Governance : Securities & Exchange Commission : Short Sale Restrictions : Uptick Rule
Address to Mutual Fund Directors Forum Ninth Annual Policy Conference
Critical Issues for Investment Company Directors
Thank you, David, for that kind introduction. I am pleased to be speaking before you today and particularly pleased to stand beside former SEC Chairman David Ruder whose wisdom, tenacity and commitment to investors are well-known and widely respected. When I first joined the SEC as a Commissioner in 1988, David was the Chairman. Since I rejoined the agency just three months ago, David has been generous with his time and wise counsel and I am very grateful.
Securities and Exchange Commission
It is always wonderful to see so many old friends and most especially, John Fry, who you know as a director of the Delaware Funds, but who I know as the brilliant president of Franklin and Marshall College, on whose Board I served for many years.
I am also honored to be in a room with so many of you who are committed to serving fund investors in the challenging fiduciary capacity of a mutual fund director. Ninety-two million mutual fund investors rely on you to oversee their investments and serve as their advocates in fund boardrooms across America. Your role as guardians of investor confidence is critical. And your focused oversight, vigilance and dedication as fund directors is more essential now than perhaps ever before given the current challenging economic environment. As we meet here today, Americans across this country and from all walks of life are struggling to meet their expenses, pay for their children’s educations and invest for retirement.
According to a recent report, $28.5 trillion in world stock market value was destroyed in 2008. Ten trillion dollars was lost in U.S. stock markets alone. In 2008, the Dow Jones Industrial Average and S&P 500 Index both fell more than 30 percent, constituting their worst performance since the 1930s, and the NASDAQ fell slightly more than 40 percent, which was its largest decline ever. International stock markets fared no better. The Dow Jones World Index fell 46 percent last year.
Mutual funds and their shareholders were certainly impacted by these steep market downturns. Assets of stock mutual funds declined by $2.8 trillion, or 43 percent, in 2008, of which almost $2.6 trillion was attributable to falling stock prices and $170 billion to shareholder redemptions. During the same period, income and hybrid fund assets declined by $330 billion, or nearly 14 percent.
Needless to say, investor confidence has been deeply shaken, and restoration of investor confidence is an essential element to moving the nation’s economy forward. The SEC is taking several steps to help restore investors’ badly shaken faith in our securities markets.
Short Sale Restrictions
Tomorrow, we will hold a Roundtable on various short sale restrictions proposed by the Commission last month. A particular focus of the Roundtable will be the impact that certain short sale restrictions, including both price tests and circuit breaker approaches, could have on overall investor confidence in our nation’s securities markets, especially as investor concern over abusive short sale activity continues to mount.
As many of you are aware, the Depression era “uptick rule” was eliminated in July 2007. Given the deteriorated state of our markets since the repeal of the uptick rule, I believe we owe all investors, including your mutual fund shareholders, a consideration of what, if any, impact elimination of the uptick rule has had on our markets and the significant market declines of the last year. There are times when an agency’s policy decisions, even ones made with in-depth study and careful consideration, must be re-examined to evaluate whether the ultimate result of the policy decision is harming the very people that the agency is sworn to protect. Investors deserve a careful re-examination of the uptick rule, and they will get one.
Re-examination of the uptick rule and other short sale price tests and circuit breaker approaches is part of a comprehensive, holistic SEC approach toward short selling activity. If abusive short sale activity is inappropriately distorting market prices, that must end. If short sellers are manipulating our markets, enforcement actions will be brought. And if failure to deliver securities in connection with short selling activity is causing market disruptions and increasing the costs and uncertainty of trading, then controls must be implemented. As the protector of the capital markets, the SEC cannot tolerate distorted pricing, manipulated markets or unnecessary market inefficiencies, whether caused by short sellers or long-only investors.
Another area where we are seeking to rebuild investors’ confidence involves access to corporate proxies. Very soon, the Commission will consider a proposal to ensure that a company's owners have a meaningful opportunity to nominate directors to corporate boards. As mutual fund directors, you have an important role to play in overseeing how your funds vote proxies and ensuring that funds use their proxy votes and access to proxies to appropriately further fund investors’ interests. The proxy access initiative is intended to empower investors and enable them to have a greater say in the nomination of directors of the companies they own.
This focus on proxy access and corporate boards underscores the SEC’s commitment to helping to ensure that investors’ needs are met and their voices heard. I believe that empowered investors equate to confident investors. It is my expectation that enabling investors to participate meaningfully in the nomination of directors through proxy access will foster a sense of enhanced legitimacy to the director nomination process – and promote investor confidence, as well as accountability among managers and directors.
