Testimony: Appropriations for Fiscal Year 1999
TESTIMONY OF
ARTHUR LEVITT, CHAIRMAN
U.S. SECURITIES AND EXCHANGE COMMISSION
CONCERNING APPROPRIATIONS FOR FISCAL YEAR 1999
BEFORE THE SUBCOMMITTEE ON
COMMERCE, JUSTICE, STATE AND JUDICIARY
OF THE SENATE COMMITTEE ON APPROPRIATIONS
U.S. SENATE
MARCH 19, 1998
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
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TESTIMONY OF
ARTHUR LEVITT, CHAIRMAN
U.S. SECURITIES AND EXCHANGE COMMISSION
CONCERNING APPROPRIATIONS FOR FISCAL YEAR 1999
BEFORE THE SUBCOMMITTEE ON
COMMERCE, JUSTICE, STATE AND JUDICIARY
OF THE SENATE COMMITTEE ON APPROPRIATIONS
MARCH 19, 1998
Chairman Gregg and Members of the Subcommittee:
I appreciate this opportunity to testify in support of the Securities
and Exchange Commission’s (SEC or Commission) fiscal 1999 budget. During
the past year, we have seen phenomenal growth in our markets. The Dow
reached an all-time high, more investors are investing in our markets than
ever, and technological advances have made our markets more accessible to
more people.
In this time of record-breaking growth and technological innovation,
we also see an increase in innovative schemes to defraud American
investors. The Commission has been creative and diligent in trying to
protect investors and promote the integrity and efficiency of our markets.
It is abundantly clear that if we are to keep pace with market changes, the
Commission needs additional staff and funding.
Accordingly, the President’s appropriation request for the SEC
includes $341.1 million and 2,827 staff years in fiscal 1999, an increase
of $26.1 million and 30 staff years from the Commission’s fiscal 1998
appropriation. If approved, this will be the first increase in
appropriated staffing and funding (except primarily for mandatory expenses)
that the agency will have had since 1995.
Role of the SEC
The SEC performs an essential function: overseeing one of the largest
sectors of our national economy--the U.S. capital markets. The trillions
of dollars invested in our markets fuel the U.S. economy. Since its
creation in 1934, the Commission has been charged with protecting investors
and maintaining fair and orderly markets.
Since 1991, our markets have enjoyed the longest and most vigorous
bull market in history. Accordingly, to put the SEC’s requested
appropriation in perspective, it has to be viewed against the backdrop of
exponential growth and rapid changes in our markets.
Current Challenges Facing the SEC
Extraordinary Market Growth. Many Americans now invest their
retirement savings in the securities markets, often through mutual funds.
Americans now have an unprecedented stake in our markets. Our children’s
futures, our retirement money, and our future financial well-being are
increasingly dependent on the success of our markets. More than ever
before, Americans are investing in America. Consider the following
statistics.
* As recently as 1980, only one in 17 households invested in mutual
funds; today that number has risen to more than one in three.
* Assets in mutual funds have reached record levels of $4.5
trillion--a figure that greatly surpasses the more than $2.7
trillion Americans have on deposit at commercial banks--and
continue to grow monthly.
* The number of first-time small investors participating in the
U.S. securities markets continues to grow.
* A recent survey (conducted by a private concern) indicated that
24% of those responding were very much dependent on the market
for their retirement and 46% were somewhat dependent.
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The U.S. markets are widely regarded as the deepest, most liquid, and
fairest markets in the world. We have seen tremendous expansion in our
capital markets, and this exponential growth continues.
* Within the past two years, the Dow broke 6,000, then 7,000, and
then 8,000.
* Within the past six months, the New York Stock Exchange and the
Nasdaq Stock Market each have seen stock trading volume hit
record highs.
* In 1997, total dollar volume traded on the exchanges and the
Nasdaq Stock Market exceeded 1996 dollar volume by 41%.
* After three years of rapidly rising stock prices, American
households have more of their assets invested in the stock market
than at any time in history.
* In 1997, the number of investment company portfolios increased 8%
from 24,265 in 1996 to 26,231.
* A record $1.44 trillion in securities were registered with the
Commission during 1997, a 20% increase over the $1.2 trillion
registered in 1996.
* Over $100 billion in securities was registered in 1997 by foreign
companies, setting a record for foreign company offerings in a
single year.
Market participation is at an all-time high. The influx of less
sophisticated investors into our markets, however, has emboldened some to
prey upon the unwary. In addition, new securities products and new
technology have created new opportunities for fraud and abuse.
