Setting Forth Goals for 2015: Address to Practising Law Institute’s SEC Speaks in 2015 Program

Commissioner Luis A. Aguilar

Ronald Reagan Building and International Trade Center
Washington, D.C.

Feb. 20, 2015

Good morning.  I am honored to be here this morning for my seventh SEC Speaks as an SEC Commissioner.  Before I begin, let me start by issuing the standard disclaimer that the views I express today are my own, and do not necessarily reflect the views of the Securities and Exchange Commission, my fellow Commissioners, or members of the staff.

During the past seven years, the SEC has taken action on a significant number of issues.  There is little doubt, that these years have been one of the most active periods in SEC history.  For example, during this period, the Commission voted on almost 250 rulemaking releases, both proposing rules and adopting final rules.[1]  Many of these rulemakings have been ground-breaking.[2]

Still, even with all that activity, the SEC has not finished its work on many ongoing issues, such as the need to improve disclosures related to target-date funds and municipal securities.  The Commission also has not completed many of its outstanding statutory mandates.  I plan to use my time with you today to lay out a few important priorities that the SEC should pursue in 2015 in order to move toward completing its outstanding work, to strengthen the Commission and do right by the public.

I.  Complete the Work on Dodd-Frank Rulemaking

First, the Commission must complete the rulemakings required by the Dodd-Frank Act.[3]  Adopted after the worst financial crisis in recent memory, the Dodd-Frank Act was designed to address many of the regulatory gaps and loopholes exposed by the market crisis.  With this law, Congress tasked the Commission with creating a regulatory regime to address these regulatory failures by, among other things, bringing greater transparency to the securities-based swaps market; giving investors a voice on executive compensation;[4] improving the practices of credit rating agencies;[5] correcting serious flaws in the asset-backed securities markets;[6] and limiting the conflicts that arise when NRSROs rely on client payments to drive profits.[7]  In fact, the Dodd-Frank Act mandated the Commission to promulgate approximately 95 separate rulemakings.[8]  Unfortunately, according to a January 2015 report, the Commission had only finalized 56 of these rules.[9]  Clearly, there is more work that needs to be done, particularly the Commission needs to complete the rulemakings relating to derivatives regulation and corporate governance.

It is important that the Commission finalize these rules because they are vital to the protection of investors, the stability of our capital markets, and our overall economy.  Finalizing these rules creates regulatory certainty.  The Commission’s failure to finalize these rules creates a “regulatory limbo” that impedes many business decisions.

One area where I would like to see more action is in the derivatives rulemaking.  There is little doubt that one of the most important mandates of the Dodd-Frank Act is for the Commission, along with the CFTC,[10] to promulgate an effective regulatory framework to oversee the derivatives market.  The significance of this market to the overall capital markets cannot be overstated; the derivatives market has been estimated to exceed $692 trillion worldwide, with more than $14 trillion representing transactions in security-based swaps regulated by the SEC.^[11]

Unfortunately, the most current data shows that the Commission has only finalized less than half of the required Title VII rulemakings under the Dodd-Frank Act.[12]  Although, the Commission has adopted some of the rules necessary to regulate the securities-based swaps market,[13] the vast majority of these new rules will not be effective until the entire Title VII regulatory framework is put in place.[14]  With this delay, the Commission is failing to achieve the goal of increasing transparency and oversight of the derivatives market by bringing trading of security-based swaps onto regulated markets.^[15]  This is crucial to ensuring that security-based swaps do not continue to be transacted in an opaque market[16] with significant regulatory gaps.[17]

Another important component of the Dodd-Frank Act is enhancing accountability by ensuring that shareholders have a voice in corporate governance matters.  Unfortunately, the Commission has adopted some of the Dodd-Frank rules, it has yet to propose or finalize many of the corporate governance, such as rules on disclosures about pay-for-performance, the disclosure of the ratio between the CEO’s compensation and the median of all other company employees, disclosure by large investment managers of their “say-on-pay” votes, and prohibiting the exchange listing of securities of issuers that have not implemented claw-back policies.[18]  These and other rules are important to shareholders.

