Preparing for the Regulatory Challenges of the 21st Century

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent remarks at the Georgia Law Review’s Annual Symposium, Financial Regulation: Reflections and Projections; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

During my tenure as an SEC Commissioner, our country’s economy has experienced extreme highs and lows. In fact, the country experienced the worst financial crisis since the Great Depression, followed by the current period of significant economic growth where the stock market has grown by around 165% from the low point of the financial crisis.

I have had a front-row seat to all of this, as I became an SEC Commissioner just weeks before the financial crisis hit our nation. As a result, I witnessed first-hand just how fragile our capital markets can be, and the need for a robust and effective SEC to protect them. First, let me provide a snapshot of what went on. I was sworn-in as an SEC Commissioner on July 31, 2008. Within a few weeks, on September 15, 2008, Lehman Brothers filed for bankruptcy. To give you a sense of its rapid decline, within 15 days, its share price went from $17.50 per share to virtually worthless. The demise of Lehman Brothers is often seen as the first in a rapid succession of events that led to an unimaginable market and liquidity crisis. These events included:

  • Substantial economic damage to a number of storied financial institutions;
  • A crisis that engulfed the money market industry;
  • The freezing up of the short-term capital markets; and
  • The discovery of a long list of Ponzi schemes as cash became in short supply, the most famous of which was the Bernie Madoff Ponzi scheme.

Any one of these events would have been a significant market event, but taken together we had a financial system on the verge of collapse. A discussion of all that went wrong could fill several volumes of the Georgia Law Review.

Needless to say, the ensuing turmoil shook the global economy to its core and exposed the weaknesses of many regulatory regimes—both in the United States and abroad. Eventually, it became abundantly clear that years of lax attitudes, deregulation, and complacency about the virtues of strong regulation contributed significantly to the financial crisis.

The events of the financial crisis substantially affected the Commission, as the primary regulator of the U.S. capital markets. It is no exaggeration to say that the SEC’s continued existence was in doubt. In fact, in early 2009, there were reports that the White House and the U.S. Department of Treasury were considering a plan that would reduce the SEC’s authority to protect investors, and transfer this authority to a new federal “super cop.”

I was a new Commissioner at the time, and the Commission, as well as our country, faced an avalanche of unprecedented issues. I marveled at the timing of my arrival at the SEC. Looking back, I thought about my long career as a partner at several nationally recognized law firms, as the General Counsel, Head of Compliance, and Executive Vice President for one of the world’s largest and most successful asset management firms, and as the President of one of its broker-dealers. And now I found myself at the SEC, faced with the possibility that we would be asked to turn off the lights and close the doors for the very last time.

Fortunately, Congress and the White House realized that the SEC played an essential and necessary role. In fact, the Dodd-Frank Act expanded the SEC’s authority and jurisdiction. As a result, during my tenure, a refocused SEC has tackled head-on a wide variety of complex issues. Indeed, the years following the financial crisis have been one of the most active periods in SEC history. Much of this work involved taking an honest assessment of our shortcomings, which resulted in significant internal restructurings, including reorganizing the Enforcement Division, creating a new division to focus on economic analysis and risk assessment, and revamping our inspection and examination program.

Moreover, during this same time period, the Commission has entered into one of its most active periods in promulgating new rules. In fact, the Commission has voted on almost 250 rulemaking releases during my tenure. Most of the Commission’s new rules rightly focused on addressing flaws in our own capital markets. For example, some of these rules sought to remedy the conflicts of interest that led credit rating firms to knowingly give their highest ratings to a slew of investments that were extremely risky, and which turned out to be worthless, or close to it. Other rules address the poor disclosures for the asset-backed securities markets that were at the epicenter of the 2008 market turmoil. Of course, the Commission has also proposed and/or adopted a wide range of other regulatory requirements across the expanse of the capital markets—impacting equity and option exchanges, broker-dealers, investment advisers, and hedge funds—to name just a few.

Many of these rulemakings have been groundbreaking. Still, even with all of this activity, the Commission remains behind on many of its mandates under the Dodd-Frank Act, the more recent JOBS Act, and other important initiatives. The Commission still has much work to do.

In addition to the focus on the domestic market, the Commission is also working internationally to address the dangers arising from the growth and interconnectedness of the global financial markets, and the reality that risks from less-regulated overseas markets can ultimately come to our shores.

