November 5, 2004 LAWFUEL – SEC news, law, legal, law firm news

November 5, 2004 LAWFUEL – SEC news, law, legal, law firm news Let me begin by thanking the SIA for giving me the opportunity to address this annual meeting. I have also had the chance since arriving in beautiful Boca to meet informally with a number of you and have profited from the open exchange of thoughts and ideas.

I’d like to start by recognizing SIA’s outgoing chairman, Dick Thornburgh, who has helped to guide this organization through a most challenging period in our securities markets. He provides an outstanding leadership model for SIA’s incoming chairman, Danny Ludeman, to replicate. I’d also like to acknowledge the efforts of Marc Lackritz, who continues to be a strong and respected voice for higher standards throughout the securities industry.

But before going any further, let me offer the standard and obligatory disclaimer that the views I express here are my own and do not necessarily represent those of the Commission or its staff.

It was just a year ago that I delivered my first address to the SIA as Chairman of the SEC. I began that speech by saying my message was “important, but unpleasant.” Dark clouds were hanging over the industry, and I’m sure for some my remarks only darkened those clouds. For those of you old enough to have followed the comic strip Li’l Abner, my remarks last year may have reminded you of the character Joe Btfsplk, who walked around with a perpetually dark cloud just above his head, and induced dark clouds for others wherever he went!

But I believe my concern was called for. The nine months since I had taken office as Chairman had been, to say the least, sobering — for me, the Commission, your industry, and most importantly the American investing public. Trading volume on the New York Stock Exchange was continuing to slide and would finish lower in 2003 than in 2002 – the first year-on decline since 1989-90. The IPO market was also in a prolonged state of paralysis.

At the SEC, we were struggling to repair some of the damage caused by the corporate scandals at entities such as WorldCom and Enron. Within 45 days of my swearing-in, we concluded the Global Research Analyst Settlement. We then filed a range of other enforcement actions against Qwest, Merrill Lynch, Citibank, J.P. Morgan, HealthSouth, just to cite just a few.

In March of 2003, we asked every SRO to reexamine its corporate governance and report on their findings and proposed solutions. In May, the Commission approved Bill McDonough to head the Public Company Accounting Oversight Board. And in July, we were happy to announce the completion of all the rulemaking mandated by the Sarbanes-Oxley Act. We also marked the first anniversary of Sarbanes-Oxley that month.

But in 2003, we would also see the opening of a Pandora’s box of abuses in the securities industry, laying bare astounding compliance and governance failures and the urgent need for corrective measures.

First came the results of our breakpoints investigation. We learned that some brokerage firms had been overcharging their mutual fund customers by not affording them the discounts in sales charges they had been promised. Then came the “shelf space” and mutual fund sales practices cases. We became extremely concerned about what prospective mutual fund investors were being told about revenue sharing arrangements, and other incentives doled out by mutual fund management companies and mutual funds themselves to brokerage firms who agreed to feature their funds.

Everyone in the industry was in for even more of a shock as the details of late trading and market timing at mutual funds began to emerge. Those and other actions have led the Commission, over the past 14 months, to bring more than 50 enforcement cases related to the mutual fund scandals and to levy approximately $900 million in disgorgements and $730 million in penalties.

Last, but certainly not least, the New York Stock Exchange experienced a perfect storm. There was the struggle within the exchange to deal with the effects of decimalization, the revelations of consequent wrongdoing by specialists, and the prolonged controversy over the compensation of its Chairman.

So when I was here at this time last year, the forecast looked rather bleak. I pledged that we at the SEC would respond, but that “all of us” – and that included all of you and your industry’s leaders – “must be bold, decisive and aggressive in our plan of attack.”

SEC Initiatives

A first step was working closely with Chairman Reed of the New York Stock Exchange to approve new, far reaching governance changes. We brought significant enforcement actions – and obtained approximately $250 million in disgorgement and penalties – against the specialists on the NYSE. We have pursued vigorous investigations of all potential SRO violations in this vein.

