“The SEC after the Financial Crisis: Protecting Investors, Preserving Markets”

Thank you, Terry [Lundgren], for that generous introduction.

As always, it is great to be back speaking at The Economic Club of New York.

I especially appreciate the invitation to speak to you today, three days away from completing my term as the 31st Chair of the Securities and Exchange Commission.  I am often asked for my reflections on this period of my public service.  My most frequent response is “never a dull moment.”  My less irreverent observation is how proud I am of what the agency has accomplished for investors and the markets in the last four years.  But I will leave it to others to catalog and assess what we have done.  My topic for today is forward looking.

As you know, right now, there is a lot of discussion about how the new administration may weaken or even reverse many of the reforms that the Commission and our fellow financial regulators have implemented since the financial crisis.  While that is a concern that I very much share, my focus today reaches even further down the road to how, as we move beyond the regulatory response to the financial crisis, the SEC should continue to optimally protect investors and preserve our capital markets as fair, orderly, and efficient engines of economic growth.

Almost exactly 42 years ago, my predecessor, Chairman Ray Garrett, chose this forum to announce that the SEC was unfixing all securities commission rates, ending close to 183 years of a business practice that began under the famous buttonwood tree on Wall Street.[1]  The SEC’s action was a momentous step, and it came at a time of great turmoil for the American economy.

It was 1975.  OPEC had quadrupled oil prices; an economic malaise had descended; and the stock market had crashed.  The 1975 Securities Acts Amendments were enacted that summer, giving the Commission broad new powers, including a directive to establish a national market system.[2]  Many then called on the Commission to also use its regulatory authority to cushion the impact of the economic downturn, and perhaps just as many warned against meddling with the functioning of the capital markets.  Then, as now, there were also voices arguing against diminishing the SEC’s independence as it charts the course of financial regulation for the markets.[3]

I have no specific announcement for you today that compares to Chairman Garrett’s back then, but the importance of reassessing the SEC’s role as an independent financial regulator now harkens back to the environment in 1975, when the Commission’s role was being similarly reviewed.  We are barely six years out from the most devastating financial crisis in recent memory, and the Commission, as in 1975 and throughout its history, has been chastised for both doing too little and doing too much.  Major legislation – for us, the Dodd-Frank Act and the JOBS Act – has reshaped the Commission’s responsibilities in ways that are still being debated, and that now face a fresh round of discussion and legislative activity.[4]

The questions facing the SEC at this crossroad are the same ones that it has faced many times before, but which – as in 1975 – events have now rendered acute.  First, beyond facilitating investors’ access to full and fair disclosure, what is – and what should be – the role of the Commission in regulating the capital markets after the financial crisis?  And, second, how does the Commission continue as a strong independent agency in the current environment?

I will not attempt to address these questions fully today.  They are both very complex and nuanced and, frankly, I do not have all the answers.  But these questions are central to defining the role that the Commission will play in financial regulation for years to come, and they have consumed much of my time as Chair.  Today, I will share with you my thinking on what is required – and what we have already done – to build an SEC that has the strength and flexibility to oversee the constantly evolving post-crisis markets.  Most importantly, I will describe some of the critical work that we have left for the Commission to finish.

My bottom line: for the SEC to be a strong market regulator, wiser from the experience of the financial crisis, we must be ready to use the full array of tools available to us – not relying on disclosure and enforcement alone.  And we must do so with a fierce independence in applying our expert, best judgment to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate the formation of capital by the companies whose innovation and growth drives the American economy.

Building the Post-Crisis Commission

The U.S. capital markets today, of course, bear little resemblance to the markets that Chairman Garrett oversaw in the 1970s.  While their mainstay remains the issuance and trading of equities and bonds, the algorithmic trading and mostly hushed floors of today would be unrecognizable to an observer from 1975.  The last 40 years have seen the advent of securitization, seismic changes in wholesale financing, a significant expansion in the size and diversity of asset management vehicles, and derivatives markets that now reach far beyond the single-stock option.  These developments and others, which went largely unnoticed by the broader investing public, were pushed abruptly to center stage during the financial crisis in 2008 and – to a much lesser, but still quite consequential, extent – during the “flash crash” of 2010, when the U.S. equity markets experienced an exceptionally rapid decline and recovery in a matter of minutes, unexplained by market fundamentals.

