Remarks to the First Annual Conference on the Regulation of Financial Markets
Commissioner Michael S. Piwowar
May 16, 2014
Good afternoon and thank you, Kathleen [Hanley], for that wonderful introduction. It is a privilege to be the lunch speaker at this inaugural conference on the regulation of financial markets sponsored by the Securities and Exchange Commission (SEC) and the University of Maryland Robert H. Smith School of Business. Like the other SEC speakers, I must provide a standard disclaimer that the views I express today are my own and do not necessarily reflect those of the Commission or my fellow commissioners.
Academic research is critically important to the SEC’s mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. Other financial regulators have long benefitted from holding academic research conferences on issues of importance to their agencies and it is high time for the Commission to do likewise. So it is quite exciting for me to be part of your activities today.
This conference would not have been possible without the efforts of our staff in the Division of Economic and Risk Analysis (DERA) and the staff at the University of Maryland. In particular, I would to thank Kathleen Hanley, Russ Wermers, and Jennifer Marietta-Westberg for their efforts in putting together the conference. I also want to recognize Janet Schmautz and Carmen Bratton from our staff for their tremendous administrative and logistical support. I also appreciate the efforts from the many Division staff members who served on the paper selection committee for this conference. DERA has come a long way from the SEC’s Office of Economic Analysis (OEA), which I was part of between 2002 and 2006. Back in those days, the OEA staff numbered only about 32, as compared to the nearly 140 professional and support personnel that constitute DERA today.
Since returning to the Commission last August, I have observed a substantial change in the role played by economists with respect to rulemakings, enforcement, and inspections of regulated entities compared to the old OEA days. Under the leadership of Craig Lewis, who stepped down from his post as the Commission’s chief economist two weeks ago to return to the Vanderbilt University Owen Graduate School of Business, DERA has been transformed into a division that provides critical economic analysis at the front end of tackling regulatory problems. Craig was instrumental in developing the staff guidance on economic analysis in Commission rulemakings, which was disseminated in March 2012. The guidance noted that that high-quality economic analysis serves as an essential part of SEC rulemaking and helps inform the Commission about the likely economic consequences of a regulation.
Economic analysis has become part of the Commission’s DNA. During Craig’s tenure, the stature of the chief economist position within the agency was restored after it had wrongly been downgraded by removing that position as a direct report to the SEC chairman. We have now hardwired into the management structure of the Commission that the chief economist also serves as the director of DERA.
The significance of today’s conference is recognized by the presence of two former SEC chief economists – Larry Harris and Chester Spatt. Coincidentally, Larry and Chester were my two supervisors at the Commission. Both have been ardent supporters of integrating academic research into the economic analysis at the Commission and laid the groundwork for much of DERA’s current success. Larry and Chester continue to be extremely generous with their time and talents to the Commission – and to me personally – in support of our core mission. Because of the tireless work of Larry, Chester, and Craig, the Commission is not only the home of the most-improved economic research group among the financial regulators, we are without question the best at integrating economic analysis into our regulatory processes.
The Commission could not have asked for a better partner in establishing this inaugural conference than the Smith School of Business. Located just seven metro stops from the SEC in College Park, Maryland, the Commission has long benefited from our relationship with faculty at the Smith School. For example, Pete Kyle’s insights have assisted the Commission in a number of ways. Pete appeared before the Commission in 2006 at our roundtable on the Regulation SHO pilot project. Subsequently, he served as an expert consultant to the Commission’s inspector general for an audit released in 2008 on the SEC’s consolidated supervised entity program in the wake of the failure of Bear Stearns. More recently, Pete again served as an expert to our inspector general as part of his review of the economic analyses performed by our staff in rulemaking projects.
Another example of our important relationship with the Smith School of Business is Kathleen Hanley, who taught finance at the University of Maryland for five years before coming to the Commission as an economist and eventually rising to become the deputy chief economist and deputy director of DERA under Craig Lewis. Kathleen left the SEC last year to return to the faculty at the Smith School of Business.
Other University of Maryland faculty and graduates serving as visiting academics here also have contributed to the Commission’s efforts. Most recently, Jerry Hoberg served on the DERA staff in 2012 and 2013. We have also been fortunate to have had a number of University of Maryland Ph.D. graduates join the Commission staff as visiting academic scholars or financial economists, including Katie Moon and Matthew Kozora.
Working papers by University of Maryland faculty have been frequently presented in the SEC’s academic seminar series over the past several years. For example, I remember the lively seminar presentation and discussion of “Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations” co-authored by Alex Triantis, who is now Dean of the Smith School of Business.