Combatting Fraud. Commission staff investigate and prosecute
violations of the federal securities laws. These violations include
fraudulent offerings of securities, market manipulation, insider trading,
and violative conduct by regulated entities. The Commission has been
vigilant in pursuing its law enforcement responsibilities, while trying to
adapt its programs to changing market conditions.
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Internet Fraud. Much of the remarkable expansion and momentum of
the markets is a reflection of the current, ongoing technological
revolution. The Internet now allows securities to be marketed directly to,
and traded directly by, individuals around the world. We have seen
fraudulent offerings of securities, manipulations, and other violative
action conducted over the Internet.
These developments, in combination, present extraordinary challenges
to the SEC’s law enforcement program. The Commission has been active in
addressing these challenges.
* The Commission stepped up its efforts to combat fraud committed
over the Internet, forming a “cyberforce” to monitor Internet
activity through surveillance.
* The Commission focused its efforts on investor education. The
Commission’s website provides information to investors about
fraudulent schemes.
* The Commission is actively investigating fraud on the Internet
and brought approximately 20 enforcement actions to curb the use
of the Internet to perpetrate securities fraud.
Microcap Fraud. The market shows signs of an increase in abuses
in the market for low-priced stocks or “microcap” stocks. Microcap stocks
are issued by companies with lower capitalizations and are usually quoted
on the National Association of Securities Dealers Over-the-Counter Bulletin
Board, the pink sheets operated by the National Quotation Bureau, and the
Nasdaq SmallCap Market. This part of the market provides legitimate
opportunities for small and new businesses to raise capital, but also
provides opportunity for criminals to prey on innocent investors. Microcap
fraud often is accomplished through the use of sales practices such as
abusive high-pressure cold calling, unauthorized trading in a customer’s
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account, and stock manipulation schemes that enable the manipulator to reap
profits while investors suffer losses after the manipulation stops.
Addressing microcap stock fraud presents the difficult challenge of
controlling the fraud without damaging the market for securities issued by
legitimate small businesses. The Commission has begun a far-reaching
campaign against microcap fraud. The Commission’s initiatives include
examinations and inspections, investor education, enforcement, and
regulatory oversight.
* Through Investor Alerts, the Commission’s website, and town
meetings, the Commission educated investors about practical tips
on how to spot securities fraud.
* Our examination staff intensified its examinations of broker-
dealers and performed a “sweep” of brokers trading in microcap
securities.
* We increased our coordination of enforcement efforts with
criminal authorities, the states, and self-regulatory
organizations.
* The Commission implemented a number of ten-day trading
suspensions in stocks for which there was suspicious activity.
* The Commission recently proposed amendments to strengthen its
disclosure and broker-dealer regulations to reduce opportunities
for microcap fraud.
Municipal Securities Markets. The Commission continues to work
to eliminate pay-to-play practices, improve transparency, and improve
disclosures made to investors. We brought a number of significant
enforcement cases in the municipal securities area. In 1997, we brought 14
cases, as compared to 8 cases in 1996.
Inspections and Examinations. The Commission’s inspections and
examinations provide compliance oversight of self-regulatory organizations,
broker-dealers, transfer agents, and investment companies and advisers. In
recent years, a number of developments in the securities industry have
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required significant staff attention and resources. These include:
development of highly sophisticated products, increasing dependence on
complex technology, a dramatic increase in assets under management by
investment advisers, and growing popularity of microcap securities.
Despite the demands placed on its resources, the Commission has remained
vigilant in overseeing regulated entities. Recent initiatives include: a
heightened emphasis on coordinating examinations with other regulators;
using sweep examinations to obtain a more systematic view of industry
problems and practices; and developing risk-based examination techniques
that allow the more effective use of resources. Of course, our examination
program continues to emphasize fundamental investor protection issues such
as broker-dealer sales practices.
International Agreements. We now live in a global marketplace.
The growing internationalization of the securities markets increasingly
affects U.S. markets. While this trend provides new opportunities for
investment and capital formation, it also creates new challenges for
securities regulators. The Commission negotiates information-sharing
agreements with foreign regulators to minimize the extent to which borders
are used to escape detection and prosecution of fraudulent securities
activities. During the past year, the Commission entered into formal
information sharing agreements with the Bank of England, with Germany’s
securities regulator, and, just last week, with India’s securities
regulator, among others. Improving Disclosure and Educating Investors.
The Commission recognizes that the increase in less sophisticated investors
presents new challenges for the Commission in carrying out its
responsibility to protect investors.
