[Senate Hearing 109-969]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 109-969
 
                 A REVIEW OF CURRENT SECURITIES ISSUES 
=======================================================================
                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                                   ON

    EXAMINATION OF CURRENT SECURITIES ISSUES, FOCUSING ON IMPROVING 
             FINANCIAL DISCLOSURE FOR INDIVIDUAL INVESTORS

                               __________

                             APRIL 25, 2006

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah              PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming             TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska                JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania          CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky                EVAN BAYH, Indiana
MIKE CRAPO, Idaho                    THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire        DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina       ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida

             Kathleen L. Casey, Staff Director and Counsel

     Steven B. Harris, Democratic Staff Director and Chief Counsel

                         Mark Oesterle, Counsel

                          Justin Daly, Counsel

                 Dean V. Shahinian, Democratic Counsel

             Alex Sternhell, Democratic Professional Staff

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)















                            C O N T E N T S

                              ----------                              

                        TUESDAY, APRIL 25, 2006

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Sarbanes.............................................     2
    Senator Hagel................................................     3
    Senator Dodd.................................................     3
    Senator Bunning..............................................     4
        Prepared statement.......................................    38
    Senator Sununu...............................................     4
    Senator Allard...............................................     5
    Senator Carper...............................................    21
    Senator Bennett..............................................    25
    Senator Crapo................................................    32
    Senator Stabenow.............................................    38

                                WITNESS

Christopher Cox, Chairman, U.S. Securities and Exchange 
  Commission.....................................................     5
    Prepared statement...........................................    39
    Response to written questions of:
        Senator Crapo............................................    45
        Senator Enzi.............................................    46
        Senator Santorum.........................................    47
        Senator Stabenow.........................................    48

                                 (iii)


                 A REVIEW OF CURRENT SECURITIES ISSUES

                              ----------                              


                        TUESDAY, APRIL 25, 2006

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:08 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Richard C. Shelby (Chairman of 
the Committee) presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    Today, the Banking Committee continues its review of the 
regulatory landscape in the securities markets. I would like to 
welcome back Chairman Christopher Cox, returning to the 
Committee for the first time since being confirmed to lead the 
Securities and Exchange Commission.
    Chairman Cox's appearance this morning will provide the 
Committee an opportunity to learn more about his ambitious 
investor protector agenda at the SEC. I commend the Chairman 
for making vigorous enforcement of securities laws his top 
priority. Investor confidence in the fairness and the integrity 
of U.S. markets simply would not exist without an aggressive 
and relentless pursuit of wrongdoers. Chairman Cox's 
initiatives to improve the quality and usefulness of 
information and corporate disclosure will also benefit 
investors and the markets.
    For example, his efforts to enhance the transparency of 
executive compensation will allow shareholders to compare in a 
meaningful way the total pay packages awarded to corporate 
management. Similarly, his technology-driven proposals 
promoting electronic delivery of proxy materials and the use of 
interactive data will empower shareholders to make better 
informed investment decisions.
    Last month, the Committee held hearings on two important 
issues affecting investors and capital markets. The Committee's 
hearing on credit rating agencies demonstrated that 
Congressional reform of this self-regulated industry is long 
overdue. I was pleased to learn that a virtual consensus exists 
on the need to promote competition, address embedded and 
pervasive conflicts of interest, and establish regulatory 
oversight. I intend to continue working with Senator Sarbanes 
and other Members of the Committee in the coming months on a 
legislative solution to this longstanding problem.
    The other recent Committee hearing examined the state of 
self-regulation in the securities markets. The most important 
development in SRO area is the conversion by each of the two 
major U.S. markets to for-profit, shareholder-owned 
corporations. The New York Stock Exchange's unprecedented 
decision to make its regulatory apparatus a wholly owned 
subsidiary of the for-profit parent company, has generated 
substantial controversy. Almost all of the Committee's 
witnesses, representing a diverse group of market participants, 
questioned whether the fiduciary obligations to maximize 
shareholders' profits and the statutory obligations to oversee 
the exchange's customers and competitors could both be 
satisfied.
    Along with rating agencies and SRO's, the Committee intends 
to review hedge funds, pension accounting, and other securities 
issues this year. I anticipate a wide-ranging discussion this 
morning on some of these matters.
    Chairman Cox, again we thank you for your appearance today. 
We thank you for your service to the country, and we look 
forward to your testimony.
    Senator Sarbanes.

             STATEMENT OF SENATOR PAUL S. SARBANES

    Senator Sarbanes. Thank you very much, Chairman Shelby. 
This is another instance of the Committee continuing to perform 
its important role of overseeing the regulators and the 
important issues under our jurisdiction.
    I join the Chairman in welcoming Chairman Cox, the 28th 
Chairman of the Commission, back before the Committee, I think 
the first time since we did the confirmation. Already he has 
worked to improve the disclosure of executive compensation, to 
streamline accounting rules, and to enhance the usefulness of 
data filed with the SEC through XBRL.
    The Baltimore Sun, in an article, said, ``SEC Chief seeks 
data to empower tiny investor,'' and went on to note that it 
also should vastly improve the analysis of firms by 
professionals in the field.
    The Chairman has met with other regulators to address 
issues raised by the CFTC reauthorization, and by Regulation B, 
and given his skills in the Congress, working at developing 
consensus, we think the Chairman can be a very constructive 
person in the regulatory environment.
    We appreciate the war on complexity. Things should be 
written in simple English. It is a new departure in this area. 
He has also enhanced the protection of vulnerable groups, 
particularly elderly investors. I think that is extremely 
important and I commend the Chairman for that initiative.
    Another vulnerable population, I just want to note, is 
young military personnel. We have held some hearings here on 
that, and we have received testimony about abusive sales 
practices used by some to sell unsuitable financial products to 
young military personnel.
    Furthermore, the Commission's effectiveness in these 
efforts can be, and is, enhanced by cooperating with State 
regulators. I am pleased that Chairman Cox has placed some 
emphasis on this. He noted in a recent speech that it is 
vitally important that we partner with them, and the 
complementary nature of our regulatory regimes makes us far 
stronger together.
    There are a number of other items on the Commission's 
agenda, which I am sure we will review in the course of the 
question period here this morning.
    I do want to commend the good work environment now 
prevailing at the SEC. It was recognized in September 2005 as 
one of five best places to work in the Federal Government, a 
study by the Partnership for Public Service and U.S. News and 
World Report. That effort began when Chairman Cox assumed his 
responsibility, and a lot of it actually came from this 
Committee, as we tried to get resources for the Commission, pay 
parity for its employees, to stem the outflow of seasoned 
personnel, but I know that Chairman Cox is very strongly 
committed to enhancing and sustaining this position, and we 
hear--I do not know whether to describe it as the grapevine--
but we heard through lots of sources that things have gotten 
better at the Commission in terms of the work environment. We 
think it is important to continue that. I notice the Chairman 
is having considerable success in attracting some very able 
people to fill important positions, although he has still got 
some open positions yet to go.
    Mr. Chairman, I look forward to the question period.
    Chairman Shelby. Thank you.
    Senator Hagel.

                STATEMENT OF SENATOR CHUCK HAGEL

    Senator Hagel. Mr. Chairman, thank you, and I look forward 
to hearing from our witness, the respected Chairman of the 
Securities and Exchange Commission, and also appreciate his 
efforts in leadership over the last year.
    Thank you.
    Chairman Shelby. Senator Dodd.

            STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Thank you, Mr. Chairman, for holding the 
hearing. And we thank Chairman Cox for being here with us as 
well. Now he had a little bout in January, and he tells me he 
is back on his feet and got a clean bill of health, so we 
welcome you to the Committee. It is good to see you. It has 
been a while but we are grateful for your presence here today.
    I have had a chance to look over your testimony, and 
Senator Sarbanes and the Chairman have highlighted some of the 
points that you make in the testimony, which are worthwhile. 
Certainly, helping out those who may be most vulnerable in our 
society, particularly seniors and others, to understand exactly 
what they are getting into is worthwhile, so I commend you for 
that.
    This is a quiet time in some ways in terms of the 
securities industry. We welcome that to some degree, 
considering what we have been through, but it is also an 
important time. It is during these quiet periods that not only 
we do not end up passing a lot of legislation, but also what 
the regulator does during the quiet time can really make a huge 
difference. I have been impressed in watching the Commission as 
it has grappled with some very significant issues.
    I am very interested in hearing from you, Mr. Chairman, on 
the advisory committee's report on Sarbanes-Oxley, which is a 
big issue that has gotten some attention in the media recently. 
I am interested in hearing about the mutual fund regulations as 
well. I know that has also received a lot of attention. The 
credit rating agencies, a very important issue to come before 
the Committee. So there are a lot of major issues the 
Commission is grappling with that will have significant 
implications. So while we are not passing major bills up here 
right now, it is a very important time, in my view, in terms of 
setting the table for what the investor community can 
anticipate.
    I had a chance, privately, just a minute ago, talking to 
the Chairman about the speech he gave in China as well, and I 
am interested in hearing maybe some comments on your experience 
there and what is going on internationally in terms of people, 
foreign investors coming to the United States, and the kind of 
environment we create here, and whether or not we are going to 
sustain that environment, a very important issue as well.
    So thank you for being here. I look forward to your 
testimony. I notice that the Dow Jones had a 6-year high 
yesterday, and I asked the Chairman whether or not he was going 
to take credit for that this morning, and he wisely said, ``I 
do not think I will because it is apt to go down in a couple of 
days and I do not want you accusing me of being responsible for 
that either.'' So we will leave the Dow record here as being 
caused by other events.
    But I wanted to underscore the point Senator Sarbanes made 
as well, and that is, the environment at the SEC. You are 
following a very good Chairman, and following him in many more 
ways than just succeeding him, so I commend you for the 
environment you are creating there and the quality of people 
that you have working with you.
    Thank you for being here.
    Chairman Shelby. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    Welcome, Chairman Cox. It is good to see you, and I am glad 
to see that you have recovered from the surgery that you had.
    I am happy to read in your testimony that you are focusing 
your efforts on the individual investor, I do not think many 
SEC chairmen have done that, and also using plain English. As 
our Chairman has said, the language of the SEC is unusual to 
say the least. To allow individual investors to step on a level 
playing field is a great step in the right direction. I wish 
more in Washington would follow your lead.
    Anything that can be done to improve access to information 
and people's understanding of it will help both the new and 
experienced investor. Your program to use modern electronic 
communications to reduce the burden on companies and the SEC 
will lead to more efficient regulation and management. But most 
importantly, it will give investors more and easier access to 
financial data, and that will help them make better investment 
decisions, and hopefully, encourage more Americans to get into 
the markets.
    Welcome, Chris. I am glad to see you here. Thank you.
    Chairman Shelby. Senator Sununu.

              STATEMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Mr. Chairman.
    Welcome, Chairman Cox. Last year, I believe of the 25 
largest initial public offerings of stock in the world, only 4 
of the public offerings were issued on U.S. exchanges. I think 
there are real questions as to whether, at least in part, that 
dramatic change in the focal point of U.S. exchanges is being 
that the best source of capital in the world was due to new 
regulation, Sarbanes-Oxley or other regulations, or changes in 
the regulatory environment on the U.S. exchanges. I think it 
would be a huge mistake if American exchanges lost their 
standing and their position in the world for attracting 
listings, for attracting capital, for attracting investors, and 
that really is a cornerstone of our American economy.
    So, I am very interested in the work you are doing to 
address the concerns that have been raised with Section 404 in 
particular, and I certainly applaud the work that you have done 
on improving transparency and disclosure, improving some of the 
technology that is being used to share information with those 
individual investors Senator Bunning spoke of, and I look 
forward to your testimony.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Thank you, Mr. Chairman. I would also join 
the other Members of the Committee in welcoming Chairman Cox 
before our Committee. I am looking forward to your testimony.
    As we all know, vibrant security markets are vital to more 
than 50 percent of the families throughout the country. A lot 
of people have a stake in the stock market. And in order for 
our Nation to continue to prosper, I think we need to have a 
lot of confidence, there has to be a sense of fairness, 
integrity, and efficiencies in the stock market.
    I would share some concerns also with what is happening now 
with the exchanges and the self-regulatory principles that we 
have put in place, and how they are applying today. I am 
convinced that as the new Chairman, you will stay on top of the 
new technologies and everything, because I know this is 
something that has always been of interest to you. So, I just 
want to take this opportunity to welcome you to the Committee. 
I consider you a friend, having been a former colleague of 
yours in the U.S. House. I have always viewed you as somebody 
who is willing to step up to the plate and make changes when 
necessary. I would like to hear some of your thoughts, so I am 
looking forward to your testimony today.
    Chairman Shelby. Chairman Cox, again, welcome to the 
Committee. Your written testimony will be made part of the 
hearing record in its entirety. You proceed as you wish.

