Testimony on “Enhanced Oversight After the Financial Crisis: The Wall Street Reform Act at One Year”
by Chairman Mary L. Schapiro
Before the United States Senate Committee on Banking, Housing and Urban Affairs
July 21, 2011
Chairman Johnson, Ranking Member Shelby, and members of the Committee:
Thank you for inviting me to testify on the occasion of the one-year anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Act”).1
This landmark legislation set out to reshape the U.S. regulatory landscape, reduce systemic risk and help restore confidence in the financial system. Among other things, the Act brings hedge fund and other private fund advisers under the regulatory umbrella of the Investment Advisers Act, creates a new whistleblower program, establishes an entirely new regime for the over-the-counter (“OTC”) derivatives market, enhances the SEC’s authority over nationally recognized statistical rating organizations (“NRSROs”) and clearing agencies, and heightens regulation of asset-backed securities (“ABS”).
To help fulfill its objective, the Act directs the SEC to write a large number of rules necessary to implement the Act and, over the past year, the SEC has accomplished much. Of the more than 90 mandatory rulemaking provisions, the SEC already has proposed or adopted rules for more than two-thirds of them -- not including rules stemming from the dozens of other provisions that give the SEC discretionary rulemaking authority. Additionally, the SEC has finalized ten of the more than twenty studies and reports that it is required to complete under the Act. While the Commission has voted unanimously on the vast majority of these rules and studies, specific rules, proposals and studies have generated robust debate among Commissioners. Even in the instances where the votes were not unanimous, the diverse views and input from Commissioners has benefited and strengthened the work product as we try to develop the best possible rules.
While we have had much success, we are continuing to work diligently to implement all provisions of the Act for which we have responsibility – even as we continue to perform our longstanding core responsibilities. Indeed, we are well on our way to completing the rulemakings and studies assigned to us under the Act.
In my prior testimony before this Committee on Dodd-Frank Act implementation, I outlined our efforts to modernize our internal processes to enable us to better accomplish both our preexisting responsibilities and those added by the Act. Among others, these efforts include the creation of new cross-disciplinary working groups; our focus on increasing transparency, consultation and public input; and the forging and strengthening of collaborative relationships with other federal regulators and our international counterparts. To date, we have participated in scores of interagency and working group meetings, conducted five public roundtables, met with hundreds of interested groups and individuals including investors, academics and industry participants, and received, reviewed and considered thousands of public comments.
While some feel we are moving too quickly and others feel we are not moving rapidly enough, I believe we are proceeding at a pace that ensures we get the rules right. And, provided the SEC receives the appropriate funding and uses its resources effectively and efficiently, we will be able to successfully implement those rules and help further protect investors, as the law intended.
The progress we have made so far is the result of the exceptional work of my fellow Commissioners and our staff, whose extraordinary efforts have enabled us to accomplish so much in a relatively short time. While the Dodd-Frank Act added significantly to their workload, they have been implementing the Act in a thoughtful, thorough, and professional manner.
My testimony today will provide an overview of these activities, emphasizing the Commission’s efforts since the Committee’s Dodd-Frank Act implementation hearing in February.
The Commission already has completed a suite of rulemaking under the many Dodd-Frank Act amendments to the Investment Advisers Act of 1940 (“Advisers Act”). Those rules require registration and reporting by investment advisers to hedge funds and other private funds.
Several of those rules, adopted by the Commission on June 22, 2011, become effective today, including rules that:
The three new Advisers Act exemptions from registration include: (i) advisers solely to venture capital funds; (ii) advisers solely to private funds with less than $150 million in assets under management in the U.S.; and (iii) certain foreign advisers without a place of business in the U.S. and with only a de minimis amount of U.S. business.3 The Commission also approved a rule defining “family offices” – a group that historically has not been required to register as advisers – that excludes private advisers to a single family from the definition of investment adviser.4 The Commission also defined “venture capital fund” as required by the Act.
As a result of these rules, both regulators and the public will have access to identifying data and an operational overview of private fund advisers and the hedge funds and other funds they manage.
In addition, on January 26, 2011, in a joint release with the CFTC, the Commission proposed a new rule that would require hedge fund advisers and other private fund advisers to report systemic risk information on a new form – Form PF.5 This new form requires the non-public reporting of information about private funds managed by advisers for the purpose of the assessment of systemic risk by the Financial Stability Oversight Council (“FSOC”), as provided in Title IV of the Dodd-Frank Act.
