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______________________________________ Sarbanes Oxley Compliance Professionals Association (SOXCPA)

Sarbanes Oxley Compliance Professionals Association (SOXCPA) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 Web: www.sarbanes-oxley-association.com

The Public Company Accounting Oversight Board announced sanctions in settled disciplinary orders against a Hong Kong audit firm, its New York affiliate, and four individuals for violations of PCAOB rules and standards arising from audits of a NASDAQ-listed company located in the People's Republic of China. AWC (CPA) Limited, a Hong Kong audit firm, and its managing director and director of audit were sanctioned for improperly relying on management representations, ignoring red flags indicating possible fraud, impaired independence, and other violations. AWC LLP, an affiliated firm in New York, and its two partners were sanctioned for quality control, impaired independence, and other violations. "Investors are relying on PCAOB-registered audit firms, including foreign-based firms, to perform their audit responsibilities as gatekeepers to our capital markets," said James R. Doty, PCAOB Chairman. "The Board's disciplinary action demonstrates that these firms and their personnel are accountable under U.S. law for their significant failures." To read more: https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-016-AWC-CPA.pdf https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-017-AWC-LLP.pdf

http://www.sarbanes-oxley-association.com/

https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-016-AWC-CPA.pdf

https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-016-AWC-CPA.pdf

https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-017-AWC-LLP.pdf

https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-017-AWC-LLP.pdf

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US Economy in a Snapshot Opening remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Economic Press Briefing on the US Economy in a Snapshot, Federal Reserve Bank of New York, New York City Welcome to our Economic Press Briefing. Today we are going to introduce you to a data product that we have been making available to the public, U.S. Economy in a Snapshot. My role is to put this product in the broader context of the Federal Open Market Committee's (FOMC) communication strategy about the economy and policy. My colleague Robert Rich will then walk you through the structure of the product and discuss excerpts from the May release. As always, what I have to say reflects my own views and not necessarily those of the Federal Open Market Committee or the Federal Reserve System. Conventional U.S. monetary policy is conducted by targeting the level of the federal funds rate - an overnight interest rate on bank reserves. Few participants in our economy have any direct interaction with this interest rate. How, then, is controlling this interest rate such an important part of setting monetary policy and steering an 18 trillion dollar economy toward the Federal Reserve's dual mandate objectives of maximum sustainable employment and price stability? This is the remarkable aspect of monetary policy. Just as a pebble dropped into a lake disturbs the water not just at the point of impact but ripples outward far from the origin, changes in the federal funds rate influence the prices of financial assets more broadly and this, in turn, affects the broader economy. An important insight of modern monetary theory is that this transmission of monetary policy to the broader economy through its many channels works best when the central bank is transparent about its goals, policy strategy and approach to implementing its strategy. In this case, market participants and households both understand and can anticipate actions by the central bank. By doing so, the transmission

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channels of monetary policy are enhanced. This places considerable importance on effective central bank communication. Recognizing this, the FOMC has undertaken many initiatives over the years to improve its communications with the public. These include providing clarification in terms of the goals of monetary policy, discussions of the FOMC's broad policy strategy, as well as FOMC participants' ongoing explanations of their views on monetary policy. As part of this effort, I provide a comprehensive update on my outlook for the economy and monetary policy several times during the year. Once a year we publish our staff's judgmental economic forecast. We have also provided in the Liberty Street Economics blog discussions of an internal staff model-based economic forecast. In addition, we now regularly release our real-time forecast of "current quarter" real GDP growth. All of these help the public to understand our assessment of economic conditions through the lenses of these different types of forecasts. When asked about the trajectory for the monetary policy stance, I always point out that it is data dependent. The FOMC calibrates the stance of monetary policy to best achieve our twin objectives of price stability and maximum sustainable employment, taking into account our forecast for how the economy is evolving. This forecast reflects the ongoing flow of the data. Data releases that are close to our expectations have little additional impact on the forecast, while data releases that deviate significantly from our expectations can lead to more significant revisions of the forecast. It is, therefore, important for market participants and households to be able to follow the data along with the FOMC and to understand how we are likely to interpret and react to incoming data. While market analysts readily have access to economic and financial data, this access is not widely available to everyone. To help fill this information gap, for the past year we have been making available on our website a monthly publication called U.S. Economy in a Snapshot. This publication contains a set of key data charts as well as commentary by our staff economists. The purpose is to provide interested readers easy

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access to clear and concise presentations of important economic information. The associated commentary provides some pertinent observations one might draw from the data. Our goal is to provide information that helps households and businesses follow the data along with the Fed. If people know more about how the economy is performing and how that is likely to influence our actions, this should make it easier for us to achieve our twin objectives. I will now turn it over to Rob to discuss the Snapshot in greater detail. To read more: https://www.newyorkfed.org/research/snapshot The May 2016 Snapsot: https://www.newyorkfed.org/medialibrary/media/research/snapshot/snapshot_may2016.pdf?la=en

https://www.newyorkfed.org/research/snapshot

https://www.newyorkfed.org/medialibrary/media/research/snapshot/snapshot_may2016.pdf?la=en

https://www.newyorkfed.org/medialibrary/media/research/snapshot/snapshot_may2016.pdf?la=en

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PCAOB Update – Recent Activities and Next Steps Jay D. Hanson, Board Member 2016 SEC and Financial Reporting Institute Conference, Los Angeles

Good Afternoon, Thank you for that kind introduction and for inviting me to join you at this important conference. It has been a few years since I have attended, but I was a regular during the years I lived in Southern California. I am honored to be here to talk about the work of the PCAOB, along with our Director of Inspections, Helen Munter, from whom you heard during the last panel. I am going to discuss today some of the Board's work in the areas of inspections, standard setting, and other outreach, and I will close by talking about my view of some important next steps for the PCAOB. But before I go further, I should note that the views I express today are my own and do not necessarily reflect the views of the Board, any other Board member, or the staff of the PCAOB.

Background As you know, the PCAOB was created by Congress almost fourteen years ago through the passage of the Sarbanes-Oxley Act of 2002 in the wake of numerous accounting scandals in order to protect the interests of investors. The PCAOB began operations in April 2003 and has responsibility for registration and inspection of public accounting firms; setting of auditing standards for the audits of public companies and broker-dealers; and investigations and disciplinary proceedings in cases where auditors may have violated the securities laws or applicable standards or rules. The Board is comprised of five members, two of whom must be CPAs, while the other three may not be. We have total staff of over 850 located in 16 cities across the country.

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Recent Inspections In 2015, we inspected over two hundred firms that audited issuers. Ten firms are subject to annual inspections because they audited more than 100 issuers. The other firms are generally on a three-year inspection cycle. As you just heard from Helen Munter, frequent inspection findings continued to be observed in the area of ICFR. I will give this topic a rest for now, though I will get back to it toward the end of my remarks. Other areas with recurring deficiencies in 2015 included assessing and responding to risks of material misstatement, including instances where auditors did not: - Perform sufficient substantive procedures and controls testing - Take into account relevant audit evidence that appeared to contradict

assertions in the financial statements - Sufficiently evaluate the presentation of the financial statements,

including disclosures In addition, some triennially inspected firms insufficiently identified and assessed fraud risk, particularly in the area of revenue recognition (a high risk area that is frequently the focus of PCAOB inspections). Finally, inspection findings recurred in 2015 in the area of auditing accounting estimates, including fair value measurements, particularly in connection with the valuation of assets and liabilities acquired in a business combination and evaluating impairment analyses for goodwill and other long-lived assets. Deficiencies also were identified in the areas of financial instruments, revenue-related estimates and reserves, allowance for loan losses, inventory reserves, and tax-related estimates. In some instances auditors did not fully understand how estimates were developed or did not sufficiently test significant inputs and evaluate the significant assumptions used by management. Auditors, in some cases, also did not perform testing beyond inquiry of management in both tests of controls and substantive tests.

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Overall, we saw improvements in the inspection findings among the ten annually inspected firms. Each of these firms is at a different point in their evolution of identifying and remediating areas of weakness, but, in my five years as a Board member, I have seen great strides in firms' efforts to make improvements and increase consistency in their audit practice. Among smaller, triennially inspected firms – including many of the international affiliate firms of the largest U.S. firms – inspection results were a bit more mixed in 2015. Some have made significant efforts to remediate problem areas and are showing improvement, while others continue to struggle. Among the smallest firms, we see some do excellent work, particularly those firms who focus on a particular industry or type of audit and do not stray from their areas of expertise. But we also continue to encounter firms that do not have the resources, expertise or, in some cases, willingness to perform high quality audits. Many of these firms become targets of our enforcement efforts, while others decide on their own to get out of the business of public company audits. We also watch carefully the migration of clients from firms which registrations are revoked through our enforcement efforts, as, in some cases, clients collectively move to another firm that has some relationship to the prior firm or its owners. If we see that type of activity, it is likely that our inspectors will soon be in touch to take a look at the quality of the firm's work.

2016 Inspections In 2016, our inspectors again will focus on these same areas of recurring inspection findings. In addition, we will focus on certain economic and environmental risks, including appreciation of the U.S. Dollar, segment disclosures, mergers and acquisitions, income taxes, and going concern.

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We are going to look at risks arising out of technology and cyber-security, particularly risks to the financial statements or implications for internal control over financial reporting arising out of these areas. Finally, as we often do, inspectors will review the implementation of a recently adopted auditing standard, AS 18, Related Parties, which the Board adopted in 2014. The purpose of this standard is to strengthen audit procedures for identifying, assessing, and responding to the risks of misstatement arising out of a company's related party transactions. Our inspectors will review audits to determine whether firms have appropriately implemented the standard and have complied with its requirements in their 2015 audits.

Standard Setting Speaking of new standards, let me turn now to several ongoing projects that I believe merit your attention.

Auditor's Reporting Model A few weeks ago, the Board issued a reproposal of amendments to require auditors to expand the content of the auditor's report to include a discussion of so-called "critical audit matters" or "CAMs." Like the original proposal (issued in 2013), this reproposal responds to investor demands for more information about the audit by requiring auditors to say more about the audit than merely issuing an opinion on whether the financial statements are fairly stated. Rather, auditors would be required to determine whether there are any matters that were communicated or required to be communicated to the audit committee and that: - Relate to accounts or disclosures that are material to the financial

statements, and - Involved especially challenging, subjective, or complex auditor

judgment.