It was natural – indeed compelling – in 2008 and 2010 to ask whether the Commission’s regulatory approach was appropriately matched to the modern market.  As many of you will recall, there was a jumble of possible solutions, ranging from eliminating the agency to greatly augmenting its authority.  My predecessor Mary Schapiro had it right when she said, in her first remarks as Chairman in 2009, that the crisis demonstrated how important a strong investor advocate remains.[5]  And now, with no sense of complacency, I am confident in reporting that the agency is today a stronger protector of investors than ever before and much better equipped to meet the challenges of the fast-paced, complex, and interconnected securities markets of 2017.

We have retooled and strengthened our enforcement and exam programs;[6] we have made the equity markets more resilient;[7] we have enhanced the oversight of the asset management industry;[8] and we are seeking ways to continually improve the information available to investors with our public company disclosure effectiveness review program.[9]  The Commission has also completed some of the most significant rulemakings in recent memory, with the last three years alone marked by – among other measures – major reforms addressing money market funds, over-the-counter derivatives, asset-backed securities, municipal finance, clearance and settlement, and private offering reform.[10]

My tenure has come to mark what I call the first “post-crisis” Commission.  But the passage of time has not dissipated the urgency of the question highlighted in the crisis about the Commission’s appropriate role in modern financial market regulation.  The continuing debate about the appropriate role of the SEC is no doubt partly due to the many statutory mandates given the agency over the last six years – many more than any other financial regulator, and many dealing with highly controversial issues.

Executing these statutory mandates has occupied a significant space in the Commission’s agenda.  And, thanks to the work of this agency’s exceptional staff, the bulk of these mandates are now complete.[11]  Throughout my tenure, however, I have sought to preserve bandwidth for our many “day jobs” – from reviewing thousands of issuer filings to overseeing hundreds of changes to exchange operations.  And I have sought to return to the essential issues raised by the financial crisis to build the lasting regulatory frameworks necessary for modernizing the Commission’s oversight of the capital markets.

Considerations for Post-Crisis Market Regulation

In building these frameworks, I have been guided by three principles that I believe are essential for the SEC to remain a strong capital markets regulator after the financial crisis.  First, investor protection must be paramount.  Markets depend on investors, who must have confidence in relying on the information in the marketplace.  But, we must be clear-eyed about the limits of even the best disclosure to meaningfully inform the full range of investors about how today’s complex, interdependent products work and create risk.

Second, a market regulator must preserve the ability of investors to take informed risks and face the consequences, whether good or bad.  While all financial markets involve some degree of risk, a fundamental distinction between investments and bank deposits in the modern era has been the absence of any promise that money invested will be protected by the government or otherwise.  This risk is central to the vitality of the capital markets.  It is a critical part of what fuels innovation in the economy, which an unduly heavy hand from regulators can threaten.

Finally, a market regulator today and going forward must view the capital markets in the context of the larger financial system.  While some segments of today’s capital markets operate with considerable independence from the rest of the world’s financial machinery, most are closely connected to the broader financial system, including depository institutions and insurance products.

For more than 80 years, mandatory disclosure has been the SEC’s central tool for advancing our mission.  Investors expect, and rely on, full and accurate disclosure to make investment decisions and take risks; the Commission, in turn, is charged to act sharply to stop fraud and prevent unfair and dishonest practices, including misleading disclosures.  Disclosure will continue to play a key role in post-crisis regulation.  Indeed, I have sought to comprehensively reconsider what disclosure should look like and how best to deliver it in today’s securities markets so that, in light of recent and possible but inevitable further technological changes, our foundational disclosure regime keeps pace with the needs of investors.[12]

There are limits, however, in the ability of disclosure alone to adequately protect investors, especially as markets have expanded in size and complexity.  Disclosure is a critical tool, but it would be foolish – indeed, I would say irresponsible – for the modern market regulator to ignore the other tools available to it.