Four years ago, DERA – then known as the Division of Risk, Strategy, and Financial Innovation (RiskFin) – was created to integrate financial economics and rigorous data analytics into the core mission of the SEC. Today, DERA is involved across the entire range of SEC activities, including policymaking, rulemaking, enforcement, and examinations. DERA provides detailed, high-quality economic and statistical analyses, and specific subject-matter expertise to the Commission and other divisions and offices within the SEC. Among DERA’s important tasks is to work with outside experts in academia and industry to strengthen the Commission’s foundation of market knowledge.
DERA economists contribute outside the Commission by authoring high-quality research and publications in peer-reviewed journals and by participating in, and contributing to, academic and industry conferences. This continuing academic research is critical to our core mission. In the past several years, SEC economists have published articles on mission-critical topics in top-tier journals, including the Journal of Finance, Review of Financial Studies, Journal of Financial Economics, Journal of Accounting and Economics, and the Journal of Financial and Quantitative Analysis.
DERA economists also prepare economic analyses and white papers during the course of rulemaking and other Commission initiatives. The Commission’s internal review process for DERA work product often surpasses that of leading journals because of the direct, immediate, and material impact of SEC rules on the financial markets and the broader economy. I frequently find myself reviewing DERA’s work when considering how the Commission should proceed in a particular matter. If you read our rulemaking releases, you will often find them replete with citations to either DERA analyses or memoranda or to working papers and published articles from other academics that have been identified by DERA during their literature review. Today, DERA helps other Commission staff to appropriately identify problems and frame issues at the outset, rather than merely playing a support role to quantify costs and benefits for policy decisions that have already been made.
Recently, the Commission considered whether to grant a waiver to a public company that had been convicted of certain crimes in order for that issuer to remain eligible as a “well-known seasoned issuer,” or WKSI. One of the documents that I reviewed in making my decision was a working paper co-authored by one of our financial economists, Josh White, which evaluated the effects the Commission’s 2005 securities offering reform – which created the category of WKSI issuers – on the informational environment for publicly-traded securities.
Another area where the contributions of DERA economists have been noteworthy is money market funds. In the aftermath of the 2008 financial crisis, the Commission adopted a number of reforms in 2010 to address concerns about money market mutual funds. After adopting the 2010 reforms, the question was raised as to what, if any, further action the Commission should take with respect to such funds. It was unfortunate that, at the early stages of such efforts, the full resources of DERA were not tasked with assessing the situation. Ultimately, once DERA was fully engaged, the Division produced a very thoughtful and comprehensive report that laid the foundation for our current proposal to further regulate the activities of money market funds. In addition, Craig Lewis disseminated a working paper last November on the economic implications of money market fund capital buffers, observing that a capital buffer designed to absorb large scale defaults would, in essence, render the product economically unstainable. Most recently, DERA submitted four more analyses to the public comment file for the Commission’s current money market fund reform proposal, to assist the Commission in developing final rules.
Another one of our financial economists, Laura Tuttle, has been conducting research on off-exchange trading of national market system (NMS) stocks, including through so-called “dark pools.” Laura has been studying the issue for some time and published two white papers on the SEC website. I understand that Laura’s first white paper was downloaded 2,752 times on the day it was posted and nearly 7,300 times during the first two weeks. In light of a recent book by a bestselling author on high-frequency trading that has been receiving a lot of attention, Laura’s important work is just one example of how our economists have been at the forefront of the issues well before the book was published. While the mainstream press may be slow to pick up on the work that DERA does, for those of us in the field of market microstructure, we recognize the importance of this type of research far before others.
In addition to our in-house research, the SEC provides data to the academic community, so that you can perform your own analysis about how the capital markets are functioning. Last October, the Commission rolled out its market information data analytics system, or MIDAS, website to the public. These analytical tools allow the SEC to publicly share evolving data, research, and analysis about the equity markets. The data and related observations address the nature and quality of displayed liquidity across the full range of U.S.-listed equities – from the lifetime of quotes and the speed of the market to the nature of order cancellations. The MIDAS website also includes staff reviews of current working papers and published research on issues such as market fragmentation and high frequency trading. I hope that the academic community takes advantage of this website as a source for new analysis and new papers. More importantly, I hope that academics provide us feedback on how we can make our data disclosure tools and mechanisms even better and more useful.
Finally – before provide some of my own comments and observations on the papers being presented today – I would like to talk a bit about what I see the need for the SEC to conduct a multi-year, comprehensive review of equity market structure.
The first step should be to explore how our equity markets have evolved to where we are now. We must incorporate a retrospective analysis of our regulations. We should examine what the incentives are that underlie the current market structure. What drives the supposed “need-for-speed?” Why are traders directing flow to so-called “dark pools” rather than “lit” markets? These are not easy questions, but they are threshold questions. Once we identify the incentives – whether they are market-based or government-based – we can then make choices about which alternatives may best facilitate competition on choice, pricing, and innovation.