Also, this month, the Commission issued an order that raises, to adjust for inflation, the dollar amount thresholds in Rule 205-3 under the Advisers Act, that determine whether an investment adviser can charge its clients performance-based compensation.6 The Commission also has proposed related amendments to the rule that would specify the method for calculating future inflation adjustments of these dollar amount thresholds, and exclude the value of a client’s primary residence from the calculation of net worth.7
Staff Studies Regarding Investment Advisers and Broker-Dealers
In January, the Commission submitted to Congress two staff studies in the investment management area as required under the Dodd-Frank Act.
The first study, mandated by Section 914, analyzed the need for enhanced examination and enforcement resources for investment advisers that are registered with the Commission.8 It found that the Commission likely will not have sufficient capacity in the near or long term to conduct effective examinations of registered investment advisers with adequate frequency. Therefore, the study stated that the Commission’s examination program requires a source of funding that is adequate to permit the Commission to meet new examination challenges and sufficiently stable to prevent adviser examination resources from continuously being outstripped by growth in the number of registered investment advisers.
The study highlighted the following three options to strengthen the Commission’s investment adviser examination program: (1) imposing user fees on Commission-registered investment advisers to fund their examinations; (2) authorizing one or more self-regulatory organizations that assess fees on their members to examine, subject to Commission oversight, all Commission-registered investment advisers; or (3) authorizing FINRA to examine a subset of advisers – i.e., dually registered investment advisers and broker-dealers – for compliance with the Advisers Act.
The second staff study, as required by Section 913 of the Dodd-Frank Act, addressed the obligations of investment advisers and broker-dealers.9 This study reviewed the broker-dealer and investment adviser industries, the regulatory landscape surrounding each, issues raised by stakeholders who commented during the preparation of the report, and other considerations.
The study made two primary recommendations: that the Commission (1) exercise its discretionary rulemaking authority to implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when they are providing personalized investment advice about securities to retail investors; and (2) consider harmonization of broker-dealer and investment adviser regulation when broker-dealers and investment advisers provide the same or substantially similar services to retail investors and when such harmonization adds meaningfully to investor protection.
Under Section 913, the uniform fiduciary standard to which broker-dealers and investment advisers would be subject would be “no less stringent” than the standard that applies to investment advisers today.
As the study notes, the distinction between an investment adviser and a broker-dealer is often lost on investors and it remains difficult to justify why there should be different rules and standards of conduct for the two roles – especially when the same or substantially similar services are being provided. Investment professionals’ first duty must be to their clients, and we look forward to implementing the study’s recommendations.
Section 922 of the Dodd-Frank Act established a whistleblower program that requires the SEC to pay an award to eligible whistleblowers who voluntarily provide the agency with original information about a violation of the federal securities laws that leads to the successful enforcement of an SEC action.
In May, the Commission adopted final rules to implement the new program.10 The rules outline the process by which individuals can apply for awards, describe the Commission’s procedures for making decisions on claims, generally explain the scope of the whistleblower program to the public and define certain critical terms.
There were many complex policy considerations associated with the promulgation of these rules. These included, for example, whether the program should reward culpable whistleblowers who participated in the alleged misconduct, and whether the rules should require employees to first report possible violations through their employer’s internal compliance procedures before coming to the SEC. The Commission’s proposed rules provoked strongly held and diverse views on these and a number of other significant topics. The proposal underwent a robust comment process, which included hundreds of comment letters from various interested constituencies including whistleblower advocacy groups, public companies, corporate compliance personnel, professional associations, and individual investors.
Perhaps the most vigorously-debated issue was the effect of the whistleblower program on internal corporate compliance processes. Many advocated that the Commission require whistleblowers to report violations through their employers’ internal compliance systems before or at the same time they report to the SEC in order to qualify for an award. After careful consideration, the Commission concluded that an absolute requirement that whistleblowers report internally to qualify for an award would be detrimental to the SEC’s enforcement program.
