Fiscal Year 2009 Appropriations Request
by Chairman Christopher Cox
U.S. Securities and Exchange Commission
Testimony Before the Subcommittee on Financial Services and General Government
Committee on Appropriations
U.S. House of Representatives
April 16, 2008
Chairman Serrano, Ranking Member Regula, and Members of the Subcommittee:
Thank you for the opportunity to testify today about the President's fiscal year 2009 budget request for the Securities and Exchange Commission.
As you know, until this year the Congress had not increased the SEC's budget for three years. If the President's budget request for another increase this year is approved, then after years of flat budgets, the SEC will have received a roughly four percent increase over two years. After taking inflation and pay increases into account, this budget for FY 2009 would permit the SEC to keep staffing on par with levels in FY 2007 — at about 3,470 full-time equivalents.
In return for the SEC's not-quite-$1 billion budget, the tax-paying public gets significant value. The SEC oversees the nearly $44 trillion in securities trading annually on U.S. equity markets; the disclosures of almost 13,000 public companies; and the activities of about 11,000 investment advisers, nearly 1,000 fund complexes, and 5,700 broker-dealers. By way of illustration, let me outline some of what the agency achieved during FY 2007.
Review of Fiscal Year 2007
For the SEC's Enforcement Division, which polices the markets and helps keep investors' money safe, FY 2007 was truly a notable year. The Division's results are impressive both in number of cases filed — the second highest in Commission history — and in their substance, covering a range of topics of critical importance to investors.
Among many highlights, the Division halted multiple scams targeting the retirement savings of senior citizens, bringing 30 enforcement actions involving fraud against seniors. The Commission brought one of the most significant insider trading cases in 20 years. We filed options backdating cases against executives at companies in a range of industries, to stamp out that notorious abuse. Even non-investors benefited from the Commission's efforts: our anti-spam initiative was credited with a 30-percent reduction in the volume of stock market spam emails in an independent industry review. In all, the SEC forced wrongdoers to give up more than $1 billion in illegal profits and pay more than $500 million in financial penalties.
The SEC's examination program seeks to identify compliance issues at brokerage firms and investment advisers and ensure that problems are corrected before they could harm investors. In FY 2007, SEC examiners in our Office of Compliance, Inspections and Examinations conducted more than 2,400 examinations of investment advisers and investment companies, broker-dealers, transfer agents, and self-regulatory organizations. Overall, 75 percent of investment adviser and investment company examinations and almost 82 percent of broker-dealer examinations revealed some type of deficiency or control weakness. Importantly, most examinations resulted in improvements in the firms' compliance programs. Where appropriate, inspection results were referred for enforcement action.
In FY 2007, we also initiated a new program for broker-dealer chief compliance officers that seeks to help them improve their compliance programs, called the CCOutreach BD program. This program has been a great success, involving hundreds of participants.
On the regulatory front, the Commission reformed the implementation of Section 404 of the Sarbanes-Oxley Act, to fulfill the congressional intent that the law's objectives be achieved without waste and inefficiency. These reforms included Commission approval of a new auditing standard to ensure that 404 audits are conducted in a more cost-effective way, and that they focus on areas that truly matter to investors. The Commission also adopted Section 404 guidance for management, who previously had to rely on the rules intended for auditors. Currently, the staff is undertaking a study to determine whether as a result of these reforms Section 404 is in fact being implemented in a manner that is efficient and that will be cost-effective for smaller reporting companies. The study will be completed before small companies are required to have their first audit under Section 404. In addition, during 2007 the Commission approved a series of reforms to help smaller companies gain faster and easier access to the financial markets when they need it.
One of the most significant disclosure initiatives in the Commission's history was our new comprehensive disclosure regime for executive compensation, which took effect in 2007. The complete and readily accessible information about executive pay that this initiative has opened up to investors has provided a valuable new insight into corporate governance in the nation's public companies.
