McKinsey Executive Rountable Series in International Economics: The SEC in a Globalizing Securities Market - A Conversation with the Past Four Chairmen

Wednesday, February 22, 2006
William H. Donaldson
Chairman & CEO, Donaldson Enterprises, Inc.; former Chairman, Securities and Exchange Commission (2003-2005)
Richard C. Breeden
Chairman, Richard C. Breeden & Co.; former Chairman, Securities and Exchange Commission (1989-1993)
Arthur Levitt
Senior Adviser, The Carlyle Group; former Chairman, Securities and Exchange Commission (1993-2001)
Harvey L. Pitt
CEO, Kalorama Partners; former Chairman, Securities and Exchange Commission (2001-2003)
Senior Fellow and Director of International Economics, Council on Foreign Relations

Council on Foreign Relations


BENN STEIL: I want to extend a particularly special welcome to those of us who are joining from around the world via webcast on the Council’s website,

This is the first meeting in 2006 of the council’s prestigious McKinsey Executive Roundtable Series in International Economics, which is cosponsored by the Council’s Maurice R. Greenberg Center for Geoeconomic Studies and the Corporate Program.

It’s a great privilege for us to have with us today the four past chairmen of the Securities and Exchange Commission: Bill Donaldson, Harvey Pitt, Arthur Levitt and Richard Breeden. You have their illustrious bios in your handout, so I won’t cut into the session reciting them for you.

I would, however, like to remind you all that this session is on the record.

And finally, in the interest of maintaining a fair and orderly marketplace for ideas, I would ask you all, please, to turn off your cell phones and any other noise-making gadgetry you may have on your person.

So I’m going to kickoff the discussion for the next 30 minutes or so, and then we’ll open the floor to questions.

Okay, gentlemen, since we’re all assembled here today at the Council on Foreign Relations, why don’t we start with a question or two on American foreign policy. And specifically what I’d like to touch on is the issue of growing congressional and pressure-group demands that the SEC adapt some of its important procedures and rule-making to specific American foreign policy concerns.

Congressman Frank Wolf, who chairs the House Appropriations Committee, which is responsible, among other things, for the SEC’s budget, as well as a number of prominent congressional committee and commission reports have since the late 1990s been calling on the SEC to become involved in foreign policy issues as diverse as international weapons proliferation and human rights abroad by barring certain foreign companies, particularly Chinese and Russian, from raising capital in the United States.

Harvey, let me start with you on this one. (Laughter). No collaboration!

MR. : Did you call on me?

STEIL: No, no. I’m going to start with Harvey on this one.

Harvey, in 2001 Congressman Wolf wrote a series of letters to your immediate predecessor, Acting Chairman Laura Unger, calling on her, among other things, to de-list a Chinese oil company, PetroChina, from the New York Stock Exchange because of its activities in the Sudan, which is a country that has been accused of significant human rights abuses. He also called on Laura Unger to widen the SEC’s traditional understanding of that critical legal term, materiality in financial disclosures, such that companies—foreign companies listing in the United States, raising capital in the United States would have to make legal disclosures to investors that went beyond things that had simply financial consequences. The SEC has traditionally interpreted materiality in terms of financial consequences. It would include things such as moral consequences or U.S. national security concerns.

Now, Laura Unger in her response to Congressman Wolf—in the words of The Financial Times—dropped a bombshell in the U.S. securities markets by appearing to widen this understanding of materiality. In specific, she suggested that companies needed to consider disclosing to shareholders if they did business in nations considered rogue states by the U.S. government. And she revealed that the SEC was instigating, quote-unquote, “interagency cooperation with the State Department’s Office of Religious Freedom.”

Now you were strongly lobbied by business groups such as the National Foreign Trade Council to disown Ms. Unger’s guidance. So where do you stand, then, on this issue of materiality and disclosure when it comes to U.S. foreign policy concerns?

HARVEY PITT: Well, I see my time is up. (Laughter.)

You know, when I had my confirmation hearings I was asked a question about this, and I gave my response that issues of social importance can well be material financially and can have disclosure consequences but that I didn’t think you could convert the federal securities laws into a device to require disclosures on all sorts of issues, however significant.

That gave me a free ticket to spend many very, actually pleasant hours with Congressman Wolf, who was a little bit concerned about my comments and wanted to make sure that I understood his point of view. And we had, I thought, a very wonderful interchange. I’ll tell you what I said to him about the letter that was written—and I think it was a May 5th letter of 2001, something in the May time frame.

If it suggests that merely doing business in a country that is a rogue state becomes automatically material, I believe that the letter would have changed the law. And while we can all debate whether that would be a good change or a bad change, the SEC does not have the ability to change the law by writing a letter. And so I suggested to Congressman Wolf that either the letter was intended to state existing law or else it was beyond the pale, because it would be intending to change the law.

And I told him that we would monitor this, and we did. We set up an electronic monitoring system, which he was very pleased with, so that we could identify companies that were doing business in very difficult jurisdictions—jurisdictions where it may be illegal to do business or otherwise—and that that would give us the predicate for deciding whether in an individual case the information rose to the level of financial materiality.

STEIL: But the critical point I think you’re emphasizing is—that it remains financial materiality that you believe the SEC should be focusing on.

PITT: I believe that the SEC has to limit itself to that. But as I said, there are all sorts of qualitative materiality standards: how companies are socially responsible, how they govern themselves. All of these are very, very critical issues, and disclosure can be exceedingly important on that.

Richard is starting a fund dedicated to companies that have good corporate governance, and that, it seems to me, shows how important these issues are. So any of them can have financial materiality and can be significant to investors, but I don’t think it’s the place of the SEC to decide which current en vogue questions should be treated as material unless there is some nexus to how the company is doing, how it’s performing, how it’s operating and what its results are.

