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Speech by SEC Commissioner:
Practicing Law Institute — My Top 10 Observations as an SEC Commissioner


Commissioner Cynthia A. Glassman

U.S. Securities and Exchange Commission

Washington, D.C.
March 5, 2004

Thank you. I am delighted to see you all here again. I can't believe I have been at the Commission over two years. In some ways, the time has flown by. On the other hand, looking back on all the problems we have tackled, it sometimes seems like an eternity.

With the standard disclaimer that the views I am about to express are my own - and not those of the Commission or the staff - and with the risk of raising completely false expectations that this will be a comedy routine, I thought that I would spend my ten minutes with you talking about my top 10 observations as a commissioner. Here they are:

1) Just because that's the way it has always been done, doesn't make it right now. Rules can become obsolete for different reasons. Some outlive their original purpose. For example, Rule 12b-1 fees, the fees used by mutual funds to pay broker-dealers to distribute their funds, may have outgrown their original purpose of helping the nascent mutual fund industry grow some 25 years ago. Other rules, including the trade-through rule, may become unfair or ineffective because of changing technology. Although the problems with that rule are often stated in terms of its requiring a choice between speed and price, I think it's more of a case of a "bird in the hand is worth two in the bush." My understanding is that trying to get the so-called "best price" may mean giving up a price certain on an electronic market for a better, but not guaranteed price on a manual market. Further, some rules or statutory provisions are abused. Soft dollars, whose purpose is to cover mutual fund research costs, have sometimes been used to fund items unrelated to the manager's investment decision-making process such as adviser overhead costs, and travel and entertainment expenses. Other rule changes affect the impact of existing rules. Decimalization, by creating additional price points, has made it easier to "step ahead" of orders, while decreasing liquidity for larger sized orders. In these and other cases, I question whether the status quo still works. If it does not, we need to recognize that and make changes promptly.

2) We shouldn't write rules just because we can. Writing rules is easy. Writing good rules is hard. Writing no rules in this environment is even harder. We need to focus on whether a proposed rule is a real solution to a real problem, not window dressing and not form over substance. When we have the opportunity to do some "clinical testing" with real data before we finalize a rule, we should. Our pilot de minimus exemption from the trade-through rule for ETFs and our proposed pilot program on the short sale rule are examples of how the Commission can gather empirical information. Mutual fund governance is another excellent example of how we can use existing data to test the efficacy of proposed rules. As I said when I voted to put the rule proposal out for comment, unless we have credible evidence that a specific board structure - in this case, an independent chairman and 75% independent directors -- makes a difference to the outcomes that are important to investors, we should not kid ourselves or the rest of the world that we have solved the problem of complacent Boards. I'd like to see data on this. In addition, when we don't have data before rules go into effect, we should monitor them after implementation to identify unintended consequences, and revisit the rules, if appropriate.

3) We can't legislate ethics, but we can motivate people to do the right thing. While I normally prefer carrots to sticks, there is no question that fear is a potent motivator. Therefore, if fear of an investigation or enforcement action motivates board directors and executives to make sure that their companies are complying with the spirit and the letter of the securities laws, that's OK with me - just as long as the result is that people are encouraged to, and in fact, do the right thing without good people being scared away from being company directors or executives.

4) Complexity and the lack of transparency hide problems. Not only is the result that people don't understand what is happening, we have also seen, in some cases, that they don't ask appropriate questions. There are a number of possible reasons for this, including that they are not paying attention, don't know what questions to ask, or fear that they will look dumb. Ultimately, as with the Emperor's new clothes, someone finally points out the naked truth. Examples of this phenomenon include the use of special purpose entities to hide financial frauds, the impact of derivatives and their complex accounting treatment on financial reporting, and questionable compensation packages. In contrast, clarity and transparency promote better behavior. People think twice about what they are doing if the naked truth is staring them and the rest of the world in the face. This is why I have urged the fixed income markets to move towards real-time price transparency as quickly as possible.

5) Every sector in this business has an agenda. What the past few years has taught us is that some market participants seem to have forgotten that treating customers fairly should be their top objective. While our mission is to protect investors and promote efficient capital markets, I sometimes feel like I am being asked to be a referee among competing business interests. For me, the most effective advocates for their position are those who can address both sides of an issue fairly and explain why their way is better for investors. Which brings me to my next point.

6) We at the Commission can't please everyone, nor should we try. In many cases, the Goldilocks theory applies. That is, if some people think we have gone too far, and others think we have not gone far enough, then we probably got it right. In those cases, we can get consensus agreement. Many of the Sarbanes -Oxley rules fit that description. However, there are times, albeit relatively few in my experience, when it is difficult to reconcile everyone's views - both the public's and our own - and a compromise solution cannot be reached. In those cases, a divided vote is the only answer - essentially, we agree to disagree, and the majority position rules.

7) Money is money - a fee by any other name is still a fee. The various issues surrounding mutual fund fees prompted this observation. Mutual fund investors deserve full, clear, and timely disclosures of the fees and costs that come out of their pockets - directly or indirectly - to pay for all activities of the fund, including payments for marketing, distribution, transactions, and research. Giving fees arcane labels such as 12b-1 fees or soft dollars makes it very difficult for average investors to understand the extent to which their investment dollars are used for something other than investment. We need to focus on making sure investors get the information they need. Following along on that point,

8) Developing clear, concise and informative disclosures is very hard. It is particularly hard when securities lawyers used to dealing with complex or arcane issues try to write something in simple, plain language that can be understood by a financially unsophisticated investor. But it can be done, and if it meets the objective, it is definitely worth the effort.

9) Survey after survey shows that investors at all stages of life are woefully lacking in the knowledge needed to make sound investment decisions. We must continue our efforts to educate investors. I am particularly excited about the role our new investor education fund will play. Which brings me to my final point.

10) Gordon Gekko to the contrary, greed is bad. As I review case after case in our enforcement docket, I am constantly asking the question: "What were they thinking?" That question does not just apply to the perpetrators of frauds. It sometimes applies to the victims. How can someone really believe that a 13,000% a year return could be legitimate? And I am not making that up. Proving that there's no honor among thieves, the most ironic cases of greed involve the scammers who lose their ill-gotten gains to other scams. We have seen that more than once. And while cooperating in our enforcement actions may result in reduced sanctions, it is really better to avoid engaging in bad conduct in the first place.

To conclude, we continue to face a number of challenges in carrying out our mission. The scope and pace of our work have not let up. I want to thank the Chairman and my fellow Commissioners for their dedication, and I want to thank our staff for the tremendous effort they continue to put forth. I also want to express my appreciation to the members of the securities bar, who support our efforts in developing and implementing our rules. Together, we are maintaining the world's best capital markets and making the world safer for investors.

Thanks - and see you next year!


Modified: 03/05/2004