-------------------- BEGINNING OF PAGE #1 ------------------- TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING THE COMMISSION'S AUTHORIZATION REQUEST FOR FISCAL YEAR 1997 BEFORE THE SUBCOMMITTEE ON TELECOMMUNICATIONS AND FINANCE COMMITTEE ON COMMERCE U.S. HOUSE OF REPRESENTATIVES February 28, 1996 EXECUTIVE SUMMARY Introduction. The SEC performs an essential function: overseeing the dynamic U.S. capital markets, worth trillions of dollars, that fuel the U.S. economy. The Commission does so, moreover, with a modest staff and limited resources, operating in partnership with the private sector rather than through pervasive regulation. Today's authorization request for appropriations of $317 million in fiscal year 1997 would put the Commission on a tight budget: it would allow for an increase of only $16 million in funding above the level available to the Commission in fiscal year 1995 (following a year of no increases in SEC funding in 1996). The $317 million requested for 1997 will allow the SEC to maintain staffing at our current level, but will also require the agency to stretch our limited resources to the maximum in 1997. We are willing to take on that challenge. Recent Commission Achievements and Ongoing Initiatives. The Commission's authorization request should be viewed in the context of the dramatic growth that has occurred, and continues to occur, in our markets, and in the context of the SEC's ongoing efforts to "reinvent" itself. Over the past two years, to cite just a few highlights, the Commission has undertaken to: * rationalize its own structure and processes, by (for example) reorganizing its examination program to make SEC examinations more efficient; centralizing its small business disclosure program to make better use of SEC resources; recommending legislative repeal of an outdated statute administered by the Commission; and redoubling efforts to work with the private sector to provide cost-effective, efficient regulation; * promote capital formation, by streamlining and reducing certain registration and disclosure requirements for companies that seek to access the securities markets; * simplify disclosure requirements for corporate issuers and mutual funds, thus reducing compliance costs while offering investors more user-friendly information; * promote the international competitiveness of U.S. markets through initiatives to simplify foreign issuer access to U.S. securities markets; and * enhance investor protection through continued, vigorous law enforcement and investor outreach efforts. Funding Structure. The Commission strongly supports the new funding structure developed and proposed by Chairmen Bliley and Fields, together with Chairmen Rogers and Archer. The proposal would gradually move the SEC from reliance on increased offsetting fees towards full appropriation status, providing a long-term solution to the SEC's funding problems. -------------------- BEGINNING OF PAGE #2 ------------------- TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING THE COMMISSION'S AUTHORIZATION REQUEST FOR FISCAL YEAR 1997 BEFORE THE SUBCOMMITTEE ON TELECOMMUNICATIONS AND FINANCE COMMITTEE ON COMMERCE U.S. HOUSE OF REPRESENTATIVES February 28, 1996 Chairman Fields and Members of the Subcommittee: I appreciate this opportunity to testify on behalf of the Securities and Exchange Commission (SEC or Commission) regarding the Commission's authorization for fiscal year 1997. The Commission seeks authorization for appropriations of $317 million in fiscal year 1997.-[1]- This request represents a realistic estimate of the resources the SEC will need to maintain effective regulation of the U.S. securities markets in the face of rapid market growth, while recognizing Congressional budgetary concerns in an era of fiscal restraint. The SEC performs an essential function: overseeing the fast-moving U.S. capital markets, worth trillions of dollars, that fuel the U.S. economy. The Commission does so, moreover, with a modest staff and limited resources, operating in partnership with the private sector rather than through pervasive regulation. Today's authorization request would put the Commission on a tight budget. It would allow for an increase of only $16 million in funding above the level available to the Commission in fiscal year 1995 (following a year of no increases in SEC funding in 1996), nearly half of which is due to mandatory increases.-[2]- The $317 million requested for 1997 will permit the SEC to maintain its current staffing levels of 2,797 full- time equivalents (FTEs). Funding at this level will require the Commission to stretch its limited resources to the maximum in 1997 in order to adequately fulfill its responsibilities to investors in the rapidly expanding, ever-complex U.S. securities markets. We are willing to take on that challenge. --------- FOOTNOTES --------- -[1]- The Commission last submitted an authorization request in June 1994, covering fiscal years 1995-97. That earlier request sought appropriations of $382.7 million for fiscal year 1997. Today's revised request has been significantly reduced in recognition of current budget realities and would represent a modest increase over the SEC's 1995 and (projected) 1996 total budget authority of $301 million (consisting of $297 million in appropriations plus an additional $4 million in prior year carryover funds). -[2]- The authorization requested for 1997 represents a moderate increase over the Commission's (projected) appropriation for FY 1996. After mandatory increases in pay and related personnel benefits, the remainder of the increase in the Commission's authorized funding would be available for such projects as EDGAR modernization and litigation support. Additional information regarding the Commission's 1997 authorization request is set forth in the attached appendix. -------------------- BEGINNING OF PAGE #3 ------------------- Role of the SEC The U.S. securities markets are widely regarded as the deepest, most liquid, and fairest markets in the world. They serve the needs of almost 13,000 public corporations,-[3]- raising capital to support new industries, finance operations, create jobs, fund research and development, and support growth for the future. In 1995 alone, over $800 billion of corporate securities were sold in our markets. Capital was raised directly from both institutional investors (including mutual funds and pension funds) and private individuals. One in three American households participates in the U.S. securities markets, directly or through mutual funds.