[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

                              ----------                              
                                                                   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.]

                                 
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