[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
STRATEGIC PLANNING, RESOURCE ALLOCATION AND CRISIS MANAGEMENT--IS THE
SEC READY?
=======================================================================
HEARING
before the
SUBCOMMITTEE ON GOVERNMENT EFFICIENCY
AND FINANCIAL MANAGEMENT
of the
COMMITTEE ON
GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
APRIL 20, 2004
__________
Serial No. 108-177
__________
Printed for the use of the Committee on Government Reform
Available via the World Wide Web: http://www.gpo.gov/congress/house
http://www.house.gov/reform
______
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COMMITTEE ON GOVERNMENT REFORM
TOM DAVIS, Virginia, Chairman
DAN BURTON, Indiana HENRY A. WAXMAN, California
CHRISTOPHER SHAYS, Connecticut TOM LANTOS, California
ILEANA ROS-LEHTINEN, Florida MAJOR R. OWENS, New York
JOHN M. McHUGH, New York EDOLPHUS TOWNS, New York
JOHN L. MICA, Florida PAUL E. KANJORSKI, Pennsylvania
MARK E. SOUDER, Indiana CAROLYN B. MALONEY, New York
STEVEN C. LaTOURETTE, Ohio ELIJAH E. CUMMINGS, Maryland
DOUG OSE, California DENNIS J. KUCINICH, Ohio
RON LEWIS, Kentucky DANNY K. DAVIS, Illinois
JO ANN DAVIS, Virginia JOHN F. TIERNEY, Massachusetts
TODD RUSSELL PLATTS, Pennsylvania WM. LACY CLAY, Missouri
CHRIS CANNON, Utah DIANE E. WATSON, California
ADAM H. PUTNAM, Florida STEPHEN F. LYNCH, Massachusetts
EDWARD L. SCHROCK, Virginia CHRIS VAN HOLLEN, Maryland
JOHN J. DUNCAN, Jr., Tennessee LINDA T. SANCHEZ, California
NATHAN DEAL, Georgia C.A. ``DUTCH'' RUPPERSBERGER,
CANDICE S. MILLER, Michigan Maryland
TIM MURPHY, Pennsylvania ELEANOR HOLMES NORTON, District of
MICHAEL R. TURNER, Ohio Columbia
JOHN R. CARTER, Texas JIM COOPER, Tennessee
MARSHA BLACKBURN, Tennessee ------ ------
PATRICK J. TIBERI, Ohio ------
KATHERINE HARRIS, Florida BERNARD SANDERS, Vermont
(Independent)
Melissa Wojciak, Staff Director
David Marin, Deputy Staff Director
Rob Borden, Parliamentarian
Teresa Austin, Chief Clerk
Phil Barnett, Minority Chief of Staff/Chief Counsel
Subcommittee on Government Efficiency and Financial Management
TODD RUSSELL PLATTS, Pennsylvania, Chairman
MARSHA BLACKBURN, Tennessee EDOLPHUS TOWNS, New York
STEVEN C. LaTOURETTE, Ohio PAUL E. KANJORSKI, Pennsylvania
CANDICE S. MILLER, Michigan MAJOR R. OWENS, New York
MICHAEL R. TURNER, Ohio CAROLYN B. MALONEY, New York
KATHERINE HARRIS, Florida
Ex Officio
TOM DAVIS, Virginia HENRY A. WAXMAN, California
Mike Hettinger, Staff Director
Larry Brady, Professional Staff Member
Sara D'Orsie, Clerk
Mark Stephenson, Minority Professional Staff Member
C O N T E N T S
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Page
Hearing held on April 20, 2004................................... 1
Statement of:
Bogle, John, Bogle Financial Markets Research Center, founder
Vanguard Mutual Funds...................................... 21
Hillman, Richard, Director, Financial Markets and Community
Investment, U.S. General Accounting Office................. 65
McConnell, James M., executive director, U.S. Securities and
Exchange Commission........................................ 47
Morey, Matthew R., Ph.D., associate professor of finance,
Lubin School of Business, Pace University.................. 35
Spitzer, Eliot, attorney general, New York................... 4
Letters, statements, etc., submitted for the record by:
Bogle, John, Bogle Financial Markets Research Center, founder
Vanguard Mutual Funds, prepared statement of............... 26
Hillman, Richard, Director, Financial Markets and Community
Investment, U.S. General Accounting Office, prepared
statement of............................................... 67
McConnell, James M., executive director, U.S. Securities and
Exchange Commission, prepared statement of................. 51
Spitzer, Eliot, attorney general, New York, prepared
statement of............................................... 10
STRATEGIC PLANNING, RESOURCE ALLOCATION AND CRISIS MANAGEMENT--IS THE
SEC READY?
----------
TUESDAY, APRIL 20, 2004
House of Representatives,
Subcommittee on Government Efficiency and Financial
Management,
Committee on Government Reform,
New York, NY.
The subcommittee met, pursuant to notice, at 10:30 a.m., at
the Michael Schimmel Center for the Arts, Pace University, New
York, NY, Hon. Todd Russell Platts (chairman of the
subcommittee) presiding.
Present: Representatives Platts and Towns.
Staff present: Michael Hettinger, staff director; Larry
Brady and Tabetha Mueller, professional staff members; and Adam
Bordes and Andrew Delia, minority professional staff members.
Mr. Platts. A quorum being present at this field hearing of
the Subcommittee on Government Efficiency and Financial
Management will come to order.
We are pleased to be here in New York City today to conduct
an important oversight hearing into strategic planning and
resource allocation at the Securities and Exchange Commission.
I certainly would like to take this opportunity to thank
our subcommittee's ranking member, Ed Towns, for his active
participation in helping to arrange this hearing and helping to
ensure that the SEC is effectively regulating the mutual fund
industry, the focus of our hearing in resource allocation
today. So, Ed, thanks for your assistance.
We appreciate not just Ed's hospitality in being here
today, but also Pace University. We're delighted to be here on
campus and appreciate you hosting as well.
We are here today because we believe Chairman William
Donaldson and his senior staff at the Securities and Exchange
Commission have made great strides toward making strategic
planning at the SEC a priority. However, we also believe there
is more work to be done.
The Commission is responding to unprecedented challenges.
We have seen corporate accounting scandals and illegal
practices in the mutual fund industry, both of which have
shaken the very foundation of our financial markets and
undermined investor confidence. We have seen technological
advances that have given more people access to investment
vehicles and contributed to the globalization of our markets,
conditions that have increased the SEC's workload
exponentially. Further increasing the SEC's responsibilities,
Congress enacted Sarbanes-Oxley, giving the Commission a
significantly larger oversight role in corporate finance.
Congress also recognized the need to transform the SEC and
granted pay parity and hiring flexibility to the SEC along with
significant resources to hire new staff and update existing
technology.
All these changes and challenges, whether good or bad,
require a bold and creative strategic focus. One of the most
important challenges today for the SEC will be responding
effectively to the mutual fund crisis. The mutual fund industry
is critical to the health of our economy. More than half of all
U.S. households, 91 million investors, are invested in mutual
funds to the tune of $7.5 trillion. If the SEC's goal is to
protect the maximum number of individual investors, effective
regulation and enforcement of the mutual fund industry should
be of the highest priority.
The SEC responded to this most recent crisis with
aggressive rulemaking initiatives. Congress is considering
several avenues to reform the industry. Regardless of which
rules and laws are finally enacted, it is effective regulation
and enforcement that will make the difference. This
subcommittee believes that regulation enforcement is
accomplished, in part, by effective strategic planning which
directs resources where they will have the greatest impact.
The subcommittee is grateful to Attorney General Eliot
Spitzer for his work in prosecuting perpetrators of the mutual
fund scandals, and we are certainly honored to have the
Attorney General here today to discuss his successful
enforcement efforts, and we appreciate your being with us.
Of course, prosecuting criminals is only one side of the
equation; effective regulation is the other. The use of
statistical modeling and data mining can greatly enhance
regulatory efforts. One example is a recent study conducted by
Dr. Morey, from here at Pace University, who will testify today
about a method he developed to detect ``window dressing'' in
bond funds. With the appropriate technology and staff with the
right expertise, the SEC can be more proactive as it polices
the mutual fund industry and looks out for investors large and
small every day.
With the right strategic focus as a blueprint, the new
resources for technology and human resources can be put to use
in the most effective manner. Oversight of strategic planning
at the Commission has been a high priority for this
subcommittee. Our July 2003 hearing was encouraging, and we
applaud the continuing joint efforts of Rick Hillman and his
team at the General Accounting Office and the Office of the
Executive Director at the SEC, Jim McConnell, who is here with
us today. We are eager to see the fruits of your labor, and
this hearing will provide a forum for an in-depth update on
your progress.
We also have the benefit today of hearing from Mr. John
Bogle, the founder of Vanguard Funds and a vocal advocate for
improving the mutual fund industry.
I would like to thank each of our witness who will be
testifying today and for your testimony you submitted in
writing prior to today's hearing. We certainly look forward to
your testimony.
And I now would like to yield to our ranking member, the
gentleman from New York, Mr. Towns for the purposes of an
opening statement.
Mr. Towns. Thank you, Chairman Platts.
Let me begin by thanking you for holding this hearing in my
hometown, the financial capital of the world. It is the ideal
place to examine how we can strengthen the oversight of our
mutual fund industry. This is the century for the integrity of
the financial sector in the protection of millions of
investors.
I would also like to thank the Provost and Pace University
for graciously hosting this hearing which has great importance
to the New Yorkers, of course, and the Nation.
This hearing of the Securities and Exchange Commission is
the result of a series of breakdowns in the Commission's
regulatory enforcement efforts. As many know, there have been
widespread reports of deceptive and fraudulent practices in the
mutual fund industry, many uncovered by one of our witnesses
here today, Attorney General Eliot Spitzer. For too long the
SEC has been reactive to these scandals and unethical
practices. We need to ensure that the SEC has the resources,
tools, expertise, planning to be proactive so it can identify
and prevent abuses before they happen.
Due to the recent rash of corporate scandals and mutual
funds abuses there has never been a greater need for the SEC to
fulfil its mission, which is to protect investors and maintain
the integrity of the securities market. The Congress has
attempted to assist the SEC in restoring confidence through the
enactment of the Sarbanes-Oxley Act. However, such laws and
regulations will be futile without effective enforcement.
Making matters more challenging, the SEC's workload has been
growing exponentially. Today more Americans are invested in
stock and other capital markets. According to the General
Accounting Office, mutual funds have grown from a $400 billion
industry to one with $7.5 trillion in assets during the past
two decades. In fact, more than 95 million Americans invest in
mutual funds. These numbers speak to the importance of
maintaining the integrity of the mutual fund industry.
The Congress significantly increased the SEC's financial
resources. Last fiscal year the SEC received appropriations to
hire 842 new employees to help meet the increasing workload. In
fact, over the last 2 years the Commission has had an
appropriation increase of 73 percent. Congress has given the
SEC special flexibility to set wages and hire employees so they
can compete for the best and the brightest. However, in spite
of these efforts there are still more than 500 employee
vacancies remaining of the newly created permanent positions.
We need to know why the vacancies continue to exist. If
there is something that we need to do in Congress to help fix
this.
I am hopeful that Mr. McConnell will shed some light on
this issue by presenting a detailed information on how the SEC
will utilize its resources and what hurdles remain in producing
a concise strategic plan.
I am also anxious to hear from today's witnesses on the
areas they believe the SEC needs to focus on to improve its
oversight.
I look forward to the testimony of Attorney General
Spitzer, who has been instrumental in uncovering numerous abuse
practices within the industry.
On that note, Mr. Chairman, I yield back.
Mr. Platts. Thank you, Mr. Towns.
We will proceed to the testimony from our panels. Certainly
first, as is evident, the Attorney General we will have your
statement and then questions, and then we will go to our second
panel with Dr. Morey and Mr. Bogle. And then our third panel
with Mr. McConnell and Mr. Hillman.
So, Attorney General Spitzer, if you would like to begin.
Actually, I need to swear you in first. If I could have you
stand and take the oath.
[Witness sworn].
Mr. Platts. The clerk will reflect that the witness has
answered the oath in the affirmative.
And Attorney General Spitzer, the floor is yours.
STATEMENT OF ELIOT SPITZER, ATTORNEY GENERAL, NEW YORK
Mr. Spitzer. Thank you, Mr. Chairman and Congressman Towns.
It's a pleasure to be here. Thank you for visiting New York and
having this hearing, and thank you also to the other witnesses
and Pace University.
I want to congratulate Mr. Bogle on having made what we
call the Times 100, the 100 most important people in the world,
I think it is, being somewhat akin to the Fortune 500 for
individuals. Mr. Bogle years, perhaps even decades speaking for
the issues that we are dealing about and talking about today
and what has been recognized and what we are getting to
recognize, and quite rightly so.
I wanted to begin by putting into something of a
theoretical framework many of the issues that have troubled the
financial securities industry over the last number of years,
and suggest to you that really two polices that have been
intentionally adopted by Congress by our regulatory framework
have collided in the past number of years to generate the
problems that we have encountered, problems that have
manifested themselves in research that was being marketed to
individuals that was improper, and I truly believe problems in
the mutual fund context and other problems that will in due
course emerge, perhaps.
And these are two policies are, first, an intentional
effort to promote concentration within the financial services
sector, and this is what I call the city group model where
Congress over a number of years, actually it was regulatory
agencies initially and then Congress, affirmatively repealing
Glass-Stegall, has encouraged our financial services sector to
seek additional concentration.
The underlying motivation for this was, first, a sense that
the historical rationale for enacting the Glass-Stegall perhaps
was flawed. And second, a concern that capital concentration
overseas in the European and the Asian banks were getting to
the point where competition in the U.S. banks would get to the
point where U.S. banks, U.S. financial service companies could
not compete. So we were driven by what were, perhaps, wise
decisions, perhaps not. But certainly an agreed upon policy to
seek additional concentration in the financial services sector.
And therefore, we continued to see larger and larger financial
service sector companies that all wanted opportunities, provide
opportunities for one-stop-shopping for clients whether it be a
major company or an individual can obtain any product at that
one entity, whether its Citi, Morgan Chase, Bank One, etc., we
obviously have seen and continue to see this increased
concentration.
The other policy that is also unambiguously and affirmative
one as the first one that I suppose some would question. The
second policy is one of encouraging all Americans into the
capital markets. And, Mr. Chairman, you referred to this when
you gave the numbers that now capture the enormity of the
mutual fund sector, 91 million Americans and over $7 trillion.
We have seen what we call this democratization of the capital
markets over the last number of decades. This has been
unambiguously good both for the markets and for the individual
investors. It has encouraged, and we have encouraged and
rightly so, Americans to take their savings to invest them in
equities and generate and participate in the growth that
resulted there from.
The problem that we have, unfortunately, is that the
interface between these two policies has been uncomfortable. We
have larger and larger financial service sector companies
dealing with more atomized investors. And rather than seeing
these investors and individuals whom you owe fiduciary duty and
figuring out how to live up to that fiduciary duty, we have
seen the financial service companies view these investors as
fee generators. When they are viewed as fee generators rather
than an individual to whom you will owe a fiduciary duty,
unfortunate things can result. That is, I think, what binds
together the issue of improper research that we were addressing
last year, the issue in the mutual fund context where we have
seen fees spiral out of control, and other contexts where we
see smaller, smaller investors not getting the advice, not
getting the benefits of the fiduciary duty that is owed to
them, but rather the view is they're taken advantage of to
generate fees.
Now, I am not suggesting, obviously, that either one of
these policies necessarily should be reversed. What I am
suggesting, I said the same thing to the CEOs of the companies
that have increasedly dominated our financial services sector,
that these companies and of course the regulators who deal with
these issues, need to figure out how to generate an interface
between the small investor and the large financial service
sector companies that will provide proper protection for the
fiduciary duties that is owed to the investor. That is the
difficulty, the problem, the issue that has confronted you on
these companies. It is one they have to think about very deeply
because if they don't answer it, then I think they will see not
only increasingly regulatory response, but also they will see
their customers move away to other entities. And so for
business rationale as well as basic obligations of ethics,
these companies need to address this issue. And I hope,
certainly, that they do so down the road.
And I can tell you that the issues that we continue to look
at that are far afield from the issues that have already made
their way into the public area, are issues that go to the fore,
issue of is a fiduciary duty being breached. That is the issue
that binds together our concerns, at least in my office.
