by T. GormanPosted on Posted in SECActions

In three recent addresses SEC Chair Mary Jo White has given definition to her vision for the agency. In one, she discussed Enforcement policy (here). A second focused on market structure (here). In a third, titled The Importance of Independence, delivered to the 14th Annual A.A. Summer, Jr. Corporate Securities and Financial Law Lecture, Fordham Law School (October 3, 2013)(here), Ms. White focused on the meaning of being independent. While many of her comments on independence reiterate the basics, her views on the settlement of enforcement actions are significant.

The remarks

“Under the law the SEC is an independent agency . . . “ Ms. White began. That “does not mean that the SEC does not listen to the ideas and recommendations that come from beyond our building. Indeed, we depend upon hearing and evaluating the ideas and recommendations of those who will be impacted by our rules. . . At the end of the day, however, we make our decisions based on an impartial assessment of the law and the facts and what we believe will further our mission. . . “

With this preface Ms. White outlined her view of independence in three contexts: 1) political; 2) rule making and 3) enforcement settlements. Drawing on her experience as a U.S. Attorney, Ms. White stated that while Commissioners are appointed through the political process, their job is to make decisions on the facts, implementing the mission of the agency. The SEC, Ms. White declared, has a strong tradition of being independent of the political process. In support of this point she cited examples of actions taken by former Chairman over the years.

Independence comes not just from inside the SEC’s building however. Rather, it “should be respected by those outside, including the industry, other agencies, Congress and the courts.” In the context of rule making this means that “the agency’s unique expertise – should be, for example, respected by those who seek to effectuate social policy or political change through the SEC’s power of mandatory disclosure. “

It is essential in implementing disclosure policy that the agency “shape disclosure rules consistent with the federal securities laws and its core mission.” In some instances Ms. White stated that she may question if the Commission’s disclosure mission should be utilized to implement policy. One example is the Dodd-Frank mandate that the agency write disclosure rules regarding conflict minerals. While Ms. White allowed that this may be good social policy, she questions using the federal securities laws as a mechanism to implement it.

Nevertheless, “I recognize that when Congress and the President enact a statute mandating such a rule, neither I nor the Commission has the right to just say ‘no.’” We cannot say that a law does not comport with our mission as we see it. . . .” Rather, the question is what leeway the law affords the agency in writing the rules. It is the responsibility of the agency to utilize its expertise within that context, according to the SEC Chair.

Finally, Ms. White “urge[d] the courts to defer to the SEC’s independence and expertise.” This means in the first instance the deference that is due under decisions such as Chevron.

Turning to the question of requiring admissions as part of a settlement while declining to comment on any pending cases, Ms. White reiterated the parameters of her new policy. In select instances the Commission will demand admissions a part of the settlement of an enforcement case. At the same time the “neither admit nor deny” formulation will continue to be an important tool in resolving those cases. The decision to either policy is one for the agency in its discretion, not the courts Ms. White stated. Acknowledging that under the law the court can review a settlement, its role is limited: “A court reviewing a consent judgment in one of our cases has a narrow focus – making sure that the settlement is not ambiguous and that it does not affirmatively harm third parties or impose undue burden on the court’s own resources.”

Analysis

The notion that the SEC is independent and should make decisions based on the merits and not on politics is axiomatic and fundamental to its core mission. Equally clear is the fact that the SEC is obligated to write rules within the context directed by the statutes written by Congress and signed by the President. As Ms. White noted, regardless of the personal views of Commissioners on the wisdom of certain statutory directives, it is the responsibility of the agency under the law to write the rules as directed.

Less clear, however, is Ms. White’s vision of the court’s role in effectuating an enforcement settlement. The basic premise that the implementation of agency policy is within the sound discretion of the regulator should not be controversial, although that issue may be given new definition when the Second Circuit resolves the pending Citigroup case on the role of the courts in SEC settlements (here). Accordingly, the question of whether admissions should be sought or the settlement can be effected on a neither admit nor deny basis should typically fall within the discretion of the agency. Stated differently, whether one settlement policy or another is employed should generally be reserved to the discretion of the agency.

