Remarks at the “SEC Speaks” Conference 2017: Remembering the Forgotten Investor
Acting Chairman Michael S. Piwowar
Feb. 24, 2017
Thank you very much, Stephanie [Avakian] and Dave [Grim], for your kind introduction.
Before I begin, I would like to continue a tradition of the SEC Speaks conference and ask that all current staff members of the Securities and Exchange Commission stand so that we may show them our appreciation. SEC employees devote countless hours of hard work and careful thinking in preparing for this event. Next, I would like all those who have ever served at the Commission to rise. I am certain that I speak for my fellow Commissioner, Commissioner Stein, when I express our gratitude for your many years of loyal service to the agency and to our country. Thank you very much.
As is true across the federal government, we are at a time of transition at the SEC. Hopefully we will soon have a Chairman confirmed and the other two vacancies on the Commission filled. In the meantime, the agency remains steadfastly devoted to our core mission, and our work continues.
The Forgotten Investor
In my public statements and speeches, I have stressed the importance of the Commission’s threefold mandate. I do so because all of us—the Commissioners, the staff, market participants, and the public—stand to benefit from a reminder from time to time. Let me continue the refrain: the Commission shall (i) protect investors, (ii) maintain fair, orderly, and efficient markets, and (iii) facilitate capital formation.
Reflecting on our core mission focuses the mind on important questions. Where do we see market failures occurring? What has Congress authorized us to do about them? Why is Commission intervention necessary? How can we regulate most effectively? Which of our menu of regulatory alternatives is best? Yet, all too often, missing from the equation is another question: Whom do we serve?
My theme today is “Remembering the Forgotten Investor,” by which I mean the men and women of our country whom securities regulation is meant to serve and protect but so often has not. I am borrowing here, of course, from the great Yale sociologist of the late-19th and early-20th centuries, William Graham Sumner (1840-1910), who is perhaps best known for coining the term “Forgotten Man” in an essay of the same name. Sumner defined his concept in almost algebraic terms:
As soon as A observes something which seems to him to be wrong, from which X is suffering, A talks it over with B, and A and B then propose to get a law passed to remedy the evil and help X. Their law always proposes to determine what C shall do for X or, in the better case, what A, B, and C shall do for X.
For Sumner, “C”—not “X”—is the Forgotten Man, or rather, the “man who is never thought of.” He is “the victim of the reformer, social speculator[,] and philanthropist,” even where, as is sometimes the case, actions may be motivated by the very best of intentions. It is the Forgotten Man who is commonly dragooned into someone else’s quixotic crusade, sometimes without his knowledge or consent, and often contrary to his interests.
I would like to persuade you that Sumner’s formula has something to teach us about the course of securities regulation in our day. Sumner’s Forgotten Man is, in our case, the Forgotten Investor, and that forgotten investor has suffered in a number of contexts over the years. I will focus on just a few such examples today, including special-interest disclosure provisions, the “accredited investor” threshold, and civil monetary penalties.
Disclosure and Its Discontents
Disclosure-based securities regulation is the great innovation of our agency. As Justice Louis Brandeis famously wrote, “sunlight is said to be the best of disinfectants; electric light the most efficient policeman.” Notice that in Brandeis’s epigram, disclosure is the disinfectant; disclosure is his policeman. Without disclosure, investors have only the most indistinct impressions of a corporation’s finances or a mutual fund’s portfolio holdings—they perceive the world vaguely, as “through a glass, darkly.” But give investors light, and they will have eyes to see.
Imagine, arguendo, that we lived in a utopian world in which perfect disclosure of all material information about every company simply existed as a natural feature of the market landscape. Securities markets would be perfectly efficient, with a common state of knowledge immediately and effortlessly transmitted to all investors. Investors would have just what they need—not too much, not too little—to make perfectly informed investment decisions to buy, sell, or hold securities. I need not remind you, however, that we do not live in such a Goldilocks world where the level and content of disclosure is predestined to be “just right.”
The Commission thus has an obvious and active role to play in empowering investors through disclosure. Unlike merit-based regimes, our system of disclosure comports well with American traditions of self-reliance, pioneering spirit, and rugged individualism. By arming investors with information, they can evaluate and make investment decisions that support more accurate valuations of securities and a more efficient allocation of capital. Yet we must never lose sight of the legal standard of materiality. As Justice Thurgood Marshall, writing for a unanimous Supreme Court in the seminal case of TSC Industries v. Northway, stated, “[t]he question of materiality, it is universally agreed, is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor.” Justice Marshall expressed his concern that an unnecessarily low standard of materiality and the resulting fear of exposure to substantial liability might cause issuers to “simply bury the shareholders in an avalanche of trivial information—a result that is hardly conducive to informed decision making.”
