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News April 11, 2011 Issue

Schapiro Describes An Agency on the Move

We know regulation is necessary, so how do we make it effective?

SEC chairman Mary Schapiro described her agency’s efforts to be an effective regulator in remarks to the Society of American Business Editors and Writers on Friday.

"I believe we have put in place a strong foundation that will support the most effective regulatory regime possible – a regime that will encourage the economic growth we need," she said. 

That foundation relies on core principles, input-maximizing process, and operations that include effective oversight, examinations and enforcement.  "After all," she asked, "if you don’t enforce a rule do you really have one?"


Transparency, fairness, and structural reliability form the SEC’s core principles, said Schapiro.

Transparency is a fundamental principal of effective financial regulation. Markets should be transparent, said Schapiro, because people allocate capital more efficiently and make better decisions when they have the information they need. 

Transparency is a guiding principle in the overhaul of derivatives regulation, too. In 2000, the Commodity Futures Modernization Act excluded over-the-counter derivatives from regulatory oversight. When the financial crisis hit seven years later, regulators were without tools they needed to address the problems, she said.

The SEC is now working to change that. "We believe that the transparency and other benefits of more formally defined trading, reporting and clearing regimes for derivatives will diminish the chance of another systemically challenging event," said Schapiro.

Creating a new regulatory structure – virtually from the ground up – can have unintended consequences, she said.  The SEC is committed to taking the time and gathering the insights needed to get it right.  By moving derivatives trading to more transparent platforms and well-regulated clearing regimes, said Schapiro, "we will reduce risks in the system and regulators will get a better picture of the interrelated positions which, in times of stress, can help a crisis spread in unexpected ways." 

In addition to the broader use of central counterparty clearing agencies, transparency itself may help reduce counterparty-specific risk by allowing many more participants to get a clear understanding of the overall market.  This will, in turn, allow the discipline of the marketplace itself to be exercised more effectively.

Fairness is a key component of quality rulemaking. Market rules should be fair. The playing field should be level, disclosure should be full and fair, and those who violate the law will be held to account, said Schapiro.

The new derivatives rules will be structured to diminish the chance that less sophisticated investors – including municipalities and small pension funds – will find themselves losing millions of dollars on trades that they may not have entered into if they had fully understood the product, she said.

The SEC is also developing new business conduct standards for derivatives intermediaries. The standards will help improve sales practices in derivatives markets and bring counterparties critical information through enhanced disclosures.  These standards will provide additional protections for pension plans, governmental entities and endowments.

The SEC’s standard of care report recommended a uniform fiduciary standard of care for all financial professionals providing advice to retail investors, said Schapiro. The report noted that few investors are aware of or understand the difference between the fiduciary standard required of investment advisers and the less strict "suitability" standard observed by broker-dealers. 

"As I have long advocated, … I believe that investment professionals’ first duty must be to their clients, and I look forward to beginning work soon to codify the report’s recommendations," said Schapiro.

Structural reliability in the markets ensures market integrity. Investing risk should be confined as much as possible to the financial risk that comes with any investment, rather than risk arising from structural deficiencies of the marketplace or its technology.

These principles are evidenced across the SEC "in the work we do and the rules we write," she said.

The structure of today’s markets – in part because of past SEC actions – offers high liquidity, low spreads and innovative investment options.  There’s much room for improvement, though, said Schapiro. 

For example, the May 6 "flash crash" resulted in a series of rules that:

  • Trigger circuit breakers for certain individual stocks that experience a rapid increase or decline; 
  • Clarify how and when erroneous trades will be cancelled; and
  • Effectively prohibit "stub quotes" – the phenomenon that results in stocks trading at pennies in the U.S. equity markets.

Further, the SEC is working with its CFTC colleagues on an initiative to update market-wide circuit breakers – which have only been triggered on one day in the past 20 years. 

Another area of interest is the risk presented by systems and technology that may break down when volume surges, or which may be vulnerable to intrusion from outside.  

 An additional goal would be to reinforce the current expectation that markets report systems changes, malfunctions and intrusions to the SEC and publicly disclose material problems. "We owe the public – who entrusts these markets with their capital – nothing less," she said.


There’s talent and dedication on the staff, and that caliber is ever-increasing.  Even the most talented people, however, benefit from considering the ideas and opinions of others, especially when outside ideas challenge internal assumptions.  That’s where process comes into play, said Schapiro. 

The SEC emphasizes a process that brings together staff from many different backgrounds; that invites stakeholders with differing viewpoints to be a part of the rulemaking discussion; and that is often informed by Congressional debate.

"And every now and then a journalist raises a point that we haven’t considered, as well."

In response to the passage of the Dodd-Frank Act, the SEC launched a particularly expansive information-gathering effort, said Schapiro.  The SEC established a series of e-mail boxes on its website, allowing interested parties to comment on provisions of the Act even before formal rulemaking had begun or the official comment periods had opened.

Senior staff has been encouraged to honor requests for face-to-face meetings as often as possible.  The SEC held public roundtables on key components of the Dodd-Frank Act. And Schapiro gave directions that the Dodd-Frank implementing rules be considered from every angle.   

