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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Charles Hamilton Houston Lecture


Paul S. Atkins

U.S. Securities and Exchange Commission

Washington, D.C.
April 4, 2005

Thank you, Dean Schmoke, for your introduction. It is I who am honored to share a stage with you and to share time with this wonderful student body. Dean Schmoke has been a personal inspiration to me for years, particularly for his tireless and innovative efforts in Baltimore and beyond to improve the quality of education, enhance economic development in our inner cities, revitalize our neighborhoods, and think out of the box on topics such as the war on drugs and its effect on our society. I also should mention that I am grateful that just a few weeks ago he appeared as the keynote speaker at our agency's Black History Month program.

Along with you, Dean Schmoke, the list of illustrious deans of this law school includes Charles Hamilton Houston, after whom this lecture series was named. Dean Houston was a native Washingtonian, graduate of Harvard Law School, and zealous opponent of segregation. In addition to the enormous contributions that he made in his own right, Dean Houston served as mentor to many future champions of civil rights. Among his mentees was a young Thurgood Marshall, whose illustrious legal and judicial career, has inspired many aspiring lawyers. It is, therefore, a great honor to be here with you to honor the memory of Dean Houston and the students who are here today, who will carry on that memory in their own legal and business careers.

Before I begin, I must remind you that the views that I express here are my own and do not necessarily represent those of the Securities and Exchange Commission or my fellow commissioners.

As Dean Schmoke mentioned, I worked at the SEC 15 years ago. In those days, I remember calling other government offices and introducing myself as calling from the SEC. In the alphabet soup of Washington, I learned quickly that I needed to enunciate S-E-C clearly, or say the complete name. Otherwise, I invariably would be asked if I meant the FCC, FEC, or FTC. No, I would reply, the Securities and Exchange Commission. "Is that a government agency?" I would be asked. "Are you based in Washington or New York?"

Well, those days have certainly changed - the SEC has gone mainstream. Strangely enough, SEC investigations are now the subject of story lines of hit television shows! But, unlike the depictions in these shows, we do not carry M-16s when we arrest Homer Simpson, chase down yachts of inside traders in SEC police boats, or parachute James Bond style into an illicit corporate board meeting. It is MUCH tamer than that. We don't carry guns; we have no boats; we have no planes. We do not even have authority to arrest people.

I am one member of this five-member commission, each of whom is appointed by the President and confirmed by the Senate. The SEC is one of the many so-called "independent agencies," which means that it performs a mix of executive, legislative and judicial functions. The SEC has civil (not criminal) enforcement powers against people who violate the securities laws and our rules; it has power to write rules pursuant to statute; and it acts like an appellate court in reviewing appeals from sanctions that the stock exchanges and the professional organization of brokers levy against their members.

The students present today have important career choices to make in the next several years. I urge those of you who are law students to consider securities law. It is an exciting area in which to practice, particularly in light of the recent significant changes to the statutory and regulatory landscape. Whether you choose private or government practice, you can help to shape the contours of that landscape.

Those of you who are business students likewise have an important role to play in determining how regulation will evolve. I encourage you to bring with you into the corporate world a willingness to confront problems and devise solutions, without waiting for mandates from regulators like me. As a supporter of the free market, it distresses me when business people do not react to perceived problems using a principle-based approach to guide the conduct of their organization and the industry. Those with fresh perspectives, such as new business school graduates, are well-equipped to fight against corporate complacency, identify problems, and engineer new solutions to those problems.

For all of you. it is also rather easy advice for me to give, in this time of challenges to corporate rectitude, that you should choose your employer carefully. Remember that old adage that you can judge a person by the company he keeps? Well, that saying can have a different - and much needed -- meaning today. It goes for whether you are entering a company as a salesperson or as a prospective officer or director. A firm's ethical compass and culture is very important. This culture is set by many influences, but mainly the tone set by its executives, the firm's organizational structure, compensation incentives, and the degree of oversight activity by gatekeepers such as directors, auditors, and attorneys. A CEO's tolerance or lack of tolerance of ethical misdeeds and a CEO's philosophy of business conveys a great deal throughout the organization. A corporation that focuses on ensuring the long-term success of its business is more likely to implement strict internal controls than one that is primarily concerned with achieving short-term targets.

I cannot tell you how many enforcement cases have come before us commissioners lately of hapless corporate employees who have gotten into situations over their heads. Some make the right choices for themselves and the shareholders; others do not. Some cases concern a new hire to a company, who shortly after coming on board discovers that financial fraud is occurring. What do you do in that case, especially if you have moved yourself and your family across the country to take a new job? You are excited about the new job, want to be loyal to your boss and your colleagues, and want to think the best of the situation. What if your boss turns out to be crooked and tells you to do something against your better judgment, but yet you don't know enough about the company to be sure?

