U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
The Securities Industry: Some Thoughts on What Lies Ahead

Remarks by

Commissioner Laura S. Unger

U.S. Securities & Exchange Commission

Before the Westchester/Southern Connecticut Chapter of The American Corporate Counsel Association

October 12, 2001

Good Afternoon. It's an honor to be here in front of such a distinguished group of counsels today. I have been warned that you ask difficult questions, but I have nonetheless reserved time following my remarks for Q&A. Before we get to that, I thought I would discuss what I believe to be some of the critical issues facing the securities industry today and in the years ahead.

September 11

At the outset, I want to note that none of the challenges facing the securities industry come close to the challenges we faced following the September 11 attack on the World Trade Center and the Pentagon. This was truly a horrific and devastating tragedy in America's history - one that will never be forgotten. Whether intentional or not, it was a direct hit to Wall Street. In the weeks that have followed, relief workers and market participants have banded together working nonstop to get the markets up and running.

Behind the scenes, the Commission also took action as the markets prepared to reopen. For the first time, we used our emergency powers under Section 12(k)(2) of the Exchange Act to temporarily ease certain regulatory restrictions.

Just days after the disaster, the Commission eased volume and timing restrictions on issuer repurchases; permitted brokerage firms to calculate net capital without considering the days the market was closed; and permitted mutual funds to borrow from and lend to related parties. The Commission also relaxed requirements for in-person meetings in order to facilitate mutual fund board meetings, and issued an interpretative release that allowed accounting firms to provide bookkeeping services to and help recover records for clients with offices in and around the World Trade Center, without violating auditor independence rules.

In the following days, it became apparent that the airline and insurance industry would be particularly hard hit by the September 11 tragedy. On September 28, the Commission took certain steps to assist airline and insurance companies. We established telephone and e-mail hotlines for the airline and insurance industries, their underwriters and other advisors to help them obtain immediate answers to financing and disclosure questions. The Commission also directed the Division of Corporation Finance to take certain short-term actions to facilitate short form registration on Form S-3 for airline and insurance companies to enable them to raise capital quickly.

We continue to work with the markets and issuers to resume normal market operations in these abnormal times. Two days ago, to address continuing problems resulting from aged fail transactions on government securities and unresolved reconciliation differences with accounts or clearing corporations or depositories involving government securities, we granted additional relief to broker-dealers in calculating net capital under Rule 15c3-1 and for purposes of calculating the amount of special reserves required to be maintained under Rule 15c3-3.

One thing we have learned in using our emergency authority is that Section 12(k)(2) does not give us enough time to grant ongoing relief. As it stands, the Commission's authority to take emergency regulatory action under Section 12(k)(2) is limited to 10 business days. In using this authority for the first time, we learned that 10 business days might not be sufficient time for the markets to absorb the impact of a major market disturbance. We have asked Congress to expand our emergency authority by granting the Commission the flexibility to issue emergency orders under all federal securities laws (not just the Exchange Act) for a period of 30 business days with extensions running up to a total of 90 calendar days.

In the interim, we have used our general exemptive authority under Section 36 of the Exchange Act to extend certain relief - such as the relief from the net capital provisions I just described and the issuer repurchase relief.

Reform of the Capital Raising Process

Other challenges to the securities industry may pale in comparison to dealing with the aftermath of the September 11 attack, but must be confronted nonetheless. I think that one of the first things that comes to mind when looking ahead is the need for Securities Act reform. This is something our new Chairman has spoken about. Obviously, the current regulatory system was created in a time when technology was not what it is today. The Commission has attempted to recognize the progress of technology over time - some Commissioners more than others - but the time has come for more comprehensive change.

Indeed, when the Commission issued its 2000 release on the use of electronic media ("2000 Release"), commenters called for a drastic overhaul to the conceptual framework governing both the public and private offering process. Many in the industry rightly believe that either the Commission or Congress needs to make the capital-raising process more efficient and less costly. I'll mention just a few areas that particularly need reform.

The first is embracing technology and the Internet in the offering process. Although companies raised more than $400 billion in the U.S. private market last year, the Commission's rules constrain companies from taking advantage of low-cost electronic communications to raise capital from potentially qualified investors. Eliminating the "general solicitation" prohibition in the private market would enable small companies to use the Internet to reach a wider breadth of potentially qualified investors. By substantially reducing the costs and burdens of capital raising for small businesses, we could actually generate additional wealth for that sector of the economy.

The second is addressing the distinctions between oral and written communications that have become anomalous with advancements in technology. Is streaming video "oral" until it is archived? The legal distinctions between written and oral communications mostly discourage disclosure - which does not make for an efficient market. For example, to prevent issuers from "conditioning the market" during an offering, current rules limit how and what issuers communicate to the public.

Another area where the oral versus written distinction makes little sense is with electronic roadshows - not that there are a lot of IPO roadshows right now. Under certain circumstances, electronic roadshows are permissible and not deemed to be an illegal prospectus - that is, unless it is posted on an issuer's website with no restrictions on the number of times a user may play it back. Then, the roadshow may constitute a "writing" and become an illegal prospectus.

Finally, the third area, the Internet could speed up the "back office" part of transactions - especially IPO investments. Although technology means that access to an issuer's prospectus can be real time, the Commission continues to insist on brokers satisfying the prospectus "delivery" obligation. Any new system will have to consider whether and to what extent access may be deemed delivery.

These are only a few items that have not been resolved, but will be a part of any extensive review of the capital raising process. The list goes on and so could I, but I'll move on to some other issues.

