Semiannual Report to Congress: October 1, 1994 to March 31, 1995
March 31, 1995
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1995 Semiannual Report to Congress
April 1995
EXECUTIVE SUMMARY
During this reporting period (October 1, 1994 to March 31, 1995) the Office of Inspector General (Office) completed seven audits and nineteen investigations. In addition, three audit memoranda and three reports, making management recommendations arising from investigations, were issued.
Program audits of the efficiency and effectiveness of program operations, involving the Filing Activity Tracking System and Market Contingency Preparedness, were completed. Program and administrative management controls in two regional offices were audited during the period. Recommendations on the selection of receivers in enforcement cases were also made to program management.
Administrative findings and recommendations concerning space management (Appendix A contains additional details), information technology, contractor lobbying, and the imprest fund were also reported during the period.
We referred two investigative matters to the Department of Justice. One case involved voucher forgery. The other matter concerned time and attendance abuse.
Four matters were referred to the Commission. The staff involved in two of the matters resigned from the Commission before administrative action could be completed. One person was reprimanded; the other matter is pending.
We remain very concerned that the Commission does not have adequate, tested disaster recovery plans or resources for its Electronic Data Gathering and Retrieval (EDGAR) system. Until contingency backup plans are developed, resources obtained, and recovery procedures tested, the loss of this critical function remains a real and significant risk to the Commission's program operations.
The Inspector General testified before the Subcommittee on Commerce, Justice, State, and the Judiciary of the House Committee on Appropriations. The purpose of the testimony was to assist the Subcommittee in identifying budgetary savings and spending reductions in the Commission's budget request.
All Office audit reports and our Semiannual Reports to Congress will be available on IGNet. Commission staff will also have access to these documents through the OIG Bulletin Board carried on the Commission's Local Area Network (LAN).
AUDIT PROGRAM
The Office issued seven audit reports and three audit memoranda, as well as three investigative reports with management recommendations, during the reporting period. A total of seventy-two recommendations were made in these reports, which are further described below. Management generally concurred with the recommendations.
Market Contingency Preparedness
We evaluated Commission preparations for responding to unusual market events (e.g., a sudden and significant drop in market prices) and operational difficulties (e.g., problems with the exchange computers that track securities trades). Our audit focused on two Commission guides: the Market Volatility and Contingency Guide (MVCG) and the Quick Understanding of Industry Contingency Controls (QUICC) Guide.
During the audit, we interviewed Commission and Self-Regulatory Organization (e.g., the New York Stock Exchange) staff, reviewed available documentation, and observed operations and communications in the Commission's Market Watch room. We also conducted a survey of Commission staff working in the area.
We found that over the last several years, the Commission significantly enhanced its capabilities for responding to market events, and that further enhancements were planned. In addition, we found that the MVCG and the QUICC Guide were generally accurate and useful.
Overall, the Commission appeared to have made adequate preparations for responding to unusual market events, to the extent such events can be reasonably foreseen. It also showed a willingness to continually improve its preparations, based on its experience. We commended the Commission for its efforts.
We recommended that the Commission implement its planned enhancements, make certain additional changes to its contingency guides, and schedule periodic training on market events for senior officials. Generally, the Division of Market Regulation concurred with our report.
Filing Activity Tracking System
We audited management controls over the Filing Activity Tracking System (FACTS), an automated information system in the Division of Corporation Finance. We sought to determine if the controls ensured data integrity and accuracy, and if the system met user needs.
During the audit, we interviewed Division staff, reviewed available documentation, and conducted tests of a sample of FACTS entries. We also surveyed FACTS users on the utility and adequacy of the system.
Generally, we found that the controls were adequate and the system met user needs. We recommended several enhancements, however, including improving procedures to delete users who leave the Division, minimizing duplication with another information system (Workload), and putting the FACTS manual on-line.
The Division generally concurred with our findings and is taking appropriate action to implement our recommendations.
Office of Space Renovation
The Office of Inspector General (OIG) contracted with an independent CPA firm (Cotton & Company) to evaluate the management controls in the Office of Space Renovation (OSR). The objectives of the audit were to determine if the OSR controls provided reasonable assurance that contract and lease administration practices comply with appropriate laws, rules, and regulations and were efficient and effective.
