Advancing and Defending the SEC’s Core Mission
Commissioner Michael S. Piwowar
U.S. Chamber of Commerce
Washington, D.C.
Jan. 27, 2014
Thank you, Chris (Donahue), for that very kind introduction. David Hirschmann, I commend you for the work that you do at the Chamber’s Center for Capital Markets Competitiveness to promote America’s global leadership in capital formation. I have had the pleasure of working with a number of talented people at the Center over the past few years and I want to take a moment to acknowledge just a few. Tom Quaadman, it has been great to join you in your efforts to ensure that the financial regulatory agencies are following the law and basing their decisions on the best available information about a regulatory action’s likely economic consequences. Jess Sharp, who was in the trenches with me at the White House during the height of the global financial crisis, please continue to advocate for bringing regulatory and public transparency to the over-the-counter derivatives markets while preserving Main Street’s ability to hedge their business risks. Alice Joe, I have enjoyed working with you on money market fund reforms that are consistent with the Securities and Exchange Commission’s (SEC’s or Commission’s) goal of preserving the benefits of the product for investors and the short-term funding markets.
I also want to thank everyone for being so understanding about rescheduling my speech due to the federal government shutdown last October. I am happy to finally be here to talk about some of the issues we are facing at the Commission. Before proceeding, I need to provide the standard disclaimer that the views I express today are my own, and do not necessarily reflect the views of the Commission or my fellow Commissioners.
I would like to take the opportunity today to articulate how I believe an SEC Commissioner should approach each and every issue that comes before the Commission. As you know, the SEC is confronted with a wide range of matters including rulemakings, exemptive requests, interpretive guidance, and, of course, enforcement actions. Regardless of the area, when making decisions, a Commissioner should be guided by the SEC’s core mission: to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
My overarching philosophy as an SEC Commissioner is pretty simple. It boils down to a question that I ask myself every morning on my way to work: What can I do today to help advance and defend the SEC’s core mission? I choose the words “advance” and “defend” carefully. They are words that can be used to describe both sports strategies and military strategies, which are appropriate analogies for an SEC Commissioner. Some days I feel like I am in a friendly competition that involves well-defined and well-enforced rules. Other days I seem to be in hand-to-hand combat with outside forces.
First, I will explain what I mean when I say “advance the SEC’s core mission,” by highlighting some items that I believe should be priorities for the Commission over the next several months. Then, I will focus on how we can and should “defend the SEC’s core mission.” By way of example, and as I will discuss further, money market fund reform presents an opportunity to both advance and defend the SEC’s mission. I have not yet reached any conclusions on the substance of money market reform, but I do want to preview how I am approaching the issue. Finally, time permitting, I am happy to answer any questions you may have.
Advancing the SEC’s Core Mission
Obviously, the Commission is quite busy with our Dodd-Frank Act and JOBS Act mandates. Nonetheless, there are areas in which we can and should undertake efforts to advance our core mission. Let me highlight five.
Comprehensive Review of Equity Market Structure: I recently gave a speech in which I called for a comprehensive equity market structure review program that draws on lessons from the 1963 “Report of the Special Study of Securities Markets of the Securities and Exchange Commission”[1] and the 2012 UK Foresight Programme report on “The Future of Computer Trading in Financial Markets – An International Perspective.”[2] Without going into great detail, there are two key features of my vision for a comprehensive review of equity market structure. First, in order to allow us to cover a wide range of topics, it should be a multi-year review. Second, so that each issue can be considered and addressed in sufficient depth, the Commission should leverage the resources of outside parties by leading a collaborative effort with market structure experts from the private sector and the academic world.[3]
Tick Size Pilot Program for Small Capitalization Companies: It is clear that the one-size-fits-all approach to market structure is not working for small capitalization companies. One idea to test how to allow the securities of small cap companies to trade more efficiently is to create a pilot program for alternative minimum tick sizes. I support such a pilot and would like to see it implemented as soon as possible. Even if increasing the tick size does not produce the benefits that proponents suggest it will, a pilot program will provide useful information about the dynamics of liquidity in our equity markets.
Incremental Fixed-Income Market Structure Changes: During my previous tour at the Commission, I was very involved with price transparency initiatives in the corporate bond and municipal bond markets. In one research study, my colleagues and I were able to show that providing post-trade prices on corporate bond transactions decreased transaction costs, which translated to investor savings of more than $1 billion per year.[4] Subsequent research shows that more can be done to enhance the fixed-income markets for the benefit of investors and issuers, including opportunities to “pick low-hanging fruit.” For example, while commissions on agency transactions must be disclosed, the same is not true for markups and markdowns on riskless principal transactions, even though the trades are economically equivalent. Therefore, I have asked the staff of the Commission’s Office of Municipal Securities to work with me to develop a few proposals to improve how the fixed-income markets operate.