                  STATEMENT OF CHRISTOPHER COX

       CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION

    Chairman Cox. Thank you very much, Mr. Chairman, Senator 
Sarbanes, and Members of the Committee. I want to thank you for 
giving me this opportunity to be here today to testify about 
the initiatives and the priorities of the Securities and 
Exchange Commission, in particular with reference to improving 
financial disclosure for individual investors, which several of 
you have referenced in your opening comments.
    Several years ago, in the midst of financial scandals that 
rocked the country, and a crisis of investor confidence, this 
Committee held a series of very consequential hearings on the 
topics of corporate responsibility and investor protection. 
Those hearings laid the groundwork for landmark reforms that 
have restored investor confidence and the health of our capital 
markets. I want to commend you for your efforts, and I am happy 
to report that the Securities and Exchange Commission is using 
the tools that you gave us to ensure that those reforms are 
implemented in exactly the way that Congress intended.
    A lot has happened in the 9 months since I was last here 
before you, and I appreciate this opportunity to give you a 
report on the new initiatives the SEC has undertaken and to 
hear further from you about your priorities.
    The principal subject of my brief testimony is improving 
disclosure for the benefit of individual investors. If I may, I 
would like to take a step back and put these efforts into 
context.
    As a Member of Congress for 17 years, I was constantly 
reminded by my constituents of the real-world impact of the 
decisions that we make here in the Capitol every day. Like you, 
I learned the importance of being a good listener, and of 
remembering that the common sense of ordinary Americans is the 
essence and the strength of our democracy.
    Most of our constituents are not investment bankers, 
accountants, or lawyers, but most of our constituents are 
investors. It is a stunning fact of life in the 21st century 
that a majority of Americans now own stocks, either directly or 
in the form of mutual funds. It is chiefly to serve these 
people that the SEC exists. Our mission, to protect investors, 
promote capital formation, and maintain orderly markets, must 
always put ordinary Americans first.
    Since making the transition from the halls of Congress to 
the SEC, I have set out to rededicate the Agency's ongoing 
efforts in virtually every area to the service of the 
individual investor.
    In a well-ordered market, educated consumers can choose 
from a number of competitive products, and find what they want 
at a price that they are willing to pay. But, in order to 
educate themselves, investors need comparative facts. So while 
investors must bear the responsibility of learning what they 
can about their investment choices, the correlative duty of 
sellers of investment products is to provide the relevant 
information.
    To more closely match the theory of a well-ordered market 
with today's reality, the SEC is currently pursuing four key 
initiatives to improve the quality and usefulness of disclosure 
for individual investors. These four initiatives are: Moving 
from boilerplate legalese to plain English in every document 
intended for retail consumption; moving from long and hard-to-
read disclosure documents to easy-to-navigate webpages that let 
investors click through to find what they want; reducing the 
complexity of accounting rules and regulations; and focusing 
our antifraud efforts, in significant part, on scams that 
target older Americans.
    It is the SEC's job to see to it that financial data and 
qualitative information about the issuers of securities are 
fully and fairly disclosed. But we cannot say that we have 
achieved that objective if the information is provided in a way 
that is not clearly understandable for the men and women to 
whom it is directed.
    Empowering investors does not just mean better access to 
information, it also means access to better information. 
Empowering investors is our number one job. And simply put, the 
question is: Once that SEC-mandated information is available, 
is it understandable? The answer all too often is a resounding 
and frustrated ``no.''
    Exhibit A, when it comes to convoluted disclosure, is 
today's regime for reporting executive compensation. Ordinary 
American investors have a right to know what the company's 
executives are being paid, because those investors own the 
companies. The executives work for them.
    How can an investor judge whether he or she is getting the 
best executive talent at the best price? Too often the most 
important parts of total compensation are hidden away in the 
footnotes or not even disclosed at all until after the fact.
    Three months ago, the Commission voted unanimously to 
propose an overhaul of the executive compensation rules. The 
proposal would require better disclosure on several fronts.
    First, companies would report a total figure, one number, 
for all annual compensation, including perquisites.
    Companies would also outline retirement benefits and 
payments that could be made if an executive is terminated, and 
would fully disclose all compensation to board members for the 
past year. That is something that does not happen under today's 
rules.
    In addition, a new Compensation Discussion and Analysis 
section would replace the Compensation Committee Report and the 
performance graph under today's regime, because in today's 
system that disclosure is all too often pro forma, boilerplate, 
and legalese.
    Finally, since the purpose here is to improve 
communications for the consumer, the proposed rules require 
that all of this disclosure be in plain English, the new 
official language of the SEC.
    Just to be clear, the Commission does not propose getting 
into the business of determining what is the proper method or 
level of compensation. It is not the job of the SEC to 
substitute our judgment for that of the board. Nor would I, 
speaking as Chairman, subscribe to the notion that all 
executive pay is excessive. Surely, many executives deserve 
every penny they get and more. Being a CEO requires a rarified 
collection of attributes and skills that are in all too short 
supply, and compensation in the market for executive talent can 
be fierce. At the same time, I need not cite here the several 
notoriously public cases of extravagant waste of shareholder 
assets by gluttonous CEO's and pliant compensation committees.
    It is a testament to the importance of this issue that, 
when the comment period on these proposed executive 
compensation rules was closed, we had received 17,000 comments, 
one of the highest totals in the 72-year history of the 
Securities and Exchange Commission.
    Making the SEC's mandated disclosures actually useful to 
investors is the idea behind another of our initiatives: 
Interactive data. Today, the SEC has over 800 forms. Yet it has 
been estimated that the SEC might instead have need for no more 
than a dozen.
    The key to making this happen is looking at the data on the 
forms independently from the forms themselves. That is what we 
mean by interactive data. Computer codes can tag each separate 
piece of information on a report and tell us what it is: 
Operating income, interest expense, and so forth.
    For individual investors, this means they will be able to 
quickly search for any information they want, without slogging 
through an 80-page disclosure document. Our initiative to let 
investors get information fast, easily, and all in one place 
envisions this added benefit: Instead of long and hard-to-read 
annual reports and proxy statements, investors could have easy-
to-navigate webpages that let them click through to find what 
they want.
    With today's SEC reports, an investor or analyst who is 
looking for comparative data on, say, annual capital 
expenditures of two companies has to search through hundreds of 
pages of the filings of each company, page-by-page. Not 
surprisingly, this very time-consuming task has created a 
cottage industry in rekeyboarding information in SEC reports so 
that it can be downloaded into spreadsheets and other software. 
Investors, or more precisely, the intermediaries, whose fees 
they pay, can then buy this information from both domestic U.S. 
firms and overseas providers to whom the drudge work has been 
outsourced.
    One hates even to think of the human error and data 
corruption that inevitably occurs in this process.
    Interactive data is a way to eliminate these problems, and 
to connect investors directly to the information in a company's 
filings. The SEC is strongly committed to interactive data and 
has taken major steps to promote it. We have offered 
significant incentives for companies to file their financial 
reports using interactive data, and companies are now beginning 
to do this.
    These incentives include expedited review of registration 
statements and annual reports. A number of well-known firms--
the list is now 17 and still growing--have already begun to 
lead the way and are filing their reports using interactive 
data. Starting in June of this year, the Commission will host a 
series of roundtables focused on how we can move to interactive 
data faster.
    Revolutionizing the way the world exchanges financial 
information is a worthy goal. We intend to achieve it.
    When it comes to giving investors the protection they need, 
information is the single most important tool that we have. It 
is what separates investing from roulette. But, if the SEC is 
truly to succeed in helping investors with more useful 
information, we will need one more ingredient: An all-out war 
on complexity.
    At the SEC, we are looking at results from the vantage 
point of the ordinary investor, and what we are finding is 
that, in many cases, we are not getting the right results.
    It is not just public companies that have a problem using 
plain English. Our accounting rules and regulations also can be 
complex and difficult to interpret; and, when the rules are 
difficult to interpret, they may not be followed very well. 
And, if the rules are not followed very well, then, 
intentionally or not, individual investors inevitably will 
suffer.
    Weeding out the counterproductive complexity that has crept 
into our financial reporting will require the concerted effort 
of not only the Securities and Exchange Commission, but also 
the FASB, the PCAOB, and every market participant. This cannot 
be a one-time effort. We will have to commit for the long-term. 
But it will be well worth it.
    Finally, let me turn to our efforts to protect older 
Americans against financial fraud. Consider these statistics. 
An estimated 75 million Americans are due to turn 60 over the 
next 20 years. That is an average of more than 10,000 people 
retiring every day. Households led by people aged 40 or over 
are already owners of over 91 percent of America's net worth. 
Very soon the vast majority of our Nation's net worth will be 
in the hands of the newly retired.
    Following the Willie Sutton principle, the scam artists 
will swarm like locusts over this increasingly vulnerable group 
because that is where the money is.
    On a daily basis our Agency receives letters and phone 
calls from seniors and their caregivers who have been targeted 
by fraudsters. Often the victims have already been taken in. 
These fraudulent schemes may begin with a free lunch, but we 
want to make sure that they end with a very high cost to the 
perpetrators.
    That is why we are attacking the problem from all angles, 
from investor education, to targeted examinations, to 
aggressive enforcement efforts. Because State securities 
regulators share our concerns in this area, we are cooperating 
in this initiative with State regulators across the country.
    Each of the four initiatives I have outlined is part of an 
overall strategy to make the individual investor, the average 
American, the ultimate beneficiary of everything that we do at 
the SEC. Our Agency has for many years proudly worn the badge 
of the investor's advocate. In the months and years ahead, we 
are pledged to rededicate ourselves to that mission.
    I appreciate the opportunity to be with you here today, Mr. 
Chairman and Members of the Committee. I want to thank you for 
your continuing strong support of the work of the Commission, 
and I am happy to be here to answer any questions that you 
have.
    Chairman Shelby. Thank you, Chairman Cox.
    The Banking Committee has been actively reviewing the role 
of credit rating agencies in the capital markets. The rating 
industry is extremely powerful and is dominated by only two 
firms that do not actually compete with each other, as 
evidenced by the fact that Standard & Poor's and Moody's, each 
rate more than 99 percent of the debt obligations and preferred 
stock issues publicly traded in the United States.
    In your view, Mr. Chairman, what is the impact of this 
extreme concentration and absence of competition with respect 
to ratings quality, pricing, innovation, and business 
practices?
    Chairman Cox. Mr. Chairman, as you know, this area has been 
one of intense focus, both for the SEC and for this Committee. 
It has also been a subject of legislative interest in the other 
body.
    First, let me say I appreciate the Congress's bicameral and 
bipartisan attention to this issue, particularly your emphasis 
on increasing and encouraging competition in the market for the 
provision of credit ratings, given that the market, as you 
point out, is dominated presently by a few firms.
    The principles that I think that we support at the 
Commission and that I know have been the focus of discussion 
here in the Congress, when it comes to a regulatory approach to 
the NRSRO's, would be, first, avoiding erecting any new 
barriers to entry and promoting competition in the market for 
the provision of credit ratings for regulatory compliance 
purposes. Second, utilizing an entry process that is 
transparent, timely, and that accommodates a variety of 
business models. Third, I think the focus that we have seen and 
the discussions in this Committee and throughout the Congress 
on managing conflicts of interest is very important. Conflicts 
of interest can arise between NRSRO's and issuers, and we have 
to ensure that ratings issued for regulatory compliance 
purposes, notwithstanding these potential and sometimes actual 
conflicts of interest, are independent and objective.
    Finally, I think we have to prevent the misuse of material, 
nonpublic information by NRSRO's or their associated persons. 
So all of these things have to feature into any reforms that 
are adopted either legislatively or in a regulatory way. And as 
you know, we are deeply into this at the Commission, and have 
been for several years now.
    Chairman Shelby. Thank you. Following up on that, it is my 
understanding, Mr. Chairman, that the regulation of rating 
agencies essentially begins and ends when a rating agency 
receives a license from SEC staff designating it as nationally 
recognized statistical rating organization. That is to say, it 
is my understanding there is no ongoing oversight or 
inspections by the SEC once the NRSRO license is awarded.
    Given the overwhelming evidence--and we have had a hearing 
here on this, as you know--relating to conflicts of interest, 
aggressive and anticompetitive practices, and the well-known 
failures to warn investors about impending bankruptcies--Enron, 
WorldCom, and others, including a place you are familiar with, 
Orange County, California--do you believe that self-regulation 
is working in this area of the concept?
    Chairman Cox. Chairman Donaldson testified to this 
Committee on this subject, that without additional legislative 
authority, the SEC will not be able to regulate in a 
thoroughgoing way, the NRSRO's. What we can do under present 
law is withdraw an NRSRO's no-action letter. We can bring an 
enforcement action against an NRSRO for violation of the 
antifraud provisions of the Federal securities laws, and at 
least with respect to S&P, Moody's, and Fitch, which are 
registered as investment advisers, we can regulate them under 
the Investment Advisers Act.
    Chairman Shelby. We want to work with you to give you 
whatever means you need, and I believe we can do it in a 
bipartisan way.
    The New York Stock Exchange Regulation, the Committee 
recently held a hearing, Mr. Chairman, on the state of self-
regulation in the securities industry with a particular focus 
on the implications of the New York Stock Exchange's 
unprecedented decision to keep its regulatory unit in-house 
even after conversion to a for-profit, shareholder-owned 
entity.
    As your colleague, Commissioner Paul Atkins, at the SEC 
recently noted, revenues derived by the NYSE regulation will 
roll up on a consolidated basis to the New York Stock Exchange 
Group, the public company. That means that penalties collected 
by the New York Stock Exchange Regulation will roll up into the 
aggregate revenue calculations of the New York Stock Exchange 
Group. This further compounds the inherent conflict of a for-
profit entity possession regulatory authority over customers 
and potential competitors.
    Do you have some concerns there. Some of us do, but we 
think the ground has changed a little out there.
    Chairman Cox. The ground is changing. This is a new world 
that we are entering upon. The evolution of our major exchanges 
into for-profit entities, the demutualization of the markets, 
and the prospect of global competition present challenges to 
our historical regulatory approach.
    The fundamental principle that we need to keep in mind 
going forward is that, in order to be effective, regulation 
needs to be independent and arms' length. The for-profit 
structures that----
    Chairman Shelby. Has to be considered open too, does it 
not?
    Chairman Cox. Pardon me?
    Chairman Shelby. Fair. A regulation has to be considered to 
be fair too.
    Chairman Cox. Of course. The reality and the perception are 
equally important; and, of course, ultimately the perception is 
driven, one would expect, by the reality.
    The Commission has already taken action designed to 
strengthen regulatory independence, but I look at this as a 
beginning, not an end. When we approved the NYSE merger, we 
requested--and the NYSE Board accommodated us in those 
requests--some additional changes to further strengthen the 
independence of regulation there. But, in my conversations with 
the management of the NYSE, I made it very clear--and I think 
it is their understanding as well--that we are at the threshold 
of understanding where this is all going to lead us, and we 
have to be very nimble in our approach. We have to be willing 
to constantly adjust and improve.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    I want to make a couple observations before I put a 
question. First of all, Senator Dodd referred to the fact that 
things were relatively quiet, and that the Dow Jones average 
reached a 6-year high on Friday. It seems to me that creates 
something of a tendency to forget, or to get a a sense of 
amnesia. Just to make sure that does not happen, I want to just 
note three enforcement actions that have happened in the last 
month or so.
    On March 16, the SEC settled on enforcement action against 
Bear Stearns for securities fraud for facilitating unlawful 
late trading deceptive market timing of mutual funds by its 
customers, and customers of its introducing brokers. They will 
pay $250 million--$160 million in disgorgement, $90 million in 
penalty.
    Tyco agreed to pay a $50 million settlement to the SEC 
charges that is used improper accounting, overstating its 
reported financial results, smoothing those reported earnings, 
hiding vast amounts of senior executive compensation, and a 
large number of related party transactions from investors.
    April 20, just a few days ago, JPMorgan Chase and Company 
announced that it agreed to pay $425 million to settle class 
charges over its role in a scheme in which 55 underwriters 
allegedly defrauded investors of billions of dollars through 
hundreds of initial public offerings during the 1990's 
technologies bubble.
    So the responsibility of the SEC is to do all that it can 
to prevent and preclude such practices, and sustain the 
reputation of our capital markets for integrity, transparency, 
and honesty.
    Now, Ernst & Young has just done a report on Global IPO 
Trends, 2006. And in that report they note that the U.S. 
capital markets are perceived by issuers and investors as the 
gold standard, particularly as it relates to corporate 
governance. Companies realized evaluation premium in the form 
of a higher-price earnings, or similar multiple, as compared to 
what a similar company receives on another exchange. One 
observer has said: Motivation for most companies listing in the 
United States is evaluation premium averaging 30 percent that 
accrues as a result of adhering to high standards of 
governance.
    Now, that report went on to note that exchanges outside the 
United States have significantly different regulatory and 
corporate governance requirements, and that some exchanges are 
aggressively marketing the fact that their exchange has lower 
regulatory requirements than in the United States.
    They go on to say, ``These lower regulatory requirements 
translate into increased risk for investors participating in 
those exchanges, as they often do not have similar investor 
rights and protections.''
    I just simply want to say I think the United States should 
consider on the path of high standards, of having the gold 
standard. It has served us well in the past. I think it will 
serve us well into the future.
    Some say, well, you know, these IPO's are being issued on 
other exchanges. But then you have to look a little into that, 
and one of the things that is clear, when you do that, is that 
the major driver of the global IPO markets is the privatization 
of former state-owned enterprises. The top five IPO's in 2005 
are all former state-owned enterprises. This trend is probably 
going to continue, but, there is usually political direction to 
list those IPO's on local exchanges. The Chinese Construction 
Bank went to the Hong Kong Exchange. The two other Chinese 
IPO's in the top five also listed in Hong Kong, and the two 
French IPO's in the top group listed on Euronext. I just urge 
the Commission to hold to its standards. I think we are going 
to come out ahead if we do that.
    The question I want to put to the Chairman involves hedge 
funds, and the resources the SEC will need and be devoting to 
make sure that the investigative and enforcement staffs at the 
Commission are sufficiently knowledgeable and experienced in 
the activities of these funds.
    Last Friday, Floyd Norris wrote an article in The New York 
Times headed: ``Are These Hedge Fund Results Real?'' He went on 
to say, ``For those who favor open markets and open investment 
management, it may look like the best of times, but it may 
really be the worst, and we may not learn just how bad it is 
until something horrible happens. More and more trading and 
more and more money now falls outside almost all regulation. 
Hedge funds trade with virtually no disclosure of what they are 
doing.''
    The New York Times ran a story in late March, ``An anxiety 
about the growing power of hedge funds.'' ``These funds have 
increased sharply in number, size, and effect on the market. 
According to stock exchange officials they constitute from one 
quarter to one half of all trading on that exchange every day. 
Hedge funds operate with a fair amount of secrecy, which 
naturally shrouds them in mystery, and often suspicion. Combine 
that with a veiled practice of shorting and the devaluation of 
stock research since the market collapse, and it becomes a 
recipe for concern.'' And there are a whole series of comments 
to that effect.
    We recognize hedge funds perform an important function in 
the markets, but given these concerns that are being expressed, 
I want to ask the Chairman whether the SEC has the necessary 
resources and authority to understand, investigate activities 
in this area, and if necessary, to bring enforcement actions?
    Chairman Cox. The straightforward answer to the last part 
of your question is yes. We have been bringing enforcement 
actions and regulating hedge funds to the extent that some of 
them have been registered as investment advisers for the last 
decade. We are now implementing authorities under a new rule 
that went into effect within the last 90 days as you know.
    I should bring to the attention of the Committee that as a 
result of compliance with that new rule, we have essentially 
doubled, nearly doubled the number of hedge fund advisers that 
are registered with the Securities and Exchange Commission, and 
our presumption is that virtually the entirety of those new 
registrations are in consequence of our new rule. This is 
giving us some reliable census data about how many advisers are 
operating within the United States that are subject to our 
jurisdiction, and that is one of the main things that we had 
hoped would occur.
    We are also training our inspectors specifically for the 
purpose of understanding how to inspect hedge funds. This is a 
new emphasis for the Commission. We are devoting significant 
resources to it, and, importantly, we have drawn on the 
expertise and resources of academics and hedge fund experts as 
part of this training. So, I think that we are well-prepared to 
embark on at least this next step. And, as we internalize this 
new information that we are gaining from the hedge fund adviser 
registration, and learn from it, I think we will then be 
prepared with the recommendations of our professional staff on 
what should be next steps.
    Senator Sarbanes. I think it is an important process you 
are going through. Some of us on this Committee lived through 
the savings and loan debacle, and I think it is imperative that 
the Commission and the Committee try to anticipate potential 
problem areas, because once they hit, they can hit with 
tremendous force, have wide-ranging repercussions, and so an 
ounce of prevention is worth a pound of cure, and encourage the 
Commission in its work.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Hagel.
    Senator Hagel. Mr. Chairman, thank you.
    Picking up on the conversation, the exchange that you have 
just had with Senator Sarbanes regarding hedge funds, with the 
support and concurrence of Chairman Shelby, Senator Dodd, and I 
will be holding a hearing in our Subcommittee on Securities, on 
hedge funds on May 16, and as you know, Mr. Chairman, you have 
been, or a representative of the SEC, asked to testify. I think 
so far all representatives of the President's Working Group 
will be in attendance, recognizing that there is a lawsuit 
challenging the SEC's ruling on hedge funds. But nonetheless, I 
would hope--and I know we will have an opportunity to discuss 
this in some detail privately this week--that the SEC will be 
represented at the hearing.
    A couple of follow-up questions to you, Mr. Chairman, 
regarding Senator Sarbanes' questions. Could you give this 
