Speech by SEC Commissioner:
The Commission Comes To a Fork In the Ocean
Commissioner Isaac C. Hunt, Jr. *
U.S. Securities and Exchange Commission
At the Practicing Law Institute's 30th Annual Institute on Securities Regulation, New York
November 5, 1998
*The views expressed herein are those of Commissioner Hunt and do not
necessarily represent those of the Commission, other Commissioners or the staff.
Thank you for inviting me to address this conference. Before I begin my remarks, please know that the views I express today are my own, and not necessarily those of the Commission or my fellow Commissioners.
For just a moment, let's leave the world of billable hours and C.L.E. credits behind. There's a lovely scene in Lewis Carroll's book Through the Looking Glass where Alice comes to a fork in the road. She's lost and unsure of where to go. Alice sees the Cheshire Cat and asks "Which road do I take?" Instead of answering directly, the Cheshire Cat asks Alice "Where do you want to go?" When Alice responds "I don't know," the Cat slyly replies "then it does not matter" which road she takes.
The SEC too has come to a fork in the road, and some of us are unsure of which way to go. But unlike the Cheshire Cat, we can't pretend that the choice does not matter. Three weeks ago, the SEC approved issuing for comment a far-reaching rewrite of the Securities Act of 1933. The project is called "Aircraft Carrier," so it may be more appropriate to refer to the SEC as coming to a "fork in the ocean." But since that phrase doesn't have the wonderful imagery of a fork in the road, I think I'll use the road metaphor for a while longer.
One road would alter comprehensively the way we regulate most aspects of the securities offering process. This is the approach taken in Aircraft Carrier. We would discard -- arguably and hopefully for the better -- certain investor protections and/or linguistic particulars built into the Securities Act. Among many other things, certain aspects of the Aircraft Carrier would:
Issuers and issuers' counsel clearly would benefit most from such changes. But there also would be real benefits for investors under some aspects of the proposal, such as mandatory early distribution of transactional information in so-called "term sheets," and expanded and more timely periodic Exchange Act disclosure.
- (1) minimize or eliminate prospectus delivery requirements;
- (2) clarify the separation between what is a "public" and what is a "private" offering, and then lessen current restrictions related to the integration of such offerings; and
- (3) encourage now forbidden, or limited, communications by issuers and others during the "quiet period" and at other times during an offering.
With apologies to Robert Frost, Aircraft Carrier represents not just a road in the woods less-travelled, but a superhighway not yet built. The SEC would rely upon its heaviest and least-tested equipment (that is, our new broad exemptive authority under the Securities Act) to cut down not just the dead timber in the Act, but also some of the Act's healthiest branches.
There are many powerful reasons offered for taking this approach, and good people who support it. And we certainly need a new superhighway from time to time. I know that your panelists today will do a fine job of guiding you along this road.
The second road is more-travelled. It starts with the premise that problems arise under the Securities Act, as they do from time to time with all of the laws the SEC administers. And while rulemaking can be proposed in either piecemeal or comprehensive fashion to address these problems, we best craft our proposals when we do so in a targeted way to allow SEC Commissioners and commenters to better focus on those things we want to change, and step back from those things we do not.
In deciding which road I would take with respect to Aircraft Carrier, I have drawn on my experience as a securities laws professor at three law schools. In addition, from late-1996 through mid-1997, my personal staff accompanied other SEC staff to informal meetings with participants in the offering process, such as issuers and underwriters, and their respective counsels, analysts, rating agencies, portfolio managers, etc. Those discussions focused on what, if any, changes should be made to the offering process. And, frankly, with the exception of most issuers' counsel and some issuers, the participants in those meetings attended by my staff did not advocate widespread fundamental changes.
Recently, of course, I've considered voluminous materials on the Aircraft Carrier provided by Brian Lane, Anita Klein and their fine staff in the Division of Corporation Finance. Each of these people deserve our gratitude for their hard work and dedication. Many of the other Divisions and Offices at the SEC offered their own comments and perspectives, and I'm grateful to them as well.
After all this, I seriously question the wisdom of choosing the less-travelled road. As I said at the Commission meeting at which Aircraft Carrier was considered, I have reservations as to whether we should have proposed it without further consideration within the SEC, and had it been up for adoption, I would have voted against it. I also said that I would keep an open mind about the proposals and the comments we receive, and I will.
I'm especially interested in comments from investors and, in this vein, I'll rely on the considerable talents of our Corporation Finance Division and our Investor Education Office to aggressively seek out investor comments and to schedule focus groups with investors on any specific proposals. After all, when earlier this year we approved substantial changes to the way mutual funds are sold, we were able to say in our adopting release that the SEC had "never had a more detailed, comprehensive, and compelling basis for a rulemaking ... Through focus groups and written comments on the initiatives, investors have confirmed that they concur strongly [with the SEC's views]." Should we adopt any substantial changes to the way individual securities are sold, I would want to be able to make a similar statement.
The Securities Act has served the markets and investors extraordinarily well for 65 years, and it might be helpful to review the Act's regulatory approach, as well as the SEC's mission in interpreting and enforcing the Act. I'll start with the latter: the SEC's mission.
Our primary mission is to protect investors. Chairman Levitt correctly points out that investor protection is so crucial because "our nation faces few higher economic priorities than maintaining the integrity of our markets. Without it, that fragile cornerstone of our markets -- investor confidence -- crumbles under the weight of uncertainty and doubt." But I believe all of us at the SEC recognize that while dramatic changes in our markets may require us to reconsider our regulatory frameworks, we should not compromise effective investor protection or weaken investor confidence in the process.
