[Senate Hearing 105-770]
[From the U.S. Government Publishing Office]
S. Hrg. 105-770
THE YEAR 2000 TECHNOLOGY PROBLEM:
PENSIONS AND MUTUAL FUNDS
=======================================================================
HEARING
before the
SPECIAL COMMITTEE ON THE
YEAR 2000 TECHNOLOGY PROBLEM
UNITED STATES SENATE
ONE HUNDRED FIFTH CONGRESS
SECOND SESSION
on
THE READINESS OF THE SECURITIES INDUSTRY FOR THE YEAR 2000 TECHNOLOGY
PROBLEM
__________
SEPTEMBER 17, 1998
__________
Printed for the use of the Committee
Available via the World Wide Web: http://www.access.gpo.gov/congress/
senate
U.S. GOVERNMENT PRINTING OFFICE
51-128 cc WASHINGTON : 1998
_______________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Printing
Office
Washington, DC 20402
SPECIAL COMMITTEE ON THE
YEAR 2000 TECHNOLOGY PROBLEM
[Created by S. Res. 208, 105th Cong., 2d Sess. (1998)]
ROBERT F. BENNETT, Utah, Chairman
JON KYL, Arizona CHRISTOPHER J. DODD, Connecticut,
GORDON SMITH, Oregon Vice Chairman
SUSAN M. COLLINS, Maine JEFF BINGAMAN, New Mexico
TED STEVENS, Alaska, Ex Officio DANIEL PATRICK MOYNIHAN, New York
ROBERT C. BYRD, West Virginia, Ex
Officio
Robert Cresanti, Staff Director
T.M. (Wilke) Green, Minority Staff Director
(ii)
C O N T E N T S
------
OPENING STATEMENT BY COMMITTEE MEMBER
Robert F. Bennett, a U.S. Senator From Utah, Chairman, Special
Committee on the Year 2000 Technology Problem.................. 1
CHRONOLOGICAL ORDER OF WITNESSES
Laura S. Unger, Commissioner, Securities and Exchange Commission. 4
Alan D. Lebowitz, Deputy Assistant Secretary for Program
Operations, Pension and Welfare Benefits Administration........ 6
Matthew Fink, president, Investment Company Institute............ 15
Don Kittell, executive vice president, Securities Industry
Association.................................................... 17
Eugene F. Maloney, trustee, senior vice president and corporate
counsel, Federated Investors................................... 19
Jim Wolf, executive vice president, TIAA-CREF.................... 28
Vincent P. Brown, assistant executive officer, Financial
Administrative Services, California Public Employees'
Retirement System.............................................. 29
Bert E. McConnell, senior vice president, Fidelity Investments... 31
John R. Towers, executive vice president and chief of Global
Opportunities, State Street Corp............................... 33
Thomas M. Rowland, senior vice president, Capital Group
Companies, Inc................................................. 34
Michael A. Waterford, group vice president, DST Systems, Inc..... 36
APPENDIX
Alphabetical Listing and Material Submitted
Bennett, Hon. Robert F.:
Opening statement............................................ 1
Prepared statement........................................... 49
Brown, Vincent P.:
Statment..................................................... 29
Prepared statement........................................... 50
Responses to questions submitted by Chairman Bennett......... 54
Collins, Hon. Susan M.: Prepared statement....................... 57
Dodd, Hon. Christopher J.: Prepared statement.................... 57
Fink, Matthew:
Statement.................................................... 15
Prepared statement........................................... 58
Responses to questions submitted by Chairman Bennett......... 96
Kittell, Don:
Statement.................................................... 17
Prepared statement........................................... 101
Responses to questions submitted by Chairman Bennett......... 105
Lebowitz, Alan D.:
Statement.................................................... 6
Prepared statement........................................... 106
Responses to questions submitted by Chairman Bennett......... 108
Maloney, Eugene F.:
Statement.................................................... 19
Prepared statement........................................... 109
Responses to questions submitted by Chairman Bennett......... 111
McConnell, Bert E.:
Statement.................................................... 31
Prepared statement........................................... 113
Responses to questions submitted by Chairman Bennett......... 115
Moynihan, Hon. Daniel Patrick: Prepared statement................ 117
Rowland, Thomas M.:
Statement.................................................... 34
Prepared statement........................................... 118
Responses to questions submitted by Chairman Bennett......... 123
Towers, John R.:
Statement.................................................... 33
Prepared statement........................................... 125
Responses to questions submitted by Chairman Bennett......... 128
Unger, Hon. Laura S.:
Statement.................................................... 4
Prepared statement........................................... 132
Responses to questions submitted by Chairman Bennett......... 137
Waterford, Michael A.:
Statement.................................................... 36
Prepared statement........................................... 139
Responses to questions submitted by Chairman Bennett......... 144
Wolk, Jim:
Statement.................................................... 28
Prepared statement........................................... 146
Responses to questions submitted by Chairman Bennett......... 148
THE YEAR 2000 TECHNOLOGY PROBLEM: PENSIONS AND MUTUAL FUNDS
----------
THURSDAY, SEPTEMBER 17, 1998
U.S. Senate,
Special Committee on the Year 2000
Technology Problem,
Washington, DC.
The committee met, pursuant to notice, at 9:31 a.m., in
room SD-192, Dirksen Senate Office Building, Hon. Robert F.
Bennett, (chairman of the committee), presiding.
Present: Senators Bennett, Collins, Dodd, Bingaman, and
Moynihan.
OPENING STATEMENT OF HON. ROBERT F. BENNETT, A U.S. SENATOR
FROM UTAH, CHAIRMAN, SPECIAL COMMITTEE ON THE YEAR 2000
TECHNOLOGY PROBLEM
Chairman Bennett. The committee will come to order.
Good morning to everyone. We welcome you to the seventh
hearing of the Senate Special Committee on the Year 2000
Technology Problem. We may be a new committee, but we are
running up a very rapid total of hearings, and I think that is
appropriate, given the fact that there is a clear time problem
connected with the challenge that we are facing.
We are going to spend the next few hours exploring the Year
2000 readiness of the securities industry. Particularly, we
will focus on the topics of pensions and mutual funds. Those
who followed this issue for the last year and a half know that
I first became concerned about it in my role as chairman of the
Senate Banking Committee Subcommittee on Financial Services and
Technology. And through a series of hearings on that
subcommittee, I have come to understand that the Year 2000
problem creates serious risks for participants in the financial
services industry--from bank customers who want to make sure
they can access their ATM accounts to investors in the stock
market who want to be sure that the companies in which they put
their money have got solutions to the companies' Y2K problems.
I have come to understand over the past year just how
important it is for customers and investors to get useful
information about the Year 2000 technology problem,
particularly with regard to the readiness of companies with
which they do business and in which they invest.
Over the past year, I have worked with the SEC, Chairman
Levitt and Ms. Unger, on this whole question of disclosure. We
have worked together to develop enhanced disclosure rules to
try to ensure that investors get that information, and the SEC
released their revised rules in July. I am looking forward to
seeing more meaningful disclosures as a result of those rules
in the coming months.
In considering the subject for today's hearings, Senator
Moynihan and I have chosen to focus on pensions and mutual
funds because they are the primary vehicles through which most
Americans access the stock market. Over 84 million Americans
participate in pension plans. The Department of Labor reports
that of the $3.6 trillion in assets held by private pension
plans, nearly half of those funds are invested in equities.
Over the past decades, Americans have directed increasing
amounts of their discretionary investments to the stock market,
particularly funds accumulated for long-term investment goals,
such as college or retirement. Since 1991, individuals have
funneled $1.1 trillion into stock mutual funds, and that amount
has been increasing at the rate of $21 billion a month.
Americans have made these investments largely because the
stock market historically has outperformed other more secure
investments, leading many investment advisors to recommend that
funds accumulated for long-term goals should be invested in
equities. Investment advisors have also encouraged small
investors to invest in mutual funds rather than stocks of
individual companies because pooling funds in an investment
company can allow for greater diversification and, therefore,
reduced risk.
Pension and mutual funds are investment vehicles over which
most Americans have little day-to-day control. Individual
investors rely on fund managers to research and analyze
portfolio companies as they make investment decisions. Those
managers, therefore, have a high fiduciary duty under the law
to make investments that are in the best interests of the
underlying investor. But it remains unclear whether, and to
what extent, fund managers are considering the Year 2000
problems as they decide what to buy, sell, or hold on equity
investment and whether the fund managers are getting the
information that they need to make informed judgments--if they
do decide to focus on them.
It is important for investors in these funds to feel
confident that the managers of their pension funds and
investment companies are taking the necessary steps to secure
their investment against the Year 2000 problem. If we cannot
get that confidence into the marketplace, individual investors
will start to move available funds from the stock market in
anticipation of the century date change, and that movement of
funds could have a dramatic impact on the world markets and the
global economy.
I have said over and over again in these hearings that we
are not Chicken Little, and we do not want to support the
notion that the sky is, indeed, falling. If investors lose
confidence in the money managers over the issue of the Year
2000, the sky may not fall, but the Dow certainly will.
First, what are participants in the pension and mutual fund
industry doing to prepare their own systems to ensure that all
essential operations, such as access to funds and
recordkeeping, will continue without interruption after the
century date change? In other words, we are looking, first,
inside the industry itself to make sure that it does not have
any Year 2000 problems.
In order to preserve confidence in this sector, it is
important for pension beneficiaries to know that their checks
will arrive on time, just as mutual fund holders need to know
that their accounts will be managed without interruption and
their balances will be kept with clarity, so that they can be
tracked and not lost in cyberspace somewhere.
Second, what steps are industry participants taking to
avoid investing customer funds in companies where there are
serious questions about Year 2000 readiness? That is a more
difficult question to answer, but its difficulty does not mean
we should not try.
Are fund managers getting the information they need in
order to make informed judgments on this issue? There is no
such thing as certainty in investing, but it is important to
know what fund managers are doing in this area, so investors
can make their own decisions accordingly.
Now, we will also hear, as part of this examination of what
is going on in this area, from Don Kittell of the Securities
Industry Association. The Securities Industry is leading the
way in that they have conducted publicly reported tests on how
well their system will work, and we will hear the results of
those tests in testimony here this morning.
Now, before we start with the witnesses, I want to take a
moment to follow-up on our June 12 utilities hearing. Some who
follow this issue with us may recall that we were unable to
determine at that hearing whether the lights will stay on
because there had been no industrywide Year 2000 assessment.
I am pleased to report that the North American Electric
Reliability Council, or NERC, in the obligatory Washington
acronym, plans to release its industry assessment today. My
reading of the advance results suggests that there is both good
news and bad news.
The good news is that this is the most comprehensive Year
2000 assessment the committee has seen to date in any industry
sector and such assessments are needed desperately in every
industry sector. NERC should be commended for this monumental
undertaking and for getting the report out in a timely fashion.
The bad news is that the progress continues to be slow.
One-third of the electric utility companies have still not
completed assessment of their computers and imbedded devices.
That is a task that should have been completed a year ago. The
hard part--fixing, testing, and implementing--is still yet to
come. So there is still cause for concern with respect to the
reliability of the power grid and still no firm and definitive
answer to the question will the lights stay on. Nevertheless,
the NERC study represents an excellent starting point from
which to monitor Year 2000 progress over the next critical
months, and I assure you that this committee will conduct that
monitoring activity.
I also want to say that just because we cannot answer the
question absolutely affirmatively that the lights will stay on,
neither should anyone interpret that as an answer affirmatively
that they will go off. Chicken Little still should stay in the
coop with respect to this. We are not ready to start giving
dooms-day scenarios.
[The prepared statement of Chairman Bennett can be found in
the appendix.]
Chairman Bennett. With that report of our previous hearings
and where we are, let me introduce our first panel for today's
hearing.
I will tell you that Senator Moynihan, who has a particular
interest in this area and has taken the lead on this area in
the committee, has indicated that he will be here later. Vice
Chairman Dodd, of course, will be here, and we expect other
members of the committee to come in as their schedules permit.
Commissioner Laura Unger has been before both the committee
and my subcommittee before. Ms. Unger, you are becoming a
regular on this beat, but we are glad to have you here because
of your understanding of the issue and your leadership in
moving the SEC as an active player to help get this problem
solved.
Commissioner Unger has spearheaded the SEC's Year 2000
effort, and her dedication to this topic is evidenced by the
fact that she interrupted maternity leave in order to testify
today. I will say, as an aside, that the staff director of this
committee is perhaps on the most urgent maternity leave. He is
not with us. His wife is expecting and we expect to hear word
any time that there is a new Cresanti in the world. But like
the Year 2000, you cannot be sure. [Laughter.]
Alan Lebowitz is the Deputy Assistant Secretary for Program
Operations at the Pension and Welfare Benefits Administration
in the Labor Department. As I indicated, the Labor Department
has done a number of studies on this issue which have been
very, very useful to the committee. And, Mr. Lebowitz, we are
grateful to you for your willingness to be here.
So we will hear from these two witnesses in the first panel
and, Ms. Unger, we will start with you.
STATEMENT OF LAURA S. UNGER, COMMISSIONER, SECURITIES AND
EXCHANGE COMMISSION
Ms. Unger. Thank you for your kind introduction, Mr.
Chairman, and I do think that the Year 2000 will be more than
an acorn. [Laughter.]
I am pleased to be here today to testify before the Special
Committee, on behalf of the Securities and Exchange Commission,
on matters relating to the Year 2000 technology program.
Chairman Bennett. Could you get a little bit closer to the
microphone.
Ms. Unger. You would think I could get closer than last
time.
My testimony focuses on one of America's most successful
and important businesses, the mutual fund industry, and its
progress in addressing the Year 2000 challenge. As you well
know, mutual funds play a key role in the economic life of many
Americans. Over one-third of U.S. households now own shares of
mutual funds. These funds have more than $5 trillion in assets,
over a third of which are estimated to be retirement plan
assets. Through the efforts of this Special Committee and
others, most people are aware by now that the world's computer
systems need to be assessed to ensure that they recognize the
Year 2000. Mutual funds, and their investment advisors and
other service providers, like most other securities-related
enterprises, are heavily dependent upon computer systems.
The Commission has approached the Year 2000 problem from
many directions in recognition of the potential for adverse
consequences to so many investors if funds do not act and act
soon to address the Year 2000 problem. The Commission has taken
a number of steps to promote useful disclosure about Year 2000
issues by mutual funds.
First, the Commission staff has issued guidance to mutual
funds regarding their Year 2000 disclosure obligations and
established a task force to monitor compliance with the
Commission's disclosure directives. Then, in July 1998, the
Commission issued an interpretative release on Year 2000
disclosure requirements that sets forth the considerations that
the Commission expects mutual funds to address in the Year 2000
context.
Over the past 3 months, the Commission's inspection staff
has conducted nationwide examinations that are focused on Year
2000 compliance. As of the end of August, our examination staff
has conducted inspections of mutual funds representing over
one-third of total fund assets. Thus far, data that we have
collected show that funds are making progress in addressing
their Year 2000 problems. Based on this incomplete data, 90
percent of funds indicate they were taking steps to correct
their Year 2000 problems, 77 percent of funds have written
plans to address Year 2000 compliance, and 95 percent of the
funds have made inventories of all of their computer systems
affected by the Year 2000 problem.
To supplement our examination program, the Commission has
proposed to require that almost all registered investment
advisors, including mutual fund advisors, report their progress
on making their systems Year 2000 compliant. The reports would
be similar to our recently adopted reporting requirements for
broker dealers and transfer agents. Registered advisors would
be required to provide information about the readiness of their
mutual funds for the Year 2000, as well as their own readiness.
The Commission believes that the proposed Year 2000 reports
will further encourage advisors and funds to proceed
expeditiously in preparing for the Year 2000. The Commission
has proposed to make certain information from the reports
available to the public on our web site and will use the
information gathered in the reports, among other things, to
fulfill congressional requests for information regarding the
securities industry readiness for the Year 2000 problem.
The Commission staff intends to use the reporting
information to obtain a more complete picture of the industry's
overall Year 2000 preparations and to identify any firm,
specific problems. Advisors that report questionable or
inconsistent information will be asked to explain any problems
that we will find and could be subject to follow-up compliance
examinations. The Commission expects to take final action on
this rulemaking by the end of this month.
The information that the Commission staff has gathered to
date shows that the mutual fund industry is aware of the
potential problems that the Year 2000 presents and is preparing
to meet this challenge in a timely manner. As we approach the
millennium, the Commission will continue to gather information
and evaluate the status of the mutual funds industry's
readiness for the Year 2000. If we find deficiencies, we will
aggressively address them with the funds and their investment
advisors, conduct further examinations and, as appropriate,
bring enforcement actions.
Thank you.
[The prepared statement of Ms. Unger can be found in the
appendix.]
Chairman Bennett. Thank you very much. Mr. Lebowitz, we
have been joined by Senator Collins. Would you like to make an
opening comment? We will ask you to refrain.
Senator Collins. Thank you very much, Mr. Chairman. I have
an opening statement, which I will submit for the record in the
interest of time.
I served for 5 years in Maine State government as the
commissioner of Professional and Financial Regulation, and my
responsibilities included the Securities Division. We did a lot
of work with investor education, as well as going after some of
the bad actors in the securities industry. But I must say
nothing in my experience during those 5 years prepared me for
the Y2K problem and what its effect might be on our markets and
the investments of individual people in the State of Maine and
throughout our Nation.
I recently participated with the SEC in an excellent
investor education program through the town meetings that the
chairman of the SEC has been having, and I look forward to
talking further with our witnesses. I know the SEC has a lot of
consumer information on the Internet about what questions
should be asked by investors, and I look forward to exploring
that.
Thank you.
[The prepared statement of Senator Collins can be found in
the appendix.]
Chairman Bennett. Thank you very much.
Mr. Lebowitz, now, please.
STATEMENT OF ALAN D. LEBOWITZ, DEPUTY ASSISTANT SECRETARY FOR
PROGRAM OPERATIONS, PENSION AND WELFARE BENEFITS ADMINISTRATION
Mr. Lebowitz. Good morning, Mr. Chairman and members of the
committee. Thank you for the opportunity to testify about the
steps that the Pension and Welfare Benefits Administration is
taking under the Employee Retirement Income Security Act to
assist employers and others responsible for managing employee
benefit plans in addressing the Year 2000 problem.
I am Alan D. Lebowitz, Deputy Assistant Secretary for
Program Operations at PWBA.
We are the agency within the Department of Labor that is
responsible for administering and enforcing ERISA, which is the
primary Federal statute that governs employment-based pension
and welfare benefit plans. ERISA establishes comprehensive
fiduciary standards to govern the conduct of those responsible
for management and administration of employee benefit plans.
Among other things, a plan fiduciary must discharge his or
her duties, with respect to a plan, solely in the interests of
the plan's participants and beneficiaries. In addition, the
plan fiduciary must discharge those duties with the skill,
care, prudence, and diligence under the circumstances then
prevailing that a prudent person acting in a like capacity and
familiar with such matters would use in the conduct of an
enterprise of like character and with like aims.
A fiduciary's failure to comply with ERISA's fiduciary
responsibility provisions may result in personal liability for
losses incurred by a plan or its participants and
beneficiaries. In accordance with these standards, plan
fiduciaries, such as administrators, trustees, and investment
advisors and managers, are responsible for ensuring that plans,
and their participants, and beneficiaries are protected. Such
protection includes the establishment and implementation of a
prudent procedure for ensuring that the plan's own computers
and, to the extent possible, those of plan service providers
are Year 2000 compliant.
Because the Year 2000 problem could have a substantial
impact on plan investments, benefit payments, and other
essential plan operations, plan fiduciaries are responsible for
establishing and implementing a strategy to evaluate and ensure
Y2K compliance. Given the complex and technological nature of
this problem, plan fiduciaries may need to hire competent
outside consultants and experts to inventory, review, assess,
convert and test the computer systems relating to the plan.
The plan's fiduciary selection of Y2K service providers is
itself subject to the same fiduciary considerations as the
selection of other plan service providers. In addition to
addressing the Year 2000 problem as it relates to computer
systems under their control, fiduciaries have an obligation to
determine whether the plan's critical operations will be
endangered by the systems of individuals and organizations that
provide services to plans, such as third-party administrators.
In this regard, fiduciaries are responsible for obtaining
information sufficient to evaluate the Year 2000 compliance of
all of the plan's existing service providers and determining
what action is appropriate to ensure that the interests of the
plan, and its participants and beneficiaries are protected.
In addition, when selecting service providers, fiduciaries
should include Year 2000 compliance among the most important
factors to be considered. The plan fiduciary is also
responsible for monitoring service provider operations to
assure ongoing compliance with Year 2000 issues.
PWBA has implemented a comprehensive national outreach
program to help fiduciaries responsible for the over 700,000
pension plans and more than 4.5 million other employee benefit
plans offered by America's private-sector employers to be
prepared as they can be to address the Year 2000 issue. We have
issued two national alerts to the employee benefit community
warning about the Year 2000 problem and calling for immediate
action.
We have developed an extensive question and answer brochure
designed to give employers and other plan officials an
understandable explanation of how the Y2K problem impacts their
plans. We have posted all of this material on our web site, and
it is available through our 800 line.
We have provided technical assistance to hundreds of people
who have called following up on those issuances. Our senior
officials have engaged and will continue to engage in a
grassroots education campaign to raise the fiduciary
implications of the Year 2000 problem in speeches, lectures,
and other presentations to groups of plan sponsors,
professionals, actuaries, accountants, attorneys, investment
advisors and managers.
We have participated with the AICPA in their development of
an Audit Risk Alert relating to employee benefit plan audits,
and our investigators have been, for some time, reviewing the
Year 2000 problem with plans as in the ordinary course of
conducting examinations and investigations.
Just as with the selection of service providers,
fiduciaries of plans must also consider Year 2000 preparedness
in selecting investments and assessing their current
portfolios. The obligation to consider Year 2000 compliance is
especially important for employers providing retirement
benefits through 401(k) plans. Over 25 million American workers
are active participants in 401(k) plans. Workers who
participate in these plans contribute part of their salary
toward their retirement savings and may, in many instances,
assume responsibility for directing their own investments from
investment options selected by the plan fiduciary.
We strongly encourage plan administrators to disclose to
their participants and beneficiaries the extent of the plan's
Year 2000 preparedness and the steps they are taking to ensure
that the issue does not interrupt the operation of the plan or
participants' and beneficiaries' access to their accounts. In
addition, because information regarding Year 2000 compliance
may be necessary to make informed investment decisions,
participants and beneficiaries in 401(k) plans who have the
responsibility for directing their own investments should
consider the Year 2000 issues when determining how to invest
their retirement assets.
Finally, I would like to note that, like the rest of the
Federal Government, we at PWBA are taking the Year 2000
situation very seriously, and we are taking appropriate steps
to make sure that our own systems continue to work correctly
after December 31, 1999.
Thank you very much, and I would be happy to respond to any
questions that you or any member of the committee might have.
[The prepared statement of Mr. Lebowitz can be found in the
appendix.]
Chairman Bennett. Thank you. We appreciate it.
We have asked all of the witnesses to keep their opening
statements very short because we want to, frankly, have the
witnesses interact with each other. We will learn more from
them in the questioning period. We can read the formal
statements and, in both instances, your statements submitted to
the committee in advance of the hearing will be included in the
record as if fully read.
Ms. Unger, the staff of this committee, conversing with
people in the investing world, have had conversations in
confidence with individuals who assert that a very high
percentage of the Year 2000 disclosures that are filed pursuant
to the SEC requirements are either misleading, incomplete, or
outright wrong. The argument goes that a company has more risk
in exposing Y2K problems than it does in keeping them hidden
because, at this time, there is an independent auditing in
place to challenge Y2K statements and no fines for
misstatement.
I would like to have your comment on those allegations that
we are receiving, put them on the table and let you react to
them.
Ms. Unger. Are you talking about the companies that mutual
funds invest in or mutual fund----
Chairman Bennett. I am talking about companies who respond
to the SEC requirements for disclosure in a formal way to all
investors that might look at those responses.
Ms. Unger. I think the last time I was here we did
acknowledge the fact that the disclosure was not what we had
hoped it would be based on our last survey and the task force
analysis of the statements that they reviewed, the filings that
were reviewed, and that led us to the actual Commission's
interpreted release in July, the end of July, actually. It is
our hope and belief that the next set of filings that are due,
which are actually due soon, will reflect more disclosure and
better disclosure based on the enhanced guidance that we put
out in the interpretative release that was published in July.
Chairman Bennett. It is the committee's hope that that will
be the case, and we are delighted that you produced this
additional requirement in July.
Ms. Unger. I would like to add to that.
Chairman Bennett. Sure.
Ms. Unger. If at the time that I think there is an intent
to review the new set of filings to see how the interpretation
has had an impact, and if you would like our staff or me to sit
down with you and/or your staff to review those and see exactly
how we are doing, we would be happy to do that.
Chairman Bennett. I am sure that we will do that. What
actions would the SEC be prepared to take against a company
that files a misleading report?
Ms. Unger. I think the difficulty with a misleading report
is finding out that it is misleading. We would hate to wait
until the Year 2000 to bring an enforcement case because by
then it would be virtually meaningless. What we would like to
do is, and which will be easier in the areas where we have
actual Y2K reports due, such as the one I described in the
testimony and the one that I described last time I was here for
the broker dealers and transfer agents.
If the information in those reports are misleading or the
reports are not filed, then we have the basis for an action.
The way we could bring an action for misleading statements
prior to the Year 2000 would be if there were other statements
made in the public by representatives of that company that were
inconsistent with the statements that were filed with the
Commission.
So we are on the lookout for that, and I do think we find
that it would be important--and enforcement is definitely
focused on this issue--to bring cases now, so that we can
emphasize how important we believe this issue is and that the
best disclosure possible is made by companies.
Chairman Bennett. I think it is important that companies
understand that there will be a consequence if they file a
misleading or an incomplete report rather than just leaving it
on the honor code and say we hope everybody does it right, but
if they do not, nothing will happen to them.
Now, you have testified that the mutual funds you have
examined to date, and I understand that is about a third of the
assets held in mutual funds, only 1 percent have failed to
prepare a written plan and conduct an inventory of their
systems. There are still two-thirds out there. That 1 percent
number may grow. What action do you plan to take against that 1
percent or others that you identify in future examinations?
Ms. Unger. Well, we do have this filing requirement that we
hope to have finalized by the end of this month that will
require investment advisors to file reports with the Commission
about their Year 2000 preparedness. That will enable us to go
out in the examination process and target those filings or the
issuers, rather the fund complexes and advisors whose filings
that we think show that there is a problem with their Year 2000
preparations. So that will enable us to focus our resources
most effectively prospectively.
I do believe we intend to visit the other two-thirds
independently, but I believe that the most effective--and I am
not sure about that--but I do know the intent is to take the
reports and to analyze the information and then visit the funds
or the advisors that do have problems based on the reports--or
that appear to have problems.
Chairman Bennett. Thank you.
Mr. Lebowitz, you have given us in your testimony a heavy
emphasis on the oversight and outreach that the Pension and
Welfare Benefits Administration is conducting on the
operational side of pension fund management--the accounting
systems, payment systems and so on--and you spoke about your
own internal efforts to be Y2K ready. Could you give us more
detail on how you are guiding and leading pension fund
fiduciaries to be on the lookout for Y2K problems in their
investment decisions.
Mr. Lebowitz. Mr. Chairman, to a large extent, pension
plans are really customers, in a sense, of others who provide
data to them. So the extent to which a pension plan may be
exposed to Year 2000 problems is, in many cases, almost
entirely dependent upon how successful others are in getting
their systems fixed. For instance, the plan may have some
internal systems for cutting checks and paying benefits to
individuals, but to determine who is eligible, they are
completely dependent on information from employers. Their
investment information may be held by brokers, and banks, and
insurance companies and investment managers.
So what we have concentrated on in our outreach efforts is
to lay out for plan administrators and plan fiduciaries an
approach to asking the right questions of all of those with
whom they deal, so they can, for themselves, come to a
conclusion about the extent to which they are vulnerable and
the extent to which they may need to make decisions like
changing investment managers, changing bank trustees, getting a
different third-party administrator to do the day-to-day
bookkeeping and, to the degree necessary, of course, to look
internally at their own systems to see how they all integrate
together.
Chairman Bennett. You trigger a memory. I once served on
the board of a pension fund. It was made very clear to me, when
I was recruited for the board, that I would have nothing to do
with investment decisions; that all I would do would be to hire
the manager, who would make those decisions. So I think you are
right in that it is the responsibility of the board, and I hope
you are helping them remember that responsibility, to ask this
question of the investment advisors.
Mr. Lebowitz. Right.
Chairman Bennett. Senator Collins.
Senator Collins. Thank you, Mr. Chairman.
Mr. Lebowitz, in your testimony you stated that your agency
strongly encourages plan administrators to disclose to their
participants and beneficiaries the extent of the plan's Year
2000 preparedness and the steps taken to ensure that the Year
2000 issue does not interrupt the operation of the plan or
participants' and beneficiaries' access to their individual
accounts. Obviously, there could be very serious consequences,
as far as access to individual accounts, and the operation of
the plan if the steps are not taken to ensure compliance.
Why then are you only strongly encouraging plan
administrators to take these steps? Why are you not requiring
it? It seems to me it is part of the fiduciary responsibility
of any plan administrator, given the potential consequences for
the plan if it is not Y2K compliant.
Mr. Lebowitz. Well, Senator, the answer to that is, like
everything in ERISA, a bit complicated. ERISA's disclosure
rules are quite extensive, but they are relatively fixed in the
statute, and the discretion that we have to require disclosures
beyond that which is specifically provided for in the statute
is quite limited.
Much of what the statute requires relates to the terms of
the plan itself. What is the benefit formula? What kind of
payment do I get? How is my benefit calculated? What are my
appeal rights if I am not happy with the decision when I file a
claim, that kind of thing.
Financial information and operational information is
disclosed indirectly to participants through the annual report,
the 5500 report, which, for large plans, is a very significant
document. This report is not required to be filed with us and
the Internal Revenue Service until 7\1/2\ months after the end
of the plan year to which it applies. So we are only now, for
instance, just receiving annual reports for plan year 1997.
So the statute really does not provide a very effective
framework for the types of disclosures, important disclosures,
that you are talking about. Also, the significance of this
information to participants may well vary, depending on the
type of plan. In a 401(k) plan, for instance, the sort I spoke
about earlier in my testimony, where participants are making
their own investment decisions, everyone else is relieved of
fiduciary liability resulting from those decisions.
If that protection from liability is going to continue to
apply, participances are going to have to have enough
information to enable them to make considered, intelligent
investment decisions. And in that circumstance, the statute and
our implementing regulations require that participants be given
enough information, including information about Year 2000
readiness of those investment choices.
In other types of plans, traditional pension plans where
people get a benefit which is a function of salary and years of
service, the risk really is on the employer because the
employer, in almost all cases, entirely funds that benefit. So
the employer is the one who needs the information.
Senator Collins. In a defined benefit program you are
talking about.
Mr. Lebowitz. That is right. This is a long answer to your
question--but I think the answer is that it does depend on the
type of plan, but to the extent that individuals have the
responsibility for making investment decisions, they should
have enough information to be able to make intelligent
decisions and to know about the Year 2000 vulnerabilities
within that context.
Participants certainly have the right to ask their plan
administrators, even in a defined benefit plan, what is going
on? What are you doing to get ready? Am I going to be able to
count on my benefit check coming every month if I retire next
year? We encourage people to ask those questions. We encourage
employers and plan administrators to answer them, and we
encourage people to come to us if they cannot get satisfactory
answers to those questions and we will.
Senator Collins. It seems to me that if you think ERISA is
not clear on this point, as far as your authority to require
plan administrators to disclose this information, that you
should come to Congress and ask us to clarify that. I think
this is very important. It seems to me that the Department
would find a plan as not fulfilling its fiduciary obligations
to the participants and the beneficiaries if it were not taking
steps to become Y2K compliant and did not disclose that. Would
you disagree with that?
Mr. Lebowitz. Well, there is certainly liability under
ERISA on a plan fiduciary whose responsibility is to see to it
that the plan continues to be a viable enterprise and who does
not take those steps that are necessary to deal with this
problem.
Whether the participant has a right to detailed information
about what that fiduciary is doing to bring themselves into
compliance is going to vary, as I said, from plan to plan.
Senator Collins. It is interesting because it seems to me
the SEC has taken a different approach in this area, and I want
to turn to Commissioner Unger and talk about the question that
the SEC has put out for investors to ask in assessing a firm's
compliance with Y2K.
Could you go through the kinds of questions that the SEC is
recommending that investors ask of their money managers or
brokers.
Ms. Unger. I did know there were eight questions up on the
web site, but I did not have them with me. However, the person
that you saw come over----
Senator Collins. I noticed you had an astute staff.
Ms. Unger. Yes, I do. When you hear the SEC has wonderful
staff, it is absolutely true.
The questions are as follows:
What is the firm doing to become Y2K compliant?
How can the investor be satisfied that they really are
compliant?
How will the investor be affected if the company is not
ready?
Assuming the firm is ready, will the exchange's clearing
agents and other market participants be ready?
What provisions does the company have to test the other
market participants before Year 2000?
Will the company participate in any industrywide testing?
What happens if the investor wants to sell in late 1999 or
early 2000 and the trade cannot be executed? What will the firm
do?
Is the research personnel evaluating Y2K compliance as part
of the decision to recommend a buy or sell?
How will this affect the investor's interest and/or
dividend payments?
Senator Collins. I appreciate your sharing those with us
because I think they are exactly the kinds of questions that
need to be asked.
The SEC, in my judgment, has really done a terrific job on
investor education, and I really salute the Commission, under
Arthur Levitt, for making that such a priority. I had 600
people attend the Investors' Town Meeting sponsored by the SEC
in Bangor, ME. Unfortunately, the chairman was unable to get
there because of weather problems, but we hooked him up via the
phone. This, however, is one issue that we did not touch on,
and I think we should have, in retrospect, given the potential
implications.
Ms. Unger. Actually, I participated in one recently, not
that recently, about 6 months ago maybe in Boston, and I do not
think it came up then either. But as we get closer, I do think
that investors are getting more and more aware, are becoming
more and more aware of the issue.
Senator Collins. I would like to suggest to the SEC that
you modify your town meeting program to have a segment on Y2K
because I think it is an issue that investors do need some
preparation on.
Just one final question, and it is a little bit off the
issue of pensions, but it does relate to the issues before us
and that the chairman has raised, and that is the speculation
that we have heard, that corporations and their filings with
the SEC have not been as forthcoming as they should be about
the extent of their Y2K compliance because they fear the impact
on their stock price.
Is the SEC doing any sort of spot audit or review to test
the truthfulness and completeness of the filings on this issue?
[Chorus of ayes.]
Ms. Unger. Well, in the area of investment advisors, and
those reports are not due yet, we will be checking for that. We
do not inspect issuers, and that is the problem.
Senator Collins. It is just disclosure?
Ms. Unger. Exactly, and that has been the problem with this
whole disclosure issue is that we do not have direct authority
over issuers other than in the area of disclosure. The reason,
I believe, that we think--I, personally, at least think--that
issuers were not as forthcoming as the guidance that we gave
was staff guidance, and it maybe was not as strong a guidance--
it definitely was not as strong a guidance as the Commission-
interpreted release that we issued at the end of July.
So I believe with these hearings, and with the public
attention focused on the issue, and our increased interest and
willingness to come out with a stronger position on what needs
to be disclosed that I expect the filings will be much more
forthcoming on this issue.
And, again, I said to the chairman, Senator Bennett, that
we would be happy to sit down and talk about the most recent
filings and what we have discovered, in terms of improvement,
as far as disclosures and what we hope to be improvement, when
those filings come out. So I certainly would extend the same
offer to you.
Senator Collins. Thank you, Commissioner, and thank you,
Mr. Chairman, for your continued leadership in this area.
Chairman Bennett. Thank you. We have been joined by Senator
Moynihan. Good morning, sir. The panel is available for your
witnesses or the committee for your opening statement.
Senator Moynihan. You are very kind, Mr. Chairman. I am
late. I am going to have to slip away for a moment to introduce
the new head of the Bureau of the Census and find out where
they are on the Y2K. It would be interesting if we found out
there was nobody in the United States--the computers did not
work. [Laughter.]
But I have read your testimony in advance and thank you
both.
Chairman Bennett. Thank you very much. Let me ask you the
unfair question, and I realize it is unfair, but it is the
unfair question we get asked, so we have to ask you, what is
your gut feeling about what is going to happen in the Year
2000? Is this industry going to be ready or not?
Ms. Unger. Would you like to go first? [Laughter.]
I will go. I believe that the industry will be ready, more
or less, and that the more competitive firms will be more ready
than some of the smaller firms. I think, as much as we push to
get awareness out there, and disclosure, and enable us to
better assess the situation, a lot of it has to do with a
business decision, and I am sure you are more acquainted with
that than I.
But in order to be competitive, and in order to be viable,
and in order to serve customers and continue to have a lively
and robust market, they are going to make sure the exchanges,
and the broker dealers, and the broker dealers, and the
investment advisors, that they are prepared for Year 2000. And
if there is a way to do it, I think they will find a way to do
it.
Chairman Bennett. Thank you very much. Did you want to add
anything, Mr. Lebowitz, to the----
Mr. Lebowitz. Just to say that pension plans themselves I
think will fare very well if there is a lot of information out
there in the marketplace to enable responsible officials to
make appropriate decisions. The competitive issues that
Commissioner Unger is talking about will result in some
companies to be well prepared and others not. As long as there
is information out there that plan fiduciaries and investment
managers can access easily and take into account in making
decisions about what to do with their assets, who to hire for
various services, then pension plans will come out of this
fine. If the information is not reliable or it is not there,
then they are going to suffer.
Chairman Bennett. Thank you both. We appreciate your being
here. I echo the congratulations to the SEC. This is one
regulatory agency which, from the very beginning, has taken
this matter very seriously and worked very hard at it.
We will go to the second panel. We have Matthew Fink, who
is the president of Investment Company Institute; Don Kittell,
executive vice president of the Securities Industry
Association, and I will take note that Mr. Kittell responded to
our last-minute request for a report on the recent testing in
the securities industry and, Mr. Kittell, we thank you very
much for your willingness to do that and be with us.
Mr. Kittell. Thank you, Senator.
Chairman Bennett. And Eugene Maloney, who is the trustee,
senior vice president, and corporate counsel for Federated
Investors, and he is an expert on the fiduciary
responsibilities in the context of Year 2000.
STATEMENT OF MATTHEW FINK, PRESIDENT, INVESTMENT COMPANY
INSTITUTE
Mr. Fink. Thank you, Mr. Chairman. I would like to say as
strongly as I can that the mutual fund industry takes this
issue very seriously. We, frankly, cannot afford to do
otherwise because the whole future of the mutual fund industry
is dependent on investor confidence.
In considering Y2K issues as they relate to the fund
industry, I think there are three special characteristics that
ought to be borne in mind.
First, unlike other American corporations, mutual funds are
subject to the very stringent requirements of the Investment
Company Act, which gives a special sense of urgency to Y2K. The
act requires a mutual fund to determine the price of its shares
every single business day and to offer an investor the right to
redeem or sell his or her shares every business day. Other
companies in the country run the risk of damaging relationships
with customers because of Y2K. Mutual funds face the normal
business risk, but also the simultaneous risk of violating
Federal law, the Investment Company Act, if they do not comply.
Second, the fund industry has very substantial experience
dealing with modification of its computer systems. Over the
years, computer systems in the industry have been changed on a
regular basis to comply with new legal requirements and to deal
with new shareholder services. Obviously, Y2K issues present
unique complexities, but I think that the fund industry,
because it is so computer dependent and has gone through so
many computer changes, is relatively well-conditioned to deal
with the Y2K change.
Third, the arrival of Y2K will have no impact on the
protections of the Investment Company Act I mentioned earlier.
If a mutual fund experiences a Y2K problem, its shareholders
will be protected by the Investment Company Act. In order to
explain the efforts that fund organizations are making to
comply with Y2K, I might try to explain to you the structure of
the typical mutual fund organization. Because it is a bit
complicated, I brought a chart with me.
The mutual fund itself is a pool of assets that has no
employees of its own. It relies on external entities for
management. Those entities are the fund's investment advisor,
who selects portfolio investments for the fund, and the fund's
principal underwriter, who distributes shares to the public
directly or to brokers who, in turn, distribute to the public.
That is why in the center of the diagram we have three
entities: the mutual fund itself, the advisor, and the
underwriter.
Let me turn to outside service providers, if I might. Funds
have transfer agents who keep records of their shareholders.
Some of the funds use transfer agents that are affiliated with
the advisor, but many use independent, third-party transfer
agents. On the next panel you will be hearing from a leading
one of those transfer agent, DST.
Second, funds under the Investment Company Act have to have
a custodian to hold their assets. You will be hearing from one
of those custodians, State Street Bank. The diagram also shows
other service providers like pricing services and brokers.
Y2K compliance is a very high priority in the industry.
Funds have dedicated staffs and separate budgets, and provide
periodic reports to the funds' own boards. The funds are also
very heavily monitoring the compliance programs of their
various service providers. In addition, the industry was one of
the major participants in the very excellent testing that Mr.
Kittell's organization, the SIA, has undertaken for the whole
of the securities business.
We are also keeping the SEC apprised of our efforts, both
through formal surveys and informally. We are communicating
with shareholders through SEC-required prospectus disclosure,
and also voluntarily on web sites and in newsletters. I have
attached to my written testimony an example of web site and
newsletter disclosure.
There are a number of parties looking over our shoulder, in
addition to the Congress. They include mutual fund directors--
each fund has its own board of directors--other regulators, the
SEC, and the media are all focusing on the subject. In
addition, the fund industry is somewhat unique, Mr. Chairman,
in that we have a captive insurance company, ICI Mutual, who
writes insurance for about 70 percent of the industry. It is
particularly underwriting Y2K risks in its normal underwriting,
and it will either decline coverage or raise premiums or put in
exceptions if it independently, for its own business reasons,
finds a Y2K problem with a particular fund.
Turning to the other subject you raised of fund portfolio
companies. Many of those companies, if not all, of course, are
heavily dependent on computers. Therefore, fund advisors, in
appropriate cases, are reviewing the Y2K compliance system of
companies in which funds invest by reviewing their official
disclosure statements, meeting with management, asking a series
of questions, and considering their portfolio companies' Y2K
compliance with other factors. You will hear on the next panel
from three mutual fund groups--Capital, Fidelity, and TIAA-
CREF--about what they are doing specifically.
I might say, in conclusion, this is one of those efforts
sometimes too rare, where I think Congress has really been
leading. I think the efforts of Chairman Bennett and of the
committee as a whole have helped the SEC, who has done a very
good job and pushed this area generally.
Particularly the fund industry would like to thank the
committee and the SEC for improving disclosure by portfolio
companies which our advisors need in order to manage their
funds.
Thank you for the opportunity to testify.
[The prepared statement of Mr. Fink can be found in the
appendix.]
Chairman Bennett. Thank you, sir. We have been joined by
Senator Dodd. Do you have an opening statement or comment?
Vice Chairman Dodd. I would just ask unanimous consent to
put it in the record, and I apologize to our witnesses on being
a bit late and to the first panel that I missed, but we will
just proceed.
[The prepared statement of Senator Dodd can be found in the
appendix.]
Senator Moynihan. Mr. Chairman, could I put my statement in
the record?
Chairman Bennett. Yes, of course, without objection in both
instances.
[The prepared statement of Senator Moynihan can be found in
the appendix.]
Chairman Bennett. Mr. Kittell, we appreciate, as I said,
your being here and look forward to your telling us what
happened in the first industrywide test of Y2K that I am aware
of.
STATEMENT OF DON KITTELL, EXECUTIVE VICE PRESIDENT, SECURITIES
INDUSTRY ASSOCIATION
Mr. Kittell. Thank you, Senator Bennett. My name is Don
Kittell, executive vice president of the Securities Industry
Association.
The Y2K effort in the securities industry is the largest we
have ever undertaken, with a cost estimated between $4-and $6
billion over 4 years. Since 1995, our primary goal has been to
protect the industry, the financial markets and the investing
public from the Y2K conversion problem.
From the beginning, our goals have been to promote
awareness of Y2K issues to share our experience with
international financial markets, other industries, and the
public sector and, most importantly, to fully disclose our
progress at every checkpoint along the way.
My principal message today is that, based on our progress
over the last 3 years and our plan over the next year and a
half, the securities industry will be ready for the Year 2000,
and you will not have to take my word for it. The industry will
demonstrate its readiness next year.
The cornerstone of all Year 2000 conversion efforts is
testing. Organizations test their systems. They test their
interfaces with other organizations they do business with. The
unique characteristic of the securities industry's testing
program is that we have brought together the industry's
exchanges, clearing, settlement organizations and hundreds of
securities firms in an industrywide test, which simulates
trading of our major products over the four-day period from
Wednesday, December 29, 1999, to Monday, January 3, 2000.
It is important to note that a test on this scale has never
been attempted before, and for that reason, we determined that
we needed a test of the test conducted early enough to ensure a
successful industrywide test in 1999. We call that test of a
test a beta test, and we completed it in July of this year
after a year of preparation. Some 28 firms volunteered to
participate, together with the major exchanges and
depositories. Those firms represent about 50 percent of the
trading volume in the U.S. securities markets. The products
included are all of the major security products ranging from
equities to fixed-income to futures, options and so on.
Here is what we learned: First, the beta test participants,
both the firms, and the exchanges and depositories, came
through with flying colors.
Second, but they did so only after significant commitments
of resources. We found no basis for complacency as a result of
the beta test.
Third, for the industrywide test to be successful, all
participants--300 or 400 firms at one level and more firms at a
secondary level--must be prepared to make the same commitment
of resources that the beta test firms did in July. In order to
manage the large number of firms, we need an extensive
education program, we need extensive prerequisite testing by
these firms prior to the industrywide test, we need extensive
help desk resources at the time of the test, and we need to
gather the results in ways that are useful to both the
participants and the regulators who are concerned about
protection of investors and counterparties.
Now that the beta test is completed, we are preparing for
the industrywide test. The first project is October 2, when we
are holding an industry conference to launch the education
campaign, and we will follow that with a comprehensive
pretesting program for the next six months.
We have expanded the scope of the test to include the
investment management community, links to market data vendors
and to payment systems tests conducted by the Federal Reserve
Bank, the New York Clearinghouse, and international payment
settlement organizations. We are actively engaged with the
major international market participants to coordinate cross-
border testing.
In conclusion, the securities industry is making a huge
investment to successfully meet this challenge. We believe that
investment will pay off in three ways. First, our markets will
function successfully during the millenniumdate change. Our
goal is to do so with flying colors. Second, our systems will
have been upgraded with greater functionality and capacity than
we have ever had before. And, third, we will have developed a
project management team within the industry to deal with
industrywide operations and technology projects that go well
beyond the Year 2000 conversion. That team will serve us well
in the conversion of the equity markets to decimals in the Year
2000 and in the conversion from 3-day settlement to 1-day
settlement by 2002 or 2003. Those latter efforts are in the
planning stages today.
We are confident that that investment will preserve the
leadership position of the U.S. financial markets for years to
come.
I would like to thank you, Senator Bennett, and the
committee for the work you have done in this area and for your
support of the Year 2000 Information Readiness Disclosure Act.
Thank you, also, for the opportunity to appear before you
today.
[The prepared statement of Mr. Kittell can be found in the
appendix.]
Chairman Bennett. Thank you. That is a very good summary
and both reassuring and sobering to understand how well you
have done and, at the same time, how much remains to be done.
Mr. Maloney.
STATEMENT OF EUGENE F. MALONEY, TRUSTEE, SENIOR VICE PRESIDENT
AND CORPORATE COUNSEL, FEDERATED INVESTORS
Mr. Maloney. Good morning, Senator. I am an executive vice
president and corporate counsel with Federated Investors. I am
also a member of the board of directors of the firm and a
member of the executive committee of the firm. For the last 11
years, I have been a member of the faculty of Boston University
Law School, where I teach a course in the master's program on
the trust and securities activities of banks.
Federated is a New York Stock Exchange listed company
which, through various subsidiaries, organizes, manages,
administers and distributes a family of mutual funds used
primarily by financial intermediaries. As of the close of
business yesterday, we either managed or had under
administration assets in excess of $150 billion. A substantial
majority of the assets in our funds represent investments made
by corporate fiduciaries acting in either a trustee or ERISA
capacity.
Since the beginning of May, our firm has focused
significant resources on the Y2K issue as it relates to the
investment management process. At the present time, our
investment professionals are assembling information from
primary and secondary sources, which will allow them to apply
traditional analytical tools to the processes of evaluating
which securities to buy, sell, or hold, as the case may be, as
the millennium approaches.
We have retained counsel skilled in Y2K matters to assist
us as we move forward. We have also consulted with members of
the accounting profession, who have experience in reviewing and
opining on the financial statements of public companies. This
dimension has been useful and will continue to be such as the
regulatory agencies, particularly the Securities and Exchange
Commission, require more forthright disclosure from issuers as
to Y2K readiness in their public filings.
Modern portfolio theory operates on the premise that
everything that is known or knowable about the price of a
publicly traded security is already fully reflected in its
price. Professional securities analysts are, thus, largely
limited to interpreting information in the public domain and
available to other analysts. This process is just beginning to
take shape, and we detect a growing awareness on the part of
the analyst community of the need to broaden their evaluation
of the securities they follow to include Y2K preparedness in
the context of the ability of a company to continue as a going
concern over the millennium. This will require an adjustment of
sorts on their part in that conventional wisdom holds that the
price of the security represents the present discounted value
of its future earnings.
Until recently, the analyst community had not focused on
the issue of business risk as it relates to Y2K and were
content with the vague statements of many issuers as to
expenses incurred to date and their self-evaluation of their
Y2K readiness. I expect this to change dramatically as issuers
begin to comply with the disclosures requirement by the
Securities and Exchange Commission in their recent release.
Working with counsel, we have written to the majority of
companies whose equity or fixed income securities are owned by
the funds we manage. In the domestic equity area, for example,
to date, we have received a 23 percent response rate, the
quality of which is very uneven. Follow-up mailings have been
made to those companies or issuers which did not respond to the
initial mailing. A Y2K file has been opened on each security we
own, and our analysts have the responsibility of tracking
issuer readiness as we go forward.
Each of our investment areas has a Y2K coordinator and all
activities relating to Y2K readiness of issuers or efforts made
to increase our understanding of Y2K and its impact on the
capital markets is documented in the central file.
