[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
PROTECTING INVESTORS AND
FOSTERING EFFICIENT MARKETS:
A REVIEW OF THE SEC AGENDA
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
MAY 3, 2006
__________
Printed for the use of the Committee on Financial Services
Serial No. 109-90
HOUSE COMMITTEE ON FINANCIAL SERVICES
U.S. GOVERNMENT PRINTING OFFICE
31-036 PDF WASHINGTON : 2006
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Washington, DC 20402-0001
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair DARLENE HOOLEY, Oregon
RON PAUL, Texas JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio BRAD SHERMAN, California
JIM RYUN, Kansas GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio BARBARA LEE, California
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut JOSEPH CROWLEY, New York
VITO FOSSELLA, New York WM. LACY CLAY, Missouri
GARY G. MILLER, California STEVE ISRAEL, New York
PATRICK J. TIBERI, Ohio CAROLYN McCARTHY, New York
MARK R. KENNEDY, Minnesota JOE BACA, California
TOM FEENEY, Florida JIM MATHESON, Utah
JEB HENSARLING, Texas STEPHEN F. LYNCH, Massachusetts
SCOTT GARRETT, New Jersey BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida DAVID SCOTT, Georgia
J. GRESHAM BARRETT, South Carolina ARTUR DAVIS, Alabama
KATHERINE HARRIS, Florida AL GREEN, Texas
RICK RENZI, Arizona EMANUEL CLEAVER, Missouri
JIM GERLACH, Pennsylvania MELISSA L. BEAN, Illinois
STEVAN PEARCE, New Mexico DEBBIE WASSERMAN SCHULTZ, Florida
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin,
TOM PRICE, Georgia
MICHAEL G. FITZPATRICK, BERNARD SANDERS, Vermont
Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina
JOHN CAMPBELL, California
Robert U. Foster, III, Staff Director
C O N T E N T S
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Page
Hearing held on:
May 3, 2006.................................................. 1
Appendix:
May 3, 2006.................................................. 49
WITNESSES
Wednesday, May 3, 2006
Cox, Hon. Christopher, Chairman, United States Securities and
Exchange Commission............................................ 7
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 50
Ackerman, Hon. Gary L........................................ 52
Kanjorski, Hon. Paul E....................................... 53
Cox, Hon. Christopher........................................ 54
Additional Material Submitted for the Record
Cox, Hon. Christopher:
Responses to Questions from Hon. Deborah Pryce............... 67
Responses to Questions from Hon. Emanuel Cleaver............. 70
Responses to Questions from Hon. Vito J. Fossella............ 72
PROTECTING INVESTORS AND
FOSTERING EFFICIENT MARKETS:
A REVIEW OF THE SEC AGENDA
----------
Wednesday, May 3, 2006
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Michael Oxley
[chairman of the committee] presiding.
Present: Representatives Oxley, Leach, Baker, Pryce,
Castle, Royce, Lucas, Ney, Kelly, Paul, Gillmor, Biggert,
Shays, Fossella, Kennedy, Feeney, Hensarling, Garrett, Pearce,
Neugebauer, Fitzpatrick, McHenry, Campbell, Frank, Kanjorski,
Maloney, Gutierrez, Velazquez, Watt, Hooley, Sherman, Meeks,
Lee, Moore of Kansas, Capuano, Clay, Israel, Baca, Matheson,
Scott, Green, and Cleaver.
The Chairman. The committee will come to order. Consistent
with Rule 3(f)(2) of the Rules of the Committee on Financial
Services of the 109th Congress, the Chair announces that he
will limit recognition of opening statements to the Chair and
ranking minority member of the Full Committee, and the Chair
and ranking minority member of the Subcommittee on Capital
Markets, Insurance, and Government Sponsored Enterprises, or
their respective designees, to a period not to exceed 16
minutes, evenly divided between the majority and minority.
The prepared statements of all members will be included in
the record. The Chair will make an exception for the gentleman
from California in this case. The Chair recognizes himself for
an opening statement.
Good morning. We are here today to hear from a former
colleague and good friend, Securities and Exchange Commission
Chairman Christopher Cox. Nine months ago, Chairman Cox was
sworn in as the 28th Chairman of the SEC, and he assumed the
responsibility of directing the Commission in its
responsibilities of overseeing the capital markets and
protecting investors.
As a former securities lawyer, Chairman Cox was a natural
selection for that post, and an excellent one. And in making
this appearance to discuss the priorities of the Commission,
Chairman Cox returns to our hearing room, where he once sat as
a member of this committee.
Chairman Cox takes the reigns of the Commission through a
dynamic time for our capital markets. The New York Stock
Exchange has merged with Archipelago Holdings. The NASDAQ has
merged with Instinet, and has taken a 15 percent stake in the
London Stock Exchange. Retail investors are investing in a
wider range of security products than ever before. And by
almost all barometers, the American economy has recovered well
from the corporate scandals that shook investor confidence
several years ago.
In the wake of these scandals, this committee shepherded
through the House legislation to reform corporate governance
and accounting oversight. One of the goals of the Sarbanes-
Oxley Act was to strengthen the financial reporting of our
public companies. Although it is difficult to quantify the
benefits of this legislation, it is clear that investors once
again trust our capital markets. The Dow Jones industrial
average hit a 6-year high just yesterday.
I must commend the efforts of the Commission in overseeing
the execution of the mandates contained in the Act. It is true
that the implementation of the Act's internal control
requirements has been more onerous than originally predicted.
However, it is critical that we allow our regulators to rectify
the implementation difficulties that public companies and their
auditors face.
In this regard, I am encouraged by the efforts that
Chairman Cox and the Commission have made, and continue to
make, in engaging in discussions with public companies and
auditors about these internal control requirements.
Following up on last year's roundtable, next week the
Commission and the Public Company Accounting Oversight Board
will be hosting a roundtable on internal controls to discuss
second year experiences with these provisions. Following that
initial roundtable, both regulators issued additional
guidelines relating to the internal control reporting
requirements.
The Commission will also soon be taking into consideration
the recommendations of its Advisory Committee on Smaller Public
Companies, created by the Commission to assess the regulatory
burdens smaller public companies face. Again, I am pleased by
the proactive efforts of the Commission.
I also want to commend Chairman Cox for his recent
initiatives to enhance the financial reporting in our public
companies. Realizing that the heart of our capital markets is
timely and accurate disclosure of financial information,
Chairman Cox decided to make this financial information more
understandable and accessible to investors.
This past December, Chairman Cox, along with Robert Herz,
Chairman of the Financial Accounting Standards Board, announced
an initiative to reduce the complexity in financial reporting.
This effort includes revising outdated and complicated
accounting standards, as well as working towards the
convergence of international accounting standards.
In addition, Chairman Cox's advocacy of the use of
Extensible Business Reporting Language, or XBRL, has the
potential to empower millions of investors with better
financial analysis.
And finally, I would like to mention one area of reform
which this committee has championed since the corporate
scandals a few years ago. The credit rating agency became a
focus of Congressional interest because the dominant rating
agencies had rated WorldCom and Enron investment grade just
prior to their bankruptcy filings. This committee and the
capital markets subcommittee, under the leadership of Chairman
Baker, have held a series of hearings focused on the lack of
competition, accountability, and transparency in the credit
rating industry.
Congressman Fitzpatrick has introduced legislation, H.R.
2990, that would bring more competition, transparency, and
oversight to this industry. I am hopeful that this committee
can work in a bipartisan manner, and with the Commission, to
make this reform a reality.
We had our field hearing in Philadelphia that was, I think,
very instrumental in moving this issue forward. I look forward
to hearing from our distinguished witness, the Chairman of the
SEC, on these and other Commission initiatives. And I yield to
the gentleman from Massachusetts for an opening statement.
Mr. Frank. Thank you, Mr. Chairman, and I am pleased to
welcome our former colleague, and to express my admiration for
the work he has been doing. I think that he has shown how you
can be an effective and very admirable chairman. It is a body
that had some fractures before, and I think he has provided a
useful kind of continuity, and has been faithful to his mandate
as a law enforcement officer, which is, of course, one of his
primary jobs.
I want to begin by expressing my agreement with you, Mr.
Chairman, on the Sarbanes-Oxley law. I believe that it is
appropriate that we look to the Commission for any kind of
improvements that you would expect. No one passes a law,
particularly a law breaking new ground, and one that deals with
a lot of complexity, and expects it to remain unchanged.
And I would hope that--I know that the chairman understands
this--if there are changes that he and his fellow commissioners
think appropriate, I think--I believe that there is now
authority for them to make appropriate changes, in terms of the
administration. If they wouldn't, they should obviously feel
free to come to us, and we can work in a cooperative manner.
I do not think we should be correcting--and I don't think
this committee would be inclined to go in wholesale exemptions,
but improvements in the method, taking into account the impact
of entities of different sizes, that would seem well within the
scope that the Commission has, and I would hope that they would
exercise it, and I expect that they will.
The next issue I want to get to, Mr. Chairman, is the
question of executive compensation, and as you know, we have
discussed this. I have a letter that has been signed by all of
the Members of the minority, which invokes Rule 11 of the House
Rules. Under Rule 11, when a hearing has been called on a
particular subject, the minority, if it is not given a chance
to have other witnesses, can invoke Rule 11, and have an
additional day of hearings with witnesses that it wishes to
call on a subject related to the hearing. And we are exercising
our right to do that, specifically with one of the matters
where the Commission is in the process of taking some very
important steps, and that is executive compensation.
I have written in support--as have many others--of the
proposed rule by the Commission on executive compensation. I
have sponsored legislation which parallels what the Commission
does. In some respects, goes beyond what the Commission would
do in other respects. And it's not clear that they have the
statutory authority.
And it is clear that we have the statutory authority,
although under this Administration, it is not always clear that
when we have statutory authority and exercise it, anything will
result from that, because the President may just decide to
ignore it. But that is probably less likely to happen where the
SEC is involved.
And what we have done is to say that there should be,
published by every public corporation, all the information
relevant to judging the compensation of the top number of
executives--depending on the size of the corporation--including
what happens in case of a bail-out, including what happens in
case they get incentive pay and it turns out--as, for instance,
happened with Fannie Mae--that the incentive pay appeared to
have been granted inappropriately, because the targets that
were supposed to be hit were not really hit.
We ask about pensions. We want all that information made
public. And that--we are very close to what the SEC is
proposing--they haven't acted on it yet--but we also ask that
it be put to a shareholder vote.
We are not proposing in our legislation that any
corporation be told by the Congress or anybody else what it can
pay the chief executive. If the stock holders of Corporation X
want to buy the newspapers of some billionaire in perpetuity,
they can do that. Maybe if we get a particularly modern
billionaire, they can pay for his or her Internet
subscriptions, and finance his or her blogs. That's all up to
the stockholders. We just think they should know that they are
doing it.
We have had problems in this country where we have seen
buy-outs, mergers, and payments to the CEO's followed by a
reduction in workforce. We have seen problems where CEO's get
large amounts of money while pension funds are underfunded. I
think those things are in grave error in a number of ways, but
one of the things we should be very clear about--and this is
one of the things that affects this committee--I think most of
the people on the Financial Services Committee think that there
is in the country today too little trust in the economic
system, too much resistance to trade, too much suspicion about
the implementation of information technology, and too much
resistance to international involvement in our economy. I agree
with some of those views, and it's gotten too far.
But people need to understand it's not simply that this
descended on the American people. It is a reaction to trends in
this economy of growing inequality. And when people read that
the economy is doing well, but their wages in real terms have
not gone up, and their pensions have been put at risk, when
their health care may be declining in what they get, when they
get laid off, and then they read not only that the economy is
doing well, but a handful of people are doing extraordinarily
well, receiving far more money, almost in perpetuity, than
anybody ever thought was necessary, and when this appears to
be, as it does look like, by virtue of every metric,
unconnected to the success of the underlying institution, then
those fears are greater.
So, for that reason, Mr. Chairman, we ask that we have this
hearing, and we hope that we can proceed to action on the
legislation that I have talked about.
The Chairman. The gentleman's time has expired. The
gentleman from Louisiana, Mr. Baker.
Mr. Baker. I thank the chairman. I am delighted to welcome
Chairman Cox back to the committee. I am very pleased to have
someone of his abilities and philosophy exercising the
responsibility of Chairman of the Commission. Someone might
translate that into I think he agrees with me on a lot of
issues. That's okay.
But, in any event, I am delighted that he has taken on this
responsibility, and to make the point that in the current
environment, household wealth is at an all-time high. More than
half of all homeowners are invested in the markets. And this is
despite the fact that much of the rules that govern securities
activities were written in 1933 and 1934. So, I know that the
chairman shares the view that there is much work to do.
And although it would appear to some that the goals are not
necessarily cohesive, enhancing investor protection while
enabling markets to function more efficiently are not mutually
exclusive.
I am very pleased to hear of the chairman's interest in the
deployment and broad utilization of XBRL. I am confidant that,
as we examine our general accounting system, which is now a
retrospective rules-based system, that we can work toward a
more principles-based forward-looking system. Because the
current methodologies require the expenditure of significant
resources to provide the markets with a great deal of
information they, in fact, may not use.
I do believe that holding those accountable for the
opportunity to become a corporate official is important. I am
pleased that the Commission has exercised its responsibilities,
pursuant to creation of the fair fund in Sarbanes-Oxley. I am
told, as of today, that the collections identified as ill-
gotten gains that the Commission personnel are now pursuing
exceeds $7.5 billion, with approximately $5 billion already
having been collected in those enforcement actions.
That's a Commission activity that is, I think,
extraordinary, and is rarely noted. But it's an instance where
governmental officials are actually working on behalf of the
investors by seizing ill-gotten gains, and ironically, giving
them back to the people from whom they were taken. What a great
idea.
And finally, I want to speak to the need for a broad and
ongoing continual review. It is clear that in our
internationally competitive marketplace, that we are slipping
in our ability to maintain our primacy. The number of IPO's
that have chosen to move offshore is a signal, I think, that
regulatory review is not only appropriate, but significantly
warranted. And I do not speak specifically to Sarbanes-Oxley,
but the general regulatory world.
And how we can ensure that, going into the next decade, the
United States maintains that role of primacy is something I
look forward to working with the chairman on in the coming
years, and believe it to be a vital role for our long-standing
economic health within our great country. And with those
remarks, I am pleased to be here, and to hear the chairman's
words today. I yield back.
The Chairman. The gentleman yields back. The gentleman from
Pennsylvania.
Mr. Kanjorski. Mr. Chairman, I join with my colleagues in
welcoming the Securities and Exchange Commission Chairman
Christopher Cox to our panel.
