[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE U.S. SECURITIES AND
EXCHANGE COMMISSION'S OPERATIONS,
ACTIVITIES, CHALLENGES, AND
FY 2012 BUDGET REQUEST
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MARCH 10, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-14
U.S. GOVERNMENT PRINTING OFFICE
65-674 WASHINGTON : 2011
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HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
KENNY MARCHANT, Texas BRAD MILLER, North Carolina
THADDEUS G. McCOTTER, Michigan DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JOE DONNELLY, Indiana
BLAINE LUETKEMEYER, Missouri ANDRE CARSON, Indiana
BILL HUIZENGA, Michigan JAMES A. HIMES, Connecticut
SEAN P. DUFFY, Wisconsin GARY C. PETERS, Michigan
NAN A. S. HAYWORTH, New York JOHN C. CARNEY, Jr., Delaware
JAMES B. RENACCI, Ohio
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
Larry C. Lavender, Chief of Staff
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
C O N T E N T S
----------
Page
Hearing held on:
March 10, 2011............................................... 1
Appendix:
March 10, 2011............................................... 47
WITNESSES
Thursday, March 10, 2011
Cook, Robert, Director, Division of Trading and Markets, U.S.
Securities and Exchange Commission............................. 11
Cross, Meredith, Director, Division of Corporation Finance, U.S.
Securities and Exchange Commission............................. 9
di Florio, Carlo, Director, Office of Compliance Inspections and
Examinations, U.S. Securities and Exchange Commission.......... 13
Khuzami, Robert, Director, Division of Enforcement, U.S.
Securities and Exchange Commission............................. 7
Rominger, Eileen, Director, Division of Investment Management,
U.S. Securities and Exchange Commission........................ 14
APPENDIX
Prepared statements:
Hinojosa, Hon. Ruben......................................... 48
U.S. Securities and Exchange Commission...................... 49
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Written responses to questions submitted to the SEC.......... 78
Hinojosa, Hon. Ruben:
Written statement of the U.S. Chamber of Commerce............ 86
Written statement of the Financial Planning Coalition........ 88
Written statement of the North American Securities
Administrators Association, Inc. (NASAA)................... 90
OVERSIGHT OF THE U.S. SECURITIES AND
EXCHANGE COMMISSION'S OPERATIONS,
ACTIVITIES, CHALLENGES, AND
FY 2012 BUDGET REQUEST
----------
Thursday, March 10, 2011
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Royce, Biggert, Neugebauer, Marchant, McCotter, Pearce, Posey,
Hayworth, Hurt, Grimm, Stivers; Waters, Sherman, Hinojosa,
Miller of North Carolina, Maloney, Perlmutter, Himes, and
Peters.
Ex officio present: Representative Frank.
Chairman Garrett. Good morning. This hearing of the
Subcommittee on Capital Markets and Government Sponsored
Enterprises entitled, ``Oversight of the U.S. Securities and
Exchange Commission's Operations, Activities, Challenges, and
FY 2012 Budget Request,'' is hereby called to order.
As we are joined now by some of our colleagues, we will
begin with opening statements and then turn to our panel for
your statements, followed by questions. Breakfast has just been
served. I will yield myself 2 minutes for an opening statement.
I welcome our witnesses to the committee today. I look
forward to what I hope will be an educational hearing where
members, especially some of our freshmen, have a good
opportunity to hear what the different Divisions of the SEC are
working on. At least some of the focus, I believe, will be
focused, of course, on the SEC's budget. And, of course, when
you get into that, there have been press reports about how
Republicans are trying to starve the SEC, so on that point, let
me just examine the facts for a moment.
Back in 2000, under the last year of the Clinton
presidency, the SEC was allocated about $369 million. In Fiscal
Year 2011, the SEC has a budget of about $1.14 billion. So in
just over a decade, the SEC budget has, in fact, tripled.
Especially in this day and age, when we are running
deficits of over about $1.6 trillion, I do not think it is fair
to say that the SEC is being starved. In fact, it is just that
sort of rhetoric that you hear, that only comes out of
Washington, D.C., that language, which basically gets unleashed
in Washington every time someone around here tries to do the
fiscally responsible thing. So we want to get into that a
little bit.
I am also interested to hear from each of the witnesses
about spending priorities that they have for each of their
Divisions and offices. I am less interested in this area of
hearing about how underfunded the agency is, especially as we
wait for the study that is about to come out that will
hopefully provide us with some thoughtful recommendations on
how the Commission can and must become more efficient, reduce
management overhead, and enact other internal reforms.
Before we even think about giving the agency yet another
funding increase, at a minimum, the agency will need to show
some major progress in implementing some of those recommended
reforms.
So at today's hearing, I also hope to explore the lack of
economic analysis being done on the SEC's proposed rules, which
has led to some D.C. court appeals to basically rebuff
Commission rules on a number of occasions in the last several
years.
Finally, the SEC's union activities also need to be looked
into. Several fundamental questions need to be asked in this
area. For instance, is the union hampering reform efforts
within the institution? Is it even appropriate for a bunch of
basically highly paid government attorneys to be organized into
a union, and if so, why?
There is plenty to be discuss today, so I look forward to
our witnesses' testimony and a robust question-and-answer
session. And with that, I will yield back my time, and yield 5
minutes to the ranking member.
Ms. Waters. Thank you very much, Mr. Chairman.
Last month, House Republicans passed H.R. 1, a continuing
resolution that would slash funding for the SEC. We know that
H.R. 1 would have serious consequences for the SEC's ability to
police our capital markets, so I am pleased to have a
representative from each of the SEC's Divisions to tell us
directly about SEC's funding needs and how a lack of funding
will impact their respective Divisions.
I have long maintained that cutting funding to the SEC
would take Wall Street's cop, its only cop, off the beat. Since
H.R. 1 passed the House, we have learned of several enforcement
actions the SEC has taken against fraudulent actors.
On February 28th, the SEC charged a major supplier of body
armor to the U.S. military and law enforcement agencies for
engaging in a massive accounting fraud. On March 1st, the SEC
announced insider-trading charges against a Westport,
Connecticut-based business consultant who has served on the
boards of directors at Goldman Sachs and Proctor & Gamble.
Also on March 1st, the SEC charged a Bay Area hedge fund
manager with concealing more than $12 million in investments
proceeds that he owed to investors in his fund. On March 3rd,
the SEC charged a former financial adviser at UBS Financial
Services, LLC, with misappropriating $3.3 million in a scheme
that included bilking investors in a private investment fund he
established.
So you see, Mr. Chairman, in 4 days, the SEC brought
charges against 4 different actors for accounting fraud,
insider trading, and misappropriation of funds. These high-
profile cases aside, we know the SEC also does other low-
profile work that is just as critical to the functioning of our
markets. I am very concerned about the SEC's ability to be our
cop on the beat, if it doesn't receive the funding it needs.
In 2008, we saw the consequences of an underfunded and
understaffed SEC when our financial markets collapsed. To
prevent another crisis, we passed the Dodd-Frank Wall Street
Reform and Consumer Protection Act. The law authorizes the SEC
to regulate derivatives, provide oversight of investment
advisers and broker-dealers, and rein in credit rating
agencies.
Dodd-Frank gives the SEC the tools it needs to protect our
financial markets. However, in order to fully implement Dodd-
Frank, the SEC needs additional funding. If the SEC is funded
at the levels in the CR, it would have to lay off hundreds of
staff and cut its information technology budget down to 2003
levels. The result would be the inability of the SEC to
implement the new systems they need to protect the Nation's
securities market.
What does this mean for the average investor? Without
adequate funding, the SEC won't be able to do its job of
protecting them. As financial markets and investments become
more and more complex, the average inventor has confidence in
making an investment because he or she knows there is a system
in place to protect them. H.R. 1 and other attempts to reduce
funding for the SEC will undermine that system.
Thank you, Mr. Chairman, and I yield back the balance of my
time.
Chairman Garrett. I thank the gentlelady.
I yield now to the gentleman from California for 1\1/2\
minutes.
Mr. Royce. Thank you. A couple of quick observations, Mr.
Chairman. First, the Democrats had the House and the Senate for
4 years. Whatever amount of funding they wanted to give the
SEC, they could have given them.
But the point is that if more money necessarily meant a
more effective SEC, then I would understand the concerns being
raised here. But unfortunately, over the last decade, the
opposite has been the case, because we have seen the SEC's
budget more than triple, and it has repeatedly failed to stop
the most egregious cases of fraud.
The agency was largely absent during the financial crisis.
Records show that they knew about the Stanford Ponzi scheme
since 1997 and it did nothing to stop it. Over a 16-year
period, the SEC and other regulator bodies examined Bernie
Madoff's firm 8 times, 3 Administrations over that period of
time. Neither the examination nor the repeated attempts from
industry to alert the SEC were enough.
And as Mr. Markopolos told this committee, this episode was
directly attributable to a lack of market experience combined
with an investigative ineptitude within the SEC. As he has
said, it is not monetary, it is cultural.
The SEC is an overlawyered, overly bureaucratic agency that
needs fundamental reform, and simply throwing money at the
problem is not the solution, especially given our budgetary
crisis.
I yield back.
Chairman Garrett. I thank the gentleman from California.
I now yield to the other gentleman from California for 3
minutes.
Oh, sure.
The gentleman from Massachusetts, the ranking member of the
full committee.
Mr. Frank. How much time?
Chairman Garrett. Three minutes, if that is--
Mr. Frank. I believe we are confronting a great piece of
illogic--namely, that because the SEC has not performed well in
the past for a variety of reasons, we should punish the
American people by depriving it of the resources to do its job
in the future.
Some of those reasons were ideological, some may have been
incompetence, but the notion that the SEC, which was given new
duties to protect investors, to register hedge funds, to deal
with unregulated derivatives, should get less money in the
current year than it had the year before makes no sense, except
if you do not believe in regulation, if you continue to
believe, despite all the facts of the past few years, that the
market is best left to itself.
By the way, there is an interesting comparison here. A
majority of this House voted during the continuing resolution.
We were told we have to save money. We voted in this House,
over my objection--I lost; a number of others voted with me--to
send $1.2 billion to build up Iraqi security forces.
If you were going to look at how money is spent
efficiently, the SEC on its worst day will look a great deal
better than the Iraqi security forces. And the question is,
from what are Americans in greater danger? From problems in
Iraq, that the Iraqi security forces very ineffectively, it
seems to me, deal with, or from abuses of investors here, of
financial crises here? That is the issue.
Yes, the SEC needs expertise. They are not going to get it
with a budget that is smaller than before. And the numbers make
it very clear.
By the way, the amount that we need for the SEC barely--it
is just about equaled for it to be able to do its job a little
bit less than the amount the majority has voted to send to
Brazilian cotton farmers.
Brazilian cotton farmers are going to get $150 million a
year, last year, this year, the next couple of years, in
American tax dollars so that we can continue, according to my
Republican colleague, to subsidize American cotton farmers.
So much for free enterprise. Probably if you have read--
none of that applies to agriculture.
So, it is hardly money. When we can send more than that to
Iraqi security forces, when we can send that amount to
Brazilian cotton farmers, you are in ideological opposition to
the SEC taking on new regulatory powers. And the notion that
they can do these new powers better than they have done in the
past, with less money that they had in the last year, is not a
serious argument.
It is simply an effort to hide behind budgetary
considerations, when this comes from people who are prepared to
waste far more money in other ways to hide in ideological
opposition.
And by the way, we ought to be clear. What the Republicans
want is for the SEC to become even more of a profit center,
because at the budget level they are talking about, it brings
in about probably a little bit more than would be spent. And
the notion that we would not allow the SEC to carry out the
responsibilities this Congress gave it, over the objections of
my Republican colleagues, but which we gave it, is a great
mistake.
Chairman Garrett. I thank the gentleman.
Moving off of international policy and agricultural policy,
to the gentleman from Texas for 1\1/2\ minutes.
Mr. Neugebauer. Thank you, Mr. Chairman.
I want to read a couple of things here. One is, according
to the SEC's conduct regulation, ``The Securities and Exchange
Commission has been entrusted by Congress with protection of
the public interest in a highly significant area of our
national economy. In view of the effect which the Commission
action frequently has on the general public, it is important
that the employees maintain unusually high standards of
honesty, integrity, impartiality, and conduct.''
According to the standards of ethical conduct for employees
of the Executive Branch: ``Employees shall endeavor to avoid
any action creating the appearance that they are violating the
law or ethical standards set forth in this part. Where the
particular circumstances create an appearance that the law or
these standards have been violated should be determined from
the perspective of a reasonable person with knowledge of
relevant facts.''
One of the concerns I have is a recent investigation by
Chairman Baucus, Mr. Garrett, Mr. Hensarling and me into Mr.
Becker's positions at the SEC. I have called into question
where an employee has actually admitted that they may have a
potential conflict, and yet that was addressed very lightly.
And when I look at the appearance standard in the reasonable
person standard, it appears that possibly that was not followed
in this issue.
As an agency that is called to call others to very high
standards of ethics and transparency, I am very concerned about
the standards inside the agency and how those are being
enforced. And so, I hope that we will have more time to discuss
that today.
I yield back.
Chairman Garrett. The gentleman yields back.
The gentleman from California, for the remaining 2 minutes.
Mr. Sherman. Thank you.
Back in 1996 when I got here, and for many years, experts
came and sat where you are sitting now and told me that we were
the most prosperous country in the world because we had the
best capital markets in the world, because we had the best
securities regulators in the world.
