Remarks of Commissioner Sharon Y. Bowen before the Managed Funds Association Forum 2016
June 21, 2016
Thank you very much for the wonderful introduction. I’m very pleased to be here at Forum 2016. I’d also like to thank Paul for serving as moderator of our fireside chat. Today, I want to talk to you about a topic that is near and dear to my heart: improving the culture of finance and improving corporate governance. As many of you know, I spent over 30 years as a corporate lawyer in New York, and I had the privilege of counting many of the top players on Wall Street as my clients. I am a firm believer in both our markets and in the system that holds them up.
But sometimes markets aren’t perfect. They can focus too much on short-term gains at the expense of long-term profitability – what others have called “quarterly capitalism.”1 We saw the effects of that skewed focus in the recent financial crisis, we’ve seen them before the crisis, and I think we continue to see their effects even today. I believe this misaligned focus should be addressed, and that improved corporate governance is the best tool for the job.
Based on my 30-plus years on Wall Street, I’ve learned that everything – communication, a culture of compliance, a focus on reasonable risk-taking, and an appreciation of mission – flows from governance. It’s not just another tool in our regulators’ toolkits. Better governance decreases systemic risk. Better governance increases profits. Better governance acts as a superstructure on which all other market and proscriptive regulations are built.
It is worth noting, by the way, that there have been governance regulations put in place in parts of finance already. For instance, two of our systemically important DCOs are subject to governance regulations, and the governance rules we proposed in 2010 and 2011, but did not finish, were strong rules that I largely support. I believe that more needs to be done.
Today, I will discuss my ideas to improve governance in CFTC-regulated entities. These ideas are in addition to our prior governance proposals and I hope they become a part of the corporate governance rule re-proposal.
I also hope that these ideas go beyond the CFTC and the markets we oversee. As I have said before, governance is not a topic that is unique to the futures or swaps markets. Instead, ideas for improving culture and governance should be broad enough that they can be applied to not only firms in other parts of finance, but theoretically to companies in other sectors of the economy. After all, a principle that boards should be holistically independent and have a significant number of independent directors can be just as easily applied to the board of a manufacturing company as it can to the board of a Swap Execution Facility (SEF).
I therefore hope that these ideas can become part of a broader conversation about improving culture. Many people, both in the U.S.2 and internationally3 are crafting principles and standards that can be applied in a variety of settings. In the U.S., I hope to work with other financial regulators to create better governance requirements.
II. Craft Qualitative and Quantitative Standards for Directors.4
Improving corporate governance starts with the board of directors. First, we need to make sure each director and the board as a whole has the necessary levels of experience and independence to effectively oversee the corporation. To do this, we need to set both qualitative and quantitative standards.
As a basic requirement, firms should be required to establish appropriate fitness standards for their boards of directors, in accordance with our rules. For instance, all directors, including public (i.e., independent) directors should have significant experience in the industry. Also, the Commission should require that the board’s membership be reviewed annually.5 For example, swap dealers and major swap participants should avoid having directors on their boards who lack any tangible financial experience.
Furthermore, the CFTC could require that our registrants to have each board member attest to his or her level of independence on the board. Similarly, each registrant could be required to submit a statement attached to its annual review about the state of its board’s holistic independence.
Board members should meet certain fitness standards. For example, if a person is subject to a civil settlement with the CFTC or another financial regulator for market manipulation, a non-recordkeeping violation of the CEA, or securities fraud, then that individual should be prohibited from serving on the board, or significant committee of the Board for a set number of years.
I do not believe that board independence can be created overnight. Developing and fostering independence requires perseverance and the proper corporate culture. However, many small steps taken in the right direction can lead to us to the right place. A truly independent board will be less-inclined to sign off on management strategies which, while generating short-term profits, may endanger the organization’s longer term goals and prospects. An independent board will shift their focus away from quarterly capitalism to a model of sustained success that will last across the tenure of board members and Chief Executive Officers. A focus on long-term investments over short-term profit-taking should have positive ramifications for both the organization and the broader economy.
III. Require Boards to Consider Issues of Culture in their Mandatory Annual Self-Review.6
A further area of worry comes from companies’ culture. While at this point it is certainly cliché that a culture of compliance starts at the top, to perform effective oversight, a board must create a strong company ethos. To do this, the Chief Compliance Officer, who reports to the board, should be responsible for monitoring and improving the culture of compliance at each firm.
Next, the CFTC should require the board, as part of its annual review, to review any ongoing enforcement or criminal actions involving the entity and devise ways to prevent similar events in the future. In particular, attention should be paid to whether there were any settlements or court judgments for market manipulation – just as manipulation is an exceptionally serious offense, boards should take even more rigorous steps to ensure that their companies do not again engage in manipulation.
