Fiscal 2008 Appropriations Request
by Chairman Christopher Cox
U.S. Securities & Exchange Commission
Before the U.S. House of Representatives Subcommittee on Financial Services and General Government,
Committee on Appropriations
March 27, 2007
Chairman Serrano, Ranking Member Regula, and Members of the Subcommittee:
Thank you for the opportunity to testify today about the Securities and Exchange Commission's budget request for fiscal year 2008.
Before I begin, I would like to congratulate you, Mr. Chairman, on your new role as head of this subcommittee. I look forward to working with you and all the members of this subcommittee for the benefit of the nation's investors.
As you know, the President's budget requests $905.3 million for the SEC in 2008. I fully support this request for increased funding over FY 2007, which will allow the SEC to continue the important initiatives underway to protect and assist the average investor.
These initiatives all have in common that they are aimed at benefiting the average retail customer whose savings are dependent on healthy, well-functioning markets. Since I became Chairman, I have worked to reinvigorate the agency's focus on the ordinary investor. This is the SEC's traditional responsibility. Back in Joseph Kennedy's day, our first SEC Chairman was amazed that "one person in every ten" owned stocks. But today, more than half of all households own securities, and the median income for shareholders is a very middle-class $65,000. When you then consider all of the teachers, government employees, and workers in other industries who have pensions, it becomes clear that nearly all taxpayers have a personal interest in fair and honest securities markets.
In fact, when one considers the staggering growth in Americans' participation in the markets, the enormity of the SEC's task becomes apparent. About 3,600 staff at the SEC are responsible for overseeing more than 10,000 publicly traded companies, investment advisers that manage more than $32 trillion in assets, nearly 1,000 fund complexes, 6,000 broker-dealers with 172,000 branches, and the $44 trillion worth of trading conducted each year on America's stock and options exchanges.
These daunting numbers make it clear that, even if the SEC budget were to double or triple, the agency would have to carefully set priorities. That is exactly what we are doing in this proposed budget for FY 2008. We must continue to think strategically about which areas of the market pose the greatest risk, and which areas of potential improvement hold the greatest benefit for investors. And given the fast changing conditions in America's and the world's capital markets, we must remain agile and flexible enough to redirect our resources with little notice.
This risk-based and flexible approach guides the SEC's examination program as we focus the agency's energies on those practices in the marketplace, and those investment advisers and mutual funds, that are most likely to be high-risk. It also provides the basis for the selection of targets for comprehensive examination sweeps on cross-cutting issues that could present a significant threat to investors. And it drives the SEC's enforcement, rulemaking, and disclosure review functions as well. In each case, the objective is to apply the taxpayer's resources in ways that provide the biggest investor protection bang for the buck.
In recent years, the SEC has professionalized the culture of risk assessment that informs so many of our programs throughout the SEC. From relatively modest beginnings as a discrete office within the SEC established by my predecessor, William Donaldson, the risk assessment function is now wholeheartedly embraced in every major functional division and office of the agency.
If I may, Mr. Chairman, I would now like to discuss some of the major areas in which the SEC is currently focusing its energies, in order to provide the maximum benefit to America's retail investors.
Fighting Fraud Against Seniors
As you know, an estimated 75 million Americans will turn 60 over the next 20 years. And they will live longer than any generation before them. As the baby boomers turn 60 -- more than 10,000 of them every day for the next 20 years - they will need to continue to actively manage their investments for higher yield over their longer lifetimes, rather than switching into low-yield, safe investments as their parents did. This will have enormous consequences for our capital markets. Households led by people aged 40 or over already own 91% of America's net worth. The impending retirement of the baby boomers will mean that, very soon, the vast majority of our nation's net worth will be in the hands of our nation's seniors.
Following the Willie Sutton principle, scam artists will swarm like locusts over this increasingly vulnerable group - because that is where the money is. And it is already occurring. Nearly every day, our agency receives letters and phone calls from seniors and their caregivers who have been targeted by fraudsters.
That is why the SEC has focused its energies in this area, and why we organized our fellow regulators and law enforcement officials at the first-ever Seniors Summit in July 2006. This year's Seniors Summit, which will integrate even more of our national resources, will take place in just a few months. With our partners, the SEC has developed a strategy to attack the problem from all angles - from aggressive enforcement efforts, to targeted examinations, to investor education.
Fighting fraud against seniors means taking aggressive action. Over the past year, the SEC's Division of Enforcement has brought 26 enforcement actions aimed specifically at protecting elderly investors. Many of these were coordinated with state authorities.
For example, the Commission coordinated with law enforcement authorities in California to crack down on a $145 million Ponzi scheme that lured elderly victims to investor workshops with the promise of free food -- and then bilked them out of their retirement money by purporting to sell them safe, guaranteed notes.
In another case, we filed an emergency action to halt an ongoing securities fraud that targeted individuals' retirement funds. At "free" dinner and retirement planning seminars, seniors were urged to invest their savings in non-existent businesses with promises of alluringly high rates of return.
