by
Chairman Christopher Cox
U.S. Securities and Exchange Commission
November 14, 2008
Dear Investor,
The mortgage meltdown and ensuing global credit crisis
during the past year have confronted our markets with
unprecedented challenges. The government´s response to
the financial turmoil has been equally unprecedented: the
Federal Reserve and the Department of the Treasury have
together committed over one trillion dollars in taxpayer funds
to support insurance companies, banks, thrifts, investment
banks, and mortgage giants Fannie Mae and Freddie Mac.
The Emergency Economic Stabilization Act (EESA),
signed into law in October 2008, gives the Chairman of
the SEC a formal oversight role with respect to the
Troubled Asset Relief Plan administered by the Department
of the Treasury. In addition, the Housing and Economic
Recovery Act of 2008 gives the SEC Chairman similar
oversight and advisory responsibilities with respect to the
conservatorship of Fannie Mae and Freddie Mac supervised
by the Federal Housing Finance Agency. These duties come
in addition to the new responsibilities the SEC is already
discharging as the statutory regulator of credit rating
agencies, and the mandate that the EESA has given the
agency to report by January 1, 2009, on the results of a
congressionally-mandated study of fair value accounting.
Response to the Credit Crisis
The agency has taken a number of other actions in recent
months to address significant issues that have arisen in the
credit crisis. When the auction rate securities market froze
early in 2008, the Enforcement Division immediately
commenced investigations of potential securities law
violations by the largest sellers of these instruments. Preliminary
settlements were reached in principle with six of the largest
firms, which would return more than $50 billion to injured
investors and make these settlements, when concluded, by
far the largest in the agency´s history. (While settlements in
principle were reached during FY 2008, the amounts were
not included in the enforcement statistics for this report
because they were not finalized by the close of the fiscal
year on September 30.)
As of the close of FY 2008, the Commission had over
50 pending subprime-related investigations involving
lenders, investment banks, credit rating agencies, insurers,
and broker-dealers. During the past year the SEC charged
the managers of two Bear Stearns hedge funds in connection
with last year´s collapse of those funds. The
Commission returned $356 million to investors harmed
when Fannie Mae issued false and misleading financial
statements. And the Division of Enforcement is currently
in the midst of a nationwide investigation of potential
fraud and manipulation of securities in some of the
nation´s largest financial institutions through abusive short
selling and the intentional spreading of false information.
As part of this aggressive law enforcement investigation
into potential manipulation during the subprime crisis, the
Commission approved orders requiring hedge funds,
broker-dealers and institutional investors to file statements
under oath regarding trading and market activity in the
securities of financial firms. The orders cover not only
equities but also credit default swaps. To assist in analyzing
this information, the SEC´s Office of Information Technology
is working with the Enforcement Division to create a
common database of trading information, audit trail data,
and credit default swaps clearing data. Our Office of
Economic Analysis is also supporting this effort by helping
to analyze the data across markets for possible manipulative
patterns in both equity securities and derivatives.
During FY 2008, the Enforcement Division also brought
the highest number of insider trading cases in the agency´s
history. In addition, the SEC brought a record-high number
of enforcement actions against market manipulation in
2008, including a precedent-setting case against a Wall
Street short seller for spreading false rumors. Overall for
the fiscal year just ended, the SEC completed the highest
number of enforcement investigations in any year to date,
by far. We also initiated the second-highest number of
enforcement actions in agency history.
Not just in 2008, but in each of the last two years, the
Commission set the record for the highest number of
corporate penalty cases in the agency´s history. And for
the second year in a row, the SEC returned more than
$1 billion to harmed investors using our Fair Funds authority
under the Sarbanes-Oxley Act. To support this record
level of law enforcement, the SEC now devotes more
than one-third of the entire agency staff to our enforcement
program. That is a higher percentage of the SEC´s
total staff than at any time in the past 20 years. The
SEC´s internal allocation of funds for enforcement in FY
2008 was the highest in the agency´s history. In this past
year, we also increased the number of enforcement
personnel by 4 percent.
