Thank you for inviting me to testify today regarding the current work and initiatives of the U.S. Securities and Exchange Commission (SEC or Commission).[1] The SEC is a critical agency that serves as the bulwark safeguarding millions of investors and the most vibrant markets in the world. Thanks to the exceptional work and commitment of our superb staff, the Commission has in recent years strengthened its operations and programs across the agency –aggressively enforcing the securities laws to punish wrongdoers, adopting strong measures that protect investors and our markets, and investing in the people and technology required to ensure that our markets remain the strongest and safest in the world. These and other efforts across our extensive areas of responsibility are all in furtherance of our essential mission: to protect investors; to maintain fair, orderly, and efficient markets; and to facilitate capital formation.
The Commission’s actions and accomplishments since I testified before this Committee in September 2014 have been extensive.[2] Each of the last three years has been marked by vigorous enforcement and examination programs, empowered with new tools and methods to detect and hold wrongdoers accountable and protect investors. In fiscal year 2015 alone, the Commission brought over 800 enforcement actions, an unprecedented number; secured over $4 billion in orders directing the payment of penalties and disgorgement, an all-time high; performed approximately 2,000 exams, a five-year high; and, even more importantly, continued to develop cutting-edge cases and smarter, more efficient exams. Aided by enhanced technology to analyze suspicious activity and strengthened by initiatives like self-reporting, SEC staff has been able to identify and target the most significant risks for investors across the market.
The Commission over the last three years has pursued very consequential rulemaking and other measures designed to protect investors, strengthen the markets, and open new avenues for capital-raising. Since I last testified, the agency, for example, has advanced major rules addressing important equity market structure issues – including controls on the technology used by key market participants, the transparency of alternative trading systems, and the consolidated audit trail – while moving forward with a comprehensive assessment of other fundamental structural questions. We also issued a series of proposals to address the increasingly complex portfolios and operations of mutual funds and exchange-traded funds (ETFs). We adopted new rules for crowdfunding and smaller securities offerings under Regulation A, while proposing additional avenues for small businesses to raise capital. We finalized critical components of the regulatory regime for security-based swaps. We also proposed the full suite of rules regarding executive compensation practices. And we continued to execute a comprehensive review of the effectiveness of our disclosure regime.
This work, which is described in greater detail below, marks the latest phase of an extraordinary regulatory effort by the agency since before I became Chair, enlisting all of our policy divisions and offices. Beyond our discretionary initiatives, the Commission has now adopted final rules for 66 of the 86 mandatory rulemaking provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) directed to the SEC, the majority of them since I became Chair.[3] We have completed all of the rulemakings directed by the Jumpstart Our Business Startups Act (JOBS Act). And we have made significant progress advancing the rulemakings required of us late last year under the Fixing America’s Surface Transportation Act (FAST Act). Some of the most significant initiatives of the last three years include:
- Equity Market Structure. An imperative of our modern equity markets is strong technological systems and operations, and the Commission has adopted Regulation Systems Compliance and Integrity (SCI) to require critical market participants – including exchanges, clearing agencies, and large alternative trading systems (ATSs) – to implement wide-ranging measures designed to reduce the occurrence of systems issues and improve resilience when such issues do occur. The self-regulatory organizations (SROs), acting under Commission oversight, have also continued to develop further measures to enhance the operational integrity of the markets. In addition, the Commission has proposed new rules to enhance market transparency, with the first-ever major update of Regulation ATS, and I expect that we will very soon propose rules requiring important new disclosures for how investor orders are handled by broker-dealers. The Commission has also proposed enhancements to our core regulatory tools of registration and firm oversight. And we have put out for notice and comment the final plan for the consolidated audit trail, as well as expanded our consideration of additional market structure reforms through the establishment of the Equity Market Structure Advisory Committee.
- Money Market Funds and Asset Management. To address the risk of investor runs, as experienced during the financial crisis, the Commission in 2014 adopted rules that fundamentally change the way money market funds operate, rules that will become fully operational this coming October. Following that work, the Commission undertook to enhance its regulatory regime for the broader asset management industry. In furtherance of that goal, the Commission last year proposed four major rules to address potential risks in the modern asset management industry, including rules that would improve and expand the information reported to the Commission and investors, impose new controls on how funds manage their liquidity, and enhance the regulation of funds’ use of derivatives.