Over-Reliance on Proxy Advisory Firm Recommendations: I see many similarities between the influence that proxy advisory firms wield today and how credit rating agencies were relied upon pre-crisis, including an over-reliance by investors on their recommendations.[5] Investment advisers are increasingly looking to the recommendations of proxy advisory firms for purposes of satisfying their fiduciary duty in connection with voting (or not voting) client securities. This reliance, in effect, shifts the fiduciary duty from the advisers to the proxy advisory firms, which, due to their relationships with issuers of the securities, may have their own distinct conflicts of interest. The Commission hosted a very productive Proxy Advisory Services Roundtable last month that highlighted these issues and made clear that we cannot continue to ignore the need for reform.[6] The Commission must not lose the momentum that was generated from the roundtable and should quickly move forward with initiatives to curb the unhealthy over-reliance on proxy advisory firm recommendations.
Compliance with Section 2 of Executive Order 13579 – Retrospective Analyses of Existing Rules:[7] Over two years ago, President Obama signed an Executive Order that, among other things, directs independent agencies such as the SEC to develop and implement a plan to conduct ongoing retrospective analyses of existing rules. The stated goal is “to determine whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency’s regulatory program more effective or less burdensome in achieving the regulatory objectives.” The Commission has not yet undertaken a serious effort to conduct a retrospective analysis of our existing rules in accordance with the directive. This must change.
As if the SEC does not already have enough to do to advance our core mission, we are also faced with the need to defend it. Currently, I see two outside forces that are threatening our ability to effectively protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
The first threat is special interests, from all parts of the political spectrum, that are trying to co-opt the SEC’s corporate disclosure regime to achieve their own objectives. The Commission, therefore, should carefully consider whether any additional disclosures benefit investors or whether they enable the agenda of special interests to the detriment of investors.
With simply our current disclosure requirements, I worry that investors are already suffering from what former SEC Commissioner Troy Paredes calls “information overload.” Commissioner Paredes points out that “[i]ronically, if investors are overloaded, more disclosure actually can result in less transparency and worse decisions, in which case capital is allocated less efficiently and market discipline is compromised.”[8] Last year, he called for a top-to-bottom review of the Commission’s disclosure regime.[9] I wholeheartedly agree. Such a review could help us identify special-interest disclosures that may have crept into our present disclosure regime and are counterproductive to creating informed investors.
The second threat to our core mission is banking regulators trying to impose their bank regulatory construct on SEC-regulated investment firms and investment products. Yet the Commission – not the banking or prudential regulators – is responsible for regulating markets. My concern is that the banking regulators, through the Financial Stability Oversight Council (FSOC or Council), are reaching into the SEC’s realm as market regulator. Therefore, one of my first acts as a Commissioner was to request that I be afforded an observational role at FSOC meetings. I also asked that, in addition, or in the alternative, my counsels be allowed to attend the biweekly FSOC Deputies Committee meetings. To be clear, I understand that the Dodd-Frank Act designates the SEC’s Chair as the Commission’s only voting member of the FSOC.[10] However, the statute also designates the Commission as a “member agency” of the Council.[11]
Unfortunately, my requests to attend FSOC meetings as a non-participating guest were denied. I do not think that they were unreasonable requests, and I did not ask for any special favors. I simply asked the FSOC to treat the SEC the same way it treats the Federal Reserve. If you look at the minutes from past FSOC meetings, which are publicly available on the FSOC’s website, you will see that three people from the Federal Reserve regularly attend FSOC meetings – the Chairman of the Federal Reserve Board of Governors (the Federal Reserve’s voting member), and his two guests: a Federal Reserve Governor (Daniel Tarullo), and the President of the Federal Reserve Bank of New York (William Dudley). I would like the FSOC to extend the same courtesy to the SEC and other member agencies.
One of the responses I received to my request was that, if the SEC started bringing multiple people to the Council meetings, then every agency would want to do the same. My answer to that concern is that the FSOC should get a bigger table. Or, it should stop allowing the Federal Reserve to bring three people to the Council meetings when other member agencies are afforded only one seat. This issue is not just an abstract one for me. The FSOC, within which the banking and prudential regulators exert substantial influence, represents an existential threat to the SEC and the other member agencies.