Requiring whistleblowers to first reveal incriminating information to the very persons they may be suggesting acted unlawfully would significantly decrease the likelihood of whistleblowers coming forward. That is why the rules leave the decision as to whether or not to report internally in the hands of the person best equipped to make that decision – the whistleblower, considering the circumstances of his or her individual situation. But, recognizing the significant value that effective corporate compliance programs deliver in identifying, remediating, and deterring wrongdoers, the rules include a number of provisions designed to incentivize whistleblowers to utilize their companies’ internal compliance and reporting systems, when appropriate, by increasing the likelihood and potential recovery for an award in instances where a whistleblower chooses to report internally first.
The whistleblower rules reflect a thoughtful and thorough weighing of the comments that were received and a careful balancing of these and many other important policy considerations. Although it is too early to assess the impact of our new whistleblower program, the agency is already seeing the effects of the whistleblower provisions in the quality of tips we are getting. While the SEC has a history of receiving high volumes of tips and complaints, the quality of the tips has improved since the enactment of Section 922, and this trend is expected to continue.
Section 924 of the Dodd-Frank Act also required the SEC to establish an office to administer the whistleblower program. The new Office of the Whistleblower is now staffed and busy reviewing whistleblower complaints. Due to budgetary constraints, the office has been staffed by detailing current Commission staff from their normal responsibilities until we can hire permanent staff.
Nationwide Service of Process: The SEC is seeing the benefits of the many other enforcement-related investor protection provisions contained in the Dodd-Frank Act. For example, Section 929E allowed for nationwide service of process so that the SEC can compel a witness to appear at trial anywhere in the United States. Already, this authority has enabled our trial team to subpoena and present witnesses’ live testimony, and ultimately prevail, in the recent SEC v. Delphi trial.
Live testimony can be invaluable in litigating securities law violations, which often turn on the credibility of those testifying. Our trial teams have also used the new provision to subpoena documents, which enables them to more efficiently present documentary evidence.
Collateral Bars: With respect to new sanctions available to the Commission, the Dodd-Frank Act provides the SEC with the authority to bar or suspend persons -- who have engaged in misconduct in one industry that the Commission regulates -- from other industries that the Commission regulates. Since the enactment of Section 925, the Commission has used this “collateral bar” authority to impose broad prophylactic relief to provide more effective protection to investors.
In one example, the Commission last month imposed cross-industry sanctions against a Swiss trader employed by a registered broker-dealer and investment adviser for engaging in insider trading that netted him illegal profits of almost $1.2 million.11 Prior to the enactment of Dodd-Frank, the Commission would have been able to bar the respondent from the broker-dealer industry, but it would not have been able to similarly protect investors in any of the other industries we regulate. Using the new authority, the Commission was able to extend the protection to other vulnerable investors by barring the respondent from associating with any broker, dealer, investment adviser, municipal securities dealer, transfer agent, municipal advisor, or nationally recognized statistical ratings organization.
In another example, just last week, the Commission sanctioned an unregistered broker for his role in an offering fraud and Ponzi scheme that raised at least $2.5 million from approximately 75 investors.12 Under Section 925, the Commission was able to bar this person from associating with any transfer agent, broker, dealer, investment adviser, municipal securities dealer, municipal advisor, or nationally recognized statistical rating organization.
Penalties in Cease and Desist Proceedings: The Commission also has used the authority granted in Dodd-Frank Section 929P(a) to impose penalties in administrative cease and desist actions against non-regulated individuals and entities. Although the Commission could impose penalties against regulated persons administratively prior to Dodd-Frank, it could obtain penalties against non-regulated persons only in enforcement actions filed in district court. The Act now permits the Commission to obtain penalties against non-regulated violators of the federal securities laws in either forum.
In one recent example of our exercise of this authority, the Commission imposed a $200,000 administrative penalty against Hudson Highland Group, Inc. for its failures to maintain appropriate internal controls and books and records relating to its sales tax liabilities that resulted in a $3.9 million tax liability for the corporation.13 Prior to the Dodd-Frank Act, the Commission would not have been able to impose a penalty against Hudson in a cease-and-desist proceeding; that sanction would only have been available in a district court action. Accordingly, to obtain full relief, the Commission would have had to either file the entire action in district court or, alternatively, file two separate actions – one administrative and one civil. With the new authority granted in Section 929P(a), the Commission no longer has to file multiple actions or abandon what may be the more appropriate forum in order to obtain an appropriate penalty.