While many things in this room may look familiar to him and
to us, he is now sitting on a different side of the table, and
serving in a different role. We should, therefore, expect him
to have a different perspective on the issues that we once
actively debated together.
I want to commend Christopher Cox for his hard work during
his first months at the Commission. Like a number of his
predecessors, he has taken over the helm of the Commission
during a challenging time. I have been particularly impressed
with his desire to improve financial disclosures for investors.
He has also, himself, faced and overcome personal
adversity. I hope that he now continues to enjoy good health
for many years to come.
As I just mentioned, the Commission presently has before it
a number of important issues. One of the key issues that
Chairman Cox is addressing is the implementation of section 404
of the Sarbanes-Oxley Act. I will be particularly interested in
hearing his thoughts today about how we can improve the ability
of companies both large and small to assess the accuracy of
their internal controls without adding unnecessary costs.
Another issue that I hope that we will examine today
concerns the evolving structure of our capital markets. The
Commission has now approved many regulatory modifications to
our national market system and our security markets are now
working to implement those changes.
In addition, a number of our exchanges have gone public in
recent months. These privatizations raise questions about the
ability of exchanges to continue to protect investors at the
same time as they work to maximize shareholders' profits.
As Chairman Cox also knows, the other side of credit rating
agencies has recently been the subject of considerable
discussion on Capitol Hill. The Commission has before it a
proposed rule to address these matters. It is also discussing a
voluntary agreement that would improve transparency and
oversight of the credit rating industry.
Because we may soon consider a bill in this area, I would,
therefore, like to learn more about the status of these
actions. The successful and speedy resolution of both rule-
making and the voluntary agreement would, in my view, likely
preclude the need for us to legislate on rating agencies.
One final issue that has attracted my attention in recent
weeks concerns exchange-traded funds. These funds are
increasingly popular with investors, growing nearly 200 percent
between the end of 2002 and the end of 2005. It seems, however,
that the process to review and approve ETF applications has not
kept up with investor demands.
In fact, I have heard that some applications have remained
unresolved for years. I thus want to know what the Commission
is doing to address these matters, consistent with its
investors' protection responsibilities.
In closing, Mr. Chairman, I look forward to hearing from
our former colleague. I also hope that he will specifically
advise us as to what the Commission is doing about the
oversight of the rating agencies, and the process for approving
exchange-traded funds.
The Chairman. I thank the gentleman. The gentleman from
California, briefly.
Mr. Royce. I thank you, Mr. Chairman. I would just like to
welcome our good friend, Chris Cox, back to this chamber, my
former Orange County colleague. And Chris, while your presence
in this chamber is sincerely missed, your insights and
leadership at the SEC are invaluable.
I would just say that I think, on behalf of all of us, we
realize that for the United States of America, our capital
markets in this world economy are the niche that's most
important as we compete globally, and there are probably few
jobs as important as the regulation at the SEC over our capital
markets, and your quest to achieve proper investor protections
and to achieve transparency.
And so, I think I speak for many when I say this Nation is
very fortunate to have you at the helm of the SEC, and when I
say we all look forward to what you have to say here today,
Chris. Thank you very much for being with us. I yield back, Mr.
Chairman.
The Chairman. The gentleman yields back. We now turn to the
distinguished chairman, and former member of this committee.
Welcome back, and we are glad to have you back.
STATEMENT OF THE HONORABLE CHRISTOPHER COX, CHAIRMAN, UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Mr. Cox. Thank you very much, Mr. Chairman, Ranking Member
Frank, and members of the committee. I want to thank you very
much for your gracious words. I want you to know that, on
leaving the Congress, the most difficult thing for me, the
hardest part of the transition, is losing contact with the
people with whom I interacted every day, and it's very nice to
be back among you. Thank you for inviting me.
As you know, this is my first formal appearance in the
House since I became Chairman of the Securities and Exchange
Commission. I am pleased to have the opportunity to report to
you on the new initiatives that the SEC is taking to protect
individual investors, and specifically to improve the financial
disclosure that they receive.
Of course, my brief testimony this morning is necessarily
focused on just some of the top priorities of the Agency. I
assure you that it does not cover the entire panoply of
important issues that the SEC is dealing with on a day-to-day
basis. For that reason, I am happy to be here, not only to
answer your questions, but also to learn from you about your
priorities.
As a member of the House for 17 years, I was constantly
reminded by my constituents of the real world impact of the
decisions that you make in the Capitol here, every day. Like
you, I learned the importance of being a good listener, and of
remembering that the common sense of ordinary Americans is the
essence and the strength of our democracy.
Most of your constituents are not investment bankers. They
are not lawyers or accountants. But most of them are investors.
It's a stunning fact of life in the 21st Century that a
majority of Americans now own stocks. It's chiefly to serve
these people that the SEC exists. Our mission, to protect
investors, promote capital formation, and maintain orderly
markets, must always put ordinary Americans first.
Since making the transition from the halls of Congress to
the SEC, I have set out to rededicate the Agency's ongoing
efforts in virtually every area to the service of the
individual investor.
In keeping with this important focus, I am very pleased to
announce this morning that, thanks in major part to the efforts
of Chairman Oxley, Representative Frank, Chairman Baker,
Representative Kanjorski, Representative Fossella, and many
members of this committee, the SEC is cutting fees on
securities transactions by $1 billion, starting October 1,
2006. That money will stay in investors' pockets, exactly as
Congress intended.
This is great news for investors. It means individual
Americans will have more money for their retirement, for
college, for medical expenses, and many other important savings
objectives.
As you know, the Investor and Capital Markets Fee Relief
Act made this dramatic fee reduction possible. On behalf of the
Commission and our Nation's investors, I would like to offer
all of you who serve on this committee our sincere thanks and
gratitude.
In a well-ordered market, educated consumers can choose
from a number of competitive products, and find what they want
at a price that they are willing to pay. But, in order to
educate themselves, investors need comparative facts. So, while
investors must bear the responsibility of learning what they
can about their investment choices, the correlative duty of
sellers of investment products is to provide the relevant
information, and to do so in a way that makes that information
accessible to, and understandable by, the individual investor.
To more closely match the theory of a well-ordered market
with today's reality, the SEC is currently pursuing a number of
initiatives to improve the quality and usefulness of disclosure
for individual investors.
These initiatives include: first, moving from long, hard-
to-read disclosure documents to easy-to-navigate Web pages that
let investors click through to find what they want; second,
moving from boiler plate legalese to plain English in every
document intended for retail investment consumption; third,
reducing the complexity of accounting rules and regulations;
and fourth, focusing our anti-fraud efforts, in significant
part, on scams that target older Americans.
The first of these initiatives, making the SEC's mandated
disclosures actually useful to individual investors, is the
reason that we are so energized about interactive data. I know
that interactive data is a long standing interest to many on
this committee, including, in particular, Chairman Baker. Under
my predecessor, Bill Donaldson, the SEC got the ball rolling by
launching an internal effort to investigate the technology.
Since then, we have launched the XBRL voluntary filing
program as a first step toward getting every company to file
its financials in an interactive format.
Consumers of financial data, particularly individual
investors, have a great deal at stake here. Properly
implemented, the move to interactive data can dramatically
improve the information available to investors about their
investment decisions. Mechanically, it's a relatively simple
concept. Computer codes tag each separate piece of financial
information and tell us what it is: operating income; interest
expense; and so forth. That way, every number in a report or a
financial statement is individually identified, both
quantitatively and qualitatively.
For individual investors, the result of this innovation is
that they will be able to quickly search for any information
that they want, without slogging through an 80-page document.
Investors will be able to get information fast, easily, and all
in one place. And, instead of long, hard-to-read annual reports
and proxy statements, investors could have easy-to-navigate Web
pages that let them click through to find what they want.
With today's SEC reports, an investor or analyst who is
looking to compare data on, say, annual capital expenditures of
two companies, has to search through hundreds of pages of the
filings of each company, page by page. Not surprisingly, this
time-consuming task has created a cottage industry in re-
keyboarding the information in SEC reports, which are
essentially static; that information is tied to the page that
it's written on.
So, that information now is re-keyboarded by commercial
vendors, some in this country, some overseas in India and in
China, so that it can be downloaded into spreadsheets and
software. And either individual investors or, more likely,
their intermediaries have to pay in order to get the benefit of
the mandated SEC disclosures.
One hates to think of the human error and the data
corruption that inevitably occurs in this process. I can tell
you because we have examined it at the SEC, that the number is
unacceptably high. Interactive data is a way to fix these
problems, and to connect investors directly to the information
in a company's filings.
Today, the SEC has over 800 different forms. It has been
estimated that the SEC might instead have need for no more than
a dozen. The key to achieving that objective is looking at the
data on the forms independently from the forms themselves.
That's another opportunity presented by interactive data.
The SEC is strongly committed to interactive data and has
taken major steps to promote it. We have offered significant
incentives for companies to file their financial information
using interactive data, including expedited review of their
registration statements and their annual reports.
A number of well-known companies--the list is now 17 and
growing--have already begun to lead the way and are filing
their reports using interactive data. And, starting in June of
this year, the Commission will host a series of roundtables
focused on the move to interactive data. Revolutionizing the
way that the world exchanges financial information is a worthy
goal, and we intend to achieve it.
When it comes to giving investors the protection that they
need, information is the single most powerful tool that we
have. It's what separates investing from roulette. But, if the
SEC is truly to succeed in helping investors with more useful
information, we will need one more ingredient: an all-out war
on complexity.
It's the SEC's job to see to it that financial data and
qualitative information about the issuers of securities are
fully and fairly disclosed. But we can't say that we have
achieved that objective if the information is provided in a way
that isn't clearly understandable to the men and women for whom
it's intended.
Empowering investors doesn't just mean better access to
information. It means access to better information. Simply put,
the question is, once that SEC-mandated information is
available, is it understandable? The answer all too often is a
resounding and frustrated ``No''.
Exhibit A when it comes to convoluted disclosure is today's
regime for reporting executive compensation. Ordinary American
investors have a right to know what company executives are
paid, because these investors own the companies. The executives
work for them. But how can an investor judge whether he or she
is getting the best executive talent at the best price?
Too often, the most important parts of total executive
compensation are not even disclosed at all until after the
fact.
Three months ago, the Commission voted unanimously to
propose an overhaul of the executive compensation rules. The
proposal would require better disclosure on several fronts.
First, companies would report a total figure, one number, for
all annual compensation, including perquisites. Companies would
also outline retirement benefits and payments that could be
made if an executive is terminated and would fully disclose all
compensation to board members for the prior year.
In addition, a new compensation discussion and analysis
section would replace the compensation committee report, and
the performance graph which now comprises mostly boiler plate
and legalese.
Finally, since the purpose here is to improve
communications, the proposed rules require that all of this
disclosure be in plain English, the new official language of
the Securities and Exchange Commission.
Just to be clear, the Commission does not propose getting
into the business of determining what is the proper method or
amount of compensation. It's not the job of the SEC to
substitute our judgment for that of the board. Nor would I,
speaking as Chairman, subscribe to the notion that all
executive pay is excessive. Surely many executives deserve
every penny they're paid, and more. Being a CEO requires a
rarified collection of attributes and skills that are in all-
too-short supply, and compensation in the market for executive
talent can be fierce.
At the same time, I needn't cite here the several
notoriously public cases of extravagant wastes of shareholders'
assets by gluttonous CEO's and pliant compensation committees.
It's a testament to the importance of this issue that we have
received nearly 17,000 public comments on the proposed rule.
That's one of the highest in the 72-year history of the
Securities and Exchange Commission.
At the SEC, we look at results from the vantage point of
the ordinary investor, and what we're finding is that, in many
cases, we're not getting the right results. It's not just
public companies that have a problem using plain English. Our
accounting rules and regulations also can be complex and
difficult to interpret. And, when the rules are difficult to
interpret, they may not be followed very well. And, if the
rules aren't followed very well, then, intentionally or not,
individual investors are going to suffer.
Weeding out the counterproductive complexity that's crept
into our financial reporting will require the concerted effort
of the Securities and Exchange Commission, the Financial
Accounting Standards Board, the Public Company Accounting
Oversight Board, and every market participant. This can't be a
one-time effort. We will have to commit for the long term, but
it will be well worth it.
Finally, let me turn to our efforts to better protect older
Americans against financial fraud. Consider these statistics:
An estimated 75 million Americans are due to turn 60 over the
next 20 years. That's an average of more than 10,000 people
retiring every day. Households led by people over 40 already
own 91 percent of America's net worth. Very soon, the vast
majority of our Nation's net worth will be in the hands of the
newly retired.
Following the Willie Sutton Principle, scam artists will
swarm like locusts around this increasing vulnerable group,
because that's where the money is.
On a daily basis, our agency receives letters and phone
calls from seniors and their caregivers who have been targeted
by fraudsters. Often the victims have already been taken in.
These fraudulent schemes may begin with a free lunch, but we
want to make sure that they end with a very high cost to the
perpetrators.
That's why we're attacking the problem from all angles,
from investor education, to targeted examinations, to
aggressive enforcement efforts. And, because State securities
regulators share our concerns, we are cooperating in this
initiative with State regulators across the country.
Each of the initiatives I have outlined today is part of an
overall strategy to make the individual investor, the average
American, the ultimate beneficiary of all that we do at the
Securities and Exchange Commission. Our Agency has, for many
years, proudly worn the badge of investor's advocate. In the
months and years ahead, we pledge to rededicate ourselves to
that mission.
I appreciate the opportunity to be back with you today. I
want to thank you, Mr. Chairman, Representative Frank, and
members of this committee, for your continuing strong support
for investor protection and for the work of the SEC. I am happy
to answer any questions that you may have.
[The prepared statement of Chairman Cox can be found on
page 54 of the appendix.]
The Chairman. Thank you, Mr. Chairman. And again, welcome
back, and your record on a number of issues in this committee
in the past have been extraordinary, and your knowledge. And I
share the views of members on both sides of the aisle when I
say that your appointment was excellent from many perspectives.
And also, congratulations on your priorities, particularly
the announcement of the $1 billion cut in SEC section 31 fees.
We worked long and hard on that, and we--our colleague, Vito
Fossella, it was his legislation, and it truly did make a
difference in the markets, and we thank you for your leadership
on that issue, as well as your project on interactive data,
which has tremendous upside potential in molding the technology
with the traditional markets. We are most appreciative of that.
I know the gentleman from Massachusetts will have some
questions on executive compensation, but that area as well,
your leadership is most appreciated here in the Congress.
Let me ask you, you were participating, were on the
committee on the legislation that became Sarbanes-Oxley. And
I'm just wondering what your view is from the other side of the
divide, now that you are Chairman of the SEC, what do you think
that the general impact has been on the individual investor?
And secondly, what can we do, working together, to make
this legislation work even better?