STEIL: Bill, you also spent many wonderful hours with Congressman Wolf, if I recall. In 2003 Congressman Wolf in an appropriations recommendation called for the creation of an office of global security risk within the SEC. Now, President Bush responded to this by saying that he would interpret it as being merely advisory because it appeared in an appropriations bill.

You did, however, create such an office within the SEC, and in your March 2004 testimony before the House Appropriations Committee, you and Congressman Wolf appeared to engage in a rather elaborate and complex dance over the issue of materiality. Congressman Wolf pressed you quite hard on issues related to, for example, religious rights in China and Sudan. And you appeared, politely but quite firmly, to adhere to the SEC’s traditional interpretation of materiality as being strictly financial materiality.

But can you give us your take on what this office of global security risk will be doing and how the SEC should or should not be addressing Congress’ specific foreign policy concerns?

WILLIAM DONALDSON: Well, to begin with Congressman Wolf’s concern with the Appropriations Committee—you know, we did have very interesting conversations about this. The office, which we did set up—currently it has five people in it and it is strictly a consultative office. The whole business in this day and age of, you know, attacks against the United States and so forth, the State Department and the Defense Department have offices that are charges with tracking down terrorists and charged with tracking down illegal payments and so forth. And our people are in touch with them. We talk to them. We learn from them.

But in terms of the concept of materiality, it remains a concept of exploring what is a material fact that would be of interest to an investor. And again, the concept of materiality is a pretty broad one. I mean, it isn’t X percent of your earnings affected by this. I suspect that if we discover that some company had sold a vital piece of nuclear weaponry to a country that this would be something we would ask—to a rogue country—we would ask that they disclose that.

And this office does look into, as we go over filings and so forth and see the potential for that sort of stuff, we ask the company just exactly—to elaborate to us just how large this is and what it is that they’re doing.

STEIL: Are you confident that over the long run that your interpretation of what the office of global security risk should be doing is one that Congress can live with?

DONALDSON: Well, we’re never confident of where Congress is going to end up; but yes, I am. In terms of the way the office has been set up, our understanding with those who have responsibility in Treasury and State who are, you know, in this day and age are following the sources of relationships between countries, yes. We are simply talking to them. We’re not a policy center.

STEIL: Arthur, you were chairman of the SEC when the debate about what we should do about PetroChina listing on the New York Stock Exchange started bubbling over. There were claims from some who were very supportive of keeping PetroChina off the New York Stock Exchange, that if we could do that, then U.S. investors wouldn’t be financing such a company, because U.S. investors would be loath to invest overseas in a foreign company that was kept out of the U.S. capital markets.

When I read about this, I checked PetroChina’s financial disclosures and found that the single largest shareholder in the company—outside the Chinese government—was Warren Buffett. In 2004 he owned 14 percent of the publicly traded shares. So then I checked where he actually bought those shares and I found that he bought 95 percent of them on the Hong Kong Stock Exchange. He could have bought them on the New York Stock Exchange, but he didn’t. He bought them in Hong Kong.

The New York Stock Exchange, as many in the audience may have read recently, is also losing quite badly to the London Stock Exchange in the competition for foreign listings.

So Arthur, how does the SEC go about regulating foreign issuers and protecting U.S. investors when those issuers are increasingly choosing to stay outside of the SEC’s jurisdiction and U.S. investors are themselves choosing to go outside of the SEC’s jurisdiction in order to invest?

ARTHUR LEVITT: I remember the dialogue with Congressman Wolf. And I think, for one thing, all of us on the platform have in common—I think we have a lot of things in common—is our belief in markets and our resistance to politicizing market principles. I think the notion of where companies trade has become almost quaint. By that, I mean America’s—the primacy of the United States as the leading capital market in the world for the first time has come into question. And it’s come into question with the background music of a rapidly approaching globalized electronic market system. And I don’t necessarily feel passionate about where the trading takes place. It’s going to take place in a market which has the greatest liquidity and transparency.

And Buffett probably very shrewdly executed that transaction for a variety of reasons, but I’m not worried about that because I think, in terms of competition, U.S. markets will adapt to the electronic world that we are approaching. And I think it’s a great win for our investors. And I think that’s what’s key—to see to it that our investors are as well protected whether a transaction takes place in one market or another. And that gets into the whole area of convergence and how do we arrive at some kind of regulatory and accounting convergence. And that doesn’t mean a formulaic solution, because I think that would be very wrong. I think we have to respect sovereignty and cultures which are very different.

Having said that, I think all of us would agree that we have to support very rigorous and very transparent kinds of convergence. And that’s my long-winded answer to your very complex question.

STEIL: Richard, I want to keep you on this question of international competition or order flow from U.S. investors.

You’ve been very outspoken in the post-Enron debate about reforming corporate governance in the United States. The legal centerpiece of the American response, of course, has been Sarbanes-Oxley. But when foreign companies listing in London these days instead of New York are asked why, the number one response is always Sarbanes-Oxley or the requirements of Sarbanes-Oxley.

Now, how should the SEC go about trying to improve corporate governance for the benefit of American investors while, at the same time, trying to encourage rather than discourage foreign companies from raising U.S. investor capital inside our national borders rather than outside?

RICHARD BREEDEN: Well, thanks for being—for inviting me here. It’s a pleasure to be with all of you. I’m a fan of the Three Tenors—(laughter)—so I’m not sure whether we’re going to call this The Four Chairmen or The Four Horsemen; we’re still debating that.

I just—before you left the views of the good congressman, the thing I find offensive about the whole predicate is the idea that it’s the government’s money. The capital market is composed of money that belongs to investors, not congressmen. And if they want to invest it in a company that does business in the United States or anywhere else in a particular type of industry or take certain kind of risks, the function of the SEC has always been to make sure that investors had the information they needed to evaluate those risks but not to get in the way of the people who own the capital in making the decisions about where it should go.

