Author
When Arthur Levitt became chairman of the U.S. Securities and Exchange Commission in 1993, he could look back on 16 years of Wall Street experience and know how arcane the world of investments might appear to the average investor. He set out to dispel the myth of the investment broker as being all-wise, and made it his special mission to educate the consumer. Levitt established the SEC's Office of Investor Education and Assistance and implemented a series of town hall meetings focused on investor education. In the following interview with Minneapolis Fed President Gary Stern, Levitt says, "If there is any legacy that I would wish to leave to this institution, it is that this commission respected the interests of the individual investor."
Levitt also talks about the effects of the Gramm-Leach-Bliley financial
modernization legislation and the impact of a globalized electronic
market on regulatory structure. Although acknowledging increased
fraud as a result of the Internet, Levitt says, "If I had a magic
wand, would I wipe out the Internet to protect investors from that
fraud? No way." He adds, "The balance of benefits from the Internet
vastly outweighs the negatives of the mischief that can be created."
STERN: Prior to passage of Gramm-Leach-Bliley, you and others raised questions about the proposed regulatory structure that would result from financial modernization. Did the eventual legislation address your concerns?
LEVITT: Yes, it did. My primary concern was preserving the principles of functional regulation for securities activities. I think that the act successfully addresses that by striking a good balance between removing, among other things, the banks' blanket exception from broker-dealer registration while letting banks continue to engage in certain traditional bank securities activities directly. I was concerned with that part of the legislation that tried to define the roles of financial regulators. I think the act does this by recognizing each regulator's area of expertise. We're currently working with other regulators to draft a memorandum of understanding that would put meat on the bones so that we can coordinate our oversight responsibilities. We also called for the creation of a new type of holding company, an investment bank holding company, that would have the commission as its umbrella supervisor, and the act incorporates the investment bank holding company concept. We're considering rulemaking at this point to flesh out these new investment bank holding companies so that U.S. broker-dealers that opt into this model can compete overseas effectively without being subject to banklike rules that really do not fit their business models.
You know, I'm often asked the question about how you put aside issues of turf and come to grips with joint regulation of financial structures. And I've often thought that the fact that [Fed Chairman] Greenspan and [former Treasury Secretary] Rubin and I have known one another for 40 years has made for better policymaking than might otherwise exist. There was never a question in our minds as to whether we could rely on a commitment made by one another. There was never the need to go through the kind of "getting to know you" that often takes up most of the term of an incumbent agency head. Now, does that lead to success? I hope so, but it hasn't always been that way. The recent relationships certainly have made for better policy decisions.
Back to Gramm-Leach-Bliley. Lastly, I'd add that the act addresses my concerns about the mutual fund area. In particular, it addresses the conflicts of interest that may arise when banks advise or affiliate with mutual funds. We intend to go through rulemaking to implement the provisions of the act. The act recognizes the traditional jurisdiction of the commission and the bank regulatory agencies.
STERN: You refer to the term "investment bank holding company." Is that what we in the banking business would call the financial holding company that's created by the act? In light of, for example, Schwab's purchase of U.S. Trust, do you expect the difference between banking and securities firms to persist over time, or is that something that—if we're sitting around talking about it 10 years from now—won't be a distinction we'll make?
LEVITT: Investment bank holding companies are similar to financial holding companies. Without getting into too much detail, the investment bank holding company structure permits U.S. broker-dealers to have the commission—rather than one of the bank regulating agencies—as their global consolidated supervisor. As for your second question, it's my personal feeling that the distinction will endure. While the financial services industry is quickly moving forward toward the integration of its securities, insurance and banking sectors, I strongly believe that you will continue to find a growing cadre of specialists who provide specialized services. I don't see a gigantic consolidation of banks and brokerages that will eliminate the kind of entrepreneurial spirit that has contributed to making our capital markets some of the strongest in the world. I think for every PaineWebber that may be acquired by someone, there will be a new specialty kind of brokerage firm that grows up that will be the PaineWebber of the future.
STERN: I remember, back in May 1975, all the predictions that we were going to wind up with a handful of major brokerage firms and that would be it. Obviously, like a lot of extreme predictions it turned out to be dead wrong.
LEVITT: I do not expect that.