Mr. Cox. Well, you had pointed out that not only was I a
member of this committee when we considered that legislation,
but I also served on the conference committee that negotiated
the final result between the House and the Senate. And I have
to say that one of the most interesting parts of my new job is
that I am now in a position to implement, through regulation,
legislation that I worked on as a Member of Congress.
I listened very carefully to Representative Frank's
comments on section 404 that he made during his opening
statement, and I will say that I think, just as Mr. Frank does,
that this legislation can work--and just as you do, Mr.
Chairman.
There is nothing about the legislation, the law itself,
that is inherently onerous, that is guaranteed to cost more
than the investor benefit--than was intended. It's a very brief
passage. It has a very simple concept that is unobjectionable
at its core, and that is that public companies should have
solid internal controls. It should be a priority of management,
and there should be a way to check on that through outside
auditing.
What has happened in practice is that it hasn't worked
exactly as you all intended. It's more expensive, compared to
the benefits that we all expect to get from that legislation,
than it needs to be. And so, as the administrators of this law,
the people who are bound to make it work--we at the Agency want
to make sure that we get back to what Congress intended.
There is a great deal of benefit to be had from this
provision, it's a very important provision, and we aim to apply
it in a sensible way that squeezes out the maximum amount of
shareholder benefit and investor protection at the lowest
possible price. We want to make sure that there is not a focus
on the unimportant. We don't want to drive down cul-de-sacs; we
don't want an instinct for the capillary instead of the
jugular, but rather we want to make sure we're going after
those things that are material to the audit, that are material
to the investor protections that Congress was interested in
obtaining.
As you know, this is a particular focus for smaller public
companies. The Commission has exempted them, temporarily, from
compliance since the law was enacted. My predecessor, Bill
Donaldson, appointed an advisory committee on smaller public
companies that looked at this problem for a year and has just
reported. I commend the authors of that report for their hard
work over a year. I think they have done an outstanding job at
presenting the perspective of smaller public companies, and the
special problems that are faced there.
Taking into account all of those recommendations and the
many other sources of comment that, as you know, we have, what
the SEC will next move to do is ensure that the application of
section 404--not only by the SEC, but very importantly, by the
PCAOB, which has written AS2, and the bulk of the specifics
that are being followed to implement the law--will work
together to try and get it right. I am absolutely certain that
this can be done.
The Chairman. That's encouraging. Do we have any idea about
the timing of that proposal, specifically the recommendations
from the small business committee?
Mr. Cox. Well, yes. As I mentioned, they have just provided
us with their 32 recommendations after 13 months of looking at
the problem. We are now on the threshold of making a decision
about whether to extend the current exemption, or instead, to
move forward. You can expect a result in the next few months
from the Commission.
The Chairman. Thank you. The--as you know--and this is a
bit far afield, but I think it's important because of its
affect on the capital markets, and that is the whole CFIUS
process. You obviously followed the uproar that occurred with
the Dubai Ports proposal. There is now legislation in the
Senate, and there is discussion here in this committee about
legislation on CFIUS.
It occurs to me that we need to be very judicious about how
we approach this issue, because the entire issue of direct
foreign investment and its obvious benefits sometimes are lost
in emotional arguments.
What kind of advice would you give the committee, going
forward, regarding the CFIUS process?
Mr. Cox. Well, as you know, I do not sit as a member of
CFIUS. I do sit as a member of the President's working group on
financial markets, which is chaired by the Treasury Secretary,
and it includes the Chairman of the SEC, the Chairman of the
CFTC, and the Chairman of the Fed.
The SEC, for its part, has a good deal of international
focus that is certainly a cognate of the issues that CFIUS is
concerned with. In particular, because of the anticipated
globalization of exchanges, securities markets, and perhaps the
integration of the trading platforms themselves, we're focused
on potential acquisitions, not only of foreign exchanges by
U.S. markets, but also the obverse, and that is the potential
acquisition of our now publicly owned exchanges by foreign
interests.
Because of the importance of those issues, before a real
transaction is on the table, before it's clear whose ox is
getting gored if we go one way or the other, I'm trying to lay
out with my counterpart regulators and other nations--
particularly our major trading partners--what principles we are
trying to achieve with our regulation.
The national security concerns that are at the center of
the CFIUS process are the special focus, in part, of the Office
of Global Security in the Securities and Exchange Commission.
That's a relatively modest office, but the mission of that
office is shot through the review and evaluation that is
conducted in almost every case, both for offerings and for
periodic filings, by the Division of Corporation Finance.
The Chairman. Well, of course, you were the first Chairman
of the Homeland Security Committee, so you obviously have some
interesting background, both on the foreign investment side and
the market side, as well as the homeland security--
Mr. Cox. I am trying to confine myself to comments that I
am suited to give, as Chairman of the Securities and Exchange
Commission, and not lapse into what I might tell you I think
about CFIUS as a former Member of Congress.
The Chairman. Even when we ask for free advice?
Mr. Cox. I will restrain myself.
The Chairman. The gentleman from Massachusetts?
Mr. Frank. About section 404, I have to say I was talking
to the chairman about this. I think this is the right time to
act on this. I think there are dangers of going too far in--
what I think is too far--in the total exemption for other
people, and then not doing enough to be flexible. So, I am glad
to hear that you are going to move on that, and I think that is
useful.
On executive compensation, I very much agree with what you
said. Obviously, I think we should go further and not set any
guidelines here, but allowing--making sure the shareholders--I
again--it's relevant to Sarbanes-Oxley, too. Sometimes we don't
do a balance here.
During the bad times of MCI, and Enron, etc., there was a
lot of concern about the extent to which people would feel
secure investing their money in the market. You know, one of
the things that Sarbanes-Oxley has done, people forget that
those fears once existed. We sometimes tend to kind of pocket
the good and forget that something happened.
And the stability of the market, the total confidence
people feel in investing, is important for our economy, and
it's one of the consequences of Sarbanes-Oxley. So it is
important that we improve that some without weakening it in any
substantial way.
Similarly, I think we are now at a crisis where what's
happening is an increasing number of Americans don't believe
that they have the kind of stake that they want to have in
progress in this country. There has been kind of a disconnect
between the overall GDP and their sense of how they benefit.
And if people in the financial community and the business
community don't understand that the extraordinarily high levels
of compensation that, in many cases, appear to be unconnected
to any metric of success, that that's contributing to this
problem. And when they see an over-reaction in their minds with
regard to CFIUS, or excessive resistance to trade, they don't
make these connections. They are missing something.
Now, let me ask you about a couple of issues that have once
bubbled up here, and you now preside over them. One of the
things I think we don't do, we sometimes don't give ourselves
credit when something good has happened, but we also don't go
back and revisit predictions of disaster, when disaster has not
come.
I have shared before--it's not universally shared--that
there are two phenomena which seem to me to be greatly related
in one respect. That is the expensing of stock options in the
financial statements of companies, and same sex marriage in
Massachusetts. In both cases, we heard great predictions of
chaos, travail, and tribulation. And I think most people are
now pretty bored with both subjects. So, I won't ask you about
the Massachusetts one, but--
[Laughter]
Mr. Frank. But I will about stock options. We have now had
the expensing of stock options. You have had to preside over
some questions about it. What has been the result, so far, of
the requirement that stock options be expensed?
Mr. Cox. Well, you are right that this requirement is just
now being digested, both by filers, registrants on the one
hand, and by the markets on the other hand. And I think you are
also right that the clocks haven't stopped, and the world
hasn't come to an end in consequence of this.
Indeed, at the Securities and Exchange Commission, in our
executive compensation proposal, we have decided to use the
same approach that we're taking with stock options for
financial statement presentation purposes, and incorporate that
into the way that we are coming up with one number for an
executive's compensation. This will put, I think, increasing
pressure on the whole system to get it right.
It is very important, I think, that we keep our eye on the
ball. The main object here is, to the maximum extent possible,
accuracy. We want to make sure that the number which, after
all, is somewhat notional--it's a forecast--is as close to
reality as possible.
And so, the Office of Economic Analysis and the Office of
the Chief Accountant at the Securities and Exchange Commission,
as well as our Division of Corporation Finance, are going to be
working very, very closely together, and interactively with the
regulator community, to constantly review proposals to do a
better job of getting it right.
Mr. Frank. People who thought it was going to have a
tremendous effect were underestimating the ability of investors
to assimilate information. The fact that it might have been
presented differently didn't change the information.
The common thread in both cases is we have confidence that
if we just give information to the people who are going to be
investing, they will use it wisely.
One other issue that had been an issue and may come back
again, a couple of years ago this committee was very seized
with the notion that it was very important to mandate that
mutual funds separate the position of CEO from the position of
chairman. And this was a very important issue, according to
this committee.
I must say I was skeptical that it was going to make much
difference, one way or the other. I didn't see any studies that
showed it made much difference. But the SEC then adopted it. It
was held by the courts not to have done it right in the kind of
midnight judge's approach. Your predecessor, on his last day in
office, readopted it. The courts re-disadopted it, and it's now
back before you.
And I am wondering, because this was, at one point, a very
hot issue for many members of this committee, who believed that
it was essential to protect investors and the integrity of the
industry, that we mandate this separation. It is now before
you, before the Commission. I am wondering what the status of
it is. Do people still think it's important? I'm wondering
whether you will be hearing from--you know, is this committee
still urging you to move ahead, or is that another issue that
seems to have faded with time?
Mr. Cox. Well, your rendition of the history lays the
foundation for my answer very accurately. There were two parts,
before and after the court decision, to my ability to influence
this process as chairman.
The first, prior to the court's decision, came when I
announced, virtually the day I got to the SEC, that we would
implement that rule exactly as it was written, as with all
rules that had been previously enacted by the Securities and
Exchange Commission.
The second was very recently, when the court asked us to
review, again, a particular provision of the rule that had been
contested because of defects that they saw in our
administrative procedure. And so we're going to do exactly what
the court expects. The court, in its ruling, indicated it would
withhold the issuance of its mandate for 90 days. We're due to
report back to the court in 90 days. We will do so. The
professional staff of the SEC and the Commissioners themselves
are now discussing exactly how we will take the next step.
Separate and apart from that substantive decision, I am
also working with the Office of Economic Analysis and the
Office of the General Counsel to examine the way that we do
economic analysis of all of our rules.
You mentioned that you hadn't seen studies that you were
impressed with, contemporaneously with the consideration of
this issue by the Commission last time around. I think what the
court has invited us to do is to make sure we avail ourselves
of the best evidence before we make a decision. So, instead of
the fore-shortened process that the court objected to, we will
have a very thorough process this time around.
The Chairman. The gentleman's time has expired. The
chairman of the subcommittee of jurisdiction?
Mr. Baker. I thank the chairman. Chairman Cox, I want to
point out in your initial offer here to lead the Commission in
the direction of a plain English disclosure standard that, in
your discussion of appropriate remedies to excessive executive
compensation, you spun immediately to the work perquisites,
which I found sort of contradictory to the plain English
standards. You might want to think more along the lines of--
Mr. Cox. Perhaps I could have said ``perks.''
Mr. Baker. That's probably what would have summed it up.
But as I understand it, that's sort of the care and feeding
standard of an executive. So if you're doing an executive
washroom remodel, or the corporate jet, or catered meals, or
anything he charges to the company, that's all bundled up so
that the shareholder can be appropriately affronted--if that is
the proper response--to the total package, not just the
underlying salary, which some people have difficulty in
absorbing already, and that the remedy to many abuses in
corporate America is simply a transparency standard to disclose
to the affected parties that own the company, so that they
might take whatever action they deem appropriate. And I just
heartily commend you for the proposed rule, and the direction
which you are taking.
Secondly, on the XBRL project, there are two elements of
that that I want to throw into the mix, as to possible
benefits. As the taxonomy is more effectively described, that
may have the tangential effect of bringing foreign capital in
as accounting standards become more harmonized. I am told today
that many companies contemplating registering in the United
States choose not to do so because of the extraordinary time
and expense of coming to our generally accepted standards, and
that XBRL may yield that benefit.
And then, secondly, with regard to the current practice of
quarterly income disclosures, I have found that to be a
contributor to many decisions made by corporate leadership to
meet or beat the Street. And that, I think, energized, to some
extent, some of the problems which this Congress and the
Commission has had to address.
By moving beyond the current 8K standard to a more real-
time material fact disclosure methodology, which is based on an
XBRL platform, would be, I think, a terrific outcome of this
project. So I simply want to compliment the Commission for your
view on this subject, and encourage you to move forward as
quickly as is practicable.
As to the question that I principally wanted to ask before
I got sidetracked by all this other stuff, I am--the committee
has conducted hearings over some period of time relative to the
designation system for the NRSRO's. It's my opinion; I can't
speak for others on the committee, that that designation system
has yielded us a very uncompetitive market for all those rating
agency operations.
Congressman Fitzpatrick has introduced legislation which,
in essence, creates a registration system as opposed to
designation. Have you had the opportunity to contemplate which
methodology might be the most advisable going forward? Or, more
particularly, if you have had the chance to even review the
Congressman's bill, can you opine on your view of that
legislation, if you can be that specific?
Mr. Cox. I can do both, I think. First of all, I want to
take the view, as a former Member of Congress, and as the
current Chairman of the SEC, that we are going to be very
respectful, as an agency, of the legislative process of the
Congress. So, if the Congress is moving legislation in this
area, we offer ourselves as a professional resource for
technical assistance, if you seek it.
We don't know yet--I can't know, I don't think anyone
knows, because of our bicameral process--whether there will be
legislation in the near term. And so, simultaneously with your
consideration of legislation here, we are, at the SEC,
reviewing exactly these same questions.
We are concerned, as are you, with the achievement of the
public policy objectives of this whole structure. We want to
make sure that there is competition, transparency, and investor
protection. Whether or not one or the other of the two models
that you have described is superior is a question that I don't
think the Commissioners or, speaking separately, the
professional staff, have definitely answered.
But we are very deep into this process right now. It is the
central focus for us. And I know for the credit rating agencies
themselves, who are working on their voluntary framework, that
seeing a result of this process is vitally important.
The Chairman. The gentleman's time has expired. The
gentleman from Pennsylvania.
Mr. Kanjorski. Following on the questions of Mr. Baker, I
am very much interested in what the status is of the rule,
streamlining the process for approving applications of the
nationally recognized statistical rating agencies. Is the
Commission moving full speed ahead, or is there some lag time?
Because there is--it seems to me there would be no need for
legislation, if in fact you are ready or capable of
implementing something that is acceptable.
Mr. Cox. Well, the question of whether there is need for
legislation to accomplish a specific objective depends, in
substantial part, on how ambitious you are about restructuring
regulation of the credit rating agencies. The SEC certainly
has, within its existing authorities, power to do something. I
do not know that we have the power to do everything that has
been contemplated in some legislation.