Many articles are starting to appear which predict a global
technology winner. While some level of turmoil is to be
expected, we are of the view that it will be temporary in
nature. No credible source has predicted a permanent impairment
in the value of the securities of publicly traded companies,
either as a group or by industry. There will be issuer risk,
however, and it is our view that the market will soon start to
identify those companies who have been remiss in addressing the
Y2K issue.
Fiduciary investment is a process of balancing risks, using
professional judgment to weigh information available. We have
no reason to believe that this approach will not work relative
to which securities to buy, sell, or hold, based on our
evaluating the impact Y2K will have on share prices. We do not
feel that additional legislation is needed to protect the
interests of mutual fund shareholders, be they plan
participants, trustee beneficiaries, or individual investors.
For example, under the standards articulated in ERISA, a
prudent portfolio manager is already required to evaluate risk
in the portfolio. Y2K issues are simply an element of risk that
a prudent portfolio manager should analyze as part of the
existing prudent man standard of ERISA.
Thank you, Senator.
[The prepared statement of Mr. Maloney can be found in the
appendix.]
Chairman Bennett. Thank you very much, all of you.
Mr. Maloney, I am troubled by what you are saying. I think
everything you say is accurate, but as they say, that does not
make it any less troubling. You say analysts are just beginning
to assess Y2K risk.
Mr. Maloney. Yes.
Chairman Bennett. Senator Dodd knows that we held hearings
on this subject in the subcommittee of the Banking Committee
almost a year ago on why analysts should pay attention to Y2K
risks and, quite frankly, we were ridiculed, maybe not publicly
because a lot of people do not like to publicly ridicule a U.S.
Senator unless he is running for re-election. [Laughter.]
And both of us are, so I guess we are fair game.
Vice Chairman Dodd. We are used to it.
Chairman Bennett. We are used to it. [Laughter.]
But privately, as I would hold conversations with people on
Wall Street, they would say things to me like, ``We have a rule
of thumb that says whenever there are two web sites on an issue
that means the issue has been fully aired and the market has
automatically discounted everything that is on the web site.
And since there are dozens of web sites on Y2K, that means the
analysts already know everything there is to know, and Y2K will
hit the world like a serious snowstorm. It will shut things
down for a day or two and then everything will be fine.''
My reaction the first time I heard that was, ``You have not
been following. You do not understand what we are talking
about,'' and I later added to that the comment, ``Snow melts of
its own accord. This problem is not going to go away of its own
accord. It is going to require enormous resources.''
Mr. Kittell, I think, has pointed out the truth of another
facetious statement that I have made, ``The way to solve the
Y2K problem is very easy, just start in 1994, and you will have
it under control.'' And there are many companies that did not
start in 1994 or 1995 or 1996, who are just getting started and
I, as an investor, would not want to put my money in a company
that has been lax in its own computer systems or that does not
realize that in today's global economy, in the food chain of
just-in-time inventories and deliveries, the company could have
all of its own computers under control and still be vulnerable
to serious Y2K disruptions.
Every time I have this conversation with an analyst or with
somebody who considers himself a professional in this area, he
always says, ``Oh, well, you are just paying attention to those
Chicken Littles on the web sites that we ignore because the
herd mentality * * *'' and these are not their words, these are
mine put into their mouths ``* * * the herd mentality of
conventional wisdom says this is not a big deal.''
In your written testimony you say that, as of May of this
year, ``it was clear that the analyst community had not focused
on the issue of business risk as it relates to Y2K.'' Now in
your testimony here you say that they are just beginning to
focus.
Mr. Maloney. Correct.
Chairman Bennett. Am I completely out on a limb here being
concerned that the analysts are behind the curve on this and
may very well catch up to it too late and then we get the
Chicken Little syndrome among them?
Mr. Maloney. My involvement in this issue, Senator, was
random. As I mentioned to you when we exchanged greetings
earlier, I thought Y2K was a rock group up until early this
year. [Laughter.]
Our IT people came----
Vice Chairman Dodd. It may also be a rock group.
[Laughter.]
Chairman Bennett. Yes.
Mr. Maloney. As a matter of fact, our IT people came in my
office the other day and took my computer because I did not
know how to turn it on.
I got involved in this for the simple reason that we
received a letter from a trust client on the West Coast in
early spring asking us to recite for them what we were doing
from a portfolio management standpoint to get ready for Y2K,
and if they were not satisfied with the response that we gave
to them, they were going to ``go to all cash over the
millennium,'' the very thing you mentioned in your opening
remarks.
Well, as a director of the firm and someone who has been
there 26 years, we take a great deal of pride in responding to
concerns from our clients. So I, basically, went to school on
the subject, knew nothing about it. And I have been through the
early process of going to the various seminars, where you come
away scared and personally threatened by something you really
do not completely understand, and I decided I had to dump all
of the personal emotional baggage over the side and figure out
what, as a company, we were going to do to deal with this and
then communicate.
So I went to New York. I started calling analysts I knew
asking the kinds of provocative questions that you have been
asking and then, quite frankly, evaluating their answers. And
the answers I got, personally, were not, in my opinion,
satisfactory. It was blown off as the kind of temporary
phenomenon you described, and it was not going to cost very
much money and, oh, by the way, to prove that I started to get
copies of 10Ks, filings by public companies, where there was
Y2K disclosure, and it was pap. There is no way you could make
an informed investment decision to buy, sell, or hold based on
that stuff. Moreover, the numbers were pathetically low, based
on the kinds of information I was getting from our investment
experts. So that was the reason for my comment in my written
remarks. I did not think, at that point in time, that the
analysts fully understood the dimensions of Y2K.
I then invited our local auditors out to breakfast because
that is the second leg of the stool, disclosure. And I said,
``Are you looking at Y2K from a business risk standpoint?'' and
the answer I got was, ``You are not pinning this one on us. We
cannot get our arms around it from a business risk standpoint,
so how do you expect us to opine?'' There is the second leg of
the disclosure triumvirate that an analyst, that we would use
to make the decision to buy, sell, or hold.
And, last, of course, you have the lawyers, always the
lawyers. The lawyers would tell you anything you put in writing
is going to wind up in a courtroom, so do not say anything. So
what you have essentially done is cut off the information flow
that an investment professional would use to make the
appropriate evaluation to buy, sell, or hold a security.
We now just see the analysts starting to look at Y2K from a
business risk standpoint. It is our opinion that the recent
release by the Securities and Exchange Commission, the fruits
of which we think we will see in the next anniversary of
financial statements, will now start to have the kind of
disclosure that we can use to apply traditional analytical
tools to the investment management process. Our message to our
clients is the best way to ameliorate risk is through a broadly
diversified portfolio of securities and what better way to do
that than the use of a mutual fund.
What we have also done, just because of the nature of our
client base, we have enlisted the assistance of John Langbein
from Yale University Law School. A piece by Professor Langbein
is in my written submission. He is the author of the Prudent
Investor Act. His first take on Y2K and, of course, he has an
opinion on everything, was this is just a variation on a
familiar theme. It is risk management, albeit a unique risk.
Chairman Bennett. Thank you for sharing that with us. You
have encapsulated in a relatively short 6-month period what
Senator Dodd and I have been going through for a year and a
half. We came to the same sense of frustration and
determination that the analyst community, frankly, did not have
a clue about the time you were getting into it.
I do have friends whose judgment I trust, who have told me
absolutely they are out of the market, and they are going to
stay out of the market until they can get the kind of
information that you are talking about. I talked to one of them
just this week. He said, ``I got out of the market in
January.'' He said, ``It was Y2K concerns that caused me to do
it,'' and he says, ``Frankly, the return on the bonds that I
purchased, compared to the Dow, I have done better than if I
had stayed in the market,'' and I do not think Y2K had anything
to do with it.
But, yes, if we are going to have informed investors, we
have to have that information flow, and you have very carefully
and accurately summarized the three blockages that impede
information from coming forward.
Vice Chairman Dodd.
Vice Chairman Dodd. Thank you, Mr. Chairman. The chairman,
I think, has identified appropriately the concerns that we all
have, and I appreciate immensely your testimony here this
morning.
I just want to pick up on that last major point I think the
chairman was trying to make and was making in his comments. In
looking at your testimony, Mr. Maloney, where you state, ``Our
courts do not demand infallibility, nor hold a trustee to
prescience in investment decisions.'' It is troubling, with all
due respect, it is sort of a cavalier mentality in a sense. I
mean, I suppose you could make the analogy that with a huge
storm developing in the Sahara, as the example cited, it is
true that people on the coast of Florida, and North Carolina,
and South Carolina, on up to New England, that many other
things could happen to them, but we would be highly
irresponsible not to track and warn about the potential harm
here that could occur. So while no one anticipates or expects
infallibility, certainly this is something we know is going to
happen.
I, therefore, am interested in your comments and I will ask
you to address this as well as the proposed legislation that
Senator Hatch, Senator Leahy, Senator Bennett, and myself have
introduced dealing with information sharing, which is, I hope,
going to be a positive step. We are trying to get that done in
the next few days. But I am growing concerned because I can
sort of hear the rumbling already about protections that we
will be asked to provide legislatively for tort actions and so
forth.
And I am concerned that in pension fund and mutual fund
reports that Y2K information is being sort of buried--it is
asterisked in the bottom of reports, if at all. The foundation
of economic security for most Americans is their home and their
pension fund, and for a growing number of Americans, their
investment in the stock market.
I wonder if you might, No. 1, just comment on this proposed
legislation dealing with the information sharing.
No. 2, Mr. Kittell, I wonder if you might share with us
whether or not SIA is testing to uncover any problems with
foreign telecommunication systems and, if not, are you
concerned about this--obviously, for a variety of reasons,
certainly investors' decisions made in overnight activity in
foreign markets, but also as we know that our own major
exchanges are now listing, products that are off shore, and to
what extent are we looking at those industries to make sure
that they are going to be compliant.
Maybe if you would just address those two issues. I address
them to all three of you. Mr. Fink, if you want to begin.
Mr. Fink. On the first issue, we would support enactment of
the pending legislation, which deals with one of the problems,
to a limited extent, on information sharing. I think that is
very important because for firms that deal with the same
vendors it obviously would be a lot simpler to pass on
information to each other about that vendor's status without
worrying about antitrust.
If I might go on, I think after you complete hearings, it
would be good to look at it litigation reform more generally in
this area. Any legislation is going to have to be a balancing
act and mutual funds are on both sides of it. We are issuers of
securities and can be subject to frivolous lawsuits. On the
other hand, we buy securities and often are plaintiffs. But you
do not want to create a safe harbor that is so broad that
companies continue to make no decent Y2K disclosures. On the
other hand, you do not want to have strike suit lawyers really
profiting on Y2K. But I think a second piece of legislation
would be worthwhile.
I cannot speak to what Mr. Kittell is doing, or how the SIA
is looking at foreign issuers, but I might just say a word
about mutual funds in that regard.
Vice Chairman Dodd. Let me just interrupt for 1 second. As
you may know, and Senator Bennett was a tremendous help on
this, it has been about 7 years finally getting a securities
litigation reform bill passed, and then this year we did the
uniform standards legislation, and I think we did a very sound
job in limiting these strike suits, where mere fluctuation of a
stock could provoke a computer-driven lawsuit.
I just want to put people on notice that I see this as a
very different situation here. It is going to be awfully
difficult to make the case to a majority of our colleagues that
somehow this issue was not--people did not know about it or
whatever else. I mean, you are going to have an awful time. I
mean, as someone who feels very strongly about these strike
lawsuits and so forth, I do not know how it can stand up.
And having gone through 2 years of this, of hearing, after
hearing, after hearing, after hearing, and day after day after
day, we still find--and I understand we are trying to deal with
some of these questions--but lack much necessary information.
So for anyone to come back later and say, ``Well, we were
afraid of lawsuits'' is not going to be a good defense to not
disclose information. And for those who will want legislation
that proivides liability protection, I just tell people ahead
of time, I mean, I would not look for much cover up here anyway
when it comes to that.
Mr. Fink. What I hope to say, Senator, is that I think you
ought to look at it, but be careful, because it is a balancing
act. I do not think it is as clear as either of the prior two
pieces of legislation. That is what I was----
Vice Chairman Dodd. Yes. You wanted to mention something
about the----
Mr. Fink. Well, just on the foreign issue, funds get
involved in two ways. We buy foreign securities, and we have to
do analysis of those securities and those markets. Second, we
rely on foreign infrastructure much like we rely on U.S.
infrastructure, and there we do it through our custodian banks.
I just want to point out that funds are involved in this
inquiry both ways, both the issuers they are buying and the
markets they are buying in.
Mr. Kittell. Yes. Thank you. I would like to comment on
both questions.
The first, the SIA favors the proposed legislation. I am
not a lawyer. Many of the people I work with are not lawyers.
They are operations and technology practitioners. And in their
view, the real liability of the Year 2000 problem is not making
an all-out effort to fix it, and that the liability associated
with sharing information or disclosing information is minuscule
compared to the overall liability of not making a best-efforts
effort to fix it. We have been frustrated by the legal
community and some of our firms who have been a little, in my
opinion, cautious on this issue. My own view is that this will
open up over the next year as people become more confident with
their own plans and are willing to talk about it some more.
I think our challenge to our legal community in the
securities industry is to tell us how we can go about sharing
vendor information and testing information in a way that is
acceptable rather than telling us not to or to be cautious
about that kind of sharing.
With respect to international. SIA's own program, in
addition to the testing, has done a great deal of work with its
primary vendors, including the telecommunications industry and
the power industry. We also are actively engaged with a Global
2000 group, which is basically a global SIA, if you will. It is
made up of over 100 multi-national investment banks, and they
are organized in the same way that we are here in the U.S.
There is a testing group, a contingency planning group, and
there are also vendor groups that are working with the
telecommunications companies in the major markets.
This group has been in business for about a year. It has
been to London, Paris, Tokyo, Hong Kong. This week it is in
Budapest. In October it will be in Frankfurt, and in December
it will be in Brazil.
The way it works, there are country representatives on this
group who deal with the same kind of infrastructure issues that
I referred to earlier in the United States, working with the
local exchanges, and depositories and so on to understand their
testing programs and to give such advice as might be
appropriate. Those groups are also working on a local basis
with the telecom and power people in each of those markets.
They report back to this Global 2000 group. We have information
dissemination issues there. We do have a web site for that
group, as well as for SIA. We would like to put out country
readiness reports. We would like to put out detail on the
telecom industries in each of those countries. I am optimistic
that we will be able to be doing that, although we have not
found our way clear to do it yet.
My own view, I have heard a lot about the fact that the
United States is perhaps ahead of some of the international
markets. There have been distractions by the conversion to the
Euro. There have been distractions in Asia due to market
conditions. Our personal face-to-face work with the major
exchanges, depositories and firms in these markets lead me to
believe that they are very much aware of what is going on. They
are committed to getting it right. They are certainly behind,
and they have a lot of work to do in the next year and a half.
But I feel that the commitment and the awareness are both
there.
Mr. Maloney. Senator, in the conclusion to my written
submission, ERISA, and the Prudent Investor Act, and the
prudent man rule, the laws under which professional fiduciaries
will be evaluated on Y2K, are process-driven statutes. They are
not outcome-based statutes, nor do they require clairvoyance,
but they do require process. The point I made is, if you are
not writing it down, and building your file, and documenting
your analysis of this process, eventually you become a
guarantor of the performance of the investment if your conduct
was found to be imprudent.
From a corporate standpoint, we have decided we are going
to communicate. There are extensive studies showing that if an
investor understands risk, they are much better prepared to
tolerate risk. As you know, the securities markets are where
you place your capital at risk in the expectation of making a
profit.
And we have urged our clients that they, in turn, need to
communicate with the individual shareholder because--my comment
the other day was--if you do not manage Y2K, Y2K will most
assuredly manage you, and it will become a self-fulfilling
prophecy. Your clients will essentially panic, and what we all
are concerned about preventing will, in fact, happen, a so-
called all cash over the millennium.
The lawyers, frankly, are a major problem. You have seen
the predictions as well as I have, of a trillion dollars in
liability, and issuers, I think, are justifiably concerned.
Anything the Congress can do or the regulatory agencies can do
to compel the free flow of information will be enormously
helpful to organizations like ours.
I should tell you that, in leaving the firm yesterday, our
investment professionals told me that they are having terrific
success contacting issuers directly and having the kinds of
candid discussions one needs to have to determine whether or
not the issuer is, in fact, close to Y2K readiness. We have
gone beyond the public documents because we have concluded they
simply are not helpful. But the information is there. The
investment professional simply has to role up his or her
sleeves and go get it.
Vice Chairman Dodd. Just the one, and maybe the chairman
had, I guess, the same question maybe on this, but, Mr.
Kittell, the 28 firms who participated in the beta test, and
these are obviously the largest in the industry, and we have
looked at information. We had an interesting meeting, and I
have not had a chance to tell the chairman about it, yesterday
with the Gartner [ph.] Group, their staffs. In fact, we ought
to plan some means of hearing their analysis of this. But they
pointed out to us that when you start looking at industries,
their assessment of this, the larger industries look like they
are going to be fine, and as you move down to mid-size and
smaller, the expectations are not as good at all.
Mr. Kittell. You mean the larger companies.
Vice Chairman Dodd. The larger companies, yes. And their
assessment, looking at their 15,000 firms in various industries
in certain areas and making these assessments, The obvious
question I have, if you are looking at these firms, are, by and
large, the largest firms, you know, to what extent should we be
concerned, one, about the mid-size and smaller firms, No. 1.
No. 2, this is a voluntary, they are voluntarily participating
and, obviously, a firm that voluntarily participates is more
likely the one that is sort of ready. It seems to me I would be
far more interested in the ones that do not want to
participate. I would like to know what the hell they are up to
in terms of where this is going.
It is sort of an obvious question, a layman's question
here. So what degree of confidence can we have about a study
that does focus on larger firms and is voluntary and,
therefore, leaves open the obvious questions?
Mr. Kittell. I think in the case of the securities
industry, you can be highly confident. There are 5,000-and-
some-odd broker dealers registered by the NASD. The SIA
membership is about 800. We believe that the 800 in the SIA do
in excess of 90 percent of the business in the industry. So you
have many registered players at the NASD who are one-man, two-
man kind of operations.
Second, the way the securities industry operations work,
many firms introduce their business to clearing firms. In fact,
within the SIA membership, if you look at let us call it 300
firms, you have covered the back office processing, the order
entry, settlement and so on, of the remaining 5,000. So we
envision a test being utilized by every clearing firm.
As to the mandatory issue, I never personally got too
concerned about the issue on mandatory because I thought the
business purposes or the business motivation for participating
in a test was so high that we would have very high
participation anyway. That notwithstanding, the boards of
Depository Trust, and National Securities Clearing Corp, and
the regulators, the NYSE and the NASD, are talking about
mandatory testing. That is fine with us. I think that means
that that fringe area that might not have otherwise tested will
have to come in.
So I see very widespread participation in the test. Because
of the structure of clearing firms and introducing firms, our
coverage of the real money in the industry gives us some
grounds for optimism.
Vice Chairman Dodd. I should have mentioned, by the way,
the SIA has had a wonderful reputation. You have done a very
good job as an association, and I guess I should have begun my
questions by stating that. I apologize having it come at the
end. But I do respect immensely what the SIA has been doing.
Mr. Kittell. Thank you, Senator. I will take it at the
beginning or the end. [Laughter.]
Chairman Bennett. Thank you very much for your testimony.
It has been very helpful and fits into the historic pattern
that we have developed in the two bodies, the subcommittee on
the Banking Committee and this committee. We are grateful to
you, Mr. Fink. Can we hang onto your chart? Because I think it
will apply to the next panel.
Mr. Fink. Certainly, Senator.
Vice Chairman Dodd. We may have some additional questions,
too, we could submit to you, if that is appropriate, and if we
could get some responses back, we would be grateful to you.
Chairman Bennett. On our third panel we have Mr. Jim Wolf,
who is the executive vice president for TIAA-CREF. He will
explain all of that to us; Mr. Vince Brown, who is the
assistant executive officer for financial administrative
services at CalPERS, the California Public Employees'
Retirement System; Bert McConnell, senior vice president at
Fidelity Investments; John Towers, executive vice president and
chief of global operations for State Street Corp.; Thomas
Rowland, a senior vice president for Capital Group Companies;
and Mike Waterford, the group vice president for DST Systems,
Inc.
The reason I asked Mr. Fink to hang onto the chart is
because each of you gentlemen represent some portion of what is
up there. On this panel we have representatives of major
pension funds, investment companies, and a transfer agent.
So we will start with you, Mr. Wolf, and ask you each to
give your presentation. And as we said to the previous panel,
we have asked you to keep your opening remarks very brief
because we expect to learn most from the interaction that will
come when you start talking to each other.
STATEMENT OF JIM WOLF, EXECUTIVE VICE PRESIDENT, TIAA-CREF
Mr. Wolf. Thank you and good morning, Mr. Chairman.
Vice Chairman Dodd. I should point out Mr. Wolf is a
constituent, and we welcome him.
Chairman Bennett. Oh, well, then----
Mr. Wolf. Yes, I am. Thank you.
Good morning, Mr. Chairman. Good morning, Senator Dodd. I
am Jim Wolf, executive vice president of Corporate Management
Information Systems for TIAA-CREF. That is Teachers' Insurance
and Annuity Association and College Retirement Equities Fund.
TIAA is a nonprofit life insurance company that provides
retirement annuities and insurance products. CREF is its
nonprofit companion organization that issues variable
annuities. Together, TIAA-CREF invests assets, which totalled
$235 billion as of the end of June 1998, that are primarily
used to fund retirement plans at more than 8,000 educational
institutions that cover almost 2.3 million American educators.
As the committee recognizes, Year 2000 is a serious issue
that demands our focus and attention. At TIAA-CREF it is
getting that focus through the commitment of senior
management's time, budgeted resources and staffing allocations.
Since 1996, we have been addressing the five-step
requirements of Year 2000; awareness, assessment, renovation,
validation, and implementation. Approximately, 86 percent of
our application system program code has been remediated and is
currently back in production. Comprehensive Year 2000
certification testing is underway and completion is anticipated
for December 31, 1998.
We think keeping our public informed on Year 2000 is
important and, consequently, we have communicated our Year 2000
plans and progress several times to our participating
institutions, individuals and employees via corporate
publications, brochures, and our Internet Web site. Our
trustees and our audit committees are also kept informed on a
regular basis.
Much has been accomplished, but much is left to do. For
example, we are continuing to work on our PC hardware and
software environments and have plans to test our external
vendor interfaces as fully as possible when those vendors are
ready.
Our contingency plans are being finalized with particular
focus on our ability to provide monthly benefit payments to our
approximately 300,000 pensioners. This would be done, for
example, by ensuring that we can produce paper benefits checks
should electronic payment distribution systems fail.
Year 2000 readiness is also an important topic we focus on
relative to companies we invest in. During 1997, prior to the
publication of any regulations, we contacted over 5,000 of our
investment portfolio companies to ensure they each had a Year
2000 program. Currently, the responses to those letters are
made available to our investment analysts, and this
information, along with the SEC-required information, is
available for their discussion and due diligence meetings with
respective company management. Y2K is only one of the many
factors we use to make our investment decisions.
In summary, we believe TIAA-CREF is in a strong position to
meet the challenges of Year 2000. Lots of work and especially
testing, both internally and with others we are dependent upon,
is still left to be done. One of the most important things
still to do is to participate as much as possible in that
planned Wall Streetwide testing effort that is scheduled for
first quarter of 1999. That test should prove whether many of
us truly are ready for Year 2000.
Thank you.
[The prepared statement of Mr. Wolf can be found in the
appendix.]
Chairman Bennett. Thank you. Mr. Brown.
STATEMENT OF VINCENT P. BROWN, ASSISTANT EXECUTIVE OFFICER,
FINANCIAL AND ADMINISTRATIVE SERVICES, CALIFORNIA PUBLIC
EMPLOYEES' RETIREMENT SYSTEM
Mr. Brown. Thank you, Mr. Chair. For the record, I am Vince
Brown, assistant executive officer of Financial and
Administrative Services of the California Public Employees'
Retirement System, commonly known as CalPERS. I am also the
executive sponsor for CalPERS' Year 2000 Compliance Project.
I would like to thank you, Mr. Chair, and members of the
committee, for the opportunity to report the status of our Year
2000 Compliance Project. This hearing will make an important
contribution to the Year 2000 dialog.
CalPERS began planning our Year 2000 Compliance Project in
earnest in the fall of 1995. At the outset, we approached the
problem as an enterprisewide business concern, not just a
technology problem. To ensure compliance, we have adopted a
three-pronged approach.
First, we are developing a state-of-the-art integrated
corporate database to replace many of our older mainframe
computer systems with Year 2000 compliance systems.
Second, we are making Year 2000 compliant those PC
applications and mainframe computer systems that cannot be
built as part of the corporate database project.
And, third, we have developed a comprehensive business
enterprise program to mitigate any external risk to CalPERS'
business operations. The CalPERS board, CEO, and senior
management have made compliance the top priority for our fiscal
year 1998-1999.
To date, under our corporate database project, we have
implemented four major business systems; an actuarial valuation
system, health system, financial system, and investment
accounting reconciliation system. All four systems are Year
2000 compliant.
Year 2000 modifications have been made to our mainframe
Legacy computer systems, and we are currently in the testing
phase, with completion targeted for June and, after that,
additional testing on an integrated basis to make sure that
everything is in operation.
Compliance work on our PC applications is 45 percent
complete. We are on schedule to complete this effort by
December 1998. The Business Enterprise Project, which focuses
on internal and external risks, is now in the mitigation phase
of our Year 2000 compliance effort. We are on schedule to
complete this work by April 1999 and contingency planning will
occur as a result of the Business Enterprise Project.
Of paramount concern to the chair, and this committee, and
our members and employers is how we are addressing Year 2000
issues relative to CalPERS' investment portfolio. We share your
concern. As the chair stated in your written statement, pooling
funds in an investment allows for greater diversification to
reduce investment risk. CalPERS is a long-term investor with a
diversified portfolio. Our asset allocation planning process
anticipates market fluctuation. This reduces the risk to our
portfolio and, ultimately, our members.
I should note to the committee that I am not an investment
professional, and if there are detailed questions relative to
our portfolio, our investment staff would be more than willing
to provide additional information.
As we have discussed here with the Securities and Exchange
Commission today, we will be following the disclosure
requirements of the SEC. We would like greater disclosure
because I think that will help our professional investment
staff better analyze the portfolios.
Investment staff will also monitor the Securities Industry
Association's testing to gather Year 2000 compliance
information as well. In addition, our investment staff is
currently researching ways of surveying the more than 2,300
public companies in our investment portfolio on their Year 2000
compliance progress. The survey information will allow them to
independently evaluate companies and develop strategies to
protect our investments.
CalPERS' investment staff will develop a proposal for
discussion before our Investment Committee, which meets as a
committee of the entire board in October. We believe these
steps will assist investment staff to make informed judgments,
as you noted, Mr. Chair.
In conclusion, CalPERS recognized the seriousness of this
issue early and developed a comprehensive mitigation plan, and
we are on schedule in completing our Year 2000 Compliance
Project.
Thank you for the opportunity to report, and I applaud the
chair for his leadership in this area.
[The prepared statement of Mr. Brown can be found in the
appendix.]
Chairman Bennett. Thank you.
Mr. McConnell.
STATEMENT OF BERT E. McCONNELL, SENIOR VICE PRESIDENT, FIDELITY
INVESTMENTS
Mr. McConnell. Chairman Bennett and Vice Chairman Dodd. I
am Bert McConnell. I am senior vice president of Fidelity
Investments, and I am head of the Year 2000 program for
Fidelity.
Fidelity is the Nation's largest mutual fund company and
one of the Nation's leading provider of financial services with
total managed assets exceeding $615 billion. We are a
technology-intensive company with more than 6,000 information
technology professionals dedicated to meeting customer needs
and through the use of state of the art technology solutions.
Early in 1996, we began to prepare all of our systems to
seamlessly handle the Year 2000 problem. We recognized the
issues involves more than just changing lines of code in
mainframe systems. It involves extensive testing of our
software and hardware, as well as testing with outside vendors.
With both the size and the challenge in mind and the strong
support of top-level management, we have dedicated more than
500 people exclusively to the Year 2000 project. Our staff
includes systems and business professionals throughout
Fidelity, and our firmwide Year 2000 budget exceeds $300
million.
Today, we are well on our way to meeting our goal of
seamless processing for Fidelity systems and are on schedule to
provide uninterrupted service to our customers going into the
Year 2000. In fact, we have every confidence that we will be
ready well before the Year 2000. Specifically, 100 percent of
our mission-critical systems have been inventoried and all
internal code for these systems has been analyzed. By mission
critical, we mean all of the business systems that are directly
linked to our ability to service our customers. Fidelity has
also already changed 94 percent of the code in these business
systems. We expect to change the remainder of the code in our
systems by the end of 1998.
While much is said about fixing lines of code, the real
challenge of the Year 2000 project is testing the systems. This
is where Fidelity is currently allocating most of our Year 2000
resources.
We are testing in three distinct phases or what we call
waves. Wave 1 tests all Fidelity business systems individually
using tools to simulate the Year 2000. In effect, we are making
our computers think it is the Year 2000. For example, during
this phase, we would test our ability to open a new customer
account. To date, 86 percent of these mission-critical systems
have been successfully tested, and we are on schedule to
complete wave 1 by the end of this year.
In wave 2, all of the Fidelity systems are tested together
in a computer that has the internal clock actually set to the
Year 2000. This is sort of a time machine. In these time
machines, we install only Year 2000-ready Fidelity and vendor
software. For example, during this phase we would test the
ability to enter orders for mutual fund shares, process the
order based on end-of-day net asset value received from our
pricing systems, and prepare confirmation of the transactions
through our automated print systems. We are more than halfway
through our wave 2 testing and expected completion is February
1999.
Finally, in wave 3, we use our time machines again to test
with our outside business partners, stock exchanges, banks,
broker dealers and others. During wave 3, for instance, we
would test our ability to price a fund by testing the data
feeds from our data service providers. And because the
financial service industry does not stop at our national
borders, wave 3 testing also includes vendors in the United
States and abroad. Wave 3 testing started this summer with the
successful participation in the SIA trial run of its planned
1999 street test, and wave 3 testing will run through September
of 1999.
We are pleased to report all phases of testing are on
schedule, and we have not encountered any significant problems.
Let me touch on the status of companies that we depend on.
We rely on 165 technology vendors, 90 other companies who are
essential to serving our customers. We have an active
communication and monitoring program with these companies, and
the majority have given us assurances that they will be Year
2000 ready. For those who may not be, we are developing
detailed contingency plans and will move to alternate
suppliers, if necessary.
In addition to preparing our own company for Year 2000, we
know that the Year 2000 is an issue for companies in which
mutual funds invest. As a mutual fund company, Fidelity's
overriding obligation is to maximize shareholder value for its
investors consistent with the investment objectives of the
funds. However, we think it would be inappropriate to seek to
impose on a fund manager a specific obligation to evaluate the
Year 2000 risk differently from the way all other risks are
evaluated.
In conclusion, we appreciate the opportunity to describe
Fidelity's Year 2000 program. We welcome congressional
participation to ensure the Federal Government will also be
Year 2000 ready. We also encourage legislation to promote the
information sharing and higher level of awareness in
preparation by limiting liability of companies that work
diligently to develop and implement Year 2000 programs.
This concludes my testimony. Thank you.
[The prepared statement of Mr. McConnell can be found in
the appendix.]
Chairman Bennett. Thank you.
Mr. Towers.
STATEMENT OF JOHN R. TOWERS, EXECUTIVE VICE PRESIDENT AND CHIEF
OF GLOBAL OPPORTUNITIES, STATE STREET CORP.
Mr. Towers. Mr. Chairman, Senator Dodd. Thank you for the
opportunity to appear before you today. My name is John Towers,
and I am executive vice president for Global Operations at
State Street Corp.
I will focus my remarks today on our own commitment to the
readiness for Year 2000, with particular reference to the
services we provide to the mutual funds industry.
State Street provides safekeeping and financial services
for over $4 trillion in assets held by mutual funds, insurance
companies and pension plans. We process over 50,000 trade
settlements daily in over 80 markets around the world and
manage over $400 billion on behalf of institutional investors
worldwide.
Our Year 2000 program, Resolution 2000, began in 1996 and
covers four areas of Year 2000 compliance and contingency
preparations: Information technology, suppliers and vendors,
counterparties and business partners, and business area
operations.
Progress and impact are regularly and methodically reported
at all levels of the corporation from the board of directors to
every level of our staff and to our customers. Year 2000
compliance is a challenge, but State Street and other global
financial firms are accustomed to constantly upgrading and
recoding our software to accommodate changes in customer and/or
market requirements. We currently deliver daily prices for over
1,200 U.S. mutual funds or about one-third of all funds in the
country. Those prices are delivered both to our customers and
to other intermediaries, and we have done so over many years,
despite numerous natural disasters and extraordinary global
securities market turmoil from time to time.
Today, we provide services for over 3,000 mutual funds
ranging from fund accounting to daily pricing and fund
administration. In the course of providing these services, we
interface electronically with securities depositories, broker
dealers, banks, stock exchanges and our customers, as well as
providers of pricing and other investment data services to
ensure that our customers receive all of the data which they
require.
To date, nearly 90 percent of our 350 core corporate
applications have been completed, and 97 percent of the
programs specifically directed to supporting mutual funds have
been renovated for the Year 2000 and are currently in various
levels of testing to validate compliance.
Externally, we continue our efforts to monitor and
influence the compliance of essential third parties globally
and are developing strategies and approaches for testing with
them. In cases where we find noncompliance, we will replace
vendors, work around them, develop internal capabilities to
replace them, or make necessary renovations to enable us to
provide Year 2000 compliance services to our customers.
Our compliance target for all internal systems continues to
be December 31, 1998, to meet the recommendations of the FFIEC.
We will devote our efforts during 1999 to external testing and
to developing appropriate contingency plans with key industry
counterparties, customers and vendors.
Mr. Chairman, we commend your broad efforts in raising
sensitivity to this issue, and we also commend the SEC,
particularly, for its recent effort in coming forward and
extending safe harbor protection for forward-looking statements
in this area.
These are the kind of actions that are needed to encourage
and create incentives for further information sharing and
candid disclosure of readiness. Disclosure of technical
information among all participants in the financial industry is
a key ingredient in fixing Year 2000 problems, but full
disclosure and information sharing is often inhibited by
concerns about the risk of potential litigation, especially
punitive and consequential damages.
Mr. Chairman, we urge the members of this committee to
continue to find ways to create incentives for cooperation and
openness among all parties. In our view, this would be the most
effective assistance you could provide.
Thank you very much.
[The prepared statement of Mr. Towers can be found in the
appendix.]
Chairman Bennett. Thank you.
Mr. Rowland.
STATEMENT OF THOMAS M. ROWLAND, SENIOR VICE PRESIDENT, CAPITAL
GROUP COMPANIES, INC.
Mr. Rowland. Thank you and good morning. My name is Thomas
Rowland. I am the senior vice president with the Central
Services Division of the Capital Group Companies. I am the
individual with primary responsibility for the Year 2000
project at Capital. Prior to joining Capital early this year, I
was an audit partner at Deloitte & Touche. I, and the entire
Capital organization, appreciate the opportunity to testify
before this Special Committee today and applaud your effort and
that of the SEC in helping focus public attention on this very
important issue.
Capital Group Companies is comprised of several affiliated
entities that provide investment management-related services to
individuals, corporations and institutions throughout the
world. Capital Research and Management, one of these companies,
is a sponsor and investment manager of the 28 mutual funds in
the American Funds Group. This mutual fund complex has over
$225 billion in assets and more than 9 million shareholder
accounts. Other Capital Group companies have over $110 billion
assets under supervision.
It may be worthwhile talking briefly about the project
organization. Capital is addressing the Year 2000 challenge on
a coordinated, enterprisewide basis. A significant number of
people with diverse backgrounds and skills are involved, with
the Year 2000 Steering Committee and the Year 2000 Program
Management Office providing overall coordination and support.
Our compliance project plan applies to all Capital Group
Companies, including Capital Research and its two subsidiaries
companies providing services to the U.S. mutual funds; American
Funds Service Company, our transfer agent, and American Funds
Distributor, our principal underwriter.The plan covers all
Capital Group systems and facilities worldwide and their
activities undertaken on behalf of both U.S. and non-U.S.
clients.
The board of directors of a number of Capital Group
Companies, including Capital Research, have formally approved
the project, including the enterprisewide approach and its
reliance on the Steering Committee, the Program Management
Office, the information and technology business areas for
implementation.
Quarterly reports of our progress are submitted to the
boards, as well as the mutual funds in the American Funds Group
and their outside auditors. In addition, we are making
information available concerning Year 2000 projects available
at our corporate and mutual fund Web sites.
Capital is committed to achieving Year 2000 compliance
across all of our significant business systems and operations.
We have a well-defined plan, ample resources, and excellent
momentum toward achieving our goal. Our progress to date
indicates that we will meet our December 31st target for Year
2000 compliance for our internal systems.
Within the areas of our businesses that support mutual fund
operations, as of June 30, we were substantially complete with
the first two phases of our project--inventory and risk
assessment and planning--and more than 90 percent complete with
the remediation phase, and testing was between 70 and 80
percent complete.
While we have made significant progress to achieving
compliance within our information technology infrastructure and
other support areas for the mutual fund operations, our focus
is now on assessing Year 2000 readiness for our significant
vendors and developing appropriate contingent plans.
Where electronic interchanges and dependencies exist, we
will conduct appropriate tests, including point-to-point tests
with these individual firms and streetwide tests with other
industry participants. Testing with third parties has already
begun, and we will continue that through 1999.
We think it is important to emphasize a large number of
interconnections and interdependencies present within and
outside this industry and need to work diligently to anticipate
and prepare for external events.
At the moment, there are many serious issues facing
companies and other organizations, including central banks and
other governmental agencies around the globe. Thus, the
possibility exists that parties outside of our control or
influence will not be as prepared as they should be and
investors may suffer as a result. I am sure that Capital and
other industry participants will take steps to address these
risks, both in terms of their mutual fund operations and
investments, but there may be no way to eliminate them
entirely.
I understand the Special Committee is interested in knowing
whether we are considering Year 2000 readiness of companies in
our client portfolios. Although I am not an investment
professional myself, I know that our research analysts and
portfolio counselors are well aware of this issue. They are
reviewing portfolio companies' public disclosures and making
inquiries of management and, generally, receiving positive
assurance. However, our people realize they are not technology
experts and, in any event, they are not in a position to
independently verify the assertions made by management.
On the other hand, at Capital, at least, we tend to make
and maintain long-term investments in companies we believe to
be well-managed and with good prospects for the future, and it
may be entirely reasonable for investment professionals to
conclude that a company's statements about Year 2000 readiness
are solidly grounded. Well-run companies with significant
resources and good prospects are more likely to address the
issue in a responsible and effective manner. Clearly, the Year
2000 issue is more significant for some companies than others,
and the degree of our analysts' concerns reflect this.
Finally, although our investment professionals recognize
the importance of this issue, they also feel strongly that it
is only one of many factors that ought to be taken into account
as part of the investment process, and it would be
inappropriate to consider statements about Year 2000 to the
exclusion of other equally pertinent investment considerations.
Thank you very much for the opportunity to testify.
[The prepared statement of Mr. Rowland can be found in the
appendix.]
Chairman Bennett. Mr. Waterford.
STATEMENT OF MICHAEL A. WATERFORD, GROUP VICE PRESIDENT, DST
SYSTEMS, INC.
Mr. Waterford. Mr. Chairman and Senator Dodd.
My name is Michael Waterford, and I am a group vice
president of DST Systems, Inc. We appreciate the opportunity to
provide testimony on the Year 2000 problem and the efforts of
the mutual funds industry to prepare for it. We believe that
the work of the committee is vitally important in creating
public awareness of the problem and an appropriate level of
corporate response.
DST Systems was founded in 1969 to address the shareholder
recordkeeping requirements of the mutual funds industry and,
today, we are the leading recordkeeper for shareholders in the
industry. We provide shareholder recordkeeping to over 200
mutual fund companies, representing over 48 million shareholder
accounts. Over the last decade, we have invested hundreds of
millions of dollars in infrastructure and systems to address
the growing needs of the industry.
The typical services which we provide for mutual funds
shareholder recordkeeping involves maintaining records of
shareholder ownership in mutual funds. DST is a registered
transfer agent regulated by the SEC. Our portfolio accounting
services are provided by a separate software product, the
Portfolio Accounting System. These services enable mutual fund
managers to record the underlying securities in the mutual fund
portfolio.
Our first preparations for the Year 2000 started in 1989,
when we added a century to the dates in the mutual funds
shareholder recordkeeping system. In November 1996, we
established a project office, headed by myself as a senior
officer, to carry out day-to-day oversight of all Year 2000
activities.
DST has set a corporate goal of achieving internal Year
2000 readiness of our systems and services by December 31,
1998. At the time of this statement, we have essentially
completed the remediation of our shareholder recordkeeping and
portfolio accounting systems and the remediated programs have
been placed into production.
Testing internally is well advanced, and we expect to
complete it on schedule by the end of 1998. However, our
external testing with clients, the industry, and other third
parties is likely to continue well into 1999 and possibly into
the fourth quarter. We are participating in the SIA testing
program.
As our testing has progressed with relatively few problems,
we have become more comfortable with our ability to meet our
internal timeframes for readiness. That is not the same as
saying that we expect to be error free. In spite of the
considerable amount of testing which we have undertaken and
will continue to undertake, we must expect that there will be
issues requiring continuing attention when we cross into the
next century.
Our program of communicating with our mutual fund clients
includes monthly newsletter, as well as information on our Web
site for our shareholders, our clients and the press.
Additionally, our attendance is requested at mutual fund client
meetings increasingly, including mutual fund boards discharging
their fiduciary responsibilities with respect to the Year 2000.
As we review our readiness for the Year 2000, we are
becoming increasingly aware that there is a range of risks
which is almost completely outside our control and for which
little information is currently available. These concern what
we think of as national infrastructure, such as the basic
utilities and the national telecommunications network. I was
glad to hear that an electricity assessment is becoming
available.
Although DST, together with other organizations in the
mutual funds industry, is reasonably well advanced with its
Year 2000 preparation, we believe that readiness will continue
to require the allocation of significant resources of people
and equipment, together with consistent management attention,
at least through early 2000.
That concludes my testimony. Thank you.
[The prepared statement of Mr. Waterford can be found in
the appendix.]
Chairman Bennett. Thank you all. Let me make some general
observations.
As I listened to this distinguished group, I think the
lawyers had their hand in drafting the statements. You all
made--not all--but most of you made the point that, of course,
we are going to evaluate risk, and we are going to evaluate all
risks, and Y2K is not just the only risk, and we must look at
all of the rest of it. We are not suggesting in any way that
any analyst should change his or her evaluation of all of the
other risks.
The frustration that has come to us is that analysts are
ignoring this risk. And one of the reasons they are ignoring
this risk, going back to the testimony of Mr. Maloney and the
previous panel, was that, A, they do not have enough
information about it; B, they are afraid of possible lawsuits;
and, C, they think the easiest thing to do is to say nothing
and hope the problem goes away.
It is a little like, if I may, the movie ``Tucker.'' I do
not know whether the movie ``Tucker'' is an accurate
description of what really happened with the Tucker automobile.
I am old enough to remember the Tucker automobile, and I do not
think it was nearly as romantic as the movie made it out to be.
But in the movie, Mr. Tucker, the swashbuckling entrepreneur,
promises that the automobile will be delivered at a time
certain. And when the time comes for him to unveil the
automobile, it is not ready. But he does not, at any point,
admit that there are any problems. In the movie, the mechanics
are pushing the automobile onto the stage while Tucker is
making his remarks in front of the curtain. And dramatically,
as the curtain opens to reveal the automobile, the mechanics
are scurrying away so that they do not get caught in it. People
are left with the impression that the automobile was driven up
there and that everything is wonderful, and he gets away with
it, even though, as I say, they had to push it up there.
I have the feeling a lot of people are saying, ``We are
going to say everything is wonderful with Y2K and hope we can
push this onto the stage, so that when the curtain opens on New
Year's Eve, it will be there and everything will, in fact, be
wonderful.'' Whereas, a prudent investor wants to know and
deserves to know in advance that the automobile has no engine
and, in fact, will not run when the curtain opens and people
get to see the gleaming chrome.
Now, if that is not an accurate analogy, it, nonetheless,
summarizes some of the frustrations that I have had here with
people saying, ``Well, the industry is going to be fine. Well,
everything is going to be fine. Well, gee, do not ask us to
highlight this risk because we have other risks.'' Nobody is
asking anybody to downgrade the other risks. We are just asking
you to pay attention to this one in ways that, up until now,
analysts have not done.
So, for me, the issue is not evaluating risk differently
with respect to Y2K; the issue is disclosing where the risk is,
making sure that people can evaluate it.
Mr. Rowland, I would like to focus on you for just a minute
because you have, perhaps, more than the others on this panel,
expertise in an area that concerns me, and I would like to take
advantage of your being here.
Capital Group maintains offices in London, Geneva, Hong
Kong, Singapore, and Tokyo. Information that we have developed
in the committee elsewhere says that, on a country-by-country
basis, we should have the most confidence in your offices in
London and Singapore, with perhaps less confidence about what
might happen in Geneva, Hong Kong, and Tokyo. Have you engaged
in any general assessment about the overall Y2K state of
readiness in those countries? I am talking about infrastructure
issues that could impact your operations: Telecommunications,
power, utilities, transportation, et cetera. Because I think
things are going to be better in the U.K., in the United
States, and in Singapore than they are in other countries,
based on information, as I say, that the committee has.
What inquiries have you made about the state of readiness,
beyond your own company, in the environment in which you
operate and how could that affect your ability to serve your
customers?
Mr. Rowland. I would like to answer that in two parts. The
first part is our work with custodian banks. Our primary link
to the foreign markets are through the custodian banks and the
subcustodian networks. We deal with approximately 100 custodian
banks at Capital and intensely with probably a half-dozen of
them. So we are meeting frequently with the custodian banks in
reviewing the activities that the custodian banks are taking in
these foreign markets, as they are our primary contact in those
areas.
Our experience with the custodian banks are they are taking
it very seriously. They started a year ago assessing
information in their subcustodian network. They have people on
the ground in these countries who are very well aware of the
situation and are gathering information.
The one disappointment, I would say, that we have seen is
they are a little reluctant to be specific with respect to
subcustodians and concerned about litigation risk, but they are
providing us with in-country information with respect to this
readiness.
In the second part, I had a meeting with our global
research people last week, where we discussed this topic, and I
believe that where we are headed with it, we have people on the
ground in many of these countries, and we are looking at using
our country specialists in these countries in helping us gather
information with respect to the companies and the
infrastructure in these countries. Now, I would have to say
that that is where I think we have some sentiment to do that.
We will need to develop a way to communicate that information
among the investment professionals in our company.
The other aspect of gathering information is that we
started probably about a year ago making inquiries of our
significant business partners and vendors about readiness and,
to tell you the truth, we did not get very good response. And
in reflecting on it, I would have to say that, if we were asked
a year ago where we were on the project, we would have to say--
we could not give very substantive responses either. So I think
we are entering an era where we should expect to get pretty
substantive responses because, I mean, the issue has been
around and people have had time to become prepared for it. So I
think, as we move ahead, I think we should expect to get more
substantive responses to inquiries.
Chairman Bennett. Well, I do not want to be critical of
you. Basically, I heard the answer to my question as no. You
have not engaged in general assessment of this country's state
of Y2K readiness. You have talked to corresponding banks, you
have talked to other companies, but nobody has gone out in Hong
Kong and said, ``Are the telephones going to work?''
Am I wrong in coming to that conclusion?
Mr. Rowland. I am not aware that we have made that specific
inquiry at this point.
Chairman Bennett. Well, if I can just make a general
observation. I think every company that has anything to do
overseas ought to be asking those kinds of very direct
questions, and they ought to be part of the analysis. I used to
run a very small company that--well, yeah, before the big one.
[Laughter.]
Vice Chairman Dodd. I am sorry. My chronology was off
there.
Chairman Bennett. Some day I will tell you how many
companies I have run. Most of them were very small.
I used to run a very small company that was dependent on--
the principal item in its product--on a manufacturer in Taiwan.
We could not manufacture the product in the United States as
cheaply as we could get it manufactured in Taiwan. We did all
of the enhancements to the product in California, and our sales
force and everything else was located in the United States, but
the key component came from Taiwan. If I were running that
company today, I would be very, very nervous about the state of
readiness nationally in Taiwan.
It was a publicly traded company, so the analysts who
looked at our stock would be lulled into a sense of false
security if I were to say, ``All of our computers are fine. All
of our billing systems are fine. All of our database for our
customer mail order activity is fine. Everything is wonderful.
By the way, the key product that without which we will shut
down is manufactured in a country where I have no idea whether
there is going to be a dial tone on the telephone, whether I
can fly in because the air traffic control system is still
working, in order to check on the factory, whether the factory
can get any power,'' all of those kinds of key questions are
essential to my telling my analyst whether or not I am going to
be in business.
That is one of the frustrations that I have. As we talk
about analysts, I do not find any that seem to be pursuing the
Y2K question beyond the assurances that we are going to be OK.
The supply chain I keep talking about sometimes runs out very,
very far. The just-in-time inventory system that we are all
dependent upon runs through computers that could break down
and, again, runs overseas again, and again, and again.
I do not know, Mr. Wolf or Mr. Brown, whether your analysts
have done any kind of investigation as to what the foreign
exposure might be in your portfolios or whether any of them
have asked these questions. I picked on Mr. Rowland because of
where his company has offices, but this has to do with
everybody I think.
I would just send that message, that the complexity of this
thing, as we become more and more acquainted with it in this
committee, is enormous. Analysts that are looking at portfolios
of huge sizes--I mean, trillions of dollars, even to
Washington, is a big amount of money--ought to be paying
attention to all of these things. We are back to the disclosure
that ought to be available to the analyst, and through the
analyst, ultimately, to the investor, as to where we are on
this.
Now, having unburdened myself of that tirade, does anybody
want to respond? I do not want to intimidate anybody. I want to
stimulate you.
Mr. Wolf. I would just say I think you are absolutely
correct. If you ask the pointed question, have our analysts
gone and asked the infrastructure questions of the various
foreign countries, I am not aware of that answer being yes. The
questions we ask are specifically of the companies and, yet, in
the foreign investments that we make, I am not so sure their
disclosure is any better than what we are assuming in a lot of
our domestic companies as well.
Questions are being asked, I know that. The quality of the
answers is a different question and whether or not we are
looking at country infrastructures, I doubt we are doing that
at this point, and I will carry that message back.