STERN: Let me ask you about functional regulation, which you've touched upon. How uncomfortable should we in the banking regulatory business be with functional regulation, given that as you already mentioned, your perspectives and purposes are different from a bank regulator's? And yet we have to defer to you in those particular lines.
LEVITT: Like so many things in government, the best regulators, the best administrators, are ones who respect the utility of the word "balance." And it's a mistake to assume that a bank regulator is not interested in eliminating fraud just as much as a securities regulator. It's also a mistake to think that the commission is not concerned with the financial riskiness of brokerage firms. So the lines are not that rigid, and I think through the years the philosophic gaps between us have diminished. With the proliferation of banks getting into the securities and mutual fund business, all of us will recognize that some of those same principles will be maintained in both environments. In fact, I believe they must be maintained in both environments.
STERN: Let me focus a little more explicitly on the SEC. Both the SEC and the Fed were created after economic crises to respond to particular needs, but over time both organizations have evolved to meet changing needs and have constantly had to reassess their roles and functions. Generally speaking, do you foresee changes in the core responsibilities of the SEC in the coming five or 10 years and if so, of what type?
LEVITT: I think every commission has to be mindful of the environment in which it operates. It's not merely the political environment, which very often is a constraining factor on any government agency, but it's also both the economic environment and the systemic environment. Now, when I say the systemic environment, I am referring specifically to the dramatic changes we are experiencing in the area of market structure. And to respond to those changes, this agency in the past two years has been compelled to be more proactive in terms of market structure than any commission in history. I think that's likely to continue.
STERN: By market structure what do you mean precisely?
LEVITT: How we integrate electronic markets with existing agency markets. I believe we're moving inexorably toward a globalized electronic market—not within the next decade but within the next five years. How does our regulation encourage that rather than so discourage participants and investors that our preeminence in that arena diminishes or evaporates? What kinds of self-regulating structures are adequate to this new electronic environment? What kinds of regulatory entities are necessary to protect very different kinds of players engaged in the markets of the future?
STERN: I assume those are types of issues you're grappling with right now.
LEVITT: Yes, and we will continue to grapple with these issues even more in the future. The securities acts of 1933, '34 and '40 have been among the most remarkably resilient acts in the history of our country in that they have subjected themselves to amendment and adaptation to allow our markets to do as well as they've done. That process of change has been very dramatic in the past two years and will continue to be even more dramatic over the course of the next two or three years, because for the first time there is credible international competition. And I think it's the obligation of future commissions to see to it that we don't lose our edge.
STERN: How should consumers feel about the evolution you're describing, from the kind of markets we've known to a global electronic market?
LEVITT: I think the evolution will create more opportunities for investors, greater amounts of diversity, more sources of information and more competition. The commission, through its change in the order-handling rules and through a number of initiatives, addresses this issue and drives home the point that this commission is motivated above and beyond everything else by a concern for the individual investor. If there is any legacy that I hope to leave a successor, it's the firm commitment to primacy of the individual investor in terms of every policy we embrace and every decision we make.
STERN: Do you think the information disclosed by banks and bank holding companies allows the investors to accurately price their equity and debt, and if not, what additional types of disclosure would you recommend?
LEVITT: I would say that, by and large, bank disclosure has improved through the years and will continue to improve. I think this poses unique challenges to regulators and raises both systemic and risk management concerns. Now as you probably know, we're working with other financial regulators and a private sector advisory committee on public disclosure chaired by Walter Shipley [recently retired chairman and chief executive officer of the Chase Manhattan Corp.] to analyze the types of information that financial firms publicly disclose. It's the goal of this committee to develop best practices to improve market discipline through public disclosure. I guess it's too early for me to comment on an issue that's currently being analyzed by the various financial regulators and Walter Shipley's committee.
STERN: Even so, would you care to embellish your comments further?
LEVITT: I think that banks have come a long way. They are far more transparent today than ever before. Would I like to see greater transparency? Sure. We are working with the Fed and the Comptroller's Office to support Walter Shipley's committee, and I understand the goal of the committee is to develop options for improving public disclosure by both banking and securities organizations.
STERN: Again, speaking specifically about banks and bank holding companies, do you think that investors in holding company debt and equity provide at least some market discipline on these firms and if so, why? And if not, why not?