Other significant actions in connection with the credit
crisis included proposed rulemakings using our new
authority under the Credit Rating Agency Reform Act to
address weaknesses and conflicts of interest in the ratings
process and to develop strong additional new requirements
for credit rating agencies. In July, we released the
findings from extensive examinations of the three largest
credit rating agencies: Moody´s, Standard & Poor´s, and
Fitch. Our examinations included hundreds of thousands
of pages of the rating agencies´ internal records and
emails relating to their ratings of subprime residential
mortgage-backed securities and collateralized debt
obligations. SEC staff also analyzed the ratings history of
thousands of structured finance products.
The examinations uncovered serious shortcomings at
these firms, including a lack of adequate disclosure to
investors and the public, a lack of policies and procedures
to manage the rating process, and insufficient attention
to conflicts of interest. In response to the findings, the
Commission proposed sweeping new rules to regulate the
internal policies and business practices of credit rating
agencies. The reforms addressed conflicts of interest and
required new disclosures designed to increase the transparency,
accountability, and competition in the credit
rating industry.
In the last year, the Office of Compliance Inspections
and Examination also conducted examinations of the
effectiveness of broker-dealers´ and investment advisers´
controls on preventing the spread of false informationa
particularly salient concern in the midst of the ongoing
market turmoil.
The Office of the Chief Accountant and the Division of
Corporation Finance acted on multiple occasions during FY
2008 to address questions regarding disclosure of fair value
measurements of hard-to-value assets in inactive markets,
consolidation of off-balance sheet entities, and the accounting
treatment of bank support for money market funds. Staff
from the SEC and the Financial Accounting Standards Board
also worked together to assist preparers and auditors by
providing clarifications of existing fair value measurement
guidance in the current environment.
When money market funds faced serious pressure in
the latter part of FY 2008, the Division of Investment
Management worked closely with investors, fund managements,
and independent directors of money market
funds to ensure the protection of shareholders, including
in particular investors in the Reserve Primary Fund, which
suspended redemptions in late FY 2008. The division also
worked closely with the Department of the Treasury in
support of its Temporary Guarantee Program for Money
Market Funds.
The Division of Trading and Markets worked to protect
customers of Lehman Brothers´ broker-dealer, investment
advisory, and investment management subsidiaries
following the firm´s bankruptcy during the last month of
the fiscal year. The division also coordinated numerous
market regulation issues including the imposition of new
restrictions and penalties for naked short selling. The
division prepared recommendations during the height of
the market turmoil in the final quarter of FY 2008, when
the Commission used its emergency authority to temporarily
restrict short selling. These temporary actions were
taken in close consultation with other regulators around
the world. The Commission also required disclosures to
the SEC of significant short positions.
In coordination with the CFTC and the Federal Reserve,
the SEC in FY 2008 worked with the financial services
industry to develop one or more central counterparties,
clearance and settlement systems, and trading platforms
for credit default swaps, as an operational step toward
bringing additional transparency to this $55 trillion
unregulated market. We also entered into separate
Memoranda of Understanding with the Federal Reserve
and with the Commodity Futures Trading Commission to
make sure that key federal financial regulators share
information more efficiently and coordinate regulatory
activities in important areas of common interest.
Future Regulatory Reform
On several occasions during FY 2008, I reported to the
Congress on serious shortcomings in the regulatory
structure that were exposed by the collapse of the mortgage
market and the ensuing credit crisis. These include
the fact that there was no statutory regulator for investment
bank holding companies. The holding company in
the case of Lehman Brothers, for example, consisted of
more than 200 significant subsidiariesincluding OTC
derivatives businesses, trust companies, mortgage companies,
offshore banks, and reinsurance companies. The SEC
was not the statutory regulator for 193 of them.
I told the Congress that when SEC regulation is backed
up with statutory authority, it is strong and successfuland
that voluntary regulation of businesses the SEC does not
regulate by statute does not work. For this reason, reforms
are needed to address other regulatory gaps as well. There
is no public disclosure nor any legal requirement for the
$55 trillion market in credit default swaps to report to the
SEC or any other agency. Congress needs to pass legislation
that would not only make credit default swaps more
transparent but also give regulators the power to rein in
fraudulent or manipulative trading practices and help
everyone better assess the risks involved.