The Commission’s efforts continue across a wide range of regulatory initiatives, any of which are worthy of an in-depth discussion. Today, I plan to project forward and focus on certain fundamental challenges facing the Commission that will cut across several important regulatory responsibilities, and demonstrate the need for the Commission to evolve and adapt to changing times. In particular, I will focus on:

  • First, how the SEC should prioritize its use of data and technology to become a more effective regulator; and
  • Second, how the global nature of the crisis illustrates the increasingly interconnected nature of the global economy and underscores that the SEC faces a future of needing to work globally to protect American investors.

The Evolving Capital Markets and the Need For High-Quality Information

First, I want to discuss how the Commission is evolving into a more informed regulator through various data gathering and technology driven initiatives.

Today, our capital markets are more sophisticated, larger, faster, and more technologically driven than at any time in history. This rapid change requires that a regulator be able to quickly spot risks, identify emerging trends, and understand how new financial products and evolving market conditions are impacting investors and the capital markets as a whole, both here and abroad.

For example, within the past few years, high-tech, automated trading has come to dominate the world’s capital markets. This reliance on technology has resulted in a market structure increasingly characterized by high-speed trading executed at many different trading venues. To illustrate this point, in January 2005, the New York Stock Exchange’s (“NYSE”) average speed of execution for small, immediately executable orders was 10.1 seconds. More recently, the average speed has accelerated to a half a second or less. This speed can bring benefits as it allows for quicker executions and delivery of market data. However, it can also wipe out billions of dollars in just a few minutes, such as when the Flash Crash in May 2010 caused $1 trillion to evaporate in just 20 minutes, before making a partial recovery; and, when Knight Capital suffered a $460 million trading loss over a 45-minute period in August 2012 that resulted from a computer malfunction.

The new technology has enabled the growth of a very fragmented trading environment and encouraged the proliferation of so-called “dark pools.” As evidence of this development, in 2005, NYSE executed approximately 80% of the consolidated share volume of listed stocks. Today, NYSE’s share of volume is less than 24%. Where we once had just a handful of brick-and-mortar securities exchanges, like NYSE, there are now 18 national securities exchanges and perhaps as many as 40 to 50 dark pools where trades are executed, mostly through automatic, electronic networks. Estimates show that, in 2012, automated trading accounted for about 50-75% of the volume traded on all of the exchanges each day.

It is no secret that the Commission is struggling to keep up with these market and technological developments while trying to assess whether these evolutionary changes benefit or detract from our capital markets. In fact, just last summer, Chair White announced that the SEC would “comprehensively review and address core market structure policy issues, such as the overall fairness of trading in high-speed markets [and] changes in the number and nature of trading venues….” As a further step, the Commission recently established an advisory committee to provide a formal mechanism through which it can receive input on market structure issues. In fact, the first meeting of this committee is scheduled for May 13, 2015.

The Need for Timely, Accurate, and Complete Data and Information

No one can doubt that effective oversight of the capital markets requires that the SEC be well-informed. However, one of the most difficult challenges facing the SEC today is the lack of information, particularly at a time when the capital markets’ reliance on the newest and most advanced technology to generate and process information keeps increasing exponentially.

The Commission’s lack of access to critical data was laid bare by the Flash Crash. It took the staffs of both the SEC and CFTC over four months to get the data and analyze the events of those fateful 20 minutes in May 2010, when the prices of many U.S. equities experienced extraordinarily rapid and extreme swings. The Commission’s need for data is even more acute, as markets are continuing to grow more complex and fragmented. Moreover, the lack of access to critical data goes beyond market structure and cuts across the Commission’s responsibilities including enforcement, corporate disclosures, and the asset management industry.

The financial crisis, and its aftermath, made clear that the SEC needed far more information to effectively supervise a number of important market sectors—such as money market funds, hedge funds, derivatives activities (including credit default swaps), municipal advisors, credit rating agencies, and others.

Efforts to Obtain Critical Data and Information

To that end, even though the SEC is not a self-funded agency, like many of its counterparts, the Commission is devoting significant amounts of its limited resources to enhancing the agency’s data gathering and analytics. These initiatives are important if the Commission is to properly keep track of, among other things, the activities of over 25,000 regulated entities, the approximately 9,400 publicly-traded companies that file reports with the SEC, and the 15,000-16,000 tips, complaints, and referrals we receive per year.

In particular, the Commission has been working to capture data and automate its analytical capabilities to allow our staff to proactively identify areas of risks, emerging trends, and fraudulent activity. These initiatives will allow the staff to spot issues in ways we were not able to do before the crisis.