The audit found that, although desirable space had been obtained at competitive rates, OSR (a relatively new office) had not developed comprehensive policies and procedures. As a result, a number of important problems had been encountered. In contracting for its largest space rental to date, OSR procured more office space than needed for current staffing (in anticipation of new legislation); carried out the project without signed contracts; used landlord funds (i.e., the Tenant Improvement Allowance) to purchase furniture and equipment; supplemented landlord funds with unspent year-end appropriated funds; and maintained incomplete and unorganized project records.
The principal recommendation was that OSR enhance its controls by developing a comprehensive set of regulations to assist it in resolving issues efficiently and effectively. The Office of Space Renovation generally concurred with the recommendations, although they did not agree with all of the findings.
Survey of Information Technology
The primary objective of the survey was to gather information about the Office of Information Technology (OIT) to assist in strategic audit planning. We also sought, where feasible without detailed testing, to identify possible enhancements to OIT's operations. During the survey, we interviewed OIT and other Commission staff, reviewed selected documentation, and observed computer room operations. Only limited tests of certain security functions were conducted.
During the survey, we identified several possible enhancements to OIT's policies and procedures. These included improving access controls for the headquarters computer room; developing detailed information on the Commission's software applications; and issuing security guidance, among other matters. Management generally agreed with our recommendations, and is taking steps to implement them.
Midwest Regional Office
We performed an audit of the administrative and program controls in the Commission's Midwest Regional Office (MWRO). The audit found that MWRO controls were generally functioning adequately. We recommended certain improvements, however, including that the MWRO should document its market searches and justify use of sole source procurement for purchases; periodically reconcile its records with the Comptroller's; formally appoint an ADP liaison; and tighten controls over the transit subsidy program, among other improvements. It should also assist in the development of guidance for investment company/investment adviser inspection workpapers.
Generally, the MWRO agreed with our findings and recommendations, and began corrective actions.
Southeast Regional Office
We performed an audit of administrative and program controls in the Southeast Regional Office (SERO). We found some SERO administrative controls needed improvement, especially in view of SERO's recent upgrade from a branch to a regional office. The new SERO Regional Director had already identified weaknesses in the office's administrative practices, and was taking steps to improve them (e.g., by hiring a new Administrative Officer).
We commended the SERO for its efforts to improve administrative practices. Additional recommendations were made with respect to travel, property, time and attendance, budget and accounting (including the imprest fund), transit subsidies, data processing, and personnel. Recommendations were also made concerning case management and examination tracking program controls.
From a Commission-wide perspective, the most significant finding concerned travel advances. After determining that SERO staff held unnecessary advances, we extended the scope of our audit work to all Commission staff. We found that approximately $110,000 in unnecessary travel advances was outstanding. We recommended that the Comptroller's Office collect these funds. Generally, management concurred with our findings and recommendations.
Contractor Lobbying Statute - 1994
As required by statute, we evaluated Commission compliance with the lobbying disclosure requirements. Our review included discussions with contracting staff in the Office of Administrative and Personnel Management (OAPM), and analysis of eleven fiscal year 1994 contracts subject to the requirements.
We found that OAPM incorporated the appropriate Federal Acquisition Regulation clause in the eleven contracts reviewed. OAPM also submitted the required Semiannual reports on lobbying activities to the Congress during fiscal year 1994. OAPM concurred with our findings. No recommendations were made.
Audit Memoranda
Three audit memoranda were issued during the period. These memoranda are used to transmit recommendations to management concerning control issues that arise outside a formal audit but need to be addressed promptly.
The audit memoranda recommended that: the payroll system software be modified to block inappropriate access to data protected by the Privacy Act; software needed to protect regional computers in the event of a power shortage be procured and used; and passwords controlling access to data processing reports be kept non-public and changed regularly. Management generally concurred with the recommendations.
Investigative Reports with Management Recommendations
Three investigative reports, making audit-like recommendations to management, were issued during the period. These reports are public and do not contain allegations, evidence, and names of subjects, but rather focus exclusively on corrective actions needed to strengthen controls. More traditional referral reports to management, Justice, etc. are also issued, as appropriate.
Recommendations were made with respect to: imprest fund controls, selection of recommended receivers in Enforcement cases, and leasing contracts.