Now that we live with this economic catastrophe, we don't
hear from them. But the fact is that it is a direct result of
the failures of the SEC, that the SEC has not failed to carry
out its primary mission, which is to protect the titans of Wall
Street, to make sure they are still getting our 401K money
directly, but that that our raft is diverted.
So we have our budget hearings. We can have a lap dog, or
we can have an emaciated lap dog. This isn't much of a choice
for the American people. When you see how the Madoff situation
was handled, because it is much simpler than the much more
important handling of mortgage-backed securities, you have a
hear no evil, see no evil, protect all the folks on Wall Street
who go to the right clubs approach.
And then, you see no one get fired. Yes, if you watch porn,
you will be fired, but no one gets fired for intentionally
closing their eyes to obvious information, whether it is AAA
for Alt-A, or whether it is Madoff, or whether it is Stanford.
And so I hope that we will have hearings not just on their
budget, but on the culture of the SEC and what we can do to
turn them into the watchdogs they ought to be.
I yield back.
Chairman Garrett. I thank the gentleman for yielding back.
And, of course, the gentleman is free to explore those other
issues today during your questioning period.
Mr. Sherman. I thank the Chair for his decision to give me
20 or 30 minutes to question the witnesses.
Chairman Garrett. There you go. And if we want to go around
for a second time, maybe the panel is going to be here.
But at this point, I yield 1\1/2\ minutes to the gentleman
from New Mexico.
Mr. Pearce. Thank you, Mr. Chairman. I appreciate the
opportunity to have this hearing. I am glad at the end of the
long title that you put that we are discussing the 2012 budget
request, because I am not sure how we could ever get all of the
things in.
I, like many other members, have looked with dismay at the
Madoff situation, but beyond that, I look at the decision
models going down the stretch of 2008, and I remember us
sitting down here on a Sunday night, discussing whether or not
mark-to-market should be suspended. It was pulling capital
basically off the ability to loan at a very desperate time when
we needed to be lending money.
The decision to stop short sales at the particular point
that decision was made was another incongruity that made it
look like you all work in procyclical rather than
countercyclical--that is, that if it is going good, you try to
make it go better; if it is going bad, you try to make it go
worse. Your decision models really, I think, bear scrutiny, and
I would love to participate in that today.
But the final piece that I wonder about is the leveraging,
why no one felt that the holding companies should not be
leveraged 40-to-1. I wonder why no one raised a question about
that.
So I will be interesting to hear answers on these before we
discuss the budgets because if you are going to work
procyclical, I do see a reason of depriving you of the
resources that you need to drive us deeper into a recession
with your decisions.
Thank you.
Chairman Garrett. And the gentleman yields back.
The gentlelady from New York for a minute-and-a-half.
Dr. Hayworth. Thank you, Mr. Chairman.
And thank you, all of our witnesses, for appearing before
us today.
My particular interest is your views about the implications
of one specific provision of Dodd-Frank, namely Section 953(b),
which directs you to issue regulations requiring all public
companies to disclose the ratio of the median compensation of
all employees, the median total compensation to the total
compensation of the CEO.
I would submit respectfully to you, and this is why I am so
eager to hear about what you have to say about this, that the
substance and the language of 953(b) are problematic. As it is
currently formulated, it certainly appears as though it will
create far more burdens than benefits, create more heat and
light and more work than actual useful information. And that is
a significant problem in this era, particularly when we have to
have resources dedicated with ever more force toward investment
and job creation.
As a Congress, we are charged with looking after the best
interests of our citizens. That includes our investors, of
course. And it includes the enterprises that create jobs.
The SEC has a crucial providential role in assuring that we
do have confidence in our markets. But I submit to you that
Section 953(b) is an example of how well-intentioned regulation
can in fact create impediments and obstacles. And I would
submit as well that it was in fact many well-intentioned
actions that were very damaging, indeed contributed materially
to the crisis of 2008 to begin with.
So I look forward to hearing your views on how we can
mitigate the negative consequences of Dodd-Frank, particularly
that section. And I thank you for your testimony.
Mr. Chairman, I yield back.
Chairman Garrett. And I thank the gentlelady.
I thank the panel for being with us today. And we will
begin the panel with Mr. Khuzami.
I understand that there is one written statement for the
panel. And, of course, without objection, your written
statement will be made a part of the record. Mr. Khuzami, you
will be going first, but you will all be recognized for 5
minutes.
Mr. Khuzami?
I am sorry, just pull your microphone a little closer and
make sure--I guess the green light should be on. Is that still
on? Or I might be losing my hearing.
Mr. Khuzami. Let us try one more time. Thank you.
Chairman Garrett. There you go.
STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT,
U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Khuzami. Thanks for the opportunity to testify today
concerning the President's Fiscal Year 2012 budget request for
the Commission and to report on the broad responsibilities
performed by the SEC, the recent reforms we have undertaken
under the leadership of Chairman Shapiro, and the challenges
that lie ahead for the agency.
I come to the Enforcement Division as a former Federal
prosecutor with the United States Attorney's Office in the
Southern District of New York. In that office, I served as
chief of the Securities and Commodities Broad Task Force and in
the office's counterterrorism unit, where I was a member of the
prosecution team that convicted the ``Blind Sheik,'' Omar Ahmad
Ali Abdel-Rahman and nine co-defendants for an international
terrorism conspiracy, including the 1993 bombing of the World
Trade Center.
After that and before joining the Commission, I served as
general counsel for the Americas Deutsche Bank AG, and before
that, as the bank's global head of litigation and regulatory
investigation.
Since my arrival at the Commission, it has been abundantly
clear that the SEC's ability to successfully meet the
challenges posed by a continuously and rapidly evolving market
place is critical to restoring investor confidence and market
integrity.
At the same time, we must fulfill the significant
additional responsibilities mandated by Dodd-Frank, and we are
for that reason requesting a Fiscal Year 2012 budget of $1.407
billion. Under the Dodd-Frank Act, appropriations for the SEC
will be fully offset by our industry fees, thus making our
funding deficit neutral. Each of my colleagues here today will
detail how this funding level is essential for the operations
of their Divisions.
And in the Enforcement Division, our funding needs are
great, but we also understand that we must be efficient,
innovative, and responsible in spending taxpayer money. As I
told my staff on the very first day I served as Director, ``We
need to be as efficient as we can with what we have now. That
means improved information technology, better allocation of
resources, better distribution of lower value and high value
work and more streamlined staffing. And it will require each of
us to examine our own individual efforts, think about how we
spend our day, how we allocate our time, and how we can be more
productive.''
To achieve the goals that we set out on that first day, we
undertook the most significant restructuring to the Enforcement
Division since 1972. We introduced five new national
specialized investigative units dedicated to high-priority
areas of asset management, market abuse, structured products,
Foreign Corrupt Practices Act violations, and municipal
securities and public pensions.
We adopted a flatter, more streamlined management structure
under which we doubled our staff-to-manager ratio and
reallocated managers back to the frontline of conducting
mission critical investigations.
We established an Office of Market Intelligence to correct,
collect, risk-weight, assign, and monitor the thousands of
tips, complaints, and referrals that the SEC receives every
year.
We created a COO's office to handle operations such as IT,
workflow, budget and project management, tasks formerly handled
by lawyers--and, frankly, that is not their core competency.
And we adopted streamlined procedures to initiate formal
and informal investigations and issue subpoenas.
We are also adopting new whistleblower authority given to
us under Dodd-Frank to compensate individuals who provide the
SEC with useful information about securities law violations.
And although statistics alone cannot capture the breadth of
the Division's efforts, we have seen significantly increased
enforcement activity that occurred despite the dislocation that
came with that very significant restructuring.
In each of the past 5 years, we have filed more enforcement
actions than in the previous year. In 2010, our actions
resulted in $2.85 billion in ordered disgorgement and
penalties, a more than 176 percent increase over the amounts
ordered in 2008.
We brought emergency relief in 37 actions and obtained 57
asset freezes to preserve investor funds and distributed nearly
$2 billion to harmed investors.
During the past year, we have brought significant actions
against individuals and companies arising out of the financial
crisis, including cases involving companies such as Countrywide
Financial, Morgan Keegan, Goldman Sachs, Citigroup, State
Street Bank, New Century Financial, Indy Bankcorp, and Colonial
Bank, to name just a few.
We have brought significant actions arising out of the
Foreign Corrupt Practices Act, as well as actions involving
municipal securities and accounting fraud. We filed cases
alleging insider trading by corporate directors and by hedge
funds, using technology company employees posing as consultants
in expert networking firms.
Despite this success, the enforcement program continues to
face significant challenges. Whether it be high-frequency
trading, hedge fund performance, asset valuation, pension
liability analysis, or any number of other areas, we are more
and more faced with the need to understand and identify
wrongdoing in products, markets, transactions, and practices
that are increasingly complex, fast-paced, or both.
For those reasons, our resource needs are most acute in the
areas of IT, data access and analysis, human expertise, and
paraprofessional and administrative support.
I look forward to working with Members of Congress on these
issues. Thank you.
[The joint prepared statement of Directors Khuzami, Cross,
Cook, di Florio, and Rominger can be found on page 49 of the
appendix.]
Chairman Garrett. Thank you.
Ms. Cross?
STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF CORPORATION
FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION
Ms. Cross. Good morning, Chairman Garrett, Ranking Member
Waters, and members of the subcommittee.
My name is Meredith Cross, and I am the Director of the
SEC's Division of Corporation Finance. I rejoined the
Commission staff in June of 2009. I have been a securities
lawyer for over 25 years, with about 18 years in private
practice and 9 years of government service. I am pleased to
testify today along with my fellow Directors.
The Division of Corporate Finance's core functions are
reviewing company filings, making rulemaking recommendations to
the Commission that relate to corporate finance matters, and
providing interpretive advice to market participants and the
public about the securities laws and corresponding regulations
for corporate finance matters.
With a staff of approximately 485, we are responsible for
the review of about 10,000 reporting companies, including tens
of thousands of disclosure documents each year, plus initial
public offerings and other public capital markets transactions
of corporate issuers, public asset-backed securities offerings,
and proxy statements, public mergers, acquisitions, and tender
offers.
Approximately 80 percent of the staff of the Division is
assigned to this review function. The Sarbanes-Oxley Act
requires the Division to review the financial statements of all
companies reporting under the 1934 Act at least once every 3
years, and more frequently where circumstances warrant.
This is no small task. Following enactment of the Sarbanes-
Oxley Act in 2003, the Division revised its review program to
meet the new review mandates and hired significant numbers of
new staff accountants, which has enabled us to meet the review
mandate each year.
In light of the lessons learned from the financial crisis,
the Division recently made some targeted changes to its
operations, including adding three new offices: the Office of
Structured Finance, which will help us address some
complexities and changes in the asset-backed securities market;
the Office of Capital Markets Trends, which will evaluate
trends in securities offerings and our capital markets to
determine if our rules and review approach are adequately
addressing them; and a new review group in disclosure
operations that will focus on the largest financial
institutions.
While the Division has established these offices and will
transfer some existing staff to them, our aim to fully staff
these offices has been deferred until funding has been
resolved.
In addition to the review function, Corporation Finance
makes rule recommendations to the Commission to address areas
in need of change. The Division expects to recommend changes to
existing rules in a number of areas in Fiscal Years 2011 and
2012, including modernizing our core disclosure requirements
which haven't been updated in more than 30 years, reducing
burdens and facilitating capital formation for small
businesses, providing disclosure about credit rating shopping,
addressing company and investor concerns about the proxy voting
system and updating our beneficial reporting rules.
In addition, Corporation Finance is responsible for
preparing a wide variety of rules to implement a significant
number of Dodd-Frank Act requirements. We have temporarily
reassigned a number of attorneys from throughout the Division
for this rulemaking.
Dodd-Frank topics that Corporation Finance is addressing
include, among others: asset-backed securities; corporate
governance and executive compensation rules such as say-on pay
and golden parachutes, compensation committees and compensation
consultants; clawbacks of the erroneously awarded compensation,
pay versus performance and pay ratios disclosure, and employee
and director hedging; specialized disclosures provisions
relating to conflict minerals, coal, or other mine safety, and
payments by resource extraction issuers to foreign or U.S.
Government entities; and finally, with regard to exempt
offerings, revisions to the definition of accredited investor
and disqualification of offerings involving felons and other
bad actors from relying on Rule 506 of Regulation D.
In addition to our review and rulemaking responsibilities,
the Division of Corporation Finance responds to tens of
thousands of requests for interpretive advice from market
participants and the public.
In Fiscal Years 2011 and 2012, we expect our workload in
this area may increase beyond that of recent years, primarily
as a result of the Commission's adoption and implementation of
the rules required by the Dodd-Frank Act.
Thank you again for inviting me to appear here before you
today, and I look forward to answering your questions.
[The joint prepared statement of Directors Khuzami, Cross,
Cook, di Florio, and Rominger can be found on page 49 of the
appendix.]
Chairman Garrett. Thank you, Ms. Cross.
Mr. Cook?
STATEMENT OF ROBERT COOK, DIRECTOR, DIVISION OF TRADING AND
MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Cook. Thank you. Good morning, Chairman Garrett. Thank
you, Ranking Member Waters and members of the subcommittee.
Thank you for inviting me to testify today on behalf of the
Division of Trading and Markets for the Securities and Exchange
Commission regarding the Division's operations, activities,
challenges, and the Fiscal Year 2012 budget request.
It is a pleasure to appear here today with my colleagues
from the--
Mr. Pearce. Mr. Chairman, can he pull the microphone closer
to him?
Mr. Cook. Can you hear me better now? Sorry about that.
