regulating the derivatives market, the Commission has also been given the responsibility for the oversight of hedge fund advisers, and new responsibilities for the registration of municipal advisers.
These new responsibilities are necessary; but by the same token, although the Dodd-Frank Act significantly increased the Commission’s workload, it did not fundamentally address the resources that will be available to the SEC to meet the challenges of the increased workload.
This is the snapshot of where we are right now. In fulfilling our responsibilities under the Dodd-Frank Act, the Commission has already proposed many rules and is on the precipice of beginning to adopt actual requirements. It is the responsibility of the Commission, and other financial regulators, to promulgate rules that make these statutory mandates a reality and serve the public interest. Until these rules are adopted, the regulatory structure in these areas will remain incomplete and unresolved, as will the serious issues that were demonstrated during the financial crisis. It is the final rules that are adopted that will have the long-lasting impact on the protection of investors, the functioning of our markets, and the overall effectiveness of our regulatory structure.
To give you a sense of the inflection point where we find ourselves, as of last month, the Commission had issued 34 proposed rule releases, seven final rule releases, and two interim final rule releases in connection with the Dodd-Frank Act. Additionally, the Commission has received thousands of public comments, completed seven studies, and hosted five roundtables.i The Commission has also taken steps to create the new Whistleblower Office in the Division of Enforcement.ii Clearly, however, although we’ve been busy, most of the heavy lifting is in front of us.
With that background, I would like to use my time to highlight two sections of the Dodd-Frank Act. One of which is solely focused on investors, and that is the creation of the new Investor Advisory Committee and the Office of the Investor Advocate. These two initiatives have not been implemented, and I believe they should be implemented quickly. The second item I would like to highlight is the say-on-pay rules that the SEC has already promulgated, which are currently effective.
Investor Initiatives Required in The Dodd-Frank Act
First, I would like to discuss two investor initiatives required by the Dodd-Frank Act. Section 911 of the Dodd-Frank Act requires that the SEC establish and maintain an Investor Advisory Committee (IAC). The goal of the IAC is to provide the Commission with the views of a broad spectrum of investors on their priorities concerning the Commission’s regulatory agenda. This Committee is of critical importance to ensuring that the SEC is focused on the needs and the practical realities facing investors. Investors face an impossible challenge of representing themselves in front of the Commission, particularly retail investors. They do not have the money or the resources to write lengthy comments letters or participate in meetings with SEC Commissioners and the staff. If the Commission is to be an effective advocate for investors, it will need a strong and effective IAC to ensure that reality.
The SEC had only recently established its first ever IAC in June of 2009, and the Dodd-Frank Act fortified it by establishing a statutory mandate for this Committee, which was already in existence. The Committee in existence was then wound down with the promise that the statutorily-mandated Committee would be up and running in no time. Unfortunately, that seamless transition has not occurred. The delay in establishing the new IAC has been largely attributed to the delay in approving the Federal budget. However, now that the SEC’s budget has been established for this year, we should make it a top priority to organize the IAC. As the sponsor of the Commission’s first Investor Advisory Committee, I saw firsthand the benefit of creating a committee of investors and investor representatives to advise the Commission. I believe that the SEC must re-establish the IAC as soon as possible, particularly now that the SEC has so many issues under consideration that fundamentally impact investors.
Second, the Dodd-Frank Act’s Section 915 requires that the SEC establish an Office of the Investor Advocate. The Investor Advocate is tasked with assisting retail investors to resolve significant problems with the SEC or the self-regulatory organizations. In its report, the Senate Banking Committee explained that it was “necessary to create an office of the Investor Advocate within the SEC to strengthen the institution and ensure that the interests of retail investors are better represented.”iii The Committee was quite clear that this Office was intended to “ensure that the interests of retail investors are built into rulemaking proposals from the outset and that agency priorities reflect the issues that confront average investors.”iv Senator Akaka, who authored this provision stated, “The Investor Advocate is precisely the kind of external check, with independent reporting lines and independently determined compensation, that cannot be provided within the current structure of the SEC. It is not that the SEC does not advocate on behalf of investors, it is that it does not have a structure by which any meaningful self-evaluation can be conducted. This would be an entirely new function”v It is in the interests of both investors and the SEC, to have this Office up and running as soon as possible.
I encourage all of you to engage on these investor initiatives, and that you encourage that these requirements of the Dodd-Frank Act be implemented with all haste. The establishment of the IAC and the Office of the Investor Advocate will benefit investors, our markets, and the SEC.
The second provision of the Dodd-Frank Act I want to highlight is in an area where the SEC has been able to complete its rulemaking, and where we are now starting to see the effects of its implementation. Specifically, the Dodd-Frank Act requires public companies to solicit non-binding shareholders’ votes at least once every three years on the compensation of their highest paid executive officers.vi You have probably heard this new requirement referred to as “say-on-pay.”vii The reports from companies and shareholders alike are that these new requirements are sparking a productive dialogue for companies and shareholders.