With respect to our own rulemaking, as you know, the SEC
actually proposed a rule in March of 2005, to define the term
NRSRO for purposes of our own rules and regulations. We
received 30 comment letters on that rule proposal. The
professional staff in the division right now are formulating a
recommendation to the Commission as to whether to take further
action on that proposal, or instead, an alternative proposal.
Mr. Kanjorski. Can you inform us of what the status is on
the voluntary framework discussions that you are having with
the credit rating agencies, is that moving forward?
Mr. Cox. It is, indeed. And, as I just alluded to, I think
that those agencies are, themselves, very anxious to have this
process move as quickly as possible.
Our Commission staff are continuing to provide technical
assistance to them in that process, in the process of their
development of a voluntary framework. In fact, I understand
that there were discussions via teleconference between the
rating agencies and the staff last week, so this is an ongoing
matter for us.
Mr. Kanjorski. Very good. It sounds to me like there is a
question of whether we're going to strive for quantity or
quality. And in a way, your expertise and the Commission's
expertise is far greater than the committee in understanding
that issue of quality and quantity. This, of course, is an
ongoing pressing issue before the committee, and you're
probably unlikely to indicate to us whether we should put our
foot on the pedal, or put it on the brake?
Would you give some--I mean, yes, we have 2 or 3 months
now, potentially, left in this session. Should we move and
devote time to this effort, or wait and cooperate with the
Commission, see what the next 2 or 3 months produces, as a
result?
Mr. Cox. My predecessor testified that, in order to do
aggressive oversight, the SEC would need greater authorities.
What I have just told you is that I ought to be as respectful
as I can of the separate roles that the legislative and
executive branches play. I want to be sure that the SEC does
not just do its level best, but does a superb job of
implementing the intention of Congress when it comes to
administering our statutes.
So, I--it would be the easiest thing in the world for me,
as a former Member, to start opining on bills, and telling you
what I would like you to do. I understand full well the
legislative process, and the role of this committee and of the
Senate Banking Committee. And so I am trying to resist the
temptation to offer that advice. We will work with you, either
way.
Mr. Kanjorski. Thank you. Moving to another subject, I
mentioned in my opening remarks the ETF's applications and the
time delay. Is it possible, without causing a great deal of
expense and time, that we get a handle on just how many
applications are pending, and how long they have taken with the
idea in mind is there something we can do to assist in that
effort?
Because I am starting to wonder whether or not, since the
products have been on the market for more than a decade,
whether there is sufficient body of experience now in
evaluating the success of ETF's mechanism to standardize the
application process, and permit a wider variety of products,
which seem to be in demand, but not being held back.
Mr. Cox. Well, I think I share your premise, your implicit
premise, that the length of time that it has taken to process
exemptive applications is too long. And as Chairman, I am
working to shorten it substantially.
The investment management staff--to answer your question--
is currently working on over 215 exemptive applications. They
range in complexity from the routine--in other words,
applications for exemptive relief that have been previously
issued to other applicants--to quite complex questions, such as
people seeking authority to operate and actively manage ETFs.
With respect to the age of this backlog, 85 of the 215
exemptive applications--or I should say approximately 85--have
been pending for over a year. The division, under my direction,
is taking several steps to achieve our goal of improving the
timeliness of our exemptive applications process.
First, the staff is preparing recommendations that the
Commission adopt new exemptive rules that would eliminate the
need for filing at all, certain of these routine exemptive
applications, including fund-of-fund applications that are
contributing to the backlog.
Second, we are identifying other rules that the Commission
could adopt or amend, to further eliminate the need for filing
other kinds of exemptive applications, such as those related to
inter-fund lending, frequent capital gain distributions, and
index-based ETFs.
Third, we have spent considerable resources identifying and
moving out in the division applications--or I should say moving
out of the division applications--involving products such as
ETFs, for which the applicant has legitimate concerns regarding
timing of the markets. And we are doubling our efforts to
reduce the current exemptive applications backlog by
identifying those pending applications that can be processed
promptly, and by providing more timely comments on other
applications.
The Acting Director of the Division, Susan Wyderko, is
strongly committed to the steps. She has exercised a lot of
management creativity, and I think she is having great success
in achieving the objectives. So I hope that you will have
tangible results to see in this area very soon.
Mr. Kanjorski. Thank you.
The Chairman. The gentleman's time has expired. The
gentleman from Texas, Mr. Paul.
Mr. Paul. Thank you, Mr. Chairman. Welcome, Chairman Cox. I
had a question about section 404, but I think you have touched
on that already, and I don't know whether you can add anything
new on it. But I do want to assess the general principle of
regulation.
As you know, I am not a champion of regulation. As a matter
of fact, I see Federal regulation as nothing more than moving
us toward central economic planning, and I think we can make
pretty strong economic and constitutional arguments against a
lot of what we do around here.
Also, on economic terms, we do know that large companies
are less resistant to a lot of regulation than the small
companies, because handling of regulations is much more
difficult for the small company. And therefore, we have a
greater penalty placed on the small company.
We also know that the general rule that when Congress or
other government bodies regulate, for every regulation, every
law that we pass, we generally create too many problems. And I
think the case could be made that the Sarbanes-Oxley bill has
had some bad consequences.
I would like to mention a few things where there has been
some dire assessments of Sarbanes-Oxley, and I would like to
give you a chance to refute these, and see whether or not we
should refute these negative assessments, or move in the
direction of reforming the legislation.
First off, I would like to quote from a rather famous
economist that many of us know about, and that is Milton
Friedman. And he was commenting on Sarbanes-Oxley and he said,
``It's terrible. It ought to be eliminated. It's costing the
country a great deal. Sarbanes-Oxley says to every
entrepreneur, `For God's sake, don't innovate, don't take
chances, because down will come the hatchet, we're going to
knock your head off.' '' Those are pretty strong terms. I would
never use that type of language.
And also, there has been other assessment. An economist
writing in the Wall Street Journal not too many months ago said
that it is very costly, it has cost public company shareholders
$1.4 trillion, $460 for every man, woman, and child in the
United States.
And another important aspect of this--and we have seen
several articles on this--the London stock exchange did a
survey of 80 IPO's that were coming on to the market. Of those
80, 90 percent of the 80 that contemplated American markets
versus London, 90 percent chose to go overseas into the London
market. So that is a consequence that we either ignore or we
have to say these assessments are completely wrong.
There was another study done by Foley & Lardner, a law
firm, which said that it has increased the cost associated with
being a publicly held company by 130 percent. These are rather
astronomical figures.
And what would it take for us to assess this, and decide
that maybe we ought to back off section 404? I certainly would
like to see the whole section repealed. But do we wait until
problems get much worse? But if these numbers are true, this is
very, very costly to us, and as time goes on these costs will
increase because we're really still in the early stages of
implementing this law.
Do you have any comments along this line? Or what do you
think of some of these assessments?
Mr. Cox. Well, I think you have nicely set the table for
discussion of the broad impact of what undoubtedly was landmark
legislation. The significance of the events that gave rise to
that legislation is still before us. The trial is going on in
Houston right now. And yet, it has been a few years. And so we
have had the opportunity to assimilate some of this significant
change that Congress mandated.
My considered view is that--considered, in the sense that I
have now had three calendar quarters as Chairman of the SEC to
look at this from that perspective--is that there is nothing
about the law itself, the way it's written, that should prevent
us from being wise in its administration so that the benefits
that Congress hopes to get from it can be obtained, while the
costs--the unnecessary costs, which are what you're talking
about--can be wrung out.
It's not investor protection to cause investors to pay for
something they don't want and don't need and can do without.
What investors do demand are protections for their money, so
that their investment will be safer, ultimately yield a higher
return. We've got to distinguish between, in other words, what
is worthwhile and what isn't.
I have a great deal of respect for Dr. Friedman. In fact,
when I was chairman of the policy committee here in the House,
we had a board of advisers, and he served ably on it. I have
always been anxious to hear his perspective on things.
When he says that Sarbanes-Oxley is terrible and ought to
be eliminated, I believe he is referring, in a gross sense, to
some of the pathologies that are being ascribed to the law,
which--in as much as he is an economist and didn't serve on
this committee when we drafted the legislation, I will allow
him that kind of generality. But speaking with that
generalization, I think we need to recognize the difference
between what the legislation mandates and what's actually
happened.
When the climate in the board room is anti-risk, when
people are hunkering down, they're concerned about a lot of
things. Part of it was the climate that produced our
legislation, and the way that everyone, from litigants to
insurers, to the accounting firms themselves, which had been at
the center of many of these scandals, was reacting.
And so, I think now that things have settled down a bit, we
have an opportunity at the SEC--and I have been there for just
a few months, so whatever costs have been incurred heretofore,
be they start-up costs, initial costs, capital outlays, what
have you, that's water under the bridge. I want to make sure,
going forward, that we do this wisely. And I absolutely believe
that we can.
There are some things, in terms of international
competitiveness that you alluded to that I think we have to be
mindful of. And that is, while Sarbanes-Oxley presents
compliance issues and potentially disproportionate costs for
smaller companies, if you take a look at what's going on in the
smaller company market, in 2005, close to 100 foreign companies
registered with the SEC for the first time. That doesn't get
headlines; these are mostly smaller companies.
So, that's telling us that we are still an attractive
market for foreign listings, and we just need to make sure that
we recognize as, simultaneously, markets in other countries are
becoming more mature and more attractive, and more realistic
possibilities as places to list--we didn't always have that
competition in the past--that the United States of America
retains its lead as the biggest, deepest, most liquid capital
market in the world, in part because we also have the most
predictable and safe rule of law and regulations that are
consistent not only with investor protection, but also with
capital formation and the maintenance of orderly markets. That
is our mission. I hope we can do that.
The Chairman. The gentleman's time has expired. The
gentlelady from New York.
Mrs. Maloney. First, I would like to welcome the chairman
back to the Financial Services Committee, and I congratulate
him on his appointment and his hard work.
I appreciate your mentioning the Investors Fee Relief Act,
which I introduced with Congressman Fossella, and I am very
glad to see that you're continuing to cut the fees to reflect
the reality of what is appropriate to support the regulation.
It is very important to the investors I represent, and all
investors.
I would like to go back to section 404. In my district,
small companies are really concerned about the cost and burden
of complying. I know that you are aware of the legislation that
has been floated by Representatives Feeney and Sessions that
would make section 404 voluntary for companies with market
capitalization under $700 million.
You testified before the Senate that you want one standard,
you don't want a different standard for large and small firms,
but that you would be open to addressing unnecessary costs.
One idea that was put before the House Financial Services
Committee by Marshall Carter, chairman of the board of the New
York Stock Exchange--last week he proposed that the SEC and the
Public Accounting Oversight Board move to a 3-year Sarbanes-
Oxley section 404 review cycle as a way to reduce regulatory
burdens. This could be accomplished without having to pass
legislation to amend the law. Could this proposal help small
companies by reducing the cost and the burden of compliance,
which is very difficult for smaller firms? Your comments?
Mr. Cox. I am very well aware of the proposal advanced last
week by the chairman of the New York Stock Exchange. That
proposal, as well as a wide range of alternatives, is, as you
would expect, under very active consideration right now at the
SEC, as we try to make work the discussion we have been having
here this morning.
We are also gathering as much data as we possibly can from
the experience of companies that have already implemented
section 404. And that includes a fair number of smaller public
companies that, in most ways, are exactly like the companies
that have heretofore been exempted. So we have ample empirical
data that we can avail ourselves of.
And, as you know, we have this public roundtable coming up
at the SEC next week that is going to be focused on these very
issues of full implementation. That's going to be an all-day
affair. If you can put it in the context of your experience
here as a Member of Congress, sitting on the dais at this
hearing, we as Commissioners are going to be there all day and
listen to 50 witnesses. We're going to get a wide variety of
perspectives. I think we're going to get a lot of quality data
and comment at that hearing.
Mrs. Maloney. Chairman Cox, as you know, the securities
industry that I represent is very, very concerned about
reducing global market access barriers and national treatment
barriers. The United States is a world leader in providing
financial services.
And although our trade deficit is over $700 billion, in the
area of financial services our country boasts a trade surplus
of almost $17 billion, which is very, very important. The
industry tells me, though, that the barriers that they face
prevent them from providing their clients with the global
products and services that they demand. And they are hoping
that you will do everything--and that our country, our U.S.
trade negotiators, will do everything--to support the
competitiveness of this very important export industry of the
United States.
So, I would like to ask you, do you support the goal of
securing access to foreign markets for U.S. firms that is
comparable to the access foreign firms enjoy in the United
States? And this access would include the ability of our
firms--meaning U.S. firms--to supply services from the United
States to sophisticated investors in foreign markets on a
cross-border basis without having to establish a commercial
presence. I would appreciate your comments on this issue.
Mr. Cox. Well, it's an excellent question, and it tempts me
to give a very elaborate answer, because I'm so interested in
so many aspects of this topic. But the way you have put the
question, it's susceptible to a yes or no answer, and the
answer is yes.
Mrs. Maloney. Would you like to elaborate further?
Mr. Cox. Sure.
[Laughter]
Mrs. Maloney. Can we achieve this? Is this competitiveness
for our financial services markets a priority of our country?
Will we fight at the table for their ability to sell these
products without a commercial presence in the country?
Mr. Cox. Yes. Obviously, our trade negotiations generally
are the province of the USTR and other parts of the executive
branch beyond the SEC. But, specifically with respect to
securities regulation, the SEC conducts a fair amount of
international intercourse with our trading partners.
Just yesterday, for example, I hosted Chairman Shang of the
CSRC, China's securities regulator, and we executed a joint
agreement that is going to permit us to expand substantially
the level of our cooperation and information sharing. We are
very anxious in China, as well as in every other country on
Earth, to make sure that our financial services have the kind
of access that we provide here to their firms.
And so, that principle of reciprocity is vitally important
to us as securities regulators, as I am sure it is to our trade
negotiators.
Mrs. Maloney. Thank you, Mr. Chairman--
The Chairman. The gentlelady's time has expired.
Mrs. Maloney. My time is up. I just want to tell you how
much I enjoyed working with you on this committee, and your
leadership on the Anti-Terrorism Insurance Act. And I hope you
will continue to keep your eye on making sure that vital
program is there for the American economy.
Mr. Cox. Thank you for your kind comments. I certainly, as
I said at the outset, miss seeing all of you here more than
anything else, more even than I miss the work of the Congress,
and we will have our corner of the counter-terrorism world to
maintain at the SEC, and I am going to continue to apply myself
there.
Mrs. Maloney. Thank you so much.
