Rick A. Fleming, Investor Advocate
U.S. Securities and Exchange Commission
This is a Keynote Address given at the University of Maryland, Robert H. Smith School of Business Center for Financial Policy on Nov. 16, 2016
This is the presentation on this subject.
Thank you, David [Lynn], for that kind introduction. I also want to thank Jim Allen and the sponsoring organizations for extending the invitation to speak, and to all of you for participating in this important discussion.
Today, we will consider the future of financial regulation and, more specifically, whether the Dodd-Frank Act went too far. I am happy to share my views with you, but before I begin, I must give the standard disclaimer that my remarks are my own and do not necessarily reflect the views of the Commission, the Commissioners or my colleagues on the Commission staff.
The Dodd-Frank Act, of course, was adopted in the wake of the financial crisis—which, as you’ll recall, was no ordinary crisis. As of January 2011, when the Financial Crisis Inquiry Commission issued its Final Report, about 4 million families had lost their homes to foreclosure and another four and a half million had slipped into the foreclosure process or were seriously behind on their mortgage payments. Nearly $11 trillion in household wealth had vanished, with retirement accounts and life savings swept away. Millions of Americans had lost their jobs, with unemployment peaking at about 10 percent in October 2009 and staying above 8 percent for 3 years. Stock values plunged, too, with the S&P 500 shedding 55 percent of its value between October 2007 and March 2009.
Given the depth of the financial crisis, it took a massive response by our government to keep it from turning into a new Great Depression. And it is not surprising that it resulted in a hefty piece of legislation – the Dodd-Frank Wall Street Reform and Consumer Protection Act – which covered a vast array of topics in its 540 sections.
Given the scope of the Act, it is difficult to make blanket judgments about the Act as a whole without examining individual pieces of it, and we don’t have time for me to go through every little piece. Even if we focus exclusively on the changes to securities regulation and set aside the aspects that address banking regulation and other things that fall well outside my areas of expertise, we could be here all day. So I will just highlight a few items.
First, I want to point out that a few of the lesser-known sections of the Act are, in my humble opinion, masterful works of legislation. In particular, I am a fan of Section 915, which created the Office of the Investor Advocate and established my current role, which is to help ensure that the concerns of investors are appropriately considered as decisions are being made and policies are being adopted at the Commission, at self-regulatory organizations (SROs), and in Congress. Similarly, Section 919D created an Ombudsman at the Commission, housed within my Office, to assist retail investors in resolving problems they may have with the Commission or an SRO. And Section 911 established the SEC’s Investor Advisory Committee, or IAC, to advise the Commission on regulatory priorities and initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. We are fortunate to have Kurt Schacht, the Managing Director of the CFA Institute, as the current Chair of the IAC.
Taken together, these three provisions seem to reflect a recognition that the voices of investors were underrepresented at the SEC in the years leading up to the financial crisis. They restore balance by institutionalizing the investor presence at the Commission. Now, I’m not naïve enough to think that my Office, our Ombudsman, or the IAC can, on our own, prevent the next financial crisis, but we play important roles in highlighting the needs of investors in internal policymaking and public debate, and in assisting individual investors in their dealings with the Commission and the SROs. Our hope is that we can encourage the adoption of rules and policies that will serve the interests of investors, strengthen the markets and, ultimately, prevent future calamities.
Putting aside my fondness for these three parts of the Dodd-Frank Act, I think it is legitimate to question, six years after its adoption, whether the other pieces of the Act have done more harm than good. And to answer this question, I think it is appropriate to judge the provisions of the Act by their effectiveness in addressing the underlying causes of the financial crisis. This is the lens I will use to examine a few particular provisions of the Act.
I recognize that the causes of the crisis are the subject of debate, but for my purposes, I will rely upon the official report of the Financial Crisis Inquiry Commission, or FCIC. Within their extensive findings and observations, they cited “profound lapses in regulatory oversight” that contributed to the crisis. They found many underlying causes of the crisis, and a number of them fall outside the purview of the SEC, so I will focus on three causes for which the SEC bears a significant responsibility to address: asset-backed securities, derivatives, and credit ratings.