And there is no faster way that we would destroy the attractiveness of the U.S. market, either to foreign capital sources, who provide liquidity in our markets, or to U.S. investors who, thank you very much, don’t need congressmen to advise them how they ought to invest.

I think on the issue of Sarbanes-Oxley, there’s been a lot of gnashing of teeth about it; there’s been a lot of wailing and crying and costly—and SOX 404 can be costly. We probably spent at MCI $500 million in accounting fees on restating the fraudulent financial statements and controls, all combined. That’s probably a record that I hope will never be matched. Although my friends Jim Quigley (sp) and the heads of the accounting firms probably wouldn’t mind if it was matched.

So sure, law enforcement can be costly. All the laws we have against money laundering, the law we have against fraud, they all involve costs. But you can’t distill the world down that our most important social objective is to make sure the New York Stock Exchange gets listing fees. That isn’t that high on the priority. It’s not unimportant but isn’t at the top of the priority list of what policymakers for the capital market should be worried about.

And by the way, since my time, London has been claiming that it’s winning the listings battle. And guess what: last time I saw, they’re in play to be acquired by either the Germans or the Americans or somebody from Australia. So I wouldn’t put quite so much credence on their supposed primacy on listings.

The U.S. capital market is still the most attractive market in the world, and we can keep it that way as long as we remember that what made it great was having it be an attractive place for investors to participate in the market.

STEIL: Oh, and Lord knows—

BREEDEN: And by the way—excuse me for interrupting—I serve on the board of a Spanish bank, one of the two large global Spanish banks. We’re almost at 50 billion (dollars) in market caps and we have to comply with stocks that were traded here in New York. It actually has been not a trivial expense, but I think both the board and the management team regard it as a very worthwhile expenditure.

It’s not something that has caused us to consider fleeing from the U.S. markets. And I think that the dangers of stocks in terms of foreign listing or anything else are a bit overblown. It’s just as potentially damaging to small U.S. companies as it could be to small foreign companies. And we always ought to be careful when we’re creating regulatory programs that things that might work well for ExxonMobile or the largest corporations that we’re careful about tailoring it so that it doesn’t have an undue effect on smaller businesses. But the effort to try and have reliable financial statements and not to repeat what we saw in Enron and WorldCom is still an effort that makes sense.

STEIL: Bill, Arthur brought up the issue of accounting standards, international accounting standards. Now, Chairman Cox recently echoed your call for the elimination by 2009 of the current requirement for foreign companies listing in the United States to publish financial disclosures according to, or reconciled to, U.S. accounting standards, otherwise known as U.S. GAAP.

All companies in the European Union have since last year had to produce their financial statements according to what’s called international financial reporting rules—that is, U.S. GAAP is not longer acceptable. It used to be in some jurisdictions in the EU. These international financial reporting rules are really expanding quite rapidly around the globe as a standard, say, in competition to U.S. GAAP.

Now, if the SEC were to accept non-GAAP financial statements, that would be quite a dramatic shift in policy for the SEC. Looking out longer term, is there a risk of the SEC perhaps going too far in helping the U.S. exchanges and financial services firms attract business—becoming, in effect, a trade negotiator or an advocate for U.S. industry and sacrificing its core investor protection mission in consequence?

DONALDSON: Well, I think that what you have to deal with is the present situation, which is that both FASB and the international accounting standard setters are on a course of bringing together IFRS and GAAP—taking the best of both—and I think that’s a very positive thing.

In fact, this sort of roadmap to 2009 is just that. And you must recognize that what the SEC said is that that’s the goal but that we’re going to be taking the accounting that’s being used now—this year and the next year and so forth—and seeing if there is a consistency to it and trying to iron out areas where there isn’t a consistency. But I think as a long-term goal to have a common accounting standard—difficult as it’s going to be to get there, starting from a rules-based versus a principle-based bias—I think that’s a very, very good thing for investors throughout the world, and particularly American investors, who are increasingly investing money overseas. I mean, if you look at where the world’s GNP is coming from, I mean, two-thirds of it is coming from outside the United States. And yet very few American investors have two-thirds of their equities outside the United States, but we’re heading toward that. More and more money’s going overseas.

STEIL: The EU Single Market Commissioner Charlie McCreevy was recently speaking at the council in Washington. He praised Chairman Cox for not requiring strict convergence of U.S. GAAP with international financial reporting rules before the SEC would allow these rules to be used for foreign companies within the United States. That leads one to suspect that we’re actually going to be having within our capital markets a competition among different accounting rules. That is, companies will be presented with a menu: you can choose whether you want to obey U.S. GAAP or another set of accounting rules. Is that the direction we should—

DONALDSON: I don’t think so, but I think we just have to wait and see how this thing plays out over the next couple of years and see if the bringing together of the two systems is something that, as I said before, I believe is proper and forward-thinking and reflects the times that we’re in in terms of global investing. Now whether we can, in fact, through practice reconcile some of the areas where there are differences remains to be seen.

But it’s not—that timetable to 2009 is based on what happens in-between now and then.

STEIL: And you presumably want to see some material convergence?

LEVITT: You know, I can’t help but be reminded how the rhetoric has changed on this subject. When Richard was chairman, and to a modestly lesser degree when I was chairman, it was U.S. GAAP, period. Now, what we don’t recognize is that accounting standards have changed internationally. The environment that we dealt with—in Germany in particular, where Richard spent a huge amount of time—they had no equity culture whatsoever and GAAP was a poisonous concept for them. That’s not today’s environment.

As a matter of fact, in some jurisdictions, certain accounting standards appear to be better than U.S. GAAP standards. And I think we have to recognize that—not as a sellout to the interests of a different market but as a natural, evolutionary process driven by, I think, a very constructive international accounting standards board that has worked very constructively. And I think this is an evolutionary process that is working, I think, well until the politicians step in, and that’s where it becomes messy.