- Capital Formation. Implementing mandates from the JOBS Act, the Commission adopted rules to increase access to capital for smaller companies by revamping and enhancingRegulation A, and other rules to permit companies to offer and sell securities through equity crowdfunding. Separately, the Commission has also proposed rules to facilitate intrastate and regional securities offerings, including offerings relying upon recently adopted intrastate crowdfunding provisions under state securities laws. We also worked with the SROs to build a pilot program to widen the minimum quoting and trading increments – or tick sizes – for stocks of some smaller companies, which should aid in understanding whether wider tick sizes enhance the market quality and secondary liquidity of these stocks. This work follows on the Commission’s adoption of rules to allow general solicitation for certain offers and sales made under Rule 506, as well as a rule to disqualify certain felons and other “bad actors” from participating in private securities offerings made under Rule 506.
- Disclosure Effectiveness. The staff of the Commission has undertaken a comprehensive assessment of the effectiveness of our disclosure regime for investors and issuers. As part of that assessment, the Commission issued a major concept release that seeks input on modernizing certain business and financial disclosure requirements in Regulation S-K for the benefit of investors and companies. We also issued a request for comment for certain financial reporting and disclosure requirements in final statements under Regulation SâX. I expect that the Commission will also shortly propose revisions to Industry Guide 7, which applies to disclosures about the projections and properties of mining companies.
- Security-Based Swaps. The Commission has implemented a substantial portion of a regulatory regime for security-based swaps required by the Dodd-Frank Act, which is designed to ensure that the $11 trillion market for security-based swaps is safer, more transparent, and more efficient. Since I last testified, the Commission adopted the core rules for reporting security based swap transactions to regulators and the public through security-based swap data repositories. We also adopted the framework for registering security based swap dealers and major security-based swap participants with the Commission, as well as rules to help ensure that non-U.S. dealers participating in the U.S. market comply with our rules. Most recently, the Commission adopted extensive requirements for how these entities must conduct business with counterparties and acknowledge and verify their transactions. Finalizing the remainder of the rules for trade reporting and dealers activities – and operationalizing those regimes – is a priority for 2016.
- Asset-Backed Securities. The Commission in 2014 adopted wide-ranging rules to enhance transparency and better protect investors in the asset-backed securities market. The Commission completed rules requiring significant enhancements to registered offering disclosures for asset-backed securities, a market with $4.8 trillion in issuances over the past decade that stood at the epicenter of the financial crisis. Since I last testified, acting jointly with five other federal agencies, the Commission also adopted credit risk retention rules, which require securitizers of asset-backed securities to keep “skin in the game” for the securities they package and sell.
- Executive Compensation. In 2015, the Commission adopted the rule mandated by the Dodd-Frank Act requiring a company to disclose the ratio of compensation of its chief executive officer to the median compensation of its employees. The Commission in 2015 also proposed the remaining executive compensation rules required by the Dodd-Frank Act, including disclosure of whether a company allows executives to hedge the company’s stock, disclosure of pay versus performance measures of executive compensation, and new disclosures and rules for clawing back incentive compensation erroneously awarded. We also in 2016 re-proposed, jointly with other regulators, rules regarding disclosure and restrictions for certain incentive-based compensation arrangements at large financial institutions.
- Credit Rating Agencies and Credit Ratings. The Commission has adopted a comprehensive package of reforms in 2014 for the regulation and oversight of credit ratings agencies, including new controls on the management of conflicts of interest. The Commission has also acted to remove almost all of the references to credit ratings from its rules and forms.
- Broker-Dealer Financial Responsibility. The Commission, soon after I became Chair, adopted rules to provide additional safeguards with respect to a broker-dealer’s custody of customer securities and cash, as well as to strengthen the audit requirements for broker-dealers. In addition, the Commission adopted amendments to the broker-dealer financial responsibility rules to enhance protections for customer assets, firm capital requirements, and risk management controls. In 2016, we proposed, jointly with the Federal Deposit Insurance Corporation (FDIC), rules that implement procedures for the orderly liquidation of covered broker-dealers.
- Municipal Advisors. The Commission has established a new regulatory regime to protect municipalities and investors from conflicted advice and unregulated advisors by requiring municipal advisors to register with the SEC and to comply with the rules of the Municipal Securities Rulemaking Board (MSRB). And we continue to work with the MSRB to establish the full suite of regulatory obligations for municipal advisors.
- Volcker Rule. The Commission, in December 2013, adopted, jointly with other regulators, rules to implement a prohibition on proprietary trading and certain relationships with hedge funds and private equity funds. Compliance with those rules was required in 2015, and the SEC is now working in coordination with the other financial regulators to ensure that firms have taken the necessary steps.