I joined the Division of Trading and Markets as Director in
January of last year. Before coming on board, I was a lawyer in
private practice, where I focused on derivatives and securities
regulation and transactional matters.
I would like to start today by briefly describing the core
functions of the Division and then discuss some of our
activities related to the Dodd-Frank Act.
Broadly speaking, the Division is responsible for
establishing and maintaining standards for fair, orderly, and
efficient securities markets. We work to establish regulatory
standards from markets and market intermediaries, including 15
securities exchanges, over 60 active alternative trading
systems and over 5,000 registered broker-dealers. We also
oversee FINRA, the MSRB and the SIPC, and we have
responsibility for rules relating to 9 active clearing
agencies, around 500 transfer agents, and 10 credit rating
agents.
Our core functions include: processing proposed rule
changes from exchanges, clearing agencies and other SROs, which
address issues ranging from fee structures to trading rules;
initiating changes to market rules to keep pace with market
developments; establishing or approving rules governing broker-
dealer activities, including rules pertaining to capital
adequacy, protection of customer assets, anti-money laundering
and sales practices; actively participating in international
working groups to help ensure that international standards are
consistent with Commission policy and in the interests of the
United States; leading and administering Commission initiatives
with respect to a wide range of trading practices; and
supervising the capacity and resilience of our largely
electronic exchanges to minimize potential disruptions to
market continuity.
The Division also leads Commission efforts to respond to
significant equity market events, such as the severe market
disruption of May 6, 2010, following which we published two
joint reports with the staff of the CFTC and led the
development and implementation of key regulatory responses.
The Division's mission has become ever more challenging
with the exponential growth in the size and complexity of the
U.S. securities markets. In this fiscal year and the next, the
Division plans to focus on several key initiatives to improve
market oversight.
First, we will continue to explore the issues raised in the
Commission's 2010 concept release and public roundtable on
equity market structure, including high-frequency trading and
undisplayed liquidity.
Second, we plan to continue to work on proposals regarding
large trader reporting and a consolidated audit trail system,
both initiatives designed to enhance market surveillance.
Third, we plan to continue to identify and, as appropriate,
develop rules to respond to significant equity and options
market developments. This process includes the development of a
``limit-up, limit-down'' functionality for equity markets and
the review of proposed exchange mergers and business
combinations.
Our core functions have been substantially expanded by the
mandates of the Dodd-Frank Act. All told, the Division is
responsible for over 25 separate rulemaking initiatives, with
adoption deadlines of 1 year or less.
Most notably, we have been charged with responsibility for
developing the registration and regulatory regime for
participants in the security-based, over-the-counter
derivatives market, namely, security-based swap execution
facilities, data repositories, dealers, major participants, and
clearing agencies.
Going forward, this will mean that the Division will be
registering these new entities, monitoring market developments,
and promulgating new rules and guidance where necessary.
The Division is responsible for implementing many other
aspects of the Dodd-Frank Act, a number of which will increase
the demands on the Division's personnel, including rules
related to enhanced oversight of financial market utilities,
proprietary trading activities of broker-dealers under the
Volcker Rule, certain incentive-based compensation arrangements
at broker-dealers, and audit requirements for broker-dealers.
Pending the creation of new offices for credit rating
agencies and municipal securities, the Division is also
continuing to carry out our existing functions in these areas,
including the preparation of rules required by the Act.
While the Division's workload continues to be dominated by
a diverse range of core functions that are vital for protecting
investors and markets, the scope of its responsibilities has
expanded tremendously. Many of these rulemakings are the first
step in a new, ongoing supervisory and regulatory function for
the Division that will extend into Fiscal Year 2012 and beyond.
Thank you for inviting me to share with you the work of the
Division of Trading and Markets. I look forward to answering
your questions.
[The joint prepared statement of Directors Khuzami, Cross,
Cook, di Florio, and Rominger can be found on page 49 of the
appendix.]
Chairman Garrett. Thank you, Mr. Cook.
Mr. di Florio?
STATEMENT OF CARLO DI FLORIO, DIRECTOR, OFFICE OF COMPLIANCE
INSPECTIONS AND EXAMINATIONS, U.S. SECURITIES AND EXCHANGE
COMMISSION
Mr. di Florio. Good morning, Chairman Garrett, Ranking
Member Waters, and members of the subcommittee. Thank you for
the opportunity to testify today on behalf of the United States
Securities and Exchange Commission.
I joined the SEC on January 25, 2010, just over 1 year ago.
Prior to that, I was a partner in the financial services
regulatory practice of PricewaterhouseCoopers in New York,
where my practice focused on corporate governance, enterprise
risk management, and regulatory compliance.
The SEC's examination program helps protect investors and
ensure market integrity by examining for fraud, monitoring
risk, improving compliance, and informing policy as the eyes
and the ears of the agency in the field. Our exams assess
whether registrants are treating investors fairly and complying
with the Federal securities laws and regulations designed to
protect investors and prevent fraud.
The examiners in the national exam program take a risk-
based approach to examining over 20,000 registrants, including
investment advisers, broker-dealers, mutual funds, hedge funds,
derivatives dealers, credit rating agencies, SROs, national
exchanges and transfer agents, and clearing agencies.
Our Fiscal Year 2012 budget requests new examiner positions
so we can fulfill our new responsibilities under the Dodd-Frank
Act, execute our core mission, and enhance our limited coverage
of registered investment advisers.
In addition, we are also very focused on the resources we
have been provided. Under the direction of a new leadership
team over the past year, OCIE has undertaken a broad self-
assessment of our strategy, our structure, our people, our
processes, and our technology. This has resulted in a
comprehensive restructuring and improvement plan to become
stronger and more efficient.
For example, we are building a national exam program
supported by a new governance framework that breaks down silos
and facilitates coordination, consistency, effectiveness, and
accountability across the country and across Divisions.
We have implemented a new central risk analysis and
surveillance unit to enhance our ability to target those firms
and practices that present the greatest risk to investors,
markets, and capital formation.
We have begun to recruit experts and launch new specialty
groups that will bring deep technical experience and expertise
to our exam program in such areas as derivatives, complex
structured products, hedge funds, credit rating agencies, high-
frequency trading, and risk management.
We are working to implement a new certified examiner
training program that will establish technical training and
certification standards across the country. And we are
streamlining the exam process and clearly defining new
expectations, beginning to automate our exam tools,
implementing an internal compliance program to monitor our
performance and ensure our quality control.
No matter how much we improve our current program, however,
the fact remains that our examiners can only cover a small
portion of the 20,000-plus registrants that we regulate. For
instance, our examiners were only able to examine 9 percent of
registered investment advisers, and over one-third of
registered investment advisers have never been examined.
With the addition of the positions sought in the Fiscal
Year 2012 budget, we will be able to more effectively fulfill
our new responsibilities, strengthen our core mission, and
expand our impact on investment adviser exams.
Equally important, it will help us invest in the risk
assessment and surveillance capabilities needed to allocate our
limited resources to their highest and best use to protect
investors and ensure market integrity.
Thank you, and I welcome the opportunity to answer your
questions.
[The joint prepared statement of Directors Khuzami, Cross,
Cook, di Florio, and Rominger can be found on page 49 of the
appendix.]
Chairman Garrett. Thank you, Mr. di Florio.
Ms. Rominger, please? And I would like to welcome you to
the panel for the first time.
STATEMENT OF EILEEN ROMINGER, DIRECTOR, DIVISION OF INVESTMENT
MANAGEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION
Ms. Rominger. Thank you. Chairman Garrett, Ranking Member
Waters, and members of the subcommittee, thank you for the
opportunity to testify today.
My name is Eileen Rominger. Today marks my 16th day on the
job as Director of the Division of Investment Management at the
SEC. Although I am new in this role, I have had over 30 years
of experience in the asset management industry, managing client
portfolios and leading teams of portfolio managers. Most
recently, I was chief investment officer at Goldman Sachs Asset
Management, responsible for portfolio management teams that
encompassed about 500 people in 8 different countries.
I have met with hundreds of retail clients over the years,
and I am well aware of the challenges that they face with
increasing complexity in the investment choices available to
them. I am dedicated to working with the Commission staff to
address these challenges, to enhance transparency so that they
can make informed choices, while maintaining a healthy asset
management industry that sets the standard for the rest of the
world.
The Division of Investment Management assists the
Commission in its mandate of investor protection and support of
capital formation. The Division oversees and regulates
America's $38 trillion investment management industry. We
administer the Investment Company Act and the Investment
Advisers Act and develop regulatory policy for investment
advisers, mutual funds, and other investment companies.
The rulemaking program of the Division of Investment
Management is currently focused on implementing the provisions
of Dodd-Frank as they relate to investment companies and
advisers. As the rules are adopted, much of the work will shift
to the Division's Disclosure, Interpretive Advice, and
Exemptive Relief Programs.
Dodd-Frank meaningfully changed the universe of regulated
entities for which the Commission is responsible by increasing
the threshold for investment adviser registration to $100
million in assets under management and by requiring advisers to
hedge funds and other private funds to register with the
Commission.
Approximately 750 new private fund advisers will be added
to the registrant pool, but the number of registered advisers
is anticipated overall to shrink by about 28 percent. At the
same time, their assets under management will rise, and the
complexity of those assets will actually increase pretty
substantially.
Dodd-Frank also requires reporting by certain investment
advisers that are exempt from registration.
In November, the Commission proposed rules and rule
amendments to implement these new investment adviser
requirements. These included new exemptions from registration
created by Dodd-Frank for advisers to certain private funds
relating to venture capital funds and advisers with less than
$150 million under management. We are reviewing the comments
and developing our recommendations for the Commission to adopt
final rules.
Systemic risk reporting is another important area in which
we must implement the requirements of the Dodd-Frank Act. In
January, the Commission proposed reporting requirements for
private fund investment advisers to assist the Financial
Stability Oversight Council in monitoring for potential
systemic risk. We will carefully consider the comments received
and expect to prepare a rule adoption for the Commission to
consider this year.
The Division hopes to hire additional staff with the
expertise necessary to monitor, analyze, and make good use of
the information that will be collected. In addition to
implementing the provisions of Dodd-Frank, the Division is
working on a number of important initiatives in other areas.
In January 2010, the Commission adopted important reforms
in money market fund regulation, including a requirement for
them to report their portfolio holdings on a monthly basis.
This year, we plan to improve our monitoring of money market
funds and our ability to analyze trends in their portfolio
exposures, their liquidity levels, and their average maturity.
We are also considering further reforms aimed at lessening
the susceptibility of money market funds to runs, including
those options that were outlined in the President's Working
Group report on money market funds that was released last
October.
In the last year, there have been a number of other
important investor protection initiatives. These include Rule
12b-1, relating to distribution fees, which the Commission has
proposed to rescind and replace with a new rule and regulatory
framework.
The Commission has also proposed changes to rules regarding
target date funds specifically relating to the naming
conventions and marketing materials. We are thoughtfully
reviewing those comments and will evaluate whether to recommend
that the Commission adopt these reforms.
In addition to our role in Commission rulemaking, a large
part of our responsibilities also involve providing formal and
informal legal guidance in the form of interpretative and no-
action letters, as well as exemptive relief from the provisions
of the Investment Company and Investment Advisers Acts. We also
review filings of registrants in order to monitor and enhance
compliance with disclosure and accounting requirements.
Pursuant to the requirements under the Sarbanes-Oxley Act,
the Division reviews the annual reports of all registered
investment companies no less frequently than every 3 years. The
other responsibilities of the Division include provision of
technical advice and active participation in international
groups such as IOSCO and also provision of legal and policy
guidance to the Division of Enforcement on matters concerning
investment managers.
Again, thank you very much for the opportunity to testify
today, and I look forward to your questions.
[The joint prepared statement of Directors Khuzami, Cross,
Cook, di Florio, and Rominger can be found on page 49 of the
appendix.]
Chairman Garrett. Thank you for your testimony.
I thank the panel as well.
So, I will begin, and before I get into the weeds on some
of the questions, if I bring up on the screen up here--
After you do that, you can begin my time.
Just to dispel the myth with regard to the first issue,
regarding lack of funding for the agency, I know it is a little
hard, but that chart basically shows the SEC budget obligations
from the year 2000 to 2011. And you can see it is almost a
straight line up, and what that is, is a basic average year-
over-year increase on average of over 10.8 percent from 2000 to
2011.
Now, if you go to the next chart to find out--
Next chart? Starting the next chart--how about that one?
That chart asks the question, what was the actual rate of
inflation during those years? It goes up and down, of course,
but the average period was 2.5 percent. So that last chart
showed you that they were getting around over 10.8 percent each
year. This is the actual increase in inflation overall, 2.5
percent.
So this final and third chart put these things together for
you and shows you--there you go--what would have been their
funding, had they been increased on funding level at a constant
level of 2.5 percent year over year over year, compared to the
initial charts. I think that sort of dispels the myth that
there has been an agency that has been starved.
Understandably, there has been a larger marketplace, more
to regulation, and Dodd-Frank increases all the
responsibilities, as all have said, but overall, it is a stark
difference between where they would be, had they been like most
other businesses, families, what have you, living within the
means of the average increase of 2.5 percent--instead, actually
over 4 times as much of the 10.8 percent year-over-year.
So, that is the funding aspect. But let us get into some of
the things that you are actually working on right now.
Mr. Cook, just a quick question here with regard to a
consolidated audit trail, and doing so in real time. Can you
tell me where we are on that? Are you still pursing a real-time
consolidated audit trail, briefly?