At the same time it is difficult to view the court’s role as limited to little more than proof reading, checking to see that the papers are clear and ensuring that the arrangement will not cause harm or be burdensome. As Judge Gleeson remarked in holding that the court had authority to approve a deferred prosecution agreement in U.S. v. HSBC Bank USA, N.A., Case No. 12-cr-763 (E.D.N.Y. Order dated July 1, 2013)(here), it is the parties who chose to file the case with the court and invoke its authority. It is the parties who came before the court and asked it to take certain actions. In taking those steps the parties submitted themselves to the authority of the court and its supervisory powers.

This is particularly true of most Commission enforcement settlements. In those cases it is the SEC that invokes the jurisdiction of the court by filing the action. Likewise, it is the SEC requesting that the court enter certain orders which can then be enforced through its contempt power. Viewed in that context the Court cannot be reduced to what Judge Gleeson called – citing a now famous statement – a potted plant.

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by T. GormanPosted on Posted in SECActions

SEC Chair Mary Jo White has been reshaping the agency in the months since she joined the Commission. A new “get tough” policy has been adopted. Settlement procedures for enforcement cases have been modified to require admissions in select cases. A new financial statement fraud task force has been created. And, a new enforcement doctrine detailed in remarks delivered to the Council of Institutional Investors on September 26, 2013 (here).

Now the new SEC Chair is addressing market structure and the related issues. In remarks delivered on October 2, 2013, Ms. White addressed the Security Traders Association 80th Annual Market Structure Conference, Washington, D.C. Her address, titled Focusing on Fundamentals: The Path to Address Equity Market Structure (here), centered on the notion that “Gathering, disseminating, and analyzing data, testing assumptions about our complex, dispersed marketplace, and ensuring the integrity of market technology are the fundamental steps that are needed to address today’s market structure concerns in a responsible manner.” In developing this theme Ms. White detailed several critical points. What may be more interesting about her remarks is what she did not address.

The remarks

Ms. White began with the straight forward notion that the key point for the U.S. capital markets is their integrity and the perception of fairness by investors and issuers. Capital formation depends on the participation of investors and public companies, the new SEC Chair declared. Critical to the process is not just the direct access of business to raise capital, but a secondary market since it “assures investors will have an efficient means of liquidating their positions if and when they choose. And a strong secondary market generates price discovery that helps efficiently allocate capital to the companies most able to put it to productive use.” This process depends on a market structure which generates confidence thereby attracting investors and companies.

While the U.S. markets are the envy of the world, in recent years the number of U.S. listed companies has significantly declined. Likewise, the number of U.S. households participating in our markets has declined since 2007. In analyzing these trends it is important to consider three fundamental points: 1) technology; 2) basic assumptions; and 3) market data.

There is no doubt that technology is fundamental to the markets today. In this regard it is important that there be operational integrity. Stated differently, the systems must work properly. While there is always a risk of failures, the proper steps must be taken.

There has been progress in this area, and the SEC staff has addressed the questions with new Regulation SCI. Yet more must be done in view of recent failures Ms. White stated. Accordingly, in a recent meeting with executives of exchanges, Ms. White requested that they develop a kind of action plan moving forward to address critical issues. Likewise, the exchanges and FINRA were requested to “prioritize” their efforts on a number of initiatives to make sure that when issues do arise they are resolved quickly.

In addressing questions of market structure it is also important that key underlying assumptions be rethought and changes made where necessary. One key assumption is the “one-size-fits-all” premise – that all markets must be the same. Following-up on one suggestion, Ms. White has instructed the staff to work with exchanges to consider a “plan to implement a pilot program that would allow smaller companies to use wider tick sizes.” Another assumption which must be critically evaluated is if “the current regulatory structure continues to meet the needs of investors and public companies. Does it provide sufficient flexibility for exchanges to implement transparent trading models that can effectively compete for investor orders? Does the current approach to self-regulation limit or support exchange trading models?”

