Sovereign Wealth Funds and Public Disclosure
Linda Chatman Thomsen
Director, Division of Enforcement
U.S. Securities & Exchange Commission
Before the U.S.-China Economic and Security Review Commission
February 7, 2008
Chairman Wortzel, Vice Chairman Bartholomew, and members of the Commission:
Thank you for inviting me on behalf of the Securities and Exchange Commission to discuss issues raised by the participation of government-owned commercial investment funds in the U. S. capital markets. I am going to focus my remarks on the law enforcement issues, especially issues related to the enforcement of the federal securities laws. I have also attached to my testimony two recent speeches1 by Securities and Exchange Commission Chairman Christopher Cox which address other, broader issues.
Government ownership of large investment funds, known as sovereign wealth funds, is not new, but it is a markedly growing trend that raises important issues for policymakers to consider. The world's sovereign wealth funds (estimated to hold $2.5 trillion in assets) are significantly larger than all of the world's hedge funds combined. According to some estimates, sovereign wealth funds could grow to hold as much as $12 trillion over the next eight years. The Abu Dhabi Investment Authority, Norway's Government Pension Fund, and Saudi Arabia's wealth fund, according to IMF estimates, each currently have more than a quarter of a trillion dollars in assets to invest. Kuwait, Singapore, Russia, and Hong Kong also each have sovereign wealth funds totaling more than $100 billion in assets. Focusing specifically on China, the Chinese government recently established the China Investment Corporation, with assets estimated at $200 billion. This new Chinese government fund appears to be taking a measured approach to its investments and is acting as a passive investor.
I should note that not all government-directed investment funds are foreign. For example, the Alaska Permanent Fund (a $40 billion fund) has diversified its oil income into stocks, bonds, and real estate. The permanent funds of Texas were originally oil based (and continue to have income derived from oil royalties from state-owned lands), but are today mostly financial portfolios.
These funds raise a number of securities law enforcement issues.
At the Securities & Exchange Commission an essential part of our mission is investor protection. Those investors include all investors, whether they are individual retail investors or very large institutional investors such as pension funds, hedge funds and sovereign wealth funds. Essential to the protection of investors is the protection of market integrity.
As with other participants in the U. S. capital markets, sovereign wealth funds are subject to the requirements of the federal securities laws including a variety of disclosure requirements as well as the anti-fraud provisions. Generally speaking, the disclosure requirements, found in Sections 13 (Periodic and Other Reports) and 16 (Directors, Officers, and Principal Shareholders) of the Securities Exchange Act of 1934, require disclosure of certain share ownership and other information to the Securities & Exchange Commission. These provisions include requirements that:
Owners of more than 5 percent of a registered class of securities disclose their share ownership and any plans for influencing or taking over the issuer;
Institutional investment managers with discretion over accounts holding more than $100 million of SEC-registered securities file quarterly reports on all SEC-registered securities in the accounts; and
Owners of more than 10 percent of a class of equity securities registered with the SEC report on the size and composition of their holding and on changes to that ownership.
The anti-fraud provisions of the federal securities laws generally prohibit a wide variety of fraudulent conduct including insider trading, market manipulation and other trading related abuses. It falls to the Enforcement Division to investigate potential violations of our laws, and to recommend action to the Commission in appropriate cases.
One series of enforcement issues associated with sovereign wealth funds are similar to the issues associated with hedge funds. More specifically, we are concerned that some sovereign wealth funds, or persons associated with them, like some hedge funds, or persons associated with them, may undermine market integrity by engaging in insider trading or other market abuses. Sovereign wealth funds, like hedge funds, are relatively opaque. Also, sovereign wealth funds, like hedge funds, have, by virtue of their substantial assets, substantial power in our financial markets. However, in addition to this financial power, sovereign wealth funds, unlike hedge funds, have power derived from being governmental entities, which may give them access to government officials and information that is not available to other investors. There is the potential for these powerful market participants to obtain material non-public information, either by virtue of their financial and governmental powers or by use of those powers, to engage in illegal insider trading using that information. The magnitude of any such conduct could be quite large given the assets these funds have at their disposal. In our last fiscal year, ending on September 30, 2007, we brought 47 insider trading cases involving 110 defendants or respondents. Those cases showed a disturbing number of market professionals, including professionals associated with hedge funds, engaging in illegal insider trading.