Unfortunately, agreement as to the question of materiality has not been as universal as Justice Marshall supposed. As my good friend, former Commissioner Troy Paredes, noted on this same stage four years ago, an avalanche of immaterial information has been very much in evidence in recent years. Our disclosure regime has repeatedly been coopted for purposes unrelated to investor protection as traditionally understood. Politically motivated disclosure provisions are a manifestation of A and B’s taking advantage of C. Or, in Sumner’s pithy summation: “Such is the Forgotten Man. He works, he votes, generally he prays—but he always pays—yes, above all, he pays . . . . All the burdens fall on him, or on her . . . .”
The Dodd-Frank Act is rife with examples of burdens ultimately borne by the Forgotten Investor through shareholder money and company resources being expended to provide non-material disclosures—the conflict minerals, pay ratio, and resource extraction provisions to name a few. In an attempt to rationalize our disclosure regime and, in particular to consider impacts on the Forgotten Investor, in recent weeks I have directed the SEC staff to begin reconsideration of two Dodd-Frank mandated rules. Congress and President Trump have vacated a third.
- On January 31, I asked the staff to consider whether its 2014 guidance on the conflict minerals rule “is still appropriate and whether any additional relief [may be] appropriate.” I did so not from any lack of familiarity with or sympathy for the plight of the beleaguered people of the Democratic Republic of the Congo region. As I noted in my public statement, “while visiting Africa last year, I heard first-hand from the people affected by this misguided rule,” which has caused a “de facto boycott of minerals from portions of Africa.” I am concerned that “withdrawal from the region may undermine U.S. national security interests by creating a vacuum filled by those with less benign interests.” Nevertheless—whatever the purported benefits of the rule may be—I believe it is categorically wrong to use shareholder assets to fund a humanitarian effort better left to executive agencies with the requisite experiential knowledge.
- Similarly, on February 6, I asked for public comment on any “unexpected challenges” encountered in the implementation of the pay ratio rule, specifically directing the staff “to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.”
- On February 14, President Trump signed into law a joint resolution of Congress, passed under the Congressional Review Act (the “CRA”), that vacated the Commission’s rule requiring resource extraction disclosures. I have asked the staff to take a fresh look at the rule mandate to determine how we can comply with our statutory obligations in a manner that better aligns with our core mission.
I look forward to working closely with the Division of Corporation Finance and my fellow Commissioners to advance these and other disclosure initiatives in the year to come.
The Accredited Investor Threshold, or How the Other Half Lives
In other contexts, we do not even have to apply Sumner’s Forgotten Man framework to identify those investors whose best interests are being overlooked. Take the registration requirements under the Securities Act of 1933 (the “Securities Act”) and the various exemptions therefrom, including Regulation D. We commonly analyze these rules from the perspective of issuers of securities, with a view to promoting capital formation in the United States. But what if we were to consider these rules from the perspective of the Forgotten Investor?
The Securities Act prohibits the use of any instrument of interstate commerce to offer or sell a security, unless pursuant to a registration statement declared effective by the Commission. It also prohibits “every attempt or offer of, or solicitation of an offer to buy, a security or interest in a security, for value,” defining “offer” broadly to encompass any public statements that might “condition the market” or arouse interest in an issuer. Of course, the Commission has extended certain exemptions from this system, prominently including Regulation D’s safe harbor for private offerings. Regulation D is based on a provision of the Securities Act that exempts “transactions by an issuer not involving any public offering,” an exemption that the Supreme Court has held turns on whether “the particular class of persons affected needs the protection” of the securities laws.
Distinguishing investors who can fend for themselves from those who cannot is a line-drawing exercise fraught with peril. The Commission did just that in 1982 when it adopted Regulation D, dividing the world of private offering investors into two categories: those persons accorded the privileged status of “accredited investor” and those who are not. Like something out of the ancien régime, investors lucky enough to earn $200,000 or more in annual income or with a net worth of more than $1 million have available to them myriad investment choices, both public or private. By contrast, les Misérables on the other side of the line are severely restricted in their investing options. The $200,000 income test has not been updated since 1982, whereas the net worth test was revised by the Dodd-Frank Act to disallow the counting of home equity, raising the bar even higher to qualify as an “accredited investor.”
In my view, there is a glaring need to move beyond the artificial distinction between “accredited” and “non-accredited” investors. I question the notion that non-accredited investors are truly protected by regulations that prevent them from investing in high-risk, high-return securities available only to the Davos jet-set.
Here, I appeal to two well-known concepts from the field of financial economics to show that, in maintaining an “accredited” status in our regulatory structure, we may have forgotten—and in fact disadvantaged—a set of investors. The first is the risk-return tradeoff. Because most investors are risk averse, riskier securities accordingly offer higher returns. Therefore, prohibiting non-accredited investors from investing in high-risk securities amounts to a blanket prohibition on their earning the very highest expected returns.