Let me quickly, if I might go through the three distinct
chapters that I have seen emerge in the mutual fund
investigation. I remind you that the entire period of this
inquiry, at least from a public perspective, is hardly 8 months
old. This issue as to what was reached publicly right after
September 3rd, right after Labor Day of 2003 and over the
succeeding 8 months we have succeeded in returning close to $2
billion to investors. I think it is amazing and even addressing
some of the fundamental structural problems that the industry
has to confront. And so we have made good progress, I think,
considering the speed and the timeframe that this issue has
been in the public arena.
Chapter one simply dealt with the trading violations that
were diagnosed and laid out in the Narry affidavit last
September 3rd, those related to the late trading and the timing
issues. Late trading, obviously, being in our view almost a per
se or indeed a per se violation where trades were put in after
the NAB had been determined after the 4 p.m. deadline. Timing
being a slightly more subtle issue and the legality or
illegalities of timing is contingent to time with respect to
statements of the individual mutual fund. But those two issues
frame the first aspect of the debate.
I think the good news is that these are issues that merely
by being exposed got resolved. It is increasingly difficult to
have to believe for traders now to put in their trades after
the NAB has been set, not only because the individuals are more
weary of being caught but because there is an enormous and
exponentially greater degree of scrutiny to that potential
abuse. And so that practice certainly has diminished, if not
been eliminated.
In addition the SEC has proposed certain rules with respect
to the 4 p.m. deadline that would make it at a regulatory level
that much easier to prosecute those cases.
The issue of timing, as well, has been diminished. We have
seen diminution in the volume of money that has been sloshing
around these various hedge funds dedicated to time abuses. We
have seen, again, an exponentially greater effort on the part
of the mutual funds to crack down on timing. And I have
believe, although it is hard to statistically measure, that we
have seen a dramatic reduction in the quid pro quo arrangements
that have been struck where people would give so called sticky
assets to mutual funds in return for the opportunity to take
advantage in that capacity.
So I think that with respect to chapter one, the old
saying, if sunlight is the best disinfectant, by exposing these
problems, we have to a certain extent remedied them, which is
not to say a more defined regulatory and/or legislative
response is not appropriate. But I think chapter one by
revealing the problems we also began to solve the problems.
Chapter two in my analysis, at least, is the issue of fees.
And here numerically we are dealing with an issue that is
greater in terms of measuring harm, if more harm is imposed or
inflicted upon ordinary investors by the what I consider to be
exorbitant fee structure that the mutual funds industry has
managed to impose upon investors than the magnitude of harm
imposed by late trading and time. Even though billions of
dollars of harm have been imposed by late trading and timing,
we think we tend to donate the dollars of harm have been
imposed upon investors every year by virtue of improper fee
structure.
It is not merely an issue of disclosure, although I think
every committee in front of which I have testified from both
sides of the aisle there has been nearly unanimous agreement
that the disclosures that have been made by the fund companies
have been woefully inadequate and it is impossible for most
people to parse the mutual fund prospectuses and have any real
sense of what fees they are paying and what the impact of those
fees is upon their annualized return. And it is in this context
that I refer to, you know, one of my favorite cliches, but
compound interest is the eighth wonder of the world. When you
look at the impact of the 1 or 2 percent differential between
fees that are being charged or a 30 or 40 basis point
differential between fees that are being charged and fees that
should be charged, you say to people 30 basis points they
either do not understand what basis points are, it sounds so de
minimus, they say well big deal. But when you run the numbers
and compound that differential over the long term, it
essentially eliminates whatever upside might have existed by
virtue of the performance of the mutual fund or in fact
accentuates the lack of performance and drives investors into
the issue where compared to having an index fund, they end up
in a negative position.
Therefore, the fees that are charged by mutual fund
companies must be addressed by this committee, by the SEC, by
other regulatory entities. In the settlements in my office
struck with mutual fund companies, we have obligated them to
discount their fees for a period of 5 years by a significant
number, hundreds of millions of dollars of benefits have
accrued to investors by virtue of our settlements. There was a
response to that, which a skeptical response by some who said
are you involved in price fixing by virtue of what you are
doing. And the answer I will give you is a resounding no. And
here is why.
We have not said we have not arbitrarily or unilaterally
taken a fee and said this is what you will charge and this is
what you must charge. What we have said to mutual fund
companies is in every instance is we conclude a differential
between what you were charging the individual investors and
what you were charging institutional investors for identical
services. Where there is that gap, that delta, it cannot be
justified because if they do an apples-to-apples comparison you
are charging one group of investors who actually negotiate for
the fees that are charged a certain fee. And you charge others
who are relying upon a board to negotiate for them, you charge
them a higher fee. Then this reflects to me a failure of
negotiation, a failure to live up to the fiduciary duty that's
owed to the small investor. And consequently a pawn that has
been imposed upon the small investor that should not have been
imposed on them. And we have said to the fund companies
therefore we think that in order to remedy you improper
behavior here, you could give a discount that would begin a
process of moving your fees back to where the market would
bring them if you would have behaved in the marketplace the way
you should have. That is why we have delved into this fee
issue. It is an issue that has imposed, as I said, tens of
billions of dollars of harm upon investors, and we will
continue to do this.
Let me say that there has been a bit of back and forth
between my office and the SEC on this issue. It is an area
where we have agreed to disagree, and I think the record is
clear that we are able, in fact are very successfully moving
forward with settlements even though we disagree on this issue.
I believe deeply the fees should be diminished and that the
market has failed because the board did not act properly and
that we have to push for us to behave more appropriately, that
the SEC is moving forward with us to settle with the companies
on issues A and B, reform and restitution while we also get
settlements with the fund companies on fees. So we are managing
to overcome our difference there, which takes me to issue
three. Issue one was late trading timing issue, issue two was
fees, issue three in board behavior.
As in so many instances that have emerged over the last
couple of years where we have seen violations in the corporate
arena, ultimately it comes down to a board that was not paying
attention. What we have seen in the mutual fund context,
unfortunately, is that the board of the fund companies have not
been living up their mandate to protect the small investors.
They have been all too often, and I wold refer you to Warren
Buffet's shareholder letter from this year and the Berkshire
Hathaway letter that is probably one of the most read
investment documents every year in which he goes after, as he
has for some period of time now, the mutual fund boards of
directors and really is partially critical of them for not
being sufficiently or indeed at all intuitive to their
obligations to protect investors. Those boards, frankly, were
asleep at the switch. And what we have to do is re-invigorate
them and say to them live up to your duties and if you fail to
do so, we will seek to have you removed. And, indeed, in the
settlement that we entered with the Bank of America a couple of
weeks ago now, I think the aggregate number was $675 million in
restitution and fee discounts. Perhaps the most important
aspect of it to me was that eight of the board members of the
mutual fund board are going to be forced to cycle off the
boards in reasonably short order. The reason for that is that
we felt that there was a record that they failed to be properly
inquisitive, failed to respond to information that should have
indicated that there was ongoing timing and that there was an
abuse of the investors, and their passive response to the
violation of a duty that they should have, and therefore in
order to reinvigorate the protection we need for investors
those board members should cycle off. That is ultimately where
we need to get reform. I think that is the area where
legislative action is important, in the area where defining
these standards of fiduciary duty is owed to investors is
critically important. And as much as the SEC is doing, and I
have been partially critical at various times over the last
several years, to applaud them for really rolling out a
sequence of rulemaking proposals that beings to address these
issues, nonetheless I think legislative response is appropriate
here and important in order to ensure that we have a bulwark of
statutory framework that is appropriate.
One final word, and I thank you for your indulgence and I
didn't mean to go on this long. And that final word relates to
the regulatory structure in which we live. I don't want to
focus on the SEC here. I want to focus on self-regulatory
organizations.
The SROs over the last number of years, unfortunately, have
failed our investment community. And we are seeing new
leadership, very wise new leadership in New York Stock
Exchange, we have seen in the NASV and other SROs as well. But
I think the SROs that are supposed to be the primary and first
line of defense in the investment world were not attentive to
the changing dynamics and the changing structures that should
have been paid attention to. I think we need to question in a
very serious way whether the SROs can reform themselves, if
they will live up to their critical mandate. I hope the answer
is yes, but it is an issue we have to raise.
Finally, we have to ask ourselves whether the voices of
industry, the ICI, the SIA, the AICPA, have not been too
powerful; whether their capacity to almost define the terms of
debate to Washington has unfortunately reminded the Congress
and the regulatory agencies the need is immediate to examine
the critical issues.
And I think the story of the AICPA after they stopped the
SEC from dividing, auditing and consulting several years back
is an instructive story and it tells the all too frequently
told story of an industry voice that stopped a reform measure
that had it been in place, probably could have prevented some
of the most egregious accounting frauds that ultimately brought
down some of our major companies.
So I think we need to ask ourselves whether the ICI, the
AICPA, the SIA have not been woven too much into the fabric of
our Washington environment to whether we need to relieve
skepticism about their counsel and their perspectives as we
move forward.
And thank you for the opportunity to appear before you, and
certainly will try to answer your questions.
[The prepared statement of Mr Spitzer follows:]
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Mr. Platts. Well, thank you, Mr. Attorney General. And,
again, both the written testimony provided and your thoughts
today are very helpful, which we appreciate.
A place I would like to start in the questioning is in
laying out the three different chapters; the trading practices
that were wrongful and that you have been a great leader in
addressing both in the disclosure of those practices, which as
you said, is in and of itself had a great impact and in your
enforcement efforts and prosecutions in pursuing those
wrongfully practices, but also the fee issue and the fiduciary
duty or the lack of fulfillment of that duty to especially the
small investors by some of the fund managers.
I am not sure if you will be able to hear the testimony of
Mr. Bogle after you, but one of his recommendations that he has
been promoting, I believe, from his testimony, for 8 years is
kind of a comprehensive economic study of the mutual fund
industry. He suggests that as part of the SEC's strategic plan
and vision, that we really get an in-depth understanding of the
industry and the fees associated, how the managers are actually
conducting themselves, that's critical to going forward to
effectively managing and overseeing and regulating this
industry. And from your testimony it sounds like that is
something you think would be a very wise approach for the SEC
to embrace?
Mr. Spitzer. Absolutely. The SEC does have a division that
is dedicated to oversight of the mutual fund sector. Having
said that, I think it is critical that we step back and say
what has happened in the sector, what returns are people
actually garnering, how were those returns presented to the
investing public, what the people know, what variables do they
rely upon, what variables should they reply upon?
And let me make it perfectly clear, it is not government's
job and never should be our job to make the investment decision
for the individual investor. What we do have to make clear,
however, what we do have to do is provide to the individual
investor the tools so that he or she could make the
individualized determination based upon full disclosure and the
important variables that a wise investor would want to have at
his or her fingertips to make those decisions.
Mr. Platts. Yes.
Mr. Spitzer. And all too frequently when you read a
prospectus it is impossible to determine whether or not this is
a good or bad investment because the fee structure is not
there, the informant's numbers are not given in a format that
is meaningful.
You know, I have analogized to the disclosure on the side
of any food item when you go to the supermarket. You know, you
could look at a little grid and it tells how much fat, what----
Mr. Platts. I try not read those, because you know they
make me feel like I am eating too unhealthy.
Mr. Spitzer. Well, I am with you. I read them all too often
after my kids have already eaten them.
Mr. Platts. Exactly.
Mr. Spitzer. You get 800 percent of your daily allotment of
sugar when you have one bite of the cereal. But if we were to
have that sort of disclosure with respect to fees on a monthly
statement or quarterly statement, however often they come, the
impact on fees over the past 10 years or the next 3 years of
the fee structures depending upon certain rates of return or
the actual return, or a hypothetical $1,000 investment, how
that investment would have fared over the last 10 years based
upon the actual return, its return net of fees. There is so
many ways to present this in a way that would be more
meaningful to investors. And I think Mr. Bogle's idea of
studying the industry to understand these factors and then come
up with a way to present it to the public is critically
important.
Mr. Platts. And I do appreciate your analogy to that label
on the food box. And as a parent of a 5 year old and a 7 year
old, they want that high sugar just as I did when I was their
age. But a good analogy; more transparency, more knowledge for
investors to make their decisions on.
You know, our focus for our subcommittee is the management
efforts of the SEC. And whatever the rules are, the
regulations, the law, how are they meeting the charge that they
have with their resources, and especially their human capital
resources.
In the three areas, again, the three chapters, which is I
think a good way of looking at the mutual fund issue, what is
your view on the SEC's response from that resource allocation
aspect? They have done a good job on the trading practices and
the regs they've proposed and have been more aggressive since
your efforts since last September, but not as aggressive, and
you agree to disagree I guess is your statement on the fees--on
the three chapters. How would you----
Mr. Spitzer. It goes without saying, and Mr. Chairman I am
trying very hard these days not to gratuitously scratch at a
wound or at a relationship that has had ups and downs,
obviously. But certainly the SEC is doing everything it can do
these days to address these issues and we are probably going to
be working together. So I just want that a predicate to
anything I say.
Mr. Platts. Yes.
Mr. Spitzer. And Steve Cutler, who is Chief of Enforcement,
is someone I speak to on a regular basis so we are on the same
page in what we are doing. As Chairman Donaldson and I would
also speak on a regular basis. So I do not want this to be
interrupted or have gratuitous criticism.
I think the SEC has done a better job with respect to the
trading abuses than it has done with respect to fees. I think
that there is a bit of schizophrenia at the SEC with respect to
the fee issue because it has been hesitant, as I said, to get
involved in what it thinks should be a market determination
with respect to fees. And we all agree, it should be a market
determination. However, the market will determine fees properly
only if the participants in that negotiation are sufficiently
and properly aggressive in playing the role it's supposed to
play. And hence, my discomfort at not pushing toward what's
supposedly the voice for the small investors more aggressively
in saying to them you must act in a particular way, get
competitive data, ask the management companies what the
comparative fee structure is for other types of investors,
determine what the profit margins and revenue have been for the
management companies. In other words, amass the very
information that you would amiss if you were in a traditional
negotiating contract.
The ICI did a report several months ago now, I think it was
December of last year, in which it tried to rebut my allegation
that fees that were being garnered for an individual investor
were higher than fees that were being garnered for
institutional investors. And they rolled this out and they
said, ha,ha, see there is only 3 basis point differential, they
figured 18 to 21 basis points in those two pools of money.
I said wait a minute, you have proven my point. Not because
it is a 3 basis point differential, but because the comparison
they did, and my recollection as I do not have it in front of,
18 basis points for institutional investors at fees, 21 basis
points for individual investors when they had a subadvisor that
had competed to get the advisory services for the individual
investor. For subadvisors is the wrong comparison. That itself
is only a small piece of the mutual fund pool of money. And it
is the only piece of it where there is actual competition.
If you were to compare the institutional 18 basic points to
the probably 30, 40 basic points that is being charged
elsewhere in the industry, then you have that enormous gap that
is generating what I spoke of earlier, which is the tens of
billions of dollars that is improperly flowing to the mutual
funds from companies which, in my view, they are not properly
getting their hands on.
Mr. Platts. In kind of following along with allocation,
whether it be not on the fee setting but on how fees are
disclosed and, again, the allocation of the resources, you
touched a lot on the important fiduciary duty to that typical
Joe on the street, you know that smaller investor, and that
they especially need that. And as your fee issue highlights,
the need for involvement of the SEC.
In your opinion, especially in light of the SEC's request
for a significant funding increase regarding the regulation of
hedge funds versus mutual funds, is that something that we
should be worried about that it is again focusing too
disproportionate an amount of their resources on a select few
of large investors as opposed to the 90 plus million small
investors?
Mr. Spitzer. This goes back to my very opening comment
about breach of the fiduciary duties being my primary concern.
I am a little skeptical of the effort to focus so much
attention on hedge funds right now, and let me be very clear.
There are clearly hedge funds that abuse trading practices and
trade in a way that is violate to the law. They have a poor
position, they disseminate false research, they play market
manipulation cases that should and will be prosecuted when they
exist. However, hedge funds are designed to be nimble capital
that moves quickly through the market, and that's what the law
has always contemplated. Hedge fund managers are doing what
they are supposed to do for their investors who are
sophisticated investors and defined so statutorily through
regulations. And, therefore, I am a little less worried about
hedge funds abusing their relationship to their investors and
when hedge funds individually act improperly in the market
place, hopefully they'll be caught. So I do not think the
notion of regulating hedge funds as a general area should be
getting quite as much attention as it has been.