With the benefit of 20/20 hindsight years later, it is easy for a government official to argue that you should have seen the clear warning signs, blown the whistle, and quit. Would you be brave enough to do that? What if you are wrong? What does that do to your career? When you face these questions in your ethics classes, pay attention!

Those of you who end up in public service will come to appreciate the difficulty of wielding the extraordinary power of the government effectively and fairly. Much of this power is housed in the many departments and agencies that are charged with carrying out specific functions of government. Those who do not have daily interactions with a government agency may not realize just how much influence bureaucracies wield.

Dean Schmoke is a good example of someone who has worked effectively both in the public and private sectors. Our system relies on what is sometimes derided as the "revolving door." Actually, I think that this criticism is misplaced and the "revolving door" should be commended.

Without a revolving door, we are left with the alternative of a class of career government employees, with no industry experience, relying only on what they have read about to make decisions that have real economic consequences. This is a troubling proposition. Fresh blood from the private sector helps to build knowledge in the halls of government about how things are done and realistic bases for standard-setting. And, importantly, the recirculation of people with government experience back into industry helps to spread the word of what good behavior is before bad conduct happens. These people with regulatory backgrounds become good proselytes for lawful behavior.

The impetus for the rise in reliance on regulatory agencies is that decisions can be made by experts outside the political process. That's why we need experts from industry to help shape these decisions. The complexities of securities law, for example, lend themselves well to expert deliberation. There are, however, dangers to this decentralized, non-political approach to government decision-making. Of great concern to me is lack of transparency and accountability. Process matters. I'd like to explore these concerns in the context of financial regulation.

Back to the SEC. As I mentioned earlier, the SEC is a five-member commission and, generally, all five members vote on official decisions of the Commission. The Commission relies on a staff of over 3,000 to develop recommendations for formulating and implementing Commission policy. Aside from specific areas in which the Commission has delegated authority to the staff, the staff is not empowered to make decisions for the Commission. In practice, however, the Commission has allowed the staff to set Commission policy in important areas. Some of these policies are made in areas in which authority has been expressly delegated. In other instances, staff interpretations are de facto rulemaking.

So, Congress has set up independent agencies because the subject matter is too technical for Congress to legislate on detailed matters. Congress, through statute, sets the general policy and relies on the agencies to implement it. Now, we commissioners often delegate, or by virtue of inaction, implicitly delegate policy making decision to civil servants. Although we have a highly-skilled staff, by vesting policy-making authority in them, we insulate SEC decision-making from the formalized public input it deserves. It is tempting for the Commission to turn matters entirely over to the staff, particularly matters that are highly technical. But, because the devil is often in the details, we need to restrain this impulse as often as possible.

One area in which our staff exercises enormous power is enforcing the securities statutes and the SEC regulations under those statutes. Many of the enforcement actions brought by the Commission against individuals and entities that have violated the securities laws are jointly agreed settlements, rather than cases that are litigated before a judge or jury. Sometimes the Commission staff investigates a problem, negotiates a settlement, and brings it to the Commission for approval - all before any commissioner has heard anything about the case. Oftentimes, the subjects of our actions view acceptance of a settlement by the staff as the equivalent of acceptance by the Commission and they announce their settlements to the public before the Commission has even had a chance to consider them. This places both the staff and the Commission in an awkward position. How does the Commission reject or alter such a public settlement?

For us, this issue has come to a head recently since many of our settlements of late have involved extraordinarily high dollar amounts, which would have been unthinkable five years ago. This is important because commissioners, who are the only public officials at the agency, should be making the determination of whether a $500 million penalty is more appropriate than a $500,000 penalty in a particular case.

This issue concerns me particularly in situations that involve financial fraud where corporate managers have been cooking the books and lying to shareholders. In many of these cases, I would argue that corporate monetary penalties are inappropriate. A fine on a corporation whose managers have engaged in financial fraud punishes the very shareholders who were injured by the financial fraud. That is because corporations are ultimately owned by shareholders, who, at the end of the day, bear most of the costs imposed on the corporation. Fundamentally, the corporation - by that I mean the shareholders - may already have been punished through reputational and stock-price damage.

Unless the corporation is a criminal enterprise, or the shareholders themselves have somehow benefited from the fraud to the detriment of other corporations or the marketplace as a whole, and the fine serves as a disgorgement of ill-gotten profits, fines against shareholders do not seem to be appropriate. Some situations in which the company - and the shareholders - may have benefited at the expense of others include anti-trust matters, environmental problems, and money-laundering transgressions. But, corporations fined for disclosure-based transgressions use shareholder money to pay for behavior of which the shareholders were the victims. We have to ask ourselves: Who are the victims? Who really is paying the fines? By imposing such fines, are we not punishing the very people who were already punished through the marketplace when the stock price was clobbered?