Also in need of additional transparency are troubled
Fannie Mae and Freddie Mac, both of which are now
under government control. Although recent legislation
required Fannie and Freddie to comply with some of the
SEC´s rules, it did not subject them to the full disclosure
requirements that other public companies must follow. As
Congress determines how Fannie and Freddie will emerge
from government control, this is an omission that lawmakers
must correct.
Still other regulatory gaps persist, including a statutory
divide between the supervision of broker-dealers under
the Securities Exchange Act of 1934 and that of investment
advisers under the Investment Advisers Act of 1940.
One of the agency´s significant efforts to reconcile the
supervision of these overlapping financial services was
struck down by the courts last year. Congress has an
important opportunity to modernize the more than
half-century old legislation in this area in any comprehensive
overhaul of the regulatory system, and the SEC stands
ready to provide its expertise.
The multi-trillion dollar municipal securities market falls
in yet another regulatory black hole. It entails many of the
same risks, and is subject to the same abuses, as other
parts of the capital markets. As the economic slowdown
makes it increasingly difficult for many states and localities
to meet their obligations, and as many municipalities
continue to use interest rate swaps in ways that expose
them to risk that the financial institution on the other side
of the contract may fail, investors need to know more
about what they own. In FY 2008, investors were facing
what would have been the largest municipal bankruptcy
in American history in Jefferson County, Alabama, while
the multi-billion dollar fraud in the City of San Diego, in
which the SEC charged five former city employees this
past year, injured both investors and taxpayers alike.
Over the last two years, I have repeatedly asked
Congress to give the SEC the authority to bring municipal
finance disclosure at least up to par with corporate
disclosure by repealing the Tower Amendment. Using the
Commission´s existing authorities, in FY 2008 the
Commission proposed improving municipal disclosure by
requiring that secondary market disclosure information be
provided, in an electronic format, to a single repository. In
addition, the Commission is considering rule changes by
the Municipal Securities Rulemaking Board to expand its
Electronic Municipal Market Access system, or EMMA, to
accommodate secondary market disclosure information.
Beyond the significant issues raised by the ongoing
market turmoil, and the several actions the SEC took
during the past year to address them, the Commission
made several important decisions in areas of ongoing
interest to investors during FY 2008.
Improved Disclosure
During the past year, the SEC unveiled the successor to
the agency´s 1980s-era EDGAR database. The new
system, called IDEA (Interactive Data Electronic
Applications), will give investors faster and easier access
to key financial information about public companies and
mutual funds. IDEA will at first supplement and then
eventually replace the EDGAR system, which will become
an archive of SEC filings made prior to the new era of
financial reporting in interactive data format. Companies
and mutual funds could begin providing financial information
using interactive data as early as next year.
The decision to replace EDGAR marks the SEC´s transition
from collecting government-prescribed forms and
documents to making the information itself freely available
to investors in a user-friendly format they can readily use.
Instead of sifting through one form at a time in EDGAR and
then re-keying the information to analyze it, investors will
be able to utilize interactive data to instantly search and
collate information to generate reports and analysis from
thousands of companies and forms through IDEA.
During FY 2008 the SEC also launched the 21st Century
Disclosure Initiative, a wide-ranging internal effort to
fundamentally rethink public company disclosure. The
Initiative is examining the basic purposes of disclosure from
the perspectives of investors and markets, with a view to
creating a comprehensive high-level plan for overhauling
the current forms-based disclosure system. The Initiative is
focused on using new technology to gather information
from registrants in new ways that can generate more
dynamic, accessible, and easier to use disclosure for
investors. These same improvements would provide the
Commission with tools to better analyze risk, be more
productive with existing human resources, and better fulfill
its mission of protecting investors, maintaining orderly
markets, and facilitating the formation of capital.
This past fiscal year also saw final Commission action
removing impediments for investors and companies to set
up electronic shareholder forums, in which an unprecedented
level of shareholder involvement and interaction
might take place in the future. The Commission also gave
investors access to searchable proxy statements on the
Internet and required the electronic filing of Form D as
well as electronic filing of applications under the
Investment Company Act, and of other regulatory information.
After overseeing vast improvements to the audit
standard for internal control over financial reporting, the
Commission scheduled the final phase-in for smaller
public companies to comply with the audit requirements
of the Sarbanes-Oxley Act for fiscal years ending after
December 15, 2009.