INVESTIGATIVE PROGRAM
Nineteen investigations were closed during the period. The Office referred two of the matters to the Department of Justice and four matters to Commission management. The most significant cases are described below.
Exercise of Commission's Independent Leasing Authority
We completed an investigation of a number of allegations of misconduct and performance related to the leasing program (see Appendix A for details). The investigation earlier resulted in a referral to management of an apparent conflict of interest. Our final report made recommendations to strengthen controls over leasing contracts and recognized a Memorandum of Understanding between the Offices of Executive Director and General Counsel regarding the respective roles of the offices in contracting matters.
Unauthorized Outside Employment
Evidence indicated that a Commission attorney represented a private party in court without authorization. This is prohibited under the Commission's Rules of Conduct. The staff member resigned before administrative sanctions could be served.
Physical Threats/Time & Attendance Abuse
An employee made threats of physical violence to supervisors and other staff. Our investigation also indicated that the staff member regularly clocked in at a second job without sufficient time to travel, assuming the employee left the Commission on time. The employee resigned while administrative action was being taken.
At the close of the period, fourteen investigations were pending. The investigations include allegations of:
- Failure to supervise, allowing time & attendance abuse,
- Receipt of a bribe,
- Unauthorized disclosure of non-public documents,
- Misuse of a government facility,
- Theft,
- Misuse of official position,
- Unauthorized outside employment,
- False statements,
- Intellectual property infringement, and
- Procurement irregularities.
SIGNIFICANT PROBLEMS
No new significant problems were identified during this reporting period.
SIGNIFICANT PROBLEMS IDENTIFIED PREVIOUSLY
We remain very concerned that the Commission does not have adequate, tested disaster recovery plans or resources for its Electronic Data Gathering and Retrieval (EDGAR) system. Until contingency backup plans are developed, resources obtained, and recovery procedures tested, the loss of this critical function remains a real and significant risk to the Commission's program operations.
The lack of a long-term disaster recovery plan for the EDGAR system had been previously reported. During this reporting period, the Commission purchased additional EDGAR computers to provide a disaster recovery capability. However, an EDGAR disaster recovery plan has not been developed and the computers have not been tested. Moreover, procedures for manual, paper backup of EDGAR, as the automated system is being phased in, have not been developed or tested.
ACCESS TO INFORMATION
The Office of Inspector General has received access to all information required to carry out its activities. No reports to the Chairman, concerning refusal of such information, were made during the period.
OTHER MATTERS
Testimony of the Inspector General
The Inspector General testified concerning the Commission's 1996 appropriation on March 1, 1995. The testimony was before the Subcommittee on Commerce, Justice, State, and the Judiciary of the House Committee on Appropriations. The purpose of the testimony was to assist the Subcommittee in identifying budgetary savings and spending reductions in the Commission's budget request. A copy of the written testimony is attached as Appendix B.
OIG Semiannual and Audit Reports are on IGNet
Starting last period, all audit reports and OIG Semiannual Reports to Congress will be on IGNet. The previous Semiannual Report and audits completed since October 1, 1994 were submitted to IGNet during the period.
Commission staff will have access to these documents through a bulletin board carried on the Commission's Local (Wide) Area Network (LAN), as well as through IGNet.
Executive Council on Integrity and Efficiency
The Office actively participates in the activities of the Executive Council on Integrity and Efficiency (ECIE). The Inspector General attends all ECIE meetings and is an active member of several of its committees including the Peer Review and Financial Institutions Regulatory committees.
The Counsel to the Inspector General is a member of the President's Council on Integrity and Efficiency, Council of Counsels. The Council considers legal issues relevant to the Inspector General community.
