Can the U.S. Be an International Financial Center? Remarks at Women in Housing & Finance Public Policy Luncheon
Commissioner Daniel M. Gallagher
Jan. 13, 2015
Thank you for that generous introduction Anastasia [Stull]. At the outset, I want to congratulate this organization as you celebrate 35th years of promoting policy discussion and development, along with the interests of women in the housing and financial services industries.
The start of a New Year is always a good time for reflection on the year gone by, and an opportunity to resolve to improve. Today, I’d like to both reflect on the state of our capital markets, asking where we are and how we got here, and suggest some New Year’s resolutions aimed at where I believe the U.S. capital markets can be and how we can get there.
I have a resolution for policymakers in Washington. Every day in 2015, we should ask ourselves, “Are the U.S. capital markets competitive?” That is, where do our capital markets stand vis-à-vis both established and emerging global markets? Sadly, I believe the answer is that – without timely and intense introspection and reaction – the United States is at risk of losing its status as the world’s capital markets leader. Maybe not in the next year, or ten, but the trend is unmistakable.
Unfortunately, at this moment in time, I’m not sure anyone is focusing on this issue – or, if they are, they may believe that such a transformational change is impossible. I see it everywhere: rather than thinking creatively about ways to promote capital formation, legislators and regulators are layering on law after law, regulation after regulation – strangling entrepreneurs, their enterprises, and of course their employees and customers. We are not even resting on our laurels—we are actively throwing those laurels on a bonfire.
Thankfully, it wasn’t always like this. I am a fervent believer in the U.S. capital markets and the spirit of American entrepreneurs, and I believe that we can find a way to reverse the downward spiral of anti-competitiveness we find ourselves in, so that the U.S. capital markets will remain the most vibrant in the world for generations to come.
So let’s wind the clock back a decade and survey the landscape. Concerns about the competitiveness of the U.S. capital markets were being expressed from all corners. In 2007, a report issued by a bipartisan U.S. Chamber of Commerce committee noted that the United States was steadily losing market share to other international financial centers. It cited, among other things, internal, self-inflicted factors – such as an increasingly costly regulatory environment and the burdensome level of civil litigation – as problems that urgently needed to be addressed.
Around the same time, the Committee on Capital Markets Regulation, an independent and non-partisan research organization led by Harvard Law School Professor Hal Scott, issued a pair of reports also calling attention to the declining competitiveness of the U.S. securities markets. The Committee cited a significant decline in the U.S. share of equity raised in global public markets, a precipitous drop in the U.S. share of the twenty largest global IPOs, and a legion of statistics indicating that foreign and domestic issuers were taking steps to raise capital either privately or in overseas markets rather than in the U.S. public equity markets. The Committee also noted that the costs associated with shareholder class action lawsuits have a dramatic negative impact on U.S. capital formation, and that issue persists today.
A report from the non-partisan Financial Services Roundtable concluded that the United States should make changes to its regulatory system that would enable it to adapt and respond to “growing global competition,” “innovative market developments,” and “the dynamic financial needs of all consumers.” Similarly, the Chamber’s Center for Capital Markets Competitiveness issued a report in March 2008 noting that “[t]he reality is that America is no longer the sole capital markets superpower,” and called for a modern, coherent regulatory structure and fair legal, regulatory, and enforcement processes.
As you all know, March 2008 also gave us the failure and bailout of Bear Stearns, viewed by some as the official start of the financial crisis. In the scramble to respond to the financial crisis or, more precisely, to use the financial crisis to further long-standing partisan policy goals, we unfortunately lost the thread of this critically important policy debate.
Post financial crisis, it is imperative that policymakers make a resolution to not only question the pro-regulatory wisdom of Dodd-Frank and other policy responses, but also to dust off the good work that was done pre-crisis on the subject of U.S. capital market competitiveness and bring it to date. Fortunately, some are beginning to do so. This past November, the Committee on Capital Markets concluded that the global competitiveness of the U.S. primary markets was at an historic low through the third quarter of 2014. The Alibaba IPO notwithstanding, foreign companies are choosing to raise capital outside U.S. public markets at rates far below the historical average. And, as they did pre-crisis, foreign companies that raised capital in the U.S. did so overwhelmingly through private markets, rather than initial public offerings. While I am a firm supporter of robust private markets, their popularity should not be attributable to the extreme burdens we place on public companies.