While regulatory reform and investor protection are not mutually exclusive goals, they may be difficult to realize simultaneously. Reasonable people may disagree on what investor protections from the 1930s remain necessary in the 1990s. Reasonable minds also may differ on whether new investor protection tools are more effective than prior mechanisms.
In considering such issues, I find it helpful to look to Congress's intent in adopting a statute. Most people here know that the primary purpose of the Securities Act is the prevention of fraud. Not the prosecution of fraud mind you, but the prevention of fraud. There's a tremendous difference between preventing fraud, and being permitted to deal harshly with those who commit fraud. If anyone here is confused by that distinction, let me explain it this way: for the victims of securities fraud, the consequence often is financial ruin. Even where fraudsters are brought to justice, victims often don't get any money back, or get back just a small portion. I must assume that for such victims, learning that the SEC has won a Section 10(b) injunction against someone who took away their life savings, or in rarer cases that that person was criminally convicted, is not very satisfying.
So Congress had a bold idea. It would try to prevent fraud from occurring in the first instance. It required: registration of public offerings, disclosure of specific information, and a delivered prospectus. Congress also decided that it must regulate offers, not just sales, as a prophylactic measure against fraud.
Of course, the markets have changed dramatically since 1933. And Congress did speak again in 1996, when it gave the SEC broad exemptive authority under the Securities Act, ostensibly in part so we could act on a company-based registration regime similar to one advocated by my good friend Steve Wallman.
Although I agree with certain concepts raised in Aircraft Carrier, some proposals and the package as a whole may shift too far the Securities Act's emphasis on preventing fraud towards an emphasis on greater efficiency and flexibility for issuers. I am concerned that the we did not focus enough attention in this proposal on our ability to prevent and police fraud.
But my concerns can be addressed. The SEC should: conduct a survey of fraud in our markets, analyze whether our proposals would change the current fraud landscape, and conclude whether new enforcement tools or changes to the proposals are needed for us to effectively police the markets. I'm confident that our Division of Corporation Finance and our Division of Enforcement can accomplish this without undue delay. I also welcome our state counterparts' views, and I understand that the North American Securities Administrators Association has formed a task force to evaluate our proposals and their potential impact on the states' ability to fight fraud.
Notably, Dean Joel Seligman, a leading securities laws expert, offered a similar view on an earlier proposal to fundamentally amend the Securities Act. He wrote: "I would be troubled by the adoption of ... systematic reforms ... until there was an equally systematic study of the current existence of securities fraud..."
In the next few minutes I'll briefly discuss just a few of the issues I intend to consider as I review comment letters in the upcoming months.
Threshold for Form "B" offerings. The SEC must ensure that those companies qualifying for Form B's maximum flexibility are fully "seasoned." Almost every commentator participating in the informal meetings my staff attended thought a $75 million float test to determine "seasoning" was far too low. Many thought that amount should be tripled or quadrupled. Nevertheless, our Aircraft Carrier proposals also include an "average daily trading volume" test, and the two together may be sufficient.
One other thing on this point that we must consider: as the proposing release notes, under the Commission's threshold test for using Form B, four percent of the companies eligible to use this form would have less than three analysts covering them. Query whether four percent is too great a percentage for the Commission to allow in a system relying on an "efficient market" hypothesis. Moreover, a company with two or fewer analysts may be covered solely because the analysts are affiliated with the brokerage firm conducting the underwriting. There may be undue pressures on such analysts to favorably review the securities for which their firm is simultaneously underwriting the offering.
Some at the SEC believe that Aircraft Carrier fits nicely with our Plain English rulemakings and interpretations, which of course generally are limited to risk disclosure aspects of a securities offering. This may in fact be the case. Nevertheless, the Aircraft Carrier raises an interesting question; namely, whether the SEC now needs to apply Plain English principles to all disclosure documents and especially Exchange Act documents. After all, to the extent we minimalize investor reliance on Securities Act disclosure documents for improved Exchange Act disclosures, we may need to take such action.
One of the most controversial proposals here may be allowing unlimited "free-writing." The SEC will have to decide whether traditional concerns relating to "conditioning the market" remain valid. We'll have to consider whether we're providing too much flexibility in this area, and whether the proposed 30-day "cooling-off" period is sufficient.
I noted earlier that we must aggressively seek out investor comments. The SEC received extensive comments when we considered earlier proposals to fundamentally amend the Securities Act, but too small a percentage of them were from investors. We received a particularly thoughtful comment letter from the American Bar Association. You are fortunate enough to have the co-drafters of that letter -- Ms. Quinn and Mr. Williams -- here today as two of the panelists you will hear from shortly. The ABA saw the issues I've described to you today much differently than I do. The ABA said that the "premises" of the Securities Act had "been rendered essentially irrelevant by changed market realities," and that the Act was an "unacceptable anachronistic impediment" but for SEC actions over the last few decades to liberalize its terms. I guess I should be prepared to have the ABA say that the SEC did not go nearly far enough in its current proposal towards eliminating issuer-imposed burdens.
In closing, I'll repeat Robert Moses's oft-quoted remarks: we should "[h]ave no fear of change as such and on the other hand, no liking for it merely for its own sake." While I have publicly stated my concerns regarding Aircraft Carrier, I'll consider the proposals with an open mind, and I'm prepared to adopt these or similar proposals if I am convinced that they ensure our ability to successfully prevent fraud and to police the markets. In my remarks, I hope that I have conveyed my concerns about the proposal, my desire to obtain feedback on the proposal from commenters, and my suggestions on a few ways in which my concerns can be alleviated.