Thank you, Andrew [Ceresney], for that kind introduction and for helping to organize this conference. I appreciate this opportunity to share a few thoughts at this marquee event for the SEC.

This morning, I would like to describe some of the trends my Office has observed in the rulemakings of the U.S. stock exchanges, particularly with regard to their listing standards. Based upon our research, we note that few people seem to be paying much attention to the rulemakings of the exchanges, and there appears to be a troubling downward drift in the listing standards of the exchanges since they have become for-profit businesses.

As you probably know, the national securities exchanges are required to file with the SEC any proposed changes to their rules. What you are less likely to know, though, is how many rule proposals they actually file. In calendar year 2015, for example, the exchanges filed and the Commission published for public comment about 1,050 proposed rule changes.[2]

The rule proposals can be broken down into two categories. The larger category includes what are known as B3A filings, which is a shorthand reference to Section 19(b)(3)(A) of the Exchange Act.[3] Generally speaking, these are rules that are more technical in nature and expected to be non-controversial. For example, they may involve changes to fees or extending the length of a pilot program. These rule changes become effective upon filing with the SEC and are subsequently published for comment.

The second category is known as B2 filings, referencing Section 19(b)(2) of the Exchange Act.[4] These include the more substantive rule proposals, such as changes to the listing standards of an exchange, the priority of bids and offers on the exchange, and new order types and instructions. These proposals are published for public comment prior to their approval or disapproval by the Commission.

In 2015, approximately 900 B3A filings were published for public comment, and it appears that only 23 of them received any comment. Hopefully, this simply reflects the fact that the B3A process is being used appropriately for truly non-controversial matters.

More troubling, however, is the lack of public participation in the B2 process. Last year, approximately 150 B2 filings were published for public comment. Of those 150 filings, we found only 15 comment letters that tended to advocate for the interests of investors on a substantive level.[5]

This lack of investor comment is unfortunate, but it should come as no great surprise. When a rule is changed, the costs are often concentrated on a relatively small number of industry participants, while the benefits are widely dispersed among the investing public. Or, the reverse is true—the benefit falls on industry participants while the costs are dispersed among all investors. In either case, individual investors are rationally apathetic, having little individual incentive to follow hundreds of exchange rule filings, digest thousands of pages of complex legal jargon, and then spend the time necessary to submit comments. This is why I like to remind policymakers that they should never count comment letters as though they are votes for or against a proposal, with public policy choices going to the side with the most votes.

In my view, the Office of the Investor Advocate was created, at least in part, to counteract this weakness in the public comment process. It is the job of my Office to monitor rulemakings— including those that may otherwise fly under the radar—and provide a voice for investors. Among other statutory duties of my Office, we are required to analyze the impact on investors of proposed rules of self-regulatory organizations (“SROs”), including the exchanges, and we are expected to identify areas in which investors would benefit from changes in SRO rules.[6]

Our efforts to monitor the SRO rule filings were significantly enhanced last year with the addition of an experienced Trading and Markets Counsel, Adam Moore, and a well-organized paralegal, Denene Dent. On behalf of American investors, they spend many hours reviewing the exchanges’ rule filings and bringing significant issues to the attention of SEC leadership. They also helped me file my first formal recommendation to the Commission last year—a recommendation to disapprove a proposal by the New York Stock Exchange (“NYSE”) to lower a listing standard.

In isolation, the proposal by the NYSE looks relatively minor. It exempted early stage companies from a requirement to seek shareholder approval before issuing up to 20 percent of outstanding shares to certain related parties, provided that the company’s audit committee or a comparable board committee approves the transaction. However, my Office opposed the rule because, in our view, it was yet another incremental step in a more disturbing trend. We were concerned about a potential “race to the bottom” by the exchanges, whereby they lower their listing standards in order to attract more companies to list with them.

Recently, my Office has begun to look more closely at this issue. Specifically, we have attempted to examine all of the changes to NYSE quantitative and qualitative listing standards[7] for operating companies[8] since 2005, when NYSE began the process of converting from a mutualized exchange to a for-profit business, following in the footsteps of Nasdaq.[9] We continue to review historical patterns in the rulemakings of the other exchanges, but our research of NYSE rulemakings suggests that the listing standards of NYSE have gradually deteriorated since 2005, particularly with respect to their quantitative listing standards.

Quantitative Listing Standards

Quantitative listing standards establish specific thresholds that an issuer must meet in order to list on an exchange. These standards are intended to ensure that a company has sufficient public float, investor base, and trading interest to provide the depth and liquidity necessary for fair and orderly trading. In June 2005, following an extensive pilot, NYSE received approval to adopt an amended set of quantitative listing standards.[10] Since those were adopted, my Office has identified 22 substantive adjustments to what we would classify as quantitative listing standards. Of those, we found that 17 lowered the listing standards to allow the exchange to list more companies,[11] 3 appeared to have a neutral impact,[12] and, in our judgment, only 2 of the 22 amendments sought to significantly raise the listing standards.