-[4]- Thus, the U.S. securities markets serve not only as a powerful engine for capital formation but also as an important vehicle for savings and investments by U.S. citizens. The Commission plays a vital role in preserving the strength and integrity of these markets. Since its creation in 1934, the Commission has been charged with protecting investors and maintaining fair and orderly markets. It is first and foremost a law enforcement agency. It fulfills its statutory mandate by policing fraud in the securities markets as a whole, requiring full disclosure by issuers of securities, overseeing the regulation of the nation's securities markets, and directly regulating the investment company and investment adviser industries. By protecting market integrity, the SEC's regulatory and enforcement programs foster the continued success of the U.S. capital markets. The SEC is able to handle its broad mandate with a small staff by regulating, to a large extent, through a public-private partnership. The Commission takes responsibility for the "big picture" areas,-[5]- while much of the direct, day-to-day regulation of securities market participants is done by firms themselves-[6]- and by private membership organizations (self- regulatory organizations or SROs), under SEC oversight.-[7]- --------- FOOTNOTES --------- -[3]- This figure does not include the roughly 5,000 registered investment companies (representing over 23,000 separate portfolios) that also raise capital in the U.S. markets. -[4]- In 1995 alone, investors bought nearly $120 billion worth of funds that invest primarily in U.S. stocks. See Investment Company Institute Press Release 96-02 (Jan. 25, 1996). Funds that invest primarily in American stocks had over $1.07 trillion in assets at year-end 1995. See id. -[5]- These include core regulations concerning fraud, financial responsibility of securities firms, the clearance and settlement process, and market structure. -[6]- Under the federal securities laws' system of self- regulation, senior personnel at securities firms may be sanctioned if they fail to supervise their employees to ensure that they comply with the law in their trading and other activities. Thus, firms themselves are the first line of regulation and enforcement. -[7]- Under the Exchange Act, SROs must register with the Commission and obtain Commission approval of their rules, and market participants must become members of the SROs through which they do business. SROs are responsible for monitoring the activities of SRO (continued...) -------------------- BEGINNING OF PAGE #4 ------------------- This regulatory approach is markedly different from the approach taken by other federal regulators, and allows the SEC -- with only 2,797 employees across the country -- to oversee dynamic markets that have grown to be worth more than $10 trillion.-[8]- The key to making self-regulation work effectively is SEC oversight. Commission oversight helps to ensure that the SROs exercise their power responsibly: the SEC inspects SROs and performs targeted oversight examinations of their broker-dealer members to determine whether the SROs are in fact effectively supervising the financial condition and business practices of their members. The SEC also must approve (and may amend) SRO rules as consistent with the public interest. Thus, the system for regulating the U.S. securities markets is one of shared regulation between the SEC and the industry. This cooperation means that informed industry participants can contribute their expertise and unique perspective in establishing and enforcing standards that protect the investing public and promote the fairness of the U.S. markets; the SEC, for its part, can concentrate its attention on monitoring the SROs, assuring financial responsibility, overseeing the markets generally, requiring full disclosure, and providing strong enforcement. Market Growth To put the SEC's authorization request in context, it has to be considered against the backdrop of the dramatic growth and rapid change our markets have experienced over the past 15 years. Between 1980 and 1995, for example, the value of public offerings (including debt and equity, but not investment company securities) increased more than ten-fold, from $58 billion to $768 billion. Between 1990 and 1995, the dollar volume of equities traded on U.S. securities exchanges and NASDAQ grew 182%, with over $5.94 trillion traded in 1995. Volume continues to explode. December 15, 1995, was the heaviest trading day in the history of the New York Stock Exchange, with over 636 million shares trading hands. On NASDAQ, record daily volume was set on February 22, 1996, with volume exceeding 641 million shares. Over the last few months, there have been several instances in --------- FOOTNOTES --------- -[7]-(...continued) members in their dealings with each other and with the public. They also are responsible for market surveillance and for rule enforcement with respect to their members. -[8]- Other federal regulators operate under different statutory structures -- with a corresponding difference in their staffing requirements. For example, the federal banking statutes provide for direct, comprehensive regulation of banking activities, in lieu of a system of self-regulation. As a result (and notwithstanding recent personnel cutbacks), the federal banking regulators maintain staffs that are, in the aggregate, much larger than the SEC's staff. See Jonathan Glater, Banking Industry Mergers Spur Regulatory Cutbacks, Wash. Post, Aug. 18, 1995, at A11. The FDIC, for example, employs some 10,000 staff to carry out the agency's function as insurer and backup regulator of around 12,000 insured banks and thrifts. See id. The Commission does not wish to suggest, however, that one scheme of regulation is better than the other; each model has different strengths, tailored to the requirements of the relevant industry. -------------------- BEGINNING OF PAGE #5 ------------------- which daily share volume on all U.S. markets combined has exceeded one billion shares. Dramatic growth also has occurred with respect to assets under management by investment advisers. Between 1980 and 1995, assets managed by investment advisers (excluding investment advisers to registered investment companies) rose from $205 billion to $7.6 trillion (an increase of 3,607%). Over the same period, assets of investment companies increased 1,203% from $235 billion to $3.062 trillion. The numbers of securities firms and professionals registered with the Commission or with the SROs have also surged. Between 1980 and 1995, the number of registered advisers increased from 3,500 to 22,000 (an increase of 529%). The number of broker- dealers grew, over the same period, from around 5,200 to approximately 8,500 (an increase of 62%), and the number of registered representatives grew from 196,000 to over 505,000 (an increase of 158%). Technological change and internationalization also have had a significant effect on the U.S. securities markets. New and more complex financial products are rapidly emerging as a result of the continuing globalization of commerce and financial markets and major advances in information processing and telecommunications. Investors are increasingly using electronic communications media to trade securities and obtain market information and advice. U.S. securities markets and firms have played a leading role in many of these changes. The Commission's responsibilities have expanded with the securities markets. The Commission's staffing, however, has grown at a significantly lower rate. Despite a 39% increase in the