While our work in enforcement and rulemaking are perhaps the most prominent examples of the agency’s achievements, the imperatives of our mission are carried forward each day by all of the dedicated staff of our divisions and offices. The Division of Corporation Finance, for example, reviews the annual and periodic reports of thousands of issuers each year, helping to ensure that investors receive full and fair disclosure about the public companies in which they invest. And staff in the Office of Small Business Policy alone responded last year to over a thousand inquiries from small businesses about their questions and concerns. During the same period, the Division of Trading and Markets reviewed more than 2,100 filings from exchanges and other SROs to preserve a fair and orderly marketplace for all investors. The Division of Investment Management reviewed filings last year covering more than 12,500 mutual funds and other investment companies, where many individuals invest their hard-earned money to save for retirement, college, and other important goals. Our economists in the Division of Economic and Risk Analysis produced more than 30 incisive papers and publications in 2015, including two major analyses to help inform our work on asset management. And the numbers are only a small part of the story. Each instance of such engagement makes our markets better and safer for investors.
Throughout the agency, we are increasingly harnessing technology to better identify risks, uncover frauds, sift through large volumes of data, inform policymaking, and streamline operations. The Commission’s emphasis on technological improvements is continuing to pay dividends, improving efficiencies while allowing us to cover more ground than ever before. We continue to build on this progress by seeking sufficient appropriated funds for a number of key information technology (IT) initiatives, including improvements to the Electronic Data Gathering, Analysis and Retrieval (EDGAR) system and our enforcement surveillance tools.
While the Commission today is stronger and more effective than ever before, challenges remain if we are to continue our current trajectory and address the growing size and complexity of the securities markets. We now oversee approximately 28,000 market participants and selectively review the disclosures and financial statements of over 9,000 reporting companies. From 2001 to 2015, assets under management of SEC-registered advisers more than tripled from approximately $21.5 trillion to approximately $66.8 trillion, and assets under management of mutual funds more than doubled from $7 trillion to over $15 trillion. Trading volume in the equity markets from 2001 through 2015 nearly tripled to over $70 trillion. And, as this Committee knows, the SEC’s responsibilities have also significantly increased, with new or expanded responsibilities for security-based derivatives, hedge fund and other private fund advisers, credit rating agencies, municipal advisors, clearing agencies, and crowdfunding portals. As I have testified before both the House and Senate, the SEC is significantly under-resourced for the extensive responsibilities it has, even though our budget is deficit neutral and funded by very modest transaction fees.
It is critical that we have the resources necessary to discharge our responsibilities, both the new ones and the many others we have long held in the face of a growing and ever-more sophisticated financial services industry. I deeply appreciate the serious charge we have to be prudent stewards of the funds we are appropriated, and we strive to demonstrate how seriously we take that obligation by the work we do. At the same time, the cuts and limitation to the SEC’s budget that some have proposed would imperil the progress we have made and our ability to fulfill our mission. Only with Congress’ continued assistance can we continue to successfully execute our mission to protect investors, preserve the integrity of our markets, and promote capital formation. We very much appreciate the Committee’s support.
Vigorously Enforcing the Securities Laws
The SEC’s vigorous enforcement program is at the heart of our efforts to protect investors and instill confidence in the integrity of the markets. The Division of Enforcement (Enforcement) advances these efforts by investigating and bringing civil charges against violators of the federal securities laws. Successful enforcement actions impose meaningful sanctions on securities law violators, result in penalties and disgorgement of ill-gotten gains that can be returned to harmed investors, and deter future wrongdoing.
Enforcement delivered very strong results on behalf of investors in FY 2014, FY 2015 and continues to do so in FY 2016. The SEC filed a record 807 enforcement actions in FY 2015 covering a wide range of misconduct, and obtained orders totaling $4.19 billion in disgorgement and penalties, both at record levels. Of the 807 enforcement actions, a record 507 were independent actions for violations of the federal securities laws, and 300 were either actions against issuers who were delinquent in making required filings with the SEC or administrative proceedings seeking bars against individuals based on criminal convictions, civil injunctions, or other orders.
Even more important than the numbers, these actions addressed many of the most important issues for investors and markets, spanned the securities industry, and included numerous “first-of-their-kind” actions. Significantly, approximately two-thirds of our substantive actions in FY 2015 also included charges against individuals. A few other important features of our enforcement program also bear highlighting.
