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Transformative changes afoot for the SEC in 2014

Feb 9, 2014 @ 12:01 am

The following is an edited excerpt of a Jan. 27 keynote address, “The SEC in 2014,” by Securities and Exchange Commission Chairman Mary Jo White to the 41st annual Securities Regulation Institute in Coronado, Calif.

For nearly 80 years, the SEC has been playing a vital role in the economic strength of our nation. Year after year, the agency has steadfastly sought to protect investors, make it possible for companies of all sizes to raise the funds needed to grow, and to ensure that our markets are operating fairly and efficiently.

That is our three-part mission.

But while commitment to this mission has remained constant and strong over the years, the world in which we operate continuously changes, sometimes dramatically.

When the commission's formative statutes were drafted, no one was prepared for today's market technology or the sheer speed at which trades are now executed. No one dreamed of the complex financial products that are traded today. And not even science fiction writers would have bet that individuals would so soon communicate instantaneously in so many different ways.

It is because we operate in this vast, fast and ever-evolving securities market that the commission, as the regulator of that market, must constantly adapt in order to continue to be effective.

With that in mind, I thought I would speak about some of the transformative changes at the SEC in 2014 and, while doing that, also preview a few of the specific rule makings and other initiatives that I expect to be on our 2014 agenda.


Although there have been many significant changes since the SEC's inception, few have had as much impact on our markets as the advances in technology. The manual trades on the exchange floor of the 1930s have given way to trading that is high-tech, high-speed and widely dispersed among many different venues, some of which didn't even exist when I last gave this address but which now occupy significant parts of the market landscape.

And that landscape changes and evolves further every day.

It is not only our job to keep pace with this rapidly changing environment but, where possible, also to harness and leverage advances in technology to better carry out our mission.

And despite significant resource challenges, we are doing precisely that across the agency. Let me give you a few examples.

Our Quantitative Analytics Unit in our National Exam Program has developed a revolutionary new instrument called NEAT, which stands for National Exam Analytics Tool.

With NEAT, our examiners are able to access and systematically analyze massive amounts of trading data from firms in a fraction of the time it has taken in years past. In one recent exam, our exam team used NEAT to analyze in 36 hours 17 million transactions executed by one investment adviser.

Among its many uses, NEAT can search for evidence of potential insider trading by comparing a database of significant corporate activity like mergers against the companies in which a registrant is trading and analyze how the registrant traded at the time of those significant events. NEAT can review all the securities the registrant traded and quickly identify the trading patterns of the registrant for suspicious activity.

In 2014, our examiners will be using the NEAT analytics to identify signs of not only possible insider trading but also front running, window dressing, improper allocations of investment opportunities and other kinds of misconduct.


This past year, we also brought online another transformative tool that enables us to collect and sift through massive amounts of trading data across markets instantaneously, an exercise that once took the staff weeks or months. We call this technology MIDAS — the Market Information Data Analytics System.

Every day, MIDAS collects 1 billion records of trading data, time-stamped to the microsecond. Previously, only sophisticated market participants had access to this type and amount of trading data, and even fewer were able to process it. At the SEC of 2014, we are aggregating this data and presenting it on our website along with a wide range of analyses. We have made these analyses readily accessible on your computer or even your tablet, with data available in clear, easy-to-read charts and graphs.

MIDAS is already revealing some important data-based realities that may resolve some of the speculations about behavior in today's market structure. This month, for example, the SEC staff published an analysis showing that for the most part, the advent of public transparency for “odd lot” trades does not seem to correspond with a decline in such trades. The staff noted that this result suggests that a lack of transparency may not have been one of the drivers for breaking trades into odd lots, which some observers have suggested is a technique to hide trading activity.


Our approach to technology in 2014 is not limited to building systems like these for us to keep pace with the evolving technology of the markets. We are also focused on ensuring that the technology used by exchanges and other market participants is deployed and used responsibly in a way that reduces the risk of market disruptions that can harm investors and undermine confidence in the integrity of our markets.

Most recently, following the interruption of trading in Nasdaq-listed securities last August, I met with the leaders of the equities and options exchanges. At my urging, they pledged to work toward enhancing the integrity of market systems, including the critical market infrastructures that can prove to be “single points of failure,” such as public feeds of quotes and trades.

They have since been working hard to develop and implement such measures, and I expect more to be done to address these vulnerabilities in 2014.

In addition, I anticipate that the commission's 2014 rule-making agenda will include consideration of the adoption of Regulation SCI, which stands for Systems Compliance and Integrity. As some of you know, Regulation SCI would put in place new, stricter requirements for the use of technology by exchanges, large alternative trading systems, clearing agencies and securities information processors. Regulation SCI can be and should be the market-side counterpart to the intermediary-focused Market Access Rule adopted by the commission in 2010 to better regulate how broker-dealers manage the technological and other risks associated with direct access to markets.

It is not just technology that has changed over the life of the agency. So too have the financial products that investors, businesses and other market participants use.


In 1990, for instance, few people would have heard of a credit default swap or any of a number of the other products that make up today's over-the-counter derivatives market. Yet two decades later, such derivatives comprise a multitrillion-dollar market.

The Dodd-Frank Act directed the SEC for security-based swaps and the Commodity Futures Trading Commission for all other swaps to create an entirely new regulatory regime for this massive market. Once this regime is fully in place, many over-the-counter derivatives will be traded and cleared on venues accessible by a wide range of market participants, with trade data made readily available to regulators and disseminated to the public. What was once an opaque, bilateral market will largely become a transparent, centrally cleared market.

The commission has proposed substantially all of the rules required to implement this new regulatory framework. With our proposal for the cross-border application of this framework last year, I expect the commission in 2014 to move forward with finalizing and implementing these rules.