Commission's staff between 1988 and 1995, the overall growth of the Commission's staff from 1980 to the present has fallen far short of the rate of market growth. For example, while the Commission's staff grew at an annual rate of 1.9% from 1980 to 1995, the assets under investment company management grew at an annual rate of 18.7% over the same period, and the assets managed by investment advisers increased at an annual rate of 23.6%. Recent Commission Achievements and Ongoing Initiatives: Selected Highlights The Commission has a long-standing commitment to efficiency and economy in regulation. Today, the rapid growth of the U.S. securities markets (combined with increasing pressures on government resources) demands that the Commission function as efficiently as possible. The SEC has tried to anticipate and respond to these new challenges, and to address them -- in partnership with the private sector -- through initiatives that will: * rationalize the Commission's own structure and processes; * promote capital formation; * simplify disclosure requirements; * promote the international competitiveness of U.S. markets; and * enhance investor protection. It is not possible to describe all of the Commission's programs here; but the balance of this testimony will try to highlight some of the SEC's recent and ongoing achievements and initiatives in these five areas. "Reinvention" Efforts: Rationalizing Agency Structure and Processes -------------------- BEGINNING OF PAGE #6 ------------------- The Commission seeks on an ongoing basis to "reinvent" itself. The agency continually searches out new ways of regulating more effectively but less intrusively, and at lesser cost to industry and investors. Recently, for example, the Commission developed plans to centralize its small business disclosure function in SEC headquarters, phasing out its regional office disclosure function. This move will allow the Commission to make better use of its scarce resources, permitting the Commission to reallocate 38 staff positions to its investment adviser examination program. At the same time, we recognize that the special needs of small businesses must be met. The Commission, accordingly, plans to implement three initiatives in connection with the centralization of the disclosure function: * creating a new dedicated headquarters branch that will specialize in small company filings and the needs of small companies; * disseminating information specifically tailored to the interests of small companies through the SEC's Internet Web site; and * assigning staff liaisons within each region to facilitate communications between small businesses and SEC headquarters. In other actions over the past two years, the SEC has tried to streamline its own operations and to reduce regulatory burdens through such initiatives as: * conducting a comprehensive review of the 60-year old statute (administered by the SEC) that governs public utility holding companies, and recommending legislative repeal of that Act; * eliminating the need for prior review of certain SRO rule filings; * facilitating access to market information by providing increased public access to corporate filings on the Commission's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system, and by reevaluating and updating EDGAR to take advantage of new technology; * revising the SEC's rules governing adjudications and administrative proceedings, to streamline the adjudicative process and allow speedier, more efficient completion of administrative proceedings; * realigning the regional/district office structure to improve program accountability and resource utilization; * reallocating existing resources to establish a new Office of Compliance Inspections and Examinations to conduct and coordinate examinations of brokers, dealers, SROs, investment companies and advisers, and transfer agents; and * reallocating existing resources to create a new Office of Municipal Securities to provide expertise, coordination, and assistance in rulemaking and enforcement efforts affecting the municipal securities -------------------- BEGINNING OF PAGE #7 ------------------- market. As part of the Commission's ongoing "reinvention" program, the agency has also redoubled its commitment to working with industry to provide cost-effective, efficient regulation in partnership with the private sector. Recent SEC-industry efforts have included the following: * Clearance and settlement. On June 7, 1995, the Commission's Rule 15c6-1 went into effect, shortening from five to three business days the standard settlement period for certain securities trades. The T+3 (trade plus three business days) standard was adopted, as recommended by the private sector "Group of 30" and the Bachmann Task Force, as a means of reducing systemic risk and improving market stability in times of crisis by reducing the number of trades that, at any one time, remain outstanding and unsettled. In a more recent development, the Commission also worked with the securities clearing agencies and the Federal Reserve Board to facilitate implementation on February 22, 1996, of a same-day funds settlement convention for the corporate and municipal securities markets. These and related changes will offer investors and financial intermediaries faster trade settlements with less risk of financial loss. * Derivatives. In August 1994, at the urging of the Commission and the Commodity Futures Trading Commission (CFTC), the six broker-dealers with the largest derivatives affiliates formed a Derivatives Policy Group (DPG). The DPG undertook to develop a framework for voluntary oversight of the over-the-counter derivatives activities of unregulated affiliates of securities firms. Its recommendations, released in March 1995, include provisions for improved management controls, enhanced quantitative reporting to the SEC and the CFTC, and guidelines designed to foster integrity and responsible conduct with respect to end- users of derivatives. The Commission currently is receiving reports from the members of the DPG and is integrating this information into the SEC's financial responsibility and risk assessment program. * Municipal securities. The Commission, in cooperation with the private sector, has undertaken initiatives to enhance disclosure, particularly in the secondary markets; improve price transparency; and restore the integrity of this vitally important market. The SEC has also encouraged industry initiatives and approved the Municipal Securities Rulemaking Board's rules G-37 and G-38 regarding municipal market "pay-to-play" practices. * Broker-dealer practices. Raising the standards of broker sales practices has been a high priority for the Commission. Toward this end, the SEC has worked with the securities self-regulatory organizations to develop continuing education requirements for securities sales personnel. The Commission also encouraged firms within the securities industry to re-evaluate their broker- dealer compensation practices. * Mutual fund examinations. In December 1995, the -------------------- BEGINNING OF PAGE #8 ------------------- Commission announced the formation of a public-private panel to study the agency's mutual fund examination program. The SEC, in consultation with the Investment Company Institute, asked several distinguished members of the mutual fund community to help review the Commission's new, not yet implemented, mutual fund examination manual. Panel members will field test portions of the manual on their own funds and will then provide the Commission with their findings and suggestions. Promoting Capital Formation Consistent with the Commission's "reinvention" efforts and other public-private initiatives, the SEC is making concerted efforts to streamline and promote the capital formation process. Today, companies need to raise more capital, and to do so more quickly, more easily, and more cost-efficiently than ever before. The securities markets are critical to that capital formation process. Regulation, the Commission is aware, can burden the operation of the capital markets. The Commission is also aware, however, that judicious and effective regulation -- by protecting the integrity of our markets and supporting investor confidence - - is essential to the success of the capital formation process. Through a number of recent rulemaking initiatives, the Commission has sought to reduce the costs of capital-raising without compromising investor protection. For example, in recent years the Commission has created a new, simpler, registration and disclosure regime for small businesses that seek to access the securities markets. The Commission also greatly expanded the number of companies eligible to use short-form and shelf registration for securities offerings, which allows immediate access to the markets at a lower cost. The Commission's efforts in this area continue. For example, just last summer, the Commission proposed rules to, among other things: * allow an issuer contemplating an initial public offering to "test the waters" -- in other words, to gauge investor interest before incurring the significant cost of filing a registration statement under the Securities Act; and * exclude certain small businesses from the registration and full disclosure requirements of the Exchange Act by doubling the total assets threshold (from $5 million to $10 million). In August 1995, an internal Task Force on Disclosure Simplification (Task Force) was created and charged generally with reviewing all forms and all disclosure requirements imposed on public companies. The Task Force -- whose outside advisor is Philip Howard, author of a book on regulatory simplification entitled The Death of Common Sense -- is expected to make its recommendations to the Commission in March 1996. Indications are that the Task Force will recommend eliminating or modifying dozens of Commission rules and forms in an attempt to modernize the regulatory framework that governs corporate finance and accounting. In addition to exploring possible refinements and improvements to the existing securities disclosure system, the Commission is currently taking a fresh look at that system in its entirety. The SEC has established an Advisory Committee on the Capital Formation and Regulatory Processes to consider long- -------------------- BEGINNING OF PAGE #9 ------------------- term, comprehensive reforms of the registration and disclosure process -- primarily consideration of whether requiring the registration of companies, rather than securities, would promote capital formation while enhancing the information provided to investors. We expect to receive the recommendations from the Committee early this year. Improving Disclosure Requirements Through its work with the Task Force, the Advisory Committee and other initiatives, the Commission has sought to simplify and streamline its disclosure requirements. This is an important task: the Commission recognizes that compliance with the disclosure requirements of the federal securities laws can involve considerable expense. But disclosure simplification also calls for a careful balancing of interests, because disclosure is the cornerstone of the regulatory scheme established in the federal securities acts. Under the federal securities laws, the U.S. securities markets are open to all companies. Market integrity is safeguarded, not by barring companies from issuing securities in the market, but by requiring companies to disclose the information that investors need in order to make informed investment decisions.-[9]- In order to reduce the costs, while retaining the benefits, of the disclosure-oriented federal securities regulatory scheme, the SEC in recent years has launched several efforts to simplify and streamline disclosures. The Commission has paid particular attention to improving the usefulness of the information received by investors (by encouraging, among other things, "plain English" disclosures) while at the same time minimizing the regulatory costs and burdens imposed on issuers. Profile prospectus. In the investment company area, the SEC has worked with the investment company industry and state securities regulators to develop the concept of a "profile prospectus." The key element of the profile prospectus is a standardized, short-form summary that accompanies the full- length prospectus and is designed to enable mutual fund investors to better understand what they are buying. Pilot "profiles" developed by eight fund groups have been available to investors since August 1, 1995. Initial investor reaction has been very positive. Improved disclosures by mutual funds. Toward the same end, the Commission in July 1995 proposed improved disclosure requirements for money market funds. The proposed standards are designed to simplify money market fund prospectuses considerably, making them less costly to prepare and allowing investors to focus on a short document (four to six pages) that contains the most essential information about the fund. In addition, the --------- FOOTNOTES --------- -[9]- While compliance with the securities disclosure requirements may involve costs to issuers, it is important to bear in mind that the principle of full disclosure protects the fairness, integrity, and ultimately the success of our markets -- and that issuers always have the choice of whether or not to go to the public markets for capital, and whether or not to subject themselves to the disclosure requirements that apply to publicly traded companies. A disclosure regime, moreover, is less intrusive than a regulatory scheme based on the direct regulation of securities issuers. -------------------- BEGINNING OF PAGE #10 ------------------- Commission in March 1995 issued for public comment a concept release discussing the ways in which investment company risk disclosure can be improved so that investors better understand the risks presented by funds. Disclosures regarding derivatives. During 1994 and 1995, the Commission's staff reviewed disclosures by over 500 registrants and considered findings published by various public and private sector organizations to evaluate the effectiveness of existing disclosure