TESTIMONY OF JAMES M. MCCONNELL, EXECUTIVE DIRECTOR U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING SECURITIES TRANSACTION FEES BEFORE THE SUBCOMMITTEE ON FINANCE AND HAZARDOUS MATERIALS COMMITTEE ON COMMERCE UNITED STATES HOUSE OF REPRESENTATIVES SEPTEMBER 28, 1999 Chairman Oxley, Ranking Member Towns, and Members of the Subcommittee: On behalf of the Securities and Exchange Commission (SEC or Commission), I appreciate this opportunity to appear before the Subcommittee today to discuss securities transaction fees and current proposals to address the issue of fee collections in excess of the cost of funding the SEC. The SEC shares the Subcommittee’s concern regarding excess fee collections. The existing fee structure, last revised in 1996, was the product of many years of negotiations, involving many players with competing interests. However, tremendous market growth in recent years has pushed fee collections far beyond the levels anticipated during those negotiations. The SEC welcomes an inclusive and reasoned dialogue on potential solutions to the problem of excess fee collections. Given the complexity of the fee collection issue, I will first review the history of SEC fees, the fee agreement contained in the National Securities Markets Improvement Act of 1996 (NSMIA), the Budget Enforcement Act (BEA), and SEC’s efforts to address fee issues before addressing the current proposals.[1] History of Fees Federal securities laws direct the Commission to collect three different types of fees: registration fees, transaction fees, and fees on mergers and tender offers. Securities registration fees (Section 6(b) fees) are paid by corporations and investment companies when they register securities for sale. These were first enacted at a rate of 1/50th of 1 percent under Section 6(b) of the Securities Act of 1933. Starting in 1990, the Section 6(b) fee rate was increased yearly through the appropriations process. The first 1/50th of 1 percent goes directly to the U.S. Treasury and is unavailable for funding the SEC. The amount over the 1/50th of 1 percent (called offsetting collections) can be used to fund the agency through appropriations. Transaction fees (Section 31 fees) are paid when securities are sold. These were enacted at a rate of 1/300th of 1 percent on exchange-listed securities under Section 31 of the Securities Exchange Act of 1934 (Exchange Act). Proceeds from this fee are deposited directly in the U.S. Treasury and are not available to fund the agency. Fees on mergers and tender offers are paid by corporations directly to the U.S. Treasury and also are not available to fund the agency. The SEC’s fee collections have been a subject of concern since 1983, when the Commission first began contributing more to the U.S. Treasury than was required to fund the agency. In 1988, the Securities Subcommittee of the Senate Committee on Banking, Housing, and Urban Affairs requested that the SEC examine its fee collections and funding structure. The report prepared by the SEC in response to this request was the first step in the process that eventually led to the compromise reached in Title IV of NSMIA.[2] Fee Agreement in NSMIA Title IV of NSMIA mandates a fee structure that was the result of extensive negotiations between six different Congressional Committees, the Administration, and the SEC. In general, the NSMIA fee structure was designed to: * gradually reduce total fee collections; * “level the playing field„ by extending Section 31 transaction fees, which had previously only applied to transactions involving exchange- listed securities, to securities subject to “last sale reporting„ in the over-the-counter (OTC) market; * gradually align fee collections with the funding needs of the SEC; and * provide the SEC with a stable, long-term funding structure. NSMIA set in motion a gradual reduction in Section 6(b) registration fee rates over a ten-year period intended to more closely align fee collections with the funding needs of the SEC. Specifically, NSMIA authorized the Commission to collect securities registration fees at the rate of 1/50th of 1 percent of the aggregate offering price in fiscal year 2006, declining annually from 1/34th of 1 percent in 1998. In fiscal year 2007, the rate will be further reduced to 1/150th of 1 percent. In addition, NSMIA classified the portion of the Section 6(b) fees in excess of 1/50th of 1 percent (i.e., the portion declining from 1998 to 2006) as offsetting collections that can be used directly to fund Commission operations, subject to prior approval by the Commission’s appropriations committees. After fiscal year 2006, Section 6(b) fee revenue will only go into the General Fund of the U.S. Treasury and will not be available to fund Commission operations. NSMIA also provided equity in the application of Section 31 fees by authorizing the SEC to collect these fees on transactions involving securities subject to “last sale