Aguilar Discusses Regulatory Reform and Independent Directors

Commissioner Luis Aguilar talked about the SEC's role in regulatory reform, the role of a systemic regulator and the role of independent directors in a speech at a recent independent directors conference workshop in Boston. Aguilar maintained that the SEC's role is more critical than ever and that its mission is a necessary foundation to the financial system. As a result of the financial crisis, the entire regulatory structure seems to be on the table, he said. Aguilar believes that the crisis presents an opportunity to develop a more robust financial regulatory system. His remarks are posted on the SEC's Web site.

Aguilar said that a focus on investors is essential to any credible regulatory restructuring. When discussing systemic risk, many people focus on preserving institutions that are deemed too big to fail. Aguilar said this approach may result in a regulatory model that focuses on institutions rather than investors. The government then picks the winners and losers among companies at the expense of investors and market certainty, he said.

Aguilar believes that systemic risk regulation should focus on continuing systemically important market functions and on investor protections. Systemic risk regulation should prevent institutions from becoming too big to fail, in his view. Systemically important market functions should be isolated within an entity so that they can be separately maintained if other parts of the entity fail, he said. Systemic risk regulation should focus on the continuation of market functions and not necessarily institutions, according to Aguilar.

Aguilar added that the systemic risk regulator should serve as a supplement to, rather than a replacement for the primary regulator. He believes the "council of regulators" model is one viable option once a number of issues are worked out. The council must be independent, for example, and free from any political influence. The council must adopt work processes for information sharing and decision-making. The council's authority must be determined so that it can work with primary regulators to leverage their expertise.

Among the issues to be decided are whether such a council should have separate information collection powers, access to a federal credit facility and the ability to seize institutions. Its membership should be composed of primary regulators with expertise across the financial markets. The SEC should be a key member of such a council, according to Aguilar. The SEC is the only regulator charged with protecting investors, maintaining fair and orderly markets and promoting capital formation, he said. It is the first line of defense for the financial regulatory system with respect to the capital markets and investors.

Aguilar said the cooperative effort among the Federal Reserve, Treasury and the SEC to assist the money market fund industry was an example of what a systemic risk council of regulators can accomplish. The SEC's Division of Investment Management is currently working on a proposal to strengthen the regulatory framework for money market funds. Aguilar noted that money market fund assets are increasing, which suggests that investors see them as safe investments for their liquid assets.

Independent directors have a key role in restoring investor confidence, in Aguilar's view. They set the tone for the fund and make sure that investors' interests are protected. Directors must ensure that funds have adequate resources for legal, accounting and compliance functions, he said. They must challenge the effectiveness of funds' policies, procedures and internal control and demand accountability from those to whom responsibilities have been delegated.

Directors must be diligent in their oversight of risk, Aguilar added. He urged them to pay attention to their compensation structures to see if they encourage excessive risk-taking. Aguilar cited a recent study which found that 26 mutual fund groups voted in favor of management compensation proposals 84% of the time, which represented an increase over the previous two years. Aguilar said those statistics "raise eyebrows" given the focus on excessive compensation.

Aguilar also discussed the benefits of having a diversified board of directors. He urged boards to implement practices to increase board diversification and to develop a diverse slate of candidates before a board opening is available.