Speech by SEC Chairman:
Remarks Before the International Organization of Securities Commissions
by
Chairman William H. Donaldson
U.S. Securities and Exchange Commission
New York
October 28, 2004
Good morning. Let me begin by thanking my colleague, SEC Commissioner Roel Campos, for your generous introduction. Commissioner Campos represents the Commission at IOSCO and the Council of Securities Regulators of the Americas. He has worked with the head of our international office and international program, Ethiopis Tafara, in designing and organizing this conference. They both deserve the thanks of all of us.
I also want to thank IOSCO's Technical Committee — and Chairman Sheng in particular — for giving me the opportunity to address this distinguished audience. All of us attending this conference share a commitment to high standards of regulation, and cross-border cooperation. I hope the proceedings can help to advance those twin goals, and contribute to the shared recognition of the extraordinary opportunities — and challenges — in today's rapidly-changing global marketplace.
Before I proceed, let me issue the obligatory standard disclaimer that the views I express here today are my own and do not necessarily represent those of the Commission or its staff.
A high priority for the United States, for the SEC, and for me as SEC Chairman is helping to foster the growth of capital markets, not only here at home, but also abroad. I speak from the perspective of having labored in and around international markets for much of my professional life. During my time helping to start and build an investment bank, I worked with investors from around the world. As Chairman of the New York Stock Exchange I worked on a range of international issues. After leaving the Exchange in 1995, I returned to investment banking, as a senior adviser to my old firm. I traveled to regions where there were emerging investing opportunities and provided guidance to companies in those regions. These experiences gave me a richer understanding of the benefits that flow from globalized markets, such as lowering the cost of capital, providing a more stable platform for long-term economic growth, and creating opportunities for investors around the globe to achieve higher returns.
More recently, we have seen the pace of capital-market integration continue to accelerate, as new investing opportunities in the countries of the European Union have blossomed and as China's dramatic economic expansion has continued. The statistics are impressive. Cross-border equity flows, for example, reached nearly $320 billion in recent years, up from less than $15 billion in 1990, the value of international securities offerings in 2002 was nearly $1.2 trillion — or quadruple the level in 1991. In the United States alone, more than 1,300 foreign companies are listed on U.S. stock exchanges, which is triple the number of listings in 1991.
As financial markets have become more integrated, we have also witnessed an increase in the size of the companies, and the number of companies listed on the world's stock exchanges. From 1994 to 2003, global market capitalization more than doubled, to nearly $32 trillion. Some of the most impressive growth has been in emerging nations: In India, for example, the market cap of listed companies is $279 billion, an increase of 128 percent since 1996; China $681 billion, up 499 percent since 1996; Russia $231 billion, up 520 percent since 1996. The story is the same in many other countries throughout the world, and the trend speaks to the widespread value of public ownership and a public listing. Not only is it a vehicle for capital formation and wealth creation, it also creates an imperative for rules and standards for companies, which promotes the transparency and integrity that must underpin a country's economy.
Another challenge is addressing cross-border ownership of equities. American retail investors, for example, own more than $2 trillion worth of foreign stocks, either directly or indirectly — up from $279 billion in 1991 — but this represents just 13.9 percent of total U.S. stock portfolio holdings. In France, about 10 percent of individual holdings are of foreign stocks, and in Japan the figure is about 5 percent. Home-country bias is a big factor here, but current trends indicate that this domestic bias is declining and that investors throughout the world have a growing desire to move their capital to those markets and corporations offering the most attractive investing opportunities, wherever they may be.
Current Regulatory Issues
Facilitating the rapidly growing global aspirations of investors must be a high priority for regulators. But a more immediate and demanding priority, however, must be addressing the range of current domestic issues presently facing our domestic markets. China, for example, is making the transition from an economy based on command-and-control to one based on capitalism. In the more developed markets, such as the European Union and the United States, regulators have had to address far-reaching market structure issues. Regrettably, the ebullient markets of the 1990s coincided with a growth in malfeasance associated with corporate accounting, mutual funds, and stock exchanges.