I am more focused on the theoretical and actual breach of
fiduciary duties we have seen toward mutual funds and their
small investors the 90 million investors you are talking about.
That is where there is an issue of your concern that I think we
should be focusing on.
In terms of resources, let me say this and again I do not
say this to be gratuitously sharp with respect to the SEC. As
important as resources are, I think that it is case selection
that is more important. Cases have to be brought based on a
strategic determination that they will have an impact in the
marketplace. One case on market timing for late trading can be
brought, as it opens an entire arena of impropriety and you
then can solve a problem. And not to pat ourselves on the back,
but everything we have done in the last 20 years is with about
15 lawyers total, which is a tiny percent of what the SEC has.
And I do not say that to say look how good we are. Not at all.
But I think it is case selection and making triage decisions
that will lead you to the cases that will reveal structural
problems that is most important.
Mr. Platts. I would like to yield to the ranking member,
Mr. Towns.
Mr. Towns. Thank you.
Let me just pick up on that point. You have been able to do
all this with 15 lawyers. Are you saying then that it is the
mind set of the SEC is the reason why they have not been able
to do even more with the limited resources?
Mr. Spitzer. Let me, Congressman, let me turn this and
state it affirmatively.
Mr. Towns. OK.
Mr. Spitzer. Just so it is not to sort of re-inflame our
relationship.
I think that recently we have seen a much more properly, a
much more aggressive attitude on the part of the SEC with
respect to examining structural issues that deserve to be
examined. I think what the SEC is now doing, and very wisely
so, is stepping back from the marketplace and asking itself
where have there been shifts and new dynamics that have emerged
such as with research so that you want to say wait a minute, is
research being disseminated because it is believed in or
because research is being used as bait for investment banking
clients, and if it is the latter how do you need to respond in
a regulatory level. So the SEC is beginning to ask the
appropriate questions that will bring to the fore the cases
that should be brought.
Mr. Towns. All right. Thank you.
You talked about in terms of fiduciary responsibility and,
of course, protecting the small investors. And you said that it
might require a legislative response. Do you have any specific
ideas, some things that we might be able to do legislatively to
boost this?
Mr. Spitzer. Well, I will bootstrap on Mr. Bogle's idea,
which again he has been pushing for quite a while, which has
very legislatively defined the fiduciary obligation that is
owed by a mutual fund or to the small investor. I mean, that is
something that should be done, I think.
You will hear, no doubt, from the industry, so you have
already heard it or you will get submissions from them in which
they claim well the fiduciary duty has been a little ambiguous
and there have been some case law that makes it unclear what it
is. Fortunately here in New York I think we can make the case
that we have the State law that is pretty good and we can use
that, and have been using that. But I think the notation that
there is just a very rigorous fiduciary obligation explosion
has been--unambiguous fiduciary obligation explosion is
something that should be enshrined statutorily. And Mr. Bogle
has been pushing that notion for a while, and I think he's
right.
Mr. Towns. You are very sensitive to the comment about the
relationship between the SEC and your office, and I understand
that.
Mr. Spitzer. Yes.
Mr. Towns. You do not want to distort at all, you are
trying to help, and I understand that. And I recognize that.
But have they discussed a strategic plan with you at all?
Mr. Spitzer. Oh, sure. Well, they did not discuss the
particulars of stepping back and looking at the mutual fund
industry, as has been suggested. But let me make it clear, I
speak to Steve Cutler on a regular basis, the lawyers in my
office speak to the lawyers in the Enforcement Bureau on a
regular basis. We are reviewing the entire litany of
enforcement actions that are pending. How we could think about
these cases. I speak to Chairman Donaldson about these issues.
Yes, there is appropriate integration of thinking and
discussion at this point. And that is progress. That has not
always been the case, but perhaps there was not always the need
for that to be the case. But certainly now we are working well
together and are discussing these issues as they surface.
And let me make another point. It is important not only in
terms of getting the maximum utility from the enforcement
dollars that are allocated by Congress to the SEC and by the
State to my office and other States to their enforcement
entities, but also to prevent the risk of incoherence or
inconsistency. And one of the things that I noticed in a topic
of discussion on Capitol Hill, and rightly so, is the need for
coherence and the need for eliminating any chance involved in
evasion of enforcement that would lead to the incongruities of
how we interpret the law and how we enforce it so that this
effort to speak with the SEC and work together is driven by
both of those motivations.
Mr. Towns. Right. Let me ask this, I want to deal with the
SEC. I think that if there is anything that you feel we need to
do through Congress to make--I guess more in terms of
reassuring people, you know, and I think that the integrity is
there. And I think that is something that we have to be
concerned about, you know, as we move forward is the integrity.
And what can we do in the Congress to come up with rules and
regulations and legislation in particular that might give
people that reassurance?
Mr. Spitzer. Here is what I would say, and I have
absolutely no reason to think or suspect when you use the word
``integrity,'' that it is inferred a failure of integrity in
terms of somebody intentionally overlooking an issue. So I want
to put that aside.
I think that something that Congress, and perhaps this
subcommittee could wisely spend a bit of time on would be an
examination of what--and I don't say this with any disrespect
to Paul Royce who is the head of the Legal Fund Division of the
SEC, but examination of what that division had besides for 2 or
3 years ago set as its regulatory priorities. In other words,
it would be a fair question what were you examining when in
your oversight capacity with respect to the mutual funds, I
mean had you foreseen this. Of course, with the 9/11 Commission
sometimes, you know, retrospective examinations can get a
little partisan but I think in a moment of quiet it would be
useful to say were you looking at the issue of fees, were you
looking at the issue of fiduciary obligations and how those
would be fulfilled. Did you have any evidence that there were
issues related to timing and late trading, and if so what was
done with respect to that effort. And I think it would be a
good case study of regulatory, what we now can say I think
would be regulatory failure. And it would be a useful exercise
to go through again, not in an effort that sort of points
fingers and says ahah, I caught you. But I think there will be
lessons there that could guide us prospectively so that 10
years from now we do not say in other sectors that, gee, we
should have thought of that.
Mr. Towns. Right. You testified before the House Financial
Services Committee that there must be fundamental change in the
mind set at the SEC.
Mr. Spitzer. Right.
Mr. Towns. So I guess you now feel that change has started
taking place?
Mr. Spitzer. Well, I am trying to be kinder and gentler but
it certainly--yes. It certainly happened. And I did say that,
and as I said I have been pretty critical of the SEC at
different points in time, and I am not going to take back any
of those words.
Mr. Towns. No.
Mr. Spitzer. But I think that there has been a real change
in that perspective in an effort to really rachet up or down in
perspective the degree of intensity of examination, and that is
very much to the SEC's credit. I think it was needed. And I
think that there was certain complacency, perhaps, several
years back when the markets were booming, people were happy.
Those things happen. And so I think that is, however, perhaps
when one needs to be most diligent and attentive. And I think
now we have turned that corner and I think that is good for the
investor.
Mr. Towns. I yield to the chairman.
Thank you.
Mr. Platts. Thanks, Mr. Towns.
I think that is an important point in that is that just
because the market is booming and numbers are going in the
direction you want, does not mean that there are no problems
out there. Because the market was doing so well we were not
looking maybe as close as we should have been at some of these
issues. And I appreciate that you are seeking to be kinder and
gentler today than maybe in the past.
And the followup, and it is not to point fingers but to get
a true understanding, and one of the things that you bring is
an outside perspective, you know, at the State level and in the
Attorney General's office versus the regulatory side. Once you
got into the issue, the mutual fund issue, was it just not
enough resources being put into this area by the SEC that they
were not catching these trading practices?
Mr. Spitzer. I think that there was perhaps too great a
willingness to accept sometimes what was being said by the
industry. I mean, you think about the mutual fund industry, I
have said repeatedly that my office found abuses not because we
are so smart, and I think we are but I really do not think we
are any better or any smarter or any more diligent than anybody
else. It is just that we saw what should have been obvious to
everybody because it was known by everybody on the street. That
was the case of fraud research. It was the case of fees that
were too high. The late trading perhaps was a little more
subtle. But the timing, I will tell you, there were hedge fund
prospectuses that were floating around there, anybody who had
seen them, and certainly the SEC and others had seen them, you
knew that there were billions of dollars that had been raised
and allocated by hedge funds to the timing of mutual funds.
Now, as I have said, there is nothing wrong, illegal on the
hedge fund side of that equation if you can do it depending
upon where you are on the mutual fund side. But certainly if
you were a mutual fund regulator and you were aware that there
is this new pool of money sloshing around the mutual fund world
dedicated to timing of funds, you would want somebody to say
where is it going, how does that effect. Everybody knew that
had a negative impact on the individual investor. So certainly
I think some of those questions should have been asked. And the
mutual fund industry has maintained for years and gotten away
with that, and they say every year they will cure.
And so I think there has been an acceptance of that without
a sufficiently inquisitive challenge to some of these
practices.
Mr. Platts. With the strategic plan that we are pushing and
looking forward to hopefully here in the near future, to see
from the SEC, our committee when we had a hearing last summer
and we talked about strategic plan, we think it is critical if
we are going to talk about a 12 percent funding increase for
one segment of the enforcement regulatory efforts, that if you
do not have the big picture what are you taking those funds
from and is it mutual funds, is it other important priorities?
And in getting to that point that we have a strategic plan, if
I understood your answer to Mr. Towns' question you have a
regular dialog with the SEC and your staff do, but there has
been no specific request for your input on this strategic plan
and their focus to the allocation of manpower and resources
regarding enforcement?
Mr. Spitzer. No, no. There has not been. And, frankly, I
would not expect them to ask my perspective on that. You know,
I would not ask them to tell me how to allocate the budget
within my organization. I would not expect them to say, hey
what do you think.
Mr. Platts. I think that's kinder, as you say. But I also
think it is relevant in the fact that you have mentioned you
have 15 attorneys, and the success and efforts you have
undertaken and important efforts for those typical investors
out there, given the size of the SEC and that you are obviously
being fairly efficient with your resources and your allocations
and prioritization. And that is something we will get into with
the SEC as far as who are they asking for feedback from
regarding their strategic plan.
In your approach I assume that technology is an important
part of your efforts to maximize your manpower. Do you use data
mining and that type practice or is it more manpower?
Mr. Spitzer. Yes. But I would say that the cases--and I
wish I could tell you otherwise, but the cases do not emerge
from data runs that lead us to irregularities for trading
patterns that we then say we have to look at this. Part of it
is that we do not have that capacity nor the data at our
fingertips.
We certainly use enormous data runs once we have a theory
that we either begin with, just somebody creates it or somebody
brings it to us. We then test that theory. And one minor
example of that is, perhaps, in our efforts to calculate
dilution effects from the impact of timing of mutual funds, we
do enormous quantitative analyses and you have spectacular
economists at my office who is involved in running these
numbers and comes up with models to figure out how we could
quantify. So we do not do it data in theory, we do it theory
can we turn it into and try to do that.
Mr. Platts. Right.
Mr. Towns, did you have other questions.
Mr. Towns. No. Thank you very much, Mr. Chairman. I would
like to thank the Attorney General for coming and the work that
he is doing in this area. He has 15 lawyers, I mean you would
have to be impressed with that.
Mr. Spitzer. I think they are very good lawyers.
Mr. Towns. Evidently so. Thank you so much.
Mr. Spitzer. Thank you.
Mr. Platts. OK. And I would like to add my thanks again for
your time today and the great efforts of you and your staff in
doing right by that typical investor out there. We appreciate
your work, and wish you well.
Mr. Spitzer. Thank you very much, Mr. Chairman.
Mr. Platts. Thank you.
Mr. Spitzer. Thank you.
Mr. Platts. We will take a quick 2 minute break as we get
our second panel with Mr. Bogle and Dr. Morey and reconvene
here shortly.
[Recess].
Mr. Platts. We are ready to reconvene this hearing.
Thank you, Mr. Bogle and Mr. Morey for your statements.
Will your raise your right hands and answer the following?
[Witnesses sworn].
Mr. Bogle, we will hear your testimony first.
STATEMENT OF JOHN BOGLE, BOGLE FINANCIAL MARKETS RESEARCH
CENTER, FOUNDER VANGUARD MUTUAL FUNDS
Mr. Bogle. Thank you for inviting me to speak with you
today. I hope that my experience in the mutual fund industry
will be helpful in considering the issues before you regarding
resource allocation and strategic planning at the Securities
and Exchange Commission.
I have been involved in this business since I began to
write my Princeton senior thesis which I began in 1949. In
1951, I went to work for industry pioneer Wellington Management
Co., and ran that company from 1965 to 1974. In 1974, after
being fired from Wellington Management Co., I founded a new
mutual fund organization, called the Vanguard Group of
Investment Companies. Vanguard, surprisingly enough,
represented my attempt to create a firm that would measure up
to the goals I set forth for the fund industry in my Princeton
senior thesis, all those years ago:
No. 1: To place the interests of fund shareholders as the
highest priority; No. 2: To reduce management fees and sales
charges; No. 3: To make no claim to performance superiority
over the stock market indexes; No. 4: To manage mutual funds,
``in the most honest, efficient, and economical way possible.''
These goals, of course, were clearly aligned, not only with
what I regarded as the ``spirit'' of the Investment Company
Act, but with its ``letter'': to insure that mutual funds are
``organized, operated, and managed'' in the interest of
shareowners, rather than in the interest of managers and
distributors.
We've done our best at Vanguard, to achieve those goals,
and we are now the lowest cost provider of mutual funds in the
world. And we are also one of the two largest firms.
After relinquishing my position as Vanguard's senior
chairman in 1999, I have been engaged in researching, writing,
and speaking about investing in the mutual fund industry. I
have also written a half-dozen op-ed pieces for the New York
Times and the Wall Street Journal, and four books, all with
strong views about this industry's need to better serve its
shareholders. But I am sorry to tell you gentlemen, the fund
industry has yet to measure up to those idealistic, yet wholly
realistic, goals I urged upon it way back in 1951.
Disgusting as they are to someone like me who has made fund
management his life's work, the recent market timing scandals
have a good side. They call attention to the profound conflicts
of interest that exist between mutual fund managers and mutual
fund shareholders, conflicts that arise from an inherently
flawed governance structure in which fund owners, in practice,
have very little if any voice. The trading scandals are but the
small tip of a very large iceberg, with the cost of time zone
trading estimated to be $5 billion a year. By contrast, in 2003
alone, the total cost of managing the industry's $7 trillion of
assets came to more than $100 billion counting turnover costs.
An amount that is, of course, largely if not entirely
responsible for the shortfall that mutual funds demonstrate in
being able to keep with the returns on the markets themselves.
If the management portion of those costs were subject to arms-
length negotiation, tens of billions of dollars would be saved
year after year after year.
The same kind of stewardship that demands that fund
directors effectively represent the shareholders who elect them
and to whom they are responsible under the law is rarely found
in this industry. Rather, managers have focused not on
salesmanship but on salesmanship. Their agenda is inarguably
dominated by the desire to bring in assets under management.
That marketing agenda led us to create 496 new ``new economy``
funds during the stock market bubble, not because they were
prudent investments, but simply because we saw that the public
was eager to buy them. And in the ensuing market crash, these
very funds cost the public quite literally hundreds of billions
of dollars. The conflicts of interest that engendered these
unhappy and costly outcomes for fund shareholders must be
resolved in favor of fund owners, not fund managers. And the
recent scandals give us the opportunity to at last build a fund
industry that is worthy of its early heritage, one that does
what I have long--sometimes, I think forever suggested: To give
this industry's 95 million investors a fair shake.
Achieving this goal, make no mistake about it, must come
from the industry itself, from within the industry and from
investors. But it cannot be accomplished without an active,
energetic, dedicated, fully staffed Securities and Exchange
Commission. During my long career, both before and after the
market bubble and the corporate and mutual fund scandals, I
have had frequent occasions to work with members of the
Commission and its staff. And it is absolutely without
hesitation that I report to you on the subcommittee that,
virtually without exception, I have found these individuals to
measure up to the very highest possible standards of public
service, integrity, expertise, education, intellectual
curiosity, and willingness to listen and make reasoned
decisions. And I would like to take this opportunity to salute
the Commission and its staff.
