The Falling Leaves of the Buttonwood Tree
Rick A. Fleming, Investor Advocate
U.S. Securities and Exchange Commission
The SEC Speaks in 2016<br>Washington, D.C.
Feb. 19, 2016
Thank you, Andrew [Ceresney], for that kind introduction and for helping to organize this conference. I appreciate this opportunity to share a few thoughts at this marquee event for the SEC.
This morning, I would like to describe some of the trends my Office has observed in the rulemakings of the U.S. stock exchanges, particularly with regard to their listing standards. Based upon our research, we note that few people seem to be paying much attention to the rulemakings of the exchanges, and there appears to be a troubling downward drift in the listing standards of the exchanges since they have become for-profit businesses.
As you probably know, the national securities exchanges are required to file with the SEC any proposed changes to their rules. What you are less likely to know, though, is how many rule proposals they actually file. In calendar year 2015, for example, the exchanges filed and the Commission published for public comment about 1,050 proposed rule changes.
The rule proposals can be broken down into two categories. The larger category includes what are known as B3A filings, which is a shorthand reference to Section 19(b)(3)(A) of the Exchange Act. Generally speaking, these are rules that are more technical in nature and expected to be non-controversial. For example, they may involve changes to fees or extending the length of a pilot program. These rule changes become effective upon filing with the SEC and are subsequently published for comment.
The second category is known as B2 filings, referencing Section 19(b)(2) of the Exchange Act. These include the more substantive rule proposals, such as changes to the listing standards of an exchange, the priority of bids and offers on the exchange, and new order types and instructions. These proposals are published for public comment prior to their approval or disapproval by the Commission.
In 2015, approximately 900 B3A filings were published for public comment, and it appears that only 23 of them received any comment. Hopefully, this simply reflects the fact that the B3A process is being used appropriately for truly non-controversial matters.
More troubling, however, is the lack of public participation in the B2 process. Last year, approximately 150 B2 filings were published for public comment. Of those 150 filings, we found only 15 comment letters that tended to advocate for the interests of investors on a substantive level.
This lack of investor comment is unfortunate, but it should come as no great surprise. When a rule is changed, the costs are often concentrated on a relatively small number of industry participants, while the benefits are widely dispersed among the investing public. Or, the reverse is true—the benefit falls on industry participants while the costs are dispersed among all investors. In either case, individual investors are rationally apathetic, having little individual incentive to follow hundreds of exchange rule filings, digest thousands of pages of complex legal jargon, and then spend the time necessary to submit comments. This is why I like to remind policymakers that they should never count comment letters as though they are votes for or against a proposal, with public policy choices going to the side with the most votes.
In my view, the Office of the Investor Advocate was created, at least in part, to counteract this weakness in the public comment process. It is the job of my Office to monitor rulemakings— including those that may otherwise fly under the radar—and provide a voice for investors. Among other statutory duties of my Office, we are required to analyze the impact on investors of proposed rules of self-regulatory organizations (“SROs”), including the exchanges, and we are expected to identify areas in which investors would benefit from changes in SRO rules.
Our efforts to monitor the SRO rule filings were significantly enhanced last year with the addition of an experienced Trading and Markets Counsel, Adam Moore, and a well-organized paralegal, Denene Dent. On behalf of American investors, they spend many hours reviewing the exchanges’ rule filings and bringing significant issues to the attention of SEC leadership. They also helped me file my first formal recommendation to the Commission last year—a recommendation to disapprove a proposal by the New York Stock Exchange (“NYSE”) to lower a listing standard.
In isolation, the proposal by the NYSE looks relatively minor. It exempted early stage companies from a requirement to seek shareholder approval before issuing up to 20 percent of outstanding shares to certain related parties, provided that the company’s audit committee or a comparable board committee approves the transaction. However, my Office opposed the rule because, in our view, it was yet another incremental step in a more disturbing trend. We were concerned about a potential “race to the bottom” by the exchanges, whereby they lower their listing standards in order to attract more companies to list with them.