The Chairman. The gentleman from Connecticut, Mr. Shays.
Mr. Shays. Thank you, Mr. Chairman, and new Mr. Chairman.
It's great, Chris, to have you here. I would like to ask you
about the 202 rule involving the Investment Advisory Act, and
also about hedge funds.
First, with hedge funds, you are requiring, as of February,
managers of certain hedge funds to register with the SEC and
subject themselves to certain reporting requirements. I am
interested to know the status of this rule--not in depth, but
in general.
Mr. Cox. It has just gone into effect. It is giving us the
opportunity to gather census data, if you will, about the scope
and scale of the issue that we face. We have nearly doubled the
number of registrants as a result of the effectiveness of this
rule. We believe that--at least we infer--that all of these new
registrations are on account of the rule.
And so, I would guess that 9 to 12 months down the road we
should be in a position to infer something from all of this new
data that we are gaining about whether, and if so how,
additional regulation of the funds themselves is advisable.
As you know, the regulation, the rule that has gone into
effect, is focused on the advisers, and not the funds.
Mr. Shays. No preconceptions on where you are headed, just
totally open about the data you're going to get and then
drawing conclusions afterwards?
Mr. Cox. Well, I don't have any preconceptions about the
data that we haven't seen yet. Of course we have studied the
issue of hedge funds, generally. And so, there is at least that
preconception, if you will. We are not without a background on
the issue. And indeed, for a variety of reasons, including the
potential retailization of hedge funds, the systemic risk, and
impact on the markets themselves, not only I, but my
counterpart regulators in other countries, are watching this
like hawks.
Mr. Shays. The other area I would like to get into is the
issue of the Investment Advisors Act and the Securities
Exchange Act.
There is a concern among a number--I represent a huge
number of financial institutions. And there is a concern of
when--if the Commission intends to provide some guidance to
financial institutions in order to clarify the potential
problems with the new 202 rule, in terms of when are they
advisers and when are they just, you know, dealing with
transactions?
And the question I am asking is do you see this as a
problem, and are you hearing that guidance is needed?
Mr. Cox. Well, it is, and I am also hearing that it is. We
are very busy working on this right now. I am hosting
collaborative discussions among the SEC and the bank regulators
to implement Regulation B, which I take it is what you're
asking me about.
It has been a long time since Gramm-Leach-Bliley, since we
worked on that in this committee, Mr. Chairman. Indeed, it was
a different millennium than we're now in. It was 1999.
And so, it's about time that we had rules and guidance. I
think it's vitally important that we do so. It has obviously
been a sticky wicket, that's why it's taken this long. But I
have decided to rededicate the Agency to getting it done, and I
am leading those efforts personally, getting personally
involved in them.
We are having a series of multi-hours-long meetings to work
it out, step by step, very patiently. And I think that we can
achieve a result.
Mr. Shays. You have only been there 9 months, and I marvel
at the things that you have to be prepared for. Do you feel
that you are kind of caught up, or do you still feel that you
are still in somewhat of a learning mode, in terms of
understanding where your fellow Commissioners are, and where
your staff is?
Mr. Cox. Well, I have to answer that in two ways. I believe
that, in part, because of the absolutely outstanding
professional staff of the Securities and Exchange Commission,
it has been possible for me to get up to speed on a number of
issues very, very rapidly.
But second, I have to say that you learn some humility in
Congress, where you are required to take responsibility for
such a broad array of different issues. We have all got to
dedicate ourselves to lifetime learning. And I certainly am
enjoying that opportunity at the SEC.
Mr. Shays. Just one last point. Not a question. I was,
frankly, surprised to learn the salary of your position. And I
just want to state to the chairman that I, given all the people
in the position that the chairman--this chairman here, I just
think we need to determine why the salary, frankly, is so low
and what can be done to raise it up a bit.
The Chairman. The gentleman's time has expired. Does the
chairman want to respond to that?
[Laughter]
Mr. Cox. No, I just want to say, Mr. Chairman, that the
Congress, if not by design, then by accident has put me as
Chairman of the SEC in a remarkable position of moral
leadership to talk about executive compensation.
[Laughter]
The Chairman. Well said. The gentleman's time has expired.
The gentlelady from New York.
Ms. Velazquez. Thank you, Mr. Chairman. Welcome back,
Chairman Cox.
Mr. Cox. Thank you very much.
Ms. Velazquez. Mr. Chairman, in order to go public today,
small companies must be more sophisticated and more mature than
ever before, and they must employ a sizable administrative work
force to comply with the many regulations they face.
In addition, other factors have increased the challenges
that these firms face in accessing the public markets, such as
the liquidity demands of institutional investors, as well as
consolidation within the underwriting industry.
Do you believe that it is harder for small firms to go
public today than it has been in the past?
Mr. Cox. Well, I have no better source of information than
what public companies, or companies on the threshold of going
public, tell us. And there is no question what they're saying.
They are saying that the answer to your question is yes. That
is what we are hearing from the advisory committee that the
Securities and Exchange Commission itself appointed. That's
what we are also hearing from venture capitalists who nurture
companies to the point where they might become public.
One can argue the point and say, ``Well, this information
is wrong,'' or, ``There is another perspective.'' And actually,
the SEC does have a different perspective in many cases. But
it's impossible to deny that the people who are in this
position, who are themselves smaller public companies or
companies on the threshold of becoming public, are telling us
that, over time, this has become a greater burden and a greater
expense.
Ms. Velazquez. Is there anything that the SEC is doing to
ease the burden?
Mr. Cox. Yes. And I appreciate the way that you yourself
have drawn our attention to this issue. On behalf of many of
the smaller public companies, and the companies that are not
yet public that I was alluding to, the SEC not only can do
something here, but we have a very significant responsibility
to do something here.
I know, from firsthand experience, as a member of the
Conference Committee, that that's what Congress intended. The
Congress did not intend chaos, we didn't intend unnecessarily
high costs. We didn't intend expense all out of line with the
investor protection benefit that it purchases.
There is nothing in section 404, which is the main focus of
a lot of this criticism, that mandates that kind of chaos.
Instead, I think section 404 has a very good idea expressed
within it. I think it is expressed very economically. It's not
a very long section.
There are hundreds of pages, on the other hand, in AS2,
which is published by the PCAOB. The SEC itself has the
responsibility and opportunity to provide management guidance
in addition to the auditing guidance that's provided in AS2.
Between the SEC and the PCAOB, I am absolutely confident that
we can make this work far better.
Ms. Velazquez. Good. Thank you. The SEC permits smaller
companies to use simplified forms for reporting on the
Securities Act and the Exchange Act. In order to qualify as a
small business issuer under SEC Regulation SB, the company must
have revenues and a public float of less than $25 million.
These requirements have not been changed since the enactment of
Regulation SB in 1992.
Since 1992, stock prices have increased significantly, and
measurable inflation has occurred. Do you believe it is
appropriate for the SEC to raise the threshold associated with
regulation SB?
Mr. Cox. Yes, I do. And we are preparing to consider a
proposal at the Commission level that would do precisely that.
Ms. Velazquez. Okay. Earlier this Congress, Mr. Chairman,
Representative Kelly and myself introduced and passed
legislation modernizing the business development company
statute. As you may know, modernizing the business development
company statute is a past recommendation from the SEC's small
business forum, and the subject of several previous legislative
efforts.
These enable the SEC to meet its mission to facilitate
capital formation. However, these regulations are outdated,
which in turn limits the financing option for smaller
companies, and also hurts those that have invested in BDCs
themselves.
With this in mind, is the SEC going to propose new rules
this year to modernize BDC regulations?
Mr. Cox. Yes. And, in fact, I think that the Commission
will be ready to consider final action some time perhaps late
this summer, or maybe even early summer. I want you to know
that I certainly support modernizing the definition of eligible
portfolio company.
Ms. Velazquez. Thank you. Thank you, Mr. Chairman.
The Chairman. The gentlelady yields back. The gentleman
from California, Mr. Campbell.
Mr. Campbell. Thank you, Mr. Chairman. And it's good to see
you, Chairman Cox. As the person who succeeded you--albeit it
not replaced you--in Congress, I want to, first of all, thank
you for leaving the California 48th Congressional District in
such excellent shape, and to let you know I drove by your house
the other day and it hasn't burned down or anything.
So I just have one quick question, relative to the
complexity in financial reporting issue. As you suggested in
your testimony, a lot of the complexity, certainly in
accounting, is driven by having increasingly complex financial
instruments and increasingly complex financial transactions.
I understand that you are working on, in the SEC, perhaps
principles-based accounting system, and I just wanted to ask
how is that progressing? Where are you--where is the SEC on
that? And what is the path from here? What stands in the way,
etc.?
Mr. Cox. Well, the SEC, as you know, has a road map to
convergence of what is a more principles-based system, IFRS,
and U.S. GAAP. At the same time, we are also working very
closely with the Financial Accounting Standards Board in this
war on complexity that I advertised earlier. I think it's
vitally important for individual investors in chief, but also
for our whole system.
And part of that project, I think, is going to open up some
of these questions that you are raising.
Mr. Campbell. So, as far as the principles-based--it's
still--at this point it's just a matter of discussion and
something you're looking at, a principles-based accounting
system, or--
Mr. Cox. Well, U.S. GAAP is a very rules-based system. And
so, as we have discussions with our overseas counterparts about
our own acceptance of IFRS, as we talk about convergence of
those systems, it gives us an opportunity to move perhaps to a
more principles-based system.
Mr. Campbell. Okay. Thank you. I yield back.
Mr. Cox. But before you yield back, I want you to know
that, as you know, we just bought a new house in your district
last year, before I knew that the President was going to ask me
to do this job. So I hope that you can keep going by the
house--
Mr. Campbell. I will keep checking on it.
Mr. Cox. I was there one weekend in 2006, and so--
Mr. Campbell. I will keep checking on it. And after I have
the parties there, I will make sure that I clean up.
[Laughter]
The Chairman. The gentleman yields back. The gentleman from
Missouri, Mr. Clay.
Mr. Clay. Thank you, Mr. Chairman, and welcome back, Mr.
Chairman, and welcome back to the committee.
There is an outcry among investors that executive
compensation is too inflated, and that the disclosure of the
compensation is too vague and confusing, at best. Will your
plain English requirements apply to executive compensation
reports, and do you expect that to work, if it does apply to
it? Are there enforcement provisions with punitive measures if
reports continue to be confusing to most investors? And could
you elaborate?
Mr. Cox. Yes. The answer to the first part of your question
is absolutely yes. All of the revised executive compensation
regulatory regime is going to demand plain English. And indeed,
our ultimate goal--not just in the area of executive
compensation, but in all information that is distributed to
individual investors--is that we have plain English
requirements.
Second, with respect to what happens if you don't follow
these rules, all of the enforcement authorities that the SEC
possesses with respect to observance of its rules will apply
equally to these executive compensation rules.
Mr. Clay. Okay. Thank you for that. And I support Sarbanes-
Oxley, or otherwise known as SOX, and appreciate how it helped
to stem the tide of distrust in our financial markets caused by
the financial collapse of several large corporations. I do
understand the prohibitive cost to some of our smaller publicly
traded companies. Additionally, I understand that the second
year cost will be less costly.
However, I do recognize the need to make adjustments in SOX
for the smaller companies. Do you think that it is wise that
companies be exempted completely from Sarbanes-Oxley, or don't
we still need transparency? Would not the combination of lower
costs after the first year, and perhaps a less frequent
reporting schedule, make the process affordable while
maintaining these reporting requirements?
Mr. Cox. We are considering, as you would expect, a wide
range of alternatives on improving the implementation of
section 404, including those that you mentioned.
But, with respect to the question of exemption versus
applying the law in some fashion, I think my own view as
Chairman--and I need to hasten to add that the Commission has
not made a formal decision on this; the Commissioners are all
entitled to their views, and we are still working this out, so
I am not speaking for the Commission, but for myself--I would
like to see this law applied to public companies for, among
other reasons, the fact that the law itself seems to
contemplate that. The law does not have an elaborate exemption
provision. It was the intent of Congress, I believe, that these
provisions be applied.
But I also think it was the intent of Congress that they be
applied in a sensible way. And I think Congress would be the
first to recognize, from the wide range of experiences that
Members here have, that there is a difference between General
Motors and Joe's Motors, and an allowance has to be made for
that in designing systems to comply with this provision.
Mr. Clay. So, in your opinion, it's proven to be more
costly for some firms than others?
Mr. Cox. I think there is no question that,
proportionately, the costs are going to be higher for smaller
companies than for large companies. Certainly, as expressed as
a percent of earnings, the impact on a small company will far
outweigh the impact on a large company.
Now, whether it should be scaled in exactly that way is
another question. But we need to know, going in, that
proportionately, the impact is greater on smaller companies.
Mr. Clay. I thank you for your responses. It is good seeing
you again. I yield back, Mr. Chairman.
Mr. Shays. [presiding] Thank you. And I will now go to Mrs.
Biggert. Before recognizing her, if I am still here, I need to
clarify the issue of broker-dealer/financial planner. I am not
quite sure when I asked my question I did the proper follow-up,
and I am just going to prepare you for that.
Mr. Cox. I am sorry, I answered a Reg B question, because I
thought that's what you were asking about.
Mr. Shays. Yes. I was talking about the broker-dealer, not
the financial planner.
Mr. Cox. Yes. All right. Do you want to ask that question
now?
Mr. Shays. No, I think I will just go to Mrs. Biggert now,
and make sure that, before we leave, we get that on the record.
Mr. Cox. Okay.
Mr. Shays. Mrs. Biggert?
Mrs. Biggert. Thank you, Mr. Chairman, and thank you, Mr.
Chairman, for being here. And first of all, I would like to
thank you for making financial education your top priority for
the SEC. I have been working on financial literacy within the
Congress, and I particularly thank you for working with the
NASD to help our military and their families. It's very
important. And thank you for working to educate and protect our
elderly investors and retirees and future retirees. You're
doing a great job.
My question. The securities and futures industries in
Chicago appeared to unanimously support parity in the portfolio
margining between single stock, futures, and options. I found
it is rare that competing industry interests unanimously
support a proposal, unless it's good for the market and good
for consumers. I believe that this is an important step for the
capital markets.
Under rules proposed by the CBOE and the NYSE, a broad
array of products, including equity securities, listed options,
OTC derivatives, U.S. securities, futures, and broad-based
futures could be included in a single account margin on a
portfolio basis.
But last November, I believe that the Commission committed
to approving self-regulatory organization rules to permit the
customer portfolio margins by June 30, 2006. And I know that
you are currently taking comments on CBOE and the New York
Stock Exchange rule changes.
Do you anticipate that the Commission will be able to meet
its commitment to Congress to act on these proposals by June
30th?