Executing the Admissions Policy
The Commission continues to use its first of its kind admissions policy to aggressively seek admissions in certain cases where heightened accountability and acceptance of responsibility by a defendant is particularly important and in the public interest. These types of cases include those involving particularly egregious conduct; where large numbers of investors were harmed; where the markets or investors were placed at significant risk; where the conduct undermines or obstructs our investigative process; where an admission can send an important message to the markets; or where the wrongdoer presents a particular future threat to investors or the markets. Since implementing the admissions protocol in 2013, the SEC has obtained admissions from over 50 entities and individuals, including major financial institutions and national auditing firms. We also required individuals to admit wrongdoing in a number of cases, including a world-wide pyramid scheme targeting the Asian-American community.[4] While this is an evolving protocol that continues to be applied to more cases, as we indicated when we implemented it, the majority of cases will continue to be resolved on a “neither admit nor deny” basis, which is the norm for other civil law enforcement agencies and in private litigation.[5] We are committed, however, to requiring admissions where appropriate, and are prepared to litigate those cases if necessary.
Enhancing Focus on Key Areas of Misconduct
The Commission also continues to focus resources on key areas of misconduct. One critical area is financial reporting and issuer disclosure. Comprehensive, accurate, and reliable financial reporting is the bedrock upon which our markets are based, and is essential to ensuring public confidence in them. And at my direction, since 2013, our Enforcement Division has intensified its focus on pursuing violations in this area. Part of this effort involved creating a dedicated group of accountants, attorneys, and analysts who use cutting edge data analytical tools to look for evidence of reporting discrepancies and other early warning signs of financial reporting fraud. The SEC brought a series of significant financial reporting cases in FY 2015, including four emblematic actions last September, each of which involved sophisticated disclosure violations or cleverly masked reporting fraud.[6] Each of these cases also involved charges against senior executives. Holding individuals accountable for their role in financial misconduct is a significant priority of mine and in FY 2015, we charged 120 individuals in our substantive issuer reporting and disclosure cases, approximately twice the number of individuals we charged in FY 2014.
Another key area of enforcement is investment management, where the SEC has continued to bring actions addressing a widening range of issues, including performance advertising, undisclosed conflicts of interest, compliance issues, and private equity fees and expenses. Among these are “first-of-their-kind” actions for failures to report material compliance matters to fund boards and the improper allocation of expenses by private equity advisers. The Enforcement Division’s focus on private equity has expanded significantly over the past few years and, to date, the SEC has brought eight enforcement actions related to private equity advisers breaching their fiduciary duties by charging undisclosed fees and expenses, shifting and misallocating expenses, and failing to adequately disclose conflicts of interest.
In addition, since I last testified before the Committee, Enforcement has emphasized market structure issues, bringing significant enforcement actions involving high frequency trading, the operation of trading platforms such as dark pools, manipulative trading, and market access and technology controls. We have brought cases, for example, against ATSs for misusing confidential customer trading information, actions against high frequency traders for manipulative trading and net capital violations, and against exchanges for providing some, but not all, traders with additional information about certain order types.
Enhancing the Whistleblower Program
The SEC’s Whistleblower program continues to have a transformative impact on our enforcement program. The SEC’s Office of the Whistleblower is currently tracking hundreds of matters in which a whistleblower’s tip has caused a matter under investigation or an investigation to be opened, or which have been forwarded to Enforcement staff for consideration in connection with an existing investigation. The number of whistleblower tips received by the Commission has increased each year of the program’s operation. In Fiscal Year 2015, the Commission received nearly 4,000 whistleblower tips, representing a 30% increase over the number of tips received in Fiscal Year 2012, the first year for which the office had full-year data. In FY 2015, the Commission paid more than $37 million to whistleblowers who provided original information that led to successful enforcement actions resulting in an order or monetary sanctions exceeding $1 million, and has awarded more than $50 million since the program’s inception. Just last week, the Commission announced a $17 million award, its second largest, to a former company employee whose detailed tip substantially advanced Enforcement’s investigation. The Commission has also filed numerous “friend of the court” briefs in support of private actions by whistleblowers who have experienced retaliation for reporting internally at their companies, and has brought our own actions against firms for whistleblower retaliation and improper restrictions of whistleblowing activity in confidentiality agreements.
Preserving Investigative Tools
During my tenure as Chair, I have sought to work with Congress to modernize the Electronic Communications Privacy Act (ECPA), which governs the authority of law enforcement to obtain emails from internet service providers (ISPs). The bills currently pending in Congress to amend ECPA would unfortunately pose significant risks to the American investing public by impeding the ability of Commission staff to investigate and uncover insider trading, Ponzi schemes, and other types of fraud. Although I agree that ECPA's privacy protections and evidence collection procedures should be updated, I believe there are ways to update ECPA that offer stronger privacy protections and observe constitutional boundaries without putting innocent victims and our capital markets at risk.