Much has been written—and movies have been made—about the subprime mortgages that were bundled into toxic asset-backed securities (ABS) and spread throughout the financial system. The ABS market, totaling $4.8 trillion in issuances over the past decade, stood at the epicenter of the financial crisis. Many investors were not fully aware of the risks underlying the securitized assets until it was too late when they suffered heavy losses.
To address this problem, Section 942 of the Dodd-Frank Act mandated that the Commission adopt regulations requiring an issuer of an asset-backed security to disclose for each tranche or class of security information regarding the assets backing that security, including asset-level or loan-level data if such data is necessary for investors to independently perform due diligence. The Commission acted on this mandate on August 27, 2014, by adopting revisions to rules governing the disclosure, reporting, and offering process for various types of asset-backed securities to enhance transparency. Among other things, the new rules require loan-level disclosure for assets such as residential and commercial mortgages and automobile loans.
As expected, these rules enable investors to conduct due diligence to better assess the credit risk of asset-backed securities. Investors can now see a more complete picture of the composition and characteristics of the assets in the pool and their performance. Rather than blindly relying on credit ratings, investors going forward will be better able to understand, analyze, and track the performance of ABS.
The Commission also joined with five other federal agencies to adopt credit risk retention rules, which require securitizers of asset-backed securities to have “skin in the game” for the securities they package and sell. The Commission’s rules require the ABS prospectus to disclose the sponsor’s retained economic interest in an ABS transaction. Theoretically, at least, risk retention will discourage the creation and sale of toxic securities in the future.
The growth of securitizations such as ABS went hand-in-glove with a type of over-the-counter (OTC) derivative known as a credit default swap (CDS). The FCIC concluded that credit default swaps fueled the mortgage securitization pipeline. They were sold as a kind of insurance to investors against the default or decline in value of mortgage-related securities. AIG, in particular, sold $79 billion worth and had to be bailed out.
As the FCIC points out, the new millennium began with legislation enacted in 2000 to prevent the regulation of OTC derivatives by both the federal and state governments. They identify that legislation as “a key turning point in the march toward the financial crisis” because the resulting opacity of the OTC market became a significant source of trouble. According to the FCIC, “the existence of millions of derivatives contracts of all types between systemically important financial institutions—unseen and unknown in this unregulated market—added to uncertainty and escalated panic….”
As this conference considers whether regulations have gone too far in the post-crisis era, it is worth recalling that the march toward crisis began, in part, with a legislative act of deregulation. And it should be no surprise that the Dodd-Frank Act took aim at over-the-counter derivatives. In particular, Title VII of the Act established a comprehensive new framework for regulating the OTC swap markets. It divided regulatory oversight between the CFTC, which is responsible for the majority of “swaps,” and the SEC, which is responsible for “security-based swaps,” including most credit default swaps.
In a series of rulemakings, the Commission has established the majority of a comprehensive regulatory framework for the entire ecosystem of security-based swaps. On August 5, 2015, for example, the Commission adopted new rules to implement Section 764 of the Dodd-Frank Act, which will provide a process for security-based swap dealers and major security-based swap participants to register with the SEC. The Commission also has adopted rules to require security-based swap data repositories to register with the SEC. These data repositories will collect data on security-based swaps as they are transacted by counterparties, make that information available to regulators, and disseminate data to the public, such as the prices of security-based swap transactions.
Other Commission rulemaking addresses clearing agencies, which play an important role in mitigating counterparty risk. On June 28, 2012, the Commission adopted rules detailing how clearing agencies would provide information to the SEC about security-based swaps that the agencies accept for clearing. Later that year, the Commission adopted standards for risk management and operations of clearing agencies. The standards apply to measuring and managing credit exposures, margin requirements, financial resources and margin model validation.
