Commissioner Kara M. Stein

Washington, D.C.

Feb. 24, 2017

Good morning.  As always, it is a pleasure to be part of SEC Speaks.  This conference is an important forum that brings together Commission staff, the securities bar, and financial market participants every year to discuss issues of importance to all of us.

Before I begin, I need to remind you that the views I am expressing are my own and do not necessarily reflect the views of the Commission, my fellow Commissioner, or the staff of the Commission.

Throughout this conference you have heard a lot of detail about the policies, rules, and regulations that govern our capital markets.  Now, I want to talk about why all of that matters.  The markets exist to connect the capital of people who have saved with people who will put that capital to good use building companies and creating jobs.  Our policies should reflect that purpose—they should facilitate economic activity in a way that is fair and efficient and that benefits Americans who are saving and investing.

Promoting these goals starts with understanding where the markets are today and where they are headed.  In this regard, I am reminded of a Greek philosopher who once said, “change is the only constant.”  This is very true of our markets.  They are in a continual state of change.  Financial technology is advancing at a lightening pace.  These advances are changing not only trading and back offices, but also how Americans invest and how companies raise capital.  It is an exciting time, full of amazing opportunities.  But to grasp these opportunities, we must look forward.  We cannot drive into the future while looking in the rearview mirror.  Instead, we must look at where we are and the road ahead.

Today’s Markets

The markets are already significantly different than they were even 10 years ago.  For instance, institutional investors now dominate the U.S. equities market.  In 2016, institutional investors owned 70 percent of public shares.[1]  This is a big increase from even a few years ago.[2]  And, some of these institutional investors have become remarkably large.  Just a few of our biggest money managers control significant portions of the largest publicly traded companies.  Indeed, just three managers hold the largest ownership position in 88 percent of the companies in the S&P 500.[3]  This means they manage significant interests in companies that are directly competing with one another.   Think about how that could affect the companies.

Exchange-traded products, commonly referred to as ETPs or ETFs, are an important part of the increase in institutional investing.  Over the last decade, ETP assets under management have more than tripled.[4]  The number of ETPs has grown similarly.[5]  Trading in ETP shares also dominates today’s equities markets—13 of the 15 most actively traded securities are ETPs.[6]  Interestingly, despite the phenomenal growth and diversity of ETPs, these products continue to be governed by a patchwork of rules and exemptions largely developed a decade or more ago.

The growth and diversity of ETPs and other products institutions offer to retail investors provide them with a host of new options and opportunities.  ETPs have moved far from their original broad index-tracking origins.  And, via a variety of products, retail investors now have access to markets such as volatility, commodities, and interest rates.  Retail investors also have an increasing number of ways to access investment advice.  Roboadvisers emerged just a few years ago, but their approach to advice has found a place even among many traditional advisers.  The result is that investors can now choose among traditional advisers, roboadvisers, and advisers that are a hybrid of the two.  As the staff pointed out in guidance published this week, this array of options may open up more affordable access to advice and increase competition.  It is indeed a far different world than we lived in 10 years ago.

Trading has also changed.  Today, most equity trading is done electronically.  And, the fixed income markets are moving rapidly in the same direction.  The movement from floor trading to electronic trading brought a number of changes to the equities markets.  Trade sizes and prices are now smaller.[7]  However, we have also witnessed a number of so-called flash crashes and flash rallies.[8]  As the fixed income markets follow the equity markets into electronic trading, we are seeing some of the same changes occur.  Fixed income lot sizes are shrinking, trade volume is increasing, and spreads are tightening.[9]

Even the people working in the markets have changed as a result of the move to electronic trading.  For example, one major investment bank reportedly reduced its equity traders from 600 to just 2.  One third of its employees—9,000 people—are now computer engineers. [10]

The move to electronic trading has also increased the interconnection between securities, products, and marketplaces.  When floor trading dominated, it took time for information to become dispersed across securities.  Information could not spread faster than the sound of a human voice.  Today, information moves much faster.  What used to take minutes, now takes only seconds.[11]  The markets are more interconnected than ever.

They are also less transparent.  More and more trading is being done off exchange and in so-called dark pools.  In 2015, roughly one-third of equity trading occurred off-exchange.[12]  This move to dark markets affects both price discovery and transparency in the public markets.