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In addition to identifying the CAM, the auditor would have to describe the principal considerations that led the auditor to determine that the matter is a critical audit matter, describe how it was addressed in the audit, and refer to the relevant financial statement accounts and disclosures. If there are no critical audit matters, the auditor would state that in the auditor's report. The reproposal differs from the original proposal in several important ways in order to address concerns expressed by commenters in response to the 2013 proposal. First, in light of concerns that the original proposal was too broad and could result in the disclosure of immaterial information, the reproposal narrows the source of CAMs to matters (1) communicated or required to be communicated to the audit committee and, (2) related to accounts or disclosures that are material to the financial statements. Second, the proposal includes a less burdensome documentation requirement. While auditors will still be required to document why each material matter communicated to the audit committee is or is not a CAM, the universe of such potential matters is limited by the audit committee communications filter, making the documentation requirement less onerous. And for those matters determined to be a CAM, the audit report itself serves as the auditor's documentation. Finally, in order to address concerns by preparers that the auditors should not disclose original information about the company that is not otherwise required to be disclosed, the reproposal requires auditors, in describing the CAM, to make reference to disclosures made by management in material financial reporting areas. This should generally eliminate the need for auditor's to disclose any original information about the company (except to the extent the auditor's stated reason for identifying a CAM involves reference to facts not already disclosed by the company).

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New in this reproposal is the requirement that the auditor also discuss how the CAM was addressed in the audit. This discussion should utilize language that will make the information useful to investors, which, in my view, means that descriptions of audit procedures should not be overly technical but should convey how and why the procedure helped the auditor become comfortable with the critical matter. Overall, I am supportive of this project. Borrowing language from our economists, the project is intended to provide information to investors in order to decrease the information asymmetry between auditors and investors. I believe that providing more information about the audit could do so, which could drive increased confidence in the capital markets. However, because the proposed requirement will also impose costs and burdens on preparers, auditors, and others, we need to be sure that the information being provided is actually useful to investors. Here, I believe the jury is still out. I am hoping for thoughtful comments from investors and other financial statement users on this question. I also look forward to more definitive academic research that would demonstrate the value of expanded auditor reporting in jurisdictions where it is already in place. Finally, I have a request: Of all of the PCAOB's stakeholders, preparers have expressed the greatest opposition to the proposed changes in the auditor's reporting model. We believe we have addressed the most significant concerns, focused primarily on the disclosure of original and immaterial information by the auditor. To the extent you continue oppose the amendments as reproposed, please consider providing us with specific feedback about how the approach could be improved. While blanket opposition to any changes to the auditor's report will, of course, be considered, investor demand for more information is strong, and the momentum of the project is toward expanded auditor reporting.

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This is particularly the case in light of new requirements for similar reporting around the world. Therefore, I urge you to be part of the solution by helping us understand and address specific concerns, rather than articulating only that you would like no changes at all.

Other Auditors The second standard setting project I would like to address briefly is our recent proposal regarding the planning, supervision, and performance of audits involving other auditors, meaning auditors who participate in the audit but do not issue the audit opinion. This is an important area in light of the increase in companies with global operations, requiring the referral of audit work to other auditors around the world. Under current standards, there are multiple approaches for the oversight of such other firms or auditors, and the Board has observed varying levels of audit quality in the work performed by other auditors and varying degrees of supervision by the firm issuing the audit report. To some degree, this project represents the PCAOB catching up to what is already "best practice" by some of the largest public accounting firms. These firms have extensive experience with global audits and have incorporated into their methodologies not only the requirements of international auditing standards but also process improvements designed in response to inspection findings by the PCAOB and other regulators. These firms require frequent, comprehensive communications with other auditors and review of other auditors' work papers in areas of significant risk, steps which go beyond those currently required by PCAOB standards. Other firms, including those who do not follow international standards, continue to base their supervision of other auditors largely on existing PCAOB standards. The proposed amendments are intended to enhance supervision and provide consistency to audits involving other auditors.

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When I voted to approve the issuance of this proposal in April, I also raised several questions for commenters. One of these questions that may be particularly relevant to preparers of financial statements deals with the "sufficiency determination" requiring the lead auditor has to determine whether it is performing enough of the audit work to serve as the lead auditor. Under the proposal, this determination is based on the risks of material misstatement associated with the portions of the financial statements audited by the lead auditor relative to the portion audited by the other auditors. There are, however, are no bright lines or minimum percentages to help with this determination. This requirement is intended to increase the likelihood that the firm issuing the auditor's report performs audit procedures for a meaningful portion of the company's financial statements, but it may also raise questions for companies that operate in many different jurisdictions. In those circumstances, it may in some cases be difficult to determine which firm audits a sufficient portion of the company's financial statements to serve as lead auditor, and the criteria may not necessarily point to the firm currently serving as the lead auditor. The PCAOB's release provides extensive discussion of this proposed new requirement, including several examples. To the extent your companies have operations in multiple countries, I urge you to consider reviewing the PCAOB's release and to discuss the proposal with your auditor to better understand whether your existing arrangements would satisfy the proposed requirements.

Fair Value and Estimates We also have been reviewing for several years now our standards governing accounting estimates and fair value measurements along with those addressing the supervision of specialists who provide information relevant to the audit, including valuation specialists, lawyers, actuaries, geologists and others.

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We have issued staff consultation papers to seek input in both of these areas and we discussed potential approaches with our Standing Advisory Group and Investor Advisory Group on a number of occasions. Having conducted extensive outreach, any amendments to our standard governing the auditing of fair value and estimates are likely to focus on the following issues: - The auditor's identification and response to significant measurement

uncertainty in accounting estimates or fair value measures; - The importance of applying professional skepticism in evaluating

contradictory evidence; - The increasing use of pricing services by both management and

auditors; and - Aligning any new standards in this area with our risk assessment

standards. Notably, the international standard relating to estimates and fair value, ISA 540, is also currently under review by the International Auditing and Assurance Standards Board, and our staff is in close contact with the staff of the IAASB to monitor developments and share information. Because of the close link between standards governing fair value and estimates and standards governing the use of specialists (who often provide the information to establish fair values and estimates), we are closely coordinating our projects on specialists and on fair value and estimates. In the area of specialists, we are currently looking at both the definition of a specialist and whether and how the standard should differentiate between the auditor's use of a specialist and the auditor's consideration of the work of a company specialist. While much work remains to be done, we currently hope to issue proposals in these projects by the end of this calendar year. Stay tuned.

Audit Committee Outreach and Audit Quality Indicators Let me turn now to some other approaches – beyond inspections and standard setting – by which the PCAOB is trying to drive improvements in audit quality in order to protect investors.

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One such effort is the robust dialog we have established in recent years with audit committees. As those responsible for the direct oversight of auditors and accountable to investors for financial reporting quality, audit committee members are a natural ally for the PCAOB. Starting around four years ago, members of the PCAOB Board and senior staff have met on occasion with groups of audit committee members in a variety of settings – large conferences, small gathering organized by groups like the NACD, audit committee gatherings hosted by audit firms, academic conferences, and many others. While this outreach is less formal than our meetings with our Standing Advisory and Investor Advisory Groups, I have found it to be enormously helpful in understanding issues facing audit committees and how our actions impact them and their companies. One topic that we have discussed extensively with audit committees is our project on audit quality indicators. In late 2012, we announced our intention to study the feasibility of establishing quantitative measures of audit quality, and we have conducted extensive formal and informal outreach on this topic for the past several years. Last July, we issued a concept release to seek public comment on the content and possible uses of a group of 28 potential audit quality indicators. The feedback in response to our concept release was mixed, with some commenters supporting the project but advocating that we should let practice develop on a voluntary basis. Other commenters supported the project and urged us to act quickly to mandate public disclosure of certain audit quality indicators; however we received very little feedback on the utility of the 28 individual indicators. Several firms, as well as the Center for Audit Quality, also have been studying this area and have begun to publish certain firm level metrics that they believe may be helpful, especially to audit committees, in evaluating audit quality. We continue to digest the feedback we have received and to discuss with firms their experiences with the quality indicators they have begun to identify and track.

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While the Board has yet to make a formal determination about next steps, my expectation is that we are not likely to impose any requirements or new standards in this area in the near future. Rather, I believe we will continue to gather data about promising indicators, encourage academic study in this area, and urge firms to monitor and report publicly on some of the most informative measures. I believe it would also be useful to gather more input on whether to establish standardized definitions for certain indicators, even if their use is voluntary, in order to allow for comparability.

Evolution of the PCAOB I have described a number of our outward facing initiatives, all intended to continue the trend of improving audit quality since the establishment of the PCAOB. But in addition to continuing our work in inspections, enforcement, standard setting and related outreach, we also need to take a look inward, at the PCAOB as an organization, and determine how we need to evolve in order to maximize our effectiveness in protecting investors and the public. In recent years, we have made great strides in integrating economic analysis into our standard setting and rule-making. While this was in part a response to political forces, we have found that our understanding of the problems to be solved through our actions, and the impact of potential solutions, has deepened significantly. Hopefully, this will result in standards that are more targeted and effective, while minimizing the burden on auditors and preparers. We continue to work with our economists to improve both the substance and documentation of the relevant analysis. We are also taking a look at our inspection program. In recent years, the staff has made improvements to PCAOB inspection reports, increasing the information provided, for example, about the audits inspected and the standards giving rise to inspection findings.

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My colleague on the Board, Jeanette Franzel, spoke last month at Baruch College in New York about the potential evolution of PCAOB inspections in the future, including possible changes such as an increase in random inspections, shifting from a strong emphasis on engagement reviews to increased testing of a firm's system of quality control, or changes in reporting and communications of inspection results. Such changes will take time to design and implement, but I agree with Board Member Franzel's perspective: As audit performance improves, and the nature of risks to audit quality evolves, our inspection approach must be adjusted in order to maintain its effectiveness. Likewise, the PCAOB has embarked over the last year on a review of its standard setting process. Along with ongoing improvements in our economic analysis, we want to make sure that our standard setting proceeds as efficiently and effectively as possible. We are in the home stretch of this work and potential enhancements include, among others, doing more research in order to define the problem to be solved even before a project is added to the standard setting agenda; more economic analysis earlier in the consideration of possible alternative approaches; better coordination among the various offices and divisions involved in standard setting at the PCAOB; a more phased approach to Board decisions throughout the project; and more standardized documents. Finally, we embarked this year on our first post-implementation review of an auditing standard, AS 1220, Engagement Quality Review (formerly AS 7). The purpose of this review is to evaluate the effect of the standard, including: - Evaluating whether it is accomplishing its intended purpose,; - Identifying, wherever possible, costs and benefits; and - Identifying unanticipated consequences, either positive or negative. The staff of our Center for Economic Analysis, which is coordinating the review, has gathered internal data, including inspection results, conducted a review of academic research, and recently issued a request for comment.