Greater Access to Foreign Papers: The Dodd-Frank Act’s amendments to Sarbanes-Oxley Section 106 require foreign accounting firms that perform work for a domestic registered public accounting firm to designate an agent for service of process to allow both the SEC and the PCAOB to serve requests for documents and enforcement pleadings that may arise out of a violation of Section 106. This provision, which has aided our enforcement efforts, resolves a significant impediment to ensuring that the SEC will have the ability to serve requests for documents expeditiously.
Among the key provisions of the Dodd-Frank Act are those that will establish a new oversight regime for the OTC derivatives marketplace. Title VII of the Act requires the SEC to work with other regulators – the Commodity Futures Trading Commission (“CFTC”) in particular – to write rules that:
Title VII Implementation to Date
To date, the SEC has proposed rules in twelve areas required by Title VII:
The Commission also adopted an interim final rule regarding the reporting of outstanding security-based swaps entered into prior to the date of enactment of the Dodd-Frank Act.26 This interim final rule notifies certain security-based swap dealers and other parties of the need to preserve and report to the SEC or a registered security-based swap data repository certain information pertaining to any security-based swap entered into prior to the July 21, 2010 passage of the Dodd-Frank Act and whose terms had not expired as of that date.
In addition, in order to facilitate clearing of security-based swaps, the Commission proposed rules providing exemptions under the Securities Act, the Exchange Act, and the Trust Indenture Act of 1939 for security-based swaps transactions involving certain clearing agencies satisfying certain conditions.27 We also readopted certain of our beneficial ownership rules to preserve their application to persons who purchase or sell security-based swaps.28
Next Steps for Implementation of Title VII
While the Commission has made significant progress to date, much remains to be done to fully implement Title VII. First, there is a need to complete the core elements of our proposal phase, focusing in particular on rules related to the registration and financial responsibility of security-based swap dealers and major security-based swap participants.
In addition, because the OTC derivatives market has grown to become a truly global market in the last three decades, we must continue to evaluate carefully the international implications of Title VII. Rather than deal with these implications piecemeal, we intend to address the relevant international issues holistically in a single proposal. The publication of such a proposal would give investors, market participants, foreign regulators, and other interested parties an opportunity to consider as an integrated whole our proposed approach to the registration and regulation of foreign entities engaged in cross-border transactions involving U.S. parties.
More broadly, the SEC has been working with our fellow regulators and with market participants to consider implementation timeframes that are reasonable for the various rulemakings, and we are reviewing what steps market participants will need to take in order to comply with our proposed rules. These discussions are vital to establishing a coordinated implementation timeline that is workable.
After proposing all of the key rules under Title VII, we intend to seek public comment on a detailed implementation plan that will permit a roll-out of the new securities-based swap requirements in logical, progressive, and efficient manner, while minimizing unnecessary disruption and costs to the markets. Implementing the new rules through a coherent and sequenced plan should help avoid undue delay in the creation of a more sound foundation for the regulatory oversight of the OTC derivatives market.
Steps to Address the Effective Date of Title VII
As the Commission continues to move forward with the implementation of Title VII, it has taken a number of steps to provide legal certainty and avoid unnecessary market disruption that might otherwise have arisen as a result of final rules not having been enacted by the July 16 effective date of Title VII. Specifically, we:
Title VIII of the Dodd-Frank Act provides for increased regulation of financial market utilities and financial institutions that engage in payment, clearing and settlement activities that are designated as systemically important. Clearing agencies play a critical role in the financial markets by ensuring that transactions settle on time and on agreed-upon terms. The purpose of Title VIII is to mitigate systemic risk in the financial system and promote financial stability.
To help ensure the integrity of clearing agency operations and governance, the Commission proposed certain enhanced requirements for clearing agencies.32 Specifically, the proposed rules would require clearing agencies to maintain certain standards with respect to risk management and operations, have adequate safeguards and procedures to protect the confidentiality of trading information, have procedures that identify and address conflicts of interest, require minimum governance standards for boards of directors, designate a chief compliance officer, and disseminate pricing and valuation information if the clearing agency performs central counterparty services for security-based swaps. Many of the proposed requirements would apply to all clearing agencies, while others would focus more specifically on clearing agencies that clear security-based swaps.
