==========================================START OF PAGE 1====== THE FEDERAL-STATE RELATIONSHIP IN SECURITIES REGULATION REMARKS OF COMMISSIONER STEVEN M.H. WALLMAN BEFORE THE SEC/NASAA SECTION 19(c) CONFERENCE Washington Court Hotel Washington, D.C. April 29, 1996 *The views expressed herein are those of Commissioner Wallman and do not necessarily represent those of the Commission, other Commissioners or the staff. U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 ==========================================START OF PAGE 2====== OPENING REMARKS OF STEVEN M.H. WALLMAN COMMISSIONER U. S. Securities & Exchange Commission Before the SEC/NASAA Section 19(c) Conference Washington, D. C. April 29, 1996 THE FEDERAL-STATE RELATIONSHIP IN SECURITIES REGULATION It is my pleasure to be with you today to kick off this annual meeting of state and federal securities regulators. As you know, my remarks will be my own and do not necessarily represent the views of the Commission, the other Commissioners or the staff of the Commission. Pursuant to section 19(c) of the Securities Act, we have worked together in a collaborative and cooperative effort seeking to: (1) maximize the effectiveness of regulation; (2) maximize uniformity of regulatory standards; (3) minimize interference with capital formation; and (4) reduce the costs and paperwork imposed by government regulation on the capital raising process. These efforts have borne fruit over the years. The question always remains what more can be done, and can what is already done be done better. Recent Congressional activities in particular have quickened this ongoing inquiry. I would like to share with you some thoughts for what I believe may be a reasonable approach to our mutual securities regulation responsibilities. I come to my conclusions starting with some premises. First, we all want to prevent fraud. We want investors to make informed decisions based on truthful information. Second, duplicative regulation, unless one party or the other adds substantially different insight than the other, serves little purpose. Simply put, we should try to avoid duplication. Third, uniformity, simplicity, certainty, ease of reference ==========================================START OF PAGE 3====== (including codification of interpretations) all lower costs of compliance given a specified regulatory scheme. Looking to one place to determine what rule applies to make a filing, to calculate a fee, to communicate on comments, is easier than looking to dozens of places to do those things. Fourth, I believe strongly that flexibility must be maintained. Innovation, other than that it will occur, is hard to predict. I would be very opposed to any regulatory scheme that locked in or mandated any particular law where the scheme made change or amendments to the law practically impossible. There is a tremendous difference between encouraging uniformity and mandating it in a manner that precludes innovation. I would be very opposed to the latter. Fifth, regulatory assets should be allocated to the highest and best uses. We all have comparative advantages in what we do. We should utilize those advantages in satisfaction of our common goals. Sixth, regulation should be cost-effective. What do these premises suggest? As described more fully below, there is an essential and critical role for both the states and the federal government in securities regulation. The real issue is how best to focus or allocate our collective and scarce resources in the protection of our nation s investors. Corporate Offerings. Drawing the Line. One area potentially ripe for elimination of duplicative oversight -- and its codification -- is in connection with corporate offerings. All the states already provide exemptions for offerings by companies whose securities are listed or authorized for listing or traded or authorized for trading on the NYSE, AMEX or the NMS. One place then to draw a line is at that level. The logic for that line is plain: Companies making public registered offerings that fit that category have, in addition to satisfying our requirements of full and fair disclosure, a second set of substantive reviewers monitoring the company, namely the exchanges or the NASD. And all other companies then also have potentially a second set of reviewers in addition to us, namely all of you. Consequently, if we believe that something more is needed to supplement full and fair disclosure and the in-depth and intensive review of ongoing businesses that we provide in connection with public offerings under the Securities Act, then the exchange/NMS line has some compelling logic to it. Another argument could also be made with some ==========================================START OF PAGE 4====== persuasiveness. Namely, that if there is full and fair disclosure and an in-depth and intensive review under the Securities Act of an ongoing business, then -- except in certain problem areas that I will return to in a minute -- that single review might suffice without an additional overlay of another regulatory review. Consequently, one could draw a line for where there need not be multiple layers of governmental oversight at the level of ongoing businesses that have, for example, at least three years of audited financial statements, as opposed to those businesses that might have only two, one or even no years of operation. For discussion purposes I have called this the S-1 versus