Mr. Cook. The Commission has not yet acted on that. We are
reviewing all the comments that have come in. As you are
alluding to, part of the proposal was a real-time reporting
element, and we are looking at the comments to determine
whether that should stay as one of the elements and how that
fits together with the rest of the cost of the program.
Chairman Garrett. Okay, because that is one of the points,
obviously. It is going to be pretty expensive to do something
like that, right? And, secondly, would real-time be absolutely
necessary? Because an end-of-day aggregation would be just as
adequate, because I don't know if anyone is going to be able to
just stay up on top of it. Is that true?
Mr. Cook. It is a good question, Congressman. We are trying
to strike the right balance between finding something that is
very cost-effective that will give us the information we will
actually be in a position to use, but also, if we are going to
go through this process of building something out like this,
and it will be a multiyear process to build this audit trail,
that we build something that is not just what we need today,
but will be something that we can use in the future.
We have been thinking a lot and looking closely at new
technologies that we weren't aware of when the original
proposal came out that we are hopeful will allow us to
substantially reduce the cost.
Chairman Garrett. So it is something--in other words, you
haven't done it yet, but you are still considering going
forward with it?
Mr. Cook. Yes.
Chairman Garrett. Okay.
Mr. Khuzami? Somewhere here I have an article that was in
Bloomberg a little bit ago and I will just--I guess last June
it was--and I will just ask you--I will pick through and find
it--but what it was, it was talking about some of the efforts
to try to bring that technology to the workforce there, to the
lawyers and what have you, and the article was talking about
giving BlackBerries, which every one of us up here have, to
make sure that the folks on enforcement staff would actually be
able to be in communication with.
My understanding just from that article was that there was
pushback to that from the unions and the pushback was,
according to the piece, that ``we don't want our paid staff,
the lawyers, having to be responsible to respond after business
hours, after 5 p.m.''
Is it the case that there was pushback from the unions, and
that was part of the impediment of doing that?
Mr. Khuzami. Congressman, there were some initial comments
to that effect, but in my experience, it dissipated quickly.
People are using them, and I certainly have never had a
situation where I haven't been able to reach someone or someone
has told me that they haven't been able to reach someone for
that reason.
Chairman Garrett. But that was pushback from--where did the
pushback come from?
Mr. Khuzami. The issue was raised by--I can't remember
whether it was the union or some other individual or group of
individuals but, like I said, I don't think it gained any
traction.
Chairman Garrett. Okay. We are all here on a 24/7 process.
You would think the folks that we are talking about, these are
attorneys, are they not, in a lot of cases?
Mr. Khuzami. There is a large percentage of lawyers in the
Enforcement Division. That is correct.
Chairman Garrett. And, I guess you would agree that they
are sort of well-paid folks, so asking them to work after 5
p.m. would be appropriate responsibility.
Mr. Khuzami. Clearly. And I have seen no shortage of people
willing to commit and work hard, so I don't think that issue is
any kind of impediment.
Chairman Garrett. Okay. So another that came out, Mr. di
Florio, with regard to push back, I guess, from the unions,
there was an attempt to implement a quality control review
after each examination. And, basically, the idea from other
members' comments here with regards to the Madoff examination,
what have you, right? So you know what I am talking about.
But I understand in this case--correct me if I am wrong--
again, there was pushback by the unions in this area. And I
understand that the post-examination quality process--and tell
me if this is not correct--is still not implemented due to
continued union objection. So first of all, is that the case?
Mr. di Florio. Chairman, since I joined a year ago, I have
not had any problem pursuing quality control in the examination
process. We have implemented a number of quality control
mechanisms as we have streamlined our exam process, and we have
not had pushback from the union with regard to the initiatives
I have implemented. I am not familiar with initiatives that may
have been the case before I joined.
Chairman Garrett. So none of the things that you have tried
to do during this time have had a pushback?
Mr. di Florio. We have a process where we engage the union
in the recommendations and the initiatives, but we did a
comprehensive review with over 25 initiatives for improvement
identified, and we are moving those forward, certainly in
consultation with the union.
Chairman Garrett. Okay. So were there any recommendations
out of the report that were supposed to be implemented prior to
you coming into your position, that were not implemented, that
you have looked back on and said, these have still not been
pursued and implemented because of any other impediments
whatsoever?
Mr. di Florio. I don't believe so, Mr. Chairman, but I will
look into that when I get back and get back to you, if there
were any issues.
Chairman Garrett. Okay. And, as always, the time goes
faster than the list of questions that are before me.
To the ranking member?
Ms. Waters. Thank you. Thank you very much, Mr. Chairman.
Mr. Khuzami, Chairman Garrett just placed a chart for all
of us to examine, and he basically said that the increases that
you have received over several years were far greater than the
rate of inflation.
Why is it improper to look at those increases that way?
Could you explain that to us? What I am seeing here is that you
are operating at about 2005 levels, and you make the case for
erratic funding, and you talk about trading volume more than
doubling, the number of investment advisers have grown about
roughly 50 percent, and the funds that they manage have
increased nearly 55 percent, and on and on and on.
He is comparing your increases with the rate of inflation,
and it seems as if that is not, perhaps, the right way to do
it. Could you talk to us about that?
Mr. Khuzami. Congresswoman, as I said, let me just start by
saying we understand the need to be as efficient and effective
as we can, and that informed so much of the restructuring
effort that we underwent in the Enforcement Division.
With respect to the increases over the years, I think if
you look below the level, the actual staff members that have
increased have not been that significant, because some of those
increases went to certain dedicated efforts. The IT funding has
been volatile, and that is particularly problematic if you are
talking about trying to secure IT systems that sometimes you
have to plan for years out.
I think our staff has actually decreased about 11 percent
between 2004 and 2008. I think you can go back and forth on
that, but I think the biggest consideration is, as you say, the
complexity of the market and the challenges we face. We have
38,000 regulated entities, transfer agents, broker-dealers, and
investment advisers to regulate and oversee. And we are an
agency of 3,800 people.
Ms. Waters. Would anybody else like to add to that
explanation of why the rate of inflation may not be the correct
way to look at what your needs are?
Mr. Khuzami, the spokesman for today?
Mr. Khuzami. I just want to make one other point, too. The
banking regulators and our colleagues whom we work closely
with--I think the rough numbers show that they have
approximately one staff member for every one regulated entity.
And we are roughly at a 1-to-10 ratio. Now, those numbers may
not be exact, but they are close.
And I think that underscores the extent to which, while we
are thankful for the increases that we have gotten, there is a
significant market out there, and it is getting more complex
and more fast-paced, and that is the basis for funding requests
above and beyond the new Dodd-Frank obligations.
Ms. Waters. So let me ask Mr. Carlo di Florio. You are the
Office of Compliance Inspections and Examinations. Based on
Dodd-Frank and the additional requirements that we are putting
on the SEC, could you explain to us why you need the funding in
order to carry out your function?
Mr. di Florio. Thank you, Ranking Member Waters. As I
mentioned in my statement, there are 20,000-plus registrants
that we are responsible for regulating, and we only have 859
examiners to be able to address those registrants.
As Mr. Khuzami alluded to, the ratio that we have as a
regulatory authority relative to what the bank regulators have
or even FINRA is drastically greater. So we are at a 1-to-23
ratio of examiners to registrants. And as a result, we have not
had the ability to examine over one-third of investment
advisers, and we have only been able to examine 9 percent of
investment advisers in Fiscal Year 2010.
So in addition to that, you introduce the new requirements
regarding hedge funds and derivatives and credit rating
agencies under Dodd-Frank. There is a significant amount of new
requirements being added, and we feel that additional positions
will help us both execute our core mission more effectively and
address the new requirements under the Dodd-Frank Act.
Ms. Waters. Thank you very much.
I yield back the balance of my time.
Chairman Garrett. Thank you.
Mrs. Biggert, for 5 minutes.
Mrs. Biggert. Thank you, Mr. Chairman.
I have a question, I believe, for Ms. Cross. I introduced a
bill, H.R. 33, a clarification bill to allow church plans to
invest in collective trusts so that, like corporate and other
secular pension plans, church pension plans for clergy can have
the benefits of collective buying power, and collective trusts
generally allow pension plans to pool their assets, diversify
their investments, and share the risks and transaction costs of
other pension plans.
And I was informed that both staff at the SEC and my staff
discussed this issue and agreed upon the language included in
H.R. 33. So, can you confirm that the SEC supports H.R. 33 and
also would support its quick consideration and passage?
Ms. Cross. Thank you for your question, Congresswoman.
First off, let me note that we wholeheartedly embrace the idea
that the participants in the church plan should have the same
opportunities as participants in other plans and there
shouldn't be regulatory obstacles. The Commission hasn't taken
a position on the bill, so I need to start there.
From the staff's perspective, the only thing that we want
to make sure is that there aren't regulatory gaps that would
work to the detriment of the people in the church plans,
compared to other people in these kinds of employee benefit
plans. We would like to take a careful look and make sure there
wouldn't be regulatory gaps, and if there are, work with your
staff quickly to address them.
Mrs. Biggert. I appreciate that. Thank you. I hope that you
will support it.
I have another question, and I am not sure who to address
it to.
In January, as required by Dodd-Frank, Section 914, the SEC
staff issued a study on enhancing investment advisers
examinations. And the report offered three options for Congress
to consider to strengthen the Commission's investment adviser
examination program.
I would like to know which option you see as being the most
effective, efficient, and cost-effective for the SEC? But, more
importantly, which option do you see as the least burdensome
and least costly for small businesses?
I have heard from constituents who are very concerned about
new fees, which they see as equivalent to new taxes under any
of these proposals. Did you take into consideration the cost to
advisers and small businesses?
Mr. di Florio. Congresswoman, I will initially answer
that--
Mrs. Biggert. Okay.
Mr. di Florio. --and share the perspective that the 914
study laid out the three options of first increasing
examinations of investment advisers through user fees on the
investment advisery industry, which would allow the exam
function in the SEC to grow and close that gap of being able to
examine further investment advisers.
The second option was to, through dues, establish a self-
regulatory organization for the investment advisory program
similar to what you have with regard to FINRA and the broker-
dealers.
And then the third option was to enable FINRA to extend
their authority and review of an investment adviser, where it
is a dual registered broker-dealer investment adviser.
All three of those options are reasonable and feasible
options. As you mentioned, there are some investment advisers,
smaller businesses, medium-sized businesses, who feel that it
is more efficient to invest in the SEC since it already has the
infrastructure, is already doing the exams, and grow that
program.
There are others who feel that it would feel that it would
be more efficient to invest in a self-regulatory organization
that is closer to the industry, and that would be done through
dues.
We believe that the important objective is to increase the
number of exams done of the investment advisers, and either one
of those options are reasonable and would be effective in
achieving that objective.
Mrs. Biggert. Okay. Thank you. So that would be, I guess,
one and two?
Mr. di Florio. Correct.
Mrs. Biggert. Okay. Thank you.
And then I have one more question, if I have time. Last
month when Chairman Shapiro testified before the committee, I
asked her about the SEC interaction with the Department of
Labor, which has proposed a new definition of fiduciary that
would significantly modify 35 years of established law.
And then I also had an opportunity to ask Secretary Solis
of the Department of Labor about the same issue. I was
concerned that the Department of Labor was not listening or
really working with the SEC. So has there been further
discussion about the fiduciary between the Department of Labor
and the SEC?
Ms. Rominger. Congresswoman, I will answer that.
The Investment Management Division has a long history of
very extensive interaction with the Department of Labor, and it
has been actively involved with them on a number of issues,
including recent conversations around target date funds and on
other issues.
Their definition of fiduciary as it relates to ERISA is
really something that falls within their jurisdiction because
of their very specific focus on retirement investing. But rest
assured, we are very committed to working closely with them.
Mrs. Biggert. Thank you.
I yield back.
Chairman Garrett. Thank you.
The gentleman from California, to compress his 20 minutes
of questions into 5 minutes?
Mr. Sherman. Mr. Cook, if you allow the pitcher to select
the umpire, at the end of the game, that pitcher would be
awarded the Cy Young Award. The only thing that both the
Democrats and Republicans on the investigatory commission of
the meltdown agreed on was that the system of allowing those
who issue bonds to pick their credit rating agency was at the
core of the suffering that the American people are enduring
today.
As part of Dodd-Frank, we passed Section 939(f), which
resembled an amendment I suggested in this committee that was
further improved by Senator Franken and then kind of mashed
around during the conference committee process. It gives you 2
years as an absolute maximum. For 7 or 8 months, you haven't
published a single piece of paper to even start a process,
which is critical.
I don't think investors are going to be dumb enough to
accept AAA on Alt-A in the future, but there are so many other
bond products that could be exaggerated and form the basis of
next decade's meltdown.
Are you going to take the full 2 years, the absolute
maximum given you by the statute? And why should it take 2
years?
Mr. Cook. Congressman, we will move forward with this
study, which is a very important study, as quickly as we can.
We are hoping to--
Mr. Sherman. But you have accomplished nothing in the first
8 months.
Mr. Cook. Yes, we recommend to the Commission, and
hopefully, it will be out shortly, a solicitation of comments
from the industry so that we can take those into account in
developing this study. There are other studies that we have to
do that have a 1-year timeframe, so frankly, we have been
trying to prioritize our work in this area, as well as our work
in other areas.
Mr. Sherman. Are any of those studies designed to deal with
a problem that was more at the core of the meltdown? Eight
months, nothing happens. Sounds like business as usual. I am
not so sure that business as usual is what we expect from the
SEC.
Is it your interpretation of the code section that when
this process is over, we are going to end the system where the
bond issuer selects the credit rating agency?
