Speech by SEC Commissioner:
Social Security Privatization
Paul R. Carey
Commissioner, U.S. Securities & Exchange Commission
Before the 11th Annual Conference of the National Academy of Social Insurance, Washington, D.C.
January 28, 1999
The views expressed herein are those of Commissioner Carey and do not necessarily represent
those of the Commission, other Commissioners or the staff.
Thank you for the kind introduction and the invitation to
speak to you today. Social Security reform is an issue of
considerable interest to everyone, and I am pleased to be asked
to share my views. To that end, I should note that these are my
views and not the views of the Commission.
Last week, the President unveiled his plan to reform Social
Security. Others have put forth different proposals, and the
debate is clearly underway. I want to stress that the SEC
neither endorses nor opposes any particular Social Security
reform proposal. Given that the SEC's mandate is to protect the
interests of investors, we are, however, concerned about investor
protection. While Social Security reform has not been a
traditional area of expertise for the Commission, many of the
issues that arise -- such as investor education, financial
literacy, corporate governance, disclosure of material
information, including expense information, and sales practices -
- have long been a concern for us.
At Chairman Levitt's request, I am leading the Commission's
efforts to provide advice to policy makers on how best to address
the investor protection issues that arise under various reform
proposals. I would like to speak today about some of the efforts
that the Commission's staff is undertaking to better enable us to
provide such advice. I will be raising many questions that we
are working to answer, and that we think should be addressed in
the reform effort. While the reform proposals thus far cover a
wide range of topics, almost every reform proposal involves some
type of market investment. I will use what I think of as the two
benchmarks of the reform debate to illustrate the types of
investor protection issues that we are concerned with.
On one end of the spectrum are plans where some of an
individual's payroll contributions would be invested in an
individual private account. On the other end of the spectrum are
plans where the government would invest some or all of the Social
Security trust fund into the market. Regardless of which path
reform takes, policy makers will need to make decisions about how
to resolve basic investor protection issues.
First, I would like to discuss the types of issues that we
are analyzing in the event that Congress adopts a reform plan
that includes individual accounts. Clearly, investor education
should be a key component of any individual account program. An
individual account system could involve the creation of some 140
million individual accounts -- one for each American worker.
While many of these workers already invest in the market --
indeed, recent statistics show that one out of every three
households now owns mutual funds -- many would be new investors.
To maximize the success of this type of program, we need to
ensure that all investors understand the relationship between
risk and return. Investors must understand the rationale behind
diversified portfolio strategies. In addition, investors need to
understand that years to retirement should be a factor in
determining the appropriate level of risk.
Investors should also understand that the administrative
costs of investing in the market will diminish returns. While a
one percent administrative fee may sound modest at the time of
investment, investors need to realize that this one percent fee
will reduce an ending account balance by 17 percent over a 20
At the SEC, we have been working with the mutual fund
industry to ensure that fees are adequately disclosed to
investors. We have much investor education work left to do,
however. Recent surveys indicate that approximately eight
percent of investors fully understand the fees that funds charge.
Under any system of individual accounts, however, account
expenses must be clearly disclosed. Investors must be able to
understand the disclosure, so that they can easily compare
expenses between investment options. They also need to recognize
that switching investments may entail additional expense, thereby
Other issues deserve careful consideration. Policy makers
need to decide who should be managing workers' money. For
example, would the management of individual accounts be open to
all broker-dealers and investment advisers? Or, should criteria
be developed to determine who could manage individual accounts?
Would limiting the pool of eligible money managers decrease the
possibility of sales practice abuses?
Similarly, policy makers will need to decide what investment
choices will be permitted. Should an unlimited number of
investment choices, ranging from individual stocks, options,
bonds and private placements to mutual funds, be permitted? Or,
would it make more sense from an administrative and investor
protection standpoint for the government to designate a finite
number of choices as it does in the Federal Thrift Savings Plan?
If the answer is yes, should the finite number of choices be
limited to investments like index and money market funds?
We can learn much from the experiences of other countries
who have embarked upon privatization. We can look to countries
like Chile and Great Britain to learn about some of the benefits
that a system of individual accounts can provide. But, we also
need to educate our workers so that they do not fall prey to the
"misselling" experience that occurred in Great Britain or the
excessive switching problem occurring in Chile.