By bringing cases like these, and dozens more like them, the federal government is putting would-be fraudsters on notice that they will be caught and punished if they prey upon seniors.
SEC examiners are also working closely with state regulators across the country to stop abusive practices before seniors are actually injured. With our state partners, we're sharing regulatory intelligence about abusive sales tactics targeting seniors, and conducting focused examinations of any firms whose practices raise red flags.
For example, in Florida we initiated an examination sweep of firms selling investments to seniors, in cooperation with the State of Florida and the National Association of Securities Dealers. We subsequently expanded the sweep to include other states with large retiree populations - including California, Texas, North Carolina, Alabama, South Carolina, and Arizona. Working together with state securities regulators in those states, the NASD, and the NYSE, our goal is to see to it that the sales people at "free lunch" seminars are properly supervised by their firms, and that the seminars are not used as a vehicle to sell unsuitable investment products to seniors.
Another tool in fighting securities fraud against seniors is education. These efforts are aimed not only at seniors, but also their caregivers - as well as pre-retirement workers, who are encouraged to plan for contingencies in later life. The SEC is expanding our efforts to reach out to community organizations, and to enlist their help in educating Americans about investment fraud and abuse that is aimed at seniors. We have also devoted a portion of the SEC website specifically to senior citizens (http://www.sec.gov/investor/seniors.shtml). The site provides links to critical information on investments that are commonly marketed to seniors, and detailed warnings about common scam tactics.
Returning Funds to Wronged Investors
We at the SEC work diligently to uncover fraud against investors, gather the evidence needed to build a case, and then prosecute cases to bring fraudsters to justice. But our efforts do not end at the courthouse door. Once we succeed in convincing a court to order a penalty, we must ensure that as many of those dollars as possible go back into the hands of wronged investors as quickly as possible.
Since the Sarbanes-Oxley Act created "Fair Funds," through which penalties in SEC cases can be returned directly to injured investors, the SEC has begun to develop a considerable expertise in using this important new authority. At the time I became Chairman in 2005, this authority was only three years old, and the SEC had completed the process of disbursing funds to investors in only a few cases. Since then, we have returned over $1 billion to injured investors, including significant distributions from cases involving WorldCom, Global Analysts Research, New York Stock Exchange Specialists, Hartford, and Bristol-Myers Squibb. In addition, several large disbursements are pending and will be announced shortly.
To completely fulfill the vision that Congress wrote into Sarbanes-Oxley, however, will require a sustained effort within the Commission to train professionals in this area, to develop consistent practices, and to routinize the execution of the Fair Funds function. Too much money is still undisbursed because of the complexities of the process, leaving investors uncompensated.
That is why I have ordered the creation of a new office that will focus the efforts of all of the SEC's offices around the country, and work full-time to return these funds to wronged investors. The creation of this specialized function within the SEC will ensure that investors' money is returned as quickly as possible, while minimizing the costs of the distributions.
The efforts of this new office will be aided by a new information system, called Phoenix. The system will more accurately track, collect, and distribute the billions of dollars in penalties and disgorgements that flow from our enforcement work. The efficiency of a dedicated tracking system will remove what had been a major hindrance in our efforts to quickly distribute Fair Funds.
The agency is taking other steps in this area as well. We are collaborating with the Bureau of the Public Debt to invest disgorgement and penalty funds in interest-bearing accounts. And we are working to consolidate funds from related cases into a single distribution, where appropriate, to potentially save investors hundreds of thousands of dollars.
The SEC is dedicated to doing the very best job possible for investors in handling this responsibility. We know that you in the Congress, who entrusted us with this task, expect and deserve no less.
Another major initiative I want to bring to your attention holds great potential for investors. By using what I call "interactive data," we can give investors far more information, in far more useful form, than anything they've ever gotten from the SEC before. In the very near future, investors will be able to easily search through and make sense of the mountains of financial data contained in current company disclosures.
For years, ordinary investors have been stymied by the time and effort it takes to separately look up each SEC filing for a single company they might own, and then to do that again and again for every additional company in which they're interested. Even once the right forms are located, wading through all of the legal gobbledygook to find the right numbers has been nearly impossible for the average retail investor.
That is because the SEC's online system, know as EDGAR, is really just a vast electronic filing cabinet. It can bring up electronic copies of millions of pieces of paper on your computer screen, but it doesn't allow you to manage all of that information in ways that investors commonly need.
Not surprisingly, financial firms - who can afford it - usually end up getting the bulk of their information about companies not from the SEC filings, but from middlemen all over the world who re-key the information in SEC reports and put it in more useful form. This process is expensive and inefficient, and it also creates errors in the data. Worse, it feeds the notion that the rich and the highly sophisticated have a leg up in today's markets.
Interactive data will let any investor quickly focus on the disclosure they need. With a few clicks of the mouse, investors will be able to find, for example, the mutual funds with the lowest expense ratios, the companies within an industry that have the highest net income, or the overall trend in their favorite companies' earnings. It works by giving each piece of information a unique label, written in the eXtensible Business Reporting Language (XBRL) computer language.
