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U.S. Securities and Exchange Commission

Speech by SEC Acting Chairman:
What's New in the Land of Regulation?

Remarks by

Acting Chairman Laura S. Unger

U.S. Securities & Exchange Commission

At "The SEC Speaks in 2001"
Sponsored by The Practicing Law Institute
Washington, D.C.

March 2, 2001

Good morning. It is a pleasure to join you here at this most distinguished securities conference. Because of the dynamic changes taking place in our markets, I think you will find this year's conference particularly worth the price of admission.

In this spirit, I have titled my remarks today "What's new in the land of regulation?" It is an understatement to say that the answer is "a lot," and I am not simply referring to the fact that Arthur Levitt has stepped down as Chairman after nearly eight years and that President Bush has given me the honor of serving as Acting Chairman. There have been several developments – legislative, regulatory, and judicial – that have dramatically impacted our markets and the Commission's approach to regulation.

On the legislative front, Congress has been hard at work modernizing the financial markets through passage of the Gramm-Leach-Bliley Act and the Commodity Futures Modernization Act. On the regulatory side, the Commission has acted to bolster investor confidence by strengthening auditor independence rules and passing new disclosure rules for market centers and intermediaries to help ensure best execution. Not to be lost in the mix, of course, is Regulation FD, which for, better or worse, represents a sea change in the way public companies communicate with the markets. At the same time, important judicial decisions are altering the landscape, including one I will talk about later in my remarks that may affect the Commission's role in regulating the options markets.

In the midst of such rapid and dynamic change, standing still almost the same as walking backwards. Instead, to borrow a phrase I used in the title of my online brokerage report, we have to be vigilant to "keep pace" not just with cyberspace and advances in technology, but with the many other developments changing the nature and structure of our securities markets.

It was with this common-sense philosophy in mind that I set my agenda as Acting Chairman. The agenda has three prongs, and I'd like to use my time today to share it with you.

First, before the Commission can confidently assume any task, we must secure what has long been the key to the agency's success – our "human" resources. As anyone who has worked at the Commission knows, and I'm sure many of you in the room do know, it is an agency filled with talented lawyers and other professionals. Unfortunately, right now we face a staffing crisis. The SEC's turnover rate has risen to almost 14 percent per year – nearly double the rate of the rest of the government. The main cause of the turnover rate is the disparate salaries paid at the SEC compared with the other financial regulators and the private sector. Although no one in the government expects triple figure private sector salaries, 24 to 37 percent less for comparable government wise work is simply not fair. This does not only hamper the agency – but all those we regulate as well – since everyone benefits from efficiency, a goal that cannot be optimized with excessive staff turnover.

Accordingly, one of my highest priorities as Acting Chairman is to lead the charge for pay parity. In the wake of Gramm-Leach-Bliley, it is difficult to justify why SEC staff earn less than their counterparts at banking regulators. I testified before the Senate on pay parity – and reducing Section 31 fees – a few weeks ago and will testify before the House next week. Both of these issues are critical to the industry and the Commission. Yesterday, the Commission expressed support for the Senate bill which just passed out of committee and I am committed to working closely with Congress to enact this legislation.

Second, in accordance with President Bush's Chief of Staff's memo to the agencies which some refer to as the "Card Memo," or the regulatory moratorium, I plan to defer any new rulemaking for now. Exceptions may be made where required by statute, exigent circumstances, or for clearly non-controversial matters. I don't view the moratorium as a time to shut down the Commission, but rather as the perfect opportunity to spend added time focused on other areas, such as interpretive guidance and no-action letters.

The third prong of my agenda is to ensure that the Commission not only keeps pace with technology and other changes to our marketplace, but that we spend some time thinking about the challenges ahead. Over the years, the Commission has been rightfully fond of saying, "information is the lifeblood of our securities markets." Information is also the lifeblood of effective regulators. We cannot tackle tomorrow's problems with yesterday's information. This is particularly the case where technology is involved. Accordingly, as a strong believer in maintaining a frank and open dialogue with our regulated public, I plan on holding a few in-depth roundtables in the coming months on certain important and emerging issues.

The roundtables, which are still in the planning stage, will cover at least a portion of securities market current events. These events have led to: (1) new financial firm structures; (2) new products and markets; and (3) new information channels. I'll say a brief word about each today with a mention of some of the topics upon which I plan to hold roundtables.

Any discussion of new financial structures cannot get far without including the Gramm-Leach-Bliley Financial Services Modernization Act (GLB), which became law almost 18 months ago. GLB repealed the decades-old prohibitions against commercial and investment banks affiliating with each other. The Act permits banks and securities firms to affiliate through a "financial holding company" structure with the Federal Reserve serving as umbrella regulator – and with affiliates subject to functional regulation.