STEIL: Do you think it’s important that we actually wind up at a single set of—

LEVITT(?): No, I do not.

STEIL: That was clear. (Laughter).

BREEDEN: I don’t either, and would echo Arthur’s comment that I think we’ve made a ton of progress. And hats off and kudos to people on both sides of the Atlantic who have been working on this problem. The situation when I was able to bring Daimler-Benz into the first German listing in the U.S. and where they started from and where they had to get to was so much farther apart than is the case today. And that reflects just an awful lot of good work and good progress.

I don’t think it’s very susceptible to deadlines, and I don’t think the comments of EU ministers or U.S. ministers make a darn bit of difference. The real benchmark is going to be how the accounting standards setters all around the world do their jobs in coming up with better transparency. The risk in all of this I think—because for those of us that are in the business of hedge funds or other sophisticated investors, it doesn’t matter. You can publish the financials in any form you’d like and the analysts can reconfigure it.

And as long as the data is published and available in some format, you can put it in what you want to see in order to invest. The real challenge is to maintain a retail market and to have conditions where ordinary investors can have reasonable comparability, so that if everybody in this room is an issuer and issuing securities and you’re all doing it on completely different standards, it’d be pretty hard for the average investor to makes heads or tail of it. I don’t think that’s where we’re going. I think we’ve done a good job. It’s a frustratingly slow process, but I really think we’re getting there and in a few more years I think we’ll be at a place where the standards are close enough that we’ll have more flexibility than we’ve had in the past.

PITT: I also think it’s important to make it clear that companies won’t be able to pick and choose. That’s not what’s involved.

Companies will either be governed by international financial reporting standards or they’ll be governed by GAAP and they can’t pick the best from each one and come up with a balance sheet or financial statements that they think will present their company’s operations in the most favorable light.

So it’s important to understand that this is a very responsible approach that I believe the SEC is taking and one that is absolutely critical as we move forward to a more globalized economy.

STEIL: Harvey, let me keep you on this issue of foreign issuers.

The SEC has reacted to the foreign listing challenges at the New York Stock Exchange by proposing to relax reporting requirements on foreign firms—de-listing from a U.S. exchange. The complaint from foreign firms was essentially that the NYSE was, as the inelegant term goes, a roach motel: once you checked in, you could never check out.

The SEC is also proposing to exempt foreign companies from planned U.S. rules on disclosure of executives’ pay.

Now, if the SEC continues on this path of continuously exempting foreign companies from U.S. rules, isn’t the SEC, in effect, saying to U.S. investors, look, if you want to buy shares in a foreign company listed in New York, don’t look to us for standards, for regulation anymore. Those are now set in Europe or China, or wherever.

Is that the direction in which we might be moving?

PITT: I don’t think so. I think Arthur made a very important point that I think has to be stressed here, and that is that the U.S. does not have a monopoly on the most difficult and complex standards.

We are seeing a move afoot all over the globe to see foreign regulators come up with new standards that often either mimic what we’ve done in Sarbanes-Oxley or go beyond it or come up with different approaches that are more creative sometimes than the ones we’ve come up with.

So the notion that companies who list in the U.S. can withdraw from listing in the U.S., it seems to me, is not a very difficult concept to get a hold of. Why should a company be forced to comply with the laws in the U.S. if it chooses not to?

What I do believe is that the global marketplace will differentiate between companies that meet the higher standards and those that don’t. There is going to be a competitive impact. In the U.K., in Canada, in many countries, regulators have said they want to emulate a lot of the standards that we have established in Sarbanes-Oxley. And companies that aren’t listed on the New York Stock Exchange may find themselves confronted with an advertising campaign that basically says that some of these companies may have substandard governance, substandard accounting—if that were the case—substandard activities, et cetera. And investors will have the ability to make those decisions. But to me, the notion of forcing a company once it has made the decision to de-register to stay here makes absolutely no sense.

STEIL: If I understand you correctly, your broad principle is that the market is going to lead us to higher standards, that we don’t need to be concerned about a global race to the bottom, as it were, because the market will demand higher standards—not just within our borders but abroad.

PITT: Well, I do believe that what we are witnessing globally is that the global regulatory system is increasing and elevating standards. I don’t think that we any longer have the capacity to let all of this subject be decided basically by global competition. That is not what I am suggesting at all. But what I do think is that regulators are working much more closely together in sync. The international activities of the SEC have borne enormous fruit. And the regulators are all trying to elevate standards within their own country. And as a result, I believe both the market and the regulators globally will elevate the standards, and that’s as it should be.

STEIL: Richard, I want to bring you on to the question of competition among exchanges globally.

New York Senator Chuck Schumer recently called on the CFTC—that’s our derivatives regulator—to stop the Intercontinental Exchange, ICE, from listing crude oil contracts that would compete with futures listed on the senator’s hometown New York Mercantile Exchange.

Now, the logic behind this call was that trading of the contract would be regulated by a foreign regulator—in this case the U.K. Financial Services Authority—because the contract was originally developed and listed in the U.K. and that U.S. investors could not be properly protected by a foreign regulator.

Now since the ICE is totally electronic and has offices and clients around the globe, it is obviously very difficult to say where the trading is actually located. The CFTC classified the ICE as a so-called exempt commercial exchange leaving it free from CFTC oversight because of the presumed sophistication of the firms buying and selling in its marketplace. But at what point can we say that an exchange begins to be American and is therefore subject to our regulations?

BREEDEN: I feel like I’m taking a law school exam here. (Laughter.) It takes me back.

Well, it’s an interesting question. I served until the closing of the merger with the New York Stock Exchange and will serve on the board of Archipelago, the world’s finest and most efficient electronic exchange. (Laughter.)

I suppose when things are done in cyberspace—and I would defer to the architect guys to correct me, one of whom’s here this morning, if I’m wrong about this. But in theory, you can say it’s going on anywhere. A regulator or ex-regulator like me would kind of look for where are the computers and which wall are they plugged into and what country is that in, if you really had a question about somebody’s power to regulate.