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While we are still learning and developing our approach to post-implementation review, I am pleased that we have taken steps to establish this important process. I will close with a few comments on the topic covered extensively before lunch: ICFR. As you heard from Helen Munter, frequent inspection findings continued to be observed in the areas of ICFR, including insufficient testing of: - The design and operating effectiveness of selected controls, especially

in high risk financial reporting areas; - Controls that contain a review element;

- Controls over the accuracy and completeness of system-generated data

and reports. As you also heard during the ICFR panel this morning, there continues to be an expectation gap between preparers, auditors, and the PCAOB and SEC with regard to the appropriate level of scrutiny, testing and documentation by auditors of companies' internal controls. Preparers have expressed concern that auditors are doing unnecessary work as a result of PCAOB inspection findings. Although we are comfortable that our inspectors are not imposing new auditing requirements through inspections, it is possible that firms' concerns about the frequency of our inspection findings in the area of ICFR, and firms' efforts to remediate the related quality control deficiencies, have caused some audit teams to do more work. In some cases, their work may be focused on the wrong areas, resulting in unnecessary burdens on management. As discussed during the last session, we at the PCAOB, in coordination with SEC staff, will continue to focus on this issue in order to make sure we have an appropriate balance between auditors' doing sufficient and meaningful audit work to gather the right amount and the right type of audit evidence, while not imposing unnecessary burdens on management or causing needless delays in the financial reporting process. After completing the post-implementation review of AS 1220 (AS 7) and making any necessary adjustments to our process, I believe we should give

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serious consideration to conducting such a review of the standard on auditing internal control, AS 2201 (formerly AS 5). The implementation of this standard represented a sea change in public company audits, imposing extensive costs but also driving what many believe were significant improvements in financial reporting quality. Of course, post-implementation review of such a complex standard would require extensive time and resources. But it is precisely our most controversial regulatory actions that should be subject to such scrutiny to determine whether they have achieved their investor-protection objectives. With that, let me thank you for your attention this afternoon. I am happy to take any questions.

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PCAOB Sanctions Five Firms and Seven Individuals for Audit Failures, Violations of Engagement Quality Review Rules, or Noncooperation with an Investigation The Public Company Accounting Oversight Board announced sanctions in settled disciplinary orders against five audit firms and seven individuals for audit failures, violations of engagement quality review (EQR) rules, or for noncooperation with a Board investigation. The PCAOB also obtained admissions to some or all of the facts, findings, and violations from four of the firms and six of the individuals. "The PCAOB's requirements for engagement quality reviews provide safeguards against unsupported audit opinions, while the requirements for cooperation with investigations support the Board's oversight mandate," said James R. Doty, PCAOB Chairman. "Both protect investors and audit firms should take the requirements seriously." According to the orders, some of the firms permitted companies to issue their audit reports without obtaining approval from engagement quality reviewers. In some instances, firms had multiple violations of the EQR standard and failed to obtain sufficient appropriate audit evidence to support their audit opinions. One firm and an associated individual violated the provision of the EQR standard that requires an engagement quality reviewer from the same firm to be a partner or in an equivalent position. Another firm violated the Securities Exchange Act of 1934 by knowingly failing to resign or to report that a company it audited had filed incorrect financial statements. In another matter that did not involve engagement quality reviews, a firm and three associated individuals failed to cooperate with a Board investigation by refusing to provide sworn testimony or documents. "Obtaining admissions from auditors who engage in misconduct enhances their accountability," said Claudius B. Modesti, PCAOB Director of Enforcement and Investigations. "These orders demonstrate that the PCAOB will continue to seek admissions of wrongdoing where appropriate."

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The audit firms and associated individuals named in the orders released today, as well as the violations that they settled, can be found in the attachment here. The investigations that resulted in the settlements announced today originated with information obtained through the PCAOB inspection program. PCAOB Enforcement staff members David Florenzo, Stefan Hagerup, Noah Berlin, Christina Carroll, Michael Davis, Tina Bell, Ke Xu, James Welch, Pamela Woodward, Tima Hawes, and Marques Jenkins conducted the investigations, which were supervised by Kyra Armstrong and Raymond Hamm. The PCAOB oversees auditors' compliance with the Sarbanes-Oxley Act, professional standards, and PCAOB and Securities and Exchange Commission rules. Further information about the PCAOB Division of Enforcement and Investigations may be found on the PCAOB website. Suspected misconduct by auditors can be reported to the PCAOB Tip and Referral Center.

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The advantages of probabilistic survey questions Keynote address by Mr Simon M Potter, Executive Vice President of the Markets Group of the Federal Reserve Bank of New York, at the IT Forum and RCEA Bayesian Workshop, Rimini, Italy

I would like to thank Marco Del Negro, Giorgio Topa, and Wilbert van der Klaauw for their excellent assistance in the preparation of these remarks, Luis Armona, Daniele Caratelli and Joseph Fiorica for able research assistance, and colleagues in the Federal Reserve System for their insightful comments and suggestions. Good afternoon. It’s a pleasure to talk with you about a topic that intrigues me as a former academic researcher, and that’s of significant importance to me in my current role as head of the New York Fed Markets Group and as manager of the System Open Market Account for the Federal Open Market Committee (FOMC): the measurement of policy-relevant expectations through surveys. It is entirely fitting to talk about this topic here in Italy, given the Bank of Italy’s long history of research and experimentation on expectations data. This history includes extensive work on data gathered from surveys using a probabilistic question format – the focus of my talk today. Since 1989, the Bank of Italy’s Survey of Household Income and Wealth has used this question format to ask households about their expected labor or pension earnings in the next year. The findings from these surveys have provided new insights into consumer behavior, such as the impact of subjective earnings uncertainty on precautionary saving.

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The Bank of Italy was also a pioneer in using probabilistic questioning to elicit expectations from businesses in its 1993 Italian Survey of Investment in Manufacturing. Data from this survey have been used to analyze the impact of uncertainty about future product demand on the investment decisions of Italian manufacturing firms. As always, the views expressed are my own and do not necessarily reflect those of the Federal Reserve Bank of New York or of the Federal Reserve System.

Why are expectations data useful? The importance of compiling high-quality data on the expectations held by economic agents has been increasingly recognized in both academic research and policymaking. Most economic decisions involve uncertainty, and are therefore determined not only by preferences but also by expectations for future outcomes. Typically, neither preferences nor expectations are directly observed – a condition that poses a significant challenge to understanding economic behavior. Although different combinations of preferences and expectations may be consistent with the same observed behavior, they could result in different responses to shocks or to alternative policies and could therefore have different implications for public policy. The standard way to address this problem within economic models has been to assume rational expectations – that is, expectations that are consistent with equilibrium behavior in the model. In nearly all cases considered to date, this leads to the conclusion that expectations of economic agents are identical or will converge over time. While this approach has given us invaluable insights in a multitude of models and applications, it faces a major empirical problem: in practice, economic agents hold widely differing views about the future path of economic variables, as I will illustrate throughout these remarks.

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Thus, recent research has focused on alternative assumptions regarding the nature of expectations held by economic agents. Measuring subjective expectations directly can inform our modeling assumptions on the information sets available to agents, and on the nature of the expectations formation and updating process. There are many Bayesians in the audience today. However, for the benefit of those who are not as familiar with Bayesian terminology, let me quickly define what I mean by “subjective expectations” or beliefs. This term refers to the personal probability distributions that individuals hold over uncertain events. Apart from the laws of probability and rules about how beliefs are updated with the arrival of information, there are no restrictions on these probability distributions, hence the use of the word “subjective.” Further, individuals might act according to their subjective beliefs without being able to fully articulate in standard forms their underlying probability distribution. Thus, a need arises to elicit these views in order to understand behavior more fully. In monetary policymaking, central bankers have long pointed out the importance of measuring the expectations of financial market participants, households, and firms – especially with regard to inflation and the central bank’s so-called “reaction function” to changes in the economic outlook. For example, measuring market participants’ expectations for the policy rate path sheds light on both the central bank’s effectiveness in communicating its policy intentions and the transmission of anticipated future monetary policy actions into financial conditions. Inflation expectations of households, firms, and other economic agents influence a variety of decisions, including those related to consumption, saving, investment, and the setting of prices and wages, as well as the determination of the real interest rates that influence these decisions. The aggregation of these choices in turn determines realized inflation in equilibrium. Thus, inflation expectations are a crucial determinant of actual inflation and, as such, need to be carefully monitored. Further, the effectiveness of monetary policy and central bank communication relies on longer-run inflation expectations being wellanchored, making their reliable measurement very important for policymakers.

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More generally, expectations by consumers and businesses about a number of household, firmlevel, and economy-wide outcomes are increasingly useful inputs into a variety of forecasting and “now-casting” models. In addition to tracking measures of expectations implied by asset prices, central banks today rely increasingly on survey-based measures of subjective expectations. At the New York Fed, we conduct a diverse set of surveys to measure policy-relevant expectations. Today I will talk about the surveys of households and market participants we conduct: the Survey of Consumer Expectations (SCE), the Survey of Primary Dealers (SPD), and the Survey of Market Participants (SMP). These surveys highlight the innovative and cutting-edge research conducted at the New York Fed and represent the culmination of the Bank’s decade-long investment in the collection of better policy-relevant expectations data. As I will now explain, much of this investment has been directed toward introducing probabilistic survey questions, but we have also learned other important lessons about question design and survey mode, particularly regarding the measurement of inflation expectations which I will also discuss. In some cases such as results of the SPD and SMP the underlying probabilistic nature of survey questions is immediately apparent, in the case of the SCE as I will describe the underlying probabilistic question is not so apparent for many of the results.