As I have said before, a comprehensive equity market structure review does not necessarily mean developing a grand plan for solving all problems, real or imagined, big or small. Rather, it means that we should put everything on the table for discussion and approach the review with a completely open mind. We must be open to the possibility that any problems we identify might be direct or indirect consequences of our own actions, such as Regulation NMS. As Chair White has said, our approach must be data-driven and disciplined in order to address complex market structure issues.
An equity market structure review also must not be conducted in a vacuum. As with anything we do, it is important that we hear the views and perspectives of the public to inform the debate. This is where the SEC can benefit to the utmost degree from the thoughtful analysis and research of the outside academic community.
Academic research challenges us to think about regulatory policy in different ways. It can provide facts and analysis that cause us to abandon widely held beliefs based on false narratives. It can prompt us to question the premises upon which prior policy decisions were made. It can be disruptive to our current processes, and at times may be inconvenient, but it is a necessary part of a healthy and effective regulatory process. By stimulating thought and debate over regulatory policy, academic research – such as the papers being presented at this conference – serves the Commission in support of our core mission.
The papers presented today run counter to some of the traditional beliefs held not only by members and staff of the Commission, but all financial regulators and some members of Congress. In the first session, one paper disputes the efficacy of implementing Section 939F of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), commonly referred to as “The Franken Amendment,” and the other paper contests the fire-sale narrative of the financial crisis that was used as a justification for a number of Dodd-Frank provisions. The papers in the second session challenge the market design of the continuous limit order book and the notion that so-called “dark pools” are primarily used as channels to hide private information. In the third session, we will see a paper that questions the idea that smaller firms and smaller investors benefit more from using Twitter, and a paper that refutes the presumption by many of the say-on-pay advocates that the new rule would lead to a decrease in levels of CEO pay. The papers in the fourth session confronts the notion that the total impact of shareholder activism can be measured by focusing solely on the target firms and the methods we use to uncover evidence of strategic performance allocation across clients by delegated portfolio managers.
Of course, each of the papers being presented and discussed at today’s conference cover much more than my simple descriptions, but I will leave the details to the presenters and the discussants. In closing, to all of our academic friends, keep working on research that informs the Commission and challenges us to constantly question and re-question what we are doing. Keep us informed of your research and keep sending us your colleagues and students.
Thank you. Enjoy the rest of today’s great conference.
 See “Fiscal 2006 Congressional Budget Request,” at 3, available at http://www.sec.gov/about/secfy06budgetreq.pdf; “FY 2015 Congressional Budget Justification,” at 14, available at http://www.sec.gov/about/reports/secfy15congbudgjust.pdf.
 See “Current Guidance on Economic Analysis in SEC Rulemakings,” Mar. 16, 2012, available at http://www.sec.gov/divisions/riskfin/rsfi_guidance_econ_analy_secrulemaking.pdf.
 Christian Leuz, Alexander Triantis, & Tracy Yue Wang, “Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations,” Journal of Accounting and Economics 45.2 (2008): 181-208.
 See “Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher,” Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission, Nov. 30, 2012, available at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf.
 See “The Economic Implications of Money Market Fund Capital Buffers,” Craig M. Lewis, DERA Working Paper 2014-01, available at http://www.sec.gov/divisions/riskfin/workingpapers/rsfi-wp2014-01.pdf.
 See Comments on Proposed Rule: Money Market Fund Reform; Amendments to Form PF,
(Rel. Nos. 33-9408, IA-3616, IC-30551; File No. S7-03-13), available at http://www.sec.gov/comments/s7-03-13/s70313.shtml.
 See “Alternative Trading Systems: Description of ATS Trading in National Market System Stocks,”
Laura Tuttle, Oct. 2013, available at http://www.sec.gov/marketstructure/research/alternative-trading-systems-march-2014.pdf; OTC Trading: Description of Non-ATS OTC Trading in National Market System Stocks, Laura Tuttle, Mar. 2014, available at http://www.sec.gov/marketstructure/research/otc_trading_march_2014.pdf.
 See, e.g., “Equity Market Structure Literature Review – Part I: Market Fragmentation,” Staff of the Division of Trading and Markets, U.S. Securities and Exchange Commission, Oct. 7, 2013, available at http://www.sec.gov/marketstructure/research/fragmentation-lit-review-100713.pdf; “Equity Market Structure Literature Review – Part II: High Frequency Trading,” Staff of the Division of Trading and Markets, U.S. Securities and Exchange Commission, Mar. 14, 2014, available at http://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf.
 See “Testimony on ‘Oversight of the SEC’s Agenda, Operations and FY 2015 Budget Request,’ Apr. 29, 2014, available at http://www.sec.gov/News/Testimony/Detail/Testimony/1370541674457.