Although these shareholders sometimes end up with a portion of the disgorgement and penalties generated by the Commission action, it would be more efficient, more equitable, and a more effective deterrent to simply charge the individuals responsible for the fraud. Not surprisingly, the officers and employees at fault often prefer to negotiate a deal in which the company pays hefty fines and individuals are not charged at all. It becomes a dangerous combination if prosecutors have one eye on the public relations effect of their actions (that, after all, is the deterrent effect) and if management at some defendant companies are all too willing to offer up the shareholders' money - after all, it is other people's money - in order to try to deflect personal responsibility of particular managers. Thus, decisions about whether and how much to fine corporations should be made by the Commission, which can be held accountable for those decisions, and not the staff.

It is also important for the Commission to monitor the enforcement process to ensure that it does not become a tool for informal rulemaking. In instances in which our hindsight tells us that a particular action should have been prohibited, it is tempting to punish people for behavior that was not clearly prohibited by statute or SEC rule at the time the behavior took place. The Commission needs to ensure that enforcement actions are premised on statutes and regulations that were on the books at the time of the behavior in question.

Another area in which informal rulemaking has flourished is the SEC no-action letter process. This process is intended to provide those subject to our rules with informal guidance on how to apply the rules in practice. A person or entity that is regulated by the Commission writes to the staff to ask whether, given a particular set of facts and circumstances, it can take a particular action. If the SEC staff believes that the described activity is acceptable, it writes back with a promise not to recommend enforcement action to the Commission based on the precise facts and circumstances that were set forth in the letter.

Despite the clear admonition that these letters are fact-specific, regulated entities tend to treat them as blanket permission for the industry to take the action described in the letter. The staff anticipates that the relief it provides will be relied upon by persons other than the one who requested the no-action relief. In some instances, our staff even states that they will no longer respond to requests for no-action relief unless the requests present novel or unusual issues. It would be more appropriate for the Commission to propose and adopt rules to deal with situations that arise repeatedly. Instead, it has allowed no-action letters to form the basis for widespread industry practices.

The Commission has also exhibited inappropriate deference to informal staff rulemaking in the provision of accounting guidance. In one manifestation of this informal rulemaking, the staff issues accounting bulletins, which are intended to deal with limited technical issues. The importance of accounting practices has been highlighted over the past several years in a number of high profile enforcement actions and court cases. Policy decisions in this area are extremely important. The staff's technical guides often end up exerting a powerful influence on corporations and the ways in which they account for their activities. In fact, these pronouncements are often determinative in deciding the fate of huge financings and mergers and acquisitions. If major transactions must be structured in conformance with staff pronouncements, then these staff pronouncements do not sound much like "non-binding, informal" guidance, do they? It looks and sounds like agency rulemaking. You know what they say, if it barks like a dog, smells like a dog, and looks like a dog, then it's probably a dog!

You might be asking yourself, why should I care if the rule or guidance is provided by the SEC commissioners or a member of the SEC's staff? This is a GREAT question. And, it has been answered by Congress. Congress has appropriately directed agencies how they should provide rules and binding guidance. This directive is called the Administrative Procedures Act, or the "APA". It is a rather dull piece of legislation and has given birth to an entire practice of its own. I'd expect that you will address this in your Administrative Procedure course. Try to stay awake during this dry course - especially if you plan to live and practice in Washington DC, you need to know this stuff!

The APA provides basic due process protections that regulatory agencies must follow. We are required to give adequate notice to the public of our intended rulemaking, ask for comment on that proposed rule, and then when adopting the rule explain how those comments were acted upon. This is certainly in keeping with our constitutional notions of accountability and due process.

Just as I believe in the importance of our monitoring the activities of our own staff, I believe that investors and the regulated community should monitor us. Thus, our actions should be taken as much as possible in the public eye - better scrutiny and accountability lead to better regulation.

So, you as business and law students have quite a challenge ahead of you in this environment. We need your enthusiasm and fresh perspective to help us confront all of these issues.

The news media tend to make a big deal of polls that show how much confidence the generic man-in-the-street places in various professions. Year after year, true public servants like teachers, fire fighters, and police consistently rank very high - say, more than 80 percent. Lawyers, reporters, and politicians consistently rank at the bottom - say, around 20 percent. In the last couple of years, corporate executives have fallen from the 60s to join the lawyers today. So, all of us in this room - lawyers and business students - are in this together. We can work to restore openness and public trust in government, corporations, and the law.

I look forward to working with you when you join those ranks. Thank you very much for your attention.


Modified: 04/05/2005