Speech by SEC Commissioner:
Remarks at SEC Speaks
by
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
Washington, D.C.
February 8, 2008
Thank you, Linda [Thomsen], for your kind
words. Through Linda's embrace of efficiencies,
such as the automated case tracking system that
is being introduced now, she has brought
much-needed management improvements in the
Division of Enforcement.
It is hard for me to believe, but I have
known Linda now for almost 25 years! I first got
to know Linda when we were colleagues at the
same firm. I was a newly minted associate and
came down on trips from New York to Washington
to file securities registration packages. Now,
for you youngsters in the audience, once upon a
time, before EDGAR and e-mail, someone had to
get on the airplane and fly to Washington to
hand deliver the package to the SEC. That
someone was always the junior associate who had
been up all night at the printer. So I had to
file the registration statement, deliver a
courtesy package to the reviewer in Corp Fin,
and call back to the lead underwriter's
syndicate desk to tell them that the filing was
effective. After doing that, I would go
bleary-eyed to my firm's D.C. office. Linda was
always the good-sport and organized lunches with
other lawyers in the firm to celebrate my having
escaped the fate of other junior associates who
made it into the annals of associate lore like
the guy who did not get his registration
statement filed because he checked it with his
luggage, which got lost, or the guy who fell
asleep and missed his flight. Linda's good
nature and good humor continue to make it a
pleasure to work with her more than two decades
later.
It is an honor and pleasure to be a part of
the nineteenth edition of "SEC Speaks." The idea
for "SEC Speaks" program was conceived by Al
Sommer, Alan Levenson, and PLI's Mary Mulι as a
mechanism for private lawyers, accountants, and
others to hear about the latest developments at
the SEC, to get a glimpse into the minds of the
commissioners and staff, and to share ideas in
an informal setting. Before I begin, I must say
that the views that I express here are my own
and not necessarily those of the Commission or
my fellow Commissioners.
I have noticed in my almost 10 years at the
SEC first working for two chairmen and then as
a commissioner myself that the audience of SEC
Speaks seems to hang on every word that is said.
Law firm associates take copious notes and then
race back to their offices to see who can be
first to get a newsletter out to advise clients
on the current views. In recent years, the
bloggers in attendance post what is said and
opine on what it all means.
It is as if Hermes came down from Mt. Olympus
to deliver the message from the Olympians. Well,
unlike Greek mythology, there should be nothing
mysterious about what we do. We should not
require a Hermes to deliver our messages,
although I know a few lawyers in this room who
have made a rather good living trying to fill
that role. Some sport Hermθs scarves and ties to
boot. The SEC is not Olympus, and we certainly
are no Olympians. And besides, the last time I
partied with the Greeks was in college!
I promise, that is as close as I will come to
a joke. I began last year's speech with a series
of jokes. I have been informed, however, that
jokes could be too controversial given the
current composition of the Commission.
Therefore, I will wait until we get two more
Commissioners before I joke again.
Seriously, there should not be anything
mysterious about what happens at the SEC, but
somehow we have allowed an Olympic-like cloud to
shroud our workings. Investors, companies,
brokers, advisors, attorneys, accountants, and
others participating in our capital markets
should be able to predict whether conduct is
permissible or prohibited. Predictability is
critical to protecting the rights of those with
whom we interact and ensuring a fair and just
process.
Predictability must exist both in procedure
and substance. With respect to procedure, the
SEC must follow uniform procedures both within
headquarters and across divisions and regions.
With respect to substance, the SEC must provide
predictable outcomes, and the manner in which
those outcomes are reached must be transparent.
As a government agency, we owe the taxpayers,
investors, and marketplace no less.
Unfortunately, I think we at the SEC could do
a better job of providing predictability to you
and your clients in the private sector. We need
to implement more systems and procedures to
ensure better predictability and transparency in
how we operate. The SEC must respect the rule of
law and the rights of those with whom we
interact.
With that in mind, this seems like a perfect
opportunity to suggest a few steps that I hope
the SEC will consider in the coming months to
ensure better predictability.
One of the most glaring examples of lack of
predictability is determining what constitutes
materiality. The crux of our federal disclosure
system is that all material information
must be disclosed with an emphasis on
material. Yet the age-old question is: What does
it mean to be "material"?
Issuers, investors, and regulators have
struggled with applying the materiality test
since the enactment of the securities laws.
Materiality is an objective test: the Supreme
Court has said that something is material if
"there is a substantial likelihood that a
reasonable shareholder would consider it
as
having significantly altered the 'total mix' of
information made available."
It is not enough that some investors
may view a fact as important; rather, it must be
important to the reasonable investor.
In coming to this standard, the Supreme Court in
1976 in TSC Industries v. Northway,
specifically overturned a test applied by the
Second Circuit that material facts include
all facts that a reasonable shareholder
might consider important. Can you imagine
what prospectuses and proxy statements would
look like if that standard had prevailed? TSC
Industries is an example of the Supreme
Court showing judicial restraint by not
expanding the securities laws. Does this sound
familiar? We have seen similar restraint in
recent Supreme Court decisions this year and
last in the area of securities law.