Mr. Cox. I do. And let me add that I am committed, in my
capacity as a member of the President's working group on
financial markets, to implementing portfolio margin rules in
collaboration with the CFTC. I think it makes a great deal of
sense, from the investor's standpoint, from the investor
protection standpoint.
Mrs. Biggert. Thank you. And then, in your testimony, you
mentioned improving disclosure of financial data, and there is
a fair disclosure from issuers of securities. And in addition,
you mention that disclosures should be in plain English, and
accounting complexity should be reduced.
In 2004, this committee held a hearing on corporate
governance in accounting for oil and gas reserves due to
several financial restatements by the companies in these
industries. And in recent days, the accounting method of last-
in first-out has come into question, as it relates to these
industries.
Are investors in the American public getting clear and
accurate financial statements from the oil and gas companies,
including accuracies about the oil and gas reserves? And is
this something that the SEC is examining?
Mr. Cox. It is, indeed. Rules, as you know, in this area
are old. They date back to the 1970's. And one of the things
that has happened, in the meanwhile, is that technology has
changed. And so, the technological premise for these rules
needs to be re-examined.
Under our current rules, an oil and gas company is
prohibited from disclosing any reserves, other than proved
reserves under this definition. And so, if there is disparity
between real life and good science, on the one hand, and what's
in our publicly-mandated disclosures on the other hand, we need
to address it.
Mrs. Biggert. Are you looking at the rules to be--to see if
you can bring them into the 21st Century? Is that something
that you can do?
Mr. Cox. We are looking at it. The view of the professional
staff to date has been that they have been unable to conclude
that the newer technologies in use since the 1970's have been
demonstrated to be routinely reliable for the attribution of
proved reserves in the context that we're talking about here,
for financial reporting.
But the Commission staff did allow the use of those new
technologies in calculating proved reserves in the Gulf of
Mexico, following a special project that it undertook.
Allowing the use--I think we all understand here--of new
technologies would likely produce reports of increased levels
of proved reserves, and what we're weighing is whether or not
we're going to conversely reduce the reliability of the
estimate. And we don't want to do that, of course.
Mrs. Biggert. Thank you. Thank you, Mr. Chairman. I yield
back.
Mr. Shays. I thank the gentlelady. Mr. Cleaver, thanks for
your patience.
Mr. Cleaver. Thank you, Mr. Chairman. Chairman Cox, thank
you for being here. I did not have the privilege of serving on
the committee with you, but everybody who has speaks so highly
of you, so it's a privilege for me to have the opportunity to
have an exchange with you.
I have become somewhat obsessed with our national debt and
with the investments by foreign nations in our government. Do
you know the current size of the U.S. investments held by
foreign entities?
Mr. Cox. I don't have that figure to quote for you right
now, and I would actually be surprised if I turned around and
somebody did, but I will check.
Yes, I mean it's a very easy figure for us to get, and in a
very formal proceeding such as this I would hate to do it seat
of the pants. So why don't we get you the precise figure
following this hearing?
Mr. Cleaver. And I am interested also, if you can, in what
portion of that is held by China and Japan.
Mr. Cox. We would be very happy to do that.
Mr. Cleaver. Thank you. But is that something, though,
under normal circumstances, that the SEC would monitor?
Mr. Cox. Well, you know, the Securities and Exchange
Commission is very concerned with cross-border capital flows,
and the maintenance of healthy, transparent, open markets that
look after the interest of our own investors. It's impossible
to do that job these days, and restrict yourself to our
national border or not notice which way the capital flows are
moving, which country's regulatory regimes necessarily we are
dealing with, because they are the preponderant trading
partners in the capital markets, and so on.
So, I think your question is right down the center lane of
what we're interested in at the SEC.
Mr. Cleaver. Is it what you consider dangerous if the
interest of foreign--the investments of foreign entities
reached a portion where they actually almost controlled major
portions of our Wall Street companies?
Mr. Cox. Well, I don't believe that we should erect
barriers to foreign investment in our country, for the simple
reason that we don't want foreign countries to erect barriers
to our investment.
I would see--and here I am going to try and restrict myself
to the role that I am testifying in, as Chairman of the
Securities and Exchange Commission, and not give you a
perspective as the Chairman of the Homeland Security Committee,
or a former Member of Congress, which, being in these
surroundings, I am almost tempted to do.
But what we do at the SEC is evaluate the disclosures made
by market actors. And the transparency of market actors is
something that we have to be able to enforce through our
regulations. If the people that are making the investments are
not strictly market actors, but sovereigns, that's harder to
do.
And so, if you're dealing with nations themselves, or their
surrogates and their wholly controlled entities, I think it
presents a different public policy issue than if you were
dealing with purely market actors, private market actors from
other countries. I think they tend to act for market reasons;
governments act for reasons of national interest.
Mr. Cleaver. Thank you, Mr. Chairman.
Mr. Shays. Thank you very much. The Chair would recognize
Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman, and let me add my
voice to the chorus of those welcoming Chairman Cox to our
committee. And I am certainly just as happy as I could be that
a man of his integrity and leadership and philosophy has been
chosen for this position.
Chairman, let me offer an apology here. I had to run off to
a prior speaking engagement. So, although I heard your
testimony, I have missed much of the question and answer
period. So, if this is redundant, please forgive me.
In your testimony today, you expressed concerns with
ensuring that our public investors have access to accurate and
useful market data. I think the Commission has now been
reviewing possible reforms to the consolidated model of market
data for over a decade. Even by government standards, that's a
fairly excessive period of time.
Recently on the Senate side, I believe, in your hearing
there, you indicated that market data reform was something that
was a front burner issue for the Commission.
And so, my question is, as this issue sits on the front
burner, is it on low, medium, or high? In other words, do you
have a time table yet on when the Commission will address this
issue?
Mr. Cox. Well, it's very salient for, among other reasons,
the reason that the pricing of market data and the revenue
generated by market data are of exceptional relevance to the
now-public markets in the United States.
Back in December of 1999, the SEC issued a concept release
dealing with the regulation of market information and fees, and
so on. That focused primarily on the fees charged for market
information, and the role that revenues derived from those fees
played in funding the operation of the SRO's, and thus the
operation of self regulation in the market.
The majority of the commenters on that issue--and the
concept release generated a fair amount of comment--believed
that the SEC's cost base approach, which was expressed in that
concept release, would be unnecessary and impractical. They
weren't fans.
The commenters cautioned that, for example, classification
of common costs couldn't be done without significant
disagreements, continual auditing, and considerable expense.
And some of them pointed out that, historically, cost-based
systems have encouraged cost padding, and creating
disincentives to reduce the cost through efficient operation or
innovation.
So, that then took us to the appointment of an advisory
committee in 2001. And the SEC's advisory committee on market
information then expressly rejected this cost-based approach in
its report to the Commission. They recommended that the SEC
retain the consolidation and move from a single consolidator
model towards a system of competing consolidators.
Then we had Reg NMS, which was adopted shortly before I
came to the SEC. That didn't take any action on the competing
consolidator idea. And in fact, it even reaffirmed the single
consolidator system for best-priced quotations and for last
sale information.
It did take some limited steps to confirm that SRO's could
sell data other than currently consolidated data, but it left
it to the Commission to explore whether further action was
necessary to address concerns with the pricing of consolidated
market data.
Mr. Hensarling. But any time table on--
Mr. Cox. The next step, in order to solve this problem, and
to deal with it in a good way, is for us to understand with our
counterpart regulators--for example, the FSA--you know, how we
intend to deal with what we expect to be the new shape of the
industry and the markets, now that they are for-profit
entities.
It is this interplay between the interest that we have in
transparency, and the transmission of this information to the
market in real time, on the one hand, and the role that the
revenues play in sustaining the SRO's themselves, it's that yin
and yang that we have got to deal with.
So, I don't have a date that I can give you here in this
hearing, by which all these questions will be resolved. But I
hope it's of some comfort to you that this is a front burner,
not a back burner item. It's something that we are very, very
intently focused on.
Mr. Shays. The gentleman's time is--
Mr. Hensarling. Unfortunately, I already see the red light
is on, so apparently you didn't want to answer my other
question. Thank you, Mr. Chairman.
Mr. Shays. Mr. Fitzpatrick?
Mr. Fitzpatrick. Thank you, Mr. Chairman. Earlier today,
there was some discussion on a bill that I introduced that's
pending before the committee--H.R. 2990--the Credit Rating
Agencies Duopoly Relief Act. And currently, the SEC has only
designated five credit rating agencies as nationally recognized
statistical rating organizations, NRSRO's, for use in SEC
regulations.
My view, Mr. Chairman, is that 5 is not enough. And to
compound matters, 2 of the 5, Moody's and S&P, control about 80
percent of the market share. I introduced H.R. 2990, which
would eliminate the SEC's designation process in order to
engender some competition and to protect investors.
Congressman Kanjorski earlier asked an excellent question,
which is given the fact that there is legislation pending, and
at the same time SEC staff is reviewing the designation
process, should we put our foot on the accelerator or the
brake, he said.
And I believe you had essentially two responses. One is
that, given the difference between the legislative and the
executive process, you respect the legislative process we're
going through, and we appreciate that.
Now, the second is that currently staff is in the process
of defining the term ``NRSRO,'' and I think you indicated,
through the rule-making process that started back in March of
last year--I'm not sure what--whether or not we have actually
gotten to the actual definition. Has that been completed?
Because it goes to Mr. Hensarling's question as to how long is
this reform process going to take? Has NRSRO been defined at
this point by the SEC?
Mr. Cox. Well, as you know, the proposal was put out in
March of 2005. We received comments on it, the comment period
closed. And now we have been in extended study period. I think
the inference you can draw from that is it wasn't just right
the way it is.
Mr. Fitzpatrick. So, 14 months later, we still--I mean,
defining an NRSRO is just the very beginning of the reform
process. And 14 months later, we haven't gotten to the
definition?
I think my view would underscore the need for legislation
proposing reform. So I won't ask you your specific position on
the legislation. But I would ask, as a general matter, do you
believe that by encouraging competition in the industry,
ratings quality will improve? Will costs come down?
And perhaps most importantly, will the anti-competitive
practices such as--which is rampant in the industry today
providing unsolicited ratings with a bill, sometimes in the
industry referred to as the ``shake-down,'' which I find very
offensive, would this kind of legislation improve the process?
Mr. Cox. Well, since you--if I understand your question
right--are not asking me to comment on the legislation, but on
the goals of the legislation, specifically competition,
transparency, and possibly greater Commission authority to
provide oversight in this area--those are our goals, as well.
I am not trying to be opaque in my answer, either to
Representative Kanjorski or to you. So let me be very clear
about what I mean to say there, when I say that I understand
and appreciate the role of the Congress here.
Many times, on many different subjects, I had the pedal to
the metal, my foot on the accelerator, trying to pass
legislation as urgently as it could possibly be enacted. And I
also was frustrated, because that didn't always happen.
So, if you ask me whether to go full speed ahead or not,
even if I said yes, I still don't know whether or not that's
going to result in legislation. And, if so, whether it would
result in legislation this year or next year, or when. And I
dare say that you might not know, either. That's the way the
legislative process works. And that's all I meant.
So, what the SEC is responsible for doing is what the SEC
has control over. And that is our own process. We are not
waiting for something to happen here legislatively. On the
other hand, we are not suggesting to you that, because we're
doing something, you shouldn't. But we strongly share your
goals.
And some of the things--I think I also alluded to this in
my answer to Representative Kanjorski--some of the things that
you could do legislatively, we can't do through rulemaking. So
the two are a little bit ``apples and oranges''.
Mr. Fitzpatrick. As a follow-up, your colleague,
Commissioner Campos, who helped spearhead the development of
the IOSCO voluntary code of conduct for rating agencies, has
stated that he believes rating agencies legislation is needed,
citing his unhappiness with voluntary agreement negotiations
between the Commission and the SEC, designated rating agencies.
Chairman, do you think that the Commission needs statutory
authority in this area to properly oversee the credit rating--
the industry?
Mr. Cox. The Commission has not taken a formal position on
this, but I have the same position as did my predecessor, and
that is that we would appreciate the provision by Congress of
enhanced authorities for the SEC in this area.
Mr. Fitzpatrick. Thank you.
Mr. Shays. I thank the gentleman. Mr. Chairman, we have two
remaining giants of the committee to ask questions, Mr. Gillmor
and Mr. Leach. Mr. Gillmor?
Mr. Gillmor. I don't feel like a giant, but thank you, Mr.
Chairman. Mr. Chairman, congratulations on your appointment. I
would like to welcome you back. You and I came in the freshman
class of 1988, and I am glad that between you at the SEC and
Porter Goss at the CIA, at least some did pretty well.
I want to bring up two areas. One, back in the 106th
Congress, at that time you and I were both serving on the
Energy and Commerce Committee, in the financial services area.
I had introduced a bill which you cosponsored, along with then-
subcommittee chairman Mike Oxley, which would have required
publicly-traded corporations to disclose to their shareholders
significant charitable contributions. The theory behind that
was that that's the shareholder's money, they ought to know
what's happening with it.
And, in fact, a lot of public companies voluntarily
disclose it, but some of them don't want the shareholders to
know what they're doing. And I have reintroduced that
legislation this year.
I guess my question is do you still have the same view you
did when you co-sponsored that bill, in terms of public
disclosure, and would the SEC consider, either with or without
that legislation, requiring public companies to disclose
significant charitable contributions and insider-affiliated
charitable contributions on an annual basis?
Mr. Cox. Well, first, let me acknowledge the very generous
compliments that you gave, and I want you to know how much I
appreciated sitting next to you on this, and the committee
across the hall. And I also recognize that you're being unduly
modest in comparing a couple of your classmates to yourself. I
think the country very much benefits from your being here, as
well. And I appreciate the opportunity to appear before you in
this capacity.
I didn't realize when I was a Member of Congress, and you
and I were working on this together, that in response to your
request, the SEC, before I was Chairman, conducted a
feasibility study on implementing your legislation on requiring
public companies and mutual funds to disclose information about
their contributions in their SEC filings. Obviously, you know
about that, and I have learned about it in my capacity as
Chairman.
The result, as you know, of that study was that the
Commission--at least at the time--believed that requiring this
disclosure would, in fact, be feasible. And public companies,
the Commission believed, are capable of tracking and disclosing
this information to investors.
So, from the standpoint of giving technical guidance on
your legislation, I think that is still operative, and that
should still help you as you deal with the legislative process
here.
Insofar as our ability to do this, or our interest in doing
this separate from legislation, the staff noted at the time--
again, before I was Chairman--that charitable contributions
make up a relatively small proportion of a corporation's
financial activities. And, particularly in the case of mutual
funds, the Commission staff found that the vast majority of
funds didn't contribute to charitable causes.