reporting„ in the OTC market. Unlike the Section 31 fees imposed on sales of exchange-listed securities, these new OTC fees are classified as offsetting collections and, therefore, can be used to fund Commission operations, subject to approval by the Commission’s appropriations committees. Under NSMIA, all Section 31 fees will fall to 1/800th of 1 percent in fiscal year 2007. Because the fees collected by the SEC are tied -- directly and indirectly -- to market activity, they are nearly impossible to predict accurately. The fee rates established in NSMIA were based on 1996 projections of market activity. However, the tremendous growth in the markets over the past few years has far exceeded the 1996 estimates on which NSMIA was based, resulting in fee collections well in excess of original estimates. Unfortunately, the potential for either excess collections or shortfalls is inherent in activity-based fees. While the NSMIA fee structure has eliminated the funding uncertainties and crisis situations that surrounded the agency’s funding from the late 1980s to the mid-1990s, it has not reduced total collections due to unexpectedly strong market activity. Moreover, the SEC’s long-term funding structure remains at risk. Notably, current estimates of the Congressional Budget Office (CBO) indicate that the SEC will collect $285 million in offsetting collections in fiscal year 2007, which would not even be enough to fund the agency today. Budget Enforcement Act The rules enacted as part of the BEA have restricted efforts to undertake a comprehensive fee reduction. The BEA splits our fee collections into two different categories: “mandatory„ and “discretionary.„ Under the BEA, any fees in existence prior to 1990 are deemed mandatory and are deposited directly into the General Fund of the U.S. Treasury; they are unavailable for SEC use. The SEC’s fees that fall into this category are: * the first 1/50th of 1 percent of Section 6(b) registration fees; * * Section 31 fees on transactions involving exchange-listed securities; and * * fees on mergers and tender offers. These fees, which account for nearly 70 percent of total SEC collections, are estimated by CBO to exceed $1.1 billion in fiscal year 2000. Because these collections currently are protected by the BEA rules, they cannot be reduced without a corresponding increase in revenues or decrease in federal spending elsewhere. According to CBO’s estimates, to fully repeal these fees, other collections flowing to the Treasury’s General Fund would have to increase by $9.6 billion over the next seven years, or spending from the General Fund would have to be reduced by the same amount. The remaining 30 percent of SEC collections, deemed “discretionary„, were not in existence prior to 1990 and are unaffected by the requirements of the BEA. These fees are the offsetting collections that have traditionally been used by our appropriators to fund the agency. Specifically, they are: * Section 6(b) registration fees collected above 1/50th of 1 percent; and * * Section 31 fees on transactions in securities subject to “last sale reporting„ in the OTC market, as enacted in NSMIA. As the traditional source of SEC appropriations, these offsetting collections are crucial to full and stable funding of the SEC. The following chart shows the current CBO estimates of total fee collections broken down between mandatory and discretionary under the BEA. ($ in millions) ------------------------------------------------- Fiscal Mandatory Discretionary Total Year Collections ------------------------------------------------- ------------------------------------------------- 2000 $ 1,155 $ 501 $ 1,656 ------------------------------------------------- 2001 $ 1,206 $ 498 $ 1,704 ------------------------------------------------- 2002 $ 1,260 $ 503 $ 1,763 ------------------------------------------------- 2003 $ 1,314 $ 516 $ 1,830 ------------------------------------------------- 2004 $ 1,422 $ 508 $ 1,930 ------------------------------------------------- 2005 $ 1,544 $ 552 $ 2,096 ------------------------------------------------- 2006 $ 1,675 $ 601 $ 2,276 ------------------------------------------------- 2007 $ 783 $ 285 $ 1,068 ------------------------------------------------- ------------------------------------------------- As the chart illustrates, total fee collections are projected to increase through fiscal year 2006, and then fall sharply in 2007 when the final NSMIA fee reductions go into effect. We understand that there may be a major change in the budget rules under the BEA in the event that an on- budget surplus materializes as expected, which could have an important effect on the fee debate. Specifically, there is a possibility that fee rates could be changed without having to accommodate the requirement of an offsetting revenue increase or spending cut for any reduction in fees classified as mandatory under the BEA. Fee Reductions by the Commission