The scope of their oversight of tens of thousands of
corporations, and exchanges, and accounting firms, broker-
dealers, advisers, mutual funds is enormous. And as these
activities exploded during the bubble, the Commission's
workload soared accordingly. So, as you know, did the SEC fees
paid by these entities, from $750 million in 1996 to $2.3
billion three or four times as much--in 2000. If only those
fees had flowed directly to the Commission, it might have had a
fighting chance to hire and retain and motivate a staff
sufficient in number and talent not only to deal with that
cascading flow of paperwork, but to increase its investigation
and overview and probe much more deeply into the emerging
issues of the era. However, the SEC fees collected do not
represent the funds appropriated for SEC operations, as you and
the Congress know. In fact, the Commission's appropriation for
2000 was just $370, 16 percent, one-sixth, of the SEC fees
paid. It is hard to imagine that the Commission would not have
been far more able to handle the added regulatory
responsibilities engendered by the bubble had its funding grown
apace with its responsibilities. I'm pleased they are finally
starting to get much more funding. For a Commission starved in
resources and plagued by high staff turnover, is a Commission
unable to fulfill its mission of overseeing our Nation's vital
system of financial markets. That said, I do not want to appear
to excuse, solely on the basis of limited resources, the
Commission's failures in its oversight of issues, markets, and
funds. Economics, after all, is all about the allocation of
limited resources in a world where needs are always unlimited.
Neither private enterprise nor public agency ever succeeds in
getting its resource allocation exactly right. And if I may say
so, I can assure you that in running two different mutual fund
management companies, I certainly never got the resource
allocation exactly right. But I think we have to acknowledge
our mistakes, as I try and do, learn from them, as the SEC is
doing, and use that wisdom to do a better job in the future.
I believe the Commission is doing that. I am impressed, and
always have been, with the leaders of both the Division of
Enforcement and the Division of Investment Management as they
respond to the clear evidence that we've been discussing today,
illegal behavior among firms that were once considered industry
leaders.
I am also impressed with Chairman Donaldson's willingness
to tackle how the Commission operates, and particularly his new
Office of Risk Assessment and Strategic Planning which is
positively responsive, of course, to the subject of your
hearing today.
As I am most familiar with the Commission's Division of
Investment Management, my written testimony lists 7 issues that
either need additional attention or should be upon the SEC's
planning agenda. I will not go through them.
In the time available to me, just let me say a couple of
works about each.
No. 1: Mutual fund market timing. You should know, as my
testimony points out, it has been going on for at least a
decade and we all knew it.
No. 2: Hedge funds. They have played a major role in the
mutual fund scandals, as Attorney General Spitzer mentioned. An
article that was published in the Financial Analysts Journal in
2002 identified 30 hedge funds that were doing this and nobody
did anything. So for these reasons and others, I do endorse
Chairman Donaldson's view that hedge funds must--must--be drawn
under the Commission's purview.
No. 3: Compensation of portfolio management disclosure.
Right now we have proposed rules that would describe how
portfolio managers are compensated, but not how much they are
compensated. That is notably the same as no disclosure at all.
I believe we need disclosure of the dollar amount of
compensation not only of portfolio managers, but of the five
highest paid executives of the company. Why should the mutual
fund industry be exempt from the disclosure required of other
corporate executives.
No. 4: Fees paid by pension accounts that are managed by
fund managers. Why are the fees funds pay often from 100 to 150
times as large, as for example, the fees that California's
personal retirement plan, (CALPERS), pays those same managers,
presumably the same portfolio of essentially the same
securities.
No. 5: 401-k plans. Recent press reports have detailed
clandestine payments from fund managers to pension clients,
often in the form of rebates. The SEC investigation of this
area simply has to be a high priority.
No. 6: The role of financial conglomerates is almost never
discussed. When I came into this business, fund management
companies were privately owned organizations owned largely by
the fund managers themselves. Today public ownership and
ownership by giant financial conglomerates have gradually
become the industry's modus operandi. Of the 50 largest fund
management groups, 36 are owned by huge financial
conglomerates.
Why do conglomerates buy mutual fund management companies?
They do it to earn a return on their capital, the
conglomerate's capital. Yet the 1940 Act makes earning a return
on the fund's shareholder's capital the overriding priority.
This rarely acknowledged conflict of interest cries out for
study.
No. 7: Yes, an economic study of the mutual fund industry.
A few minutes ago, Attorney General Spitzer mentioned the
need for an economic study.
Now to conclude just very briefly having laid out the
litany of priorities of a strategic study by an SEC whose
resources are already stretched, I fully recognize the job
before the Commission is large and its resources, while large
are still limited. These tasks, however, are not only
worthwhile, but essential for the protection of investors.
However, I want to offer now a final recommendation in more
detail in my written testimony that could in the long run
actually reduce the Commission's regulatory responsibility.
Just think about this: One of the principle reasons for
existing regulation and the existing additional regulation, and
the areas of study I've noted above, is the need to deal with
the profound and obvious conflict of interest that exists
between mutual funds and their shareholders on the one hand and
management companies and their shareholders on the other. The
timing and trading scandals, the setting of appropriate fees,
the focus on asset gathering are all issues that reflect this
conflict, and the costs they impose are deducted from returns
of the financial markets, and trickle down, if you will, to
fund shareholders. Those things must be addressed.
The Investment Company Act of 1940, our Constitution, the
law of the land, puts the fund in the driver seat and the
management company in the rumble seat. A narrow reading of the
act would not even allow the management company into the car.
Read the act and see if you don't agree with me. The fact is,
however, that it is the management company that's driving the
darn car. If funds were truly organized, operated and managed
solely in the interest of fund shareholders, most of today's
regulatory problems would vanish. The funds would protect their
own shareholders. That is what they are supposed to do. How to
get to that goal is a good question for the highest use of
SEC's strategic resources.
That concludes my testimony. And I thank you for your
attention.
[The prepared statement of Mr. Bogle follows:]
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Mr. Platts. Thank you, Mr. Bogle. And we'll save questions
until we have Morey's statement and then have questions for
both of you.
Dr. Morey.
STATEMENT OF MATTHEW R. MOREY, Ph.D., ASSOCIATE PROFESSOR OF
FINANCE, LUBIN SCHOOL OF BUSINESS, PACE UNIVERSITY
Dr. Morey. Thank you very much. I wanted to thank the
Committee for inviting me here to attend the meeting and also
to thank you for coming to Pace. It is wonderful when we get
the opportunity to have you all here. And I hope you consider
having other meetings here in the future.
With this testimony I wanted to give my thoughts on two
particular issues concerning the regulations of the mutual fund
industry.
First, I wanted to relate that the SEC recently has been
making impressive strides to improve the institution's ability
to regulate the fund industry; however I think more should be
done given the increased importance of mutual funds in the
United States.
And second, I believe that disclosure is the most important
issue to focus on with regards to regulating the fund industry.
And I wanted to sort of be up front and say that it is my
belief that I think investors are in fact intelligent. If they
are informed of the basic operations of mutual funds in a
clear, concise and accurate way, investors can understand the
differences between funds and I believe make better investment
decisions. And I say this because I think many of the problems
that we are talking about in the last couple of years and so on
relating to the fund industry are associated with this lack of
disclosure.
Now in terms of the SEC's role in regulating mutual funds,
I believe that Chairman Donaldson is moving the regulatory
institution in the right direction. The much needed, recent
increases in the SEC's budget have allowed it to hire many more
people, pay them more competitive salaries, and so on. And
this, combined with the SEC's fresh interest in investigating
many of the most important mutual fund abuses such as
disclosure, fees and market timing, are all major improvements.
However, I would encourage the committee to push for even more
funding and support of the SEC with regards to the mutual fund
industry.
Consider for a moment that the size of the SEC's budget,
and now using what we're basically considering the SEC's budget
for the future, the best SEC's budget has gone from $166
million in 1990 to a proposed $913 million for 2005. And this
constitutes an increase of 5.5, 6 times, if you will. From 1990
to 2002, mutual fund asset--of course in 2002 they much lower
at that time because the market had gone down--mutual funds
assets have increased about six times during that time. So, on
the surface, it does look like the funding now with the recent
increases is keeping up with the growth of the industry. But if
you look more deeply at mutual funds themselves, these figures
do not illustrate the entire picture. For example, in 1990 only
6.7 percent of total financial assets held in U.S. households
were in mutual funds, only 6.7 percent. Twelve years later at
the end of 2002, the percentage was almost 18 percent, 17.8
percent to be exact. So almost a threefold increase. And hence,
while the SEC funding may be close to matching the growth of
the industry if you look at those numbers I was giving you
before, it does not take into consideration the importance of
this industry. It really has grown dramatically. And in fact, I
can quote some studies that have basically found that the
amount of money in mutual funds today is more than are in
private U.S. banks. And it is a major financial institution
that deserves to have some type of regulation that these other
financial institutions have.
Furthermore, I would encourage the committee to push for
more support of the SEC during the times that it needs it most:
bull markets. Paradoxically, the very moments when the SEC
needs the largest increases in funding are, I believe, when
markets seem to be behaving well. It is during these times that
many scandals arise as support for regulation declines
considerably. Congress, like the SEC, must be farsighted enough
to know that bull markets do not necessarily mean the fund
industry is functioning well.
The second issue I wanted to talk about is disclosure. And
this has been talked a lot about by our previous witnesses.
As I said before, I believe that many of the problems that
we have in the fund industry today are associated with the lack
of disclosure and that forcing the industry to be more up-front
about fund practices would greatly help the industry in the
future.
First, consider expenses or fees, which have been widely
talked about already. As is well known, mutual funds do not
clearly state or describe their expenses to investors. While
the expense ratio does give information on the cost of running
many of the aspects of the fund, brokerage fees are not
included in this calculation. And what this means is it is
difficult, if not impossible, for investors to discern the true
expenses of a fund. Now this is vital information for the
following reason: In almost all the academic research on mutual
fund performance, the one consistent factor that is shown to be
of help in terms of predicting future mutual fund performance
is of the expenses. That is, low expense funds, on average,
out-perform high expense funds. However, because not all
expenses are disclosed to investors, they are left without the
key information to help them invest wisely. If the SEC were to
require full and complete disclosure of fees and expenses, it
would greatly help investors in selecting funds and, I believe,
it would help restore trust in mutual funds.
Second, another problem with mutual funds that is related
to disclosure is window dressing. Until recently the SEC
required funds to disclose their actual portfolio holdings only
twice a year. And recent academic research--some of this by
myself--however, indicates that since disclosure is so
infrequent or has been so infrequent, some funds practice a
behavior known as window dressing, whereby they cosmetically
alter their portfolios right before disclosure in an effort to
make the portfolio look better than it actually is.
For example, a bond fund manager may attempt to hold
slightly higher quality bonds right at the time of disclosure
in an effort to show a safer portfolio. However, immediately
after disclosure, the manager dismantles these cosmetic
positions. For investors, the detrimental effects of window
dressing are two-fold.
First, investors can be misled about the sources of fund
performance. Taken to the extreme, this deception could conceal
investing behavior inconsistent with the fund prospectus.
Second, additional explicit transactions costs are borne by
investors to build and dismantle cosmetic positions. It is my
belief that window dressing can and probably will be mitigated
with more regular disclosure. If funds have to disclose their
holding more often, more frequently, say on a quarterly basis
which is the new change that the SEC has implemented I believe
last 2 months ago, it would be more difficult for a fund to
hide what it is actually holding and more expensive to practice
window dressing, as funds would have to build and unwind these
cosmetic positions more often. And although this more frequent
disclosure does increase administrative costs, I believe that
the gains of more frequent disclosure, i.e., less window
dressing and just more information to the public, to the
investor, outweighs these additional costs.
The last issue I wanted to discuss with the SEC is making
mutual fund information easier to understand for the average
investor. Indeed, I feel that some recent developments in the
mutual fund industry to sell funds via brokers have actually
made it more difficult for an average investor to understand
mutual funds and that actually have hurt the industry.
For example, consider the issue of multiple share classes.
About 12 years ago, almost all funds in the United States,
there were some exceptions but most of the vast majority of
funds in the United States were either load or noload mutual
funds. However around the mid-1990's, just as investors were
beginning to understand the difference between a load and a no-
load fund, many funds moved to multiple share classes as a
result of the adoption of rule 18f-3 by the SEC in 1995. Just
like other mutual funds, multiple-share-class funds represent a
portfolio of underlying assets. However, unlike other funds,
they have different share classes differentiated only by how
investors pay fees. For example, a single-class fund only has
one fee structure whereas a multiple-share-class fund can have
two, three, even four different fee structures on the same
underlying portfolio.
Now, I don't think the impact of these multiple-share-
classes is well understood by a lot of people in the industry.
To understand the impact of the multiple-share-classes consider
that at the end of 1991, the Morningstar mutual funds data base
indicated that there were 2,373 funds. By the end of December
2000, the same data base indicated that there were 12,029
funds; a more than fivefold increase in 9 years. However, since
each share of a multiple-share-class fund is counted separately
by Morningstar, these numbers are completely overstated.
Indeed, when multiple share classes are adjusted for, these
numbers drop to 2,322 funds, again at the end of December 1991
and only 5,349 funds. Hence, the rise of multiple-share-classes
is responsible for about 69 percent of the increase in the
reported number of funds over this period.
And although the stated intentions of this rule 18f-3 seem
quite positive for investors, i.e., investors would now be able
to choose the best fee structure that suits them without the
funds having to pay the costs of creating several funds, many
of the effects of this rule change have actually been quite
negative for investors.
For example, one of the most obvious problems with
multiple-share-class funds is that mutual fund fees have become
more complicated for investors. And we have been talking about
how important fees are in terms of terms. Again, indeed, just
as investors were getting used to the distinction between load
and no-load funds, the industry adopted an alphabet soup of
fund share classes that investors now have to sift through. So
after they pick a fund, they now have to pick the share class
that they are actually going to undertake.
Moreover, and maybe the most negative consequence of
multiple share classes, a colleague of mine, Edward O'Neal and
some other people have well, have found that the introduction
of multiple share classes has given rise to broker compensation
arrangements that can be quite different across share classes.
For example, brokers may receive more compensation for selling
a deferred-load class, particularly known as a B share class,
rather than a front load class share. And O'Neal documents that
such incentives have lead to clear conflicts of interest as
brokers try to sell a share class that is the best for them and
not necessarily best for the investor.
So to conclude, I would encourage the committee to more
fully support the SEC with regards to mutual fund regulation.
The industry has seen its importance increase dramatically and
this fact alone, just alone merits more funding for the
industry's chief watchdog.
In terms of the focus of the SEC's regulation efforts, I
believe that fuller disclosure with an emphasis on relatively
easy-to-understand statements of fees, expenses and portfolio
holdings is the way to go. At some point, mutual funds have to
be self-regulating, but it is my belief that the SEC should
allow investors to make more informed decisions by requiring
funds to disclose much more information to the public.
Thank you.
Mr. Platts. Thank you, Dr. Morey. And, again, my thanks to
both of you for your testimony and we will proceed into the
questions.
Mr. Bogle, again, certainly your many years in the industry
and your perspective of having been regulated by the SEC brings
a unique perspective to our hearing today. And I wanted to say
your standard that you set in that 1949 thesis statement and
the high ethical standards I commend. And as I say in the
political arena in my approach to politicking and person-to-
person that some of my views are deemed idealistic. I say,
well, idealism and realism combine; you can be an idealistic
realistic or a realistic idealist. But either one I think is a
worthy goal.
Mr. Bogle. Absolutely, sir.
Mr. Platts. And I think that is something that is
important, that your perspectives are idealistic but
realistically achievable goals is important for all of us to
understand.
Some of what has transpired in the mutual fund industry and
with the Attorney General, and efforts on the market timing and
late trading, seem to be kind of just fully known and just
accepted practices, although within the ethical and legal
standards that really should have been pursued. And it gets
into our focus today on that strategic planning process of the
SEC, its resource allocation. Given how pervasive the knowledge
was of these practices, what is your view of what went wrong
that the SEC was not proactive in identifying these practices
that were hurting that average investor if it was so openly
known?
Mr. Bogle. I think, first of all, the Investment Company
Institute, the trade association for the industry, has always
had a heavy influence on the SEC staff. And the people that run
this industry, the chief executives of the management
companies, are persons of very high ethics but they are
involved in a business that has a whole lot of things that we
take for granted that we should not.
