SEC COMMISSIONER GALLAGHER'S REMARKS AT "SEC SPEAKS IN 2013" CONFERENCE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Remarks at "The SEC Speaks in 2013"
byCommissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Washington, D.C.
February 22, 2013

Thank you, Craig [Lewis], for your kind introduction. This is my second year addressing this conference as a Commissioner. Last year, I spoke as one of five Commissioners, while this year, as you well know, we’re temporarily down one member. And so, I understand that the organizers are offering a 20% discount which you can collect after my remarks. Just kidding. The truth is that they asked all of us to give longer speeches, and since I am still the junior Commissioner, the others dumped their extra time on me. So, I hope you are ready for an hour long adventure.

Before I begin, let me remind you that as usual, my remarks today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners.

On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic "blocking and tackling" of securities regulation. Today, therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies.

As I’m sure all of you know, Congress created the SEC in the Securities Exchange Act of 1934. What some of you may not know, however, is that the Securities Act of 1933 originally tasked the Federal Trade Commission with administering the new federal securities laws. Indeed, the FTC was the initial choice of many, including President Franklin Roosevelt, to administer the Exchange Act as well.<sup>1 Ultimately, however, a consensus emerged that the difficult task of administering the federal securities laws required the creation of a new independent, bipartisan agency with a high level of technical expertise in securities matters that could focus exclusively on the nation’s capital markets. For example, during consideration of the House version of the legislation that would ultimately become the Exchange Act, Representative Charles Wolverton cited the "high degree of technical skill and knowledge," that would be necessary to administer the new federal securities laws in his support for the creation of a five-member, expert Commission to take over the administration of those new laws.2 Similarly, during consideration of the corresponding Senate bill, Senator Duncan Fletcher explained the belief among "[m]any people, Members of Congress and others . . . that a special commission ought to be provided to administer the measure because the provisions are largely technical, and we ought to have men experienced in business of the kind involved."3

The final version of the Exchange Act that emerged from Congress in the summer of 1934 provided the newly-established Commission with a broad mix of regulatory and quasi-judicial authority to carry out the legislative policies set forth in the Securities Act and the Exchange Act. The movement toward the establishment of expert, independent agencies represented a major shift in the regulatory paradigm, and it wasn’t long before this model was challenged. A year after Congress created the SEC, the Supreme Court took up the issue of independent agencies in the case of Humphrey’s Executor v. United States, which arose from President Roosevelt’s attempt to remove William Humphrey from his position as an FTC Commissioner. Much to the chagrin of the President, the Court ruled that as "an administrative body created by Congress to carry into effect legislative policies," an independent agency such as the FTC "cannot in any proper sense be characterized as an arm or an eye of the executive. Its duties are performed without executive leave and, in the contemplation of the statute, must be free from executive control."
4 Most recently, in its 2010 decision in Free Enterprise Fund v. PCAOB, the Supreme Court implicitly referenced the Commission’s independence, proceeding on the understanding that SEC Commissioners "cannot themselves be removed by the President except under the Humphrey’s Executor standard of inefficiency, neglect of duty, or malfeasance in office."5 This stands in contrast to, for example, Cabinet secretaries, who, while subject to Senate confirmation, serve at the pleasure of the President.

Having established the SEC as an expert, independent agency with the authority to administer the federal securities laws, Congress has traditionally provided the Commission with considerable flexibility to exercise that expertise and authority. Historically, Congress has avoided imposing minutely detailed mandates on the Commission. Instead, Congress has, in conjunction with past grants of authority to the SEC, largely left it to the Commission to study issues and formulate rules which the Commission deemed in its discretion to be "in the public interest or for the protection of investors," a phrase that appears time and again in our securities laws.
6 As President Roosevelt himself remarked upon signing the Investment Company Act and Investment Advisers Act into law in 1940, "[E]fficient regulation in technical fields such as this requires an administering agency which has been given flexible powers[.]"7