requirements and practices with respect to derivatives activities and related market risks. Following up on that review, the Commission at the end of 1995 released for comment proposed rule amendments that are designed to help investors better assess the market risks faced by public companies and how those risks are managed. Streamlining disclosures by corporate issuers. Last summer, the SEC proposed rules to, among other things, simplify disclosure by corporate issuers. For example, the Commission proposed streamlining financial statement prospectus disclosure requirements relating to significant business acquisitions to parallel information required of companies for the trading markets. The Commission expects to do more to simplify the disclosure requirements that apply to corporate issuers as a result of the report of its in-house disclosure Task Force, which is expected shortly. Electronic filing. In addition, the Commission is continuing to take steps to bring the filing and dissemination of disclosure documents into the electronic era. By May 1996, most issuer filings with the SEC will be submitted electronically through the Commission's EDGAR system. In September 1995, the Commission initiated its own Internet Web site, following up on a National Science Foundation initiative funded by Congress. The SEC's "home page" contains SEC releases and announcements, investor information, and EDGAR filings, updated on a daily, 24- hour delayed basis. The Commission also approved the issuance of an interpretive release designed to encourage the use of electronic media in providing prospectuses and other disclosure documents to investors. In this rapidly developing area, the Commission and its staff will continue to support the development of various means of electronic delivery of information to investors and the market. Promoting the International Competitiveness of U.S. Markets The integrity as well as the depth of the U.S. securities markets have attracted increasing numbers of foreign issuers and investors and have made our markets preeminent in the world. This continuing internationalization is beneficial for U.S. markets and investors alike: it promotes the leading position of the U.S. markets and gives U.S. investors a broader array of investment choices within the strong disclosure and investor protection framework of the U.S. markets. The Commission, accordingly, has sought to promote the internationalization of the U.S. markets, while safeguarding their transparency and fairness, through initiatives to: * streamline registration, reporting, and reconciliation requirements for foreign companies; * permit, in cross-border offerings, the use of certain international accounting standards in portions of financial statements filed with the Commission; and -------------------- BEGINNING OF PAGE #11 ------------------- * streamline financial statement disclosure requirements for both foreign and domestic issuers with respect to acquired foreign businesses. In addition, the Commission, through the International Organization of Securities Commissions (IOSCO), continues to provide active support to the efforts of the International Accounting Standards Committee to develop high quality, comprehensive international accounting standards. Due in part to the Commission's internationalization efforts, foreign issuers are increasingly turning to the U.S. markets to raise capital. Foreign issuer offerings of securities in U.S. markets have grown from about $30 billion in 1990 to approximately $90 billion in 1995. Since January 1, 1995, 119 foreign companies from 24 countries have entered the U.S. reporting system, including companies from Chile, China, France, Indonesia, Italy, and the United Kingdom. As of December 31, 1995, 744 foreign reporting companies representing 45 countries were registered with the Commission. With increased international trading comes a need for better cooperation and communication regarding the regulatory and enforcement issues that may arise between the U.S. and foreign markets. In recent years, the Commission has entered into Memoranda of Understanding (MOUs) with 27 countries. By providing for cooperation among regulatory agencies, the MOUs facilitate enforcement investigations into cross-border securities transactions.-[10]- Similarly, in the regulatory area, the Commission is working with its foreign counterparts to address concerns relating to global systemic risk. For example, in July 1995, the SEC entered into a joint initiative with the U.K. Securities and Investments Board to conduct in-depth studies of the controls used by certain financial institutions that engage in significant cross-border derivatives and securities activities. On a multilateral basis, the Commission has taken a leading role in international efforts to set market standards and coordinate enforcement activities through organizations such as IOSCO and the Council of Securities Regulators of the Americas. Enhancing Investor Protection Enforcement of the federal securities laws will always be a priority for the Commission. It is especially important because under our regulatory scheme we rely so much on the efforts of securities firms themselves, and the securities self-regulatory organizations, as the front line defense against violations of the securities laws. The Commission's enforcement, examination, and investor education programs back up that front line defense, by detecting and deterring misconduct.-[11]- --------- FOOTNOTES --------- -[10]- In 1995, the Commission made 230 requests for enforcement assistance to foreign governments, pursuant to MOUs or other less formal arrangements. The success of the Commission's international enforcement program has been recognized; our system has served as the model for other domestic legislation and for securities regulators around the world. -[11]- Of course, many of the Commission's regulatory and rulemaking activities have investor protection and/or the public interest as their goal. Throughout the federal securities laws, the Commission is charged with (continued...) -------------------- BEGINNING OF PAGE #12 ------------------- Law enforcement. The Commission continues to pursue its traditionally vigorous enforcement program in a time of increased caseload and scarce resources. In the past two years, the Commission has brought almost 1,000 enforcement actions against approximately 2,200 defendants and respondents.