You know, Mr. Chairman, there is a wonderful quote from
Upton Sinclair that says it is amazing how difficult it is for
a man to understand something if he is paid a small fortune not
to understand. And this is an enormously economically
attractive industry. So I think they were sort of persuaded by
their own rhetoric and more able to persuade to the SEC that
things were not serious, they were not problems. And the ethic
in our business was kind of everybody else is accepting these
timers. Now our marketing department says if we do not allow
market timing by a brokerage firm, they will take us off their
preferred list; all that kind of thing and all the shelf space
and point of sales stuff that affects this industry. And I
think we did not realize how bad it was. I do not think we
thought through that it was actually damaging the existing
shareholders. But I have to say, and it will sound self-
serving, and in a lot of ways it is self-serving, but when we
started Vanguard it was to be run for the shareholders. And
believe me, we have been dealing from almost the day we
converted from a load system to a no-load system in 1977 with
people trying to break through the doors and do market timing.
And I hate to tell you, I would not dare tell you, how many of
them I have almost personally thrown out. You do not like that
and you know it is not good for the fund shareholders, but many
felt that if it is depriving the management company of the
revenues, you kind of think well it is not too bad.
Certainly some of the stuff that was criminal is an
exception. But very few people thought they were behaving
unethically because the system under which the industry runs
and the industry ethic, if you will, we are all competing and
our competitors are doing it, our peers are doing it and we do
not think that there is anything too bad. I do not think the
SEC really knew as much as was going on as the industry itself
it did, even though that Financial Analysts Journal article was
out there for anybody to read. Maybe nobody in the SEC reads
the Financial Analysts Journal. I will bet they are reading
them now.
Mr. Platts. We hope so. And, you know, as a dad I put a lot
of things in perspective and I maybe better understand how my
dad always commented to put things in perspective as his dad
did himself when he talked about us kids. And it is almost--you
know, my kids will say why can I not do that? Well, all the
other kids are able to do it.
Mr. Bogle. Yes.
Mr. Platts. You know, and if they can do it, why can I not?
And it is just kind of unfortunate, that mentally. But
certainly given the very import fiduciary duty the SEC has,
just because it is accepted, certainly is it within the balance
of the law. And a lot of what your testimony brings forward is
a big part of what our committee is focused on. Certainly there
is certain statutory changes that are needed to account for the
change in the marketplace and to keep up with those changes.
But what I took from your testimony is a better enforcement in
regulation of the marketplace under existing laws is really
going to go a long way to protecting that investment. Your
analogy to the rumble seat and under the law they should not be
in the car and yet they are driving the car; that is not a
change in law, it is enforcing the law. And what our hearing's
focus is from the strategic allocation of resources to better
enforce the law.
You certainly well highlight the challenge that the SEC had
as we--you know. I was not in Congress in the 1990's, but it
looked like the Federal Treasury was looking to the SEC as kind
of the rainmaker for the Federal Treasury. Just generating more
and more money and we are going to give you a smaller and
smaller percentage of what you are generating. And instead of
reinvesting that we were going the opposite direction. And
manpower certainly was a prominent issue and we are seeking to
address that.
Mr. Bogle. A lot of these things did not need to have
happened, sir.
Mr. Platts. Yes.
As we are now trying to give them manpower, give additional
authority to SEC and the SEC is actively engaged thanks to the
leadership of Chairman Donaldson and his staff of having a more
comprehensive approach, is there one or two items that we as a
subcommittee should especially be looking for in their
strategic plan that they might coming forward here in the near
future to us and to the general public, to investors and to the
community, that we really should be especially focused on in
their strategic plan?
Mr. Bogle. Yes. I tried to list a fairly large number. I
would put quite high on the list the economic study of the
mutual fund industry.
Mr. Platts. Of those seven, that would be----
Mr. Bogle. That would probably be my highest. And the
second is one that is literally not discussed. I do not know
anybody who said a word about it except you know who seems to
be getting in trouble all the time with his fellows in the
industry. And that is the conglomerate takeover of the
industry. Is that good? What does it mean when the whole idea,
their idea is to gather assets? Just the gathering the
staggering amounts of assets. Now the largest mutual fund
manager happens, thank God, to be an indexer. Runs $1 trillion
worth of assets. Those are huge amounts of money, but when you
get trying to manage them, can money be managed at that level
effectively? Is there any thought about saying that a certain
size of mutual fund can no longer carry out the objectives that
it has in the prospectus?
Size is one. Buffet tells us that a fat wallet is the enemy
of superior returns and there is not a money manager in America
that does not know that, and yet we keep looking for more
assets in the industry. And so that would be probably my second
one.
Mr. Platts. Those are your top two? And those are insights.
And I did appreciate, as I read the Attorney General's
testimony ahead of today's hearing and as you reflected in your
opening statement, how closely aligned as he talked about his
three chapters, it really is almost like you know, he had a
copy of your testimony on that economic study.
Mr. Bogle. Let me make the record clear, Mr. Chairman, that
we did not share. I know you know we did not.
Mr. Platts. I know you did not, but certainly you dove
tailed well with each other from him on the enforcement side as
Attorney General and you coming from the regulated side in the
industry. It really made a great joint message.
And I want to go to our ranking member and then we will
come back some additional questions.
Mr. Towns.
Mr. Towns. Thank you very much, Mr. Chairman.
As a former industry leader, Mr. Bogle, let me say to you,
I am really impressed with your testimony (inaudible).
What must the SEC do to ensure that the financial community
take these regulations seriously? They may have regulations,
but they are not taken seriously.
Mr. Bogle. Well, they are not taken seriously for a couple
of reasons. First, the SEC has no criminal, as I understand it,
no ability to prosecute under the law. They have to refer that
over to the Justice Department. One of the great advantages
Attorney General Spitzer has is he can do that. He can put
people in jail. And believe me, when people start to go to
jail, and we have one mutual fund executive, he happened to be
named mutual fund executive the year in the year 2002, who is
now in the slammer. And that is the bigger they are, the harder
they fall.
So the Attorney General has something quite strong going
for him. Because white collar criminals have quite a different
life there when they find themselves in jail. And then we
cannot expect the SEC to do that.
But I think it is strong enforcement. I think the
Commission is reticent, and more reticent than they should be
in making fee reductions a part of their settlements with these
various mutual fund companies. There is sort of a philosophical
divide between Attorney General Spitzer's approach and the
Commission's approach. But I would use, you know when you get a
struggle like this, a fight like this is you will, I think the
SEC should use every weapon at its command. And I would say fee
reduction would be an important part of that.
I would also hope that the chairman would use the bully
pulpit that the chairman of the SEC has to stand up and talk
much more boldly and bluntly about these abuses and about the
industry in which they have occurred.
He is a terrific chairman, but I do not think he realizes
the power of the bully pulpit as much as he might.
Mr. Towns. Right. Thank you.
Since approximately 20 percent of all pension funds are
invested in mutual funds today, should that be a specific focus
on how particular investments in mutual funds are regulated,
that is the stake from the individual investors?
Mr. Bogle. You raise a very, very good question, Ranking
Member Towns. A really good question. Let me just give you an
interesting fact.
Of the 100 largest financial institutions in America, which
happen to control 56 percent of all the stock in America, the
13 are State pension funds and 87 are private firms; 78 of
those 87 firms, the overwhelming majority, actually run both
mutual funds and private pension accounts. The mix, in other
words, it is very hard. I think we have to change our mind set
and maybe even our vocabulary a little bit to talk about money
managers because the issues in both classes are not very
different. When you are marketing to individuals, which is the
mutual fund side by and large, particularly the 401k area, you
know you are marketing to a huge number of people. But you are
still marketing to the institutional side and then you got
salesmen out there trying to say well I am better than
everybody else and all those kind of things that they do, but
they are both afflicted by very much the same things.
I am not sure you need heavy regulation. The advisors of
the pension plans are registered separately and are usually
affiliated companies that register separately under the
Investment Advisors Act. But that is, by and large, at least by
my standards kind of a reporting statute. But I think there
should be considerable attention given to the conflicts, I
would say, in those two areas, fee setting.
Another good example is these advisors, the same advisors
mind you now with different corporations in the same company,
but the same organizations who will offer very low fees to
State pension plans and also offer them incentive fees that say
we will not take anymore fee than this unless we give you good
returns. Why, one might ask, is not the same deal offered to
their mutual fund clients? It seems sort of amazing, does it
not? But it is not. Incentive fees in the mutual fund area are
virtually nonexistent. I think 1 percent or 2 percent of all
mutual funds use them, which, I think Vanguard makes up half.
We like incentive fees because the adviser gets paid if he does
well and pays a penalty if he does not.
So, I think you are right, that there should be some--
without having a regulation that is all encompassing, certainly
a parallel regulation in which there is a recognition that
these two businesses are one in the same and becoming
increasingly associated.
Mr. Towns. Let me thank you. And I thank you for all your
work you are doing, and re-thank you for your testimony today.
Thank you.
Mr. Bogle. Thank you.
Mr. Platts. Thank you, Mr. Towns.
Dr. Morey, your study on the window dressing issue and the
kind of gaming system for that investor looking at a
prospective investment.
Dr. Morey. Yes.
Mr. Platts. Is that something in your assessment that the
SEC should have been able to identify long before your study.
It seems that once you did it, and identifying the practice, it
should have been something that you know was more quickly
identified by those laboring in the industry. What is your
assessment?
Dr. Morey. Yes, it is something I think that they could
have investigated a lot earlier. I mean, there have been
evidence of window dressing in many different areas. And, you
know, the economic significance of window dressing maybe is not
of the level of market timing, things of that sort. I do not
know if I would put it up at that high of level. But it is
something that has been an issue and anecdotally talked about,
and it has been talked about in a number of research papers for
many years in the recent decade.
So as I think I relayed in the paper, if you have read in
the paper, so the SEC has not brought up one single
investigation of window dressing. So I really think it is
something that they could have looked at. And part of the
reason they have not looked at it is they are just under
staffed, under paid. A lot of those things that have been kind
of been talked about before. So I do think it is something that
they certainly looked into more. And the movement of going to
more frequent disclosure, quarterly disclosure I think really
does indicate that the SEC is moving in the direction of trying
to, you know, be concerned about window dressing.
Mr. Platts. I would agree in the sense of, as we have heard
from the Attorney General as well, disclosure in and of itself
helps address some of these. That self regulation----
Dr. Morey. Right.
Mr. Platts [continuing]. Ultimately is going to come from
within the industry as we get better disclosure, whether it is
on issues of window dressing or related issues; that the
sunshine will help to force the industry to better regulate
itself as self. But the point being made, you know, that an
aggressive proactive SEC--also that I use the analogy with your
student and you have a homework assignment and the teacher is
actually going to call on you in class, you are more likely to
pay attention to it. So if you are in industry you know that
the regulators are more likely to actually look into what you
are doing, you are more likely to be a little more diligent in
fulfilling your duties to the investigators.
Mr. Bogle. And if you knew your directors were going to
take you to task, if you knew your fund directors were going to
take you to task, which there has not been nearly of.
Mr. Platts. Yes, from within the industry itself, right?
Mr. Bogle. Yes.
Dr. Morey. I mean, the No. 1 role of the regulatory
institutes is it always be bending over backward for the small
investor, I really believe. And I do not think it has been
doing that for the last 10 years or in many ways.
Mr. Platts. Well, that was actually a question I wanted for
both of you, because I know Mr. Bogle you have a train to
catch.
Mr. Bogle. That is all right. I am at your service.
Mr. Platts. So we want to make sure--as we work with the
SEC and they are coming forward with the strategic plan and
where are they going to focus? And I appreciate in your talk
and you are agreeing with Chairman Donaldson, the importance of
the SEC being involved in the regulation of hedge funds, but
how with limited resources, even though they have more, there
are still ever going to be enough in any one's view, is their
strategic plan. What is the right balance between large
investors, a small number of them and the smaller investors but
a huge number? What should we be looking for in their strategic
plan? How do they truly go about their resource allocation in
that regard?
Mr. Bogle. Well, I certainly agree with Dr. Morey that the
small investor needs a lot more protection than the large
investor does, and there cannot be any question about that. And
sooner or later we have to try and educate the small investor
about how to protect him or herself. We have gone through an
era of great human greed, a great market bubble and if
everything looked easy, we had for 20 years 18 percent annual
returns in the stock market. Even a poor performing mutual fund
probably doubled your money. And that is probably only a 5-
percent return or something like that. But all those things
kind of came together. You could even argue it was kind of a
perfect storm.
And it is a little hard to say where the SEC should put its
resources. But, you know, one thing which actually Dr. Morey
inspired in my mind as I was listening to him here is that the
SEC--the work that comes out of the academic community in the
financial area is staggering.
You know, the personal computer has made every academic
able to explore thousands of academics for every single aspect
of everything that goes on in the financial fields and the work
just pours out; there are three, four, five, six, seven
academic journals. Some of them are written in English, some of
them are written in a language with which I am not familiar.
But the SEC, honestly and I am not kidding about this, should
have one or two people; one who can speak the English and
translate all these formulas into English and see what is
worthwhile. A lot of it is not worthwhile. Some of it just
priceless. But just capitalizing on the work that is done out
there does not require using the research others. Using the
work of others would be a very useful thing to do.
I would try and convene groups of people in the industry. I
am not sure how you get them to talk. I have been lucky enough
to be in a position where I can talk to Commission division,
and I have talked informally actually this year to the Director
of the Division of Enforcement, Steve Cutler, for whom I have
the highest regard for and his whole division. And I will be
talking with Paul Royee (phonetic) in Division of Investment
Management.
But we ought to have people from the industry come and talk
to them about, you know, about the reality as it is in the
industry. Not all the double talk, not all the public
relations, not all the veneer. What is really going on and are
there economic issues and management issues and conflict issues
that go on in this industry. And I think those things should
not demand too much of SEC resources.
Once we get to the areas you could really focus on, then
put the resources on them.
Dr. Morey. Yes, I would say the same sort of thing. I mean,
I really do believe that the smaller investor really most of
the attention should be put in terms of regulation. Yo know,
again, it comes back to the disclosure. I really do feel that,
you now, individuals should be responsible to some extent about
where they are investing their money, but we should be able to
give them as much information in as clear a way as possible.
And, you know, just multiple-share-class stuff. I can
understand why the mutual fund industry wanted this, because
most mutual funds are not bought, they are sold. That is
literally how the industry people, they are sold to other
people. But still, I mean, trying to basically protect
investors by keeping it as clear, as easy to understand as
possible is really imperative. And that is what I would really
stess in terms of the SEC and (inaudible) share.
Mr. Platts. One final question. I want to yield to Mr.
Towns to wrap up this portion, but Mr Bogle, you addressed in
the sense of your meeting with the Enforcement Division and
sharing some of your great wealth and knowledge with them to
get that kind of how things really work on the street. And I
was going to ask you, I am glad to hear that type dialog is
happening.
The second half of that is, Dr. Morey, based on your study
and when addressing issues, has there been any effort by the
SEC to reach out to you and to your fellow professors working
so that you are aware of to do as Mr. Bogle has said----
Dr. Morey. Right.
Mr. Platts [continuing]. Kind of just pull in your
knowledge as a source of some additional information?
Dr. Morey. Yes, there has been. We, in fact, presented this
paper at the SEC not too long ago. One of my colleagues used to
work at the SEC, actually, in that direction.
Mr. Platts. Great.
Dr. Morey. So, yes, I do think there is some, but not
enough. Not nearly enough. And I will give you one example that
has worked pretty well, which is ICI, Investment Company
Institute, every 2 years has put together a conference where
they bring in academic, mutual fund academics and with
practitioners. And although some of the practitioners are a
little guarded about what the are saying, and so still there
has been an incredible useful thing. Because we can ask them
the questions that we are interested in, they can ask the
questions.
At the last one we were really trying to talk a lot about
like compensation, the stuff that Mr. Bogle was talking about.
Why isn't the mutual fund manager's compensation disclosed. You
could even disclose it in anonymous ways that we could do
studies on it. But, you know, those kinds of issues. So that
was very helpful and maybe if the SEC could do something like
that in a broader way with a conference or something of that
sort, it would be very helpful.
Mr. Platts. Thank you.
I yield to Mr. Towns.
Mr. Towns. Right. Thank you very much.
And let me thank you also, Dr. Morey for your testimony.
And, of course, I also appreciate the fact that you have given
us another invitation to the University as well. We certainly
appreciate that.