This is not a radical concept.  For decades, the Commission has used its authority to regulate directly most of the key participants in the securities markets, including exchanges, broker-dealers, and investment companies and advisers.  The Commission, to name just a few examples, sets financial standards for broker‑dealers, establishes market-wide trading rules, reviews the rule filings by exchanges, and supervises the clearing of securities.  Perhaps the most important question for the post-crisis Commission is how we should judiciously use these authorities of direct intervention to further the three principles I have just outlined.

At the most basic level, it ought to be indisputable that regulators need better and more timely information about the capital markets and market participants so that we can identify, assess, and respond to potential risks early.  For too many years, the Commission’s ability to monitor the markets has been out-paced by the rapid and diversifying developments in those markets, and I have spent much of my time as Chair trying to close that gap.

Similarly indisputable, as technology has come to dominate virtually every segment of the marketplace, it is imperative that there is a robust regime to protect the reliability of our market infrastructure and strengthen the resilience of market participants.  The growing and intensifying challenges of cybersecurity have heightened the importance of this protective regime.  No investor should be asked to assume the risk of an operational failure, and the Commission should not shy from necessary safeguards – for market participants and itself – in favor of a bit of short-term cost savings.

The more challenging questions center on what direct regulatory limits beyond these measures should be set to ensure that investors are protected, markets are orderly, and issuers can attract capital.  The Commission has a long history of avoiding what is dubbed, in overly simplistic short hand, “merit” regulation.  Our founding statutes are predicated on, as Chairman Garrett put it, “the relatively free operation of the markets, where investors are fully informed, as nearly as may be, and the markets are operated fairly and honestly.”  That is still true.

But the Commission and the exchanges have long intervened directly to address problematic practices that were recognized as sufficiently adverse to the interests of investors.  For example, after unfixing commissions in 1975, the Commission established financial responsibility requirements for broker-dealers, including rules for keeping adequate capital on hand and locking up customer assets.  There is also a whole suite of rules aimed at preventing fraud through controls on trading, such as limits on the trading by a firm that is leading a new public offering.  Investment companies face clear limits on their borrowing to achieve leverage.  And so on.

These kinds of measures can be powerful and yet quite targeted, and it is important that the Commission continue to use them where appropriate in developing post-crisis regulation – especially in light of the developments of recent decades.  In some cases, these changes have been in fundamental business practices – both asset management and equity trading today, for example, encompass a far broader array of strategies, including ETFs, than they did 20 years ago.  Another key development, as the financial crisis made clear, is the strong interest that market regulators have in the vitality of the whole financial system – that is, in reducing systemic risk.  Indeed, I believe that the goal of reducing systemic risk is a central tenet of the SEC’s long-standing mission.

There is much work to do, and the appropriate path forward must continually evolve.  While acknowledging this changing landscape, I will highlight just a few ways that the Commission has sought to chart its post‑crisis role.

Implementing Post-Crisis Market Regulation

Asset management industry is among the most important areas of our regulatory responsibility – the college and retirement savings of so many Americans are directly connected to this part of our mandate.  The Commission has long been the primary regulator of investment companies and advisers in the United States, and market regulation is natural given the nature of the industry – an agency business that manages investments across a diverse range of markets and products.  In my time as Chair, we have built a framework for modernizing our regulation of asset management that has used all of the tools at our disposal.[13]

We started with the basics, enhancing the information that is available to investors about funds and their managers – as in other areas, disclosure to investors has remained central to our efforts on asset management.[14]  But we also expanded significantly the information that will be provided on a regular basis to the Commission, including detailed data about a fund’s portfolio, liquidity position, and financing activities.  This information will give the Commission an unprecedented ability to monitor and better understand market practices and, if necessary, act to protect investors.

The Commission has also implemented new controls on how funds manage the liquidity of their portfolios and proposed rules to enhance the management of derivatives positions.[15]  These steps marked an important shift in the Commission’s approach to asset management: disclosure and monitoring remained critical, but the expansion in funds across asset classes and derivative instruments also demanded more direct steps to enhance risk management.  So too with business continuity and transition planning, which was the subject of a separate proposal.[16]  It will be important for the next Chair and Commission to make it a priority to lead the effort to complete the last stages of this initiative.