-[12]- Recent notable cases have involved domestic and international insider trading, Ponzi schemes, government securities trading fraud, misleading disclosure, kickbacks or conflicts of interest relating to municipal securities offerings, broker-dealer sales practices abuses, prime bank notes, and unregistered securities offerings over the Internet. For example: * In the Matter of PaineWebber Incorporated. In this case involving the sale of partnership interests, PaineWebber consented to a cease and desist order requiring it to comply with its representation that it had paid or would pay $292.5 million to defrauded investors, and requiring payment of a $5 million civil penalty. * Orange County Actions. In the wake of the financial collapse of Orange County, California, the Commission brought enforcement proceedings against Orange County, its former treasurer, and others. In addition, the Commission issued a Report of Investigation concerning the conduct of individual members of the County Board of Supervisors. The proceedings concern the fraudulent offer and sale of over $2.1 billion in municipal securities issued in 1993 and 1994. --------- FOOTNOTES --------- -[11]-(...continued) adopting rules that are "necessary or appropriate in the public interest or for the protection of investors." This section does not separately detail all of the Commission's recent regulatory initiatives to protect investors and enhance the public interest, although some of them are discussed elsewhere in this testimony. For example, recent Commission initiatives in municipal securities disclosure, mutual fund risk disclosure, and broker-dealer sales practices seek to enhance investor protection. The Commission has begun to seek input on some of these initiatives from a broad spectrum of the public, including investors and small businesses, by going beyond publication in the Federal Register and distributing plain English requests for comment and other user-friendly material through the media, the Internet, and other non-traditional channels. -[12]- It is not clear what impact the recently-enacted Private Securities Litigation Reform Act of 1995 (Pub. L. No. 104-67) will ultimately have on the Commission's law enforcement responsibilities. President Clinton has asked the Commission to report by year-end on how the Act affects the agency's programs. We are currently monitoring developments in this area, in addition to carrying out the Act's mandate to study protections for senior citizens and qualified retirement plans. Without knowing more about the Act's impact, and recognizing the need for fiscal restraint throughout government, we are not requesting additional resources at this time. -------------------- BEGINNING OF PAGE #13 ------------------- * SEC v. Qualified Pensions, Inc. This enforcement action involves the misappropriation of approximately $10.8 million that was to have been maintained in Individual Retirement Accounts and other retirement plans. More than 14,500 individuals allegedly were induced to transfer at least $270 million of their retirement savings to unsuitable investments. * SEC v. Nicholas Rudi. The Commission alleges that more than $300,000 in kickbacks were paid to a financial adviser in connection with the offering of debt securities by New Jersey's Camden County Municipal Utilities Authority. Three individuals have consented to injunctions, and agreed to pay a total of $347,000 in disgorgement and prejudgment interest. The case is pending as to another individual and an advisory firm under his control. Examinations. Investment adviser inspections present a continuing challenge for the Commission. Today, investment advisers (excluding investment advisers to mutual funds) are responsible for managing almost $7.6 trillion of investor assets, sixteen times the figure of ten years ago. Unfortunately, while investors have entrusted more and more of their savings to the care of investment advisers, the SEC's inspection resources have not increased commensurately. As a result, at present, the SEC inspects the 8,000 higher-risk investment advisers with custody of or discretionary management authority over client assets only once every 8-10 years, on average. The remaining 13,000 advisers are currently inspected only on a "for cause" basis or in geographic sweep examinations conducted with the state securities regulators; as a result, such advisers are inspected, on average, only once every 44 years. In 1995 (as noted above), the Commission transferred existing headquarters staff to a new Office of Compliance Inspections and Examinations. While this reallocation of internal resources has helped to improve the efficiency of inspections, it will not necessarily make adviser inspections more frequent. In the current budgetary environment, the Commission has sought to develop alternative approaches to shortening the inspection cycles for investment advisers. One such approach would be to change the existing regulatory scheme through legislative action. If Congress delegated responsibility for the regulation of smaller advisers to state regulators, the SEC could focus its efforts on larger investment advisers, i.e., those who have the most assets under management. These advisers tend to have business activities that cross many state lines and that affect national markets. The states, in turn, could regulate and examine smaller advisers, who tend to have community-based business and, therefore, are best regulated at the state level.-[13]- Since this approach would require legislative action to implement, the SEC has also sought other ways to improve the efficiency of its examinations. * By shifting resources within the agency (as described above), the Commission plans to reallocate 38 staff --------- FOOTNOTES --------- -[13]- A similar approach is set forth in S. 148, the "Investment Advisers Integrity Act," introduced last year by Senator Gramm. -------------------- BEGINNING OF PAGE #14 ------------------- positions to the investment adviser examination program. When this staff is in place and fully trained, the SEC will be able to shorten the examination cycle for advisers with discretion over client funds to one examination every five years. * The examination staff has increased the extent to which it coordinates inspection efforts with state securities regulators. SEC examination staff conduct specialized adviser inspection training programs for state examiners with follow-up joint inspections with the trainees from the states. * In June 1995, the Commission and the Office of the Comptroller of the Currency (OCC) agreed on a framework for conducting joint examinations of bank-related mutual funds and investment advisers. We expect this arrangement with the OCC to serve as a model for future discussions with other banking regulators. * Staff from the Office of Compliance Inspections and Examinations recently began conducting geographical sweep examinations of financial planners on a joint basis with state securities examiners. Going forward, the SEC plans to conduct at least eight such joint sweeps each year in various locations throughout the country. * In May 1995, the SEC and the United Kingdom's Investment Management Regulatory Organization entered an understanding to facilitate the sharing of information, cooperation in inspections, and access to reports generated in the oversight of cross-border investment management activity. A similar understanding was reached with the Hong Kong Securities and Futures Commission in October 1995. While the investment adviser and mutual fund programs have been an important focus of concern, the Commission has continued to improve the effectiveness of its other examinations as