SB-2 approach. The idea is to separate those companies with significant audited, operating history for which full disclosure and intense review is meaningful, from those where it is not. Obviously, in order to ensure further that the review is meaningful in the sense that there is a substantial company with a track record that will serve as a basis for an effective review (in other words to ensure that there is something actually to review), one could add to, or one could substitute for, the three-year audited history requirement, an asset, earnings, revenue or other test. One reasonable test would be to add the post-offering assets level that triggers required filings under 34 Act Section 12(g). That level, which is increased periodically, will soon be $10 million. The logic here is simple: at that level of assets the company has substance, there is something to review and it is expected that the company will remain in the full federal scheme of periodic disclosure requirements under the 34 Act. A $10 million dollar asset test alone (without an audit component) would have resulted in exclusively federal review of 27 out of 70, roughly 40%, of the NASDAQ small cap equity IPO s in 1995. ==========================================START OF PAGE 5====== In sum, either of these lines: exchange/NMS; or S-1 plus, meaning three years of audited operating history (as contrasted to the SB-2) and/or a post-offering 12(g) asset test, would make sense. I have a mild preference for the S-1 plus approach. Other alternatives, such as $25 million of public float or revenues that simply duplicate the list of NMS and above companies do not make sense -- if we were to opt for that level, better we should just make it clear and not confuse the public by leaving the line at NMS and above. Finally, as this matter is discussed, let us keep these numbers in mind -- at the $10 million assets level, for example, we are only talking about affecting approximately thirty offerings a year. Areas where Dual Regulation is still Needed. There are problem areas as I mentioned where I believe investors would be benefitted by dual regulation, both federal and either state or exchange/NASD. These are the offerings involving so-called bad persons (persons promoting or associated with the deal with some history of securities violative conduct); blank checks; blind pools; "penny stocks; limited partnerships and other direct participation programs; and roll-ups. Of course, if the line is drawn at the NMS and above level, then any legislation addressing the federal-state relationship need not specifically address this concern because it is already covered. Other Corporate Offerings where Federal Codification of Preemption is Appropriate. In addition, as noted as one of the premises, to the extent there are opportunities to codify at the federal level various universally-accepted exemptions from state registration, such as for employee stock option or other benefit plans and sales to the extent they are made to qualified purchasers, we should do so. Such codification provides beneficial certainty, simplicity, ease of reference and uniformity. Indeed, such codification, including with respect to corporate offerings as described above, would be a valuable benefit to be obtained through federal legislation. As an aside, various secondary market transactions, in particular those falling under sections 4(1), 4(3) and 4(4) of the Securities Act, would best be governed by a single federal standard. Relieving Burdens on Small Business. Finally, if there is to be state regulation for our smallest offerings, consideration could also be given to whether burdens on small businesses at the federal level could be reduced. This could be accomplished by providing for Regulation A offerings to reach the $10 million as opposed to $5 million level, while ==========================================START OF PAGE 6====== extending Rule 504 (in its old form where registration in at least one state was required) to $5 million. The current Rule 504 could be left at $1 million. Such increases would be consistent with the rationale underlying the increase in the 12(g) threshold about to be adopted by the Commission. Investment Companies. With regard to investment companies I share the prevailing wisdom at this time, i.e., that such companies should be regulated and overseen by the Commission. State regulators should, of course, maintain their anti-fraud authority, to the extent such authority it is not used for back-door regulation. ==========================================START OF PAGE 7====== Investment Adviser and Associated Person Regulation. Let me turn briefly to investment adviser and associated person regulation. With respect to examination and inspection of investment advisory firms, the current approach embodied in the Gramm bill, namely that firms with some minimum dollar amount in assets under management be reviewed by the Commission and other firms be reviewed by the states, seems quite reasonable. Whether the line should be at $5 million or $50 million or some other number, I will defer to further study. But the approach has clear merit and, not coincidentally, is reasonably reflective of my views as discussed on corporate offerings. The area of associated person regulation is more complex. Let me reaffirm what I have said before. I believe there to be a significant developing issue here, namely, the changing demographics