Chairman Bennett. Fine. Mr. Towers.
Mr. Towers. Yes, Mr. Chairman.
I would answer it from an operational point of view. Much
as we look at the vendors who support the services that we
provide to our mutual fund customers and other customers here
domestically, we also have that same process underway in the
non-U.S. locations, where we operate either directly or through
our subcustodian network. I would say we are probably not as
far along on that process globally as we are here, and I think
we are experiencing some of the same issues that were mentioned
by other members of the panel, in that some of the
infrastructure and telecommunications companies have not been
as forthcoming in their responses as have been members of the
securities industry. But those inquiries are underway.
Chairman Bennett. Does anyone have any idea how big an
exposure you have in your portfolios with respect to foreign
investments; what percentage of your total portfolio would have
this kind of exposure as opposed to an entirely domestic
content, U.S. content?
Mr. Brown. Mr. Chair, I would like to comment on the former
question, as well as the latter, and I do take your
admonishment constructively.
State Street Bank is our custodian, and we have had them
appear before our Finance and Audit Committee two times in the
last year. One of the key issues that has been addressed to
them is the preparedness of the global custodians and
subcustodians to be operational. We are still working on
getting a satisfactory answer, but I think that is a well-
placed question, and one of our board members has already asked
that question of our custodian.
Relative to asking those questions, perhaps, of firms that
we invest in, we have 750 equity stocks in our international
portfolio. As I had indicated earlier, we are in the process of
developing a survey for all of the companies we invest in. As
part of putting together those questions for our investment
committee, we have our investment staff working in concert with
our audit staff, who is a part of this group, to provide the
oversight on the business side, along with our Year 2000 staff.
Those are the types of questions that I think need to be asked
as well, that go beyond the normal, ``Are you going to be up
and operational? How is your infrastructure?''
From the standpoint of our portfolio, our portfolio,
audited July 31, was approximately $143 billion. Obviously, it
has fluctuated due to the market volatility recently. But of
that, about $32 billion or about 22 percent is in the
international market. Again, we are a long-term investor, and
we have a diversified portfolio. The majority of our funds are
invested internally in the United States in passive portfolios,
be they fixed income or equity.
I would just like to add one thing because you are asking
the questions not only about the infrastructure that need to be
asked of those firms you invest in, and custodians, and third
parties, et cetera, but we are asking those questions of our
providers in Sacramento. We have scheduled for February a test
in the telecommunications area. One of the contingencies that
we are looking at is having more than one provider coming into
our building.
We have already begun discussions with our major power
provider relative to their status as to Year 2000. And,
obviously, we are not getting the types of answers we want at
this point, but I am very heartened to hear that this survey is
up, and that is one of the things that I marked down that we
want to try to follow-up on.
Additionally, as we look forward, we have begun--and I do
not want to go to, as you put it, the Chicken Little syndrome--
but as part of our disaster business recovery exercise in
preparing the contingency in the event power does not come on,
there is no water, et cetera. So we have been thinking along
those lines, as well as our internal operations, and thrusting
out externally.
Chairman Bennett. Vice Chairman Dodd.
Vice Chairman Dodd. Thank you, Mr. Chairman.
Let me just underscore again what the chairman has said and
second it in terms of the concern about getting the information
and the growing sense--it is not here alone we are sensing it,
by the way. We have had hearings on medical issues, and
utilities, and down the line. There is a sense that there is
almost sort of a laissez-faire kind of notion about all of
this.
I mean, we are not trying to engage in some hyperbole here,
but rather, when you start listening to people who are making
assessments of the situation--and, again, I mean, the Gartner
Group is one group, and Mr. Wolf and I are very familiar with
them because they are a Connecticut-based company, but they
have done about 98 percent of the assessments for Fortune 500
companies that are doing global assessments--and you sit and
talk with them, as we did yesterday, and they paint a scenario,
and it is chilling in terms of where the rest of the world is,
and this includes Great Britain, by the way.
They are very pessimistic, even among our European allies,
let alone in the Pacific rim, and in Latin America and Africa,
in their assessment of where companies are by clusters and
groups. This is the company that is out making the assessments.
And they are talking about 36 months as the lead time you need
in order to deal with this issue.
So when we are dealing with 470 days to go here, it is
worrisome to a couple of people up here, and although neither
of us claim any technical expertise relating to remediation and
testing. I gather it is a pretty labor-intensive set of
functions that you have to go through.
Let me just ask a few questions, could you give us the
percentage, and I realize this is information you may not have
at the tips of your fingers, but it will be very helpful I
think to us if you could forward that information to the
committee and just a breakdown of to what extent your
portfolios are dependent upon foreign operations being Y2K
ready or compliant. I think that was the question. It might be
helpful. Again, it may be difficult.
I will begin with my constituent, Mr. Wolf, if I can. In
your recent survey of portfolio companies, you show a great
deal of initiative, I might point out, in tackling the complex
issues related to this problem. You did a survey of 5,000
companies, as I understand it, and only about 25 percent, if I
read this correctly, of the companies you contacted provided
information in response, and only about 10 percent of the
responding firms claimed that they were 2000 compliant.
Now, the math on this one says that out of 5,000 firms you
have got 125 that claim that they are ready. Maybe the other
ones are, but it is troubling when they do not answer. I
presume you would have the same concerns. If they are not
answering, something is going on here. It is not--the level of
that percentage, 1 or 2, whatever, there may be just a
communications problem here.
So I wonder, one, if you are planning to contact the other
3,750 companies here, the nonresponding organizations, and ask
about their current status, and do you have any information
about why those firms chose not to answer your questions, and
how do you analyze the 75 percent of the companies that do not
respond? At this point here, you would have to draw some
conclusion about that, I presume, to people who are going to
make financial decisions about them.
So I wonder if you might shed some light on that.
Mr. Wolf. I will be happy to. The original motivation for
our sending a letter to 5,000 portfolio companies was mainly
for awareness of the Y2K issue. We did it in early 1997 and,
again, it was before any regulatory involvement from the SEC
requiring information to be filed that we were doing that
because we were concerned as to whether or not those companies
really were aware and whether they had programs.
Vice Chairman Dodd. Right.
Mr. Wolf. So we wanted to know whether they had a program
in place and whether their senior management was involved. We
were not surprised that we did not get a much bigger percentage
coming back because, in fact, we did not think enough companies
were really on top of the situation in early 1997. We used it
as an awareness effort. We do not intend and we have not
followed it up.
We are looking to the work that the chairman is taking in
this, the committee is taking, as well as the SEC. We applaud
the efforts that you are pushing the SEC even more to be more
demanding. But we do not feel we have enough clout to get to
the level of information we need by simply going after the
companies individually. We need a little bit more leverage, and
I think the SEC and this committee is helping to provide that.
Vice Chairman Dodd. I appreciate that. But if I were using
your firm to make some investment decisions, to what extent are
you letting me know, to the extent that a package or whatever
of investments that I may be making are going to be in
companies that have not responded to this? Is that kind of
information available to people who then want to make those
decisions in terms of the Y2K?
Mr. Wolf. We have not made the specific responses available
to our policyholders or investors, if you will. It is available
to our internal analysts, and they carry that information when
they meet one-on-one with the company management. It is one of
the primary questions that does get asked. Again, the quality
of the responses may not be there, at this point in time, that
we would like to see. But we are asking the questions.
Vice Chairman Dodd. By the way, we are getting a broad
spectrum of people not responding--sometimes the Federal
agencies, where there are specific questions being asked of
them, and they are not responding.
Again, as the chairman has said, I mean, obviously, we are
dealing in risks here, and some are unanticipated risks. We do
not know what happens in Japan and other places, and you have
got to certainly try to factor that in. This is an anticipated
risk. There is not a lot we can say with any certainty about
what the world is going to look like on January 1, 2000. We
know this is a problem. Now, we do not know to what extent, but
we know it is a problem. There is no question. This hurricane
is going to hit. Now, maybe it will blow itself out and it will
be relatively minor or it could be very serious. But there is
no question it is coming.
I do not think we can say about any other risk that you may
be assessing with absolute certainty what is likely to happen.
And it seems to me that as you talk about these risks there is
a difference. Some are unanticipated and you cannot predict,
but this one you can. This is pretty clear.
And I would sure want to know, if I were an investor, I
would like to know that company, X or Y, is just not responding
to inquiries about this issue. I may decide to go with them
anyway. I mean, I may decide that I have got enough confidence
in them in the other factors here, but, boy, I would like to
put that one into the old mix here. If they are not answering
the questions on this, that is a significant factor, I would
think. Now, again, maybe we are overstating the case, but it is
important.
I wonder if you could also tell us how your organization
assures that responses to your inquiries about compliance all
use the same definition. This is a big problem. We get
companies who say they are compliant, some say they are ready.
I think there are a variety of other words they use.
Chairman Bennett. I have heard several.
Vice Chairman Dodd. Several. And, again, I think those
words are selected very carefully and, again, I am sure the
lawyers are saying, ``Look, when you answer these things, you
better use the right word here.'' What does ready mean? What
does compliant mean?
But do you find any difference, even in the responses you
are getting, does that send any signals to you about----
Mr. Wolf. I cannot give specifics--because, again, I am on
the data processing side of the house--on the specific
responses we are getting. But I would have to agree with you,
Senator, that we are going to get very different quality
answers. Again, we are trying to use some of the SEC
requirements. But at the same time, if we are looking at 5,000
companies we are investing in, we are banking on the diversity
of that 5,000 relative to any particular TIAA-CREF fund in
which those companies are held by our investment individuals
such that we get diversification.
So, if there is not consistent answers, at least we have an
opportunity from the diverse pool to get what is, hopefully, a
reduced risk.
Vice Chairman Dodd. Yes. I thank you for that.
Mr. Brown, you mentioned in your testimony that CalPERS is
researching ways to survey its portfolio companies for the Year
2000. Now, one, when do you expect to begin that survey? And I
don't need to, again, you know the clock is ticking here. We
have got 470 days. Mr. Wolf's company they, back in 1997, sent
out surveys or letters to 5,000 companies. You are researching
ways to survey your companies, and we are closing out 1998 in a
few weeks, a few months, and we are going to be into 1999. I
find that disconcerting. Disabuse me of my fear here, that you
are researching ways to survey, when, it seems to me, at this
point, that should have happened and the survey should have
gone out already. Why has that not happened?
Mr. Brown. Senator----
Vice Chairman Dodd. Am I right in that, by the way? Correct
me if I am wrong.
Mr. Brown. I think I need to clarify a little bit on that.
We are a little further along than researching to do a survey.
And I do not want to be premature because our investment
committee has to make the decision to tell staff to go forth
and do this, but as part of our annual planning process for
October for shareholder issues, the Year 2000 question is going
to be part of that thrust, our annual thrust there.
Internal staff, investment staff, audit staff, and Year
2000 staff has developed a number of potential questions to go
into the October board agenda packet. The investment staff has
already done some--I would not say survey--but researching on
firms that would be out there to help us to conduct this
survey. So that is where we are at this point. It is part of
the board's annual planning on this.
From our standpoint, although it looks to be a little bit
late, we still think we are in the prudent timeframe, given the
responses that the SEC has received and the responses here. I,
generally, liked the way he talked about the awareness point.
Part of our planning is that the methodology that we will be
using is follow-up letters essentially drafted under certain
audit protocols.
Vice Chairman Dodd. What are we talking about? What is the
universe of portfolio companies you would be talking about
CalPERS?
Mr. Brown. At CalPERS it is 2,300-plus.
Vice Chairman Dodd. Companies. So the board will make a
decision in October whether or not they are going to do the
survey and the kind of survey that is going to be done.
Mr. Brown. That is correct.
Vice Chairman Dodd. And then when would you anticipate,
just give me some idea here, and I am not holding you to date
certains, but if the board meeting is in October and the
decision is made to go forward with the survey, would that more
than likely begin in January or would it begin immediately?
Mr. Brown. Senator, I really cannot answer that question. I
really need to ask the investment staff, and that is something
I could get back to you immediately on.
Vice Chairman Dodd. Fine. I am just curious, again, about
time. Again, by the time you get back that information, I am
just worried about this shrinking of time. So if you get
information here, then how do people react to it? What do you
do? How do you respond?
You noted that you have developed a contingency plan for
the worst-case scenario at CalPERS. In your scenario
development, I wonder if you might share with us what did you
determine would be, in fact, the most likely contingency? Now,
you have identified that one of those areas would be the check
writing out of the California State Controller's Office--check
processing I should say.
Mr. Brown. A couple of points. As far as the State
Controller's Office, we have had the Controller's Office, along
with State Street and the State Treasurer's Office, make a
presentation to our board regarding their compliance efforts
and all of the touch points in the State treasury system.
The Controller's Office performs a number of functions for
the State of California, one of them being the check write for
our retiree warrants. We are currently in testing mode with
them to ensure that they are compliant. What essentially--and I
do not want to get too technical--is we give them a tape and
they cut the checks. For us, that is the first area that we
need to determine if they are going to be able to perform or
not. If not, we have begun developing a contingency plan, and
the contingency plan essentially is that, by July 1, 1999, we
will have a contract in place with a check processor or a bank
to process those checks.
Recently, in October, we brought that to our Benefits and
Program Administration Committee and were given the go ahead by
our committee. We have currently on contract Moore business
which is in Utah that is a potential for one of our back-ups--
--
Chairman Bennett. Naturally, it will work. [Laughter.]
Mr. Brown. We have, for example----
Vice Chairman Dodd. We knew you would get that in there
some way or another. [Laughter.]
Mr. Brown. EDS in Rochester, NY, and we have another firm,
LCS in Santa Clara, CA. We are in the process. We already have
contract language. We have been talking to these firms about
their capacity. They have been in to meet with us. And, quite
frankly, we were ready to pull the trigger in October and go
outside the system, but the Benefits and Program Administration
Committee take a little bit longer on your planning and do it
over the next several months, but we are very close to having
such a system in place, so that we will assure our retirees
that they get their checks.
Vice Chairman Dodd. And did I hear you respond properly on
the Controller's Office in terms of how you are checking about
their ability to be able to----
Mr. Brown. Yes, a couple of things. One, we have been
working with them for over a year and a half, and we have
already passed a data file over to them to run it through their
system to test it from that standpoint.
Chairman Bennett. We have a vote going on.
Vice Chairman Dodd. We do. Let me try and move along.
Chairman Bennett. I am going to have to leave right now, so
you can carry on as long as you feel comfortable before the
vote gets us.
Vice Chairman Dodd [presiding]. Well, they know it is going
to be relatively brief with a vote on. So I will move along
pretty quickly here. Maybe you will have to send some of these
in writing.
Mr. McConnell, you noted it would be inappropriate, I
think, to seek to impose specific fund manager obligations to
evaluate Y2K risk differently from the way other risks are
evaluated and, again, the chairman has talked about this and I
have, as well.
I wonder if you might share with us how our Y2K risk is
integrated into portfolio managers' and research
analysts'identification and evaluation of all facts impacting
on a company's value. And then, second, what level of
confidence is there that all mutual fund companies are
educating their fund managers and analysts sufficiently to
include in their portfolio evaluations and decisions?
Mr. McConnell. Senator Dodd, I am probably the wrong person
to answer that question for you, very honestly. The thing that
keeps me up at night these days are the 1,500 applications, the
5,300 software/hardware network vendors we deal with, the
30,000 desk tops we have to get ready, and all of the
interdependencies that we have within our industry.
I have met with our director of Research in Fidelity
Investments. We do brief the investment analysts in Fidelity
with our program and things that we look for in our own
exercises. So they are very well educated on the process of
what Year 2000 is all about, and they do have a series of
questions that they do ask senior management when they evaluate
companies.
So I can speak for the fact that our analysts are doing
that process. They do ask the questions. It is not a simple
yes/no answer on compliance or not compliance. It is questions
about----
Vice Chairman Dodd. Could you get us a copy of that? I
mean, I would kind of like to see it.
Mr. McConnell. We can get that for you. I do not have it
handy right here, but it is questions like the size of the
program, what is the nature of the program, the elements of the
program, what is your expected completion dates of certain
phases of the program that we are tracking ourselves
internally.
Vice Chairman Dodd. I would appreciate that.
Mr. McConnell. Sure.
Vice Chairman Dodd. Just to jump along here fairly quickly.
I was sort of impressed with your wave 1, wave 2, wave 3
approach on this. Although when I started doing the math on it,
I come down to wave 3, and you leave yourself about 12 weeks.
Mr. McConnell. Oh, no, no, no. These are overlapping waves.
That was miscommunicated probably. Wave 1 actually started
probably in the middle of 1996 and is just wrapping up as we
speak. Wave 2 started the beginning part of 1997 and will
continue into 1999. And wave 3 we started with the street tests
with the SIA, the beta street tests.
Vice Chairman Dodd. So that is overlapped. All right.
Mr. McConnell. That is also a continuum, yes.
Vice Chairman Dodd. The area of the vendors indicated you
relied on 165 technology vendors and approximately 90 other
essential outside parties. Again, what kind of response have
you had in evaluating their Y2K preparedness? And for those who
have told you they are ready, I wonder if they--again, I go
back to the definitions. Would you ask them what do you mean by
ready or do you just kind of take ready as an answer?
Mr. McConnell. We have a saying that we listen to everyone,
we believe no one, and we test everything.
Vice Chairman Dodd. Yes.
Mr. McConnell. The answer to that really comes down to, of
these 258 vendors that we really speak to intimately on the
subject, only 6 have not given us adequate assurances at this
point in time that we will be ready. We are also in the process
of, part of our wave 3 testing, of putting test plans in place
with every one of them. So, while they will tell us one thing,
we will verify that testing in the coming months.
Vice Chairman Dodd. Listen, we have got about 3 or 4
minutes left on this vote, and I have got to get over and do
that. But I, certainly on behalf of the chairman, and I will
submit--I apologize to you, Mr. Towers, Mr. Rowland, and Mr.
Waterford, but I have some questions for you. I just did not
get there, but I will submit them to you. If you can, try and
respond to them for us on a couple of these other things that
were raised, particularly the one involving just the percentage
of exposure of some of your companies.
But we are very grateful to you. I mean it has been
tremendously helpful, and I am sure there were those who
probably said, ``What are you accepting going to testify in
front of a committee like this for?''
But I appreciate it immensely and, hopefully, it will serve
as a source of encouragement to other people to come forward,
so that we can sit around here in January or February of the
Year 2000 and say, ``Boy, what was that all about? Things
worked well.'' I would like to think that one of the reasons it
did was because, through this process, we encourage people more
to share information, and to get as much out there, and to act
as an incentive for those who may be dragging their feet a bit,
that they ought to pick up their speed on this issue. So I am
very, very grateful to all of you for your willingness to be
here.
And, by the way, if you have got some additional thoughts
as to how you think we ought to deal with this a bit more
effectively--you are on the street, you are dealing with people
every day on this, aside from the legal questions, obviously,
your investors' confidence in your portfolios, in no small
measure, will be determined by how well this all functions, to
some degree--so any ideas you have as to how we could do a
better job of moving this ball along a bit more quickly, I know
the chairman will be grateful, and I certainly would be as
well.
So, with that, the committee stands adjourned. I thank you
all.
[Whereupon, at 12:15 p.m., the committee was adjourned.]
A P P E N D I X
______
ALPHABETICAL LISTING AND MATERIAL SUBMITTED
______
Prepared Statement of Chairman Robert F. Bennett
Good morning and welcome to the seventh hearing of the Senate
Special Committee on the Year 2000 Technology Problem.
We will spend the next few hours exploring the Year 2000 readiness
of the securities industry, in particular the topic of pensions and
mutual funds. Many of you know that I first became concerned about the
Year 2000 problem in my role as Chairman of the Senate Banking
Committee's Subcommittee on Financial Services and Technology. Through
a series of hearings in that subcommittee, I have come to understand
that the Year 2000 problem creates some serious risks for participants
in the financial services industry--from bank customers who want to
make sure they can access their accounts at ATM machines to investors
in the stock market seeking to make sound investments.
Over the past year, I have also come to understand just how
important it is for customers and investors to get useful information
about the Year 2000 readiness of the companies with which they do
business and in which they invest. Over the past year, I have worked
with the SEC to develop enhanced disclosure rules to try to ensure that
they get that information. The SEC released their revised rules in July
and I am looking forward to seeing more meaningful disclosure in the
coming months.
In considering the subject for today's hearing, Senator Moynihan
and I have chosen to focus on pensions and mutual funds because they
are the primary vehicles through which most Americans access the stock
market. Over 84 million Americans participate in pension plans, and the
Department of Labor reports that of the $3.6 trillion in assets held by
private pension plans, nearly half of those funds ($1.8 trillion) are
invested in equities. Over the past decade, Americans have directed
increasing amounts of their discretionary investments to the stock
market--particularly funds accumulated for long-term investment goals,
such as college or retirement. Since 1991, individuals have funneled
$1.1 trillion into stock mutual funds and that amount has been
increasing at a rate of $21 billion a month.
Americans have made these investments largely because the stock
market historically has outperformed other more secure investments,
leading many investment advisors to recommend that funds accumulated
for long-term goals should be invested in equities. Investment advisors
have also encouraged small investors to invest in mutual funds rather
than the stocks of individual companies. Pooling funds in an investment
company can allow for greater diversification and therefore, reduce
investment risk.
Pensions and mutual funds are also investment vehicles over which
Americans have little day-to-day control. Individual investors rely on
fund managers to research and analyze portfolio companies as they make
investment decisions. Those managers have a fiduciary duty under the
law to make investments that are in the best interest of the underlying
investor.
Nevertheless, it remains unclear whether and to what extent fund
managers are considering the Year 2000 as they decide whether to buy,
sell, or hold an equity investment and whether the fund managers are
getting the information they need to make informed judgments. It is
important for investors in these funds to feel confident that the
managers of their pension funds and investment companies are taking the
necessary steps to secure their investments for the Year 2000. Without
this confidence, investors will move available funds from the stock
market in anticipation of the century date change, and that movement of
funds could have a dramatic impact on world markets and the global
economy.
Today we hear from witnesses from the pension and mutual fund
industry and their regulators. I have asked the witnesses to address
two risks pension and mutual fund investors face as a result of the
Year 2000 problem.
First, what are participants in the pension and mutual fund
industry doing to prepare their own systems to ensure that all
essential operations (such as access to funds and record keeping)
continue without interruption after the century date change? In order
to preserve confidence in this sector, it is important for pension
beneficiaries to know that their checks will arrive on time just as
mutual fund holders need to know their accounts will be managed without
interruption.
Second, what steps are industry participants taking to avoid
investing customer funds in companies where there are serious questions
about Year 2000 readiness? Are fund managers getting the information
they need to make informed judgments on this issue? While there is no
such thing as certainty in investing, it is important to know what fund
managers are doing in this area so investors can make their own
investment decisions accordingly.
We also will hear from Don Kittell of the Securities Industry
Association, who will report on the results of recent Year 2000 testing
in the securities industry.
Before we get started, I would like to take a moment to follow up
on our June 1 2th utilities hearing. As you may recall, we were unable
to determine at that hearing whether ``the lights will stay on''
because there had been no industry-wide Year 2000 assessment of the
industry. I am pleased to report that the North American Electric
Reliability Council (``NERC'') plans to release its industry assessment
today. My reading of advance results suggests that there is both ``good
news'' and ``bad news.''
The good news is that this is the most comprehensive Year 2000
assessment the Committee has seen to date in any industry sector. Such
assessments are needed desperately in other industry sectors. NERC
should be commended for this monumental undertaking. The bad news is
that progress continues to be slow. One third of the electric utility
companies have still not completed assessment of their computers and
embedded devices--a task that should have been completed a year ago.
The hard part--fixing, testing, and implementing--is yet to come.
Nevertheless, the NERC study represents an excellent starting point
with which to monitor Year 2000 progress over the next critical months.
I assure you that this Committee will be watching closely.
__________
Prepared Statement of Vincent P. Brown
Good morning. I am Vince Brown, Assistant Executive Of ricer of the
Financial and Administrative Services Branch of the California Public
Employees' Retirement System--commonly referred to as CalPERS. I am
also the executive sponsor of CalPERS' year 2000 compliance project.
I want to thank you, Mr. Chairman, and members of this committee,
for the opportunity to report on our Y2K compliance activities.
CalPERS is a retirement and health benefits system. We administer
pension and health plans for more than 2,000 California public
employers and more than a million active and retired California public
employees and their family members.
Our current membership is comprised of 776,000 active members and
332,000 retired members. Roughly one-third of the total 1.1 million
CalPERS membership are current and retired state employees. Another
third are current and retired public agency--or local government--
employees. And the remaining third are current and retired school
employees.
CalPERS is administered by a 13-member Board of Administration. Six
board members are elected by a segment of the membership, three members
are appointed, and four are designated by statute.
We recognized the seriousness of the Y2K issue early and developed
a comprehensive compliance plan. We are now in the middle of
implementing the plan, making necessary system modifications, and
testing those modifications. Implementation of our compliance plan is
on schedule. We expect all necessary system modifications and testing
to be completed by the middle of next year.
The CalPERS Y2K program began in earnest in the fall of 1995. Our
board recognized the importance of the issue and directed staff to
develop a comprehensive mitigation plan. In particular, Robert Carlson,
Chairman of the CalPERS Board Finance Committee, has been a leading Y2K
compliance advocate on our board.
I believe a large part of our success in this area is the result of
the support and tenacious oversight of our board. The staff regularly
provides Y2K updates at board meetings. The board regularly asks tough
questions and demands that appropriate attention be given to the issue.
And just as importantly, our board has been willing to provide the
necessary resources to get the job done.
calpers year 2000 compliance overview
From the very beginning, we approached the year 2000 problem as an
enterprise-wide business concern that affects a broad range of business
operations--not just information technology or computer systems.
We've adopted a comprehensive three-prong approach to ensuring year
2000 compliance at CalPERS:
--First, we are developing and bringing online a state-of-the-art Y2K
compliant integrated corporate database system to replace many
of our older mainframe-based business information systems.
--Second, we are making Y2K compliant those mainframe and PC
applications that cannot be incorporated into the new corporate
database system prior to the year 2000.
--Third, we developed a comprehensive Y2K business enterprise program
to mitigate internal and external risks to CalPERS business
operations. That is, we want to make sure our contractors and
service providers, along with the products that we purchase,
are year 2000 compliant.
Specifically, we have Y2K compliance programs for equipment,
contracts, telecommunications, external interfaces, and commercial
software products.
Additionally, we have nine Y2K tracking programs: for banks,
environmental systems at our headquarters building in Sacramento, off-
site buildings, insurance, investments, standard forms, the State
Controllers' Office and the State Treasurer's Office--two of our major
business partners--and State Street (formerly known as State Street
Bank), the master custodian of our investments.
comet system development
We expect our new fully Y2K compliant integrated corporate database
system--which we call the COMET System (for CalPERS Online Member and
Employer Transaction System)--to replace many of our older mainframe
business applications before the year 2000 arrives. Here's a brief
overview of where various key COMET applications currently stand:
--Our new Actuarial Valuation System is online. To appreciate the
importance of this system to CalPERS, you have to understand
that CalPERS does not manage just one pension plan--we manage
approximately 1,900 pension plans. That means we have to run
actuarial valuations every year for 1,900 plans. An actuarial
valuation places a value on the assets and liabilities of a
pension plan, compares plan assets to liabilities, and
determines the amount of funding needed in future years, in the
form of employer and employee contributions, to properly fund
the plan.
--A new Health Benefits System was brought online in August. This is
the system that maintains the records of our more than 1
million health benefits members--such as personal information,
their employer, and the health plan they belong to. Since our
health benefits program is one of our major operational
responsibilities--from administration to customer service--
having a modern Y2K compliant health benefits system provides
tremendous peace of mind for us, the administrators, and for
our members, the customers.
--A new Financial System came online in June. We use the Peoplesoft
financial system that has been customized specifically for
CalPERS to handle all aspects of our internal accounting and
budgeting.
--A new Investment Accounting Reconciliation System was also brought
online in June. The system uses the Princeton Financial Systems
investment accounting reconciliation system. This system
reconciles our accounting of the $85 billion of internally
managed assets with the accounting of our master custodian,
State Street. Later this fiscal year, we plan to enhance our
new investment accounting system by building the infrastructure
to link all of our external money managers to the system.
--Later phases of the COMET project will replace our employer and
member database and transactions systems after the year 2000.
These are the two major business information systems at CalPERS
that will continue to be handled by existing mainframe-based
applications that are being modified for year 2000 compliance.
legacy mainframe systems upgrade
One of the biggest challenges of any Y2K compliance program
involves the modifying of older mainframe computer systems, often
referred to as ``legacy'' systems, to make them Y2K compliant. As
previously stated, two major CalPERS systems, our employer and member
databases, will continue to be mainframe based through the year 2000
and therefore must be properly modified to function properly.
We broke down the mainframe modification project into two
components--what we call Level 1 and Level 2.
In Level 1, we reviewed and modified applications codes and
replaced our older mainframe computer with a new unit that is year 2000
compliant.
The Level 1 coding review focused on the identification and
correction of all date references. Because we started the process
early, we were able to manually review 2.3 million lines of computer
code instead of using a less reliable automated program. We hired
consultants expert in the COBOL and Natural programming languages to
review each line of code and make the necessary changes. All Level 1
code changes have been made and tested.
In addition to the coding changes, we upgraded our mainframe
operating environment by migrating to a year 2000-compliant IBM MVS
system. The migration to the new operating system was successfully
completed this past July.
We are also employing a technique called ``windowing'' whereby
applications are programmed to treat all two-digit year codes within a
certain ``window'' of years to be a 2000 year rather than a 1900 year.
For example, an application can be programmed to recognize all two-
digit year codes from 00 to 10 as years 2000 to 2010 while year codes
11 through 99 would be treated as 1911 through 1999. This technique,
combined with manual editing of exceptions, will allow us to process
two-digit year codes in the year 2000 and beyond until all of our
business applications are replaced by the Y2K compliant COMET System.
We are now engaged in Level 2 testing. Level 2 testing involves
running the modified applications through a ``compiler'' program to
update older COBOL coding into a newer version of COBOL that can run
properly on our new operating system. Then, we run test scripts--
hypothetical transactions--on the modified, updated systems to see if
they are processing data accurately.
Once a system has been satisfactorily tested, it can be put back
into production, or normal operation. As a matter of priority, we are
starting with our mission critical systems such as the Employer,
Benefits, Contribution Reporting, and Member Services systems. All of
these mission-critical systems are currently in various phases of
testing. The Benefits System, one of our largest, was just recently
turned over for user testing.
As a result of our successful mainframe migration, beginning this
month, we began accepting four-digit year data from our users. That
means CalPERS employers can send us a payroll data tape with either a
two-digit year code (for windowing) or a four-digit year for production
use by our Employer system.
contingency planning
To further protect ourselves and our customers, we have developed a
Y2K contingency plan for the worst case scenario. Our compliance plan
calls for integration testing of our mainframe systems by June 1999.
Integration testing involves operating our various mainframe systems
and applications together, simulating normal operating conditions, to
see if all system components operate properly together.
After integration testing, every program will have been unit and
user tested, so we do not expect any unpleasant surprises. However, as
a part of our contingency planning, and to provide an added measure of
assurance, we have scheduled additional system-wide integration tests
from June through August of 1999 to double check the performance of our
mainframe systems in the year 2000 and beyond.
Clearly, our biggest Y2K concern is making sure our 332,000
retirees continue to receive their benefit payments on time. Therefore,
another contingency plan is our development of an alternative in-house
check writing and payment system, to provide us with the additional
capability to service our customers in the event that the California
State Controller's Office is unable to process our checks because their
systems are not Y2K compliant.
personal computers
At the beginning of our Y2K compliance program, we identified 162
personal computer applications that are used by our operational
divisions to conduct a variety of business functions. The applications
ranged from single user to client-server applications that are accessed
by over 600 users, such as our member correspondence tracking system
and our employer training system. To date, we have completed 45 percent
of the modifications and are on schedule to meet our target date of
December 1998 for Y2K compliance.
In addition to the applications, all of our 1,800 desktop and
laptop PCs have been checked for Y2K compliance. The PCs that failed
the Y2K test are being replaced.
business enterprise program
Taking a broader business perspective, beyond computer systems, our
Y2K business enterprise compliance project involves a comprehensive
evaluation and mitigation of year 2000 impacts on business functions
enterprise wide. A major emphasis of the business enterprise project
focused on identifying equipment and control systems with embedded
computer chips that might not be Y2K compliant.
The CalPERS Y2K business enterprise team has completed the initial
phases of awareness, inventory, risk assessment, and solution design
and planning. We identified Y2K risks ranging from telephones, fax
machines, and building security systems to our ability to issue benefit
payments to our members. All of the individual risks were consolidated
into 14 basic categories of ``at risk'' assets or business
relationships. Mitigation plans were developed for the 14 risk
categories. The remaining phases of implementation, testing, and
monitoring will be conducted according to the mitigation plans.
Our business enterprise risk mitigation plan is divided into two
procedures--a compliance program and a tracking program. Compliance
programs entail a more detailed set of risk mitigation procedures that
can be controlled by CalPERS. Tracking programs entail risk mitigation
procedures that seek to verify entities outside of CalPERS, but with
whom CalPERS has a business relationship, are taking adequate steps to
be year 2000 compliant.
The CalPERS Office of Audit Services is conducting two compliance
programs (external interfaces and equipment) and all nine tracking
programs. CalPERS Y2K business enterprise staff is conducting the
remaining three compliance programs (contracts, telecommunications, and
commercial software).
The CalPERS Y2K business enterprise project is currently on
schedule with a target completion date of April 1, 1999. After that
date, monitoring and ongoing program maintenance efforts will be
initiated.
investment operations and management
Of paramount concern to this committee, and our members and
employers, is how CalPERS is addressing Y2K issues relative to our
investment portfolio. The following information was supplied to me by
our investment staff.
Our investments are diversified through an asset allocation process
and strategy determined by our Board of Administration. Our asset
allocation is the starting point and most important factor in achieving
sound investment returns with minimal risk.
We invest in stocks, bonds, real estate, and private equity
investments, domestically and internationally. The vast majority of our
$140 billion portfolio is invested in public equity and fixed income
markets. As of the end of July, CalPERS had more than $92 billion
invested in U.S. and international equities and more than $37 billion
invested in domestic and international fixed income instruments. The
remaining $12 billion was in private equity, real estate, and cash.
On a percentage basis, approximately 68 percent of our assets are
invested in equities, 28 percent in fixed income, and 4 percent in real
estate. Approximately 22 percent of our total holdings are invested in
international markets.
The management of our assets is consistent with our investment
strategy of being a long-term investor. Approximately 80 percent of our
domestic stock holdings are internally and passively managed in an
indexed portfolio that replicates the broader equity market. The
remaining 20 percent of our domestic equity investments are actively
managed by external money managers, with the goal of adding value to
the fund. All of our domestic fixed income investments are managed
internally by CalPERS staff.
The CalPERS Investment Office is a full participant in the CalPERS
year 2000 compliance program and has taken a number of steps to ensure
compliance. All PC hardware and software applications are either
already year 2000 compliant or are in the process of being made year
2000 compliant by December 1998.
All new contracts and amendments to existing contracts with our
investment advisors, consultants, money managers, and ancillary service
providers contain Y2K compliance language requiring the vendors to
certify year 2000 compliance.
As you know, the Securities and Exchange Commission is requiring
all publicly traded companies to disclose their progress on Y2K
compliance. The marketplace, including CalPERS, can then objectively
evaluate the Y2K progress of the individual companies.
We are shareholders in more than 1,600 American companies and over
750 foreign companies. Therefore our investment staff is considering
additional steps to help us protect the value of our investments. We
are currently researching ways of surveying the more than 2,350 public
companies in our investment portfolio on their Y2K compliance progress.
The survey information will allow us to independently evaluate
companies and develop strategies to protect our investments. Our
investment staff is developing a survey proposal to present to our
Investment Committee in October.
conclusion
In conclusion, we recognized the seriousness of the Y2K issue
early. As such, we developed a comprehensive compliance program to
address all aspects of our business operations. Implementation of our
Y2K compliance project is on schedule for completion in advance of the
deadline.
Our highest priority at CalPERS is to ensure that our customers are
secure in knowing that their retirement funds are safe and that they
will continue to receive the same high level of service they have
always received from CalPERS.
______
Responses Vincent P. Brown to Questions Submitted by
Chairman Bennett
Question 1. You mention in your testimony that CalPERS is
researching ways of surveying its portfolio companies for Year 2000
compliance. When do you expect to begin that survey? (Note TIAA-CREF
has already completed theirs so CalPERS in behind the curve.)
Answer. We have decided to break our survey of portfolio companies
into two parts: companies regulated by the Securities and Exchange
Commission and those not regulated. As you know, the SEC has come up
with Y2K disclosure requirements that are quite extensive. Because
these disclosures are required, we are comfortable that CalPERS can
rely on them in the same way we rely on other SEC information from 10K
and 10Q reports of fundamental financial information. Any survey we
conduct would not be any more extensive than the SEC disclosure
requirements and would likely receive a far lower response rate.
Because we would not have any enforcement mechanism for response, or
even for intentionally misleading information, a survey by CalPERS
would almost certainly be less useful than the SEC data. Thus, unless
our intent is to try to uncover proprietary information regarding Y2K
compliance on a handful of companies and act on that information in our
portfolios, encouraging full public disclosure through the SEC
requirements and letting the markets decipher the results is our best
alternative. However, we will write individual letters to all of our
domestic holdings, more than 1650 companies, strongly encouraging them
to fully disclose all pertinent Y2K information to the SEC. As for
CalPERS being ``behind the curve,'' we suggest you talk to TIAA-CREF.
They will tell you that the response rate for their survey was very
low, and that the answers they received were not very helpful. They
attribute this in large part to the fact that it was sent too early,
before the Y2K focus intensified. We plan to send out the CalPERS
communication before the end of 1998.
The second prong of our approach is to survey those companies that
are not bound by SEC disclosure rules. These are the approximately 700
companies held in our portfolios around the world that are traded on
foreign securities exchanges. Since the local reporting requirements on
Y2K issues are very likely to be inferior to the requirements set by
the SEC, we believe a CalPERS survey may be able to gather useful
information, encourage voluntary disclosure, and perhaps prompt some
companies into action on addressing their Y2K issues. Our plan is to
mail a short questionnaire with 4 to 5 ``bottom line'' compliance,
cost, and potential impact questions, which we hope will encourage a
higher response rate. We plan to post the survey results on our
Corporate Governance Web site and will indicate this in our
correspondence with the companies. We plan to send out this survey by
the end of 1998 and begin posting results in February 1999.
Question 2. In your testimony, you indicated that necessary
resources to get the job done have been provided. How much have you
spent to date and how much is budgeted to complete the project? How
able are you to absorb or respond to an increase in cost if projections
turn out to be low, as so often has been the case with Y2K efforts?
Answer. Our budgeted amount for the Y2K effort in fiscal year 1997-
98 was $7.1 million. For the current 1998-99 fiscal year, the budgeted
amount is $8.9 million. The total amount budgeted for the Y2K effort to
date is $16 million. Approximately $8 million has been spent to date.
The Y2K budget is monitored closely so we can tell if we are spending
more than the budgeted amount. The Y2K Project is the top priority at
CalPERS, and funds will be redirected to cover any shortages incurred
by the project.
Question 3. Have you completed an inventory of all of your
interfaces both internal and external? Have they all been prioritized?
How do you plan on coordinated testing with them and what is the
schedule for it?
Answer. Our inventory of critical external interfaces was completed
in January 1998. In the prioritization methodology, most external
interfaces were rated high risk, so all external interfaces are being
addressed. These external interfaces have since been validated by users
in affected business units. During validation, the nature of the
interface was clarified, determinations were made concerning the date
sensitivity of the data exchanged, and testing procedures were
discussed. Most of the date-sensitive data that's been exchanged is
processed by systems maintained and operated by CalPERS' Information
Technology Services Division (ITSD); consequently, ITSD has initiated
communication with major CalPERS business partners, primarily the State
Controller's Office, to identify exchanged data, confirm date formats,
and schedule testing. This communication has been formalized in a
memorandum of understanding (MOU), and various interagency agreements
(IA's), specifying services to be provided.
CalPERS' Actuarial and Employer Services Division (AESD) has
established procedures to receive and process Y2K-compliant payment
contributions data from participating employers in conjunction with
ITSD. The procedures are based on ``windowing,'' a technique that
recognizes the applicable century designation based on the value of the
two-digit year field. Optionally, employers can submit contribution
data tapes in a four-digit compliant format, provided they notify
CalPERS of their intent, so that testing can be scheduled. These
procedures, together with a Year 2000 compliant record layout, were
sent to all contracting public agencies on May 18, 1998.
CalPERS exchanges data with various health plan carriers. We are
pleased to report that data exchanged with these carriers have already
been determined Y2K compliant.
CalPERS prepares income tax information (Form 1099) for benefits
received by retirees, including retired judges and legislators, and
reports it to the IRS. Tax data is reported to the IRS on magnetic
tape, prepared to IRS specifications. The IRS specifications were
recently modified to add more data storage capacity to the record,
including expansion of date fields for Year 2000 compliance.
Question 4. You noted that you have developed a Y2K contingency
plan for the worst case scenario? In your scenario development, what
did you determine to be the most likely contingency? Have you developed
a contingency plan for it?
Answer. The worst case scenario, from a CalPERS business enterprise
perspective, would be if our external business partners could not
provide critical services relative to payments to retirees, delivery of
health care services, and execution of timely and accurate investment
transactions. CalPERS management has determined the most likely
contingency to involve a breakdown in one of the core functions, and is
planning accordingly. CalPERS has been actively communicating with its
business partners to assure optimal availability of these critical
services. However, CalPERS is researching the possibility of processing
payments in-house, which will provide a greater level of confidence
that our retirees and health care carriers will be paid on time.
Regarding timely and accurate execution of investment transactions,
CalPERS funnels its investment transactions through its master
custodian, State Street Bank. SSB is engaged in extensive Year 2000
readiness activities, and will likely weather any problems posed by the
century change. However, in the event that the services of SSB become
unavailable, CalPERS can conduct its investment activities directly
with the brokerage houses. Moreover, CalPERS is currently working with
SSB to provide back-up investment transaction capability through State
Street's Alameda, California, facility.
CalPERS is also in the process of developing additional payment
processing contingency plans. Please see our response to question 8.
Question 5. You identified providing on time benefit payments,
which hinges on the California State Controller's Office check
processing, as your biggest Y2K concern. What level of risk is
associated with the California State Controller's Office ability to
process checks?--what's their status? Is your contingency of an in-
house check writing and payment system feasible? How long can you
maintain it?
Answer. The concern with State Controller's Office on the Y2K issue
is with their external entities. We are able to test our interface and
data exchange with the SCO but must rely on their assurances that they
have conducted a thorough test on the data stream process for our data.
In a recent audit by the State Bureau of State Audits, SCO refused to
cooperate. Recently, communications have improved and we are hopeful
that the SCO will certify Y2K compliance. However, we are continuing
with our efforts to develop in-house capability to produce retiree
benefit payments. We are looking at a permanent capability to process,
print, and mail benefit payments. The project is currently at the
feasibility study stage.
Question 6. For your legacy mainframe modification project, you
discussed two ``levels'' of components to the modification project. I
did not hear anything about end-to-end testing, could you explain how
you plan on conducting them?
Answer. As stated, there are two ``levels'' to the modification
process. In Level I, a date window technique was added to all programs
that had logic looking at a two-digit year. Once the modifications were
done, the programs were recompiled and a baseline and regression unit
test was performed. The purpose for this test is to ensure that the new
output is identical to the old code before the modifications. Level II
is really broken down into two parts. Part 1; legacy COBOL programs are
processed through a software package called ``MHTRANS''. MHTRANS
prepares the code for the MVS COBOL compiler that is Y2K compliant.
Another baseline and regression test is performed to ensure the MHTRANS
process did not alter functionality.
Part 2 of Level II is the compliancy testing of the legacy systems.
As part of this testing, users will run various date scenarios through
the systems to ensure it will perform in the Year 2000 and beyond. Once
the testing is completed for all the legacy systems, integration
testing will be performed. Integration testing at this point should go
very smoothly since we have already performed a mini integration test
of the individual systems. This would be our full-blown end-to-end
testing.
Question 7. In Level 1 of your mainframe modification project you
indicate that the focus is on the identification and correction of all
date references. Have you also looked at faulty date logic that is
associated with Y2K: ability to identify Y2K as a Leap Year and the use
of date fields for other purposes (extended symantics)?
Answer. Data Dimensions Incorporated (DDI), a consultant firm, was
brought in by CalPERS to review and make the necessary modifications to
any logic that references two-digit date fields. Every line of code was
manually reviewed by DDI for date hits. Any faulty date logic was fixed
or brought to the attention of the analyst of that system for
resolution. In many programs, a date routine is used to convert date
fields to Julian dates or to identify Leap Year. The testing for Leap
Year is included in Level II compliancy testing.
Question 8. You indicated that you have a business enterprise risk
management plan consisting of a compliance program and a tracking
program. Do you have and could you describe your business enterprise
continuity and contingency plan?
Answer. CalPERS' business continuity planning targets CalPERS
mission critical functions. The three core functions that CalPERS has
determined to be mission critical are as follows: (1) processing
benefit payments to retirees, (2) assuring the availability of health
benefits for our members, and (3) maintaining investment transaction
and accounting capabilities.
We have developed a plan that identifies the various objectives
that must be met by each division that provides support to these core
functions. Emergency response teams have been formed, and each CalPERS
division maintains an action plan that supports the continuity of
CalPERS business operations in the event there is a disruption in our
business environment. We have an emergency site plan, an executive
action plan, and an enterprise-wide plan for coordinating the entire
process.
Contingency planning is in progress, and Year 2000 threats
identified from the risk assessment phase must be related to the core
functions to determine various Year 2000 scenarios that CalPERS may
face. These scenarios will be worked into tabletop response exercises
and tested. Trigger dates will be firmly established.
Question 9. Are you relying on the SEC required Y2K disclosures to
assess your risk with individual companies? What is your level of
confidence in these disclosures?
Answer. Yes, we intend to rely on SEC disclosures to assess the Y2K
exposure of the companies we are invested in, which is discussed in
greater detail in our response to question 1. Our confidence in the
accuracy of these disclosures is high. Just as fundamental financial
information gathered by the SEC is the foundation upon which most
investment decisions are made, we feel confident that the quality of
the information received by the SEC will be higher than could be
obtained through any other practical means. The issues of how to
analyze and interpret the SEC information and what to do about
companies which fail to meet the SEC reporting requirements are much
more problematic than the quality of the information received.
__________
Prepared Statement of Senator Susan M. Collins
Let me first thank you Mr. Chairman for holding today's hearing on
this important topic. My position as Commissioner of the Maine
Department of Professional and Financial Regulation taught me a lot
about the securities industry, but mainly on who the bad actors were
and what they did wrong. Unfortunately, it did not prepare me to
prognosticate potential Y2K disruptions to our economy and their effect
on our financial markets.
What I have always instructed investors to do is to first utilize
the wealth of available information to investigate their investments.
My second suggestion has been to set reasonable goals for these
investments.
But how can anyone follow my advice when it comes to investing in a
Y2K climate? We have wide disparities in the estimates of what impact
Y2K will have on our global, financial markets. While some are
expecting a mild interruption in basic services, others believe that
there is a 70 percent chance of a recession similar to what we
experienced in the early 1970's. Our own Y2K committee staff has had a
difficult time assessing the readiness of key sectors of our economy.
The truth is, Y2K is without historical precedence, and we are left in
the dark about what may happen. This is far from an optimal environment
in which to invest.
The subject of our hearing today, pensions and mutual funds, is of
critical importance because of what they represent to their owners--
their life-savings. We often hear of the long-term fiscal troubles of
the Social Security system and the increasing need, especially for
young people, to rely on individual investments, pensions, and mutual
funds for retirement income. Many are counting on these investments to
grow and expand. Yet, what happens to these investment vehicles if
something as innocuous as two digits in a computer code causes
disruptions in the stock market.
I look forward to examining what pension and mutual fund managers
are doing to prepare for potential economic fallout from Y2K and how we
can assist investors in ensuring that they don't see their hard-earned
savings drop like the big ball in Times Square when the clock strikes
midnight December 31, 1999.
__________
Prepared Statement of Christopher J. Dodd
Thank you Mr. Chairman for holding this hearing. I am pleased that
this committee continues its active review and oversight of year 2000
readiness in important industry sectors and government agencies. With
each passing week and each passing hearing, I have learned more and
more about the enormity and complexity of this issue, while at the same
time realizing that we have less and less time to correct the problems.
There are 470 days to be exact. We have 470 days to insure that planes
fly, electricity flows, oil is delivered, medical devices function,
financial transactions are executed, and investments are safeguarded.
In short, this is a very tall order and I hope that Senator Bennett and
I can be heard and that we can communicate to other Members, to
industry, to the Administration, to the people and to the press that we
have quite a challenge ahead of us.
There are moments that I am encouraged. Such a moment occurred
yesterday when a bipartisan group of senators came together to announce
a bill which will be marked up today in the Judiciary Committee. This
bill will encourage companies to disclose and share vital year 2000
information by limiting their liability for such disclosures. This bill
represents the considerable efforts and cooperation of the House, the
Senate, the Administration and industry to quickly act on legislation
that is important to our country and our people. This cooperative
effort is an example of the best that we can be.
Today we come together to examine the securities industry with
particular focus on pensions and mutual funds. To understand the
importance of both we should remind ourselves that for most Americans
the foundations of their economic security can be found in their home
and their pension fund and increasingly they rely on investments in
mutual funds for long term investments. Over the past decade, Americans
have invested significant amounts of money in the stock market via
pension funds and mutual funds. Indeed one of the great financial
success stories of this decade is the very widespread access to the
stock market by individuals from all walks of life.
Yet, individuals with money invested through pension funds or
mutual funds have less control over these investments, * * * Relying on
fund managers to invest the pooled funds. Fund managers are fiduciaries
under the law and are legally obligated to safeguard assets for the
benefit of investors. But what are pension fund and mutual fund
managers doing to insure that their operating systems are prepared for
year 2000, and more importantly what steps are they taking to assess
the year 2000 compliance of companies in which they invest? Many fund
managers invest by ratio in a variety of industry sectors. For example,
they may have their fund equally divided among utilities,
telecommunications, and financial services just to name a few. Yet if
specific sectors have been identified as having potential year 2000
problems, will these sort of industries represent a sound investment?
These are very important issues and I hope that each of our
panelists will give the committee their views.