So, given that our disclosure regime operates fundamentally
on a materiality premise, the question arises whether, if
that's what is guiding us here, we would do that following our
own lights.
On the other hand, materiality is the floor. Everything
that is material must be disclosed. Some things that our
specific disclosure requirements mandate are not inherently,
per se, material, and we require them anyway. This is true, for
example, in the environmental area. So I think Congress would
be well within its rights, if it decided, as a matter of public
policy, that this kind of disclosure should be mandated,
notwithstanding that it might not in every case otherwise be
material under the Supreme Court standard.
Mr. Gillmor. The other area I want to ask you about is the
area of disclosure of taxes. One of the things that I am
concerned about is that, in many instances, shareholders
receive from companies information that is, in fact,
misleading, even though it's accurate.
And one of the areas is the reporting of income for SEC
purposes, which goes out on the Street, and that's what people
look at as corporate earnings, in terms of determining whether
to buy or sell shares.
On the other hand, there is another figure which is not
always disclosed, and that's the income for public companies
that is reported to the IRS.
So, the thrust of my question is, do you think it would be
possible to have a system where a corporation would have to
disclose SEC-reported income and IRS-reported income, similar
to what companies do with executive compensation?
It seems to me that it's a rather key fact in order that
investors can make a fair decision about whether they want to
buy or not.
Mr. Cox. Well, as you may know, the Commissioner of
Internal Revenue, Mark Everson, has publicly floated this idea,
and I have heard from him on it. We have discussed it. I
certainly share the goal of increasing transparency of
financial disclosure. I am not certain that publicizing tax
returns is the best way to that result.
Mr. Gillmor. I am not suggesting to go so far as to making
the tax returns public, which I think you brought up. It's
simply providing some comparable figures, so that--I may be
wrong, but if a shareholders knows that a company reported $1
billion to the IRS, but says to you they made $2 billion, and a
person makes an investment on the $2 billion--so I'm not
suggesting we make the whole return public.
Mr. Cox. Well, your question began by noting how much of
the information that's provided to investors right now might
not be useful. And indeed, it might be confusing, and so on. I
want to make sure, in all of the disclosure that the SEC
mandates, that we are illuminating, and not making it harder
for people to figure out what's going on.
Mr. Gillmor. Right.
Mr. Cox. A lot of the disclosure that the SEC requires is
necessary for them to understand, for example, a corporation's
tax deferral strategies. It might not be helpful to an
investor's understanding of the overall financial condition of
the company.
So, I am certainly going to pay close attention to this
discussion, work with my counterpart regulator at the IRS, and
work with the Secretary of the Treasury in my capacity as a
member of the President's working group, to talk about this. I
think it will get a good deal of attention.
But I want to be clear. This is an IRS idea that has been
floated. It is not an SEC initiative. We are going to look at
it, but I am certainly not pre-sold on it.
Mr. Shays. Thanks to the gentleman.
Mr. Gillmor. Thank you, Mr. Chairman. Good luck on the new
job.
Mr. Cox. Thank you.
Mr. Shays. The Chair at this time would recognize Mr. Leach
for whatever time you may consume.
Mr. Leach. Well, thank you, Mr. Chairman. And I certainly
share the earlier comments made about your service, Chris. We
welcome you in this job. And I think your presentation today
has been very impressive, particularly your emphasis on
transparency and more simplified, timely disclosures.
I want to raise an issue that is very difficult for you,
also for those of us in Congress. And that is the remuneration
issue. And you point out--and I think quite properly--that you
are reluctant to enter into this issue.
On the other hand, there are two perspectives that I think
have to be raised at this time. One relates to the market
itself. If the public loses confidence in public corporations
and their mission--that is, is their mission to serve the
shareholders or to serve insiders--you can have a real shake in
confidence in the market. If the public loses faith in the
market, that is not a trivial circumstance.
You point out--I think quite properly--that remuneration is
largely the province of the board. But what happens when a
board and a CEO are pretty much in tandem? I mean, we have this
example that the Wall Street Journal has laid forth of a public
corporation over the last decade that has given a couple of
billion dollars in stock options to a CEO, and at the same
time, a couple of hundred million dollar stock options to the
board. That is an extraordinary situation.
I don't know if it's an SEC issue or not. But if it is, has
the SEC examined this case?
Secondly, I have the good fortune to represent the
University of Iowa. A distinguished scholar at the university,
a professor named Eric Lee, has done a study of stock options,
and he has examined literally thousands of public corporations.
He has concluded that it is rather impressive how many
stock options were granted at low points, just before shares
had risen. And he has concluded that the odds of such a happy
coincidence for the recipients is so high that it is about
twice as high as winning a Powerball with a dollar ticket,
which implies that it is conceivable that some of these grants
of options were done retroactively, which implies, as I
understand it, a possible violation of law.
And so, my query: is the SEC looking at this particular
circumstance at this time, and is there a market confidence
type of dilemma that occurs with these remuneration issues?
Mr. Cox. Well, particularly with the pathology that you
just described, there is a market confidence issue, I mean,
because that either is or borders on fraud in its most extreme
forms.
When I said earlier that the SEC doesn't want to second
guess the board, make judgments in place of the board about the
methodology or the levels at which executives are compensated,
what I mean, of course, is that we don't want to substitute our
own judgment for the honest judgment, the business judgment, of
the board of directors.
Mr. Leach. Fair enough.
Mr. Cox. But if an individual executive or confederates on
the comp committee or on the board are in any way violating the
trust of the shareholders, that's an entirely different matter.
And our enforcement division is very interested in that.
Mr. Leach. Well, I appreciate that. And I just think we
would be shirking our duty if we didn't raise this kind of
issue. And your institution is the singular one in our society
that can look at these things. And so I appreciate your
attention. Thank you.
Mrs. Kelly. [presiding] Thank you. Mr. Sherman?
Mr. Sherman. Thank you, Madam Chairwoman. Chairman Cox,
it's good to see you again. I don't see you on the plane as
often; I guess your new job doesn't involve trips to Newport
Beach. Other than that, I hope you like it. I have quite a
number of questions that I will pose. Maybe you will have a
chance to respond, or maybe you can respond for the record.
The first is that the accounting statements that are
audited contain the same information that accountants have been
providing for about 100 years. A few decades ago we went beyond
the income statement, the balance sheet, to a funds flow
statement that is really the same information presented in a
different format.
Yet the markets are much more interested in other
information, and are willing to act on it, even though it comes
to them in unaudited form. For example, if you are dealing with
Boeing, you want to know what they have in the way of back
orders. If you're dealing with a retail store, what is its
revenue per square foot? All this information tends to get
reported. None of it is audited on a quarterly basis, or even
on an annual basis.
And so, I hope that the SEC would move beyond the 100-year-
old income statement and balance sheet to at least a system
where companies would be encouraged to provide information
relevant to their industry that is audited, so that it can be
relied upon, and so that even if you are producing weekly or
monthly reports that are unaudited, the management knows that,
by the end of the year, there is going to be an audit of what
they have been presenting, just as we get unaudited quarterly,
and sometimes even more frequent information about the income
statement, and eventually it is audited.
The second area I would like you to focus on is that of the
SEC as an enforcement agency. And here, my information may be a
little stale. But most of this hearing has focused on those
investors who are making investments in something that a
securities professional would say, ``Looks like a legitimate
investment.'' They are buying a publicly registered stock on a
stock exchange, comes with a prospectus. Even Enron came with a
prospectus.
But then there is a whole group of absolutely phony
investments that you or I would look at and say, ``My God, this
is a violation of every securities law,'' being hawked on the
Internet. And I am told that the SEC is prevented by law from
even having its people pose as potential buyers on the
Internet. You can't even have your people surf the Net to find
the apparently bogus investments.
And I hope that, in addition to protecting the reasonable
investor who is buying stocks in companies on stock exchanges,
etc., that the SEC would devote some resources and get whatever
legislative authority it needs to at least pose some risk to
these charlatans selling investments on the Internet and in
other ways.
The third issue I would like to bring up is the issue of
minority shareholder rights. One that we know you have talked
about, executive compensation. One way to deal with that is to
have a group of shareholders dispossess the current board and
install a board more responsive to shareholder interests.
And yet, we have a system in which companies go to the
State with the lowest possible minority shareholder rights
standards. And I hope that you would present this Congress with
some ideas of setting minimum rights for minority shareholders
of all publicly-traded corporations, rather than have Delaware
and Nevada and others fight to provide the most possible
protection for entrenched management. I would like you to
respond, time permitting.
Mr. Cox. Well, first, I want to thank you for your generous
comments, and let you know that while my current occupation
doesn't permit me to be on the plane with you as much, I
certainly intend, as a Californian Chairman of the SEC, to make
sure that the portion of America west of the Mississippi has
just as much representation in our regulatory system as does
the East Coast.
Mr. Sherman. Does that mean you're volunteering to speak in
the San Fernando Valley?
Mr. Cox. Well, we can talk about that.
Mr. Sherman. Okay.
Mr. Cox. It's--you know, particularly we should talk about
that for around January or February I think.
Moving directly to your questions. First, you're certainly
one of the few CPA's I know in the Congress, if not the only
one. And I think, having looked at these issues from the
vantage point of a Member of Congress with that background for
such a long time, you're more keenly aware than most of the
anachronism that you pointed out in your question, the mismatch
between a system that relies on snapshots taken at year-end, on
the one hand, and the fast moving economy that we live in
today, where information moves 24/7--
Mr. Sherman. And if I can interject, it's also just a
snapshot of the things that accountants decided over 100 years
ago should be photographed, and does not include such things as
employee turnover rates, which, to me as an investor, might be
more important than just quarterly sales.
Mr. Cox. And I think you're absolutely right, first of all.
I agree with the entire premise of your question. And second,
you're absolutely right that the kinds of other things that
investors are interested in and could benefit from, were they
available, are not only are things that are off balance sheet,
off income statement, or off funds flow statement, but they may
be only quasi-quantitative. They may be qualitative. In the
information economy, with services being such an important part
these days, the manufacturing model may not always fit.
And so, as we take a look at the overhaul of accounting and
all of its complexity, one of the things that we have to keep
uppermost in mind is that, to serve investors, we need to give
them real information that they can use. That means, as I
pointed out earlier also, that it should not be confusing; it
should be in plain English.
Interactive data, which is one of the big initiatives of
the SEC, as you know, is very well suited to helping us move in
this direction, because it's real time, because it applies to
all data, potentially. It doesn't even need to be a number; it
can be text. Being able to move this information around
immediately in real time is going to help the preparers. It's
going to help management from an internal control standpoint,
from a management control standpoint. And ultimately, I hope,
therefore, it helps us to come up with better numbers, and in
some cases, audited numbers that today we just can't have
access to.
With respect to the SEC posing as potential buyers, the
SEC--I have just consulted with general counsel--I don't
believe is legally inhibited, but we can check on this. But
rather, it is by long standing practice that the Commission, in
our enforcement activities and in our inspection activities,
foreswears any deceptive conduct.
Mr. Sherman. Mr. Chairman, if that's the case, I would urge
that your employees get practice in using the Internet, and
seeing the investments that are being put forward there, and
that the tradition of ``not being deceptive'' should not
override an efficient effort to protect Americans from the
investments that you and I would laugh at, but that others are
putting their money into.
Mr. Cox. Yes, I assure you that--because that's where I was
headed next--that we are doing so. And you would expect from an
agency that is focused on interactive data, that we are very
keen on exploring investor protection for those investors that
are already on the Web. The SEC has very recently set up scam
Web sites so that investors that think that something looks too
good to be true, and are about to buy it on the Internet, can
click all the way through and then find out at the end that
it's really the SEC.
So, we have sort of threaded that needle. We have been able
to do what you're describing. But then in the end, you know, we
tell them, ``This could have been real. And if it had''--and it
serves as investor education.
We also have a portion of our enforcement that is focused
on Internet enforcement, as you would expect. So we are very
much working this area.
Mrs. Kelly. Thank you very much, Mr. Sherman. Mr. Scott, I
am going to ask if you are prepared to go now. I have not yet
asked my own questions, but since you--barring the advent of
another one of our colleagues, since you are the last man
standing on this committee at this point, I will do the mop up,
and you go ahead, if you're ready to--are you ready for your
questions?
Mr. Scott. I certainly am, and thank you for referencing
Bruce Willis's great movie, ``Last Man Standing.'' Those of you
who haven't seen that, I am sure you will enjoy that amazing
shoot-out.
Let me just commend you, Chairman Cox, on the excellent job
you are doing. You certainly distinguished yourself in a very
short period of time, bringing tremendous leadership and some
very good, positive changes to the Securities and Exchange
Commission, and I want to commend you for your leadership and
the work you are doing there.
Let me ask you about regulation B in my first question. Can
you provide us with some sort of report on the status of the
proposed regulation B, and any efforts that the Commission has
made to work with banking regulators to propose a regulation
that merits the legislative intent of Gramm-Leach-Bliley?
Mr. Cox. Well, in fairness, since I was asked earlier about
the definition of investment advisor and broker, and I answered
by giving the status of Regulation B, I should answer your
question now by describing where we are in--
[Laughter]
Mr. Cox. But I won't. I will tell you that because Gramm-
Leach-Bliley is, at this point, not a new law, it was passed in
1999, I think it's high time that we have rules implementing
the statute. And so, I am committed to promulgating Regulation
B as early as is humanly possible. I have convened meetings of
the banking regulators and the SEC to go over this
collaboratively to come up with a solution that makes sense for
all of the regulated community, and I think we can do it. I
would hope that we have a result, even this year.
Mr. Scott. Good. All right. Thank you very much. Let's go
very quickly to Sarbanes-Oxley. I don't know if this question
may have been asked prior to me, but I would be very interested
in getting your take on the application of section 404, and
where you stand on the recommendations vis a vis the smaller
cap companies and the exemptions applicable to those.
Mr. Cox. First, I am very appreciative of the work that our
smaller public company advisory committee did for the
Securities and Exchange Commission, and for the benefit of
America's investors. They worked for 13 months and produced a
report very recently. As you know, I think it well reflects the
concerns from smaller companies, including smaller public
companies.
Their recommendations are going to be taken to heart at the
SEC. They are one of several sources of information and input.
With respect specifically to that portion of their report,
the 1 of their 32 recommendations that suggested that we exempt
certain smaller public companies, I will say as 1 of 5
commissioners in this capacity--because this is going to be a
Commission decision, and so I'm speaking now for myself--that I
am hopeful that we could achieve the objective that they
sought, not by the blunt instrument of an exemption, but rather
by the tailored application of the statute with full mind of
the Congressional intent to smaller public companies in their
different circumstances.