The U.S. also has declined in the measure of “economic freedom” for seven straight years. The economic freedom index scores nations on 10 factors that include business freedom, investment freedom, and financial freedom. Now at # 12, the U.S. plummeted to its second lowest rating in the 20-year history of the index. Hong Kong is ranked first, and Singapore, Mauritius, and Ireland all rank higher. The U.S. has earned the “dubious distinction of having recorded one of the longest sustained declines in economic freedom, second only to Argentina.”
As the U.S. loses its competitiveness, global competitors have grown significantly. And unlike the pre-crisis concerns about market share lost to London, competition these days is coming from non-traditional markets. This is the case with Middle Eastern and Asian markets that did not experience the full brunt of the financial crisis, nor the resulting regulatory over-reaction prevalent in western countries. Instead, they have been spending the past decade enhancing the competitiveness of their markets.
As another example of the stark contrast between where we and our competitors are, we can look to something as simple as branding. The U.S. must compete with a burgeoning number of self-declared international financial centers – and in particular the financial centers that are “designated as special economic zones, or free zones, in order to incentivize business activity, especially as it relates to the financial sector.”
This past fall marked the 10th anniversary of the Dubai International Financial Centre, whose official mission is to “to promote the growth and development of financial services and related sectors within the UAE economy and to provide state-of-the-art infrastructure and competitive services to stakeholders.” The DIFC has its own legal system and courts distinct from the UAE, with jurisdiction over corporate, commercial, civil, employment, trusts and securities law matters. The DIFC is now home to over 1,100 active registered companies, and the financial sector’s contribution to GDP rose from 5.5% in 2004 to more than 12% today.
The government of Qatar established the Qatar Financial Centre in 2005 to attract international financial services to grow and develop the market for financial services in the region. Similar to Dubai, the QFC consists of a commercial arm, the QFC Authority; an independent financial regulator, the QFC Regulatory Authority; and its own independent judiciary comprised of a civil and commercial court and a regulatory tribunal. There is only a 10 percent tax rate on locally sourced profits and there is no restriction on foreign ownership.
Singapore has intently focused on becoming a preeminent financial services market in Asia. Indeed, in just over four decades, Singapore has become a thriving financial center and is home to over 700 financial institutions and maintains deep and liquid capital markets.
Despite the adage that it is impossible to teach old dogs new tricks, many countries see the significant benefits to establishing an international financial center and are committed to developing them. Unlike the U.S., these countries are being introspective – rather than regulatory – and are focusing on capital formation.
Even ancient countries are re-thinking their role in the global financial markets. For example, the Turkish government is establishing the Istanbul International Financial Center with an ambition for Turkey to rank among the world’s top 10 economies.
Likewise, the Governor of Tokyo is determined to make Tokyo an international finance center. Last May, the metropolitan government held the first meeting of what they call the Tokyo international financial center study task force, which is comprised of a group of financial experts and government officials that will examine various issues, such as the easing of regulations.
In Spring 2009, the Chinese government announced its goal for Shanghai to become an international financial center by 2020. Consequently, the Chinese government established a free trade zone in Shanghai in 2013 where, among other things, restrictions on foreign investment are eased.
Surprisingly, even Moscow is trying to become an international financial center. They may have a long way to go, but the government recognizes that it is a long-term project and formed a special task force in 2010 headed by Alexander Voloshin to develop plans and manage joint international financial center efforts by state authorities and finance market professionals. The point is, they’re trying.
This is just a sampling as there are several other markets that are actively fighting to develop financial centers to compete globally. I called it “branding” earlier, but that really sells the concept short: the common theme of these markets is that their governments are all trying proactively to address impediments to capital formation. They are organizing their efforts towards building their capital markets up to compete on a global scale. They have a principle, a goal, and an ideal toward which they can focus their efforts.
These facts about growing international financial centers should warm the hearts of those, like me, who believe that vibrant global markets should support and complement vibrant U.S. capital markets. At the same time, they should stir the U.S. competitive spirit, as we now know the extent to which global markets are making inroads into markets and activities that once were dominated by the U.S. We cannot sit here idly, the capital markets monopolist, convinced that everyone must still come to the deep and liquid U.S. markets to transact, raise capital, and so forth, so we don’t have to make an effort. Or like other monopolists, innovation and disruption will come for us, too.