Capital raising is seeing a similar move to less transparent venues.  Today, more money is raised in unregistered private offerings than in registered offerings.[13]  Initial public offerings (“IPOs”) are less common.[14]  And, overall there are now fewer public reporting companies.[15]  Indeed, the shares of some very large companies are not registered with the Commission and, thus, are not subject to public disclosure obligations.[16]

It is important to remember that the effects of securities being offered and traded in the dark are not isolated to a few of the most sophisticated investors.  Many of these securities are ultimately owned by millions of Americans through institutional investors.  Indeed, the changes in the markets—the rise of institutional investors, the move to private markets, and the evolution of electronic trading—are all closely intertwined.

What do These Changes Mean?

So what do these changes mean?  How do they impact the ability of markets to connect those who have saved money with those who will put it to good use building companies and creating jobs?

Let’s start with whether the money is being put to its best use.  Stock ownership is becoming increasingly concentrated in the hands of a small group of large institutional investors.  This raises several questions.  Are the markets allocating money to those who will put it to the best use? Are smaller companies able to access the capital they need to grow and create jobs?  Does ownership concentration affect the willingness of companies to compete and invest in innovation?   These are all important questions that need answers going forward.

We also must ask whether the market changes are having an effect on the willingness and ability of Americans to provide the capital that these companies need.   Disclosure and the resulting transparency have been the foundation of our market system since the Great Depression.  Since that time we have relied on the principle that “there cannot be honest markets without honest publicity.”[17]  Investment and trading are not done in a vacuum—they run on information.  Capital finds it best uses when a wide range of participants can fairly weigh relevant, reliable information.  So, does the move to opacity impact the effectiveness and efficiency of our capital formation process?  Is there sufficient transparency or should we be considering a different foundational principle?

And, lastly, let’s talk about the impact of market changes on how money moves through our system.  Computerized trading is here to stay.  Are the markets sufficiently resilient in this new, faster world?  Will the algorithmic traders remain in the markets when we need them the most?  Do we have sufficient safeguards against cyberattacks?  Or even simple technical glitches?

The Path Forward

These questions reflect an enormous amount of work that needs to be done.  Fortunately, some of this work is already underway.  The Commission and the exchanges have undertaken various pilot projects to address the mini-flash crashes and flash rallies our markets have been experiencing.  Similarly, the Commission and the self-regulatory organizations have started to develop the Consolidated Audit Trail (“CAT”) which will allow us to peer into the markets.  But, despite all of this, much more needs to be done.

As the ground beneath our feet continues to shift, we need to assess whether our current structure is sufficient to withstand the changes we face.  Are there better ways for us to address the challenges of a computerized market?  Are anti-manipulation laws passed in an era of floor trading sufficient for an electronic marketplace?  Do these laws need to be amended?

We also need to understand why more companies are staying private for longer periods of time.  Should we apply enhanced disclosure laws to these private companies?  Or perhaps they require a unique set of rules.

Technology is also giving us an opportunity to make information more understandable for investors, while at the same time making it easier for companies to report that information.  Rather than rush to eliminate disclosure, we should embrace the chance to use technology to make disclosure better.  This would facilitate more efficient capital allocation which would ultimately benefit our entire economy.

We also must address the impact that market changes are having on investors.  I urge Commission staff to keep a careful eye on highly complex retail products to ensure that there is adequate information.  Further, we should look at whether our rules and laws adequately protect investors harmed by illegal activity.  For instance, the amount of money victims lose is often far greater than the gain to wrongdoers.  However, the Commission cannot make victims whole because it can only obtain disgorgement, not restitution.  Should this change?

These are but a few of the tasks that confront us.  The landscape in which we operate is quickly and fundamentally shifting.  We too need to change.  We cannot address the new world by simply turning the clock backward.  Instead, we must look to the future.  As President John F. Kennedy said:  “Change is the law of life.  And those who look only to the past or present are certain to miss the future.”[18]  We cannot miss the future.  Our financial markets are too important.  They help companies raise capital.  They create jobs.  And, they help Americans save for their children’s education and their own retirements.  The markets are vital to our economy.  And, we need to help them adapt to meet the demands of a new and ever changing world.

I look forward to working with all of you on these very important issues.

Thank you.