Specifically, it appears that the say-on-pay rules have provided shareholders with a useful way of expressing their views on executive compensation at a company, and is incentivizing companies to reach out. It also is empowering compensation committees who are interested in improving pay packages.viii It remains to be seen how widespread and how significant an effect say-on-pay will have, but the early indicators are that say-on-pay is clearly having a positive impact. Here is what is being reported:
First, say-on-pay seems to have resulted in increased communication between shareholders and corporate management.ix Reports seem to indicate that both shareholders and corporate management are pro-actively initiating discussions regarding executive compensation, which is far from the predictions that say-on-pay would lead to disrepair or at best be ineffective — this sounds like a positive development to me.
Second, the reports indicate that shareholders are making their voices heard. For example, as of this month, 31 public companies have failed to obtain majority support for their executive compensation packages.x
Lastly, some pay practices appear to be changing in deference to shareholders’ views. Some companies have actually altered the pay and benefits of top executives. Many companies are putting in more performance-based compensation plans and they are addressing items that shareholders often criticized, such as: excessive severance; perks; federal income tax payments; and pensions.xi For example, approximately 40 of the Fortune 100 companies have eliminated policies that had the company pay certain tax liabilities of executives.xii As another example, General Electric modified the pay of its CEO two weeks prior in anticipation of the shareholder vote, deferring the vesting of certain options and conditioning the vesting on whether the company meets certain performance targets.xiii According to news reports, this was apparently done to avoid losing a say-on-pay vote.xiv
There seems to be real evidence that say-on-pay is one catalyst to increasing shareholder engagement more broadly. According to a recent study, the level of engagement is continuing to increase. Additionally, the study reported that 80% of the surveyed corporations said that the dialogue with investors was always or usually successful.xv
While say-on-pay is focused on improving the executive compensation practices at operating companies, Congress also recognized the reality that many investors are more exposed to corporate America through mutual funds and other kinds of collective investment schemes, rather than through direct beneficial ownership of company shares. As a result, the Dodd-Frank Act requires disclosures from investment managers regarding how they are using their voting power in say-on-pay votes. After all, mutual fund shareholders should understand whether their fund manager is using the fund’s voting power to actively improve pay practices, or to facilitate pay practices that do not serve the interests of shareholders.
The Commission is currently working on the final rules to implement this disclosure by investment managers, and it is my hope that the rules provide investors with fulsome and useful information.
Challenges Facing the SEC
Finally, I’d like to discuss some of the challenges I see for the SEC going forward. One of the most significant challenges is to make sure that the SEC has the resources necessary to carry out its responsibilities. The Dodd-Frank Act expanded the SEC’s jurisdiction and responsibilities by significantly adding to the SEC’s longstanding, core responsibilities. As a result, the SEC is facing greater responsibilities and it is doing so after having been chronically underfunded for a number of years, and without any real control over its own budget.
To give you a sense of the gravity of the problem, over the last 20 years, the SEC’s budget, workforce, and technology programs have fallen far behind the growth in the size and complexity of the securities markets. During that time, the average value of securities transactions per day has risen by about 2,500%, and the value of investment adviser assets has grown by about 3,070%. The SEC’s workforce, however, failed to keep pace during this period. This mismatch between the changes in the markets and in the SEC has been exacerbated since 2005. Between 2005 and 2007, for example, the SEC’s workforce and technology investments had to be cut back, and they are only now returning to 2006 levels. In 2005, the SEC’s funding was sufficient to provide 19 examiners for each trillion dollars in investment adviser assets under management. Now, that figure stands at 12 examiners per trillion dollars.
Another challenge for the SEC is the need to improve the agency’s technology in order to keep up with the rapid changes in the financial markets. To further put the SEC’s technology needs in perspective, a number of financial firms the SEC oversees spend more each year on their technology budgets, alone, than the SEC spends on all of its operations.xvi Clearly, the SEC needs to invest in new technology initiatives, such as the development of risk analysis tools to assist with the triage and analysis of tips, complaints and referrals, and a digital forensics lab that enforcement staff can use to recreate data from computer hard drives and cell phones to capture evidence of sophisticated fraud.xvii
Over the past several years, I have consistently advocated that Congress allow the SEC to be self-funded -- exactly like the FDIC, the Federal Reserve, and other financial regulators. Self-funding would enable the SEC to set multi-year budgets and respond promptly to drastically changing markets, while also maintaining appropriate staffing. Why is this significant? For many reasons, I will concentrate on two. Being self-funded would allow the SEC to make multi-year budgeting decisions similar to the entities it regulates and the other financial regulators. It also means that the SEC would no longer suffer the paralysis of the continuing resolution process, much as it did this year.