So can the U.S. be an “international financial center” as conceived by these upstarts? Not on its current path. The cost of doing business in the U.S. only continues to increase – and one major component contributing to that increase is the costs of complying with the growing number of regulations placed on U.S. companies. It is a Washington truism – the amount of regulation only ever increases! In my tenure as Commissioner, it seems that the SEC has only eliminated redundant rules when Congress has made us do so, and even then, as with the 2013 proposed Reg D amendments, the regulatory empire can strike back. And as my friend and colleague Commissioner Piwowar has stated, “[w]e must … recognize that, with truly global capital markets, our actions [as regulators] have the power to shift the markets themselves. If our rules are unnecessarily harsh and we reject international cooperation, market participants may rationally seek other jurisdictions in which to operate.”
Here are some troubling statistics: According to the Mercatus Center, total regulatory restrictions have increased nearly 20 percent since 1997 to more than 1 million. A recent study found that between 1949 and 2005 the accumulation of federal regulations slowed U.S. economic growth by an average of 2 percent per year.
The SBA Office of Advocacy issued a study in 2010 that undertook the mammoth task of trying to estimate the total cost of regulation in the U.S. It concluded that the total annual cost of federal regulation in the United States was $1.75 trillion in 2008. Yes, trillion with a “T”! Another important, if not obvious, conclusion of that study is that small businesses bear the greatest burden when it comes to allocation of regulatory costs.
The scope and cost of federal regulation has increased significantly since 2008. For financial regulators like the SEC, the impetus for most of these costly regulations is the 2319-page Dodd-Frank Act, a legislative monstrosity that was passed in 2010 under the guise of a Congressional response to the financial crisis.
The Commission has spent much, if not most, of its time and resources for half a decade dealing with Dodd-Frank, in many instances allocating precious bandwidth to politically motivated mandates that do nothing for investors except decrease their returns. Even after all this effort, of the 100 rulemakings mandated to the SEC by Dodd-Frank, we still have more than half left to finalize.
The cost of doing business in the U.S. increases with each new mandate that is promulgated. Moreover, calculations of the cost of regulation often ignore businesses that never form in the first place because of regulation – because those businesses don’t have a voice.
Some say this intense regulatory burden is an acceptable consequence of responding to the financial crisis and Dodd-Frank’s purported ability to stave off the next crisis. But this assumes that Dodd-Frank will actually work, a leap hard to make when you consider that it does not address the primary cause of the crisis – failed housing policy. They also say that all the regulatory effort committed to eliminating sources of “systemic risk” will result in the identification and elimination of risks that would cause another crisis. The government will catch and eliminate every bad risk, while not eliminating good risk-taking. You’ll have to pardon me for viewing this Soviet-style command and control exercise skeptically.
Another answer as to why the U.S. capital markets are losing their competitiveness is the desire of bank regulators to extend their reach into our capital markets – known to them as “shadow banking” markets. As I have stated on several occasions, it makes no sense to regulate capital markets like banking markets. Banks operate in a principal capacity and are levered institutions. If a bank loses the confidence of its depositors, and there is a run on the bank, it will likely fail and could impact the government safety net. So it makes sense for banks to take limited risks and for bank regulators to be concerned about safety and soundness – both of the bank and the banking system.
In the capital markets, we want investors and other market participants to take risks – informed risks that they freely choose in pursuit of a return on investment. When market participants take excessive risk, they can and should fail. Attempts to de-risk the capital markets only constrain the choices of investors and financing options of issuers. Risk-free capital markets have no future, and the U.S. economy is incredibly dependent on the vibrancy of these risk-taking markets.
So, where do we go from here and how can we restore the competitiveness of U.S. markets? I, of course, look at this through the SEC lens. The SEC’s threefold mission is to protect investors, maintain fair and efficient markets, and promote capital formation. These three mandates are closely intertwined. Too often, we hear them discussed as distinct, even competing, priorities. And sometimes, the latter two mandates are simply ignored. The fact is, promoting capital formation and maintaining fair and efficient capital markets must be at the core of any effort to protect investors. Promoting capital formation leads to broader and deeper markets that provide more opportunities to more investors. Ensuring that those markets are fair and efficient allows investors the confidence to enter and remain in those markets.