Another area of particular focus for me has been equity market structure.  Here, too, we have initially used the tools of expanded disclosure for investors and enhanced monitoring for the Commission.  Among our most prominent measures recently has been the adoption of a final plan for a consolidated audit trail, a game‑changing initiative that will for the first time give regulators full information about all equity and options trades in U.S. markets.[17]  We have also worked to significantly enhance the operational integrity of the critical market infrastructure that stands at the center of the capital markets, including through the comprehensive Regulation Systems Compliance and Integrity.[18]  There are also outstanding proposals to enhance the transparency of all significant alternative trading venues for equities and to provide investors more information about where and how their orders are handled. [19]  The staff has also developed its recommendation for a pilot program to assess the impact of potential conflicts of interest in how exchanges and broker-dealers are compensated for order flow and execution.[20]

But there is other significant work to be done to optimize the functioning of our equity markets.[21]  In particular, the staff has now developed detailed analyses demonstrating how certain trading strategies can be destabilizing in vulnerable market conditions – there is a clear need for a tailored anti‑disruptive trading rule to reduce the potential harm from these types of strategies.  So too is there a need to further clarify the dealer registration requirements for proprietary trading firms – high frequency trading firms that execute a significant volume of intraday trading for their own accounts, frequently turn over their positions by buying and selling securities throughout the day, and generally carry small overnight positions relative to the amount of their intraday trading.  Preventing sources of needless instability in our equity markets will depend on the next Chair and Commission taking further steps to address the registration and other regulatory requirements for these types of firms.

Another area for further work is the financial responsibility rules for broker‑dealers.  The Commission completed a major update to these rules in my first year,[22] and the next Chair should carry this program forward.  The staff has been working to prepare updates for all clearing broker-dealers, which would enhance their capital and liquidity requirements as well as formalize certain stress tests.  These updates would provide important additional investor protections, as well as mitigate the broader market impact of the failure of a large clearing firm, whether or not it is affiliated with a bank.

A related effort is focused on ensuring that the public disclosures of financial institutions, including bank holding companies, has kept pace with the vast changes in our disclosure regime and how such institutions operate.  The staff has reexamined the principal guide on this matter, which was issued in 1976, and prepared a public request for comment.  It will be important for the next Chair to have the Commission approve this request to gather feedback from stakeholders and then advance appropriate changes to make financial institution disclosure more effective for investors.

This work – both completed and to come – illustrates how different the role of a market regulator must be today from the role envisioned in 1934, when there was a serious debate about whether an agency distinct from the Federal Trade Commission was even necessary.  I think it is clear to all that capital markets today require more than just basic consumer protection – they require constant monitoring and, increasingly, calibrated safeguards and market stability measures.

The actions of other regulators will also inevitably bear on the assessment of new measures.  Our regulatory models and those of our colleagues must recognize and address the interrelationships between financial institution and market, appropriately calibrated to both protect investors and support the risk-taking that is at the heart of our capital markets.  The Financial Stability Oversight Council is a particularly important forum for that dialogue, but it will also be essential for the Commission to continue to engage in the full array of forums in which it engages, domestic and international.  Modern financial markets cut across regulatory lines that were drawn in a different time, and we need to have the assertiveness, flexibility, and open-mindedness to continue to play a leadership role in the broader financial regulatory regime.

Preserving Independence

Our independence is vital to serving in that leadership role and doing our job optimally.  The Commission has always guarded its independence fiercely, a proud history that I have defended from my very first days as Chair.  Not all of our actions and views have been uniformly praised.  They never have been.  At the core of being a good steward of the mission of the SEC is acting independently from the executive and legislative branches of government, fighting for that independence whenever necessary, and withstanding the inevitable criticism and pressure to change that follows.

Like many Chairs and Commissioners before me, I strongly believe that the agency’s independence has been critical in allowing it to use its expert judgment to do what is best for investors and the markets – a task that could otherwise be rendered impossible by the whims of political pressure or the public mood.  The Commission, in fact, was created as an independent expert agency in 1934 precisely because Congress identified a need for that strength in overseeing the American capital markets.

Of course, as Congress recognized at the time, this model does not mean – and, as I have personally experienced, has not meant – an absence of oversight.  Independence only works when it is matched with accountability.  And, we are held accountable.  We are subject to annual appropriations from Congress, regular public oversight, and an established body of law – centered on the Administrative Procedure Act – dedicated to preserving due process.  The courts have also not been shy about holding us to account under the law.