__________
Prepared Statement of Matthew P. Fink
i. introduction
Good morning. My name is Matthew P. Fink. I am President of the
Investment Company Institute, the national association of the American
investment company industry. The Institute's membership includes 7,288
open-end investment companies (mutual funds), 450 closed-end investment
companies and 9 sponsors of unit investment trusts. Its mutual fund
members have assets of about $5.092 trillion, accounting for
approximately 95 percent of total industry assets, and have over 62
million individual shareholders.
I appreciate the opportunity to testify on the mutual fund
industry's preparations for the Year 2000, also known as ``Y2K.'' As
members of the Committee are aware, there is concern that computer
systems that are programmed to read only two-digit dates will assume
that 01/01/00 is January 1, 1900, rather than January 1, 2000. Unless
this problem is corrected, it could have widespread adverse
consequences.
The mutual fund industry takes this issue very seriously. The
industry's continued success is predicated on maintaining the
confidence of investors. Thus, it is critically important that we
strive for the smoothest possible transition to the 21st century.
Today I will begin by briefly describing the structure and
operations of mutual funds. I will then outline the steps funds are
taking to prepare for Y2K, including undertaking internal Y2K
compliance efforts, working with their major service providers and
participating in industry-wide testing, communicating with regulators,
and communicating with shareholders. I will also discuss oversight of
mutual funds' Y2K compliance efforts by regulators and others. Finally,
I will cover Y2K issues related to portfolio companies in which mutual
funds invest.
No one can guarantee that there will be no problems when the Year
2000 arrives--in fact, some temporary glitches are probably inevitable.
When considering this issue in the context of the mutual fund industry,
however, it is important to bear in mind three points.
First, mutual funds are subject to a stringent and unique
regulatory regime under the Investment Company Act of 1940. For
example, funds are required to price their shares on a daily basis and
to offer shareholders the ability to redeem fund shares on a daily
basis. Thus, in addition to the business incentives to devote
substantial efforts and resources to resolving Y2K issues, which mutual
funds share with other companies, funds also must undertake these
efforts in order to ensure that they comply with regulatory
requirements.
Second, the industry is highly automated and thus relies heavily on
the use of computer systems. While this reinforces the need for the
industry to take the Y2K issue seriously, it also serves to demonstrate
that problems involving modifications of large-scale computer
operations are not unusual for our industry. For example, changes to
these systems are made on a regular basis in order to comply with new
regulatory requirements \1\ and to offer new or enhanced services to
investors.
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\1\ For example, in 1993, the Securities and Exchange Commission
adopted rule amendments that shortened the standard settlement cycle
for most securities transactions from five business days to three
business days. See SEC Release No. 33-7022; 34-33023; IC-19768 (October
6, 1993). This change required extensive modifications to computer
systems throughout the securities industry, including the fund
industry.
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Thus, in general, the mutual fund industry (including its major
service providers) is accustomed to modifying, re-building or re-
engineering computer systems as part of day-to-day business operations.
The Y2K problem differs from other instances of systems overhaul
because it permeates all systems, and the need to coordinate the
efforts of numerous parties presents substantial challenges.
Nevertheless, based on their experience in dealing with computer
systems modifications on a regular basis, mutual fund industry
participants are relatively well-conditioned to address Y2K issues.
A third important point is that mutual fund assets are well-
protected and can be expected to remain so as of January 1, 2000 and
beyond.\2\ To the extent that the industry experiences any Y2K-related
problems, the consequences to fund shareholders of such problems most
likely would be in the nature of delayed statements or other temporary
administrative glitches. It would be most unfortunate if investors and
savers, including mutual fund shareholders, became fearful that their
money could disappear as a result of Y2K. As the millennium approaches,
it may be appropriate at some point for Congress and regulators to
convey a message of reassurance to all investors and savers so as to
avoid any unnecessary panic.
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\2\ For example, as discussed below, the Investment Company Act of
1940 requires that a qualified custodian (usually a bank) hold custody
of mutual fund assets. The arrival of Y2K will have no impact on this
and other protections afforded to shareholders under the Investment
Company Act and related rules.
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ii. the structure and operations of mutual funds
A. The mutual fund
A mutual fund is an investment company that pools the money of many
investors and invests it in a wide variety of stocks, bonds, or money
market instruments. An investor in a mutual fund buys shares of the
fund. Most mutual funds continuously offer new shares. Each share
represents a proportionate interest in the securities held in the
fund's portfolio. Mutual fund shares are redeemable, which means that
an investor has the right to sell his or her shares back to the fund at
any time at their current net asset value.
Mutual funds are organized under state laws as corporations or
business trusts and are governed by a board of directors (or
trustees).\3\ The directors of a mutual fund have oversight
responsibility for the management of the fund's business affairs. They
must exercise the care that a reasonably prudent person would take with
his or her own business. They are expected to exercise sound business
judgment, establish procedures and undertake oversight and review of
the performance of the investment adviser, principal underwriter and
others that perform services for the fund.
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\3\ The Investment Company Act of 1940 requires that at least 40
percent of a fund's board of directors be independent of the fund's
investment adviser or principal underwriter. Where the principal
underwriter is affiliated with the investment adviser, which is
typically the case, a majority of the directors must be independent. In
fact, virtually all fund boards have a majority of independent
directors. Independent fund directors serve as watchdogs for
shareholder interests and protect them against potential conflicts of
interest.
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B. The mutual fund organization
Most mutual funds are externally managed by a separate entity.
Thus, they do not have employees of their own and all of their
operations are conducted by third parties that include affiliated
companies and independent contractors. Mutual funds' primary service
providers include: the investment adviser, the principal underwriter,
the transfer agent and the custodian.
In most cases, the fund's investment adviser and its principal
underwriter are part of the same overall organization as the fund or
funds they serve.\4\ The transfer agent to a mutual fund may be either
an ``internal'' transfer agent that is part of the mutual fund
organization, or an ``external'' transfer agent that provides
substantially all transaction processing and shareholder services to
unaffiliated mutual fund clients.\5\ The fund's custodian is usually an
unaffiliated bank.
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\4\ In some cases, funds employ unrelated investment advisers, sub-
advisers or principal underwriters.
\5\ In some cases, a mutual fund employs an external transfer agent
but the mutual fund organization itself performs limited shareholder
servicing functions such as telephone communication, written
correspondence, or account research. In addition, internal transfer
agents include both the ``remote'' transfer agent that contracts with
an outside service company for use of its data processing system, and
the ``captive,'' or fully internal, organization that utilizes its own
computer resources and shareholder accounting system.
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Other important mutual fund service providers include various
intermediaries that sell fund shares, institutional broker-dealers
through which investment advisers purchase and sell fund portfolio
securities and pricing services.
A diagram depicting a typical mutual fund organization, including
the fund's key service providers, is attached as Exhibit A.
C. Mutual funds' principal service providers
The functions performed by the principal service providers to
mutual funds are outlined below. Each of these entities performs
services pursuant to a contract with the fund. All of the entities
listed are subject to federal regulation either by the SEC or by bank
regulators.
1. Investment adviser
An investment adviser to a mutual fund is responsible for selecting
portfolio investments consistent with the fund's investment objectives
and policies, as described in its prospectus.
2. Principal underwriter
As noted above, most mutual funds continuously offer new shares.
Fund shares are offered to the public at a price based on the current
value of fund assets (plus a sales charge, if applicable). Mutual funds
usually distribute their shares through a principal underwriter. The
principal underwriter arranges for the sale of fund shares to the
public. Fund shares are sold to investors primarily in two ways. In
some cases, investors purchase fund shares directly from the fund or
its principal underwriter. In other cases, fund shares are distributed
through a sales force, which may be employees of the fund's principal
underwriter or of independent firms (as discussed further under
``Independent Sales Force,'' below).
3. Transfer agent
Fund transfer agents maintain records of shareholder accounts,
which reflect daily investor purchases, redemptions, and account
balances. Transfer agents typically serve as dividend disbursing
agents, and their duties as such involve calculating dividends,
authorizing payment by the custodian, and maintaining dividend payment
records. They also prepare and mail to shareholders periodic account
statements, federal income tax information, and other shareholder
notices. In many cases, transfer agents also prepare and mail
statements confirming transactions and reflecting share balances. In
addition, transfer agents maintain customer service departments that
respond to telephone and mail inquiries concerning the status of
shareholder transactions and accounts.
4. Custodian
The Investment Company Act of 1940 requires mutual funds to keep
their portfolio securities in the custody of a qualified bank or
otherwise protect them pursuant to SEC rules. Nearly all mutual funds
use bank custodians. The custodian's primary responsibilities are
safekeeping of the fund's portfolio securities and cash, clearing and
settling transactions, collecting and distributing income, and
reporting and processing corporate actions.
The selection of custodians for foreign securities is governed by
special requirements designed to ensure that fund assets held by those
custodians are adequately protected.\6\ Mutual funds typically rely to
a significant extent on the expertise of their U.S. custodians in
selecting foreign subcustodians.\7\
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\6\ See Rule 17f-5 under the Investment Company Act of 1940.
\7\ We understand that the major U.S. custodian banks are
performing due diligence with respect to the Y2K status of foreign
subcustodians within their global network. The U.S. custodian keeps its
mutual fund clients apprised of these efforts.
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D. Other important service providers
The service providers described below typically contract with the
principal underwriter (in the case of an independent sales force) or
the adviser (institutional broker-dealers and pricing services), rather
than directly with the fund.
1. Independent sales force
As mentioned above, some mutual funds distribute their shares
through an independent sales force. Such a sales force may include
employees of broker-dealer firms, financial planners, bank
representatives and insurance agents.
2. Institutional broker-dealers
The investment adviser purchases and sells securities for the
fund's portfolio through institutional broker-dealers.
3. Pricing services
In order to price their shares daily, as required by the Investment
Company Act, mutual funds must determine the value of their portfolio
holdings each day.\8\ Many funds use independent, third-party pricing
services to assist in this process. Pricing services often collect and
transmit market prices of portfolio securities to funds and also
provide prices for those portfolio securities for which market
quotations are not available.
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\8\ See Rule 2a-4 under the Investment Company Act of 1940, which
provides that a mutual fund must calculate its net asset value by
valuing securities for which market quotations are readily available at
their market value and other securities and assets at their fair value
as determined in good faith by the fund's board of directors.
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iii. mutual fund industry preparations for the year 2000
Specific steps that mutual fund firms are taking to prepare for Y2K
are described below. The information provided below is based on, among
other things, a recent Institute survey of the status of members' Y2K
compliance efforts (``1998 survey''),\9\ discussions with members at
Institute committee and other meetings, and informal conversations with
members.
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\9\ A copy of the survey is attached as Exhibit B. The Institute
distributed the survey to members in March 1998. To date, we have
received responses from 82 firms, representing 67 percent of industry
assets. Many firms' Y2K compliance efforts have further progressed
since they responded to the survey. The Institute expects to conduct
another survey in April 1999.
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A. Internal Y2K compliance efforts
All available indications are that Y2K compliance is a very high
priority matter for mutual fund companies and it is receiving attention
at senior management levels. Many firms have dedicated staffs working
on Y2K compliance, have established separate budgets for Y2K
compliance, and provide periodic reports to their mutual funds' boards
of directors concerning the progress of Y2K compliance efforts.
The Institute's 1998 survey indicates, among other things, that 89
percent of the firms responding had planned to complete a risk
assessment for Y2K issues by July 1998. Over 96 percent had expected to
have performed an inventory of software applications by that time, and
95 percent of firms had planned to have established a comprehensive
methodology to become Y2K compliant as of July 1998. According to our
survey, over 75 percent of the firms completing the survey plan to be
Y2K compliant by December 1998.\10\
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\10\ We note that Morningstar recently conducted an informal survey
of several mutual fund firms' Y2K compliance efforts. Based on the 15
responses received, Morningstar concluded that ``[m]utual fund
companies appear to be hard at work readying their computer systems for
problems associated with the Year 2000 * * * .'' Valerie Putchaven,
``Squashing the Y2K Bug,'' at http://www.morningstar.net/news/Ms/
BehindTheScenes/Year2000/intro.msnhtm.
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B. Working with major service providers
As discussed above, mutual funds themselves are pools of assets
whose operations rely on various service providers. The fund itself
typically does not have its own computer systems. Rather, the system
that runs mutual fund operations is usually that of the fund's sponsor
(which may be its investment adviser or another organization). This
system, in turn, typically is linked to those of the custodian,
transfer agent, broker-dealers, pricing services and other service
providers.
Consequently, mutual fund firms have been assessing their
interdependencies with these various parties with whom the funds (or
their investment advisers or principal underwriters) exchange critical
data. Fund groups routinely request information and assurances from
such parties regarding their Year 2000 compliance status.\11\
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\11\ The Institute and ICI Mutual Insurance Company will be co-
sponsoring a conference on Y2K issues for mutual funds in October. A
copy of the preliminary conference program is attached as Exhibit C.
Among those who have agreed to speak are representatives of several of
the major independent suppliers of mutual fund transfer agency and
custody services. This forum will provide additional opportunities for
mutual fund firms and these third party service providers to exchange
information and coordinate compliance efforts.
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Mutual fund firms are conducting private testing of their
interfaces with major service providers. In addition, for over a year,
the Securities Industry Association and the National Securities
Clearing Corporation have been coordinating plans for ``street-wide''
Y2K testing designed to ensure that securities transactions clear and
settle among all parties after January 1, 2000. The overall effort
encompasses nine ``product settlement groups;'' mutual fund investor
transactions (i.e., transactions in mutual fund shares) constitute one
of the groups. Several Institute members, as well as the Institute,
participated in the development of the Mutual Fund Test Plan. The plan
was issued on April 1, 1998 and called for initial tests to be
conducted in July and October 1998. The overall results of the July
test were very positive. The few, minor problems that did arise were
not related to Y2K issues but rather involved issues associated with
using newly-established test environments and coordinating test
scripts. They were quickly resolved. Comprehensive street-wide testing
is scheduled to take place in March 1999.
Most of the major users of central clearing facilities for
transactions in mutual fund shares have participated or will
participate in these initial tests. Virtually all of such users will be
participating in the March 1999 testing.
Institute members also are monitoring the Y2K compliance progress
of intermediaries that sell the members' funds (where applicable),
institutional broker-dealers through which fund portfolio securities
(as opposed to shares of the fund) are purchased and sold, and pricing
services that supply price information for fund portfolio securities.
C. Communicating with regulators
An important part of the industry's Y2K compliance efforts is
keeping regulators informed about the status of these efforts. Some
avenues through which this information has been or will be communicated
are described below.
1. Institute surveys
In April 1997, at the request of the SEC staff, the Institute
surveyed its members regarding their Y2K compliance plans. The
Institute forwarded the survey results to the SEC for use in responding
to a Congressional request for information about the Y2K readiness of
the securities industry. As noted above, the Institute surveyed its
members again this year and provided the results to the SEC for use in
its June 1998 report to Congress. The Institute has regular contacts
with SEC staff members that provide opportunities to discuss Y2K and
other issues.
2. SEC reporting requirements
The SEC recently adopted rules requiring certain registered
transfer agents and broker-dealers to file Year 2000 readiness reports
with the SEC.\12\ Under the transfer agent rule, all covered transfer
agents must complete Part I of Form TA-Y2K, which is a check-the-box
style report on the status of the transfer agent's Y2K remediation
efforts. Non-bank transfer agents must also complete Part II of the
form, which requires a narrative discussion of efforts to address Y2K
problems. Similarly, the broker-dealer rule requires all covered
broker-dealers to complete a check-the-box style questionnaire, and
larger broker-dealers must also provide a narrative discussion of their
efforts to prepare for the Year 2000. Each rule required an initial
report to be filed with the SEC by August 31, 1998; a second report is
due by April 30, 1999.
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\12\ SEC Release No. 34-40163 (July 2, 1998) (transfer agent
requirements); SEC Release No. 34-40162 (July 2, 1998) (broker-dealer
requirements).
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The SEC also has proposed, and is likely to adopt, Y2K reporting
requirements for registered investment advisers.\13\ As proposed, Part
II of Form ADV-Y2K would require information about the Y2K compliance
status of any mutual funds advised by an adviser completing the form.
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\13\ SEC Release No. IA-1728 (June 30, 1998).
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The information provided in these various reports should help give
the SEC a clearer picture of the mutual fund industry's Y2K compliance
status and identify organizations that may need to accelerate their
progress in order to meet the challenges of the new millennium.
D. Communicating with shareholders
As mentioned above, the confidence of investors is critical to the
mutual fund industry's success. Many mutual fund organizations are
taking steps to keep investors informed about Y2K issues in an effort
to preserve their confidence. Institute members are communicating with
their shareholders about Y2K issues through several means.
First, in accordance with SEC guidance regarding the disclosure
obligations of investment companies and investment advisers with
respect to the Year 2000,\14\ mutual fund prospectuses typically
contain disclosure that alerts investors to possible Y2K issues,
briefly describes the steps that are being taken to address them, and
notes that the fund is unable to guarantee that no Y2K problems will
arise.
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\14\ See Statement of the Commission Regarding Disclosure of Year
2000 Issues and Consequences by Public Companies, Investment Advisers,
Investment Companies, and Municipal Securities Issuers, SEC Release No.
33-7558; IA-1738; IC-23366; International Series Release No. 1149 (July
29, 1998).
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Second, many mutual fund organizations have posted information
about Y2K issues on their websites. Third, mutual fund organizations
have used newsletters, statement inserts or other publications to keep
shareholders informed about Y2K issues.\15\ Fourth, many fund groups
have telephone representatives who respond to investor inquiries about
the organization's Y2K compliance status.
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\15\ Examples of information on Y2K issues that some fund groups
have sent to investors or made available on their websites are attached
as Exhibit D.
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Mutual fund firms thus are making efforts on several fronts to keep
shareholders informed and to assure them that all reasonable steps are
being taken to address Y2K issues. Well-informed shareholders are less
likely to panic or take irrational action such as redeeming their
mutual fund shares when the Year 2000 draws nearer.
E. Oversight of mutual fund industry Y2K efforts
Mutual fund firms have every incentive to address Y2K issues in a
thorough and responsible fashion. Their efforts--quite appropriately--
are being subjected to scrutiny by a variety of interested parties.
For example, as part of their general oversight responsibilities,
mutual fund boards of directors routinely are requesting (and
receiving) periodic reports from fund advisers or other responsible
parties concerning the status of Y2K compliance efforts. Fund
shareholders likewise are requesting assurances that appropriate steps
are being taken to address any potential Y2K problems.
In addition, the SEC has focused on Y2K compliance in recent
inspections of mutual funds, investment advisers and transfer agents
and, as discussed above, is requiring certain of these entities to file
Y2K readiness reports. Also, earlier this year, the National
Association of Securities Dealers, Inc. required its members (which
include almost all mutual fund principal underwriters) to complete a
questionnaire concerning their Y2K compliance status.\16\
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\16\ See Special NASD Notice to Members 97-96 (December 1997).
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Moreover, ICI Mutual Insurance Company, the captive insurance
company that provides fidelity bond and directors and officers'/errors
and omissions liability insurance coverage to participants in the
mutual fund industry,\17\ is requesting detailed information from
policy holders about Y2K remediation efforts in connection with its
ongoing insurance underwriting process.\18\ Thus, yet another body is
focusing on the efforts that fund organizations are engaging in to
become Y2K compliant. As a result, fund organizations have an
additional incentive to keep their Y2K efforts on track--it may help
them avoid the possibility of exclusions, higher premiums or other
consequences based on Y2K risks when renewing their insurance coverage.
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\17\ ICI Mutual's member insureds include over 3,800 investment
companies with assets of approximately $3.3 trillion, representing over
60 percent of the industry's total assets.
\18\ A copy of the Y2K questionnaire that ICI Mutual is requiring
its insureds to complete as part of this process is attached as Exhibit
E.
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Similarly, Comdisco, a major supplier of disaster recovery services
for the mutual fund industry, recently issued guidelines for customers
wishing to participate in its ``Ready Y2K Program.'' Only those firms
meeting the guidelines will be eligible for certain disaster recovery
services in the event of a Y2K related failure.
iv. portfolio companies
Just like mutual funds and their various service providers, many of
the issuers of securities in which mutual funds invest rely on
computers in carrying out their businesses and could experience
problems if those computer systems are not Y2K compliant. The risk that
the value of securities in which a fund invests could be affected by
the Y2K compliance status of the issuer is one of many factors that a
mutual fund's investment adviser may need to assess when determining
which securities to buy, sell or hold for the fund.
Thus, in many cases, as part of their normal research process,
mutual fund investment advisers are reviewing issuers' efforts to
address potential Y2K problems. This may include, for example,
interviewing company officials and gathering other available
information (such as reports that public companies file with the SEC).
The results of the adviser's research are considered along with all of
the other factors that the adviser deems relevant to making an
appropriate investment decision.
In certain other cases, however, this type of analysis may not be
done because it would be inconsistent with the fund's investment
objectives and policies, as disclosed in the fund's prospectus. For
example, index funds typically have as their objective seeking to match
the performance of a securities index. Therefore, it is not necessary
and, in fact, would be inappropriate for the manager of such a fund to
consider the issuer's Y2K risk exposure as an investment criterion.
In all cases, it is important that the investment adviser retain
the discretion to evaluate this factor in the manner and to the extent
that it deems appropriate in the particular circumstances (including,
among other things, prospectus disclosure concerning the fund's
investment objectives and policies and concerning how the adviser
selects securities for the fund's portfolio). This is precisely what
shareholders (through the fund) pay the adviser to do on their behalf.
And, due to the competitive nature of the mutual fund industry, fund
advisers have a very strong incentive to make good judgments so as to
maximize shareholder value consistent with the investment objectives
and policies of the fund.\19\
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\19\ Moreover, mutual funds typically have broadly diversified
portfolios. Thus, the risks of holding any single security can be
offset by the different risk/reward characteristics of other securities
in the portfolio. It is well-recognized that it is not appropriate to
judge the performance of an investment adviser by focusing on
individual securities in isolation.
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Where portfolio companies' Y2K readiness is a relevant
consideration, the adviser's ability to make sound judgments is
enhanced by the availability of reliable information about such
companies' readiness.\20\ We applaud the efforts of Committee Chairman
Bennett and SEC Chairman Arthur Levitt to promote meaningful Y2K
disclosure by securities issuers.
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\20\ As information about companies' Y2K readiness becomes
available in the marketplace, stock prices should begin to reflect that
information (to the extent it is material).
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v. conclusion
The mutual fund industry is deeply involved in efforts to identify
and remediate computer problems that could otherwise occur with the
arrival of the Year 2000. These efforts encompass both internal systems
and programs and systems and programs that interface with those of
third parties. The industry is keeping regulators and investors
informed about Y2K issues through a variety of means, and the
industry's efforts are subject to oversight by regulators and others.
Finally, where appropriate, investment advisers are reviewing the Y2K
readiness of companies in which they invest on behalf of mutual funds.
Thank you for the opportunity to participate at this hearing on Y2K
issues. We commend the Committee for its strong leadership in this
area. We would be pleased to provide any additional information that
the Committee might request.
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EXHIBIT D--MUTUAL FUND COMMUNICATIONS REGARDING THE YEAR 2000 CHALLENGE
The American Funds Group and the Year 2000 Challenge
The American Funds Group, along with the various companies that
serve the funds and their shareholders, including American Funds
Service Company, American Funds Distributors, Inc., Capital Research
and Management Company and their affiliates in The Capital Group
Companies, Inc., have made Year 2000 compliance an extremely high
priority.
We are committed to achieving Year 2000 compliance on a timely
basis across all of our significant business systems and operations. We
have a well-defined plan, ample resources, and excellent momentum
toward achieving that goal. We remain on track for reaching compliance
with our internal systems by December 31, 1998. During the remainder of
this year, we will develop appropriate contingency plans. Testing with
business partners, vendors and other industry participants will
continue through 1999.
a world-class team and methodology
Associates from all Capital Group Companies are involved in the
effort. The Year 2000 Steering Committee and Year 2000 Program
Management Office provide overall coordination and support. Capital is
also using its Disaster Recovery resources to help with contingency
planning. The entire project is subject to oversight by a number of
corporate boards and securities and banking regulators.
All business areas are examined using a five-stage process:
--Inventory and Risk Assessment.--identify hardware systems, software
applications and crucial vendors throughout the companies and
assign risk and business-impact ratings.
--Planning.--examine all high-and most medium-risk systems to see how
they can be modified, retired or replaced to create Year 2000-
compliant components.
--Remediation or Construction.--replace hardware, upgrade software
and modify custom application code to ensure dates will be
handled correctly in the year 2000.
--Testing.--test individual components, test with their related parts
and then review entire systems in user acceptance tests. Once a
component has passed all these, we designate it ``Year 2000
ready.''
--Implementation or Close.--document the Year 2000-ready component
and place it back into actual working environment (production).
Separate, additional testing may be performed on essential Year
2000-ready computer applications, using our Time Machine Test
Environment. A functionally-complete replica of our internal mainframe,
mid-range computers and networks, this system runs with all dates set
ahead to simulate Year 2000 conditions. When a system has been
completely tested using these 21st century dates, we designate it
``Year 2000 compliant.''
We are also working closely with business partners and vendors,
conducting extensive tests of each system that shares information
outside the companies. This ongoing effort will continue through 1999.
The American Funds Group will also participate in a Year 2000 test
organized and conducted by the Securities Industry Association.
progress highlights
We have substantially completed the first two phases of our
process--Inventory and Risk Assessment and Planning--for all business
and technology areas of The Capital Group Companies worldwide. We have
also made significant progress in the modification, retirement or
replacement of those systems presenting Year 2000 risks.
We have also made excellent progress in applying the five-stage
process to our Information Technology Infrastructure. All areas, from
the mainframe to midrange computers, file servers to desktop machines
and data, voice and video networks are on schedule to be Year 2000
compliant by December 31, 1998.
Vendors have been identified and categorized by the nature of the
business relationship. Critical vendors with high business impact have
been contacted to determine their Year 2000-compliance progress.
contingency planning
We know that some vendors will not be ready with Year 2000-
compliant products when we are ready to test. Some have declared that
they will not update their products. This means that we must develop
contingency plans to ensure we retain critical business functions.
Our plans take into account how much the organization relies on the
vendor or business partner and how critical the product or service is
to our business. In some cases vendors are being replaced in advance of
potential problems. Through the end of 1998, we will be actively
planning for the possibility that a number of our business partners and
vendors will not have Year 2000-compliant products and services
available on a timely basis.
Capital Disaster Recovery resources are working together with the
Year 2000 Program Management Office to reduce the likelihood that we
will suffer business interruption due to Year 2000 problems. We expect
these plans to be substantially complete by December 31, 1998.
______
The Capital Group Companies and the Year 2000 Challenge
a letter from our project managers
On behalf of each of The Capital Group Companies, we are pleased to
report that we continue to make steady progress toward achieving Year
2000 compliance across the entire organization and in all office
locations around the world. This newsletter is an integral part of our
communications program and is designed to provide you with the
information you need to understand our compliance goals, methodology
and progress through June 30, 1998.
Capital is committed to achieving Year 2000 compliance on a timely
basis across all of our significant business systems and operations. We
have a well-defined plan, ample resources, and excellent momentum
toward achieving that goal. We remain on track toward achieving
compliance with respect to our internal systems by December 31, 1998.
During the remainder of this year, we will develop appropriate
contingency plans. Testing with business partners, vendors, and other
industry participants will continue through 1999.
In addressing the Year 2000 challenge, we have adopted an approach
which is consistent with the way our operating subsidiaries manage
assets--a significant number of people with diverse backgrounds and
skills are following a disciplined, yet flexible process in pursuing
our compliance goals. Associates from throughout the Capital
organization are involved, with the Year 2000 Steering Committee and
the Year 2000 Program Management Office providing overall coordination
and support. Our progress is being monitored by a number of corporate
boards and regulators.
Inside this report you will find a brief description of the Year
2000 problem and what constitutes ``Year 2000 compliance.'' We also
review the methodology we are using to achieve compliance--including
the five different phases of work we apply to each project component.
The Capital Group Companies track and report progress in each
significant technology and business area in relation to the level of
completion of these five phases. Within a given area, overall
completion levels for each phase reflect actual progress achieved with
respect to individual project components, with each component's
contribution to the overall figure weighted according to its potential
impact on our business.
In addition to an overview of recent activity, the report presents
an in-depth look at our progress as of June 30 in the following areas:
Information Technology Infrastructure, Time Machine Testing, Core
Investment Management and Reporting Systems, Administrative Business
Applications, American Funds Group' Accounting and Reporting Systems,
Desktop Applications, Business Partner/Vendor Compliance and
Facilities. The report summarizes progress achieved and work remaining
in each area.
The report also touches on a subject we expect to report on in
greater detail in the future--Contingency Planning. Although we are
already engaged in this activity to a limited degree (in relation to
specific vendors and business partners), we plan to significantly
expand this effort in coming months. Although some issues go well
beyond the financial services industry, the large number of
interconnections and interdependencies within this industry require us
to work diligently to prepare our internal systems and anticipate
external events.
Thank you for taking time to learn more about The Capital Group
Companies Year 2000 Project.
Thomas M. Rowland
L. Edward Prickard
project overview--methodology
The Capital Group Companies are following a five-phase, iterative,
interactive methodology for the Year 2000 Project. The approach is
thoughtful, thorough, and diligently applied.
The first phase is Inventory and Risk Assessment. Survey forms were
completed by information technology and business area managers within
each company, business function and location. These surveys identified
information technology usage, business flows, and external vendors that
could be impacted by two-digit date processing. A risk assessment was
used to categorize each component into high, medium, or low business
impact and processing risk.
The second phase is Planning. All high- and most medium-risk
components are examined to determine if the component should be
remediated (fixed), retired, or replaced with a component which is Year
2000 compliant.
The Remediation or Construction phase is where the Year 2000
problem is solved for each component. Computer hardware chips are
replaced, purchased soft-ware is upgraded, custom application code is
modified, and/or vendor processing is revised to ensure that dates will
be handled correctly in the Year 2000.
The fourth phase is Testing. Each component is individually tested,
and then tested again with related components in a system test.
Finally, the entire system is reviewed in a user acceptance test. When
the component has passed the complete series of Year 2000 date tests,
it is described as ``Year 2000-ready.''
During the Implementation and Close phase, the Year 2000-ready
component is documented and placed back into production.
Separate, additional testing may also be performed on Year 2000-
ready computer applications. Because of the complex interactions
between multiple hardware and system soft-ware components, our critical
business systems also undergo time machine testing. This is a full-
scale operation run with system dates set forward and rolled through
several dates. When these business-critical systems have been
completely tested with these dates, we designate them ``Year 2000-
compliant.''
More testing is being done with business partners and vendors.
Critical external interfaces are subject to point-to-point testing;
this is currently underway and will continue through 1999 with business
partners. In addition, The American Funds Group will participate in an
industry-wide Year 2000 test organized and conducted by the Securities
Industry Association.
year 2000 progress reports in specific areas
Information Technology Infrastructure
This fundamental technology area supports offices throughout the
United States, London, Geneva, Hong Kong, Singapore, and Tokyo.
Components of the infrastructure include: computer platforms and
operating systems, database software suites, network topologies, and
data center operations and support.
The foundation computer infrastructure consists of an S/390
mainframe environment, a midrange environment including an AS/400 and
several HP/UNIX platforms, and a distributed desktop environment
consisting primarily of Compaq and IBM Windows NT platforms.
More than 500 vendors provide in excess of 1,200 products that form
the infrastructure. The path to compliance begins with the introduction
of Year 2000-ready components into the environment following
established upgrade procedures. Once determined stable in the current
environment, each Year 2000-ready product is tested for compliance by
setting system clocks and calendars to several key dates in late 1999
and 2000. Following successful compliance testing, Year 2000-compliant
components are implemented consistently over the infrastructure.
The following chart indicates overall completion levels for each
phase of compliance work undertaken in the Information Technology
Infrastructure area.
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Time machine testing
The Capital Group Companies have constructed a complete mainframe
time machine test environment which replicates the production
environment. All project components that rely on system clocks are
tested for Year 2000 compliance. both individually and in combination,
with system dates and data set forward and rolled through a number of
critical dates. This environment uses only those hardware and software
components which our vendors have designated as Year 2000-compliant
versions.
Except for database releases from two software vendors and an
upgrade release from a print services vendor, the time machine test
environment construction was completed on schedule (June 30, 1998).
Work-around solutions are in place for the delivery delays of these
software components, and the performance of these vendors is being
closely tracked.
Although some systems have been tested in the client-server time
machine environment already, the bulk of our time machine testing will
occur in the third and fourth quarter of this year.
Core investment management and reporting systems
Excellent progress has been made on the Investment Management and
Reporting Systems. There are twelve integrated systems which address
most of the investment analysis and administration business cycles.
These are newer systems that run on midrange client-server computers.
They were tested in a client-server time machine test environment from
March through May, and have been placed back into production. Final
documentation of the Implementation and Close Phase is underway.
Following completion of this process, these major business systems will
be deemed Year 2000-compliant.
The mainframe-based system for portfolio accounting and record-
keeping is on schedule to achieve Year 2000-ready status. Remediation
will be complete by July 31, with time machine testing complete by
August 31, 1998.
Our non-U.S. portfolio accounting and recordkeeping systems are
provided by a third party service provider in Geneva, Switzerland using
a mainframe-based system. All Inventory and Assessment, Planning and
Remediation of these systems has been completed, and final Testing and
Implementation is underway.
Overall completion levels for Core Investment Management and
Reporting Systems are indicated in the following chart.
[GRAPHIC] [TIFF OMITTED] T7SP98G.012
We have substantially completed the Inventory and Risk Assessment
and Planning phases for all business and technology areas of The
Capital Group Companies world-wide. In addition, we have made
significant progress in the remediation, retirement or replacement of
those systems components presenting Year 2000 risks.
Progress within our Information Technology Infrastructure has been
excellent. All aspects from the mainframe to midrange computers, file
servers to desktops, and data, voice and video networks are on schedule
to be Year 2000 compliant by December 31, 1998.
We have made rapid progress with third parties in the last quarter.
Vendors have been identified and categorized by the nature of the
business relationship. Critical vendors with high business impact have
been identified and contacted to determine their Year 2000 compliance
progress.
We have constructed a separate time machine test environment with
dedicated mainframe and midrange computers, network connections and
operating systems software mirroring our production environment. Within
this test environment we are able to set both computer clocks and test
data forward to simulate the turn of the century. This environment is
being used to thoroughly test Year 2000 date processing for our major
business systems.
Administrative business applications
There are several business applications important to The Capital
Group Companies, even though they do not directly affect the core
investment management process. These administrative areas include
Payroll, Human Resources, Finance and Accounting, Tax and Treasury,
Investment Administration, and other similar systems.
As indicated in the chart, Inventory and Assessment and Planning
phases are substantially complete for many of these applications. The
Remediation, Testing and Implementation Phases are on schedule to be
complete by October 1998. The same high standards for Year 2000
compliance are being adhered to for these and all other Capital Group
applications.
[GRAPHIC] [TIFF OMITTED] T7SP98G.013
American Funds Group accounting and reporting systems
Applications utilized by The American Funds Group consist of 29
systems supporting both dealer activities and shareholder accounting
and reporting. Virtually all of the systems supporting these business
areas were Year 2000 ready as of June 30, 1998. This means they have
been through the Inventory and Risk Assessment. Planning, Remediation
or Construction phases, undergone unit, system and user acceptance
Testing, and, during the Implementation and Close phase, are being put
back into production.
Our core shareholder recordkeeping system is provided by a third
party service provider. American Funds Group associates have maintained
a close working relationship with this service provider during its Year
2000 remediation project. All Inventory and Assessment. Planning and
Remediation of this system has been completed.
In September-October 1998, all systems within this area will be
tested in the time machine test environment. These tests will include a
series of integrated, industrywide tests sponsored by the Securities
Industry Association and involving, among others, the primary service
provider supporting shareholder transaction activity in The American
Funds Group. Point-to-point testing with other business partners is
planned over the next twelve months.
Overall progress in this important area is shown in the following
chart.
[GRAPHIC] [TIFF OMITTED] T7SP98G.014
Desktop applications
In addition to shared Information Technology systems, many office
productivity, spreadsheet, and local databases reside on network file
servers accessed by associates' desktop computers.
We have licensed the use of a software tool to identify potential
Year 2000 date processing problems in desktop applications and to
classify those problems by severity level. A process was developed to
scan every network file server, flag the potential problems for manual
inspection, correct the problems, test, implement into production, and
re-scan to make sure the corrections are complete. The process was
tested in a pilot group, validated, and is now being rolled out to all
Capital Group locations worldwide. All desktop applications are
scheduled to be Year 2000 compliant by December 31, 1998.
Business partner/vendor program
Perhaps one of the most challenging Year 2000 areas is assessing
the Year 2000 compliance efforts of our business partners and vendors.
The Capital Group relies on hundreds of hardware and software vendors
for its Information Technology Infrastructure. We also rely on dozens
of custodian banks and hundreds of brokers to process financial
transactions accurately and quickly. Our ability to continue managing
client assets through the Year 2000 depends not only upon our own
organization's ability to achieve internal compliance, but also on the
ability of our business partners and vendors to deliver Year 2000-
compliant products and services.
The Capital Group has identified all of its significant business
partners and vendors and categorized each one by the type of service
relationship. This approach enables us to tailor our business partner/
vendor compliance plans to match the services provided and to enlist
our business area associates in the evaluation process.
Risk assessments of each business partner have been completed: A
``most critical'' list has been identified, and Capital Group
associates with relationship responsibility for Year 2000 compliance
have been designated. During the next quarter, we will begin ``point-
to-point'' testing to confirm our ability to transact business with
these parties in the year 2000. Testing with a number of business
partners will continue through 1999.
The Capital Group methodology requires all significant vendors to
be contacted and their Year 2000 compliance efforts evaluated by
December 31, 1998. Where contingency planning is appropriate, plans
must be established by the same date.
Facilities
The office facilities utilized by The Capital Group Companies are
also being examined for possible Year 2000 problems. Building security
systems, clock-controlled lighting and temperature controls, elevators
and power grids all present a risk to normal business operations. The
Inventory and Risk Assessment of Facilities is complete. Each office
location was reviewed and prioritized based on its computer
dependencies and contribution to overall business activities. Visual
inspections are being conducted and approximately 80 percent of all
required testing is being performed at that time. All critical systems
are scheduled to be tested in 1998. Critical business vendors have been
identified and are being addressed through the vendor management
program. We are developing contingency plans for high-impact utility
companies. The expected completion date for Year 2000 compliance of
Capital Group Facilities is December 1, 1998.
Contingency planning
Our early experience shows that some vendors may not be ready with
Year 2000-compliant products when we are ready to test. In fact, some
vendors have already declared that one or more of their products will
not be made Year 2000 compliant. This means we must develop contingency
plans to ensure we retain certain business functions.
Our contingency plans take into account the level of reliance we
have for each business partner and vendor and how critical the product
or service is to our business operations.
In some cases, vendors are being replaced in advance of potential
problems occurring. During the next six months, we will be actively
planning for the possibility that a number of our business partners and
vendors may not have Year 2000-compliant products and services
available on a timely basis.
Capital is using its Disaster Recovery resources in concert with
its Year 2000 Program Management Office resources to reduce the
likelihood that we will suffer business interruption due to Year 2000
problems. We expect these plans to be substantially complete by
December 31, 1998.
year 2000 project organization
Capital is carefully tracking the progress of the Year 2000
Project. The program is being overseen by a number of internal and
external groups, including the Year 2000 Steering Committee, the
Program Management Office, associates in information technology and
business areas, a number of boards of directors/trustees, and
securities and banking regulators. The role of each of these groups is
described below.
Year 2000 Steering Committee
Who has primary responsibility for implementing the Year
2000 Project?
Capital's Year 2000 Steering Committee, comprised of 15 senior-
level managers representing key business and technology areas, has
primary responsibility for implementing the Year 2000 Project and
achieving its goal of timely compliance across the entire organization.
How does the Steering Committee fulfill its
responsibilities?
The Steering Committee provides oversight, including strategy and
direction, sets priorities and applies resources across all Capital
Group Companies and office locations worldwide. The Steering Committee
facilitates the development and execution of compliance strategies and
efforts in specific information technology and business areas. The
Steering Committee meets twice each month to review progress and
discuss issues.
Program management office
Who implements decisions, strategies and procedures
established by the Steering Committee?
Capital began work on the Year 2000 Project in the first quarter of
1997. In June 1997, the Year 2000 Program Management Office (PMO) was
formed with a dedicated manager, staff, and budget. External
consultants were engaged to initiate the Year 2000 Project definition
and evaluation. A leading consulting firm was engaged to establish the
methodology, provide documentation tools, and supplement and advise PMO
staff. The PMO leads Capital's comprehensive, enterprise-wide Year 2000
compliance effort. The PMO provides guidance, management, coordination,
tracking and support as it assists associates in each of Capital's
information technology and business areas with each phase of the
project, including conversion of their systems, applications, and
services.
What are some of the PMO's specific responsibilities?
The PMO established compliance guidelines, a testing and
certification infrastructure, and an overall process for managing the
Year 2000 Project. The PMO establishes and tracks project deliverables,
facilitates compliance decisionmaking and priorities, and coordinates,
monitors,and integrates multiple compliance projects. The PMO also
plays an important role in monitoring the progress of outside vendors
and other service providers in achieving Year 2000 compliance. The PMO
works closely with the Steering Committee and serves as a liaison among
various working groups and with outside parties and regulators.
Information technology and business areas
What are the roles of the information technology and
business areas in relation to the Year 2000
Project?
Information technology area managers are responsible for ensuring
that technology infrastructure, hardware, networks and operating
systems are all Year 2000 compliant. They must replace non-compliant
hardware and systems, and remediate applications used across the entire
Capital organization. The information technology area is also
responsible for establishing and supporting a Year 2000-compliant test
environment in which hardware and software systems and applications are
tested in a replica of the production environment.
Business area managers have supplied the PMO with inventories and
risk assessments of applications specific to their areas. They are also
responsible for ensuring that project plans and activities are
comprehensive and meet required implementation deadlines. Associates in
the business areas also participate in the development and execution of
Capital-wide application testing, and vendor/service provider
assessments and monitoring.
Board oversight
How involved are the boards of directors affiliated with
The Capital Group Companies in overseeing the Year
2000 Project?
The Boards of Directors of The Capital Group Companies, Inc. and
each of its principal operating subsidiaries have formally approved the
Year 2000 Project, including its enterprise-wide approach and its
reliance on the Steering Committee, the PMO and the information
technology and business areas for implementation. Regular reports are
submitted to these Boards of Directors, at least quarterly, on internal
corrective efforts as well as the ability of Capital's major vendors
and service providers to provide Year 2000-ready products and services.
A number of Steering Committee members also serve on these Boards.
Similar reports will be submitted at least quarterly to the Boards
of Directors and Trustees of the mutual funds managed by Capital
Research and Management Company as well as the funds outside auditors.
Regulatory oversight
How are Capital] Year 2000 efforts being monitored by
regulatory agencies?
A number of Capital Group Companies, including Capital Research and
Management Company, American Funds Service Company, American Funds
Distributors, Inc., Capital International Limited (United Kingdom),
Capital International K.K. Japan) and Capital International, Inc.
(United States), are subject to governmental oversight in the
jurisdictions in which they operate as a result of their securities-
related activities.
In addition, the California- and Nevada-based operations of Capital
Guardian Trust Company undergo regular examination by state banking
authorities. Moreover, self-regulatory organizations play an active
role in monitoring the activities of certain Capital Group Companies.
Regulators in all three categories are very much interested in
determining whether we (and other firms in the financial services
industry) will be ready for the Year 2000. As a result, we have
discussed the status of the Year 2000 Project with a number of these
regulators and submitted written reports upon request. We expect
regulatory activities to increase in frequency and scope as the year
2000 approaches.
the nature of the problem
The Year 2000 problem, although conceptually simple, is a serious
business challenge for all companies, financial and otherwise. rather
than a narrow technical issue. The problem arises from the fact that
many computer and other office systems were designed using a shorthand
approach to dates, often to conserve valuable memory resources.
Unfortunately, even though systems capabilities improved
considerably over the years, many programming professionals continued
to employ the practice of using only two digits to indicate the year--
for example, ``98'' instead of ``1998.'' As a result, a significant
number of existing software and certain hardware and other systems will
require upgrading or replacement to avoid date-related errors.
Systems that will recognize the change of century and operate
properly when doing comparisons, calculations or other date-related
operations in both the 20th and 21st centuries are known as ``Year 2000
compliant.''
selected capital group companies
U.S. Mutual funds
Capital Research and Management Company
American Funds Distributors, Inc.
American Funds Service Company
Global Institutional Group
Capital Guardian Trust Company
Capital Guardian Trust Company, A Nevada Corporation
Capital Group International, Inc.
Capital International S.A. (Switzerland)
Capital International Limited (United Kingdom)
Capital International K.K. (Japan)
Capital International, Inc. (United States)
______
Fidelity Investments and the Year 2000
what is the ``year 2000'' issue?
Computers use dates in calculations. Many software programs were
written using 2 digits for the year (e.g. 98), rather than 4 digits
(e.g. 1998). These systems automatically assume that the first two
digits of a year are ``1'' and ``9'', which means they'll misinterpret
all dates after December 31, 1999. This situation would make an infant
born on January 2, 2000 appear to be 100 years old and a credit card
bill due on the same day 100 years overdue.
Known as ``Y2K'' or the ``millennium bug'', this problem is
inherent in billions of lines of computer programming. Left unchecked,
this could cause unpredictable results. The software and hardware of
systems spanning all industries could be affected. Global financial
institutions, air traffic systems, defense networks, and life support
equipment are just some of the areas this glitch could disrupt. The Y2K
challenge is particularly complex for the financial service industry,
which is heavily dependent on technology for operations that rely on
date-sensitive calculations for automatic deposits, retirement
benefits, stock trade settlements, and other financial transactions.
has fidelity investments begun converting its systems to be year 2000
compliant?
Yes. Fidelity Investments launched its enterprise-wide Year 2000
program in early 1996. The program is sponsored by executive
management, and actively engages business line presidents and other
executive management The mission of the Fidelity 2000 project is to
achieve seamless processing for all Fidelity systems and applications,
resulting in uninterrupted business operations and service to Fidelity
customers.
In addition, the Year 2000 project has extensive involvement from
all Fidelity business units. Members of the non-technical community
participate in several working and steering committees which help guide
the project. Fidelity Investments is aiming to achieve seamless
processing and meet the Y2K challenge. How many people at Fidelity are
working on the Year 2000 project? Fidelity has over 500 employees and
Year 2000 specialists working on the project, consisting of three
dedicated teams, each with a unique responsibility to the success of
the project:
--Aware: Responsible for raising awareness of the Year 2000 issue and
the project itself within Fidelity Investments. This team
facilitates communication and disseminates information
firmwide.
--Assure: Provides guidance and oversight to all Fidelity business
units through an assessment process developed with internal
audit and through monitoring the progress of each business
unit. It is also responsible for tracking the efforts of
Fidelity's vendors and business providers.
--Technology Center: Charged with analyzing and modifying the
millions of lines of code throughout Fidelity. The Technology
Center also tests and evaluates all of Fidelity's enhanced
systems--from the mainframe to the desktop--to attain the goal
that Fidelity Investments will be ready for the Year 2000.
will all of fidelity's systems be checked?
Yes. All of Fidelity's internal applications, vendor products, and
business partner systems have been inventoried and are maintained
through an internal tracking system and reporting database. These
systems are then analyzed for Year 2000 deficiencies, and corrected as
necessary. In the cases where a vendor or a business provider cannot
provide Fidelity with Year 2000 compliant products in time to test,
Fidelity is developing plans to move to another product.
how is fidelity testing connections to outside computers for y2k
problems?
Fidelity has implemented a strategic plan to verify systems will
function in the Year 2000, not only for its internal systems and
applications but for its external business provider data providers, and
other organizations in the financial services industry. This inter-
dependence makes it imperative that Fidelity participate with industry
trade groups to respond to the Year 2000 issue. Fidelity is taking a
lead in assisting these firms, through industry trade groups, in
developing the ability to process their business correctly into the
Year 2000.
what is the impact of the year 2000 on facilities' equipment, such as
elevators, heating equipment, air conditioning equipment, telephones,
security and alarm systems, and fax machines?
Fidelity has a dedicated team of facilities experts focusing on
this machinery, so that it will be functional in the Year 2000. All
machinery has been inventoried, and is being evaluated and tested to
sustain operability.
when will fidelity be finished?
Fidelity is well on its way to completing the conversion of its
core systems by the end of 1998. These systems will then be tested
throughout 1999, including participation in the Securities Industry
Association test, which is a test of the exchanges and utilities (e.g.
New York Stock Exchange) and the financial organizations that
communicate with them electronically.
In addition, all new software developed at Fidelity is being
developed to execute properly in the Year 2000.
what happens if fidelity investments is not able to meet the year 2000
conversion on schedule?
Fidelity is currently on target for meeting the Year 2000
milestones. However, we are creating backup plans so that critical
business functions continue to operate through the Year 2000.
what do i need to do?
Fidelity continues to be proactive in addressing the year 2000
issue. We'll update this information accordingly. Watch for statement
inserts and more information on www.fidelity.com as we get closer to
December 31, 1999. If you have further questions about Fidelity and the
Year 2000 Project, please e-mail.
______
Franklin Templeton Combats the Year 2000 Problem
(By Charles B. Johnson President, Franklin Resources, Inc.)
As we near the 21st century, Franklin Templeton is taking important
steps to tackle the computer glitch dubbed the Year 2000 Problem, Y2K,
or the Millennium Bug. The problem originated from software designers'
attempt to save memory by recording years in a two-digit format--``98''
instead of ``1998,'' for example--but didn't take into account that the
year 2000, or ``00,'' could also be interpreted as 1900. Uncorrected,
this problem could prevent computers from accurately processing date-
sensitive data after 1999.
Franklin Templeton's Information Services & Technology division
established a Year 2000 Project Team that has already begun making the
necessary software changes to help ensure that our computer systems,
which service the funds and their shareholders, will be Year-2000
Compliant. As changes reach completion, we will conduct comprehensive
tests to verify their effectiveness. We will also require all of our
major software or data-services suppliers to be Year-2000 Compliant.
In addition, with an estimated 80 percent of businesses facing the
Year 2000 Problem, mutual fund portfolio managers must be aware of the
impact it could have on companies in their portfolios. That's why
Franklin Templeton portfolio managers consistently keep this issue in
mind while selecting investments and managing their portfolios.
