Speech by SEC Staff:
Remarks before the 2005 China Capital Markets Conference
Director, Office of International Affairs
U.S. Securities and Exchange Commission
October 19, 2005
Panel on Industry Best Practices for Regulating Financial Intermediaries
Thank you, Keith. And thank you, ladies and gentlemen, for inviting me to address this joint conference of the Securities Industry Association and Tsinghua University here in Beijing.
Before I begin, I must start with the SEC's standard disclosure: These remarks reflect my own views and do not necessarily reflect the views of the Securities and Exchange Commission, the Commissioners, or other members of the SEC staff.
While the title of this panel is "Industry Best Practices for Regulating Financial Intermediaries," I've been asked to focus my remarks today not on the regulation of intermediaries but rather the transparency by which the SEC develops and formulates the rules that govern financial intermediaries.
For the SEC, transparency is something akin to religion. It is encoded in our DNA, going back to the very beginning. Louis Brandeis, the grandfather of our securities laws and one of our greatest Supreme Court judges, wrote a book in 1910 called "Other People's Money." In the book he noted that transparency is the key to preventing market fraud. "Sunlight," he wrote, "is said to be the best disinfectant [and] electric light the best policeman." Transparency, following this line of thought, would disinfect a market of harmful practices and police it against abuse.
Following the Stock Market Crash of 1929, the US Congress accepted Brandeis' advice. It adopted a disclosure-based regulatory regime for the US markets. The SEC was given the job of making sure that the market is transparent, and the information given investors is complete, accurate and not misleading.
Investors still bear responsibility for their decisions. As Louis Loss, one of the United States' most famous securities law professors, observed, "The Securities Act does not take away from a man his God-given right to make a fool of himself. It only prohibits others from making a fool of him."
Today, the SEC still follows this disclosure-based approach. In our view it remains the best way to preserve the strength of a free market system while preventing financial fraud and other activities that might undermine that system. But the transparency the SEC imposes on market participants is also expected of the legislative and rule-making process affecting market participants.
The first of the US securities laws were considered by Congress in 1933, to full public hearings. The public nature of these hearings was invaluable, because they allowed the final law to be more effective. The original bill would have required the SEC to opine on the "soundness" of the business model of public companies. The full debate in Congress showed this approach to be flawed. The debate also allowed critics of the final rule - many of whom claimed that disclosure based laws would raise the cost of capital and drive US companies offshore - to make their arguments and state their opinions, in public and on the record.
This was a good thing because we can now look back, read what was said, and see how wrong the critics were. Today, there are close to 15,000 public companies in the United States. In relative terms, the $16 trillion market capitalization that these companies represent make up half of the world's total. Also, without the transparency of this Congressional record, it would not be apparent how similar these criticisms are to things being said today about the Sarbanes-Oxley Act.
Transparency is also built into the SEC itself. Today, a securities regulator with powers to set rules for a market, investigate violations, and levy fines against violators does not engender controversy. In fact, it's commonplace, in the United States, in China and around the world. But in 1934, administrative agencies, such as the SEC, were still controversial. These agencies combine powers traditionally divided between the legislative, administrative and judicial branches of our government.
To address these legitimate concerns, in 1946 Congress passed the Administrative Procedures Act. The Act defines the transparency that governs the rulemaking process of US federal agencies, such as the SEC. Because of the Act, when the SEC considers a new rule:
- It must first publish the proposed rule in the Federal Register for the public to review;
- Except in emergency circumstances, it must allow a period for the public to comment on the proposed rule;
- The Commission staff must consider the comments in finalizing the rule; and
- When the rule is finalized, it generally must publish the rule at least 30 days before it goes into effect.
- The Act also gives the public an opportunity, if it so wishes, to petition for a rule's issuance, amendment, or appeal.
The SEC is also subject to what is called the Sunshine Act. This law fosters transparency by requiring government agencies to provide public notice of their meetings and to hold these meetings in public. In practice, this means that nearly all Commission deliberations on market rules, issuer disclosure requirements, and other SEC policies are debated in public. Only consideration of enforcement matters are typically deliberated behind closed doors, to protect the privacy of those involved. And even in enforcement matters, when the SEC brings an action against an individual or firm, or imposes a fine or other penalty, the findings are published.
With the blessings of modern technology, the SEC has even been able to extend its transparency and that of public companies in ways unimaginable even 20 years ago. Today, all of our proposed and final rules, and notice of all enforcement actions, are made publicly available on the SEC's website. The SEC's website also links to the SEC's Electronic Data Gathering and Recovery system - the famous Edgar database that lets anyone in the world connected to the World Wide Web read required disclosures and filings of any individual or entity registered with the SEC. In other words, the financial statements of thousands of companies are available to potential investors around the world, instantly, at the click of a mouse. And with the increasing use of Xtensible Business Reporting Language, in the future these electronic filings will be interactive, so investors can manipulate the disclosure data in ways most useful to them.
Technology also greatly expands public input into the Commission's own deliberations. SEC rulemakings have been public for decades, but, for practical reasons, only if you were in Washington, DC and could find a seat in our hearing room. Today, anyone, anywhere in the world, can listen to our public hearings via the Internet. These hearings are even archived on our website, so that you can listen to them after the event - which is probably particularly useful to any listeners in China for whom the "live" event might be taking place at 3 in the morning.
The SEC also now accepts comment letters on proposed rules via our website. In other words, concerned parties around the world - not just US citizens or US companies - can read a proposed rule, listen to the Commission's deliberations on the rule, and then submit their own comment on the rule - all through the Internet. These comments are then posted on the SEC's website, and in this way the world sees what we see.
And, finally, SEC rules are also subject to a cost-benefit analysis requirement. This means that the SEC must conduct an analysis to confirm that the benefits of the new rule outweigh the costs. As a practical matter, this means the SEC is forced to justify new regulations and to give reasons why the new requirement will help investors and markets.
In my opinion, all of this transparency translates into far better regulation.
I would have to say that I am not as pessimistic of human nature as China's ancient Legalist philosopher, Han Fei-tze.2 I tend to agree with Confucius, that, by nature, humans are good. However, in at least one important respect, I think Han Fei-tze was right: "The law wants nothing more than publicity." Where rules are not formed transparently - or not universally applied, markets will suffer, just as Han Fei-tze warned.
Regulatory transparency, in this sense, is the mirror image of market transparency. Markets can handle good news and they can handle bad news. What they hate is uncertainty. And investors and market participants particularly hate uncertainty about rules that apply to their activities. As another great philosopher - in this case, Adam Smith, the grandfather of economics - once wrote:
The individuals, who hoard whatever money they can save, and who conceal their hoard, do so from a distrust of the justice of government, from fear that if it was known that they had a hoard, and where that hoard was to be found, they would quickly be plundered. In such a state of things few people would be able, and nobody would be willing, to lend their money.
As regulators, we owe it to markets to make sure this doesn't happen.