WHEN: TODAY, WEDNESDAY, AUGUST 5TH AT 2PM ET
WHERE: CNBC'S "STREET SIGNS"
Following is the unofficial transcript of a one-on-one interview with SEC Chairman Mary Schapiro today, Wednesday, August 5th on CNBC's "Street Signs."
All references must be sourced to CNBC.
Ms. MARY SCHAPIRO: I think they're important issues because I think they go to this whole issue and concern about whether we're developing a two-tiered market where some people have access to more information than others do. And that's a concern, obviously, for the SEC. So with respect to flash orders, we're looking at whether they should continue to be permitted. And we'll go through a process, if we have to, at the SEC to deal with that. On high frequency trading, dark pools, some of the other issues that are related, we're going to take a very thoughtful approach, try to surface all of the issues, particularly the ones that go to fairness to investors on some of these strategies, and decide what kind of rule making or other action might be appropriate for us to take. But I would agree with you, they have really caught people's imaginations very quickly.
BURNETT: They have. Senator Charles Schumer yesterday actually went so far as to say that a ban by you of flash trading was imminent. You haven't done it yet. Did you have a conversation with the senator where you indicated you're moving in that direction? I mean, should expect a ban? It's just a matter of time?
Ms. SCHAPIRO: Well, I have talked to the senator, but I've also talked to the markets, major market participants and investors who are all interested in this issue, and so we're going to look very carefully at how to deal with the inequity that's created by flash orders. And there's been a widespread call not just from Senator Schumer, but from others as well. Even some markets that engage in flash trading have called for a ban.
BURNETT: The Nasdaq, I know, has given you a letter of...(unintelligible).
Ms. SCHAPIRO: Exactly. So I think my personal view is we're headed in that direction. The commission will obviously have to vote to take that position. It has to be done by rule making, so it can't happen instantaneously. But we're moving quite decidedly in that direction.
BURNETT: And on high frequency trading, we've seen numbers anywhere between half and two-thirds of daily trading...
Ms. SCHAPIRO: Yes.
BURNETT: ...is quote/unquote "high frequency." That is a number that can just make people afraid when they hear it. But just because people are trading quickly or with high frequency doesn't necessarily mean that it's fraudulent or in some way inappropriate, right?
Ms. SCHAPIRO: You're right about that. I mean, in fact, there's a very good argument that it's brought tremendous liquidity to the marketplace and narrow spreads rather dramatically, which is very much of a benefit to all investors. So we have to balance the good and the bad here, and we have to do that in a very thoughtful way. This is a--an enormous part of the marketplace today. What we want to be sure we're guarding against is real inequity to retail and other investors.
Ms. SCHAPIRO: So at the same time, we want to conscious of the fact that the liquidity that can be brought to the marketplace from high frequency trading is a benefit.
BURNETT: Dark pools is another issue, and I know that in some senses they're linked because some people, obviously, have information that others don't. Dark pools, as a concept, have been growing. I mean, all--many banks have their own exchanges that aren't linked to stock exchanges in any way.
Ms. SCHAPIRO: Right.
BURNETT: Some hedge fund managers that I've spoken to say that there is a place for dark pools, that when they have a massive position in a stock--I'll make one up, Citigroup--and they want to unload it, it's hard to do so on a--on a market that everyone knows where they stand. I don't know if that argument makes sense to you or not. I mean, is there a place at all for a dark pool which enables somebody to be setting a price that not everybody has access to?
Ms. SCHAPIRO: I think--the jury's out, I think, very much on dark pools, and that's part of the analysis that we're going through right now and we'll seek public comment broadly. I do think that we have to be conscious of the fact that there are very large trades that have to be accomplished in the marketplace, akin to the old block desk in investment banks.
Ms. SCHAPIRO: And so we need to think about that and how that translates into this new, you know, very technologically empowered trading market that we have today. And so again, we want to be thinking about the market structure.
Ms. SCHAPIRO: We want to be eliminating the inequities to the great extent we can. But we also understand that there is a need for some anonymity in the marketplace. My real concern is with indications of interest and whether these are orders, sometimes, and should be displayed publicly...
Ms. SCHAPIRO: ...so that everyone has access.
BURNETT: Right. So maybe some changes in how dark pools operate. But it sounds like you, at least--not necessarily the entire commission, but you, at least, recognize that there may be a role for them.
Ms. SCHAPIRO: I think that's right.
Ms. SCHAPIRO: And I think, you know, questions come up; should they be linked? Should they be doing small size orders?
Ms. SCHAPIRO: You know, what kind of transparency should there be post-trade so that people know where transactions are happening?
Ms. SCHAPIRO: So as I say, the jury is very much out on these, and we're going to look at the full range of issues and see what we think is appropriate. Our guidepost in all of this will be investor protection.