One of the most significant data collection rules that the Commission has adopted is the requirement for a Consolidated Audit Trail (“CAT”). CAT, when operational, will be the world’s largest data repository of securities transactions. CAT should improve the oversight of the markets by allowing the Commission to identify and address potential risks before they metastasize into larger problems. CAT will also be a game-changer with respect to combatting securities fraud, which is more difficult to identify due to market fragmentation and the rise of electronic trading.

While we’re waiting for CAT to be implemented, the SEC is developing tools to utilize data in new ways. First, in 2013 the SEC staff rolled out a data collection initiative entitled Market Information Data Analytics System, or as we call it, MIDAS. It is designed to collect publicly available market information, such as commercial feeds of market quotes and data from national exchanges. On any given day, MIDAS collects about one billion trading records from each of the national equity exchanges. The SEC staff is utilizing MIDAS to provide market structure information to the public and to help the staff develop better insights into the capital markets. Nonetheless, the system does have some significant constraints. In particular, it only collects publicly available information and it does not provide information regarding the lifecycle of a trade, the various components of a trade, the identities of parties involved in the trade, or any of the off-exchange trade and order flow information. These are gaps that an operational CAT should address in the future.

Beyond better utilizing public data, the SEC is using several data-analytic tools to assist its enforcement investigations. For example, the Enforcement Division is using a sophisticated, data-driven, proprietary analytical program, called Aberrational Performance Inquiry, to identify and investigate hedge funds and financial advisory firms with suspicious returns. In Fiscal Year 2014, the Enforcement Division brought its eighth case, as a result of this initiative. Similarly, the Division’s Automated Bluesheet Analysis Project, which was started in 2011, continues to be an effective and proactive tool to detect suspicious trading patterns and relationships among traders who attempt to profit through illegal insider trading. In addition, working with the Division of Economic and Risk Analysis, or DERA, the Enforcement Division is also using a tool called the Accounting Quality Model (“AQM”), which helps the staff determine whether an issuer’s financial statements stick out from the pack in a way that requires further review.

Furthermore, in response to criticisms about the Commission’s ability to process the tips, complaints and referrals (“TCR”) received, the SEC upgraded its technology to make it easier and more user-friendly for the public to submit tips, as well as to provide the SEC staff with the automated ability to access and analyze real-time data. The Commission now has an automated centralized information system for tracking, analyzing, and reporting on the handling of tips and complaints. This program assures that no tip will be neglected, a problem the SEC had faced in the past.

The Commission recognizes that data gathering is only the start. It also should be able to effectively use and analyze the data. To that end, the Commission is improving the transparency and the overall usefulness of some of the disclosure information it receives, by requiring data tagging. The idea is simple: data tagging allows investors, regulators, and market participants to organize and analyze massive amounts of data and information more efficiently by associating pieces of information with keyword tags. The ultimate result is that data tagging improves the retrieval, searchability, and analysis of relevant market data by the SEC staff and the public alike.

The focus on data tagging began in earnest in 2009, when the Commission adopted its so-called “smart disclosure” rules to require interactive data tagging for the financial statements of public companies; the risk/return information of mutual funds; and certain information provided by credit rating agencies. But it’s not just the SEC that benefits from data tagging. To further enhance transparency of this data, the Commission’s public website now contains organized data sets of quarterly and annual data from XBRL-tagged financial statements filed with the Commission. These data sets should help the public and interested users more easily consume large amounts of data for comparison and analysis. Moreover, the SEC staff has developed analytical tools to use this tagged data to identify and investigate possible enforcement matters.

Finally, another example of the benefits of collecting real-time data information can be found with respect to money market funds. The financial crisis made clear that the information being received by the Commission was too stale to be of regulatory use. When a prominent money market fund “broke the buck,” and other funds came under pressure, we simply did not have the data at hand to determine what other funds could “break the buck.” Accordingly, the Commission promulgated a rule to require money market funds to provide monthly disclosures of their investment portfolios. This new data has proven invaluable, as it allows the Commission to put its finger on the pulse of these funds, and better monitor their activities.

For example, this new data allowed the SEC staff to monitor closely whether and how money market funds were adjusting their holdings during the Eurozone crisis in 2011. In particular, this data allowed the staff to determine that money market funds were not—as had been widely speculated—overexposed to Irish banks and other European securities during the Eurozone crisis.