Money Market Funds
Of particular interest to you as fund directors are the SEC’s efforts to address investor confidence in money market funds. Approximately 770 SEC-registered money market funds hold nearly $4 trillion in investor assets. This sizable market is critically important for both retail and institutional investors who use money market funds as a cash management tool. It is also important for banks, corporations, municipalities and other borrowers for whom money market funds are a key source of short term credit.
I know that many of you in this room have spent considerable time since August 2007 focused on money market fund issues and the impact of certain investments, including structured investment vehicles, on your funds’ net asset values. Despite the turmoil in the credit markets in 2008 and the first “breaking of the buck” by a widely held money market fund last fall, aggregate money market fund assets actually increased by $750 billion last year, representing a 23 percent increase in assets. However, the impact on investor confidence resulting from the events of last year can be seen in the change in composition of money market fund assets during 2008.
Assets of Treasury and government money market funds increased by more than $700 billion or 90 percent. On the other hand, assets of prime funds, which invest in corporate commercial paper, declined by $55 billion or 3 percent. Thus, there was a significant “flight to quality” as investors pulled their money from other segments of the market and placed it in Treasury and government money market funds, expecting a relatively safe and liquid investment.
In light of the events of last fall, it is essential that the SEC comprehensively re-examine the money market fund regulatory regime. We should do so with a view toward enabling money market funds to afford investors the relatively safe and liquid investment that they expect from an SEC-registered money market fund. Our staff is closely examining the credit quality, maturity and liquidity provisions currently applicable to money market funds to consider ways to strengthen their requirements and better protect money market fund investors.
I have asked the staff to present a proposal to the Commission in June. In addition, we are carefully reviewing whether more fundamental changes are needed in money market fund regulation, including whether floating rate net asset values for money market funds would better protect investors from potential abuses and runs on the funds.
The report on money market reform recently issued by the ICI Money Market Fund Task Force represents an important and very constructive first step toward reconsideration of money market fund regulations. But it is just that, a first step. The SEC’s examination of the issues and our eventual reforms are likely to extend beyond those advocated by the ICI’s report. As front row spectators and on-the-ground participants for many of the challenges that money market funds have faced since August 2007, your input will be greatly valued as the SEC pursues money market reform to better protect investors.
Target Date Funds
Another area the SEC is examining for the benefit of fund investors is target date funds. As you are aware, target date funds generally invest in a mix of equities, fixed income securities and other instruments. The proportionate percentages of these asset classes change over time, so that as a fund approaches its “target” date, its asset allocations move toward a more conservative allocation. The shift in allocation is often referred to as a fund’s “glide path.”
Target date funds have become quite popular. Over the past three years, target-date fund assets have increased from $66 billion at the end of 2005 to $152 billion in March, after peaking at $178 billion in 2007. Growth in target date fund assets is likely to continue since these funds can be default investments in 401(k) retirement plans under the Pension Protection Act of 2006. More than 60 percent of employers now use target date funds as a default contribution option, compared with just 5 percent in 2005.
However, target date funds have produced some troubling investment results. The average loss in 2008 among 31 funds with a 2010 retirement date was almost 25 percent. In addition, varying strategies among these funds produced widely varying results. Returns of 2010 target date funds ranged from minus 3.6% to minus 41 percent.
One explanation put forward for these outcomes is that many target date funds underlying retirement plans actually establish their “glide paths” based on the assumption that investors will continue to maintain their investments, and partially live off the proceeds, for a number of years following retirement. If that is the case, it must be plainly disclosed to investors. A target date fund underlying a college investment or so-called 529 plan, on the other hand, would need to more closely track its target date since it is far more likely that investors would need access to their investment at or near the fund’s target date.
I can assure you that SEC staff is closely reviewing target date funds’ disclosure about their glide paths and asset allocations. The staff also is examining whether the same target date funds underlie both retirement and college savings plans. The staff has been working closely with the Department of Labor in light of target date funds’ prevalence in participant-directed retirement funds. This important issue has also been an area of focus for Chairman Kohl and the Senate Special Committee on Aging.
I challenge those of you who are directors of target date funds to carefully review your funds’ asset allocations and investments. Consider, in particular, whether your target date funds’ asset allocations and investments are consistent with investor expectations. Are they consistent with your own expectations of how a fund with a “target date” of 2010, 2015, or 2020 should invest?
While you do your part, we at the SEC will do ours. We will consider whether additional measures are needed to better align target date funds’ glide paths and asset allocations with investor expectations. Among other issues, we will consider whether the use of a particular target date in a fund’s name may be misleading or confusing to investors and whether there are additional controls the SEC should impose to govern the use of a target date in a fund’s name. As we pursue this analysis, we will have a special focus on the expectations of the millions of everyday Americans who use target date funds to invest for retirement and educational needs.