Committee a status report on where the SEC is on the current 
regulation, even though it is being challenged in Federal 
Court? Is it still the current regulation, the regulation that 
in fact requires hedge fund managers to register? Has there 
been any change in the status of the regulation as a result of 
the lawsuit?
    Chairman Cox. No. As I mentioned, I believe within 24 hours 
of being sworn in as Chairman, we intended to, and we have, put 
that rule into effect exactly as it was written. And it did in 
fact require advisers to register by a deadline of February 1 
of this year. That deadline has now, obviously, passed, and the 
result is that over 2,400 investment advisers have registered. 
That is, at least as of March 31, 2006, the most current data 
that I brought with me to this hearing.
    That covers more than 11,500 hedge funds with assets of 
almost $2 trillion. The census information that we were hoping 
to acquire, I think we are acquiring in a sturdy way. I should 
reemphasize, as I mentioned in response to the question from 
Senator Sarbanes, that roughly half of hedge fund advisers had 
already been registered by their choice, and so, now that this 
rule has gone into effect, I think we have our arms around what 
is the true population.
    Now, we understand inferentially that, because of the 
lawsuit, there is a small group of people who may be holding 
out and not registering, but I do not think that statistically 
that is material.
    Senator Hagel. We will have an opportunity to further 
engage this issue with more specific questioning when we have 
the hearing on May 16. Thank you.
    Let me turn to a Wall Street Journal article, January 27, 
2006. The headline is: ``New York Stock Exchange Grants Fannie 
Request for Continued Listing.'' I will just set this question 
up this way. The beginning of the article states, ``Embattled 
mortgage finance company, Fannie Mae, announced Friday that the 
New York Stock Exchange recently granted the company's request 
to continue listing its stock despite the fact that Fannie has 
not filed an earnings statement since the second quarter of 
2004. The Securities and Exchange Commission approved last week 
a controversial amendment that saves Fannie from certain 
delisting procedures that were slated to begin as soon as March 
under the New York Stock Exchange original rules for companies 
that had fallen behind in their SEC filings.''
    ``Fannie, in an SEC disclosure, filed after the markets 
filed Friday, said the New York Stock Exchange approved the 
company's request last Thursday, which is also when the SEC 
okayed the change.''
    Can you explain to the Committee why you did that, and are 
you concerned that this sends a very dangerous message to 
others? And maybe take us down into some detail as to what was 
the reasoning behind that approval?
    Chairman Cox. We do not begin with the presumption or the 
intention of forcing delisting. I have discussed these specific 
cases with the New York Stock Exchange. We are watching very 
carefully the promised compliance, and it appears that we are 
now within reach of getting what we have expected. If that does 
not come to pass, obviously, our approach will change 
dramatically.
    Senator Hagel. What do you mean getting what you expected?
    Chairman Cox. We have right now a timetable by which we 
expect that the work that was necessitated on account of 
restatements will be completed and the filings with the 
Securities and Exchange Commission will be made. We can review 
those per normal.
    Senator Hagel. I have to tell you, Mr. Chairman, you have 
presented to the panel this morning, and you took a great deal 
of time doing it and I think we all agree with it, a priority 
of being concerned for investors. And I would have a concern 
for investors when a public company has not presented 
financials since the second quarter of 2004 and is still is 
allowed to trade on a major stock exchange.
    That would be a concern for me as an investor and one who, 
like you, is concerned about investors. I would strongly 
suggest that we need to take a further look at this. At least I 
would like to have a further conversation with you about this. 
There will be, I am sure, some additional hearings on this.
    But I think this is a very serious problem aside from the 
fact that it sends the wrong message to the markets. And I am 
wondering also, which Senator Sununu got into a little bit with 
you and I am sure he will follow up in his time for questions, 
why is it that we are falling behind in IPO's here in the 
United States?
    Is this all connected? Are we having a confidence problem? 
I will let Senator Sununu take that because my time is up, but 
I again thank you for coming before the Committee, Mr. 
Chairman.
    Chairman Cox. Thank you. I want you to know that I take, 
and the Commission takes, your message to heart. It is the 
unusual circumstance of the transition to 1934 Act compliance, 
and the coincidence of that with these massive restatements 
that has landed us in this, what I expect to be temporary, 
position. But, going forward, the kind of compliance that you 
expect is the same kind of compliance that we would expect at 
the SEC.
    Senator Hagel. I think when you exempt companies, you are 
headed for trouble, and we know that we have some trouble that 
we are talking about, so we will follow this up in a private 
conversation. Thank you.
    Chairman Shelby. Senator Dodd.
    Senator Dodd. Thank you, Mr. Chairman. Again, thank you, 
Chairman Cox, for being here today. I know you have this 
advisory committee on Sarbanes-Oxley, regarding smaller 
companies, is about to--has it reported to you yet formally?
    Chairman Cox. Yes, just this week, just yesterday.
    Senator Dodd. I am interested in hearing your initial 
reactions to the report. And in the context, I would like to 
raise two issues that struck me as being--certainly all 
hearings, as Members of Congress, we hear from corporations and 
others in our respective States. I think probably all of us ask 
when we meet with a corporate executive, how are you doing, how 
is Sarbanes-Oxley affecting you? It is a common question. If we 
do not raise it, certainly they will with us when the 
opportunity presents itself.
    I have been struck, by and large, by the positive reaction 
to Sarbanes-Oxley. I have heard some very good comments about 
the overall effect this has had on corporate governance, the 
effectiveness of audit committees, the weeding out of board 
members who were not necessarily doing a good job or serving on 
too many boards. They describe it as having a very salutary 
effect overall.
    There have been some questions raised about the cost and so 
forth to smaller companies, Section 404 questions and so forth 
have come up. But I was struck in some reports that in fact the 
cost of compliance under Sarbanes-Oxley is actually reduced by 
45 percent over the last 2 years, and that if we were to follow 
the recommendations of the advisory committee, as they have 
been proposed, some 80 percent of all corporations presently 
covered by Sarbanes-Oxley would be exempt. I want to know if 
those two facts are true and what your initial reaction is to 
this advisory board?
    Chairman Cox. As you rightly observed, we have just 
received this advisory committee report. I just yesterday had 
an opportunity to congratulate the co-chairs of the advisory 
committee and all of their members for a year of very hard 
work. I think they performed admirably in representing the 
concerns of small business, which are among the several 
concerns that we will have to take into account as we go 
forward.
    As for the specific recommendations of the advisory 
committee, I will simply represent what I have previously 
stated, our emphasis is on making Section 404 work, and 
implementing it in a way that provides all the needed investor 
protections without unnecessary cost. This is all meant to be 
for the protection and the benefit of investors, and therefore, 
they are entitled to the maximum amount of investor protection 
at the lowest possible cost. We do not want unnecessary cost. 
We do not want make work. So we should be able to learn from 
early experience and implementation.
    Section 404 itself is a very modest part of the overall 
legislation. It is just a few lines of text. The implementation 
through AS 2 is hundreds of pages, and the practice that has 
developed under that guidance is itself another gloss on the 
statute. But what is very important, it seems to me, is to make 
the statute work. So we are still in the early stages of 
discussing these recommendations, having just received them, 
and I cannot possibly represent the views of other 
Commissioners, since I have not had a chance to really 
thoroughly go through all of this with them and gain the 
benefit of their reactions.
    I can say that certainly my goal as Chairman is to find a 
way to make Section 404 work, so that it should not be a 
question of whether to apply it to companies of all sizes, but 
rather how. The question you put to me also asked me to tell 
you whether it is right or wrong that costs are coming down. I 
think the answer is that some costs are coming down, and some 
are not. There is a difference between internal and external 
costs, the fees that auditors are charging as opposed to the 
internal cost that companies bear.
    I would further observe that going forward, one would 
expect in a workable system that these costs will be coming 
down simply because the work is routinized. If there is not any 
routinization to this, and we keep inventing the wheel year 
after year, then something has to be wrong. For foreign private 
issuers, they are now just embarking on the front end first 
year costs, and so I am sure that the concern about cost is 
going to be with us throughout 2006 and maybe into 2007. We are 
aggressively going to be working implementation with the PCAOB 
so that we get all the benefits of 404 without needless cost.
    Senator Dodd. The question I raised as well about the issue 
of--as I understood it--and I am not suggesting this is the 
position you have taken--but if the full recommendations of 
this advisory committee were to be adopted, is it a fact that 
about 80 percent of the corporations presently covered by 
Sarbanes-Oxley would be exempt?
    Chairman Cox. Yes, and it depends, of course, on whether 
you are categorizing these companies by their, for example, 
market capitalization or simply counting them up. There are 
many small companies, and so in terms of a number of issuers 
you get to a very high fraction of the total. On the other 
hand, if you look at it from the standpoint of how big are 
these companies, all the biggest firms would continue to be 
covered even under their recommendations, and the lion's share 
of market capitalization in the United States. So, I think both 
statistics are correct and useful ways of looking at the 
problem.
    Nonetheless, I want to get back to what I consider to be 
the main point, and that is that there should be a way--and the 
advisory committee's recommendations contemplate this, I will 
say-- to make this work. The advisory committee report focuses 
on the fact that there seems to be lacking a framework 
applicable specifically to smaller companies, but certainly we 
can work that aspect of the problem as well. COSO is developing 
such a framework at the request of the SEC, and that may well 
be available as a place where we can hang our hat.
    Senator Dodd. Mr. Chairman, I suggest that we might want 
to--this is such an important issue that the Committee at some 
point, in consultation with you and, obviously, Senator 
Sarbanes and others, that we would be able to stay closely in 
touch with the SEC as it works its way through this. I would be 
very interested in making sure we had hearings and so forth on 
the subject matter as it progresses.
    Chairman Cox. I think we would welcome that. This is, after 
all, an agency implementation of a still relatively recent 
Congressional enactment, and so it is our main purpose to make 
sure we are doing exactly what Congress intended.
    Senator Sarbanes. You do have a roundtable already 
scheduled for mid-May, do you not, to look specifically at the 
question of further guidance that would come from the SEC and 
the PCAOB?
    Chairman Cox. That is exactly correct.
    Senator Sarbanes. With respect to the very issue we have 
been talking about?
    Chairman Cox. Our 404 roundtable is the second annual such 
event, and we are trying to take a look at lessons learned from 
one more year under our belt.
    Senator Dodd. Just one additional question, Mr. Chairman. 
It may have been raised. I apologize, Senator Hagel may have 
raised this, on the issue of international exchange mergers? 
Have we touched on that, the merger issue, the exchange 
mergers? Make it easier for U.S. citizens based in the United 
States to trade in foreign listed securities, which has some 
possibilities, but what entity? I am curious about what entity 
would then have supervisory control over the holding company, 
in effect, if the exchanges remain functionally regulated by 
the home State, if you will, or the home country?
    And then on a related matter, whether or not any thought 
has been given to the possibility that a foreign interest could 
purchase a U.S. exchange? And if so, what thoughts are then--we 
have been through something fairly recently, not involving an 
exchange but something else, and whether or not we have a 
system set up to examine the implications of such a possible 
acquisition?
    Chairman Cox. The approach that I am taking is that this is 
inevitable, that this globalization is proceeding apace and is 
not to be ignored, whether or not, for example, the Nasdaq play 
for the London Exchange actually materializes. These things, 
these kinds of transactions in this category, will occur, and 
presumably, with increasing rapidity. This is just a function 
of the fact that these are now for-profit exchanges which have 
their own stock as currency to make acquisitions. They are 
interested in acquiring the capacity to deliver new products.
    One of the key questions that needs to be answered in order 
to know what form regulation takes is whether in these mergers 
the trading platforms are going to be merged. It is entirely up 
to the people who structure these future transactions whether 
or not they subject themselves, at least under current law, to 
regulation country by country, or to multinational regulation.
    I am taking the view that it is best for the United States 
and our overseas counterparts to work out some of these 
conceptual issues in advance before a real deal is on the 
table, and we know whose ox is being gored. And so the 
leadership of the FSA and I will be getting together for some 
quality time very soon. We have already met, of course, on 
this, but we decided we need to set aside, in a retreat as it 
were, more than a full day just to talk about these issues and 
get our minds around the problems.
    I think, through hearings and otherwise, this Committee 
will want to do the same, because we have had a regulatory 
structure in this country for 7 decades that really has not 
contemplated any of this. Maybe it can be made to work. On the 
other hand, maybe it is like stretching the new facts onto a 
procrustean bed of regulation that just does not fit.
    Senator Dodd. As I said, I would rather talk about it now 
than have a specific case emerge and us scurrying around trying 
to sort it out, or condemning it because it is occurring, and 
then trying to write rules and regulations after the actual 
event has occurred.
    So, again, it is one of those issues, Mr. Chairman, with a 
busy schedule and a lot of issues on the table, but one I would 
be very interested in hearing what happens as a result of these 
conversations you are having and any recommendations and 
thoughts the SEC would have. I am sure Senator Hagel, as the 
Chairman of our Subcommittee, would be interested as well.
    This is, again, a fact of life. It is moving in that 
direction. Clearly, as you point out, we should be thinking 
about it, and something we never contemplated in the past, but 
I think we had better start paying attention to it very 
clearly.
    Chairman Shelby. Senator Dodd, I think your recommendation 
and observations are excellent, and the timing could not be 
better.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    About 12 months ago, 14 Members of this Committee sent a 
letter to then-Chairman Bill Donaldson, urging the Commission 
to withdraw its proposed Regulation B, and resubmit it for 
comment after talking to the banking regulators on the proper 
scope of the regulation.
    Shortly after taking office, you agreed to postpone 
compliance, and indicated that you would revisit the 
regulation. Now that you have been at the Commission for about 
9 months, can you provide a report on the status of the 
proposed Regulation B and any effort the Commission has made to 
work with the banking regulators to propose a regulation that 
merits the legislative intent of Gramm-Leach-Bliley?
    Chairman Cox. I can certainly provide you with a status 
report. Working backward from today at 2:00 o'clock, depending 
on when this hearing adjourns, I am scheduled to get together 
with the banking regulators for the next in our ongoing series 
of meetings to try and hammer out a collaborative response on 
Regulation B.
    Going back to the other end of the spectrum, I remember 
when I was a conferee on Gramm-Leach-Bliley, it was in a 
different millennium. It was a long time ago.
    Senator Bunning. Seems like.
    Chairman Cox. Literally was. It was a 20th century issue. 
We worked on it for several years during the 1990's. The law 
concluded, the conference concluded in 1999. It is about time 
that we had regulations implementing the law.
    So my view is we should get this done. We can get it done, 
and we intend to follow Congressional intent as closely as 
humanly possible.
    Senator Bunning. That would be a wonderful thing if you 
could do that. On bonds, I understand the New York Stock 
Exchange Group has filed a request with the SEC to allow them 
to trade certain unlisted corporate bonds on its automated bond 
system. That would greatly expand the number of bonds that 
investors could trade on the exchange. When do you think the 
SEC will act on this application, and do you have any thoughts 
on the impact it will have on bond transparency for all 
investors?
    Chairman Cox. Well, to answer the first question first, I 
think that we can reach a resolution to this issue in the near-
term. With respect to the more general question, we share the 
concern of the Bond Market Association and others that the 
industry not be burdened with duplicative trade reporting for 
securities traded on the NYSE's automated bond system. The 
Commission staff is currently discussing with both the NASD and 
the NYSE the best way to address the duplicative reporting 
issue, and that is the basis for my confidence that we can 
resolve this very quickly.
    Senator Bunning. Last, but not least--because there are 
others waiting--proposed rules on online availability of proxy 
materials. The Commission has proposed a rule that would allow 
companies to provide shareholders with annual reports and proxy 
statements only online unless the investors ask for printed 
materials. Today, many investors, particularly the elderly and 
low income, do not have access to the Internet, nor do they 
feel comfortable doing their financial business online. We do 
not want to discourage investor participation, and I know many 
comments were filed expressing concerns about the options 
proposed by the Commission. What is the correct balance between 
increasing investors' participation and cutting the cost of 
shareholders communication, and how can the Commission 
accomplish both goals? Are there other options that are being 
considered after the comment period for the rule ended?
    Chairman Cox. Well, as you would expect of us, we are 
taking thoroughly into account the comments that we received, 
and I can say, having been through many of them myself, that 
there are some good suggestions in there that will help us 
address some of the problems and the concerns that have been 
raised.
    When it comes to balancing the interests of investor 
protection and trying to save money on sending them disclosure 
documents, I have to say that I put by far the greatest weight 
on the former and very little on the latter. It has been 
pointed out there might be some cost savings if we move to 
electronic delivery rather than paper delivery. But that is not 
the reason that I would support it.
    What I am interested in, as I mentioned in my opening 
comments, is making the disclosure useful to customers. And if 
what the customers are getting right now is a long document 
written in legalese that they throw away, then we are not doing 
the job. We have to find ways----
    Senator Bunning. That is what we are getting.
    Chairman Cox. Exactly. We have to find ways to turn this 
into what it was supposed to be all along, and that is user-
friendly information from a customer standpoint. If the 
customers are throwing away your product, you have to ask 
yourself what is wrong with your model.
    When it comes to seniors, and particularly because this is 
such a focus of our efforts now at the SEC, we are looking at a 
number of issues. First of all, for people of very advanced 
age, many times the issue is not whether it is electronic or 
paper, but who is managing that money, and is there a caregiver 
involved, and can we find someone there that is authorized to 
deal in their behalf, and have we got people selling things to 
people who are non compos mentis? That is a big opportunity for 
fraud, and we want to make sure that, as more and more of the 
Nation's assets are held in that way, it does not come back to 
bite us.
    We will never get away from paper delivery. There will 
always be paper delivery. Some people, sometimes me, but some 
people always prefer paper to electronic delivery for a variety 
of reasons. We want to make it as easy as it can possibly be 
for people to get the information in whichever form they want. 
And so, as we go forward with this final rule, we want to make 
sure that we do not have so much of forced opt-in or -out as a 
painless way to get your choice.
    And to make sure that if it were possible--actually, one of 
the things that we are thinking about is, is it possible--we do 
not know quite yet if it is possible--but, if it were possible, 
could you call one number once for everything you own, and say, 
``I just want it in paper.'' That would be a lot simpler than 
having to do it with every single security that you own. One of 
the comments we received is, ``Find a way to do that,'' and we 
are looking to see whether that is possible.
    Senator Bunning. Thank you.
    Chairman Shelby. Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Thank you, Mr. Chairman.
    Chairman Cox, it is great to see you. Welcome, and hope you 
are doing well, and we appreciate your being with us today.
    In reading your testimony, sometimes you read these 
testimonies--you have read a lot of them in your time as well--
and say, what are they trying to say? And every now and then we 
come across testimony that is as clear as a bell. It is 
interesting too, because in your testimony you talked about 
among the things you are trying to do is to move from 
boilerplate legalese to plain English in every document 
intended for retail consumption. And I just want to say it is 
great to know that in your statement today, it is very clear, 
it is well said, even understandable to a recovering Governor 
from Delaware, so I thank you for that.
    You mentioned in a section here in your testimony, talking 
about making disclosure understandable for ordinary investors. 
I am going to be down in Salisbury, Maryland later this 
evening, Senator Sarbanes, and your hometown, and they are 
having the Annual Delmarva Poultry Dinner. It is a big dinner, 
as you know. I want to talk to the people that gather there, a 
couple thousand people gather from all over the Eastern Shore, 
Delaware, Maryland, and Virginia. I want to talk with them 
about some things that we have been doing with respect to 
getting a greater effort from the U.S. Department of 
Agriculture to help us ensure that we are doing a better job of 
testing chicken flocks for avian influenza.
    My staff gave me a statement, a speech they thought I could 
give, and it sounded like a speech that was written by somebody 
right here in Washington, who had never been to a poultry farm, 
maybe not even eaten chicken.
    [Laughter.]
    So, I gave it back to them and I said, ``I am going to be 
speaking to hundreds of farmers, poultry farmers, and I want to 
have something I can explain that they will understand.'' So 
when I read this part of your testimony, it just really rang 
clear with me.
    You speak to, in the first part of your testimony, about 
executive compensation. And you say very plainly that some 
executives, CEO's, deserve every penny they are paid and 
probably more, and frankly, some do not.
    I came across a story recently about a big company in this 
country where the CEO was paid a large amount of money, and the 
article examined the firm that is retained by this big company, 
who come in and recommend, among other things, compensation for 
the CEO. And then it turns out that this firm who recommends 
compensation for the CEO, also has a big consulting contract 
with the whole company, and to the extent that it is worth a 
whole lot more than the value of their making recommendations 
for the CEO's compensation. It turned out the CEO serves on 
other boards, where the other people from the other companies, 
these boards he serves on, serve on his board, and he is on the 
compensation subcommittees of these other boards. It just 
struck me, I think an ordinary person looking at this would 
just say this does not pass the smell test.
    And I do not know if you are familiar with the situation I 
am talking about. I am sure that it is not by itself. There are 
probably a number of those. But just your reaction to that kind 
of thing, and what you and your colleagues at the SEC are 
trying to do about it?
    Chairman Cox. The independence of compensation committees 
is key to solving the problem that you described. I have to 
say, even before I jump into this, earlier when you mentioned 
that you were given a statement that looked like it had been 
written by somebody in Washington who had never eaten chicken, 
I was going to say that my experience in Congress is there are 
very few people who have not had a chicken dinner.
    [Laughter.]
    There are also few enough people who write in clear, plain 
English, so I appreciate your remarks with respect to what we 
are trying to accomplish for customers at the SEC there.
    When it comes to executive compensation being determined 
fairly in the interest of shareholders, obviously, the SEC's 
main tool is disclosure, and we want to make sure the market 
works the way it is supposed to work, on the basis of clear 
