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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks Before The Securities Industry Association


Commissioner Paul S. Atkins

U.S. Securities and Exchange Commission

Orlando, Florida
April 7, 2003

Thank you for that kind introduction. It is a pleasure to speak to you this morning. Before I begin, I have to do what my own legal and compliance officers demand of me: please note that the views I express here today are my own and do not necessarily reflect those of the SEC as an institution or of the other Commissioners.

As you just heard, I can confess to being a recidivist SEC employee. Seeing many former SEC colleagues here, I'd encourage you at some point to consider coming back. You would be surprised at how easy the transition is.

Things have certainly changed in the almost 13 years since I first arrived at the SEC. Some things are very similar - such as the war in the Persian Gulf areas, which is a sobering thought. But as for changes, who would have thought that the SEC would ever be featured so much on the front pages of small-town newspapers all around the country, or that a guy like an airport security man, on seeing the letters "SEC" on my laptop, would ask me if I worked for the Securities and Exchange Commission? I was stunned. Since he looked like an ex-football player, two years ago he probably would have asked about the Southeastern Conference. When I was last at the SEC, I used to have to enunciate clearly the agency's initials or say the whole name, since it seemed that everyone would otherwise hear FCC or FEC or FTC. A decade ago, I even found that many in government circles would not know that the SEC is a government agency in Washington. They thought it was a private institution in New York.

We certainly have gone mainstream, which is understandable when you look at how the country has changed. To put some of this into perspective, the other day I spoke to the Council of Institutional Investors in Washington, and in preparing my remarks I ran across an old speech that we had prepared for Richard Breeden in 1990.

Thirteen years later, the statistics that then-Chairman Breeden cited in his speech seem almost quaint. U.S. equity markets had grown during the 1980s by about 400% to $3 trillion. Even after the bursting of the 1990s bubble, the market stands today at a capitalization of about $17½ trillion. That means, assuming that the market has stabilized, one could estimate the size of the 1990s bubble itself at about $7 trillion, which is more than twice the entire market cap of 1990. So, at least on paper, we are richer. But try telling that to the millions of Americans who lost billions of dollars of their savings and their retirement prospects, and in many cases even their jobs. All from the 1990s bubble of over-expectations in what makes a sustainable business model.

I don't need to tell you about the political effect those losses had in the election year of 2002. Congress, through the Sarbanes-Oxley Act, reacted to a public that was outraged at the corporate scandals that threatened their financial ability to fund their children's college education and their own retirement. We now live now in a country in which the defined contribution retirement plan is more or less the norm and in which, for the first time ever, more than 50% of all households are stockholders, directly or indirectly.

I also do not need to tell you that during the past six months, the SEC has engaged in its largest rulemaking period since its inception. Most of this rulemaking, of course, was a result of our long list of "homework" from Sarbanes-Oxley.

People often ask me what it is like to be at the SEC during this period. I can honestly tell you that the eight months since my confirmation seem like a couple of years. For many of you, I am sure that you can say the same thing even more emphatically from your vantage point, where your businesses and careers may have been on the line.

The storm that many legal and compliance officers had been dreading and trying to prepare their firms for during the 1990s finally hit. With research analysts, IPOs, trading practices, retail sales practices, internal controls, policies and procedures, accounting practices, corporate governance, and professional conduct by accountants and lawyers all at issue, you certainly have your hands full.

To say that Sarbanes-Oxley is expansive would be an understatement. It does contain many long-overdue provisions that address the complex relationships between management, the board of directors, auditors and attorneys. It also addresses perceived conflicts of interest, to try to improve the quality of financial information, and seeks to strengthen market transparency through disclosure rules for issuers and research analysts.

Before I discuss with you some of the industry-wide aspects of Sarbanes-Oxley, let me address a concern that is rather parochial to most of you in this room: the provision requiring the SEC to adopt final rules regarding "minimum standards of professional conduct" for attorneys.

These were truly uncharted waters. Some point out that Sarbanes-Oxley is the first significant effort by Congress to mandate federal regulation of lawyers. Others view these rules as a necessary step toward bolstering investor confidence, by forcing attorneys appearing and practicing before the SEC to help ferret out misdeeds. Still others have called the Act's attorney regulation mandate a "wake-up call" to the profession, noting that enforcement of legal ethics rules has typically been directed at suppressing competition, as opposed to protecting the interest of clients.

These are critically important issues for attorneys. The bar itself does not necessarily have the best record of disciplining its own. The Public Company Accounting Oversight Board was created because of deep failings in the accounting profession's willingness and ability to regulate itself. I think it is safe to say that the legal profession would not like to see this sort of organization created to regulate it in a similar fashion.

The rule that we proposed in December of 2002 was controversial in many ways. It took an expansive view of who could be found to be "appearing and practicing" before the SEC. It appeared to reach attorneys performing functions outside of legal departments, such as compliance and business personnel. And, it raised issues of jurisdiction and enforceability. Especially abroad.