These are all positive steps forward. The Commission is now using data and technology in ways it had not done before the crisis. The demonstrable results are that the SEC staff is able to review and analyze information more efficiently and effectively.

But, it is not enough and there is much more to be done. As I project into the future, the SEC must push forward with its efforts to embed interactive data in more of its regulatory filing requirements. As one example, as a result of the Dodd-Frank Act, the SEC is promulgating new rules that require additional corporate governance information to be provided in proxy statements, including matters involving executive compensation. These rules should include, where appropriate, data tagging requirements that would enable this information to be reviewed and analyzed more efficiently by the Commission staff and investors alike.

Data Collection and Analysis: A Work In Progress

Ultimately, enhanced data gathering and technological developments can help the Commission fulfill its mission of protecting investors, fostering capital formation, and ensuring the market is fair, orderly, and efficient. However, to accomplish those goals, Congress will need to provide the SEC with sufficient and reliable funding to utilize cutting-edge technologies. In addition, the SEC requires funding to hire staff with specialized skill sets to analyze the data and improve the agency’s ability to assess risk, conduct examinations, and detect and investigate fraud.

Simply stated, to be an effective regulator, the Commission must have a vast repository of vital data from market transactions, public companies and regulated entities, in a format that the staff can easily use, search, and compare. The Commission requires systems that can efficiently manage this volume of information and allow the information to be reviewed and analyzed more effectively by the Commission staff and the public. We’re getting there, but we’re not there yet—not by a long shot.

At the end of the day, whether or not the SEC will be an effective regulator in the years to come will depend on its ability to obtain and efficiently analyze full, accurate, and timely data as to market activity and all the companies we oversee.

The Globalization of Securities Regulation

Let me now turn to another growing challenge—and that is the growing globalization of securities regulation.

Technological advances that have impacted the domestic securities markets have also significantly affected the global securities market and have accelerated the movement of capital across international borders. Over the past 20 years, the global securities market has grown in both size and sophistication—and as the global markets grow, Americans have a greater ability to invest in securities markets around the world. This increase in investment opportunities has been facilitated, in part, by advances in technology that provide investors—through their desktops and smart phones—with access to nearly limitless investment opportunities worldwide.

These developments require that the SEC think more globally and recognize that its registrants will increasingly be global players, that fraud perpetuated at home can be initiated by those who have never set foot in the United States, and that a market meltdown can have global origins and ramifications.

Consequently, as I project forward, the protection of American investors will require that the SEC increase its efforts to communicate, coordinate, and cooperate with its international counterparts, something that is easier said than done. The differences between civil and common law jurisdictions, the variances in cultures and traditions, and the dissimilarities in local laws and how they are enforced pose serious challenges. Oftentimes, the applicable law is a patchwork of separate and localized regulations that, at best, result in a fragmented, uncoordinated, and sometimes conflicting system of regulations, and, at worst, can result in a “race-to-the-bottom.”

Fostering a Global Environment for Combating Fraud

An important aspect of international cooperation, of course, is addressing cross-border fraud. In fiscal year 2013, for example, almost 20% of the SEC’s enforcement cases involved foreign persons and entities. Moreover, the Commission expects future cases to continue to have international elements. To effectively investigate and prosecute these cases, the Commission will need cooperation from our international partners. To that end, the Commission has entered into over 130 information-sharing arrangements with foreign regulators and law enforcement agencies. In addition, the SEC conducts a wide variety of technical assistance programs to train our international regulatory and law enforcement partners on enforcement and examination topics. In Fiscal Year 2014 alone, the SEC trained more than 2,300 regulatory and enforcement officials from around the world.

Recent statistics underscore the growing need for mutual cooperation in cross-border enforcement. A quick look at the SEC’s recent international enforcement cases include numerous cases in the areas of insider trading, market manipulation, foreign bribery, and other securities fraud cases. This growing trend requires a good deal of international cooperation in order to prosecute these cases successfully. In Fiscal Year 2014, for example, the SEC made about 735 requests for international assistance, and, in turn, received approximately 460 requests for assistance from foreign regulators. In addition, the SEC often provides access to its files to foreign regulators and uses its compulsory powers to assist foreign investigations.

