Good morning.
It is a pleasure to be here today, to see so many familiar faces and to be surrounded by professionals who appreciate the importance of our capital markets — who rely on those markets for your livelihood — and who set out to ensure that those in the industry are playing by the rules.
You understand that we all benefit when Americans have confidence in our financial system — and when they are willing to invest their hard-earned dollars in hopes of receiving steady returns.
Our nation's success relies in large part on the fairness and efficiency of our capital markets. It is where manufacturers raise capital to create new jobs, where municipalities raise funds to build new schools, and where businesses raise money to conduct research and develop technology.
Our capital markets are the engine of our economy. And that engine is fueled by millions of individual investors.
Ensuring that investors have the information they need to make intelligent decisions; fair and honest markets in which to execute their trades; and robust enforcement of the laws that were designed to protect them is a core mission of the SEC. And, in the wake of the greatest economic crisis since the Great Depression, we are refocusing our efforts on doing just that.
For investors, securities professionals and regulators alike, the past few years have been trying times. The credit crisis shook our financial system to its core.
It was an experience that touched us all — and has led us to think about what could have been done differently, and how we can change things to prevent such a catastrophe in the future.
There's no question that the securities landscape will only become more complex, more sophisticated, more international in scope and more technologically-driven in the years ahead. But, as I consider the future of regulatory reform and the SEC's role, I find myself thinking of the past — back to a time 75 years ago, when our nation was emerging from an earlier financial crisis.
At that time a group of determined legislators came together and drafted laws that focused on a few key principles they thought should guide our country's new approach to regulating investments.
One central principle was transparency — that is, providing investors with all the information they needed about the companies whose stocks they sought to buy. They talked about sunlight and its power to both inform and protect the public from abusive practices and worthless products. Sunlight allows both market participants and regulators to make rational decisions concerning risk and reward.
A second principle was fairness — every investor should play on as level a field as possible.
And a third principle was enforcement — because rules about fairness and transparency carry only so much weight. It's the enforcement actions we are empowered to bring that help ensure that transparency and fairness are actually delivered by financial intermediaries and issuers.
These principles helped our financial markets emerge from The Great Depression as a driver of unprecedented growth and prosperity. And today, as we look to emerge from our most recent crisis, those same principles should guide — and are guiding — the SEC's actions once again.
When the securities laws of the 1930s were passed, the products were simpler. There were stocks and there were bonds. The information was easy — or at least easier — to digest. Most investors could appreciate the risks inherent in each transaction. And, as a result of the federal securities laws, most transactions were public. This allowed the market to price trades rationally, and market participants to see trends and spot risk.
Since then, trading and the products being traded have become far more complex — often in ways that provide less transparency to investors. So, for instance, the inability of individual investors or even so-called experts, to accurately judge the assets underlying asset-backed securities led to massive losses which helped to put the current crisis in motion.
And, for another example of the ruin caused by opacity, we can look at trading in over-the-counter derivatives that magnified the crisis dramatically once it began.
Asset-Backed Securities: As you well know, asset-backed securities are created when loans or other assets are bundled together to create a security, and sold to investors. There are, of course, many ways to build on the relatively simple ABS base — dividing the bundles into different tranches with different levels of risk and different degrees of returns; rebundling existing securities into other, more complex CDOs; creating synthetic CDOs, and so on.
Understanding the risk in any of these products demands an accurate analysis of the risk of the original individual assets underlying them all. Yet investors in recent years have been unable to penetrate all of what makes up each ABS.
If investors could not appreciate the risks in the securities, then one culprit may have been a lack of transparency — or at least a lack of sufficiently accessible transparency.
That's why we recently proposed rules that would revise the disclosure and offering process in the ABS arena. Our proposals are intended to provide investors with more detailed and current information about these products and more time to make their investment decisions. For the first time, the information requirements would be extended to private offerings made in reliance on our safe harbors.
Under the rules, asset-backed securities issuers would be required to provide detailed data for each loan in the asset pool, both at the time of securitization and on an ongoing basis.