______
Putnam Investments--News & Outlook
the year 2000
You have undoubtedly read headlines and heard news reports about
the impact of the year 2000 on computer systems around the world. And
while some reports' ``doomsday'' scenarios may be overly dramatic, it's
important to recognize that the change from 1999 to 2000 could cause
serious disruptions for businesses whose computer systems aren't
prepared. Fixing the problem is complex and requires diligent analysis,
reprogramming, testing, and retesting of computer systems well in
advance of the new millennium. Unlike the media--which have only just
begun to pay close attention to this issue--Putnam has been working on
it for many years. In fact, our comprehensive year 2000 (Y2K) strategy
was established in 1995.
--What exactly is the problem?
--An overview of Putnam's strategy
--Staffing the project
--Testing is key
--External systems and contingency plans
--Auditing
what exactly is the problem?
When computer software programs were being developed in the 1970s,
the programmers didn't anticipate that their software would still be in
use 25 years later and that the programs would need to process dates
after 1999. Therefore, programmers set aside only two spaces to
identify the year in computer code--the year 1970, for example, was
entered as 70. If this software is not adjusted, computer systems will
interpret the year 2000 as the year 1900. While the problem is simple
to understand, its solutions are incredibly complex. Once a computer
system misinterprets a date, it has the potential to spread the wrong
information to many other computer systems. In addition, the erroneous
information could come from within a company's computer system or from
external computer systems.
an overview of putnam's strategy
Putnam's Y2K strategy is designed to ensure that all of Putnam's
systems are Y2K compliant, which means they will be able to accept and
process a four-digit year and will continue to function in the year
2000 and beyond as they do today. In addition, if Putnam receives
external data that are not Y2K compliant, Putnam's systems will be able
to expand the date to a four-digit year.
Putnam has completed a comprehensive review of all technical areas
that play a role in our ability to perform necessary business
functions. These include hardware, software, vendor feeds, and
interfaces. The results of this review indicate that we will be in
compliance with all Y2K requirements well before 2000. Already, a
number of Putnam systems have been enhanced to handle dates into the
21st century.
staffing the project
Putnam hired several consulting firms early in the process to
conduct inventory and impact analysis of every system and to identify
the appropriate strategy for bringing each system into compliance.
Putnam also has an internal team of technology professionals dedicated
to implementing our Y2K strategy. Because we established consulting
partnerships quite a while ago, we were able to obtain reasonable rates
for the service. Recently, the availability of Y2K consultants has
become limited and costs have risen accordingly. As major conversions
are completed, we are able to decrease the number of consultants,
managers, and developers working on the project.
testing is key
Testing the systems well in advance of 2000 is a vital part of
Putnam's Y2K strategy. Putnam's testing is rigorous and extensive; we
are working on more than 380 separate systems and are developing a
specific strategy for each. Because these hundreds of systems vary in
size and complexity, the timeline for testing varies as well.
Putnam has developed a two-phase approach for testing its converted
systems.
Phase I: Century compliant.--The objective of this phase is
to verify that there is no negative impact on the functioning
of our computer systems when their codes are converted to
display a four-digit year.
Phase II: Year 2000 compliant.--This phase of testing is
designed to ensure that all systems will continue to function
in the year 2000 and beyond in the same way that they function
today.
Putnam plans to complete testing by December 31, 1998. However, a
few replacement projects and vendor upgrades will not be completed
until the first quarter of 1999.
external systems and contingency plans
Another critical component of our Y2K plan is to ensure that any
data we receive from outside our organization are also compliant.
Putnam maintains a comprehensive inventory of all third-party systems
on which we are dependent. We have been in contact with every vendor
and we are working with each organization to determine its status and
preparation for Y2K. We are also working with clearing houses, banks,
and sub-custodians to conduct external tests of our systems. In cases
where vendors have unacceptable target dates, we have developed
contingency plans. And, by mid 1999, we will have a plan in place to
deal with any system failures that might occur in 2000.
auditing
Putnam's Y2K plan and progress are being monitored by FDIC auditors
as well as by auditors of our parent company, Marsh & McLennan, and by
our external auditors, PricewaterhouseCoopers. Each review has been
documented and all issues are being addressed. A project detail report,
which tracks every phase of the conversion and implementation process,
is maintained as each system undergoes the internal Y2K certification
process. The report is available for review by internal and external
auditors.
______
Vanguard Prepares for the Year 2000
how is vanguard addressing the challenge?
To meet the Year 2000 Challenge, Vanguard has more than 85 computer
experts dedicated to fixing every affected computer program well before
January 1, 2000. In addition, we have retained top-quality outside
consultants for portions of this project.
All Year 2000 compliance changes to Vanguard computer programs are
scheduled to be completed by the third quarter of 1998--well in advance
0f 2000, enabling us to conduct business as usual through the turn of
the century. This early completion will permit full-scale testing of
all programs, plus continuous monitoring of computer systems as 2000
approaches.
As a Vanguard shareholder, you do not have to do anything to
prepare for the year 2000--and you will not have to change the way you
do business with Vanguard.
example of the year 2000 challenge
Say you were born on May 11, 1929. The government says you have to
start withdrawing money from your retirement plan by April 1, 2000--the
year after you reach age 70\1/2\. You've chosen to receive the required
minimum distribution as a monthly check, starting in January 2000. But
now it's January 4, 2000, and nobody has prepared the retirement plan's
computer system for years past 1999. The computer determines that you
are--29 years old (the current year, 00, minus your year of birth, 29).
Obviously, this is not a valid retirement age, so the computer bypasses
your distribution. If you fail to realize that the checks aren't
arriving, you could become subject to a 50 percent penalty tax on the
amount that should have been withdrawn.
what is the year 2000 challenge?
The Year 2000 Challenge (``Year 2000'') stems from the fact that
countless computer programs use a two-digit shorthand for calendar
dates. Many existing programs will assume that 01-01-00 is the first
day of 1900, rather than 2000. If not corrected by January 1, 2000,
this glitch could disrupt the calculation of bond interest payments,
stock trade settlements, retirement benefits, and other financial
transactions.
Some have mistakenly assumed that the Year 2000 issue is a problem
merely for older systems. In fact, many new applications are also
vulnerable--especially those that interact with or use data stored in
older applications. The interconnected nature of today's computer
systems means that a single tainted application could have sweeping
repercussions in an organization.
frequently asked questions
How important is Vanguard's Year 2000 project?
Providing superior investment performance and related financial
services to our shareholders is the sole mission of The Vanguard Group,
and information technology is absolutely vital to that mission. Quite
simply, it would not be possible to run a modern mutual fund company
without reliable computer systems. We believe it is critical that we
protect these systems--and, by extension, our clients--from problems
that could arise when the calendar reaches the Year 2000.
To ensure that the Year 2000 Challenge does not create problems for
shareholders, Vanguard went to work early to address the changes
required. We plan to complete the changes necessary to our computer
systems by the third quarter of 1998, leaving ample time for rigorous
testing and monitoring.
Houw many people at Vanguard are working on the Year 2000 Challenge?
Vanguard has committed more than 85 seasoned computer experts to
identifying and eliminating any computer-programming problems related
to the Year 2000. For some portions of analysis, renovation, and
testing, top-quality outside consultants have been brought in.
A full-time Program Manager for Vanguard's Year 2000 project was
appointed in 1996. Reporting directly to Vanguard's Managing Director
of Information technology, this Program Manager is responsible for
ensuring that Vanguard's systems--as well as those of clients,
partners, and providers--are properly modified and tested.
A Year 2000 advisory committee--composed of Vanguard's senior
Information Technology staff and a representative of each major
internal business group--meets every other week to track progress.
The Year 2000 team includes ten experienced systems managers and
more than 75 programmers, software engineers, quality assurance
specialist, and compliance testers.
Are all of Vanguard's business areas included in the project?
Yes. Our businesses and services include Vanguard Brokerage
Services, Retirement Programs, Personal Financial Services,
Institutional Investor Service, Vanguard Variable Annuity Plan, and
Individual Investor Services. The Year 2000 project encompasses every
record or process that is dependent on computers at all Vanguard
locations: The main campus in Malvern, Pennsylvania, as well as offices
in Philadelphia; Phoenix, Arizona; Charlotte, North Carolina; and
Melbourne, Australia.
Are all Vanguard's systems being checked?
Yes. The systems being examined include all accounting systems for
institutional and individual shareholders, online access systems,
telecommunication systems, custon-built software, imaging systems, mail
room equipment, and more. In addition, the Year 2000 team will verify
that the systems that control elevators, heating and air conditioning,
lighting, and security systems at Vanguard will not pose any threat to
our ability to provide service. We are committed to completing Year
2000 changes on internal applications by the third quarter of 1998 to
allow ample time for rigorous testing.
Who will be affected by the Year 2000 Challenge?
Potentially, the challenge could affect everyone who uses a
computer. The use of two digits instead of four for calendar years is
so embedded in software language that most businesses, agencies,
institutions, and individual users risk problems when the calendar
turns to 2000.
Why are dates so important?
Computers use dates in all sorts of calculations, including those
involving dividend payments, automatic deposits or exchanges,
retirement benefits, control of inventories, and money transfers--
particularly across time zones.
Why can't we just switch all the dates from two digits to four?
Sheer volume makes it all but impossible to expand every date in
the millions of lines of computer code that companies use. Furthermore,
any change must be compatible with every program and file that can be
linked to it. Although dates will be expanded to four digits where
essential, many organizations (including Vanguard) will use
``windowing,'' a technique that assigns the correct century to any
given two-digit year date.
Is this a hardware problem or a software problem or both?
It is a software problem affecting applications, operating systems,
and utilities. But it also involves hardware--some computers cannot
work properly with dates beyond 1999 and must be replaced.
Why do some people call this problem a bug or virus?
Like a virus, the problem could cause unwanted, unpredictable, and
sometimes damaging results that would spread through linked computers.
However, the two-digit shorthand for dates was not started as a prank
or as sabotage. It was used by programmers who had to be frugal with
their allocation of resources in days when computers had little memory
and storage capacity.
How widespread are dates in an information system?
Dates are everywhere. If a database did not contain dates, it would
mean that the information recorded had no relation to time--which is
never the case. Consequently, the problem cannot be simplified. It
potentially involves all programs and all applications.
What does it mean to be ``Year 2000 compliant''?
An information technology product or service is Year 2000 compliant
only if it will accurately process data before, during, and after the
calendar change from 1999 to 2000--and if it can do so even when data
is exchanged with other systems.
Vanguard is poised to meet this challenge. Renovations to
Vanguard's internal systems environment is planned for completion by
the third quarter of 1998. Full-scale testing will follow renovation,
and continued compliance monitoring will maintain our environment
through the turn of the century.
How can Vanguard be sure it won't have problems with connections to
outside computers? How will Vanguard minimize risk?
We are dedicated to working with our many clients, business
partners, and providers. An assessment of Year 2000 risks is being
performed for each external relationship. Vanguard will strive to
accommodate those with compliance schedules that vary from our own
timetable, but Vanguard will also develop contingency plans for cases
of noncompliance.
For the past few years, all new systems at Vanguard have been
required to retain four-digit years, and they have been carefully
reviewed for Year 2000 compliance. A set of compliance guidelines has
been established for use by all information technology developers and
software engineers at Vanguard. Methods of enforcing compliance in
information technology development have also been established.
The integrity of electronic data exchanged with our clients,
outside portfolio manages, banks, financial advisers, and other
providers will also be verified. Vanguard's intention is to complete
the project well in advance of 2000 and to conduct ``business as
usual'' as the 21st century approaches. Our team of dedicated
information technology professionals expects to provide uninterrupted,
high-quality service to shareholders through the turn of the century.
What would happen if the Year 2000 challenge was not completed?
It could lead to incorrect results in any arithmetic calculations,
comparisons, or data-field sorting that involved years later than 1999.
The worst-case scenario is computer failure. Vanguard started early and
is moving aggressively to thwart that unacceptable outcome.
______
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Responses of Matthew P. Fink to Questions Submitted by Chairman Bennett
Question 1. You indicate in your testimony that ``where
appropriate'' investment advisers are reviewing the Y2K readiness of
companies in which they invest on behalf of mutual funds shareholders.
Can you estimate what percentage of fund managers are reviewing their
portfolio companies for Y2K readiness, and what percentage of companies
within their portfolios would typically be reviewed? How are such
reviews conducted; are the reviews usually based on the SEC quarterly
filings or are they more rigorous? What does ``where appropriate''
mean; when would it not be appropriate to review companies for Y2K
readiness?
Answer. The Institute has not formally surveyed its members to ask
whether they review the Y2K readiness of portfolio companies.
Accordingly, we are not in a position to state precisely what
percentage of fund managers perform such reviews, or what percentage of
companies within their portfolios would typically be reviewed. We have
discussed these issues with a number of our members, however, and it is
our understanding that in general, fund managers are reviewing the Y2K
readiness of portfolio companies and considering it as one element of
risk when determining which securities a fund should buy, sell or hold.
While some fund managers are reviewing the Y2K readiness of all
portfolio companies, other managers tend to focus on issuers of
securities in which they hold, or may acquire, relatively large
positions, or which they believe may be particularly vulnerable to Y2K
issues (e.g., because of heavy reliance on computer systems).
Members have told us that their portfolio managers or analysts
review issuers' periodic and other SEC filings but that this is just
one source of information about Y2K readiness. In many instances, fund
managers are circulating Y2K questionnaires to portfolio companies and/
or interviewing management on Y2K issues. In addition, in some cases,
fund managers or analysts review information generated by third parties
concerning companies' Y2K readiness, where such information is
available. Of course, even the most thorough due diligence efforts
cannot assure that no Y2K problems will materialize. For example, an
issuer whose own systems are Y2K compliant may be affected by
infrastructure failures. Obviously, it would be impossible for fund
managers to investigate and evaluate every potential Y2K-related risk
that possibly could impact each issuer. Thus, as with other factors
that fund managers consider in making investment decisions, with
respect to issuers' Y2K readiness, fund managers take reasonable steps
to permit them to make informed judgments.
Additional information about whether fund managers consider the Y2K
readiness of portfolio companies will soon be available in reports
required to be filed with the Securities and Exchange Commission. The
SEC recently adopted a proposal that requires every registered
investment adviser that either has at least $25 million of assets under
management or is an adviser to a registered investment company (e.g., a
mutual fund) to file Y2K readiness reports with the SEC. An initial
report must be filed by December 7, 1998 and a follow-up report is due
by June 7, 1999. Investment advisers will be required to indicate in
these reports whether, in formulating investment recommendations for
clients, they take into account the extent to which the issuer has
prepared for Y2K and, if so, where the adviser obtains information
about issuers' preparedness.
As indicated in my testimony, there are instances in which it may
not be appropriate to review portfolio companies for Y2K readiness
because this consideration is irrelevant to the fund's investment
strategy. For example, so-called index funds typically seek to match
the performance of a specified index (such as the S&P 500 Index) by
investing in the issuers (or a statistically selected sample of the
issuers) that are included in the index. These funds employ a passive
approach to investing that does not involve any fundamental analysis of
the issuer. Thus, in the case of an index fund, it would be
inconsistent with the fund's investment objective and strategies, as
disclosed in its prospectus, for the adviser to use information about
an issuer's Y2K readiness as the basis for determining whether to buy,
sell or hold the issuer's securities. The same could be true for other
types of funds whose stated investment strategies involve selecting
securities according to a formula or other specified criteria and do
not involve fundamental analysis.
Question 2. We have reason to believe that many companies
understate the seriousness of the Year 2000 problem in their public
disclosures fearing the potential negative impact on the company's
stock position if significant problems are disclosed. Do you believe
the quarterly filings correctly characterize the impact of the problem
on publicly-traded companies? Will the Y2K safe harbor legislation,
being marked up in the Judiciary Committee this morning promote better
disclosure or is it simply a business decision?
Answer. Based on our discussions with members, we understand that
the disclosure in public companies' quarterly SEC filings tends to be
general. This is understandable to some extent; many companies'
computer systems are interdependent with other systems that they do not
control, and as to which they are not in a position to assure
compliance. Concerns about potential liability also may discourage more
specific disclosure. We are hopeful that the pending Y2K safe harbor
legislation, as well as the SEC's recent disclosure guidance, will
promote better disclosure. In addition, disclosure may improve as
companies get farther along in their Y2K assessments and testing
efforts. As noted above, however, periodic and other filings often are
just one source of information about issuers' Y2K readiness that fund
managers consider. Moreover, many of our members invest in companies
based in large part on the quality of corporate management, and it is
believed that well-managed companies would be more likely to address
Y2K issues in a diligent fashion.
Question 3. You indicate in your statement that the Investment
Company Institute represents 95 percent of the mutual fund industry.
Our Committee has found in other industries that large companies will
generally be better prepared for the Year 2000 than medium and small
companies. Do you think this will also be true of mutual funds, i.e.
will large funds be better prepared than small funds?
Answer. In contrast to other types of companies, in the case of
mutual funds, there are several reasons why the size of a fund (or fund
complex) will not necessarily correlate with the level of its Y2K
preparedness.
For example, as I indicated in my testimony, mutual funds
themselves are merely pools of assets; their operations typically are
conducted by external service providers. Because of this dependence on
service providers, a critical determinant of funds' Y2K readiness will
be the Y2K readiness of their key service providers. This is true
regardless of the size of the fund or fund complex.
Moreover, in general, smaller fund complexes may be more likely to
outsource functions to large, third party service providers such as
transfer agents and custodian banks. For example, a large fund complex
may encompass its own, affiliated transfer agent because this structure
can make sense where there are numerous funds within the complex
requiring transfer agency services. In contrast, a smaller fund complex
may be more likely to contract with a third party transfer agent for
these services. A relatively small number of well-established
organizations provide mutual fund transfer agency and custodian
services. The prevalence of outsourcing may tend to enhance smaller
complexes' Y2K readiness and put them on a par with large fund
complexes.
In addition, some smaller fund complexes might have fewer, and/or
newer, computer systems. As a result, their exposure to Y2K problems
could be reduced.
For these reasons, it would be inappropriate to assume that medium
and small fund companies will be less well-prepared for Year 2000 than
large fund companies.
Question 4. Other than loss of public confidence, what potential
Y2K problems are your members most concerned about?
Answer. Loss of public confidence is an overarching concern. One
specific issue that Institute members anticipate they may face as Y2K
approaches is an unusually high volume of phone calls from investors.
Many firms have contingency plans in place designed to ensure that they
will have the capacity to handle this situation. Our members also are
reviewing possible infrastructure issues and developing contingency
plans for back-up power supplies, for example. Another potential
concern is the ability to receive prices for portfolio securities from
pricing services or other outside sources. Fund groups are testing
their interfaces with these sources to seek to avoid problems of this
type.
Question. 5. What percentage of the total dollar investment in
mutual funds are in IRA's, 401K's, or other retirement or pension
programs? Are fund managers taking any special action to ensure that
these funds are protected from Y2K-related problems?
Answer. Institute data show that the share of mutual fund assets
held in retirement accounts (including IRA's and employer-sponsored
accounts) was approximately 35 percent in 1997.
In response to the question of whether our members are ``taking any
special action to ensure that these funds are protected from Y2K-
related problems,'' it should be noted that our members' Y2K compliance
efforts do not distinguish between different types of fund shareholders
(e.g., those who hold shares of a given mutual fund directly versus
those who hold shares of the same fund in an IRA or through an
employer-sponsored retirement plan). Thus, all fund shareholders (and,
indirectly, plan participants) benefit equally from these efforts.
Another important point to keep in mind is that ERISA generally imposes
on plan sponsors (and not service providers such as the fund's
investment adviser) a fiduciary duty with respect to plan participants.
That being said, many of our members are communicating regularly with
plan administrators and sponsors about the fund group's Y2K compliance
efforts. In some cases, members have prepared letters or other special
publications for this purpose. Some samples are attached to this
letter. In addition, many fund groups are systematically testing their
interfaces with all third parties--including administrators and
sponsors of retirement plans.
______
Attachment--Sample Letter on OppenheimerFunds, Inc. Year 2000
Preparations
August 14, 1998.
Attention
Vice President
Dear
4We have received your recent letter and in answer to your
questions, we wanted to take this opportunity to make you aware that as
the next century approaches, OppenheimerFunds, Inc. is aware of the
potential problems associated with the advent of the Year 2000. In
order to address the potential problem associated with the Year 2000,
OppenheimerFunds, Inc. has developed a very detailed Year 2000 project
plan that incorporated all facets of our business.
The Plan: Our Year 2000 project plans highlight 365 individual
milestones spread across 18 categories of areas that might potentially
have Year 2000 problems. These include categories for dependencies
(including bank partners), client/server application software, client/
server and LAN system software, client/server and LAN hardware,
commercial off the shelf software, mail room software and hardware,
telecommunications equipment and services, firmware, potential early
failures, validation, transmissions, and interfaces. Each category of
effort further encompasses the following major tasks and deliverables:
Inventory--What do we have? Assessment--Does it have a Year 2000
problem? Test Prioritization--How important is the product and when do
we test it? Contingency Planning--What will we do if it doesn't work?
Communication Plan--How do we let everyone know the status? Test Plan
Development--How do we test the product and who needs to be included in
the test? Implementation--Correct any Year 2000 problem or if not
possible or feasible, replace the product with a product that is Year
2000 compliant. Testing--Test any implemented changes in a test
environment with aging processes.
The Year 2000 Team: OppenheimerFunds, Inc. has had a dedicated
project loam in place working on the Year 2000 issue since l995. This
team now includes 25 people including existing employees, persons hired
specifically for the Year 2000 effort, and consultants hired became of
their expertise in this area. The Year 2000 team is supported by
employees in the rest of the organization through help in testing,
implementing changes and preparing contingency plans.
Inventory and Assessment: To date, the Year 2000 team has completed
the inventory and assessment of all of the hardware and software
currently utilized by OppenheimerFunds, Inc. They have also created a
sophisticated repository which is continually updated and that
includes a vast array of information about critical inventory data.
This repository allow OppenheimerFunds, Inc. to track the progress of
the Year 2000 effort as well as verify the Year 2000 readiness of any
particular system. Additionally, the Year 2000 team has completed a
comprehensive PC test plan which was used to test every type of PC used
at our facilities. After completing the tests, recommendations were
developed for replacing or correcting all non-compliant PC's.
As part of the Inventory and Assessment, OppenheimerFunds, Inc. has
worked to locate and evaluate any systems that may encounter Year 2000
problems before the Year 2000. A plan is being formed to deal with
these potential early failures.
Implementation: As of the date of this letter, we have completed
248 out of 365 milestones in our project plan. This includes all
inventory, assessment, communication and contingency plans and test
prioritization of all categories. Other milestones such as test plan
development, implementation, and validation are well underway with
significant progress expected to be made the last half of 1998.
OppenheimerFunds, Inc. is well aware that the success of its Year
2000 plan relies on the readiness of many of its outside vendors and
with our business partners with whom it exchanges information on a
daily basis. To that end, we have a dedicated group in the Year 2000
team working with all known outside vendors and business partners to
establish testing plans and implement changes as necessary.
OppenheimerFunds, Inc. sent letters to vendors and business partners
requesting information regarding their Year 2000 readiness. All vendors
of hardware and software except two have responded positively that
their products are either compliant now or will be made compliant by
early 1999. We have also hard from most of our business partners. The
Year 2000 team is now working on contracting any outside business
penner who has not yet responded to our request for information. When
necessary, OppenheimerFunds, Inc., will work with our outside business
partners and vendors to develop testing plans to help ensure that
services are not interrupted because of Year 2000 issues.
Testing: The internal testing of software to address the Year 2000
project is a large part of the OppenheimerFunds Year 2000 project plan.
To facilitate the testing, OppenheimerFunds, Inc. established a
specific test environment including separate Logical Partition on our
IBM mainframe system, client/server database, and Local Area Network.
The Year 2000 team coordinates test plan development and actual testing
of both internal and third-party applications with business developers
and technical support areas. At this point minor problems were
uncovered with two internal applications and these were corrected and
retested. Two third-party software packages have been found to be non-
compliant, vendors were notified, and we are awaiting corrections. We
have also uncovered four problems win hardware including one on a PC
where we will correct the BIOS, and three on telecommunication hubs
that we will either work around or the vendor will replace the
components. OppenheimerFunds, Inc. continues to work with various
vendors to implement compliant software as soon as it is available. The
majority should be available for testing by the end of 1998 with the
remaining completed in 1999. Our project plan includes continued
validation efforts for software through June 1999.
Industry-wide testing: OppenheimerFunds, Inc. recognizes the value
of the industry-wide testing designed to address Year 2000 problems. As
a part of the Year 2000 project plan, OppenheimerFunds, Inc. will have
a dedicated team focusing on the scheduled industry testing by the end
of 1998. In order to be prepared to fully participate with the point-
to-point industry-wide testing, members of the Year 2000 team attended
the SIA conference earlier this Year and will attend the conference to
be held in October of this Year. Our industry testing teem will include
Year 2000 team members, user testers and technical personnel. We will
participate in other industry wide tests scheduled to be performed in
third or fourth quarter of 1999. Additional, we are working directly
with various business partners to test specific applications and
transmissions.
Implementation of tested software: OppenheimerFunds has started
adding enhancements where necessary to allow for appropriated date
processing to accommodate the change of century and work towards full
century compliance. We have implemented a significant amount of the
software that we believe is Year 2000 compliant and we are currently in
the process of testing that software.
Contingency Plans: An important part of our Year 2000 project plan
is to develop contingency plans for any problems associated with the
Year 2000. These contingency plans include plans for early failures,
mainframe software and hardware, client/server applications, mail room
products, telecommunications equipment, firmware and off the shelf
products. Plans were established for dealing with potential failures of
business partners, service providers and we have also, when possible,
developed contingency plans for any problems with utilities or
facilities.
Management Involvement: All levels of management at
OppenheimerFunds, Inc. have some responsibility for addressing
potential problems associated with the Year 2000. The management in
each business was directly involved in the assessment and
identification of the various products utilized by OppenheimerFunds,
Inc. Additionally, many of the business units are assisting the Year
2000 team in implementing changes necessary to accommodate the change
of century. The management of each business unit will also be involved
in developing and performing testing of products in their areas for
Year 2000.
Additionally, OppenheimerFunds, Inc. has also established an
executive steering committee for the Year 2000 project as well as an
operational steering committee at each of its offices. Both executive
and operational Year 2000 steering committees meet regularly to review
progress of the Year 2000 project and resolve high level or company
wide issues.
In addition, formal presentations are given to other management
staff quarterly and to Boards of Directors for the Oppenheimer funds.
We also strive to provide updated information to all of our officers,
managers, and employees. A newsletter specifically devoted to Year 2000
awareness is published for all employees on a semi-annual basis.
Additional information is also included on our Internet site at
oppenheimerfunds.com.
As you know, this is a world-wide problem and we want to assure you
that we here at OppenheimerFunds, Inc. have been actively wording on
changes to our computer systems to help ensure that our systems will be
adapted in time for Year 2000. As a company, we have placed a very high
level of importance on the Year 2000 project. We hope this information
addresses your concerns. Should you have any further questions, please
feel free to call me at (303) 768-2935.\1\
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\1\ The document ``The Vanguard Guide to Year 2000 Compliance'' can
be obtained by contacting The Year 2000 Program Officer at either: P.O.
Box 2600, VM310, Valley forge, PA 19482 or 1-610-669-2000 (Toll-free)
1-800-230-2000. To send e-mail [email protected]
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Sincerely,
George C. Bowen,
Senior Vice President & Treasurer.
Prepared Statement of Donald Kittell
introduction
Senator Bennett and Members of the Committee. My name is Donald
Kittell, and I am Executive Vice President of the Securities Industry
Association (``SIA'').\1\ I appreciate the opportunity to testify today
on Year 2000 testing in the securities industry. I ask that a copy of
my statement be included in the record.
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\1\ The Securities Industry Association brings together the shared
interests of nearly 800 securities firms to accomplish common goals.
Accounting for 90 percent of the securities business done in North
America. SIA member-firms (including investment banks, broker-dealers,
and mutual fund companies) are active in all markets and in all phases
of corporate and public finance. The U.S. securities industry manages
the accounts of more the 50-million investors directly and tens of
millions of investors indirectly through corporate, thrift, and pension
plans. The industry generates approximately $270 billion of revenues
yearly in the U.S. economy and employs more than 380,000 individuals.
(More information about SIA is available on its home page:
www.sia.com.)
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The Year 2000 effort is the largest business and technology effort
the financial services industry has ever undertaken, with a cost
projected to range between $4 and $6 billion. In 1995, SIA's Data
Management Division \2\ organized a project team to address this issue.
As past of this effort, SIA, its member firms, and a cross-section of
other organizations (including clearings corporations, depositories,
exchanges, custodians, and self-regulatory organizations), formed a
workings committee to develop a plan to fix the problem. From the
beginning, our primary goal has been to protect the U.S. investing
public by ensuring a successful transition to the Year 2000. Developed
by several industry committees, the project plan is simple in concept
but extremely complex in implementation. It is continuously updated,
but the key tasks include: (1) inventorying all date-related conditions
within the industry's hardware and software; (2) remediating all date-
related conditions to the Year 2000 environment; and (3) testings
industrywide all hardware and software to determine whether the
remediation was successful. Each of these tasks must be performed by
every securities firm, exchange, bank, clearance and settlement
organization, service bureau, and vendor that supports the industry
since each interfaces with the other.
---------------------------------------------------------------------------
\2\ SIA divisions are composed of individuals engaged in
specialized areas of activity who work together in addressing issues
and problems in their spheres of expertise and educate their
constituents via seminars and conferences throughout the year. The
divisions maintain close liaison with other elements of SIA through the
Operations Committee of the SIA as well as other committees, but are
autonomous in their operations.
---------------------------------------------------------------------------
SIA has played a major role in promoting awareness of critical Y2K
issues in the United States and abroad, sharing our expertise with
other industries and the public sector. Specifically, we have:
--Increased awareness within the industry about the millennium bug
and the need to resolve the problem;
--Surveyed the financial services industry to determine Y2K
readiness;
--Organized industry conferences, symposiums, and other forums to
update industry and government on the progress of the Y2K
initiative;
--Briefed Congress, the Administration, and other government agencies
on the industry's Y2K efforts;
--Supported U.S. government efforts by speaking at government and
industry forums and educating Congressional staff; and
--Maintained a web site designed to provide the securities industry
and others with the most up-to-date information on Y2K.
Additionally, SIA is a founding member of the Steering Committee of
the Global 2000 Coordinating Group, whose efforts parallel the goals of
SIA in creating awareness and assisting in Y2K readiness activities
around the world. Currently, the group includes commercial and
investment banks, insurance companies, industry associations, and
others. Efforts are focused on sharing best practices, testing
methodologies, and generating dialogue on issues concerning global
linkages.
sia's year 2000 committees
Year 2000 Steering Committee
Early on it became clear to us that the Year 2000 required the
attention of senior management. In older to raise Y2K awareness to the
highest levels in the firms, SIA created a Year 2000 Steering Committee
to serve as a liaison to senior industry management. Over time, the
Committee has established several subcommittees concerned with
identifying and reducing risks associated with the Y2K conversion.
Vendor subcommittees
The securities industry relies heavily on financial information and
services supplied by outside vendors. Data providers, such as Bloomberg
and Telerate, are critical to the smooth functioning of the U.S.
capital markets. Third party vendors, such as IBM, Microsoft, Oracle,
AT&T, and Lucent, supply the industry with computer hardware, software,
telecommunications, and other critical products and services. The Data
and Service Providers and Third Party Vendor Subcommittees were created
to address issues specifically related to outside vendors. They have
been working with data providers and vendors to define common industry
testing schedules and to assess their level of Year 2000 readiness.
Physical facilities subcommittee
We are well aware that our conversion efforts will be meaningless
if we cannot access our buildings and open for business on January 3,
2000. The Physical Facilities Subcommittee was established to assess
and encourage Year 2000 readiness among utility companies, landlords,
and vendors. The subcommittee is particularly concerned about the state
of the building facilities, as well as security systems.
testing
The most important element of the conversion project is a
comprehensive testing program. Before going into detail about testing,
I want to highlight the tremendous progress we have made over the last
six months and say that we are strongly encouraged that Wall Street
will be ready when Year 2000 arrives.
Testing is a multi-step process. First, each individual industry
participant must test its own critical systems. Then, participating
firms must test with their key processing partners, including banks,
clearance organizations, and third patty vendors. Finally, industrywide
testing must occur. This testing must simulate trading from order entry
through the settlement and clearance process or, to use the jargon,
``end to end.''
The securities industrywide testings program will begin in early
1999. In July 1998 we conducted a rehearsal, or so-called ``beta
test.'' This ``test of the test'' gave the industry a chance to review
the testings plans and gauge the readiness of the firms, markets,
clearing films, and depository organizations. SIA has devoted
considerable time over the last two years defining the critical issues
and developing a testings methodology that would best serve the
securities industry. Workings groups were formed to analyze the
conditions and sequence of events for each test product and to create
sample trades, which are known as ``test scrips.''
Twenty-eight films (the ``control regroup'') participated in the
testing, along with 13 exchanges and utilities. These firms handle
about 50 percent of the total U.S. daily trading volume. Six products
were tested (equities, options, corporate bonds, municipal bonds, unit
investment trusts, and mutual funds): money market installments,
government securities, and mortgage-backed securities are being tested
separately. Each firm, depending on the specific tests in which they
participated, input approximately 500 hypothetical trades on each of
the testing days. Test scripts included specific conditions such as
canceled trades, good-till-canceled orders, and other types of
transactions that occur on a normal day. Firms were able to process the
complete cycle of a trade in the days between the time 1900 ``ended''
and the year 2000 ``began.''
The purpose of the beta test was to validate the methodology for
the upcoming industrywide test rather than to determine specific
information on each firm's level of preparedness. We wanted to know
whether the test concept worked and if it could be applied to the
entire securities industry. From this perspective, we believe the test
was a major success. Additionally. we have compiled the following
conclusions from the beta test that will assist the industry in
preparing for the industrywide testings:
--By and large the results strengthened our confidence in the extent
to which the industry has marshaled the resources--manpower,
expertise, money--to be ready for the Year 2000.
--The beta test showed us that we have improvements to make in the
testing methodology, but these chances are relatively minor.
These include:
1. Developing a method whereby we can communicate
simultaneously with a group of hundreds of
participants.
2. Spending more time educating participants about
the testings procedures and what they must do to
prepare for it. This means, for example, getting the
test script to firms as soon as possible.
3. Having an extensive ``help desk'' on testing days
to field questions quickly as the test unfolds.
industry wide testing
With beta testing complete, we are using the knowledge we gained to
prepare for the industrywide test starting in early 1999. Similar to
the beta test, industrywide testings will simulate a trading cycle and
will include broker-dealers, exchanges, and utilities. Most self-
regulatory organizations (SRO's) are imposing some level of required
Year 2000 testing. SIA is striving to ensure that the SROs' testing
parameters are included in SIA's test. To participate in the SIA test,
firms will register via our Web site. They will be required to complete
a set of prerequisites as stipulated by the exchanges, clearing
organizations, and depositories. If during the test a firm successfully
processes hypothetical trades through the full transaction cycle--trade
through settlement--with the appropriate internal balancing of the
trades to the cleating organizations, then they would have demonstrated
that their systems can interact with Wall Street's infrastructure.
Successful completion of the test is not an indication that a firm is
totally Year 2000-ready. Other internal systems not affected by trade
processing systems will still have to be properly remediated and
tested.
To facilitate the industrywide test, SIA, in conjunction with
PricewaterhouseCoopers, developed a ``How To Test Guide'' for
participants. The document is in its final steps of preparation and
will be released at SIA's upcoming Year 2000 Update Conference on
October 2, 1998. It will include:
--A preliminary in-house check list to prepare for the test;
--Point-to-point testing requirements;
--Reference to the requirements of the individual exchanges or
utilities;
--Required setups for participation in the test;
--Fixed testing schedules;
--Links to an up-to-date contacts list;
--Input and output time frames; and
--Frequently-asked questions or problems, and their respective
answers or resolutions.
conclusion
I think it is important to note that our approach to the Year 2000
conversion is unique and has served as a model for other industries.
Additionally, because of the securities industry's early start, it is
well along and on schedule in its preparations for a smooth transition
to the new millennium. Indeed, our successful beta testing efforts
indicate that our concept is working and we are looking forward to the
much bigger challenge of industry testings in 1999.
We have experienced great success so far, which we attribute to the
massive and unprecedented effort by industry volunteers. We certainly
hope that the teamwork demonstrated throughout the Year 2000 project
becomes the foundation for all future industry efforts. SIA would like
to acknowledge the cooperation of regulators, exchanges, depositories,
and broker dealers in makings our efforts successful to date. We will
continue to draw upon that cooperative effort throughout next year and
into 2000. We intend to keep you fully apprised of our progress and
results as we go forward in our efforts. As always, the SIA Web site is
a current source of all related activities. The address is www.sia.com.
Exhibit A.--Securities Industry Association: Frequently Asked Questions
about Testing
Question. What is a beta test?
Answer. The beta test is a ``dress rehearsal'' for the industrywide
testing that will begin early in 1999. It is a test of the test, but
more than that, it will give us the chance to review the testing plans
to date and gauge the readiness of the firms, the exchanges, clearing
firms, and depository organizations to proceed.
Question. What is actually going to be tested?
Answer. Testing will begin on July 13 for equities, options,
municipal bonds, corporate bonds, Unit Investment Trusts, and mutual
funds.
The test will simulate a trading cycle--from order entry to
settlement--in a Year 2000 environment. Product Focus Groups,
consisting of volunteers from members firms, have reviewed the scripts
to incorporate product-specific characteristics in the material.
The test for government securities will begin July 1998, and be
conducted Monday through Thursday of each week during the month. The
first round of testing of mortgage-backed securities for the Mortgage
Backed Securities Clearing Corporation began on June 6, and will
continue on June 13, 24, and 27. The futures industry beta test is
scheduled to start Saturday, Sept. 12. The remainder of the test will
be Saturday, Sept. 26, 1998.
Question. How many organizations are participating in the beta
test? Which firms are involved?
Answer. In addition to the 29 firms, 12 exchanges, markets,
utilities, and depositories will participate. A complete list of the
organizations participating in each test is included in the material
provided.
The beta test firms have been members of SIA's Year 2000 Testing
Subcommittee, and have been involved for more than a year in developing
the testing plans and have satisfied the prerequisites.
Question. What are the prerequisites to participate in beta
testing?
Answer. To participate in the beta test, a firm must have a
separate Year 2000 testing environment, dedicated test communication
lines, and have satisfactorily completed point-to-point tests with the
appropriate counterparty. In addition each exchange, utility, and
depository has its own set of prerequisites for testing.
Question. How will the testing process be managed?
Answer. Coopers & Lybrand has been retained to oversee the testing
process. The firm will handle information tracking with participants in
the beta test, maintain lists of contacts at participating firms, and
act as an information resource for firms.
The SIA has set up the following communication links for the
testing: a toll-free number (888-925-4742) and an e-mail address
([email protected]).
Question. How thorough are the tests?
Answer. The scripts test the most common orders for each product in
an average trading environment. Firms should internally test conditions
not covered in the industry test, such as high volume periods, and any
other specific products that are an integral part of their business.
Question. Who is evaluating the results? What will you be looking
for?
Answer. The SIA Year 2000 Project Team and Coopers & Lybrand, the
testing project manager, will analyze the test data.
We will be evaluating the thoroughness of the testing scenarios, to
see if additional steps need to be added. We will also evaluate the
preparedness of the participants--firms, exchanges, clearing firms, and
depositories--and make appropriate recommendations to enable them to
proceed on schedule with industrywide testing.
Question. What if the results show that the test scripts need to be
revised? That firms aren't ready?
Answer. The purpose of the beta test is to uncover any problems or
areas that have been overlooked in the original testing scripts. We are
anticipating a certain amount of modification of the scripts, based
upon the results. A second beta test may be scheduled in September or
October to test the revisions.
Firms that need to do more work on their systems will have time to
correct the problem and participate in the subsequent round of testing.
If no further testing is scheduled, they will work one-on-one with the
securities markets and utilities to test their interfaces with them.
Question. The test is being run during the regular work week. Will
the firms be able to continue regular operations?
Answer. The firms in the beta test have the capability to run
separate communication lines and equipment or logical partitions (a
portion of the computer) dedicated to the test. By testing during
regular business hours, when all parties involved in will be fully
staffed, the test will receive maximum support.
Question.Many firms may find the cost of becoming Year 2000-
compliant burdensome. What can they do?
Answer. There are a number of options available to smaller firms
that are behind schedule or underbudgeted for the conversion. They can
prioritize their systems based on their criticality to the functioning
of the business and focus the resources on ensuring that those systems
are compliant. The sooner these firms begin addressing the issues, the
more options will be available to them.
Question. Are some firms totally replacing their systems?
Answer. Many firms have discovered during the inventory process
that replacing their systems now offers not only Year 2000-compliance
but increased efficiency. Management at these firms is seeing this
process as an opportunity to invest in state-of-the-art software.
The Information technology platforms that result from the entire
Year 2000 remediation process will be well documented and well tested,
more powerful and more disciplined than ever.
Question. With decimalization, OATS, ACATS, and a host of other
projects on the table, is it possible for firms to get the necessary
work done in time?
Answer. SIA commissioned The Tower Group to study the technological
resources of financial services firms and their ability to complete
nine significant projects between now and the year 2000. The
respondents expressed confidence that the necessary resources would be
committed to the projects, but emphasized that those projects that must
be completed by December 31, 1999 should not be compromised by projects
that can be deferred.
______
Responses of Donald Kittell to Questions Submitted by Chairman Bennett
Question 1a. First, let me commend the Securities Industry
Association (``SIA'') for being a leader in its approach to Year 2000
problems. The Committee has often cited the SIA industry-wide or
``street-wide'' testing approach as the model for other industries to
emulate. You say in your statement that SIA's recently completed beta
test ``by and large'' strengthened your confidence in the industry's
Y2K preparedness. Can you elaborate on the basis for that confidence?
Answer. Our level of confidence improved with the successful
completion of the Beta test. We learned that the participating firms
were able to input trades in a simulated Year 2000-environment, send
them to the appropriate market for execution, and the appropriate
financial utility for confirmation and clearance. The markets and
financial utilities demonstrated that they were also able to process
the trades and rout them to the appropriate parties and counter-
parties. In addition, the majority of the software that was remediated
and used by the exchanges and financial utilities in the Beta test is
in use today.
Question 1b. Didn't you experience some unanticipated interface
problems among participants in the test?
Answer. Many of the incidents reported resulted from the Beta test
prerequisites which included establishing a separate Y2K testing
environment that duplicated the firms' production environment. The
resulting Beta test set-up and configuration issues were resolved as
the test progressed. For example, early in the test some firms had
problems communicating with the exchanges and utilities. In addition,
some reports and files were not successfully transmitted to the
participants.
Question 1c. Did the testing reveal any other unanticipated
problems?
Answer.
beta test problems, comments
--Test scripts required some minor corrections. For example, not all
test cases were executable on all of the regional exchanges.
These scripts are being reviewed and revised specifically by
regional exchange.
--Some firms requested more differentiation in the scripts with
respect to prices, symbols, etc., to facilitate internal
balancing.
--Some minor problems occurred because security information was set-
up inconsistently in the master files of the markets,
utilities, or participants. These problems were resolved as the
test progressed.
--Coordination of the beta test required constant communication among
the participants, and the markets, and the utilities. We are
reviewing our communication strategy for the industrywide test.
lessons learned
--Pre-testing for connectivity and passing data between participants
and the markets and utilities must occur before the industry
test. A new focus group was formed to develop the pre-test
requirements for each participant.
--It appears as though some participants will have difficulty
utilizing production systems for the industrywide test due to
the amount of time required to complete their normal weekend
processing and then complete the proper set up for the Year
2000 environment. In addition, the window of time on each
weekend allocated for the industry test may not be sufficient
for all participants to prepare their systems for Monday
morning production processing. As a result, the strategy for
industrywide testing is being reviewed and will require
additional work.
--The scripts need to be streamlined for the industry test.
--More differentiation is required in the test scripts with regard to
test symbols, prices, and quantities to facilitate the checkout
process for participant firms.
--Reporting of test results needs to be modified. The current web-
based application is being reviewed to streamline the reporting
of results.
The input received from participants will be incorporated as SIA
refines the testing scripts and procedures in preparation for the
industrywide test in March 1999. SIA will be developing a method to
provide for ongoing communication among participants throughout the
testing cycle.
Question 2. You indicate in your statement that 28 firms
participated in the recently completed beta test, and that these arms
represent 50 percent of the total daily trading volume. The Committee
has found without exception that the largest firms in each industry
sector have been the most aware and generally best prepared for Y2K.
Since the 28 firms who participated in the beta test are obviously the
largest in the industry, do you have confidence that the others are
similarly prepared?
Answer. We share your concern about the level of readiness amongst
the medium and smaller size firms. Now that the Beta test is over we
are focusing on education, SIA and the committees are concentrating on
the firms that were not part of the Beta test. We recently held a Year
2000 Update Conference in NY on October 2, with over 700 attendees. The
program was quite extensive and it featured an overall update on our
project. In addition, on February 2&3, 1999, we have scheduled a
testing seminar whereby we will devote the entire two days to
explaining the test with representation from our committees, and the
exchanges and financial utilities.
Question 3. According to your testimony, the recently completed
beta test was just the beginning of an extensive course of ``street-
wide'' testing to be conducted next year. Do you anticipate more
problems and more complex problems as you add more and more arms to the
testing process?
Answer. We have taken several steps to address the anticipated
problems which may result in broadening the participation in the test.
After the Beta test, a testing strategy committee was formed to analyze
the results and recommend how we can scale the test up for 300-400
participants. It was decided to proceed with our original plan with the
test starting on March 6, 1999. In addition, we will enhance our web
application for broadcast messaging and test registration. We have
planned regional educational seminars for the first two weeks of
November.
Question 4a. Isn't it true that firms participate in SIA's testing
on a voluntary basis? If so, won't the firms most prepared be the only
ones that will participate and, thus, miss the firms that could most
benefit from testing?
Answer. Firms are participating in the SIA test on a voluntary
basis. However, most exchanges and financial utilities are in the
process of implementing a mandate that will require their members
engage in some form of Year 2000 testing. We are working with them to
ensure that the SIA test satisfies their requirement. SIA has sent a
letter to its membership requesting that all clearing firms register
for the test.
Question 4b. What percentage of firms are opting out of the testing
process?
Answer. We do not have the percentage of firms that have opted out
of the testing process as yet. However, my opinion is that firms not
participating in the test would be limited to those who would be
placing their production operation in jeopardy. An example of this may
be a firm with only one processor and does not have the resources to
participate. SIA will address this issue if it becomes necessary, and
will suggest an alternate testing solution.
Question 4c. What steps will you take to ensure that non-
participants will be Y2K ready?
Answer. The SEC has joined the SIA's Year 2000 Steering Committee.
We will provide the SEC with a list of firms that have registered for
the test.
Question 5a. You indicate in your statement that successful
completion of industry-wide testing is not an indication that a firm is
totally Year 2000 ready. What else must firms do to demonstrate that
they are ``totally'' Y2K ready?
Anwer. The SIA test allows a firm to test with the rest of the
street's infrastructure. We are simulating a true trading cycle from
trade date through settlement date. Therefore, only the internal
systems that interact with the trade processing portion of the business
will be tested. Firms are responsible for testing other systems such as
payroll and accounts payable/receivable.
Question 5b. From SIA's perspective, what do you view as the most
significant Y2K problems facing the securities industry?
Answer. Our biggest Y2K concern would be any outside provider that
is beyond our capability to test such as power, telecom and water.
__________
Prepared Statement of Alan D. Lebowitz
Mr. Chairman and Members of the Committee, thank you for the
opportunity to testify about the steps the Pension and Welfare Benefits
Administration (PWBA) is taking under the Employee Retirement Income
Security Act, or ``ERISA,'' to assist employers and others responsible
for managing employee benefit plans in addressing the Year 2000
problem. I am Alan D. Lebowitz, Deputy Assistant Secretary for Program
Operations for PWBA.
PWBA is the agency of the U.S. Department of Labor responsible for
administering and enforcing ERISA, the primary Federal statute that
governs employment-based pension and welfare benefit plans. ERISA
establishes comprehensive fiduciary standards to govern the conduct of
those responsible for management and administration of employee benefit
plans. Among other things, a plan fiduciary must discharge his or her
duties with respect to a plan solely in the interest of the plan's
participants and beneficiaries. In addition, a plan fiduciary must
discharge those duties with ``the care, skill, prudence and diligence
under the circumstances then prevailing that a prudent person acting in
a like capacity and familiar with such matters would use in the conduct
of an enterprise of a like character and with like aims.'' A
fiduciary's failure to comply with ERISA's fiduciary responsibility
requirements may result in personal liability for losses incurred by a
plan or its participants and beneficiaries. In accordance with these
standards, plan fiduciaries, such as plan administrators, trustees, and
investment managers, are responsible for ensuring that plans and their
participants and beneficiaries are protected. Such protection includes
the establishment and implementation of a prudent procedure for
ensuring that the plans' own computers, and, to the extent possible,
those of the plans' service providers are Year 2000 compliant.
Because the Year 2000 or ``Y2K'' problem could have a substantial
impact on plan investments, benefit payments and other essential plan
operations, plan fiduciaries are responsible for establishing and
implementing a strategy to evaluate and ensure Year 2000 compliance.
Given the complex and technological nature of this problem, plan
fiduciaries may need to hire competent outside consultants and experts
to inventory, review, assess, convert and test the computer systems
relating to the plan. The plan fiduciary's selection of Y2K service
providers is subject to the same fiduciary considerations as the
selection of other plan service providers.
In addition to addressing the Year 2000 problem as it relates to
computer systems under their control, plan fiduciaries have an
obligation to determine whether the plan's critical operations will be
endangered by the computer systems of individuals and organizations
that provide services to the plan, such as third party administrators.
In this regard, plan fiduciaries are responsible for obtaining
information sufficient to evaluate the Year 2000 compliance of all of
the plan's existing service providers and determining what action is
appropriate to ensure that the interests of the plan and its
participants and beneficiaries are protected. In addition, when
selecting service providers, plan fiduciaries should include Year 2000
compliance among the factors to be considered. The plan fiduciary is
also responsible for monitoring as appropriate service provider
operations to ensure ongoing compliance and protection of the plan's
interests. Finally, due to the pervasive nature of the Year 2000
problem, it may not be possible to prevent a disruption of computer
operations. In recognition of that possibility, a plan fiduciary must
determine how best to protect the plan and its participants and
beneficiaries through the establishment of a contingency plan that will
be implemented in the event the plan's essential operations are
affected.
