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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks before the Ninth Annual Conference on SEC Regulation Outside the United States


Commissioner Cynthia A. Glassman

U.S. Securities and Exchange Commission

London, England
February 24, 2005

Thank you, Mark. It is a pleasure to be back. Before I begin, let me state that the views I express today are my own and do not necessarily reflect the views of the Commission or the staff.

Last year, I spoke to you about the SEC's regulatory response to the corporate and mutual fund scandals of the past few years, and mentioned a number of areas in which I felt reassessment of the decades-old regulatory status quo was in order - SRO governance, oversight of credit rating agencies, soft dollars and market structure. We are in the process of reassessing all of these areas, and we are also beginning to reassess some of our newer rules and proposals.

With the benefit of another year of experience at the SEC, I am more convinced than ever of the importance of objective thinking about the impact and effectiveness of our rulemaking proposals. Our rules should represent real solutions to real problems. We should pay serious attention to the comments we receive and weigh the evidence carefully in making decisions on whether to make a rule, change a rule or go in a different direction from a rule proposal. Changing a proposal based on new information should not be perceived as "backing down." On the contrary, the whole point of the notice and comment process is to get the benefit of commenters' views. Thus, it is gratifying to me when we get the process and the outcome right - and in most cases, I think we do.

For example, in the aftermath of the mutual fund scandals, the Commission proposed a number of reform measures. I supported rule proposals that I believed created the right incentives for good behavior, such as the rule requiring fund companies to hire a compliance officer and adopt supervisory procedures. Many funds already had compliance officers, but not all funds did, and the rule signaled the importance of having strong compliance procedures and designating - and empowering -- individuals responsible for enforcing them. By contrast, I raised questions about other proposals that seemed to be overbroad or not sufficiently likely to deter abusive practices. The "hard 4" proposal, for example, was designed to prevent late trading, but its prescriptive approach could have caused other problems, so we have been exploring different, and more creative, alternatives. A mandatory redemption fee always struck me as a relatively ineffective way to deter market timing, and the proposal had a number of flaws, as was pointed out in the comment letters. We will be considering adoption of a revised proposal shortly.

When it comes to disclosure, a good way of getting input on the advantages or disadvantages of proposed rulemakings is to present proposed disclosure language to real live investors. The Commission is working right now on a "point of sale" disclosure document intended to give mutual fund investors a clearer understanding of the fees and costs they pay for all the activities related to the operation and sale of the fund and the conflicts of interest that may arise from their broker-dealer's distribution of fund shares. Investors have a right to know that their broker's recommendation may have been influenced by payments the broker and/or the firm receive from mutual funds to distribute their shares or to place their shares on a firm's preferred list. The Commission's Office of Investor Education and Assistance has worked with investor focus groups to get a better sense of the information that investors would find most helpful, and we will be seeking additional comment on certain disclosure forms based on what the investor focus groups found most useful.

The one area that the point of sale document would not cover is mutual fund transaction fees, which we are looking at separately. The Commission published a concept release in 2003 soliciting comments on how to improve disclosure of mutual fund transaction costs. It's easy to measure commissions. It's harder to measure soft dollars, and we recognize that it's even more difficult to measure spread, market impact and opportunity costs. One suggestion I made for getting at costs and market impact was to have funds gross up their assets with transaction costs and then compare the grossed-up number to the value after transaction costs and other expenses are deducted. The difference should capture all explicit and implicit costs.

Going forward, I strongly believe the Commission should conduct a full-scale, top-to-bottom review of the mutual fund disclosure regime, encompassing not only the prospectus and SAI, but also annual and semi-annual reports, account statements, advertising and websites. Starting with a blank sheet of paper, we should identify the most meaningful and helpful disclosures to investors and determine what content, format and disclosure vehicle works best. As with the "point of sale" forms, getting input from real investors will be critical to assessing the type of disclosure that would be informative and useful.

Another area in which the Commission is grappling with disclosure issues involves a current rule proposal intended to clarify the scope of the broker-dealer exception to the Investment Advisers Act, particularly the meaning of advice "solely incidental to" a brokerage business. As you know, a broker-dealer providing non-discretionary advice that is solely incidental to its brokerage services has traditionally been excluded from the definition of investment adviser as long as no special compensation was received. The Tully Report commissioned by the SEC in 1995 encouraged the development of asset-based compensation as a way to more closely align brokers' interests with their customers' interests, and many brokerage firms offer fee-based as well as commission-based services. Our reproposal would permit a broker-dealer to provide non-discretionary advice that is solely incidental to brokerage services to be paid for on an asset-based or fixed-fee basis without treating the account as an advisory account. The proposal would also treat all discretionary brokerage accounts as advisory accounts.

Surveys show that investors do not make distinctions between the suitability requirement of a broker and the fiduciary obligation of an investment adviser, believing that financial advisors of any stripe are required to put investors' interests first.1 Therefore, we have proposed to require ads and account opening documents for fee-based, non-discretionary accounts to include disclosure that the customer is opening a brokerage, not an advisory account, and that there are differences between the obligations of a broker as opposed to an investment adviser. We are not proposing that the disclosure delineate all the differences nor are we suggesting that one regime is better than the other. It is important to make clear, however, that there are differences and that investors should make sure they understand the differences before they decide which type of account is appropriate for them. Our investor education office is working with investor focus groups on the proposed disclosure, and I will be extremely interested to see the results of the outreach.

