July 7, 2011
Good morning. Today, we are voting on the first major tranche of regulations to be finalized under the Dodd-Frank Act. Before we start, I would like to thank each of the five teams for their work on the regulations. Moving from proposed to final regulations has been – to say the least – an involved process, and each team has advanced with unrelenting dedication.
With the Commission’s approval, the regulations before us today will become not only the law of the land, but the Commission’s official statement as to its interpretation of the Act it is charged with administering. So, it is appropriate to consider our duties to market participants and the public generally before issuing final regulations. Our duties can be characterized in two words: (i) transparency and (ii) clarity.
First, we should provide greater insight into our process for finalizing regulations. Last week, I requested that the Chairman and each of the Commissioners consider posting drafts of the final regulations on the Commission website seven (7) days before the public hearing in order to provide the greatest possible transparency into these final rulemaking proceedings. I have not yet received an answer regarding whether the Commission will adopt this proposal. Such transparency is valuable because it is likely to lead to more informed Commission decisions as the public receives one last chance to identify unintended consequences.
Considering the speed at which the Commission will make policy decisions through the rest of the year, and the impact of such decisions on the markets, this last and final check will improve our process and improve the quality of our final regulations. I am not asking for any extension in time, just additional transparency.
Second, market participants deserve clear and straightforward regulations so they can readily identify (i) their legal obligations and (ii) when (and with what resources) they need to begin complying with such obligations. Failure to provide clear guidance will not only generate market uncertainty, but it may prevent us from effectively enforcing our own regulations. Two of the final regulations before us today –Anti-Manipulation and Large Trader Reporting – demonstrate the strides that the Commission has made towards issuing clear and enforceable regulations, and what that we have yet to do.
Last October, I expressed concerns about how the Commission would interpret its new anti-manipulation authority. I was concerned that the Commission would fail to provide clarity as to how this new genre of manipulation would be defined in relation to the prohibition of price manipulation under Section 9(a)(2) of the Commodity Exchange Act (“CEA”), which was specifically preserved by the Dodd-Frank Act, and in relation to the new antidisruptive trading practices. In spite of receiving comments from twenty-seven parties, the Commission has determined that, but for a single word inadvertently left out, the proposed regulatory text was neither vague nor susceptible to due process constitutional challenges.
I have concerns that the Anti-Manipulation rule has not provided adequate clarity and that such vagueness as to the course of action that will be taken by the Commission in enforcing this rule will add confusion to the markets. The wholesale incorporation of standards and case law developed under Rule 10b-5 of the Securities Exchange Act of 1934 runs the risk of disregarding the unique qualities of the futures and derivatives markets in its attempts to apply concepts developed in the securities markets such as insider trading based on misappropriation. It is therefore essential for the Commission to be clear as to how judicial precedents under Rule 10b-5 guide our judgment and decision-making as we exercise authority under this rule.
More generally, the preamble could be clearer as to how the Commission will use the new authorities in Section 6(c) in conjunction with other new authorities such as those over antidisruptive trading practices and insider trading. I believe the Commission could have been more responsive to requests for guidance through the provision of examples of violative conduct. This is especially so with regard to relatively new concepts of liability in our markets such as insider trading and “fraud-on-the-market.”
Upon implementation of this rule, the duty will primarily fall on the enforcement staff to pursue cases that will ultimately define and distinguish reckless and intent based behavior as manipulative or fraudulent and sort out the confusing new penalty authorities, which this rule seems to purposely avoid. It will be up to the Commission to guide enforcement staff as they begin to pursue these new areas of authority, and I am confident that my colleagues will take this particular role very seriously.
Make no mistake; this rule will give the Commission clear authority to pursue cases of intentional conduct designed to deceive or defraud market participants without the heavy burden of proving that such conduct ultimately resulted in an artificial price. Such authority not only furthers the goals and purposes of the CEA, but brings greater consistency to legal standards of manipulation across all financial markets.
I support the Large Trader Reporting Rule because obtaining data is fundamental to our oversight responsibilities. The Large Trader Reporting Rule has made a number of changes to address public comments. Certain of these changes allow the Commission to fulfill its market surveillance goals without imposing extraneous costs on end users. For example, Large Trader Reporting clarifies that end users may keep information regarding their cash market transactions in the format that they have developed in the normal course of business, rather than a format that the Commission dictates.