Mr. Cook. My understanding of the statute is that we will
study the conflicts and alternative ways of addressing the
conflict and either then pursue the version that was in the
bill that had been passed by the committee or another version,
if we find that is appropriate.
Mr. Sherman. But another version to achieve the objective.
Mr. Cook. Yes, to achieve the same objective.
Mr. Sherman. Thank you.
Mr. di Florio. Congressman, I would also--
Mr. Sherman. Yes?
Mr. di Florio. I was just going to say I would also add
that the bill requires, and we have begun to execute,
comprehensive exams of all credit rating agencies, looking at
things including conflicts of interest. That is an extensive
process. We are three-quarters of the way through that--
Mr. Sherman. That is a different process. I am really
focused on the 939(f) process, but I do have a question or two
for you.
Let us talk about Madoff. He files financial statements
year after year showing billions of dollars. The first thing
you look at on a financial statement is the auditor's letter.
Is it an unqualified opinion? Who signed it? You look at the
Madoff letter. It is signed by an accounting firm nobody has
heard of--take 10 minutes to realize the accounting firm was
too small to do the audit and to be independent of the client.
So if somebody had spent even an hour in anytime in a
decade, looking at those financial statements, they would have
discovered the Madoff problem. Who at your organization decided
not to spend an hour at anytime in a decade looking at Madoff's
financial statements? How much time was spent reviewing his
filings year after year after year after year? And has anybody
been fired for deciding not to look at his statement?
Mr. di Florio. Congressman, the process that was in place
regarding looking at firms and those kinds of risks has changed
significantly.
Mr. Sherman. I am not asking about the changes. I am asking
about the past.
Mr. di Florio. With regard to specific--
Mr. Sherman. How much time was spent looking at the Madoff
material in the decade prior to his catastrophe?
Mr. di Florio. In fairness, a significant amount of time
was spent looking at Madoff and examining Madoff.
Mr. Sherman. If you had spent half an hour looking at his
filings--you didn't have to go out to his office, you just had
to look at what he filed with you for half an hour--this thing
is obvious.
Mr. di Florio. And so today we have procedures
specifically--
Mr. Sherman. I am not asking about today. I am asking why
your organization, whose job it is to impose accountability on
the biggest financial institutions in this country and in the
world, has zero accountability for its own employees. You are
the accountability list accounts.
Mr. di Florio. An independent party firm was brought in to
do an extensive investigation of the individuals involved in
the Madoff matter. That independent third party has issued its
recommendation--
Mr. Sherman. How much does whitewash cost?
Mr. di Florio. I am sorry?
Mr. Sherman. When buy whitewash at the hardware store, how
much does it cost? It is 2 years. Nobody has been fired. Nobody
is to blame. Nobody is accountable. And that is the only agency
we have, or we have no agency at all.
Mr. di Florio. There are individuals going through the
disciplinary process now, and that is reaching a conclusion.
And the government rules are defining that process, but it is
close to reaching a conclusion.
Mr. Sherman. Could you submit to this committee a due
process for dealing with employees, so that if something like
this happened again, the responsible parties would be fired
within a couple of weeks? That was a question.
Mr. di Florio. We would be happy to work with the parties,
the Office of Management and Budget and others, that represent
the government rules, that define our disciplinary process, to
share our experience on that process. We would be happy to
inform any amendments or reforms to that process.
Chairman Garrett. I thank the gentleman.
The gentleman from Texas?
Mr. Neugebauer. Sorry. I didn't--
You said in your testimony, I think, that the request for
the $369 million is deficit neutral. So I assume you are going
to make up the $369 million by doing what?
Mr. Khuzami. Congressman, what I meant by that is that
there is also the legislation, the transaction fees and
revenues that the Commission bring in, that our budgets were
going to be tied to those amounts.
Mr. Neugebauer. But in reality, we are taking money out of
the economy. Is that correct?
Mr. Khuzami. It is coming from the people who engage in
securities transactions and registrants.
Mr. Neugebauer. I think that is kind of the Washington
mentality up here is that if the money is coming from fees,
somehow that doesn't count. But what we're all working on here
is trying to make sure we leave enough capital in the system to
create jobs. And so, while it may be deficit neutral, it is not
economic neutral to the economy. Would you say that?
Mr. Khuzami. I would certainly agree that money is coming
from somewhere. That is correct. My personal view is that is a
good investment in contributing to sound markets and investor
confidence, which I think aids and benefits everybody.
Mr. Neugebauer. Ms. ``Rominger'', is that correct? Yes?
Ms. Rominger. ``Rominger.''
Mr. Neugebauer. ``Rominger.'' Thank you. To people with a
name like ``Neugebauer'', I am sure you have had to repeat that
just a couple of times.
You said your Division was hoping to hire folks with
special expertise, and I assume those folks more than likely
would come from the private sector. Is that correct?
Ms. Rominger. They could come from a variety of different
places.
Mr. Neugebauer. And so with some of these specialists, one
of the concerns I have and I made in my opening testimony is
that, making sure that there is a process in your organization
for conflicts of interest. I think all of us would have been
extremely disturbed that someone who had investment ties to Mr.
Madoff was actually in working on the negotiations of
settlements with some of the investors.
And when we sent letters over there, the ethics approval
process was, somebody sent an e-mail to somebody that said,
``Hey, do you think there is a conflict of interest?'' A few
minutes later, they get acknowledged, ``Everything seems to be
fine.''
For an agency that holds high standards for the people who
fall under your purview, it appears to me within the
organization, that same standard doesn't hold true for the
people working inside the organization.
And back to Mr. Khuzami's statement about making sure there
is integrity in the marketplace, I think it brings, as some of
my colleagues have said, a little bit of question of the
integrity within the organization; are you policing yourselves?
You want to police these organizations, but the question
is, are you policing yourself? What kinds of things--as you
hire these new people, how will you assure us that these people
have been vetted properly and that conflicts of interest are
addressed, and that we don't have these kinds of issues coming
up in the future?
Ms. Rominger. I share your expressed view that our
standards must be held very, very high in this area. And I have
not hired anyone yet, but certainly when I do so, I will make
sure that we comply with every element of the enhanced ethics
standards that are in place at the SEC.
Mr. Neugebauer. So what is the process today? If you start
hiring people, what are you going--how does that work in your
organization? And I will leave that open to any of you. Does
anybody want to address that?
Mr. di Florio. I would be happy to, having had a little
more experience in this matter.
Mr. Neugebauer. You have been here more than 14 days?
Mr. di Florio. Right. Under Chairman Shapiro's leadership,
there has been extensive review of the ethics and compliance
program and process. A new Chief Compliance Officer has been
brought on board. A new Ethics Counsel has been brought on
board. An electronic system to log and manage any possible
financial disclosure conflicts has been implemented.
We all have to go through extensive training now regarding
the ethics and conflicts issues, and that is repeated annually
so there is a much more robust process and policy in place
today, again, under Chairman Shapiro's leadership.
Mr. Neugebauer. So when did that start?
Mr. di Florio. Our new Ethics Counsel came on board just in
the past few months. The Chief Compliance Officer came on board
just a few months prior to that, so much of this has happened
in the past year. The new electronic system to document, log,
and monitor financial disclosure conflicts has come online just
in the past year plus. So it is all relatively new, but all
very positive developments and a reflection of industry-leading
practices for managing ethics conflicts.
Mr. Neugebauer. Don't you find it a little odd that has
happened in the last few months? An agency that holds other
people to such high standards that all of a sudden you decide,
hey, maybe that works for us, too?
Chairman Garrett. We will let the gentleman answer that--
Mr. di Florio. I think Chairman Shapiro, since she came on
board, started a process of initiating a number of reforms,
including taking a fresh look at the entire process, recruiting
and identifying the right people to take on those leadership
positions and the ethics function and the compliance function.
So it is a process that has made, I think, good progress
over the past 2 years and will need to continue in the near-
term to come.
Chairman Garrett. I thank the gentleman--
Mr. Khuzami. Congressman, if I just might add, before these
new measures were taken, my personal involvement is I dealt
with the ethics office on conflict matters. I found them to be
careful and candid and, frankly, erring on the side of caution
in the circumstances that I dealt with them. And the rules and
obligations both for individuals coming in as well as going out
of the Commission, I think, are clear and well known.
So I don't want to leave the impression that the ethics
world started only a few months ago. There were systems in
place, and from my experience, they have worked effectively.
Mr. Neugebauer. I think there is evidence, evidently, with
some cracks in the system.
Chairman Garrett. I thank the gentleman.
The gentleman from North Carolina?
Mr. Miller of North Carolina. Thank you, Mr. Chairman.
We have discussed in this committee a lot how to revive
bank lending, but before the crash, roughly half of all lending
was the securitization market. In the last couple of years,
there has been one issue of a couple hundred million for
residential mortgage-backed securities, and that is it. And
that would be an asterisk compared to what the market was
before.
I have talked to mortgage investors, and they have said
that there is no way that anyone is going to buy asset-backed
debt, based upon the way the market was before. The way it
worked before is they would get a call saying we are going to
market in a couple of hours with a mortgage-backed security
that has a AAA rating. Are you in?
And they are not interested in doing that again, and they
can contrast the kind of disclosures, the kind of
standardization that is available to investors who are buying
stock issues, public offerings of stock--the waiting periods,
the opportunities potential investors have to do their own due
diligence, the standardization of what they are getting--and
really said that is what they need for debt as well.
The SEC has recently issued a rule in this area, and there
had been repots that the issuers of mortgage-backed securities
did in fact have third-party review of the mortgages, and I
think the phrase from the J.P. Morgan Chase e-mails was that
some of the mortgages were ``poo,'' but they did not tell the
rating agencies that the mortgages were ``poo.'' In fact they
represented the mortgages to investor as ``non-poo.''
And the investors say that the SEC has not gone far enough
to say that just that kind of due diligence by the issuer
itself or by third parties would be made available to them.
They should still--they aren't going to trust that either, and
the result may just be that there is less due diligence by the
issuer, and that they want the chance to look at themselves to
do their own due diligence to see what it is they are buying.
And they want standardization as well, waiting periods, all of
that.
Do you think you have statutory authority to issue rules
like that? Do you need Congress to act? What kind of reaction
have you gotten to the rule that you have issued? Obviously,
the securitization market has not exactly sprung back to life.
Ms. Cross. I think this one is for me. We have a rule
proposal that we put out in April 2010 that would significantly
reform the offering process for asset-backed securities,
including imposing a 5-business-day waiting period between the
time that you have a complete prospectus, which includes asset
by asset loan level data in structured .xml form for people to
be able to look at every single asset and the computer program
of the waterfall so they can see how the assets would pay out
in different scenarios.
We have full authority to adopt those rules. Those rules
were out when Dodd-Frank was passed. And so we thought it was
important that the reforms worked together with the Dodd-Frank
ABS/MBS rules and regulatory reforms, including the joint
project now that is going on with risk retention.
The Dodd-Frank Act actually requires us to require loan
level data, which is consistent with our rule proposal. We look
forward to implementing that.
There are a number of other pending projects through the
Dodd-Frank Act that will be important to basically sync up all
the requirements so that when this is all put together, there
will be a robust regulatory environment that will be workable,
because it doesn't do any good to put something together and
then people don't use it. We are working to make it workable.
But we have full authority to do what you are talking
about, and I believe we have proposed this.
Mr. Miller of North Carolina. Okay. Do your proposed rules
allow potential investors to actually examine a sampling of
loan files?
Ms. Cross. I don't think that is in our proposal. The way
our proposal works is they get an actual data dump on every
single loan.
Mr. Miller of North Carolina. Oh, I see.
Ms. Cross. And so I haven't heard the request to see the
loan files, but I will certainly talk with my staff about
whether we have been getting that request and whether that is
something that we need to address in the proposal.
Mr. Miller of North Carolina. I yield back.
Chairman Garrett. The gentleman from California?
Mr. Royce. Thank you, Mr. Chairman.
Let us see. Ms. Rominger, I wanted to ask you a question,
and it would be about the oversight of private funds, of just
thinking about the problems that the financial system went
through, these funds did not seem to play a role in the
financial crisis, and they certainly didn't receive any
bailouts. And they tend to be much smaller in size.
And from the testimony we have gotten, they don't have the
kind of leverage that the other financial institutions had. And
so, despite all these factors, Dodd-Frank mandates registration
for them with the SEC. And I was going to ask what concrete
steps has the SEC taken to ensure it has the capability to
adequately oversee these funds?
And I was doing so in light of some of the things we heard
from Mr. Markopolos. What he really drove home with us was that
many of the people within the SEC that he had encountered over
the many years that he kept bringing this problem to the SEC,
this Bernie Madoff problem, he said they just failed to grasp a
relatively simple fraud, a basic little Ponzi scheme. This is a
part of the market that the agency has very little experience
with.
Now, when we start talking about this, the question of
private funds, is this going to be like it was with the SEC
when they didn't have portfolio managers, they didn't have
people who really could comprehend the kinds of frauds that
they were supposed to look into?
The SEC has been tasked with overseeing this now, and I
wanted to ask you about that.
Ms. Rominger. Thank you, Congressman. That is an excellent
question, because of course, you know in the private fund
arena, there is a vast range both in terms of the size of those
funds--
Mr. Royce. Right.
Ms. Rominger. --their assets under management, their
investment strategies and the imbedded complexity of those
strategies.
And the way that the rules have been proposed really scale
the requirements to acknowledge that and to acknowledge that
the information that is appropriate to our request from a
relatively small or straightforward strategy, is very different
than what should be requested from a larger or more complex
strategy that could be more pertinent to the issue of systemic
risk.