I think, you know, it’s interesting—these are not new issues, and if you—when you leave, when you go back to your office and if you’re on a high floor and you look out at the New York skyline and you look at all those tall buildings, it’s not surprising that an elected official of the state of New York cares about having people in all those buildings, and the financial industry is quite important to us here in New York City and to the United States. And the same is true in London and in Hong Kong and in other places that are financial centers.

And so it was true of my time. I’m sure every single one of us who have dealt with the fact that there is an element of mercantilism that comes on the part of both elected officials and regulators in countries all over the world that if they can use the regulatory game to make business more attractive in New York or more attractive in London, they’ll do it.

What is important in the global market is to recognize that globalization is a discipline on all of us. If you impose impractical, unworkable and excessively costly rules in any country, people who have a choice will move their activity somewhere else. And so that doesn’t mean you have to plunge headlong into a race to the bottom. And by the way, the SEC has always given foreign companies different executive compensation disclosure rules for 50 years, so that’s a new race to the bottom.

But you know, you have to weigh, when you’re a regulator, the importance in your value system of things that you think are important to accomplish, like investor protection, like efficiency of the market that can’t exist without transparency. But you also have to keep an eye on, all right, how many burdens are we loading onto the system before people will unplug the computers, put them in a container and ship them to Dubai—or at least ship them through Dubai’s ports to—(laughter)—to somewhere else. And I don’t think those pressures are going to go away. There’s nothing—they go back to Adam Smith, and that’s a consequence of free markets. And we love free markets.

So you know, I just think that’s something that’s a discipline on regulators all around the world. And hopefully in the U.S. we’ve done a good job in the past of maintaining our system of high levels of investor quality but also doing it in a way that doesn’t drive business out of the country.

LEVITT: You know, what Richard says I think is a common denominator for every one of us. If there’s one word that we’ve all wrestled with, and I think fairly successfully, it’s balance. And I think each of the people on this platform today have wrestled with the issue of how far you go in balancing the interests of investors with corporate interests. And they don’t always coincide, no matter how politically appealing that argument might be.

And I think that because of this sense of balance, you’d find very few differences on any significant issue that any of the four of us have taken.

I think that’s rather remarkable since we represent different political ideologies and yet, the commission has been remarkably immune from political pressure through the years.

STEIL: Well, Bill, I’m going to give you the last word before I open this up to the floor. I’m going to see if I can bring out some differences, maybe not necessarily within the SEC or within this panel, but between the SEC and the CFTC.

This concept of an exempt commercial exchange, allowing a foreign derivative exchange to operate in the United States, having U.S. members without direct CFTC oversight is not a concept that the SEC has.

Arthur, you know when you were SEC chairman that you were lobbied very intensively about European exchanges being allowed direct access into the United States.

How do you see that tension between the more liberal CFTC regime and the somewhat more restrictive SEC regime resolving itself over time?

LEVITT: Well, I think the SEC has always stood for equal regulation in this country of foreign entities coming in here. And I guess I believe in that. So I guess I would not think that somebody that’s going to operate in this country should not have to conform with our laws.

PITT: I just want to make one observation. This was always much more difficult when I was on the staff at the SEC than when I became chairman. It’s very hard when you’re on the staff not to think that the world revolves around the SEC, that every issue really should be decided by the SEC.

I think as both Richard and Arthur and as Bill is indicating as well—have suggested when you’re chairing an important regulatory agency, you do need a sense of balance.

But it is in my view inappropriate to assume that you can compare what the CFTC does on a direct one-to-one basis with what the SEC does. The SEC’s task is really dealing with corporations and with investors as well as with capital markets. And the CFTC’s role really deals in the trading of commodities or financially derived commodities, and that’s a very different role.

And you can’t always (import ?) what the SEC does for a company that has public shareholders with what the CFTC does with organizations that trade certain kinds of instruments. They just aren’t directly comparable in my view. And therefore, I think we make a mistake in trying to suggest that the two organizations have to have exactly the same approach.

One of the most rewarding experiences I had was when we implemented the Commodity Futures Modernization Act standard and there was finally allowed to be the creation of single-stock futures, which look very much like options and so on, Congress in its infinite wisdom—I use infinite in the poetic sense—(laughter)—but Congress in its infinite wisdom suggested that the rules that came out had to be jointly adopted by the SEC and the CFTC. And if you look back, we adopted every single rule unanimously, both by the SEC and the CFTC, and it was a very useful and constructive working experience.

I just think they have a very different regulatory mandate and mission from the SEC, and it’s important for people to keep that distinction in mind.

STEIL: Okay. I’m going to open up the floor for questions now.

When I call on you, please wait for the microphone to come around, stand up, speak directly into the microphone. Tell us who you are; tell us your affiliation. And please direct your question to a specific member or specific members of the panel so we can accommodate as many questions as possible.

Right here in the front.

QUESTIONER: Joe Bartlett, Fish and Richardson.

My concern is the size of the orphanage in the United States and the fact that liquidity events for deserving small and midcap companies are difficult to impossible with a threshold of 600 million (dollars) in market cap versus on the AIM 50 million (dollars) in market cap. My question, having to do with transparency and competitiveness: Is there a way for the regulatory regime in this country to solve the problem of—what is it, 7(,000), 8(,000), 9,000 companies in the orphanage with little transparency because there is no analytical coverage and not enough money to pay for analytical coverage? Is the AIM, the Alternative Investment Market, going to eat our lunch with a $50 million threshold for small to midcap companies who would like to go public and their investors who would like to have an IPO liquidity event? Or will the IPO window stay closed for anything below, say, 6(00 million dollars) to 700 million (dollars), which is the ordinary mantra today?

That’s a question to everybody in the panel.

To you, Harvey, first, I guess.