The proposal was the result of close work between the Commission staff and staffs of the CFTC and the Federal Reserve Board (“Board”). The proposed requirements are consistent with – and build on – current international standards, and they are designed to further strengthen the Commission’s oversight of securities clearing agencies, promote consistency in the regulation of clearing organizations generally, and thereby help to ensure that clearing agency regulation reduces systemic risk in the financial markets.
In addition, as directed by Title VIII, the SEC staff worked jointly with the staffs of the CFTC and the Board over the past year to develop a report to Congress reflecting recommendations regarding risk management supervision of clearing entities designated as systemically important by the FSOC – each called a “designated clearing entity” or “DCE”. The staffs of the agencies met regularly and engaged in constructive dialogue to develop a framework for improving consistency in the DCE oversight programs of the SEC and CFTC, promoting robust risk management by DCEs, promoting robust risk management oversight by DCE regulators, and improving regulators’ ability to monitor the potential effects of DCE risk management on the stability of the financial system of the United States. The joint report recommended finalizing rulemakings to establish enhanced risk management for DCEs, formalizing the process for consultations and information sharing regarding DCEs, enhancing DCE examinations, and developing ongoing consultative mechanisms to promote understanding of systemic risk. The report should establish a strong framework for ongoing consultation and cooperation in clearing agency oversight among the Commission, the CFTC, and the Board, which in turn should help to mitigate systemic risk and promote financial stability.
Under the Dodd-Frank Act, the Commission is required to undertake approximately a dozen rulemakings related to NRSROs. The Commission adopted the first of these required rulemakings in January, and in May, the Commission published for public comment a series of proposed rules that would largely implement this requirement.33 The proposed rules are intended to strengthen the integrity of credit ratings, including by improving their transparency. Under the Commission’s proposals, NRSROs would, among other things, be required to:
The proposals also would require disclosure concerning third-party due diligence reports for asset-backed securities.
The Act also requires the SEC to conduct three studies relating to credit rating agencies. In December, the Commission requested public comment on the feasibility and desirability of standardizing credit rating terminology.34 The Act also requires (1) a two-year study on alternative compensation models for rating structured finance products and (2) a three-year study on NRSRO independence.
With respect to alternative compensation models, the Act directs the Commission to study the credit rating process for structured finance products and the conflicts associated with the “issuer-pay” and the “subscriber-pay” models. The Act further requires the Commission to study the feasibility of establishing a system in which a public or private utility or a self-regulatory organization would assign NRSROs to determine the credit ratings for structured finance products. Accordingly, in May the Commission published a request for public comment on the feasibility of such a system, asking interested parties to provide comments, proposals, data and analysis by September.35
In addition, the Act requires every federal agency to review its regulations that require use of credit ratings as an assessment of the credit-worthiness of a security and undertake rulemakings to remove these references and replace them with other standards of credit worthiness that the agency determines are appropriate.
In September 2010, as required by Section 939B of the Act, the Commission adopted a rule amendment to remove communications with credit rating agencies from the list of excepted communications in Regulation FD.40
In addition, the Dodd-Frank Act requires the SEC to conduct staff examinations of each NRSRO at least annually and issue an annual report summarizing the exam findings. Our staff is in the process of completing the first cycle of these exams, but at our current funding level achieving that statutory mandate has required drawing away critical resources from other parts of our examination and NRSRO programs.
In January, the FSOC approved and released to the public a study formalizing its findings and recommendations for implementing Section 619 of the Dodd-Frank Act, commonly referred to as the Volcker Rule.41 Informed by these recommendations, the Commission staff is working closely with staffs from the federal banking agencies and the CFTC in drafting proposed rules to implement Section 619. The agency staffs are consulting and coordinating efforts in order to assure that the proposed regulations are comparable and provide for consistent application and implementation across regulated entities subject to the Volcker Rule, to the extent possible. We anticipate that the proposal will solicit comments on a variety of issues, including the costs and benefits of the proposed rule and its potential impact on competitiveness.
Section 975 of the Dodd-Frank Act requires the registration of municipal advisors with the Commission. This new registration requirement became effective on October 1, 2010, making it unlawful for any municipal advisor to provide advice to a municipality unless registered with the Commission. Last September, the Commission adopted an interim final rule establishing a temporary means for municipal advisors to satisfy the registration requirement.42 In December, the Commission proposed a permanent rule creating a new process by which municipal advisors must register with the SEC. 43 We have received approximately 1,000 comment letters on the proposal, including many expressing concerns regarding the treatment of appointed officials and traditional banking products and services. We will give all of these comments careful consideration before adopting a final rule.