So that scalability, I think, is a feature that attempts to
get at what I think is the concern about requiring something
that goes beyond what is necessary.
Mr. Royce. Thank you. I was going to ask Mr. Cook a quick
question, too. And this goes to Section 913 of Dodd-Frank,
which requires the SEC to study the effectiveness of current
standards of care for broker-dealers and investment advisers.
In January, the SEC released a study that recommended the
adoption of a uniform fiduciary duty standard for broker-
dealers and investment advisers that would harmonize the
differing standards that are out there currently.
Can you point to any economic research or empirical data or
economic analysis that shows the need for this harmonization?
And what benefit does a fiduciary standard provide that could
not be provided by simply improving disclosures so all parties
understand who they are dealing with and what they can expect
from either their investment adviser or broker-dealer?
Mr. Cook. Congressman, I think that there have been studies
to show that investors are confused about the nature of the
relationship that they have with a different source of
providers.
And so one of the rationales for doing this would be so
that when an investor walks in to an investment adviser or to a
broker-dealer, that they would not have to become an expert in
those various regimes that apply.
I think going forward we certainly will need to think
about, as we implement this, the nature of the two regimes, how
they apply to different types of financial intermediaries, and
how we can best tailor this fiduciary duty and the
harmonization of duties beyond that to different types of
business models.
Mr. Royce. Thank you, Mr. Chairman. I am out of time.
Chairman Garrett. The gentleman from Colorado, or not?
Mr. Perlmutter. Mr. Chairman, I would like to pass to Mr.
Peters, and then come back to me.
Chairman Garrett. Then we shall do so, for 5 minutes.
Mr. Peters. Thank you, Mr. Perlmutter. I appreciate the
passing.
And thank you, Mr. Chairman.
Like some of my colleagues, I have a concern about some of
the SEC registration requirements that have been put on place
for private equity firms, in particular, the smaller and
medium-sized private equity firms.
During the consideration of the Dodd-Frank Act, I worked
with Mr. Meeks and Mr. Garrett on an amendment that would have
exempted private equity firms with up to $500 million in
assets. Unfortunately, we were only able to secure an exemption
for those under $150 million.
We did, however, include language directing the SEC to come
up with regulations that take into account the risks posed by
these smaller and mid-sized firms when the rules are actually
issued.
Private equity firms are not highly leveraged and are not a
source of liquidity in the markets. And just like venture
capital, many of these small private equity firms engage in a
buy and hold investment strategy designed to bring about
returns through long-term growth opportunities. Such funds
don't pose systemic risk to the financial sector and to the
larger economy.
I have concerns that treating a $200 million private equity
fund the same as we are treating basically multi-billion dollar
hedge funds doesn't make a lot of sense. And it certainly
doesn't make sense for those funds to have to spend hundreds of
thousands of dollars perhaps in compliance. And I have seen
some estimates of anywhere from $200,000 to $600,000 of
compliance for these private equity firms.
And that certainly to me doesn't seem to make a lot sense
for the SEC as well, with your very limited resources, and we
are hearing today all of the many demands on those very limited
resources that you are going to be required to spend money to
review these registration materials.
So, Ms. Rominger, first off, congratulations on your 16
glorious days with the SEC. But I would like ask you whether
you think you think small or medium-sized private firms do pose
the same risks either investors or systemic risks that a large
hedge fund may pose.
Ms. Rominger. Thanks, Congressman. That is a great
question. And one of the things I was surprised to learn,
actually, in joining the SEC is that somewhere over about half
of our registrants actually are below $150 million in assets
under management, which was a figure I wasn't familiar with,
but it does seem like there are quite a few registrants that
would fit into that size category.
I think that the principle is that our madate is to protect
investors, regardless of the type of portfolio strategy that
they are considering investing in, including private equities.
But clearly, we value input. We recognize the need to scale
our requirements to the complexity and the size of firms and to
be very attentive to the cost-benefit of a proposal. So we will
take all of that into consideration.
Mr. Peters. In listening to your answer there, if there are
firms that may pose more risk than others, does it make sense
to be treating them all the same way? Or will you definitely be
differentiating these in you rules?
Ms. Rominger. Again, ultimately it is a decision by the
Commission, but about half of our registrants would fall into
that category of having $150 million under management. The goal
has been to give investors the information that they might need
to make their investment choices, regardless of portfolio
strategy.
Mr. Peters. Although you would recognize portfolio strategy
does make a difference as to the amount of information that may
be necessary for an investor?
Ms. Rominger. Yes, clearly, there are differences in
complexity and different types of funds, yes.
Mr. Peters. So if that is the case, do you believe it would
be possible to come up with some sort of scheme where firms
that don't pose as much risk may file some just basic
information on Form ADV1 this July and delay maybe the
imposition of some further more burdensome and, as we can see,
potentially very costly requirements until we can put in place
a regulatory scheme that protects investors, which is first and
foremost, and the economy, but also doesn't waste SEC resources
by requiring firms to file detailed information that the
Commission doesn't need and, quite frankly, maybe investors
don't need?
Ms. Rominger. Those are very helpful comments and I look
forward to incorporating those comments and others into the
work that my team does, as I become more involved in the
process under way for these funds.
Mr. Peters. Good. I look forward to working with on that in
some future conversations. Thank you for your time.
Ms. Rominger. Thank you.
Chairman Garrett. I thank the gentleman.
The gentleman from Arizona, Mr. Schwiekert?
Mr. Posey?
Mr. Posey. Thank you, Mr. Chairman. That microphone--we
need to get it fixed.
If I understand correctly, despite the fact the SEC says it
is underfunded presently for its operations, the SEC is
promulgating a rule so that you are going to branch out and
regulate the environmental stewardship of companies within your
purview? Is that correct? Am I correct when I hear that?
Ms. Cross. I am not sure what you are referring to. Under
the Dodd-Frank Act, there are a few rules we are required to
adopt: one relating to Congo conflict minerals; one relating to
payments to resource extraction issuers to government; and one
relating to mine safety. Are those what you are referring to?
Mr. Posey. The information that I got is program-specific.
If that is all there is, then I am not really that concerned.
Ms. Cross. On the rule proposals, those are rule proposals
that we have out now that are required by the Dodd-Frank Act,
and we are in the process of getting comments on them. We don't
have any rule proposals with regard to the environment out,
besides those.
Mr. Posey. Okay.
Since I have been here, I have been seeking some sort of
accountability for the blunders of the Madoff scandal. I don't
think that is any secret at the SEC. And so far, to our
knowledge, there has been no discipline in the agency for
allowing Madoff to plunder all those victims. No one has even
been lectured, to our knowledge. No one has had their wrist
slapped. Of course, nobody has been fired or demoted or been
given any time off.
Most of the people that I represent think that is
abhorrent. They are offended by that and, quite frankly, I
don't blame them. It doesn't bode well for the agency that it
lets just a few incompetent employees cast such a bad shadow
over so many other employees, hopefully, who get up and try and
do a good day's work for their government every day.
I have heard it said by those who have watched some of the
other proceedings that it appears the agency is more concerned
with protecting incompetent employees than protecting consumers
on the street. And I think they arrived at that conclusion,
because each time I have asked the Secretary or somebody from
the agency what was happening in regard to accountability for
the negligence, ineptitude, or whatever it was with the
employees, they said, ``Well, we are still working on that. We
have a process we have to go through.''
And the IG made a pretty clear inference of what was wrong.
Books available in the public domain make it pretty clear the
depth and level at which people were involved. And at this
time, Madoff is in prison and we still can't slap the wrist of
an employee, and that just doesn't seem logical.
So when we look at going forward with a reformed agency,
you would think that the first step of reforming the agency
would be to establish some kind of accountability and
credibility from where we have been and where we are. You make
a plan. You say, where do we come from, where are we, where are
we going to go?
And I think without properly setting a foundation by
admitting some culpability or establishing some type of
accountability for the agency, you are just not going to get a
whole lot of sympathy and support that you otherwise would
have. I would like your comments on that.
Mr. Khuzami. Certainly, Congressman. Look, the experience
of the Madoff matter has left a deep imprint on the agency. And
I have said it in these halls before and I will say it again.
It was a horrible tragedy, and one for which we failed in our
mission and one for which we are doing many things across the
agency to rectify.
Speaking narrowly about the question of discipline, let me
just give you some numbers and some timelines just to put it in
context and then speak to the broader question.
The Inspector General's report identified a total of 56
people mentioned in the report. Since that time, 35 people have
left voluntarily. That leaves 21 persons. There are six
disciplinary proposals working their way through the system.
The reason it has taken some period of time, frankly, is
because no proceedings began until after the Inspector General
issued its report, which I believe was, give or take, September
of 2009.
Chairman Shapiro then ordered an outside law firm to
conduct an independent, full, and complete review with
recommendations, which took a period of time. Those
recommendations were then reviewed, and the process got under
way.
The process dictated by Office of Personnel Management
rules and regulations has certain protections and certain
procedures that have to be followed. We hope that we are close
to the end of that process, but I want the Congress and the
American people to know we are not turning a blind eye to this.
We understand the importance of it. We understand the
expectations of the American people, and we are prepared to
address it.
With respect to the broader issue, as I said, it has
informed so much of what all of us here have done since we have
arrived. My restructuring of the Enforcement Division, the
biggest one since 1972, was focused largely on the shortcomings
that were identified as a result of that and other matters,
increased expertise so that the people could understand complex
matters.
It wasn't just a Ponzi scheme. We do dozens and dozens and
dozens of Ponzi schemes every year. It was a complicated split-
strike conversion strategy having to deal with options, and
that is not an excuse. Mr. Markopolos identified the problems.
But what it did reveal was that we didn't have enough places to
go in order to fully understand, in that case, options trading
other types of expertise. So we have created specialized groups
in order to do that.
We understand that investment advisers who self-custody
their own assets are a potential warning flag. Accounting firms
that leave their engagement are potential red flags. So we are
doing things like canvassing all hedge funds for aberrational
performance. Anybody who is beating the market indexes by 3
percent and doing it on a steady basis, we are going to look
for them.
Mr. Posey. Let me interrupt because they are going to call
me out of time here in a minute. But my point is not the
future, but what we are doing about the misdeeds of the past.
If half the people no longer work there, that is not a
satisfactory discipline. That is not an answer.
I said one time it is like a pedophile leaving a
neighborhood and going to another neighborhood. And my response
is, they are all good people. I am not saying they are not good
people. I am saying I hope, I hope the nicest thing we could
say about them is they are incompetent. That is the nicest
thing we could say about them for allowing to happen what did
happen. And just saying they are no longer at the agency or we
don't know where they are, that is not satisfactory.
I think we would like to know where they are. Are they
investigating or examining for another agency? Or are they
retired? And it would just be good to know what happened to the
people who were identified and who the agency has admitted were
culpable in all this stuff, so that we don't--
Chairman Garrett. The gentleman's time has expired.
Mr. Posey. --put them in place.
Thank you, Mr. Chairman--for their failure.
Thank you.
Mr. Khuzami. Let me just--the only reason I raise this is
we don't have jurisdiction over people who are no longer at the
agency, with respect to disciplinary issues. But I understand
your request for the information about where they might be, and
I will see if we can provide it.
Mr. Posey. Thank you.
Chairman Garrett. The gentleman from Colorado?
Mr. Perlmutter. I thank the Chair. Let us just kind of try
to wrap this subject up. What disciplinary actions--in general,
without naming names, so that we don't have some kind of breech
that gives somebody who might be culpable in some fashion or
another something to discuss--are being taken, Mr. Khuzami?
Mr. Khuzami. At this point, Congressman, they are proposed
recommendations, and I think they range across sanctions from
counseling through removal from Federal service.
Mr. Perlmutter. Okay.
Mr. Khuzami. And let me--I just want to say one other
thing. Fifty-six people were identified in the report. The
report doesn't indicate that all 56 people engaged in
wrongdoing or somehow were responsible for what occurred.
Mr. Perlmutter. I understand that, but I guess what I want
to know, what Mr. Posey wants to know, even though he is sort
of editorializing a lot, is what actually is being done. And so
you said anywhere from some kind of disciplinary action,
removal from the SEC to some other kinds of things.
What are the kinds of penalties that these people could
suffer if you find that there was either gross negligence or
some kind of culpable action?
Mr. Khuzami. In a general matter, the disciplinary
recommendations span everything from counseling to reprimands
to suspensions to removal from service.
Mr. Perlmutter. And potentially, if somebody was found to
be on the take, there could be criminal actions as well, which
I am not saying there was any indication of that, but that is a
possibility too--
Mr. Khuzami. that is.
Mr. Perlmutter. --I would assume.
Mr. Khuzami. I will say the Inspector General's report, I
believe that there was no improper motive and no failure of
people to work long and hard--
Mr. Perlmutter. Okay.
Mr. Khuzami. --with respect to this matter.
Mr. Perlmutter. And just for chronological sake, this all
occurred in 2008 or before, right? Mr. Markopolos came to us
and said that in a span of 2000 to 2008, he had suggested to
the SEC on a number of occasions that there was something wrong
here.
Mr. Khuzami. That is correct.
Mr. Perlmutter. Okay. And since 2008, you have been
investigating and trying to come up with what actually
happened, correct?
Mr. Khuzami. Correct.
Mr. Perlmutter. I would ask the chairman if he could make
those slides available. You don't have to put them back up, but
I would like a copy of those, because I think they prove just
the opposite point that you would like them to prove.