Finally, I would like to discuss an issue of great import to both fund investors and fund directors. That is the use of so-called 12b-1 fees, which are drawn from fund assets, to pay for shareholders’ distribution and service expenses. Rule 12b-1 is an area in need of re-consideration, and the SEC will pursue that re-consideration with the interests of investors first and foremost in our minds. I am committed to a meaningful and open-minded review of rule12b-1. The timing of our review of this rule has to be prioritized with the other reforms that I’ve mentioned, including those that are directly related to our current financial crisis. While we may not act in the next month, 12b-1 reform is an issue that deserves and will receive SEC attention.
As fund directors, I applaud your skepticism. Every board meeting is an opportunity for you to reinforce that the central focus of fund management should be their funds’ investors. Time spent focusing on the needs of investors is time well-spent, whether in the boardroom or between formally scheduled meetings as you monitor your funds’ activities and interact with management. Serving as a fund director may appear to be a part-time job, but as you know, you have full-time responsibilities. And your fund shareholders are relying on you to fulfill those responsibilities with dedication, determination and vigilance.
Mutual fund managers, like all participants in the financial services industry, are under tremendous pressure in light of the market downturn. There will be temptations and economic pressure to cut corners, decrease investor services and even take on additional investment risks to try to make back some of what has been lost. As fund directors, you are the ones who may stand between a good idea for investors and a bad one. You will be the ones fighting for a square deal for your fund shareholders. And you will be the ones asked to stand up for investors’ rights when some may want to follow a course of action that may benefit fund managers over fund investors.
Whether you are undertaking your statutory responsibilities to review advisory contracts and approve auditors, or your general oversight obligations under state corporate law, or the variety of duties you have under SEC exemptive rules, I encourage you to perform your functions with the diligence and care of a fund fiduciary.
I understand that a particularly challenging, yet critically important, function for you as fund directors is your role in the annual reconsideration of a fund’s investment advisory contract. I also understand that your role in the contract review process will be subject to considerable scrutiny since the Supreme Court has decided to take up the issue in the Jones v. Harris case. The appropriateness of mutual fund advisory fees; whether they are too high; and whether fund boards adequately scrutinize the level of services provided to investors are key issues for the 92 million Americans invested in mutual funds. Given the significance of this case for fund investors and fund directors, I expect that the SEC will voice its views through the amicus process.
In closing, I leave you with a final thought. As fund directors, you play a critical role as the watchdogs of fund management and the champions of fund investors. I urge you to approach that role with a strong spine and an overarching commitment to serving fund investors. If there was ever a time when investors are relying on your to protect their interests, that time is now. I thank you for being up to the challenge.
Thank you, and I would be happy to take any questions.
Securities and Exchange Commission
Mary L. Schapiro is the 29th Chairman of the U.S. Securities and Exchange Commission. Chairman Schapiro was appointed by President Barack Obama on January 20, 2009, unanimously confirmed by the U.S. Senate, and sworn in on January 27, 2009. She is the first woman to serve as the agency’s permanent Chairman.
Chairman Schapiro’s priorities at the SEC include reinvigorating a financial regulatory system that must protect investors and vigorously enforce the rules; and working to deepen the SEC’s commitment to transparency, accountability, and disclosure while always keeping the needs and concerns of investors front and center.
Prior to becoming SEC Chairman, she was CEO of the Financial Industry Regulatory Authority (FINRA) — the largest non-governmental regulator for all securities firms doing business with the U.S. public. Chairman Schapiro joined the organization in 1996 as President of NASD Regulation, and was named Vice Chairman in 2002. In 2006, she was named NASD’s Chairman and CEO. The following year, she led the organization’s consolidation with NYSE Member Regulation to form FINRA.
Chairman Schapiro previously served as a Commissioner of the SEC from December 1988 to October 1994. She was appointed by President Ronald Reagan, reappointed by President George H.W. Bush in 1989, and named Acting Chairman by President Bill Clinton in 1993. She left the SEC when President Clinton appointed her Chairman of the Commodity Futures Trading Commission, where she served until 1996.
Chairman Schapiro is an active member of the International Organization of Securities Commissions (IOSCO). She was Chairman of the IOSCO SRO Consultative Committee from 2002 to 2006.
A 1977 graduate of Franklin and Marshall College in Lancaster, Pa., Chairman Schapiro earned a Juris Doctor degree (with honors) from George Washington University in 1980. Chairman Schapiro was named the Financial Women’s Association Public Sector Woman of the Year in 2000. She received a Visionary Award from the National Council on Economic Education (NCEE) in 2008, honoring her as a “champion of economic empowerment.”