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The Commission has tried to develop programs to promote more informed
investment decisions. The Commission implemented a number of initiatives
to improve disclosure and educate investors about investing and their
investments. For
example, the SEC:
* began a series of national and community initiatives that will
culminate at the end of this month in an unprecedented national
public awareness campaign, “The Facts on Saving and Investing
Campaign,” and will include a town meeting broadcast nationwide
and to 21 countries participating in a hemispheric conference;
* held town meetings in local communities to educate investors
about investing;
* required issuers to use plain English principles in drafting
prospectuses and developed a plain English writing guide for
issuers;
* adopted rules to improve the disclosure of information about
mutual funds to investors, including rules to improve fund
prospectuses and a rule permitting funds to use a summary
“profile” document;
* issued staff guidance to the public and industry on disclosure
obligations arising from year 2000 conversion;
* transmitted its billionth page of text and data on the SEC’s
World Wide Web site, which now has an average of 3 million “hits”
per week and downloads an average of approximately 35 million
pages of financial information per week -- making it, we believe,
consistently to be the most active federal website in operation;
and
* created a Task Force on Investment Adviser Regulation to
implement the National Securities Markets Improvement Act of 1996
(NSMIA), to review and modernize Commission regulations, and to
develop a means by which investors can easily obtain information
about investment advisers.
Promoting Fair and Successful Markets. During the past year, we also
have seen increasingly complex financial instruments in our markets that
have presented new and demanding challenges to the SEC. The SEC seeks to
be flexible in adapting its regulations to encourage innovative products
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and services, consistent with investor protection. The Commission has
undertaken several initiatives designed to promote improvements in market
structures and operations and to encourage innovation in capital-raising
activities.
* The Commission issued a concept release that reexamines the
regulation of the U.S. securities markets in light of
technological developments, particularly with respect to
alternatives to traditional exchange trading and electronic links
to foreign markets.
* The Commission implemented the new order handling rules to assure
that markets are fair and open to investors and are based on
competition.
* The Commission published for comment rules for a class of
registered dealers active in OTC derivatives markets. The
proposal is designed to allow U.S. securities firms to establish
dealer affiliates -- called OTC derivatives dealers -- that would
be able to compete more effectively in global OTC derivatives
markets by tailoring capital and other regulatory requirements
for the OTC derivatives business.
* The Commission held a series of town meetings with small
businesses to educate them on capital raising strategies.
To date, we believe that the Commission has been successful in
carrying out its mandate, and investor confidence in our markets is high.
Investor confidence must remain high if our markets are to continue to
grow. Limited resources, however, may pose a threat to investor protection
and market integrity. In recent years, the Commission has targeted its
existing resources carefully to maintain effective performance levels. The
Commission’s request for additional funds is necessary for it to continue
to fulfill its mandate to protect investors and support its efforts to
promote market integrity and fairness.
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Priorities and Allocation of Additional Resources
The SEC currently carries out its broad mandate with 2,797 staff
years. The agency is able to accomplish its objectives by regulating, to a
large extent, through a public-private partnership. This system of shared
regulation between the SEC, self-regulatory organizations, and the industry
is markedly different from the approach taken by other federal regulators.
It enables us to leverage our resources with the efforts of the private
sector. Even so, additional resources are urgently needed.
Between 1980 and 1994, the number of SEC authorized positions
increased 35%. To put that in perspective, for the same period assets
under management of investment companies and investment advisers increased
964% and 2082%, respectively.
However, since 1995, authorized positions have been flat. We have
been able to maintain a vigorous program at the SEC with flat staffing
through fiscal restraint, conservative management, and the reallocation of
existing resources. Of course, the Commission is mindful of the need to be
fiscally responsible. However, if we fail to increase our staffing levels
to keep pace with market expansion, we may risk failing to fulfill our
mandated responsibilities. Expanding our human resources will allow us to
further existing priorities and pursue new initiatives.
Law Enforcement
Combatting Fraud. As discussed above, changing markets present new
challenges for the Commission. The recent resurgence of microcap fraud and
the use of the Internet to accomplish securities fraud are but two examples
of the challenges. Thus, the Commission intends to allocate 15 additional
staff years for the Prevention and Suppression of Fraud program. Staff in
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the program will monitor potential fraudulent securities activity on the
Internet and other on-line information services and will respond to
continued growth and change in electronic forms of communication.
While existing resources were devoted in 1998 to combatting microcap
fraud, with the new staff, the SEC will be better able to coordinate its
nationwide effort to address microcap issues, including: intervening in
microcap frauds at the earliest point possible to minimize investor harm;
enhancing surveillance; and coordinating with other federal, state, and
industry regulators.