We confronted the crisis of investor confidence in the mutual fund industry head-on. The Commission has approved 9 of 12 major new mutual fund reform initiatives, including one that requires funds, relying on certain exemptive rules, to have an independent chairman and 75 percent independent board members. The Commission also filed and settled actions against brokers, including those who had engaged in breakpoints violations and shelf-space and mutual fund sales practice violations. In the past two fiscal years, the Commission has brought more than 1300 enforcement actions against entities throughout the securities industry, and obtained orders for penalties and disgorgements totaling a record $5 billion.

The Commission has also moved to bring greater scrutiny to hedge funds. Just last week, as you know, the Commission adopted the hedge fund adviser registration rules. These rules will afford us greater insight into the activities of hedge fund advisers, at a time when hedge funds are growing dramatically in size and influence in the securities markets.

Our Corporation Finance division is focused on improving disclosure at public companies. We issued an interpretive release suggesting major improvements in Management’s Discussion and Analysis, or MD&A. We adopted an important revision to Form 8-K that will bring greater timeliness to reporting. We are continuing work on a new regulatory and disclosure framework for the huge asset-backed securities market. And finally, we have just proposed new rules aimed at reforming Securities Act regulations on public equity offerings.

We also proposed Regulation NMS, to modernize the structure of our markets. We will soon be considering new proposals to improve the governance and financial transparency of all self-regulatory organizations. And shortly we will issue a concept release about the future of self-regulation. We continue to study how we can bring balanced reform to the proxy process. Finally, guiding our action on other fronts will be the forthcoming recommendations from task forces we established on a number of important issues facing the securities markets.

The “bold, decisive and aggressive plan of attack” I promised at last year’s meeting has also included internal reforms at the SEC. Since December 2002, we have hired more than one thousand new professionals – accountants, lawyers, economists. As we bring in new people, we are also trying to improve communications across the lines of our operating divisions and offices to protect against any “silo” mentality.

Most importantly — through our newly established Office of Risk Assessment — we are trying to have risk assessment and risk mapping inform not only everything we do, but also how we do everything. We are seeking to create an enhanced oversight regime that will equip the Commission to better anticipate, find, and mitigate areas of financial risk, potential fraud, and malfeasance. We want our efforts to be more anticipatory and preventative in nature — to look over the hills and around the corners of the securities markets.

New Approaches, New Relationships

In sum, the SEC has in the past two years engaged in a broader agenda than at any other time in the history of the Commission, with the exception of the period immediately following the Commission’s very creation in 1934. I am now more convinced than ever that it is imperative for everyone in the securities industry – whether in investment banking, brokerage, venture capital, private investment, or mutual funds – to re-examine how they do business. I might add that the SEC must be included in the “rethink” of traditional practices. We all need to take heed of the trends that have influenced, and continue to influence, the securities industry, such as:

* The cumulative damage to investor confidence inflicted by the 2000-2002 market decline, and the corresponding revelations of corporate corruption.

* The competitive challenges, and opportunities, posed by global securities markets that know no borders.

* The proliferation of new investment technology, and its impact on new financial instruments and trading activities.

These and other phenomena need to be incorporated into operating procedures in a way that benefits investors, but does so while also mandating that honesty and integrity are embedded in the DNA of your companies. These objectives won’t be realized by having each company simply adopt a “politically correct” written code of ethics. Companies and managers and employees from top to bottom must embrace a spirit of integrity that goes well beyond simple adherence to the letter of the law. What’s really needed is a commitment to be guided by a moral compass. This compass should guide you in hiring decisions, your operating practices, and your internal policies and procedures regarding the questionable practices of yore.

To achieve this transformation of the securities industry, the SEC, too, must adapt to this new business climate. We need to strengthen our methodology as we pursue more sophisticated, and more complex, forms of malfeasance. As I said earlier, we also must become more anticipatory. As capital markets become increasingly globalized, we have a higher obligation to continue our cooperation with securities regulators from around the world. We must also take care, as we pursue regulation, not to saddle businesses with so much regulation and expense that their competitiveness will be hampered and their appetite for risk-taking dramatically reduced.

We at the SEC intend to identify areas where your goals can align with ours. We must recognize our shared interest in deterring and preventing potential violations of the securities laws.