LEVITT: Whether the market forces can adequately assess a particular bank's risk profile is something that regulators continue to talk about. Some would say that the market can assess the risk profile of a particular firm if there's enough public information available. Others argue that share price is only loosely related to a firm's riskiness and, in fact, may really reflect the liquidity of the firm's shares rather than the firm's riskiness. They point to interest rates and Internet stocks to show that factors other than an entity's risk profile may predominate in an investor's evaluation of market price. The commission is looking at these issues through participation in a joint disclosure project, which may issue a report by the end of year on what may be the proper forms of risk disclosure.
STERN: Is there something unique about regulating an e-trade Internet site compared to the traditional brokerage operation?
LEVITT: Yes. I think the unique part of it deals with public perception. I have some concern that the typical user of an electronic site having read about, seen movies about, watched television shows about the power of the trader, fancies himself or herself a trader. To do things with the stroke of a key, and to feel that they couldn't do it any other way, is dangerous in my judgment, because these people lack the discipline, the resources and the temperament of a professional trader. I worry about individuals feeling that they've got the power of a trader. It's largely a job of investor education. Is there more fraud as a result of the Internet? You bet. If I had a magic wand, would I wipe out the Internet to protect investors from that fraud? No way. I think the balance of benefits from the Internet vastly outweighs the negatives of the mischief that can be created. No government agency has the resources to adequately protect investors from their own foolishness. But we are, I think, effectively using our Web site, holding town meetings all over America and using other educational devices to inform the public about the risks inherent in the Internet.
There are a few significant differences, and the issues that arise include suitability. Traditional brokers are required to know their customers and only make recommendations that are suitable to their customers' personal situations. Online brokerages, for the most part, are not giving advice, so in most cases suitability principles do not apply. The commission is monitoring the situation to see if marketing techniques used by online trading firms trigger those suitability requirements.
STERN: Are there in fact more people trading?
LEVITT: Yes.
STERN: And foreigners as well?
LEVITT: Yes.
STERN: Is the SEC concerned about the proliferation of volatile high-tech stocks, and is there a corollary in history to an industry that issued a large number of IPOs in a short period of time?
LEVITT: I think there have been aberrations as long as we've had markets. Biotechs, oil stocks at different points in time and others that I could mention created those aberrations, and investors who weren't cautious paid the price. I have no doubt that those investors who are more emotional than intellectual at this point in the market's development will pay a similar, or perhaps even a greater, price. I'm not particularly worried about volatility in our markets. I think volatility is part of market euphoria and has its own measure of discipline imposed upon those who are mindless of risks. Investors who don't understand that risk and reward have an inexorable relationship will pay a price, and the longer the market bull run exists the higher the price that will be paid.
I think, again, investor education has been a major initiative of this commission to leverage our resources. I believe it's an aspect of the commission that will endure. It is a vital component. In the past, it's been commission action in partnership with self-regulating organizations and private rights of action that have created a triad of protection for investors. I think we've added something that's more powerful than any of the three in terms of investor education: the ability of investors to protect themselves. The three-legged stool has become a four-legged stool.
STERN: Let me pursue the education issue one step further. You created the SEC's Office of Investor Education and Assistance. Please describe how this idea developed and what you hope it will accomplish.
LEVITT: My own experience as a retail broker, as the manager of a very large cadre of retail brokers around the world, has taught me that many investors are reluctant to ask tough questions for fear of seeming stupid in the hands of an adviser whom they credit with almost godlike wisdom. Combined with that is my feeling that this agency lacks the resources to totally protect investors. So we initiated a program in Cherry Hill, N.J., seven years ago, which was attended by 35 people who asked me questions about investing for about three and a half hours. And that triggered a regular national program where within the past year we attracted 1,000 people in Albuquerque, 1,000 in Chicago and nearly 8,000 people in Los Angeles, where individuals came out and asked questions about investments, how to choose a broker, what commissions to pay—a whole galaxy of what might seem to be obvious questions.