Based on what I saw, there was a flat--there was no
increase 2005, 2006, 2007 into 2008 at a time when there was
inflation, and this agency did not have the cops on the beat to
stop the crash in any way that occurred in the fall of 2008,
which in my opinion caused millions of people to lose their
jobs.
So I would ask the chairman to make those available to all
of us, if he could.
Chairman Garrett. I will be glad to provide the charts to
you, which show, actually, a 10.8 percent year-over-year on
average between 2000 and 2011.
Mr. Perlmutter. That is why you have to have the bar chart
and your little line chart. You and I have spent some time in
the courtroom proving cases. I would like those charts.
My question to the panel as a whole is, what is happening
on nano-trading or high-frequency trading? What has happened
with any kind of investigation regarding that crash back last
May, with anybody?
Mr. Cook. I will take that, Congressman. As you know, the
SEC, jointly with the CFTC, studied the events around May 6th
and issued a report, a staff report in September. That will
continue to inform our review of high-frequency trading. It is
a review that began in January of last year as part of the
concept release that we had issued and it is, frankly, still
under review.
We also just received the recommendations from the Joint
Advisory Committee that was formed right around the time of the
May 6th flash crash. It helped advise us on cross-agency issues
and how to think about them. They have made a number of
recommendations. Many of them have already been implemented or
are well along the way to implementation, and others we will be
studying very closely as we move forward.
Mr. Perlmutter. Thank you.
And then I would just sort of finish with this, that at a
time when I feel like we are finally getting some confidence
back in the markets, the time when you all have been getting
your job done, my friends on the Republican side want to cut
your funding, reduce your funding. And this country suffered so
much in the last 2 years that that kind of effort is just the
wrong way to go.
So with that, I yield back to my friend.
Chairman Garrett. Your friend appreciates your yielding
back, even though we are cutting everyone's funding.
The gentlelady from New York?
Dr. Hayworth. Thank you, Mr. Chairman.
We are talking, of course, about the direct cost of
administering the enormous job that all of you have made all
the more so by Dodd-Frank. And I submit that another aspect of
considering the cost of the SEC, if you will, is how much what
you do requires from our issuers.
That is, obviously, the other half of the equation, if you
will, because for every regulation that you must promulgate and
assure that it is carried out, obviously, there is a whole team
on the other side, while you have been on those teams that have
to invest resources in compliance and, of course, also consider
the liabilities that are conferred by every new layer of
regulation with which they may find one or another snag.
I introduced the topic of Section 953(b) earlier, and I
would be eager for any of you to comment.
And I think, Ms. Cross, you may be the first in line
regarding the way in which it was written regarding what would
seem to be fairly conspicuous deficiencies in the way in which
it specified as it stand now in trying to determine--
Ultimately, the big concept is, is this really useful to
do, you know how do we--we can get into the weeds about
specifics, but is it ultimately going to provide useful
information? So whatever you can comment about the challenges
of getting to those specifics and about whether or not it
really should supplant the existing requirements regarding
compensation disclosure. So, please.
Ms. Cross. Thank you very much, Congresswoman. I have to
start by saying that the decision of whether this information
is useful is a policy call that is included in the Dodd-Frank
Act.
Our job at the SEC is to implement the requirements of the
Dodd-Frank Act in a manner consistent with investor protection
and all of our other missions, including a good cost-benefit
analysis and weighing the concerns that the registrant
community, the corporate community, is raising about this
particular proposal--or this particular requirement.
We have not done a rule proposal on this one yet. It does
not have a deadline under the Dodd-Frank Act, and we are doing
the ones with deadlines first.
We have an e-mail box where people have been putting in
their comments in advance, and we have had many meetings with
registrants. People are very concerned about this provision
being costly.
I have to say, I wish I had something else to say. It is
very prescriptive how it is written in the statute. It doesn't
actually give us leeway. It is written so that it has to be in
every filing, it has to be every employee, it has to be
compensation as calculated under Rule 402 the day before the
Act was signed.
I don't know that we have leeway. So we always want to
implement the rules in a way that is workable, but we have to
do what Congress has directed us to do. And so, I will say now
I have concerns about how workable we can make them.
Dr. Hayworth. And I appreciate your candid assessment. May
I challenge you just that little bit further to ask because it
is a legitimate question? Yes, we are the Congress. We can
change these things.
Would it make sense for us to undertake a change in that
requirement, perhaps even--I am not asking you advocate for its
elimination necessarily, but would it be reasonable to endeavor
to change it in ways that would presumably eliminate the
relative ratio of burden to benefit, if you will?
Ms. Cross. I am not speaking for the Commission. I am
speaking for myself. I think that if Congress wants to have
this pay ratio disclosure, the spirit of it, there are changes
you could make to it to make it less difficult.
I don't know that those would be consistent with the policy
behind it, but using the median employee is a complex thing. An
average is not as complex. Using the 402 calculation instead of
W-2--there are a lot of things you could think about that might
make this more workable.
But I do want to be careful, because the policy--I don't
want to undermine the policy if Congress has in mind--
Dr. Hayworth. I respect that, and I don't want to put you
on the spot in that way, but I respect all of you as experts.
You have lived these things, and we need to heed your thoughts
on these matters, because if we don't, then good intentions
lead to stasis at best and to harm at worse.
And there is a tremendous devotion of resources that could
really go into computing a median, assuming or determining a
median, assuming that we could actually successfully define all
the ways in which employees are designated, in which types of
compensation are fit into the calculations. Just a quick
reading of it--
Ms. Cross. It is a complex requirement, and I think that,
again, we have been working on our Dodd-Frank rulemaking
initiatives to balance where we can the benefits and the
burdens. In this instance, it is a very clear requirement, and
absent other direction, I believe that it is what it is.
Dr. Hayworth. Yes, ma'am. I am very grateful for your
guidance in that regard.
And I yield back my time, Mr. Chairman. Thank you.
Chairman Garrett. The gentleman from Virginia, Mr. Hurt?
Mr. Hurt. Thank you Mr. Chairman.
I want to welcome you all and thank you for being here.
Obviously, as we discuss your budget, we have to take into
account the fact that certainly the scope of your regulation
necessarily reflects what your requirements will be. And I
think that some of these discussions about the scope of your
regulation will help us figure out where we end up in terms of
funding for your agency.
And let me also thank you for your work, the important work
that you do.
I come from a rural district in Virginia and we have many,
many Main Streets all across this rural district. And the
relationship of small banks to our business community is the
lifeblood for job creation. I have places in my district that
have unemployment as high as 25 percent, so job creation is
very important, getting capital on the street is very
important, and you all know how important that is to job
creation.
With respect to the derivative regulation under Dodd-Frank,
obviously, small banks are going to be subject to new, clear
requirements under the SEC and the CFTC unless they are
exempted as end-users. And when you stop and think about the
high cost of regulations and the small part of the swaps market
that small bank comprise, I would like to know from you, Mr.
Cook, whether or not the SEC will exercise its authority to
exempt small banks as end-users?
Mr. Cook. Thank you, Congressman. The proposal that the
Commission issued with respect to end-users did include an
exemption for small financial institutions. This is an
exemption, as you may know, that the statute directed us to
consider providing to basically cover small banks and exempt
them from the mandatory clearing requirement.
That is in the proposal, so it is something we are
requesting comment on, and the Commission will take those
comments into consideration.
Mr. Hurt. Thank you.
My second question deals will be for Ms. Rominger, and it
deals with the private equity investment advisers. I know that
Mr. Royce and Mr. Peters have talked a little bit about it. And
you talked scalability. I would like to know a little bit more
about what you mean there?
I would subscribe to some of the same sentiments that have
been expressed with respect to private equity investment
advisers, and I think that overregulation of them could
certainly lead to lost opportunities to preserve jobs and
create jobs, because obviously at least a big part of what they
do relates directly to jobs.
And so I would like to hear more about the scalability
issue that you talked about. And I would also like to know
whether or not under Section 206A of the Investment Advisers
Act, whether or not you all would consider exempting private
equity firms pursuant to Dodd-Frank until Congress can take
further action with respect to that issue?
Ms. Rominger. Right now, it is my understanding that we are
receiving comments on the proposals. I have been impressed in
my short time at the Commission with the high degree of thought
and content that comes through in the comment process. And we
certainly will be very, very attuned to some of the issues that
you are mentioning and raising here and that will come through
in the comment process.
Mr. Hurt. Do you agree that you said the SEC has that
exemptive authority under the Act, and will the SEC consider
that?
Ms. Rominger. This is a matter that I look forward to
spending a great deal more time on with my staff--
Mr. Hurt. Is there anybody else who can help on this
question?
Ms. Cross. I don't think we have someone here at the table
who is familiar with what the exemptive authority might be
under this provision, but we would be happy to get back to you
with a written response.
Mr. Hurt. Okay. I would appreciate that. And in the event
that you are not, that is not something that is viewed to be
within the authority of the SEC, certainly I would ask you to
consider postponing the registration requirements to the extent
that can be done to allow Congress to give further guidance on
this issue.
Ms. Cross. And we are certainly happy to get back to you
with a written response.
Mr. Hurt. And one last question to anybody, but maybe we
can start with you, Ms. Rominger.
I am very concerned about the implementation of Dodd-Frank
and the hundreds of new registrants that will suddenly have to
be regulated. Have there been any efforts to identify what kind
of burden this is going to be on the States, who also have in
many cases concurrent jurisdiction over these matters? Are we
going to be passing huge, unfunded mandates down to the States
when we suddenly have this increased registration? And that
could go to anybody.
Ms. Rominger. Their degree of preparedness, I would
imagine, spans a range. And I certainly hope that they would be
prepared to take this on.
Mr. di Florio. I would just add in addition to what Ms.
Rominger said, there has been an ongoing dialogue between the
SEC and the States regarding the transfer of private fund
advisers under $100 million. And the States--we get calls bi-
weekly to talk about the transfer and the readiness around that
transfer.
The States are very organized in regard to their strategy
with regard to those advisers. So there is an ongoing dialogue
that is cross-functional in the agency with the States about
that transfer.
Mr. Hurt. Mr. Chairman, could I just follow up?
Mr. Schweikert. [presiding] The time has expired.
Mr. Hurt. Thank you.
Mr. Schweikert. But if Congressman Stivers would like to
yield you some time, he is more than welcome to do so.
Congressman?
Mr. Stivers. Thank you, Mr. Chairman.
Thank you to the panelists for coming today, and I would
like to thank you for what you do to regulate the securities
industry.
And I just want to kind of put all this budget stuff in
context. America is broke. We are running at a $1.5 trillion
annual deficit, and we have a $14 trillion national debt. And
my daughter Sara, who is 18 months old, owes $45,000 as her
share of the national debt.
I am not asking about your specific expenditure here, but
how many of the panelists think it is morally okay for us to
borrow $1.5 trillion from our kids every year? If you do think
it is okay, raise your hand, because I don't think it is okay,
and I don't see anybody raising their hand.
I know that you are required to do a lot of new things
under Dodd-Frank, so I am not trying to be negative here. You
are required to create 123 new rules. You are required to do 32
new studies. And I guess my point is during this time of really
expansive government and, frankly, in a time when we can't
afford everything we are doing, I think it is a time to really
focus and prioritize, so I wanted to ask some questions about
that.
Has the SEC looked at all its activities and tried to
recommend things that can be cut or reduced or savings that can
be found in the SEC, because maybe you have and I haven't seen
it, and I don't know the right person to ask. Would anybody
like to take a shot at that one?
Ms. Cross. I can start us off. We are just now going to be
receiving the recommendations from the study that was done of
our organizational structure from the Boston Consulting Group.
And we will very carefully review those recommendations and see
what cost savings are available from that. I think that will
be--
Mr. Stivers. That is a great answer. Thank you. And I
appreciate you doing that.
Ms. Cross. Okay.
Mr. Stivers. Second question, do you do cost-benefit
analysis on every rule that you perform, and do you make that
public?
Ms. Rominger. Yes, we do, for rulemaking. In the second
half of the rules after we describe in the beginning of the
release what the rule proposal is, the second half of it
includes a robust cost-benefit analysis. And we have a new
Division of Risk, Strategy, and Financial Innovation that has
top-notch economists in it, who help us with that.
We get public comment on the cost-benefit analysis and
often make changes to our final rule based on the comments we
receive on a cost-benefit analysis.
Mr. Stivers. Thank you.
I know that under Dodd-Frank there was language that
required you to look at the fiduciary duty. And broker-dealers
are currently just under a suitability standard for investors,
and there is a proposal to take them to a fiduciary standard,
fiduciary duty standard.
I have seen studies that say that will increase costs for
consumers and increase litigation. Have you looked at that as
part of your cost-benefit analysis with regard to that
particular regulation?
Mr. Cook. We haven't issued any proposed rules on that. And
there is no statutory timeframe to issue the proposed rules, so
if the Commission does issue proposed rules, there will be a
cost-benefit analysis of that.
Mr. Stivers. And it will include the potential increased
cost of litigation and increased cost to consumers of changing
that standard for broker-dealers?
Mr. Cook. We will work with our economists to take into
account all of the direct costs.
Mr. Stivers. I would like to ask you to specifically take a
look at that.
Now, I would like to look at something that Mr. Royce, Mr.
Peters, and Mr. Hurt have all talked about, and that is private
equity funds. We have a lot of mezzanine-based funds in all our
jurisdictions that help create jobs. I have one, for example,
in my area, and they do all FDIC funds now, but they have some
old legacy funds that would require them to register, because
they don't get an exemption if they have any non-FDIC funds.
But they--frankly, it would cost them about $300,000 to
register and then about $50,000 a year in round numbers on an
ongoing basis. Is there any thought--and those old funds are
obviously just running off--to taking a look at folks like that
and saying okay, you kind of meet the spirit here?
