Remarks at “The SEC Speaks in 2012”

Thank you for the warm welcome.

The opportunity to serve as a member of the Securities and Exchange Commission – an agency with such a long tradition of distinction – is a terrific honor. I am humbled each day I walk into the building to do my job. A big part of why my job is so rewarding is the chance to work with the Commission staff. So to the staff, I want to express my appreciation for your hard work and your commitment to advancing the SEC’s mission.

My job is also gratifying because of engaging gatherings like SEC Speaks, where ideas and perspectives are shared in the expectation that the exchange of viewpoints will improve how the federal securities laws are fashioned, administered, complied with, and enforced. I, for one, greatly benefit from events like this, because by hearing the insights of others, I can better appreciate the real-life impacts of the difficult policy choices before us as securities regulators; and, as a result, I can better assess the tradeoffs we face when deciding whether and how to regulate.

With the opportunity that SEC Speaks affords me to share with you some of my thoughts, I have decided to speak to a particularly consequential rulemaking this afternoon: the “Volcker Rule.”

There is more to say about the Volcker Rule than I can cover today. Indeed, the notice of proposed rulemaking is lengthy, dense, and complex and asks hundreds of questions. Plus, with the torrent of comment that we received when the rule proposal’s comment period closed earlier this month, there is much to evaluate, and I look forward to doing so. Still, given that the proposal for implementing the Volcker Rule appears to have missed the mark so considerably, some initial thoughts are in order.

Before saying more, though, now would be a good time for me to pause to remind you that the views I express here today are my own and do not necessarily reflect those of the Securities and Exchange Commission or my fellow Commissioners.

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In general, the Volcker Rule, as embodied in Section 619 of the Dodd-Frank Act, prohibits a banking entity from engaging in proprietary trading or from acquiring or retaining an ownership interest in a hedge fund or a private equity fund or from sponsoring such a fund. These statutory prohibitions, in turn, are qualified by several statutory exemptions that expressly permit banking entities to engage in so-called “permitted activities.” Exempt from the Volcker Rule’s restrictions, for example, are transactions in certain government securities; underwriting and market making-related activities; and risk-mitigating hedging activities. But even these permitted activities are subject to limitation, such as if the activity gives rise to a material conflict of interest that taints the banking entity, materially exposes the banking entity to high-risk assets or trading strategies, threatens the banking entity’s safety and soundness, or threatens the country’s financial stability.

This statutory construct – whereby certain activity is banned, unless it is permitted, but then the activity is permitted only to the extent that it is not otherwise limited – is not the most straightforward. Drawing regulatory lines to give life to all of these distinctions has proven to be difficult, as even a quick review of the proposing release reveals. Where “prop trading” ends and “market making” begins, for example, is not self-evident, but how regulators exercise their discretion in drawing this line is exceedingly important.

My vote last October in favor of issuing the Volcker Rule proposal for comment was far from an endorsement of the proposal’s substance. To the contrary, at the SEC’s open meeting, I stressed that I was “willing to support the [proposal] in the interest of getting the benefit of commenters’ input,” noting that I had “significant reservations” with the proposing release, among them that the proposal would decrease liquidity and frustrate capital formation by curtailing market making and underwriting and would put U.S. banking entities at a competitive disadvantage globally.¹

Subsequently, when the public comment period was extended for 30 days, I joined Commissioner Gallagher in calling for an even longer extension of the comment period to ensure that parties had enough time to carefully study the release and prepare their submissions given that the proposal could “dramatically and irrevocably impact the U.S. financial markets.”² My support for a longer comment period was part and parcel of my ongoing concern with the rule proposal’s excessive complexity and its potential to threaten investor-friendly and issuer-friendly transactions that, in fact, should not be banned or chilled.

The comment period closed on February 13. By any measure, a huge volume of comment has come in that we are obligated to digest thoughtfully – an obligation that will take time to meet. The process of reviewing, understanding, evaluating, and balancing the input we received cannot be rushed if the integrity and soundness of the rulemaking process are to be maintained.