in this country that are causing a paradigm shift in the role of advisory professionals -- a shift to where investment advisers are becoming extraordinarily important. We have substantive licensing and examination at the state level of contractors, beauticians, dieticians, doctors and lawyers, not to mention securities brokers and real estate brokers. With the increase in self-direction of retirement accounts, the importance of the associated person providing point of sale advice to a retail customer becomes apparent. These advisers will be determining how one s life savings will be invested for the future. How many other professionals will play as important a role in our society? For that reason, I believe we all need to give great thought to whether there should be substantive education, licensing or qualification requirements -- traditionally state regulatory requirements -- for those wishing to provide advice to retail customers. Obviously, advisers to mutual funds would not need to be included because the fund directors have a fiduciary responsibility to oversee the adviser and can monitor competency. Advisers primarily to non-retail investors similarly should not have to satisfy such requirements: those sophisticated investors generally can fend for themselves. The bottom line for me is clear though, we should all consider whether some form of licensing is necessary to ensure the competence of retail oriented associated persons -- a category of professionals that I believe will grow greatly in numbers over the next decade. Consequently, with respect to initial licensing or continuing education-type qualifications, I would be loath to support at this time any notion that the states should be preempted, regardless of whether such persons work for an investment adviser who has more than some specified level of assets under management. To do otherwise would be to say that lawyers, doctors and accountants need not be licensed, even if they sell only to unsophisticated persons, if they happen to work for a large enough law firm, HMO or accounting firm. However, we all ==========================================START OF PAGE 8====== must keep an open mind as this issue is considered. The best solution may well be for the states to recognize private accreditation -- such as CFA -- in lieu of a state run procedure. I would also suggest for your consideration that state regulators themselves could coordinate better -- for example, state insurance and bank regulators should work together with state securities regulators to review the overall system of licensing relating to those persons who provide financial planning advice to retail customers. Broker/Dealers. With respect to broker/dealers, I believe there are some areas where exclusive federal jurisdiction makes sense. For example, we should have one national standard for matters that are inherently "firm" oriented: things like "books and records, "net capital, "bonding," and other requirements that pertain to the financial responsibility of the organization. These are items where the states enforcement efforts should be run in parallel with the Commission s, but the standards themselves should be federal. This can be accomplished, for example, by having the states adopt standards that are the same as the federal standards. Clearly, however, where we have nationwide businesses operating across state lines, we should attempt to avoid multiple, differing standards. By contrast, I believe quite strongly that items that essentially relate to sales practices should be subject to both federal and state regulation. There are "point of sale" problems where more locally based regulators may be first alerted to the problem and may be better able to monitor the offending behavior. And there are endemic problems in some firms that require a broader approach, and many problems that seem local are in fact widespread. We at the SEC need to be involved as well then. In this area of sales practices, etc., the answer to promoting a better allocation of resources is continued coordination and cooperation among regulators, not preemption of the states. Anti-Fraud Enforcement. Before reaching my last topic, and one of my favorite ones, namely technology and the changes it will bring, let me mention what I believe is probably the most difficult topic of all in this area of federal-state securities regulation: namely, what to do in the anti-fraud area. I recognize that this issue is one that has major interest groups on both sides, and that nothing will happen on this issue soon, and that it will not even be addressed in the current legislative session. Nevertheless, I believe responsible participants in this debate must recognize the issue and, eventually, inform their thinking with the merits of the different arguments. Specifically, one has to wonder if ==========================================START OF PAGE 9====== we will be able to have a viable system of national, and increasingly international, capital formation, if we are to have multiple, disparate anti-fraud laws. We all know in this room that anti-fraud laws can be used to merit regulate, to impose substantive requirements, and in fact to create whole new regulatory regimes. When employed at the federal level, the use of the anti-fraud laws in this manner can be dealt with. Even where a national offering must endure fifty disparate state regulatory regimes, make