But the level of interest in these meetings suggests to me that policymakers and political leaders have not adequately assessed the passion that lies out there about investments and investor concerns. So the program has grown. We now have a hotline; investors call the commission and ask questions directly. All the commissioners of the SEC get on this hotline and answer questions posed by investors. It's really a hands-on grass roots kind of program. My experience in the private sector taught me that the generally held view is that the Washington bureaucrats sit in their offices and do very little to reach the man and woman in the street, and we were determined to bring Pennsylvania Avenue to Main Street. It's very much what the New York Stock Exchange did when it brought Wall Street to Main Street. We're getting out and speaking from the hustings. We're identifying with political leaders in communities and with the media in those communities who jointly sponsor these events and turn out vast numbers of people vitally interested in how to better protect themselves.
STERN: It sounds like there's been a democratization of investment just as there's been a democratization of credit, and that is mostly good news but it has some downside, too, because some people are taking risks that perhaps they didn't intend to take.
LEVITT: I think in this kind of market environment greater risks are being taken and the need to protect the interests of that individual investor becomes more compelling, because I believe they represent the foundation of our markets. SEC initiatives on accounting issues, on market structure issues, on educating investors, on disclosure are all premised on the notion that without public confidence—for the first time in the history of our markets—we stand the risk of losing our pre-eminence to other markets growing in different parts of the world. If there's any legacy that I would wish to leave to this institution, it is that this commission respected the interests of the individual investor.
STERN: Among many other topics, you have recently been particularly involved with two issues, namely auditor independence and selective disclosure. Let's talk about the first one. What do you see as the reasons for taking steps to promote greater independence in the auditing profession?
LEVITT: For decades, trust in the judgment of the public accountant has helped lay the foundation for our capital markets. And that trust is dependent on the fact and appearance of the auditor's independence from the client—without confidence in an auditor's objectivity and fairness, how can an investor know whether to trust the numbers? Our financial markets simply cannot work without access to strong, high-quality financial reporting.
What we've seen in recent years is the accounting profession undergoing tremendous change—more dual-career families, increasing mobility among professionals, greater employment by audit clients of their auditors' partners, staff and spouses. And we felt the time had come to re-examine the financial and employment relationship rules.
At the same time, consolidation, product line expansion and globalization have been fundamentally altering firm structures and revenues. Many of the biggest accounting firms have become multidisciplinary professional service organizations. As a result, you can see how the debate over the role of the auditor—and the inherent pressures of practicing within a firm offering clients a range of nonaudit services—has become more pressing.
The commission believes that these developments now call for a significant and comprehensive re-examination of the rules that govern independence. And I think it's so important that at a time when more Americans' economic futures are tied to the underlying health and resiliency of our capital markets, the commission and the profession work together to ensure that the auditor independence requirements are both effective and fair.
STERN: And selective disclosure? Many say that looking out for the individual investor has been a hallmark of your seven-year tenure. How will the recently passed Regulation FD further this goal?
LEVITT: As I travel around the country visiting with investors at our town hall meetings, one of the common refrains I hear is that folks are tired of feeling that Wall Street insiders have the upper hand when it comes to getting important information. Our new rule—Regulation FD, for fair disclosure—is simple, but powerful. It says that when companies release important information, such as earnings forecasts or the introduction of a new product, they must tell everyone, not just a select group of analysts or institutional investors.
This rule struck quite a chord among investors. We've received more than 6,000 comment letters—a record—mostly from individual investors. People talked about fairness and equity and said it was about time we did something to level the information playing field. One investor said that the stock price of a company he owns fell significantly one day, though no news had been made public. But several days later the company told the world of a problem it was having. That's just wrong.
Selective disclosure undermines the integrity of the securities markets. And if people begin to lose faith in the integrity of our markets, there will be quite a price to pay. I think our selective disclosure rule will go a long way toward treating all investors alike and ensuring that individual investors, in particular, believe our markets are fair and honest.
STERN: Let me pose one final question, and that has to do with the role of the Internet, the speed with which investors can get information and make trades. Against that background, has the media become more or less important to the market?
LEVITT: More important, much more important, especially when you think of the amount and quality of information available to investors. The media is crucial in holding market participants—brokers, markets, regulators—accountable to a much higher standard. And while undoubtedly there is a substantial amount of useful information available on the Internet, the financial press continues to serve a critical role in synthesizing that information and making it readily accessible and understandable to the investing public.
STERN: Thank you, Mr. Levitt.
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