In June, the Commission proposed amendments to its broker-dealer financial reporting rule in order to strengthen the audits of broker-dealers as well as its oversight of the way broker-dealers handle their customers’ securities and cash.44 The proposed amendments also would facilitate the ability of the Public Company Accounting Oversight Board to implement its new oversight authority over independent public accountants of broker-dealers that was provided in Section 982 of the Dodd-Frank Act.
During the past year, the Commission has been active in implementing Subtitle D of Title IX of the Dodd-Frank Act, entitled “Improvements to the Asset-Backed Securitization Process.” Most recently, on March 30, 2011, the Commission joined its fellow regulators in issuing for public comment proposed risk retention rules to implement Section 941 of the Act.45 Section 941, which is codified as new Section 15G of the Securities Exchange Act of 1934, generally requires the Commission, the Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and, in the case of the securitization of any “residential mortgage asset,” the Federal Housing Finance Agency and Department of Housing and Urban Development, to jointly prescribe regulations that require a securitizer to retain not less than five percent of the credit risk of any asset that the securitizer – through the issuance of an asset-backed security – transfers, sells, or conveys to a third party. Section 15G also provides that the jointly prescribed regulations must prohibit a securitizer from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain.46
Under the proposed rules, a sponsor generally would be permitted to choose from a menu of four risk retention options to satisfy its minimum five percent risk retention requirement. These options were designed to provide sponsors with flexibility while also ensuring that they actually retain credit risk to align incentives. The proposed rules also include three transaction-specific options related to securitizations involving revolving asset master trusts, asset-backed commercial paper conduits, and commercial mortgage-backed securities. Also, as required by Section 941, the proposal provides a complete exemption from the risk retention requirements for ABS collateralized solely by “qualified residential mortgages” (or QRMs) and establishes the terms and conditions under which a residential mortgage would qualify as a QRM. We have received a number of comments regarding the QRM exemption, which we will carefully consider as we move forward with the interagency rulemaking process. Although the original comment period was scheduled to close on June 10, 2011, in light of requests from various sources for an extension to allow sufficient time for data gathering and impact analyses related to the provisions of the proposed rule, we extended the comment period to August 1, 2011.
In January 2011, the Commission proposed rules in connection with Section 942(a) of the Dodd-Frank Act, which eliminated the automatic suspension of the duty to file reports under Section 15(d) of the Exchange Act for ABS issuers and granted the Commission authority to issue rules providing for the suspension or termination of this duty to file reports. The proposed rules would permit suspension of the reporting obligations for ABS issuers when there are no longer asset-backed securities of the class sold in a registered transaction held by non-affiliates of the depositor.47
The Commission also adopted rules in January 2011 implementing Section 943, on the use of representations and warranties in the market for ABS,48 and Section 945, which requires an asset-backed issuer in a Securities Act registered transaction to perform a review of the assets underlying the ABS and disclose the nature of such review.49
We also are working on rules prohibiting material conflicts of interest in certain securitizations50 and rules requiring the disclosure of asset-level information regarding the assets backing each tranche or class of security.51
The Dodd-Frank Act includes an array of corporate governance and executive compensation provisions that require Commission rulemaking. Among others, such rulemakings include:
The Commission also is required by the Act to adopt several additional rules related to corporate governance and executive compensation, including rules mandating new listing standards relating to specified “clawback” policies,56 and new disclosure requirements about executive compensation and company performance,57 executive pay ratios,58 and employee and director hedging.59 These provisions of the Act do not contain rulemaking deadlines, but the staff is working on developing recommendations for the Commission concerning the implementation of these provisions of the Act.
Title XV of the Act contains specialized disclosure provisions related to conflict minerals, coal or other mine safety, and payments by resource extraction issuers to foreign or U.S. government entities. The Commission published rule proposals for the three specialized disclosure requirements in December 2010, and the comment period ended on March 2, 2011.60 The staff is developing recommendations for the Commission’s consideration. The Commission expects to consider adoption of final rules implementing these specialized disclosure provisions in the late summer or early fall of this year.