QUESTIONED COSTS
|
Number |
Dollar Value |
|||
|
(in thousands) |
||||
|
Unsupported |
Questioned |
|||
|
Costs |
Costs |
|||
|
A. |
For which no management decision has been made by the commencement of the reportingperiod |
3 |
37 |
[ 52 ] |
|
B. |
Which were issued during the reporting period |
0 |
0 |
[ 0 ] |
|
Subtotals (A + B) |
3 |
37 |
[ 52 ] |
|
|
C. |
For which a management decision was made during the reporting perperiod |
1 |
0 |
[ 8 ] |
|
(i) dollar value of disallowed costs |
1 |
0 |
[ 8 ] |
|
|
(ii) dollar value of costs not disallowed |
0 |
0 |
[ 0 ] |
|
|
D. |
For which no management decisionhas been made by the end of the reporting period |
2 |
37 |
[ 44 ] |
|
Reports for which no management decision was made within six months of issuance |
0 |
0 |
[ 0 ] |
RECOMMENDATIONS THAT FUNDS BE PUT TO BETTER USE
|
Number |
Dollar Value |
||
|
(in thousands) |
|||
|
A. |
For which no management decision has been made by the commencement of the reporting period |
0 |
0 |
|
B. |
Which were issued during the reporting period |
1 |
110 |
|
Subtotals (A + B) |
1 |
110 |
|
|
C. |
For which a management decision was made during the reporting period |
1 |
110 |
|
(i) dollar value of recommendations that were agreed to by management |
1 |
110 |
|
|
- based on proposed management action |
1 |
110 |
|
|
- based on proposed legislative action |
0 |
0 |
|
|
(ii) dollar value of recommendations that were not agreed to by management |
0 |
0 |
|
|
D. |
For which no management decision has been made by the end of the reporting period |
0 |
0 |
|
Reports for which no management decision was made within six months of issuance |
0 |
0 |
REPORTS WITH NO MANAGEMENT DECISIONS
Management decisions have been made on all audit reports issued before the commencement of this reporting period (October 1, 1994).
REVISED MANAGEMENT DECISIONS
No management decisions were revised during the period.
AGREEMENT WITH SIGNIFICANT MANAGEMENT DECISIONS
The Office of Inspector General agrees with all significant management decisions.
APPENDIX A
SUMMARY OF WORK RELATED TO THE COMMISSION'S EXERCISE OF INDEPENDENT LEASING AUTHORITY
In 1990 the Commission received statutory authority from Congress to independently lease office space for its needs. Beginning in 1991, the Commission, this Office, Congress, and the General Accounting Office received numerous anonymous and attributed allegations concerning a wide range of matters involving the exercise of this authority.
This Office, GAO, and the Office of Special Counsel conducted a series of investigations and audits into these matters (as described below). Generally, this work identified some serious control weaknesses. Recommendations to strengthen the controls have been or are being implemented.
However, allegations concerning these matters continue to be received. At our recommendation, the Commission recently conferred with the Public Integrity Section, Criminal Division of the Department of Justice about all of the allegations and the reviews to date. This provided Justice an opportunity to advise the Commission as to the appropriateness and sufficiency of the Commission's response.
Office of Inspector General Investigations
In fiscal year 1993, the Office began an investigation into numerous allegations regarding Commission leasing. The allegations, which primarily concerned a proposed headquarters lease, included: alleged conflicts of interest, bias against certain bidders, violations of the Federal Acquisition Regulation, circumvention of the role of the General Counsel in processing contracts, misrepresentations to Congress, inadequate performance of a contractor, insufficient justification for initial selection or continued retention of a contractor, retaliation against a whistleblower, failure to assign leases from GSA to the Commission, and improprieties in construction of the headquarters fitness center.
The investigation did not provide sufficient evidence to substantiate most of the allegations. We referred an apparent conflict of interest to management. In addition, we identified several non-conduct issues, including violations of sound contracting practices and a need to clarify the roles of the Offices of the Executive Director and the General Counsel in leasing matters. These issues were addressed in a public report (OIG-117), issued in March 1995. Management is taking corrective action on this report.
During the investigation, a purported whistleblower filed a formal complaint with the Office of Special Counsel. The complaint is currently pending.
Many of the allegations initially investigated by the Office were also made to then Chairman John Dingell of the House Energy and Commerce Committee. He requested an investigation of the allegations by the General Accounting Office. Investigators and auditors from GAO were briefed on our investigation several times over the course of our work. They also reviewed our reports of investigation.
Office of Inspector General Audits
Anonymous allegations were received in 1991 that the Commission's (then) plans to relocate computer facilities to a new operation center were motivated by the (then) Chairman's personal desire to occupy the space for an office. In June 1991, we issued a report (Review 164) of our review of the plans to lease space for the Commission's Operations Center in Alexandria, Virginia. We concluded that the proposed move seemed reasonable.