well. For example, in November 1995, the Commission entered into a Memorandum of Understanding with other broker-dealer regulators to share information, coordinate examinations, create a computerized tracking system, and hold regular planning summits. The agreement was signed by the SEC, the North American Securities Administrators Association (on behalf of its members who are state securities regulators), the New York Stock Exchange, the NASD, the American Stock Exchange, and the Chicago Board Options Exchange. The MOU should enhance regulatory effectiveness while reducing burdens on the securities industry. Investor outreach. In 1995, approximately 17% of all agency enforcement investigations were initiated, at least in part, on the basis of investors' complaints to the SEC. Over 42,000 complaints and inquiries were handled by the SEC's investor education and assistance staff. One of the best ways to prevent fraud, and minimize the need for enforcement actions, is to educate investors so they are better able to protect themselves. The Commission and its Office of Investor Education and Assistance have made concerted efforts to reach out to investors through "town meetings," its home page on the World-Wide Web, focus groups, and other innovative means. Working with the industry and many of its trade associations, the SEC has prepared and distributed brochures which provide self- -------------------- BEGINNING OF PAGE #15 ------------------- protection tips for investors about choosing investment professionals, information on mutual funds, and the settlement of securities trades. Other outreach efforts include: * consultation with a Consumer Affairs Advisory Committee, in order to identify and address the problems that investors encounter in dealing with investments and investment professionals; * operating an automated telephone information line that provides investors with basic information and the ability to order educational materials; * improving complaint resolution and assistance by retraining staff to provide information in plain English and to resolve problems more quickly; and * involving investors in SEC rulemaking by publicizing new rule proposals through the electronic media and other nontraditional channels. Funding Structure The proposed resolution to the perennial problem of SEC funding and fees is perhaps the most important aspect of this reauthorization hearing. The Commission would like to take this opportunity to thank Chairmen Bliley and Fields and their staffs, who have spearheaded this effort, as well as Chairmen Rogers and Archer. As the reauthorization process moves forward, we hope that we can continue to look to them, and their hard-working staff, for continued support and assistance in working towards a long-term solution to the SEC's funding problems. As most of you know, the SEC has been a net contributor to the U.S. Treasury, collecting more in fees than is necessary to cover its budget in every year since 1983. In recent years, however, the SEC has received a declining amount of appropriated funding through the General Fund. Instead, the bulk of the SEC's funding has been generated through "offsetting collections," which have been produced by increasing the rate of the fee the SEC collects when securities are registered (the so-called Section 6(b) fee). These offsetting fee increases have been imposed through the appropriations process, and therefore have been in effect for only one year at a time. The problems inherent in this funding approach came to a head in the Fall of 1994 during the fiscal 1995 appropriations process. Because the fees collected by the SEC so far outstripped the amounts appropriated to it, the SEC, together with concerned members of Congress, had long expressed concern that the rising Section 6(b) fees could constitute a "tax" on capital formation. At the same time, a more stable source of funding for the agency was required so that the agency could better manage its limited resources to cope with the large growth of the industry, particularly in the investment company area. To address these issues, legislation was proposed and approved by the House, with the strong support of this Committee, that would have created a "user-fee" funding mechanism for the SEC, while also eliminating the excess fees generated for the U.S. Treasury. Unfortunately, this legislation was not considered by the Senate, and the SEC's fiscal 1995 budget was held up pending yet another short-term funding solution. Last summer, Chairman Bliley, after negotiations with the House Appropriations and Ways and Means Committees, developed a new approach to SEC funding that would reduce Section 6(b) fees over a five-year period and equalize the application of existing -------------------- BEGINNING OF PAGE #16 ------------------- securities transaction fees. Under this approach, the SEC would also act to eliminate certain fees that it collects pursuant to the Independent Offices Appropriations Act of 1952 (IOAA fees), which include a fee of $250 that must be paid in connection with filings of annual reports. In lieu of a "self-funding" or "user- fee" system, the SEC would gradually move from reliance on increased offsetting fees towards full appropriation status. The Commission believes that adoption of this approach could provide a long-term solution to the SEC's funding problems. The Commission's experience with its budget in fiscal year 1996 again illustrates the need to stabilize the SEC's funding. The SEC, like many other government agencies, has seen its appropriation for the current fiscal year delayed due to broader budget controversies. As a result, on two occasions, when continuing resolutions to fund the government lapsed and were not immediately renewed or replaced, the Section 6(b) filing rate reverted from 1/29th of one percent to 1/50th of one percent. Both times the higher rate was subsequently (and retroactively) restored when the next continuing resolution was ultimately adopted. These not always predictable changes in the filing rate created considerable planning and bookkeeping difficulties for industry and the Commission alike -- difficulties which again underscore the need for a stable SEC funding mechanism. Conclusion The Commission is a small agency that has a large and vitally important job: oversight of the world's largest and most dynamic securities markets. With modest resources, we protect investors and promote the fairness, stability, and capital- raising potential of the markets that fuel the U.S. economy. The Commission is also an agency that takes very seriously the directive to "reinvent" government. Through the initiatives described in this testimony, we have taken important steps toward reducing bureaucracy, streamlining regulatory requirements and eliminating unnecessary burdens. We have done so, throughout, with the input of the industry we regulate, working in a public- private partnership. In framing today's authorization request, the Commission has been mindful that government resources are strained. But the Commission also recognizes