As GLB opens up opportunities for securities firms, banks, and insurance companies to affiliate with each other, firms that have historically operated in one financial sector will increasingly seek to provide a wide array of financial services. Competition in the financial services industry will certainly heat up as these conglomerates figure out ways to differentiate themselves from one another.

With the blurring of financial services comes the possibility for blurring or overlapping regulation – something that obviously needs to be avoided if possible. Although GLB provides for coordinated functional regulation of complex financial services firms, it does not lay out specifically how to accomplish this goal.

We are coordinating closely with our banking counterparts, and are currently in the process of working out the details with the Fed, the FDIC, the OCC and the OTS regarding information sharing among the agencies. One of our biggest concerns in this area is ensuring that any framework for coordination and cooperation gives us a full and complete picture of the securities activities of financial services firms. If coordinated and non-redundant oversight is to be effective in this new regulatory scheme, clearly, there must be symmetrical relationships among the regulators, as well as symmetrical sharing of information.

GLB opens up the possibility of banks developing new financial products. It establishes a process for the Commission to decide whether banks selling new hybrid securities products must register with the Commission as brokers or dealers. The Act would permit a bank to develop and offer or sell a product that is not clearly an "identified banking product," unless the Commission determines that the product is a security and that public interest considerations would require broker-dealer registration. It is difficult to predict what products banks will develop, but the potential certainly exemplifies how the regulatory environment will need to adapt to the increasingly complex financial services industry.

The topic of new financial products really came to the fore in late 2000 when Congress enacted the Commodities Futures Modernization Act (CFMA). In addition to providing increased legal certainty for OTC derivatives under the Commodity Exchange Act and the federal securities laws, the CFMA establishes a framework under which the Commission and the CFTC will jointly regulate the market for single stock futures and narrow-based stock index futures. Both broker-dealers and futures commission merchants will both be able to trade these products on existing and yet to be created commodities and securities exchanges. The CFMA opens up opportunities for new products, new participants, new regulation and certainly new competition.

Under the old Shad-Johnson Accord, the Commission reviewed on a case-by case basis indexes to determine whether they were broad or narrow-based. Because the Shad-Johnson Accord banned futures on narrow-based indexes and single stock futures, this effectively allowed the Commission to veto the designation contract markets. Let me tell you, our review of these contracts was no simple undertaking – as I personally experienced in the matter involving the application by the Chicago Board of Trade seeking contract market designation for futures and futures options contracts on the Dow Jones utilities and transportation average indexes.

Under the CFMA, there is now a more objective test for determining when an index is narrow-based. The Commission will no longer be required to do an index-by-index review as it did under the Shad-Johnson Accord. Under the Act, if an index satisfies the objective numerical test for a "narrow-based" index, a future on such index is a security.

The Commission and the CFTC still must jointly work out some details related to the definition of a narrow-based security index. For example, the Act instructs the SEC and CFTC to jointly adopt rules that establish requirements related to indices traded on or subject to the rules of a foreign board of trade. Under the new regime, defining these products as securities triggers key provisions in the securities laws and regulations which the Act then limits if they are redundant to CEA provisions.

As you can tell, both the CFMA and GLB call for unprecedented joint supervision among regulators in overseeing new financial entities and new financial products. From the Commission's standpoint, we must contemplate how these new financial entities and new products will impact market integrity, investor protection and overall competition. Our challenge is to find an effective way to coordinate with other regulators and try to arrive at a single effective regulatory approach that will address their concerns and ours while encouraging marketplace growth and competition.

Alongside these new products and new business structures, new markets and new trading models are developing in tandem. Electronic trading platforms – some of which didn't exist just a few years ago – are now matching buyers and sellers of hundreds of millions of shares every day, anonymously and for fractions of a penny a share. Meanwhile, our traditional markets are proving that you don't need to be the new kid on the block to innovate. Both the NYSE and Nasdaq are in the process of incorporating greater automation into their markets – for example, NYSE Direct, and the SuperMontage. Go to the floor of most of our equity and options exchanges today and you'll see less paper and more hand held mobile terminals being used to negotiate and confirm transactions.

It's a new world and it's still unfolding.

To get a sense of the pace of change, and the interplay between new products and new markets, consider the QQQs. Not the lines in London, but the index product that tracks the performance of the Nasdaq 100. If you haven't heard of it, don't feel bad. It didn't exist two years ago. Remarkable, though, is that it has become one of the most actively traded stocks in the world before reaching its second birthday. Yesterday, it traded more than Microsoft.