For nearly eighty years, the Commission, like other independent agencies, has brought its expertise and judgment to bear in fulfilling the legislative mandates established by Congress in the federal securities laws. Yet, in today’s post-financial crisis, post-Dodd-Frank regulatory environment, the Commission is faced with a variety of challenges that carry with them the potential to erode its independence. The Commission must remain alert to these challenges and must respond when appropriate in order to preserve its ability to act independently in fulfilling its core mission. My concerns here do not derive from ideology or a desire to perpetuate seemingly age old agency turf wars. Instead, this is about the need to preserve a long-standing regulatory model that eschews a one-size-fits-all approach in favor of allowing expert, independent agencies to craft rules that, when necessary, are appropriately tailored to the specific entities and products they regulate.

And then came Dodd-Frank. I worry about the limits placed on the Commission’s ability independently to apply its expertise and judgment under the paradigm established by the Dodd-Frank Act. The Act contains approximately 400 specific mandates to be implemented through agency rulemaking, around 100 of which apply directly to the SEC. Many of these mandates are highly prescriptive, and instead of directing the Commission to regulate in an area after studying the relevant issues, compiling data, and determining what, if any, regulatory action may be appropriate, they require the Commission to issue strictly prescribed and often highly technical rules under short deadlines. Unfortunately, although the Commission always has some degree of discretion when implementing a Congressional mandate, these more prescriptive rules limit the Commission’s flexibility in the rulemaking process while occupying time and resources that could be better spent fulfilling the Commission’s other important responsibilities. If one of the duties of an independent agency is to work proactively with Congress to ensure that statutes do not impose unnecessary or inappropriate mandates, then on that front the Commission unfortunately came up short with respect to many Dodd-Frank mandates.

Ideally, when Congress provides the SEC with statutory authority to draft and implement rules in a new area, it will allow the Commission the time and flexibility necessary to study the issues involved and formulate smart regulation that reflects a complete understanding of the underlying data, including the costs and benefits associated with regulatory action. This is, after all, how the Commission was intended to operate when it was established nearly eighty years ago. In fact, I believe it is the Commission’s duty as an expert, independent agency to continue to employ this data-driven approach as best it can even in the face of prescriptive mandates from Congress.

Although the Commission continues to stare down an overflowing plate of Dodd-Frank mandates in addition to its other responsibilities, as an expert, independent agency, the Commission must not allow itself to assume a secondary role in the regulation of matters squarely within its jurisdiction and core competencies. This, I’m afraid, is exactly the role that the Commission has taken thus far with respect to critical initiatives, including the Volcker Rule.

Pursuant to Section 619 of Dodd-Frank, the three Federal banking agencies, the SEC, and the CFTC must together adopt regulations to implement the Volcker Rule’s two prohibitions on banking entities and their affiliates: its prohibition on engaging in proprietary trading and its prohibition on sponsoring or investing in "covered funds" such as hedge funds or private equity funds. Unfortunately, there is little doubt that notwithstanding the valiant efforts of the SEC staff, the Commission for too long has taken a back seat to the banking regulators in this rulemaking process. As I have said in the past, despite the Rule’s ostensible application to banking entities, the Rule is actually focused on the conduct to be regulated, not the entities that engage in this activity. There is no question that the specific trading, hedging, and investing activities to be regulated under the Rule fall firmly within the Commission’s core competencies, as they deal directly with SEC registrants and registration requirements. It makes little sense, therefore, for the Commission to defer to the banking regulators in this area when for decades it has regulated securities market-making in order to facilitate liquidity and promote the efficient allocation of capital.

The implementing rulemaking for the Volcker Rule was proposed in October 2011. Almost a year and a half — and over 18,000 comment letters — later, the Volcker Rule remains at the proposal stage. Indeed, it appears that the proposal’s broad definitions of statutory terms have taken a bad situation and made it worse. Commission staff continue to engage in discussions with the bank regulators and the CFTC regarding the many concerns raised in those 18,000-plus comment letters. For this rule to get done and get done properly, the SEC must take a leadership role. In fact, I believe it is our duty as the independent financial regulator with primary authority over, and expertise in, the activities to be regulated to ensure that the final Rule meets the aims of Congress without destroying critically important market activity that the Rule explicitly intends not to eliminate. Moreover, in accordance with its core mission, it is the Commission’s responsibility to balance the bank regulators’ focus on safety and soundness and Dodd-Frank’s overarching focus on managing systemic risk with legitimate considerations of investor protection and the maintenance of vibrant markets.