Why use probabilistic survey questions? A key feature of the New York Fed surveys is their focus on collecting rich quantitative data on subjective expectations. Extending a practice with a longer tradition in the field of psychology and in surveys of professional forecasters, economists, and other financial experts, our surveys rely heavily on a probabilistic question format to elicit the likelihood respondents assign to different future events. This approach builds on a large and growing body of research, led by econometrician Charles Manski, that has demonstrated survey

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respondents’ willingness and ability to answer questions expressed in this way. Traditionally, surveys ask respondents to express their answers in one of a few ways: for example, using a Likert scale (specifying whether an event is “very likely,” “likely,” or “not too likely”), selecting the outcome they consider most likely (“Do you expect the unemployment rate to be higher or lower than today?”) or giving a point response (“By what percent do you think prices will increase over the next year?”). A problem with the Likert scale is that it does not allow comparisons across respondents, because different respondents may interpret the scales differently. A well-known illustration of the problem was provided by Daniel McFadden, who looked at a health status measure that used a Likert scale ranging from “excellent” to “poor.” While 62 percent of Danish men reported their health to be excellent, only 14 percent of French men did so, despite their enjoying two more years of life expectancy. A problem with questions asking for the outcome considered most likely – that is, questions asking for the modal outcome – is the ambiguous information content of the responses. For example, in the case of an event with a binary outcome (where the event either occurs or not), the modal outcome can be assigned a probability that ranges from 50 percent to 100 percent. Finally, a problem with questions asking for a point forecast – “what do you think will be” or “by how much do you expect” – is that it is not clear whether the estimate individuals provide represents a mean, mode, median, or something else. Research also suggests that some respondents provide a point estimate that reflects varying degrees of loss aversion rather than just a pure forecast. Among the advantages of questions asking directly for the likelihood or “percent chance” of different outcomes are ease of interpretation, comparability across respondents, and the ability to measure subjective uncertainty.

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The consistency of a respondent’s answers can be checked using the laws of probability, and importantly, probabilistic questions permit elicitation of the quantitative measures of belief and uncertainty typically required in estimating economic models. Researchers can use a variety of methods to check the validity and information content of probabilistic subjective expectations data. First, one can look at response rates, reported ease and clarity of the questions used to elicit expectations, the use of focal points in responses, and the internal consistency of responses. Second, one can consider whether reported expectations vary with observable characteristics in a predictable way. Third, whenever possible and assuming a stationary environment, one can check for relevance of reported expectations, looking at whether they are meaningfully related to future or past realizations. Fourth, one can ask whether subjective expectations help predict actual behavior. Finally, one can look at whether agents update their reported expectations in sensible ways upon receipt of relevant information. Based on these criteria, a literature that has grown rapidly since the mid-1990s has demonstrated the validity and information content of responses to probabilistic questions about a broad spectrum of economic concepts. This evidence extends beyond the United States and Europe to developing countries. Thus, probabilistic questions, with appropriate instructions and visual aid tools, have been successfully used not only in the Survey of Professional Forecasters and the U.S. Health and Retirement Survey (and its sister surveys in Europe and Japan) but also in surveys of fisherman and farmers in India, aspiring migrants in Tonga, poor households in rural Colombia, and junior high school students in Mexico. Some of these questions ask respondents to assign probabilities to various ranges of outcome – so-called density forecasts. Generally, people across a wide range of countries and walks of life appear to be able to answer probabilistic questions, and their expectations are found to be useful in forming predictions of future economic outcomes.

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The survey of consumer expectations Turning now to the development and use of expectations surveys at the New York Fed, let me first discuss our Survey of Consumer Expectations (SCE). Over the last ten years, we extensively tested and eventually implemented a new survey of households, with the goal of collecting timely and accurate information at high frequency on U.S. consumers’ expectations and decisions on a broad variety of topics. The SCE, launched in June 2013, was designed to fill gaps in existing data collections about consumer expectations and outcomes, to provide a more integrated data approach, and to take advantage of state-of-the-art survey techniques. The SCE is implemented as a monthly, nationally representative survey of about 1,300 household heads. Recently the Bank of Canada implemented its own version of the SCE, fielded at a quarterly frequency. The SCE has various components, which are outlined on Slide 2.

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First, respondents are asked a core monthly module of questions concerning their expectations about various macroeconomic and household-level variables. These questions cover inflation expectations and expectations regarding changes in home prices and the prices of various specific goods and services, such as gasoline, food, rent, medical care, and a college education. The core survey also asks for expectations about unemployment, interest rates, the stock market, credit availability, taxes, and government debt. In addition, respondents are asked to report their expectations about several labor market outcomes, including changes in earnings, the perceived probability of losing their current job or leaving it voluntarily, and the perceived probability of finding a new job. Moreover, respondents are asked about the expected change in their household’s overall income and spending. As I will describe in more detail below, these expectations questions are fielded at various time horizons and with various formats, including both point forecasts as well as density forecasts based on probabilistic questions. The second component of the SCE contains a supplementary “ad hoc” module each month on special topics. Finally, SCE respondents also fill out longer surveys each quarter on various topics. These are up to thirty minutes in length and are separate from the monthly survey. Before giving more details about the SCE questions and some background on the research underpinning them, I would like to briefly point out two other important design elements of the SCE. First, responses are collected using an online survey tool. While it has become harder to obtain nationally representative samples with telephone and mail surveys, for which response rates have been falling, the opposite has been true for online surveys. Moreover, some evidence suggests that respondents are more likely to answer financial questions posed in online surveys. In a recent randomized survey experiment conducted by colleagues at the New York Fed and the Dutch central bank, the share of respondents

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reporting their inflation expectations in online interviews slightly exceeded the share reporting their expectations in face-to-face interviews. In addition to being more cost effective, online surveys, when fielded at high frequency, provide important flexibility by allowing questions to be added or changed at short notice. It is thus possible to collect information on new economic and financial developments, such as the impact of recent changes in the price of oil. Other attractive features of online surveys are the ease of incorporating graphics and other visual refinements and the ease of conducting randomized interactive experiments to analyze the updating of expectations and the links between expectations and behavior. A second key design element of the SCE is that it uses a rotating-panel sample design, with approximately 1/12 of respondents rotating in each month, after which they stay in the panel for up to 12 months and then rotate out. In addition to keeping the sample representative over time, this rotational structure allows us to track the changes in individuals’ responses over time. In other words, we can compute changes in expectations over time after differencing out individual idiosyncratic effects. This design contrasts with repeated crosssectional surveys in which an entirely new sample is drawn each month. The panel structure of our survey, with a more stable sample composition, therefore reduces volatility in summary statistics due to a changing sample and increases the signal-to-noise ratio. Finally, it is possible to use the panel to link short-term expectations to actual realizations, and measure individual-level forecast accuracy and its implications in real time.

Designing survey questions for household inflation expectations The launch of the SCE followed an extensive testing phase, dubbed the Household Inflation Expectations Project (HIEP), which was initiated in 2006 to explore the feasibility of implementing a new survey of consumer expectations with a focus on inflation expectations.

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The HIEP had several objectives: to improve existing measures of consumer expectations, to clarify the process of expectations formation and updating, and to study the links between reported expectations and actual behavior in a variety of realms. The HIEP set up a working group – composed of New York Fed and Federal Reserve System economists, academic economists, behavioral psychologists, and survey design experts – that devised, conducted, and analyzed a series of cognitive interviews and experimental surveys to explore various dimensions of the planned new survey. In particular, the HIEP analyzed the information content of the inflation expectations questions in the University of Michigan Survey of Consumers, the primary source of information on household inflation expectations at the time; tested alternative wording of potential inflation expectations questions; studied the feasibility of eliciting individual uncertainty about future outcomes for inflation, house prices, and earnings growth; and introduced a panel dimension to the experimental data collection effort in order to study the persistence of inflation expectations and their responsiveness to inflation surprises. The HIEP considered different potential time horizons for its inflation expectations questions. For the short-term expectations, we settled on the one-year-ahead horizon – similar to the Michigan survey. We also examined the feasibility of asking for inflation expectations over a longer time horizon. The Michigan survey asks respondents by what percent per year they “expect prices to go up or down on the average, during the next 5 to 10 years”. We replicated this question in our experimental surveys, and found that the Michigan question elicits a mixture of interpretations, with some respondents using a 10-year horizon and others thinking about a 5-year horizon. From the results of our cognitive interviews and experimental surveys, we decided in the SCE to elicit medium-term inflation expectations at the one-year two-year-forward horizon. For example, in this month’s edition of the SCE we ask respondents what they expect the rate of inflation to be “over the 12‐month period between May 2018 and May 2019.”

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Our testing suggests that respondents understand this format better than that of the 5–10 year Michigan question; consumers are better able to provide their expectations over a specific time period in the future, and there is little value in asking them about a longer time horizon. In addition, we believe that the one-year two-year-forward horizon adopted in the SCE is better suited to measure inflation expectations at the medium-term horizon that matters most for central bankers, since monetary policy is expected to exert its full effect within that time frame. With regard to question wording, it is important to note that the Michigan Survey asks about changes in “prices in general.” The HIEP tested three alternative wordings of a potential inflation expectations question: we presented respondents with questions about the change in “prices in general” (the wording used in the Michigan survey), the change in “prices you pay,” and the “rate of inflation.” Compared with the “rate of inflation,” the phrases “prices in general” and especially “prices you pay” induced respondents to think more about their personal price experiences and to focus on specific price changes for individual items, such as food or gasoline. In related research, we have shown that respondents tend to express more extreme inflation expectations when they are prompted to think of specific prices in answering the question rather than overall inflation. In the SCE, we therefore ask directly for expectations about the rate of inflation or deflation.

Probabilistic questions on the SCE As I noted earlier, a key feature of our survey is its use of probabilistic questions. Following the current practice in the literature for the elicitation of expectations about continuous variables, we tested questions that elicited density forecasts by asking respondents to assign the percent chance that the value of interest would fall within different pre-specified ranges or “bins.” For instance, for inflation, we ask for the subjective probability distribution over a range of possible future inflation outcomes. This is shown in Slide 3.

