It is a pleasure to once again join you at this conference.

The last time that I appeared before you I told you that one of our most important tasks was maintaining the integrity and efficiency of this nation's capital markets.

This rests in large part on two strong pillars. First, we have developed a complete and transparent financial reporting system built on full and fair disclosure, and independently promulgated, generally acceptable accounting principles. Second, the SEC, with its investor protection mandate and effective antifraud enforcement program, has operated to give the public confidence in the fairness of our markets.

The Commerce Committee will be dealing with several initiatives that could significantly effect either or both of these pillars.

The SEC Budget

In The Transformation of Wall Street, Joel Seligman's seminal history of the SEC and modern corporate finance, the author writes that "during the Eisenhower Administration, the Securities and Exchange Commission reached its nadir." The agency had, at that time, a reputation as the best of the independent regulatory agencies and enjoyed strong bipartisan support. Nonetheless, the SEC's enforcement and policy-making capabilities were severely crippled by the Eishenhower Administration's commitment to a balanced budget, to the elimination of "excessive" federal regulation, and to its general preference for amicable relations with business.

The GOP's Contract With America strikes these same themes. The Commerce Committee's Subcommittee on Telecommunications and Finance, which is chaired by Rep. Jack Fields, has yet to hold hearings on the SEC's funding authorization. The SEC has been put on notice that its funding may be cut even though the user fees that it collects make it a net positive contributor to the U.S. Treasury. It has also been asked to identify programs that can be abolished or cut back. You may recall that the SEC was almost shut down last year by Senate brinkmanship on its budget. A weak and crippled SEC will not encourage public confidence in our markets.

Capital Raising and Accounting Generally

Congressman Fields has announced his intentions to introduce later this summer legislation to modernize and deregulate the Securities Act of 1933 and the Securities Exchange Act of 1934. He has asked for recommendations from a broad range of government and industry representatives. It is unclear at this time what direction any such bill would take, but it could have significant implications for investor protection and continued public confidence in our markets.

Separately, but relatedly, the SEC has set up an Advisory Committee on Capital Formation and Regulatory Processes to undertake a broad re-examination of the basic elements of the U.S. registration process, the SEC's current integrated disclosure system, and possible alternatives. A factor in this survey is the cost of complying with U.S. generally accepted accounting principles. Among the questions being considered are the following:

1. Does the current regulatory scheme strike an appropriate balance between the capital-raising needs of companies and the disclosure needs of investors?

2. How have companies adopted their public and private offering disclosure practices to address regulatory and market uncertainties? Would movement to a company registration scheme, or some other, alternate model, reduce or remove any of the uncertainties?

3. What effects would implementation of a company registration model have on investors? Would such a system favor one type of investor over another?

4. What role does the current private placement market play in the U.S. capital formation process, and should that role be expanded, diminished or otherwise modified?

5. What factors motivate companies to raise capital through domestic private placements or offshore offerings rather than tapping the U.S. public markets?

6. What effect would adoption of a company registration model have on the role of traditional underwriters and the underwriting process? Under such a system, would underwriters continue to be able to perform the same level of due diligence? Should they be required to do so? Are there others who would and could perform a similar function?

7. Would adoption of alternative registration models, such as company registration, increase, decrease or otherwise have any impact on the incidence of fraud?

Litigation Reform and Financial Fraud Reporting

In March, the House passed H.R. 1058, the Securities Litigation Reform Act, one of the 10 planks of the GOP Contract With America.

As a nation, we have an interest in minimizing frivolous and costly litigation but we also have a strong stake in deterring fraud. Balancing those competing and often conflicting goals is not easy. As SEC chairman Arthur Levitt testified before us: "it is impossible to eliminate all meritless cases without also affecting the cases that do have merit." While we were able to soften the original bill's more egregiously anti-investor provisions, H.R. 1058 requires further modification in the Senate.

The House bill, for instance, was amended on the Floor to include a safe harbor for forward-looking statements which provides that a "projection, estimate, or description of future events" does not constitute a fraudulent statement if it is clearly identified as such and if the statement clearly identifies "the risk that such projections, estimates, or descriptions may not be realized." The bill provides expressly that an issuer assumes no duty to update a forward-looking statement.

The helpful result of this provision is to encourage managements to discuss their prospects more fully with investors. However, the House provision's definition of forward-looking statements is overly broad and would give an immunity bath to required disclosures, perhaps including parts of the financial statements. Moreover, the provision as structured would shield those who use projections to mislead as well as to inform. These are serious defects that must be fixed in order to maintain our high standards for honest corporate disclosures. The SEC already is revisiting and working on revisions to its existing safe harbor rule, having issued an extensive concept release and conducted public hearings on this issue. It may be preferable to defer to the SEC in this matter.

Other of the bill's provisions also raise significant concerns: (1) the recklessness standard -- originally eliminated altogether but then reinserted with language requiring deliberate action, rather than reckless behavior, for liability; (2) the loser pays provision -- which also is opposed by the Chairman of the Senate Banking Committee; (3) the actual reliance/fraud-on-the-market liability formulation -- which would undermine the integrity of municipal securities and other markets for securities not traded on national securities exchanges or quoted on an automatic quotation system; and (4) the bill's pleading requirements -- which would require judges to toss out a case if an investor at the outset before discovery, could not allege facts that, if true, would demonstrate not only bad behavior but also evil intent, thus closing the courthouse door to everyone but soothsayers.

Conclusion

As we deal with these issues, I hope that we will, as always, have the benefit of your advice and counsel. These are highly technical issues, but extremely important for the future of the industry.

Back to the Public Record Home Page