While in many instances, service providers to plans may have
responsibility under existing licenses, agreements or maintenance
contracts to participate in solving the problem and developing
contingency plans, in the end it is the plan fiduciary's responsibility
to be certain that their service providers are on top of the problem.
PWBA has implemented a comprehensive national outreach program to
help fiduciaries responsible for the over 700,000 pension plans and
more than 4.5 million other employee benefit plans offered by America's
private sector employers be as prepared as they can be to address the
Year 2000 issue:
--PWBA has issued two national alerts to the employee benefit
community warning plan administrators about the Year 2000
software problem and calling for immediate action. Those alerts
received widespread coverage by the trade and national press.
--PWBA has developed an extensive question and answer brochure
designed to give employers and other plan officials an
understandable explanation of how the Year 2000 problem impacts
their employee benefit plans and what steps they need to take
to address the problem.
--PWBA has posted all its Year 2000 materials on its Internet site at
www.dol.gov/dol/pwba, and has made those materials available to
the public through our toll-fee publication hotline at 1-800-
998-7542.
--PWBA has provided technical assistance in response to hundreds of
telephone inquiries on the issue both at the national office
and at the 15 regional and district offices.
--During the past year, senior officials from PWBA's national and
regional offices have engaged in and will continue to engage in
a grass-roots education campaign to raise the ERISA fiduciary
implications of the Year 2000 problem in speeches, lectures and
other presentations to groups of plan sponsors and employee
benefit plan professionals, including actuaries, accountants,
attorneys, institutional investors and plan administrators.
--PWBA's Office of the Chief Accountant has worked with the AICPA in
ensuring that the AICPA's 1998 Audit Risk Alert for the
employee benefit plan industry contains a section that gives
guidance to employee benefit plan auditors on informing clients
about Year 2000 preparedness.
--PWBA's investigators have already been reviewing the Year 2000
problem in the course of new and ongoing investigations.
Just as with the selection of service providers, fiduciaries of
plans must also consider Year 2000 preparedness in selecting
investments and assessing their current portfolios. The obligation to
consider Year 2000 compliance is especially important for employers
providing retirement benefits through 401(k) plans. Over 25.2 million
American workers are active participants in 401(k) plans. Workers who
participate in 401(k) plans contribute part of their salary towards
their retirement savings and may, in many instances, assume
responsibility for directing their own investments from investment
options selected by the plan fiduciaries.
PWBA strongly encourages plan administrators to disclose to their
participants and beneficiaries the extent of the plan's Year 2000
preparedness and the steps being taken to ensure that the Year 2000
issue does not interrupt the operation of the plan or participants' and
beneficiaries' access to their individual accounts. In addition,
because information regarding Year 2000 compliance may be necessary to
make an informed investment decision, participants and beneficiaries in
401(k) plans who have responsibility for directing their investments,
like plan fiduciaries, should consider Year 2000 issues when
determining how to invest their retirement assets.
I want to emphasize that PWBA is itself attending to its own Year
2000 matters. PWBA, of course, processes data--including submissions
from employee benefit plans--for public disclosure and to safeguard
these benefits. Following the practices and schedules through the
Federal Government, PWBA is working to ensure that the Year 2000
problems will not impair use of these important data.
As is shown by the other regulatory agencies and private sector
associations that are participating in this hearing, employee benefit
plans are getting assistance from various sources in assessing and
dealing with the Year 2000 problem. For example, the Securities
Exchange Commission and the Comptroller of the Currency as part of
their regulation of financial institutions, such as mutual funds,
banks, and insurance companies, and the Small Business Administration
in connection with small businesses, have also instituted Year 2000
initiatives. We believe those efforts also provide additional
protections to participants and beneficiaries with regard to the
computer problems and solutions faced by participants and beneficiaries
making investment decisions with regard to their retirement accounts.
Finally, I would note that, like the rest of the Federal
government, PWBA takes Year 2000 matters seriously and is taking steps
to make sure its systems continue to work correctly after December 31,
1999.
Thank you.
______
Responses of Alan D. Lebowitz to Questions Submitted by Chairman
Bennett
Question 1. Would you give us more detail on how the PWBA is
guiding and leading pension fund fiduciaries to be on the look out for
Y2K problems in their investment decisions?
Answer. PWBA's efforts to guide plan fiduciaries in addressing Year
2000 problems with respect to plan investments and other fiduciary
decisions have focused primarily on educating fiduciaries regarding
their duties and responsibilities in this area. In this regard, PWBA
has made public announcements aimed at alerting plan fiduciaries to
their potential liability and issued guidance both in print and on the
Internet that was designed to aid plan fiduciaries in identifying,
analyzing, and evaluating Y2K problems in all aspects of plan
operations, including investment decisions. PWBA's public outreach and
education approach also includes the Y2K reviews being conducted by
PWBA's field office the course of all new and ongoing civil
investigations. When a problem or issue is identified, the field office
staff will notify the plan fiduciary of the findings and issue a
warning that requests voluntary action to comply with ERISA's fiduciary
requirements. PWBA will soon be issuing additional guidance for
evaluating fiduciary liability which will include sample questions used
by field office staff in the course of conducting Year 2000 reviews.
Question 2. What is the scope of your outreach?
Answer. PWBA's Year 2000 outreach efforts are aimed at the broad
spectrum of individuals and entities that represent or provide services
to employee benefit plans. To reach such a large number of diverse
individuals and entities, PWBA has sought to employ the Internet and
presentations to groups representing major constituent groups, such as
employee benefit plans as well as plan service providers such as
attorneys, accountants and actuaries. By using these means PWBA has
capitalized on the ``multiplier effect.'' For example, the items
published on the Internet have been republished in trade journals and
individuals attending the group presentations have distributed the
materials to their own clients. The types of groups to which PWBA
officials have made recent Y2K presentations have included the American
Bar Association, the American Institute of Certified Public
Accountants, the American Society of Pension Actuaries, the
International Foundation of Employee Benefit Plans, and the U. S.
Chamber of Commerce.
Question 3. How often is your web page and ``1-800'' line utilized
to obtain help on making Y2K investment risk decisions?
Answer. Although the Department's web counting system does not
track the actual number of ``hits'' on PWBA's Y2K materials, other
available information indicates there have been about 2,000 hits on the
material since July 1998. In addition, the Y2K brochure which was
published on the Internet to answer questions relating to plan
fiduciaries' potential liability in connection with Year 2000 issues
was also printed in hard copy.
Approximately 2,300 copies of the Y2K brochure were initially
printed and all have been distributed. In response to demand, an
additional printing of 25,000 brochures has been ordered and, when
completed, will be available to the public through PWBA's ``800''
document request number.
Question 4. Would you tell us what you are finding at this moment
on how Y2K is impacting fund administration and operations?
Answer. Information obtained from PWBA's field offices indicates
plan fiduciaries are generally aware of the Year 2000 problem, however,
at the present time, we cannot conclude that this awareness has
resulted in the necessary corrective actions being taken. In conducting
their Year 2000 reviews, the field office staffs are notifying plan
fiduciaries of their obligations and potential liability with respect
to the Year 2000 problem and of the need to take appropriate measures
to protect the plans' interests. Such measures include the plan
fiduciary evaluating a plan's administration and operation for Year
2000 compliance. Because the Year 2000 problem is not expected to
adversely impact the fund's administration and operations until after
December 31, 1999, to date, the PWBA field office staffs have not
identified any losses resulting from the Year 2000 problem.
As noted above, the focus of the PWBA field office staffs at this
time is on educating plan fiduciaries regarding their obligations to
address the problem before such losses actually occur. In those cases
where field office investigators have determined plan fiduciaries have
not taken appropriate action to protect the plans' interests, the field
offices have been directed to conduct appropriate follow-up measures.
Commencing October 1, 1998, field office staffs will be using a list of
sample questions to conduct more in-depth reviews of the Year 2000
issue. As indicated above, the detailed guidance and accompanying
sample questions will soon be made public.
Question 5. How about strategic investment decisions?
Answer. As noted above with respect to fund administration and
operations, little information is available to evaluate how the Year
2000 problem is impacting strategic investment decisions by plan
fiduciaries. PWBA's efforts have focused on informing plan fiduciaries
that they have an obligation under ERISA to consider the impact of the
Year 2000 problem when making investment decisions. Like other
investors, however, plan fiduciaries can only base their investment
decisions on information available in the marketplace. Accordingly, the
SEC's requirements relating to the disclosure of Y2K information by
publicly-traded corporations, investment advisers and mutual funds are
important because these rules are designed to ensure that all investors
have access to the type of Y2K information needed in making investment
decisions. To the extent such information is available, plan
fiduciaries are obligated under ERISA to consider it in the course of
making their plan investment decisions.
__________
Prepared Statement of Eugene F. Maloney
Good morning. My name is Eugene F. Maloney. I am Executive Vice
President and Corporate Counsel with Federated Investors in Pittsburgh,
Pennsylvania. I am also a member of the Board of Directors and the
Executive Committee of the firm. For the last eleven years I have also
been a member of the faculty of Boston University Law School where I
teach a course in the Masters Program on the Trust and Securities
Activities of Banks.
Federated Investors is a New York Stock Exchange listed company
which, through various subsidiaries, sponsors, manages, administers and
distributes a family of mutual funds used primarily by financial
intermediaries. As of the close of business yesterday, assets under
management or administration exceeded $150 billion, which places us in
the ranks of the top ten asset managers in the United States. A
substantial majority of the assets in our funds represent investments
made by over 1,500 bank trust departments acting in the capacity of
either a personal trustee or ERISA fiduciary.
Since the beginning of May, our firm has focused significant
resources on the Y2K issue as it relates to the investment management
process. Briefly, I will take you through what we have done to date,
and what we intend to do in the future. At the present time, our
investment professionals are assembling information from both primary
and secondary sources which will allow them to apply traditional
analytical tools to the process of evaluating which securities to buy,
hold or divest as the case may be as the millennium approaches. We have
retained counsel skilled in Y2K matters to assist us as we move
forward. We have also consulted with members of the accounting
profession who have experience in reviewing and opening on the
financial statements of public companies. This dimension has been
useful and will continue to be such as the regulatory agencies,
particularly the Securities and Exchange Commission, require more
forthright disclosure from issuers as to Y2K readiness in their public
filings.
Modern Portfolio Theory operates on the premise that everything
that is known or knowable about the price of a publicly-traded security
is already fully reflected in its price. Professional securities
analysts are thus largely limited to interpreting information in the
public domain and available to other analysts. This process is just
beginning to take shape, and we detect a growing awareness on the part
of the analyst community of the need to broaden their evaluation of the
securities they follow, to include Y2K preparedness in the context of
the ability of a company to continue as a going concern over the
millennium. This will require an adjustment of sorts on their part in
that conventional wisdom holds that the price of a security represents
the present discounted value of its future earnings.
In May of this year when I became involved in the Y2K issue, it was
clear that the analyst community had not focused on the issue of
business risk as it relates to Y2K and were content with the vague
statements made by issuers as to expenses incurred to date and their
self-evaluation of their Y2K readiness. I expect this to change
dramatically as issuers begin to comply with the disclosures required
by the Securities and Exchange Commission in their recent release.
Working with counsel, we have written to the majority of companies
whose equity or fixed income securities are owned by the funds we
manage. In the domestic equity area, to date we have received a 23
percent response rate, the quality of which is very uneven. Follow-up
mailings have been made to those companies or issuers which did not
respond to the initial mailing. A Y2K file has been opened on each
security we own, and our analysts have the responsibility of tracking
issuer readiness going forward. Each of our investment areas has a Y2K
coordinator, and all activities relating to determining Y2K readiness
of issuers or efforts made to increase our understanding of Y2K and its
impact on the capital markets is documented in a central file.
Shifting to the whole area of money management, we think that it is
critical that Y2K be kept in a proper context. One of the principal
responsibilities of the professional fiduciary is to manage risk. The
prism through which his conduct vis-a-vis Y2K will be viewed is the
Prudent Investor Act (the ``Act''). The Act requires a trustee to
diversify the assets of a trust, unless the trustee reasonably
determines that because of special circumstances the purposes of the
trust are better served without diversifying. Mutual funds have been
identified as the ideal instruments for achieving the degree of
diversification required by the Act. One then has to ask if the
prospective impact of Y2K on the capital markets in general is the
``special circumstance'' \1\ contemplated by the Act which would permit
or require a fiduciary to underdiversify a portfolio by going to all
cash, for example, while at the same time recognizing significant
capital gains with the attendant tax liability. The justification for
not requiring diversification is Andrew Carnegie's: ``Put all your eggs
in one basket and watch the basket.'' A court that accepts Modern
Portfolio Theory is likely to regard diversification as mandatory
except upon a showing of special insight by the trustee. No such
insight has become apparent to us which would countenance a fiduciary
abandoning a strategy of broad diversification as a way to successfully
counter any issuer risk presented by Y2K.
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\1\ The official comment to the Act identifies two situations in
which resisting diversification might be appropriate: first, when the
tax cost of selling low-basis securities would outweigh the gain from
diversification; and second, when the settler mandates that the trust
retain a family business.
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Many articles are starting to appear which predict a global
``technology winter.'' While some level of turmoil is to be expected,
some people say it will be temporary in nature. No credible source has
predicted a permanent impairment in the value of the securities of
publicly traded companies either as a group or by industry.
Time is one of the most important dimensions of the money
management process. In that the investment horizon of a corporate
fiduciary tends to be long term, the Prudent Investor Act functions as
a deterrent to those tempted to liquidate highly appreciated securities
to deal with the consequences of a short-term event. We feel that it is
important that our clients begin the process of ensuring that their
clients in turn have a proper understanding of time horizon to put Y2K
in proper context.
If the client's risk perceptions are inaccurate, he cannot make
wise decisions. Our task is to provide a frame of reference that
enables the client to correctly perceive risks within the context of
his situation. Surprisingly, a client's risk tolerance can change
within a rather broad range, based on an improved understanding of the
investment management process. The informed modification of risk
tolerance is one of our major responsibilities to our clients, and
represents a great opportunity to add value. The modification of risk
tolerance is often in the direction of helping clients to become more
comfortable with equity investments for long time horizons.\2\
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\2\ Roger C. Gibson, ``Asset Allocation: Balancing Financial
Risk,'' Richard D. Irwin, Inc.. 1990, p. 98.
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In an article written for the Iowa Law Review, John Langbein, the
author of the Prudent Investor Act, provides the fiduciary community
with the rosette stone to decipher the Y2K riddle:
``Efficient market theory instructs us that it is impossible to
outsmart the market by predicting which securities will do better or
worse. Owning many securities enhances the chances of offsetting losers
with winners.
``In the literature of Modern Portfolio Theory, a telling
expression has been coined to describe what is wrong with
underdiversification: uncompensated risk.
``Diversification tends to push the investor toward very large
portfolios. Although much of the benefits of diversification can be
achieved with a carefully selected smaller portfolio, optimal
diversification probably requires a portfolio containing hundreds of
issues. Relatively few investors, or for our purposes, relatively few
trust funds have that much money to invest. Accordingly, an investor
who seeks to eliminate the uncompensated risk of underdiversification
will usually need to invest in some form of pooled investment vehicle,
such as mutual funds * * *'' \3\
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\3\ John A. Langbein, ``the Uniform Prudent Investor Act and the
Future of Trust Investing,'' Iowa Law Review, March 1996, Vol. 81/No.
3. pp. 648-649.
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Neither the Prudent Man Rule nor the Prudent Investor Act are
predictive nor outcome-based statutes. A corporate fiduciary is not
required to be clairvoyant; rather, the prudence or imprudence of an
act will be evaluated based on the process which was utilized that
resulted in a particular course of conduct. As Y2K comes into sharper
focus, it is incumbent on the fiduciary to create a record that its
implications on how a portfolio is managed were considered.
It was not shown in any instance that the losses to the trust fund
resulted from imprudence or negligence. There was evidence of attention
and consideration with reference to each decision made. Obviously, it
not sufficient that hindsight might suggest that another course would
have been more beneficial; nor does a mere error of investment judgment
mandate a surcharge. Our courts do not demand infallibility, nor hold a
trustee to prescience in investment decisions.\4\
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\4\ In Re Kemshe Trust, 305 N.W.2d 169.
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______
Responses of Eugene F. Maloney to Questions Submitted by
Chairman Bennett
Question 1. You have reported several things in your [written]
testimony that give me great pause. First, you said that as of May of
this year, ``it was clear that the analyst community had not focused on
the issue of business risk as it relates to Y2K * * * .'' You said that
you expected that this would change dramatically as issuers begin to
comply with SEC disclosure requirements. I feel it is already quite
late for analysts to begin focusing on this issue.
--Can you give this committee and the American public any assurance
at this time that attention to Y2K risk is actually occurring
now in the investment analyst community?
--How soon is this likely to happen?
--What will be the surefire indications that analysts are taking Y2K
risks seriously?
Answer. It is the opinion of our Investment Research Department
that the analyst community is now viewing Y2K in a business risk
context as well as its implications for current and future earnings. It
is our opinion that the stock market will begin to factor Y2K
readiness, or lack thereof, into the price of an issuer's securities
early in the first quarter of 1999, if not sooner. In conversations
with two brokerage firms, I have been given to understand that analysts
who have been given specific responsibility for understanding and
articulating Y2K in a capital markets context will make statements in
behalf of their firms in the late fourth quarter of 1998 or early first
quarter of 1999. I further understand that the statements will be
delivered in the context of business risk as opposed to the impact Y2K
might have on issuer earnings.
Question 2. Mr. Maloney, you mentioned that working with counsel
you wrote to the majority of companies whose equity or fixed income
securities are owned by the funds you manage and you only received a 23
percent response rate. Why do you think the response rate was so low?
You characterized the responses as uneven. Could you elaborate on what
you mean by this?
Answer. It is our view that the 24 percent response rate we
received as a by-product of our writing to a majority of the companies
whose securities we own is based on a lack of understanding by senior
managers of the respective organizations that Y2K risk can very quickly
get translated into shareholder value or lack thereof. Furthermore, it
is not presently understood by senior officers of public companies that
at some point a lack of candor on Y2K readiness will be translated into
a decision by institutional investors not to buy or hold their
company's securities. We see this attitude changing based on the
disclosure required by the Securities and Exchange Commission in the
next generation of financial statements public companies are required
to file. Responses that we did receive ran the gamut from elaborate
personalized letters within which the authors went into considerable
detail to explain their company's Y2K readiness to handwritten notes on
our inquiry letter that were of no value. In our view, the unevenness
is a further reflection of the lack of understanding by senior officers
of publicly-traded corporations of the impact the lack of Y2K readiness
is going to have on their company's shares and, hence, shareholder
value.
Question 3. At what point should a prudent investment adviser begin
to divest their ownership interests in companies because they are not
able or are unwilling to answer questions about their Y2K readiness?
Answer. Our company and I suspect the vast majority of other money
management firms are still in the information gathering phase of Y2K
preparedness. We have not formally decided at what point we will sell
shares of companies who are either unwilling or unable to respond to
our inquiry concerning Y2K readiness. On a very preliminary basis, we
have concluded that a lack of candor in response or no response at all
will, in all likelihood, require us to divest.
Question 4. Mr. Maloney, you make the point in your testimony that
(1) Y2K is just one of many risk factors that an investment analyst
should consider and (2) that by ``helping clients to become more
comfortable with equity investments for long-term horizons,''
investment advisers can help investors feel more comfortable about the
Y2K problem. Also, you conclude your written testimony with, ``Our
courts do not demand infallibility, nor hold a trustee to prescience in
investment decisions.'' I must say that I find this position very
cavalier. Y2K is very much like a hurricane forming off the Sahara and
heading toward U.S. shores. It is a known threat rather than an unknown
possibility. Would it be responsible for the U.S. Government to advise
coastal residents that hurricanes are just one risk we must face and
that anyway, in the long run, things will be all right overall?
Besides, one can't hold the Government responsible since the Government
can't predict exactly where the storm will hit?
Answer. It was not my intent either in my oral testimony or written
submission to suggest that Y2K presents risks that are similar to other
risks that an analyst might factor into his recommendation in the
ordinary course of business. We have concluded that Y2K presents unique
risks to issuers. As a result, an analyst, in order to make an informed
decision as to the circumstances of an issuer, needs to make every
effort to develop protocols on how to ascertain issuer readiness beyond
what a company might say in a public filing. In all likelihood,
conversations will probably have to take place between the analyst and
information technology officers or Y2K project managers at the
companies they cover. This is not familiar territory for an analyst who
is trained to evaluate a company's prospects based on present estimates
of future earnings. The money management community is subject to the
provisions of ERISA, the Prudent Man Rule and the Prudent Investor Act,
all three of which are process-driven statutes. They are not predictive
nor do they require the money manager to be clairvoyant. The point I
wished to make in my testimony was that a financial intermediary that
does not adequately document the steps he has taken to ascertain the
Y2K readiness of an issuer runs the risk that at a future point in
time, he will become the guarantor of the performance of the security.
I did NOT mean to suggest that Y2K is in any sense of the term an
ordinary risk and should be treated as such.
__________
Prepared Statement of Bert E. McConnell
Mr. Chairman, Mr. Vice Chairman and other distinguished members of
this special committee, thank you for the opportunity to describe
Fidelity Investments' program to address the Year 2000 problem. My name
is Bert McConnell. I am a Senior Vice President at Fidelity Investments
and head of the Fidelity Year 2000 program.
First let me tell you who we are. Fidelity Investments is the
nation's largest mutual fund company and one of the leading providers
of financial services. We are also the No. 1 provider of 401(k)
retirement savings plans and one of the largest discount brokerage
firms in the United States, with total managed assets of over $615
billion. Fidelity is a technology-intensive company, with over 6,000
information technology professionals dedicated to meeting customer
needs through the use of state-of-the-art technology solutions. Our
Year 2000 program includes our technical professionals in all of our
sites, including Boston, New York, Covington/Cincinnati, Dallas, and
Salt Lake City, as well as our international locations.
In early 1996, we recognized the need to begin preparing all of our
systems to seamlessly handle the change of year from 1999 to 2000. We
also recognized that the issue involves more than changing lines of
code on mainframe systems; it involves extensive testing of our
software and hardware platforms, from the mainframe to client server
systems to the desktop, as well as testing with outside vendors.
With the size of our challenge in mind and with the strong support
of top level management, Fidelity began its Year 2000 project in March
1996. We currently have well over 500 people dedicated exclusively to
the Year 2000 project, including systems and business professionals
across all areas of Fidelity's operations who are overseen by our
Fidelity 2000 team. Each Fidelity business unit is involved in our
extensive company-wide communications strategy and awareness campaign
and has direct responsibility for managing its Year 2000 effort.
Fidelity's firm-wide budget for this project is in excess of $300
million. Fidelity today is well on the way to meeting our goal of
seamless processing for all Fidelity systems and applications, and we
are on schedule to provide uninterrupted business operations and
service to our customers going into Year 2000. In fact, we have every
confidence that we will be ready well before the year 2000.
More specifically, 100 percent of our mission critical systems and
supporting products have been inventoried, and all of Fidelity's
internal code for these systems has been analyzed. By mission critical
we mean all business systems that are directly linked to our ability to
service our customers. In addition to analyzing all of our internal
code, Fidelity has already made code changes to over 94 percent of
these business systems. We are on track for fixing the remainder of
these mission critical systems by the end of 1998.
Although we hear a lot about fixing lines of code, the real
challenge of the Year 2000 project is, in large measure, testing the
systems. This is where we are currently allocating most of our
resources. Fidelity's testing involves three distinct phases we call
waves.
Wave 1 tests all Fidelity business systems individually using tools
to simulate the Year 2000. In effect, we make our computers think it's
the Year 2000. During this phase we test, for example, our ability to
open a new mutual fund account. We have already successfully tested 86
percent of our mission critical systems and are on schedule to complete
Wave 1 by the end of this year.
In Wave 2, all of our systems are tested together. Wave 2 takes
place on computers that have had their internal clocks actually set to
the Year 2000, a sort of ``time machine.'' In the ``time machine'' we
only install Year 2000-ready Fidelity and vendor software. During this
phase, for example, we test the ability to enter a buy order for shares
of a mutual fund, process the order based on the end of day net asset
value received from our pricing system and prepare a confirmation of
the transaction through our automated print system. We are more than
halfway through our Wave 2 testing cycles and are on track to complete
the last cycle in February of 1999.
In Wave 3, we're using our time machines to test with our outside
business partners, such as stock exchanges, banks, and broker dealers.
During Wave 3, we will test, for example, our ability to price a fund,
by testing the data feeds from our data service providers as well as
posting fund activity and money movement through outside banks. Because
the financial services industry does not stop at our national borders,
Wave 3 testing includes vendors in the U.S. and abroad. We are proud to
take a leadership position with the Securities Industry Association's
(SIA) successful industry-wide Year 2000 test this past July. We will
take a similar leadership role in the SIA's final industry-wide Year
2000 test next Spring. Wave 3 testing will run until September 1999.
We are pleased to report that testing is on schedule and no
significant problems have been encountered.
I've just finished describing how our corporate systems are being
fixed and tested for the Year 2000. Now I'd like to describe our
program for fixing and testing desktop personal computer hardware and
software. The desktop program includes analyzing, fixing, and testing
desktop software and hardware for over 30,000 employee workstations.
Due to continual changes and upgrades in personal computer hardware and
software, we intentionally launched this program early this year and
expect to complete it by June of 1999.
Up to this point, I've been talking about all of the work that
we've been doing internally. However, Fidelity knows that the
investment business is global. We interact daily with a large number of
companies, both in the United States, and internationally, that provide
services to Fidelity. For example, in order to process a stock trade,
we communicate with broker dealers, transfer agents, and stock
exchanges. We recognize that our success is not only dependent on our
being ready, but on these major business providers--especially the
utilities and telecommunications industries--being ready as well.
We rely on approximately 165 technology vendors, and approximately
90 other outside parties who are essential to serving our customers. We
maintain an active communication program with these vendors and outside
parties and are encouraged that the majority of these companies has
given us assurances that they will be Year 2000 ready. We monitor these
companies and work with those who may not be Year 2000 ready. We are
developing detailed contingency plans and will move to alternate
suppliers if necessary.
Fidelity's contingency planning for the Year 2000 is part of our
normal disaster recovery and risk management contingency planning.
Contingency planning has been broken down into three key areas. The
first would be for those events which affect everyone across the
industry and have no viable alternative, for example if we were without
power, telephones or water for an extended period of time. The second
is more reactive contingency planning, i.e. what to do if there are
selective outages. We are identifying and developing alternatives that
would be instituted for a limited of period of downtime. The third key
area involves being more proactive. We are conducting readiness
assessments of our vendors and business service providers and are
validating interface testing as part of the Wave 3 effort. We have more
than 150 business contingency planners across Fidelity focused on
identifying, testing and, where needed, implementing appropriate
contingencies.
In the midst of our Year 2000 testing, we receive letters, phone
calls and electronic mail messages daily from our customers about Year
2000 issues. They want to know that we are taking appropriate actions
so that on Monday, January 3, 2000 their money will be available to
them, their statements will reflect accurate balances, and they will be
able to execute transactions with Fidelity. This is what we call
``seamless processing'' and Fidelity has committed the time, the money,
and the expertise to achieve this level of processing. In addressing
these concerns, our continued focus and commitment is to stay on track
in our plan to achieve Year 2000 readiness. We are also addressing our
customers' concerns by communicating with our customers through our
Year 2000 statement on our website, fidelity.com, and responding to
customer inquiries.
For Fidelity, Year 2000 readiness is an ongoing process, not a
result that can be achieved in 1998 or 1999. We know that our efforts
cannot stop once our systems are fixed, or on January 1, 2000. It will
be a continual effort to maintain Year 2000 readiness throughout the
organization and to minimize risks to seamless processing for Fidelity
systems and our customers.
That concludes my brief description of Fidelity's Year 2000
technology program. We also know that the Year 2000 is an issue not
only for financial services companies, but also for the portfolio
companies in which mutual funds invest. Fidelity agrees with Mr. Fink's
statement. As a mutual fund company, Fidelity's overriding obligation
is to maximize shareholder value for its investors consistent with the
investment objectives of the funds. We think it would be inappropriate
to seek to impose on a fund manager a specific obligation to evaluate
the Year 2000 risk differently from the way that other risks are
evaluated.
Fidelity continues to use a bottom-up approach in its research. Our
portfolio managers and research analysts seek to identify and evaluate
all facts about a company that may have an impact on the value of a
company. Our analysts and fund managers have been briefed on the Year
2000 issue and equipped with appropriate questions to ask senior
management of these companies. The information on Year 2000 that we
receive is only one piece in the mosaic of information we consider in
making investment decisions. Evaluation of Year 2000 risk for a given
portfolio company cannot be made in isolation but rather must be
weighed in the total mix of information that bears on the investment
merits of that company. In addition, no single investment is viewed in
isolation but is evaluated in terms of its place within the portfolio
of a given fund.
We appreciate the opportunity to discuss with you Fidelity's Year
2000 program and we welcome Congressional participation in ensuring
that the Federal government will also commit the necessary resources to
prepare for the Year 2000. We also welcome Congressional support for
legislation that will encourage information sharing and a higher level
of awareness and preparation by limiting the liability of companies
that work diligently to develop and implement Year 2000 programs.
This concludes my testimony. Thank you.
______
Responses of Bert E. McConnell to Questions Submitted by
Chairman Bennett
Question 1. In your testimony, you outlined a very comprehensive
Year 2000 Project, however I did not hear you address embedded
microchips. On your WWW page, you note that a team of dedicated
facilities experts is addressing this issue. Would you please describe
their efforts and progress. What kind of response are they receiving
from device/system manufacturers? Are you performing additional testing
to verify claims/statements of compliance? If so, how would you
characterize the results of your tests? How are embedded device/systems
integrated into your contingency plans?
Answer. Although Fidelity's mission critical systems do not depend
upon embedded microchips to the extent that systems operated by other
industries, such as manufacturing, do, we have inventoried our physical
infrastructure products, and have contacted the appropriate
manufacturers regarding these products' Year 2000 readiness.
Manufacturers have been responsive to our queries and have provided
assurances that they are Year 2000 ready. However, whenever we
encountered these embedded microchips, we are verifying the
manufacturer's information by testing these products, and replacing or
upgrading them if necessary. Moreover, we are also focusing on owned
and leased facilities occupied by Fidelity employees. We are working
with landlords of leased buildings to determine the status of their
Year 2000 programs. In addition, Fidelity is conducting detailed
contingency planning for equipment as necessary. These detailed
contingency plans include alternative plans for substituting,
replacing, or switching to other sites or equipment if there were a
problem with an embedded microchip.
Question 2. You note that it would be inappropriate to seek to
impose specific fund manager obligations to evaluate Year 2000 risks
differently from the way other risks are evaluated. How are Year 2000
risks integrated into portfolio managers' end research analysts'
identification and evaluation of all facts impacting on a company's
value? What level of confidence is there that all mutual fund companies
are educating their fund managers and analysts sufficiently to include
it in their portfolio evaluations and decisions?
Answer. Fidelity communicates company-wide information about Year
2000 risk and the status of our own internal Year 2000 remediation plan
at internal business briefings, articles in employee newsletters,
company-wide e-mails, and the company's intranet site. In addition, we
have specifically communicated Year 2000 risks and issues to our
analysts and portfolio managers and have furnished them with questions
to consider in evaluating companies.
Fidelity cannot speak for all mutual fund companies. However, our
experience with our business providers, data suppliers, and the
participants in the SIA Beta street test indicates that significant
attention and resources are being focused on this problem.
Question 3. How are the 500+ people exclusively dedicated to the
Year 2000 project spread among your three dedicated teams: Aware,
Assure, and the Technology Center teams? How is responsibility and
accountability for Year 2000 efforts fixed throughout these teams?
Answer. The number of people that Fidelity applies to the Year 2000
project will vary over the life of the project. We began staffing the
project and dedicating resources early in 1996. We are currently
peaking with well over 500 people in late 1998, with plans to reduce
the project staff by year-end 1999, as coding and testing are
completed. In addition, Fidelity has over 6,000 information technology
professionals that can be reassigned to play a role in this project if
necessary. When the clock rolls to the Year 2000, all of our technical
professionals will become ``Year 2000'' support technicians, able to
address problems that may arise.
Fidelity has hired contractors and consultants to augment its staff
for the Year 2000 project. All contractors and consultants are under
the supervision of full-time Fidelity employees. The Fidelity 2000
project includes the following functions:
--Awareness/Communications: Year 2000 communications efforts are
broken out into two groups. The first, Aware 2000, is
responsible for internal communications--raising awareness of
the Year 2000 issue and the project itself within Fidelity
Investments. This team facilitates communication and
disseminates information firmwide. For example, an extensive
Desktop Compliance awareness program has been put in place to
communicate to Fidelity employees through corporate-wide
electronic mail campaigns, articles in internal newspapers, and
participation at Fidelity's internal technology presentations.
A second team, Communicate 2000, is responsible for
coordinating and facilitating external communications to
customers and external parties. As of September 24, 1998, these
communications teams consisted of 10 dedicated professionals
working in conjunction with Corporate Communications and the
business units.
--Assurance: Assure 2000 provides guidance and oversight to all
Fidelity business units through an assessment process and
through monitoring the progress of each business unit. It is
also responsible for disseminating internal guidelines among
the business units, tracking the efforts of the organization's
vendors and business providers, and coordinating the external
industry-wide Securities Industry Association ``street test''.
As of September 24, 1998, this team consisted of 52
professionals.
--Technology Center: Brokerage Build 2000, Build 2000, and Test 2000
are groups of technical experts with significant Fidelity
financial systems experience, as well as expertise in
mainframe, midrange, and client server technologies. These
groups are responsible for: remediating a significant
percentage of Fidelity's systems; providing specialized Year
2000 technical services to Fidelity business units; and
coordinating the test efforts for all of the applications that
are undergoing system testing, integrated regression testing,
and testing with external third parties. Additional activities
include reviewing test strategies, providing environments, and
accomplishing test objectives. As of September 24, 1998, this
team consisted of 227 professionals.
--Business Unit Year 2000 Teams: Each Fidelity Investments business
unit has assigned a Year 2000 project manager and necessary
staff consisting of technical experts with significant Fidelity
financial systems experience. They are responsible for
remediating Fidelity's systems, defining test strategies, test
plans, test cases and installing the completed system back into
a full production environment, all as components of the overall
Fidelity 2000 project. As of September 24, 1998, these teams
together comprised over 225 individuals.
Question 4. How long did it take to inventory all of your systems?
In the process of conducting your systems inventories, how did you
address and inventory the issue of system interfaces? In your testimony
you indicated that you are more than halfway completed with ``Wave 2''
and scheduled to complete it in Feb1999. What issues have arisen that
may give you pause in anticipation of scheduling ``Wave 3'' testing
into September 1999? Is three months enough for any unanticipated
problems with ``Wave 3?'' What types of contingency planning are being
done for this possibility?
Answer. The process of performing the inventory of applications was
the first step in our Analysis activities. This phase began in 1996.
All systems, other than desktop systems, were inventoried in 1996, and
a refined inventory was completed by the middle of 1997.
In the course of inventorying systems, we conducted an additional
inventory of each core interface by querying the application experts
concerned, and creating a database of these interfaces so they could be
monitored, fixed and tested. When systems interfaces were identified
and required remediation, we remediated our own systems, or contacted
the data provider or other interface owner to initiate planning for the
Wave 3 testing effort.
The Wave 2 and Wave 3 testing phases overlap in time. Wave 3
involves interfaces with external parties such as financial services
business providers and data suppliers, all of which will not be
available to test with others until late 1998 or early in 1999. The
Wave 2 and Wave 3 test phases overlap because many applications will
have completed Wave 2 testing at separate times, and external providers
are ready to test with us at different times. As a result, we begin
Wave 3 testing as soon as both parties are ready to test.
Wave 2 began late in 1997 and will continue into the first quarter
of 1999. Wave 3 began in mid 1998 with the SIA Beta industry-wide test,
and will continue through September 1999. However, critical aspects of
Wave 3 testing, such as the full SIA Street test, the market data
industry-wide test, and certain major client testing is expected to be
completed by June 1999.
We believe there will be ample time to test with the remaining
third parties between June and September 1999. We are developing
detailed contingency plans in the event that any of these external
parties do not meet Fidelity's standards for Year 2000 readiness.
Question 5. As a leader in the Securities Industry Association's
July industry-wide Year 2000 test, what lessons can you share with us?
How are the results of this ``pre''-test being integrated into the
planning for next Year's final industry-wide testing?
Answer. The SIA industry-wide Year 2000 test, which involved
leaders in the financial services industry, was by and large a very
successful test. Problems detected were not directly related to the
Year 2000, but were logistical connectivity problems between the
participating firms and the Wall Street exchanges and utilities. The
major lessons learned were the involvement necessary to create the
communications between these organizations. To simulate the majority of
transactions, simplified and streamlined test scripts should be
developed that reduce the time spent in communications coordination in
the test environment. Complex transections' testing can also be made
more efficient by streamlining the test scripts.
To prepare for next year's test, Fidelity and other SIA member
firms will be conducting additional pre-tests, to test the final
approved scripts and connectivity via test and production systems.
Question 6. In your testimony you indicated that you relied on 165
technology vendors and approximately 90 other essential outside
parties. What kind of response rate have you had in evaluating their
Year 2000 preparedness? For those that have assured you of that they
will be Year 2000 ``ready'', do they provide you with their definition
of ``ready?'' What is your level of confidence in their response? Are
you performing independent testing to confirm their assurances?
Answer. Of over 250 core vendors, all but six have provided quality
responses to our Year 2000 inquiries. The Assure 2000 group performs
assessments of the core products that Fidelity depends upon. As we do
not rely exclusively on any one's statement, we are testing all
critical systems interfaces. We do ask vendors how they intend to
become Year 2000 ready (windowing, expansion, other) and we test for
Year 2000 readiness consistent with their responses.
__________
Prepared Statement of Senator Daniel Patrick Moynihan
Over the past decade, Americans have invested increasing amounts of
money in the stock market. The vast majority of individuals invest
their funds in pension plans and mutual funds. Eighty-fve million
Americans participate in pension plans that accounts for $3.6 trillion
in assets, about half of which is in the stock market. There are 6,889
mutual funds in the United States with total assets of $4.9 trillion,
of which 55 percent is invested in stocks. Pension plans and mutual
funds are a vital part of the economy, and it is essential that fund
managers fix their computers and make sure that the companies they
invest in are Year 2000 (Y2K) compliant. Failure to do so could be
catastrophic.
At today's hearing, our distinguished panel will talk about how
pension plans and mutual funds are progressing on the Y2K problem. I
remind some of our witnesses today that as fund managers they are
fiduciaries under the law and are legally obligated to safeguard assets
for the benefit of investors. As part of their fiduciary duties, fund
managers are obligated to make sure their computers, as well as the
computers of the companies they invest in, are Y2K compliant. As for
our government witnesses, I remind them of John Locke's conception of
government as a fiduciary trust with the obligation to act in the
interest of the people. They, too, need to address the Y2K problem to
fulfill their fiduciary responsibilities.
On July 6, 1998, Senator Robert F. Bennett (R-UT) and I held a
hearing on Wall Street to see how the financial service sector was
progressing on the Y2K problem. At the hearing, the Senior Vice
President and Chief Technology Officer of the New York Stock Exchange,
William A. Bautz, said that the Y2K problem is the ``biggest business-
technology effort that the world has ever experienced.'' The biggest
business-technology effort that the world has ever experienced.
The Securities and Exchange Commission (SEC) and the securities
industry are working hard to tackle this challenge. In fact, I was most
pleased to see that the securities industry conducted an industry-wide
test this past summer and the results were positive. One of the keys to
solving this problem is testing. At the hearing in New York, the First
Vice President of the Federal Reserve Bank of New York, Ernest T.
Patrikis, said that ``he does not think it is possible to over-
emphasize the importance of testing to help improve readiness.''
While the U.S. financial service sector is making good progress on
Y2K, I am concerned about the reluctance of companies to share
information on Y2K. In their SEC filings this past summer, the top 250
largest companies did not release adequate details on their progress on
Y2K. Most companies, in fact, avoided specifics, leaving investors and
analysts uncertain about how vulnerable they are to the bug.
We must encourage companies to share information on Y2K. It is for
this reason that I joined with Senators Robert Bennett and Christopher
J. Dodd (D-CT) on July 30, 1998 in introducing President Clinton's
``Y2K Information Disclosure Act''--legislation that promotes the
opening sharing of information. Yesterday, the White House and members
of the Y2K and Judiciary Committees reached a compromise on the bill.
The Judiciary is expected to mark up the bill today. I cannot stress
the importance of passing this legislation.
There are now just 470 days until the year 2000 and just a few
months before the government and the private sector must start their
testing. No time to waste. I am hopeful that we will have this problem
in check come the year 2000, but, as the Duke said of Waterloo, it will
be ``a close run thing.''
__________
Prepared Statement of Thomas M. Rowland
i. introduction
I am Thomas M. Rowland, Senior Vice President--Central Services
Group, of The Capital Group Companies, Inc. (CGC). I am the individual
with primary responsibility for the Year 2000 Project at The Capital
Group Companies. I and the entire Capital organization appreciate the
opportunity to testify before the Special Committee today on our
efforts to prepare for the Year 2000. The Special Committee (and the
Securities and Exchange Commission, our principal regulator), should be
commended for their leadership in helping focus attention on this
issue--one with broad-reaching implications for the public, including
those who invest in U.S. mutual funds.
As background, The Capital Group Companies provide investment
management and related services to a diverse client base, including
individuals, corporations and institutions. Capital Research and
Management Company (CRMC) is the sponsor and investment manager of the
28 mutual funds in The American Funds Group. The funds are sold through
independent broker-dealers and currently have more than $225 billion in
assets and more than 9 million shareholder accounts. CRMC is also the
investment manager of the 10 variable subaccounts in the American
Legacy variable annuity. The Global Institutional Group, including
Capital Guardian Trust Company and four other management companies,
provides global institutional investment management services to clients
throughout the world. Overall, the Global Institutional Group manages
more than $110 billion in institutional assets.
CGC provides centralized administrative and information technology
services to the entire Capital organization (which is owned by
employees and traces its roots back more than 65 years).
ii. current status at capital group
Capital is committed to achieving Year 2000 compliance across all
of our significant business systems and operations by December 31,
1998. We have a well-defined plan, ample resources, and excellent
momentum toward achieving that goal. Our progress to date indicates
that we will meet the December 31, 1998 target for Year 2000 compliance
of our internal systems. While we have made significant progress toward
achieving compliance within our information technology infrastructure,
our focus is now on assessing the Year 2000 readiness of our
significant vendors and development of appropriate contingency plans.
Where electronic interchanges and dependencies exist, we will conduct
appropriate tests, including ``point-to-point'' tests with individual
firms and ``street-wide'' tests with other industry participants.
Testing with third parties has already begun and will continue through
most of 1999.
iii. current status within the mutual fund industry
Although the Investment Company Institute is probably the best
source of information about the mutual fund industry as a whole, we
thought we might offer some additional observations based on our own
situation and experience. We think there is room for some general
optimism, for a couple of reasons. First, we have within this industry
a number of large investment advisory firms that for many years have
relied on computers to deliver high quality services to their clients,
including mutual funds. They have developed and operate quite
sophisticated computer systems, and have large technology
infrastructures (including personnel) that are capable and available.
Even for the smaller advisers, who may not have these resources in-
house, typically they have chosen to rely on outsourced services
provided by large, well-established companies with similar resources.
The past decade has been a good one for the industry as a whole, and so
most firms have been investing in newer technology which is less
susceptible to Year 2000 issues. Moreover, to the extent they have
exposure to the problem, they should have the necessary financial
resources available to get the job done right and on a timely basis.
Nevertheless, we think it is important to emphasize the large
number of interconnections and interdependencies present within and
outside this industry--and the need to work diligently to anticipate
and prepare for external events. At the moment, there are many serious
issues facing companies and other organizations (including central
banks and other governmental agencies) around the globe--thus, the
possibility exists that parties outside our control (or influence) will
not be as prepared as they should be and investors may suffer some
inconvenience or even losses as a result. I am sure that Capital and
other industry participants will take steps to address these risks,
both in terms of their mutual fund operations and investments, but
there may be no way to eliminate them entirely.
I understand that the Special Committee is interested in knowing
whether we are considering the Year 2000 readiness of companies in our
client portfolios. Although I am not an investment professional myself
(I was an audit partner at Deloitte & Touche LLP prior to joining
Capital in January 1998), I know that our research analysts and
portfolio counselors are well aware of this issue. They are reviewing
portfolio companies' public disclosures and also making inquiries of
management--and generally receiving positive assurances. However, our
people realize that they are not technology experts, and that in any
event they are not in a position to independently verify assertions
made by management. On the other hand, for Capital at least, we tend to
make and maintain long-term investments in companies we believe to be
well-managed and with good prospects for the future--and thus it may be
entirely reasonable for our investment professionals to conclude that a
company's statements about Year 2000 readiness are solidly grounded.
Well-run companies with significant resources and good prospects are
more likely to address this issue in a responsible and effective
manner. Clearly, the Year 2000 issue is more significant for some
companies than others, and the degree of our analysts' concern reflects
this. Finally, although our investment professionals recognize the
importance of this issue, they also feel strongly that it is only one
of many factors that ought to be taken into account as part of the
investment process--and that it would be inappropriate to consider
statements about the Year 2000 to the exclusion of other, equally
pertinent, investment considerations.
The testimony which follows concerns itself primarily with our
internal preparations for the Year 2000, as well as our efforts to
ascertain the readiness of our business partners and vendors.
iv. project scope, organization and oversight
Capital is addressing the Year 2000 challenge on a coordinated,
enterprise-wide basis. We are doing this work in a manner which is
consistent with the way our operating subsidiaries manage assets--a
significant number of people with diverse backgrounds and skills are
following a disciplined, yet flexible process in pursuing our
compliance goals. Associates from throughout the Capital organization
are involved, with the Year 2000 Steering Committee and the Year 2000
Program Management Office providing overall coordination and support.
Our written plan for achieving Year 2000 compliance applies to all
Capital Group Companies, including CRMC and its two subsidiary
companies providing services to U.S. mutual funds--American Funds
Service Company (transfer agent) and American Funds Distributors, Inc.
(principal underwriter). The plan covers all Capital Group systems and
facilities worldwide, and activities undertaken on behalf of both U.S.
and non-U.S. clients. Although it is difficult to provide a meaningful
figure for Year 2000-related expenses (in light of accelerated systems
and application upgrades and the large number of associates working
part-time on the project), we expect our aggregate direct costs of
implementing the plan to be approximately $30 million over the three
fiscal years ending on June 30, 2001.
As indicated above, several groups of Capital associates have
significant responsibilities for achieving Year 2000 compliance. The
Year 2000 Steering Committee, comprised of 15 senior-level managers
representing key business and technology areas, has primary
responsibility for implementing the Year 2000 Project and achieving its
goal of timely compliance across the entire organization. The Steering
Committee sets priorities and applies resources. The Committee meets
twice each month to review progress and discuss issues.
The Program Management Office (PMO) was established in June 1997
with a dedicated manager, staff and budget. Consultants were engaged to
help initiate the project, and establish its methodology, provide
documentation tools, and supplement and advise PMO staff. The PMO
staff, which currently consists of 15 full-time associates, provides
guidance, management, coordination and tracking of project deliverables
as it assists associates in each of Capital's information technology
and business areas with each phase of the project, including conversion
of their systems, applications and services.
The PMO established compliance guidelines, a testing and
certification infrastructure, and an overall process for managing the
Year 2000 Project. The PMO establishes and tracks project deliverables,
facilitates compliance decision-making and priorities, and coordinates,
monitors and integrates multiple compliance projects. The PMO also
plays an important role in monitoring the progress of outside vendors
and other service providers in achieving Year 2000 compliance. The PMO
works closely with the Steering Committee and serves as a liaison among
various working groups and with outside parties and regulators.
Information technology area managers are responsible for ensuring
that technology infrastructure, hardware, networks and operating
systems are all Year 2000 compliant. They must replace non-compliant
hardware and systems, and remediate applications used across the entire
Capital organization. The information technology area is also
responsible for establishing and supporting a Year 2000-compliant test
environment in which hardware and software systems and applications are
tested in a replica of the production environment.
Business area managers have supplied the PMO with inventories and
risk assessments of applications specific to their areas. They are also
responsible for ensuring that project plans and activities are
comprehensive and meet required implementation deadlines. Associates in
the business areas also participate in the development and execution of
Capital-wide application testing, and vendor/service provider
assessments and monitoring.
The Boards of Directors of The Capital Group Companies, Inc. and
each of its principal operating subsidiaries (including CRMC) have
formally approved the Year 2000 Project, including its enterprise-wide
approach and its reliance on the Steering Committee, the PMO and the
information technology and business areas for implementation. Regular
reports are submitted to these Boards of Directors, at least quarterly,
on internal corrective efforts as well as the ability of Capital's
major vendors and service providers to provide Year 2000-ready products
and services. A number of Steering Committee members also serve on
these Boards.
Similar reports will be submitted at least quarterly to the Boards
of Directors and Trustees of the mutual funds managed by Capital
Research and Management Company as well as the funds' outside auditors.
In addition, we are making Year 2000-related information available at
the following Internet websites: www.capgroup.com and
www.americanfunds.com.
capital group technology overview
The computer systems that support investment management and
accounting operations at The Capital Group have been managed, developed
and operated internally. We have a large information technology staff--
in excess of 500 associates. Most of our core investment management
systems were developed within the past five years and operate in a
modern, client-server environment. Our mainframe (legacy) applications
were also developed internally--but now are of lesser significance. We
do rely on a limited number of third party service providers--however,
these are large, well-run organizations with which we have had good
working relationships for many years.
vi. project methodology
The Capital Group Companies are following a five-phase, iterative,
interactive methodology for the Year 2000 Project. The first phase is
Inventory and Risk Assessment. Survey forms were completed by
information technology and business area managers within each company,
business function and location. These surveys identified information
technology usage, business flows, and external vendors that could be
impacted by two-digit date processing. A risk assessment was used to
categorize each component into high, medium or low business impact and
processing risk.
The second phase is Planning. All high-and most medium-risk
components are examined to determine if the component should be
remediated (fixed), retired, or replaced with a component which is Year
2000 compliant. The Remediation or Construction phase is where the Year
2000 problem is solved for each component. Computer hardware chips are
replaced, purchased software is upgraded, custom application code is
modified, and/or vendor processing is revised to ensure that dates will
be handled correctly in the Year 2000. The fourth phase is Testing.