In order to complete its work and fulfill its mandates under the Dodd-Frank Act the Commission must redouble its efforts.  It is important to provide certainty to businesses and regulatory entities and get beyond this constant state of living in a world of unfinished mandates.  It has been five years since Congress passed the Dodd Frank Act, and, at the rate we’re going, it will be at least another five years before the Commission fully satisfies its statutory mandates.

This is not a good state of affairs for industry participants, regulated entities, public companies, investors, the public, and the SEC itself.  A well-regulated and transparent market instills investor trust and confidence, which is vital to protecting the continuing growth of our economy.

II.  JOBS Act

Second, I would like to see the Commission continue its progress implementing the various provisions of the Jumpstart Our Business Startups Act (“JOBS Act”) that are intended to facilitate the ability of smaller businesses to access the capital markets.[19]  In particular, the Commission should adopt final rules to Regulation A-plus and Crowdfunding, and, importantly, amend Regulation D to mitigate the risks posed to investors involved in general solicitations.[20]

The Commission has long recognized the importance of smaller businesses as the engine that powers the U.S. economy.  However, it is also well-documented that investments in small or emerging businesses also carry heightened investment risks,[21] including higher risks of small business failures,[22] lower liquidity of issued securities, and, unfortunately, a higher incidence of outright fraud.[23]

Consequently, the Commission must proceed carefully in implementing the JOBS Act provisions, and to do so in a manner that is consistent with the protection of investors and maintaining the integrity of the capital markets.

As the Commission works through implementing the various provisions of the JOBS Act, which include multiple registration exemptions with, at times, overlapping offering amounts, I believe that there are certain macro principles that should be kept in mind: 

• First, we need to consider the nature and experience of the investor who will be putting their dollars at work in any particular offering.  For example, we need to ask whether any particular offerings should be limited to investors who are able to fend for themselves, such as with private placements publicly offered to so-called “accredited investors” under Regulation D.[24]  And, if so, have we properly identified the characteristics and criteria that are likely to reasonably identify the investors that are able to fend for themselves?  Or will offerings be available to investors that are likely to be less financially sophisticated, such as those anticipated with Crowdfunding transactions?[25]  And, in such cases, should investor purchases be limited, and what is the purpose and role of limiting the amounts that investors may make—either in the aggregate or individually?  Ultimately, the nature, type, or experience of the targeted investor, among other things, should inform the applicable disclosures and any investment limits or other requirements.

• Second, once we have identified the nature and experience of the investor, we need to consider the type of information that is necessary to permit the targeted investors to make informed investment decisions.  For example, what salient information makes the most sense under the circumstances?  Should issuers be required to provide audited financial statements?  Should we require ongoing disclosures, such as those contemplated in the proposed Regulation A-plus and Crowdfunding provisions?[26]

• Third, we need to consider the overall regulatory environment, such as the role of state securities regulators, in protecting investors and promoting capital formation for smaller offerings.  We should recognize that the states have long been at the forefront of combating securities fraud in smaller offerings, and should therefore carefully consider the extent to which state securities regulators will be involved—or not involved—in enhancing the SEC’s limited resources in overseeing the market for smaller offerings.[27]

• Fourth, and something often overlooked, we need to consider the secondary trading environment that will exist, or not exist, as more and more companies distribute their shares to a wider group of investors—many of whom are expected to be less financially sophisticated.  For example, several provisions of the JOBS Act, such as those under Regulation A-plus, Rule 506(c) of Regulation D, or Crowdfunding, permit wide distributions and also allow securities to be freely traded by security holders immediately upon issuance,[28] or after a one-year holding period.[29]  These exemptions also provide—or are expected to provide—for lesser ongoing reporting requirements than is typically required for listed securities.  Accordingly, we should ask whether investors will be able to subsequently sell the shares purchased in these offerings in a fair, liquid, and transparent market.  Given the smaller offering size and/or reduced disclosures for these securities, these securities are expected to be highly illiquid.  Thus, we should also ask whether the Commission has properly addressed the risks to investors that may result from such a secondary trading environment.  Are wide swaths of investors going to own securities that they cannot sell when they need to? And, if so, what, if anything, should the Commission do?  Are “venture exchanges” an answer to this looming problem, or will listing on such an exchange result in the stigma of second-class corporate citizenship?

