Speech by SEC Commissioner:
Women's Syndicate Association — "What Were They Thinking? Observations of an SEC Commissioner"

by

Commissioner Cynthia A. Glassman

U.S. Securities and Exchange Commission

New York, New York
March 4, 2004

Thank you very much for the invitation to speak to you tonight. It is indeed a privilege to speak to the Women's Syndicate Association and the distinguished members in this room. Since joining the Commission two years ago, I've done a lot of public speaking before a lot of different groups, but I particularly enjoy talking to women's groups - especially during Women's History Month. I've really been looking forward to a discussion about our experiences in the financial services arena - yours and mine. I'm sure I have more to learn from you than the other way around.

Before I begin, let me state that the views I express here today are my own and do not necessarily reflect those of the Commission or the Commission's staff.

As an SEC commissioner, a big part of my job is to review enforcement actions brought by our Division of Enforcement. Usually once and sometimes twice a week, the Commission meets in closed session for 2-3 hours to review enforcement recommendations from our staff. The staff's job is to detect, investigate and recommend to the Commission appropriate action against those who violate the federal securities laws. They investigate financial fraud in corporations, Ponzi schemes, research analyst conflicts of interest, pump and dump schemes, insider trading, and bogus sales pitches to mom and pop investors over the Internet, just to name a few types of cases. In short, we're on the lookout for securities law violations everywhere, from boiler rooms to the boardroom. In addition to fraud investigations - which is the type of SEC investigation the public is most familiar with - the enforcement staff investigates and brings actions based on registration, reporting, books and records, net capital, failure to supervise and other securities law violations.

This process has been a big eye-opener for me, and I'm constantly asking the question: "What were they thinking?" And that question doesn't just apply to the perpetrators. It sometimes applies to the victims too. How can someone really believe that a 13,000% annual return could be legitimate? I am not making that up. And that was a scam that raised over $12 million! And, proving that there's no honor among thieves, the most ironic cases are where the scammers lose their ill-gotten gains to other scams. We have seen that one more than once.

The SEC combats these violations through enforcement actions such as those we have seen coming out of the financial scandals of the recent past. Investor education is another important weapon in our arsenal because an educated investor is our first and best line of defense against fraud. A financially literate investor can ask better questions about a potential investment and is better able to discern investment claims that are just "too good to be true."

Last fall we announced a $1.4 billion global settlement of enforcement actions against ten of the nation's top investment firms and two individuals alleging undue influence of investment banking interests on securities research at brokerage firms. The final judgments provide that seven of the brokerage firms involved must pay a total of $80 million for investor education over a five-year period. While $80 million isn't going to cure all of our investor education needs, it is certainly a step in the right direction.

Another investor education initiative was an ingenious idea that our investor education staff came up with. A while ago, the Commission created a website that advertised a scam guaranteeing outrageous profits. When eager investors tried to sign up for the deal and send in their money, they clicked onto a screen revealing that the offering was designed by the SEC as a way to educate investors about the dangers of investing in quick money schemes. We got over two million hits on that website, making it the most viewed piece of investor education literature we have ever done. And while we got many letters and emails supporting our investor education efforts, we also received several hundred letters from people angry that our advertised offering was not real!

In addition to enforcement and investor education programs, the Commission also uses its rule-making powers to change incentives and disincentives in order to make the securities markets fair for investors. This is another big part of my job. Let me give you a few examples of how our enforcement and rulemaking powers work hand in hand in the context of the recent financial scandals.

The chief ingredient in the recipe for the financial scandals - whether in corporate America or in the mutual fund industry -- is greed. However, conflicts of interest, complacency, complicity and a lack of transparency have all - unfortunately -- made major contributions to the problems confronting the financial services industry.

Greed is just part of human nature, and there is very little any regulator can do to eradicate it. But by changing incentives and disincentives, we've tried to channel greed in a better direction. We've adopted rules requiring the certification of financial information in companies' periodic reports by CEOs and CFOs, better disclosure of off-balance sheet arrangements, restrictions on the use of non-GAAP information and a management report on internal controls over financial reporting. And certainly there's a clear trend towards the ratcheting up of sanctions in SEC civil actions as well as in cases brought by the criminal authorities. Prison time for securities violators may be the ultimate deterrent, but we believe that more aggressive pursuit of disgorgement, higher civil penalties, and the wider imposition of officer and director bars in SEC enforcement actions will have a deterrent effect as well.

Conflicts are ubiquitous in the financial services field. The conflicts that got some of the companies that have been in the headlines and their gatekeepers into trouble are all too familiar to us now. And I am always wondering: What were they thinking? We've seen analysts write favorable research reports to preserve investment banking relationships with issuers - even when they privately held far less positive views. We've seen auditors fail to uphold professional standards or to challenge aggressive accounting for fear of losing a lucrative client. And situations in which attorneys appeared to have forgotten that when they represent a corporation, they are representing the company - not the officers -- were the genesis of our "up the ladder" reporting requirements for attorneys practicing before the Commission.

Additional conflicts have surfaced in our mutual fund investigations. We've seen investment advisers who, notwithstanding prospectus disclosure to the contrary, permitted market timing in mutual funds in exchange for the timers' deposit of "sticky" assets in their funds or in related hedge funds, which increased management fees. We've seen portfolio managers market-timing their own funds. We've seen broker-dealers being paid by mutual funds to get their funds placed on a firm's "preferred list" and the firms paying their brokers more to push those funds. Needless to say, the special compensation wasn't adequately disclosed to customers, who never got a real opportunity to gauge its effect on their brokers' recommendations. What could these firms and brokers possibly have been thinking?

Complacent boards of directors contributed to the problems too. What were they thinking? In too many situations, it appears that boards were of the "potted plant" variety that did little more than rubber-stamp management's decisions. Judging from their actions, many directors failed to comprehend the scope of their responsibility to demand that management act ethically and put investors' interests first. Simply put, they weren't thinking.

Complicity can be another part of the problem. We have attempted to get at this problem by focusing on a company's internal controls. We've also taken enforcement action against external entities that enabled financial frauds, including action against some big banks that assisted Enron in misleading its shareholders by disguising what essentially were loan proceeds as cash from operations. We also recently charged an individual for his alleged involvement in providing financing to the market-timers and late traders. You have to wonder what these firms and individuals were thinking!

And finally, transparency. Many of the rules we adopted under Sarbanes-Oxley were designed to encourage the integrity and transparency of corporate financial reporting, and we have adopted and proposed several new rules that will give mutual fund investors better information, not just about the fees and expenses they're being charged, but about some of the conflicts their brokers may have. I've also been urging greater price transparency in the fixed income markets. Actually, this is a good example of another significant part of my job. Speeches and other public appearances can often be an effective way for the Commissioners and the Commission staff to make our individual views known.

So I will use this speech to reiterate a view that I have talked about before. From my perspective, there are three components to achieving good corporate behavior. The Commission has a big role in two of the components: we provide incentives for good corporate behavior by requiring compliance with the appropriate rules, and we punish bad behavior through the enforcement process.

But the third component - an ethical corporate culture - is beyond our ability to instill. As women who have risen to the top, I know that you must appreciate how much the culture of a firm and the "tone at the top" matters.

Thank you for asking me to be here tonight, and I'd be happy to take your questions.

http://www.sec.gov/news/speech/spch030404cag.htm