Are you saying that the SEC should have a mandate for
educating investors? Are you saying that should be their
responsibility to spend more time in terms of making certain
that investors are educated?
Dr. Morey. I guess education----
Mr. Towns. Are there responsibilities in the law, I should
say?
Dr. Morey. Yes. I think they have responsibility to make
sure that user funds disclose fees completely and accurately,
and also clearly. Now, if that is educating, I would say yes to
that. But I think it can be done very clearly and so on in the
ways that you really do not have to basically, you know, put a
tremendous amount of energy into educating investors. I think
if you put it down in pretty simple language and a very concise
statement, I think that the education of investors really is
not needed as much. It is almost really just disclosing things
in a clear way.
So if that is education, yes. But I do not really see it as
that. I see it as basically putting things down in a very clear
easy to understand sort of method and full disclosure of those
things.
Mr. Towns. What impact can you discern from your research
in terms of the mutual funds scandals had on investors'
confidence in the industry? Was that affected in any way?
Dr. Morey. Yes, I think it initially affected it a lot. I
did effect it. But, I mean, the problem is that, you know, most
people when they are investing money, you know, they are doing
through their pension plans and so on, they do not have that
many other options and they are still investing money back into
mutual funds. So, yes, I think it had a big impact initially
and I think people are more weary of funds. And we have seen
basically more movement toward index funds and things like that
because of the fee structures and so on. But I guess just
because of the very fact that this is what everybody basically
invests in now or whatever does for the most part with their
retirement money.
You know, there is going to be a tremendous amount of money
still invested regardless of the scandal. So I mean, I think it
has been sort of short term to some extent and then over the
longer term, if you will, a lot of that sort of has became a--I
will not say it has fallen into memory or fallen away, but it
is not as prevalent as it was. OK.
Mr. Towns. Consistent with in terms of this morning, every
witness has indicated the fact that the small investors need to
be protected.
Dr. Morey. Yes.
Mr. Towns. What do we do as members of the U.S. Congress to
assist in that, making certain that they are protected?
Dr. Morey. Well, I think, you know again given the
resources of the SEC that, you know, they are in budget
constraints and everything, I think what is most important
again is disclosure. I really do think it comes down to that.
And that since a certain amount of the burden has to be put on
the investors, but investors have a right, the actual right to
have full information about what these funds are doing. And I
cannot emphasize enough that almost the academic research--I
mean some research has found certain things to predict mutual
fund performance better than others, but the one single thing
that really comes across is expenses. Expenses clearly are the
issue. If you are trying to figure out, you know, a high
performing fund and once you figure out the right style that
you want to be in and so on, go to a low expense fund.
And, again, when investors do not have that kind of
information, when they do not really know what the actual
expenses are, it makes it a very hard case to say that, you
know, we are regulating industry correctly.
So I really do believe that given the resource constraints
that what the SEC could be doing is really focusing on
complete, easy to understand disclosure of fees and, you know,
we can talk about some of these other issues. But that would be
the main, main thing I would do. But the burden, to some
extent, in the investor's hands. But still with all----
Mr. Towns. OK.
Mr. Chairman, I am going to yield but I just am going to
make this comment. I do not know whose idea it was to put them
first and then allow the SEC to come last. But I tell you, that
did make a lot of sense.
Mr. Platts. I'm not sure if Commissioner Donaldson would
agree.
Mr. Bogle and Dr. Morey, we greatly appreciate your time
with us today and your efforts in making sure that average
investor is in the driver's seat and not in the rumble seat.
And we are grateful for the knowledge you have shared with us,
and look forward to perhaps having a chance to work with you
again in the future.
Thank you so much.
Mr. Bogle. Thank you very much.
Dr. Morey. Thank you.
Mr. Platts. You are welcome.
We will take a minute or two break while we get to the
final panel, and get started here shortly.
[Recess.]
Mr. Platts. OK. I think we are ready to get started with
our third and final panel. Saved the best for last, right?
If I could ask our two witnesses to stand and I will
administer the oath.
[Witnesses sworn.]
Mr. Platts. The clerk will reflect that both witnesses
responded in the affirmative.
And, Mr. McConnell we will begin with you and then, Mr.
Hillman your opening statement and then save questions for both
of you.
If you would like to begin, Mr. McConnell.
STATEMENT OF JAMES M. MCCONNELL, EXECUTIVE DIRECTOR, U.S.
SECURITIES AND EXCHANGE COMMISSION
Mr. McConnell. Chairman Platts, Ranking Member Towns, thank
you for the opportunity to testify on behalf of Chairman
William Donaldson regarding strategic planning and the
allocation of our recent funding increases.
The SEC experienced unprecedented staffing and budgetary
growth over the last 3 years. And the Nation's investors and in
the industry we oversee need to be assured that we have a
thorough, thoughtful plan employed at this moment. Our 2005
request of $913 million is nearly twice the size of our 2002
budget and demonstrates the strong commitment by this
administration to addressing the many challenges confronting
the agency.
Before I begin, and perhaps a bit uncharacteristically for
a Federal agency, I would like to thank the GAO staff and Rick
Hillman for the work that they have done over the past 2 years
in working with the SEC. Their work and recommendations have
been an asset to the commission and has improved the agency's
operations.
Also, I would respectfully request that in addition to my
complete written statement, a copy of Chairman Donaldson's
recent Congressional testimony on the Commission's efforts to
reform the mutual fund industry be a part of the record.
Mr. Platts. Without objection.
Mr. McConnell. Thank you.
Since last February, the SEC has spent considerable energy
examining and reforming our organizational structure,
operations and our work flow processes. Our goal is to become
more proactive and to better anticipate risk. We need to be
able to respond quickly to our changing environment by seeing
around corners and over hills. Having this ability is vital to
the success of the agency and developing this capacity has been
one of Chairman Donaldson's highest priorities. Right now I
would like to highlight a few of our initiatives in this area.
When the Commission first received its funding increases in
fiscal 2003, we began a comprehensive planning initiative to
determine how best to allocate these funds. Throughout the
process, the chairman's primary concern was that resources be
deployed as effectively and efficiently as possible to maximize
the value to taxpayers and investors alike. To achieve this
objective, the chairman held a rigorous series of meetings with
the heads of the divisions and major offices to review their
mission, environment, goals and strategies. The chairman's
office then initiated top to bottom reviews of the new
organizational structure proposed by the divisions and offices
to incorporate their new staff. These reviews have examined
whether positions are being deployed effectively, are fully
consistent with agency priories and are accompanied by the
appropriate level of supervision.
Now that the initial round of reviews is complete we intend
to use the process as the model for analyzing future division
and office reorganizations, as staff increases.
Risk assessment. As we highlighted in the hearing last July
we have initiated a new risk management program and laid the
groundwork for the Office of Risk Management and Strategic
Planning, the first of its kind at the Commission.
Fundamentally this initiative is instilling a new spirit into
our everyday activities so that we constantly are searching for
new and emerging risks to investors and U.S. financial markets.
We are focusing on anticipatory risk, the most difficult to
assess but the most important type to try and understand.
The first stage of this new effort has been to organize
internal risk teams made up of representatives from each major
program area. When fully staffed, the new office will then work
in coordination with the internal risk team to then apply new
or resurgent forms of fraudulent, illegal or questionable
activities.
In addition to fostering better communication and
coordination with the Commission, the risk assessment
initiative will help us proactively identify existing and
emerging problem areas within our industry and adjust
operations and resources accordingly.
Performance dashboards. As we discussed also during last
year's hearing, the performance dashboards are management
reports designed to present regular snapshots of the divisions'
and offices' progress when we do budget, staffing and
performance objectives. We have been generating dashboards for
the last 7 months and they continue to evolve as divisions and
offices refine their performance measures.
Our dashboards are helping us identify emerging problems.
They reinforce each executive's accountability for their staff,
performance of this initiatives and proactively adjust
operations and resources as necessary.
Strategic planning. The chairman feels strongly that
completing our 5 year strategic plan is critical, not just
because it is required, but also because it embodies our
comprehensive strategy for the next several years. Though the
plan is being completed later than we originally anticipated,
we have taken the time necessary to make sure it is useful for
the agency in a critical time in its history.
In particular, the strategic plan has been substantially
enhanced due to the work I have just outlined in the areas of
organizational review, risk assessment, and performance
dashboards. The draft of the SEC's strategic plan is being
reviewed by the chairman's office. It will soon be voted upon
by the committee.
It was written by a team of senior managers and staff
throughout the agency who actively conferred to their office or
division leadership and interacted with external stakeholders.
You will receive a copy as soon as it is improved, and we
look forward to your feedback.
GAO has stressed the importance of having a strategic plan
upon which to base agency wide resource decisions, and we
strongly concur. While we would have preferred to have a
strategic plan prior to deployment of additional resources and
staff, the environment in which we are operating did not permit
us that luxury. As you can see from my testimony, it has been
necessary for the staff to undertake multiple tasks
concurrently. While our plan has been completed later than
anticipated, the vision, mission and values have guided our
activities for quite some time.
I now want to spend a moment to discuss the SEC's human
capital. Thanks to significant budgetary help from the
President and Congress, the agency received appropriations in
February 2003 for resources needed to hire 842 new employees.
Our accepted service hiring authority, which would not have
become law without the instrumental support of this
subcommittee, was especially important because it allowed us to
put critical staff in place much more quickly than would have
otherwise been possible. Since 2002 we have hired about 770 new
staff, 39 percent attorneys, 22 percent accountants, 22 percent
examiners, and the remaining 15 percent in other positions.
Approximately 107 more will begin working at the SEC by the end
of June. We will then have 403 vacancies remaining, that is
compared to our normal vacancy level of about 150. Of the 403
vacancies, 38 percent are attorneys, 28 percent accountants, 15
percent are examiners and 23 percent represent other positions.
We have refused to hire employees simply to fill chairs,
but rather to focus on hiring the best and most appropriate
people to fulfil our mission and are deployed where each staff
can do the most good. By the end of the year we fully expect
that our hiring efforts will achieve targeted staffing levels.
As GAO has previously identified, we would be better served
by not just focusing on paying more attention to hiring but
also creating a comprehensive work force planning effort to
assure that we reach our human capital goals and objectives. We
have begun to make progress in this area on a variety of
fronts.
For example, the SEC launched the SEC University, an
initiative to redesign and enhance our training and orientation
programs to help staffing managers to better perform their
responsibilities and to keep abreast of industry trends. We
have begun to review the Commission's succession. Our
preliminary findings demonstrate that we are unlikely to face
in significant waves of coming retirements as is the case for
much of the rest of the Federal Government.
We have implemented a new pay-for-performance system
designed to reward job performance based upon employee's
contributions to the Commission's overall mission.
These and other efforts have helped the SEC think and act
proactively in recruiting and retaining the right staff, our
most important asset.
Investments in the SEC's information technology are
critical to help us delve deeper in our investigations and
inspections, improve investors' access to company disclosures,
and otherwise support the Commission's efforts to protect
investors.
The Commission has made progress on a variety of fronts.
Early this year, we hired a new Chief Information Officer to
guide the agency's information technology program. In the short
time since his arrival, our CIO has begun adding staff to
manage a broad range of IT projects and has started to reshape
our capital planning process and he will soon begin building a
new IT strategic plan. This plan will guide the various IT
initiatives we have or will soon have underway including a new
document management system that streamlines case management,
infrastructure architecture, information security enhancements,
and a new design of our disclosure and review process.
For the last 2 years the subcommittee and GAO have raised
important concerns regarding SEC's lack of an updated strategic
plan. We agree with those concerns and that the SEC must deploy
resources efficiency and effectively and respond quickly to the
fast paced environment.
With the initiatives I have mentioned today we have
confidence that we are proceeding down the correct path.
We once again would like to thank the subcommittee for
inviting to me testimony today. These are very important issues
for the Congress and for the Commission.
I look forward to addressing your questions.
[The prepared statement of Mr. McConnell follows:]
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Mr. Platts. Thank you, Mr. McConnell.
Mr. Hillman?.
STATEMENT OF RICHARD HILLMAN, DIRECTOR, FINANCIAL MARKETS AND
COMMUNITY INVESTMENT, U.S. GENERAL ACCOUNTING OFFICE
Mr. Hillman. Thank you very much. I am pleased to be here
today to discuss the Securities and Exchange Commission's
ongoing strategic planning effort and the challenges that it
faces in proactively overseeing the Nation's mutual fund
industry.
As has been discussed in the last 20 years, mutual funds
have grown from under $400 billion to over $7.5 trillion in
assets, and that becomes vital components of a financial
security of more than 95 million American investors estimated
to own them. However, as you know, various allegation of
misconduct and abusive practices involving mutual funds have
recently come to light. As a result insuring that SEC has the
necessary resources and strategic focus to adequately oversee
our nation's mutual fund industry has never been more
important.
My testimony today discusses how the abusive practices
involving mutual funds came to light and SEC's subsequent
responses, SEC's plans for increasing its staffing in the
divisions and offices responsible for overseeing mutual funds
and the progress it has made in developing a strategic plan.
And also challenges that may be affecting SEC's ability to
effectively oversee the industry.
Regarding our first objective and abusive practices in the
mutual fund industry came to light, we found that in late 2003
state authorities were the first to act against various abusive
practices in the mutual fund industry, but since then SEC has
taken swift and vigorous action designed to punish wrongdoers
and better prevent a detected use of practices in the future.
SEC did not identify these abusive practices involving mutual
funds for various reasons.
According to SEC staff many of the cases involving fraud
and collusion among personnel in such activities is very hard
to detect in routine examinations. Also, according to testimony
by the head of SEC office that conducts mutual fund
examinations, SEC examiners did not reveal these practices
because their examinations focused primarily on the operations
of the mutual fund and trading of the funds portfolio security
practices, which are areas we have acknowledged potential for
abuse. As a result, their examinations did not generally
address the trading in the funds own shares.
SEC also faced resource challenges for years that have
affected its ability to conduct oversight in the mutual fund
industry and in other areas. For example, we reported on SEC's
difficulties during the 1990's to keep pace with the growth in
the industry and its inability to examine funds and investment
advisers frequently. In prior testimony the Director of the
SEC's office that conducts examinations noted that prior to
1998 SEC's examinations of mutual fund firms have been as
infrequent as once every 12 to 24 years. However, since these
abuses have come to light, SEC and the National Association of
Security Dealers which oversees the broker dealers that sell
fund shares have acted vigorously to address inappropriate
practices in the mutual fund industry.
For example, SEC has already taken 15 enforcement actions
that involve late trading and inappropriate market timing. SEC
and the National Association of Security Dealers also have
issued at least 9 proposed rules to address abusive practices
in the mutual fund industry. SEC has also taken some actions
that address longstanding concerns over mutual fund practices,
including the lack of transparency of some fund fees and costs
and the potential for conflict of interest in fund distribution
and sales practices.
Regarding our second objective on SEC's staffing decisions
and progress on developing a strategic plan we report that
after experiencing an extended period in which increases in
SEC's workload grew faster than its staffing and other
resources, SEC has received recent budget increases that have
begun to allow it to increase its staffing, including positions
in the divisions and offices with responsibility for mutual
fund regulation oversight and enforcement. However, SEC has
taken these actions without the benefit of an updated strategic
plan to guide their staff deployment and the divisions and
offices with responsibility for mutual funds followed various
steps for determining their staffing needs. In the absence of a
complete and updated strategic plan that identifies its key
mission related goals, we were unable to determine whether
SEC's recent allocation decisions made the best possible use of
its resources. In making these decisions, SEC has obviously
increased staffing in key areas, including providing additional
resources to develop rules, examine participants and pursue
enforcement actions against abusive practices in the mutual
fund industry. However, without a complete and current
strategic plan that outlines the agency's priorities, the
agency lacks a key guide for ensuring that it is deploying its
resources across these areas in the most efficient way to
achieve the most effective outcomes.
Regarding our final objective, we outlined four agency wide
challenges that may be affecting SEC's ability to oversee the
mutual fund industry. These challenges include improving its
ability to head off major problems before they occur by better
anticipating and detecting abuses in the securities industry.
SEC also faces challenges in hiring and retaining all the staff
that it needs to achieve its mission as demands on staff
continue to grow. Moreover, SEC has experienced difficulties in
obtaining the information technology it needs to effectively
oversee the mutual fund industry.