Currently, the commission is considering two significant proposals for additional reform that were put out for comment last June. One is a floating net asset value for prime institutional money market funds, the type of fund that experienced problems during the financial crisis. The other proposal would require money market funds under certain circumstances to impose a liquidity fee and permit the imposition of redemption gates. This proposal is designed to stop a “run” and limit the resulting instability. These proposals could be adopted alone or together.

We have received hundreds of letters on the proposals, with a wide range of differing views that we are reviewing closely. Completing these reforms with a final rule is a critical priority for the commission in the relatively near term of 2014.


The financial crisis also revealed how another product — asset-backed securities — could create undue risks to market integrity and investors. Shortly after the financial crisis, the commission proposed a new set of disclosure rules for asset-backed securities, which have evolved with the Dodd-Frank Act. Finalizing these new disclosure rules remains an important priority for the commission in 2014.

A related effort is the rules we are required to adopt jointly with several other agencies governing the retention of a specified amount of risk by the sponsor of an asset-backed security. We re-proposed those rules late last year, and finalizing them will be a priority for 2014.

Just as we have seen market technology and products evolve over time, we also have seen massive change in the ease and speed with which information and capital flows. This, in turn, has led companies, investors, Congress, the SEC and others to reconsider how companies can seek capital and communicate with potential investors. Indeed, we are at the start of what promises to be a period of transformative change in capital formation.

In 2013, according to our estimates, capital raised in public offerings totaled $1.3 trillion, as compared with $1.6 trillion raised in offerings not registered with the SEC, with over 65% raised in new and ongoing Rule 506 offerings. So the private-offering markets already rival the public markets in terms of capital raised.

And in 2012, Congress passed the JOBS Act, directing the commission to implement rules that will have a significant impact on the private-offering markets. In July, the commission adopted rules implementing the JOBS Act mandate to lift the ban on general solicitation, and the rules became effective Sept. 23. Although the existing Rule 506 continues to be a popular method for capital raising, issuers are taking advantage of the new rule. Preliminary information collected by our Division of Economic and Risk Analysis shows that through Dec. 31, approximately 500 offerings were conducted, raising approximately $5.8 billion.

Then, in October and December, the commission proposed rules to implement the JOBS Act mandates with respect to crowdfunding and Regulation A. While the final framework of these two exemptions is yet to be determined by the commission, if the enthusiasm for them is any indication, I expect strong interest in raising capital through these mechanisms.

These rule changes for the private-offering market are just the start of the commission's efforts, for the changes demand that the commission stay focused on the ongoing implementation of the exemptions, what market practices develop, how much capital is being raised, how investors are impacted and whether fraud or other misconduct is occurring in these markets.


The agency's evolution in response to a rapidly changing market is not confined to rule making or market oversight. We have also found it necessary to adapt our policies, priorities and approach with respect to enforcement. And no discussion of the SEC in 2014 would be complete without my touching on some of these changes and giving you some idea of what to expect this year. The coming year promises to be an incredibly active year in enforcement as we continue to vigorously pursue wrongdoers and bring enforcement actions across the entire industry spectrum.

For many years, the SEC, like virtually every other civil-law-enforcement agency, typically did not require entities or individuals to admit wrongdoing in order to enter into a settlement. This no admit/no deny settlement protocol makes a great deal of sense and has served the public interest very well. More and quicker settlements generally mean that investors receive as much, and sometimes more, compensation than they would after a successful trial, and without the litigation risk or the inevitable delay that comes with every trial. Settlements also can achieve more-certain and swifter civil penalties, and bars of wrongdoers from the industry or from serving as officers or directors of public companies — all very important remedies for deterrence and the public interest.

So why modify the no admit/no deny protocol at all? It is not a new question, and one that many of you continue to ask. Even before my arrival as chairman, the Enforcement Division decided to require admissions where parallel criminal or other regulatory cases were brought with admissions. Why? Because admissions can achieve a greater measure of public accountability, which can be important to the public's confidence in the strength and credibility of law enforcement, and the safety of our markets. It is not surprising that there has also been renewed public and media focus on the accountability that comes with admissions following the financial crisis, where so many lost so much.

As we go forward in 2014, you will see more cases involving admissions. When and how we decide to require admissions will continue to evolve and be subject to further articulation in the cases we bring and as we discuss it publicly.

This year will likely see us complete our docket of major investigations stemming from the financial crisis. As we do, our focus and resources will naturally turn to other priorities. This shift has already begun.

Last fall, the Enforcement Division formed a Financial Reporting and Audit Task Force. This dedicated group has very talented accountants and attorneys who will broaden and thereby improve the way we look at financial reporting misconduct.


As I have discussed, technology has worked a fundamental shift in the way securities are priced and traded — a shift that has only accelerated in the past several years. In the past two years, we have tried to send a strong enforcement message to the exchanges and alternative trading systems that play critical roles in securities market transactions — that they must operate fairly, within the rules and with a close eye on their responsibilities to safeguard their technology.

Cases have been brought against an exchange that inadequately tested its initial public offering systems and was therefore unable to handle a highly anticipated IPO and then did not follow its own rules in the aftermath, against a different exchange for compliance failures that gave certain customers an improper head start on trading information and against a dark pool for failing to protect the confidential trading information of its subscribers. When technology presents new opportunities for innovation, changes must be deployed responsibly, after careful testing, and within the rules and parameters of the trading environment. Market structure integrity actions will remain a priority in 2014.

There are many other enforcement priorities for 2014 that you should be aware of. These include, but are by no means limited to, the Foreign Corrupt Practices Act of 1977, insider trading and microcap fraud. It will, in short, be a very busy year in enforcement.

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