BURNETT: Mm-hmm. And last fall there was--there were a lot of things that got focus on the SEC. There was a list of stocks, banks that people were not allowed to short.
Ms. SCHAPIRO: Right.
BURNETT: Because the prices kept going down. There was a whole lot of discussion about the uptick rule and whether that was causing the market to go down. And now the market's come back up and we're not hearing anything, really, about the uptick rule or new restrictions on shorting. Are both of those things still on the table?
Ms. SCHAPIRO: They are still on the table. And actually, we're still hearing from investors, in particular, about reinstating the old uptick rule. And so we published a series of rule proposals ranging from circuit breakers that would apply to individual stocks, to something akin to the old uptick rules that would apply across the market that would slow down short selling under certain conditions.
Ms. SCHAPIRO: And those went out for comment. We got 4,000, I think, comment letters that we're working our way through and haven't decided yet how we're going to go forward on that, although I hope we'll do that in the near future. But the issue hasn't gone away.
BURNETT: Mm-hmm. So by the end of the year, I know you said you have a lot of goals of things you'd like to have resolved.
Ms. SCHAPIRO: Right.
BURNETT: One of those would be flash orders. What are--what are the other things? Is it...
Ms. SCHAPIRO: Short selling I'd like to have it resolved...
BURNETT: Short selling. Uptick is one.
Ms. SCHAPIRO: ...as part of the short selling review, absolutely.
Ms. SCHAPIRO: We've done some new rules to provide shareholders the ability to nominate directors to corporate boards.
Ms. SCHAPIRO: Those are out for comment. We'd like to be able to move ahead with that. Better disclosure on executive and other compensation practices in public companies and how that's related to risk taking.
Ms. SCHAPIRO: And we think that's really important information for investors. We have money market reform rules that are out to try to make money market funds more resilient and avoid the potential for another one to break the buck the way the Reserve Fund did last fall.
Ms. SCHAPIRO: And then we have some new rules that deal with the sanctity and safety of customer assets that are held by investment advisers to try to insure better controls in that area. So we've done a lot of rule making in the last six months.
BURNETT: It seems like there's something, when you look at the derivatives market, for example, and, you know, conversations you had, statements you made or people made years and years ago...
Ms. SCHAPIRO: Yeah.
BURNETT: ...that this market was as big as the top 10 economies in the world or 12 economies in the world combined. People wanted it to be regulated. There's some things where you look at and you can think in hindsight or even beforehand, `That needs to be dealt with.' But we're in a position right now where there's a lot of people just pushing to regulate in the hopes that that will prevent the next big problem.
Ms. SCHAPIRO: Yeah.
BURNETT: That has to be something, obviously, you're fighting. You're trying to do something that's smart as opposed to just regulating for regulating's sake. How are you going to get that line right?
Ms. SCHAPIRO: Well, it's going to be a hard line, but I think there are lots of voices in the debate. I think that's really helpful to hear those different interests and different perspectives in figuring out how to draw the lines correctly. I will say on swap and over-the-counter derivatives...
Ms. SCHAPIRO: ...12 years ago when I was chairman of the CFTC, I thought they should be--swap, actually, maybe a little bit longer ago than that even.
Ms. SCHAPIRO: I felt swap should be regulated and brought onto exchanges and cleared through central counterparties or clearinghouses. And that was even before credit default swaps were created. We were just talking about commodity swaps in those days.
Ms. SCHAPIRO: So I've always thought that was a bit of a black hole in our financial system where there was really no federal oversight at all.
BURNETT: Is there a next black hole? Is there--I mean, in your crystal ball, you saw that, 10, 12 years before anyone else did.
Ms. SCHAPIRO: I...
BURNETT: Is there another thing?
Ms. SCHAPIRO: I think--I think all the regulators are highly focused on this right now, so I think we will see hedge funds come under some degree of regulation in the next year.
Ms. SCHAPIRO: OTC derivatives are certainly going to come under regulation in the next year. And I think the work that the regulators are doing with the Obama administration generally to try to identify all the gaps and fill all the holes...
Ms. SCHAPIRO: ...will be enormously beneficial as we work through the legislative process in the next year.
BURNETT: Do you have the heads, and the ability to pay those heads, to get all of this done?
Ms. SCHAPIRO: We--this is an agency, the SEC, that could be many times bigger than it is. Just to give you a little bit of a startling statistic...
Ms. SCHAPIRO: ...we regulate--we have about 35,000 regulated entities. We have 3,600 employees. To put it in real, historic terms, there are 8,000 mutual funds...
Ms. SCHAPIRO: ...11,000 investment advisers; we have 400 examiners to cover that. So we...