Recently, my Office has begun to look more closely at this issue. Specifically, we have attempted to examine all of the changes to NYSE quantitative and qualitative listing standards for operating companies since 2005, when NYSE began the process of converting from a mutualized exchange to a for-profit business, following in the footsteps of Nasdaq. We continue to review historical patterns in the rulemakings of the other exchanges, but our research of NYSE rulemakings suggests that the listing standards of NYSE have gradually deteriorated since 2005, particularly with respect to their quantitative listing standards.
Quantitative Listing Standards
Quantitative listing standards establish specific thresholds that an issuer must meet in order to list on an exchange. These standards are intended to ensure that a company has sufficient public float, investor base, and trading interest to provide the depth and liquidity necessary for fair and orderly trading. In June 2005, following an extensive pilot, NYSE received approval to adopt an amended set of quantitative listing standards. Since those were adopted, my Office has identified 22 substantive adjustments to what we would classify as quantitative listing standards. Of those, we found that 17 lowered the listing standards to allow the exchange to list more companies, 3 appeared to have a neutral impact, and, in our judgment, only 2 of the 22 amendments sought to significantly raise the listing standards.
A more detailed analysis is available on the Investor Advocate’s page of the SEC website as an appendix to this speech, but a few examples of lowered quantitative standards would include the adoption in 2006 of an alternative method for domestic listed companies to meet the NYSE’s Earnings Test;  a change in 2007 to enable the listing of certain companies based on two and a half years of financial statements instead of three full years; a new “Assets & Equity Test” in 2008 that required no operating history; and a lower public float requirement in 2010 for certain issuers. In at least 11 of the 17 instances when NYSE lowered a listing standard, including each of the foregoing examples, NYSE justified the change, at least in part, by pointing out that another exchange had lower standards already.
Unfortunately, one of the two heightened quantitative standards was adopted in response to significant investor harm. In 2011, NYSE (along with Nasdaq) adopted more stringent quantitative listing requirements for companies that become public through a reverse merger, presumably to address significant accounting fraud allegations and other concerns with respect to reverse merger companies. Since then, the only heightened quantitative requirement adopted by the exchange was to expand the pre-market hours during which listed companies are required to notify the exchange prior to disseminating material news, in order to permit the exchange to halt trading if needed.
Qualitative Listing Standards
The changes to NYSE’s qualitative listing standards, in our estimation, have been more of a mixed bag. Qualitative standards are designed to help ensure that an issuer has an adequate corporate governance structure, fair proxy voting process, and other characteristics to protect the interests of shareholders.
Since June 2005, my Office has identified 20 substantive adjustments to what we would classify as qualitative listing standards. In our judgment, 7 of those amendments will have a relatively neutral impact. Another 8 of the 20 sought to raise the listing standards, although it was often in response to Congressional or Commission action. For example, two of the enhancements in 2008 — both of which shortened the length of time for an issuer to notify the exchange of non-compliance with NYSE listing standards — merely aligned the time period with the Commission’s four-day public notice requirement under Form 8-K. Similarly, an enhanced limitation on broker discretionary proxy voting and improved compensation committee independence requirements were both required by the Dodd-Frank Act.
On the other hand, we found that 5 of the 20 amendments resulted, on balance, in lower qualitative standards. In at least 3 of these 5, NYSE justified the change by noting the competitive advantage enjoyed by other exchanges with different standards. A few examples of what we consider to be a lowering of qualitative standards would include proposals in 2013 to remove the 50 percent quorum requirement from shareholder approval votes and to permit listed companies to delay compliance with the internal audit requirement for a year, and a proposal in 2014 to allow a company to list even though it may be delinquent in certain Commission filings during the past year.
To sum up the results of my Office’s review, I would argue that the NYSE listing standards, and especially their quantitative standards, have tended to drift downward like a leaf in autumn—or, to use a more fitting analogy, like the leaf of a buttonwood tree. Occasionally, there is a scandal or a statutory mandate that comes along and acts as an upward draft, and the listing standards are pushed higher in response. But, when the wind stills, the leaf begins its gradual downward drift, pulled by the relentless force of gravity or, in the case of the exchanges, profits. And over time, small incremental changes can add up to a significant deterioration of the listing standards.