The Commission recognizes the magnitude of excess fee collections, and has tried to reduce fees, where possible, when it is within its authority to do so. The Commission has taken two specific actions to reduce fees and administrative burdens. In 1996, fees for filing certain disclosure documents were eliminated, saving public companies an estimated $8 to $12 million per year. While this is a small amount relative to the size of the industry, the elimination of these fees significantly reduced the administrative burden on registrants and the SEC. This year, the Commission responded to industry concerns that there was a double counting of transactions in the OTC market imposing an unfair burden on certain market participants. The Commission encouraged and actively supported changes in industry practices to eliminate this problem and approved NASD rule proposals to implement this change in March 1999. Fee Reduction Proposals Two members of the Subcommittee have introduced bills this session to address the issue of excess fee collections. The bills take different approaches to addressing this issue. Representative Lazio has introduced H.R. 2441, the “Fairness in Securities Transaction Act„, which attempts to address the issue by reducing the Section 31 fee rate. Representative Fossella has introduced H.R. 1256, the “Savings and Investment Relief Act of 1999„, which attempts to address the issue by capping total Section 31 fee collections. Both bills involve complex budget scoring and related issues. H.R. 2441. Representative Lazio’s bill would reduce the Section 31 fee rate from 1/300th of 1 percent to 1/500th of 1 percent on transactions involving both exchange-listed securities and securities subject to “last sale reporting„ in the OTC market. In an attempt to alleviate the BEA issues raised by a fee rate reduction involving the “mandatory„ portion of our fee collections, the bill redesignates 90 percent of the fees collected on last- sale-reported securities as mandatory (i.e., general revenue) from the current 100 percent as discretionary (i.e., offsetting collections available to fund the agency). The bill also redesignates 10 percent of the fees collected on exchange-listed securities as discretionary from the current 100 percent as mandatory. In effect, the bill reallocates 90 percent of combined Section 31 fee collections to general revenue, leaving only 10 percent as offsetting collections available to fund the agency. H.R. 2441 raises several problems in its current form. The bill does not provide the SEC with full and stable long-term funding. The reallocation of Section 31 fees significantly reduces the amount of offsetting collections available to fund the agency, making shortfalls in Commission appropriations more likely. Although the bill contains a provision to address possible shortfalls, we do not believe that the proposed language provides the necessary assurance of full funding for the Commission in the event of a shortfall. The language appears to allow the Appropriations Committees to increase Section 31 fees through a supplemental appropriation to address a shortfall. However, this mechanism would not operate in a timely fashion. It appears that the proposed mechanism would go into effect after the fact -- when a fee revenue crisis had already occurred -- making it difficult for the SEC to operate effectively in the event of a fee revenue crisis. The mechanism would appear to require our appropriators to move a supplemental appropriation through Congress in an emergency situation when quick action would be necessary to avert such a crisis. In addition, the bill does not take into consideration the timing of fee collections. The SEC collects transaction fees twice a year -- on March 15 (for four months) and on September 30 (for eight months). The larger collection in September occurs well after supplemental appropriations bills normally are enacted. Thus, H.R. 2441 has serious operational problems that need to be addressed. The bill also eliminates a portion of the Exchange Act (enacted as part of NSMIA) that provides for the continuation of offsetting fee collections in the event of a lapse of appropriations at the beginning of a fiscal year. The enactment of Section 31(d)(3) of the Exchange Act solved a serious administrative problem for the agency and eliminated potential interference with the capital raising process and confusion in the financial community. We strongly oppose its deletion. While we defer to the Congressional Budget Office (CBO) as the technical experts on budget scorekeeping issues, we believe that there may be some scoring problems with the bill. Although the bill attempts to alleviate the BEA issues, reducing the fee rate alters the economic model CBO uses to estimate fees. Revised fee estimates may potentially create scoring problems. H.R. 1256. Representative Fossella’s bill would cap the dollar amount of Section 31 fees that