This notion of taking a fresh look at our rules, reviewing them to see what is working and what no longer makes sense, including, as I said, getting reaction from actual investors, is something I had hoped to do when I arrived at the Commission at the beginning of 2002. Of course, a few rulemaking priorities got in the way. The goal of such a review would be to analyze whether our rules are accomplishing their objectives in a relevant, effective and efficient way, with minimum burden, in the markets of the 21st century. For this reason, I have been very supportive of the reform proposals under the Securities Act to free up communications during the offering process. It makes no sense that a broker can read information about an offering to a prospective investor over the phone, but would violate Section 5 if the same information were sent in an email. We should be encouraging the flow of information, not discouraging it. It also makes no sense for issuers to be spending thousands of dollars to print and deliver final prospectuses that are not required to be sent until after the investor has made his investment decision. These are just two examples of the many inefficiencies in our current securities registration system that the reform proposal addresses.

No speech would be complete without a reference to the post-Sarbanes Oxley world and specifically, Section 404. It is too early to truly assess the costs and benefits of Sarbanes-Oxley, although, for the most part, my impression is that it is accomplishing its objectives without undue burden. I do have a concern about Section 404, which requires management to report on companies' internal controls and auditors to opine on both management's assessment and on the effectiveness of the internal controls themselves. I have been concerned from the beginning that Section 404 would become an expensive, short-term, check-the-box exercise, taking focus away from management and moving it to internal and external auditors. Further, I have been concerned that the 404 assessment would not be seen by senior management and boards as an important component of their overall risk management. The problems I am hearing about include a focus on the minutiae of financial controls, while missing the bigger picture, as well as documentation for the sake of documentation. I am concerned that internal controls have become an end in themselves and not, as intended, a means to the end of limiting the possibility of fraud or mistakes in financial reports.

As the reports come out, it is critical that the marketplace puts this first year of 404 reporting in context. Disclosure of material weaknesses or significant deficiencies does not necessarily mean the financial statements are deficient. What is important is that management provides meaningful descriptions of the material weaknesses and their consequences, as well as the remedial actions that have, or will, occur to rectify the problem.

As a result of concerns about 404, the Commission is making a serious effort to understand what has worked well and what has not in order to improve and streamline the Section 404 process. We have delayed the final implementation phase for the accelerated filing dates for periodic reports to take off some of the pressure, and delayed for up to 45 days the required management report on internal controls and the auditor report on management's assessment for certain smaller accelerated filers. We've created a Smaller Public Company Advisory Committee to study the effect of Sarbanes-Oxley on smaller companies, and scheduled a broad-based roundtable discussion on Section 404 for April 13, 2005.

We've received requests from foreign issuers to delay their Section 404 compliance date, and those requests are being given serious consideration. In a related initiative, we are also looking at ways to make it easier for foreign issuers to deregister their securities. An expanding and ever-changing global marketplace is giving foreign issuers more options for raising capital than in U.S. markets. Even after delisting from a U.S. exchange or Nasdaq, however, foreign issuers cannot deregister unless they have fewer than 300 U.S. shareholders of record. Foreign issuers have requested relief from this requirement, and our staff is considering how this might be done.

Overall I think we have taken significant and constructive steps in dealing with the corporate and mutual fund scandals and in reassessing existing and proposed rules. There are certain areas in which I have disagreed, however, with the process and the position that the Commission has taken and that led me to dissent from the adoption of two recent rules: the mutual fund independent chair requirement and the registration of hedge fund advisers.

The stated purpose of the independent chair requirement was to enhance the independence and effectiveness of fund boards and to improve the ability of board members to protect the interests of the fund and fund shareholders. That sounds good, but since many investors base their mutual fund investment decisions on cost and performance, I would have expected that a comparison of those factors between mutual fund companies that have independent chairs and those that do not would have been an important factor in our consideration. Don't misunderstand me - it's NOT that mutual fund corporate governance isn't important. The point is, we were presented with no evidence that this particular requirement would actually enhance corporate governance or provide any real benefits to shareholders. By contrast, the rule will impose real costs on fund shareholders. Approximately 80% of fund companies have non-independent chairs that will have to be replaced, and the new independent chairs will need to have staff.

In my view, the hedge fund adviser registration rule suffered from a similar lack of rigorous analysis. Notwithstanding an 18-month staff review that found no evidence of increased fraud or any significant retailization of hedge funds, the Commission adopted a registration requirement for hedge fund advisers for the express purpose of combating these perceived evils. Ironically, by requiring more hedge fund advisers to register with the Commission, the rule may actually stimulate indirect retailization of hedge funds because pension funds tend to limit their hedge fund investments to funds that have registered advisers. Moreover, the carve-out for hedge funds that require at least a two-year lock-up may swallow the rule, a clearly unintended, but totally predictable outcome. Press reports suggest that longer lock-ups are in fact occurring, which could reduce market liquidity.

I have no doubt that the Commission needs more information on hedge funds. In my view, our first step should have been to articulate our concerns, then identify the type of information that would have been helpful in flagging problems and finally decide how to gather that information and put it to effective use. Unfortunately, the Commission disregarded many, in my view, viable alternatives, including obtaining information about hedge funds from other financial regulators and from market participants that we already regulate or by implementing a notice filing system for hedge funds. I understand that a Commission hedge fund task force is now working to identify the information that examiners should be looking at, but this work should have been completed prior to the adoption of the rule. We lost precious time by putting the cart before the horse. Had we approached the hedge fund issue analytically at the outset - deciding what information we needed and how best to get it - we would be in a much better position today to provide effective oversight and to see red flags.

As I mentioned at the start of my remarks, the Commission has a number of significant issues on its plate in the coming months. My hope is that we don't put any more carts before horses, that we very clearly define the problems we are seeking to address, and that we really consider all reasonable options - including market solutions - in order to meet our ultimate goals of protecting investors and promoting efficient capital markets.

Thank you.



Modified: 02/24/2005