The final rule is much less controversial. We received many thoughtful comments and suggestions, and reacted accordingly. Specifically, we narrowed the definition of those deemed to be "appearing and practicing" before the SEC. Otherwise, the rule would have been unworkable. For example, one important exclusion applies to attorneys at public broker-dealers and other issuers who are licensed to practice law and who may transact business with the SEC, but who are not in the legal department and do NOT provide legal services within the context of an attorney-client relationship. The input of many in this room through the comment process was critical to help us reach this reasoned and balanced approach.

Also very controversial was the "reporting-out" or "noisy withdrawal" aspects of our proposed rule. This is the aspect of the rule that would require corporate attorneys to disclose their clients' material security law violations to the SEC. Not surprisingly, we received many strong objections to this requirement.

Currently, we have out for comment whether it makes sense for the issuer itself to disclose when an attorney resigns because he believes the company did not respond adequately to a material violation of securities law. This new approach would not require the attorney to disclose any information other than to his client. It would also require the company to report rapidly to the SEC - two business days from receipt of the notice of withdrawal. If you have not already done so, please send us your comments on this proposal.

Your role as securities legal and compliance professionals is vital to regaining the trust of the investing public and in preventing future scandals. The securities industry did not survive the downward spiral of the market unscathed. Over the past year, the SEC, NASD and the New York Stock Exchange proposed and implemented regulations to address analyst and investment banking activity and IPO allocations. Some of you know better than I where the global settlement for the research fiasco stands. Firms are left facing the scores of investor actions seeking damages from alleged fraud or suitability claims.

The annual SIA Investor Survey for 2002 indicates that investors' attitudes toward the securities industry and their brokers are at their lowest levels since the inception of the tracking study in 1995.

The survey finds that investors believe that the securities industry should

    (1) be more honest and trustworthy;

    (2) punish wrongdoers;

    (3) increase internal controls and regulation; and

    (4) do a better job of educating investors.

Who can argue with these suggestions? They are truly self-evident to build a good business. Let's discuss each of them and apply them to the current issues that the securities industry faces.


Over the past couple of years, regulators faced the task of determining how to fix fundamental integrity problems, such as whether a research analyst honestly believes his own opinion expressed in a research report. The government's main tool to address misrepresentations like these is to bring an action under antifraud provisions. Unfortunately, the government usually cannot act until after the damage is done.

Given that the government cannot force an individual to be honest, we implemented our own rules and approved SRO rules to head off conflicts of interest. The disclosures serve as sort of an objectivity barometer for the investing public. In addition, the NASD and New York Stock Exchange have used their authority to address the structure of the research and investment banking departments within securities firms.

Individual securities firms have the power to establish a corporate culture that does not tolerate dishonest behavior. Honesty must become an important part of corporate culture set by the "tone from the top". A security firm's tolerance or lack of tolerance of ethical misdeeds, and the leadership's philosophy of business, convey a great deal throughout the organization. Since the days of the Treadway Commission, and enforcement cases before it, we have preached the importance of this tone from the top. All sorts of scandals - and formerly impressive Wall Street names now mothballed or disgraced - demonstrate how important this concept is.


Investors must be able to trust the advice that their brokers give them. The broker, of course, is the customer's agent, and so has the duty to act in the best interests of the customer, especially an unsophisticated investor. The broker must ensure that the investment is suitable to the customer's investment goals and financial circumstances, and that the customer understands the risks and fees.

The retailization of hedge funds and mutual fund fees are two current situations in which this investor trust issue is critical. Our new Chairman, Bill Donaldson, has repeatedly voiced his concern about the trend toward the retailization of hedge fund products, where we are seeing minimum investments as low as $25,000.

The NASD has also been vocal in this area. It released a Notice to Members in February reminding firms of their obligations when selling direct and indirect interests in hedge funds. The Notice to Members focused on the lowering of the minimum investment through registered funds of funds and an apparent over-reliance on the accredited investor thresholds in Regulation D. Just because someone has money does not make that person "sophisticated," and does not mean that a product is necessarily suitable for that investor. The ability of the investor to understand the risks is the key consideration. Perhaps a good way for a broker to start each phone call is to warn, "the higher the return, the higher the risk."

The NASD said that broker dealers must not just conduct due diligence - they must perform substantial due diligence with respect to the hedge funds and funds of hedge funds that they recommend to customers, and must ensure that the product is suitable for that specific customer. The NASD also said that broker-dealers must ensure that their sales force is adequately trained, so that they can properly inform investors about the risks associated with these products, again not limited to such risks as

    (1) the fund's particular use of leverage and how market changes would change the principal investment;

    (2) the illiquid nature of the product;

    (3) the possible double fee structure of the product; and

    (4) the lack of the transparency of the product.

I believe that broker-dealers performing due diligence should focus their attention on the quality of the fund's overall operational structure, including internal controls, governance system, and disclosure system, especially with respect to leverage and asset valuation, rather than concentrating just on the name of the fund manager. Of course, all broker-dealers should ensure that the fund manager or investment adviser is ethical, able, and reputable, but of critical importance when deciding which products to offer to retail customers should weigh in favor of fund structure and overall management.