IV. Limit tenure of independent members of Audit and Compensation Committees.
To increase director independence further, the CFTC should also tackle the problem of protracted director tenure. Overlong director tenure has the possibility of reducing the benefits of director independence, as a director may increasingly take on the views of the company’s management simply by virtue of having signed off on years of previous strategies from that management team.7 However, we recognize that sustained board experience can create significant benefits, including board members acquiring irreplaceable institutional knowledge. To balance these competing interests, the CFTC should limit the tenure of independent members of the Audit and Compensation Committees of DCOs, DCMs, and SEFs, potentially limiting the tenure to a meaningful number of years.8 Board members exceeding that limit can remain on these committees (subject to governing regulations and company’s rules) and the board, but they should not be considered independent.9 In this way, we can marry the need for independence and fresh and diverse thinking with the need for experience and institutional knowledge.
V. Require disclosure of the percentage of diverse directors and senior management.
Another improvement in corporate governance can come from the membership of the board itself. The best boards have members with a diversity of experiences, including business, financial, and legal experiences. But the benefits of diversity are not limited to professional experiences. They also extend to diversity in race, ethnicity, gender identity, and sexual orientation. Increasing diversity increases corporate performance over the long term.10 It is with these goals in mind that we already have a requirement that boards of designated contract markets (“DCM”) seek to recruit board members from “a broad and culturally diverse pool of qualified candidates” and for the compositions of their boards to reflect that available diversity.11
Yet, I believe that our current requirements should be expanded. First, we should we seek to mandate a diversity requirement for all our registrants’ boards similar to that for DCMs’ boards. After all, I see no reason why diversity should only be required for DCM. Diversity is a value that is universal. I firmly believe that requiring boards of other registrants, such as SEFs, to seek to increase diversity and to have their boards actually mirror the pool of qualified candidates that could serve on their boards will be a boon to our registrants’ bottom lines and our society as a whole.
Of course, there is benefit in not just having diverse boards, but also that industry participants and the public are aware of how diverse boards of our registrants are. In this vein, the CFTC should require, to the extent allowed by law, companies to disclose the percentage of women and minorities who serve as either board members or senior managers. Not only will requiring disclosure of this information give the public increased confidence that boards are, in fact, taking steps to increase their diversity, but it should also encourage boards to be more aggressive in their efforts as well. As with most things, the knowledge that a company’s progress in this space will become public can be a powerful motivator.
VI. Require SEFs to turn over their surveillance and enforcement functions to the NFA or another SRO. Alternatively, require SEFs to become members of NFA.
Board reform is not the only mechanism for improving corporate governance. To further reduce the fixation on quarterly capitalism, swap execution facilities, or SEFs, also need improvement. Specifically, all SEFs should be under one self-regulatory organization (SRO). Each SEF generally should not be its own SRO; there should be an SRO for all the SEFs, whether that is the NFA or some other SRO. While this would require a statutory change, this reform comes with multiple benefits, both on the corporate governance side and on the firms’ balance sheets. First, this will increase the efficiency of enforcement mechanisms. Because the NFA will be making the enforcement decisions, SEFs will be less conflicted in their decisions.
Next, eliminating the unnecessary duplication in surveillance and enforcement functions for every SEF will reduce costs to the SEFs themselves. This will also standardize the rules throughout the marketplace, reducing transaction costs and increasing transparency for market participants.
VII. Require registration and testing of swap intermediaries.
CFTC should also require registration and testing of all swap intermediaries. Registration could either be with the CFTC, the NFA, or another SRO. Increasing registration requirements would give the CFTC more information about who exactly is intermediating trades for the market. This will help to determine who the participants are and if their actions are appropriate.
As for testing swap intermediaries, the CFTC needs to take action to craft a robust testing regime. FINRA, the Financial Industry Regulatory Authority, which regulates broker-dealers, already has testing requirements, including the Series 7 and Series 63, to register as a securities representative. The NFA requires the Series 3 National Commodity Futures Examination in order to register as a sole proprietor or associated person of an FCM, RFED, IB, CTO, or CTA. However, people are exempt from this examination if their activities or the firms’ activities are solely limited to trading or brokering swaps.12 There is no good reason why a person must take a detailed examination before he can become a futures broker, but the same person can become a swaps broker without ever having to sit for even a five minute examination. That just doesn’t make any sense.13
Registration and testing requirements will help companies focus on their long term health by giving them the ability to identify and retain quality employees. These requirements will also enable companies to remove people willing to take on excessive risk to the detriment of the company and its clients.
At the very least, given that the SEC14 and Department of Labor15 are in the process of implementing fiduciary duties for entities they regulate, the CFTC should take stock of their rules and see if we can’t replicate those rules in the derivatives space. This would have the benefit of increasing standardization across the financial industry, thereby reducing compliance costs.