Each component is individually tested, and then tested again with
related components in a system test. Finally, the entire system is
reviewed in a user acceptance test. When the component has passed the
complete series of Year 2000 date tests, it is described as ``Year
2000-ready.'' During the Implementation and Close phase, the Year 2000-
ready component is documented and placed back into production.
Separate, additional testing may also be performed on Year 2000-
ready computer applications. Because of the complex interactions
between multiple hardware and system software components, our critical
business systems also undergo time machine testing. This is a full-
scale operation run with system dates set forward and rolled through
several dates.\1\ When these business-critical systems have been
completely tested with these dates, we designate them ``Year 2000
compliant.'' More testing is being done with business partners and
vendors. Critical external interfaces are subject to point-to-point
testing; this is currently underway and will continue through 1999 with
business partners. In addition, The American Funds Group will
participate in an industry-wide Year 2000 test organized and conducted
by the Securities Industry Association.
---------------------------------------------------------------------------
\1\ The dates to be tested include: December 31, 1999; January 1,
2000; January 3, 2000; January 7, 2000; January 31, 2000; February 28,
2000; February 29, 2000; March 1, 2000; December 29, 2000 and January
2, 2001.
---------------------------------------------------------------------------
vii. reporting methodology
The Capital Group Companies track and report progress across our
infrastructure and different groups of applications in relation to the
level of completion of these five phases. Within a given area, overall
completion levels for each phase reflect actual progress achieved with
respect to individual project components, with each component's
contribution to the overall figure weighted according to its potential
impact on our business. We believe that organizing Year 2000 progress
information in this manner (and presenting it in relation to specific
functional areas) presents a meaningful picture of readiness,
particularly since systems vary in importance and are often utilized by
associates affiliated with different companies in multiple locations.
Finally, because we prepare reports on our progress on a quarterly
basis, the information below reflects progress achieved through June
30, 1998.
viii. progress in specific areas
The Information Technology Infrastructure area supports Capital
Group offices throughout the United States, London, Geneva, Hong Kong,
Singapore and Tokyo. Components of the infrastructure include: computer
platforms and operating systems, database software suites, network
topologies, and data center operations and support. The foundation
computer infrastructure consists of an S/390 mainframe environment, a
midrange environment including an AS/400 and several HP/UNIX platforms,
and a distributed desktop environment consisting primarily of Compaq
and IBM Windows NT platforms. More than 500 vendors provide in excess
of 1,200 products that form the infrastructure. As of June 30, 1998,
within this area completion levels were as follows: Inventory and Risk
Assessment, 100 percent complete; Planning, 99 percent complete;
Remediation or Construction, 89 percent complete; Testing, 74 percent
complete; Implementation and Close, 33 percent complete.
Core Investment Management and Reporting Systems. This group of
applications consists of three main components. The first subgroup,
consisting of twelve integrated systems supporting most of the
investment analysis and administration business cycles, are newer
systems that run on midrange client-server computers. They were tested
in a client-server time machine test environment from March through May
of 1998, and have been placed back into production. Final documentation
of the Implementation and Close Phase is underway.
The second subgroup consists of a mainframe-based system for
portfolio accounting and recordkeeping. This system achieved Year 2000-
ready status at the close of August. The third subgroup, our non-U.S.
portfolio accounting and recordkeeping systems, are provided by a third
party service provider in Geneva, Switzerland using a mainframe-based
system. All Inventory and Risk Assessment, Planning, and Remediation of
this subgroup of systems has been completed, and final Testing and
Implementation is underway.
The relevant figures representing the combined progress for all
core investment management and reporting applications as of June 30,
1998 were as follows: Inventory and Risk Assessment, 100 percent
complete; Planning, 100 percent complete; Remediation or Construction,
96 percent; Testing, 80 percent; Implementation and Close, 32 percent.
Another group of applications of particular relevance to mutual
fund investors is American Funds Group Accounting and Reporting
Systems. They consist of 29 systems supporting both dealer activities
and shareholder accounting and reporting. Virtually all of the systems
supporting these business areas were Year 2000 ready as of June 30,
1998. This means they have been through the Inventory and Risk
Assessment, Planning, Remediation or Construction phases, undergone
unit, system and user acceptance Testing, and, during the
Implementation and Close phase, are being put back into production.
Progress within this area at June 30 was as follows: Inventory and
Risk Assessment, 100 percent complete; Planning, 100 percent complete;
Remediation or Construction, 100 percent complete; Testing, 97 percent
complete; Implementation and Close, 90 percent complete.
Our core shareholder recordkeeping system is provided by a third
party service provider. American Funds Group associates have maintained
a close working relationship with this service provider during its Year
2000 remediation project. All Inventory and Assessment, Planning and
Remediation of this system has been completed. In September-October
1998, our systems within this area will be tested in the time machine
test environment. These tests will also include a series of integrated,
industry-wide tests sponsored by the Securities Industry Association
and involving, among others, the primary service provider referred to
above. Point-to-point testing with other business partners is planned
over the next twelve months.
Our Administrative Business Applications are important to us, even
though they do not affect the core investment management process. These
applications include those supporting Payroll, Human Resources, Finance
and Accounting, Tax and Treasury, Investment Administration, and other
similar systems.
Progress within this group of applications at June 30 was as
follows: Inventory and Risk Assessment, 100 percent complete; Planning,
90 percent complete; Remediation or Construction, 63 percent complete;
Testing, 41 percent complete; Implementation and Close, 30 percent
complete.
ix. business partner/vendor program; contingency planning
Perhaps one of the most challenging Year 2000 areas is assessing
the Year 2000 compliance efforts of our business partners and vendors.
The Capital Group relies on hundreds of hardware and software vendors
for its Information Technology Infrastructure. We also rely on dozens
of custodian banks and hundreds of brokers to process financial
transactions accurately and quickly. Our ability to continue managing
client assets through the Year 2000 depends not only upon our own
organization's ability to achieve internal compliance, but also on the
ability of our business partners and vendors to deliver Year 2000-
compliant products and services.
The Capital Group has identified all of its significant business
partners and vendors (including hardware and software vendors) and
categorized each one by the type of service relationship. This approach
enables us to tailor our business partner/vendor compliance plans to
match the services provided and to enlist our business area associates
in the evaluation process. Assessments of potential business impact
have been completed; a ``most critical'' list has been identified, and
Capital Group associates with relationship responsibility for Year 2000
compliance have been designated. We are currently contacting third
parties to obtain information regarding their Year 2000 compliance
efforts and we are in the process of making initial confidence
assessments. During the third quarter of 1998, we will begin ``point-
to-point'' testing to confirm our ability to transact business with
those parties with which we share information electronically. Testing
with a number of business partners will continue through 1999. The
Capital Group methodology requires all significant vendors to be
contacted and their Year 2000 compliance efforts evaluated by December
31, 1998.
Our early experience shows that some software vendors may not be
ready with Year 2000-compliant products when we are ready to test. In
fact, some vendors have already declared that one or more of their
products will not be made Year 2000 compliant. This means we must
develop contingency plans to ensure we retain certain business
functions. Our contingency plans will take into account the level of
reliance we have for each business partner and vendor and how critical
the product or service is to our business operations. In some cases,
vendors are being replaced in advance of potential problems occurring.
During the second half of 1998, we will be actively planning for the
possibility that a number of our business partners and vendors may not
have Year 2000-compliant products and services available on a timely
basis. Capital is using its Disaster Recovery resources in concert with
its Year 2000 Program Management Office resources to reduce the
likelihood that we will suffer business interruption due to Year 2000
problems. We expect these plans to be substantially complete by
December 31, 1998.
x. facilities
The office facilities utilized by The Capital Group Companies are
also being examined for possible Year 2000 problems. Building security
systems, clock-controlled lighting and temperature controls, elevators
and power grids all present a risk to normal business operations. The
Inventory and Risk Assessment of Facilities is complete. Each office
location was reviewed and prioritized based on its computer
dependencies and contribution to overall business activities. Visual
inspections are being conducted and approximately 80 percent of all
required testing is being performed at that time. All critical systems
are scheduled to be tested in 1998. Business vendors critical to
operating our facilities have been identified and are being addressed
through the vendor management program. The expected completion date for
Year 2000 compliance of Capital Group Facilities is December 1, 1998.
______
Responses of Thomas M. Rowland to Questions Submitted by
Chairman Bennett
Question 1. In your statement, you note that your testing of mutual
funds operations support systems is 70 percent to 80 percent complete.
What have the results of such testing indicated to date? Can you
identify any specific problems that arose during this testing?
Answer. In general, the results were satisfactory. Most of the
problems arose as a result of shifting from the production environment
to a separate, time machine testing environment, where applications
were system clocks and data are set forward in time to simulate the
change in century.
Moving applications from a production environment on the company
network to the time machine test environment presents a number of
challenges. System node names are different, printer names are
different, interfaces to other systems don't exist, JCL (job control
language) and scheduling programs must be rewritten. These types of
problems are properly characterized as environment problems. Other
problems encountered due to two digit years vs. four digit years, leap
year problems, or other date related problems are characterized as Year
2000 problems. Since a great deal of time was spent in remediating the
applications prior to testing, a large number of problems were not
anticipated. The following is a summary of the Year 2000 problems which
were encountered.
Core Investment Management and Reporting Systems--A few instances
were found where the implicit century date (19) was hard-coded into
applications causing sort problems, or report heading problems. There
were also a few cases where the century date was expressed as one digit
(1 or 2); in these instances, we moved to a more user friendly
convention (19 or 20). There were a few cases where dates were expanded
in the data base and the application, but the field allocation was not
similarly expanded. Other errors included leap year not recognized,
incorrect date calculations, not recognizing dates in year 2000. In
addition, in a small number of cases the implicit century date (19) was
hard-coded into applications for use in creating log names, file names
or default century dates. Another error was found with date conversion
after January 1, 2000. All noted exceptions have been or will be
addressed and retested and verified by users.
American Funds Group Accounting and Reporting Systems--The majority
of problems were associated with report formatting or display problems
in changing from two digit to four digit dates or hard-coded century
dates. In a case where a single digit was used to denote the century
(0, 1 or 2), the wrong digit was used in the application. In several
applications, date information is manipulated to produce various date
formats. Some problems were encountered with creation of these date
formats. In the process of remediation and testing, several hundred
applications were identified that were no longer used in production.
These have been documented and will be removed from the production
libraries.
Question 2. What is your expected timetable for completing ``point-
to-point'' and ``streetwide'' testing? How will this testing be
conducted?
Answer. Point-to-point testing incorporates Capital Group's
strategic business partners, banks and electronic services. It is
scheduled on an individual basis. Testing will include electronic
services such as Bloomberg, Merrill Lynch, NASDAQ, Reuters, and OASYS.
Also, banks (e.g Chase, Wells Fargo, State Street Bank & Trust) and
service providers (e.g. DST, SKI, ADP, ERTI and BISYS) who exchange
information electronically with Capital will be included. The point-to-
point testing is underway and will continue through mid-1999.
The Securities Industry Association (SIA) has orchestrated testing
of many firms who are involved in securities trading. They have taken
the lead to schedule the testing periods, facilitate the creation of
testing scripts, coordinate activities with the securities clearing
houses (NSCC) and generally make this industry wide testing a reality.
There are a series of tests which lead up to the final industry wide
testing in March of 1999.
For the American Funds, DST will act as our agent for the
``streetwide'' tests. AFS has developed test scripts to validate the
transactions involved in shareholder transactions involving these
mutual funds. These scripts have been forwarded to the testing partners
assigned to DST for the American Funds. These include ADP, Waterhouse,
Smith Barney and Baird. These broker/dealers will initiate the
transactions which will be processed through their systems and on to
the NSCC. From there, the transactions will go to DST systems. Output
from the DST transactions (in the form of reports) will go to AFS on a
daily basis to verify the results.
This is the process which will be followed during the October
mutual funds test. This process will also be repeated in March if
deemed necessary.
Question 3. In your written statement, you discuss ``time machine
testing''. Can you describe what this type of testing is and how it is
conducted?
Answer. The Capital Group Companies have constructed a complete
mainframe time machine test environment which replicates our production
environment. All project components that rely on system clocks are
tested for Year 2000 compliance, both individually and in combination,
with system dates and data set forward and rolled through a number of
critical dates. This environment uses only those hardware and software
components which our vendors have designated as Year 2000 compliant
versions.
The mainframe time machine consists of three major pieces; a lab in
Brea, a lab in San Antonio and a mainframe computer in San Antonio.
Additionally, during some of the testing, the time machine extends out
to include DST's time machine environment and the Brea and San Antonio
printing centers.
Before its use, the time machine required months of IT
Infrastructure preparation. Testing is the most time consuming,
resource-intensive phase, comprising 50-70 percent of the project
effort. The combined efforts of the mainframe systems group,
telecommunications, UNIX, server, desktop, networks and many other
organizations were required to assemble and test the environment. This
was no small task, considering these same teams also had to plan a data
center move in addition to supporting daily production operations.
The purpose of mainframe time machine testing is three fold. First,
it provides for complete integration testing with hardware, operating
systems, utilities and applications that are all Year 2000-ready.
Second, it provides complete isolation of the test environment from
Capital's production environment. Third, it gives the applications a
test platform where they can uncover any Year 2000 errors that were not
fixed during the software remediation phase. Although the number of
errors uncovered is small compared to the number of changes made during
remediation, testing provides the final check to ensure that these
applications will run correctly into the new millennium.
The process for building and running the time machine is as
follows:
First, an infrastructure must be built which mirrors or closely
simulates the existing production environment. This environment
includes a mainframe, UNIX workstations, Microsoft Windows NT
workstations, Novell servers and a private network (including various
printers). This infrastructure must then be loaded with Year 2000-
compliant versions of operating systems, utilities and middleware
applications. Once the environment is ready, a complete image of the
production environment is then copied into the test environment. Data
sets that have been aged (dates changed to simulate future
transactions) are then loaded into the test environment.
Applications and JCL are modified where required to run in the
isolated environment. When checkout is complete, the system clocks on
all the components are moved forward to the first test date. Test
scripts which had previously been written and verified are then
entered. Test cycles are run and the resulting screens and reports
analyzed to see if they match the expected results. When a single cycle
is complete, the system clocks on all the environment components are
then advanced (warped) to the next test date. The cycle is then rerun
for each required test date. The application user community develops
the test scripts, enters the data, and verifies the accuracy of the
output.
Question 4. Capital Group also maintains offices in London, Geneva,
Hong Kong, Singapore, and Tokyo. Has the company engaged in any general
assessments about overall Y2K state of readiness regarding other key
areas of infrastructure in those locations which might impact
operations? (Telecommunications, Power Utilities, and Transportation)
Answer. The Capital Group's offices in Europe and Asia are leased,
and we are working with local building management to assess the Y2K
state of readiness for each facility. Telecommunications Y2K readiness
is being assessed by direct contact between Capital Group Information
Technology operations and local telephone service providers. Beyond
direct usage, Capital has not attempted to assess the general
infrastructure readiness of our five non-U.S. sites.
Question 5. Describe Capital Group's Disaster Recovery program and
how it would interface with the Year 2000 Program Management Office as
part of Capital's contingency planning?
Answer. The Capital Group has a comprehensive Disaster Recover
program which emphasizes a physical site being down due to disaster,
and addresses the needs of specific departments for each site. The
strategy includes a response phase, a recovery phase, and a restoration
phase.
The Capital Group has Recovery Notification phone calling tree
lists in place which are exercised without warning at least quarterly.
Alternate meeting sites, emergency alert stations, and emergency
hotlines are established for each department, and associates have
handbooks with instructions for use.
The Year 2000 Program Management Office is working with the
Disaster Recovery team closely in order to take advantage of existing
planning and resources, including the identification of key associate
and vendor contacts, departments and sites. This includes specific
responses to Information Technology Infrastructure system disruptions.
Building upon that, the Year 2000 team is identifying potential
external business disruptions which could arise from a vendor or
business partner's failure to perform due to date processing problems.
A key factor in this planning is the identification of high-risk
business partners and vendors that supply a critical business
requirement. The readiness of these critical third parties is assessed
through direct contact with members of their Year 2000 team. Following
one or more meetings, each party is assigned a level of confidence. Low
confidence levels require more intensive contingency planning.
__________
Prepared Statement of John R. Towers
Mr. Chairman, members of the committee, thank you for the
opportunity to appear before you today. My name is John Towers, and I
am executive vice president for Global Operations at State Street
Corporation in Boston where I oversee securities, cash and data
processing operations.
I would like to congratulate you, Mr. Chairman, for the attention
and sense of urgency this committee has brought to the issue--a sense
of urgency that we fully share.
I will focus my remarks today on State Street's own commitment to
readiness for the Year 2000, with particular reference to the services
we provide to the mutual fund industry--both as custodian and
investment manager.
I will also suggest areas of possible action that could be of great
assistance to the industry and our country in preparing to meet the
challenges posed by the Year 2000 issue.
state street's resolution 2000 program
State Street Corporation and its principal subsidiary, State Street
Bank and Trust Company, provides safekeeping and financial services for
over $4 trillion in assets held primarily by mutual funds, insurance
companies and pension plans.
Our custody systems process over 50,000 global securities trade
settlements daily in over 80 markets around the world. State Street is
also a major global asset manager, investing over $400 billion on
behalf of institutional investors worldwide.
State Street began its assault on the Year 2000 challenge early. In
the first quarter of 1996, we developed Resolution 2000, a
comprehensive program to identify and resolve our Year 2000 compliance
issues. The demands, impact and progress of Resolution 2000 are
regularly communicated throughout our organization, from the board of
directors and senior level management to every level of our
professional staff.
The program covers four areas of Year 2000 compliance and
contingency preparations: information technology, suppliers and
vendors, counterparties and business partners, and business area
operations.
Year 2000 compliance is a challenge, but technological change is
basic to our business. State Street and other global financial firms
are accustomed to constantly upgrading and re-coding our software to
accommodate changes in customer and/or market requirements.
State Street is absolutely committed to the precise, seamless and
timely delivery of all aspects of the information our customers need
and to the ability of our systems to cope with all conceivable
contingencies. And we will be thoroughly testing all aspects of our
technology both internally and with our counterparties to ensure this
is the case well before the year 2000.
Indeed, our day-to-day support of the mutual fund industry is
predicated upon operating our technology infrastructure. Not only do we
have state-of-the-art processing systems, but state-of-the-art backup
as well.
We deliver accurate daily prices for over 1,200 U.S. mutual funds,
about \1/3\ of all funds in the country, representing nearly $3
trillion in assets, to our customers and other intermediaries. And we
have done so over many years despite hurricanes, floods, blizzards,
fires, power failures and extraordinary global securities market
turmoil.
state street services to mutual funds
State Street provides several key services to mutual funds--for
which we are the single largest custody service provider. Our
commitment to these customers dates back to 1924, when we were
appointed trustee of the first U.S. mutual fund, Massachusetts
Financial Services.
Today, we provide services to mutual fund companies ranging from
fund accounting, to daily pricing and/or fund administration for over
3,000 mutual fund portfolios.
In the course of providing these services, we interact
electronically with securities depositories, broker/dealers, banks,
stock exchanges, and our own customers, as well as all the providers of
pricing and other investment data services, such as Reuters and
Telekurs, to ensure that our customers receive the data they need.
To date, nearly 90 percent of our over 350 core applications
corporation-wide have been renovated for Year 2000 and are currently in
various levels of testing to validate compliance. Nearly 150 of these
core applications support the services we provide to the mutual fund
industry, and of these particular applications, 97 percent have been
corrected already.
Externally, we continue our efforts to monitor and influence the
compliance of essential third parties globally and are developing
strategies and approaches for testing with them.
In cases where we find non-compliance, we will replace vendors,
work around them, develop internal capabilities to replace them or make
necessary renovations to enable us to provide Year 2000 compliant
services to our customers.
Our Resolution 2000 compliance target for all internal systems and
application software continues to be December 31, 1998 to meet the
recommendations of the Federal Financial Institutions Examination
Council and allow for a full year of external testing in 1999.
We will devote our efforts throughout 1999 to external testing and
developing appropriate contingency plans with key industry
counterparties, customers and vendors. In the area of Year 2000
compliance, our policy with counterparties resembles President Reagan's
arms control slogan: ``Trust but Verify.''
Throughout our own Year 2000 efforts, State Street has taken very
seriously our responsibility to communicate our progress toward Year
2000 compliance to our customers and shareholders--and we have done so
on a quarterly basis since June 1997.
We believe we have made significant progress, but we are neither
complacent nor comfortable. And we are committing the necessary
financial and human resources, and the top-level management attention
needed to reach our readiness goals well in advance of the turn of the
century.
fiduciary responsibility of investment managers
As you requested, Mr. Chairman, I would like to address the issue
of fiduciary responsibility of investment managers to evaluate the Year
2000 compliance of the companies in which they invest.
Fiduciaries--including retirement plan managers, mutual fund
advisors and other trustees--must manage assets in the best interest of
plan participants and beneficiaries.
When a fiduciary exercises investment discretion, it is responsible
for evaluating the range of risks and opportunities presented by a
company before investing fiduciary assets in the company's stocks. One
of those risks is the possibility that the company's performance will
be impaired by the Year 2000 problem.
The Year 2000 issue--or at least widespread recognition of it--is
new, but the fiduciary's obligation to consider Year 2000 questions is
not.
Fiduciaries who have management discretion have an ongoing
obligation to consider all factors that may increase risk to
participants and beneficiaries. As with previous developments such as
environmental liability, the Year 2000 issue may significantly increase
the risk inherent in some assets, and fiduciaries must respond
appropriately.
While proposed legislative or regulatory action may be intended to
reduce the potential Year 2000 risk faced by fiduciaries, there is a
hazard that these proposals may, in fact create additional risks.
Singling out the Year 2000 issue for special treatment may obscure
or subordinate other risks to the detriment of participants and
beneficiaries. It may also prevent a fiduciary from responding to the
Year 2000 challenge in the manner that best serves the interests of
such participants and beneficiaries--such as by diversifying their
portfolios.
In addition, specific Year 2000-related requirements could generate
questionable litigation. Where the fiduciary does not have investment
discretion--such as with a 401(k) or index mutual funds--a specific
Year 2000 obligation for the fiduciary could be inconsistent with the
purpose of the investment or may, in fact, be outside the fiduciary's
discretion.
State Street believes that recent guidance issued by the Federal
Financial Institutions Examination Council (FFEC) should serve as a
model for an appropriate governmental response to the particular Year
2000 risks faced by fiduciaries.
The guidance recognizes that the extent of a fiduciary's
responsibilities is determined by applicable law, such as the Employee
Retirement Income Security Act of 1974 (ERISA) and state trust and
estate laws, as well as by the particular goals of a retirement fund,
mutual fund or trust instrument.
Significantly, the guidance states that fiduciaries with investment
discretion may consider Year 2000 issues as part of their ongoing
review of each account's portfolio.
State Street acknowledges that the Year 2000 problem can be
addressed as part of the overall management of fiduciary assets, and
not as an isolated or unique issue. But we also recognize that
fiduciaries must be able to rely on public disclosures of Year 2000
readiness to make their assessments--just as they rely on public
disclosures already in the investment decision process.
how congress can assist
I congratulate you, Mr. Chairman, not only for raising the nation's
awareness of the seriousness of the Year 2000 challenge, but also for
your support for S. 2392, the Year 2000 Information Disclosure Act.
And I heartily praise the SEC for coming forward with its recent
interpretation of the application of a safe harbor from private
securities lawsuits for forward looking statements with regard to the
predicted costs and exposures related to the Year 2000 problem.
These are exactly the kinds of actions that the financial industry
needs to encourage and create incentive for further information sharing
of full and candid disclosures of readiness.
Disclosure of technical information among all participants in the
financial industry is a key ingredient in fixing Year 2000 problems.
But full disclosure and information sharing is inhibited by concerns
about the risks of potential litigation, especially punitive and
consequential damages.
Far from serving as a prod to action, undue fear about such
liability risk discourages the information-sharing we need--
particularly about areas of difficulty--to achieve Year 2000 readiness.
State Street's reputation and future business success--as well as
that of our industry peers--dictates that we successfully address the
date change problem. We have tremendous incentives to succeed. And we
depend upon the readiness of dozens of intermediaries to achieve that
success.
We recognize that success in meeting our goals depends heavily on
the joint responsibility and cooperation of all industry players--and
of vendors outside our industry such as telecommunications and utility
companies.
Mr. Chairman, we urge members of this committee to continue to find
ways to create positive incentives for cooperation and openness among
all parties. In our view, this would be the most effective assistance
you could provide.
Thank you. I welcome any questions you may have.
______
Responses of John R. Towers to Questions Submitted by
Chairman Bennett
Question 1. What specific problem areas have you identified in
regard to the global operations of State Street Corporation?
Answer. The most problematic area involves monitoring the
compliance of third parties with whom we work to provide our services
globally. Our ability to provide compliant products and services to the
market requires that we take reasonable steps to validate the
compliance of all the third-party products and services on which we
depend. State Street has over 1,800 vendors that provide us with over
6,000 products worldwide. We have 29 business partners and
relationships with over 100 subcustodian banks in 83 markets. We face
off with a number of organizations such as the Federal Reserve and the
securities depositories, and we interact with thousands of customers
daily.
We begin by assessing the readiness of the products and services
that these organizations provide us. We also assess the readiness of
the providers themselves if their compliance is essential to a critical
State Street function. These assessments are particularly difficult to
perform in countries outside the U.S. where we have found the general
lack of information a real barrier to making these evaluations. Thus,
our greatest concern regards information sharing of essential third
parties globally.
Pension plan sponsors and mutual fund companies expect global
custodians like State Street to assess Year 2000-related market risks
around the world. We understand our customers' investment decisions
may, in part, be based on these assessments. These assessments should
include an evaluation of the readiness of numerous links in the
investment-processing infrastructure in which all participants in a
given market operate, such as utilities and telecommunications. The
general lack of information sharing by these participants, however, has
seriously hampered our ability to monitor and evaluate these other
links in the investment chain. Moreover, we cannot exercise the same
level of influence over such participants, which are outside of our
direct control, as we can, to some extent, here in the U.S. And we have
found that influencing the readiness of those entities is largely
beyond the control of local market participants as well.
Notwithstanding the tremendous challenges and barriers on the
international side of this process, we are actively performing critical
assessments of our foreign counterparties. As an example, I will focus
on our in-depth program of evaluating the readiness of our subcustodian
network. We rely on these subcustodian relationships for the
settlement, safekeeping and servicing of assets in those non-U.S.
markets. Our subcustodians also serve to give us--and our customers--a
critical interface with other local market participants.
In general, our findings show that these institutions are actively
engaged in comprehensive Year 2000 compliance activities both
internally to their organizations and externally in the markets where
they operate, however, preliminary responses with respect to general
market planning reveal a wide range of variation in readiness.
Some markets have revealed little information, and some have highly
developed programs. Others are more occupied with the introduction of
the Euro or addressing recent market downturns. Moreover, we have found
significant variation in regulatory oversight within markets. Virtually
all markets view attainment of compliance as a fundamental prerequisite
for post-Year 2000 survival. Some even regard the non-compliance of
their market peer group as a competitive advantage and thus are not
sharing information even among themselves. However, while many
institutions are undertaking compliance programs, we have less
information on the development of contingency plans for post-Year 2000
failure.
Our primary concern with respect to compliance efforts is the
inconsistent regulatory approach and general lack of ``information
sharing'' globally, as I mentioned. Many market participants are taking
action--ministries of finance, central banks, government regulatory
agencies, central depositories and banking associations. But the scope
of their work varies. In some markets, the Central Banks are overseeing
the Year 2000 compliance for financial institutions in their respective
markets. Their deadlines and standards are very similar to those
established by our Federal Reserve Bank. In other markets, a single
regulator has oversight and enforcement responsibilities for all
financial institutions and participants in the market including banks
and brokers. In many new and emerging markets, from a subcustodian
standpoint, participants are already operating with new systems that
are compliant. It is important, however, that these markets and systems
be fully tested to validate compliance. Furthermore, the low levels of
investment and capitalization represent a lower risk relative to larger
markets.
In our direct contact with the market, there is some good news.
Target dates are being established, and many of our subcustodians are
targeting compliance by December 31, 1998. There also appears to be
universal acceptance that companies without effective plans risk severe
consequences. By and large, participants recognize that ``information
sharing'' would empower Year 2000 efforts. But financial institutions
face a dilemma. If they are too candid in their disclosure, markets may
over-react and investors may retreat. If they disclose too little, they
may face litigation in the case of an unsuccessful Year 2000
transition.
In this regard, we commend Congress and the Administration for
working together to enact the Year 2000 Information Act--an important
step in encouraging companies to be more open in discussing Year 2000
issues. And we commend the SEC, particularly for its recent effort in
coming forward and extending safe harbor protection for forward looking
statements in this area. These are the kinds of actions that are needed
to encourage and create incentive for further information sharing and
candid disclosures of readiness. Once this information sharing begins
to happen, as we believe it must, there are a number of international
bodies in existence capable of promulgating this information, including
the following advisory organizations:
--Basle Committee on Banking Supervision
--Bank for International Settlements
--International Association of Insurance Supervisors
--International Organization of Securities Commissions
Question 2. Have you done any specific assessments of State
Street's foreign trading partners?
Answer. We have in place a comprehensive Counterparty Assessment
Process which monitors the assessment of all significant and material
funds takers, fund providers and counterparties (e.g., global banks,
broker/dealers)--both domestic and foreign--throughout our operations.
Our Resolution 2000 risk management team is leveraging expertise from
State Street's Credit and Risk Policy area, which will continue to play
a pivotal monitoring role. Trained loan officers in each business area
and corporate credit and risk officers are performing assessments to
check the readiness of our funds providers, funds takers and capital
market/asset management counterparties worldwide.
As previously noted, State Street is taking a number of steps to
assess the readiness of our subcustodian network that consists of over
100 subcustodian banks in 83 markets. We have incorporated Year 2000
compliance into the existing comprehensive due diligence that is
performed today to see that these subcustodians are well prepared to
represent us in the markets they serve on our behalf.
An assessment performed by our team of global custody professionals
provides us with essential information regarding the subcustodians'
programs and progress, their readiness to validate compliance with
State Street and the market, and the readiness of the markets
themselves. Our reviews evaluate their testing efforts and assess the
progress of other local market participants--including securities
depositories, central banks and clearing houses. Our evaluations also
address how these participants are preparing contingency plans for
potential points of failure after the millennium.
To date, we have issued two formal questionnaires. The first was
designed to assess the subcustodians' understanding of the impact Year
2000 will have on its operations, focusing on their Year 2000 readiness
programs, planning and internal impact review. We received a 100
percent response rate that is assisting us in determining if the
subcustodians' systems are already compliant, and if not, their plans
to make them so.
The second questionnaire addresses our subcustodians' ability to
test with us as well as their plans to test with their external
relationships. State Street is reviewing all of the responses to
determine the scope of testing that will be required. We have already
received over 97 percent of their responses to the second questionnaire
and will begin testing with our subcustodians commencing in the fourth
quarter 1998 through the end of the second quarter 1999.
In addition to the formal questionnaires to assess each
subcustodian's internal Year 2000 compliance program, we initiated a
third inquiry in May of 1998 to address ``market readiness.'' Using our
subcustodian bank network as an information source in the local
marketplace, we focused this query on our subcustodians' view and
understanding of the market infrastructure readiness for the Year 2000
as of this point in time. This information will assist us in assessing
further ``market readiness'' and whether it may have an impact on our
subcustodians' ability to effectively provide consistent service to
State Street. We plan to conduct the same exercise in 1999 in order to
assess changes from our last market review.
The results from each aspect of the assessment program are
evaluated against our custody models and compared across the other
markets to verify consistency of conclusions. A database serves to
control, track, monitor and document this process and enables us to
monitor each subcustodian's Year 2000 progress toward meeting the
established milestones of our plan. Management reporting is generated
from the database to support the project management and assessment
teams in their compliance efforts. We also provide our customers with
statistical reporting on our progress.
Further, as part of our approach to evaluating the markets, State
Street participates in the Global 2000 Coordinating Group. This is a
group of multi-national financial institutions that have gathered to
assess the Year 2000 readiness of the international marketplace. The
scope of their review has been grouped into three major categories:
--Multinational infrastructure readiness (payment systems, central
depositories, exchanges, global depositories)
--Financial industry readiness (agents, nostros, depots); and
--Vendor and other third-party service provider readiness (technology
firms, telecommunications, public utilities).
Question 3. Describe the potential negative impact that failures in
the preparedness of foreign financial markets and foreign-based
financial institutions could have on the American financial market and
U.S. based financial institutions. What is being done, both technically
and from a strategic business perspective, to mitigate the risks in
these areas?
Answer. The current state of global markets has made us all very
much aware of the interdependencies among markets throughout the world.
Fundamentally, any institution, either here, or abroad, whose primary
systems are non-compliant faces the potential of eventual financial
failure. Smaller non-compliance breakage within a firm could yield
problems with a lower or more localized impact.
A failure to be Year 2000 compliant could mean many things based
upon the conditions of non-compliance. Non-compliance could range from
a most critical condition of not being able to offer financial
services, to a minimal situation of perhaps one component of a
provider's systems not being compliant. Recognizing the variability of
potential non-compliance events that could occur, we are monitoring
each of our banking relationships on their efforts to address the
impact of post-Year 2000 points of failure.
In the worse case scenario, State Street would need to find another
fully-compliant provider in the marketplace. In a lesser case, State
Street would need to work with our relationships to define an
alternative process that would continue to provide consistent service
levels. In anticipation of encountering a wide range of issues, we
designed our program to support early identification of issues and
timely response and to provide optimal time frames in which to invoke
contingency efforts as situations may dictate. These contingency
efforts may involve operational workarounds or Requests for Proposals
to identify an alternative service provider.
On the corporate level, State Street maintains a set of ``red and
yellow alert'' procedures developed to provide guidance to our
management team when we are confronted with a potential or actual
crisis situation--whether Year 2000-related or otherwise. The goal of
these procedures is to centralize the critical decision makers, provide
them with the data needed for decision making and thus closely
coordinate our corporate level response and prevent major disruption of
our business and consequent financial loss.
Examples of such crises include:
--a liquidity problem
--upheaval of an economy or financial market where we play a major
role as principal or agent
--the failure of a major counterparty or intermediary
--significant delays in the availability of market information
--the failure of a critical internal or external system
These ``event management'' procedures are designed to provide
guidance to State Street personnel confronted with a potential or
actual crisis. State Street has perfected these procedures and proven
their effectiveness through significant disruptions in domestic and
international securities markets--including the 1987 U.S. stock market
crash, the 1994 Mexican currency and financial crisis, and the recent
series of destabilizing events in the global financial markets.
Question 4. In your statement you make reference to back up systems
used by State Street Corporation. How do these systems work, and what
role would they play in mitigating Y2K risks?
Answer. State Street has multiple data centers, running mirror
images of many of its most critical applications. Each data center is
equipped with an uninterrupted power supply as well as in-house motor
generators to ensure its ability to operate in the event of an extended
power failure. In the event of a localized failure in one of our data
centers, we are able to shift workloads for these critical
applications.
More specifically, State Street's backup systems and recovery plans
include:
--Two data centers located in Quincy and Westborough, Massachusetts,
40 miles apart, and our ``hotsite'' vendor, IBM located in
Maryland. These facilities support recovery of critical data
processing and data communications functions across multiple
system platforms (Tandem, DEC, IBM and Client Server).
--Critical software and data file backups performed at scheduled
intervals. These backups are then stored at secure off-site
facilities.
--Data processing recovery tests conducted for each system at least
once a year. During 1997, forty-five (45) data processing
recovery tests were conducted to validate the effectiveness of
our recovery plans.
--Established processing capabilities from alternate locations for
each major business unit. During 1997, sixteen (16) tests were
conducted at these alternate recovery sites.
In the event of a failure, State Street has a standardized three-
tier escalation procedure in place to support event management. Each
type of processing problem has a clear escalation path with primary and
secondary manager contacts documented for problem identification,
notification and resolution. State Street's Command Center Help Desk
maintains a contact database for communicating with our business areas
and clients about network and system-related problems.
State Street's current backup systems and recovery plans (data
processing and business recovery) coupled with its event management
discipline have positioned the Company to respond effectively should
Year 2000 failures occur. However, a large-scale public utility or
telecommunications failure would leave all companies exposed, State
Street included.
Question 5. In your statement you also referenced your company's
ability to maintain operational stability despite the occurrence of
natural disasters and other basic service interruptions. In what ways
are the Y2K risks your company faces similar to those you have
encountered in the past and in what ways are they different?
Answer. The similarities are that over the years, State Street has
experienced and worked through complex incidents and failures. From a
data center infrastructure or facilities standpoint the problems tend
to be localized to a particular data center or operations site. A good
example was when severe ice storms paralyzed Quebec last winter. State
Street was able to maintain operational performance by executing its
business recovery plans. More recently, when our Luxembourg office
experienced a power failure, State Street was able to implement its
recovery plans and had that operation up and running within three
hours.
The differences are that although State Street is experienced with
large-scale technological change, never before have such a volume of
internal changes been put to the test at one point in time. There is
also potential for having to manage multiple large-scale internal
failures as well as those resulting from interfaces with external
parties. Finally, the potential exists for simultaneous large-scale
public utility, telecommunications and market infrastructure failures
to occur as well.
Realizing this, in May of this year State Street initiated the Year
2000 contingency planning element of its Resolution 2000 program. State
Street's Year 2000 contingency planning strategy is to leverage the
existing corporate contingency planning program to respond to potential
Year 2000 failures by using it as the foundation for future plans that
may be required. All business areas must evaluate current business
contingency plans and identify Year 2000 program elements that must be
added to the plans to ensure the mission critical business functions
are performed within acceptable service levels (i.e. impact of a vendor
or service provider failure).
Question 6. In your statement you say that in cases where a
fiduciary does not have investment discretion, such as with a 401(k) or
index mutual funds, a specific year 2000 obligation for the fiduciary
could be inconsistent with the purpose of the investment or may, in
fact, be outside the fiduciary's discretion. What does this mean in
practical terms and what impact does it have on your potential legal
liability?
Answer. Under applicable law and the terms of the contract
appointing an entity as fiduciary, a fiduciary's responsibility may be
limited to those services delineated in the contract. For instance, in
the case of an index fund, the fiduciary's liability is limited to
tracking the stated index. If the fiduciary buys the securities in the
index in the same proportion as the index, it is fulfilling its duty.
Imposing on such a fiduciary an additional obligation to verify
that the issuer of a stock in the index is going to be year 2000
compliant forces an additional level of review upon the fiduciary, one
that neither the fiduciary nor the client wants the fiduciary to take.
Such a regulation would make tracking an index virtually impossible and
prohibitively expensive, and could force certain fiduciaries to breach
their contracts. Similar considerations apply to investor-directed
plans such as 401(k)s and IRAs.
For example, if the fiduciary determines that a certain issuer of
stock in the index (``Issuer A'') may not be in a position to achieve
Year 2000 compliance, the fiduciary would be forced into the position
of violating one of two conflicting duties. It would have to either (i)
buy the securities of Issuer A and continue to track the index as
mandated by the client (and hence violate its new year 2000 duty); or
(ii) not buy the securities of Issuer A and carry out its year 2000
duty (and hence violate its duty to track the index).
Question 7. Describe in more detail your assertion that some
proposed legislation or regulatory action intended to reduce the
potential risks faced by fiduciaries may in fact create additional
risks?
Answer. I am referring here to legislation that would amend ERISA
to require fiduciaries of employee benefit plans to ensure that the
companies in which plan benefits are invested are year 2000 compliant.
As I stated above, a fiduciary's liability to act in the best
interests of plan beneficiaries is currently limited under ERISA and by
the terms of its contract. We are concerned about any legislation that
could be interpreted to expand that responsibility by holding the
fiduciary liable for losses to beneficiaries resulting from Year 2000
failures of a securities issuer or exchange.
By contrast, the proposed guidelines for fiduciaries recently
issued by the FFIEC are drafted so that they clearly do not expand that
liability. They recognize the fiduciary's existing duty to plan
beneficiaries under ERISA and acknowledge the extension of that
responsibility to include considerations of Year 2000 readiness of the
companies in which the fund invests.
I also think it is important to note that this task would be, for
all practical purposes, impossible for a fiduciary to perform without
being able to rely completely on companies' public disclosures of Year
2000 readiness. In addition, as noted, there are some types of plans,
such as self-directed 401(k)s and IRAs, in which the fiduciary has no
investment discretion.
Finally, this question focuses on investment managers reviewing the
year 2000 compliance of issuers whose securities they will be
purchasing. The Committee should also bear in mind that another risk,
which certainly would affect any investment manager but over which no
investment manager has control, is the more ``systemic'' risk of a
major exchange or clearing facility shutting down operations as a
result of their own Year 2000 failures. Obviously, this would have a
huge effect on investment managers' ability to manage their clients'
accounts. However, it would be impossible and illogical to hold
investment managers to any sort of liability as a result of these
forces completely outside of the managers' control.
__________
Prepared Statement of Laura S. Unger
Chairman Bennett and Members of the Committee: I am pleased to be
here today to testify before the Special Committee on behalf of the
Securities and Exchange Commission (``Commission'') on matters relating
to the Year 2000 technology problem. My testimony focuses on one of
America's most successful and important businesses--the mutual fund
industry--and its progress in addressing the Year 2000 challenge. I
also will outline the considerable number of steps that the Commission
is taking to promote Year 2000 preparedness by mutual funds.
As you well know, mutual funds play a key role in the economic life
of many Americans. Over one-third of U.S. households now own shares of
mutual funds.\1\ Mutual funds have more than $5 trillion in assets,\2\
over a third of which are estimated to be retirement plan assets.\3\
---------------------------------------------------------------------------
\1\ The Investment Company Institute, 1998 Mutual Fund Fact Book
(May 1998).
\2\ The Investment Company Institute, Current Statistical Releases,
Trends in Mutual Fund Investing (April 1998).
\3\ The Investment Company Institute, Retirement Statistics,
Retirement Plans Hold 35 Percent of Mutual Fund Assets (Oct. 14, 1997).
---------------------------------------------------------------------------
Through the efforts of this Special Committee and others, most
people are aware by now that a large percentage of the world's computer
systems will need to be modified to ensure that they recognize the year
2000. Mutual funds and their investment advisers and other service
providers, like most other securities-related enterprises, are heavily
dependent upon computer systems. If their computer systems are not Year
2000 compliant, mutual funds and their investment advisers could face
difficulties performing various functions such as calculating net asset
value, redeeming shares, providing account statements and other
information to their shareholders, and communicating with fund
custodians, transfer agents, and distributors. As I discuss below, the
Commission has actively considered and taken steps to address the Year
2000 problem for funds, and will continue to do everything that it
reasonably can to ensure that funds correct any potential Year 2000
concerns before the turn of the century.
the commission's response
The Commission has approached the Year 2000 problem from many
directions in recognition of the potential for adverse consequences to
so many investors if funds do not act and act soon to address the Year
2000 problem.\4\ Early on, the Commission took steps to raise industry
awareness of the Year 2000 problem and to collect information about
mutual funds' readiness for the Year 2000. Commissioners and staff have
addressed the Year 2000 issue in virtually every recent major speech to
the fund industry.\5\ The Commission and its staff have issued
extensive guidance to issuers, including mutual funds, regarding their
Year 2000 disclosure obligations, and have established a Task Force to
monitor compliance with the Commission's disclosure directives. Over
the past three months, the Commission's Office of Compliance
Inspections and Examinations staff has conducted nationwide
examinations that are dedicated to obtaining information on the Year
2000 problem. Most recently, we announced a moratorium on the
implementation of new Commission rules that would require major
reprogramming of computer systems by, among others, investment advisers
and funds.\6\ The moratorium is designed to facilitate and encourage
securities industry participants to allocate sufficient resources to
remediation of the Year 2000 problem. In the next few weeks, the
Commission expects to take final action on a proposed rule that would
require all registered investment advisers, including advisers to
mutual funds, to report on the funds and the investment advisers'
readiness for the Year 2000.
---------------------------------------------------------------------------
\4\ See, e.g., Revised Staff Legal Bulletin No. 5 (pub. avail. Jan.
12, 1998); Statement of the Commission Regarding Disclosure of Year
2000 Issues and Consequences by Public Companies, Investment Advisers,
Investment Companies, and Municipal Securities Issuers, Investment
Company Act Release No. 23366 (July 29, 1998); Investment Adviser Year
2000 Reports, Investment Advisers Act Release No. 1728 (June 30, 1998)
(``Form ADV-Y2K Proposing Release'').
\5\ See Remarks of Chairman Arthur Levitt at the Investment Company
Institute (May 15, 1998); ``Mutual Fund Consolidation and
Globalization: Challenges for the Future''--Remarks by Barry P.
Barbash, Director of the Commission's Division of Investment
Management, Mutual Funds and Investment Management Conference,
Sponsored by the Federal Bar Association and the ICI Education
Foundation (Mar. 23, 1998); ``Remembering the Past: Mutual Funds and
the Lessons of the Wonder Years''--Remarks by Barry P. Barbash,
Director of the Commission's Division of Investment Management, 1997
ICI Securities Law Procedures Conference (Dec. 4, 1997); ``Mutual Funds
in the New Millennium: The Opportunity To Invent Their Future''--
Remarks by Barry P. Barbash, Director of the Commission's Division of
Investment Management, 1997 ICI General Membership Meeting (May 16,
1997).
\6\ Commission Statement of Policy on Regulatory Moratorium to
Facilitate the Year 2000 Conversion, Investment Advisers Act Release
No. 1949 (Aug. 27, 1998).
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The information that the Commission staff has gathered to date
shows that the mutual fund industry is quite aware of the potential
problems that the Year 2000 presents and is preparing to meet this
challenge in a timely manner. As we approach the millennium, the
Commission will continue its Year 2000 program, taking any actions we
believe will help ensure that the mutual fund industry is prepared for
the Year 2000. We will continue to raise the industry's awareness of
the Year 2000 issue, gather information about Year 2000 readiness, and
evaluate the status of the industry's readiness. If we find
deficiencies, we will aggressively address them with the funds and
their investment advisers, conduct further examinations and, as
appropriate, bring enforcement actions.
We believe that, in addition to the Commission's actions and other
government initiatives, the disciplining effect of market forces and
self interest will promote Year 2000 compliance in the mutual fund
industry. Mutual funds and their service providers have compelling
business incentives to expend the resources necessary to protect
themselves, their clients, and their investors. We believe that strong
and effective government oversight together with market forces will
foster widespread Year 2000 compliance in the mutual fund industry.
education and information gathering
One of the Commission's top Year 2000 priorities has been to
educate mutual fund industry participants about Year 2000 issues and to
gather information on their progress in becoming Year 2000 compliant.
Since 1996, Commission examiners have raised Year 2000 concerns during
adviser and fund examinations to increase awareness of the problem and
encourage corrective action. In 1997, Chairman Levitt sent a letter to
all registered investment advisers, including advisers to mutual funds,
warning of the consequences of not being Year 2000 compliant, and
urging them to make preparations for the Year 2000 their highest
priority.
The Commission staff has been working with the Investment Company
Institute (``ICI''), the mutual fund industry's principal trade group,
to obtain data to monitor the progress of the industry in addressing
the Year 2000 problem. The Commission staff has met regularly with the
ICI to promote Year 2000 readiness and discuss the status of the
industry's Year 2000 assessment, remediation, and disclosure efforts. A
recent ICI survey indicates that 80 percent of funds responding to the
survey plan to complete their Year 2000 programs by the end of this
year.\7\ The ICI also has urged its members to participate in the
Securities Industry Association's industry-wide testing program, which
is scheduled to begin in March 1999. Several major mutual fund
complexes participated in the Association's initial round of beta
testing this July, which involved simulating a trading cycle (i.e.,
from order entry to settlement) for various types of securities,
including mutual fund shares. The funds that participated in this
testing experienced no significant problems.
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\7\ Data provided by the ICI. This information reflects responses
to the ICI's questionnaire dated March 16, 1998. Responses were
received from 77 investment company complexes between March 16 and June
3, 1998, and represent 66 percent of industry assets. Two of these
firms did not provide a response to the question by the completion
date. The program completion date for funds broke down as follows
(percentage of funds): 1998 2d Q or earlier--3 percent, 1998 3d Q--5
percent; 1998 4th Q--72 percent; 1999 1st Q--8 percent; 1999 2d Q--11
percent; 1999 Post 2d Q--1 percent.
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disclosure
The Commission has taken a number of steps to promote useful
disclosure about Year 2000 issues by mutual funds. To impress upon
mutual funds their disclosure obligations, the Commission's Division of
Investment Management jointly issued a Staff Legal Bulletin with the
Division of Corporation Finance in 1997. Under the bulletin, funds and
advisers must disclose any material effect that the Year 2000 problem
may have on their businesses, including the cost of remediation, the
consequences of incomplete or untimely resolution of the problem, and
the risk that the problems of third parties will affect their business.
After the bulletin was issued, the Division of Investment
Management formed a Year 2000 Disclosure Task Force to assess the
quality of Year 2000 disclosure being made in disclosure documents. The
Task Force was directed to assess the disclosure not simply through the
eyes of a regulator, but also through the eyes of an investor. When
appropriate, the Task Force instructed funds to provide disclosure in
plain English, and more user friendly, terms. The funds selected for
review by the Task Force represented over 50 fund complexes and over 59
percent of mutual fund assets.
The Task Force found that the number of mutual funds that are
disclosing Year 2000 information has increased substantially in the
last year. During 1997, few mutual funds made any Year 2000 disclosure.
In contrast, through May 1998, 81 percent of the new or amended
registration statements filed by funds during 1998 contained Year 2000
disclosure. In addition, 24 of the 25 largest mutual fund complexes
have made Year 2000 disclosure to their shareholders.\8\
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\8\ The remaining fund complex informed the staff that it believes
that Year 2000 issues will not materially affect its ability to provide
the services described in fund registration statements. The complex has
been working on Year 2000 corrections since 1996, reports frequently to
the fund boards, and continues periodically to review the need for
disclosure. In addition, the fund complex is considering providing
supplemental communication to shareholders about Year 2000 issues.
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In the course of its reviews, the staff became concerned that,
while more funds were discussing Year 2000 issues in their disclosure
documents, the documents in many cases could be made more useful to
investors seeking to understand the Year 2000 readiness of their funds.