As drafted, the bills would require government entities to obtain a criminal warrant when they seek the content of subscriber emails and other electronic communications from ISPs. The SEC, as a civil law enforcement agency, cannot obtain criminal warrants. Thus, the SEC would no longer be able to gather these communications directly from an ISP to obtain often critical and otherwise unobtainable evidence of serious wrongdoing. Any effort to update ECPA can, and should, be done without harming the ability of the SEC to protect our nation's citizens from securities fraud. I look forward to the opportunity to continue to work with Congress on solutions that both protect investors and privacy interests.
Building Stronger, Safer Markets for Investors and Issuers
The SEC continues to pursue an extensive program of rulemaking and other policy efforts designed to ensure that our securities markets continue to optimally and securely serve investors and issuers. Since I last testified before the Committee, the SEC has significantly progressed in implementing mandatory rulemakings under three separate statutes, as well as in pursuing an impressive range of important discretionary initiatives.
As the Committee knows, the SEC and our fellow regulators have been working hard to strengthen our nation’s financial systems by implementing the rules mandated by the Dodd-Frank Act, which responded to the worst financial crisis since the Great Depression. Over the last two years, the SEC has moved into the final phase of implementing the Dodd-Frank Act, focusing on completing all of the remaining rules in the two major remaining areas of mandates: securityâbased swaps and executive compensation.
Increasing Transparency and Oversight for Security-Based Swaps
Since September 2014, we have marked several milestones in the establishment of a comprehensive regulatory framework for securityâbased swaps, which will give us powerful tools to oversee an $11 trillion market. First, we finalized the core requirements for reporting securityâbased swap transactions to regulators and the public through security-based swap data repositories,[7] and we proposed additional requirements to ensure that reporting will produce accurate data for regulators and market participants.[8] With the adoption of these rules expected later this year, the regulatory infrastructure for transaction reporting will be complete.
Second, we adopted the framework for registering securityâbased swap dealers and major security-based swap participants with the Commission,[9] as well as rules to help ensure that non-U.S. dealers participating in the U.S. market comply with our rules.[10] Work is now underway to finalize the obligations that registered dealers and participants will be required to undertake. In April, the SEC adopted extensive requirements for how these entities must conduct business with counterparties – including special entities like municipalities and pension funds – and supervise such conduct.[11] We also this month finalized rules for timely and accurate trade acknowledgment and verification requirements for security-based swaps,[12] and have proposed a process for dealing with bad actors in the security-based swap market.[13] Next in line will be to finalize that process, complete capital, margin, and asset segregation requirements for security-based swap entities,[14] and adopt rules for recordkeeping and regulatory reporting.[15] With those steps, the regulatory structure for security-based swap dealers will be complete, a priority supported by all of the Commissioners.[16] Our goal is to finalize those rules by year-end.
Creating New Disclosures and Limits for Executive Compensation
With respect to executive compensation, the SEC last year issued proposals for all of the remaining executive compensation rulemakings required by the DoddâFrank Act, including disclosure of whether a company allows executives to hedge the company’s stock, disclosure of pay versus performance measures of executive compensation, and new disclosures and rules for clawing back incentive compensation erroneously awarded.[17] Together with five of our fellow financial regulators, we also re-proposed a joint rule regarding incentive-based compensation arrangements at large financial institutions.[18] The final rules are expected to be advanced expeditiously. And following the analysis of some 285,500 total comment letters, 1,500 of them unique, the final pay ratio rule was adopted in August 2015.[19]
Completing Implementation of the Dodd-Frank Act
Beyond these two areas, the SEC has continued to finish all of the mandates of the DoddâFrank Act since I last testified. As required by Section 1504, we re-proposed rules that would require resource extraction issuers to disclose payments made to the U.S. federal government or foreign governments for the commercial development of oil, natural gas, or minerals.[20] And, working with our colleagues at the FDIC, we proposed joint rules for broker-dealers covered under the orderly liquidation provisions of Title II, as required by Section 205(h) of the Dodd-Frank Act.[21]
These accomplishments of the last two years were, of course, only the latest in an historic undertaking by the agency to execute the most daunting rulemaking agenda in memory. Pursuant to mandates of the Dodd-Frank Act, since I arrived at the agency in April 2013, we have stood up an entirely new regulatory regime for municipal advisors,[22] and implemented sweeping changes in the securitization markets that were at the epicenter of the crisis – including the joint rulemaking on credit risk retention since I last testified before the Committee.[23] We significantly enhanced the rules for credit rating agencies,[24] strengthened the rules for how broker-dealers handle customer funds and securities,[25] disqualified bad actors from private offerings,[26] removed credit rating references from throughout our rules,[27] and, through the Volcker Rule, restricted proprietary trading by financial institutions.[28]
Facilitating Capital Formation for both Large and Small Issuers
The SEC performs a critical function for issuers seeking to raise capital to grow their businesses and the larger economy. Our rules must facilitate offerings by a diverse set of companies – large and small, engaged in all manner of commerce – while ensuring that investors have the protections they require to maintain confidence in the strongest capital markets in the world. Since I last testified before this Committee, the SEC has concentrated our commitment to this responsibility through a number of key initiatives, with particular emphasis on smaller businesses.