can be collected in fiscal years 2000 through 2006. In an attempt to alleviate the BEA issues, the bill also combines the mandatory and discretionary categories of Section 31 fees. Of the total Section 31 fees to be collected in each fiscal year, a specified amount of fee collections is designated as general revenue, and the remaining amount of fee collections, if any, up to the cap for that fiscal year is designated as offsetting collections. H.R. 1256 also raises a number of concerns in its current form. First, the bill does not provide the SEC with full and stable funding. H.R. 1256 includes the same language as H.R. 2441 addressing insufficient fee collections. As discussed above, this language does not provide adequate protection for full SEC funding in the event of a shortfall in fee collections. This bill thus exposes the SEC to the possibility of an emergency budget situation that could severely impact Commission operations. Second, the bill does not specify the degree of precision required in implementing a cap or what to do if fee collections exceed the cap. To cut off fee collections precisely when the cap has been reached would be administratively difficult, if not impossible, under the current fee collection system. To effectively implement such a tight cap, the SEC would have to develop a complex and potentially costly recordkeeping system that could track fee collections by the exchanges and the National Association of Securities Dealers (NASD) to determine when the fee cap has been reached. Over the past few months, the Commission staff has had an opportunity to discuss with industry participants the administrative and technical issues associated with implementation of a fee cap. These discussions have revealed a number of issues. The New York Stock Exchange (NYSE) staff indicated that their collection process is not entirely automated. There is currently at least a six-week gap between the time a transaction takes place on the NYSE and the time when volume information on that transaction is reported to the SEC. As a result, the NYSE currently does not have the ability to provide timely information with respect to the collection of Section 31 fees. The NYSE staff also represented that the automation of their fee collection process could not begin until mid-2000 due to Y2K and decimalization system enhancements. The NASD staff made similar comments with respect to the American Stock Exchange. The NASD staff did indicate, however, that it would have no serious programming problems with implementing a cap on an annual basis for NASDAQ. Finally, we believe that H.R. 1256 may also have CBO scoring problems similar to H.R. 2441, resulting in revised CBO estimates for the outyears. Conclusion Today, we are faced with total fee collections well above both the cost of funding the SEC and the levels anticipated in NSMIA. CBO’s estimates for fiscal year 2000 fee collections are $1.66 billion. Not only is that amount far greater than our funding requirements for fiscal year 2000, but 70 percent of that figure is unavailable to fund the agency because of the restrictions imposed by the BEA rules. Reducing fee collections, however, presents many of the same issues that required years of Congressional negotiation resulting in the compromise embodied in NSMIA. As the Commission has stated in the past, any alternative funding mechanism must: * provide full and stable funding for the SEC; * spread the costs of regulation among those who benefit; * consider the effect of market conditions on collections; and * address the competing interests of all parties. Both H.R. 2441 and H.R. 1256 raise a number of concerns. Most significantly, neither bill provides a sufficient funding mechanism for the SEC. In particular, the fee rate reduction contained in H.R. 2441 could likely result in a serious funding shortfall for the SEC in the event of a downturn in market activity. Based on our discussions with industry participants, we believe that the fee cap proposal in H.R. 1256 would be more difficult to implement, especially in light of the Y2K issues and the lack of specificity in the bill. The SEC would welcome the opportunity to discuss the current proposals in greater detail. The Commission staff is available to discuss these proposals in more detail and to provide assistance in crafting solutions to our concerns. We appreciate the help and support of all the interested parties in ensuring that the SEC remains adequately funded regardless of the funding approach taken. **FOOTNOTES** [1]: See also Statement of the U.S. Securities and Exchange Commission Concerning Securities Transaction Fees, Before the Subcommittee on Finance and Hazardous Materials of the House Committee on Commerce (July 27, 1999). [2]: Report submitted in response to the request of the Securities Subcommittee of the Senate Committee on Banking, Housing and Urban Affairs (S. Rpt. 100-105), December 20, 1988. 1