The process works, said Schapiro. Input from derivatives investors, for example, helped inform the SEC’s approach to trading procedures at security-based swap execution facilities that will host a substantial amount of derivatives trading.  The SEC has sought flexibility and openness to alternative approaches suggested by stakeholders or the markets themselves, while adhering to the mandates of the law. 

"Quality rules can’t evolve in a Washington bubble," said Schapiro.  SEC actions can have an impact on the financial markets, on companies large and small, and on individual lives.  As a result, the SEC must hear from a wide range of opinions, and consider every view as it moves forward to carry out its mission and – in the case of Dodd-Frank – its Congressional mandate.


Clear principles and an open process must be supported by good baseline operations, said Schapiro. Those operations transform goals into reality and earn the respect of the public and regulated entities.  "In short, we have to deliver after the rules are written," she said.

In many ways, this imperative is rooted in the traditional oversight and enforcement actions that keep markets fair and ensure the integrity and real transparency of financial transactions.  Work that ensures that brokerage statements reflect real sums and transactions, that 10-Ks are informative and accurate, and that traders with inside information aren’t dumping shares on unsuspecting buyers. 

With an entirely new leadership team, we have placed a priority on making the SEC a more agile and robust regulator.

Restructuring OCIE.

2010 also saw the reorganization of the SEC’s examination program – a cornerstone of investor protection efforts.  Examinations not only uncover securities law violations, they foster a culture of compliance and effective risk management in registered financial firms. 

Under its new leadership, the exam program is devoting more of their scarce resources to identifying high-risk firms whose practices or circumstances make it more likely that investors’ funds are vulnerable. 

To help bolster its ranks, the SEC has brought on board specialists in risk management, hedge funds and complex structured products.  Some of these specialists have been deployed to the SEC’s new Risk Analysis and Surveillance Unit, which analyzes a variety of public and agency data sources to strategically assess risk and determine which registrants’ risk profiles demand attention.      

"And, rather than keeping teams together for examination after examination, regardless of the circumstances, we now assemble a firm-specific team for each separate examination, one possessing a variety of skill sets appropriate for the particular challenges the firm offers," said Schapiro.

In the end, she said, the SEC’s day-to-day operations across the agency are where good ideas become effective regulation, and the agency is committed to continuing the across-the-board improvements we have seen over the last two years.

Enforcing the Law.

The SEC cannot be everywhere, said Schapiro.  So the agency has sought to leverage third parties where possible.  The broad whistleblower program mandated by the Dodd-Frank Act creates a communications channel for individuals who are often closest to fraud and who can be an invaluable source of information to our enforcement and inspection efforts.  

"Of course, it is important that our new program co-exist with registrants’ internal compliance regimes.  But the rules we have proposed send a clear message to whistleblowers that they play a critical role in protecting investors and that their efforts will be rewarded," said Schapiro.

Deficit Neutral Budget.

As important as are the core components of effective regulation, so too is the funding that allows the SEC to put those components into practice.  

Congress sets the SEC’s budget and determines if the resources are available to examine investment firms as often as they should be examined; to bring actions with the legal firepower and professional and technical support SEC attorneys need; to track down leads from would-be whistleblowers and correlate information that comes in to every part of the SEC; and to assume the new duties that the Dodd-Frank Act assigns, said Schapiro.

Last year, the SEC returned $2.2 billion to wronged investors – two dollars for every dollar in the SEC budget.  The SEC collected almost $1.5 billion in fees, against an appropriation of $1.1 billion.  That’s along with hundreds of millions of dollars in assessed penalties.  And starting next year, fees not tax dollars, will cover the SEC budget, making the agency deficit neutral, she said. 

Schapiro then made her strong pitch for agency funding. "Yet tomorrow, unlike almost every other financial regulator, we may be shut down."

Insufficient funding for the SEC means fewer cops on the beat, she said, even though fraudsters show no sign of backing off.  It means the SEC cannot hire the qualified experts eager to help it keep pace with the ever-evolving financial markets. It means cancelling IT initiatives that would help the SEC analyze market data faster and financial information more cost-effectively.  It means bringing cases to trial without expert witnesses or the information a digital forensics lab could have discovered on laptops or iPhones.

"We are dedicated to being the most effective SEC ever," she said.  The SEC has acknowledged past mistakes, changed structure and culture, and the SEC is winning back the respect of market participants and observers.  "But we cannot do our jobs as well as American investors need and deserve, if we cannot hire the people, build the systems and make the changes necessary to protect our markets and support job creation," said Schapiro. 

Summing it all up.

"There are days when I read the financial news and I feel that I must have been transported back to 1928," said Schapiro.  Far too often, the financial regulatory debate seems to ignore eight decades of financial history. A functioning and effective financial system demands an effective and committed referee.

The SEC must be that referee, she said.

The SEC doesn’t have all the answers, but it is committed to principles rooted in investor protection. It has a long-term stability that grounds the SEC’s regulatory efforts in practical considerations and broadly beneficial ideas.  The SEC process seeks to ensure thoughtful scrutiny from all sides when a concept is discussed or a rule proposed.  The SEC has and continues to dramatically improve operations. Its expert staff is intent on delivering on the commitments of the agency’s regulations.

In closing, Schapiro hoped the SEC’s debate of serious issues of regulation and growth would be engaged by involved market participants and informed commentators eager to leave the simplistic divisions of the past behind, and help find a path toward a more prosperous future."