understandable information, the best information obtainable. 
The compensation committees of the boards are the people that 
the shareholders rely on to do this job well.
    In a situation such as you describe, where we might 
suspect, because of conflicts of interest, the board is not 
doing its job, how can the shareholders know for sure? So 
putting those tools directly in the hands of the shareholders 
as well as the compensation committees is a way to provide a 
check and balance.
    If there is the greatest possible degree of transparency in 
the marketplace, and if there is the very best information, 
then not only the shareholders, but also the directors, can be 
expected to do a better job.
    Senator Carper. I commend you for your commitment to being 
plainspoken, and to making sure that the people who work with 
you are too. I commend you for your focus on executive 
compensation, and to make sure that the old adage that we treat 
other people the way we want to be treated and that we remind 
boards and people who run these companies, that there is a 
reasonable expectation that they should do that too.
    And I commend you for your commitment to trying to get the 
SEC, the five Commissioners, to be more collegial and to look 
for common ground so that when you come forward with your 
recommendations, that you find that you are more unanimous than 
less.
    Thank you.
    Chairman Cox. I have to say when it comes to executive 
compensation, I am also trying to lead by example. As Chairman 
of the SEC, I have over 800 people at the Agency that make more 
than I do.
    Senator Carper. You are a great role model there.
    Senator Bennett. [Presiding.] Senator Sununu.
    Senator Sununu. Thank you.
    Chairman Cox, Senator Hagel brought up the change in the 
New York Stock Exchange rules. They were changes that exempted 
a single company, Fannie Mae, from their mandatory delisting 
proceedings. And it was done largely on the basis of the market 
capitalization of the firm. I think your answer was 
effectively--well, we hope that they can move forward and get 
this restatement issue done in the near-term. And we all hope 
that, but the fact is the Exchange had very clear procedures 
regarding delisting and they chose to craft an exemption for 
this one firm.
    And basing it on the overall size of the market 
capitalization begs the question, well, what happens when a 
similar exemption is sought for Exxon or for General Electric 
or for Google or for Philip Morris or for any one of the 
companies that have a larger capitalization than Fannie Mae? Is 
the SEC going to agree and concur that this is a good idea when 
a similar exemption is sought for other firms that might be 
larger than Fannie Mae?
    Chairman Cox. No. This is, in my view, sui generis because 
of the coincidence of the initial subjection of this Government 
Sponsored Enterprise to the reporting requirements of the 1934 
Act and their massive restatement. Getting them online, getting 
them to be subjected to the Exchange Act, represents a 
significant change that has been, as you know, the subject of 
considerable legislative as well as Agency attention.
    Senator Sununu. It is my understanding that the delay in 
their filing of reports is not necessarily related to their 
compliance with the 1934 Act. These are their financial 
statements that have to be restated because of significant 
discrepancies and irregularities in the way certain 
transactions were accounted for. We have the findings of the 
Rudman Report that certainly validate those concerns. They had 
much more to do with irregularities in the accounting process 
and attempts to manipulate earnings than any specific changes 
that come as a result of their participation in compliance with 
the 1934 Act.
    Chairman Cox. Well, as you know, the timing of this was as 
follows. Fannie registered under the Exchange Act and became a 
reporting company for the first time on March 31, 2004. Their 
last periodic report was their Form 10-Q for the quarter ended 
June 30, 2004, that was filed August 9, 2004. And it was 
September 2004 that OFEO issued their preliminary report about 
Fannie Mae's accounting practices that led subsequently to 
Fannie seeking guidance from the Commission and our accounting 
staff regarding several of their accounting matters, including 
deferred purchase price adjustments and derivatives and hedging 
activities and so forth.
    It is that confluence of events to which I refer that I 
think makes this different than, for example, a Google or any 
other recently public company.
    Senator Sununu. I appreciate the point you are making, but 
I think it is a stretch when these are irregularities that 
occurred in 2001, 2002, and 2003 and they are irregularities 
that would have delayed or forced a restatement of earnings 
regardless of their decision to comply under the 1934 Act in 
2004. Senator Hagel made the point that it perhaps sends a bad 
message to investors, to other participants in the market. And 
I am equally concerned that it establishes a very bad 
precedent, because when you base the exemption, as was done--I 
do not think the language mentions timing or changes or 
applicability of the 1934 Act.
    The Federal Register does not mention that: Standards apply 
only in certain very rare circumstances where the Exchange 
determines that delisting would be contrary to the national 
interest and the interest of public investors--due to the 
filer's position in the market, i.e., the nature of its 
business and its very large publicly held market 
capitalization.
    That is the Federal Register from January 26, 2006.
    So if this rationale had been presented by Fannie Mae or by 
the Exchange, I might be a little bit more sympathetic. But I 
do not think that is the argument that was made, and that is 
why I have concerns about the precedent.
    Chairman Cox. But I just want to say, I agree with you that 
it cannot simply be the question of size and if you are of a 
certain size then you get a pass.
    Senator Sununu. I appreciate that clarification.
    Final question on market data. The SEC has been looking at 
this issue well before your time. They had a concept release in 
1999, an advisory committee in 2000; they proposed some changes 
to the way market data was dealt with in 2004 as part of 
Regulation NMS, et cetera, et cetera. Where does this stand? 
Can you commit to or talk about the Commission's determination 
to finally come to some conclusion on the question of market 
data, collection of revenues for market services, and the 
allocation of those revenues?
    Chairman Cox. I cannot tell you definitively how this is 
going to turn out, but I can tell you that it is a subject of 
intense focus, as you might expect. In the for-profit world, 
this is a source of potential ongoing revenue. At the same 
time, we want to make sure in the maintenance of orderly 
markets--one of our chief missions at the SEC--that we have the 
maximum amount of transparency. We also have correlative issues 
in the ongoing implementation of Regulation NMS. And so I think 
you can rest assured that this is on the front burner, but I 
feel as if I cannot tell you definitively at this moment how it 
is going to turn out.
    Senator Sununu. I appreciate that, although, to be clear, 
my question is not how will it turn out; my question is, is 
there enough focus to ensure that there will be some 
resolution, some decision, some determination, which, you know, 
has not been achieved, has not been implemented in the past. 
And I very much appreciate your point about----
    Chairman Cox. And my answer to that question is absolutely 
yes.
    Senator Sununu. I appreciate that. And to your broader 
concerns about transparency, I think this falls right into 
those sets of issues because some of the existing structure of 
the market data revenue collection distribution system can 
perhaps encourage people to break up orders--you know, take a 
1,000-share order, break it up into 10 different 100-share 
orders--in order to effectively distort and maximize a firm's 
benefit from the allocation and rebate schemes that are 
inherent in the current system.
    So from the transparency of both the regulator and an 
investor, I think there are improvements that can be made that 
would eliminate incentives to manipulate the trades and that 
would improve the transparency of trades that are occurring.
    Thank you very much.
    Thank you, Mr. Chairman.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you.
    Several items. Chairman Cox, thank you for being here and 
welcome to your first experience. I hope we have a lot of 
subsequent ones and that they are all pleasant.
    I heard the conversation about Sarbanes-Oxley. My 
experience during the break was not the same as Senator Dodd's. 
I had some venture capitalists tell me flatly they no longer do 
IPO's and Sarbanes-Oxley is the reason. And if it becomes 
necessary for them to take a company public or--``necessary,'' 
if it is the logical thing--they look to do it at some foreign 
exchange rather than in America. So as you do your analysis of 
the reports you have, this is anecdotal, there is nothing 
scientific about it, but it is a different kind of constituent 
response than the one that Senator Dodd----
    Chairman Cox. I appreciate that it is anecdotal. On the 
other hand, I was speaking up at Harvard University recently, 
Harvard Business School, to a group of venture capitalists who 
expressed precisely the same views.
    Senator Bennett. Okay.
    Chairman Cox. But that was also anecdotal.
    Senator Bennett. Right.
    Chairman Cox. There are now two----
    Senator Bennett. Okay, well, I heard Senator Dodd say he 
found nothing but good comments about it, and I had heard some 
of the other kind.
    Let me move to a subject that I have been on for some time 
and begin my remarks by saying that the SEC staff has been 
responsive. I have been talking about this for maybe a year or 
more, and they have, staff members have been in to see me, but 
the problem still exists. We are talking about naked short 
selling and the problems connected with that. One of the things 
that I have been told that I want to lay down and say I think 
this is an immaterial excuse, when they say but you get 99 
percent settlement and the FTD's are only in 1 percent of the 
dollar volume and therefore it is not really a big deal.
    You made the comment earlier with respect to Sarbanes-Oxley 
that you got 80 percent of the companies that might be made 
exempt but, if you look at a market cap, it will be very large. 
That same dichotomy exists with respect to the naked short 
selling. I got into this because I had constituents that had 
little companies, and for them it is a huge deal. And many of 
them insist that they have been destroyed by it. That is, the 
naked short sellers keep hammering their stock until finally 
they cannot raise any money, the company goes under, and nobody 
every has to cover. And I do not know that that is the case. 
Again, this is an anecdotal accusation that is made. But if 
indeed it is true, it is a demonstration of market manipulation 
that is not only clearly illegal, but also devastating to 
people who form companies and then try to turn to the markets 
to raise money and cannot because the shorts keep hammering 
them.
    I want to make it clear also, I do not think short selling 
is improper. I have sold short in my investment life. Usually I 
have been burned by it, but I have done it. And the broker that 
handled it gave me the old statement, ``He who sells what is 
not his'n must buy it back or go to prison.'' And apparently, 
some of these people are not buying it back. I always had to 
when I sold short.
    And it has gotten into the news again. I started doing this 
because, as I say, I heard from very small companies who were 
my constituents, and their stocks were traded on the pink 
sheets. And it looked like nobody cared on the pink sheets and 
they could hammer companies there all day long with naked short 
selling and nobody would look at it. And that is the thing that 
I raised with the SEC before.
    Well, now it is getting a little more currency. There is a 
piece in The Wall Street Journal on April 13. The headline 
says, ``Despite SEC Rules, the Small Amount of Naked Shorting 
Appears to Persist.'' And in that article, they talk about 
companies that have stayed on the list for months and months, 
on the list where the FTD's have not been cleaned up. 
Overstock.com, Martha Stewart Living Omnimedia, Inc., and 
Krispy Kreme Doughnuts have been on the threshold list for 
months. Overstock.com happens to be located in Utah, so that 
caught my eye.
    Then, on April 12, Forbes had a piece about short selling 
in hedge funds and how they felt that they were being taken 
advantage of. The latest Bloomberg has a piece, not 
specifically on short selling, but entitled ``Corporate Voting 
Charade,'' and says that the people who buy shares to sell them 
short then get involved in proxy fights and that people end up 
voting shares they do not own. They have borrowed the shares 
for short-selling purposes and then vote them when they really 
have no interest in the long-term health of the company.
    And there is an interesting chart in the Bloomberg piece 
about how some close corporate elections were decided by the 
voters of the short sales, and says that Alaska Air Group, the 
short sales were 4 percent of the voting and the winning votes 
were 2.4. MONY Group, 6.2 percent of the votes were in short 
proxies and the winning margin was 1.7. And El Paso, 76 percent 
were short votes and the winning margin was 17.2. And there are 
those who say this whole situation cries out for more SEC 
oversight and attention.
    So let me, with that, ask you the question, If you cannot 
answer it here, would like a response for the record. There 
have been a lot of companies that--well, ``a lot,'' several, we 
will say ``several'' companies have been on the Regulation SHO 
threshold list for a very long time. And one of them, as I say, 
is one of my constituents. Presumably, at least some of what 
has led these companies to be on the threshold list for so long 
is illegal short selling. So, I would like to know, as you 
examine the list, are you willing to use your authority to have 
the SEC continue its pursuit of basic transparency by requiring 
the disclosure of the amount of FTD's?
    Chairman Cox. Well, you covered a lot of ground.
    Senator Bennett. I apologize. Maybe I overwhelmed you here.
    Chairman Cox. I am trying to keep track of all of it.
    Senator Bennett. We will be happy to provide you with 
pieces of paper on all of this.
    Chairman Cox. Of course, I will take advantage of that as 
well.
    Senator Bennett. Sure.
    Chairman Cox. To start at the beginning and end at the end, 
the experiences that you described, some of them your own and 
many more that you have been apprised of by your constituents 
and others, are experiences that in some respects I have 
shared. When I first came to the Congress in 1989, I served on 
a subcommittee chaired by then-Chairman Doug Barnard, of 
Georgia, of the Consumer, Commerce, and Monetary Affairs 
Subcommittee. That subcommittee focused for several months on 
bear raids and short sellers and what was going on in that 
industry.
    I share completely your approach to this problem, that 
short selling is a component part of healthy markets, one that 
is perfectly respectable; and, indeed, it is an important check 
and balance in our system. From the standpoint of orderly 
markets, it is vitally important that shares be delivered. 
These are contracts, and they have to be fulfilled, and there 
has to be a rule of law.
    I also--moving to your next point--agree with you that it 
is faint comfort for someone with a microcap company to hear 
that statistically we are doing great, that we are reducing 
these failures to deliver and that life is much better now than 
it has ever been before because statistically we can prove it 
so. In a thinly traded company, life is different. So enforcing 
these rules in very different circumstances is also vitally 
important.
    Having said that, I do think it is important to recognize 
the progress that has been made under Regulation SHO, which the 
Commission, as you know, adopted in 2004, before I became 
Chairman. That rule became fully effective in January of last 
year. It has a modest ambition. It is designed not to eliminate 
but to reduce failures to deliver on short-sale transactions 
and to target potentially problematic short-selling--abusive 
naked short selling.
    What I can commit to now is that, when we have internalized 
and understood the results of our examinations, which are now 
ongoing, of compliance with Regulation SHO, and we have 
completed the examinations of some 45 firms that include 
comprehensive target exams of 19 clearing firms, I will 
recommend changes to our rules if those exams demonstrate that 
changes are necessary for the reasons that you describe.
    Senator Bennett. Let me just conclude, Mr. Chairman. I 
applaud what you are saying and I am sure you will go forward 
with that. Picking up on what The Wall Street Journal had to 
say with these three companies that are listed, that have been 
on the list for months, that might be one of the places to 
start. The company stays on the list for months, that is an 
indication to me that there is something going on that is 
unusual. I can understand an FTD, I can understand a flood of 
FTD's for a variety of benign reasons. But when a company is on 
the list 1 month, that says, well, okay, there are just some 
problems. When the same company is on the list for 2 months, 
well, maybe something is going on we need to pay--when it is on 
for month after month after month and catches the attention of 
publications like the Journal, I think that should be a rather 
informal but strong flag that says we should pay attention at 
least to these companies to see why they keep showing up on the 
threshold list.
    Thank you very much.
    Chairman Cox. Thank you very much, and I hope to be able to 
follow up with you on these things.
    Chairman Shelby. [Presiding.] Thank you, Senator Bennett.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you, 
Chairman Cox, for being here. Glad to see you are on top of all 
of these things.
    I have a whole bunch of questions on cats and dogs here, 
but one I know you have been asked about. I would just like to 
underscore my concern here as a New Yorker, that so many of the 
IPO's, none of the top 10, one out of the top 24, have not 
listed in the United States. In 2000, 9 out of 10 listed in the 
United States. And as I understand it, some people have asked 
you a little about that, but obviously I hear from somebody 
whose goal is to keep New York the financial capital of the 
world. That troubles me.
    What can we do about it? Does it worry you, I guess, is the 
first question I have, and what can we do about it to try and 
change it? Is it temporary?
    Chairman Cox. All right, let me begin by saying that I 
share your objective.
    Senator Schumer. Thank you.
    Chairman Cox. The U.S. capital markets are today, and 
certainly have been for some time, the largest, deepest, most 
liquid in the world. They are also--and, I believe, not 
coincidentally--subject to the highest standards of quality in 
the world.
    Senator Schumer. Right.
    Chairman Cox. It was remarked upon, I believe by Senator 
Sarbanes earlier, that some studies show that there is a 
quality premium that companies can demand when they list in the 
United States.
    That is the way strategically, I believe, the United States 
should continue to approach our role in the world's capital 
markets. Rather than participate in a race to the bottom that 
surely, in terms of comparative advantage, we would lose, it 
should be our objective to work together with other high-
standards countries to make sure that that is the way the world 
goes as increasingly there are more global markets.
    It is a fact of life that the domestic markets of other 
countries are becoming rather rapidly more mature. And so I do 
not think that by birthright the United States can lay claim to 
every large issue by every foreign issuer. But we certainly are 
entitled to our share. And certainly, if we are correct in our 
view that our markets are in fact the most liquid, deepest, 
largest in the world, we can expect that countries will want to 
come and list here for precisely that reason and to gain that 
premium the price premium that they should be getting.
    Senator Schumer. Right. But they are not coming now. I 
think we all agree with that. In an international world there 
is a delicate balance, obviously. You want to strike the right 
balance. It is just the change has been so dramatic over 5 
years. Five years ago, we were also the most highly regulated. 
Could it just be that others are catching up in sophistication? 
And why are people not still willing to pay that little premium 
so their investors worldwide know that they are being well-
regulated? It is a troubling phenomenon.
    Chairman Cox. I agree with you that we need to keep our eye 
on this ball. And to the extent that the perception exists, and 
I believe that it does in Europe and elsewhere, that the costs 
of regulation and of litigation in the United States are 
comparatively unpleasant and they would like to sell 
themselves, comparatively, as better in those respects, we need 
to do everything that we can to make sure that we achieve our 
objectives of high standards without unnecessary costs. And 
that is something that is all in implementation. It is perhaps 
some art as well as science. But it is what we aim to do at the 
Commission, to make sure that investors get every ounce of 
protection that we can give them at the lowest possible price.
    Senator Schumer. Right.
    You know, the cost issue troubles me some because for a 
smaller company, you get the estimates, $15 million, $30 
million the first year, but for a huge billion-dollar company, 
I mean, $30 million is still nothing to sneeze at, but it seems 
a small price to pay for the Good Housekeeping Seal of 
Approval, if you will.
    So, I cannot believe it is cost, at least for larger 
companies, that keeps them away. It has to be something else. 
Now, somebody suggested to me, and I do not know where I would 
come down on this, that their directors do not like to be under 
the kind of extra scrutiny that they are here now. Could that 
be a possibility? Or ``extra responsibility'' is a better word 
than ``scrutiny.''
    Chairman Cox. Yes, I think expressed in that way and 
understood through the prism of liability, it may well be that 
human beings, particularly the human beings in control, have an 
affective as well as quantitative response to----
    Senator Schumer. Which might not be good for their 
companies but might be better for them.
    Chairman Cox. Yes. To some of these questions. You know, to 
the extent that what we are trying to do here is for the 
benefit of shareholders--eliminate conflicts of interest, 
maximize transparency--I think that eventually it will be seen 
for what it is, as an advantage to the people whose money we 
are talking about. And so, I do not think we need to hesitate 
at all in our drive to constantly reinforce our high standards 
in this country. We do need to make sure that, as we implement 
those high standards, we are doing it with the interests of 
investors in mind.
    And it is their money. So, if we are wasting their money on 
needless complexity, some of what I talked about here earlier 
today, if the rules are being implemented in a Rube Goldberg 
way, if we have an instinct for the capillary instead of the 
jugular, we can fix those things.
    [Laughter.]
    But we do not want to miss the main point. And so to the 
extent we were talking about, elliptically here, Section 404 or 
Sarbanes-Oxley, I want to get back to my main point of 
emphasis, which is I was a conferee on that legislation, and I 
worked with many of you to put it into force. I think we can 
make it work in a way that causes people to want to list in the 
United States and that causes investors to insist on those high 
standards.
    We are seeing some of that right now. We are seeing some of 
Sarbanes-Oxley imitated in other countries, in other regulatory 
regimes. So, I do not think we have to be supine here and not 
fight back when it comes to standing up for ourselves.
    Senator Sarbanes. Chuck, would you yield for a minute?
    Senator Schumer. I would be happy to yield.
    Senator Sarbanes. There is this--I mentioned earlier, Ernst 
& Young has done this third annual report on global IPO trends, 
which is pretty interesting. And the two trends they point to 
that have an impact on all of this is, one, that a major driver 
is the privatization of former state-owned enterprises and that 
there is a lot of political direction or pressure when that 
happens for it to be done on the local exchange. Like the 
Chinese do it in Hong Kong, the French do it on Euronext, and 
so forth.
    The other point they make is the increasing pools of 
capital that are available elsewhere around the world, and so, 
the capital is not just in the New York market, it is to be 
found in other places.
    And third, some of the exchanges abroad are making a bald 
pitch that they have less regulation. You know, come to us, we 
are not as----
    Senator Schumer. We have that here in America, too. Some of 
them are doing that.
    Just one quick other one. Soft dollars, where the SEC has 
been making progress and you have been moving forward on it, 
but the question I guess I have is very simple. And that is 
when will the SEC issue a final interpretive release? Things 
were moving along nicely and now--are there bumps in the road 
now, or is there any reconsideration----
    Chairman Cox. No.
    Senator Schumer. What is slowing it down?
    Chairman Cox. No, in fact we are on the threshold of 
action.
    Senator Schumer. You are?
    Chairman Cox. Yes.
    Senator Schumer. Good.
    Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Chairman, what is the state of mutual 
fund disclosure today, and are we obscuring truly important 
information by requiring the disclosure of so much information 
that is basically boilerplate in nature? Is that a concern 
sometimes? You spoke about it earlier.
    Chairman Cox. This is a central focus of our effort to make 
things better for retail customers. Because, as you full well 
know, for retail customers mutual funds are the investment of 
choice.
    Chairman Shelby. We have nearly 100 million Americans 
investing one way or the other.
    Chairman Cox. Precisely. And so, if there were any area 
where we were going to focus our efforts--on plain English, on 
information that consumers can understand--it would be here. 
This also is an area where we are, early on, focusing our 
efforts on interactive data. And I will say that the mutual 
fund industry and the Investment Company Institute have been 
willing partners in this. Very recently they have committed to 
finishing writing the taxonomies necessary to present 
information to consumers within interactive data.
    I am tempted to go off on a riff about all the potential 