Finally, SEC faces challenges in overcoming impediments and
ability to gather information, cooperate with other law
enforcement authorities and collect moneys owed. Overall, SEC
must effectively address these challenges and each of these are
on their plate to address if they are to successfully restore
and in the long run maintain investor confidence in our
securities markets.
This concludes my prepared statement. I would be pleased to
address any questions.
[The prepared statement of Mr. Hillman follows:]
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Mr. Platts. Thank you, Mr. Hillman. And again thanks for
not just being here today, but your work week in and week out
in your job at GAO especially as it relates to this
subcommittee's focus on the SEC and strategic planning.
Mr. McConnell, I would like to know on the strategic plan,
where we are? Soon to be approved and current, what timeframe
are we talking about? A week or two or a month, and obviously
we are interested to see the plan and have an idea of the
Commission's strategy going forward?
Mr. McConnell. Well, we're nearly finished, and we
appreciate the indulgence of the subcommittee during this
process. We talked with you about it last summer and we have
discussed with you throughout the process, and it has been a
long process and we appreciate that.
The plan right now is in the chairman's office for final
review before going to the Commission. Then it must go through
a vote. It must be voted on by the five members. That will be
done seriatim, which takes several weeks. So I'm hoping that
next month is what we are looking at to get it to you. And then
we will hope to get your feedback, because no one has really
seen it.
And this process was not simply just updating our previous
strategic plan. As Chairman Donaldson said when he viewed the
first plan, ``This is a nice job but it is not my job.`` His
strategic planning ideas were substantially different. So we
essentially went back to scratch in developing this plan. And
the process we used was actually, it's a major institutional
change and that institutional change is on going and it is tied
up with the risk assessment, the organizational reviews. So all
of that was being done at the same time. And I think the
synergy that was created has helped all of those efforts.
So, hopefully in a month.
Mr. Platts. We are hoping, too.
Mr. McConnell. Yes, sir.
Mr. Platts. As we did talk last summer, and then we were
talking in the fall, by the end of the year. We are now in
April, and we are talking May. And it is not just kind of an
issue over and over, but as chairman and Mr. Towns, and both
sides' staff share the view of GAO, every month's delay just
means more decisions that you need to make. And we acknowledge
that you cannot sit back and not anything while you are putting
this together.
Mr. McConnell. Right.
Mr. Platts. But the delay in that strategic plan being
finalized, means you are having to make daily decisions and
allocations of resources and hiring decisions that are not
fully based on the big picture but on a more piecemeal
approach.
Mr. McConnell. Yes.
Mr. Platts. And we need to get to that big picture. So we
certainly hope--and I say that recognizing I always believe it
is better to do a thorough and deliberate job and have a good
product than to rush something and have a product that you
really don't use. So by your being thorough and deliberate,
hopefully that means all the more embraced the final will be
and the better it will guide the Commission and all the staff.
In your comment you said one thing that relates to my
followup questions, you said you are anxious to share with us
and GAO, and I believe that because no one has really seen it.
Mr. McConnell. That is correct.
Mr. Platts. What type of outreach has the Commission
engaged in to GAO, to individuals in the industry, to academia
to generate feedback in the drafting of it?
Mr. McConnell. Right.
Mr. Platts. I understand that there has been extensive
dialog within the Commission, with the staff, but how about
outside the SEC?
Mr. McConnell. There has a major outreach effort. And it
has been associated also with our risk assessment effort. We
have called in people with everything from a brown bag lunch to
sort of talking about what is keeping you awake at night----
Mr. Platts. People from outside the agency?
Mr. McConnell. From outside the agency, yes.
Mr. Platts. OK.
Mr. McConnell. And Mr. Bogle has been one of them.
Mr. Platts. Right.
Mr. McConnell. And we will continue to do that to going to
the industry, and to the groups that represent major portions
of the industry. We have had a lot of interactions with the
industry.
It has been in the mode of really gathering information at
this point. Of course, in the dialog that occurs they
understand the directions we're proceeding, so you get that
kind of interaction; that is good. And we are, frankly, we are
eager to see what your coments are, we want a lot of comments
coming back because this is a new document. It has not been
seen before. And we are eager for the comments from this
subcommittee and from our stakeholders as to how it has all
been put together. And we think the process has been good. We
think what we put together is quite good, but let's get the
very hard reaction.
Mr. Platts. And I appreciate you wanting that feedback, but
I want to make sure what you are going to release and vote on
is the final strategic plan?
Mr. McConnell. That is correct. It is final.
Mr. Platts. And so in a sense it seems that at that point
you will get feedback but on a final plan as opposed to a
draft. And I am glad to hear Mr. Bogle and others have been
included.
How close are you with GAO? I know there is a good
interaction there, and I appreciate your comment up front that
you are grateful for that interaction, but on the specifics of
the plan what efforts have been taken by SEC with GAO?
Mr. McConnell. Well, I will let Rick speak for himself, but
we have shared a good bit with GAO in the process in all of
these efforts. And I think he has seen some draft executive
summaries, as I recall.
Mr. Hillman. Yes. We have been given a draft outline of
their strategic plan which tends to outline the broad goals of
the organization and all the relevant information about how
they intend to achieve them. And that is consistent with the
activity that we have had with the departments and agencies
across the Federal Government in that regard.
Mr. McConnell. OK. One thing I would like to add is that
the chairman does not view this at all as a 5-year plan, to
drop it run. I mean, he thinks this is going to be updated and
it is a year-to-year process. And, of course, we report on it
yearly and there is a rigorous requirement associated with how
you follow through on these plans.
Mr. Platts. Hand-in-hand with the strategic plan is the
resource management. Your strategic plan is going to help
allocate where you put the resources including your human
capital, but it is also that you need to have it there.
Mr. McConnell. Correct.
Mr. Platts. You mentioned in your testimony another 107 by
the end of June. Those are people in the pipeline?
Mr. McConnell. We actually have names associated with
people who have agreed, who have made commitments to come on.
So those are hard numbers.
Mr. Platts. And then about 403, about almost three times
the norm that will still be vacant?
Mr. McConnell. That is correct.
Mr. Platts. Is there a timeframe for when you think you
would get to that 150 benchmark, you know----
Mr. McConnell. The end of the fiscal year is when we intend
to achieve that target level. And you are right, there will be
150 vacancies probably at the end of the year. That is right.
We build that into our plans, that is part of our budgeting,
our FTE costs are associated with that kind of a vancany rate.
Mr. Platts. Is there a concern with another 250 by
September 30th, roughly, so in the final 3 months of the fiscal
year? You said some feedback of--I mean that might be wishful
thinking just because we appreciate your being thorough and
wanting not to just fill seats but to get good people in those
slots.
Mr. McConnell. Yes.
Mr. Platts. And that there is such competition because of
Sarbanes-Oxley and what the industry is demanding to be----
Mr. McConnell. Right.
Mr. Platts. Are you pretty certain or is it, you know, what
your goal is but how realistic a goal?
Mr. McConnell. We think it is realistic. We have actually--
the competition you are talking about mainly deals with
accountants and that is where the Sarbanes-Oxley competition
occurs and where the competition with the PCAOB and with ever
major public accounting firm in the country. You are all hiring
accountants and many are the same ones that we are hiring. But
we have, I think there are about 27 percent left, to hear.
We have been using the services of an outside selection
firm for that. The pipeline has gotten pretty good. We have a
good size pipeline now of quality applications, and we have
instituted procedures in place where we are bringing on 30, 40,
50 a month. So I think we will make it.
Attorneys, we have had the competition. That has been more
of an accommodation on our part; how quickly and how effective
we can bring them in, bring them in to new places, into new
areas and how to build the organization properly.
Mr. Platts. Right.
Mr. McConnell. And we have never really had problems with
attracting attorneys.
Examiners, similarly. We have not had problems attracting
examiners. We are pretty well fully staffed up in that area.
And there we are just dealing with sort of normal attrition.
Mr. Platts. Well, and I do appreciate and I am sure
Chairman Davis appreciates the way you have embraced the
additional flexibility in the human capital side to retain and
recruit and using the resources being given to you effectively.
You're probably making a case for that type of flexibility
elsewhere in the Federal Government as well. I am sure we and
others will be watching that process.
Mr. McConnell. We have lots of attention. Lots of
attention.
Mr. Platts. I yield to Mr. Towns.
Mr. Towns. Thank you very much, Mr. Chairman.
Mr. Hillman, the SEC seems to be having difficulty
attracting, as we just finished talking about, talented and
adequately skilled individuals for professional staff. And, of
course, Congress as we have talked about here, we increased the
agency flexibility in hiring and setting pay. Is this enough to
attract the necessary qualified staff do you believe? Do you
think this is adequate?
Mr. Hillman. One of the major impediments, as Mr. McConnell
just described, is their inability to really bring on topnotch
accountants into the organization. And Congress has provided
relief to the SEC last summer to better position themselves to
complete their recruitment process in a more expeditious
fashion so that they can attract and obtain quality
accountants. And that is a problem the SEC will continue to
face because really, in the Washington, DC, area with the
Public Company Accounting Oversight Board also attempting to
attract accountants to fill their ranks, and with these major
big four CPA firms changing over as a result of the financial
scandals, doing more detailed audits of new clients, they're
clamoring for additional accountants as well. It is just a
vicious market out there right and SEC is trying to complete
the best that they can.
Mr. Towns. Right. But is it not also a problem of retaining
as well? They say if you recruit one, you hire one and another
leaves; and then at the end of the day you are at the same
level. So I am thinking that maybe you might want to become
creative by saying that after 3 years, after 5 years of being
employed by this agency, a bonus of some sort would be given.
I mean, you cannot continue to do business as usual
expecting a different result.
Mr. Hillman. Very interesting insight.
Mr. McConnell. You are absolutely right. And creativity is
needed in a lot of front, and we are adding benefits and we are
looking at various ways to maximize the authorities that we
have been given. And we are also looking at a different way to
deal with the work force.
Perhaps all of these accountants do not need to be in
Washington. There is lots of technology that's on the cusp or
already here that would allow us to have, perhaps, remote
locations where there probably is not this cutthroat
competition for accountants.
So we appreciate that concern. It is on our minds a lot,
and you are right there are creative things that have to be
done, and this chairman is prepared to do them.
Mr. Towns. Right. I thank you.
Mr. Hillman, can you cite for us any specific area that SEC
is lacking legal authority to adequately pursue mutual fund
industry investigations or general oversight? Is there any area
that you feel that the Congress should look at to see in terms
of what changes to be made in order to make it possible for
them to carry out their mission?
Mr. Hillman. We have looked at this issue, and our
Comptroller General has testified before the Senate Banking
Committee on March 10th that many of the actions that need to
be addressed to cover the abuses that have occurred in the
mutual fund industry SEC is well positioned to do. But there
are a couple of areas. In particular looking at an issue
referred to as ``soft dollars'' in the mutual fund industries
where commissions that investors pay to buy and sell their
shares, more visibility associated with what those commissions
are paying for we think are needed.
The soft dollar issue refers to a practice where these
commissions not only pay for the trades that occur, according
to investors' wishes, but also research and other services are
being provided to the fund. We in the General Accounting Office
believe that there is not adequate disclosure of those
additional costs associated with research and other services
that are being provided, and in some instances that is going to
require Congress to step in and evaluate what is referred to as
a safe harbor that Congress established in ensuring that the
commissions and these research services are being provided.
Mr. Towns. All right. Thank you.
Let me just make certain, Mr. McConnell, that I understand
how this process works in terms of the plan. Are you saying
that you send the plan out, you know, to the various
Commissioners and then they look at it and vote on it? I mean,
is that----
Mr. McConnell. That is correct. They have to vote on it.
It's a Commission vote.
Mr. Towns. I understand that, but I mean it is not a
situation where there is a meeting and that each member votes
at a time, rather then you send it to Chicago, you send it--I
mean, I want to make sure that I understand that process.
Mr. McConnell. Yes, sir.
All the Commissioners, it's just the five Commissioners
that have to vote. They are all in Washington.
Mr. Towns. I understand that.
Mr. McConnell. So we will probably not convene a meeting
where the plan is presented and they vote at one time. It is a
process we use quite frequently for reports, official
Commission documents and rulemakings where each Commissioner's
office is provided the entire document and background, are
giving briefings as they want for the process. They deliberate
and then they vote by just signing a document saying my vote is
in the affirmative or this release.
There are two basic processes for making SEC actions. One
is an open meeting where they all sit at a dias and actually
vote there, or this other more deliberative--it is a slower
process, frankly, but it is our seriatim process.
Mr. Towns. It would seem to me--I mean here again I guess
this is on another subject. But it would seem to me something
as important as this that they would all come together in the
same room and vote and make a decision, you know. I just sort
of problems in terms of my own mind----
Mr. McConnell. Yes.
Mr. Towns [continuing]. That it would be done, you know,
and I hate to use the word ``haphazard'' but I must say that I
just have problems with them not coming and doing this and
having dialog and then fashion their vote on an issue as
important, and one that we waited so long to receive.
Mr. McConnell. I do not want to give the subcommittee the
opinion that the one process is any less deliberative or
important than the other. I mean, clearly the seriatim process
is used for some of the most important actions the Commission
takes. It just really depends on the way the chairman wants to
do it, schedules of the other Commissioners and it is the
process that they want to choose.
Any Commissioner, at anytime can call for a meeting if they
do not choose to use the seriatim process. But they generally
like to do it this way. It allows them more time for review, it
is going to be over 70 pages, plus a lot of background and they
will go through it, their staffs will go through it, I will get
called into their office, Peter Derby will get called into
their office to explain things. So it allows for a lot of
iterations.
Mr. Towns. Yes.
Mr. McConnell. And explanation.
Mr. Towns. Yes. I understand all that, but I just think
that something of this magnitude, you know--but anyway, I mean
that is----
Mr. McConnell. I will let them know that.
Mr. Towns. Yes, please do.
Mr. McConnell. I will certainly express your concerns with
Chairman Donaldson.
Mr. Towns. Yes, especially I mean it would seem to me it
would be a situation where you would come together.
Mr. McConnell. Right.
Mr. Towns. And there would be dialog and then you pass it
on.
I think the question was raised earlier in terms of who did
you talk to sort of outside to be able to work, get information
input for the plan. I asked the Attorney General did you talk
to him, and of course he sort of did not quite give me a
straight answer on that one. But I want to know who did you
talk to on the outside world, you know, people that were former
Commissioners or actually in terms of--even chief of staffs did
you talk to. I mean, in terms of putting together this plan?
Mr. McConnell. Well, there has been--I mean, I could
probably give you the actual lists at some point, but I will
give you a general idea.
Mr. Towns. Just a general idea. You do not have to----
Mr. McConnell. There has been a lot of interaction, and it
has included the former staff members, former members of the
Commission, and then those groups; the ABA, you know, those
groups that you traditionally go to that either represent
segments of the industry or segments of the bar. And then we
have called in people on sort of an informal basis where it is
off the record; let us have lunch, sit around with four or five
people and talk about things like just what is on your mind,
what is troubling you, what keeps you awake at night with
respect to the industry. And trying to get as much of that in a
really non-threatening environment.
We always have to appreciate that everybody has an agenda
at times, but gathering that kind of information and having
open discussions. And that way sort of get an idea as to where
we are going and we get an idea as to what they see are
problems we should be addressing. And that is a lot of people
from all across, and that is an ongoing effort. And we are
building that into our risk assessment, the strategic planning
office will keep undertaking that.
And academics. I mean, we have a strong academic program in
our office of economic analyses. And they call in academic and
review papers. We need to do more of it. And our notion is we
have to do better at anticipating, at being proactive. We do
not really disagree, I do not think, with almost anything that
has been said during this hearing in terms of that need.
Mr. Towns. Do you have the technology to address these
issues?
Mr. McConnell. We are getting the technology. As you know,
we have had a major increase in our technology budget. It went
from $40 million to over $100 dollars.
Talk about a tough time hiring somebody, we had a really
hard time getting a CIO. That person came on board in January.
He is putting together the strategic plan review. We have a
number of major efforts already underway however. With document
management, we have an initiative to enhance substantially our
disclosure program, to take advantage of technology, data
tagging to make it easier for both our staff and mainly
investors to understand what is in these documents that are
filed with the SEC.
Our enterprise architecture is being examined and our
security. Our security program.
Mr. Towns. I yield back to the chairman.
Thank you.
Mr. Platts. Thank you, Mr. Towns.