This brings me to the elephant in the room: FSOC. FSOC was created, in part, to respond to the realization during the financial crisis that regulatory balkanization had resulted in a lack of communication and information-sharing among financial services regulators, which undoubtedly led to poor policy decisions during the crisis. None of us who lived through the crisis on the ground floor would argue against improvements to the regulatory structure that would facilitate coordination and information-sharing among regulators. However, with FSOC the threats to the Commission’s independence move from the theoretical to the immediate, for already in its short existence, this new body has directly challenged the Commission’s regulatory independence. It is also where just one member of the Commission, the Chairman, can defend that independence. Pursuant to the provisions of Dodd-Frank establishing FSOC, the group is composed not of agencies, but the individual heads of agencies, acting ex officio.

As I have said in the past, the structure of FSOC is particularly troubling for an independent agency like the SEC. While the Secretary of the Treasury and the heads of the FHFA and the CFPB may speak on behalf of their agencies — not to mention the President that appointed them — the same cannot be said of the Chairman of the SEC. To preserve its independence, Congress created the SEC as a bipartisan, five-member Commission and gave each Commissioner — including the Chairman — only one vote. This means that the Chairman has no statutory authority to represent or bind the Commission through his or her participation on FSOC. Yet as a voting member of FSOC, the Chairman of the SEC does have a say in authorizing FSOC to take certain actions that may affect — and indeed have already affected — markets or entities that the Commission regulates. While one might expect that the Chairman of the SEC would always represent the views of the Commission as a whole, there is no formal oversight mechanism available to the Commission to check the Chairman’s participation on FSOC. Moreover, although the Commission’s bipartisan structure insulates it from undue political influence, FSOC’s structure does not. On the contrary, FSOC is composed of individuals who are heads of their agencies — typically making them members of the President’s political party — and led by a Cabinet official who is removable by the President at will. These factors, among others, make FSOC particularly susceptible to political influence which, in turn, can be — and has been — exerted on the agencies led by FSOC’s members.

To further complicate matters, FSOC operates under a different mandate than the SEC, having been established by Congress with a broad mandate to identify systemic risks and emerging threats to the country’s financial stability. Putting aside the fact that FSOC’s designation of certain firms as "systemically important" likely institutionalizes the idea of "too big to fail," FSOC’s core mission is to ensure the safety and soundness of the U.S. financial system — not surprising given that a significant plurality of FSOC is composed of the heads of bank regulators. While this mission is of unquestionable importance, so, too is the distinct mission of the SEC. To be sure, proper oversight of our capital markets should positively impact the safety and soundness of our financial system. Nevertheless, the SEC is not by statute a safety and soundness regulator. In fact, the markets we regulate are inherently risky, and with good reason. By putting money at risk, investors allocate capital in a manner that spurs economic growth in the hopes of a much higher return on their investments than they could obtain from lower-risk, lower-return investments, such as bank accounts. The SEC seeks to protect these investors from fraud and to ensure that the markets in which they put their capital to work are fair and efficient. Our mission is not, and should not be, to make these markets risk-free, nor is it to preserve the existence of any particular firm or firms. Capital markets regulators and bank regulators have drastically different missions and oversee fundamentally different markets and market participants. And, importantly for me and all of those who appreciate and advocate for free markets, we must keep a healthy distance between capital markets regulation, which rightfully assumes no taxpayer safety nets, and bank regulation.

It is not difficult to see the potential tension between the SEC and FSOC missions and the resulting threat to the Commission’s ability to function independently. As the old adage goes: "No one can serve two masters." When the Chairman of the SEC faces this tension, which of these two potentially competing mandates does he or she honor?