First, we’re working to identify ways to promote safety and soundness consistent with evolving business models. For example, we adopted rules to enable the Commission to provide consolidated supervision of certain investment bank holding companies.

Second, we’re working to enhance the compliance functions within firms. For example, the Commission adopted a new rule requiring all investment advisers to designate a compliance officer in each firm to administer a fully wrought compliance regime. Our plan is to work very closely with the industry on implementation.

Third, we’re seeking to enlist your resources in areas that are troubling to us – and that we believe should be troubling to you. Perhaps the best example of this began with our September 2003 challenge to companies in the financial services industry to conduct top-to-bottom reviews of their business, to identify conflicts of interest, to take steps to ameliorate these conflicts, and to report their findings to the Commission. The primary goal was not to use this information as a basis for launching enforcement actions, but rather to help these firms, and the Commission, to better understand business practices throughout the industry. The initiative was also consistent with one of our goals, which is not just to prosecute misconduct, but also to prevent it from occurring in the first place.

Since we launched that initiative, a number of firms have told us that they have made conflict review part of their regular oversight process, and collected valuable information about themselves along the way. The results of this review are likely to ensure compliance with the securities laws in ways that new rules, or new enforcement cases, cannot.

Our efforts will, of course, depend on good faith from both sides. The Commission must exercise its good faith by continuing to demonstrate that we are measured and fair as we examine for, and help to solve, wrongdoing in the securities markets. We must continue to ensure that examinations resulting from our risk-mapping efforts do not become overly burdensome. We must continue to take care to avoid duplicative or redundant actions when potential violations are discovered. We must seek to collaborate better with SROs and with state securities regulators.

On your side, you must demonstrate your good faith to help us and your firms to prevent future securities law violations. You must demonstrate this good faith in your inculcation of a culture of ethics and compliance in your firm. Above all, you must not use this new attempt at cooperation to hide or excuse violations. For we will not hesitate to use the full power of the agency to discover and punish violations of the securities laws when they occur.

Our work on Regulation NMS is a good illustration of the current strengths and weaknesses of this new relationship. The Commission has engaged in what I believe has been an exceptionally open and interactive process, seeking out the views of a wide range of market participants. Panelists at the public hearing on Reg NMS in April provided such valuable input that the Commission published a supplemental request for comment to consider their thoughtful suggestions.

Annette Nazareth and her team in the Division of Market Regulation have been extremely grateful to those in the securities industry who have selflessly helped to think through reforms to Reg NMS. These individuals have done their best to shed their industry hats and to look at alternatives that might best serve the public interest, even though their particular firm or organization may not immediately benefit from those alternatives.

I know there are those who resist any change at all to the current system. Their refusal to confront the problems that must be fixed does not advance this new collaborative relationship.

But there will also be those who argue that wholesale abandonment of the existing regime is our only option. They will seek to make the perfect the enemy of the good. This approach could put the very real benefits of our market system at substantial risk and, if unsuccessful, may eventually lead to bigger and more intrusive government involvement. In the long run such an approach may only produce less effective solutions to the very real problems in the securities markets.


As I conclude, I’d like to acknowledge that real progress has been made – by the securities industry, and by the Commission itself – in adapting to – and meeting the needs of – this new era. But there is, of course, still more to be done. As SIA’s new survey of investor attitudes reveals, while the favorability rating toward the industry is higher than at any point since 1995, 69 percent of investors still say the industry is motivated by greed – up from 42 percent in 1999. Your survey also contains some useful data for us at the Commission, with 47 percent saying the industry and its regulators are doing a “good job,” but 50 percent saying we’re doing a “poor job” in alleviating investor concerns. We should treat these numbers as a challenge – and show investors we can be even more responsive to their concerns. As we carry out our work, we should also strive to preserve, and encourage, the entrepreneurial spirit and flexibility that is a defining feature of the U.S. securities industry. Far from being in conflict with each other, I believe these goals are mutually reinforcing.

Finding long-term solutions to these longstanding problems requires us to work together. I am hopeful – and confident – that the SIA and its members will give us that help.

Thank you again for giving me the opportunity to speak. I would be happy to take your questions or hear your observations.

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