benefits of interactive data, but that might be a topic for 
another hearing. Suffice it to say, directly to your question, 
that we can do a lot to make mutual fund disclosure more useful 
to investors. And using the Web and letting investors find what 
they want, letting intermediaries and analysts who prepare 
information for retail customers more easily compare what is in 
funds, which interactive data helps with, all is in the offing.
    Chairman Shelby. Nothing like an informed customer, is 
there?
    Chairman Cox. That is what makes markets work.
    Chairman Shelby. In the area of accounting, convergence of 
accounting standards, which are very important, I applaud your 
efforts to harmonize the international financial reporting 
standards and U.S. GAAP. In my view, this endeavor will greatly 
benefit the global capital markets, as we have been talking 
about. Could you provide the Committee with an update on this 
multiyear project now, or just for the record?
    Chairman Cox. I would be happy to do a little of it now and 
further for the record, if you would like.
    In October of last year, IOSCO announced plans for creating 
an arrangement for regulators to consult and share information 
on their decisions regarding the application of International 
Financial Reporting Standards. One end product of this project 
will be a database for cataloging interpretations and decisions 
that will help us improve cross-border enforcement of the 
application of these standards, and work is continuing on the 
development of that database. It is anticipated that IOSCO is 
going to launch this in the second half of this year.
    In February of this year, the FASB and the IASB announced 
an MOU, which outlines their topical priorities and related 
anticipated deliverables, in their efforts to further their 
standards-setting work to converge the provisions of U.S. GAAP 
and IFRS. And that MOU covers work that is planned to occur 
between this year and in 2008.
    Beginning in the second half of this year, the SEC staff 
plans to begin reviewing the 2005 IFRS financial statements and 
accompanying U.S. GAAP reconciliations filed with the SEC by 
approximately 300 foreign registrants. That in turn is going to 
help inform the SEC staff as to how IFRS is being applied and 
practiced by those registrants. To keep us on the road map, we 
want to make sure that there is a consistency in application 
both within industries and across national boundaries.
    Chairman Shelby. Mr. Chairman, Sarbanes-Oxley. In your 
view, which provision or provisions in Sarbanes-Oxley have had 
the most impact on corporate governance and financial 
reporting?
    Chairman Cox. I hesitate to pick my favorite because that 
might sound like faint praise for all the rest.
    Chairman Shelby. To my colleague sitting here.
    Chairman Cox. Exactly. Let me come at the question from the 
other end and take this advisory committee report that we just 
received on Monday. It is instructive to read that report and 
to find in it, coming from advocates for smaller public 
companies, a fairly ringing endorsement of virtually every 
provision of Sarbanes-Oxley. They have a great deal of focus 
and concern on one section, on 404, but I think, for companies 
of all sizes and for companies within and without the United 
States, essentially all the rest of Sarbanes-Oxley is proving 
to be of salutary effect.
    Chairman Shelby. Senator Sarbanes. Oh, Senator Crapo has 
not had a round yet, I am sorry.
    Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman.
    I apologize. I have had to step out of the meeting, so I am 
glad I got back before they cut you loose, Chairman Cox. I 
first of all want to welcome you here. I remember when I first 
sat together with you on the Commerce Committee in the House, 
and I have enjoyed the opportunity to work with you on many 
different issues and in many different contexts. I am very 
pleased that you are now the Chairman at the SEC.
    I did want to get back to address one issue. I found out as 
I got back that Senator Bunning already raised it, and that is 
Regulation B. I understand from what Senator Bunning brought up 
with you that you are meeting with banking regulators later 
today on Regulation B and you are going to be working on the 
issue. So, I will not go into the whole thing because I know 
you have already done it in the hearing today.
    I just wanted to pursue one other aspect of this, and that 
is I have been concerned enough about this issue that I have 
concluded that we probably need to have some additional 
legislative direction provided on the issue. And as I am sure 
you are aware, I am working with Senator Shelby, Senator 
Sarbanes, and others on the Committee on a regulatory relief 
package for our financial institutions. It is my intent to see 
if I can work with Senator Sarbanes and Senator Shelby to come 
up with an acceptable approach to provide further legislative 
guidance on how to address the issue.
    And so the main purpose of my wanting to get back here to 
talk with you about that is to ask if you would be willing to 
work with us, especially after you have had this meeting with 
the other regulators and people that you are working with on 
it, to help us to craft the right approach in the regulatory 
relief package that we are working on.
    Chairman Cox. By all means. If the Congress chooses to 
enact legislation in this area, rather obviously we would 
follow it to a T. In the process of developing such 
legislation, if you choose that course, we would be happy to 
make our professional staff available for technical support. 
And as Chairman, I would be happy to discuss the aims of any of 
this with you.
    In the meanwhile, we have a relatively new--although it is 
hard to call a 1999 enactment new for much longer--legislative 
enactment. But it is new in the sense that we have yet to adopt 
rules under it. It is my view that it is high time we did so. 
So, I intend to see if we cannot make this work in the short-
run.
    Senator Crapo. I appreciate that and I certainly believe 
that you should continue to pursue the avenue of the rulemaking 
process in terms of improving it. As you know from the letters 
that many of us sent to the SEC, to your predecessor, actually, 
at the SEC, and then from the activities of many of us, I have 
a high level of concern about the current proposed rule and the 
negative impact that it will have. So that is one of the 
reasons that I have concluded that, after waiting for so long 
to see if we could not get something resolved, that we need to 
provide further legislative guidance.
    But also, I encourage you as you work on the rulemaking 
side of it to please pay attention to the issues that we have 
raised and see if we cannot move forward in a way that does not 
create the kinds of burdens and unintended consequences that we 
have suggested are lurking in the current proposal.
    Chairman Cox. You mentioned that you and I sat next to each 
other on the Commerce Committee. When we did so back in the 
1990's, we were working on this issue. So, I think it really is 
high time for us to implement the rules.
    Senator Crapo. Thank you.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Sarbanes.
    Senator Sarbanes. I just have a couple of questions, Mr. 
Chairman. I do want to follow up on Senator Crapo's question 
just to say that we know Chairman Cox well and we have seen his 
skill in the Congress of being able to develop a consensus and 
move complicated and difficult issues through the Congress. And 
as I understand, he is undertaking that role on this Regulation 
B issue in terms of interacting with the other regulators. So, 
I think it is a welcome and important initiative on the part of 
the Chairman.
    I wanted to ask about the money laundering issue, which is 
something this Committee has spent a lot of time on. It has 
been very much the focus of attention by the Chairman. We feel 
particularly keenly because the September 11 Commission 
recently evaluated all of the different areas on which they 
have made recommendations as to how our Government was doing in 
those areas. And the only issue on which they gave up an A-
minus was on money laundering and terrorist financing. We think 
there is even more to be done, but at least we keep pressing 
that issue.
    A year and a half ago the Federal banking agencies and the 
Financial Crimes Enforcement Network, FinCEN, executed a 
memorandum of understanding to ensure better coordination and 
information sharing on the critical issue of Bank Secrecy Act 
compliance. I think it is fair to say the Committee pushed very 
hard to get that memorandum of understanding. And FinCEN has 
since advised us they are executing similar agreements with 
State banking agencies.
    The first question, it says FinCEN approached the SEC about 
executing an information sharing agreement about the results of 
Bank Secrecy Act examinations involving brokers and dealers in 
securities, and if so, is the SEC planning to execute such an 
agreement?
    Chairman Cox. Well, the answer to both questions is yes. 
Our staff are quite close, in fact, to reaching an agreement in 
principle with FinCEN which will then come to the full 
Commission for its approval. And, in the meantime, the staff 
have been having regular meetings and sharing information with 
FinCEN, including the results of examinations we propose.
    Senator Sarbanes. Second, on the Chairman's question on 
convergence with the international financial reporting 
standards. I agree with the Chairman in that it is desirable to 
achieve convergence, but I think it is important to do so 
moving the standards upward and not downwards. I know in the 
EU--well, let me put it the other way. The International 
Accounting Standards Board, I think, Sir David Tweedie and 
others take the same approach, so I am hopeful that out of that 
would come that the convergence would be achieved at a higher 
not a lower level. And I think that is a very important 
objective to keep in mind.
    I do want to--we focused on financial literacy here. I know 
you have emphasized that issue down at the Commission. And I 
want to underscore its importance. Every survey just gives the 
most distressing results about the degree of financial 
illiteracy, particularly amongst our young people. Although, as 
you point out, seniors end up getting exploited in a very 
different way, and I welcome that initiative you have taken in 
that area. But what is your view on the financial----
    You know, we set up the Financial Literacy and Education 
Commission to bring all the Federal agencies together to 
develop a program and carry it forward and then develop 
cooperative arrangements with the States and nonprofits, many 
of which work in this area--some of which have quite good 
programs, others not so good. What is your take on this effort, 
or this initiative?
    Chairman Cox. This is a priority not only for the SEC, but 
also for virtually every financial agency in the Federal 
Government and for the President's Working Group. And under 
those auspices the FLEC report was recently approved. The SEC 
for its part is doing a fair amount through our Office of 
Investor Education and Assistance to spread the word not only 
through our website and through the provision of educational 
materials, but also through seminars and cooperative efforts 
that we put on with community organizations around the country. 
And as you pointed out earlier, Senator, a good deal of this 
focus has also been on our men and women in the armed services.
    Senator Sarbanes. Yes. Finally, Mr. Chairman, since we have 
been talking about 404, I cannot resist a final comment. All 
the statute does, it has two short paragraphs, as Chairman Cox 
noted earlier. One says if you are a publicly listed company 
you have to have a system of internal controls. Presumably, if 
you talked to someone who wanted to list or was trying to get 
you to invest in their company, you said to them, well, how is 
your system of internal controls; and the person says, well, I 
do not believe in a system of internal controls, I do not have 
one. You would say, hey, now, wait a minute. What kind of 
operation is this?
    The other paragraph says that the system of internal 
controls has to be certified as being adequate, appropriate--I 
forget the exact language. And of course that is designed to 
make sure you do not have a phony system of internal controls.
    In that arena, there is considerable discretion in the 
PCAOB and the SEC in terms of developing the protocols that are 
appropriate. And it seems to me that that is where the focus 
should be in terms of addressing these issues that are being 
raised. The proposal for a total exemption would take out of 
the system a very significant number of companies, 80 percent.
    Many of the studies show that some of the worst abuses 
occur in smaller companies, not large companies, the number of 
restatements. We get these letters that come in over the 
transom from people who say I have been reading these proposals 
to exempt the smaller public companies, I used to work for a 
smaller public company, whatever you do, do not exempt them, 
they need to have some routine that improves their operations. 
And of course the Commission last year held a roundtable and 
gave some guidance, and you are going right back at it this 
year, in the middle of May, with a further roundtable.
    It is being looked at. I think the fees still remain too 
high, but they are coming down. You had a situation where a lot 
of people were not up to standards. They in effect had to make 
an investment, almost like a capital cost, in order to set the 
system up. Presumably, once set up, in subsequent years it will 
not be as expensive. And I think we have to work through that 
system. I know you are hearing a lot about it, but I want to 
leave you with that observation.
    Mr. Chairman, thank you. And I thank Chairman Cox.
    Chairman Shelby. Chairman Cox, it is my understanding that 
you will be coming back next month to the hearing dealing with 
financial literacy. You will be appearing with Secretary Snow 
and Chairman Bernanke. I hope then that we can get into more 
depth on the issue of financial literacy. We think it is very 
important.
    Oh, Senator Schumer again. Second round.
    Senator Schumer. Thank you. Another two quick ones on 
issues of some importance here.
    Chairman Shelby. Okay.
    Senator Schumer. One, this is about credit rating agencies, 
also located in the great City of New York. First, I saw that 
the Commission recognized the First Amendment issues when they 
had the interaction between the SEC and journalists. I thought 
you handled that well, Mr. Chairman.
    We have similar issues with some of these rating agencies, 
where people will threaten to sue them, you know, to threaten 
them, bamboozle them, push them around and stuff like that. 
They need to be strictly regulated. They need to make sure 
there is no conflicts of interest. But on the other hand, they 
cannot be cowered for making an independent judgment that 
somebody might not like.
    So the first question I have on this is, what steps should 
the Commission take to show the same kind of sensitivity you 
showed with reporters about these agencies in terms of First 
Amendment ability to say what they really come up with?
    Chairman Cox. Well, it goes without saying, I would hope, 
that neither the Securities and Exchange Commission nor any arm 
of Government, Federal or State, should be intruding upon the 
independent judgment of these credit rating agencies. That is 
what we expect them to be exercising.
    Senator Schumer. Right. I am more worried about private 
people pushing them around a little bit.
    Chairman Cox. At the same time, you know, to the extent 
that we can do so, we need to be completely supportive of the 
agencies vis-a-vis all comers in the exercise of that 
independent judgment.
    Senator Schumer. Right. Okay.
    Let me ask you this, because they are opposite sides of the 
same coin, obviously, if they are--if everyone thinks they are 
fair, impartial, on the level, they have more protection built 
in. So the rating agencies have issued in the last few years, 
when certain abuses were put out, codes of conduct about 
quality, integrity, transparency, they were based on the model 
code of conduct developed by the IOSCO under the leadership of 
the SEC--particularly Commissioner Campos was very involved in 
this. And rating agencies are beginning to issue reports on how 
they have implemented their codes of conduct. Moody's and S&P 
have already done so. They are making good-faith efforts to 
improve the transparency of their ratings.
    And I also understand that the SEC and the current NRSRO's 
have been working on a voluntary framework for SEC oversight of 
them. What role do you envision for the Commission in 
finalizing the framework, and what is the timeline here?
    Chairman Cox. Well, as you point out, the SEC has been 
supportive of the development of the IOSCO guidance. I think 
the recognition of the global aspect of this is very important. 
Albeit, it is essentially the U.S. firms that are dominant; 
this is a global business.
    Also, with respect to the voluntary framework that is being 
developed by the NRSRO's themselves, that effort has been under 
way since somewhere in the middle of 2004, I think. We are 
working at the Commission on the assumption that we really do 
not know the answer to the question whether you are going to 
legislate or not on this topic, and therefore we need to be 
prepared alternatively with our own action or with cooperative 
technical guidance----
    Senator Schumer. But do you intend to wait to see if we 
legislate before you do what you were doing?
    Chairman Cox. I will say, I am trying to be sensitive to 
the ongoing process. I mean, there have been hearings on both 
sides of the Capitol on this subject, and we want to be as 
supportive as we can on the technical side in the development 
of any legislation that might happen.
    But no, we are not--since I do not know whether there will 
be any legislation, we are not going to abey until we know the 
answer to that question. We are proceeding apace.
    Senator Schumer. You are?
    Chairman Cox. Yes.
    Senator Schumer. Because you might come up with something 
that makes everybody happy and we will not have to legislate.
    Chairman Cox. That would be pleasant all around.
    Senator Schumer. Yes, it would.
    Okay, thank you, Chairman Cox.
    Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Chairman, thank you very much for your 
appearance. It has taken us awhile this morning. We look 
forward to working with you. And Senator Sarbanes asked you 
earlier, alluded to the fact you have the resources you need. 
We will talk about that, because I chair a different committee 
and would like to sit down with you and see how you are doing 
with your money, what you need, and where you want to go. Fair 
enough?
    Chairman Cox. I welcome the opportunity, Mr. Chairman.
    Chairman Shelby. We will do that. Thank you.
    The hearing is adjourned.
    [Whereupon, at 12:25 p.m., the hearing was adjourned.]
    [Prepared statements and response to written questions 
supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    Welcome Chairman Cox. It is good to see you, and I am glad to see 
you have recovered from your surgery.
    Chairman Cox, I am happy to read in your testimony that you are 
focusing your efforts on the individual investor. Making plain English 
the official language of the SEC is an important step to level the 
playing field for all investors. I wish that more of Washington would 
follow your lead.
    Anything that can be done to improve access to information, and 
people's understanding of it, will help both new and experienced 
investors.
    Your program to use modern electronic communications to reduce the 
burden on companies and the SEC will lead to more efficient regulation 
and management. But most importantly it will give investors more and 
easier access to financial data, and that will help them make better 
investment decisions and hopefully encourage more Americans to get into 
the markets. I am glad you are taking your time with the new data 
program to make sure it is done right. I think it is also important to 
make sure investors continue to have access to the information in ways 
they can use.
    I hope the Commission does not rush to adopt proposals that could 
have the effect of making information, such as printed annual reports 
or proxy statements, harder for shareholders to get. The last 
Commission Chairman left you with some controversial and misguided 
proposals.
    In fact, just weeks ago, the DC Circuit sent the regulation 
requiring independent chairman and directors for mutual funds back to 
the SEC for the second time. A court decision is coming soon on hedge 
fund regulation too.
    Also, as many Members of this Committee stated in a letter to 
Chairman Donaldson, the proposed Regulation B goes against the clear 
intent of Congress in the Gramm-Leach-Bliley Act.
    I encourage you to take a fresh look at those regulations and 
whether they are needed before proceeding with them.
    I encourage you to keep looking out for all investors, and to do so 
in a way that encourages business innovation. Giving people access to 
better and more useful information is an important step, but financial 
education is also very much needed.
    I look forward to hearing other ideas you have to help the public 
better understand the securities markets.
                               ----------
             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
    Thank you, Chairman Shelby and welcome, Chairman Cox.
    I have been following your efforts over the last 8 months and I 
want to commend you on a successful beginning. You have worked to gain 
consensus with your colleagues and establish some key reforms that have 
been beneficial to investors and consumers alike. I support your 
efforts in enhancing disclosures and simplifying the law.
    As you know, the SEC's role is absolutely vital to maintaining a 
robust and vibrant economy, and providing working men and women the 
piece of mind they need to become investors in the American Dream.
    As you testify today, I am very interested in hearing your 
suggestions to improve education for the common investor. As more and 
more individuals retire, I am concerned that the average investor will 
not have the resources to appropriately scrutinize the options 
available to them upon retirement.
    In Michigan, this is a critical concern for families--workers who 
have worked hard and paid into a retirement account need to understand 
what their options are after retirement.
    Second, I am interested in your perception of the global economy. I 
understand that the largest IPO's this year have been from foreign 
companies. In fact, the top three IPO's were from Chinese and French 
companies, and the largest IPO, China Construction Bank, was the 
biggest deal in 5 years.
    In your opinion, what impact does this have on our domestic 
markets? And, how do you see this trend moving in the future?
    Last, I have been hearing from businesses in Michigan that some of 
the current regulations out there are burdensome and costly. I hope to 
hear your opinions and improvement ideas to increase security yet 
maintain a manageable process for businesses.
    Again, I want to commend you on a great beginning and I look 
forward to this ongoing dialogue on maintaining investor confidence and 
finding improvement opportunities whenever possible.
    Thank you again for sharing your time with us today.
                 PREPARED STATEMENT OF CHRISTOPHER COX
           Chairman, U.S. Securities and Exchange Commission
                             April 25, 2006
    Chairman Shelby, Ranking Member Sarbanes, and Members of the 
Committee, thank you for giving me the opportunity to be here today to 
testify about the initiatives and priorities underway at the Securities 
and Exchange Commission to improve financial disclosure for individual 
investors.
    Several years ago, in the midst of rampant financial scandals and a 
crisis of investor confidence, this Committee held a series of 
exceptionally important hearings on corporate responsibility and 
investor protection. Those hearings, and the work of the Members of 
this Committee that followed, laid the foundation for landmark reforms 
that have restored investor confidence and the health of our capital 
markets. I commend each of you for your efforts, and am happy to report 
that the SEC is using the new tools that you have given us to ensure 
that those reforms are implemented exactly as intended by the Congress.
    A lot has happened in the 9 months since I last sat at this table. 
I very much appreciate this opportunity to give you a report on the new 
initiatives the SEC has undertaken, as well as to hear from you about 
your priorities.
Introduction
    The principal subject of this brief testimony is improving 
disclosure for the benefit of individual investors. If I may, I would 
like to take a step back and put these efforts into context.
    As a Member of Congress for 17 years, I was constantly reminded by 
my constituents of the real world impact of the decisions we make here 
in the Capitol. Like every one of you, I learned the importance of 
being a good listener, and of remembering that the common sense of 
ordinary Americans is the essence and the strength of our democracy.
    Most of your constituents are not investment bankers, or lawyers, 
or accountants. But most of them are investors. It is a stunning fact 
of life in the 21st century that a majority of Americans now own 
stocks, either directly or through mutual funds. It is chiefly to serve 
these people that the SEC exists. Our mission--to protect investors, 
promote capital formation, and maintain orderly markets--must always 
put ordinary Americans first.
    Since making the transition from the halls of Congress to the SEC, 
I have set out to rededicate the agency's ongoing efforts in virtually 
every area to the service of the individual investor.
    In a well-ordered market, educated consumers can choose from a 
number of competitive products, and find what they want at a price they 
are willing to pay. But in order to educate themselves, investors need 
comparative facts. So while investors must bear the responsibility of 
learning what they can about their investment choices, the correlative 
duty of sellers of investment products is to provide the relevant 
information. What's more, in order for investors to make sound 
decisions, the seller's information has to be understandable, 
accessible, and accurate.
    These are the basic ingredients of healthy competition in every 
corner of the financial marketplace.
    To more closely match the theory of a well-ordered market with 
today's reality, the SEC is currently pursuing four key initiatives to 
improve the quality and usefulness of disclosure for individual 
investors. These initiatives, taken together, are designed to ensure 
that investors have access to more accurate and understandable 
information about the securities they own or are considering buying.
    These four initiatives are:

 Moving from boilerplate legalese to plain English in every 
    document intended for retail consumption;
 Moving from long, hard-to-read disclosure documents to easy-
    to-navigate webpages that let investors click through to find what 
    they want;
 Reducing the complexity of accounting rules and regulations; 
    and
 Focusing our antifraud efforts on scams that target older 
    Americans.
Making Disclosure Understandable for Ordinary Investors
    It is the SEC's job to see to it that financial data and 
qualitative information about the issuers of securities are fully and 
fairly disclosed. But surely we cannot say we have achieved that 
objective if the information is provided in a way that is not clearly 
understandable to the men and women for whom it is intended. Empowering 
investors does not just mean better access to information--it also 
means access to better information. Simply put, the question is: Once 
that SEC-mandated information is available, is it understandable? The 
answer all too often is a resounding and frustrated ``no.''
    Even though they are nominally written in English, the disclosure 
in some documents that are provided to investors is often so full of 
legal jargon and boilerplate disclosure that it can actually obscure 
important information.
    Convoluted language and disclosure in footnotes may serve lawyers 
and insurance companies, but it does not improve an investor's ability 
to understand the most important facts about a particular investment.
    Exhibit A when it comes to convoluted disclosure is today's regime 
for reporting executive compensation. Ordinary American investors have 
a right to know what company executives are paid, because those 
investors own the companies. The executives work for them.
    It is a direct corollary of the fact that more than half of 
Americans own stock today, that executive compensation will be judged 
just like every other labor and material cost that a firm incurs. Gone 
are the days when investors were mostly privileged, high-income elites. 
Today's investors come from middle class households that sit around the 
kitchen table and make tough choices about their monthly budgets. They 
expect the companies they invest in to do the same.
    But how can an investor judge whether he is getting the best 
executive talent at the best price? Too often, the most important parts 
of total compensation are hidden away in footnotes, scattered in 
different parts of the proxy statement, or--depending on the form the 
compensation takes--not even disclosed at all until after the fact.
    Three months ago, the Commission voted unanimously to propose an 
overhaul of the executive compensation rules. This marks the first time 
in 14 years that the SEC has undertaken significant revisions of the 
disclosure rules in this area.
    The proposal would require better disclosure on several fronts.
    First, companies would report a ``total'' figure--one number--for 
all annual compensation, including perquisites.
    Second, retirement benefits would be clearly outlined in new tables 
showing the defined-benefit and defined-contribution plans of top 
officers.
    Third, there would also be clear descriptions of payments that 
could be made if an executive is terminated. No such disclosure is 
required under our current rules.
    Fourth, for the first time, all compensation for the last year to 
board members would be fully disclosed.
    Fifth, a new Compensation Discussion and Analysis section would 
replace the Compensation Committee Report and the performance graph, 
which is now often mere boilerplate and legalese. This new narrative 
section will allow the board members to have a frank discussion with 
their bosses, the shareholders, about how they have gone about 
determining the compensation for the company's top executives.
    Just to be clear, the Commission does not propose getting into the 
business of determining what is the proper method or level of 
compensation. It is not the job of the SEC to substitute our judgment 
for that of the board. Nor would I, speaking as Chairman, subscribe to 
the notion that all executive pay is excessive. Surely many executives 
deserve every penny they are paid, and more. It should go without 
saying that being a CEO requires a rarefied collection of attributes 
and skills that are in all too short supply. And it is a fact that 
competition in the market for executive talent can be fierce. At the 
same time, I need not cite here the several notoriously public cases of 
extravagant wastes of shareholder assets by gluttonous CEO's and pliant 
compensation committees.
    By improving the total mix of information available to investors, 
the directors who work for them, and the marketplace, we can help 
shareholders and compensation committees to better inform themselves 
and reach their own conclusions.
    Sixth, and finally: Since the purpose here is to improve 
communications, the proposed rules require that all of this disclosure 
be in plain English--the new official language of the SEC. That will be 
true whether the information is in a proxy statement, an information 
statement, or an annual report.
    Plain English uses plain words--and, among other basic ingredients, 
the active voice. We want to promote the use of the active voice not 
just because it makes for punchier sentences, but because it requires a 
definite subject to go with the predicate. That is the only way that 
investors will be able to figure out who did what to whom.
    It is a testament to the importance of this issue that, when the 
comment period on these proposed executive compensation rules closed on 
April 10, we had received nearly 17,000 comments. That is one of the 
highest totals in the SEC's 72-year history. We are now reviewing these 
comments and look forward to incorporating them into any final rules 
that the Commission may adopt for improved, plain English compensation 
disclosure.
    And we will not stop there. Some years ago, under Chairman Arthur 
Levitt, the SEC began a crusade for plain English in investor 
documents. It was a noble first step that has been carried on by both 
Harvey Pitt and Bill Donaldson. During my time at the Commission, I 
hope to advance this cause still further, so that ultimately every 
communication aimed at retail investors is so free of jargon and 
legalese that it could pass muster with the editors of the Money 
section of USA Today.
Improving Disclosure via Interactive Data
    Making the SEC's mandated disclosures more useful to investors is 
the idea behind another of our initiatives: Interactive data.
    The beauty of interactive data is that it will not only make 
today's 10K's, proxies, and mutual fund prospectuses more useful to 
investors, but it will also reduce much of the time and expense that 
companies currently devote to filing SEC reports.
    Today, the SEC has over 800 different forms. Each form is required 
to have its own cover page. The genesis of this requirement dates back 
to when reports were hand-filed in steel cabinets. Back then, the cover 
pages helped Commission staff do the filing--but today, they provide no 
useful information to the public, or to the SEC. Despite the fact that 
every individual company is required to file many different forms, 
these cover pages ask over and over again for the very same information 
in a slightly different format. In other words, more junk disclosure 
that no one needs, or wants.
    If one goes beyond the cover pages to the entire form, to focus 
only on the truly unique information in each one, it has been estimated 
that instead of the 800 forms now required, the SEC might have need of 
no more than a dozen.
    The key to making this happen is looking at the data on the forms 
independently from the forms themselves. That is what we mean by 
interactive data. Computer codes can tag each separate piece of 
information on a report, and tell us what it is: Operating income, 
interest expense, and so forth. That way, every number in a report or 
financial statement is individually identified, both qualitatively and 
quantitatively.
    For individual investors, this means they will be able to quickly 
search for any information they want without slogging through an 80-
page document. And it means they could search through our database not 
by the names of individual reports, but instead just by looking up the 
companies that file them. We would no longer need what we have for 
domestic issuers today: 9 Securities Act registration statement forms, 
3 Exchange Act registration statement forms, 2 annual report forms, 2 
quarterly report forms, 1 current report form . . . and a partridge in 
a pear tree.
    And I have not even gotten to all the forms for proxy materials, 
annual reports, securities ownership, tender offers, and mergers and 
acquisitions. Investors, and the analysts who interpret financial 
information for them, should not have to hunt around for each separate 
form--all the information should be in one place, organized by company. 
Today, every one of these forms has to be filed and processed 
separately, which adds to the SEC's workload; and then the investors 
have to separately hunt down every different form for a single company, 
making more work for all of them. Rube Goldberg would be proud.
    Our initiative to let investors get information fast, easily, and 
all in one place, envisions this added benefit: Instead of long and 
hard-to-read annual reports and proxy statements, investors could have 
easy-to-navigate webpages that let them click through to find what they 
want.
    I am extremely pleased that our interactive data initiative has the 
support of the Chairman and other Members of this Committee. In 
hearings and briefings before this and other Committees, you have heard 
the technology variously described as data tagging, or XBRL, or my 
personal favorite, interactive data. But whatever one calls it, the 
point is the same: To allow investors to more easily access, search, 
analyze, and compare data provided by public companies.
    The move to interactive data represents a sorely needed upgrade in 
the SEC's electronic disclosure regime.
    From the 1930's to the 1980's, the Commission required that 
disclosure documents be filed exclusively on paper. Thousands of 
companies mailed us hundreds of thousands of documents. Each document 
was date-stamped, copied, sent to various divisions for review, and 
made available to the public for physical inspection in a Washington, 
DC library that is still maintained by the agency at significant 
expense.
    In the 1980's, the Commission pioneered the use of electronic 
filing on our EDGAR system. (EDGAR stands for Electronic Data 
Gathering, Analysis, and Retrieval.) This was a significant leap 
forward, and it became even more so with the dawn of the Internet. Now, 
investors and analysts are able to download documents with the click of 
a mouse instead of making a trip to the SEC's library in Washington, 
DC.
    But while EDGAR was a great improvement for the 1980's, 20 years is 
a lifetime in the computer age. EDGAR may be electronic, but it is not 
interactive. It does not begin to tap the potential of the Web. Because 
today's EDGAR filings are really just snapshots of paper reports that 
are stored in electronic form, the information they contain is not 
searchable. Nor can it be used in any of the myriad ways that 
electronic data now speed around offices, home computers, and the 
Internet.
    With today's SEC reports, an investor or analyst who is looking to 
compare, say, data on annual capital expenditures of two companies, has 
to search through perhaps hundreds of pages of the filings of each 
company page-by-page. Not surprisingly, the burden of this time-
consuming, tiresome task has led to the creation of a cottage industry 
in rekeyboarding the information in SEC reports, so that it can be 
downloaded into spreadsheets and other software. Investors, or more 
precisely the intermediaries whose fees they pay, can then buy this 
information from both domestic U.S. firms and overseas providers to 
whom the drudge work has been outsourced. Once the information is 
manually input, it is often first sold to third or fourth parties for 
further reduction and analysis before it eventually is made available 
to an individual investor.
    One hates even to think of the human error and data corruption that 
inevitably occurs in this process. We know from experience that the 
error rate is unacceptably high.
    Interactive data is a way to eliminate these problems, and to 
connect investors directly to the information in a company's filings--
accurately, cheaply, and quickly. It will allow anyone to easily 
search, extract, compile, compare, and analyze financial and 
qualitative data according to each individual's preferences.
    What about the benefits beyond retail investors? For preparers of 
financial reports, interactive data could streamline and accelerate the 
collection and reporting of financial information to the SEC and the 
public. Further down the road, the potential exists for companies to 
use interactive data as a means of getting real-time management control 
information.
    The SEC is strongly committed to interactive data. This is why we 
have taken major steps to promote it. We have offered significant 
incentives for companies to file their financial reports using 
interactive data. These include expedited review of registration 
statements and annual reports. A number of well-known firms--the list 
is 17 and growing--have already begun to lead the way and are filing 
their reports using interactive data.
    And because mutual funds and exchange-traded funds have become the 
investment of choice for millions of Americans, I am very encouraged 
that the Investment Company Institute and its member funds recently 
decided to throw their weight behind interactive data.
    Throughout 2006, the Commission will host a series of roundtables 
focused on the move to interactive data. The first roundtable is in 
June. The discussions will focus on several topics:

 What investors and analysts really need from interactive data;
 How to encourage the development of software for companies, 
    institutions, and retail investors that takes full advantage of the 
    potential of interactive data; and
 How to redesign the SEC's disclosure requirements to maximize 
    the advantage of using interactive data.

    Our aim is to move from long, hard-to-read disclosure documents to 
easy-to-navigate webpages that let investors click through to find what 
they want. We want to emancipate the data from the page, and let it 
find its way across the Internet and around the world in the form of 
RSS feeds, AJAX applications, and whatever comes next. Revolutionizing 
the way the world exchanges financial information is a worthy goal. We 
intend to achieve it.
Accounting Complexity
    When it comes to giving investors the protection they need, 
information is the single most powerful tool we have. It is what 
separates investing from roulette. But if the SEC is truly to succeed 
in helping investors with more useful information, we will need one 
more ingredient: An all-out war on complexity.
    It is, of course, true that a complex world often requires complex 
solutions. And certainly, there are desirable states of complexity--the 
ones that arise from a thing's intrinsic nature: DNA. A snowflake. 
Encryption algorithms. There, the complexity is essential to the 
function. But it is the contrived, artificial complexities that cause 
the problems--intricacy without function. Winston Churchill said it 
best: ``However beautiful the strategy, you should occasionally look at 
the results.''
    That, Mr. Chairman, is what we are now doing at the SEC. We are 
looking at results from the vantage point of the ordinary investor. And 
what we are finding is that, in many cases, we are not getting the 
right results. The complexity of the disclosure mandated by our rules 
too often adds nothing to function.
    It is not just public companies that sometimes have difficulty 
using plain English. Our accounting rules and regulations also can 
sometimes be complex and difficult to interpret. And when the rules are 
difficult to interpret, they may not be followed very well. And if the 
rules are not followed very well, then intentionally or not, individual 
investors inevitably will suffer.
    When complexity needlessly adds to the costs and efforts involved 
in financial reporting, it is the investors who foot the bill. And when 
a company takes advantage of detailed standards and complex reporting 
to hide information from investors, rather than to disclose it, 
investors are doubly damaged.
    Not surprisingly, users of financial statements--investors and 
regulators alike--are looking for more balance in making financial 
reporting comparable and understandable. Preparers and auditors are 
also looking for standards that are easier to understand and implement.
    The SEC has been helping to lead a major national effort to reduce 
complexity in financial reporting. The laboring oar is being manned by 
the Financial Accounting Standards Board, which is already intently 
focused on improving the understandability, consistency, and overall 
usability of the existing accounting literature. The SEC staff are 
working closely with the FASB in a supportive role.
    The first step is to systematically readdress specific accounting 
standards that do not provide the most relevant and comparable 
financial information. Examples of standards in need of reworking for 
this reason include consolidations policy, certain off-balance sheet 
transactions, performance reporting, and revenue recognition.
    The second task is to codify generally accepted accounting 
principles. The codification will be a comprehensive and integrated 
collection of all existing accounting literature, and it will be 
organized by subject matter. The aim is to provide a single, easily 
accessible source for all of GAAP. A dividend of this project is that 
it will provide a useful roadmap to those areas most in need of 
simplification.
    A third priority is to stem the proliferation of new accounting 
pronouncements from multiple sources. We are encouraging the FASB to 
consolidate U.S. accounting standard setting under its auspices, and to 
develop new standards more consistent with a principles-based, 
objectives-oriented system.
    The final element of this strategy is to strengthen the existing 
conceptual framework for U.S. GAAP in order to provide a more solid and 
consistent foundation for the development of objectives-oriented 
standards in the future.
    Making financial reporting more user-friendly goes far beyond the 
work of the FASB. Weeding out the counter-productive complexity that 
has crept into our financial reporting will require the concerted 
effort of the SEC, the FASB, the PCAOB, and every market participant. 
This cannot be a one-time effort; we will have to commit for the long-
term. But it will be well worth it.
Financial Education for Retirees and Elderly Investors
    Finally, let me turn to our efforts to better protect older 
Americans against financial fraud.
    Consider these statistics: An estimated 75 million Americans are 
due to turn 60 over the next 20 years. That's an average of more than 
10,000 people retiring every day. Households led by people aged 40 or 
over already own 91 percent of America's net worth. The impending 
retirement of the baby boomers will mean that, very soon, the vast 
majority of our Nation's net worth will be in the hands of the newly 
retired.
    Following the Willie Sutton principle, scam artists will swarm like 
locusts over this increasingly vulnerable group--because that is where 
the money is.
    On a daily basis, our agency receives letters and phone calls from 
seniors and their caregivers who have been targeted by fraudsters. 
Sometimes there is still time to help. But often, the victims have 
already been taken. These fraudulent schemes may begin with a free 
lunch, but we want to make sure that they end with a very high cost to 
the perpetrators.
    That is why we are attacking the problem from all angles--from 
investor education, to targeted examinations, to aggressive enforcement 
efforts. And because State securities regulators share our concern 
about fraud aimed at seniors, we are cooperating in this initiative 
with State regulators across the country--the local cops on the beat.
    A top priority is education. SEC programs are aimed not only at 
older Americans and their caregivers, but also at preretirement 
workers, designed to help them reach their personal savings and 
investing goals as they age. While we cannot tell investors which 
products to purchase, we can arm them with the information they need to 
assess various products and investment strategies.
    We are expanding our efforts to reach out to community 
organizations, and to enlist their help in educating older Americans 
about investment fraud and abuse.
    A portion of the SEC website is devoted specifically to senior 
citizens (http://www.sec.gov/investor/seniors.shtml). We provide links 
to critical information on investments that are commonly marketed to 
seniors--including variable annuities, equity-indexed annuities, 
promissory notes, and certificates of deposit.
    On the SEC website, investors can also find detailed warnings 
against the dangers of listening to the sales pitches of cold-callers. 
We are alerting seniors to the very real threat of affinity fraud--
scams that prey upon members of groups to which they may belong, 
including their religion, their nationality or ethnic heritage, or 
their profession.
    Seniors are often subjected to high pressure sales pitches that are 
simply not true, such as telling seniors that equity-indexed annuities 
``just can't lose money.'' There are also ``free lunch'' seminars that 
encourage seniors to buy complex products that do not fit the risk 
profile of a retiree with a relatively short life expectancy. There are 
also outright scams, such as Ponzi schemes.
    To detect abusive sales tactics that target seniors, examiners in 
our SEC field offices will share regulatory intelligence with their 
counterparts at the State level, and with other regulators. Once we 
identify firms that may be preying on seniors, we will examine those 
firms to make sure their sales practices are lawful.
    This effort has already started in Florida, where we've recently 
initiated on-site compliance examinations, along with the State of 
Florida and the NASD, of firms that sponsor ``free lunch'' investment 
seminars. Our goal is to see that the sales people at these seminars 
are properly supervised by their firms, and that the seminars are not 
used as a vehicle to sell unsuitable investment products to seniors.
    Each of our offices across the country will work closely with State 
and local law enforcement, and both Federal and State regulatory 
agencies, to target scams aimed at seniors. And they will work together 
to bring both civil and criminal actions aimed at shutting them down. 
This effort is already well under way in California.
    Finally, when we do find fraud, you can be sure that we will do 
something about it. Over the past 2 years, the SEC's Division of 
Enforcement has brought at least 26 enforcement actions aimed 
specifically at protecting elderly investors. Many of these actions 
were coordinated with State authorities.
    In one notable case, SEC v. D.W. Heath and Associates, the 
Commission coordinated with the Riverside County District Attorney's 
Office to crack down on a $144.8 million Ponzi scheme that lured 
elderly victims in southern California to workshops with the promise of 
free food. The Commission's complaint alleged that the defendants then 
bilked them out of their retirement money by purporting to sell them 
safe, guaranteed notes.
    Just last month, in SEC v. Reinhard et al., the Commission halted 
another possible Ponzi scheme, this time in Allentown, Pennsylvania. 
The Commission's complaint alleges that the defendants raised more than 
$3.9 million from at least 50 investors in several States by claiming 
to sell certificates of deposit that did not exist.
    The complaint further alleges that the primary salesman lured 
investors, many of whom are elderly, with promises of above-market 
rates on FDIC-insured CD's purportedly issued by a nonexistent entity 
called the ``Liberty Certificate of Deposit Trust Fund.'' The complaint 
also alleges that the defendants distributed fictitious investment 
documents and account statements to attract investors and to ensure 
they continued to invest in the scheme.
    As reflected in these recent cases, any would-be fraudsters should 
consider themselves on notice that the SEC's enforcement staff will 
aggressively investigate and file actions against anyone who preys upon 
seniors.
Conclusion
    Mr. Chairman, Members of the Committee--thank you for your interest 
in these vital issues. Each of the four initiatives I have outlined is 
part of an overall strategy to make the individual investor--the 
average American--the ultimate beneficiary of all that we do at the 
SEC. Our agency has for many years proudly worn the badge of the 
``Investor's Advocate.'' In the months and years ahead, we are pledged 
to rededicate ourselves to that mission.
    I appreciate the opportunity to be with you here today. Thank you 
for your continuing strong support for the work of the Commission. I am 
happy to answer any questions you may have.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO 
                      FROM CHRISTOPHER COX