In response to additional allegations, the Office contracted with an independent public accounting firm (Cotton and Company) to conduct two audits of leasing matters. The first of these audits (Audit 210 issued on September 29, 1994) focused on the leasing of Commission office space in New York City. It identified questioned costs of $7,655 and unresolved costs of $207,389. This audit was included in our last Semiannual report.
The second contract audit (Audit 221 - described in the audit section of this report) evaluated management controls in the Office of Space Renovation (OSR). The audit found that OSR, a relatively new office, had not yet developed comprehensive policies and procedures. As a result, a number of problems had been encountered, although the Commission had obtained desirable space at competitive rates. The principal audit recommendation was that OSR develop a comprehensive set of leasing regulations.
GAO Reviews of Related Matters
In November 1992, GAO issued a report (B-249159) concerning their review of seven Commission regional office leases. For technical reasons, they "were unable to determine conclusively if SEC negotiated higher or lower lease rates than GSA" or if the Commission's administrative costs "were more or less than GSA would have incurred to do SEC's leasing".
The GAO also performed considerable audit work focusing on the Commission's solicitation for a lease for a new headquarters building in 1993. Although a final report was not issued, we are unaware of any significant findings that were made by the auditors.
APPENDIX B
TESTIMONY OF
WALTER STACHNIK, INSPECTOR GENERAL
U.S. SECURITIES AND EXCHANGE COMMISSION
CONCERNING APPROPRIATIONS FOR FISCAL YEAR 1996
BEFORE THE SUBCOMMITTEE ON
COMMERCE, JUSTICE, STATE, AND THE JUDICIARY
OF THE HOUSE COMMITTEE ON APPROPRIATIONS
MARCH 1, 1995
Chairman Rogers and Members of the Subcommittee:
I am pleased to be here today to advise the Subcommittee in its deliberations on the budget of the Securities and Exchange Commission. My comments will necessarily be limited by the extent of our audit work and my knowledge of Commission proposals that may have a budgetary impact.
It is my understanding that the purpose of these hearings is to assist the Subcommittee in identifying budgetary savings and spending reductions in the budgets of the agencies involved. At the Commission any such savings or reductions would necessarily have to result from 1) reductions or change in regulatory responsibility or 2) increased operational efficiency. Accordingly, I will focus my comments on these two areas. Before I begin, however, let me provide some perspective for these comments.
BACKGROUND
SECURITIES & EXCHANGE COMMISSION
The Commission was created in 1934 as an independent agency. It administers a group of statutes in the area of securities and finance which seek to protect the investing public. The Commission achieves this objective by mandating full disclosure by issuers of securities, overseeing the regulation of the nation's securities markets, and policing fraud and malpractice in the securities and financial markets.
The Commission is responsible for securities markets which are vast and growing rapidly. For example, in 1993, investment company assets alone were $2.4 trillion, more than the amount of assets of insurance companies, bank savings accounts, or savings and loan deposits. These assets grew from $1.8 trillion in 1992, an annual growth rate of 33%. As another example, over 15,000 corporate and investment company filers sent over 11 million pages of information to the Commission. This included a total of $810 billion in equity and debt securities that were filed for registration last year.
For fiscal 1994, the Commission budget was approximately $260 million supporting 2,648 staff years. For 1996 the Commission budget requests an increase to $343 million and 3,139 staff years. The Commission is able to oversee and police the broad securities markets with a relatively small budget due to its partnership with the securities industry self-regulatory organizations. It is noteworthy that in 1994 the Commission collected $588 million in fees, an amount $328 million in excess of the Commission's budget.
The Commission is organized into four major programs, which comprise approximately 84% of its staff positions: Prevention and Suppression of Fraud, Investment Management Regulation, Full Disclosure, and Supervision and Regulation of Securities Markets.
OFFICE OF INSPECTOR GENERAL
The Commission established the Office of Inspector General (the Office) in March 1989 as required by the Inspector General Act (the Act), as amended. The primary functions of the Office are to perform audits of Commission operations and to conduct investigations of alleged staff and contractor misconduct.