Perhaps a bit paradoxically, our independence also depends on hearing regularly from a wide range of constituents with extraordinarily diverse perspectives.  Across our many activities, the Commission gathers input from investors and other market participants, representatives from throughout the government, advocacy and industry groups, public commentators, international counterparts, and many others.  This approach is certainly time-consuming, but it allows us to evaluate all perspectives on an issue and make the best decisions possible within our authority.

The extraordinary vitality of the American capital markets testifies to how well the Commission’s independence has served investors and the economy over the years.  The choices ahead for the agency – some of which I have described today – will not be easy.  Continuing to build an effective post-crisis market regulator will mean imposing measures that sometimes draw sharp outcry from interest groups, and it will mean modifying or eliminating measures that – despite strong public support from other groups – are no longer serving investors well.

My tenure has certainly been marked by hard decisions that have attracted criticism from both political parties.  We have been accused of both gutting regulation and suffocating the market with too much of it.  A few have attacked us for letting the crooks off with a slap on the wrist, while others say we are too tough or have targeted others simply to pump up our numbers.  In short, the environment necessary for independent agencies to be able to do the jobs you all want us to do is not getting better.  Indeed, recent trends have even raised the question of whether or not the independence of the SEC can be preserved at all.

One of the most prominent trends is toward increasingly specific statutory mandates – and lots of them.  It is entirely appropriate for Congress to act to change the mission of the Commission or broadly direct the agency to address a new risk or market condition.  But the highly prescriptive mandates that we see today, which tell us exactly how we should act, are much different.  This prescriptiveness frustrates the agency’s ability to exercise its expert discretion effectively, ultimately undermining the goal of the congressional mandate.  It is very eye-opening to contrast the broad directives of the 1975 Securities Acts Amendments with the highly detailed requirements set forth in the Dodd‑Frank and JOBS Acts.  The phrase – “ah, those were the days” – does come to mind.

Another current trend pushing against the independence of the Commission are the legislative proposals from Congress seeking to remake our rulemaking process.  The House passed a bill just last week that would impose conflicting, burdensome, and needlessly detailed requirements regarding economic matters in Commission rulemaking that would provide no benefit to investors beyond the exhaustive economic analysis we already undertake.[23]  These requirements would also prevent the Commission from responding timely to market developments or risks that could lead to a market crisis.  And elements of the CHOICE Act, which could be re‑introduced this session, would similarly undermine agency rulemaking as well as cripple our enforcement capabilities.[24]  The next Commission must continue to challenge these efforts, and so should all of you.

These trends and similar ones create real consequences for the efficacy of the Commission, as well as for other independent regulators.  Most visibly, they tend to increase polarization within the Commission and make it harder to forge consensus.  The strength and utility of the agency’s structure depends on an environment that rewards expertise and frank dialogue, not partisan affiliation and political games.  If the ability and resolve of Commissioners to act independently diminishes, so too will the opportunity for solutions that, while politically unpopular, best serve investors and markets.  The agency depends on being able to consider all views and facts in making an expert assessment, which can be foreclosed by increasingly detailed statutory requirements or unthinking partisanship, whether by Congress or Commissioners.  If the SEC’s discretion is not meaningfully preserved, it would be to the significant detriment of both investors and the markets.  Even a bipartisan Congress would not be nearly as well equipped to study and conclude the range of technical issues that are inherent in nearly every one of the SEC’s regulatory actions.

Conclusion

The present moment is a delicate one.  The post-crisis Commission has been revitalized and remains the investor’s strongest advocate, but it is more susceptible than ever to the erosion of its expertise and authority by the partisan tides.  It will remain independent – and therefore able to meet its broad range of critical responsibilities – only with Commissioners equipped and motivated to act expertly and with only our mission in mind.  It will also be up to others, including Congress, to offer an unwavering defense – not of the SEC’s actions – but of the agency’s independence and the right of the Commission to exercise it to further our critical mission.

I believe today’s SEC is deserving of that defense.  And I believe that Americans across this country are clearly deserving of a Commission that is empowered to independently carry out its unique and critically important obligations to investors and to our capital markets.