The Industry

It is always difficult - and often dangerous - to predict the future, including what lies ahead for the securities industry. I can, however, point to a couple of issues that will surely shape the industry's future. The first is the bear market and a change in investor attitude. During the 1990s, we witnessed a phenomenon as investors stampeded into the markets by the millions. With that stampede came a bull market unlike any we had seen before. Returns on investments turned average Americans into overnight millionaires, at least on paper. Investors went looking to get in on IPOs in hopes of hitting it big with the next AOL or Microsoft. Many on Main Street thought they could do without the help of Wall Street as they ventured into self-directed online trading. It seemed as though the market could only go up, and losing money was not a possibility.

Clearly things have changed. Although today's paper reports the good news that the market has returned to pre-September 11 levels, the market has experienced a downturn of over 11 percent from this time last year. Investors have experienced heavy market losses - even if only short-term. Whether it is the inherent need to find someone to blame or reports of analyst conflicts, undisclosed commissions in IPO allocations, or earnings management by issuers, a growing number of investor complaints and lawsuits have followed in the wake of those losses. Indeed, the number of complaints filed with the NASD's arbitration arm is up 24% -- from 5,500 last year to approximately 7,000 cases so far this year. The main complaints have been misrepresentation, unauthorized trading, and unsuitable recommendations.

As those in this room surely know, there is also no shortage of lawsuits. One of the biggest class action suits alleges that six major brokerage firms required analysts to issue positive recommendations on Internet stocks in order to drum up investment banking business - and the firms never disclosed that fact to the public. An executive committee of six law firms will serve as lead counsel to more than 800 cases seeking class action status against 171 companies and the underwriters who sold their stock to the public alleging abuses in their allocations of IPOs.

What does the increase in complaints mean? Was there a breakdown somewhere in the brokerage industry or are investors just looking to blame someone for their losses? I don't have the answer to this question, but I suspect that change will follow as a result.

One area where we have already seen some change is in the area of analyst conflicts. Thanks to substantial interest by many, analyst practices have been thrust firmly into the spotlight. I, for one, want to make sure that firms are closely monitoring analysts' involvement in firm business outside the area of research. Analyst coverage now reaches a wider audience thanks to Internet dissemination of research reports and the media star quality of some analysts. More than ever, firms have to be careful that business interests do not compromise the integrity of analysts' opinions and research. Focus on analysts has illuminated their potential conflicts for industry, regulators and investors alike.

I do expect that the industry will come up with a constructive means of reducing or more effectively managing the conflicts that threaten analysts' fairness and objectivity. Firms certainly have a powerful incentive to do so.

The SROs also will need to move expeditiously to amend their rules, and vigilantly enforce these rules, to improve disclosure of conflicts of interest by firms and their analysts.

As a final point on this topic, investor education is a very effective first step in dealing with analyst conflicts. The SEC issued an investor alert back in July setting out what investors need to understand about this issue. Fully informed investors are empowered to make smarter investment decisions.

The second area shaping the future of our industry involves the market's reaction to the Commission's new Order Execution Quality Reports and decimalized pricing. More specifically, how will transparency of execution impact competition for investor order flow and what role will decimals have on this competition?

In November of last year, the Commission adopted new rules aimed at improving public transparency of order execution and routing practices. As a result, market centers, such as the NYSE and Nasdaq, must make certain disclosures regarding their quality of executions on a stock-by-stock basis - including how market orders of various sizes are executed relative to the public quotes.

Broker-dealers that route orders in equity and option securities also must issue quarterly reports that present a general overview of their routing practices. Market centers have already begun disclosing this information, but the first Nasdaq and broker-dealer reports will come in November. Making this information public will enlighten investors and the marketplace, undoubtedly spurring competition.

Decimals pricing in the stock market will also have a profound effect on shaping the securities markets in the years to come. In just the few months since trading in decimals began on a marketwide basis, we have seen spreads between the bid and ask prices drop significantly. Competition has driven spreads down to a penny for actively traded stocks in some instances. Investors may save money as a result of these reduced spreads, or they may pay more in transaction costs because of the many price points hit in seeking to have an order filled. Only time will tell.

Narrowed spreads, however, are having a significant and much sooner than anticipated impact on market participants - much to their distress. Specifically, narrowed spreads significantly reduced the practice of payment for order flow - the system by which market maker firms pay fees to retail brokers to execute their orders. Because market makers have traditionally made their profits off of the quoted spread, reduced spreads have directly hit the bottom lines of market making firms.

Discount brokerage firms that relied on the payments for revenues have also been deeply affected. The drastic impact of decimalization has caused firms to find new ways to make money. For example, we are starting to see a new practice in which market makers are calculating a "commission equivalent" into execution prices when filling the orders of institutional customers. Although this practice is not widespread, it is beginning to attract greater attention from market participants. Clearly, many in the industry are going to have to find new ways to succeed in this highly competitive environment.


The U.S. securities industry manages the accounts of nearly 80 million investors directly and indirectly through corporate, thrift, and pension plans. In the year 2000 alone, the industry generated $314 billion of revenue directly into the U.S. economy and an additional $110 billion overseas.

Much has changed in the past ten years - and in the past month alone. While many challenges lie ahead, I am confident that we are well prepared to meet those challenges. As we forge ahead, industry and regulators must proceed with open eyes and an open mind to ensure that our markets remain the most robust in the world. Finally, we must be cognizant that efficient markets and investor protection and confidence are paramount and essential to any future success.



Modified: 10/16/2001