During the first half of FY 2011, the SEC, like other government agencies, was funded through a “continuing resolution,” which kept its funding at levels set for the previous year. I saw firsthand how this negatively impacted the SEC’s core responsibilities. The lack of funding led the agency to institute a hiring freeze and to cut back on travel for examiners. In fact, inspections involving enough distance to require an overnight stay were cancelled. Moreover, the SEC also limited the staff’s ability to hire expert witnesses in certain trials, such as in complex securities cases. Thus, the continuing resolution and its restriction on funding presented a significant challenge for the SEC, as the agency was unable to hire new staff, and enforcement and market oversight activities were delayed or cut back.xviii
Historically, the amount of money taken in by the government from securities registration and transaction fees far exceeded the SEC’s actual budget. The Dodd-Frank Act continues to support an SEC budget that has no taxpayer impact, as it requires that the SEC’s budget be budget neutral by being fully offset by matching collections of fees on securities transactions.
I still believe that the SEC should be self-funded like so many of our financial regulatory counterparts. These institutions have been able to respond to rapidly changing circumstances and growing needs by hiring staff and investing in technology in a way that the SEC can only dream about.
I thank US SIF for all the work that it has done advocating for self-funding, and by sending letters stating that the SEC needs to be adequately funded. We appreciate your support.
In closing, I want to encourage you to continue to engage with the SEC. I urge you to actively insist that the SEC engage in action that benefits and protects investors — and hold our feet to the fire to make sure that we do. Your involvement is needed now — not later. You need to be vigilant during a time when critical rulemakings are being generated that will impact the investment community for years to come. Now, is the time — this is the inflection point . . . this is not the time to sit on the sidelines or wait for someone to invite you in. The decisions made today will impact generations in the future.
I look forward to your involvement, and I would like to thank you for inviting me here today. I wish you a successful conference.
i See, Testimony on the President’s FY 2010 Budget Request for the SEC, by Chairman Mary Schapiro, Before the United States Senate Subcommittee on Financial Services and General Government, Committee on Appropriations. (May 4, 2011). http://www.sec.gov/news/testimony/2011/ts050411mls.htm
ii See, Press Release, Sean Mckessy Named Head of Whistleblower Office (Feb. 18, 2011). http://www.sec.gov/news/press/2011/2011-47.htm
iii Report of the Senate Committee on Banking, Housing, and Urban Affairs on S. 3217, S. Rep. No. 111-176.
vi Specifically, Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act added new Section 14A of the Securities Exchange Act of 1934, which requires at least once every three years a separate shareholder vote to be in included in the proxy solicitation related to an annual or other meeting of shareholders for which the SEC’s proxy rules require compensation disclosure. The separate vote is to approve the compensation of executives as required to be disclosed pursuant to SEC regulations.
vii Shareholders also will have a similar “say” on golden parachute arrangements. See, Dodd-Frank Wall Street Reform and Consumer Protection Act section 951 (amending the Securities Exchange Act of 1934 by adding new section 14A(b)).
viii See, Shareholders Are Getting Their Way on Pay, Compliance Week, May 3, 2011 (quoting Jesse Fried). http://www.complianceweek.com/shareholders-are-getting-their-way-on-pay/article/201733/.
ix See, Talking Cure Eases Remuneration Tension, Financial Times, April 25, 2011.
x See, Negative Say-on-Pay Votes Reach 31, Kristen Gribben, Agenda, June 6, 2011. http://www.agendaweek.com/c/204792/25752/negative_votes_reach?referrer_module=sideBarHeadlines&module_order=11
xi See, Shareholders are Getting Their Way by Arielle Bikard, Compliance Week, May 3, 2011.
xii See, Say-On-Pay Rules Hit US Executives, Financial Times, April 25, 2011.
xiii See, Id.
xiv See, Shareholders Are Getting Their Way on Pay, Compliance Week, May 3, 2011 (quoting Jesse Fried). http://www.complianceweek.com/shareholders-are-getting-their-way-on-pay/article/201733/.
xv See, The State of Engagement between U.S. Corporations and Shareholders. http://www.issgovernance.com/press/20110221IRRCiEngagement.
xvi See, Testimony on the President’s FY 2010 Budget Request for the SEC, by Chairman Mary Schapiro, Before the United States Senate Subcommittee on Financial Services and General Government, Committee on Appropriations. (May 4, 2011). http://www.sec.gov/news/testimony/2011/ts050411mls.htm
xvii See, Id.
xviii See, e.g., Charles Riley, SEC Starved for Reform Funds, CNNMoney, January 11, 2011. http://money.cnn.com/2011/01/11/news/economy/SEC_funding/index.htm.