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For each respondent, we fit a flexible parametric probability density function (PDF) to their bin probabilities. We can then compute several moments of interest from the fitted density forecast for each individual respondent, including measures of central tendency such as the density mean or median, measures of uncertainty, such as the interquartile range, or IQR, and measures of skewness. As I already noted, there are several important advantages to eliciting a density rather than a simple point forecast. In a world characterized by pervasive uncertainty, density forecasts provide a comprehensive representation of respondents’ views about possible future outcomes for the variables of interest. Importantly, density forecasts enable us to compute the degree of uncertainty associated with each respondent’s estimate. The measurement of forecast uncertainty is important for policymakers in order to assess the extent to which inflation expectations remain well-anchored. In addition, by eliciting density forecasts, we can focus on a specific measure of central tendency and use that for cross-respondent comparison and aggregation purposes. Research indicates that by forcing respondents

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to consider the likelihood of different outcome ranges, density-based expectations measures, such as the mean, are less prone to outliers than are one-off answers to point expectations, resulting in smaller cross-sectional dispersion. Eliciting probabilistic beliefs and density forecasts presents a number of challenges: much research is still needed on the best way to elicit such beliefs – for example, with regard to the format of the questions; the number, width, and location of bins; whether to tailor bins to individual respondents; and how to estimate the underlying continuous densities. The elicitation of such beliefs involves many survey design choices, and the extent to which the findings depend on the way in which the information is collected is not yet fully known. In line with earlier findings in the literature, our research shows that survey respondents are able and willing to provide density forecasts. In our experimental surveys, fielded as part of RAND’s American Life Panel, we observe negligible non- response rates to the bin probability questions. Further, when respondents are asked point forecast questions, some elect to provide a range, in order to express a degree of uncertainty in their forecast. We find that the use of ranges in point forecast questions, as well as the widths of reported ranges, are positively correlated with the number of bins to which respondents assign positive probability in density forecast questions, and with measures of uncertainty based on the fitted density estimates. Respondents also rate the density forecast questions only slightly harder to answer than the corresponding point forecast ones. Finally, respondents’ estimated forecast uncertainty is meaningfully associated with month-to-month revisions in inflation expectations: greater uncertainty is significantly correlated with larger revisions – qualitatively consistent with Bayesian updating. What is the best way to aggregate the information we elicit regarding probabilistic beliefs and density forecasts?

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For binary outcomes, such as the perceived percent chance of losing one’s job over the next three months, we report the mean probability across respondents. For density forecasts, we can compute several aggregate measures.

Slide 4 shows a stylized depiction of how we approach this. As our aggregate measure of expected inflation, we report the median of individual density means. We pick the density mean, which represents an individual’s expectation for the rate of inflation, as our measure of central tendency, and use the median to aggregate across respondents, since the median is less sensitive to outliers. We can also look at medians of various percentiles of the individual distributions. We measure aggregate forecast uncertainty as the median across respondents of the individual IQRs. We also monitor the probability that respondents attach to extreme inflation outcomes by computing, for instance, the median probability of deflation: in other words, the median of the individual subjective probabilities assigned to outcomes with inflation less than zero.

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Finally, to characterize the variation in inflation expectations across respondents, we compute the dispersion of expected values: the IQR of individual density means. Again, we can look at other percentiles of the distribution across respondents to detect possible clustering and polarization. We publish at a monthly frequency many of the aggregate measures of inflation expectations, as well as measures for a broad range of labor market and financial expectations, on our survey website, shown on Slide 5. In addition to providing national figures, we show trends for different demographic subgroups.

Current trends and additional research So far, we have discussed the elicitation of density forecasts for a single variable of interest. In addressing various policy questions, however, we may be interested in the subjective joint probability distributions for two or more variables.

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For instance, if we are interested in households’ expectations about real wage growth, we may want to elicit the joint distribution over future outcomes for both inflation and nominal wage growth. Measuring the joint distribution of expectations over income and spending growth may also be very useful. This is an area at the frontier of current research, and more work is needed to test alternative ways to elicit joint subjective distributions. At the New York Fed, we have experimented with questions asking for density forecasts for one variable, conditional on ranges of outcomes for the other variable of interest. These conditional probability distributions, together with the outcome probabilities for the conditioning variable, can be used to recover the subjective joint distribution for each respondent.

For instance, in the New York Fed’s Survey of Primary Dealers (SPD), we have fielded questions to elicit the joint probability distribution for the size of the Federal Reserve’s balance sheet and the state of the economy. We might also be interested in exploring the cross-section of density forecasts across respondents, for example, demographically.

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As I noted earlier, the SCE is based on a representative sample of U.S. household heads, and the data highlight the rich heterogeneity of expectations held by consumers. For example, Slides 6 and 7 show the recent trends in median three-year-ahead inflation expectations overall and sorted by the education level of respondents.

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Slide 8 shows trends in inflation uncertainty, also by education. As is common in surveys of inflation expectations, more highly educated respondents typically report lower inflation expectations, and express less uncertainty in their density forecasts. We observe similar patterns when the responses are broken out by income, numeracy, or financial literacy. These differences could reflect heterogeneity in information sets, in individual experiences, or in the way people process information about inflation. Next, I’ll share two experiments we conducted during the development phase of the SCE in order to analyze the validity and information content of our inflation expectations questions. In the first experiment, which was financially incentivized, survey respondents were first asked for their inflation expectations. They were then asked a series of ten questions offering a choice between two investments, one yielding a nominal return that varies with inflation, the other yielding an inflation-protected payoff with increasingly large amounts over the ten questions.

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When choosing between the two investments, the respondent seeking to maximize her payoff should switch investments at most once, and if so, should switch from the one yielding a nominal return to the inflation-protected investment sooner, the higher her inflation expectations. We found that the choices in the financially incentivized experiment were indeed meaningfully related to respondents’ inflation expectations, on average. Differences in reported uncertainty were also associated with different choices in the experiment, in the direction predicted by theory. Deviations from expected utility maximization were more likely to occur for respondents with low education, as well as those with low numerical and financial literacy. We were able to repeat the experiment with the same respondents six months later. We found that individual changes in expectations were significantly associated with changes in how early respondents switched between investments, and that not only the direction but also the magnitude of these changes was consistent with a simple expected utility maximization framework. To our knowledge, these results provide the first direct evidence regarding a meaningful link between survey-based inflation expectations and actual behavior. In the second experiment, we studied the formation process of inflation expectations by looking at whether and how survey respondents updated their inflation expectations when they received relevant new information. Specifically, we first elicited inflation expectations. We then randomly provided information to a subset of respondents on either past food price inflation, or professional economists’ forecasts of future inflation from the SPF. Finally, we reelicited respondents’ inflation expectations, and studied whether they were correlated with the information content of the signal they received. We found that respondents, on average, updated their inflation expectations in response to the information provided, and they did so

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sensibly and in a direction consistent with Bayesian updating – with larger revisions for less informed respondents and for those with greater baseline uncertainty. Further, there was significant heterogeneity both in how fully informed respondents were about objective inflation measures and in their updating behavior. This finding points to the potential importance of allowing for heterogeneous informationprocessing rules in our economic models. These findings are also consistent with existing sticky-information models of expectations formation, since cross-sectional disagreement falls after the provision of information. Results from the experiment also indicate that expectations about changes in the “prices you pay,” like the similar Michigan survey question about “prices in general,” are more responsive to information about food prices than expectations about the rate of inflation. This finding is consistent with our observation that wording based on “prices” causes respondents to focus more on price changes in their own consumption basket and to report expectations that are more correlated with gas and food price changes. Finally, we have been exploiting the rotating panel nature of the SCE to better understand the changes in medium-term consumer inflation expectations that has occurred since July 2015. As I mentioned earlier, the panel structure of the SCE enables us to analyze the changes at the individual level, that is, for the same respondent – thus abstracting from possible changes in expectations coming from changes in sample composition. In particular, we looked at the group of respondents who completed the survey both in September 2015 and in January 2016, and compared their three-year-ahead inflation expectations as measured by the individual density means across the two surveys. As shown in Slide 9, we found that the entire distribution of medium-term inflation expectations shifted to the left, indicating a widespread decline in expectations.

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Median expected inflation among these repeat respondents declined by 53 basis points, compared to 39 basis points without controlling for the changing sample composition. The May results of the SCE showed an increase of 29 basis points from April in the median of the individual means (see Slide 6) and this can also be examined by holding the sample constant using the panel structure. In this case we find an increase of 27 basis points from April and the distribution shifting to the right, although the statistical significance of the change is more marginal than the decline over the longer period. As can be seen in Slide 9 there is a wide dispersion in views about future inflation held by consumers.

This sort of analysis highlights the value of the panel nature of the SCE in yielding more robust measures of expectations. Let me turn next to the surveys of market professionals conducted by the New York Fed To read more: http://www.bis.org/review/r160524a.pdf

http://www.bis.org/review/r160524a.pdf

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The slides: https://www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/pot160518/potter-slides.pdf

https://www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/pot160518/potter-slides.pdf

https://www.newyorkfed.org/medialibrary/media/newsevents/speeches/2016/pot160518/potter-slides.pdf

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On lawful criminal investigation that respects 21st Century data protection - Europol and ENISA Joint Statement This Joint Statement is presented as a contribution from ENISA and Europol to the on-going debate on privacy and encryption. It is based on the practical experiences and perspectives of the two organisations and is neither intended as being the formal position of the EU Institutions on this subject, nor as having any prejudice to that.

1 The communication society The desire to preserve the secrecy and integrity of a document is as old as written communication, and is deeply inscribed in our modern legislation, touching basic rights such as freedom of expression and the right to privacy. With the move to the information society and the automation of data processing, this need is becoming ever more important. Moreover, these issues go beyond individual’s rights: in a society that is ever more depending on the correct functioning of electronic communication services, technical protection of these services is mandatory, since otherwise criminals will abuse vulnerable services. From a technical standpoint, both confidentiality and integrity may be fulfilled by the same cryptographic mechanisms. However, while secure communication services have many legitimate purposes, they may also be used to plan and conduct criminal activities. Hence, law enforcement services need tools to investigate cybercrimes as well as cyber-facilitated forms of crimes.

2 The limits of privacy An individual’s rights need to be evaluated carefully in relation to the individual rights of others to find a balance between the individual interests of the persons concerned.

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Thus, in the face of serious crimes, law enforcement may lawfully intrude privacy or break into security mechanisms of electronic communication systems. Legislation must explicitly stipulate the conditions under which law enforcement can operate. Here, we want to stress the importance of proportionality for the use of intrusive investigative tools. This requires that the intrusive effect of the investigative measure is proportionate to the crime that was committed. It also requires the selection of the least intrusive measure to achieve the investigative objective. The legislation should include the provision of appropriate supervision to ensure that intrusive measures are used in accordance with these principles. Intercepting an encrypted communication or breaking into a digital service might be considered as proportional with respect to an individual suspect, but breaking the cryptographic mechanisms might cause collateral damage. The focus should be on getting access to the communication or information; not on breaking the protection mechanism. The good news is that the information needs to be unencrypted at some point to be useful to the criminals. This creates opportunities for alternatives such as undercover operations, infiltration into criminal groups, and getting access to the communication devices beyond the point of encryption, for instance by means of live forensics on seized devices or by lawful interception on those devices while still used by suspects. Moreover, forensic methods that make use of physical fingerprints of devices might not help to intercept the communication content itself, but might provide other important clues for the investigator. Even so, there are cases in which there are no such alternatives and access to the concealed content can only be gained by a form of decryption.