I encourage the Commission and staff to consider this broader context when they evaluate changes in listing standards that appear, on their face, to be small changes. The Commission, and especially the staff of the Division of Trading and Markets, have a difficult job balancing investor protection and capital formation while trying to maintain fair, orderly, and efficient markets. They work hard to improve the quality of filings, and the downward drift of the exchange rules has likely been curtailed by their efforts. But, I believe the approval process could be improved by paying further attention to overall trends and considering the cumulative impacts of incremental changes.
Even more important, I believe the exchanges should resist the temptation to engage in a race to the bottom. NYSE, in particular, asserts in its own rule book that a listing on its exchange signifies that a company has achieved “maturity and front-rank status in its industry—in terms of assets, earnings, and shareholder interest and acceptance.” It is concerning, then, to see the NYSE justify so many changes in its rules by pointing to its competitors who traditionally have catered to different types of companies.
More broadly, in an age of for-profit exchanges, where exchanges have an inherent conflict between the interests of investors and their own bottom lines, it may be time again for the Commission to confront the larger question of whether it makes sense for a for-profit business to be entrusted with the regulatory responsibilities of an SRO. Based upon the evidence I’ve seen so far, I believe investors have cause for concern.
 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or other Commission staff.
 Additional proposals were filed with the Commission but not published for public comment because they were withdrawn by the exchanges or rejected for not meeting the relevant filing requirements.
 15 U.S.C. § 78s(b)(3)(A) (2015).
 15 U.S.C. § 78s(b)(2) (2015).
 In total, 21 comments letters advocated for the interests of investors (excluding two filed by the Office of the Investor Advocate). Of those 21, three were brief comments of a paragraph or two with little or no substantive analysis, and three were duplicated in multiple comment files because they addressed affiliated filings by sister exchanges.
 15 U.S.C. § 78d(g)(4) (2015).
 For these purposes, we began our substantive review with the 264 notices and orders published in the Federal Register since January 1, 2005 containing the phrases “New York Stock Exchange” and “Listed Company Manual.”
 For these purposes, we focused solely on exchange rule filings that appear to address primary equity listing standards for domestic operating companies. We excluded changes to listing standards for other categories of issuers and products, including foreign private issuers, limited partnerships, real estate investment trusts, special acquisition companies, exchange traded products, mutual funds, and other structured products or securities, including debt, stock warrants, and “other” securities that are not the issuer’s primary equity security where holders have only limited economic interests and rights. In addition, we did not review fee changes or what appeared to be non-substantive process changes, such as a change to the appeals process for a proposed delisting by the exchange. We also excluded 16 proposals that involved pilot programs, extensions of pilots, or otherwise appeared to be temporary changes.
 See Commission Order Approving Rule Change to the NYSE’s Business Combination with Archipelago Holdings, Inc., Release No. 34-53382 (Mar. 1, 2006), 71 Fed. Reg. 11251 (Mar. 6, 2006) (SR-NYSE-2005-77), https://federalregister.gov/a/06-2033 (“In connection with the Merger, the NYSE proposes to reorganize so that the NYSE Group will be a for-profit, publicly traded stock corporation and the holding company for the businesses of the NYSE and Archipelago.”). See also Commission Order Approving Rule Change to Nasdaq’s Separation from NASD, Release No. 34-52049 (July 15, 2005), 70 Fed. Reg. 42398 (July 22, 2005) (SR-NASD-2005-087), https://federalregister.gov/a/E5-3912 (“In 2000, NASD began restructuring its relationship with Nasdaq, which operates as an independent, for-profit company. As the result of a two-phase private placement of Nasdaq shares, a public offering recently completed in January 2005 and other dispositions of NASD shares, NASD’s common stock ownership interest in Nasdaq has been reduced to a minority interest.”).
 Commission Order Amending NYSE’s Original and Continued Quantitative Listing Standards, Release No. 34-51813 (June 9, 2005), 70 Fed. Reg. 35484 (June 20, 2005) (SR-NYSE-2004-20), https://federalregister.gov/a/E5-3156.