PITT: Why do I feel—well, nevermind. (Laughter.)

Let me say, I think that the problem that small and midcap companies have is getting appropriate coverage, and that’s a difficulty. But one of the concerns that I have, and a portion of the problems that we saw starting in 2001, is that for many companies, the notion of going public was really ill-advised. And the marketplace does not permit the system to operate as it should. Even now when we hear questions about the expenses, the small and midcap companies—something which I think is a very, very serious issue and one of the problems in Sarbanes-Oxley because it applies a one-size-fits-all methodology, which makes absolutely no sense. And indeed, Congress was importuned not to do that and that was refused. So Congress knew what it was doing. I think it made a mistake, and I think we’re dealing with that particular mistake in Sarbanes-Oxley.

But the standards of Sarbanes-Oxley requiring internal controls, for example, and other things—these are very vital and particularly with smaller companies, although we’ve now seen that you can have a company in the Fortune Top 10, like Enron, be premised on fraud.

But for these smaller companies, the critical need is for information to be out there and for people to know what they’re investing in, or for people to be taking a risk. And I’m not persuaded that the rush we saw in the ’90s because of booming capital markets for companies to go public—and we saw that in the dot-com area. Companies went public on nothing more than a lick and a promise. They had a great concept and they went public. They had no operations. They didn’t even necessarily have any great plans. They had no results. And yet, they were public companies.

And now all of a sudden, you have a statute that says well, wait a minute; before you can take money from the public or keep taking money from the public, you have to give them certain fundamental types of information. That to me is progress. And so I’m not one of these people—even though I believe very strongly in free market economy, I believe that the intended discipline of Sarbanes-Oxley was important.

So when companies that are small and midcap go public and now have a decided lack of coverage, my view is that they have to start working together to find ways to get their stories out into the marketplace and generate interest in them. But I don’t think that the SEC, for example, can artificially dictate what companies are going to get coverage and by whom. I think that really has to be a function of the marketplace.

STEIL: Arthur, very briefly: You’ve spoken out recently about the application of Sarbanes-Oxley to smaller companies. Do you want to clarify your views here today?

LEVITT: Yeah, I think it’s terribly important that in our goal of trying to bring balance and fairness into the process and relieve burdens that may fall unequally on smaller and larger companies we don’t lose sight of the fact that these are public companies. They’ve passed the threshold.

And investors who are hurt because of poor internal controls and lose money on a small public company are no less aggrieved than if it’s a large public company. So I think the notion of setting up two standards in terms of internal controls would be a terrible mistake.

And I think thoughtful people in the industry—particularly the accounting industry today, which I think is so much better leadership than it has ever had before—is beginning to think about ways of addressing this problem of how to deal with 404 in a constructive way and helping smaller filers. I think ultimately that will be the answer, but I would be very much opposed to indefinitely continuing two standards of compliance with Sarbanes-Oxley according to size. I think that’s absolutely wrong.

STEIL: Bill, you wanted to come in here.

DONALDSON: Well, I think that the—if you step back and look at Sarbanes-Oxley and look at what it has done to improve corporate governance across the board, I think the returns are very good. I think there are very few people who would disagree that corporations and boards of directors are paying more attention and that the real issue here is 404. And I think that we formed a committee, independent committee of small companies to address the specific cost problems of small companies. And that committee met yesterday, as a matter of fact, and will publish its report, and I think that will be out there for people to criticize.

I think the initial application of 404 was flawed in terms of a lack of a risk-based approach to the whole thing. And I think that we met—we being the SEC and the PCAOB—right after the first year and told corporate America that they were applying 404 in a wrong way, that they were—you don’t have to count the paper clips and count the rubber bands. You have to look at this from a risk-based stand and make that judgment and we’ll be with you.

And I think you are going to see the costs of 404 go down, not as dramatically as everybody predicted, but I think they’re going to go down in this third year that we’re in. And I think we’re going to see a more intelligent application of it.

As far as small companies are concerned, I don’t think that—I think there has to be judgment applied and that’s what we tried to bring together in a very representative group to see if we couldn’t come up with some formulations that addressed the particular problems of small companies as opposed to the one-suit-fits-all approach. And I think that’s going to happen.

BREEDEN: Michael Capellas and I spent more money on 404 compliance than anyone on the planet earth times ten or a hundred. So this is a subject that is terribly important. And 404 has had some problems. I think in the most part to echo—I think what Arthur said—it’s been the way in which the accounting profession has implemented the statutory language and there was a microscopic level of detail that is, frankly, not in the law.

And I think the PCAOB and the SEC and the profession and the business community have to work together to try and get the focus right. It’s a good concept. I am not sure that the problem really is in the law as much as in the implementation and the things Bill mentioned, and other things are going on to try and correct that.

It’s worth noting, I think, that the cost of 404 in the aggregate from every single public company is probably 1-10-millionth of the cost of executive compensation—(laughter)—and I don’t hear anybody saying we should get rid of executive compensation because it’s too costly. So the things that benefit investors, we suddenly have to get rid of, but I think we need to kind of bear that in mind.

And so I think the controls issue and even 404—it’s fixable. And we shouldn’t turn our back on a terribly important principle.

And lastly, I agree with my dear friend, Harvey almost every single time, but when you go back and read the transcript of this session, you’re going to see a line in there that says Congress knew exactly what it was doing. And I respectfully will put a little footnote on that—question mark on that.

STEIL: Okay, we’ve finally got some shades of differences in our panel here.

In the far back.

QUESTIONER: Hi. Alan Patricof, Apex Partners. I can’t resist but saying I spent my whole life with small companies and testified before the small commission that Bill’s talking about, and 404 needs to be changed for small companies. And I discussed this with Arthur as well.