Inspections and Examinations. Although Commission staffing levels
have remained constant since 1995, we reallocated resources to enhance
inspection and examination activities. As a result of those additional
examiners and new legislation that divided the regulatory responsibility
over investment advisers between the Commission and the states, the SEC
expects to meet its inspection goals in 1999. These goals include
inspecting each of the large investment advisers qualified for federal
registration and investment company complex at least once every five years.
In addition, throughout the inspection program, the staff will continue
development of risk-based examination techniques and maximize opportunities
to coordinate with other regulators.
While no additional inspection staff is being requested for 1999,
additional funding is being requested to initiate a multi-year effort to
develop and implement important new automated tools, including applications
to track and monitor the examinations of self-regulatory organizations,
broker-dealers, and investment companies and advisers, and applications to
target examinations for broker-dealers and investment advisers.
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Disclosure and Promoting Honest and Efficient Markets
The review of financial statements and registrations filed with the
SEC is a fundamental element of the Commission’s full disclosure program,
which is designed to provide investors with material information, foster
investor confidence, and facilitate capital formation. Our goal is to
encourage and enhance compliance with federal securities disclosure and
accounting requirements.
We intend to allocate six additional staff years to corporate
disclosure review. These additional staff members will enable the agency
to increase review of issuer reports 7% from 1998 levels. This review will
focus particular attention on compliance with plain English requirements
and will monitor how companies are addressing the consequences of year 2000
conversion. The review levels achieved with the additional staff will help
provide investors with access to important information on emerging and
novel issues and provide deterrents to fraud in public securities
transactions. Simplification of disclosure initiatives, including projects
designed to assist small businesses, also will remain a priority for 1999.
With respect to accounting policy, as more foreign registrants access
U.S. markets, two additional staff years are needed to keep pace with major
developments in international accounting and auditing. The International
Accounting Standards Committee is working to complete a comprehensive core
set of international accounting standards. After this is completed, the
staff will assess the standards and make a recommendation to the Commission
regarding the acceptability of those standards for use by foreign
registrants in cross-border offerings and listings.
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Additionally, eight additional staff years are requested in 1999 for
the Supervision and Regulation of Securities Markets program to continue
the re-evaluation of our approach to regulating markets, particularly the
oversight of alternative trading systems, registered exchanges, and foreign
market activities in the United States.
Investment Company Disclosure
Eight additional staff years are requested for investment company
disclosure activity. The Commission recently adopted sweeping reforms to
investment company prospectus disclosure requirements. In 1999, the staff
will work with mutual funds as they revise their prospectus disclosures to
comply with the new form requirements; review the new “profiles” filed by
mutual funds; and monitor compliance with the new rules, increasing the
number of investment company filings reviewed by the staff. The review
process enhances investor protection by seeking to ensure that an entity’s
policies, procedures, and risks are disclosed fully and fairly and that
proposed activities are consistent with the new rules.
The staff will continue to respond to the rapid changes in the
investment management industry, addressing issues such as investment
company advertising rules, periodic reporting requirements, financial
statements, and the electronic delivery of information to investors.
Improved Technology
The fast pace of technology and the pressure to deliver quickly
computer products and services has resulted in an increased reliance on
contractors with technical expertise. Outsourcing allows the Commission to
leverage private sector expertise and shift the technology staff’s focus
from day-to-day operations to contract and project management and oversight
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and strategic planning. In 1997, the Commission hired an outside
consultant to study how the operational efficiency of our information
technology services could be improved. The study recommended the use of
contractors for operations, maintenance, and application development.
The shift in focus of the information technology staff from operations
to strategic planning will result in a decrease of 15 staff years and also
in the need for different skill sets with an emphasis on project
management, contract administration, technology engineering, customer
service, and network security skills.
Additional funding ($5.7 million) also is requested to support the
SEC’s automation efforts to improve efficiency and productivity through the
use of automated PC-based computer applications. The funding will enable
the SEC to: complete the necessary conversion and testing for year 2000;
initiate the multi-year effort to develop and implement important new tools
for the inspections and examinations activity; establish an infrastructure
replacement program; improve data delivery to the regions; further enhance
document and correspondence management systems; develop software to access
on-line trading information; implement user-friendly text search tools; and
improve imaging, storage, and retrieval capabilities. Additionally, the
staff will continue to work with various industry components to address
year 2000 conversion and testing.