Today, I’ve laid out a number of ways to improve corporate governance and shift directors’ and officers’ focus away from quarterly capitalism. Because corporate governance starts at the top, the boards and their directors need significant reforms. SEFs, swaps intermediaries, and commodity brokers, though, also need governance improvements.
Yet, I have one final idea to lay out. These ideas are not designed to be an insuperable policy regime, but instead are a menu of options. I am at heart a realist when it comes to regulations and I am focused on outcomes. At the end of the day, if corporate governance and culture are strengthened and the American public once again has the highest faith in our financial markets, I will be content.
These suggestions, while creating better governance outcomes, will ultimately make the financial industry safer and increase profits. And they will hopefully be the beginning of a national and international dialogue about how we can best improve the financial markets.
Thank you for your time, and I look forward to today’s discussion.
1 See Neil King, Jr., Hillary Clinton Is Not the Only Critic of ‘Quarterly Capitalism’, Wall St. J. (Jul. 31, 2015, 7:19 AM), http://blogs.wsj.com/washwire/2015/07/31/hillary-clinton-joins-al-gore-prince-charles-and-etsy-in-criticizing-quarterly-capitalism/.
2 See, e.g., William C. Dudley, Speech: Enhancing Financial Stability by Improving Culture in the Financial Services Industry, Federal Reserve Bank of N.Y. (Oct. 20, 2014), https://www.newyorkfed.org/newsevents/speeches/2014/dud141020a.html.
3 See, e.g., Financial Conduct Authority, Business Plan 2015/16, available at http://www.fca.org.uk/static/channel-page/business-plan/business-plan-2015-16.html.
4 Commissioner Sharon Bowen, Commodity Futures Trading Commission, Remarks of Commissioner Sharon Bowen before the Managed Funds Association’s 2015 Compliance Conference (May 5, 2015), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-4.
7 See generally Yaron Nili, The ‘New Insiders’: Rethinking Independent Directors’ Tenure, 67 Hastings L. J., (forthcoming 2016), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2728413.
8 See id. at 58.
9 Id. at 55.
10 See, e.g., Credit Suisse Research Institute, Gender Diversity and Corporate Performance 6 (2012), available at http://www.calstrs.com/sites/main/files/file-attachments/csri_gender_diversity_and_corporate_performance.pdf, (“Our key finding is that, in a like-for-like comparison, companies with at least one woman on the board would have outperformed in terms of share price performance, those with no women on the board…”); McKinsey & Company, Women Matter: Women at the Top of Corporations: Making it Happen 7 (2010), available at http://www.mckinsey.com/~/media/mckinsey%20offices/france/pdfs/women_matter_2010.ashx, (“Companies with the highest share of women [on executive committees] outperform companies with no women.”); Vivian Hunt, et al., Why Diversity Matters, McKinsey & Co. (Jan. 2015), http://www.mckinsey.com/business-functions/organization/our-insights/why-diversity-matters, (“Companies in the top quartile for racial and ethnic diversity are 35 percent more likely to have financial returns above their respective national industry medians…. [F]or every 10 percent increase in racial and ethnic diversity on the senior-executive team, earnings before interest and taxes (EBIT) rise 0.8 percent.”).
11 See 17 C.F.R. § 38.1150 (2012), available at https://www.gpo.gov/fdsys/pkg/CFR-2015-title17-vol1/pdf/CFR-2015-title17-vol1-sec38-1150.pdf; see also 17 C.F.R. § 38.900 (2012), available at https://www.gpo.gov/fdsys/pkg/CFR-2015-title17-vol1/pdf/CFR-2015-title17-vol1-sec38-900.pdf (“The governance arrangements of the board of trade shall be designed to permit consideration of the views of market participants.”).
12 See Proficiency Requirements, National Futures Ass’n., http://www.nfa.futures.org/NFA-registration/proficiency-requirements.HTML (last visited Apr. 1, 2016).
13 See Commissioner Sharon Bowen, Commodity Futures Trading Commission, Testimony of Commissioner Sharon Y. Bowen before the U.S. House Committee on Agriculture, Subcommittee on Commodity Exchanges, Energy, and Credit (Apr. 14, 2015), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-3.
14 Joseph Lawler, SEC Plans Conflict-of-Interest Rule for Broker-Dealers, Washington Examiner (May 19, 2016), http://www.washingtonexaminer.com/sec-plans-conflict-of-interest-rule-for-broker-dealers/article/2591810
15 Definition of the Term “Fiduciary”; Conflict of Interest Rule – Retirement Investment Advice, 81 Fed. Reg. 20946 (Apr. 8, 2016), available at http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=28806.
Last Updated: June 21, 2016