3 Considerations on decryption While no practical encryption mechanism is perfect in its design and implementation, decryption appears to be less and less feasible for law enforcement purposes. This has led to proposals to introduce mandatory backdoors or key escrow to weaken encryption.

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While this would give investigators lawful access in the event of serious crimes or terrorist threats, it would also increase the attack surface for malicious abuse, which, consequently, would have much wider implications for society. Moreover, criminals can easily circumvent such weakened mechanisms and make use of the existing knowledge on cryptography to develop (or buy) their own solutions without backdoors or key escrow. The latest generation of encryption tools allow forward secrecy, meaning that the disclosure of a long-term private key does not allow the deciphering of messages from the past.

4 Resolving the encryption dilemma Solutions that intentionally weaken technical protection mechanisms to support law enforcement will intrinsically weaken the protection against criminals as well, which makes an easy solution impossible. So far, we observe a continued arms race between cryptographers and crypto-analysts. In terms of practical breaks, cryptographers are currently miles ahead, which is good news for all the legitimate users who can benefit from the improving protection of their data. However, there is no doubt that malevolent parties use the same techniques to conceal their criminal activities and identities. For the investigation and disruption of crimes, it is important to use all possible and lawfully permitted means to get access to any relevant information, even if the suspect encrypted it. To achieve this, it would be worthwhile to collect and share best practices to circumvent encryption already in use in some jurisdictions. Investigators would benefit from more explicit and ideally aligned regulation of the lawful online use of privacy-invasive investigative tools and the conditions under which they can be applied. Moreover, policy makers in consultation with the judiciary could further contribute by issuing clear policy guidance on the proportionality of the online use of such privacy-invasive investigative tools.

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When circumvention is not possible yet access to encrypted information is imperative for security and justice, then feasible solutions to decryption without weakening the protective mechanisms must be offered, both in legislation and through continuous technical evolution. For the latter, the fostering of close cooperation with industry partners, as well as the research community with expertise in crypto-analyses for the breaking of encryption where lawfully indicated, is strongly advised. We are convinced that a solution that strikes a sensible and workable balance between individual rights and protection of EU citizen’s security interests can be found. In this respect, the deployment of European R&D instruments may drive this collaboration while at the same time EU Agencies can work closely together in establishing best practices.

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Written testimony of NPPD Office of Cyber and Infrastructure Analysis Director Brandon Wales for a House Committee on Homeland Security, Subcommittee on Oversight and Management Efficiency hearing titled “Oversight of Federal Efforts to Address Electromagnetic Risks” Thank you, Chairman Perry, Ranking Member Coleman, and distinguished Members of the Committee. It is my pleasure to be here to discuss the threat posed by electromagnetic pulse events (EMP) to our Nation and its critical infrastructure, including its cyber, communications, and electric-grid assets. Over the past several decades, the risk to digital and physical infrastructures has grown. For example, today’s power grid and information networks may be more vulnerable to EMP than those of a few decades ago, as the grid transitions from an analog system to a digital system to improve efficiency. My testimony today will focus on the Department of Homeland Security’s (DHS) preparations to respond to and assist recovery from a potential EMP attack, as well as touch on the joint DHS/Department of Energy (DOE) effort to review the EMP science and provide a peer-reviewed estimate of the potential risks. The Federal Government plays an important role supporting the critical infrastructure community to manage risks from low-probability, high-consequence events, such as EMPs and severe geomagnetic disturbances (GMDs). DHS and its interagency partners will be using our unique resources built over the past decade to address the scale and degree of uncertainty associated with risks such as the ones I am here to discuss today. The Department takes seriously the recent review and recommendations of the Government Accountability Office (GAO) on federal efforts to address EMP risk, as well as the recommendations issued by the 2008 EMP Commission, and welcomes further cooperation with other government agencies to ensure we are appropriately responsive on this critical topic.

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Background on EMP An EMP is the burst of electromagnetic radiation created, for instance, when a nuclear weapon is detonated or when a non-nuclear EMP weapon is used. EMPs can be high frequency, similar to a flash of lightning, or low frequency, similar to an aurora-induced phenomenon. The consequences of an EMP can range from permanent physical damage to temporary system disruptions, and can result in fires, electric shocks to people and equipment, and critical service outages. There are two general classes of EMP of concern: (1) Nuclear sources of EMP, such as High altitude EMP (HEMP), and (2) Non-Nuclear sources of EMP (NNEP). HEMP results from a nuclear detonation typically occurring 15 or more miles above the Earth’s surface. The extent of HEMP effects depends on several factors including the altitude of the detonation, the weapon yield, and whether it was designed for EMP effects. On the ground, effects may be diminished by the electromagnetic shielding, or “hardening,” of assets. A high-altitude burst could blanket the entire continental United States and could cause widespread impacts to multiple sectors, including to lifeline sectors such as the energy and communications. HEMP threat vectors can originate from a missile, such as a sea-launched ballistic missile; a satellite asset; or a relatively low-cost balloon-borne vehicle. Non-Nuclear EMP (NNEP) can be created by sources such as Radio Frequency Weapons or Intentional Electromagnetic Interference devices, which are designed to produce sufficient electromagnetic energy to burn out or disrupt electronic components, systems, and networks. NNEP devices can be either electrically-driven, where they create narrowband or wideband microwaves, or explosively-driven, where an explosive is used to compress a magnetic field to generate the pulse. The range of an NNEP is fairly short (typically less than 1 kilometer) and faraday casings with line filters and surge arresters can mitigate much of the EMP effects.

Potential Impacts to Critical Infrastructure from EMP

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In some of its forms, EMP can cause widespread disruption and serious damage to electronic devices and networks, including those upon which many critical infrastructures rely. There is uncertainty over the magnitude and duration of an electric power outage that may result from an EMP event due to ambiguity regarding the actual damage to electric power assets from an event. Any electric power outage resulting from an EMP event would ultimately depend upon a number of unknown factors and effects to assets that are challenging to accurately model, making it difficult to provide high-specificity information to electric system planners and system operators. These variables include characteristics such as the EMP device type, the location of the blast, the height of the blast, the yield of the blast, and design and operating parameters of the electric power system subject to the blast. Secondary effects of EMP may harm people through induced fires, electric shocks, and disruptions of transportation and critical support systems, such as those at hospitals or sites like nuclear power plants and chemical facilities. All critical infrastructure sectors are at risk from EMP, particularly those sectors that rely heavily on communications and sensor (e.g., radar) technology, information technology, the electric grid, or that use a Supervisory Control and Data Acquisition system. The complex interconnectivity among critical infrastructure sectors means that EMP incidents that affect a single sector are likely affect other sectors – potentially resulting in additional failures.

DHS Efforts to Address GAO Recommendations DHS is working collaboratively, both internally and with external stakeholders, in various arenas to address the recommendations issued by GAO on this topic. DHS has been working on the topic of EMP for a number of years, and we will continue working on it in the future. An example of our previous work on the topic of EMP includes a 2010 study on “Electromagnetic Pulse (EMP) Impacts on Extra High Voltage Power Transformers” conducted by the National Infrastructure Simulation and Analysis Center for DHS.

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As part of DHS’s continuing commitment to this issue, there are resources across the Homeland Security enterprise engaged on this topic, including within the Federal Emergency Management Agency (FEMA), the National Protection and Programs Directorate (NPPD), and the Science and Technology Directorate (S&T). The scope of activity, as reviewed by GAO, falls into three areas of activity: (1) risk assessment and analysis, (2) communication and coordination of threat information, and (3) research and development to mitigate EMP risks. NPPD’s involvement on EMP issues resides in a number of functional components including the Office of Cyber and Infrastructure Analysis (OCIA), the Office of Infrastructure Protection (IP), and the Office of Cybersecurity and Communications (CS&C). OCIA has partnered directly with the DOE’s Office of Electricity Delivery and Energy Reliability to assess the impacts of EMP and Geomagnetic disturbance events on electric power assets. This study, facilitated through DHS’s National Infrastructure Simulation and Analysis Center and DOE’s National Laboratories, is intended to develop scientifically rigorous, peer-reviewed methods for assessing electric power asset impacts to EMP events. This study will include participation of the Intelligence Community, the broader interagency, the academic community, and the private sector, when possible. The EMP study by OCIA will leverage newly-started private sector activities that are occurring through the Electric Power Research Institute, as well as previous government investments in research which have been sponsored by DHS and DOE. The estimated completion date of this risk analysis-based study of the electric power sector is approximately mid-2017. IP and OCIA continue to work collaboratively with the Department of Energy and the Federal Energy Regulatory Commission (FERC). As the GAO report indicates, collaboration can and should be increased with an emphasis on identification of critical infrastructure assets of the electric power sector.

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Once identified, this list of assets can be used to guide protection and preparedness activities at DHS and to help prioritize response and recovery actions by DOE and DHS after a large-scale event. DHS is also increasing our collaboration with DOE and FERC in the near-term, including additional collaboration between staff-level subject matter experts. CS&C, which oversees the National Cybersecurity and Communications Integration Center (NCCIC), has been assessing the potential risks to the communications and control elements of the electric grid from EMP, as well as radio frequency weapons, solar weather, and cyber threats for several years. As part of these efforts, the NCCIC developed the “EMP Protection Guidelines for Equipment, Facilities and Data Centers” report and provided related briefings to the Continuity of Government community and to the Communications Sector, as well as other programs and sectors, to inform the community and help mitigate EMP and radio frequency weapons threats. The previously mentioned joint study by OCIA and DOE’s Office of Electricity Delivery and Energy will seek to learn and build upon the knowledge and expertise gained from the NCCIC’s previous studies on this topic. FEMA continues to leverage the National Preparedness System to build, sustain, and deliver the capabilities needed to prevent, protect against, mitigate, respond to, and recover from the threats and hazards that pose the greatest risk, including risks to the energy sector. The tools and processes within the National Preparedness System include, but are not limited to, plans, training, and exercises for managing a variety of risks to the nation’s infrastructure, including EMP and cyber vulnerabilities. FEMA is also actively developing their Power Outage Incident Annex to enhance the Response and Recovery Federal Interagency Operational Plans. The Annex, developed in partnership with the federal interagency community and the private sector, will describe the process and organizational constructs through which the Federal Government will respond to and recover from the impacts of a widespread disruption in the power grid from any cause.