Because exemptions by their nature strip investors of protections, it is incumbent upon the Commission to proceed in measured and thoughtful ways so as not to inappropriately weaken the regulatory environment. 

Capital formation is crucial to our economy and the Commission should move swiftly in completing these JOBS Act-related rule makings.  In doing so, however, we should keep the above macro principles at the front of our minds.  Investors are the lifeblood that makes capital formation possible, and the Commission should act to make sure that the exemptions work from the perspective of the targeted investor, not just for the issuers.  

III.  The Enforcement Division Must Bring Cases That Send a Real Message of Deterrence

My next goal for 2015 is for the Commission to bring more enforcement cases that have real impact—and that send the strongest message of deterrence.

One of the primary reasons that the SEC has been referred to as the “crown jewel” of federal regulatory agencies is the work of the Commission’s Division of Enforcement.[30]  During my tenure, I have been a strong supporter of the SEC’s Enforcement program.  I have advocated for an effective Enforcement program by focusing on individual accountability, effective sanctions that deter and punish egregious misconduct, and policies designed to eradicate recidivism.[31]  Many of the agency’s enforcement decisions serve to reinforce these goals and are to be commended.

The Commission has a number of tools available when it finds that fraudulent misconduct has occurred - it can seek to enjoin such activity, disgorge ill-gotten gains, and impose civil penalties against the wrongdoers.  In addition, the Enforcement Division can use trading suspensions and asset freezes to achieve immediate impact and halt ongoing fraudulent activities.  These are all important remedies.

In my view, however, one of the most potent remedies is for the Commission to prevent wrongdoers from being allowed to remain in a role that permits them to continue to hurt investors.  To that end, the Commission needs to be more aggressive in seeking permanent industry bars and officer and director bars.  These bars, not only serve to punish the wrongdoer, but also protect investors from future misconduct by such person. These bars send a clear message to the next potential fraudster.

An SEC enforcement action should not be viewed merely as a cost of doing business; rather, it should cause individuals and companies—whether or not they are part of the Commission’s specific action—to seriously reflect on their own conduct.  This is particularly true in the case of recidivist violators.  If our remedial sanctions were ineffective in reforming a fraudster, then we must seriously consider removing them from the industry—permanently.  The SEC must do this to protect American investors.

During my time as a Commissioner, I have witnessed defendants fight charging decisions on all fronts, including fighting tooth-and-nail to avoid being prevented from serving as officers or directors of public companies or from being suspended from appearing or practicing before the Commission pursuant to Rule 102(e).[32]  They much rather have their company pay a sizable penalty to continue to do what they do, unaffected and undeterred.  Recently, this was demonstrated in the Gupta matter, where a director convicted of insider trading and given a lifetime officer and director bar, tried to appeal that bar to the U.S. Supreme Court.[33]  As you may know, the Court rejected that appeal by denying cert.[34]  It is interesting to note that the $13.9 million civil fine imposed against Gupta was not appealed to the Supreme Court.[35]

Defendants’ vigor to avoid being barred is to be expected, as those bars and suspensions take fraudsters out of the industry, and often have a far more lasting impact than the imposition of a monetary fine.[36]  Their fight is the best indicator that the Commission’s ability to bar wrongdoers is an effective tool that should be used whenever appropriate.

The importance of a strong and robust Enforcement program is vital to an effective capital market on which investors can rely.  The Commission has to use all of the tools at its disposal, including imposing permanent industry bars and officer and director bars.

IV.  Improving Diversity at the SEC

An additional goal for 2015 is for the SEC to improve its diversity.  I strongly believe that a diverse workforce at the SEC is critical in order for the SEC to achieve its core missions; however, sadly, the SEC still has much to do in order for its workforce to reflect the communities we live in.  Since becoming Commissioner, I have been very active in trying to improve diversity at the SEC, and it has never been easy.