The agency has taken a variety of steps to expand the use of interactive data. First, the Commission created a voluntary program for companies and mutual funds to submit disclosures using XBRL, and offered expedited reviews of disclosures if firms agree to share their experiences with the agency. More than 35 companies, including some of corporate America's biggest names, are already participating in this program.
Second, the SEC is working with outside groups to develop the standardized computer labels for different kinds of numbers that appear in financial statements. The collections of these labels for each industry - the so-called "taxonomies" - will be completed in 2007. With the taxonomies available to every SEC registrant, we will have in place the basic building blocks of
the universal language that explains the components of every firm's financial statements.
Third, the agency is modernizing the entire EDGAR system to convert it to one based on interactive data. As part of this effort, the SEC expects to rename the EDGAR system in 2007.
In all, the Commission is investing $54 million over several years to build the infrastructure to support widespread adoption of interactive data. Companies have told us that the costs of implementing XBRL are minimal, while the benefits are substantial. In addition to providing far more useful information to investors, we believe the use of interactive data will be more efficient for companies' internal processes, for their registration and compliance reporting to the SEC, and for the SEC's own disclosure reviews for regulatory and enforcement purposes.
Credit Rating Agencies
Finally, I want to discuss a significant new responsibility that the SEC is undertaking this year to oversee credit rating agencies. This new role was given to the SEC by Congress last year.
As you know, in 2006 the Congress gave the SEC both the responsibility and the authority to register and inspect the nation's credit rating agencies, including industry giants Standard & Poor's, Moody's, Fitch Ratings, A.M. Best, as well as several other large, medium, and smaller current and potential industry participants. Because of congressional concern that the industry faces potential conflicts of interest, imposes barriers to entry for new rating agencies, and has failed to warn the market of such significant impending financial failures as Enron and WorldCom even immediately before their collapses, the SEC is tasked with devoting significant manpower and resources to this area.
Under the new law and the SEC's proposed implementing rules, credit rating agencies will be required to register with the Commission. In addition, they will be required to submit to periodic inspections to insure that they are implementing policies to mitigate conflicts of interest, prevent leaks of material non-public information, and refrain from unfair or coercive practices. The SEC takes this new responsibility very seriously. We remain committed to finalizing the new rules by the statutory deadline, and we will assemble a team of staff to oversee the program and begin conducting inspections over the next several months.
Fiscal 2008 Request
With all of this as background, I'll take just a moment to provide some useful detail about the President's budget request for fiscal year 2008.
As you know, the request is for $905.3 million. That will permit the agency to maintain its staffing levels from 2007. This level of personnel strength, which as you know is significantly higher than five years ago, will permit the agency to vigorously pursue its mission and maintain strong regulatory, enforcement, examination, and disclosure review programs.
This funding level will allow the SEC to continue its commitment to information technology, which has the potential both to reduce regulatory costs and to give investors vastly more useful information than what they receive today. In addition to the SEC's interactive data initiative, the SEC is deploying new systems to better manage enforcement and examination resources, to help us manage a higher level of enforcement activity at existing personnel and funding levels. There is absolutely no question that these technology improvements will make the SEC more productive, and give both investors and taxpayers better value for their money.
Over the last two years, the SEC has made tremendous progress in improving its operations. The fiscal 2008 request will permit us to continue improving the agency's internal financial controls. The agency has poured tremendous energy into this area during my tenure as Chairman. I am pleased to say that these efforts have generated success: under the leadership of a new Executive Director, the SEC received a clean opinion on its audited financial statements for 2006 and, for the first time, there were no material weaknesses in internal controls. This is vitally important, Mr. Chairman, because the SEC must set the example not only for other federal agencies, but for all public companies whose financial statements and disclosures we review. For this reason, the SEC will continue to upgrade its financial system, and to beef up security over its information systems.
The President's budget request also will fund pay raises for SEC staff, in accordance with the SEC's pay parity authority and our collective bargaining agreement. This is a significant fact. Including cost-of-living increases, career-ladder promotions, and merit pay increases, these raises amount to between five and six percent each year. Given that from a budgetary standpoint the increases are essentially automatic, and given further that payroll represents about two-thirds of our budget, the agency's total budget has to increase by over 3.5% just to maintain personnel at a steady state from year to year.
Finally, and most importantly, the level of funding in this budget request will give the SEC the tools we need to address new, emerging risks in the nation's capital markets - including not only such known areas of concern as hedge fund insider trading, the safety and security of 401(k) plans, and the quality of disclosure to protect against fraud in the municipal securities market, but also those threats to market integrity and investor confidence that have yet to emerge.
Thank you for this opportunity to discuss the SEC appropriation for fiscal 2008. I look forward to working with you on the best ways to meet the needs of our nation's investors, and I would be happy to answer any questions you may have.