Under Section 926 of the Act, the Commission is required to adopt rules that disqualify securities offerings involving certain “felons and other ‘bad actors’” from relying on the safe harbor from Securities Act registration provided by Rule 506 of Regulation D. The Commission proposed rules to implement the requirements of Section 926 on May 25, 2011.61 Under the proposal, the disqualifying events include certain criminal convictions, court injunctions and restraining orders; certain final orders of state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration; certain types of Commission disciplinary orders; suspension or expulsion from membership in, or from association with a member of, a securities self-regulatory organization; and certain other securities-law related sanctions. The comment period for this rule proposal ended on July 14, 2011.
In addition, the Commission proposed rule amendments in January that would implement Section 413(a) of the Act, which requires the Commission to exclude the value of an individual’s primary residence when determining if that individual’s net worth exceeds the $1 million threshold required for “accredited investor” status.62 The comment period on this proposal ended on March 11, 2011 and the staff is preparing final rule recommendations for the Commission. This section was effective on the date of enactment of the Dodd-Frank Act; the implementing rules are designed to clarify the requirements and codify them in the Commission’s rules.
In addition to the rulemaking activity described above, Title I of the Dodd-Frank Act created the FSOC, and with it, a formal structure for coordination among the various financial regulators to monitor systemic risk and to promote financial stability across our nation’s financial system. FSOC has the following primary responsibilities:
As Chairman of the SEC, I am a voting member of FSOC. Senior SEC staff and I have actively participated in the FSOC and found its focus on identifying and addressing risks to the financial system to be important and helpful to the SEC as a capital markets regulator. The FSOC also has fostered a healthy and positive sense of collaboration among the financial regulators, facilitating cooperation and coordination for the benefit of investors and our overall financial system. Since passage of the Dodd-Frank Act, the FSOC has taken steps to create an organizational structure, coordinate interagency efforts, and build the foundation for meeting its statutory responsibilities.
To begin defining and implementing the process to identify and designate systemically important financial institutions (“SIFIs”) for heightened supervision by the Board, FSOC issued an advanced notice of proposed rulemaking soliciting public comment on the specific criteria and analytical framework for the SIFI designation process, with a focus on how to apply the statutory considerations for such designations, as well as a notice of proposed rulemaking. FSOC is preparing additional guidance regarding the Council’s approach to designations and will seek public comment on it.
Financial Market Utilities (“FMUs”) are essential to the proper functioning of the nation’s financial markets.64 These utilities form critical links among marketplaces and intermediaries that can strengthen the financial system by reducing counterparty credit risk among market participants, creating significant efficiencies in trading activities, and promoting transparency in financial markets. However, FMUs by their nature create and concentrate new risks that could affect the stability of the broader financial system. To address these risks, Title VIII of the Dodd-Frank Act provides important new enhancements to the regulation and supervision of FMUs designated as systemically important by FSOC (“DFMUs”) and of payment, clearance and settlement activities. This enhanced authority in Title VIII should provide consistency, promote robust risk management and safety and soundness, reduce systemic risks, and support the stability of the broader financial system.65 Importantly, the enhanced authority in Title VIII is designed to be in addition to the authority and requirements of the Securities Exchange Act and Commodity Exchange Act that may apply to FMUs and financial institutions that conduct designated activities.66
FSOC established an interagency DFMU committee to develop a framework for the designation of systemically important FMUs, in which staff from the SEC has actively participated, and also published an advanced notice of proposed rulemaking seeking public comment on the designation process for FMUs.
On March 28, 2011, FSOC published a notice of proposed rulemaking to provide further information on the process it proposed to follow when reviewing the systemic importance of FMUs. The FSOC finalized this rule earlier this week.67
In addition to the Whistleblower Office mentioned earlier, the Dodd-Frank Act requires the Commission to create four new offices within the Commission, specifically, the Office of Credit Ratings, Office of the Investor Advocate, Office of Minority and Women Inclusion, and Office of Municipal Securities. As each of these offices is statutorily required to report directly to the Chairman, the creation of these offices is subject to approval by the Commission’s Appropriations subcommittees to reprogram funds for this purpose.68
While reprogramming approval is a necessary step in moving forward to create these new offices, the provision of additional funding to staff them at adequate levels also would be necessary for the SEC to fully execute the new responsibilities. In the meantime, the initial functions of the offices are being performed on a limited basis by other divisions and offices.