The Office of Inspector General currently consists of nine positions. When fully staffed, six of the staff are assigned to conduct audits; two perform investigations. In an effort to increase Office productivity, an auditor was recently hired to fill what previously had been a secretarial position.
Most internal audits focus on the efficiency and effectiveness of Commission programs, although we also conduct a significant number of financial and administrative audits. For example, audits currently underway include evaluations of: contingency plans for the data center and public automated broadcast exchange (PABX), collection of filing fees, the Equal Employment Opportunity program, planning of information resources, close-out of the EDGAR contract, controls on negotiated settlements, and the bankruptcy program. In many of our audits, surveys of the Commission's "customers" are performed.
Because of the nature of Commission expenditures (e.g., no transfer payments, subsidies, capital construction contracts, etc.), the amount of funds involved in a program is not a principal audit selection criterion. Moreover, rather than produce budgetary savings, many of our audit recommendations require expenditures by the Commission in order to implement (e.g., we recently recommended that the Commission subscribe to an "800" telephone service to receive investor complaints as a means to enhance investor protection).
Integrity is integral to the success of the Commission's program objectives. The Office's internal investigations focus on maintaining the standards of staff conduct established by the Commission and often address allegations that arise directly from Commission programs. Many of the allegations are ultimately proven false. However, our conviction rate is not a reasonable indicator of our performance, since our ability to resolve these matters independently is critical to the Commission. For example, with respect to the Commission's enforcement program, the Office has investigated allegations of unauthorized disclosure of investigatory material and evidence (including Grand Jury material), staff corruption, and alteration of evidence. Our reports have been requested and sent directly to the Department of Justice, Federal courts adjudicating securities matters, and Commission management.
In accordance with the Act, the Office is independent of Commission management and independently decides what it will audit and investigate. Consequently, my remarks today do not necessarily reflect the views of the Commission.
As the Subcommittee proceeds with its assessment of the Commission's budget request, it might find one or more of our reports helpful. The Semiannual Reports to Congress for 1994 and subsequent audit reports prepared by the Office were provided to the Subcommittee's staff. I look forward to briefing the Subcommittee on any of the audits it believes might be useful.
REDUCTIONS IN REGULATORY RESPONSIBILITIES
As noted in the introduction, the most significant spending reductions that Congress could achieve would result from reducing the Commission's regulatory responsibilities. Perhaps unique among Federal agencies, the Commission has actually made several proposals to reduce its regulatory responsibilities over the past fifteen years. They were to repeal or reform the Public Utility Holding Company Act and to transfer some responsibility to inspect investment advisers to the states or an investment adviser self-regulatory organization (SRO). Alternatively, the Commission has recommended an annual fee on investment advisers to fund inspections of them. None of these propositions have been adopted to date, however.
The Office did no audit work with respect to these recommendations or the respective legislative bills and, as a consequence, I cannot endorse them. However, some budgetary savings might logically be expected if the proposals had been implemented. It is important to note that numerous and significant changes in the regulatory environment have occurred since the Commission proposals were originally made. Further, the current Commissioners have not formally reviewed or adopted the proposals with respect to repeal of the Public Utility Holding Company Act, the transfer of some regulatory responsibility for investment advisers to the states, or the creation of a self-regulatory organization for investment advisers, to the best of my knowledge. A limited discussion of each proposal follows.
REPEAL OR REFORM THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
The Public Utility Holding Company Act of 1935 (PUHCA) requires that interstate holding companies register with the Commission if they have subsidiaries engaged in generating, transmitting, or distributing electric energy or are engaged in the retail distribution of natural gas. Fifteen registered and over 200 exempt companies, with $525 billion in assets, are overseen by the Commission. Twenty-three staff years were devoted to this program in 1994; 27 staff years are requested for 1996.
In 1982 the Commission endorsed the recommendation of the Presidential Task Force on Regulatory Relief to repeal the PUHCA. The Commission cited two primary reasons for their recommendation: that the main purpose of the PUHCA (reorganization of the nation's electric and retail gas utility holding companies) had been accomplished and that the abuses which were the basis for the Act were unlikely to reoccur. In testimony given in March 1988, the Commission reaffirmed its position.