Also in 2007, the SEC broke an eight-year logjam by publishing final rules to implement the Gramm-Leach-Bliley Act's bank-broker provisions. This will benefit investors who utilize banks as well as brokers to help achieve their financial objectives. And we approved the merger of the NYSE and NASD's regulatory arms, with the goal of creating a single set of rules and eliminating the regulatory gaps between markets that often made enforcement difficult.
The Commission also significantly intensified its contacts with its counterparts across the globe. As Chairman, I executed agreements with the College of Euronext Regulators, the German Federal Financial Supervisory Authority, and the UK's Financial Services Authority and Financial Reporting Council, all aimed towards enhancing information-sharing on enforcement and supervisory matters. The SEC also moved to help our markets better integrate with the rest of the world by authorizing foreign firms to use IFRS as published by the International Accounting Standards Board in preparing their disclosures in the U.S. market, thereby facilitating capital formation in the United States capital markets.
Administratively, we undertook major reforms to improve the effectiveness of the SEC's operations. In 2007, the SEC significantly augmented its investor education and advocacy functions. To reinvigorate the agency's emphasis on the needs of retail investors, we created the Office of Policy and Investor Outreach which will assess the views of individual investors and help inform the agency's policymaking. A new Office of Investor Education will promote financial literacy and help investors gain the tools they need to make informed investment decisions.
In 2007, the SEC took major steps to foster the widespread use of interactive data in corporate disclosures. Interactive data will empower investors to easily obtain and compare information about their investments in ways that previously only financial pros could.
Overall in FY 2007, the SEC had one of the most productive years in its history, aggressively pursuing wrongdoing and tackling fundamental reforms in the securities markets, all on behalf of America's investors.
Fiscal Year 2008 to Date
Already in FY 2008, the Commission has been active on a number of fronts working to protect investors, promote capital formation, and foster healthy markets. And our agenda in the coming months is no less ambitious.
Oversight of the Markets
The failure of Bear Stearns has brought to the fore the regulatory gap in the supervision of investment banks. Although federal law provides for supervision of commercial banking by bank regulatory agencies, no such scheme exists for the largest investment banks. Because the law fails to provide for supervision of even the largest globally active firms on a consolidated basis, the Commission created the Consolidated Supervised Entities (CSE) program to fill this gap. Without this voluntary program there would not have been any consolidated information available to regulators, including the Federal Reserve Bank of New York, when Bear Stearns precipitously lost liquidity in mid-March 2008. This program, which is necessary to monitor for, and act quickly in response to, any financial or operational weaknesses that might place regulated entities or the broader financial system at risk, is providing the basis for significant new collaboration with the Federal Reserve. While the CSE program is at present voluntary, and receives no dedicated funding from Congress, we understand that Congress may be acting to fill this gap. This will help us to better integrate the information we receive under this program with the broader systemic risk objectives of the Federal Reserve.
Building on the new statutory authority from Congress that became effective in June 2007, the SEC has launched a new program to oversee credit rating agencies. This is also a vitally important topic in light of recent market events. Under this new authority, the Commission is conducting inspections of rating agencies to evaluate whether they are adhering to their published methodologies for determining ratings and managing conflicts of interest. Given the recent problems in the subprime market, the SEC has been particularly interested in whether the rating agencies' involvement in bringing mortgage-backed securities to market impaired their ability to be impartial in their ratings. We will shortly propose additional rules building on the lessons learned from the subprime market turmoil. These proposals may include, among other things, requiring better disclosure of past ratings, so as to facilitate competitive comparisons of rating accuracy; enhancing investor understanding of the differences in ratings among different types of securities; regulating and limiting conflicts of interest; reducing reliance on ratings per se, as opposed to the underlying criteria that ratings are thought to represent; and disclosing the role of third-party due diligence in assigning ratings. This will continue to be an area of emphasis for the Commission in the coming fiscal year.
Through our Office of Compliance, Inspections and Examinations, the SEC is continuing to follow a risk-based approach to overseeing securities firms, including registered advisers, investment companies, broker-dealers, transfer agents, clearing agencies, securities markets, and self-regulatory organizations. Among other examination areas of focus are controls over valuations, controls to prevent insider trading, protections provided to seniors in our markets, and the adequacy of firms' compliance programs to prevent, detect and correct violations of the securities laws.