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Lastly, S&T develops near-term solutions to bridge capability gaps, and S&T has invested in multiple research programs for increasing the electric grid’s resilience against solar weather hazards. Previous research investments, such as the Recovery Transformer (RecX) project, are available for private sector risk reduction on EMP and are available to be deployed by private sector owners and operators today.

Conclusion DHS, for many years, has pursued a deeper understanding of the EMP threat, as well as its potential impacts, effective mitigation strategies, and a greater level of public awareness and readiness. These efforts have been undertaken in cooperation with other federal agencies and private sector owners and operators; and we are committed to continuing to expand our focus on this issue, as warranted by the risk environment. I want to thank the Committee for the invitation to speak here today and for your ongoing support for our work in this area. I welcome your questions.

Note: About the Office of Cyber and Infrastructure Analysis Formerly the Infrastructure Analysis and Strategy Division (IASD) within the Office of Infrastructure Protection (IP), OCIA was established as an office of the National Protection and Programs Directorate (NPPD) in 2014. OCIA has an important role in DHS’s efforts to implement Presidential Policy Directive 21, which calls for integrated analysis of critical infrastructure, and Executive Order 13636, identifying critical infrastructure where cyber incidents could have catastrophic impacts to public health and safety, the economy, and national security. OCIA builds on the recent accomplishments of the Department’s Homeland Infrastructure Threat and Risk Analysis Center (HITRAC) and manages the National Infrastructure Simulation and Analysis Center (NISAC) to advance understanding of emerging risks crossing the cyber-physical domain. OCIA represents an integration and enhancement of DHS’s analytic capabilities, supporting stakeholders and interagency partners.

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Fun LoL to Teach Machines How to Learn More Efficiently DARPA seeks mathematical framework to characterize fundamental limits of learning

It’s not easy to put the intelligence in artificial intelligence. Current machine learning techniques generally rely on huge amounts of training data, vast computational resources, and a time-consuming trial and error methodology. Even then, the process typically results in learned concepts that aren’t easily generalized to solve related problems or that can’t be leveraged to learn more complex concepts. The process of advancing machine learning could no doubt go more efficiently—but how much so? To date, very little is known about the limits of what could be achieved for a given learning problem or even how such limits might be determined. To find answers to these questions, DARPA recently announced its Fundamental Limits of Learning (Fun LoL) program. The objective of Fun LoL is to investigate and characterize fundamental limits of machine learning with supportive theoretical foundations to enable the design of systems that learn more efficiently. “We’ve seen advances in machine learning and AI enabling computers to beat human champions playing games like Jeopardy, chess, and most recently Go, the ancient Chinese strategy game,” said Reza Ghanadan, DARPA program manager. “What’s lacking, however, is a fundamental theoretical framework for understanding the relationships among data, tasks, resources, and measures of performance—elements that would allow us to more efficiently teach tasks to machines and allow them to generalize their existing

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knowledge to new situations. With Fun LoL we’re addressing how the quest for the ultimate learning machine can be measured and tracked in a systematic and principled way.” As it stands now with machine learning, Ghanadan noted, even a small change in task often requires programmers to create an entirely new machine teaching process. “If you slightly tweak a few rules of the game Go, for example, the machine won’t be able to generalize from what it already knows. Programmers would need to start from scratch and re-load a data set on the order of tens of millions of possible moves to account for the updated rules.” These kinds of challenges are especially pressing for the Department of Defense, whose specialized systems typically don’t have large training sets to begin with and can’t afford to rely on trial and error methods, which come at high cost. Additionally, defense against complex threats requires machines to adapt and learn quickly, so it is important that they be able to generalize creatively from previously learned concepts. Fun LoL seeks information regarding mathematical frameworks, architectures, and methods that would help answer questions such as: - What are the number of examples necessary for training to achieve a

given accuracy performance? (e.g., Would a training set with fewer than the 30 million moves that programmers provided to this year’s winning machine have sufficed to beat a Go grand champion? How do you know?)

- What are important trade-offs and their implications? (e.g., size,

performance accuracy, processing power considerations) - How “efficient” is a given learning algorithm for a given problem? - How close is the expected achievable performance of a learning

algorithm compared to what can be achieved at the limit? - What are the effects of noise and error in the training data? - What are the potential gains possible due to the statistical structure of

the model generating the data?

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As an historical example of what Fun LoL is trying to achieve, Ghanadan pointed to a mathematical construct called Shannon’s theorem that helped revolutionize communications theory. Shannon's theorem established a mathematical framework showing that for any given communication channel, it is possible to communicate information nearly error-free up to a computable maximum rate through that channel. The theorem addresses tradeoffs in bandwidth, source data distribution, noise, methods of communication transmission, error correction coding, measures of information, and other factors that can affect determinations of communications efficiency. “Shannon’s theorem provided the fundamental basis that catalyzed the widespread operational application of modern digital and wireless communications,” Ghanadan said. “The goal of Fun LoL is to achieve a similar mathematical breakthrough for machine learning and AI.” DARPA’s Fun LoL is seeking information that could inform novel approaches to this problem. Technology areas that may be relevant include information theory, computer science theory, statistics, control theory, machine learning, AI, and cognitive science. For more information, see the Request for Information on FedBizOpps. Deadline for responses is June 7, 2016: http://go.usa.gov/cJGsH

http://go.usa.gov/cJGsH

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National Institute of Standards and Technology

NIST to Refine Cybersecurity Framework The National Institute of Standards and Technology (NIST) is developing a minor update of its Cybersecurity Framework based on feedback from its users. In the just released Cybersecurity Framework Feedback: What We Heard and Next Steps, NIST is announcing that a draft of the update will be published for comment in early 2017. You may visit: http://www.nist.gov/cyberframework/upload/Workshop-Summary-2016.pdf NIST plans to review references in the document to ensure that they are current, and per user requests, is considering clarifying the framework’s Implementation Tiers, a mechanism for organizations to gauge their approach to managing cybersecurity risk. NIST may also add guidance for applying the framework for supply chain risk management. The need to refine and clarify small portions of the framework was evident in comments received through a December 2015 Request for Information and an April 2016 workshop (see video of event) that included 800 participants from industry, government and academia. NIST developed the Framework for Improving the Critical Infrastructure Cybersecurity, commonly known as the Cybersecurity Framework, in response to Executive Order 13636. Published Feb. 12, 2014, the framework was designed to provide voluntary cybersecurity guidance to strengthen the security of the country’s critical infrastructure such as transportation and banking. “We are working from all of the feedback we’ve received since the framework was published on its use, best practices, outreach, prospective updates and governance,” said Matthew Barrett, NIST Cybersecurity Framework program manager. “The minor updates we have planned for the framework should not disrupt anyone’s ongoing framework use.” The rich body of stakeholder feedback called for other actions that NIST will undertake:

http://www.nist.gov/cyberframework/upload/Workshop-Summary-2016.pdf


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- Publish a governance process that outlines the process of framework maintenance and evolution and defines the role of stakeholders and how they will continue to work together in the future.

- Remain as convener of framework stakeholders. - Continue framework outreach and focus on international, small and

medium-sized businesses and regulators. Also, NIST is developing a tool to help an organization assess its cybersecurity risk management process. The Cybersecurity Excellence Builder will be based on the Cybersecurity Framework and key concepts from the internationally recognized NIST-developed Baldrige Performance Excellence Program. NIST recommends stakeholders continue their work by customizing the framework for their sector or community; publishing sector or community profile documents; hosting framework meetings, workshops and conferences; advocating for the framework within a sector or community; distributing case studies of framework implementation; and sharing framework resources with NIST to add to the framework’s Industry Resources web page (http://www.nist.gov/cyberframework/cybersecurity-framework-industry-resources.cfm). NIST continually seeks feedback on all things related to the Cybersecurity Framework, so please share your comments at [email protected]. You may visit: http://www.nist.gov/cyberframework/upload/Workshop-Summary-2016.pdf



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How to Quantify the Weight of Forensic Evidence: A Lively Debate On May 5 and 6, 2016, NIST hosted a technical colloquium on an important question facing virtually every branch of forensic science today: How should forensic examiners quantify the weight of evidence they find in a case? This was the first technical colloquium in the United States to focus specifically on this issue, and it generated an animated and much needed exchange of ideas. The weight-of-evidence question comes up anytime a forensic examiner assesses the likelihood that a piece of evidence left at a crime scene originated from a particular source. For instance, a ballistics examiner compares a bullet found at a crime scene to a bullet that was test-fired from a suspect’s gun. After comparing the surface patterns on the two bullets, the expert might testify in court on the likelihood that they were or were not fired from the same weapon. But how should the expert quantify that likelihood? How should they account for the possibility that the pattern on the bullet found at the scene was actually caused by a different but similar weapon? The chances might be extremely remote, but when a person’s liberty hangs in the balance, quantifying the weight of evidence is a critical step toward a just outcome. This step is important in virtually every domain of forensic science—whether analyzing a bullet, a fingerprint, a DNA profile, a voice recording, or any other pattern-based evidence.

An Important Conversation The need to quantify the weight of evidence was highlighted in the 2009 National Research Council report that urgently called for strengthening the practice of forensic science in the United States. NIST, along with the Department of Justice, is leading an effort to do just that. But what is the best way to quantify the weight of evidence? People have divergent and strongly held opinions on the subject, and the purpose of the colloquium, held at the NIST campus in Gaithersburg, Maryland, was to open a dialog that might eventually lead to a consensus. Participants

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included forensic practitioners, forensic science researchers, and members of the legal and law enforcement communities. “We didn’t want to direct the conversation, we just wanted to start it,” said Elham Tabassi, an expert in fingerprint analysis and one of the NIST scientists who organized the event. “We wanted a free flow of ideas, and that definitely took place.” “Published papers and rebuttals can go on forever,” said Reva Schwartz, another NIST scientist who organized the event. “But having so many people in the same room really moved the conversation forward.” Among other things, participants discussed likelihood ratios, which have emerged as a leading method for quantifying the weight of evidence. Likelihood ratios compare the probabilities of two events—for instance, the probability of observing the features of a latent print left at a crime scene if the print was made by the suspect compared to the probability of observing those features if the print was made by some other, unknown, individual. A very high likelihood ratio indicates that the evidence is powerful.