that much important work lies ahead of us. To cite just a few examples, the Commission in the coming two years will have to: * address issues posed by the increasing number of small investors who invest their retirement savings in mutual funds through 401(k) plans; * respond to the special concerns raised by the increasing use of derivatives and other complex financial products; * address the new opportunities -- and new potential for abuses -- posed by the electronic revolution (for example, the sale of securities on the Internet); * combat a resurgence of insider trading in the equity markets; * continue its vigilant oversight of markets as those markets grow increasingly complex and volatile; and * deal with the continuing repercussions of the investment debacle in Orange County. -------------------- BEGINNING OF PAGE #17 ------------------- In order to take on these challenges, and to continue the Commission's excellent record of effective law enforcement, market oversight, and investor protection, the Commission will need funding at least at the level requested today -- as well as a long-term funding mechanism. We therefore urge the Subcommittee to adopt our authorization request and to implement the funding structure crafted by Chairmen Bliley and Fields, together with Chairmen Rogers and Archer, in order to allow the SEC to promote capital formation and maintain effective oversight of the vitally important U.S. securities markets. --------- APPENDIX --------- U.S. SECURITIES AND EXCHANGE COMMISSION 1997 AUTHORIZATION REQUEST The basis for calculating the authorization level proposed for fiscal 1997 is the agency's 1996 budget authority (projected) of $301,305,000. The following summarizes the total agency staffing and funding needs. 1997 Authorization Request Funding ($000) ========================= Staff Salary & Non- Positions Years Benefits Personnel Total ========= ===== ======== ========= ===== 1996 Appropriated Funding-[1]- 3,309 2,797 $205,708 $91,697 $297,405 Use of Unobligated Carryover Balances 3,900 3,900 ========= ===== ======== ========= ===== 1996 Budget Authority 3,309 2,797 $205,708 $95,597 $301,305 Annualization of 1996 Pay Increase (3 mos). 1,291 1,291 1997 Pay Increase 2.1% (9 mos) 3,201 3,201 Within Grade Increase 2,037 2,037 Health Benefits Rate Increase 112 112 Labor Dept. Benefits For Prior Employees 43 43 Economic Assumptions, 3.2% 1,677 1,677 EDGAR 2,029 2,029 Technology Initiatives (SAM) (400) (400) Litigation Support 2,000 2,000 Contingency Planning 2,700 2,700 Technology Training 499 499 Program Training 411 411 Security Enhancements 95 95 ========= ===== ======== ========= ===== 1997 Estimate 3,039 2,797 $212,392 $104,608 $317,000 --------- FOOTNOTES --------- -[1]- An appropriations bill has not been enacted for 1996. This is the funding provided under the current Continuing Resolution, which was enacted on January 6, 1996. -------------------- BEGINNING OF PAGE #18 ------------------- In this request for authorization of appropriation, the agency is not requesting any additional staff. The $317 million will allow the SEC to maintain staffing at its current level of 2,797 staff years, but will require the agency to stretch limited resources to the maximum in 1997. This request represents a realistic estimate of the resources the SEC will need to maintain effective regulation of the U.S. securities markets in the face of rapid growth, while recognizing Congressional budgetary concerns in an era of fiscal restraint. Over 50% of the total requested increase is attributable to mandatory increases. Specifically, the 1996 pay increase (including locality pay) must be annualized for three months at a cost of $1.3 million. The estimated increase for the 1997 pay increase (including locality pay) is $3.2 million, and the mandatory within grade increases total an estimated $2 million. The estimated cost increases due to inflation total $1.7 million. These estimates are based on assumptions provided by the Office of Management and Budget. In addition, the agency is anticipating spending an additional $2 million on litigation support. Litigation support is a broad term, which includes a range of efforts necessary for organizing, analyzing, and processing evidentiary documents (paper and electronic) in an investigation and for preparing and presenting cases at trial. In fiscal 1995, the agency launched efforts to provide computerized support for document management of major litigated cases and large investigations. Increased litigation support is essential to the efficient management of the Commission's law enforcement program. Separately, the Commission is working towards updating its antiquated system for tracking both investigations and litigation. This project is being worked on under the agency's strategic modernization initiative (SAM). While the total expenditures on SAM are reduced by $400,000 in this request, SAM continues to be a resource priority for the Commission. The SAM expenditures of $7 million in 1997 will focus on application development, expanded database management tools, and continued infrastructure improvements and modernization of hardware. The current contract to maintain the operations of the agency's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system expires in January 1997. The recompetition of the EDGAR contract presents the agency with an opportunity to re- evaluate the system from the ground up. The authorization request includes an additional $2 million for the EDGAR contract due to the possibility of overlapping contracts for a short period of time and the difficulty in estimating the cost of a new EDGAR contract during the procurement process. Given the agency's increased reliance on technology to perform its mission effectively and efficiently, the Commission has identified contingency planning as a priority. As part of the overall contingency plans, the agency is considering the procurement and installation of an uninterrupted power supply and electrical energy saving system, which would provide back-up -------------------- BEGINNING OF PAGE #19 ------------------- power to the headquarters building in the event of an emergency situation. A total of $2.7 million is included in this request for this expenditure. It is essential to provide adequate training in order to fully utilize improved technology, both hardware and software. The 1997 authorization request includes $499,000 for computer training for all staff members and advanced skills training for the staff within the Office of Information Technology. Additionally, more training is required for the investment company and investment adviser examiners. With the creation of the Office of Compliance Inspections and Examinations in 1995, the SEC launched a vigorous effort to make the examination process more efficient. Developing and conducting comprehensive in-house training programs is one of the key steps in that effort. This authorization request includes $411,000 for this training. Finally, $95,000 is included in this authorization request for security enhancements.