Last September, the Department of Treasury’s Office of Financial Research (OFR) published a study – and I use the term “study” loosely – prepared for the FSOC on the asset management industry.[12] The study sets the groundwork for the regulation of asset managers by the FSOC. Among the Council members, only the SEC solicited public feedback regarding the study.[13] I applaud Chair White for doing so. In response, the Commission has received more than 30 comment letters, including one from the Chamber. I vehemently believe that before the FSOC decides whether further study or action is warranted, the collective voices of the public and the SEC should be heard by the members of the Council. This is all the more important because the vast majority of asset management firms are SEC-regulated entities.
Another issue on which the SEC has ceded ground to the FSOC and banking regulators is money market fund reform. One of the most shocking decisions in the 80-year history of the SEC was the wholesale abdication of the Commission’s responsibility to the FSOC on money market funds.[14] This choice has been widely criticized by former chairmen, commissioners, and SEC senior staff as threatening the independence of the SEC and the other independent financial services regulatory agencies.[15] I am in complete agreement. The only somewhat coherent systemic risk argument about money market funds that I have heard articulated is that a run on money market funds could lead to banks failing because they cannot rollover short-term debt. The moral of that story is not that money market funds have “structural vulnerabilities.” It is that banks are too reliant on short-term funding. The banking regulators have the ability to address such a bank regulatory shortcoming directly. Nothing in the Dodd-Frank Act weakened or repealed that authority.
Instead of the FSOC spending time enabling bank regulators to encroach on the SEC’s jurisdiction in securities regulation, where we have superior expertise, the Council should focus on fulfilling its own mission of identifying threats to the financial stability of the United States. I have identified three entities that the FSOC should consider reviewing as non-bank systemically important financial institutions (non-bank SIFIs): the Federal Government, the Federal Reserve, and the Basel Committee on Banking Supervision.
Serious academic research, previous actions by the FSOC, and common sense support designating all three of these entities as non-bank SIFIs. Deborah Lucas, a prominent MIT economist and former assistant director at the Congressional Budget Office, makes a compelling case that the government is a significant source of systemic risk, and therefore it falls under the mandate of the FSOC and OFR to monitor and study it.[16] Viral Acharya, a respected NYU financial economist, posits that governments effectively operate as “shadow banks” in the financial sector, that their role as shadow banks have been at the center of the financial crisis, and that they continue to pose a threat to financial stability.[17] Even the FSOC itself recognizes that the Federal Government has a significant impact on the economy – at a recent meeting the Council discussed the effects of a government shutdown and a debt ceiling impasse on the economy and financial markets, including short-term funding markets.[18] With respect to the Federal Reserve, its balance sheet stands at over $4 trillion in assets and continues to grow at a current tapered pace of $75 billion per month.[19] Andrew Haldane, the Bank of England’s Executive Director of Financial Stability, co-wrote a paper famously titled “The Dog and the Frisbee,” in which the academic case is made for simplicity in banking regulations.[20] Among other things, the paper explores why complex regulation, such as Basel risk-weighted capital standards, are not only costly and cumbersome, but suboptimal for preventing and controlling financial crises.
Money Market Fund Reform – Advancing and Defending the SEC’s Core Mission
I thought I would end with some words on how I am thinking about whether additional money market fund reforms are needed, and, if so, how I will be evaluating each alternative.
As an economist, one of the first questions I ask in the context of any rulemaking is “What is the baseline?” In other words, what is the starting point from which I will evaluate the costs and benefits of any proposed regulatory change? In the case of money market funds, it is tempting to start with a baseline of September 2008, when the Reserve Primary Fund “broke the buck.” However, the Commission adopted a number of new money market fund regulations in 2010.[21] The stated objectives of those rules were to “increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds.”[22]
Therefore, the proper baseline from which to evaluate any additional money market fund rule proposals is the current regulatory framework, which includes the 2010 reforms. From a cost-benefit perspective, the next relevant questions are “What are the marginal benefits of additional regulations”; and “what are the marginal costs of those additional regulations?” In order to answer those questions, we need to understand how effective the 2010 regulations were. The Commission’s Division of Economic and Risk Analysis (“DERA”) has done an excellent job providing the answers to those questions in their 2012 staff report “Response to Questions Posed by Commissioners Aguilar, Paredes, and Gallagher,”[23] and in the economic analysis in the Commission’s 2013 proposing release for additional money market fund reforms.[24]
After carefully reading both of those documents and engaging in numerous discussions with Commission staff and money market fund participants, I have concluded that the 2010 money market fund regulations were, in economist-speak, “necessary, but not sufficient.” They provided much-needed investor protection improvements in the areas of disclosure, liquidity, credit quality, and operations. However, the reforms were not sufficient to address remaining investor protection concerns in at least two areas. Namely, more should be done to mitigate the first mover-advantage enjoyed by investors who run during times of heavy redemptions. There also remains a need to provide investors with more timely information about funds’ holdings, including the value of those holdings.