The statistics show that, as of January 2015, 33% of the SEC’s workforce were persons of color, and just 13% were at the senior employee level.  As of fiscal year 2013, the SEC’s senior officers were approximately 87% white, while only 5.6% were African-American, 4% Asian-American, and 2.4% Hispanic.[37]  The numbers did not change much at the mid- and first-level category of managers, which were approximately 80% white, but only 8.4% African-American, 7.5% Asian-American, and 3.8% Hispanic.[38]  In fact, as of January 2015, two of our operating divisions had no minority senior officers—zero.  Two other divisions only had one minority senior officer each, while another division—and one of our largest divisions with more than 1,240 employees—only had three minority senior officers.  These statistics cover all five of the SEC’s operating divisions.  Clearly, these dismal numbers need to be improved.

Although our lack of diversity is well-known and has been publicly discussed many times, the SEC’s recent hiring activity has not resulted in much improvement in our numbers.  For example, as of fiscal year 2013, only about 19% of attorneys at the SEC were persons of color.[39]  That percentage, however, is likely to go down if the SEC hires fewer minority attorneys in the coming years.  Indeed, in fiscal year 2013, only 15.8% of attorneys hired were persons of color.[40]  When you combine reduced rates of hiring with expected attrition, the numbers will only get worse.  The latest data for 2014 is already showing a decrease in hiring for women, an increase in separations for African-Americans, and a decrease in promotions for Hispanics, Asian-Americans, and women.  We can, and must, do better.

The SEC can also do more to retain minority and women employees.  In fact, a November 2014 report by the SEC’s Office of Inspector General made the disturbing finding that, “some minority groups and women: (1) were underrepresented in the SEC workforce; (2) received relatively fewer and smaller cash awards and bonuses; (3) experienced statistically significant lower performance management and recognition scores; and (4) filed equal employment opportunity complaints at rates higher than their percentage of the workforce.”[41]  Moreover, according to the report, the SEC had not taken required initial steps to determine whether internal barriers operated to exclude certain minority groups, and lacked a methodology for evaluating the effectiveness of its diversity programs.[42]

Unfortunately, it is not surprising that today’s event also speaks to the SEC’s lack of diversity.  Every panelist who is scheduled to speak at the 2015 SEC Speaks is a member of the SEC staff.  I am pleased to see that about 37 of the 95 SEC representatives serving as panelists at this conference are women.  However, I was struck by the lack of racial and ethnic diversity.  During this two-day conference, there are and will be, at most, only about 11 SEC panelists who are persons of color, out of a total of 95 panelists.

The SEC senior staff making the hiring decisions must understand that the continuing lack of diversity is a problem, and they must undertake to break down the barriers to finding the best and the brightest by conducting a more comprehensive search for qualified candidates.  To achieve a workforce at the SEC that reflects America, we need to establish internal processes to ensure that diverse individuals are recruited, hired, trained, mentored, compensated fairly, and promoted.  Attracting diverse candidates is an opportunity not only to add high quality and skilled employees to the SEC, but also to change the face of the SEC so that it reflects what our country looks like today.

There are two relatively recent changes at the SEC that I hope will result in policies and processes that promote diversity and inclusion.  First, pursuant to Section 342 of the Dodd-Frank Act, the SEC has established an Office of Minority and Women Inclusion (“OMWI”) to promote diversity at the agency,[43] and bring qualified minorities and women to the SEC, and to foster an environment where they can be successful.

Second, the SEC has now established a new Diversity Council to have oversight over all matters relating to the SEC’s diversity efforts and to ensure that there is full transparency and progress in, among other things, hiring, retention, and promotion of employees.  I am honored to serve as the inaugural Chair of the Diversity Council, and I expect it to be a positive force that makes the SEC more diverse and inclusive.

Only time will tell, however, if OMWI and the Diversity Council will be successful.  I am optimistic enough to think that they will—but I am a realist, and I know it will take focused attention to achieve the goals of

Conclusion

I want to end my remarks by acknowledging that none of what the Commission has accomplished—or will ever accomplish—would be possible without the work of the most committed and hardest working men and women you will ever meet.  The SEC’s staff work tirelessly and passionately each and every day to fulfill the Commission’s mission and to make our country’s capital markets the envy of the world.  I thank them for all their efforts to strengthen the SEC and to serve the American public.

Thank you and enjoy the rest of SEC Speaks.