In TSC Industries, the Supreme Court
clearly understood the problem of materiality.
In the unanimous opinion written by Justice
Thurgood Marshall, the Court observed that
"[s]ome information is of such dubious
significance that insistence on its disclosure
may accomplish more harm than good." The
potential liability for a fraud violation can be
great and, so Justice Marshall explained, "If
the standard of materiality is unnecessarily
low, not only may the corporation and its
management be subjected to liability for
insignificant omissions or misstatements, but
also management's fear of exposing itself to
substantial liability may cause it simply to
bury the shareholders in an avalanche of trivial
information a result that is hardly conducive
to informed decisionmaking."
The SEC allowed the waters to be muddied on
the issue of materiality in 1999 with Staff
Accounting Bulletin 99. Anyone who has tried to
apply SAB 99 is left with little certainty.
Regardless of how quantitatively tiny a
disclosure might be, the answer to any
materiality question seems to be "it depends."
(Of course, too often it is said to be clear
later in 20/20 hindsight.) And yet that bulletin
has been cited by courts, SEC staff, and lawyers
as authority for materiality. As a result of SAB
99, issuers feel compelled to inundate
shareholders with "an avalanche of trivial
information," which was precisely the fear of
the Supreme Court almost 32 years ago. Often,
when you read a 10-K, it is as if you are
reading Greek. Maybe we do need Hermes, after
all, to interpret the content!
Would it surprise you to learn that SAB 99
does not necessarily represent the views of the
Commission? As the title implies, it is a
Staff Accounting Bulletin. The process of
issuing Staff Accounting Bulletins is organized
to avoid "complications" with the Administrative
Procedure Act. Is that how a full-disclosure
agency should operate? The Commission never
voted on the views espoused within any SAB, so
it does not and cannot represent the views of
the SEC. Worse yet, SEC staff developed SAB 99
without public input. Substantive policy ought
not to be made by the staff in private meetings,
and ought not to be made based solely on the
wisdom and experiences of SEC staff.
Moreover, since SAB 99 was released, a lot
has changed. We now have Sarbanes-Oxley and new
case law and regulations. Some persons are
promoting new disclosure requirements on topics
such as state sponsors of terrorism, climate
change, and global warming. As the Advisory
Committee on Improvements to Financial Reporting
will discuss at its meeting next week, the issue
of materiality may need to be revisited. I
support the work of that committee and
appreciate Bob Pozen's leadership. When the SEC
takes up this issue, we must approach it by
returning to "first principles" that
materiality is determined based upon the
objective "reasonable investor" standard. The
Commission itself after proceeding with public
notice and comment should clear up this issue
with the full input of the investor, legal,
accounting, academic, and business communities.
Another area where the SEC must provide more
predictability is corporate penalties and
settlements. Companies should have a clear
understanding of what it takes to receive
cooperation credit, and that credit should be
fairly and evenly administered. And, as I have
said in the past, in measuring cooperation, the
SEC should neither credit nor debit a company
for its decisions regarding waiver of the
attorney-client privilege. Crediting waiver
amounts to the inevitability of waiver, and the
SEC should never adopt a position that leaves a
person no meaningful choice on the waiver of
such a fundamental privilege.
Resisting efforts to characterize waiving
companies as cooperative (and non-waiving
companies as non-cooperative) is particularly
important after the SEC's January 2006 Statement
Concerning Financial Penalties. Pursuant to the
Statement, the extent of cooperation in an
investigation is an element in determining how
high civil monetary penalties against
corporations could be set.
We have seen that the SEC's penalties
statement already has had its challenges in
implementation. Even after the penalty
statement, too often our penalties seem to be
justified on little more than that they "feel
right." Companies, the shareholders that
ultimately must shoulder a high penalty, and
most importantly, the market place have little
predictability when it comes to how much the SEC
will seek in penalties. In most cases, one of
the greatest economic uncertainties for a
company under investigation is the penalty that
ultimately will be levied against it.
That is not to say that the SEC's discretion
should be eliminated in favor of rote
application of a mathematical formula for
calculating penalties. Discretion plays an
important role in forgoing certain theories of
liability where a company and its shareholders
have been punished enough through other avenues.
However, discretion in other areas such as
formulating a theory of liability can be
dangerous. For instance, discretion must not
serve as a license to the SEC to test novel
theories of liability and "push the envelope" of
the law. Can you imagine how the SEC would
respond to a company that claims merely to "push
the envelope" of the law or accounting
principles? If we are to enforce the rule of
law, we must follow the rule of law in our
approach.