Next Steps But there is no firm consensus yet on how exactly to calculate a likelihood ratio, or even if that is the best approach to quantifying the weight of evidence. “I think it’s fair to say that there were intense, though always respectful, discussions on quantifying the weight of evidence using likelihood ratios, including their limitations and different statistical approaches to implementing them,” Tabassi said. One of the problems, she noted, is that certain words mean different things to different people, and an important next step will be to settle on common language. Schwartz and Tabassi plan to publish a technical review of the colloquium within the coming months. They also hope to establish an online forum where the conversation can continue. And they are already planning the next installment of this colloquium, which will take place at the NIST Maryland campus in July of 2017.

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IMPORTANT: Download the presentations http://www.nist.gov/itl/iad/ig/evidential_value_proceedings.cfm VIDEO ARCHIVE OF THE EVENT: http://www.nist.gov/itl/iad/ig/ibpc-technical-colloquium-forensic-evidence-webcast.cfm

http://www.nist.gov/itl/iad/ig/evidential_value_proceedings.cfm

http://www.nist.gov/itl/iad/ig/ibpc-technical-colloquium-forensic-evidence-webcast.cfm

http://www.nist.gov/itl/iad/ig/ibpc-technical-colloquium-forensic-evidence-webcast.cfm

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Remarks Before the SEC Historical Society – “The Continuous Process of Optimizing the Equity Markets” Chair Mary Jo White Thank you, David [Lynn], for that kind introduction and for inviting me to your annual meeting. It is truly my privilege and honor to serve as Chair of the Commission, and it is wonderful to share the room and microphone today with my friend and former Chairman Richard Breeden along with others who, from firsthand experience, deeply appreciate the value of the SEC as a critical institution with a long heritage of protecting investors and our markets. At the Commission, our history informs who we are and the work we do, and it is our great, good fortune that we have the SEC Historical Society to preserve that rich history. As you know better than anyone, the SEC has a tradition of being home to some of the smartest, most remarkable people in government. The staff of this agency are among the most talented and dedicated people I have ever met. They are who make the SEC strong and the special place it is. President Theodore Roosevelt once famously said, “It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man [or woman] who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly…who spends himself [or herself] in a worthy cause.” And while the Commission has always had its share of critics over the years, they are no match for the tremendous public servants at the agency who have served and do serve in the arena, striving valiantly and successfully in the cause of protecting America’s investors and our markets. I know we have many current and future SEC alumni here and watching the webcast today, so I would just like to emphasize my gratitude to all of you for your service to and support for this renowned institution and the public interest. As has become the custom here, I will give you a very brief report on some of the current work of the Commission.

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As you know, between the implementation of the Dodd-Frank and JOBS Acts, and advancing an important range of discretionary mission critical initiatives, the SEC has undertaken probably the most complex and daunting period of rulemakings in its history. In that regard, I am pleased to report that in May, we completed all of the JOBS Act rulemakings, and we have now reached the final phase of implementing the Dodd-Frank Act as we work to complete all of the rules in the two major remaining areas on which we made great progress in 2015 and early 2016: security-based swaps and executive compensation. But, as you know, the SEC’s mission extends far beyond that. As the markets and investor needs evolve, we must constantly evaluate areas where we can better further our mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. In other venues, I have recently detailed our progress on the ongoing modernization of the regulatory regime for the asset management industry and our disclosure effectiveness review, and extolled the record accomplishments of the Enforcement and Exam programs. Today, I thought would briefly update you on the status of our equity market structure agenda – not only because it has been a priority of mine and the agency for the past three-plus years, but also because it has been a priority for the Commission throughout its history, and always will be. That history began, of course, in 1934 with the adoption of the Exchange Act, which for the first time gave our newly created agency sweeping powers over securities trading in the secondary markets, including broad authority over the primary participants in that market: brokers, dealers, and national securities exchanges. And since the early twentieth century, the Commission has been engaged in an almost continuous review of equity market structure, constantly seeking ways to improve and optimize its operation. While I will not attempt a full historical tour today, I do want to mention a few highlights. In 1971, the Commission, for example, issued the Institutional Investor Study, finding that the markets had become increasingly complex and inefficient, due in part to exchange fixed commission schedules and institutional investor desire to avoid those commissions through direct trading relationships with broker-dealers.

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The market fragmentation noted in that study led the Commission to issue a Statement on the Future Structure of the Securities Markets in 1973 that advocated for a centralized market system. In the wake of those Commission actions in the early 1970s, Congress enacted the Securities Acts Amendments of 1975. As you know, those amendments granted the Commission broad authority to establish a national market system with the specific (and sometimes competing) goals of promoting: (1) efficient execution of transactions; (2) fair competition among broker-dealers, exchange markets, and non-exchange markets; (3) the broad availability of quotes and transaction information; (4) the practicability of brokers executing investors’ orders in the best market; and (5) the opportunity for investors’ orders to be executed without the participation of a dealer. Despite the significant changes that have occurred in our markets since 1975, these same issues remain as relevant to our market structure today as they were in 1975. The Commission used its new authority in 1975 to facilitate a national market system. Among other things, it abolished the long-standing fixed commission schedules and facilitated the creation of the consolidated market data plans that are still in use today. The Intermarket Trading System (ITS), an early predecessor of today’s Order Protection Rule, was also created to link various markets trading listed securities. Of course, the markets evolved in response to these regulatory changes and advancements in technology, and the Commission again took stock of our market structure in the Market 2000 Report issued in 1994. That study, which was initiated by former Chairman Breeden, analyzed structural issues that had existed in the markets since the passage of the

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Securities Act Amendments of 1975 and concluded that our equity market structure was sound, having benefited from enhancements in technology and competition that reduced trading costs, enhanced market transparency, and improved liquidity. It also included suggestions to further improve market transparency, competition, and the fair treatment of investors. That significant effort led to the Commissions’ order handling rules and the retail execution quality and order routing disclosure rules. The Commission continued its review of equity market structure in a request for comment on market fragmentation issued in 2000. In that action, the Commission solicited comments on a range of issues that included fragmentation, internalization practices, payment for order flow and best execution, and highlighted several potential options for addressing fragmentation. That effort culminated in the 2005 adoption of Regulation NMS, a landmark body of rules that govern all aspects of today’s national market system. Among these rules is Rule 611, the Order Protection Rule, which replaced the outdated ITS and, for the first time, required market participants to honor the best prices displayed in the national market system by automated trading centers. This established a critical linkage framework for the modern markets. The Commission is now in the midst of another significant phase of market structure review, as technology advancements continue to accelerate the pace of change in how orders are generated and executed. While these advancements have generally served retail and institutional investor interests well, as I have remarked before, it is critical that we, as regulators, keep pace with these changes with a keen focus on the fundamentals driving them. We must fully understand the evolving marketplace, identify the issues with precision before making any fundamental changes, and assess the likely consequences that may follow.

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The Commission’s continuing work in market structure is a substantial undertaking that requires updates in technology, and utilization of data and analytics to make informed decisions on enhancing market structure. That means new ways of using existing market data through tools like MIDAS, and it also means building new systems to provide even more powerful analytical capabilities for the Commission and our fellow regulators. That is why we have been moving forward on a proposed national market system plan to create a consolidated audit trail, which will be one of the world’s most comprehensive and sophisticated financial databases. That plan was put out for notice and comment in April and is expected to be finalized by the end of the year. In addition to focusing on the need for robust data and enhanced regulatory capacity, through initiatives like MIDAS and CAT, I have also prioritized a number of other targeted initiatives to optimize our market structure—namely, ensuring the operational integrity of critical market infrastructures, enhancing market transparency and disclosures, and building more effective markets for smaller companies, to mention just a few. More will follow. We have made much progress across this agenda by improving market stability through initiatives such as Regulation SCI (Security Compliance and Integrity), which strengthened the technology infrastructure of the market and expanded Commission oversight of that technology. We have also worked closely with the exchanges to address issues like order types and operations, data feed disclosures, and “single points of failure” within infrastructure systems that have the ability to significantly disrupt trading. We and the SROs are also actively reviewing the operation of the limit up-limit down pilot plan, with a focus on issues that occurred during the volatile trading of August 24, 2015. This review has included extensive public analysis by SEC staff of that day’s events and the consideration of specific improvements to refine the plan’s operation.

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We have also taken action to address enhanced market transparency and disclosure with our proposal last November to update Regulation ATS. This proposal is designed to shed light on dark pools and bring greater transparency about how ATSs operate, including the material conflicts of interests they can pose for investors and other market participants. And, as a complement to the Regulation ATS proposal, I expect the Commission to consider very soon a proposal to provide customer-specific institutional order routing disclosures and targeted enhancements to existing order routing disclosures for retail customers. These two proposals would provide valuable new information to investors about how their orders our routed and executed in today’s markets. We have also taken a significant step to do a data-driven assessment of how our market structure is working for smaller companies. In May 2015, the Commission approved a national market system plan for a two-year pilot program that will widen the minimum quoting and trading increments for stocks of smaller companies. This two-year pilot, which is scheduled to begin on October 3, 2016, will provide the Commission with valuable data on whether wider tick sizes would enhance the market quality for smaller company stocks for the benefit of issuers and investors. In early 2015, as part of our broader market structure work, we created the Equity Market Structure Advisory Committee, comprised of diverse experts who consider specific initiatives and potential structural changes. The Committee was established to assist the Commission in its comprehensive review of the structure of the equity markets, and I have been very pleased with the progress of the Committee’s work over the past year. It is taking on the core issues that are key to our efforts to optimize our equity market structure. At their most recent meeting in April, for example, the Committee was presented with draft recommendations from two of their subcommittees for an access fee pilot and trading venue regulatory reforms.

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And I expect that the full Committee will vote soon on a formal access fee pilot recommendation. As you can glean from my whirlwind summary of our market structure agenda, the Commission’s work throughout its history to promote fair, efficient and competitive markets continues with energy, thoroughness and the SEC’s characteristic focus on its mission. As I have said before, our work to optimize the equity markets is never finished. In order for our markets to remain the strongest and most reliable in the world, regulatory changes must be timely, effective, and informed – and a constant priority. Our current significant efforts are the latest in the Commission’s historical ongoing work to address the evolving market structure challenges. And we will continue to work hard and smartly to adapt and grow with the marketplace to better protect investors and to optimize the markets for the issuers who rely upon them. It is obviously one of the agency’s most important responsibilities. Thank you for listening.

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