[1] During the 2016 proxy season, institutional investors owned 73% of large cap shares, 77% of mid-cap shares, 68% of small cap shares, and 33% of microcap shares.  Broadridge & PwC, ProxyPulse: 2016 Proxy Season Review (2016), available at http://media.broadridge.com/documents/Broadridge-ProxyPulse-3rd-Edition-2016.pdf.

[2] The Conference Bd., The 2010 Institutional Investment Report (2010).

[3] Jan Fichtner, et al., Hidden Power of the Big Three? Passive Index Funds, Re-Concentration of Corporate Ownership and New Financial Risk (CORPNET, Univ. of Amsterdam, Working Paper, 2017).

[4] Total net assets of ETFs were $608 million in 2007 and $2.1 trillion in 2015.  Investment Company Institute, 2016 Investment Company Fact Book, available at https://www.ici.org/pdf/2016_factbook.pdf.

[5] There were 629 ETFs in 2007 and 1,594 in 2015.  Id.

[6] Dani Burger, Stocks Are No Longer the Most Actively Traded Securities in Stock Markets, Bloomberg (Jan. 12, 2017), available at https://www.bloomberg.com/news/articles/2017-01-12/stock-exchanges-turn-into-etf-exchanges-as-passive-rules-all.

[7] James Angel, et al., Equity Trading in the 21st Century, USC Marshall School of Business Research Paper Series, Working Paper FBE 09-10 (2010), available at https://www.sec.gov/spotlight/emsac/equity-trading-in-the-21st-century.pdf.

[8] See, e.g., CFTC & SEC, Findings Regarding the Market Events of May 6, 2010 (2010), available at https://www.sec.gov/news/studies/2010/marketevents-report.pdf; U.S. Dep’t of Treasury et al., The U.S. Treasury Market on October 15, 2014 (2015), available at https://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.

[9] Bruce Mizrach, Analysis of Corporate Bond Liquidity, FINRA Office of the Chief Economist Research Note, available at http://www.finra.org/sites/default/files/OCE_researchnote_liquidity_2015_12.pdf.

[10] Nanette Byrnes, As Goldman Embraces Automation, Even the Masters of the Universe Are Threatened, MIT Technology Review (Feb. 7, 2017), available at https://www.technologyreview.com/s/603431/as-goldman-embraces-automation-even-the-masters-of-the-universe-are-threatened/?set=603585.

[11] See, e.g., Austin Gerig, High-Frequency Trading Synchronizes Prices in Financial Markets, DERA Working Paper Series, available at https://www.sec.gov/dera/staff-papers/working-papers/dera-wp-hft-synchronizes.pdf.

[12] Changing Business Models of Stock Exchanges and Stock Market Fragmentation, OECD Business and Finance Outlook (2016), available at https://www.oecd.org/daf/ca/BFO-2016-Ch4-Stock-Exchanges.pdf.

[13] Scott Bauguess et al., Capital Raising in the U.S:  An Analysis of the Market for Unregistered Securities Offerings, 2009-2014 (2015), available at https://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10-2015.pdf (finding that in 2014, $2.1 trillion was raised through private offerings and $1.35 trillion was raised via registered offerings).

[14] EY, Why Are More Companies Staying Private?  Meeting of SEC Advisory Committee on Small and Emerging Companies (2017), available at https://www.sec.gov/info/smallbus/acsec/giovannetti-presentation-acsec-021517.pdf; Xiaohui Gao et al., Presentation to the SEC Advisory Committee on Small and Emerging Companies (2012), available at https://www.sec.gov/info/smallbus/acsec/acsec-090712-ritter-slides.pdf.

[15] Craig Doidge et al., The U.S Listing Gap, National Bureau of Economic Research Working Paper No. 21181 (2015), available at http://www.nber.org/papers/w21181.

[16] There are nearly 200 private U.S. companies with a valuation of over $1 billion.  These so-called “unicorns” have a combined valuation of nearly $700 billion.   The Unicorn List: Current Private Companies Valued at $1B and Above, CB Insights (updated daily), available at https://www.cbinsights.com/research-unicorn-companies.

[17] H.R. Rep. 73-1383, 73rd Cong., 2nd Sess. (Apr. 27, 1934).

[18] John F. Kennedy, Address in the Assembly Hall at the Paulskirche (1963), available at http://www.presidency.ucsb.edu/ws/?pid=9303.

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