 To be fair, we have excluded standards that were only lowered temporarily — for example, one was adopted for six months to allow NYSE Arca companies to transfer after NYSE’s holding company determined to stop original listings on that affiliated exchange. See Commission Order Approving Rule Change Adopting Initial Listing Standard, Release No. 34-58931 (Nov. 12, 2008), 73 Fed. Reg. 69710 (Nov. 19, 2008) (SR-NYSE-2008-97), https://federalregister.gov/a/E8-27424. We have, however, included one standard that was lowered in response to the JOBS Act’s new rules concerning emerging growth companies. See Commission Order Permitting the Listing of Emerging Growth Companies, Release No. 34-66994 (May 15, 2012), 77 Fed. Reg. 30040 (May 21, 2012), https://federalregister.gov/a/2012-12197. Finally, to avoid double-counting, we have only included the final permanent approval orders for four that were done as pilots first. We do appreciate that the pilot process allowed the Exchange to observe behavior briefly under the lower standard before making them permanent. See, e.g., Commission Order Allowing Pilot Program to Adjust Earnings of Companies, Release No. 34-58500 (Sept. 9, 2008), 73 Fed. Reg. 53471 (Sept. 16, 2008) (SR-NYSE-2008-57), https://federalregister.gov/a/E8-21544.
 In addition to the June 2005 modification, supra note 10, one filing moved the financial listing reporting criteria from a delayed 36 months to a current 33 months, one clarified a longstanding practice regarding the use of the closing price, and one allowed issuers to cure their deficient dollar stock price listing anytime within a six month period, rather than only at the end. See Commission Order Relating to NYSE’s Financial Listing Criteria, Release No. 34-53825 (May 17, 2006), 71 Fed. Reg. 30009 (May 24, 2006) (SR-NYSE-2006-38), https://federalregister.gov/a/E6-7914; Commission Order Clarifying NYSE Uses Closing Price to Determine Compliance with Price Test, Release No. 34-55574 (Apr. 3, 2007), 72 Fed. Reg. 17972 (Apr. 10, 2007) (SR-NYSE-2007-36), https://federalregister.gov/a/E7-6673; Commission Order Modifying NYSE’s Cure Provisions under Dollar Stock Price Continued Listing Standards, Release No. 34-60612 (Sept. 2, 2009), 74 Fed. Reg. 45474 (Sept. 9, 2009), https://federalregister.gov/a/E9-21646.
 Commission Order Amending Earnings Standard Included in the Exchange’s Financial Listing Criteria, Release No. 34-54887 (Dec. 6, 2006), 71 Fed. Reg. 74972 (Dec. 13, 2006) (SR-NYSE-2006-103), https://federalregister.gov/a/E6-21162 (“The Exchange believes that its proposed alternative earnings standard is at least as stringent as a standard the Commission has approved previously for another self-regulatory agency. Specifically, the Nasdaq Global Market’s Standard Three…”).
 Commission Order Enabling NYSE to List Certain Companies Based on Two Completed Fiscal Years and Financial Statements Covering the First Six Months of the Current Fiscal Year, Release No. 34-56835 (Nov. 21, 2007), 72 Fed. Reg. 67772 (Nov. 30, 2007) (SR-NYSE-2007-104), https://federalregister.gov/a/E7-23202 (“The Exchange notes that the NYSE earnings standard—both currently and as proposed to be amended by this filing—would always require a higher level of earnings in the most recently completed fiscal year than is required by Nasdaq Global Market Standard 1.”).
 Commission Order Adopting an Additional Listing Standard for Operating Companies, Release No. 34-58934 (Nov. 12, 2008), 73 Fed. Reg. 69708 (Nov. 19, 2008) (SR-NYSE-2008-98), https://federalregister.gov/a/E8-27423 (“[T]he proposed standards are low enough to qualify companies on the NYSE that previously would not qualify. However, as described above, the quantitative requirements of the new Assets and Equity Test exceed, and are more rigorous than, an existing Amex listing standard and meet or exceed the penny stock requirements in Exchange Act Rule 3a51—1(a)(2).”).
 Commission Order Allowing NYSE to Amend Certain Initial Listing Requirements, Release No. 34-61407 (Jan. 21, 2010), 75 Fed. Reg. 4897 (Jan. 29, 2010) (SR-NYSE-2010-02), https://federalregister.gov/a/2010-1849.