Finally, market structure has to be grounded in empirical evidence. To this end the staff has been developing critical sources of information about the markets. One is MIDAS, the new system which became operational in January. This system collects one billion records each day from the consolidated tapes and the proprietary feeds of each exchange. Information from this new system, along with that from the new Large Trader Reporting Rule and the Consolidated Audit Trail Rule when implemented should enhance the ability of regulators to monitor the equity markets.

At the same time current sources of information are providing the SEC with significant insights. For example, “the staff has developed a data series tacking the total volume of visible orders at all the price levels sent to our public exchanges and comparing this volume to the total volume of shares actually traded. As expected, only a small percentage of orders sent to exchanges are not canceled and actually result in trades.” The staff has also “used this data to compare the speed at which exchange orders are cancelled to the speed at which orders are executed. Recent data on corporate stocks shows that almost two-thirds of all orders ‘rest’ for half a second or longer. . . These findings not only provide an empirical basis for measuring and tracking the speed of today’s markets, but also suggest that even short-lived quotes are generally accessible by at least some traders.”

To facilitate decision making based on data the Commission will, in the immediate future, make available a website where information from MIDAS, along with other research by the staff, will be available for the public. This will provide all investors with access to information which has typically been available only to select market participants.

Ms. White concluded noting that: “Ultimately, we must be able to show investors and companies that concerns about the current U.S. equity market structure can be properly diagnosed and, when needed, properly addressed.”

Analysis

The premise of Ms. White’s remarks is fundamental: To attract investors and companies to the U.S. markets, and maintain them as the best in the world, there must be confidence in their integrity. That begins with operational integrity. In recent months there has been a series of incidents which raise significant questions regarding this point. The market outage several weeks ago is only the most recent. While there is little doubt that the SEC has put forth initiatives to try and address these issues, the difficulties persist. As Ms. White correctly noted, there is always the potential for difficulties given the highly complex technology which drives the markets.

At the same time, whether holding a meeting with executives and giving them what amounts to a “homework” assignment to come up with ideas represents an adequate solution is at best questionable. To be sure, those executives and exchange officials should have insight into the problems and their ideas should be solicited. Indeed, they have a vested interest in solving the difficulties. In the end, however, the SEC remains the regulator charged with supervising and maintaining the integrity of the U.S. markets.

Equally fundamental are the points that underlying assumptions should be re-examined and data and evidence should inform decisions. Again, there is no doubt that as the markets continue to evolve old ways of doing things should be evaluated, re-evaluated and modified as necessary. In making those decisions data such as that provided by MIDAS and other sources should prove critical. Making much of this data available on a new website should also help inform public debate and is commendable.

In all the discussion about data and markets what was not mentioned may, however, be most significant. One point we have learned from the data Ms. White noted is that most orders entered and displayed are not executed. Yet even short lived quotes “are generally accessible by at least some traders” she stated. While there may be reasons for orders not to be executed, it also suggest that in many instances investors and traders may be drawn to the markets by quotes offering an appearance of liquidity which is less than accurate. It may mean that at least in some instances investors may be lured to the markets by an appearance of liquidity created in part by orders which were put there only for that purpose and not for execution.

If some traders rapidly place orders which are displayed, attract investors and are then canceled moments later – a point which should be able to be confirmed at least in part by the data – it may suggest that certain participants are using the speed of the markets to create an illusion of liquidity, that is a false appearance. If this is the case, it presents a fundamental question about the integrity and fairness of the U.S. markets. That would undercut any claim of integrity by the U.S. markets while fueling a continued decline in investor participation. It would also undercut any “get tough” enforcement posture by the Commission.

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