The SEC is also working closely with our fellow regulators to promote the fairness and stability of the markets. Under a recently concluded Memorandum of Understanding with the Commodity Futures Trading Commission, we have established a durable process to better address the regulatory issues that in today's increasingly interconnected markets don't respect regulatory boundaries drawn up decades ago.
To anticipate future problems, I announced in February 2008 a program to more than double the size of the SEC's Office of Risk Assessment, created under the leadership of my predecessor, Chairman Bill Donaldson. With additional staff experts and the right surveillance tools, the newly expanded Office will help staff throughout the Commission look around the corners and over the horizon to identify potentially dangerous practices before they impact large numbers of investors and the economy as a whole.
The SEC is continuing to pursue wrongdoers in all corners of the securities markets, while also applying enforcement resources to the areas that pose the greatest risks to investors.
The Enforcement Division's subprime working group is aggressively investigating possible fraud, market manipulation, and breaches of fiduciary duty. Among the issues we are looking at is whether financial firms made proper disclosures about their holdings and their valuations, whether insiders used non-public information to gain from the recent market volatility, and whether naked short sellers illegally manipulated the market.
The Enforcement Division is also investigating insider trading among large institutional traders; wrongdoing in the municipal bond market; Internet and microcap fraud; and scams against seniors.
The SEC is also building upon its growing success in returning funds to harmed investors. Since the agency first received authority under the Sarbanes-Oxley Act of 2002 to use Fair Funds to compensate victims, we have returned a total of more than $3.7 billion to wronged investors. We expect to distribute another $1 billion in the next six months alone. To further professionalize the agency's execution in this area, I have created the Office of Collections and Distributions, which is led by a Director who reports to the Executive Director and the Chairman. As part of this initiative, the agency has deployed a new computer tracking system, called Phoenix, which with additional enhancements this year will help to speed the return of investors' money and maintain appropriate internal controls.
Another major productivity enhancement in the Enforcement Division is "The Hub," an agency-wide database that gives all enforcement staff access to the entire inventory of investigations. By giving line staff a window into this deep knowledge base, and permitting senior management to direct the resources of the national enforcement program quickly and effectively when necessary, The Hub is significantly increasing the effectiveness of our enforcement dollars. Additional features being rolled out in the coming months will help Division staff more readily access performance information, coordinate more effectively with the Office of Compliance, Inspections and Examinations, and better manage their investigative documents throughout the enforcement lifecycle.
International Enforcement and Regulatory Issues
The SEC's efforts in the international arena, which have markedly increased in recent years, have by necessity been a key focus of my Chairmanship. The time is long past when the SEC, or any financial regulator, can feel safe that by scrutinizing just the activities within its national borders, it can comprehend all the potential dangers ahead. In a world where capital flows freely across borders, problems or issues in one corner of the globe rarely stay there. The world's regulatory and enforcement authorities are finding that we have to collaborate if we hope to protect our own investors. Accordingly, the SEC is working closely with our international counterparts to monitor the markets and pursue fraudsters wherever they may run. We are also exploring the idea of mutual recognition among a very few high-standards countries with robust regulatory and enforcement regimes.
In recognition of the interconnectedness of global markets, the SEC will continue to expand our own expertise in IFRS, and explore additional ways that U.S. investors might benefit from increased comparability using a high-quality international standard. The continued integration of our own domestic accounting standards and IFRS will enhance the quality of both, while improving the reliability, clarity, and comparability of financial disclosure for American investors.
The SEC is committed to making public company disclosure more useful to investors. Under the leadership of the Office of Interactive Disclosure, the SEC is building upon our recent successes in constructing a foundation for the widespread use of interactive data. After years of experience through the SEC's voluntary pilot program, the Commission will consider a rule in 2008 that requires the use of interactive data by reporting companies, as well as other proposals to expand interactive data reporting by mutual funds and other market participants. These efforts will be aimed at giving investors the ability to easily find and compare key data about the companies and funds in which they invest.