The Commission must find ways to eliminate the red tape that prevents businesses from forming in the first place. This means not only reducing the costs to enter, but also opening other avenues to our markets. I have long said that small business capital formation has too often been a back-burner issue for the Commission. This lack of attention doesn’t just harm small business; it also harms investors and the public at large. Many growing businesses have consciously avoided the public markets over the past decade because of the regulatory baggage that accompanies the offering regime. Instead, they’ve chosen the far simpler options of selling themselves or staying private.
Thankfully, and as I have emphasized previously on a number of occasions, the SEC does have the ability to pursue meaningful reforms that could improve small business capital formation. For example, we can and should finalize our JOBS Act Regulation A amendments ASAP – maybe we should call it Reg A-SAP. And, we cannot ignore secondary trading of Regulation A and other small company shares. This is why I have been a vocal proponent of so-called venture exchanges.
And, as always, the SEC must be mindful of the cost-benefit analysis of its rulemaking. The SEC has successfully centralized the critical economic analysis function in the Division of Economic and Risk Analysis (“DERA”), and has published binding economic analysis guidance for our rule-writing process. The results thus far are encouraging, and we should continually strive to improve our economics function by ensuring that DERA has all the resources and Commission attention it needs to be successful.
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The U.S. capital markets can and should be the global leader for the indefinite future, but that will not be the case if policymakers resist introspection and analysis about the current state of the markets and the competition they face around the globe. The SEC is not the only player in this space, but is the primary regulator of these markets and has the ability and mandate to ensure that they can thrive for the benefit of investors, taxpayers, and the country. I plan to do my part to make sure the Commission focuses on this critically important mandate.
 Commission on the Regulation of U.S. Capital Markets in the 21st Century, Report and Recommendations (2007).
 Committee on Capital Markets Regulation, Interim Report of the Committee on Capital Markets Regulation (2006) [hereinafter “Interim Report of the Committee on Capital Markets Regulation”]; Committee on Capital Markets Regulation, The Competitive Position of the U.S. Public Equity Market (2007).
 See, e.g., The Competitive Position of the U.S. Public Equity Market, at 1-5.
 See Interim Report of the Committee on Capital Markets Regulation.
 The Financial Services Roundtable, The Blueprint for U.S. Financial Competitiveness (2007).
 Center for Capital Markets Competitiveness, Strengthening U.S. Capital Markets: A Challenge for All Americans, at 4, 23-26 (2008).
 Committee on Capital Markets Regulation, Continuing Competitive Weakness in U.S. Capital Markets (Third Quarter 2014) [hereinafter “Continuing Competitive Weakness in U.S. Capital Markets”].
 See Continuing Competitive Weakness in U.S. Capital Markets stating that “Alibaba’s choice of New York over Hong Kong was driven primarily by a desire for a dual share class structure, which could not be achieved in Hong Kong, rather than a judgment about the appeal of the U.S. regulatory framework and liability rules, i.e. securities class action” Excluding Alibaba, the U.S. share of global IPOs by foreign companies would have been 9.0%, which is far below the historical average of 26.8% during the years 1996 through 2007. Id.
 Id. Almost 84% of initial offerings of foreign equity in the United States were conducted through private Rule 144A offerings rather than public offerings, which is significantly higher than the historical average of 66.1% for the years 1996 through 2007. Id.
 2014 Index of Economic Freedom.
 Id. at 23.