What I want to ask you about is something different, and forgive me if it seems a little bit technical. But Chairman Cox just announced—maybe three or four weeks ago; maybe it’s two months ago—that he would give special consideration, expedited treatment to those companies who complied with the new technology of XBRL, which is, as you know, the tagging of every number on a financial statement. And this has, I believe, dramatic implication for the securities industry, the accounting industry, the banking industry. And I’d just like to hear what you have to say and what you think about that. And how fast do you think that may be broadened across the entire investment community?

DONALDSON: Are you asking me?

QUESTIONER: I don’t know. You’re the most recent, so you might have the most knowledge of it.

DONALDSON: I think that the XBRL has tremendous potential, not only for corporate America but also for the regulatory agencies.

For those of you who are not familiar with XBRL, I’ll give it to you in layman’s terms, which is my terms. But basically it is investing in numbers and figures on paper and electronic capability, if you will, that will allow the numbers to be manipulated. You can take data that comes in on XBRL and you can push a button and compare all the statistics of one company against an industry. The SEC used to have back rooms full of people—

PITT: Bill’s using the word manipulated in a positive sense.


DONALDSON: You’re right. (Laughter.) So I think the sooner we can get to corporate America reporting on XBRL and sending the data in, it has tremendous potential for analysis within the regulator agency and it has tremendous potential for corporate America using XBRL capabilities within their own corporation.

Can I just ask the questioner a question? Is your concern that the smaller and midcap companies, this puts them at somewhat of a disadvantage?

QUESTIONER: To your comment about 404: It’s a separate issue and not at all about—no, I’m very much supporting the XBRL. I’m just wondering if it’s adopted as a standard, it may even solve some of the problems about international differences. And certainly it will increase the ability of comparability of companies and it will be a standard.

DONALDSON: That’s absolutely the right point and that’s where I was headed with that, but you’ve clarified it.

STEIL: John?

QUESTIONER: John Beattie from UBS. This question is for Mr. Pitt.

I’d like to follow up on the issue of financial materiality of the threshold. Let us assume that a foreign oil company wants to list on the New York Stock Exchange. Let us assume further that a foreign oil company invests in a country that is already subject to U.S. economic sanctions, such as Sudan. Now, given this issue, shouldn’t it—given the fact that U.S. companies would not be permitted to invest, you know, in Sudan or such other countries, shouldn’t this be a consideration that is material as far as the SEC is concerned in determining whether or not to permit a listing on the New York Stock Exchange?

STEIL: Another bar exam question. Who’s going to tackle that one?

BREEDEN(?): The answer is no.

MR. : He addressed it to him. (Laughter.)

PITT: He used my name, but I think he really meant Bill. (Laughter.) But let me—I’ll start and say very briefly that I go back to comments that I think both Arthur and Richard made earlier. Where a stock is traded is almost an irrelevancy. And the reason for that is, if it’s not listed on the New York Stock Exchange, people will buy it on whatever exchange it is listed on. So to my way of thinking, that really isn’t the concern.

I think there are two critical concerns. The first is, where the capital-raising transactions take place—and I will admit to a very, very strong bias and prejudice. When I was chairman I wanted every capital-raising transaction to take place in the U.S., if possible. I think we have the best markets, and I’d like to see them continue that way. That’s one concern.

And the second is, when investors are put into instruments of companies like this, do they have all the material information? And to some extent, when companies like that list on the New York Stock Exchange, investors may get better information than if the companies aren’t permitted to list on the New York Stock Exchange.

I really think that this is a marketplace judgment. And in my view, if the company is doing something that can have adverse consequences on its operations, then it seems to me that investors should be aware of that because, in my view, that would have financial materiality.

But I don’t see the issue of preventing listing on the stock exchange as solving any problem that is related to the activities of the particular company.

STEIL: Before I go to the next question, I want to see if somebody else has a comment here about what I think is the heart of John’s question, that if we’re looking at companies abroad engaging in activities that Congress feels are repugnant, or they are dealing in countries against which we’ve applied sanctions, is it in any circumstance sensible stopping such companies from raising U.S. investor capital? And if so, how do we sensibly go about doing it? For example, it may not be sensible to keep them from listing on the New York Stock Exchange, but perhaps it’s sensible to prevent U.S. investors from investing in those companies—

LEVITT(?): We cannot. We cannot do it. Our whole system is not based on merit regulation; it’s based on full disclosure. And there is no way that we can prevent, no way we should try. It’s a road to market obscurity if you go down that path.

DONALDSON(?): There is no faster way we could destroy the vitality of America’s markets than—and forgive me for saying this, because I know I am in the heart of the foreign policy establishment here, and you have great concerns about these issues of foreign policy, and I don’t mean to trivialize them—but there is no faster way we can destroy the willingness of foreign institutional or individual investors to participate in the U.S. market than trying to impose our parochial standards of our foreign policy on what investors can do and not do and what they can see and not see.

Disclosure is fine. There’s no problem if you want to say, if you have operations in North Korea or Sudan that you need to disclose it. So just like in the old days, before South Africa changed, when there were a lot of investors, there were a lot of unions, there were a lot of public pension funds, there were a lot of individuals who said, I don’t want to invest in companies that have significant operations in South Africa. Well, fine. You can disclose and require people to disclose do you or don’t you operate in these countries. But you have to let the investors make the decision about whether that is important to them. It can’t be done by congressmen; it can’t be done by the secretary of State; it can’t be done by the NSA. It needs to be a free capital market. And we either believe in free markets or we don’t.

As Arthur said, if we go down the road of picking and choosing every latest iteration of our foreign policy and trying to apply it to the listing standards in the capital markets, I can’t think of anything dumber, and I can’t think of anything that is more certain to be a disaster for the long-run future of our market.

PITT: In case there’s any doubt you had. (Laughter.) You have unanimity on the platform. It’s a slippery slope, and I think it’s just impossible to believe that we can get—we—the SEC is a disclosure agency and it’s totally up to individual investors whether they want to not buy that oil company because of its operations in Sudan—not up to us to prevent—try and prevent them—

STEIL: For better or worse, this debate is not going away, as Frank Wolf will consistently remind you and your successors.