The loan-level data would cover items such as the terms and underwriting of the loan, credit information about the borrower, and characteristics of the property securing the loan. And, the information would be tagged and computer-readable so investors can synthesize large amounts of data about the underlying assets — and do it without having to rely on the sometimes flawed judgments of credit rating agencies.
At the same time, I believe we can do more to protect investors in this ABS market as well. So our proposed rules also seek to better align the interests of issuers and investors by creating a retention requirement for certain public offerings of asset backed securities.
No one may have envisioned the widespread growth of such things as ABS seven decades ago, but through an insistence on transparency and fairness, the framers of our securities laws created a regulatory regime that would be adaptable to whatever the future would hold.
OTC Derivatives: As with ABS, over-the-counter derivatives — at least as they exist today — were not even a glimmer in the eyes of securities regulators back in the 1930s.
But, by promoting transparency, the creators of our securities laws were embracing a principle that today most agree should apply to OTC derivatives.
Unfortunately, what those legislators probably didn't expect was for a subsequent law to be adopted creating a loophole for later generations of derivatives. Yet, that's exactly what the Commodity Futures Modernization Act of 2000 did.
Because over the counter derivatives trading lacked meaningful transparency, investors lacked the information needed to price derivatives accurately — bringing natural market corrections, and regulators could not appreciate the risks multiplying throughout the system.
As Congress considers financial reform, it has been our consistent refrain that the kind of transparency we have today in the corporate bond market, is essential to the successful oversight of the derivatives marketplace and to the ability of investors to knowledgeably engage in these transactions.
Another of these original principles is fairness. To the extent possible, every investor should have the same opportunity to profit from his or her investment and to be assured that they are doing business with people and institutions that are qualified, supervised and playing by the rules. This is why, for example, the SEC imposes requirements for honest sales practices, disclosure of fees and expenses for mutual fund investments, and maintains a sharp focus in our enforcement program on a wide range of activities that have the potential to harm investors.
The fairness owed to investors cannot be compromised by complexity. Today, just as products are becoming more complex, so too is the structure of our markets.
No longer do we rely on people shouting on the exchange floors to transact business. Instead, we rely on computerized trading whose speed has accelerated from seconds to milliseconds to microseconds. And, for some that isn't fast enough.
Trading volume has expanded, and new trading centers have entered the markets and captured a significant share of volume. Liquidity is now dispersed among many different venues, and these venues offer a complex array of order types and trading services.
But, once again — just because technology is progressing and trading platforms have proliferated — fairness must remain the underpinning of the market.
So we have been engaged in a serious review of the equity market structure. All in an effort to ensure that the markets remain fair for all investors — and to prevent the emergence of a two-tier system that favors only an elite few.
Already, our review has resulted in several proposed rules intended primarily to preserve the integrity of longstanding market structure principles.
One such proposal would ban flash orders, which enable a person who has not publicly displayed a quote to see orders before the public is given an opportunity to trade with those orders.
Another proposal would strengthen transparency requirements for non-public trading interest, including dark pools that do not display quotations to the public.
And, a third proposal would bolster the risk management controls of broker-dealers that provide direct market access to their customers.
I also anticipate this spring that the Commission will consider staff recommendations to have the self-regulatory organizations develop and implement a consolidated audit trail that captures customer and order event information across markets.
Our market review additionally includes outreach to the industry and investors seeking comment on a broad range of issues — focused on high-frequency trading, co-locating of trading terminals, and markets that do not publicly display price quotations.
Our goal will be to assess how these changes in the market are affecting investors and to assure the principles of the last century are still alive and well today.
That is why we are asking hundreds of questions, including such fundamental ones as:
How do we measure and assess market quality for long-term investors and have the metrics improved or worsened in recent years?
Is the current highly-automated, high speed market structure fundamentally fair for all investors?
What types of strategies are used by the proprietary trading firms loosely referred to as high frequency traders, and are these strategies beneficial or harmful for other investors?
To what extent do the interests of short-term professional traders diverge from those of longer-term investors and what are the implications of that?