We appreciate the work and support of your staff on the reprogramming
of funds for the modernization of EDGAR--the SEC’s Electronic Data
Gathering, Analysis, and Retrieval system. While EDGAR is one of the
government’s most successful large information system initiatives, the
dramatic changes in technology over the past few years necessitate its
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modernization. This modernization, to be done over a three-year period,
will greatly benefit issuers, investors, SEC staff, and other data users.
Economic Analysis
Three additional staff years are requested to provide conceptual and
quantitative economic analysis focusing on issues such as investor
protection, trading practices, market structure, and costs and benefits of
rule changes.
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Administrative Law Judges
Three additional staff years are requested to enable the
administrative law judges to file initial decisions within ten months of
issuance of the order for proceedings, as stipulated in the SEC’s
“Guidelines for the Timely Completion of Proceedings.” As a result, the
number of proceedings pending disposition will start to decrease rather
than continue on an upward trend.
Additional Funding for Retention of Staff
Our ability to retain our existing staff members is critically
important to our ability to get our job done. In fiscal 1997, turnover at
the SEC increased dramatically, especially in our three major program
occupations (attorneys, accountants, and securities compliance examiners).
For example, the SEC’s overall turnover rate in fiscal 1997 was 11.9%
compared to 9.5% in fiscal 1996. The 1997 turnover rate for attorneys was
16% compared to 11.3% in 1996. The 1997 turnover rate for accountants the
rate was 12.1% compared to 9%, and for examiners the rate was 10.8%
compared to 10.3%. By comparison, government-wide white collar turnover
has been in the range of 7-8% a year for the last couple of fiscal years.
The SEC’s ability to retain experienced professional staff is critical
to our ability to respond quickly to changing market events and enforcement
activities. The securities industry is constantly seeking to hire lawyers,
accountants, and securities compliance examiners with highly-valued SEC
experience. Market growth will continue to increase demand for our
seasoned securities professionals.
To combat this growing high attrition rate, we have requested $7
million for retention allowances. This retention initiative will utilize
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more fully the existing authorities available to federal agencies by
expanding the use of retention allowances to retain, for one or more
additional years, critically needed employees who might otherwise leave the
Commission for higher-paying private sector jobs. While realizing that the
agency cannot compete directly with private sector salary rates, we
anticipate that this initiative will extend the tenure of key professional
employees. The Office of Personnel Management and the Office of Management
and Budget have reviewed the proposal and support the strategy as a
reasonable way to use limited payroll dollars efficiently in order to try
to retain key employees.
Funding Structure
The President has proposed in his 1999 budget total funding for the
SEC of $341.1 million, using several funding sources: $118.1 million in
new budget authority, $205 million in current year offsetting collections,
and $18 million in carryover from 1998 fees. The funding mix reflects the
Administration’s government-wide fee initiative that would, among other
things, discontinue the practice of providing agencies whose budgets are
primarily financed by fees with an upfront guarantee of budget authority
which is later reduced as actual collections are received.
The $84.6 million increase in budget authority over 1998 would permit
us to carry into fiscal 2000 fees that are collected late in 1999, allowing
the SEC to be funded almost exclusively from fees. The proposed budget is
consistent with the declining fee rates established in NSMIA. However,
this approach continues the SEC’s reliance on a combination of excess fee
collections from prior years and new collections, thereby postponing the
shift to a full appropriation.
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Conclusion
The Commission plays a vital role in protecting U.S. securities
markets from fraud, manipulation, and other practices that continually
threaten to undermine the integrity of our markets. In presenting today’s
budget request, the Commission has been mindful that government resources
are limited. The Commission has requested a modest increase of staffing
and retention authority that will enable us to continue targeting areas of
market growth where our money can have the greatest impact. It also
reflects the market realities -- the loss of trained staff. Finally, our
request recognizes that important work lies ahead of us. Among the
challenges we will face over the coming year are:
* issues posed by the increasing number of small investors who
invest their retirement savings in mutual funds through
retirement plans;
* aggressively combatting fraud and maintaining public confidence
in the markets; and
* maintaining vigilant oversight of markets as those markets grow
increasingly complex and volatile.
As the year 2000 approaches, the U.S. must be ready to meet the
challenges presented by a changing marketplace in order to maintain the
leadership of its markets. To take on new challenges, to continue the
Commission’s excellent record of effective investor protection, law
enforcement, and market oversight, and to continue to fulfill its mission
of protecting the millions of U.S. investors who have invested nearly $13
trillion in the U.S. securities markets, the Commission needs the increased
resources requested today.
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The Commission looks forward to working with the Subcommittee in its
continuing efforts to ensure the effectiveness of the SEC and the viability
of our markets.
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Last Reviewed or Updated: March 19, 1998