International Coordination
The Commission´s international work was more significant
in FY 2008 than ever before. Over the last year, the SEC
made 556 requests of foreign regulators for assistance
with SEC investigationsmore than one a day on average,
and far higher than any previous year. Many of these
investigations are linked to possible wrongdoing in the
subprime area. At the same time, the SEC cooperated
with 454 requests from foreign regulators for enforcement
assistance. These international enforcement
collaborations were made possible in substantial part by
several bilateral and multilateral arrangements that the
SEC has entered into in recent years, including agreements
I executed with the College of Euronext Regulators; the
German Federal Financial Supervisory Authority; the
United Kingdom´s Financial Services Authority; the UK
Financial Reporting Council; and securities regulators in
the European Union, India, Japan, China, Korea, the
United Kingdom, France, Austria, Canada, Australia,
Portugal, the Netherlands, and Israel.
Our international relationships were especially important
this past year as the SEC worked closely with our counterparts
overseas to deal with the fallout from the subprime
crisis. As Chairman of the Technical Committee of the
International Organization of Securities Commissions, and
Co-Chair of its Subprime Task Force and of its Credit Rating
Agency Task Force, I coordinated the SEC´s regulatory
responses with regulators from every major world market.
This work provided essential analysis of how the domestic
securitization of U.S. mortgages, and the rules governing
U.S.-based rating agencies such as Moody´s, Standard &
Poor´s, and Fitch, affected risk management by banks and
institutional investors half a world away.
During FY 2008 the Commission also voted unanimously
to propose a Roadmap that could lead to the
mandatory use of International Financial Reporting
Standards (IFRS) by U.S. issuers beginning in 2014 if the
Commission believes it to be in the public interest and
consistent with the protection of investors.
The United States´ participation in the development of
global accounting standards goes back many years. In
2002, Section 108(d) of the Sarbanes-Oxley Act of 2002
required the SEC to conduct a study and report to
Congress on the adoption of a principles-based accounting
system. The report noted, among many findings, that
global accounting standardization would produce a
myriad of benefits, including greater comparability for
investors across firms and industries globally; more
efficient allocation of scarce capital among investment
alternatives; and lower costs of capital, since global
accounting standards would eliminate the duplicative cost
of preparing two sets of financial statements, and make it
easier for companies to access capital in more markets.
Since that report was completed in 2003, over 100
countries, including all of Europe, have elected to require or
permit IFRS reporting. Approximately 85 countries require
IFRS reporting for all domestic, listed companies. The market
capitalization of exchanges within those 85 countries
requiring IFRS represented approximately 35 percent of
global market capitalization in FY 2008, as compared to
28 percent for U.S. exchanges. The share of global market
capitalization represented by IFRS markets is expected to
grow still larger with the inclusion of the additional countries
that have decided to adopt IFRS by 2011. Given that today
two-thirds of U.S. investors own securities of foreign companies,
the SEC has an abiding interest in determining what
role IFRS should play in U.S. capital markets.
Conclusion
This annual report, in addition to describing the SEC´s many
accomplishments and performance results, also presents the
Commission´s financial picture for 2008, beginning on page
57. Our auditors, the U.S. Government Accountability Office,
affirm that the SEC´s financial statements are presented fairly
in all material respects in conformity with U.S. generally
accepted accounting principles (GAAP), and that the SEC had
effective internal control over financial reporting and compliance
with certain laws and regulations. Furthermore, we are
pleased to confirm that the financial and performance data
we present in this report are fundamentally complete, reliable,
and conform to Office of Management and Budget guidance.
Throughout the 75-year history of the SEC, its core
objectives have remained steady. Today our missionto
protect investors, maintain fair and orderly markets, and
facilitate capital formationis more important than ever
before. As described in this annual report, the thousands
of dedicated professionals at the SEC continue to work
tirelessly towards these ends in behalf of the American
people. Attracting and retaining the top-flight professionals
that make the SEC what it is remains a top prioritywhich
is why we are so proud that our agency has been rated in
the top three best places to work in the federal government,
our highest ranking ever. The men and women of
the SEC are committed to doing everything they can, every
day, to protect your investment in America´s future.
Sincerely,
Christopher Cox
Chairman
http://www.sec.gov/news/speech/2008/spch101808cc.htm