A more detailed analysis is available on the Investor Advocate’s page of the SEC website as an appendix to this speech, but a few examples of lowered quantitative standards would include the adoption in 2006 of an alternative method for domestic listed companies to meet the NYSE’s Earnings Test; ^[13] a change in 2007 to enable the listing of certain companies based on two and a half years of financial statements instead of three full years;[14] a new “Assets & Equity Test” in 2008 that required no operating history;[15] and a lower public float requirement in 2010 for certain issuers.[16] In at least 11 of the 17 instances when NYSE lowered a listing standard, including each of the foregoing examples, NYSE justified the change, at least in part, by pointing out that another exchange had lower standards already.

Unfortunately, one of the two heightened quantitative standards was adopted in response to significant investor harm. In 2011, NYSE (along with Nasdaq) adopted more stringent quantitative listing requirements for companies that become public through a reverse merger, presumably to address significant accounting fraud allegations and other concerns with respect to reverse merger companies.[17] Since then, the only heightened quantitative requirement adopted by the exchange was to expand the pre-market hours during which listed companies are required to notify the exchange prior to disseminating material news, in order to permit the exchange to halt trading if needed.[18]

Qualitative Listing Standards

The changes to NYSE’s qualitative listing standards, in our estimation, have been more of a mixed bag. Qualitative standards are designed to help ensure that an issuer has an adequate corporate governance structure, fair proxy voting process, and other characteristics to protect the interests of shareholders.

Since June 2005, my Office has identified 20 substantive adjustments to what we would classify as qualitative listing standards. In our judgment, 7 of those amendments will have a relatively neutral impact. Another 8 of the 20 sought to raise the listing standards, although it was often in response to Congressional or Commission action. For example, two of the enhancements in 2008 — both of which shortened the length of time for an issuer to notify the exchange of non-compliance with NYSE listing standards — merely aligned the time period with the Commission’s four-day public notice requirement under Form 8-K.[19] Similarly, an enhanced limitation on broker discretionary proxy voting and improved compensation committee independence requirements were both required by the Dodd-Frank Act.[20]

On the other hand, we found that 5 of the 20 amendments resulted, on balance, in lower qualitative standards.[21] In at least 3 of these 5, NYSE justified the change by noting the competitive advantage enjoyed by other exchanges with different standards. A few examples of what we consider to be a lowering of qualitative standards would include proposals in 2013 to remove the 50 percent quorum requirement from shareholder approval votes and to permit listed companies to delay compliance with the internal audit requirement for a year, and a proposal in 2014 to allow a company to list even though it may be delinquent in certain Commission filings during the past year.

Conclusion

To sum up the results of my Office’s review, I would argue that the NYSE listing standards, and especially their quantitative standards, have tended to drift downward like a leaf in autumn—or, to use a more fitting analogy, like the leaf of a buttonwood tree.[22] Occasionally, there is a scandal or a statutory mandate that comes along and acts as an upward draft, and the listing standards are pushed higher in response. But, when the wind stills, the leaf begins its gradual downward drift, pulled by the relentless force of gravity or, in the case of the exchanges, profits. And over time, small incremental changes can add up to a significant deterioration of the listing standards.

I encourage the Commission and staff to consider this broader context when they evaluate changes in listing standards that appear, on their face, to be small changes. The Commission, and especially the staff of the Division of Trading and Markets, have a difficult job balancing investor protection and capital formation while trying to maintain fair, orderly, and efficient markets. They work hard to improve the quality of filings, and the downward drift of the exchange rules has likely been curtailed by their efforts. But, I believe the approval process could be improved by paying further attention to overall trends and considering the cumulative impacts of incremental changes.[23]

Even more important, I believe the exchanges should resist the temptation to engage in a race to the bottom. NYSE, in particular, asserts in its own rule book that a listing on its exchange signifies that a company has achieved “maturity and front-rank status in its industry—in terms of assets, earnings, and shareholder interest and acceptance.”[24] It is concerning, then, to see the NYSE justify so many changes in its rules by pointing to its competitors who traditionally have catered to different types of companies.

More broadly, in an age of for-profit exchanges, where exchanges have an inherent conflict between the interests of investors and their own bottom lines, it may be time again[25] for the Commission to confront the larger question of whether it makes sense for a for-profit business to be entrusted with the regulatory responsibilities of an SRO. Based upon the evidence I’ve seen so far, I believe investors have cause for concern.

Thank you.

Appendix