As the SEC continues to implement the Dodd-Frank Act, Commissioner Luis Aguilar outlined five key principles to guide the deliberations and actions of the agency. “An Insider’s View of the SEC: Principles to guide Reform,” available here.
Principle one: Investor protections should be real and verifiable. Prior to the market crisis, the SEC increasingly relied on questionable assumptions as a substitute for actually determining what was necessary to protect investors, the Commissioner noted. Two critical examples of this approach are (1) excluding transactions involving sophisticated investors from the protections of the securities laws and (2) relying on the risk management of large financial institutions. The market crisis has exposed the fallacy of these points. The Commission should not rely on the judgments of the markets at the expense of its own.
Principle two: It is critical that the SEC obtain the input of investors. Typically “investor voices are . . . few and less organized than other interested parties.” Under Dodd-Frank however, there will be an Investor Advocate who will prepare an annual report to Congress. That report will cover the most serious problems encountered by investors, along with relevant recommendations for reform and legislation.
Principle three: The SEC should resist the trend toward a two-tiered market. This means that the Commission should not carve out areas where certain protections are not available. There is one market for all, not two.
Principle four: The SEC must use its authority and expertise. It is the role of a regulatory agency to use its expertise to “realize the objectives set forth in the statute.” Unfortunately, Commissioner Aguilar noted, to often in the past the SEC has been “on the sidelines.” Two examples illustrate this point. First, not adopting pay-to-play rules. Second, not updating Form ADV for decades, a step which would have ensured the collection of essential information. Fortunately, the Commission is now moving forward on these points and, in addition, Dodd-Frank compels the agency to action.
Principle five: It is critical that the SEC use its authority. Frequently in the past the Commission has not moved forward and properly used its authority. One clear example of this is SOX Section 304 (here) which provides for the clawback of certain CEO and CFO incentive compensation when there is a restatement of the organization’s financial statements from malfeasance. The Section is designed to be self-executing, according to the Commissioner. Alternatively, the SEC can bring an enforcement action. Executives, however, routinely fail to repay the compensation as required and the SEC did not bring a Section 304 case until 2005, three years after the passage of SOX. In the future, the Commission must use the tools given to it by Congress.
Commissioner Aguilar concluded by predicting that Dodd-Frank will have far-reaching consequences. “The sixty-four million dollar question is whether the SEC can deliver in a way that enhances investor protection while maintaining and improving the world’s most efficient capital market.”