Another area of concern, which may ultimately affect investor's trust, involves mutual fund breakpoint discounts. The SEC, NASD and the New York Stock Exchange completed an examination sweep of 43 of the largest broker-dealers that sold mutual funds with a front-end sales load. The regulators performed the sweep in order to determine if investors received available discounts on front-end sales charges.

The joint report, issued on March 11, found that 32% of the eligible transactions reviewed by the regulators did not receive the appropriate breakpoint discount, to the tune of an average of $364 per transaction. When you multiply that times millions of transactions, that's real money. The largest single discount not provided on a transaction was $10,289. Firms will be required to refund the money to the appropriate customers and review their policies and procedures in this area.

Winning back the trust of individual investors is a long, expensive, and hard process. Selling hedge-fund products to retail investors is an area of risk that must be reviewed carefully. Considering the implication of the NASD's notice to members, I wonder how practicable retail sales of these products can be. These products should only be sold to the retail customer if firms intend to fulfill their fiduciary obligations - I'd argue that they must do so much better than they did with breakpoint discounts.


The SIA survey indicated that investors also wanted evidence that securities firms punish wrongdoers. Meaningful accountability goes hand-in-hand with establishing an honest and ethical corporate culture. A longtime public perception about the securities industry is that firms are more lenient with high producers. If firms do not enforce accountability, a broker can get the message that unethical - or let's say even borderline - activity is OK as long as I make the firm money. Employees must know the consequences of engaging in prohibited conduct and be held accountable. This is a fundamental basis of successful management accountability programs like Six Sigma.

Instead of dealing with these ethical lapses in a secretive, Star-Chamber manner, why not publish disciplinary actions internally - even on a no-names basis? Common knowledge within the firm of prohibited activity and corresponding penalties - rather than relying on the rumor mill - might deter similar actions and protect a firm's reputation.


The SIA survey also indicated that investors want firms to increase their internal controls and regulation. Firms are required to have policies and procedures that are reasonably designed to achieve compliance with applicable rules and regulations. Legal and compliance personnel should, of course, continually review their overall compliance program for effectiveness and efficiency, rather than merely amending existing policies and procedures to reflect changes in regulation.

Compliance programs should be proactive, and as progressive as the markets and investors they are monitoring. Before I got to the SEC, I saw many boilerplate compliance manuals that do nothing more than recite blackletter law, making little or no attempt to indicate any understanding of the firm's business, or apply the law to the firm's operations so that the business side can even have a hope of achieving compliance. Compliance becomes a check-the-box activity.

Compliance officers should understand the full extent of the firm's business, understand the customer base, and cross-train legal and compliance personnel, instead of limiting them to specific sectors of the firm's business.

The goal of a compliance department should be to create a web of compliance knowledge and embed that knowledge on the business side of the firm, rather than create individual slices of a pie. The more information that your departments develop and share, the better prepared they will be to detect patterns and possible abuse between the gaps.


Finally, investors in the SIA survey requested that broker-dealers educate them. Education is a win-win for both investors and the industry. Remember those advertisements? A well-informed customer is a good customer. A smarter investor is less likely to fall prey to unethical brokers and should be better able to appreciate the risks associated with certain investment vehicles.

Firms should expand education topics from products, fees, trading, and risks to include materials about corporate governance and its relevance to investment decisions. This may become easier as some service providers are starting to offer ratings of issuers according to strength of the internal corporate governance. Investors should realize that stronger corporate governance systems and controls lower the risk of the investment. In fact, there are a few professional economic studies that try to demonstrate this correlation. This education may also benefit the markets by easing the irrational reliance on earnings numbers.

Revelations of corporate mismanagement, malfeasance, conflicts and/or incompetence have undermined the world's financial markets in a profound way. As we address this profound effect on the markets, we need to be mindful of the fact that morality and ethics cannot be legislated into existence.

Government controls alone - too often paternalistic - will never be a solution if individuals and individual firms are not upholding their own end of simple business ethics through their own effective compliance. Internal controls and the culture of an organization are basic structural aspects to reinforce the inherent nature of most people to do the right thing.

These are trying times for the investing public. As we all try in our own ways to rebuild investor confidence in the market, I would like to quote a statement made by then SEC Chairman William O. Douglas on January 7, 1938: "By and large, government can operate satisfactorily only by proscription. That leaves untouched large areas of conduct and activity, some of it susceptible of government regulation but in fact too minute for satisfactory control; some of it lying beyond the periphery of the law in the realm of ethics and morality. Into these areas self-government, and self-government alone, can effectively reach."

So, you are the guardians of your firms' reputation and, in a real sense these days, profitability and perhaps even survival. You are the key to that self-governance principle that William Douglas spoke of. Go out and do the right thing. Use your time and resources wisely. We at the SEC want to work with you to make sure that you get it right. Please don't make any more work for us, as we have plenty of it already.

Thank you very much.



Modified: 06/18/2003