I want to followup on the plan approval process. And while
it is a requirement under GPRA not just for SEC, but other
departments and agencies also. It is a little different here
because you're a regulatory agency.
Mr. McConnell. Right.
Mr. Platts. And with a board of five that do actually vote
on approval of this. This is different than a department, where
there is not that formal public vote and approval.
Given that, and this is kind of expanding on Mr. Towns' and
my questioning--in some ways it seems that this should be a
different process where while you have had a lot of input from
outside the Commission, it is from those who you have invited
input from as opposed to, perhaps, some who would like to
provide input but were not invited. It seems like analogous to
a local municipal authority or a local municipality having a
plan that we are going to take a formal vote on and we are
going to have a public hearing on it so it is out there
publicly before the vote so that all who want to have input in
writing, you know, or in person can have some input, not just
those who you invited. Was that something that was considered
by the Commissio--to actually share this in a public sense
prior to the vote to generate feedback?
Mr. McConnell. Not to my--no, it has not been.
Mr. Platts. And on the one hand I would like to urge that,
but I know that if I urge it it also would delay it longer. And
at this point I am not sure what is the best approach. I think
getting done and then we can always--but, you know, it is
something that given that is a 5-year with doing an annual
approach----
Mr. McConnell. Right.
Mr. Platts. And it is a work in progress that hopefully
will always be a work in progress to adjust to the mark that is
different challenges. I think that is something that is
considered perhaps in the future.
I also, though, as far as approving it, a simple majority;
three out of the five approves the plan?
Mr. McConnell. Yes. Right.
Mr. Platts. OK. It is just a different setting than a
typical agency.
Mr. McConnell. It is.
Mr. Platts. In the fact that there is a public vote. And
coming out of the State house, under State law you would be
required to have a hearing and allow public input before you
could vote.
Mr. McConnell. I will certainly take your concerns back to
the chairman.
Mr. Platts. Yes. Because I appreciate you seeking the
input, but sometimes human nature is we seek input from those
who have close relationship with.
Mr. McConnell. Right.
Mr. Platts. And not get input from others who maybe we do
not have a close relationship with, but would bring some
valuable knowledge to the table.
Mr. McConnell. Understand. Sunshine and full disclosure is
what we are about.
Mr. Platts. Yes.
One of the recommendations of Mr. Bogle is the kind of
comprehensive economic study of mutual funds. And the mutual
fund, while it is not the focus of this hearing, it is kind of
a case study of----
Mr. McConnell. Right.
Mr. Platts [continuing]. The importance of resource
management and why we kind of push for the strategic plan and
that big picture approach.
What would be your thoughts on the approach Mr. Bogle
suggested?
Mr. McConnell. Well, I cannot comment on that specific
approach as something that maybe the Commission would adopt or
not adopt. But we are certainly envisioning that type of
activity as part of this office of risk assessment and
strategic planning.
The office itself will be constructed or consist of five
people; a director and four or five key staff, some of whom may
be academics come in on loan. They will also have the resources
available to undertake major studies. That could be one of
them. I cannot speak for the Commissioners as to whether it
would be or not. But it certainly that type of activity is
envisioned in this approach.
Mr. Platts. And I think it helpful with your hearing not
just from Mr. Bogle and his push----
Mr. McConnell. Right.
Mr. Platts [continuing]. But hearing from the other side,
the Attorney General, somebody who has been regulated as well
as law enforcement. I would hope that it is something that is
given close scrutiny----
Mr. McConnell. As a private citizen it sounds like a pretty
good idea. Again, that is----
Mr. Platts. And continuing on the allocation issue
regarding mutual funds and, Mr. Hillman, you certainly have
watched this closely and with the reorganization, although we
have seen reorganizations prior to the strategic plan being
completed based on the necessity of a new board and put more
manpower into the mutual fund oversight, what is GAO's
assessment at this point of resources that have been allocated?
Do you believe they are sufficient and you are going to be able
to meet the challenge that come forward through the Attorney
General and other efforts?
Mr. Hillman. We think that the allocations the SEC has made
are certainly consistent with what the Sarbanes-Oxley Act
required it to do in ratching up the oversight attention to
filings that come in from corporation to make sure there are
not continuation of scandals and corporate accounting problems.
And the ratching up of the enforcement division and their
office of examination are all certainly components that they
need to provide attention to.
I guess from the General Accounting Office's standpoint,
what we are looking for and hoping to see is some assurances
from the strategic planning process and a human capital
planning process that SEC indeed does have all the resources
that it believes it needs in order to effectively oversee the
securities industry. What we have seen so far to date is that
resources that Congress has been able to provide it equated to
about 842 positions. They are asking in their recent request
for fiscal year 2005 an additional 106 positions.
What we are hoping to see is that there is some sort of an
analysis to say with these resources we feel we are going to be
able to be out in front as to what these issues are expecting
to be over the next 5 years, and effective would be able to be
proactive as opposed to reactive.
Over the years SEC has not had the resources it has needed
to oversee the industry, and as a result has had to perhaps
call back upon some of its goals it has had out there. For
example, in the recent issue with Sarbanes-Oxley, SEC has not
been able to review all the filings that it needs to review on
a timely basis and as a result, it had not reviewed the filings
that had come in from Enron and Global Crossing to be able to
detect and deter these types of activities.
And with these additional resources now Congress made it in
law a requirement that they review all filings over a 3-year
period of time. Well, 5 years hence that was an SEC goal, but
they were not able to achieve that because of resource
limitations.
Bringing it back up to date here in the mutual fund
industry, you are looking at the Office of Examinations. They
have come up with what we believe seems to be a very realistic
target of looking at the top mutual fund complexes or on a more
frequent level, perhaps every couple of years and ensuring that
all complexes overall get looked at over a 4-year basis.
With this mutual fund industry crises and the scandals that
have occurred, though, however there are now additional
examination steps that must be performed in order to ensure
that the industry is safe. The director of that office is
concerned at the moment as to whether or not they have enough
resources to do all that they need to do to oversee these fund
complexes with these now additional responsibilities that are
being placed on them and each of their routine examinations.
We would like the SEC to be able to say OK, in order to do
what it needs to do, these are the resources that it needs and
to let Congress decide if they cannot fund those because of
other competing priorities in the Nation, to make that known.
But at this moment without a strategic plan, without an
analyses review and capital planning standpoint of their
expertise and resource levels, it is difficult to say to what
extent they are able to achieve their goals.
Mr. Platts. We are kind of assuming from us outside the
Commission that request for 100 plus more in the 2005 budget
request fits in to what the Commission envisioned approving its
strategic plan. We have not seen it, we do not know that. I
assume once we see it, it will maybe jive, you know, that we
need additional positions and here is why. I mean, that is kind
of what you are getting at this point we are making that
assumption and thinking as a given that additional requests are
going to match up with their vision in that strategic plan, but
we really do not know that.
It really goes to--what you touched on--that the SEC
actually envisioned doing those regular reviews, but did not
have the resources. And I do not have a base knowledge myself
in the 1990's coming into office in 2001, what was the message
coming from this. Publicly, Congress at large, you know we kind
of looked at the SEC as a rainmaker because it was generating
billions of fees and getting a smaller and smaller percentage.
Were the SEC Commissioners, the chairman, you know, crying
uncle and saying hey, you know, we are getting overwhelmed and
Congress was ignoring it or was it just an acceptance and hey,
this is what we do and this is the way to do it.
Mr. McConnell. Well, I think we certainly are bringing the
attention to whomever we could that the mutual fund industry
was growing dramatically and needed fundamental changes. Some
fundamental changes did occur. I mean, we changed the whole
regulatory scheme back in the 1990's so that the small
investment advisers that were not holding assets were no longer
under our review. I mean, we knew we simply could not do it, so
we changed the population and changed the regulatory scheme by
which--so that was one major effort. We thought by doing that
we would be able to get back to a more--and at that time we
had, I think as Mr. Hillman indicated, a review cycle of 20 or
30 years if you just divided it up and the number staff we had.
And we have always wanted to get back to somewhere a 2 or 4 or
5 year process, depending on risk associated with that. So we
thought we had that worked out, but things continued to grow
and it is just that we are constantly playing catch up.
The last few years----
Mr. Platts. The worry is that you are playing catch up.
Mr. McConnell. Right.
Mr. Platts. Is that now we are playing catch up to the
mutual fund issue. You know, Sarbanes-Oxley has been enforced.
We already play catch up on a corporate governance, on
disclosure. Two years from now I am hoping that we are not
going to be saying now we are playing catch up on something
else that came forward because we were not proactive.
Mr. McConnell. Right.
Mr. Platts. We are continuing to be reactive.
Mr. McConnell. I cannot judge that we will have the
resources, but this chairman is guaranteeing that he is going
to let people know what we need. And that is what this is all
about.
Mr. Platts. And that is exactly what I mean. It is
important that----
Mr. McConnell. That is right. That is what this all about.
Mr. Platts. And, you know, soft peddling.
Mr. McConnell. And if we do not get the resources,
everybody knows it and it is the decision that has been made.
Mr. Platts. Here is what we need to do and here is what we
need to be able to do that.
Mr. McConnell. Exactly.
Mr. Platts. And then if Congress does not deliver, the onus
is on us.
Mr. McConnell. Congress has to make the choices.
Mr. Platts. Yes. Correct.
Actually, Mr. Towns, do you have any questions?
Mr. Towns. No. I am fine.
Mr. Platts. OK. On the office of risk assessment program,
you made the accommodation and come to the internal themes.
Again, what type timeframe are you envisioning there? Again, in
the next month or two? Is that in the next fiscal year?
Mr. McConnell. The whole risk assessment program that we
are putting in place has three major components, one of which
are these risk assessment teams that are basically--we started
those.
Mr. Platts. Right.
Mr. McConnell. They are in operation.
Mr. Platts. And so they are doing risk--now.
Mr. McConnell. They are risk mapping through the entire
agency on a program-by-program basis.
Mr. Platts. OK.
Mr. McConnell. Building through the raw data.
We also have part of it as embedded risk assessment staff
in each of the divisions and major offices. That is underway.
Those people are being hired. They will be in the division but
have a dual reporting capacity. The key is to get this final
five person office set up and then it all comes together. That
we are still struggling with finding the right person to be the
director. That has been a challenge.
We have been close a few times with some people. The kind
of people we are looking at for that job make a lot of money.
And they are highly sought out by lots of people, lots of
organizations. And we think we have a very attractive----
Mr. Platts. Did you mention it to Bogle today that you have
that--he seems like he would be a pretty good match.
Mr. McConnell. Maybe so. We will talk to him afterward. But
those are the kinds of people----
Mr. Platts. Yes. And you made it through that. Is the use
of that more than doubling the technology, can you tell us how
you are looking at using data mining, you know technology to
compliment the human capital, to really stretch the human
capital farther through technology?
Mr. McConnell. We are really excited about those
possibilities. Because, I mean, that is the way in which you
make your resources that you have work, especially in an
information rich industry like we have. I mean, there is just
lots and lots of available information.
We are starting some initiatives. We are starting two
underway now, one of which deals with mutual funds, not
surprisingly, we want to start getting a handle on that. And
the other is on full disclosure data, some more information on
data ragging.
But we have brought in a whole new data base search engine,
autonomy, that we hope to be able to maximize so that we have
data from all different sources; from enforcement cases, from
you know appropriate dealers and investment advisers have data
on people and firms that we could mind, so we want to be there.
I think we see the promise and the future of that.
Mr. Platts. And your comment on the risk assessment office,
the idea of bringing academics in and Dr. Morey is not here to
defend himself, but----
Mr. McConnell. He can sign up, too, is that what you are
saying?
Mr. Platts. Well, but I was going to say also because
sometimes in the outside academic world because you are focused
on the day-to-day, just keeping everything in place--you do not
have the time to sit back and take anymore analytical
assessment.
Mr. McConnell. That is right.
Mr. Platts. And the academic communities can do that. His
study on the window dressing issues for instance----
Mr. McConnell. Right.
Mr. Platts [continuing]. It is kind of like the type of
thing the SEC should be doing.
Mr. McConnell. Yes.
Mr. Platts. And you mentioned that you are looking
including some of the academic community, perhaps visiting
members of that office on loan or something----
Mr. McConnell. That is correct.
Mr. Platts. I think it could be helpful.
What type of outreach and specifically using the example of
the window dressing, you know he referenced there has not been
one formal investigation done. Given what he is showing, it
seems that there would be a natural reaction that this is not a
scandal but something that has been put on our plate, our radar
that we need to look at. But unless I am not aware of it, there
has not been any followup by the Commission on that specific
issue.
Mr. McConnell. I am not aware of any either. I will
certainly check with the enforcement division. But whether they
do it or not----
Mr. Platts. And again when I to talk to the reporter about
today's hearing it comes back around to the importance of the
strategic plan because----
Mr. McConnell. That is right.
Mr. Platts [continuing]. To do that it has to be not a
piecemeal decision again, but what are our total resources.
Mr. McConnell. Exactly.
Mr. Platts. So what can we put on that type of
administration. And it really goes back to the importance of
that big picture being enclosed.
Mr. McConnell. That is one of the risks that you put on the
table with all the other risks.
Mr. Platts. Right.
Mr. McConnell. And then you look at which ones are the ones
you need to go after. You make a decision as to why you do not
go after this one, and you go after this one. And everybody
knows.
Mr. Platts. And it is a question at a future hearing. I
will probably say where are we today on that window dressing
investigation. Have we done that, and if not was it because an
evaluation was made? I will understand. But a likely followup.
Mr. McConnell. Right. When would that be?
Mr. Platts. The following week. You know, I say that
joking, but seriously it is--you know, you are partnering in
your opening comment about GAO and that partnership and our
subcommittee and our efforts is to, not to play gotcha, but to
keep pushing everybody.
Mr. McConnell. We appreciate that. We really do.
Mr. Platts. OK.
Mr. McConnell. And that is the way we have operated with
your staff in a constructive----
Mr. Platts. And I say, for example, including us. Because
if you lay out here is the challenge for SEC in today's market
environment and here is what we need and here is what we do not
have to meet that need, then if Congress does not deliver, that
it is pushing up. And that is why you need to be outspoken and
be vocal. Those 91, 95 million investors out there, it is
critical to their long term economic security that we are
proactive, all of us.
Mr. McConnell. I agree.
Mr. Towns. Yes. I just want to add that, you know, the fact
that there is no plan and the fact that you have all these
vacancies and you have to realize that at some point people
begin to question. And I think that--and that if you have the
slots and you do not fill them--you know in Washington if you
do not use them, you lose them. I mean, that has been a
longstanding concept. So I do not know in terms of what you
need to do, but I think that being there is this need, you need
to try to find a way to begin to go out and get people. And you
might have to do some things within your own shop to be able to
get them and to train them, whatever it needs to be done, you
know, you need to just reach out and do that. Because, you
know, to have the money and to say that we do not have the
resources which means in terms of the people, I mean at some
point people begin to question that.
So I want you to know, I will be honest with you, as close
as I have been to this issue I have problems, you know,
understanding that part. Knowing that I know it is a difficult
time to get accountants because I know all that kind of stuff.
Mr. McConnell. Right.
Mr. Towns. But the point is that there must be a way that
you can bring them in, because they are out there in some form
or fashion.
Mr. McConnell. Right. I agree.
Mr. Towns. I give back.
Mr. Platts. Thank you, Commissioner Towns.
Mr. Hillman and Mr. McConnell, we again appreciate your
participation here today as you try to partner and go forward
and push for all of us to in the end look out for the
investors. And I use my mom who today, keeps a close eye on her
retirement investments.
Mr. McConnell. Right.
Mr. Platts. And how those mutual funds are doing. And, that
is just a dramatic change in the Nation today versus the 5, 10,
15 years ago. And so the work you are doing is critically
important.
And I certainly do echo Mr. Bogle's comments. We salute you
and all of the SEC for your diligence. While we are going to
keep pushing you, we also respect your hard work and efforts
you have put forth for all our investors--I had better stop
talking.
So, Mr. Hillman, you as well and GAO and the partnering.
And with regard to committee staff I wanted to commend both
staff on both sides for assistance in putting today's field
hearing. And again, for arranging for us to be here at Pace
University, to Pace University for hosting us. It worked out
great.
We will keep the record open for 2 weeks for any additional
submissions, otherwise this hearing stands adjourned.
Thank you.
[Whereupon, at 1:37 p.m., the subcommittee was adjourned.]