I think that should be possible, and I think that, even in
their recommendations, the advisory committee contemplated
that, if there was a suitable framework for management of
smaller public companies, that they wouldn't need an exemption.
Mr. Scott. Okay. My other question I would like to ask is
your take on another very topical issue, the committee on
investments by foreign countries directly in the United States.
We have had some very serious hearings on that issue, as a
result of the Dubai Ports deal. And we're looking at how we can
certainly protect our security, and make sure we are secure
there. Do you have any words of concern, in terms of the level
of overreach that we might do that could perhaps put a damper
on our ability to attract much desired foreign investment in
this country? And what advice would you give our committee and
the Congress, as we look at reform of CFIUS?
Mr. Cox. Well, I am going to constrain myself to answer the
portion of your question that I am qualified to answer as
Chairman of the SEC, and not stray off into the more general of
national security and public policy questions that you
necessarily have to take into account, and any restructure of
CFIUS.
From the SEC's standpoint, obviously, we are concerned
about investor protection and about maintaining the United
States capital markets as the largest, deepest, and most liquid
markets in the world, and we want to continue, as I think you
do--I infer that from your question--the attractiveness of the
United States market for foreign investors. We want to make it
clear to everyone that we welcome foreign investment in this
country.
At the same time, I think we want to distinguish, at least
for disclosure purposes, between state actors, sovereigns, who,
as one might imagine, the SEC would have a great deal of
difficulty exercising its enforcement regime against, on the
one hand, and market actors on the other hand. And that's a
distinction that I think Congress and policy makers need to
keep in mind, as well.
Mr. Scott. Thank you very much, Chairman.
Mrs. Kelly. Thank you, Mr. Scott. Chairman Cox, it's really
a pleasure to have you here in this capacity. Having been one
of our colleagues, and having served with you, I have to say I
am very interested and appreciative of the effort that you have
put in to make the SEC look and be responsive to some of the
issues that have been troubling for me personally, and others
who have been involved with the market.
Perhaps these questions that you have been asked indicate
that--I don't want you to feel that this means that people, all
of us sitting here, are not appreciative of the efforts that
you have made.
That being said, I understand that your testimony doesn't
explicitly refer to the needs of smaller public companies. They
are disproportionately affected by over-regulation. The
accounting industry has been working hard to try to lower the
costs of audits for smaller companies, and according to the CRA
report on the 404 costs, smaller public companies' costs for
404 audits and compliance have declined by approximately 30
percent from the first year of the 404 review to the second, as
companies begin to learn to work within the system.
But the industry doesn't have the authority to change the
law. And it seems clear that the law really needs to be
changed, especially for smaller companies. Recently, the
advisory committee of the SEC, on this issue, suggested that
smaller public companies needed to be excluded from portions of
section 404.
You said that--in your Senate testimony--that the question
is not whether to apply 404 to all companies, but how. I am
concerned that this answer to the other House conflicts with
your advisory committee, and also sends the message that any
company unwilling to pay a tax of $1 million a year in
compliance costs should not look to sell shares to the public.
The advisory committee recommended that companies with less
than $10 million in revenue be excluded from section 404 below
a market cap of $750 million, because the costs of compliance
were disproportionate to their revenues. I am afraid that this
benefits biotech companies, but it doesn't benefit the small
manufacturing companies.
For instance, a firm could have higher revenues, but
require the devotion of scarce personnel resources for their
compliance.
I would be interested in your thoughts on exempting from
404 review companies with less than $1 million in revenue per
employee, or a similar number.
Mr. Cox. First of all, thank you very much for your
compliments, and I want you to know how much I appreciate
seeing you in the chair.
Section 404, and more generally, the regulatory burdens
placed on smaller companies, are a very, very important focus
for the SEC necessarily, because one of our missions is
facilitating capital formation.
We are well known as the investor's advocate, but our
tripartite mission includes maintaining orderly markets and
facilitating capital formation, as well. And all of these
things, properly viewed, are complementary. We can't say that
we are doing our job of protecting investors if, in fact,
companies that are offering their securities are effectively
prevented from doing so by our regulation, and the products and
the investments are, therefore, unavailable to the investing
public.
The advisory committee's recommendation, which I have now
had the opportunity to read very carefully, premises its
recommendation on exemption of some smaller public companies on
the lack of an available framework that is tailored to smaller
public companies. I think that that is the essence of their
recommendation, that if you're going to have a 404, you've got
to make sure that it applies in a tailored way across the
board, and that you don't take the standard that works for
Exxon and apply it to a small business.
The same applies, it strikes me, when it comes to the
disporportionality of audit fees. Necessarily, the same level
of expenditure is going to much more dramatically impact a
company with smaller revenues and smaller earnings than it will
a large company. And so, to the extent that the audit of
internal controls necessitates a certain base level of
activity, there is no escaping the fact that it's going to be
more significant for smaller companies. The SEC needs to take
all of this into account.
My hope is that we can implement 404 in a way that you all
intended--and that I intended, because I was here and worked on
the development of that legislation as well. I don't think any
of us had in mind, when we voted for Sarbanes-Oxley and its
included section 404, that this provision would produce
anomalous results, or outlandish costs, or inhibit risk-taking
by companies, or keep products off the market, or in any other
way distort our investor protection regime.
And so, I am taking it as my charge to make sure that we
can make 404 effective, and see to it that it achieves
Congress's objectives at the same time that we lower the cost
and make sure that there is a regime that specifically fits
smaller companies.
Mrs. Kelly. I am glad to hear you say that. When you talk
about facilitating capital formation, there is a small-cap,
mid-cap people, these people that have revenue of less than $1
million per employee sometimes, and people who do generate this
economy capital--do increase with capital formation. So that is
a good stance.
We have been joined by Mr. Fossella, my colleague, and I
would like to come back to pursue that line of questioning a
little bit further, but let me turn to Mr. Fossella.
Mr. Fossella. Thank you, Madam Chairwoman. Mr. Chairman,
thank you. Thank you for your patience. And more importantly,
thank you for the strong leadership you have brought to the
Commission. Your consensus-building approach I think is
admirable, and I can't tell you enough how I appreciate the
fact that the President made the right choice in selecting you.
Having said that, I know you have answered a wide array,
and you have been very patient. Let me just jump into one
specific issue regarding legislation that I introduced
regarding procedural reforms, and looking at ways to
restructure the Commission.
In regards to procedural reforms, it included provisions
aimed at increasing communication between registrants and the
Commission in regards to the status and/or closure of
inspections and investigations, and requiring Commission
approval prior to the initiation of sweep examinations.
Structurally, the legislation would restore the Commission's
inspections and examinations authority to the divisions of
market regulation and investment management, to insure
examination staff are working alongside the division staff
responsible for creating and interpreting the rules.
I think you have tried to establish and strike the right
balance of protecting investors, facilitating capital
formation, but also recognize that the most effective tool we
have in ensuring the integrity of these markets, is to have an
effective and strong and vibrant SEC, especially in the
inspections and examinations.
So, I know--or so I have been told--that the Commission has
begun to implement aspects, or at least evaluate some of the
aspects of some of the reforms that are included in the
legislation. Can you please tell us what, if any, have been
made, or are in the process of being made? And prospectively,
what, if anything, we can anticipate?
Mr. Cox. I would be pleased to do so, and I want to thank
you for your interest in this area, and your active
involvement, because it is in response to comments and
feedback, including those that you provided to the Commission,
that the Commission has recently changed in several respects
the way the Commission itself oversees these SEC examinations.
And let me just go through some of these changes for you.
First, it is now the policy of the Office of Compliance
Inspections and Examinations, OCIE by acronym, to provide
advance notice to the Chairman and to the Commission of any
proposed sweep examination. That didn't use to occur. In
addition, the Office has beefed up the pre-exam process, to
ensure that exams aren't duplicative, and that they are as
minimally disruptive as necessary to accomplish the objective.
Second, OCIE is promulgating a new policy that, if an
examination hasn't been closed within 120 days after the
completion of the fieldwork portion of the review, the
registrant then is provided with notice that the examination is
still in progress. So it is no longer the case that the subject
of the examination is in the dark.
Third, at the conclusion of an examination, the registrant
is provided with a letter, either setting forth the
deficiencies identified by the staff, or informing the
registrant that the examination is being closed without
findings. We have also been working to provide greater
transparency to the firms under examination in other ways.
For example, OCIE is amending the informational brochure
that it provides to firms at the outset of every examination,
so that they understand clearly, up front: first, that most
examinations are going to be over within 120 days, after the
end of the field work; second, that they are invited, as
registrants under examination, to communicate with the exam
staff about any questions that they might have regarding the
structure of the examination; and third, they are given a phone
number to call if any issues arise they feel more comfortable
discussing through the SEC's examination hotline.
Staff at the SEC are also updating our public Web site so
that, if you are a registrant being examined, you have
immediate access to the names and phone numbers of the
supervisory staff in each SEC field office.
Mr. Fossella. Thank you for those initiatives and changes.
I'm just curious, is there any--do you see any more changes
coming down the pike, or any more formal--a ratification of
some of the other questions that have been raised in the
underlying legislation, or is the system a more fluid dynamic
process that we can anticipate?
Mr. Cox. Well, what has been accomplished has been
accomplished in a relatively short period of time, as you are
aware.
Mr. Fossella. Yes.
Mr. Cox. I am comfortable, as Chairman, that I have a good
deal of organizational authority at the Commission. I am also
absolutely convinced that the leadership of that office wants
this process to work with as much transparency as possible, and
wants to be sure that while, as you would imagine, these
examiners aren't always going to be the most popular people in
the world, that the function that we are performing is fully
understood, and that, in a larger sense, it is appreciated, if
not by the subject of the examination at the moment, then by
the investing public.
And so, I think all of the Commissioners, who share this
objective, and I, and the leadership of the office are going to
be in a position to continually improve this process. The
Office itself, as you know, is not the oldest part of the 72-
year-old SEC. It's a relatively recent addition.
And I think that the additional resources that we have been
able to deploy in the post-Enron world, with the additional
funding that's been provided by the Congress, mean that the way
we do our work in this area is becoming more salient. It will
give us more feedback and an opportunity to be more responsive
to the market.
Mr. Fossella. Thank you very much, Mr. Chairman. Thank you.
Mrs. Kelly. Thank you, Mr. Fossella. Chairman Cox, I have
two questions left. One is not mine, one is a follow-up that I
have been asked by my colleague, Chris Shays, to ask. This is
the question he asked me about.
He says that the Commission currently is exempting broker-
dealers from the Investment Advisors Act if they give financial
planning only incidental to their activities. And he is
concerned about that, and wondered if you could speak about
that.
Mr. Cox. I am happy to speak about that, and I am very
sorry that I gave him an excellent answer to the wrong
question. And I am sorry he is not here to hear it, but thank
you for asking it, and letting me respond to it on the record.
As you know, our broker-dealer investment adviser rule is
currently the subject of litigation. There is a lawsuit
challenging the rule by the Financial Planning Association. The
SEC is going to be filing a brief in the next few weeks. The
staff have provided some interpretive guidance that's of a few-
months-old vintage, and we are going to continue to consider
additional guidance on this subject in the meanwhile.
We are in the cauldron of this lawsuit right now, and I
think that things rather rapidly should become clear on that
front.
Mrs. Kelly. Thank you. I am sure Chris will get that
answer. So thank you very much.
The final question I have is that companies in my district
are increasingly coming to me with a concern about naked short-
selling in their stocks. This is a practice that is sometimes
used to hold down the valuations of companies, particularly
manufacturers, retailers, and it leaves them vulnerable. While
we know it's technically illegal, it seems that the practice is
common. And not only that, there seems to be growing evidence
that it may be deliberately taking place.
I understand that reg SHO has shown the need for more
information from the markets about shorting and failed trade,
and I wonder if you are willing today to speak about this,
what's being done. I think the SEC has--with the--I think that
reg SHO has shown this need, and I think perhaps you might have
something that you would be willing to share with the committee
on it.
Mr. Cox. Well, first of all, I think you are absolutely
right, that this is an important issue, and reg SHO, as
written, may not be the final answer. The Commission adopted
this regulation in 2004, in June. It didn't become effective
until last year. And so, we are just now in a position to begin
to assess whether or not the rule is working as it was
intended.
Since the adoption of the rule, the data that we have
assimilated thus far has told us that about 99 percent of all
trades, by dollar value, settle on time without incident. So
that's certainly part of the good news. And the overwhelming
majority of these fails are closed in less than 5 days, even
within the 1 percent.
So, on an average day, approximately 1 percent, by dollar
value, of all trades including equity, debt, and municipal
securities, fail to settle. And that's where we're focused
here. Those failed positions, we are learning, are, in the
main, getting closed out more quickly, now that the rule is in
effect.
But, like you, I am very concerned about what's in the 1
percent, because it's 1 percent of a very big number. The staff
are developing rule amendments to further reduce the
continuation of large fails to deliver position. In the
meantime, the Commission has extended our existing pilot
program through August of 2007, so that we can ensure that the
progress that we have already made isn't lost.
Mrs. Kelly. Are you aware that publicly-traded companies
and State regulators aren't allowed to see the records of the
failed trades from the Depository Trust and Clearing
Corporation? Don't you think that maybe State regulators should
know if the amount of shares trading in a state-chartered
corporation exceeds what is allowed under the State rules?
Mr. Cox. We are certainly interested in working very
closely with our counterpart State regulators for a number of
reasons, including the preponderance of the most egregious
problems in this area, with thinly traded, smaller companies
that are the normal domain of the blue sky regulators. And so
there is ample opportunity to do better in this area.
Mrs. Kelly. Thank you very much.
Mr. Cox. May I say also for Congressman Shays, who isn't
here--because I neglected to do so--that when the Commission,
before I was Chairman, last looked at the issue of investment
advisers and broker-dealers, they charged the staff with
proposing a study of this issue. The staff have now given me
enough information so that I can make a decision whether to go
forward with that study, and how, and I very recently did so.
So, among the other bits of news on that topic is that
there will be an effort, in a very serious way, to infer from
marketplace data what we should do by way of distinguishing
between the roles of investment advisers, on the one hand, and
broker-dealers, on the other hand.
Mrs. Kelly. Thank you. You have been very patient with us
on a very busy day, which is why so many people have come in
and out of the committee. We are very grateful for the time
that you have spent here, Mr. Chairman.
The Chair notes that some members may have additional
questions for this panel, so without objection, the hearing
record will remain open for 30 days for Members to submit
written questions to these witnesses, and to place their
responses in the record. This hearing is adjourned.
[Whereupon, at 12:58 p.m., the committee was adjourned.]
A P P E N D I X
May 3, 2006
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