In attempting to improve the quality of Year 2000 disclosure, the
Commission issued an Interpretive Release on Year 2000 disclosure
requirements in July 1998. The release sets forth the factors that the
Commission expects all mutual funds to address in providing Year 2000
disclosure. In particular, the release states that if mutual funds
determine that their Year 2000 risks are material, they must disclose
these risks in their registration statements and other public
documents. According to the release, a fund should consider, in
assessing its potential Year 2000 risks, whether Year 2000 issues
affect its own operations, its ability to obtain and use services
provided by third parties, or its portfolio investments. The Task Force
will continue to evaluate industry compliance with this guidance, and
will direct funds to improve their disclosure, as needed.
examinations
The Commission believes that one of the most effective means of
directly evaluating the readiness of mutual funds for the Year 2000 is
through the examination process. Beginning in 1996 and continuing
through 1997, our investment management examination program focused on
awareness: getting the message out to funds and their investment
advisers that they needed to address the Year 2000 problem. In 1996,
the Commission's Office of Compliance Inspections and Examinations sent
a letter to the ICI alerting it to the seriousness of the problem and
that remediation efforts would be reviewed during on-site examinations.
Reviews of mutual funds and their advisers at that time were designed
to alert them to the problem and to gauge whether they had plans to
remediate their computer systems that were not Year 2000 compliant. Of
the 757 investment advisers and mutual funds examined in 1996 and 1997
of which Year 2000 inquires were made, 93 percent (731) were aware of
the Year 2000 problem, and 83 percent (627) had already taken or
planned corrective actions. During late 1997, our examiners conducted
in-depth reviews of selected advisers' remediation programs. The staff
generally found that these advisers were taking the Year 2000 problem
seriously, had plans in place to deal with Year 2000 issues, and were
actively working on implementing their plans.
Beginning in the spring of this year, our examinations began
determining the extent of each fund's reliance on third parties to
ensure Year 2000 compliance, whether the fund has a written plan to
deal with Year 2000 issues, the date that the fund expects to complete
systems testing, and whether the fund plans to participate in testing
with outside parties or in industry-wide testing. Our examiners have
collected information concerning, for example, progress on meeting
completion dates and testing for a significant percentage of registered
advisers. The information gathered through this process serves both to
identify specific areas of potential difficulty that will need close
monitoring and to validate information provided from other sources. As
of this past August 31, our examination staff had conducted inspections
of mutual funds representing over one-third of fund assets. Our data
show that most funds plan to have any Year 2000 problems corrected by
the end of 1998 or during early 1999, which is generally consistent
with industry statements that corrections should be completed by
December 1998.\9\ Only a small number of funds indicated that they did
not expect to complete their corrections until mid-1999. The staff is
treating those advisers and funds with late completion dates and those
not planning to conduct internal testing as potentially requiring
additional action. We will be asking them to explain any problems that
we find, and we may follow up with on-site examinations of some of
these entities in the future.
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\9\ See ICI Survey supra note 7.
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Thus far, data that we have collected show that funds are making
significant progress in addressing their Year 2000 problems. Ninety
percent of funds indicated that they were taking steps to correct their
Year 2000 problems. Of the remaining funds, some had already completed
their corrections or indicated that they had identified no
problems.\10\ We found that 77 percent of funds have written plans to
address Year 2000 compliance, and that 95 percent of the funds have
made inventories of all of their computer systems affected by the Year
2000 problem. Only 1 percent of funds had neither a plan nor conducted
an inventory.
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\10\ Some advisers that answered that they had identified no
problems explained that they either had new systems that were Year 2000
compliant or had contracted with third parties for virtually all of the
services that might be affected by the Year 2000. The Commission staff
will send letters to other funds that provided this response asking
them to explain whether their responses indicate that they need to take
additional steps to address their Year 2000 readiness.
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proposed reporting requirement
In recognition of the urgency of the Year 2000 problem, the
Commission intends to take every reasonable step to encourage the
mutual fund industry to address the Year 2000 challenge. To supplement
our examination program, the Commission has proposed to require that
all registered investment advisers, including fund advisers, report
their progress on making their systems Year 2000 compliant.\11\ The
reports would be similar to our recently-adopted reporting regulations
for broker-dealers and transfer agents. If the advisers have mutual
funds as clients, the advisers also would be required to provide
information about the readiness of the funds for the Year 2000, as well
as their own readiness. As proposed, the reports would address the
scope and status of the advisers and funds' Year 2000 plans and their
commitment of resources and personnel to address the problem. Advisers
to funds would report on the systems that may be affected by the Year
2000 problem and the progress that they have made in addressing these
problems, including the extent to which they have conducted internal
and external testing of their systems. The reports also would include
information on contingency plans in case of system failures and the
readiness of third parties upon which the adviser or fund relies for
its critical systems.
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\11\ Form ADV-Y2K Proposing Release, supra note 4.
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The Commission believes that the proposed Year 2000 reports will
further encourage advisers to proceed expeditiously in preparing for
the Year 2000. We expect that advisers will be required to file the
reports in early December and again in June 1999. The Commission has
proposed to make the reports available to the public on our website and
will use the information gathered in the reports, among other things,
to fulfill Congressional requests for information regarding the
securities industry's readiness for the Year 2000 problem. The
Commission staff intends to use the reported information to obtain a
more complete picture of the industry's overall Year 2000 preparations
and to identify firm-specific problems. Advisers that report
questionable or inconsistent information will be asked to explain any
problems that we find and could be subject to follow-up compliance
examinations. Information in the reports, in conjunction with
information obtained from industry groups and through the examination
program, will enable the Commission staff to target its efforts for the
rest of 1998 and 1999 on particular industry segments or firms that
appear to pose the greatest risk of non-compliance. The Commission is
currently reviewing staff recommendations on the proposed rule and
expects to take final action on the rule by the end of the month.
mutual fund portfolio investments
Thus far, I have discussed the Year 2000 to the extent that it
presents potential operational risks to mutual fund shareholders. Such
a risk would be, for example, that a fund's computer systems may fail
at the turn of the century. I understand that the Special Committee
also is examining the important issue of the Year 2000 to the extent
that it presents potential investment risks to mutual fund
shareholders. These risks would include, for example, the risk that the
operations of a company in which the fund invests would be adversely
affected by the Year 2000 problem.
The Year 2000 risks presented by the companies in which mutual
funds invest, like any other investment risk, will be a factor that
investment advisers to mutual funds may consider as part of their
investment decision-making process. In discussions with major fund
complexes, we have learned that their investment advisers are
increasingly considering companies' Year 2000 compliance when they
evaluate the merits of the particular companies as potential
investments. One major fund complex advised us that its analysts ask
standard questions about all prospective portfolio companies' Year 2000
readiness, including questions about the priority assigned and assets
committed to the companies' Year 2000 program, the companies'
consideration of risks posed by third parties (e.g., suppliers), and
the current status of their progress in identifying and eliminating
Year 2000 problems. Another major fund complex reported to us that its
investment adviser's portfolio managers systematically address Year
2000 issues by carefully reviewing publicly available information about
a company's Year 2000 readiness, and then following up with on-site
visits for further fact gathering.\12\ Fund complexes generally advised
us that they expect Year 2000 analyses to become more refined as more
information about Year 2000 becomes available. We believe that this
kind of Year 2000 due diligence is, or will become, typical of the
investment decision-making process used by many funds' investment
advisers.\13\
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\12\ Public information about the Year 2000 exposure of some
portfolio companies only now is becoming widely available. See, e.g.,
Statement of the Commission Regarding Disclosure of Year 2000 Issues
and Consequences by Public Companies, Investment Advisers, Investment
Companies, and Municipal Securities Issuers, Investment Company Act
Release No. 23366 (July 29, 1998).
\13\ Our view is confirmed by a recent article, which outlines the
decision-making process of the advisers to a number of larger fund
groups. Fund Managers Hunt for Clues, Morningstar (June 16, 1998)
(reporting fund portfolio managers efforts to obtain information about
companies' Year 2000 readiness) (available at http://
www.morningstar.net).
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The Commission will continue to develop a more complete picture of
the steps that funds' investment advisers are taking to address Year
2000 investment risks. The Commission staff has recommended to the
Commission that the Year 2000 reports discussed above require fund
advisers to indicate whether and how they consider Year 2000 investment
risks in making investment decisions. This requirement will provide us
with more information about the role of Year 2000 issues in fund
advisers' investment decision-making process, and help focus advisers'
attention on this issue.
We believe that, based on the information that we have collected to
date, no further action by the Commission is needed at this time to
address fund advisers' consideration of Year 2000 investment risks. The
role that Year 2000 investment risks should play in advisers'
investment decision-making process depends heavily on the particular
context. Fund advisers are legally required to manage their portfolios
consistent with their stated investment objectives and strategies. In
some cases, it may not be consistent with a fund's investment
objectives (e.g., to invest in the S&P 500) or strategies (e.g., to
rely exclusively on quantitative analysis) for the fund's adviser to
take a companies' Year 2000 readiness into account in making investment
decisions. The Commission believes that, because of the fact-specific
nature of the investment decision-making process, imposing specific
obligations on fund advisers regarding their consideration of Year 2000
investment risks would likely be impractical and potentially
inconsistent with the way in which shareholders expect their funds to
be managed.
the role of investors
One of the Commission's primary goals historically has been to
apprise investors of the importance of understanding the risks of the
investment vehicles in which they invest. Toward this end, the
Commission has sponsored numerous public meetings to educate investors
about the importance of understanding their investments. The Commission
also has published on its website a list of eight questions that
investors should ask their mutual funds about the Year 2000, including
a question regarding the Year 2000 exposure of the portfolio companies
in which funds invest. Anecdotal evidence that we have gathered to date
suggests that investors are aware of this issue and many of them are
contacting their advisers and funds to ask about Year 2000 issues. One
major fund complex, for example, reported to us that it had received
over 600 questionnaires from investors asking, in part, about steps
that the fund's investment adviser was taking to incorporate Year 2000
considerations into its investment decision-making process.
conclusion
We believe that the mutual fund industry is well aware of the
potential problems that the Year 2000 presents, and is preparing to
meet this challenge in a timely manner. Funds and advisers generally
appear to be expending the effort and resources necessary to ensure
Year 2000 compliance. The Commission will continue to actively evaluate
the industry's readiness on Year 2000 issues, and will take further
action as necessary against those advisers and funds that appear to
present problems. Many fund shareholders and advisory clients are aware
of this issue, requiring funds and advisers to view the Year 2000
problem not just as a regulatory issue, but as a business issue. In
this regard, although we at the Commission will continue to monitor
progress and do everything that we can to address the Year 2000 issue,
funds and advisers will ultimately have to answer to the market and
their clients if they are not ready for the coming millennium.
______
Responses of Commissioner Laura S. Unger to Questions Submitted by
Chairman Bennett
Question 1. You have testified that of the mutual funds you have
examined to date (representing approximately \1/3\ of assets held in
mutual funds), only 1 percent had failed to prepare a written plan and
conduct an inventory of their systems. These are promising results.
Nevertheless, what action do you plan to take against those 1 percent
and others you identify in future examinations?
Answer. The Commission's staff is following-up with ``for-cause''
examinations of the mutual funds that failed to prepare a written plan
and conduct an inventory of their systems. The Commission's staff will
continue to monitor mutual funds that appear to be at risk.
Specifically, the staff intends to use investment advisers' disclosures
in newly adopted Form ADV-Y2K to identify advisers and fund complexes
that appear to not have addressed their Year 2000 problems.
The staff also expects the private sector to play a role in
monitoring the mutual fund industry. The staff expects interested
parties--investors, clients, business partners and vendors--to use the
ADV-Y2K disclosures to form their own conclusions about advisers' and
funds' readiness. Firms lagging behind the industry should expect to
feel the effects of business, as well as regulatory, discipline.
Question 2. It is very important that both individual investors and
investment advisers have reliable and complete information on the
companies in which they invest, including information about Year 2000
risks. Do you have any sense of whether individuals and investment
advisors are getting the Year 2000 information they need to make
informed investment decisions and recommendations?
Answer. The Commission is making every effort at making sure that
reliable and complete information about the Year 2000 preparedness of
companies is available to investors. Based on the Commission's recent
interpretive release regarding public company disclosure, the vast
majority of companies should be providing details of their Year 2000
readiness each quarter in their Commission filings. We cannot be sure
to what extent individual investors use this information in their
investment decisionmaking. To encourage investment advisers to use this
information, the Commission recently asked all advisers whether they
took into consideration Year 2000 preparation of companies whose
securities they recommend to clients. Based on the number of questions
the staff of the Division of Investment Management has received, this
question has attracted the attention of investment advisers. When
investment advisers submit their Year 2000 readiness reports to the
Commission in early December, we will have a better indication of
whether advisers are considering Year 2000 issues when they make their
investment decisions.
Question 3. The Special Committee staff has spoken in confidence
with individuals who assert that a very high percentage of Year 2000
disclosures filed to SEC requirements are misleading and outright
wrong. The argument goes that a company has more risk in exposing Y2K
problems since at this time there is independent auditing in place to
challenge their Y2K statements and there are no fines for
misstatements. In contrast, Mexico is auditing the statements being
made by their banks. Please comment on these allegations? What actions
is the SEC prepared to take against companies that file misleading
reports?
Answer. At this time, the Commission has no basis to believe that a
very high percentage of Year 2000 disclosures are misleading. If the
Commission finds that any Year 2000 disclosures are materially
misleading, appropriate action will be taken. The Commission takes the
Year 2000 problem seriously and intends to vigorously enforce the
federal securities laws relating to this disclosure issue. As I
testified, the Commission's interpretive release on Year 2000
disclosure may form the basis of Commission enforcement actions against
companies that fail to disclose material information regarding their
Year 2000 issues.
At this time, the Division of Corporation Finance staff continues
to seek better Year 2000 disclosure by raising issues through the
comment process for company filings that it reviews. More egregious
deficiencies will be referred to the Division of Enforcement for
investigation. The Commission intends to be proactive and take any
warranted enforcement action before the Year 2000 for misleading Year
2000 disclosure.
Recently, the Division of Enforcement brought actions against 37
brokerage firms for failing to file required Year 2000 related reports.
As part of this coordinated effort, the National Association of
Securities Dealers charged another 59 brokerage firms for filing their
reports late. These actions reflect the Commission's recognition of the
magnitude of this issue and willingness to promptly bring enforcement
actions for federal securities law violations.
The Commission's Office of Chief Accountant has worked with the
accounting and auditing profession to establish appropriate guidance
for auditing procedures in the Year 2000 context. The Commission itself
does not directly conduct audits of public companies since our
statutory authority is limited to eliciting disclosure. For broker-
dealers, over which the Commission has more direct authority, the
Commission recently adopted a rule that requires a broker-dealer to
file with the Commission and the broker-dealer's designated examining
authority a report prepared by an independent public accountant
regarding the broker-dealer's process for preparing for the Year 2000.
In conjunction with adopting this requirement, the Commission indicated
that the independent public accountant's report can be prepared in
accordance with agreed-upon procedures promulgated by the American
Institute of Certified Public Accountant's Auditing Standards Board.
__________
Prepared Statement of Michael A. Waterford
introduction
Mr. Chairman and Members of the Committee, my name is Michael
Waterford and I am here on behalf of DST Systems, Inc. We appreciate
the opportunity to provide testimony on the Year 2000 Problem and the
efforts of the mutual funds industry to prepare for it. We believe that
the work of this Committee is vitally important in creating the
necessary climate of public awareness of the problem and an appropriate
level of corporate concern and response.
dst's role in the mutual funds industry
DST Systems, Inc. is a publicly traded company based in Kansas
City, Missouri, and listed on the New York Stock Exchange. Our revenues
in 1997 were $650 million and we employ approximately 6,000 people
worldwide. Our company was founded in 1969 to address the shareholder
record-keeping requirements of the mutual funds industry, and today
that is still our primary business. We have other businesses which
provide products and services to the financial services and other
industries; however, this testimony is in respect to our U.S. mutual
funds business only.
DST has grown rapidly with the mutual funds industry and is the
leading record-keeper for shareholders in that industry. We provide
shareholder record-keeping to over 200 mutual fund companies,
representing over 8,000 funds or fund classes and over 48 million
shareholder accounts, with assets in excess of $1.6 trillion. A
shareholder account represents one holding by one person in one fund or
fund class. A person who invests in a dozen funds or fund classes would
have twelve accounts maintained by us. We estimate that an investor has
on average two or three accounts, so 48 million shareholder accounts
can be translated into 15-20 million investors. We also provide
portfolio accounting services to 33 mutual fund companies with over
2,000 portfolios.
Our shareholder accounting system and portfolio accounting system
are large proprietary systems which we own and operate at our own data
center in Kansas City, Missouri. We make our services available to
clients and shareholders over our own private telecommunications
network. We do not sell these systems.
The software product which we use to provide shareholder record-
keeping to the mutual funds industry is called TA2000.TM The
typical services which we provide for mutual fund shareholder record-
keeping involve processing transactions, such as maintaining
shareholder records of ownership in mutual funds. This means performing
transactions such as purchases, redemptions and exchanges; account
maintenance such as changes of address or bank account information;
processing incoming mail, responding to phone inquires from
shareholders and financial intermediaries such as brokers; sending out
confirmations, statements, checks, letters and tax forms. If a client
(i.e. a mutual funds management company) elects to have us perform all
of those services employing our own staff, we consider the client to be
a ``full service'' client. Clients who wish to perform all of the
functions themselves, accessing our systems in our data center but
employing their own staff, are considered to be ``remote service''
clients. Remote service clients may decide that they wish to perform
all the services themselves. Alternatively, they may choose to perform
only some part of the services themselves and outsource the remainder
to us. Thus the full service and remote service options should be
regarded as a spectrum along which clients may choose whichever
combination of remote and full services best suits their needs. Just
over 40 of the 200 management companies we service have chosen DST to
perform their shareholder record-keeping on a full service basis. In
respect to both full service and remote service activities, DST is a
registered transfer agent regulated by the Securities and Exchange
Commission. Since some of our clients are banks, we are examined by the
Federal Financial Institutions Examination Council (FFIEC) on behalf of
the Federal Reserve, the Federal Deposit Insurance Corporation and the
Comptroller of the Currency in connection with their regulation of our
client banks. The work of all these regulatory bodies is important in
furthering awareness of the Year 2000 Problem, and in assisting with
coordination of efforts by industry members.
Our portfolio accounting services are provided by a separate
software product, the Portfolio Accounting System or PASTE, and are
available only on a remote service basis. These services enable mutual
funds managers to record the underlying securities in the mutual fund
portfolio, to track portfolio changes as well as to record corporate
actions such as dividends and stock splits. The most critical function
of PAS is to calculate the daily net asset value (NAY) of the fund
which is published in the newspapers and used in the calculation of the
prices at which shareholder purchases, redemptions and exchanges are
made.
Increasingly, we handle shareholder inquiries and transactions via
automated interfaces. The single most important interface is the data
transmission from the National Securities Clearing Corporation (NSCC),
which offers trade placement and settlement services for mutual funds
transactions originating primarily from broker/dealers. We process over
50 percent of the NSCC's daily mutual funds volume. The numerous
interfaces which we handle in TA2000 also include direct transmissions
from mutual fund clients and financial intermediaries. Additionally, we
receive direct transactions and inquiries from shareholders using our
Interactive Voice Response (IVR) systems, which enable the shareholder
to conduct business from a touch-tone telephone, 24 hours a day, 7 days
a week. We also provide Internet access for shareholders through a
secure Web site. This is not currently a significant part of our total
volume of transactions and inquiries, but is growing rapidly.
In line with developments in the mutual funds industry, the types
of funds and accounts which we service have grown significantly during
the 1980's and 1990's. Tax-qualified accounts in particular have grown
as a percentage of total accounts and total assets in all types of
funds. An increasing percentage of tax-qualified shareholder accounts
which we service are Individual Retirement Accounts (IRA's) and a
further large number of accounts represent individual investment
choices in 401 (k) plans. Some 401 (k) plans are serviced directly by
DST using our TRAC-2000 system, which is offered to our clients as part
of TA2000. In that case the number of participants in the plan is known
and all the participant information is recorded on our system. Other
401 (k) plans are administered outside of TRAC-2000 and TA2000 by other
companies or administrators using their own software. In that case, for
each fund in the plan which we service, the plan administrator
maintains a single account on our system representing all of the plan's
assets in that fund.
Over the last decade, DST has invested hundreds of millions of
dollars in its infrastructure and systems to address the growing needs
of the mutual funds industry. We have invested in the development of
proprietary image-based systems to manage high-volume workflow
(letters, faxes, phone calls) in a clerical environment. We have
invested in large increases in data center and telecommunications
network capacity to handle increasing volume, and we have invested in
major systems development to meet our clients' needs as their mutual
funds products have evolved. Today, well over 1,500 of our staff are in
technology roles in information systems development and support as well
as computer and network operations.
dst's preparations for the year 2000 problem
DST's first preparations for the Year 2000 started in 1989. In that
year, we undertook a large project, known as ``Flex,'' at a cost of $12
million to re-engineer the data in our TA2000 mutual funds shareholder
record-keeping system. This involved both the relief of certain
constraints which had come about as a result of rapid growth in the
1980's as well as the expansion of data capacity to handle anticipated
growth over the next two decades. A key element of this project was the
addition of the century to all dates in the TA2000 data bases and we
also upgraded the date fields in those work and interface files where
DST was able to determine the format of the file. We were not able to
upgrade the formats of date fields where those were determined by
clients or other organizations. Thus, since 1990 when the re-
engineering project was completed, our mutual funds shareholder records
have generally carried the full four-digit year.
At the same time, we established a central data architecture group
to control the data architecture for our future systems development.
This group established a full four-digit year requirement for dates in
data bases and work files. The result has been a consistent standard
across all of our proprietary systems for approximately ten years which
has been a major factor in reducing the size and cost of the task of
preparing for the Year 2000. In spite of those actions, the work of
verifying our readiness has required the allocation of significant
resources, of which the majority have been deployed in our test efforts
both internally and with the outside world.
In 1994 through 1996, we conducted a review of our TA2000 system to
assess its Year 2000 status. We chose that system since it is the
largest system we operate, consisting today of approximately 15,000
programs, and represents the largest part of our overall business. We
identified certain areas with trans-century issues and carried out
several projects to address those issues. At the same time, we also
reinforced our systems development processes. These projects provided
us with key insights into the methodology of systems remediation and
maintenance in large highly active systems which have been important to
our Year 2000 readiness program. DST's standard for the Year 2000 is
that data bases and work files will contain, where possible, the full
four-digit year, and that any data bases or files which did not include
the full four-digit year will be expanded to do so. There is a
technique, called ``windowing,'' which can be used to deal with data
bases with two-digit years. This involves creating a virtual century
e.g. from 1950 to 2049, and programming the computer system to treat
years 50 through 99 as 20th century, and years 00 through 49 as 21st
century. There are many variants of windowing, but the basic concept is
the same and requires program changes. DST's standards limit the use of
windowing, because the technique is not as reliable as field expansion
in many circumstances . There are two kinds of situations where, even
with four digit years in the data base, some windowing is required. The
first is in the acquisition of date information from workstations,
where, for operational efficiency, the operator is required only to
enter a two digit year. The second is in data interfaces with third
parties where the third party has specified a two-digit year format and
does not wish to upgrade it.
In November 1996, we established a Project Office, headed by a
senior officer and staffed by qualified senior technical staff and
experienced outside consultants, to establish methodologies, processes,
and standards and to carry out day-to-day oversight of all Year 2000
activities. The organization of Year 2000 projects is based on DST's
business structure. For each software product or other area of the
organization undertaking Year 2000 remediation activities, the
executive in charge of the area is responsible for the provision of
resources and is accountable for timely and successful completion of
the work. Within the area, technical and business staff working in
project teams headed by experienced managers are responsible for
carrying out the work, including communication with clients and
organization of point-to-point testing where applicable. These managers
report directly each month to the Project Office. The Project Office
reports to a Year 2000 Oversight Committee, headed by DST's Executive
Vice President together with key operating executives as well as legal
and internal audit representation. The Oversight Committee meets
monthly to review the work of the Project Office and to ensure that
DST's Year 2000 program is completed in a timely manner.
DST has set a corporate goal of achieving internal Year 2000
readiness of our systems and services by December 31, 1998. By ``Year
2000 readiness,'' we mean that the system will operate in accordance
with its specifications or other functional description regardless of
the century with respect to which date data is encountered by the
system.
We set our timeframe for achieving readiness as an internal
timeframe because we recognize that internal readiness and external
readiness (i.e. readiness involving testing and interaction with
clients and other third parties) involve two very different sets of
issues. One of the lessons learned from our re-engineering experiences
with the Flex project in 1989 and 1990 was that internal re-engineering
projects where we have complete control of the project elements can be
executed in a structured and predictable manner on pre-determined
schedules, even if the projects are large and complex. Projects
involving external organizations to whom we provide services are
susceptible to scheduling and co-ordination difficulties and are less
predictable in terms either of the effort required to complete them or
the probable timetable for doing so. It is important for timely
achievement of internal Year 2000 readiness that it be kept separate
from external readiness activities.
Our decision to choose December 31, 1998 as a goal for internal
readiness was motivated by two considerations. The first was simply to
allow time for recovery in the case of project delays. The second was
the expectation that adequate staffing would have to be allocated in
1999 to testing with clients, the industry and other third parties. At
the time of this submission, this still appears to be the likely course
of events.
current status of dst's year 2000 readiness project
The readiness program established by the Project Office began in
early 1997 under veteran project managers. To a large extent, we have
undertaken these efforts with our own staff, and always under our own
control, which we consider to be appropriate for timely completion of
these activities. The process for Year 2000 readiness of a system
consists of taking an inventory of everything which might be affected,
determining its readiness status (assessment), carrying out the
necessary repair or replacement, testing and implementation. The
complexity of the Year 2000 Problem lies not in each individual
project. It lies in coordinating and sequencing all projects across a
large organization, and beyond the organization to numerous third
parties with which any organization communicates as part of its normal
business activities. In other words, it is not a complex technical
problem. It is a complex logistical problem.
To support its test requirements for Year 2000 readiness, DST has
created two different kinds of test facilities. The first kind is a
date-simulated environment. In the date-simulated environment, we are
operating multiple test systems for ourselves and our clients. These
test systems use data bases which are separate from our normal test
facilities and from each other, and contain test shareholder and fund
information which has been ``rolled forward'' until it appears to be
1999 or 21st century data. When tests are run, special tools create the
appearance of a 21st century environment even though the underlying
software/hardware platform is the same platform we use for current test
and production. The advantage of this is that it is highly flexible,
easy for our clients and ourselves to access and permits large amounts
of testing in widely different situations in relatively brief time
periods.
The second kind of test facility is a ``time machine.'' This is a
segregated hardware and software platform which is actually operating
as if it is in the 21st century. It is the full readiness platform
where all third party hardware and software is brought together with
our own systems to be sure that they all work together properly. The
time machine is very important, but is used more sparingly than the
date-simulation facilities because: (1) it is difficult to access due
to the need for complete isolation to avoid contamination of current
platforms; and (2) it is being built on an on-going basis as third-
party software becomes available. So the date-simulation facilities do
most of the work of testing each product, and the time machine is used
for final integration and testing of our systems.
As of the time of this testimony, we have essentially completed the
remediation of our TA2000 and PAS software systems, and the remediated
programs have been placed into production. Testing both internally and
with our clients is well advanced. Internal testing of TA2000 has been
on-going for over a year, and will continue through the end of 1998.
Internal testing of PAS began this year and will be completed this
year. The tests consist of ``cycles'' addressing specific system
functionality in a specified range of 1999 and 21st century dates.
Testing of these systems has uncovered a small number of issues, all of
which we consider to be minor and were promptly addressed. We expect to
complete our internal testing on schedule by the end of 1998. Readiness
of the time machine is less advanced, partly due to time frames for
acquiring third-party software and partly due to the time frames for
assessing certain ``in-house'' software which support our operations.
However, the time machine is in successful operation at the moment and
we anticipate that it will be complete for mission critical elements by
the first quarter of 1999 with testing continuing throughout that year.
We expect our testing with clients, the industry and other third
parties to continue well into 1999, and possibly into the fourth
quarter. Our testing with clients started on TA2000 in November 1997,
and for PAS in June 1998. Testing with clients is organized in cycles,
like internal testing, and has also uncovered only a small number of
issues which have all been promptly addressed. DST has many interfaces
with third parties other than its clients. One of the primary
interfaces, as noted earlier, is with the NSCC. DST has worked with the
NSCC to ensure that the interface formats are appropriate for the
transition into the next century, and is a participant together with
many other organizations in the financial services industry in the
industry-wide testing organized by the Securities Industry Association.
The SIA is to be commended for its leadership role in organizing and
overseeing the ``streetwide'' testing which is being carried out in
1998 and 1999. DST participated as a service provider in the ``beta''
test which was carried out in July of this year. Although this was only
a limited test in terms of volume, it afforded the opportunity to test
the interfaces between brokers, stock exchanges, mutual funds companies
and other organizations with a range of financial transactions. DST
received approximately 1,200 transactions, which it processed with no
Year 2000 problems. We will participate both in an additional mutual
funds test in October 1998, as well as the full streetwide test in
March 1999.
As our testing has progressed with relatively few problems, we have
become more comfortable with our ability to meet our internal
timeframes for readiness. That is not the same as saying that we expect
to be error-free. The state of the art in software development
unfortunately does not permit the creation of large defect-free
software products. Therefore, in spite of the considerable amount of
testing which we and other organizations have undertaken and will
continue to undertake, we must expect that there will be issues of
various kinds when we cross into the next century.
In terms of expenditure of resources, DST currently has the
equivalent of over 100 persons working on Year 2000 for its mutual
funds business, including TA2000, PAS, and infrastructure projects. Our
estimates for the effort still to be expended are subject to
fluctuation, because of the difficulty of estimating the extent to
which clients will test with us and the timeframes in which they will
do so. Our recent filing with the SEC indicated total budgeted costs
for our regulated business in 1998 and 1999 of $5 to 10 million per
year, with some residual cost of $1 to 2 million in 2000.
As described earlier, our mutual funds business is regulated by the
SEC and examined by the FFIEC. With respect to the SEC, we filed a new
report, Form TA-Y2K, on August 31, in response to the new SEC Rule
17Ad-18, and will file a further report as required by the rule on
April 30, 1999. Filings of Form TA-Y2K are public documents. The FFIEC
maintains a program of quarterly visits to service providers with
respect to Year 2000 readiness, and has published a considerable amount
of guidance to financial institutions and service providers. It has
visited DST regularly since November 1997. (The FFIEC does not permit
us to disclose its findings.)
We have put in place a program of communicating with clients to
ensure that they are kept abreast of our efforts. We publish a monthly
newsletter designed to provide an overview of our progress which is
intended for our clients' business management. We put the same
information on the Internet via our web site together with some general
material about our program designed to provide basic information to
inquirers, for example our shareholders and the press. We also provide
detailed information about the status of our products through a series
of readiness reports which are also updated monthly. These are intended
for our clients' operational and technical management. We deal with a
constant flow of information and inquiries from clients to our Year
2000 teams concerned mainly either with status requests or with the
numerous details of organizing and executing client tests.
Additionally, our attendance is requested at mutual fund client
meetings increasingly including meetings of mutual funds boards
discharging their fiduciary responsibilities with respect to the Year
2000.
It is too early to make any categorical statements about the
industry's preparedness. However, the confidence of the public in the
ability of the mutual funds industry to function normally as we cross
the century should have been bolstered by the success of the beta test
conducted by the SIA in July. DST's experience in testing with its
clients is that so far, it has been mainly the larger clients with
significant information technology investments and resources who have
been proactive. The pace of client interest and involvement is steadily
increasing. However, DST believes at the moment that numbers of clients
will seek to test only in 1999, possibly because of a current
preoccupation with internal readiness. We have also not yet experienced
a large demand from third parties for testing facilities. These include
organizations such as financial intermediaries and banks who have been
chosen by our clients to provide information and transactions to us
outside the arrangements offered by the NSCC. We are continuing to
contact such third parties, and expect that over time we will be able
to conduct point-to-point tests with many of them. Many of the
interface formats which we use for these third parties were designed by
us to have full four-digit years in dates. However, there is a
significant number of formats which were not defined by us and may only
have two-digit years. In all cases, tests have to be conducted since it
is not only the formats which are being tested, but the ability of the
third party or DST (for information flowing back after processing) to
have its computer systems provide the correct information and to ensure
that the interface connects appropriately for both parties.
We have also been working with our hardware and software suppliers.
As noted in our SEC filing, we have 85 suppliers or vendors which we
consider mission critical. All have responded positively in terms of
their ability to provide Year 2000 ready software. All the software
which they provide has to be tested and integrated into our time
machine and then deployed into our production facilities. Much of this
software will be upgraded one or more times by our suppliers in the
normal course of business between now and December 31, 1999, which
means that additional testing will be required.
Because of the nature of the problem, and the normal amount of
change in hardware and software platforms as well as our own software
systems, we have scheduled a number of regression tests in 1999 and
have allocated significant resources to do so. The exact extent of
regression testing will be determined in 1999 by the test results
already obtained and the amount and nature of changes which have
occurred since the tests were performed. The objective of the
regression tests is to satisfy ourselves that no issues have been
introduced to our platforms and systems since they were tested.
DST has in place a contingency plan which addresses the
requirements for business continuation in a range of risk scenarios. We
are in the process of reviewing that plan and expanding it to address
risks which are particular to the Year 2000 Problem. As we do so, we
are becoming increasingly aware that there is a range of risks which is
almost completely outside our control and for which currently little
information is available. These concern what we think of as national
infrastructure, which means those technology elements which are
normally taken for granted but which are critical to the ability of
organizations to function. These include the basic utilities, such as
electricity, gas and water, the transportation infrastructure, which
includes road and rail signaling systems, national telecommunications
networks, emergency services and national banking systems for payment
and check clearance. Our inquiries of organizations on which we depend
for such services have typically elicited responses of the form that
they believe they will be ready in time, but they are dependent on
third parties whose readiness may not be known. Since the assessment of
risk is critical to appropriate contingency planning, the inability to
assess that risk within a relatively wide range creates difficulties
for adequate planning. It is possible that, like many other Year 2000
issues, this will resolve itself over time as the readiness efforts of
infrastructure organizations progress but with less than sixteen months
to the next century, it is not possible to be sure that the necessary
information will be available. The sooner it is available the better
our opportunity will be to address business continuation in the event
of infrastructure problems.
In summary, we believe that DST, together with other organizations
in the mutual funds industry and the financial services industry in
general, is reasonably well advanced with its year 2000 preparation. We
also believe that readiness will continue to require the allocation of
significant resources of people and equipment, promptly augmented as
circumstances require, together with consistent management attention at
least through early 2000.
That concludes my testimony. Thank you, and I would be glad to
answer any questions you may have.
______
Responses of Michael A. Waterford to Questions Submitted by
Chairman Bennett
Question 1. You state in your written testimony that since some of
your clients are banks, you are examined by the Federal Financial
Institutions Examination Council (FFIEC) on behalf of the Federal
Reserve, the FDIC, and the Comptroller of the Currency. What efforts
has FFIEC made to assess the Y2K compliance level of DST Systems? While
we recognize the fact that under its own regulations, you are not
allowed to disclose its findings, it should be possible for you to at
least discuss the process it applies in making its assessments.
Answer. After consulting with the Office of the Comptroller of the
Currency, we can say that the FFIEC program currently has two phases.
Phase I was completed for DST in 1997. The Phase II program will be
completed in 1998, through an on-site examination starting November 30.
Additionally, the FFIEC has undertaken review activities quarterly
during 1998 through what they term ``off-site visits.'' These may
include meetings with DST personnel. DST has also provided additional
information from time to time as requested by the FFIEC. The details of
the program are available from the FFIEC web site, and DST is attaching
printed copies of that material for the Committee's reference. As we
understand it, the Phase I program is described in the document
entitled ''Year 2000 Examination Procedures.''
Question 2. You noted in your statement that testing uncovered a
small number of issues, all of which were considered minor and were
promptly addressed. Can you specify what these issues were? Are there
other financial organizations which might be subject to these same
problems?
Answer. With respect to DST's mutual funds and portfolio accounting
record-keeping systems which were the subject of the statement made to
the Committee, the total number of Year 2000 issues raised by internal
or client testing is less than 100. This is in 18 months of testing the
mutual funds system and 9 months of testing the portfolio accounting
system. The majority of these issues were found in DST's own internal
testing process, and less than ten have been found during client
testing. This number is considered by DST to be low when viewed against
the size and complexity of the two systems, which together contain over
20 million lines of COBOL program code. The issues are a range of
programming mistakes which do not constitute any particular pattern.
None of them would have resulted in inaccuracies in the mutual funds or
portfolio accounting data bases.
The issues relate more to the use of the COBOL programming language
than specifically to a given application. There is no reason to believe
that these issues are more or less prevalent in financial services than
any other industry, and since the incidence of error is small and
diverse, it is not really possible to draw any conclusions about any
other organization or any other DST system.
Question 3. You identify the National Securities Clearing
Corporation as the single most important data transmission interface,
and that you process over 50 percent of their transactions. What
efforts has DST systems taken to assure interoperability with this
vital link?
Answer. DST has maintained regular contact with the NSCC for years
to facilitate the operations of both organizations. These contacts take
place both at the management level and on a daily basis between the
operations staffs. Although DST is not a member of the NSCC, we are
invited to attend relevant NSCC meetings and provide input to them. At
the beginning of 1997, DST requested that the NSCC provide fully
remediated date fields in its transmission formats, which it has done.
The new formats were successfully tested internally by DST in May,
1998, and point-to-point with the NSCC in June. In July, we
participated in the streetwide beta test organized by the SIA, and no
Year 2000 issues were noted in that test. In October, we will
participate in the mutual funds test to verify more fully the new
remediated formats, and in March 1999 we will participate with the
industry in the full streetwide test. The full and beta streetwide
tests and the October test all involve DST clients.
Question 4. You mention in your testimony that you have not
experienced a large demand from third parties for testing facilities.
What is the status of your attempts to contact third parties about
``point to point'' testing?
Answer. DST's third parties consist of a number of different groups
and DST's contacts with them are tailored to the characteristics of
each group. For both mutual funds and portfolio accounting record-
keeping systems, the most important effort at the moment is directed
towards testing with clients. DST maintains contact with its clients on
a regular basis through its client services groups. In addition to
publishing newsletters, web site material, and providing specific
information packets on testing facilities, DST uses operations and
other meetings to create client awareness of the facilities we offer
and to organize test schedules. As of the date of this response, there
has been a significant client uptake of our dedicated client test
facilities on both systems.
For mutual funds record-keeping, additional third parties are
viewed by DST as two groups. The first is large multi-client service
and transaction providers. These include major custodian banks, the
NSCC and major broker/dealers who conduct transactions on behalf of
many mutual funds companies. DST is working actively with the large
providers to organize point-to-point testing, much of which is under
way or being scheduled for 1998. The second group consists of smaller
broker/dealers, independent financial advisers etc. generally
conducting low volumes of transactions. In all cases, these service and
transaction providers are chosen by DST's clients, not by DST. Our
approach for these smaller organizations is to work through our clients
to encourage them to test, since a direct approach to each organization
has not been generally productive.
Much of the data interchange between DST and its mutual funds third
parties takes place using standard full-year formats of either the
industry or DST. For data interchange using unremediated formats, DST
has written to the transmitters of such data requesting that they
update their formats for full four-digit years, and stating that if
they are unable to do so, we will be obliged to using ``windowing''
techniques.
For the portfolio accounting record-keeping system, approximately
half the clients are actively engaged in testing. Other third parties
consist of approximately two dozen service providers, nearly all of
whom are custodian banks or providers of pricing services generally
chosen by the client. These service providers have been contacted and
we have obtained firm or provisional testing schedules from all of
them. These schedules begin in October 1998, and continue through June
1999 with approximately half of the tests scheduled for completion by
March, 1999.
DST will conduct a review of third-party testing in the fourth
quarter of 1998 to determine what additional actions may be necessary
to increase point-to-point testing coverage with clients and other
third parties.
__________
Prepared Statement of James A. Wolf
TIAA-CREF (Teachers Insurance and Annuity Association and the
College Retirement Equities Fund) is pleased to respond to the Special
Committee on the Year 2000 Technology Problem's invitation to assess
the impact of the Year 2000 problem on retirement funds and mutual
funds. We welcome and support the efforts of this committee and eagerly
look to contribute to this effort in our role as a major retirement
services provider.
TIAA is a non-profit life insurance company that provides
retirement annuities and insurance products. CREF is its non-profit
companion organization that issues variable annuities. Together, TIAA-
CREF invests assets, which totaled $235 billion as of June 30, 1998,
that are primarily used to fund retirement plans at more than 8,000
educational institutions that cover almost 2.3 million American
educators.
TIAA-CREF's Senior Management and Trustees have identified
preparing for the Year 2000 as one of our overarching corporate goals.
We acknowledge the serious nature of ensuring that all aspects of our
business and investment programs incorporate Year 2000 critical
functionality. We recognized early on the impact that a failure to
address the Y2K problem could potentially have upon our customers and
the business community in general. We welcome and support the work of
this Committee and would like to contribute to your efforts as a major
retirement services provider.
The process of preparing TIAA-CREF for the challenges presented by
the Year 2000 began as a major corporate initiative in late 1996. The
overall scope of our efforts is enterprise-wide and includes every
business function in the company. For example, our scope includes not
only all internal systems interfaces but also all external interfaces,
such as bank balance reporting systems and equity pricing services,
that need to be addressed and Year 2000 certified. Year 2000 is not
just a systems issue at TIAA-CREF, it is a corporate challenge.
The process of ensuring that TIAA-CREF is prepared for the Year
2000 begins with our Trustees who are kept apprised of our plans and
progress on a regular basis. All of Senior Management, especially our
Chairman and Chief Executive Officer, John Biggs, play an active role
in monitoring and preparing our organization for the Year 2000. Our
internal auditors continually monitor our progress and our ability to
meet key Y2K deliverables. They report their findings independently to
our Audit Committee which is comprised of leading business and
educational representatives.
Our preparations for the Year 2000, although significant, are being
conducted without compromising our development and introduction of new
products and services. TIAA-CREF employees are actively involved in the
Y2K process from analysis to certification while also discharging their
normal day-to-day responsibilities. This commitment will continue
throughout the Year 2000.
We have followed what we believe are industry standards for
preparing any organization to meet these challenges. We began our
process in 1996 with an inventory and analysis of all our application
systems. This effort was supported by the use of automated analysis
tools that highlighted potential Y2K date field problems. After
analysis, a program code remediation process was begun utilizing our
own management and internal resources supported by additional temporary
employees and outside consultants. This approach has enabled us to
avoid dependency on external companies and their priorities and
resources. Once code is remediated, we conduct regression testing and
place the program code back into production. This process ensures that
the remediated code does not present any problems with our current
systems and environment. We then prepared for our Year 2000
certification process which is currently underway.
Initially, we examined approximately 19.2 million lines of program
code. We have projected that our cost for remediating the affected code
is under the per line costs which are often quoted in the trade
journals. We feel that beginning the process in 1996 allowed us to get
an excellent jump on the effort needed and contributed to our ability
to already be conducting our certification process. Currently, 86
percent of our application systems have been remediated and are
undergoing final certification testing. Included in this process is the
testing of all our external interfaces which is the only way we can
ensure that our business partners have achieved full Year 2000
compliance.
Our Y2K certification testing process began on March 2, 1998, and
is being conducted in a separate Year 2000 compliant environment. In
our test plan we are including nearly 20 different date scenarios which
take us from September 9, 1999 through March 31, 2000. We anticipate
that all of the testing required for dates up to Monday, January 3,
2000, the first business day of the new year, will be completed by
December 31, 1998. Testing for dates beyond January 3, 2000, including
tests for leap year processing and quarter end should be completed by
March 31, 1999.
Most recently, we completed our initial test utilizing January 3,
2000 simulated test data. The test proved successful and we will
continue to repeat this process using actual interfacing files later
this month. Included in our initial test was the processing of our
monthly retirement income benefits payments which we recognize as one
of the most critical aspects of our readiness to our customers. This
test was successful and produced test benefits both in physical check
form and electronic credits. Over 75 percent of our retirees have
elected Electronic Funds Transfer as their preferred method of payment.
Currently, we are focusing attention on our critical external
interfaces. We have written to all of our external vendors to determine
whether products or services being used at TIAA-CREF are compliant.
Regardless of their response, we included all of these vendors in our
testing process.
We have followed a similar approach when contacting our software
vendors on their Year 2000 compliance plans. In letters to our software
vendors we requested that they complete an agreement indicating whether
the software being used at TIAA-CREF was compliant and if not when it
would be. Most vendors did not complete these agreements but instead
provided us with their own documents indicating their status and plans
for compliance.
At TIAA-CREF, as with any other organization today, the personal
computer plays a major role in day to day operations. We are replacing
our PC computer desktop hardware with equipment we know to be
compliant. Our PC replacement process is currently underway so that
potential PC equipment shortages or significant price increases can be
avoided during 1999. We have also established a Year 2000 PC laboratory
in which we allow our employees to test various PC configurations to
ensure compliance. This facility is also used for the testing of PC
software in a centralized environment.
We have examined all of our other equipment (elevators, telephone
switches, copiers, security systems, air conditioning and heating
systems, etc.) as part of our Year 2000 efforts as well. As part of
this process, we have conducted in depth discussions with our vendors
and have requested and received written certification of each one's
compliance.
In 1997, prior to the issuance of any regulatory requirements, we
began the process of contacting over 5,000 of our investment portfolio
companies as well as the brokers utilized by TIAA and CREF to ensure
that they each had a Year 2000 program. The questionnaire we sent
requested information on whether a Y2K program was underway, whether
senior management was involved, whether funds were allocated to the
effort and whether or not the company was already compliant.
Approximately 25 percent of those portfolio companies contacted
responded. Most of those that did indicated a program was underway and
that senior management was involved in the process. About 10 percent of
the portfolio companies responded indicating that they were already
compliant. While we recognize the importance of Year 2000 compliance,
it is only part of the criteria used by our analysts in evaluating
portfolio companies. The results of our survey have been made available
to our investment analysts and this information along with SEC required
information, is available for their discussions and due diligence
meetings with the respective company's management. In addition to the
SEC's Y2K compliance requirements, we are also subject to the
regulatory oversight of the Insurance Department of the State of New
York.
The success of any organization's Year 2000 effort requires a
considerable amount of ongoing communications to its customers. We have
continually kept our participating institutions, as well as individual
customers informed regarding our Y2K plans and progress to date.
Recently, we sent all of our participating institutions our written
assurance that they will not be required to make any modifications to
data they are presently sending TIAA-CREF. We stated that our ``systems
will, under normal use and service, record, store, process and present
calendar dates falling on or after January 1, 2000, in the same manner,
and with the same functionality, data integrity, and performance as
TIAA-CREF's systems record, store, process and present calendar dates
on or before December 31, 1999.''
To our individual customers we provide periodic updates through our
corporate publications and our website at www.tiaa-cref.org. In
addition, we recently developed an informative brochure which discusses
our approach to addressing the Year 2000 and answers some frequently
asked questions. The brochure is available to all individuals who
contact us regarding Y2K.
We provide our employees with a regular newsletter describing our
efforts and insight on how the Year 2000 might impact them as
individuals and consumers. We anticipate continuing all of our periodic
communication processes right through the beginning of the Year 2000.
We are presently working on completing our contingency plans for
any service disruptions during the transition to Year 2000. These plans
include having critical staff on site during the weekend of December
31, 1999 and on January 3, 2000. In addition, we plan to identify any
external service providers which have not satisfactorily evidenced Year
2000 compliance and initiate steps for seeking alternative vendors by
December 31, 1998. Our contingency plans will also identify and
establish procedures for manually completing critical processes. This
task will be an extension of current procedures. We also anticipate
being involved in the Wall Street-wide financial testing which is
planned for the first quarter of 1999. Interface testing, both internal
and external, will be continuing and plans are in place to complete all
these processes during the early stages of 1999.
In summary, we believe TILA-CREF is in a strong position to meet
the challenges of the Year 2000. We have addressed the five step
requirements of awareness, assessment, renovations, validation and
implementation and all are well underway and on schedule. Although we
still have a lot of work to do, we anticipate that Monday, January 3,
2000 will be a normal processing day at TIAA-CREF.
______
Responses of James A. Wolf to Questions Submitted by
Chairman Bennett
Question 1a. Are you planning to contact the 3,750 non-responding
organizations and ask about their current status?
Answer. Yes, we plan on contacting all our current portfolio
companies that failed to respond to our initial survey. We plan on
sending another survey including a strongly worded cover letter
regarding Y2K compliance which would include references to the more
stringent Y2K guidelines developed by the SEC. This letter would be
signed by a TIAA-CREF Investment Executive.
Question 1b. Do you have any information about why those firms
chose not to answer your questions?
Answer. We currently do not have any information regarding why
firms chose not to answer our questions. We suspect companies did not
respond due to liability concerns.
Question 1c. How will you analyze the 75 percent of companies that
did not respond?
Answer. Response For companies that do not respond to our follow-up
survey, we plan on conducting discussions regarding Y2K programs as
part of our periodic meetings or telephone calls with their
managements. We would also review their individual company filings with
the SEC including their 10K and 10Q reports.
Question 2. Starting in 1996 has enabled your organization to
understand and fix your internal problems. However, you mentioned that
you were currently trying to contact all of your external interfaces.
How many external interfaces do you have? And what will you do if you
receive a 25 percent or less response to your inquiry?
Answer. We have identified 60 critical external vendors that we
work with very closely. The response to our early written requests for
information regarding Y2K compliance was nearly 100 percent and those
that did not respond were contacted directly by telephone. We plan on
testing each of these interfaces as part of our Y2K certification test.
In addition, we have established December 31, 1998 as the date when we
need to decide whether a particular vendor should be replaced.
Currently, we are contacting each of these vendors to establish a Y2K
test plan.
Question 3. In your outreach to the portfolio investment companies,
brokers and the external interfaces did you send a letter asking about
their compliance or did you use a survey?
Answer. We sent a letter outlining our concern for ensuring that
the respective organization had a Year 2000 program underway and we
included a survey which asked for particulars on their Year 2000
program.
Question 4. How did your organization ensure that the response to
your inquiries about compliance all used the same definition of
compliance?
Answer. While we did not provide each organization with a
definition of compliance, we did inquire about their ability to conduct
business on January 3, 2000 and thereafter. While we recognize that
``compliance'' may have different meanings, overall it should be viewed
as achieving a level of performance that enables the organization to
meet ongoing business obligations as the Year 2000 unfolds.