filings, become licensed and pay fees, it is time consuming and expensive but ultimately it can be done. And once an offering is cleared, the effort is over. Nevertheless, I do not believe there are many here who still think that this type of cost should be visited on those companies that are investment companies and at least NMS and above corporate issuers. But what if the scheme were multiple, disparate anti-fraud laws, all with potentially different interpretations as to what is actionable conduct and what is not that might come from different courts after years of proceedings brought by private plaintiffs after an offering is already complete and with liability in the tens or hundreds of millions of dollars for statements made in the offering or afterwards. Will issuers be able to make a cost-effective nationwide offering under that type of scheme? Is that really what we want in order to promote investor interests? So far, for a number of reasons, we have basically seen private class actions brought only under federal law. But if states begin to modify their private action fraud laws to override the federal scheme, the question will surely be raised as to whether we will continue to have the type of market that has produced so much capital and done so well for investors in this country. I do not know for sure what the answer is, and, who knows, perhaps more private actions will in fact turn out to be good -- but I do believe thought has to be given as to whether we need consistency, at least for those national offerings such as NMS and above, in our anti-fraud provisions much more than we need it in our registration and licensing provisions. At least two approaches would satisfy the consistency requirement: either require for private rights of action -- I am not concerned that state securities administrators would abuse their power -- that state anti-fraud laws not be inconsistent with the federal standard, or preempt state law in the area of private actions so that private actions are brought under the federal standard. Again, this is a very difficult, but a very important, issue. We cannot duck it -- we must fashion the best thinking we can to ensure that our system works as well in the next century as it has in this one. Electronic Technology and Securities Matters. And now let me move to the next century. As you know, the use of technology to engage in securities transactions and the ==========================================START OF PAGE 10====== securities business is an area of particular interest to me. As regulators, we need to examine how new technologies can be utilized beneficially by investors, issuers, intermediaries and others. What protections need to apply to electronic media to help and protect investors while facilitating the use of new technologies? Specific developments we are already encountering include the use of electronic technology by issuers to market their own offerings; electronic bulletin boards sponsored by third parties that list ongoing as well as proposed registered and exempt offerings; electronic bulletin boards sponsored by or associated with registered broker/dealers that offer issuers a method to locate and communicate with investors; and issuer pages that would allow willing buyers and sellers of the company's securities to locate each other. How should these matters best be regulated to serve the needs of investors -- many of whom are clamoring for the ease of service, low cost, and extra benefits that come from the new technologies? Ultimately, we must recognize that we are regulators of information and that there is nothing changing more quickly than information technology. Communications that used to be constrained easily within a state were also cost-effective communications. Local newspapers or radio, oral communication to a group, etc., were all less expensive than national media. Today, perhaps the easiest way to communicate with millions may be on the Internet where it is remarkably difficult to limit communications to within a state, or even within a country. The traditional regulation by securities administrators of information flows by geography simply breaks down. I believe then that a response based upon our historical way of regulating securities issuers, professionals and transactions will, simply put, be wholly ineffective in dealing with the increasing use of the Internet and other new technologies in the securities business. I therefore suggest that we use some of the time we have together now, and take whatever additional time this will surely take after today, to think about ways of working with this technology to provide us the best return on the use of our collective resources in furtherance of investor interests. Conclusion. We both have roles that are critical and essential to the regulation of securities. And given those roles there is much that can be done to rationalize the overlap in responsibilities, eliminate some of the duplication in our allocation of resources, reduce some of the costs that regulation imposes on others, and improve our overall regulatory system in a manner that will benefit investors. Conferences like this are a critical link in the chain of communication among all of us. I wish us all a constructive conference and hope that some of the ideas I have ==========================================START OF PAGE 11====== raised today will be useful in our discussions. Thank you.