BURNETT: So how can you prevent the next Madoff?
Ms. SCHAPIRO: Well, we can grow. We can fill the regulatory gaps with rules, for example, with respect to custody. We can employ technology more effectively and we can leverage third parties more effectively than we have. So for example, our new custody rules require that public accounting firms help to verify the existence of customers' assets at an investment adviser.
Ms. SCHAPIRO: We can get whistleblower legislation that allows us to pay whistleblowers who bring on good evidence of a fraud that's ongoing.
BURNETT: Oh, so you could pay someone like the woman in Enron, right, who brought...
Ms. SCHAPIRO: Exactly.
BURNETT: Right. OK.
Ms. SCHAPIRO: If we can leverage other entities, it's going to be critical. We've got to leverage technology.
Ms. SCHAPIRO: And the reality is the agency needs to be bigger and we need to bring in some new skill sets so that we're a little bit closer to being ahead of the curve...
Ms. SCHAPIRO: ...when we're dealing with the incredible innovation that takes place on Wall Street and that takes place in the mind of fraudsters.
BURNETT: I know that--speaking of fraudsters, you said you prosecuted a lot of--three times as many Ponzi schemes this year as last year.
Ms. SCHAPIRO: Yeah.
BURNETT: Obviously, Bernard Madoff is the one that most people think of, especially given that there were repeated warnings about him in the past.
Ms. SCHAPIRO: Right.
BURNETT: Are all of those people that you've--that you've unveiled, are they all going to jail? Is Bernard Madoff going to be the only one that goes to jail?
Ms. SCHAPIRO: No, lots of them will go to jail. Stanford's in jail, now awaiting trial. We try to do as many of these fraud cases with the criminal authorities as we can.
Ms. SCHAPIRO: So while we might be the first mover, sometimes they're the first mover.
Ms. SCHAPIRO: We are often linked with the criminal authorities, because we can't send anyone to jail at the SEC.
Ms. SCHAPIRO: We're a civil enforcement agency.
Ms. SCHAPIRO: They can. That is the most powerful deterrent of all. So anytime we can link arms with the state's attorneys general...
Ms. SCHAPIRO: ...Department of Justice, the FBI, we will do that.
BURNETT: And what about on the cases of companies? It was a while we weren't hearing a lot about it. This week there's been--our parent, GE, has paid a fine on accounting fraud; Kmart and Bank of America on misleading investors. Are we going to see a lot more headlines like that? And are people--are you going to be--again, you're civil, but are you going to be working with criminal authorities in those sorts of cases to put people in jail?
Ms. SCHAPIRO: We absolutely will work with criminal authorities in those cases as well.
Ms. SCHAPIRO: We have a very aggressive new enforcement director at the SEC who's made it really a priority for us to be much more strategic in our cases.
Ms. SCHAPIRO: Much faster in our cases.
Ms. SCHAPIRO: And you've really seen that in the last couple of weeks, I think.
Ms. SCHAPIRO: And it's bringing the cases that have the biggest impact, the highest likelihood of protecting investors and stopping ongoing fraud and problems.
Ms. SCHAPIRO: And that's the path we're on right now.
BURNETT: Just a couple more major issues. One, exchange-traded funds. They're--they are sprouting like a fungus. I know that sounds like they're all bad; but, I mean, they are everywhere is my point, and everyone is playing in them, institutions, individuals. There's levered ETFs now, where...
Ms. SCHAPIRO: Right.
BURNETT: ...if you're right you get a whole lot more than that day's gain, and if you're wrong you lose a whole lot more than that day's loss. Are you going to have a division that's just focused on ETF? Do you have the ability to ensure that all these ETFs coming to market are appropriate, are safe for individuals?
Ms. SCHAPIRO: We do have a division now, the investment management division, that covers both mutual funds and ETFs, and we're going to add some resources there...
Ms. SCHAPIRO: ...that can be specifically focused on ETFs.
Ms. SCHAPIRO: Because they are quite a phenomenon in the market place.
Ms. SCHAPIRO: The levered ones cause me some concern. We look carefully at their disclosure to ensure that investors understand the risks of being in a levered ETF.
BURNETT: Is there anything wrong with a levered ETF? I mean, are--is it possible--I know it's too early to say, but is it possible those just might not be allowed?
Ms. SCHAPIRO: Certainly possible for them to be missold, and that's always a concern that we have.
Ms. SCHAPIRO: But we're going to look carefully. We're going to take a big, deep breath and look at the entire ETF realm very carefully this fall.
BURNETT: Credit rating agencies is another thing I wanted to get you on the record on; central part of the crisis, we all know that. No one's exactly figured out how they should be changed. Do you favor ending rating agencies as we know them? I mean, do you, for example, favor a public utility model, where in a sense it comes out of the government?
