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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Opening Statement at May 26, 2004, Open Meeting


Chairman William H. Donaldson

U.S. Securities and Exchange Commission

Washington, D.C.
May 26, 2004

Good morning, this is an open meeting of the Securities and Exchange Commission. We have three items on our regular agenda this morning, then the Commission will hear oral argument in the matter of Clarke Blizzard and Rudolph Able.

1. Disclosure of Breakpoint Discounts by Mutual Funds

The first item is a recommendation from the Division of Investment Management that we adopt amendments, proposed last December, to require mutual funds to enhance the disclosure that they provide to investors about breakpoint discounts on front-end sales loads.

In late 2002, the NASD, during routine compliance examinations, raised red flags about whether mutual fund investors were receiving promised breakpoint discounts. The Commission and the NASD, along with the New York Stock Exchange, initiated an examination sweep of 43 broker-dealers that ultimately led to enforcement and disciplinary proceedings against 15 firms. Last February, these firms entered into settlement agreements in which they agreed to compensate customers for the overcharges and pay fines of more than $21.5 million.

In addition, the NASD, SIA, and ICI formed a joint task force to recommend ways in which the mutual fund and broker-dealer industries could prevent breakpoint problems in the future. The amendments before us address two of the recommendations from the task force:

  • that mutual funds provide critical data regarding breakpoints in their prospectuses and on their websites, and
  • that fund prospectuses make clear that investors may need to provide financial intermediaries with the information necessary to take full advantage of breakpoint discounts.

I am pleased to support this initiative, as it will help to ensure that investors understand the breakpoints that are due to them. While it is incumbent upon funds and brokers to give investors the breakpoint discounts they are promised, an investor who understands breakpoint opportunities is unlikely to remain silent in the face of an overcharge.

As always, congratulations and thanks go to Paul Roye and the members of his staff who have brought this recommendation to the Commission: Susan Nash and Christian Broadbent.

2. Investment Adviser Codes of Ethics

The second item on our agenda is a recommendation from the Division of Investment Management that the Commission adopt a new rule and related rule amendments, proposed last January, to require registered investment advisers to adopt codes of ethics that set standards of conduct for advisory personnel and address conflicts that arise from their personal trading.

The relationship between an investment adviser and its clients is supposed to rest on a bedrock foundation of fiduciary principals. It is extremely troubling that so much of the conduct that led to the scandals in the mutual fund industry was, at its core, a breach of the fiduciary relationship between investment advisers and their advised funds. As fiduciaries, advisers owe their clients more than mere honesty and good faith. Recent experience suggests that all too many advisers were delivering much less.

I am pleased to support this rule, which will require advisory firms to establish codes of ethics, and to ensure that the firms' ethical standards reach all employees — with particular emphasis on employees who have access to nonpublic information about the firm's securities recommendations and its clients' securities activities.

It is said that "opportunity may only knock once, but temptation leans on the doorbell." As much as we might wish to, we will never be able to set and enforce rules that govern every situation in which an investment adviser's employees might be tempted to exploit the adviser's clients for personal profit. We have no choice but to rely on the advisory firms themselves to step into the breach — establishing a culture where the highest standards of behavior are practiced and where that doorbell is never answered.

Again, our congratulations and thanks go to Paul Roye and the staff members from the Division who developed this recommendation — Bob Plaze, Jennifer Sawin, Jamey Basham, and Robert Tuleya — you have done an excellent job on this very important initiative.

3. Issuer restrictions or prohibitions on transfers of securities to or from securities intermediaries

The third item on our agenda is a recommendation from the Division of Market Regulation that the Commission propose a new rule that would prohibit registered transfer agents from transferring an equity security, if the issuer of that security has imposed a restriction against transfers to or from a securities intermediary. The new rule would therefore discourage transfer restrictions that prohibit the transfer of equity securities to securities intermediaries.

The need for this proposal is rooted in our responsibility to develop and protect the national market system. In the late 1960s and early 1970s, the securities industry was confronted by the so-called "paperwork crisis," which nearly crippled the industry and ultimately contributed to the failure of a substantial number of broker-dealers. This crisis was caused mostly by a sharp increase in trading volume and the extensive use of paper securities certificates. Compounding the problem were poor recordkeeping by the industry, insufficient controls over funds and securities, and inadequate clearance and settlement mechanisms.

To address the paperwork crisis, Congress directed the Commission to establish a national system for the prompt and accurate clearance and settlement of transactions in securities. Because the use of physical securities certificates can thwart these goals, Congress directed the Commission to end the physical movement of securities certificates in connection with the settlement of securities transactions among brokers and dealers.

The proposal that we are considering today would further these important Congressional mandates.

Recently, a small but growing number of issuers have tried to control transactions in their securities by preventing their shares from being transferred to securities intermediaries such as DTC. While these issuers argue that they are imposing these restrictions to protect their shareholders and their share price from "naked" short selling, their actions have the potential to cause a significant adverse impact on the national clearance and settlement system.

Although the Commission is concerned about abusive short selling practices, the Commission does not believe that the right way to fix this problem is for issuers to attempt to obstruct the ownership and transferability of their publicly traded securities. Instead, the Commission has taken steps to address abusive short selling through Regulation SHO, which we proposed last October, as well as through other initiatives undertaken in conjunction with the NASD.

Accordingly, we have before us a proposal that would prohibit registered transfer agents from completing any transfer of an equity security registered under section 12 of the Exchange Act, or an equity security of an issuer subject to section 15(d), if the issuer has imposed a restriction on the transfer of the security to or from a securities intermediary. The rule should encourage issuers to avoid trying to prevent their securities from being processed through the national clearance and settlement system. In doing so, the proposed rule would further the Commission's achievement of its Congressional mandate to develop a safe and efficient national system for the clearance and settlement of securities.

I would like to thank members of the staff who have worked on this proposal. In addition to Annette Nazareth and Bob Colby, I would like to thank Larry Bergmann, Jerry Carpenter and Susan Petersen of the Division of Market Regulation. I would also like to thank Elizabeth Murphy and Steven Hearne of the Division of Corporation Finance for their contributions.



Modified: 05/26/2004