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As I work through commenters’ observations and analyses, my own views will undoubtedly be influenced and continue to take shape. Even so, I can share with you today that my concern with the rulemaking persists. In amplification of the unease I expressed when the Commission put forth the rule proposal, let me further identify some of the undesirable risks that are most worrisome to me.

In sum, there is a considerable risk that, as proposed, the regulatory infrastructure to implement the Volcker Rule could unduly impede the competitiveness and dynamism of our financial markets and hinder the flow of capital to its most productive purposes at the expense of our country’s economic growth. Looking at it through the lens of the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, I am very troubled by the prospect that, as a result of the proposed Volcker Rule regime:

• Investors could be disadvantaged by higher trading costs, fewer investment options, lower returns, and less wealth. In other words, if market making and underwriting were to be squeezed and liquidity were to dry up, investors would stand to be harmed.
• U.S. securities markets could become more volatile, less efficient, and marked by wider spreads. This introduces the further concern that, if the quality of our securities markets were to deteriorate, the allocation of capital to its highest and best uses in our economy would be disrupted.
• Companies could have a harder time raising the capital they need to grow and invest, and the capital they do access could come at a higher cost. Consequently, innovation could be stymied and job creation could suffer as capital formation is frustrated.
• Agencies, authorities, and instrumentalities of cities, counties, and states could end up struggling to raise funds to finance needed public works and infrastructure projects. Put more concretely, municipal entities might be forced to cut back their investment in schools, hospitals, housing, utilities, airports, bridges, and the like.

This catalogs just some of the adverse consequences that the Volcker Rule proposal is said to threaten.

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It is too early to have reached any firm conclusions on what the exact substance of the Volcker Rule regime should be – on how, say, to distinguish proprietary trading (which is banned) from market making (which is not). It is not too early, however, to give thought to how the rulemaking process itself should unfold from here.

The many comments explaining the harm the proposed rule could cause bring into sharp relief the difficulty of fashioning a regulatory regime that is faithful to Section 619 of Dodd-Frank but that does not unduly burden and constrict the U.S. financial system or create excessive uncertainty – a balance that I worry the proposal did not achieve because it gives too narrow of an effect to the scope of permitted activities and is too complex.

So where does this leave us? My present view is that the most appropriate path forward from here would be a reproposal – a fresh start, if you will.

The extensive comment that has come in enriches our understanding of the proposed rule’s real-life impacts and allows us to better evaluate the different options we have for implementing the Volcker Rule. As we consider what changes to the proposal are warranted, it strikes me at this point that significant revisions will likely be needed so that whatever benefit might result from the rule does not come at an unacceptably high cost.

If the proposed rule needs to change as much as it looks like it does, the responsible course for us to follow would appear to be a reproposal. When a proposal changes significantly, the virtue of a reproposal is straightforward: We get the benefit of another round of comment.

In revising the Volcker Rule proposal, there is no need for regulators to speculate about how the revisions could impact investors, issuers, the operation and stability of our financial markets, or the economy as a whole. With the benefit of commenter input on a reproposal, we could be more confident that the rule revisions, whatever they may be, appropriately target the concerns motivating the changes without giving rise to a new set of unintended consequences. Put differently, the stakes are high enough that we should stand ready to take advantage of another round of notice-and-comment to help ensure that our attempt to fashion the Volcker Rule regime does not miss the mark a second time.

Concerning the SEC specifically, let me bottom line it and conclude this way: As the rulemaking process unfolds, not only does the SEC have an obligation to act deliberately, but we also bear responsibility for safeguarding the agency’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. In other words, the Commission has a major role to play in fashioning the regulatory regime that will implement the Volcker Rule.

Thank you and enjoy the rest of the program.

¹ See http://sec.gov/news/speech/2011/spch101211tap-pt.htm.

² See http://www.sec.gov/news/speech/2011/spch122311dmg-tap.htm.