The Commission still has important work left to complete all of the rules for security-based swaps. Final Commission action is still pending on other rules that, among other things, will govern security-based swap execution facilities and set capital and margin requirements for security-based swap dealers and major security-based swap participants that are not banks. But, for the first time, these regulations will allow regulators to monitor and oversee the market. And for the first time, the public will be able to see trade and price information about security-based swap transactions.
In place of opacity, we will now have visibility. In place of a tangled skein of blind spots that led to financial panic, we now have an established framework of transparency and regulatory oversight over an $11 trillion market.
Credit Rating Agencies
Let’s turn now to the role of credit rating agencies, about which the Financial Crisis Inquiry Commission made the following observation:
We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have happened without the rating agencies.
Likewise, a Dissenting Statement by three of the Inquiry Commission’s members also identified credit ratings and securitization as one of the top ten causes of the financial crisis. “Failures in credit rating and securitization transformed bad mortgages into toxic financial assets,” the Dissenting Statement observed.
Here the Commission has adopted two basic sets of reforms. The first addresses the governance, accountability, and management of credit rating agencies – including managing conflicts of interest that are inherent in the business model. On August 27, 2014, the Commission adopted new rules to implement 14 Dodd-Frank mandates. Among them was a new requirement for an annual certification by the CEO as to the effectiveness of internal controls and additional certifications to accompany credit ratings attesting that the rating was not influenced by other business activities.
In a second set of reforms mandated by Dodd-Frank Section 939A, the Commission has acted to remove almost all of the references to credit ratings from its rules and forms. On September 16, 2015, the Commission adopted amendments to remove credit rating references in the principal rule that governs money market funds, thus bringing the total to 32 rules and forms in which references to credit ratings have been removed.
But there is one thing the Commission did not do. The reforms stop short of an outright ban on the conflict-of-interest model in which issuers pay for their own credit ratings. So here the question in my mind is not whether Dodd-Frank and other reforms have gone too far, but rather have they gone far enough?
Put another way, can this particular conflict of interest be managed, or is it inherently flawed? On the one hand, the financial crisis exposed failures in the ratings of complex structured securities. On the other hand, I have been told by professional investors that the credit rating agencies actually have a good record with respect to their ratings of more traditional fixed-income securities issued by corporations. Taken together, these things suggest that the agencies’ business model may not represent a fatal flaw, but going forward, the Commission should maintain its vigilance in overseeing the industry and in monitoring the impact of the reforms.
In summary, for the three areas I have described (ABS, derivatives, and credit ratings), I believe the Dodd-Frank Act has been successful in addressing some of the real causes of the financial crisis. The rulemakings in these three areas have been complex, so they are undoubtedly imperfect, but I think they represent a drastic improvement over the pre-crisis status quo. There may be another financial crisis in our future, but I think it is highly unlikely that the next crisis will spring from these same causes. In my view, then, we should not roll back these important reforms.
However, there are certainly other areas in which the reach of the Dodd-Frank Act is more questionable in the view of many. Some would argue that the Act did not go far enough to prevent a crisis. For example, it did not reinstate the Glass-Steagall separation between banking, securities, and insurance. Others argue that it went too far as it is and that the Volcker rule is inhibiting economic growth.
Another area of debate involves the role of the Financial Stability Oversight Council (FSOC), and particularly its designation of systemically important financial institutions (SIFIs) that are subject to heightened regulation. One of the Act’s authors, Barney Frank, has suggested that the SIFI label should not be applied automatically to asset managers, and I agree. Personally, I believe the SEC can effectively regulate asset managers without the assistance of the banking regulators and other members of FSOC.
The Broader Context of Financial Regulation
I’ve now given you some of my views on certain aspects of the Dodd-Frank Act, and instead of going through a laundry list of additional provisions, I now want to take a step back and spend a few minutes looking at the bigger picture. This conference looks ahead to the future of financial regulation, but I think it is helpful to take a moment to look at the past and to consider financial regulation within its broader social context because understanding the past must inform our views of the present and our expectations for the future.