Ms. Rominger. This is why it is so valuable to get feedback
through the comment process. And your points are well taken.
Mr. Stivers. Great.
And the last question on derivatives. I want to thank you
for what you have done on derivatives regulations in a very
thoughtful way that looks at the Securities and Exchange Act of
1934, has similar definitions to the Act, but the CFTC has not
been as thoughtful.
Are you working with them to harmonize things? And you can
give me a yes or no, because I am out of time.
Mr. Cook. Yes.
Mr. Stivers. Oh, good.
Mr. Cook. We have certain rules that we have to issue
jointly, and there are certain rules that we are seeking to--we
have to collaborate and reach a comparable result where it is
appropriate, so we will be working with them to--
Mr. Stivers. You recognize where your roles today--
Mr. Cook. We recognize that there are some differences, and
we recognize we need to focus on that in terms of reducing the
burdens on the industry.
Mr. Schweikert. Thank you, Mr. Stivers, and Mr. Cook.
The Chair is going to take the next couple questions. Why
not?
Mr. Cook, just particularly because you happen to be in the
center and have actually one of the areas I am most interested
in, in your budget mechanics, how much of your Division or your
area is going into data and using data mining to find
compliance? How much is moving in improving your technology
chewing up your budget?
Mr. Cook. Right now, not enough, certainly. One of the
areas that we are weakest on, frankly, is our ability to
monitor the market and to obtain the types of data from the
market that, frankly, many of the trading firms get today on a
routine basis.
The value of getting that data is to help us understand
market quality, market metrics. And it is a very cumbersome
process today to bring that all in from many different trading
platforms. May 6th was a good example of the challenges that
data presented, and so one of the things we would like to build
out is a better analytics and data analysis capability to be
able to respond to those sorts of things.
Mr. Schweikert. You sort of beat me to where I was going
with that. Doesn't part of this sort of data mining, data
aggregation already exist in the private marketplace?
Mr. Cook. The capacity to bring together and analyze
quickly some of the data that is out there in the market in the
private sector is quite significant in some firms.
Mr. Schweikert. I expect much of that is proprietary, so
has there been the discussion of not completely having to
reinvent the wheel?
Mr. Cook. Absolutely.
Mr. Schweikert. Can you contract or buy, whether it be on
the other side of the Chinese wall, but having even a
contractor provide you those data and that access and their
analytics?
Mr. Cook. Yes, sir. There certainly are challenges in this
area in terms of being a regulatory agency and how much of that
sort of relationship it makes sense to develop with a private
firm. However, we are certainly interested in considering all
avenues with an eye to what is going to be most cost effective,
frankly.
We issued a request for information last year to learn from
potential providers of software and a data analytics tool--what
is available out there that we could buy off the shelf. How
much would it need to be customized to be able to serve our
needs?
Mr. Schweikert. My concern is having been on both sides of
that equation, when you hire programmers and build it or
contract it out, it always seems to take much longer and much
more expensive. It would be fascinating if the marketplace has
products that you could actually capture. You would obviously
respect the proprietary, because--
I didn't know if that is a path you had been looking at.
And that is true for all the Divisions. Is this a common issue
across all the different layers?
Mr. di Florio. It is a common issue, certainly, I think,
across the entire SEC, Congressman. And your point is well
taken.
We have made two very positive developments very recently
of bringing on a new COO and a new head of IT, both who come
from the private sector and have spent significant time with
massive data aggregation analytics and are very knowledgeable
about the systems that are out there. We will certainly be
leveraging them to inform the process going forward.
Mr. Schweikert. And I probably need to do this quickly.
Does anyone else want to touch this one?
Mr. Khuzami. I could just give you one small fact that
shows the challenges that we face in this area. We get three to
four terabytes of information on average per month in the
course of our investigations in the Enforcement Division.
The entire Library of Congress print book edition is 20
terabytes of information. We get massive amounts of data, and
we don't have the capability to do the kind of data analytics
that we should be doing on that information in order to make
sure we have it all, we extract the useful information, we see
that patterns and relationships that are necessary.
Mr. Schweikert. Okay. I am going to try and do a couple of
these other bits quickly, but part of the reason for that
question is I know we are discussing budget and growth, but I
have also seen many very efficient regulatory agencies, the
ability to use data and their data sets as the greatest cost
savings account.
But it is getting over the hump of that programming and
what is out there. And in 25 seconds, Mr. Cook, talk to me
about some of the muni conflict of interest regs that are
coming.
Mr. Cook. The MSRB that you may be referring to is a
proposal that they are working on to deal with the registration
and regulation of muni advisers and to address the situation,
so-called hat-switching where someone might serve as an adviser
to a municipal entity and then switch and become an
underwriter.
Mr. Schweikert. Okay. For me to be respectful to my fellow
members, without objection, I would like to go to a second
round, and I was going to give the next 5 minutes to the
gentlewoman from New York.
Ms. Waters. I don't need the 5 minutes, so you may give
them to Dr. Hayworth.
Mr. Schweikert. Thank you.
The gentlewoman from New York?
Dr. Hayworth. I thank the chairman and the gentlelady from
California.
Section 975 of Dodd-Frank, of course, as you know, requires
that municipal advisers register with the SEC. And in May of
2009, the head of SEC's Office of Municipal Securities said
that establishment of the program would be easy because there
would probably only be about--the number is here only about 260
non-broker-dealer municipal advisers.
But since the SEC has now written the rules, they actually
encompass thousands more individuals, with some interesting
exemptions, including engineers who provide engineering advice,
government officials regarding strategies to improve energy
efficiency in government buildings, that they would be subject
to registration and disclosure rules.
It is striking that there is so much potential for you to
create definitions that may be ripe with potential for
skirting, if you will, or getting around them. How do you make
them fair without incurring--again, I keep going back to the
cost of these promulgating these regulations. How do we keep
things fair and reasonable, rational?
Do you feel as though you are able to have a voice in how
these things in away that won't confer unusual costs on our
municipalities that have to deal with these things and on the
engineering firms who provide these services?
Mr. Cook. Thank you, Congresswoman. It is a challenge in
this area to get it right, I think, because we don't want to
inhibit the certain sorts of functions that occur day-to-day
that aren't really our fight.
In terms of that estimate you mentioned, I think that may
well have been based on both a different set of data than we
have today and also a different standard of what it means to be
an adviser. I think that estimate may have been based on
estimating how many independent entities out there that are
advisers and a different definition. The statutory definition
is somewhat broader than that.
But the muni adviser definition rule has been proposed, has
not been adopted. We have gotten a lot comment letters on it,
and we are going to be looking at those very carefully.
Engineering is one area where we have received some
comments. We actually did include an exception for engineers
providing engineering advice. But, of course, it begs the
question as well, what does that mean? What are the services
that are ancillary to engineering?
And I think what we want to try to do is provide the
guidance people need to have legal certainty to be able to
continue functioning and providing valuable services that were
never intended to be registered as advisers, but at the same
time not create exceptions that overwhelm the rule. So that is
the challenge, and we certainly are benefiting greatly from the
comments we have received on it.
Dr. Hayworth. And I appreciate that. It would seem that
drawing rules so very broadly again will lead to that problem
of contributing to stasis, conferring excessive costs, getting
in the way of progress, ultimately impeding effective
government that can be cost-effective and can free resources
for job creation, which is what we are talking about.
I hope that you will be able to bring to bear, and
certainly I think this committee would like to help you bring
to bear, a great measure of common sense. I do get the sense
from all of you that you have a lot of common sense.
And I want you to feel free, speaking for myself, but I
think I speak for the members of the committee, to feel free to
tell us in addition to the comments you get from the public,
which are very important, but please tell us what we can do on
the statutory side to make it possible to fulfill a mission
without tying everybody up into such knots that we get less
done than we should.
Thank you.
Mr. Chairman, I yield back.
Mr. Schweikert. Dr. Hayworth, thank you for the 5 seconds.
And you always speak for the committee.
Mr. Hurt? A couple of minutes.
Mr. Hurt. Thank you, Mr. Chairman
Just a brief follow up with Mr. Di Florio, who was talking
about the communications with States. What has been the forum
for that? And you indicated that there was regular contact.
What has been the forum for that?
And do you have any cost estimates? Have they expressed to
you cost estimates of what it is going to take for them to
comply with the kind of trickledown effect of Dodd-Frank at a
time when States are having a terrible time balancing budgets?
At least they balance the budget.
Mr. di Florio. Congressman, the forum has been bi-weekly
teleconferences. The party has been NASAA, which has been
organizing on behalf of the State regulators, and they have not
shared specific cost estimates in the context of those
discussions.
Mr. Hurt. Okay. If you get information about that, I would
certainly be interested to know, and I guess we can contact
that agency ourselves.
And then just to follow up, Ms. Cross, thank you very much
for your offer to provide information. I think it was you who
offered to provide information relating to the exemptions for
private equity firms. And I certainly look forward to receiving
that. Thank you very much for your time.
Mr. Schweikert. Thank you, Mr. Hurt.
The chairman now yields himself, let us see, the next 6
hours? You notice that no one--they are just not sure. I am so
sorry. I am going to give myself just a couple of minutes,
because I really want to come back.
You talked about your comments starting to light up when
you did some of the muni. So did my e-mail, and on many
different levels. One of the questions that was coming at me
was from those folks who are already--broker-dealers,
investment advisers in the banking world--regulated. What will
the proposed rules and how will it touch those folks.
And then there is the other side of that, the proposed
rules and where you think it is going to go in regards to
influence of the municipality to go out and bond or do a
defeasance, these sorts of things.
And I am going to start with Mr. Cook, and we will move
around to who has something to share.
Mr. Cook. The proposed definition does have carve-outs for
certain other regulated entities like investment advisers and
the like, but the area of overlap is something that we will
have to be sensitive to.
I know one issue that has been raised, for example, is that
banks, who are holding deposits for a municipality, cash
deposits, have expressed concern that the definition of
municipal adviser would include providing advice about that
cash deposit. So that is an issue we are focusing on and
talking to other regulators about and will--
An example, I think, of the point you are raising, is that
there may be overlapping regulation and therefore not a need to
impose a new regime on certain sorts of entities--
Mr. Schweikert. Mr. Cook, I know you guys are going through
sort of the modeling of what is the rule.
But in my experience as having been a country treasurer,
okay, over here I have the law firm that is also doing some of
the advising to the municipality. Okay, on the same side,
somewhere on the other side of the Chinese wall, you may have
lawyers who are also representing the property owners or some
of the others they may part of that general obligation. Over
here is the law firm that is helping move some money around,
but what if that law firm is also providing certain other
banking services?
I know we have a web here where a lot of these folks are
touching each other. And I have a real concern, if this is
really a discussion about budget, how do you guys write rules
that are effective and work--at the same time also don't blow
up your budget and make you have to come back to us and say
please, we need more resources?
Mr. Cook. I will take a stab at that. I think it is a
challenge, but I think what it means is that we need to be very
thoughtful. And I think the tools we have are the common
process, which is enormously important to help identify issues
that may be raised by the rules that we propose, taking the
time we need to get it right, and frankly, a sense of humility
about what we know and what we don't know.
And I think that is some of the leverage we have to try to
make sure that as we, given the resource constraint environment
we are in and the obligation nevertheless to promulgate certain
rules, that we strike the right balance.
Mr. Schweikert. Does anyone else wish to touch this one?
Give me--and we will try to finish up here in the next couple
of minutes so you can at least go get some lunch--share with me
what you think is the biggest crisis within that market, within
the muni market and the folks providing the advice? How big of
a distortion do we have?
Mr. Cook. We have seen some instances, and I don't know if
there may be some on the enforcement side, if you mean what are
the--
Mr. Schweikert. The problem that we are trying to fix.
Mr. Khuzami. I think that the concern is that people who
would be advising municipalities about both the issuance of
their securities and the product that they could invest the
proceeds in are not subject to oversight now in the same way
that advisers to you or me or anyone else providing similar
sorts of investment advice are.
And that can lead to concerns such as conflicts of
interest, whose interests are they really acting in? I believe
that was the policy rationale behind the act.
Mr. Schweikert. In that case, just having spent some time
in this world, I saw some issuances--actually they were, I
think, defeasances at the time--where the fee was pretty close
to almost what was being saved. So in that case since you are
doing the rulemaking, in many ways it is how do you get access
to who is actually receiving compensation.
And, motivation is there and the disclosures that come with
that, and I don't know if that creates a much more narrow cap.
My fear was you would get the bad guys, but don't do something
that blows up your budget, because now you are touching so many
people who are two or three off.
Mr. Cook. Right. And it is not just our budget. It is the
costs imposed on those people who weren't intended to be
covered by the statue.
Mr. Schweikert. All right. Does anyone else have anything
that they are burning to share? You have been a wonderfully
cooperative group. And, actually, what you do is absolutely
fascinating, being a freshman Member reading all the things you
touch.
And some of it is impossible, and I am not sure it is
necessarily money-based, as the scale of the markets seem to
change and move faster than often we can never catch them. And
that is why my fixation on you having data mining abilities,
because in many ways, this may be about technology and data,
and not necessarily the old shoe leather world of regulation.
And I am trying to convince my brothers and sisters around
here that it is time to step into the next century of
technology.
With that, the Chair notes that some members may have
additional questions for this panel which they may wish to
submit in writing. 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.
Thank you for spending time with us today.
[Whereupon, at 12:28 p.m., the subcommittee was adjourned.]
A P P E N D I X
March 10, 2011
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