 The Asia-Pacific markets had more companies go public than any other region in 2014 with 546 IPO listings, including five of the largest ten global deals . See Ernst & Young “Global IPO Trends;” available at http://www.ey.com/Publication/vwLUAssets/ey-q4-14-global-ipo-trends-report/$FILE/ey-q4-14-global-ipo-trends-report.pdf . Mainland China recently opened its exchanges to new listings and there has been a flood of IPOs. And, Hong Kong, which recently linked the Hong Kong Stock Exchange with the Shanghai Stock Exchange now ranks second in the global IPO rankings, behind the New York Stock Exchange but ahead of NASDAQ and the London Stock Exchange. See , Ho, Prudence, “Hong Kong Pulls into Second in IPOs: late Flurry of Chinese Offerings Adds to Volume”, Wall Street Journal, (Dec.16, 2014), available at http://www.wsj.com/articles/hong-kong-pulls-into-second-in-ipos-1418766999?autologin=y
 See Halfon, Jed and Mohammad Rustom, “Rise of the International Financial Center: can Casablanca Emulate Dubai’s Success?” Knowledge@Wharton (Dec. 20, 2013); available at http://knowledge.wharton.upenn.edu/article/rise-international-financial-center-can-casablanca-emulate-dubais-success/ (defining international financial center).
 See “Dubai International Financial Centre Celebrates 10 Years of Operations;” available at http://www.difc.ae/news/dubai-international-financial-centre-celebrates-10-years-operations .
 See The Global Financial Centres Index 16 (Sept. 2014); available at http://www.longfinance.net/programmes/fcf/910.html.
 See “About QFC Authority;” available at http://www.qfc.qa/about-qfca/Pages/about-qfca.aspx.
 See “Tax in the QFC;” available at http://www.qfc.qa/qfc-platform/key-facts/tax-overview/Pages/tax-overview.aspx.
See “Singapore Financial Centre Overview;” available at http://www.mas.gov.sg/singapore-financial-centre/types-of-institutions.aspx .
 “Istanbul Financial Center Initiative: Targets of the Turkish Government;” available at http://www.istanbulfinansmerkezigirisimi.com/en/RisingVision.
 See “Governor wants Tokyo to be a global financial hub,” Nikkei Asian Review (May 30, 2014); available at http://asia.nikkei.com/Politics-Economy/Economy/Governor-wants-Tokyo-to-be-a-global-financial-hub.
See Elliot, Douglas, “Building a Global Financial Center in Shanghai: Observations from other Centers” (June 10, 2011); available at http://www.brookings.edu/research/papers/2011/06/10-shanghai-financial-center-elliott
 Surely the invasion of Crimea and resulting economic sanctions, along with a crash in global oil prices, did not help.
 See “Moscow International Financial Center;” available at http://mfc-moscow.com/index.php?id=77. Additionally, Russia created a central securities depository, introduced standard accounting rules for publicly listed companies and is in the process of consolidating nearly all financial regulatory authority in the central bank by 2015. See Kramer, Andrew, “Moscow Tries to Reinvent Itself as Financial Hub,” The New York Times (April 3, 2013); available at http://www.nytimes.com/2013/04/04/business/global/moscow-tries-to-remake-itself-as-financial-center.html?_r=0
 See McLaughlin, Patrick and Richard Williams, “The Consequences of Regulatory Accumulation and a Proposed Solution,” Mercatus Working Paper (February 2014) citing Michael Mandel and Diana G. Carew, “Regulatory Improvement Commission: A Politically-Viable Approach to US Regulatory Reform” (Policy Memo, Progressive Policy Institute, Washington DC, May 2013).
 It is worth noting a belief among some that the Commission’s current practices are sufficient to constitute retrospective review in compliance with President Obama’s Executive Order 13,579.
 See Piwowar, Michael, Remarks at AIMA Global Policy & Regulatory Forum (March 6, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370540888843.
See McLaughlin, Patrick and Robert Green, “Unintended Consequences of Federal Regulation Accumulation,” Mercatus Center (May 8, 2014); available at http://mercatus.org/publication/unintended-consequences-federal-regulatory-accumulation.
 Id. citing Dawson, John, Federal Regulation and Aggregate Economic Growth, Journal of Economic Growth (Mar. 21, 2013).
 See Crain, Nicole and W. Mark Crain, “Impact of Regulatory Costs on Small Firms” (Sep. 2010); available athttps://www.sba.gov/sites/default/files/The%20Impact%20of%20Regulatory%20Costs%20on%20Small%20Firms%20(Full).pdf.