For generations, people in this country have been motivated by an idea called the “American Dream.” This is a fundamental belief that each of us, through hard work, can improve our socio-economic status. That we can achieve economic upward mobility.
Any parent with grown children has probably preached to them about the steps they need to take to achieve economic success. Start with a good education: gain knowledge, learn to play well with others, get things done on time, and develop valuable skills. Next, get a job: work hard, be conscientious, and hopefully catch a break or two along your career path. Now, with a paycheck coming in, put together a budget. Learn to live within your means. Save a few bucks. Eventually, get to the point where you can invest so that you can put your savings to work for you and begin to accumulate wealth.
Imagine, if you will, what happens if everyone in America follows this recipe for success. Imagine the powerful economic engine it creates. Pursuing the American Dream benefits not only the individual but all of us and our economy as a whole.
But what happens when something goes awry?
Let’s look first at an individual level. Suppose a person has done all the right things: schooling, hard work, a lifetime of savings, to the point where they have built up a nest egg for retirement. Then, on the eve of that retirement, somebody comes along and steals the nest egg, or engages in unethical practices that cause significant losses. In the course of my career, I have dealt with many people in that exact situation, and the devastation they feel is heartbreaking.
That, in essence, is why we have securities laws. They began at the state level, two decades before the New Deal ushered in our federal securities laws, with the rise of state “blue sky” laws. My home state of Kansas was the first to adopt a “blue sky” law. It was written by a man named Joseph Dolley, a banker who had seen customers withdraw money from banks to chase higher yields by investing in copper mines, Central American plantations, irrigation projects, or other wildcat stocks. Dolley believed that “at least ninety-five percent of all the money put in those stocks was irretrievably lost,” so he proposed a set of statutes to require governmental review of securities offerings.
Though Kansas adopted the first “blue sky” law, I can assure you that it was not because Kansas was a blue state. Mr. Dolley, in fact, was the Chairman of the Kansas Republican Party and a former Speaker of the Kansas House of Representatives. To me, that is an instructive reminder that both political parties have historically embraced the principle of investor protection.
The blue sky laws did not, however, prevent the stock market crash of 1929. That is why the federal government began to regulate the sale of securities. A Congressional investigation at the time revealed widespread manipulation of the markets and rampant insider trading. People began to hoard their money, the economic engine lost steam, and the Great Depression set in. Thus, when President Franklin D. Roosevelt recommended the passage of what became known as the Securities Act of 1933, he expressed his desire to “give impetus to honest dealing in securities and thereby bring back public confidence.”
The point of the ’33 Act, then, was not to punish businesses for getting us into the Great Depression, but rather to get us out of the Depression by restoring investor confidence—by renewing their faith in the basic fairness of the markets. This new regulatory structure gave us a foundation upon which capital formation could thrive.
Fast forward to the 21st Century and the Financial Crisis of 2008. As I recited earlier, the crisis exacted a terrible toll on households, families, and communities. And although the economy has improved significantly since then, the 2000s were a “lost decade” for a majority of Americans, with wages flat-lining or declining and middle-class jobs disappearing. The corrosive effects of the crisis have persisted to this day, and we have all witnessed a growing sense of anger, distrust, alienation, and polarization.
Now, I don’t know anybody who could have predicted the election year we’ve just lived through. But nearly six years ago, the FCIC did warn of a sense of anger and betrayal. I quote:
There is much anger about what has transpired, and justifiably so. Many people who abided by all the rules now find themselves out of work and uncertain about their future prospects. The collateral damage of this crisis has been real people and real communities.
As a result of the crisis, many Americans have seen their faith in the American Dream waver, particularly for future generations. And people are frustrated that the economic recovery has left many behind. According to an election day poll, 75 percent believe “America needs a strong leader to take the country back from the rich and powerful,” and another 72 percent believe “the American economy is rigged to advantage the rich and powerful.”