BREEDEN(?): And when he gets 218 more votes to go along with his opinion, and 51 members of the Senate, then it will get really serious debate. (Laughter, light applause.)

STEIL: Right there, John.

QUESTIONER: Hi, I’m John Watts. Thank you. I’m with FFTW, a global investment company, and also an officer of the board of a global bank’s investment company.

But I have a question about the prosecution of malfeasance or possible malfeasance in the U.S. and the balance thereof. There seems to have been in the past few years a heightened degree of disclosure and uncovering of wrongdoing in corporate America, and some of that led by the SEC and some led by others. And there have been allegations that there’s been an excessive amount of zeal and a sort of collateral damage and casualties amongst noncombatants because of this excessive zeal.

I wonder if the panel would comment generally about that charge that things have been overdone in prosecution of wrongdoing compared to the potential positive effects on the capital markets. And if, in fact, there has been excessive zeal, does this indicate that perhaps SEC, perhaps before any of you were chairman, were not as aggressive as they perhaps should have been in these prosecutions?

STEIL: Arthur, do you want to—

LEVITT: I do not think that there has been excess in this regard. This is a bad time to be a corporate miscreant. Judges, juries, editorial writers and regulators take a pretty jaundiced view of corporate misdeeds, as they should. Because ultimately it’s not Sarbanes-Oxley; it’s humiliation and embarrassment that has changed the culture of the board room.

And I do not think that the SEC has gone too far, nor do I believe that this indicates that our predecessor chairs were not doing vigilance. I think that this waxes and wanes. And the next bull market will bring its own series of corporate wrongdoings, which will be addressed by our successors.

But I think there has been—the unique part of all of this has been the empowerment of institutional America—the CALPERS, the TIAA-CREFs, the state pension funds, the mutual funds which heretofore had been very quiet participants in the process of governance—now have been in power, and some of them are taking constructive advantage of that. If they stay the course, I think that will do far more to give investors a better break than any amount of enforcement diligence. But I do not think that we have been excessive in the application of securities laws with respect to corporate wrongdoing.

DONALDSON: I think if you take what Congress asked us to do in terms of Sarbanes-Oxley, they gave the SEC new powers, if you will, to go after wrongdoers with fines that hurt, and that the fine cannot be just an ordinary cost of business. They also gave us power to repatriate through (fair ?) funds some of the monies that came in in fines that go back to our shareholders. I think it was the intent of Congress to stiffen up the penalty side of things and, in effect, as I say, make that not just an ordinary cost of doing business but something that really hurt.

STEIL: What about the question of how to decide exactly who to punish, whether we should be punishing the executives of these companies or whether we should in fact be punishing the shareholders through fines levied on the companies?

DONALDSON: Well, that’s a very good point. It’s a point that we’ve debated at the SEC, you know, ad nauseam, if you will, in terms of, are you simply hurting shareholders once again by fining them? And I think you have to take each situation.

If the company, if the shareholders have been benefited by the malfeasance, a stock that’s up, and they use the stock to acquire another company and so forth, and the shareholders have gotten the benefit of that, then that is a situation where the current shareholders should pay the fines if you will. Management certainly should pay the fine, but the shareholders as a group should pay the fines.

BREEDEN(?): I just want to follow up, Bill, because I think you almost stated it too narrowly. With all due deference to the debate that went on in the commission about this—and I do agree you have to look case by case, but the point of the sanctions and the ability to have fines on companies as well as the sanctions you have against individuals is a classic word that every single area of law enforcement recognizes is important, as well as our strategic defense, and it’s called deterrence.

You have 17,000 companies out there. And of course, occasionally, you make an example of somebody that has decided that this public company with other people’s retirement money in it, other people’s college educations is a nice honey pot that they can just steal from.

And so, of course, you want to lock up the Bernie Ebbers and the Dennis Kozlowskis and the guys who are doing the stealing. But there are definitely times when—you don’t want to get to a situation where culturally maybe you see more often in Japan where there’s some huge scandal and one person comes out and takes responsibility and resigns, and then everything goes on just like it was going on before. That’s not our system. If you want to steal from investors, you are going to get whacked, and that’s a good part of our system, and I hope it never changes. (Laughter.)

PITT: I just want to say that one of the major contributions that Sarbanes-Oxley made, it has basically discredited what I call the four-monkey defense—by CEOs, CFOs and other corporate officials—which is, I didn’t say anything, I didn’t do anything, I didn’t know anything, and I certainly didn’t understand anything.

And if you look at the defenses, that is the—that was the Ebbers defense; it was the Scrushy defense, and we’re now seeing it with Ken Lay. The four-monkey defense has been put to rest by Sarbanes-Oxley. That is not an overreaction. The people who run the show should bear responsibility for what takes place on their watch. That is a simple process.

I do think that your question raises a very significant additional question—maybe it wasn’t intended to—which is the competition between various prosecutors and regulators. And that, I think, is a disastrous consequence where people use the prosecutorial mechanism for political gain or achievement. That, it seems to me, has been a significant problem.

And make no mistake about it: If investors are to be protected and you can have people in the states bring causes of action for fraud, that helps investors. The more people who have resources and who are capable of going after fraudulent misconduct, the better it is for the investing public and the better it is for our capital markets.

But when you have people competing to try and grab headlines and to try and get credit for bringing actions without actually thinking them through, that, it seems to me, is a problem, and there needs to be greater convergence within this country of all the people who have prosecutorial power. That’s been sadly lacking, but not for want of trying by the SEC.

STEIL: Well, we at the council take pride in our own hard-close rule. It is 9:45. So I want to thank you all for coming. And I want to thank in particular our panel. You were very stimulating.










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