We are keenly aware that our rules have both costs and benefits, and that the steps we take to protect the investing public impact both financial markets and industry participants who must comply with our rules. This is truer than ever given the scope, significance and complexity of the Dodd-Frank Act. Our Division of Risk, Strategy, and Financial Innovation, which has been expanded in both stature and size, directly assists our rule writers in analyzing the economic impact of those rules.
When engaging in rulemaking, we analyze the direct and indirect costs and benefits of the Commission’s proposed decisions against alternative approaches, including, the effects on competition, efficiency and capital formation. We invite the public to comment on our analysis and provide any information and data that may better inform our decision making. In adopting releases, the Commission responds to the information provided and revises its analysis as appropriate. This approach helps ensure a regulatory framework that strikes the right balance between the costs and the benefits of regulation.69
The provisions of the Dodd-Frank Act expand the SEC’s responsibilities and will require significant additional resources to fully implement the law. To date, the SEC has proceeded with the first stages of implementation without the necessary additional funding. As described above, implementation up to this point has largely involved performing studies, analysis, and the writing of rules. These tasks have taken staff time from other responsibilities, and have been done almost entirely with existing staff and without sufficient investments in areas such as information technology.
It is incumbent upon us to use our existing resources efficiently and effectively as we strive to fulfill statutory mandates, protect investors and achieve our mission. That said, the new responsibilities assigned to the agency under the Dodd-Frank Act are so significant that they cannot be achieved solely by wringing efficiencies out of the existing budget without also severely hampering our ability to meet our existing responsibilities.
The budget justification the SEC submitted in February in connection with the President’s FY 2012 budget request estimates that, over time, full implementation of the Dodd-Frank Act will require a total of approximately 770 new staff, of which many will need to be expert in derivatives, hedge funds, data analytics, credit ratings, or other new or expanded responsibility areas.70 The SEC also will need to invest in technology to facilitate the registration of additional entities and capture and analyze data on these new markets.
The Dodd-Frank Act requires the SEC to collect transaction fees to offset the annual appropriation to the SEC. Accordingly, regardless of the amount appropriated to the SEC, the appropriation will be fully offset by the fees that we collect and will have no impact on the nation’s budget deficits.
If the SEC does not receive additional resources, many of the issues highlighted by the financial crisis and which the Dodd-Frank Act seeks to fix will not be adequately addressed, as the SEC will not be able to build out the technology and hire industry expertise and other staff desperately needed to oversee and police these new areas of responsibility. Examples of likely impacts include:
The Dodd-Frank Act also established a $50 million SEC Reserve Fund to allow the SEC to respond to unexpected market events (such as the May 6th market plunge), invest in multi-year IT projects, and manage authorized programs during continuing resolutions. If this fund is eliminated or the SEC is not permitted to access the fund, it would have significant consequences for important IT projects, such as building out the infrastructure to take in, manage and analyze the significant amounts of critical new data we will soon receive from previously unregulated markets, including a segment of the $600 trillion OTC derivatives market and hedge fund and other private fund advisers. Without the appropriate IT infrastructure, our ability to establish effective monitoring regimes will be significantly hindered.
While additional resources are needed to implement the Dodd-Frank Act, it is also critical that we use existing resources effectively and efficiently. In order to implement our new responsibilities and to effectively supervise the changing financial markets, the SEC is carefully examining its operations and processes to maximize efficiency and effectiveness. Section 967 of the Dodd-Frank Act directed the agency to engage the services of an independent consultant to study a number of specific areas of SEC internal operations. This organizational assessment was recently performed by the Boston Consulting Group, Inc. (“BCG”) 71 and is providing valuable guidance and structure for our efforts. Among other issues, the organizational assessment raises significant issues regarding SEC resources and questions whether the statutory design of the four new offices creates management complexity, duplication and a need for new support capacity when many of their functions already exist at the SEC. SEC staff is currently reviewing the recommendations of the study and will be moving forward with those suggested changes that could improve organizational effectiveness.
Though the SEC’s efforts to implement the Dodd-Frank Act have been extensive, we know our work is far from over and we are committed to finishing the job. Thank you for inviting me to share with you our progress to date and our plans going forward. I look forward to answering your questions.
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