Completing Implementation of the JOBS Act and the FAST Act
The JOBS Act, in particular, made several significant changes to the avenues for capital formation in the securities markets, especially for smaller issuers, and we have now completed all of the rules mandated by that legislation. A few months after I became Chair, we finalized the changes to private offerings required by the JOBS Act, while advancing measures to ensure the agency has the information it needs to monitor the changes and protect investors.[29] Last year, the SEC adopted final rules to update and expand Regulation A (commonly referred to as Regulation A+), an exemption from registration for small offerings of securities, to facilitate smaller companies’ access to capital.[30] And we also finalized new rules to permit securitiesâbased crowdfunding offerings by issuers and the operation of funding portals to intermediate such offerings.[31] Issuers are now actively using both of these new avenues for raising capital.
The FAST Act was enacted by Congress late last year, requiring the SEC to undertake several more rules and studies to promote capital formation and modernize disclosure. We have already made progress on implementing those mandates, adopting interim final rules to revise registration forms for emerging growth companies and smaller reporting companies,[32] and to permit issuers to include a summary in the annual report on Form 10-K.[33] Earlier this year, the SEC also approved amendments to revise the rules related to the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act, implementing provisions of both the JOBS and the FAST Acts.[34]
Creating New Opportunities for Smaller Issuers
The Commission has gone beyond the statutory mandates since I last testified and also developed and adopted a number of additional initiatives that are designed to facilitate capital formation, particularly for small businesses. In October 2015, for example, the Commission issued a rule proposal seeking to modernize Rule 147, a safe harbor to a statutory exemption for intrastate securities offerings, which would establish a new exemption to facilitate capital formation through intrastate offerings.[35] Many market participants and state regulators had raised concerns that the current requirements have not kept up with changes in the business environment and technology, which limits the usefulness of the safe harbor for capital-raising, especially for smaller state and local businesses. The rule proposal would retain the key feature of existing Rule 147 – its intrastate character, which permits companies to raise money from investors within their state without concurrently registering the offers and sales at the federal level. In recognition of the transformative nature of the internet and other technologies, however, the rule would, among other things, remove the existing intrastate restriction on offers, but – critically for the stateâbased nature of the offering and its regulation – would continue to require that sales be made only to residents of the state or territory of the issuer’s principal place of business. The proposal would also modify and modernize some of the issuer eligibility requirements to make the rule available to a greater number of businesses seeking financing in-state, while requiring that such financing occur with a set of certain investor protections and that issuers have a sufficient in-state presence within the state of offering.[36]
Another important initiative is the pilot program to widen the minimum quoting and trading increments – or tick sizes – for stocks of some smaller companies. Following a study directed by the JOBS Act,[37] the Commission in May 2015 approved a proposal, submitted in response to a Commission order,[38] by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) for a two-year pilot program.[39] The SEC plans to use the pilot program to assess whether wider tick sizes enhance the market quality of these stocks for the benefit of issuers and investors. The pilot is scheduled to begin on October 3, 2016.[40]
More broadly, the Commission staff remains committed to helping small issuers use these channels and others to build their businesses using the securities markets. The Office of Small Business Policy within the Division of Corporation Finance provides extensive guidance to small businesses seeking to raise capital or comply with our reporting requirements. Each year, the office responds to over 1,000 requests for interpretive advice, provides guidance through speaking engagements, and meets frequently with interested parties about pending rulemakings that could impact small businesses. The Commission also renewed the Advisory Committee on Small and Emerging Companies to provide the Commission with advice on capital formation and reporting requirements for smaller issuers.[41]
Updating the Definition of an “Accredited Investor”
In another important step for modernizing the private offering market, the Commission published a staff report in December 2015 regarding the key definition of “accredited investor,” which analyzes various approaches for modifying the definition and provides staff recommendations for potential updates and modifications.[42] The report recommends that the Commission consider expanding the definition to include alternative indicators for individuals to qualify as accredited investors (other than looking solely at income and net worth). The report also evaluates the impact that potential changes to the definition would have on the size of the accredited investor pool. I have directed the staff to prepare recommendations for the Commission on how the definition should be modified, and the comments we are receiving in response to the report will help inform the next steps.