In hopes of avoiding the investor losses that resulted from
the "misselling" and switching problems in these countries, we
should also carefully consider issues like how fees should be
structured and how often investors should be permitted to switch
investments. Should front-end loads be permitted, or would an
annual flat fee be a better option? It is important to
considerwhether a fee structure might unintentionally reward
money managers who convince workers to make frequent investment
switches. Should switches be permitted at any time during the
year or perhaps only quarterly or annually? Decreasing the
number of times investment switches would be permitted may curb
excessive switching, but it would also limit investors'
flexibility. An appropriate balance should be struck between
permitting flexibility, but discouraging excessive switching.
Similarly, permitting greater flexibility could have the
unintended effect of encouraging investors to try to take
advantage of short-term market fluctuations rather than managing
their account with a view to the longer term.
Small accounts present a unique set of issues. Many plans
propose diverting two percent of a worker's salary to an
individual account. There are roughly 40 million workers earning
less than $8,500 a year in this country. Under the two percent
plans, each of these workers would annually contribute $170 or
less to an individual account. Would an individual account of
this size make economic sense for both the worker and the money
manager? Or, would it make more sense for these workers to
invest in a program like the Thrift Savings Plan until their
accounts increase in value?
Government Investment of the Trust Fund
Let's now turn to some of the issues that we are analyzing
in the event that Congress adopts a reform plan that includes
government investment of some portion of the trust fund into the
market. Proponents of this approach point out that
administrative costs would be lower, and market risk would be
spread more broadly, than under a system of individual accounts.
However, this option has served as a lightning rod for criticism.
Fed Chairman Alan Greenspan has expressed concerns that the
investment decisions for the portion of the trust fund invested
in the market might be influenced by political pressures. Many
wonder who would decide what to buy, and whether there would be
political pressure on the government to invest only in companies
that produce socially responsible products. Also, critics have
asked how the government's shares would be voted.
Some plans envision the government retaining an investment
adviser to serve as portfolio manager for the portion of the
trust fund assets to be invested in the market. With respect to
voting, several arrangements come to mind. The portfolio
manager, like portfolio managers of mutual funds, could vote the
shares held by the trust fund consistent with its fiduciary
Or, in other words, the portfolio manager could vote the shares
in a manner that is in the best interest of its shareholders,
without any interference in the process by the government. Other
voting arrangements are also possible. For example, the
portfolio manager could "mirror" the votes of the other
shareholders. In simpler terms, the portfolio manager could cast
votes in the same proportion as the votes cast by the other
shareholders of the issuer. These and other types of voting
arrangements are useful to explore and may serve to lessen the
potential for misuse of voting powers.
With respect to investment choices, some of the concerns
raised may be lessened if the trust fund assets were invested in
accordance with an already existing index. Or, investment
choices could be made pursuant to pre-established investment
criteria. Of course, the selection of the portfolio manager and
the creation of the investment criteria raise other issues about
how these things would be accomplished.
Critics have also raised other important issues. Some worry
that government investment of the trust fund assets could provide
an incentive for the government to try to control market
fluctuations. If the fund invests in individual securities as
opposed to an index, should the investments be diversified?
Would sufficient quality investments be available given the large
amount of money to be invested? We also need to consider whether
the massive influx of capital into the market could affect other
market activities, like capital formation or the rate of return
Still more issues deserve consideration. Should the trust
fund be subject to protections similar to those of mutual funds,
which are subject to regulation under the Investment Company Act
of 1940? For example, mutual fund portfolio managers must comply
with restrictions on their ability to enter into affiliated
transactions with the funds they manage, and must comply with
shareholder voting rights provisions. From an investor
protection standpoint, we need to consider whether it makes sense
for these types of provisions to apply to a trust fund portfolio
manager. Similarly, we should think about what qualifications
the portfolio manager should possess.
These are challenging and compelling issues. As we all
know, there are no easy answers to these questions. But, we
continue to believe that any solutions should be guided by the
two tenets of investor protection and investor education. While
Congress wrestles with the difficult policy issues, weighs the
competing interests and strikes the appropriate balances, we are
working to ensure that we are prepared to frame the pertinent
investor protection issues and propose adequate solutions. We
look forward to providing assistance in an appropriate fashion.
And, regardless of which path the reform takes, we remain
committed to our mandate to protect investors. William O.
Douglas, the Supreme Court Justice and the Commission's second
chairman, said it best when he said of the SEC, "we are the