 I often tell people that the SEC won the Dodd-Frank “booby prize,” and we are still paying the price over four years later. See e.g., Gallagher, Daniel, “The Importance of the SEC’s Rulemaking Agenda – You are What you Prioritize”; Remarks at the 47th Annual Securities Regulation Seminar of the Los Angeles County Bar Association (Oct. 24, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370543283858. The Act was packed with roughly 400 mandated rulemakings and studies for the federal regulatory agencies, with approximately 100 assigned to the SEC — far and away the most of any of the agencies involved. And while others got substantive, germane rulemakings, we got conflict mineral and pay ratio disclosures
 In this day and age of highly technical, 1000+ page rulemakings requiring the time and attention of scores of staffers across the SEC’s divisions and offices, and collaboration with other federal agencies, completing a dozen major rulemakings a year would be a herculean task. Even at that highly ambitious pace, if we focused our entire rulemaking agenda exclusively on implementing the remaining Dodd-Frank mandates, it would take five years for the agency to reach the finish line. And there would be no time or bandwidth for the Commission to work on any other initiatives
 See Crews Jr., Clyde Wane, “How Entrepreneurs Can Speak Out About the Cost of Regulation,” Forbes (Oct. 6, 2014); available at http://www.forbes.com/sites/waynecrews/2014/10/06/how-entrepreneurs-can-speak-out-about-the-cost-of-regulation/.
 See e.g., Gallagher, Daniel, “The Philosophies of Capital Requirements” (Jan. 15, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370540629644.
 See Berlau, John “Regulatory barriers are holding back investing and lending opportunities for crowdfuning,” Forbes (Oct. 24, 2014); available at http://www.forbes.com/sites/realspin/2014/10/24/regulatory-barriers-are-holding-back-investing-and-lending-opportunities-in-crowdfunding/.
 See e.g., Gallagher, Daniel, “Whatever Happened to Promoting Small Business Capital Formation,” (Sept. 17, 2014) available at http://www.sec.gov/News/Speech/Detail/Speech/1370542976550.
 All you have to do is look at the many emerging technology companies in Silicon Valley that have sold themselves at an early stage to more established companies for billions of dollars, rather than listing on a U.S. exchange. For example, Microsoft bought Yammer for $1 billion. Facebook bought WhatsApp for $19 billion and Instagram for $1 billion.
 See e.g., Gallagher, Daniel, “Remarks at FIA Futures and Options Expo,” (Nov. 6, 2013); available at http://www.sec.gov/News/Speech/Detail/Speech/1370540289361; “The Importance of the SEC’s Rulemaking Agenda – You are What you Prioritize”; Remarks at the 47th Annual Securities Regulation Seminar of the Los Angeles County Bar Association (Oct. 24, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370543283858; Gallagher, Daniel, “Whatever Happened to Promoting Small Business Capital Formation,” (Sept. 17, 2014) available at http://www.sec.gov/News/Speech/Detail/Speech/1370542976550;.
 I have repeatedly called for the Commission to move forward on this important rulemaking, and called for two clarifications: we should raise the cap on the maximum size of offerings from $50 million to $75 or $100 million, and we should exempt shares issued pursuant to Regulation A+ from Section 12(g) of the Exchange Act. See e.g., Gallagher, Daniel, “Whatever Happened to Promoting Small Business Capital Formation,” (Sept. 17, 2014) available at http://www.sec.gov/News/Speech/Detail/Speech/1370542976550.
 See e.g., Gallagher, Daniel Remarks to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality, (Sept. 16, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370542966151; “Whatever Happened to Promoting Small Business Capital Formation,” (Sept. 17, 2014) available at http://www.sec.gov/News/Speech/Detail/Speech/1370542976550; “Remarks at FIA Futures and Options Expo,” (Nov. 6, 2013); available at http://www.sec.gov/News/Speech/Detail/Speech/1370540289361 and, “The Importance of the SEC’s Rulemaking Agenda – You are What you Prioritize”; Remarks at the 47th Annual Securities Regulation Seminar of the Los Angeles County Bar Association (Oct. 24, 2014); available at http://www.sec.gov/News/Speech/Detail/Speech/1370543283858. The idea of venture exchanges is not new or unprecedented. Countries such as Canada, England and South Korea have specially designed exchange markets that serve as incubators for smaller companies. We too need to implement a regulatory regime that is tailored to small and emerging companies and will incentivize market participants to step in and fill the secondary market void that exists for these companies today. And, of course, we must do all of this while ensuring adequate protection for investors.