I have not reached any conclusions on which alternatives in the Commission’s outstanding rule proposal best address these investor protection concerns while preserving the benefits of money market funds for investors and the short-term funding markets. I will be working with Commission staff over the coming weeks and months to evaluate the marginal benefits of the various alternatives – floating NAV, fees, gates, additional disclosures, etc. – and their associated costs.
Thank you all for your attention. I am happy to answer any questions you may have.
[1] Report of Special Study of Securities Markets of the Securities & Exchange Commission, all chapters available at http://www.sechistorical.org/museum/papers/1960/page-2.php under the heading “SEC Special Study of the Securities Markets.”
[2] See http://www.bis.gov.uk/assets/foresight/docs/computer-trading/12-1086-future-of-computer-trading-in-financial-markets-report.pdf .
[3] See The Benefit of Hindsight and the Promise of Foresight: A Proposal for A Comprehensive Review of Equity Market Structure, Commissioner Michael S. Piwowar, U.S. Securities and Exchange Commission, London, England (Dec. 9, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540470552.
[4] See Edwards, A. K., L. E. Harris, & M. S. Piwowar (2007): “Corporate Bond Market Transaction Costs and Transparency,” Journal of Finance, 62, 1421–1451.
[5] See Opening Statement at the Proxy Advisory Services Roundtable, Commissioner Michael S. Piwowar, U.S. Securities and Exchange Commission, Washington, D.C. (Dec. 5, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540449928.
[6] See http://www.sec.gov/spotlight/proxy-advisory-services.shtml.
[7] See Executive Order 13579 – Regulation and Independent Regulatory Agencies (July 11, 2011). See also M-11-28 – Memorandum for the Heads of Independent Regulatory Agencies (July 22, 2011).
[8] See Remarks at The SEC Speaks in 2013, Commissioner Troy A. Paredes, U.S. Securities and Exchange Commission, Washington, D.C. (Feb. 22, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171492408#.Ut2WJbROmM8.
[9]Id.
[10] See Section 111 of the Dodd-Frank Act.
[11] See Section 102 of the Dodd-Frank Act.
[12] See http://www.treasury.gov/initiatives/ofr/research/Documents/OFR_AMFS_FINAL.pdf.
[13] See http://www.sec.gov/divisions/investment/comments-ofr-asset-management-study.shtml. Comments are available at http://www.sec.gov/comments/am-1/am-1.shtml.
[14] See Statement at SEC Open Meeting – Proposed Rules Regarding Money Market Funds, Commissioner Daniel M. Gallagher, U.S. Securities and Exchange Commission, Washington, D.C. (June 5, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171575594.
[15] See letter from Former Chairmen, Commissioners, and Senior Staff of the U.S. Securities and Exchange Commission to the Members of the Financial Stability Oversight Council, Re: Jurisdiction of Independent Financial Services Regulatory Agencies (Feb. 20, 2013), available at
http://www.preservemoneymarketfunds.org/wp-content/uploads/2011/04/Former-SEC-staff.pdf .
[16] See Deborah Lucas, Evaluating the Government as a Source of Systemic Risk, First Draft: Sept. 30, 2011, available at http://dlucas.scripts.mit.edu/docs/SystemicRisk111012.pdf .
[17] See Viral V. Acharya, Governments as Shadow Banks: The Looming Threat to Financial Stability, Sept. 2011, available at http://www.federalreserve.gov/events/conferences/2011/rsr/papers/Acharya.pdf.
[18] See Financial Stability Oversight Council, Meeting Minutes, Oct. 31, 2013, http://www.treasury.gov/initiatives/fsoc/council-meetings/Documents/Oct%2031,%202013.pdf.
[19] See Total Assets of the Federal Reserve, available at http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.
[20] See Andrew G. Haldane & Vasileios Madouros, The Dog and the Frisbee (Aug. 31, 2012). The paper was presented at the Federal Reserve Bank of Kansas City's 36th economic policy symposium “The Changing Policy Landscape,” Jackson Hole, Wyoming, available at http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech596.pdf .
[21] See Money Market Fund Reform, Investment Company Act Rel. No. 29132 (Feb. 23, 2010), available at http://www.sec.gov/rules/final/2010/ic-29132fr.pdf.
[22] See http://www.sec.gov/news/press/2010/2010-14.htm.
[23] The staff report can be found at http://www.sec.gov/news/studies/2012/money-market-funds-memo-2012.pdf. At the time the report was conducted, DERA was known as the Division of Risk, Strategy, and Financial Innovation.
[24] See Money Market Fund Reforms; Amendments to Form PF, Investment Company Act Rel. No. 30551 (June 5, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9408.pdf.
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