Strengthening Markets with Targeted Action and Data-Driven Analysis
Since I last testified before this Committee, we have proceeded with our ongoing assessment of U.S. equity market structure to ensure that our markets remain the deepest, fairest, and most reliable in the world. It is important that our market structure is optimally serving investors and companies of all sizes seeking to raise capital. Our approach is data-driven and includes a number of identified short-term enhancements, as well as a comprehensive review of the entire structural operation of the equity markets to determine whether other changes should be made to optimize our markets for investors and issuers. The Commission staff has also continued to pursue efforts with FINRA and the MSRB to enhance the structure of the fixed income markets.
Preserving Operational Integrity in the Equity Markets
As I have remarked since my earliest days at the Commission,[43] a fundamental requirement of our modern equity markets is strong technological systems and operations. Shortly after my appearance at the September 2014 hearing of the Committee, the Commission adopted wideâranging rules designed to strengthen the technology infrastructure of the U.S. securities markets.[44] The rules – together comprising Regulation SCI – impose requirements on certain key market participants intended to reduce the occurrence of systems issues and improve resiliency when systems problems do occur.
Our efforts to preserve the operational integrity of the market extend well beyond Commission rulemaking. In response to my requests,[45] the SROs have continued to work to address issues like order types and operations, data feed disclosures, and “single points of failure” within infrastructure systems that have the ability to significantly disrupt trading.[46] Most recently, the Commission approved new rules of the New York Stock Exchange, NYSE MKT, and Nasdaq that provide for closing contingency procedures for listed securities if the relevant exchange is unable to conduct a closing transaction in one or more securities due to a systems or technical issue.[47] All of the exchanges have now conducted and completed in-depth analyses of order types and have filed proposed rule changes to clarify the operation of their order types.[48] All of the exchanges have also now submitted rule filings disclosing how they use securities information processor (SIP) feeds and direct feeds.[49] These filings provide significantly improved transparency for investors and the public on how the exchanges operate. And, also at my request, the SIPs have implemented a time stamp in their data feeds, to facilitate greater transparency on the issue of data latency.[50] In this regard, it should also be noted that the SIPs have steadily upgraded their systems to reduce average latencies from nearly one second a decade ago to less than 1/1000th of a second today.[51]
Another important component of this effort is ensuring that the moderators put in place in 2012 to address extraordinary volatility in the market work well. And the SEC and the SROs are actively reviewing the operation of the limit up-limit down pilot plan, with a focus on issues that occurred during the volatile trading of August 24, 2015.[52] This review has included extensive public analysis by SEC staff of that day’s events and the consideration of specific improvements to refine the plan’s operation.[53]
Implementing Targeted Initiatives to Optimize Equity Market Structure
The Commission is also taking action to address enhanced equity market transparency and disclosure, including our proposal issued in November 2015 to update disclosures by alternative trading systems (ATSs), [54] and I expect a proposal imminently to modernize Rules 605 and 606 of Regulation NMS. Updating Rules 605 and 606 could provide investors with important new information about broker-dealer order handling practices, empowering them to better assess the routing decisions of broker-dealers.
The Commission’s proposal on Regulation ATS, issued last November, would require ATS platforms that trade national market system (NMS) stocks to provide significant new transparency with respect their operations. In the years since Regulation ATS was first adopted in 1998, our equity markets have undergone significant change. ATSs are now an important component of our current market structure, fueled by advancements in technology and competing directly with exchanges. Consequently, the number of trading centers has increased substantially, trading activity in NMS stocks is less concentrated, and ATSs collectively now account for approximately 15% of the dollar volume in NMS stocks. This proposal, marking the first-ever major update of Regulation ATS, would require new detailed disclosures about the operation of these platforms and would create a new process for Commission oversight of them.
In addition to enhancing the transparency of our market for investors, the Commission has also advanced measures to improve our core regulatory tools of registration and firm oversight. In March 2015, for example, the Commission proposed important amendments to Rule 15b9-1 to require broker-dealers that engage in off-exchange proprietary trading to become members of a national securities association, which would enhance oversight of active proprietary trading firms.[55] The staff also continues to make progress on recommendations to the Commission to address, among other things, the registration status of certain active proprietary traders, improvements to firms’ risk management of trading algorithms, and an anti-disruptive trading rule that would address the use of aggressive, destabilizing trading strategies in vulnerable market conditions.[56]
Assessing Further Data-Driven Enhancements to Equity Market Structure
The Commission’s continuing work in market structure is a substantial undertaking that requires updates in technology, and utilization of data and analytics to make informed decisions on enhancing market structure. That means new ways of using existing market data through tools like the Market Information Data Analytics System (MIDAS),[57] and it also means building new systems to provide even more powerful analytical capabilities for the Commission and our fellow regulators. This past April, the Commission published for comment a proposed national market system plan for the creation of a consolidated audit trail.[58] This is a substantial undertaking and will result in one of the most sophisticated financial databases, providing a full lifecycle of all orders and transactions in our equity and options markets. Final implementation of the consolidated audit trail is a top priority, and I expect the staff to prepare a recommendation for approval of a final plan for Commission action later this year, consistent with Commission Rule 608 under Regulation NMS. After final approval of a plan, Commission Rule 613 requires the selection of a plan processor within two months of approval to build, operate and maintain the consolidated audit trail. Data would be reported by the exchanges and FINRA within one year of Commission approval.