 Commission Order Approving NYSE’s Additional Listing Requirements for Companies Applying to list After a “Reverse Merger” With a Shell Company, Release No. 34-65709 (Nov. 8, 2011), 76 Fed. Reg. 70795 (Nov. 15, 2011) (SR-NYSE-2011-38), https://federalregister.gov/a/2011-29439 (“Although certain commenters expressed concern that the proposal might inhibit capital formation and access by small companies to the markets, the Commission notes that the enhanced listing standards apply only to the relatively small group of Reverse Merger companies—where there have been numerous instances of fraud and other violations of the federal securities laws—and merely requires those entities to wait until their first annual audited financial statements are produced before they become eligible to apply for listing on the Exchange. While fraud and other illegal activity may occur with other types of issuers, as noted by certain commenters, the Commission does not believe this should preclude NYSE from taking reasonable steps to address these concerns with Reverse Merger companies.”).
 Commission Order Approving Rule Change Reducing Time Period Within Which Companies Must Issue a Press Release After Noncompliance with NYSE Listing Requirements, Release No. 34-58487 (Sept. 8, 2008), 73 Fed. Reg. 53303 (Sept. 15, 2008) (SR-NYSE-2008-59), https://federalregister.gov/a/E8-21332; Commission Order Approving Rule Shortening Time Period for Listed Companies to Issue Press Release After Noncompliance with NYSE Price Test, Release No. 354-58900 (Nov. 5, 2008), 73 Fed. Reg. 67241 (Nov. 13, 2008) (SR-NYSE-2008-105), https://federalregister.gov/a/E8-26894.
 Commission Order Eliminating Broker Discretionary Voting on Executive Compensation, Release No. 34-62874 (Sept. 9, 2010), 75 Fed. Reg. 56152 (Sept. 15, 2010) (SR-NYSE-2010-59), https://federalregister.gov/a/2010-22934; Commission Order Amending Listing Rules for Compensation Committees, Release No. 34-68639 (Jan. 11, 2013), 78 Fed. Reg. 4570 (Jan. 22, 2013) (SR-NYSE-2012-49), https://federalregister.gov/a/2013-01106.
 Some of the neutral rules harmonized exchange rules with related Commission rules. For example, NYSE amended two of its board director independence tests to adopt the Commission’s materiality threshold and conform to the standards on Nasdaq and Amex regarding “Direct Compensation.” Commission Order Amending Listed Company Manual with respect to Two of Its Director Independence Tests, Release No. 34-58367 (Aug. 15, 2008), 73 Fed. Reg. 50061 (Aug. 25, 2008) (SR-NYSE-2008-75), https://federalregister.gov/a/E8-19591.
 The precursor to the modern New York Stock Exchange was established under a buttonwood tree outside 68 Wall Street on May 17, 1792, when 24 stockbrokers entered into the famous Buttonwood Agreement, a copy of which hangs in the Office of the Investor Advocate.
 I also believe the process could be improved by demanding more thorough economic analysis of proposed changes to exchange rules, but that is a topic for another day.
 NYSE Listed Company Manual Section 101.00.
 In 2004, the Commission published a concept release on a range of issues relating to the self-regulatory system (“2004 SRO Concept Release”). The 2004 SRO Concept Release identified several attributes of, and new challenges facing, the SRO system, such as conflicts among and between members, market operations, issuers, and shareholders; inefficiencies of multiple SROs; cross-market surveillance; and funding of regulation. See Commission Concept Release Concerning Self-Regulation, Release No. 34-50700 (Nov. 18, 2004), 69 Fed. Reg. 71256 (Dec. 8, 2004), https://federalregister.gov/a/04-26154. At the same time that the Commission issued its 2004 SRO Concept Release, the Commission also proposed rules relating to the governance, administration, transparency, and ownership of national securities exchanges and national securities associations (“2004 SRO Governance and Transparency Proposal”). The 2004 SRO Governance and Transparency Proposal addressed the manner in which SROs manage the conflicts of interest inherent in any self-regulatory structure and the effectiveness of the SROs’ regulatory programs. See Commission SRO Governance and Transparency Proposal, Release No. 34-50699 (Nov. 18, 2004), 69 Fed. Reg. 71126 (Dec. 8, 2004), https://federalregister.gov/a/04-26153. The Commission never acted on that proposal.