Nor is FSOC merely an advisory body without teeth. To carry out its mandate, Congress provided FSOC with extraordinary powers for an inter-agency council. For example, FSOC has the authority to designate a nonbank financial company as "systemically important," and to subject these companies to prudential supervision by the Fed. FSOC may also designate a financial market utility or a payment, clearing, or settlement activity as "systemically important," and direct the Fed, in consultation with the relevant supervisory agencies and FSOC itself, to prescribe risk management standards. To the extent that these "systemically important" utilities or activities are conducted by firms for which the SEC or CFTC is the primary regulator, Dodd-Frank provides "special procedures" pursuant to which the Fed may, if it determines that the risk management standards set by the SEC or the CFTC are "insufficient," impose its own standards. That authority is not simply a threat to the Commission’s independence — if exercised, it would be an outright annexation.

FSOC also has the authority to recommend that a primary financial regulator, such as the SEC, apply new or heightened standards and safeguards for systemically significant financial activities or practices. In this regard, FSOC has been busy in recent months prodding the Commission on money market fund reforms, including through the release of proposed reform recommendations last November.

I won’t recount the history that led to FSOC’s involvement in the regulation of money market funds, an area which unquestionably falls within the core expertise and regulatory jurisdiction of the SEC. But I will emphasize that my colleagues and I have made it clear that, having now been provided with the rigorous study and economic analysis on money market funds that a bipartisan majority of the Commission asked for from the start, we fully expect the Commission to move forward with a rule proposal shortly. Why, then, is FSOC still involved in the process? FSOC was established in part to promote coordination, collaboration, and information-sharing among its member agencies. It is immensely troubling then to think of the FSOC as an institutionalized mechanism for one set of regulators to pressure another in the latter agency’s field of expertise — yet that is exactly what is happening.

Moving on from the threats posed to the Commission’s independence by Congressional mandates and FSOC intervention, there are other, more mainstream, jurisdictional incursions the Commission must monitor and manage. For example, in December 2012, the Fed, acting pursuant to Dodd-Frank authority, issued proposed regulations to apply U.S. capital, liquidity, and other prudential standards to the U.S. operations of foreign bank organizations with total global consolidated assets of at least $50 billion.
8 These rules, if adopted in their current form, would require such organizations to create an intermediate holding company that would house all of their U.S. bank and nonbank subsidiaries.

The Fed proposal would affect SEC registrants as the new holding company capital rules would treat assets held by broker-dealer subsidiaries differently than they are treated in the SEC capital rules because of the proposed leverage standard that would apply to foreign bank organizations. Specifically, a U.S. broker-dealer subsidiary of a foreign bank organization could be required indirectly to hold more capital than would be necessary to satisfy the SEC’s net capital rule to maintain the same positions.

The regulation of broker-dealers is at the heart of the Exchange Act and, as such, has been under the Commission’s regulatory purview for nearly eight decades. Using the expertise it has developed over this period, the Commission has designed capital requirements under Rule 15c3-1 that are tailored to the operations of broker-dealers and the industry in which they operate. Here, it is crucial to understand the differing theories that underlie broker-dealer and bank capital requirements. The Commission’s capital rules are meant to deal with failure, in that they are designed to ensure that when a broker-dealer fails, it has net liquid assets in excess of all non-subordinated liabilities so that the firm can be self-liquidated in an orderly manner and satisfy all creditors, particularly its customers. On the other hand, bank capital standards are not designed to require a bank to maintain sufficient net liquid assets to satisfy all creditors. Instead, banks have access to federal liquidity facilities that can be used as a funding source in the event that the bank cannot find private funding. These facilities allow the bank to be liquidated in a more orderly manner in the case of a failure. And, if the bank is "too big to fail," the facilities can operate as a tax payer-funded life support system. Accordingly, it will be very important for the Fed and the Commission to coordinate carefully as this rule proposal is considered to ensure that legitimate goals can be advanced without undermining SEC oversight.