This reflects a loss of hopefulness that, I believe, presents one of the greatest challenges of our time. If people lose hope in the American Dream, we will lose the collective ambition that has powered our economic engine for generations, and the results are frightening to ponder.
It is in that context that, I submit, we need strong and effective regulations – not to stifle financial markets and our economy, but to give them the framework to thrive. And to replace anger with trust, confidence, and hope for the future.
We just came through a difficult and divisive election, and elections have policy consequences. This is as it should be. But it is my hope that the new crop of policymakers will simply remember the people who put them here. They include people from my rural home county, where 76 percent of the voters cast their ballots for President-elect Trump.
I know those people. They are hard-working people who want to make the world a better place for their children. They did not vote with deplorable motives like racism and bigotry, and they should not be treated as though they did. And they also shouldn’t be forgotten by the party they just put in power, in favor of powerful corporate interests.
With this in mind, the protection of investors must serve as the first principle guiding our financial regulations. We should think of those regulations not as a burden to be repealed or picked apart haphazardly, but as the essential nutrient for flourishing capital markets, for a growing economy, and, yes, for the continued vibrancy of the American Dream.
To me, it is a legitimate function of a government and a capitalist society to make sure that once people have done the right things—achieved an education, worked hard, lived within their means, and invested for their future—that those people are treated fairly in the marketplace, and that their interests are not relegated below the interests of those with more money or more power. As the Investor Advocate at the SEC, that is fundamentally what my job is about, and that is what I will continue to fight for.
 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the Commission staff.
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xv (2011).
 U.S. Gov’t Accountability Off., GAO-13-180, Financial Regulatory Reform: Financial Crisis Losses and Potential Impacts of the Dodd-Frank Act (Jan. 2013) 17-18.
 Steve Santiago, Should Investors Over Age 50 Own Stocks?, Bankrate, http://www.bankrate.com/finance/financial-literacy/do-stocks-make-sense-for-the-50-plus-crowd-1.aspx.
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 911, 124 Stat. 1376, 1871 (2010) (codified at 15 U.S.C. § 911).
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xxviii (2011).
 U. S. Sec. and Exch. Comm’n, Testimony on Oversight of the U.S. Securities and Exchange Commission (2016), https://www.sec.gov/news/testimony/testimony-white-oversight-sec-06-14-2016.html.
 Press Release, SEC, SEC Adopts Asset-Backed Securities Reform Rules, 2014-177 (Aug. 27, 2014), https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542776577.
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 942(b), 124 Stat. 1376, 1871 (2010) (codified at 15 U.S.C. § 942(b)); Asset-Backed Securities Disclosure and Registration, 17 C.F.R. Pts. 229-30, 232, 239, 240, 243, 249 (2014).
 Press Release, SEC, SEC Adopts Asset-Backed Securities Reform Rules, 2014-177 (Aug. 27, 2014), https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542776577. A proposal to require loan-level disclosure for other asset classes remains outstanding. See Asset-Backed Securities Disclosure and Registration, Securities Act Release No. 9638 (Sep. 4, 2014), 79 Fed. Reg. 57183, 57190 (Sep. 24, 2014), https://www.gpo.gov/fdsys/pkg/FR-2014-09-24/pdf/2014-21375.pdf.
 The risk retention rules, as adopted, have been criticized in some important respects. Barney Frank, one of the authors of the Dodd-Frank Act, has criticized one of the exemptions from the risk retention rules as overly broad. See Assessing the Impact of the Dodd-Frank Act Four Years Later: Hearing before the H. Comm. on Financial Services, 113th Cong. (July 23, 2014) (Testimony of the Hon. Barney Frank, former Member of Congress and former Chairman, H. Comm. on Fin. Services), http://financialservices.house.gov/uploadedfiles/hhrg-113-ba00-wstate-bfrank-20140723.pdf. SEC Commissioner Michael Piwowar believes they take an arbitrary “one-size-fits-all” approach. Michael S. Piwowar, Commissioner, SEC, Remarks at ABS Vegas 2016 (Mar. 1, 2016), https://www.sec.gov/news/speech/speech-piwowar-03012016.html.