Another series of issues associated with sovereign wealth funds relates to the need for law enforcement authorities to work together in order to effectively police our increasingly global markets. Each year, the Securities & Exchange Commission makes hundreds of requests to foreign regulators for enforcement assistance, and responds to hundreds of requests from other nations. To facilitate this type of assistance the Securities and Exchange Commission has entered into more that 30 bilateral information-sharing agreements, as well as the IOSCO Multilateral Memorandum of Understanding, the first global multilateral information-sharing agreement among securities regulators.
In our last fiscal year we made 556 requests to foreign regulators, and received 454 requests from foreign regulators. These numbers reflect a 24% increase in requests to foreign regulators from our 2002 fiscal year and a 28% increase in requests from foreign regulators from our 2002 fiscal year. Returning for purposes of illustration to our insider trading cases from last year, of the 47 investigations, 16 (or about 34%) had an international component. Of the 110 defendants or respondents, 24 (or about 22%) were residents or citizens of foreign countries. It seems that insider trading cases are becoming increasingly international, as we have seen a growing number of perpetrators use foreign banks, agents and accounts to try to obscure their identities and hide the illicit proceeds abroad. Indeed, we have seen instances in which an insider trader in the U.S. sends his profits to a co-conspirator in one foreign country by way of bank or brokerage accounts in yet another country. But these strategies are of no avail - with the assistance of securities regulators and other law enforcement officials in many foreign countries; we have pursued insider traders and their profits all over the world.
To cite a very current example of our international work, this week we filed a settled action related to alleged insider trading in the securities of Dow Jones, a U.S. registered issuer, ahead of the public announcement of an acquisition offer by News Corp. The SEC's complaint alleged that a Dow Jones board member (a prominent business and political figure in Hong Kong) tipped a close friend - another very prominent Hong Kong businessman - about the News Corp. acquisition offer before it was publicly announced. Based on this inside information, the friend bought $15 million worth of Dow Jones common stock through a brokerage account in the names of his daughter and son-in-law, who were also residents of Hong Kong. The acquisition offer was substantially higher than the market price of the shares, and when it was publicly announced Dow Jones's stock price shot up by 58%. After the announcement, the friend sold all of his Dow Jones stock for a profit of $8.1 million. Seeing this highly unusual trading in a brokerage account in Hong Kong, the SEC commenced an investigation. The SEC's investigation first focused on the daughter and son-in-law as the account-holders, but ultimately led back to the Dow Jones board member and his friend. Without admitting or denying the Commission's allegations, the board member agreed to settle the action by paying an $8.1 million civil penalty, and the friend agreed to pay $8.1 million in disgorgement, plus an $8.1 million civil penalty. The daughter and son-in-law, who the SEC alleges traded on the same inside information in yet another brokerage account, agreed to pay full disgorgement of their $40,000 profit and a civil penalty in the same amount.
In conducting the Dow Jones investigation, the SEC requested and received assistance from the Hong Kong Securities and Futures Commission. Given the inherent difficulties of conducting a cross-border investigation halfway around the world, this kind of cooperation is essential for our effectiveness and the need for the cooperation is increasing. In the context of sovereign wealth funds, we are concerned that if the government from which we seek assistance is also controlling the entity under investigation, the nature and extent of cooperation could be compromised. Indeed, in other contexts, we have seen less than optimal cooperation when foreign governments have an interest in the issue or person we are investigating.
The issues raised by the growth of sovereign wealth funds are under consideration in a number of venues including the President's Working Group on Financial Markets, of which the SEC is a member, as well as in the G-7, the World Bank, the OECD, and the IMF. The outcome of these analyses may be generalized agreement about the kinds of strong fiduciary controls, disclosure requirements, professional and independent management, and checks and balances needed to prevent corruption, all of which may help protect both investors and markets.
We are of course committed to vigorously pursuing our mission of investor protection and look forward to continuing and deepening our relationships with our counterparts around the globe.
Thank you for inviting me to appear today and I would be happy to answer any questions.