One way we can achieve better predictability
is through an internal Enforcement Manual,
similar to the U.S. Attorney Manual. Such a
manual is long overdue. One item that I would
like to see in that manual is a written and
uniform "open jacket" policy for Enforcement
matters. This is not a novel idea. Those of you
who practice in the area of criminal defense may
recognize that phrase. That means the government
shows defense counsel the evidence it has
against the defendant. That is called due
process. If we have a strong case and feel we
can win in court under the "preponderance of the
evidence" standard (which is far short of the
"beyond a reasonable doubt" standard in criminal
cases), should we not be open with our evidence?
In addition to protecting the rights of
individuals and companies, an open jacket policy
has practical benefits to the SEC; defense
counsel sees the evidence the SEC has against
its client and, as a result, is less inclined to
fight it out in court.
I understand that an open jacket policy is
used by some in Enforcement, and it has not hurt
their efforts. We should take every step to
apply this policy across all the regions and
headquarters not only because it works, but
because it is the right thing to do.
Speaking of Enforcement, I would be remiss if
I did not mention some of the recent efforts of
those in the Enforcement Division in combating
fraud on investors. Last year, the SEC halted a
massive pyramid scheme with as many as 70,000
victims in 64 countries. According to the
complaint, the scheme involved the purported
sale of English and Spanish language tutorials
and preyed on Hispanic communities in Orlando,
Florida, and Puerto Rico. The tutorials
allegedly were merely a front for unregistered
sales of pools of securities with promises of
large returns. The SEC stopped the wrongdoing in
its tracks through an asset freeze, emergency
relief, and appointment of a receiver. I applaud
the efforts of Eric Busto, Chad Earnst, Cecilia
Danger, Jorge Riera, Tonya Tullis, Chris Martin,
and Trisha Sindler in our Miami Regional Office
in bringing this case and deterring other
similar wrongdoers.
And just last month, the SEC brought an
action to halt an alleged fraudulent investment
scheme run by an Omaha, Nebraska man who
promised investors many of them seniors that
they would earn a sizable monthly return from
their investment. According to the SEC's
complaint, he paid the earlier investors with
the money from newer investors, and he
misappropriated over $3.5 million in funds to
purchase luxury vehicles, renovate two homes and
capitalize other businesses that he owned. The
court already has frozen the assets and
converted the temporary restraining order to a
preliminary injunction. I congratulate the SEC
Enforcement team of Scott Friestad, John Polise,
Chris Ehrman (who also helped to apprehend the
so-called "Bishop" bomber who was threatening to
kill mutual fund executives), Alexis Palascak,
and Paul Kisslinger on their continuing efforts
to thwart this alleged fraud. Bringing cases
like these also helps to foster predictability:
would-be fraudsters should know with certainty
that the SEC will bring the full weight of the
government against them if they yield to their
temptation to defraud investors. These sorts of
cases deserve more public attention.
I have been speaking a lot about Enforcement,
but the need for better predictability and
transparency extends well beyond the Enforcement
Division. Our Office of Compliance Inspections
and Examinations (OCIE) must use its powers with
prudence, caution, and measure. OCIE should
tailor its information requests to avoid
imposing unnecessary costs on firms, and should
refrain from asking firms to produce documents
and information that they are not required to
keep. OCIE should continue and expand its
initiatives to provide greater predictability
through such programs as the CCOutreach program,
the publication of Compliance Alerts, and
efforts to make communications with firms more
uniform regardless of which office transmits
them.
The Division of Investment Management is
working to restore predictability in the
exemptive application process. Many applicants
have expressed frustration at a process that can
take years with long periods of inaction. Rather
than risk delaying an application's processing
further, applicants are likely to accede to any
and all demands made on them. Because exemptive
orders allow for innovation, creating
unnecessary obstacles to their processing
hinders developments that would expand the
options available to investors.
Predictability is particularly lacking in
areas in which cooperation among Divisions is
required. For example, Investment Management may
be on the way to approving a product only to
find that Trading and Markets, the Office of
Economic Analysis, Corporation Finance, or
another agency such as the IRS or the CFTC has
an eleventh-hour objection. These sorts of
occurrences point to the need for a
cross-divisional new products czar. That czar
should be responsible for the process and be
able to coordinate all of the relevant parts of
the SEC to ensure that all aspects of the
proposed new product are considered in an
orderly, efficient and timely manner.
Predictable, systematic, and efficient
consideration of new product ideas is important
not only out of a general sense of fairness but
also because the first-mover advantage is often
critical to the success or failure of the
product. Firms with new product ideas need to
know what to expect in the approval process and,
if their products are going to get approval,
need to have a sense of timing so that they can
plan the marketing and other release-related
activities.
In closing, I am reminded of Sir Thomas
More's words from "A Man for All Seasons," "The
law is a causeway upon which, so long as he
keeps to it, a citizen may walk safely." The SEC
must ensure that the causeway upon which its
laws rests is well marked and well lit. We must
provide as many road signs as possible, and we
must encourage companies and individuals to keep
to the causeway, rather than celebrate when we
have caught them having gone astray.
Thank you for your attention and enjoy the
remainder of SEC Speaks.
Endnotes
http://www.sec.gov/news/speech/2008/spch020808psa.htm