The story of the Qs demonstrate the way today's increasingly informed investors are driving the development of new products. At the same time, it reveals the pattern of intense competition between our markets – traditional exchange markets, alternative markets and dealers. Technically a stock, the Qs initially traded only on the Amex floor. In short order, the regional exchanges and Nasdaq dealers began competing for Q market share with the Amex specialist. More recently, ECNs have made a play, capturing almost 10% of the Qs. A year after the underlying stock began trading, Amex began trading options on Qs. On Monday, the CBOE began challenging the Amex share of options on the Qs, and the PHLX followed suit on Wednesday.

Add to this mix the trend of globalization and you begin to get a sense of the challenges facing the Commission today. Consider, if nothing else, the array of combinations and potential combinations of markets abroad that have been consummated or floated in the last eighteen months. Can you imagine predicting five years ago that a Swedish software company would make a hostile bid for the venerable London Stock Exchange?

Technology has broken down traditional borders and barriers. I can tell you that the Commission is under increasing pressure in the last few years to open the borders and allow foreign market access to U.S. investors. In any event, it is clear that the global market issue would benefit from a thoughtful public discussion. In the coming months, I plan to promote that goal by convening a roundtable discussion on global market issues.

The last new development I want to mention relates to three new sources of investment information – (1) information from the financial portals, (2) information that is being disclosed pursuant to Regulation FD, and (3) information from the soon to be implemented order execution disclosure rules for market centers and broker-dealers. As an aside, another new source of information is the revamped SEC website, launched this past weekend. Our Office of Investor Education and Assistance has worked hard to make our website more accessible, and I think they have done a tremendous job.

Financial portals provide a central location where investors can find all types of financial information and portfolio analysis tools. They can aggregate their financial account data, and they can also click on hyperlinks to broker-dealer websites to open brokerage accounts and enter trades. When portals first came on the scene, broker-dealers saw the portals as a cost-effective and benign means of attracting new customers. But as portals have gained in popularity, with Yahoo! Finance and other financial portals becoming household words, broker-dealers are increasingly finding themselves competing with the financial portals for customers. At least one of the questions broker-dealers ask is why aren't the portals registered?

My first question, though, is: what are the portals doing? What are their relationships with the broker-dealers they hyperlink to? What are their business arrangements and compensation arrangements? How do the hyperlinks work, and what do they look like? We're all familiar with the various factors considered in analyzing whether an entity must register as a broker-dealer. But these are difficult questions with broad-ranging implications. As a result, I want to make sure we are asking, and have answers to, all of the right questions. To this end, I'm in the process of organizing a roundtable to discuss some of these issues in April. I plan to include participants from a cross section of broad- and narrow-based financial portals, broker-dealers, lawyers and academics. I am confident it will provide for an interesting debate.

No discussion of information channels would be complete without mention of Regulation FD. If it's working as intended, Regulation FD should be providing investors access to previously unavailable information. A recent study by NIRI found that 28% of NIRI member companies surveyed say that they are providing more information to investors than prior to adoption of the rule, 48% say they are issuing about the same amount, and 24% say they are providing less information. While it appears that there is more information in the public domain, the question that everyone is concerned about – and a question that is hard to answer – is whether the quality of that information has been in any way diminished by Regulation FD. I have seen recent press reports suggesting that both buy and sell side institutions are concerned about the quality of information issue.

We are monitoring the various studies on Regulation FD in anticipation of the Commission's own study. While I have included Regulation FD on my list of topics for a roundtable, it may not be the first one or two because we need a little more time and experience with Regulation FD before it can be evaluated meaningfully.

A third new source of information called for by Commission rulemaking this past year requires increased disclosure of order execution quality by market centers and broker-dealers. The Commission's intent here is to better inform investors about how their orders are being handled and the true costs of trading at a particular market or through a particular broker.

By sharing these thoughts with you, I have accomplished a number of objectives: (1) identified regulatory challenges; (2) laid out my agenda; and (3) made the case for pay parity. I suspect the new developments I covered will lead us to consider closely how they will impact competition in the marketplace.

To be sure, competition and the way it drives our markets is at the front of the minds of the Commission. A recent case from the Southern District of New York refocuses our attention on competition. Briefly, the Court held that because of the Commission's active regulation of options listing, coupled with its explicit obligation to consider the effects of regulation on competition, the antitrust laws were implicitly repealed as to the options exchanges listing activities. Judge Conway was clearly moved by one of our former Chairman's speeches stating that the Commission would "guard the promise of a competitive, free and fair options marketplace." Whatever the ultimate outcome of the case, I think we can all agree that protecting and fostering competition throughout our markets must remain at the core of our mission.

I've covered a lot of ground this morning. As you can see, there are indeed a lot of changes taking place in our markets. I look forward to serving as Acting Chairman of the SEC and using this time to help stay on top of the cutting edge issues that will affect our markets for years to come. Thank you and enjoy the conference.