However, not even the Large Trader Reporting Rule can adequately resolve a fundamental issue with our final regulations. Briefly stated, the problem is: how can the Commission move forward on a final regulation implicating “swap dealers,” when the Commission has not determined if the term captures end-users? I recognize that the Commission will obtain the lion’s share of data from financial swap dealers. My concern is with those end-users that may be characterized as non-financial swap dealers. Even though the Commission is voting on Large Trader Reporting today, the Commission cannot determine the full benefits and costs of this regulation until the Commission defines “swap dealer” and “swap.” As I have stated previously, end-users did not cause the 2008 financial crisis. Every dollar of cost that the Commission imposes on end-users may translate into increases in energy or food costs or squeeze farmers and other industrial producers who are unable to pass on these increased costs.
I am pleased that the Large Trader Reporting Rule has attempted to provide some assurance to end-users by mandating compliance only after the “swap dealer” definition becomes effective. However, at that point, end-users will only know whether their day-to-day transactions constitute “dealing,” but not whether these transactions implicate “swaps.” For example, many end-users rely on trade options in their normal course of business, and will not know whether the Commission will regulate those options as “swaps.” I know that the Large Trader Reporting Rule attempts to address this dilemma by indicating that the Commission may not require such end-users to comply with the rule for an additional six (6) months. Also, the rule indicates that end-users who are not certain whether they are “swap dealers” may petition the Commission or staff for further relief. Obviously, these solutions are not perfect. The uncertainty surrounding “swap dealer,” “trade option,” and “swap” may cause end-users to divert resources from their normal energy and agricultural business towards reporting technology, while waiting for the Commission to finalize the relevant definitions. I wish we could offer end-users more clarity. Regrettably, this is the deal on offer at the moment.
Given the interdependencies of our various definitions, and the definitions of “swap dealer” and “swaps,” I would encourage the Commission to provide an implementation plan to give those end-users caught in our regulatory crosshairs some idea as to when they should expect the Commission to ultimately resolve whether they are “swap dealers.”
Final Regulation Schedule and Implementation Plan
Mr. Chairman, before I close, I must renew my request that the Commission publish, for public comment, a schedule of its consideration of final regulations and a proposed plan for implementing over 50 such regulations. As I noted in our last hearing and in previous Commission meetings, the final regulation schedule would permit the public to hold the Commission accountable for its progress under the Dodd-Frank Act. Additionally, in virtually every meeting I am in, market participants are requesting that the Commission propose an implementation plan. I believe firms are sincerely interested in fully complying with the final regulations, if only the Commission would inform them when they should be prepared to comply. Each and every meeting I am in, this view is confirmed. Market participants are preparing to implement the final regulations, but have no idea if they should be ready in 8 or 18 months. By providing the market with a plan, it will improve compliance with our regulations.
I noticed that, in her prepared remarks before the House Financial Services Committee, Chairman Schapiro indicated that the S.E.C. is working on an implementation plan that will include opportunity for public comment. As she stated:
“After proposing all of the key rules under Title VII, we intend to consider seeking public comment on a detailed implementation plan that will permit a roll-out of the new securities-based swap requirements in an efficient manner, while minimizing unnecessary disruption and costs to the markets. Let me assure you that the implementation plan is not a mechanism for delay. Instead is should help facilitate the important and necessary reform of the OTC derivatives market.”1
It’s time that we end the rulemaking mystery, and pull back the curtains so the market has the opportunity to review the implementation plan and provide comment on its feasibility.
Mr. Chairman, it is imperative that we develop a more transparent process by previewing our final rules before we vote on them and to provide market participants with a rulemaking schedule and a detailed implementation plan so the market can prepare by making the necessary investments, reorganizing their business and hiring staff in order to comply with the rules.
Mr. Chairman, let me close by thanking the staff for their hard work, patience and cooperation. I genuinely appreciate their efforts.
1 Testimony on “Financial Regulatory Reform: The International Context” by Chairman Mary L. Schapiro, U.S. Securities and Exchange Commission Before the United States House Committee on Financial Services, June 16, 2011, available at http://financialservices.house.gov/UploadedFiles/061611schapiro.pdf.
Last Updated: July 7, 2011