The Commission is currently undertaking a comprehensive study to re-evaluate its policies regarding the regulation of the holding companies. The study is considering repeal of PUHCA, as well as various reforms that will modernize and streamline regulations, while preserving the basic regulatory structure.
In July 1994, a roundtable discussion was held to solicit views and suggestions from the industry, state and Federal regulators, and other interested parties. In November, the Commission issued a Concept Release seeking comments from the public. To date, several thousands of pages of comments have been received. Several comments urged repeal of PUHCA; others have indicated that some or all of it should be preserved. The results of the study are expected this summer.
INVESTMENT ADVISER REGULATION
The Investment Advisers Act of 1940 requires that persons who, for profit, engage in the business of providing advice to others about securities transactions generally must register with the Commission. In the past, investment advisers were used mainly by wealthy, more sophisticated investors and institutions. Recently, however, smaller investors are turning to investment advisers at a rapid rate. At the end of 1994, 21,600 investment advisers managed $9.6 trillion in assets.
The Act authorizes the Commission to provide for regular and periodic inspections of registered investment advisers. In 1994 the Commission devoted 51 staff years to inspections of investment advisers; it is requesting 274 staff years to conduct inspections of investment advisers for 1996, an increase of 223 staff years to accommodate industry growth.
Over the years, the Commission has proposed three actions that would have the effect of reducing net Federal outlays for regulating investment advisers by reducing the Commission's regulatory responsibility or imposing an annual fee.
Transfer Some Regulatory Responsibility to the States
In 1988, the Commission considered a rule which would have had the effect of transferring to the states responsibility for inspecting the substantial number of investment advisers with relatively small amounts of funds under management. Under this scheme, the Commission would have continued to regulate and inspect the remaining investment advisers with large amounts of funds under management. This rule was not adopted by the Commission, at least partly because of concerns expressed by members of Congress that the objectives of the rule could not be adopted under current legislative authorities.
On January 4, 1995 Senator Gramm introduced S. 148 that, among other purposes, would legislatively reassign regulatory responsibility (including inspections) for the substantial number of investment advisers that manage less than $5 million in assets to states willing to register and regulate them (the Commission would retain regulatory responsibility for investment advisers in states unwilling to register them). If enacted, at least a portion of the expanded Commission investment adviser inspection staff would not be necessary, and the need for future growth in the funding of the program would be diminished.
Establish a Self-Regulatory Organization
In June 1989 the Commission voted to adopt a staff recommendation that Congress amend the Investment Advisers Act to allow the establishment of a self-regulatory organization (SRO) for investment advisers (similar to the structure now in effect for broker/dealers). Although the Commission considered several important regulatory concerns, resource problems and uncertainty of Congressional appropriation of necessary funds were identified as important reasons for the action. If the proposed SRO for investment advisers had responsibilities similar to the existing SROs for broker/dealers, at least some of the inspections of investment advisers to be performed by the Commission would be conducted by the new SRO.
Impose Annual Fees on Investment Advisers
The Commission supported and both Houses of Congress approved separate bills last year that required investment advisers to pay annual fees to fund an enhanced inspection program. The House and Senate bills were H.R. 578 and S. 423, respectively. The Commission estimated that $16 million in additional fees would have been generated by the fee proposal. The final legislation was not enacted, however.
WORK OF THE INSPECTOR GENERAL AND GAO ON COMMISSION PROGRAMS
The Office of Inspector General has completed audit work in connection with several Commission programs (see Appendix A). Although the audit objectives of this work did not include identifying budgetary savings or spending reductions in the programs, some of the information in the reports might be useful to the Subcommittee in its assessment of the Commission's appropriation. I look forward to providing the Subcommittee with information on any relevant work we have performed.
I should also point out that the General Accounting Office has conducted significant audit work on the results of Commission programs. Some of the evaluations they have completed include audits on: investment advisers, regulation of derivatives, rogue broker/dealers, arbitration, clearance and settlement of securities trades, penny stocks, and fines and disgorgements. Although many of their audits recommend more spending for Commission programs, GAO would be in a good position to help identify and evaluate the possible consequences of any proposed regulatory reduction.
INCREASED OPERATIONAL EFFICIENCY
As previously noted, increased efficiency could also result in budgetary savings. The Office of Inspector General, the General Accounting Office, and Commission management have each undertaken reviews to improve the economy of Commission operations. Highlights of those efforts are outlined below.