Further, next month, we will host a Market Structure Roundtable to delve deeper into the issues. In particular, I look forward to discussing the consequences of high-frequency trading for and the impact of undisplayed liquidity on long-term holders.
Finally, as you know better than anyone, market participation has grown dramatically in the last 20 years, especially as more people turn to tax-favored investments to save for college and secure their retirements. We have seen a steady stream of product and fee structure innovation in our markets, leaving many confused.
And one thing we can count on is that your firms will continue to create new products and funds in an effort to match risk and reward to individual needs. But, adherence to that principle of fairness is critical to investors' willingness to commit their capital to new products.
In an innovative market with new alternatives appearing every day, it's important that the people who turn to professionals for advice know what incentives exist beyond the client's needs, for the men and women influencing their investment decisions.
Right now, investment advisers, as fiduciaries, have an obligation to provide advice that is in an investor's best interest — and to avoid or disclose conflicts of interest. Broker-dealers, who earn transaction fees and sometimes incentives for guiding decisions towards one strategy or another, do not currently have to meet this standard, although they are subject to a more comprehensive regulatory regime.
I believe that broker-dealers and investment advisers providing the same services, especially to retail investors, should meet that same high fiduciary standard. This is an issue that I hope will be addressed in regulatory reform legislation and one that is fully consonant with the principle of fairness that helped guide the development of the securities laws.
In this vein, my staff is preparing to present to the full Commission a recommendation regarding adoption of Form ADV, Part 2 — the primary disclosure document for advisory clients. We are looking to move past the 1960s check-the-box, paper-based approach by requiring a plain English narrative discussion of an adviser's conflicts, compensation, business activities and disciplinary history.
The rule would also require disclosure of this information through the SEC's website, so that investors, regulators and the public at large have free and simple access to it.
And, finally, I have asked the staff to present a recommendation on 12b-1 fees for Commission consideration this year. In 2008, these fees totaled $12 billion, but many investors have little idea that they are being deducted from their mutual fund — or what they are paying for. We need to critically rethink how 12b-1 fees are used and whether they remain appropriate.
The third and final principle I want to briefly touch upon is enforcement.
Since the SEC's birth, we have brought tens of thousands of enforcement actions — and they are a critically important component of oversight. I believe most industry professionals appreciate the value of and the need for transparency and fairness. And, I know that the prospect of suspensions, bars or penalties helps to reinforce the importance and centrality of those obligations.
But to me, enforcement actions are not just about righting a particular wrong, but sending a message that the SEC is watching.
In the wake of the financial crisis, we have brought a number of cases including those alleging accounting fraud at subprime lenders, misrepresentation of complex investments as appropriate for retail investors seeking safe investments, fraud in connection with CDO marketing materials, and misleading investors about exposure to subprime investments.
Our cases have included actions against firms from American Home to Countrywide; from New Century to State Street to J.P. Morgan. And, we are continuing to pursue cases related to the financial crisis with many ongoing investigations involving complex products across the range of market participants.
Additionally, we continue to bring significant cases in many important areas, including Ponzi schemes, offering frauds, municipal securities, unlawful pay-to-play activities, accounting fraud, and large-scale insider trading.
Last year, I provided Congress with a package of legislative proposals that would significantly improve our ability to protect investors. Most of these provisions were adopted by the House of Representatives with little controversy. Key elements would improve the SEC's ability to exercise its enforcement and examination authorities.
One would harmonize our authority to pursue aiders and abettors in all types of Commission actions. Another provision would provide for nationwide service of process in our federal court actions. And yet another would increase our ability to obtain important information from regulated entities. The Senate should consider including many of these provisions in the final legislation, and we have advocated strongly for that.
In the wake of the financial crisis it has become a cliché that regulators cannot keep up with innovators in a market as dynamic as finance. I don't think that's true. But I think that where we sometimes go wrong is in trying to react to and respond to every change or innovation, often before its significance is known — or after it has become too apparent.
Instead, we should be looking to the future by returning to proven principles of the past, like transparency and fairness — principles that empower investors to make rational decisions and give regulators the tools they need to prevent crises, without stifling growth.
Thank you.