Having the largest aggregation of markets in the world, I sadly acknowledge that the U.S. has been at the forefront of these problems. The biggest casualty has been a prolonged loss of investor confidence. The latest UBS/Gallup index of U.S. investor optimism remains lower today than it was at any point in the five years before the September 11th terrorist attacks. A Harris Interactive poll taken earlier this year found 30 percent of those surveyed saying they had "hardly any" confidence in people running major companies — a figure that has barely changed in two years, and is higher than at any point since 1974.
This erosion of trust in business and the marketplace has been a serious and worrying development. As a principal regulator here in the U.S., we have been well aware of the need for action to calm these fears and elevate standards in all our markets. As a result, the Commission has pursued a sweeping reform agenda — the most active in the agency's 70-year history — touching almost every aspect of our markets and the corporate world. Let me mention a few of our actions.
By mid-2003, we completed — under an extremely tight deadline — the extensive rulemaking related to the Sarbanes-Oxley Act. Critically important has been nurturing the growth of the Public Company Accounting Oversight Board, mandated by Sarbanes-Oxley to restore integrity to the auditing and accounting profession.
Over the past two fiscal years, our Enforcement division has intensified its aggressive pursuit of those who have violated our securities laws and the public trust. During this period, the division has filed more than 1300 enforcement actions and obtained orders for penalties and disgorgements totaling nearly $5 billion.
We have also made real progress on the vital issue of self-regulatory organization, or SRO, governance. The Commission has approved a NYSE proposal to implement much-needed reforms, such as an organizational structure aimed at insulating the regulatory functions from conflict with the business functions.
We also believe that SROs play a critical role as standard setters for issuing companies, operators of trading markets, and front-line regulators of securities firms. We must insist on holding them to higher corporate governance standards as well. The Commission will soon be voting on new proposals to improve the governance and financial transparency of all U.S. self-regulatory organizations.
We are also reviewing the structure of our national market system, and the Commission has put forward ideas on how to modernize our markets. Regulation NMS encompasses a broad set of proposals designed to improve the regulatory structure of U.S. equity markets. While we are still reviewing a number of proposed reforms we hope to bring forth our new rules shortly.
We've also had to confront a crisis of investor confidence in the mutual fund industry, where late trading and market timing evolved into a major scandal. In addition to unprecedented enforcement activity, the Commission has approved 9 of 12 major new mutual fund reform initiatives. Taken together these initiatives seek to strengthen the governance structure of mutual funds, address conflicts of interest, enhance disclosure and transparency, and foster an atmosphere of high ethical standards and compliance.
The Commission has also moved to bring greater scrutiny to hedge funds. The hedge fund adviser registration rules, which the Commission adopted earlier this week, 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.
Perhaps most important, and longest lasting, we have also created an infrastructure at the SEC around the idea of risk assessment. I believe our program of risk assessment will change everything about how the SEC goes about its business. 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. The effort is designed around so-called risk mapping, which is a running list of potential risks identified by our field staff, and the creation of a new Office of Risk Assessment, which brings together professionals experienced in seeking out potential areas of concern. 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.
Each of these initiatives represents progress, and together they have helped to restore faith in the fairness of our markets. But there is still more work to be done.
Regulatory Issues of the Future
As we move to address our more immediate domestic challenge — rebuilding investor confidence — we must also work on a parallel track to address emerging global issues. That is why IOSCO is so important. You are working on the challenges and opportunities of the future, as is evidenced in the agenda of this conference. The agenda addresses issues such as the future of global self-regulation, the role of stock exchanges in the 21st century, and shareholder rights in a global capital market. By focusing attention on these issues now, IOSCO is helping to accelerate progress toward the truly global marketplace we are all hoping to achieve.
The work we are doing on U.S. markets, and the work all of you are doing in your markets, is part and parcel of a broader issue: the movement of millions of people throughout the world into what has been called "the shareholder society." While share ownership has historically been limited to the wealthier nations of the world, today it can be found in all corners of the globe. More than 13 million households in India are directly invested in debt or equity shares, based on the most recent statistics. And there are believed to be approximately 36 million active equity investors in China. Share ownership creates new opportunities to accumulate savings and wealth, and to put capital to use in entrepreneurial ventures that are the lifeblood of growing economies.