Ms. SCHAPIRO: I'd love to have the opportunity to explore some different models, the public utility model. Probably not so sure that the government is in a good position to do this.
Ms. SCHAPIRO: We've talked with a number of people about a buyer-owned credit rating agency. A professor at Stanford, Joe Grundfest, has proposed this, where...
BURNETT: The investors...(unintelligible).
Ms. SCHAPIRO: ...institutional investors...
Ms. SCHAPIRO: ...would create a rating agency. And the interest of that rating agency would be 100 percent aligned with those institutional investors. We would welcome somebody proposing in specific a way to do that. In the meantime, we're trying to encourage more competition in this space and move towards a subscriber paved model wherever we can encourage that, so it's not just the issuing company...
Ms. SCHAPIRO: ...that's paying the freight at the rating agencies. We're going to propose some additional disclosure, including a ratings shopping, which I think is a really pernicious problem, where a company issuing...
BURNETT: They go around and look to get the best rating they can.
Ms. SCHAPIRO: ...a structured product, and then I pick the one that's the highest.
Ms. SCHAPIRO: And we're going to deal--try to deal with that. More disclosure about conflicts and revenues, more disclosure of ratings history.
Ms. SCHAPIRO: We're going to--we're going to push in a number of areas for more reform here. And then we're going to create a group at the SEC solely dedicated to inspecting rating agencies and their adherence to their methodologies and their disclosure obligations and their handling of conflicts of interest.
BURNETT: So it sounds like, from what you're saying, that the agency does need to get a lot bigger; I mean, just looking at the numbers that you shared before. But, I mean, even from what you're saying in terms of siphoning off groups and adding people in different areas; I mean, are you going to get 50 percent bigger? I mean, how much bigger do you think you can really get right now?
Ms. SCHAPIRO: It's hard to say. The budget process is always complex in Washington. But I will say, we've had tremendous support in the both the House and the Senate...
BURNETT: Mm-hmm. Mm-hmm.
Ms. SCHAPIRO: ...and the administration. So while we're likely to grow slowly and we're not likely to grow dramatically, I think we will continue to be on an--on an upward trend. We are still, actually, smaller today in 2009 than we were in 2005. So we're catch--we've got some serious catching up to do.
Ms. SCHAPIRO: We have a lot of responsibilities. We're likely to get some more with those...
Ms. SCHAPIRO: ...(unintelligible)...derivatives and hedge funds. And it's important that we can handle them. We don't want the public to think there's a level of protection there that isn't.
BURNETT: Right. And that brings me to this whole issue of who's going to be top dog, which appears to be some 50,000 foot--feet, how it's playing out. Obviously, we've all seen the stories of the expletive-laden meeting that you were at; Timothy Geithner, Ben Bernanke, Sheila Bair, they were all there. Are you going to all get to the same place over whether the Fed is going to be the ultimate top dog, or everybody at the table, the council of regulators? I mean, is there going to be a united front here soon?
Ms. SCHAPIRO: Well, I think, at the end of the day, it's obviously Congress' call what the legislation looks like. But I would say there's far more agreement than there is disagreement among all the federal regulators. There's absolute commitment across the board to improving the financial regulatory system, making it much more robust, much more prescient, much more resilient to crises. So whether it's going to be a stronger or less strong council, the Fed as the systemic regulator or the Fed coupled with a council, I think the differences that separate us are actually pretty minor and I think we're going to be able to work through those.
BURNETT: Why would a group, which is something you put--you know, the council, why would that be better than just having it reside at the Fed?
Ms. SCHAPIRO: Well, we--the SEC's position has actually been that there should be a much more empowered council, but that there should also be a systemic regulator, that second set of eyes.
Ms. SCHAPIRO: And it certainly could be the Fed looking over the shoulder of the primary regulators just to make sure, for those really systemically important institutions and payment systems and so forth, that everything is being done as well as it possibly can be, so that while the primary regulatory would set maybe capital liquidity standards...
Ms. SCHAPIRO: ...leverage limitations, that you could have a council or a systemic regulator actually raise those standards in times of stress...
Ms. SCHAPIRO: ...if that's what was appropriate. So we actually favor a strong council and a systemic risk regulator in addition to the primary regulators with their specific areas of authority.
BURNETT: So it sounds like, at least the way you're selling it, we could have--you could have your cake and eat it, too. Every regulator could.
Ms. SCHAPIRO: I...
Ms. SCHAPIRO: I really believe--I believe there's much more common ground than there is differences.
BURNETT: All right. Well, thank you so much. We appreciate it.
Ms. SCHAPIRO: It was my pleasure. Thank you.
BURNETT: Chairman Schapiro
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