INITIATIVES OF THE OFFICE OF INSPECTOR GENERAL
Most of our audit recommendations relating to efficiency do not produce budgetary savings of the type and magnitude the Subcommittee seeks to identify. The result of some recommendations is to increase output rather than decrease costs. Other efficiencies are used by the Commission to balance recommendations that require additional resources to implement.
The Office has, however, identified approximately $800,000 in recoverable costs to the Commission. Most of these savings have already been realized. The audit recoveries include a $300,000 settlement from a contractor based on audit findings of questionable costs, $280,000 in savings from a more favorable leasing opportunity, and $110,000 in travel advances to be put to better use. In addition, approximately $37,000 in realized or future recoveries resulted from internal investigations conducted by the Office. To the best of my knowledge, however, these recoveries do not represent additional budgetary savings for 1996.
For some time, the Office has worked closely with the senior Commission management to enhance the control and use of airline frequent flyer benefits earned from government travel. As a result of this team effort, initiated by our Office, the Commission enhanced controls over these assets, established a tracking system for the benefits, and is examining various incentive programs to increase staff use of these benefits to fund Commission travel. Although the increased use of frequent flyer miles should provide the Commission an alternative source of funding for a portion of its necessary travel, it is unclear what impact this will have on the Commission's 1996 travel budget at this time. I have also proposed a joint PCIE/ECIE project to determine if these airline frequent flyer benefits can be more fully utilized to reduce Federal outlays government-wide.
Several other on-going efforts are worth noting. The Office has begun an audit of the collection of filing fees. We are also working with management on the implementation of audit recommendations related to contracting, procurement, and rental of space. Some of this work (e.g., use of fixed cost contracts instead of indefinite delivery contracts to better control contract costs) has led to cost savings elsewhere in government.
GENERAL ACCOUNTING OFFICE AUDIT FINDINGS
In preparation for this hearing, I contacted the staff assigned to oversee GAO audits of Commission operations to determine if they had identified any efficiencies that could be utilized by the Subcommittee to produce budgetary savings. Specifically, I was interested if savings from their audits of the Commission had been reported in the GAO Annual Report as part of the total savings that would be realized if all GAO recommendations for the year were implemented. I learned that their audits of the Commission had resulted in efficiencies in market and regulatory operations without any directly measurable budgetary savings.
INTERNAL EVALUATIONS OF OPERATIONAL EFFICIENCY
On a continuous basis, the Commission reviews its operations to enhance its efficiency and effectiveness. Over the last several years significant savings have been realized by the Commission through opportunities identified by management, as well as through implementation of our audit recommendations. For example, management estimates that the Commission saves approximately $862,000 annually for its headquarters building alone, through its administration of the independent leasing authority it obtained from Congress. Our Office contributes to these on-going efforts through our audit findings and other efforts, like the joint project to enhance airline frequent flyer benefits to the Commission.
CONCLUSIONS
I would like to conclude my statement today by briefly summarizing my remarks. Budgetary savings and spending reductions at the Commission would have to, by necessity, be derived from two sources: either through the reduction of regulatory responsibilities or through improved operational efficiency.
The Commission has recommended repeal of the Public Utility Holding Company Act, transfer of some regulatory responsibilities for investment advisers to the states, creation of an SRO for investment advisers, and imposition of user fees on investment advisers, in the past. Although we have not evaluated any of these proposals, their implementation would potentially impact 9.6 per cent of the total staff years requested by the Commission for 1996. However, any decision to reduce regulatory responsibility or activity must carefully consider its impact on the public interest and revenues collected.
The operations of the Commission are continuously reviewed to identify efficiencies by my Office, GAO, and the Commission itself. I believe it is unlikely that significant spending reductions can be realized from additional economies of operation without reducing regulatory activity or quality. I also believe that the Commission will continue to realize economies in its operations (e.g., adopting new technologies and more efficient procedures).
I appreciate this opportunity to address the Subcommittee. I hope that at least some of the potential opportunities for budgetary savings I have discussed prove useful. I request that my formal statement be included in the record and I would be pleased to answer any questions that you may have.
http://www.sec.gov/about/oig/audit/semi9504.htm