There are other investor-friendly improvements in store for mutual fund disclosure. Too many investors today throw away their mutual fund disclosures instead of reading them. Too often, the prospectuses are laden with legalese that makes them nearly impenetrable for the average person. In the coming months, the SEC will consider authorizing mutual funds to issue a summary prospectus that will be more user-friendly for investors. If adopted, the summary document would succinctly present key facts about the fund up front, with more detailed information available for investors on the Internet or in paper upon request. The agency also is preparing help for investors at the time they buy a mutual fund to learn about fees, expenses, and conflicts of interest.
Another important initiative relates to the $2.5 trillion worth of municipal securities currently outstanding, about two-thirds of which is owned either directly or indirectly by retail investors. Despite its size and importance, this market has many fewer protections for investors than exist in the corporate market. For example, investors often find it difficult even to get their hands on the disclosure documents for the municipal securities they own. To address this shortcoming, the Commission is working to authorize the creation of an online computer database, a so-called muni-EDGAR, which would give investors in municipal securities electronic access to disclosures filed in connection with their investments. I have also urged our authorizing committees in the House and in the Senate to update the SEC's authority in this area.
The Commission has very recently taken additional steps to safeguard investors and protect the integrity of the markets during short selling transactions by proposing a rule that would specify that abusive "naked" short selling is a fraud. In a naked short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period for trades. As a result, the seller fails to deliver stock to the buyer when delivery is due. This is known as a "failure to deliver." Sellers sometimes intentionally fail to deliver securities to the buyer as part of a scheme to manipulate the price of a security, or possibly to avoid borrowing costs associated with short sales. This is just the latest sign of the Commission's continuing focus on abuses in this area.
The Commission is also working to protect Americans' pension fund investments. In March 2008, the Commission issued a special report reminding public pension funds of their responsibilities under the federal securities laws, and warning them that they assume a greater risk of running afoul of anti-fraud and other provisions if they do not have adequate compliance policies and procedures in place to prevent wrongdoing in their money management functions.
To protect investor privacy and to help prevent and address security breaches at the financial institutions the SEC regulates, the Commission proposed new rules that provide more detailed standards for information security programs. The proposed rules provide more specific requirements for safeguarding information and responding to information security breaches. The Commission also extended these privacy protections to other entities registered with the Commission.
The Commission has also proposed an expedited process to speed up the availability to the investing public of exchange-traded funds (ETFs). ETFs are similar to traditional mutual funds, but issue shares that trade throughout the day on securities exchanges. The proposed rules would eliminate a barrier to entry for new participants in this fast-growing market, while preserving investor protections. The Commission also proposed enhanced disclosure for ETF investors who purchase shares in the secondary markets.
Mr. Chairman, these are only some of the highlights of what the agency has recently been focused on, and what we have planned for the coming year. The SEC's mandate is as broad as it is important to America's investors and our markets. On behalf of the agency, let me thank you for the support that you and this Committee have so well provided for these vital efforts.
The budget request for fiscal year 2009 will allow the SEC to continue to aggressively pursue each of these ongoing initiatives on behalf of investors, as well as to address new risk areas as they emerge. As I mentioned, the request will allow the SEC to fully maintain our current program of strong enforcement, examinations and inspections, disclosure review, and regulation.
The request also will cover merit raises for SEC staff, as the agency transitions to a new performance evaluation system. This new five-level rating system has been developed in conjunction with the National Treasury Employees' Union to provide more individualized feedback to staff, based on clear performance criteria. The system has been piloted in our Office of Human Resources, and will next be extended to the agency's senior managers. The rest of the agency's employees are scheduled to transition into the program next year.
I want to thank you for this opportunity to discuss the SEC's appropriation for fiscal year 2009. I look forward to working with you to meet the needs of our nation's investors, and I would be happy to answer any questions you may have.