This Fed rulemaking comes on the heels of the misguided repeal in Dodd-Frank of the Commission’s Supervised Investment Bank Holding Company, or SIBHC, program. This little-known program, which the Commission implemented under the authority of Exchange Act Section 17(i), should have been expanded in Dodd-Frank to allow the SEC to better oversee non-systemically important broker-dealer holding companies. Instead, Dodd-Frank eliminated Exchange Act Section 17(i), and replaced it with a new Fed program.

On a final note, the Commission must also be mindful of the effect that international regulatory bodies, even those like IOSCO and the FSB in which the Commission is a participant, can have on the Commission’s prerogatives as an expert, independent agency. Many of these organizations were formed in large part to foster cooperation, information-sharing, and coordination among financial regulators in different jurisdictions. However, we now often see from these groups one-size-fits-all "recommendations," some of which run contrary to the Commission’s existing regulations or address the substance of specific issues pending before the Commission. I believe that the Commission must remain an active, productive member of these groups, but we must ensure that policymaking remains in the hands of domestic regulators acting with the requisite independence.

Thank you all for coming to this year’s SEC Speaks, and I look forward to seeing you again next February.</sup>

SEC COMMISSIONER GALLAGHER SPEAKS TO U.S. CHAMBER CENTER FOR CAPITAL MARKETS COMPETITIVENESS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Remarks before the U.S. Chamber Center for Capital Markets Competitiveness
byCommissioner Daniel M. Gallagher
U.S. Securities and Exchange CommissionWashington, D.C.
January 16, 2013

Thank you, David [Hirschmann], for that kind introduction. I’m very pleased to be here this afternoon addressing such strong supporters of American global leadership in capital formation, one of the foremost goals of the Commission. Before I continue, I must tell you that my comments today are my own, and do not necessarily represent the positions of the Commission or my fellow Commissioners.

As I’m sure you’re all aware, next Monday the nation will observe both the Inauguration and Martin Luther King Jr.’s birthday. What you may not be aware of is that Monday also marks the two-and-a-half-year anniversary of the enactment of the Dodd-Frank Act. To commemorate the occasion, I’d like to take a few moments today to talk about the Act — specifically, the misallocation of resources and opportunity costs that have arisen from the many false assumptions underlying the Act and how they continue to impact the Commission's everyday efforts to carry out its mission to protect investors, maintain fair, orderly, and efficient markets, and to facilitate and capital formation.

You can say this about the Dodd-Frank Act: it’s a perfect example of not letting a crisis go to waste. Indeed, the Act is a model of the new paradigm of legislation — a core concept, in this case regulatory reform, overwhelmed by a grab bag of wish-list items. What continues to amaze me about the Act is not only what it covers in its 2319 pages, but also the crucial regulatory issues it does not address. The juxtaposition of the two is jarring. The Act tasks the SEC with a mandate to create unprecedented new disclosure rules relating to conflict minerals from the Congo — but not to reform money market mutual funds, which, we were later told, are ticking time bombs of systemic risk. Dodd-Frank addresses extractive resource payments made by U.S. listed oil, gas and mining companies — but leaves the reform of Freddie Mac and Fannie Mae for another day. The Act fundamentally restructures the nation’s financial regulatory infrastructure by establishing the Financial Stability Oversight Council, not to mention the Consumer Financial Protection Bureau — but failed to eliminate the redundancy of having the SEC and the CFTC share jurisdiction over substantially similar and interrelated markets and products. Dodd-Frank creates a system of regulation for so-called SIFIs but does not address the shortcomings of the short-term funding model of banks that continue to be too big to fail. The Dodd-Frank Act's attempts to "solve" the financial crisis illustrate the peril of false narratives — it justifies its mandates as answers, but only after asking the wrong questions.