Regrettably, these international efforts are not what they should be. Although some international partners have been helpful, there are too many times that when the SEC calls for help, we find only silence, or worse, there are regulatory obstacles put in the SEC’s path. These obstacles and challenges included a foreign regulatory authority’s lack of broad powers to investigate, litigate, or sanction violations; lack of regulatory independence from political and industry influences; and the lack of resources dedicated to international cooperation. Additionally, several foreign jurisdictions have privacy laws, blocking statutes, and other laws restricting or limiting the disclosure of certain information required in enforcement investigations and regulatory examinations.

Moreover, even when the SEC succeeds in obtaining remedies in federal district courts or administrative proceedings for a cross-border fraud, enforcing those judgments and orders still poses challenges. For instance, one important tool for the SEC to punish wrongdoers is its ability to seek monetary penalties. The power to impose penalties enhances the effectiveness of the Commission’s enforcement program by more effectively deterring individual and corporate violators. However, the weight of legal authority in foreign jurisdictions tends to favor the denial of court judgments and administrative orders that impose fines or penalties.

The impact of cross-border fraud on American investors is further exacerbated by the Supreme Court decision in Morrison v. National Australian Bank, Ltd. that limits the anti-fraud provision of the Exchange Act, Section 10(b), to claims that relate to frauds on an American stock exchange or that involve security transactions in the United States. The end result is that, as the internet and the growth in foreign capital markets facilitate the ability of American investors to directly deploy their money around the globe, their ability to seek redress in the United States is being limited, while their ability to be harmed is not.

Accordingly, the Commission must consider, first, what it can do to prevent, detect, and mitigate the domestic impact of fraud originating from a foreign jurisdiction; and, second, what it can do to foster global efforts to combat fraud and enhance market integrity. But, as I said before, this is easier said than done.

The challenge regulators face in pro-actively preventing fraudulent activity is demonstrated by the Public Company Accounting Oversight Board’s (“PCAOB”) difficulty in inspecting PCAOB-registered firms that reside abroad. As you may know, in order to audit financial statements of companies publicly-traded in the United States, accounting firms are required to register with the PCAOB and subject themselves to regular inspections. This is not limited to accounting firms based in the United States, and, in fact, more than 900 of the approximately 2,300 firms registered with the PCAOB are located outside the United States. Thus, for the PCAOB to be effective, it must be able to inspect all registered firms no matter where they reside—truly a global effort.

Unfortunately, the PCAOB has faced significant regulatory obstacles to its inspections in a number of international jurisdictions. In various European Union (“EU”) member states, there was a long delay before the PCAOB was even allowed to inspect registered accounting firms, oftentimes as a result of state sovereignty claims, privacy or personal data concerns, or other local law considerations in these countries. Fortunately, within the last few years, the PCAOB has made progress in overcoming some of these regulatory obstacles to global inspections.

Notwithstanding this progress, however, the difficulties continue today, as the PCAOB still is unable to conduct inspections of approximately 175 registered accounting firms in 11 EU member countries, as well as in China, Hong Kong, and Venezuela. These obstacles persist, despite the important regulatory objective of the PCAOB’s inspections in providing investors with reliable and accurate financial statements. Ultimately, these regulatory obstacles pose a threat to all investors, whether in the U.S. or abroad, who cannot be assured that companies with foreign operations in these countries will be subject to audits that meet the requisite independence and high-quality professional standards.

The PCAOB’s experience shows how difficult it is to develop cross-border oversight but, on the other hand, the progress that has been made shows it’s possible.

As we look to the future and project forward, it is clear that, as companies increasingly have foreign operations, the SEC will need to address how best to extend its enforcement reach and supervisory oversight over global operations and transactions. The success or failure of those efforts will determine if the SEC will be an effective regulator in the future.


Clearly, the past few years have been challenging. By many accounts, a large number of investors lost significant amounts of money and simply left the capital markets. Fortunately, since then, there are signs of an economic recovery and that some investors are returning to the market.

Nonetheless, we must learn from the past to project into the future. It is important to keep in mind that change is a constant in our capital markets, and the exact nature and impact of that change will be difficult, if not impossible, to predict. For instance, the dangers and risks of cyber-attacks and the impact of high-frequency trading are developments no one expected just a few years ago.

As we project forward, it is impossible to predict with certainty the challenges ahead. I do believe, however, that the country requires a well-informed and well-funded SEC to protect American investors—from both domestic and international activities. While the world keeps changing, and while the SEC will need to change with it, the one constant I hope will not change is the commitment of the SEC staff to protecting investors and the markets. As we project forward, a strong SEC is the only way to be prepared for the future.

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