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xxiv (2011).
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xxiv (2011).
 Id. at xxv.
 Press Release, SEC, SEC Adopts Registration Rules for Security-Based Swap Dealers and Major Security-Based Swap Participants, 2015-159 (Aug. 5, 2015), https://www.sec.gov/news/pressrelease/sec-adopts-registration-rules-for-security-based-swap-dealers.html.
 See U.S. Sec. and Exch. Comm’n, Division of Trading and Markets, Security-Based Swap Data Repositories (Oct. 2016), https://www.sec.gov/divisions/marketreg/security-based-swap-data-repositories.htm.
 Press Release, SEC, SEC Adopts New Procedures for Reviewing Clearing Submissions Under Dodd-Frank Act, 2012-124 (June 28, 2012), https://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171482918, and https://www.sec.gov/News/Article/Detail/Article/1365171492550. The compliance date for SBS Dealer registration has not yet been set, and no SDRs have been registered yet.
 Press Release, SEC, SEC Adopts Standards for Risk Management and Operations of Clearing Agencies, 2012-215 (Oct. 22, 2012), https://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171485518.
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xxv (2011) (emphasis in original).
 Id. at 418.
 Press Release, SEC, SEC Adopts Credit Agency Reform Rules, 2014-178 (Aug. 27, 2014), https://www.sec.gov/news/pressrelease/2014-178.html.
 Press Release, SEC, SEC Removes References to Credit Ratings in Money Market Fund Rule and Form, 2015-193 (Sept. 26, 2015), https://www.sec.gov/news/pressrelease/2015-193.html.
 Assessing the Impact of the Dodd-Frank Act Four Years Later: Hearing before the H. Comm. on Financial Services, 113th Cong. (July 23, 2014) (Testimony of the Hon. Barney Frank, former Member of Congress and former Chairman, H. Comm. on Fin. Services, stating that “Asset management firms should not automatically be designated systemic.”); Victoria McGrane and Andrew Ackerman, Five Years Later, Dodd Frank Creators Say the American Banking System is Better Off, The Wall Street Journal (July 19, 2015), http://www.wsj.com/articles/dodd-frank-creators-on-wall-street-reform-five-years-later-1437347191 (“I do think there’s a tendency for overreach by the FSOC. I do not think straightforward insurance companies or money managers should be covered [and regulated as SIFIs]”).
 Will Payne, How Kansas Drove Out a Set of Thieves, Saturday Evening Post (Dec. 2, 1911).
 Larry Bumgardner, A Brief History of the 1930s Securities Laws in the United States—And the Potential Lessons for Today, The Journal of Global Business Management, http://www.jgbm.org/page/5%20Larry%20Bumgardner.pdf .
 Message from the President—Regulation of Security Issues, Presented to Senate Mar. 28, 1933, 77 Cong.Rec. 937 (1933).
 Marianne Cooper, The Downsizing of the American Dream, The Atlantic (Oct. 2, 2015), http://www.theatlantic.com/business/archive/2015/10/american-dreams/408535/ .
 Fin. Crisis Inquiry Comm’n, The Fin. Crisis Inquiry Rep. xvi (2011).
 Marianne Cooper, The Downsizing of the American Dream, The Atlantic (Oct. 2, 2015), http://www.theatlantic.com/business/archive/2015/10/american-dreams/408535/ .
 Chris Kahn, U.S. Voters Want Leader to End Advantage of Rich and Powerful: Reuters/Ipsos Poll, Reuters (Nov. 8, 2016), http://www.reuters.com/article/us-usa-election-poll-mood-idUSKBN1332NC?il=0 .