I suppose that this shouldn’t be a surprise given that the statute was not the product of bipartisan compromise and was enacted shortly after the onset of the crisis — and many months before the bodies charged with examining the causes of the crisis issued their reports. This was a markedly different approach than the deliberative process undertaken after the 1929 stock market crash.<sup>1

In total, the Dodd-Frank Act contains approximately 400 specific mandates to be implemented by agency rulemaking, with approximately a hundred applying directly to the SEC. The SEC has adopted final rules implementing nearly a third of those statutory mandates and continues to devote tremendous amounts of resources to drafting additional proposals, completing required studies, and implementing the new rules. The result has been a dramatic increase in both the volume and pace of SEC rulemaking. As I’ve said in the past, it’s no exaggeration to say that the Commission is handling ten times its normal rulemaking volume, with "normal" being the post Sarbanes-Oxley normal, itself a marked increase from the pace before that law’s enactment.

As a result, the SEC, like other regulators, is now dealing with the problem of rushed, inadequate rule proposals that were pushed out in a bid to meet arbitrary congressional deadlines. As you might expect, it is not easy to promulgate high quality final rules from faulty proposals. The Volcker Rule serves as a case in point.

This increased pace raises two sets of concerns. The first stems from the difference between getting rules done and getting them done right. Smart regulation requires taking the time to understand the problem that needs to be addressed, including not only the proximate cause of the problem but also the often complex and hidden factors underlying that problem. It is at this stage where the peril of false narratives is at its greatest, for incorrectly identifying the causes of a problem — whether outright or by oversimplifying complicated issues— makes finding the right solution far more difficult, if not impossible. And, it should go without saying that we need to ensure that we are performing a rigorous cost-benefit analysis of all rules, whether proposed or final.

The second set of concerns centers around the concept of opportunity cost and the misallocation of limited resources. I have no doubt that the businesses represented by the Chamber understand the concept of limited resources and the need to set clear and sensible priorities far better than does the federal government. Every hour spent by the SEC staff on drafting rules or carrying out studies to implement Dodd-Frank mandates represents one less staff hour spent focusing on the Commission’s core regulatory responsibilities.

I’m not here to enumerate the flaws of the legislation as a whole, but I'd like to spend a few moments using the Volcker Rule to illustrate both of these sets of concerns. As I’m sure you all know, the Dodd-Frank Act requires the three Federal banking agencies, the SEC, and the CFTC to adopt rules to implement two significant prohibitions on banking entities and their affiliates: a prohibition on engaging in proprietary trading, and a prohibition on sponsoring or investing in "covered funds" such as hedge funds or private equity funds. The Rule identifies certain specified "permitted activities," including underwriting, market making, and trading in certain government obligations, that are excepted from these prohibitions but also establishes limitations on those excepted activities. The legislative text of the Volcker Rule defines — in expansive terms — key concepts such as "proprietary trading" and "trading account" and grants the Federal Reserve Board, the FDIC, the OCC, the SEC, and the CFTC the rulemaking authority to further add to those definitions.

The banking agencies and the SEC issued a proposal in October 2011, with the CFTC following in February of last year. Fifteen months later, the rulemaking remains at the proposal stage, with ongoing talks between the agencies aiming to address the myriad concerns raised in over 18,000 comment letters regarding the dire, albeit presumably unintended, consequences they argue would result from the proposed implementing regulations.

And yet, "If you look at the crisis, most of the losses that were material for the weak institutions — and the strong, relative to capital — did not come from those [proprietary trading] activities. They came overwhelmingly from what I think you can describe as classic extensions of credit." Those aren’t my words — Treasury Secretary Geithner spoke them in September 2009. In case Secretary Geithner merely misspoke, I’ll provide another quote from a different speaker, this time from March 2010: "[P]roprietary trading in commercial banks was there but not central" to the financial crisis. That speaker? Paul Volcker.

Don’t get me wrong — as illustrated by notable hedging failures last year, bank trading and hedging practices can indeed be a whale of a problem. It’s just not a problem the Volcker Rule, or the Dodd-Frank Act as a whole, purport to address. Like much of the Act, the Volcker Rule is a solution in search of a problem.