The second concept is modern portfolio theory. By holding a diversified portfolio of assets, investors reap the benefits of diversification. That is, the risk of the portfolio as a whole is lower than the risk of any individual asset. The correlation of returns is the mathematical key. When adding high-risk, high-return securities to an existing portfolio, so long as the returns from the new securities are not in perfect positive correlation with the existing portfolio, investors may reap higher returns with little to no change in overall portfolio risk. In fact, if the correlations are low enough, the overall portfolio risk can even decrease. As such, excluding certain investors from diversification options deprives them of important risk mitigation techniques.
These two basic concepts of economics demonstrate how even a well-intentioned policy of investor protection can do more harm than good, for instance, by exacerbating inequalities of wealth and opportunity.
Whose Pocketbook?—Assessment of Corporate Penalties
I am often asked to describe my thinking when it comes to the assessment of civil monetary penalties on corporations in enforcement actions, especially since I have voted both for and against corporate penalties. I start from the premise that we must bear the Forgotten Investor in mind when we consider imposing such sanctions.
Take a typical accounting fraud scenario. A financial reporting fraud by the managers of a large company may result in the loss of billions of dollars of market capitalization when the fraud is discovered by the market. This may have widespread direct or indirect effects on millions of shareholders, the value of whose investment plummets. It is entirely appropriate to discipline and punish corporate malefactors who violate our laws, but, when we speak of penalizing a corporation, we must also remember the innocent investors who are so often the primary victims of the fraud. Ultimately, who is actually penalized by our penalties?
Of course, every case is different. There are circumstances in which I am fully prepared to support imposition of civil monetary penalties on a corporation. Consider regulated entities, such as broker-dealers or investment advisers, for example. These entities clearly disclose in their corporate filings the degree to which they are regulated and the risk that they may be hit with a penalty if they violate the securities laws. So shareholders are on fair notice—and the market has presumably priced in—that they are investing in a type of entity subject to particular enforcement risks. Similarly, I am generally comfortable with assessing civil monetary penalties in Foreign Corrupt Practices Act cases. According to academic literature, there is evidence that when such violations are revealed to the market, the stock price does not always fall, and may even increase. In sorting through other types of entities and violative conduct, I look to the factors set forth in the Commission’s 2006 guidance on penalties and to the excellent event studies and other analyses produced by our Division of Economic and Risk Analysis.
It is all too easy to say that, even in other factual scenarios, corporations that engage in wrongdoing should be penalized where it hurts the most—financially. However, that objective often overlooks a key constituency. Again, the Forgotten Investor, who has already been victimized by corporate fraudsters, is further made to pay for the sins of others.
Three’s Company, but Two’s a Quorum
Even once we have redoubled our efforts to keep the Forgotten Investor in mind, the Commission is limited in what it can do during this period of transition. For one, as the sole members of the Commission at the moment, Commissioner Stein and I are unfortunately constrained in our ability to discuss the work of the Commission without creating a quorum and becoming subject to the Government in the Sunshine Act. Despite such challenges, the Commission’s work moves forward. I am very pleased that we have immediate opportunities to seek to provide meaningful disclosure improvements for the Forgotten Investor.
At our open meeting on March 1, the staff will present four new disclosure recommendations for the Commission to consider:
- Industry Guide 3: The last substantive revisions to Industry Guide 3 (Statistical Disclosure by Bank Holding Companies) were undertaken over 30 years ago. The Commission will consider publishing a request for comment to seek public input about disclosures provided by registrants in the financial services industry.
- Exhibit Hyperlinks and HTML Format: The Commission will consider introducing a requirement to include a hyperlink to each exhibit listed in the exhibit indices of filings under Item 601 of Regulation S-K (or on Forms F-10 or 20-F). The Commission will also consider whether to require registrants to submit such registration statements and reports to EDGAR in HTML format.
- Inline XBRL Filing of Tagged Data: The Commission will consider whether to propose amendments to require the use of “Inline XBRL” format for the submission of operating company financial statement information and mutual fund risk/return summaries. Further, the Commission will consider whether to eliminate the requirement for filers to post Interactive Data Files on their website and whether to terminate the Commission’s voluntary program for the submission of financial statement information interactive data.
- Exchange Act Rule 15c2-12: Lastly, the Commission will consider whether to propose amendments to Rule 15c2-12. The proposal would amend the list of event notices that a broker, dealer, or municipal securities dealer acting as an underwriter in a primary offering of municipal securities must reasonably determine that an issuer or obligated person has undertaken, in a written agreement or contract for the benefit of holders of the municipal securities, to provide to the Municipal Securities Rulemaking Board. The proposed amendments would add two event notices relating to certain financial obligations incurred by issuers and obligated persons.