Such broadening of ownership also poses challenges for us, whether we are regulators or business leaders. Inexperienced investors are, for example, more vulnerable to fraud, which has a corrosive ripple effect on broader confidence in a market. Regulators must be extremely active in investor-education efforts, and vigilant about trying to combat fraud and building an infrastructure to pursue, and prosecute, the wrongdoers. Similarly, inexperienced investors — including some professional investors — may be inclined to redeem their shares or move their money at the first hint of a market downturn. We must educate these investors — indeed, all investors — about market volatility, the power of compounding interest, and long-term investment goals, while also giving them reason to believe their local securities markets are fundamentally fair.
As we labor to build a global marketplace, we want to do so in a framework defined by high standards. IOSCO's leadership can also help regulators build support for high standards, and resist the siren song of lower standards. We know from experience that a lowest common denominator approach is likely to attract unscrupulous investors, and corporations with less than satisfactory internal controls.
An essential method of building support for high standards — and perhaps the best method — is to pursue them through the idea underpinning this conference: cross-border cooperation. We all face issues that pose common challenges. We should continue to share our experiences with each other in settings like this.
Cooperation, for instance, is vital to the important project on converging our Generally Accepted Accounting Principles with the IASB's International Financial Reporting Standards. The ongoing convergence project holds out tremendous potential for investors and companies seeking to allocate or raise capital on a global basis. FASB and the IASB are working together on a number of important initiatives, and it appears good progress is being made on moving our systems closer together. SEC staff are currently considering the steps that would need to be taken to allow us to eliminate the reconciliation from IFRS to U.S. GAAP. While many companies domiciled outside the U.S. register securities with us, less than 50 use IFRS for their primary financial statements. We expect a dramatic increase in this number next year, and our review of those filings will enhance our understanding of IFRS-based financial statements.
We view convergence as a two-way street, and don't believe it simply means converging to U.S. standards. FASB will look to IFRS where appropriate, and we at the SEC have been pleased to see a highest-common-denominator approach.
Cooperation is also critical as a number of nations iron out some issues regarding oversight of foreign audit firms by the new Public Company Accounting Oversight Board. Under the Sarbanes-Oxley Act, all audit firms, including non-US audit firms, providing significant audit services for issuers listed in the United States are required to be registered and inspected by the PCAOB. Because of potential conflicts with foreign privacy laws and blocking statutes, the PCAOB has made some adjustments in the information requested of foreign firms during the registration process. In addition, the PCAOB is seeking a collaborative approach to developing its oversight role vis-à-vis non-U.S. audit firms, working with counterparts in Europe and elsewhere.
Cooperation is fundamental to regulating the global marketplace. As part of the SEC's ongoing commitment to cooperation, we have signed more than 30 memoranda of understanding with other securities regulators related to information-sharing and mutual assistance. We are also a signatory to IOSCO's Multilateral Memorandum of Understanding for cooperation and exchange of information. In the past year we have strengthened our framework for regulatory cooperation with the Committee of European Securities Regulators, as well as a number of our other counterparts.
The fundamental issue for everyone involved in financial markets today, regardless of company or country, must be to maintain high standards that breed trust and confidence. This becomes increasingly important at a time when investors can — and do — move capital around the globe with a few keystrokes on a computer. Recent history has taught us that capital will flee environments that are unstable or unpredictable — whether that's a function of lax corporate governance, ineffective accounting standards, or a lack of transparency. Investors must be able to see for themselves that companies are living up to their obligations and embracing the spirit of all securities and governance requirements. This is a critical element for investor confidence not just in the United States, but also for countries as diverse as Chile and China, or Spain and South Africa.
The investment of time and effort to establish the right rules, and to build support for complying with them, is not without costs. But it will pay long-term dividends, as it will enhance integrity within companies, and inspire confidence among customers and investors around the globe.
The issues you have scheduled for discussion are the building blocks of the global marketplace. The professionals brought together here have a wide range of experience and expertise. I commend you for your gathering, and I pledge the ongoing interest and cooperation of the SEC. Thanks again to the IOSCO Technical Committee for sponsoring this conference. Within the time limits of your crowded scheduled, I would be happy to take your questions.
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