The Act, however, is still the law of the land, and banks have long since accepted the Rule and its implications for their business activities. In fact, I’ve been told by several firms that although the implementing rules have yet to be finalized, they’ve taken significant steps to shut down their U.S. prop trading activities and, in some cases, have already done so completely. Even as firms have looked to the statutory text and spirit of the Rule and proactively taken action to bring their hedging and trading practices into compliance, however, high-level staff from five regulatory agencies continue to work behind closed doors to refine a rulemaking proposal that, according to a letter sent to the agencies by a bipartisan group of six Senators, "as drafted, could adversely affect Main Street businesses by reducing market liquidity and increasing the cost of capital."
2

In another comment letter, Senators Merkley and Levin, both strong supporters of the Volcker Rule, wrote, "The Volcker Rule demands Wall Street change its culture. Implemented in a smart, vigorous way, the Volcker Rule can both protect the U.S. economy and taxpayers from some of the gravest risks created by the nation's largest financial institutions, while providing plenty of space for these financial institutions to provide the plain vanilla, low-risk, client-oriented financial services that help the real economy grow."
3 These are certainly laudable goals. Almost uniformly, however, critics of the Volcker Rule argue that it is those very "plain vanilla," Main Street customer-facing products that will be harmed, not necessarily by the text of the Volcker Rule as set forth in the Dodd-Frank Act, but by the draconian interpretation of the Rule that the October 2011 proposed rules would impose upon the financial industry — and its customers. Notably, our foreign regulatory counterparts in Europe, Canada, and Japan have been some of the fiercest critics of the proposed implementing rules.

I had the opportunity last week to meet with regulators and industry participants in the UK and Ireland, where I encountered a distinct lack of enthusiasm for either the Volcker Rule or its "ring-fencing" counterpart proposals set forth by the UK Independent Commission on Banking and the European Union’s Liikanen Group. Indeed, Sir John Vickers, chairman of the Independent Commission, has already criticized the UK coalition government for backing away from his original proposal,
4 while the European Commission’s recent report summarizing the responses received to the Liikanen Report acknowledges the widespread opposition to the proposal in a charmingly understated fashion, stating, "In general, banks welcomed the Group's analysis, but argued that a compelling case for mandatory separation of trading activities has not been made. They felt that the proposal was not backed by the required evidence, and that there was a need for a thorough impact assessment."5 With all due respect to my friends in the European financial regulatory community, when a regulatory proposal is viewed within the European Union as being too harsh on the financial industry and harmful to markets, I think that’s a clear sign that it’s time to take a step back and reevaluate.

Regardless of what happens with respect to the Vickers or Liikanen proposals, even if all of the most vitriolic allegations Wall Street's harshest critics set forth are true — even if our financial giants act solely and ruthlessly out of craven self-interest — those financial institutions know that the Volcker Rule isn't going away. As such, they have already begun the process of determining which of their activities would be prohibited under the Rule as set forth in the text of the Dodd-Frank Act and proactively moving to shut down their truly proprietary trading desks as appropriate. Accordingly, as my friend and colleague Troy Paredes and I have often stated, the final regulations implementing the Volcker Rule should, for the most part, simply be a codification of what most banks have already done in response to the requirements set forth in the legislative text. The critics of the proposing release are no longer, if they ever did, realistically contemplating repeal of the Volcker Rule. They simply want us to get its implementing regulations right.

The October 2011 proposal fails to accomplish this goal by focusing only on the latter part of Senators Merkeley and Levin's call for the implementation of the Act in "a smart, vigorous way." Operating on the narrative that banks' proprietary trading practices were a central cause of the crisis, the proposal eschews a focus on smart regulation in favor of pursuing the most vigorous possible interpretation of the Rule's mandates. The proposal throws the baby out with the bathwater — along with the rubber ducky, the bathtub and all of the plumbing as well for good measure. Rather than carefully examining banks' trading practices to determine which of those practices constitute proprietary trading and which are instead customer-facing activities providing liquidity and reducing the cost of capital, it stretches its definitions of covered activity on an almost punitive basis, as if based on an assumption that any trading that could result in profits for the trading entity must fall within the ambit of the Volcker Rule's prohibitions.