The current two-member Commission has been advancing the interests of the Forgotten Investor in other ways, too. For instance, on February 17, I was pleased to attend a ceremony with our friends and colleagues of the North American Securities Administrators Association to sign an information-sharing agreement as new rules to facilitate intrastate crowdfunding offerings and regional offerings take effect. The agreement not only builds on an already productive relationship between the SEC and state regulators, it also offers additional insights and protections as we help companies grow and create jobs while providing new opportunities to investors.
Finally, the Commission has taken action to prevent members of our nation’s Armed Services from joining the ranks of Forgotten Investors, particularly now as the military has begun its transition away from a defined benefit pension to a defined contribution plan. When I was honored to visit the sailors aboard the U.S.S. Carl Vinson recently, it became clear to me that more needs to be done to provide these brave defenders of our liberties with the tools to educate and protect themselves in planning for their retirements. While the SEC already provides military outreach through a variety of mechanisms, I saw an opportunity for us to centralize these efforts and develop new channels of military outreach to meet the investor education needs of the soldiers, sailors, marines, and airmen who so proudly serve our country. I am pleased that our Office of Investor Education has recently announced a position to do just that.
The SEC Speaks conference offers the Commission and members of the securities industry and bar an opportunity to discuss, exchange, and debate ideas. We at the Commission take this opportunity seriously, which is why we have historically devoted so many resources to this event. Throughout the next two days, we will be immersed in our specialized world of jargon and of technical detail. Like Sumner’s A and B, we may inadvertently focus so heavily on the problems we perceive in the securities markets and our favored solutions to those problems that we forget the whole reason we are gathered here today: The Forgotten Investor. I therefore leave you with a challenge: In all that you do and say at this year’s conference: Remember the Forgotten Investor!
Thank you very much for your kind attention and for your continued devotion to the SEC’s mission. Congratulations on your past successes. I look forward to working with you in the year to come.
 The views I express today are my own and do not necessarily reflect those of the Commission or my fellow Commissioners.
 William Graham Sumner, The Forgotten Man and Other Essays (Albert Galloway Keller, ed., 1918).
 Id. at 466.
 Louis D. Brandeis, “What Publicity Can Do,” Harper’s Weekly, Dec. 20, 1913, at 10, reprinted in Louis D. Brandeis, Other People’s Money and How the Bankers Use It 92, 92 (Frederick A. Stokes Co., 1914).
 I Corinthians 13:12.
 426 U.S. 438, 445 (1976).
 Id. at 448-49.
 Remarks at The SEC Speaks in 2013, Commissioner Troy A. Paredes, U.S. Securities and Exchange Commission (Feb. 22, 2013), https://www.sec.gov/News/Speech/Detail/Speech/1365171492408.
 Sumner, supra n. 3, at 491.
 Statement on the Effect of the Recent Court of Appeals Decision on the Conflict Minerals Rule, Keith F. Higgins, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission (Apr. 29, 2014), https://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541681994.
 Reconsideration of Conflict Minerals Rule Implementation, Acting Chairman Michael S. Piwowar, U.S. Securities and Exchange Commission (Jan. 31, 2017), https://www.sec.gov/news/statement/reconsideration-of-conflict-minerals-rule-implementation.html.
 Reconsideration of Pay Ratio Rule Implementation, Acting Chairman Michael S. Piwowar, U.S. Securities and Exchange Commission (Feb. 6, 2017), https://www.sec.gov/news/statement/reconsideration-of-pay-ratio-rule-implementation.html.
 Pub. L. No. 115-4 (2017).
 15 U.S.C. § 77e (2012).
 Id. at § 77b(a)(3) (2012).
 See 22 Fed. Reg. 8359 (Oct. 24, 1957).
 15 U.S.C. § 77d(a)(2) (2012).
 SEC v. Ralston Purina Co., 346 U.S. 119 (1953).
 Dodd-Frank Wall Street Reform and Consumer Protection Act, § 413(a), Pub. L. No. 111-203 (2010).
 See, e.g., The Value of Foreign Bribery to Bribe Paying Firms, Jonathan M. Karpoff, D. Scott Lee, and Gerald S. Martin (June 16, 2015), https://papers.ssrn.com/sol3/papers2.cfm?abstract_id=1573222.
 See 5 U.S.C. § 552b (2012).
 Industry Guide 3’s last substantive revision, which added disclosures regarding loans and extensions of credit to borrowers in countries experiencing liquidity problems, occurred in 1986. See Amendments to Industry Guide Disclosures by Bank Holding Companies, SEC Release No. 33-6677, 51 Fed. Reg. 43594 (Nov. 25, 1986).