In early 2015, as part of our broader market structure work, the Commission established the Equity Market Structure Advisory Committee to provide a formal mechanism through which the Commission can receive advice and recommendations on key equity market structure issues from a diverse group of experts.[59] The Committee as a whole has since met four times to consider issues such as the operation of Regulation NMS, the impact of access fees and rebates widely used by stock exchanges and the regulatory structure of trading venues, and the impact of various market structure issues on customers. The Committee has established subcommittees to look more closely at specific issues identified by the SEC staff and Committee members before presenting them to the full Committee for discussion and deliberation. The Committee is expected to convene a telephonic meeting on July 8 to receive finalized recommendations from their subcommittees on an access fee pilot program, NMS plan governance, and SRO proposals requiring technology changes. The staff and the Committee will continue to use a variety of tools to ensure both the transparency of the Committee’s consideration of issues and input from the full range of investors and other interested market participants, including coordination with our Investor Advisory Committee.
Deepening Oversight of the Fixed Income Markets
Fixed income market structure has long been a focus at the Commission, and the continued impact of technology, regulation, and other forces require us to deepen our oversight. In particular, as I have remarked before, technology in the fixed income markets may not be deployed today to achieve all of the benefits it could for investors, including the broad availability of pre-trade pricing information, lower search costs, and greater price competition.[60]
One important step is to ensure that the best execution and pricing disclosure rules for the corporate bond and municipal securities markets are robust and useful to investors, and FINRA and the MSRB have been moving forward on such reforms. At the Commission’s urging,[61] the MSRB in December 2014 adopted a best execution rule for the municipal bond market similar to FINRA’s best execution rule.[62] And both SROs have since developed and published additional guidance on the best execution obligations of broker-dealers and municipal securities dealers.[63] In 2014, I also urged both FINRA and the MSRB to move forward on markup and markdown disclosure rules, a reform also publicly supported by my fellow Commissioners.[64] Both have advanced proposals and SEC staff has been dedicated to working closely with FINRA and MSRB as the proposals are finalized.
A related effort in these markets is enhancing pre-trade price transparency. Work on this initiative is underway at the SEC. Pre-trade transparency for corporate bonds and municipal securities should remain a critical objective, and the Commission staff continues to work through the challenging issues inherent in such a transformative market structure change. The staff’s immediate goal is to develop a recommendation for the Commission’s consideration.
The initiatives in these markets also include interagency work on the U.S. Treasury market in the wake of the events of October 15, 2014.[65] One important priority for the Treasury market is developing a mechanism for postâtrade transparency, which systems operated by FINRA and the MSRB already provide in the corporate and municipal markets. Last month, the SEC and Treasury announced the consideration of concrete steps to further enhance post-trade transparency to regulators of the U.S. Treasury cash market, and I look forward to further advancing this effort.[66]
Strengthening Other Critical Market Infrastructures
Clearing agencies provide vital services to both the equity and fixed income markets every day, and it is vital that the clearance and settlement cycle continue to work effectively and efficiently as the markets grow in size and complexity. The Commission has proposed new rules to enhance the oversight of clearing agencies that are deemed to be systemically important or that are involved in complex transactions, such as security-based swaps.[67] Completing these rules is a priority this year in order to guard against systemic risk that can arise in the clearance and settlement system, and provide certainty to market participants, especially those engaged in cross-border activities. I have also directed the staff to develop a recommendation for the Commission’s consideration to shorten the settlement cycle,[68] which should yield a number of benefits including reduced counterparty risk and decreased clearing capital requirements. My fellow Commissioners have expressed strong support for this effort,[69] and it is an important measure for the Commission to advance in coordination with the broader SRO and industry efforts underway.
Last year, again with broad support from all of the Commissioners,[70] the SEC also took the first major step in the regulation of transfer agents in decades, issuing an advance notice of proposed rulemaking, concept release, and request for comment on the full regulatory regime.[71] It is important that this work progress so that the integral work of these market participants continues to serve investors and issuers.