This failure to separate market-critical, customer-facing activities from true proprietary trading illustrates the second set of concerns — opportunity costs and the misallocation of resources. The entire rulemaking exercise so far has been carried out in a manner that has wasted the resources of all of the agencies involved. By every account, the bank regulators have taken the lead role throughout the rulemaking process. Presumably, this stems from the fact that the Rule applies to the vast financial firms regulated at the bank holding company level by the bank regulators, coupled with the Byzantine nature of interagency rulemaking and the Washington power game. The Volcker Rule, however, isn't about the financial entities involved — or the relative political standing of the different regulatory agencies — but instead the activities in which those entities engage. Those activities — the trading and hedging practices of those entities — unquestionably fall within the core competencies of the SEC. For example, the SEC has built an extensive library of rulemaking and interpretive releases concerning exceptions for bona fide hedging or market making in the context of short sales. These exceptions, which date back to the early 1980s, built upon the bona fide hedging exceptions to the Commission’s proprietary trading rules for members of national securities exchanges set forth in a 1979 rulemaking. The Rule expressly envisions that quintessential market-making activity continue to be carried out by the firms affected by the Volcker Rule, yet the agency that has regulated securities market-making in order to facilitate liquidity and promote the efficient allocation of capital for decades has played a secondary role in drafting regulations to implement the Rule.

All of this comes with a cost. Both the Commission staff playing second fiddle and the banking regulators struggling to convert the widely lambasted proposing release into workable regulation could be focusing on other matters rather than spinning their wheels with no end in sight. Simply put, we could be spending our time in a far more productive manner, focusing on mandates that are critically important such as those in the JOBS Act, as well as addressing the SEC’s basic "blocking and tackling." Indeed, one personal frustration of mine has been the Commission's inability to fully implement what I believe is the most useful and important provision of the Dodd-Frank Act, the Section 939A mandate to remove all references to Commission-registered credit rating agencies, formally referred to as nationally recognized statistical rating organizations, from all agency regulations. This clear and direct mandate is actually responsive to one of the core problems underlying the financial crisis — overreliance on inaccurate credit ratings by both investors and regulators — yet the most important rules continue to include such references.

Meanwhile, FSOC, charged with averting the next financial crisis, is apparently spending more time hectoring the Commission — a purportedly "independent " agency — on the reform of money market funds — an issue that falls directly, and solely, within the Commission's regulatory sphere of responsibility but that was somehow not important enough to be addressed by the Dodd-Frank Act — than they are focusing on the bubbles that have the potential to cause another crisis. On the issue of money market funds, I am happy to report that Craig Lewis and his fine staff in our economic analysis division have completed the rigorous study and economic analysis that a bipartisan majority of Commissioners had long asked for in advance of considering new rulemaking. We are currently working with the economic analysis staff and the Division of Investment Management to shape a reform proposal based on that rigorous economic analysis.

Separately, I'm encouraged by Chairman Walter’s commitment, even as we continue to implement the Dodd-Frank mandates, to focusing as well on the everyday, core blocking-and-tackling issues that affect investors most. In the coming months, I look forward to working together to address the Commission's priorities — both short-term priorities such as the long-overdue amendments to the Commission's net capital and customer protection rules commonly referred to as the Onnig amendments and longer-term ones such as engaging in a formal, thorough evaluation of equity market structure issues, last done in a comprehensive manner in the Commission's Market 2000 Report all the way back in 1994.

For all the recent talk of gridlock in a divided Commission, I believe that notwithstanding our party and policy differences, this Commission is fully united in its desire to carry out the Commission’s mandate to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. With a clear, data and analysis-based understanding of the problems we face and the complexity of their underlying causes coupled with a deliberate, measured allocation of our resources, I believe that the Commission can accomplish great things, and can avoid the mistakes of the past, over the course of the coming year. I thank you all for your attention as well as for your commitment to advancing our nation's global leadership in capital formation by supporting capital markets that are the most fair, efficient, and innovative in the world, and I wish you a productive and successful conference.</sup>