Q.1. Last November, the Commission committed to approving by 
June 30, 2006 self-regulatory organization rules to permit 
portfolio margining for securities futures and security 
options. I understand that NYSE and CBOE rule changes are 
pending that would do that by expanding the current pilot 
program that permits certain customers to use portfolio 
margining for certain limited classes of products. Do you 
anticipate that the Commission will be able to meet its 
commitment to Congress to act on these proposals by June 30?

A.1. I am pleased to report that on July 11, 2006 we approved 
rule changes at two major exchanges--the New York Stock 
Exchange and the Chicago Board Options Exchange to permit 
portfolio margining on equity options and security futures. In 
addition, we have also noticed for comment NYSE and CBOE 
proposals to permit single stocks and OTC derivatives to be 
included in a portfolio margin account. The public comment 
period for these two proposals closed in May. After reviewing 
comments received by the Commission, NYSE and CBOE recently 
submitted technical amendments to their proposals and I expect 
that the Commission will take action on the proposals in early 
September. In addition to these rules changes, I am also 
engaged in direct discussions with Ruben Jeffery, the Chairman 
of the Commodity Futures Trading Commission, to identify 
further areas of agreement on portfolio margining.

Q.2. The proposed NYSE and CBOE rules would allow broad-based 
futures to be included in a portfolio margining securities 
account I understand that there are some obstacles to actually 
including such futures in a securities account, because all of 
the financial instruments in a securities account must be 
provided with coverage by the Securities Investor Protection 
Act (SIPA), and SIPA specifically excludes futures from its 
coverage. In testimony before the Banking Committee last 
September, Bob Colby testified that the Commission supports 
targeted amendments to SIPA to address this issue. This sounds 
like an idea where a legislative fix is the cleanest way to 
make sure that the market can take full advantage of portfolio 
margining. Do you agree? If so, could the Commission provide us 
with some technical assistance in drafting a targeted amendment 
to SIPA?

A.2. The Commission agrees that targeted legislative changes to 
SIPA are the ``cleanest'' way to make sure customers can take 
full advantage of the new NYSE and CBOE portfolio margining 
rules. Under the NYSE's and CBOE's rules, securities and 
futures positions must be carried in a securities account to 
provide a customer with the protections of applicable 
securities laws and regulations. Including futures positions in 
a portfolio margin securities account, however, raises an issue 
as to how futures positions would be treated in a liquidation 
of a broker-dealer under SIPA.
    SIPA protections apply to cash and securities held at a 
broker-dealer, but not to futures positions. This result is a 
function of the SIPA definition of ``security,'' which 
specifically excludes futures. Moreover, there is no 
corresponding statutory protection for futures customers under 
which they would receive advances if futures assets are 
missing. To assure SIPA protection to all products in a 
portfolio margin securities account, amendments to SIPA would 
enable customers to take full advantage of the portfolio 
margining rules. This legislative amendment could be very 
narrowly tailored to, in effect, provide that futures 
(including options on futures) held in a portfolio margin 
account under a Commission-approved portfolio margin program 
would receive SIPA protection, thereby extending SIPC 
protection to those futures products permitted to be deposited 
into a portfolio margin securities account. The Commission 
staff would be pleased to provide you with technical assistance 
in drafting such a targeted amendment to SIPA to address this 
issue.
    At the same time, however, the Commission is actively 
engaged in a dialogue with the Commodity Futures Trading 
Commission and the futures and securities industry regarding 
the optimal means to structure cross margining between 
securities and futures positions--whether through a single 
account or separate securities and futures accounts (the so-
called ``one-pot'' or ``two-pot'' models).

        RESPONSE TO A WRITTEN QUESTION OF SENATOR ENZI 
                      FROM CHRISTOPHER COX

Q.1. Mr. Chairman, the position of the Chairman of the Public 
Company Accounting Oversight Board has been open since November 
30, 2005. Since that time, Mr. Bill Gradison has served as 
Acting Chair, and has done an excellent job. Does the SEC have 
plans to nominate a new Chairman in the near future?

A.1. On June 19, 2006, the Securities and Exchange Commission 
was pleased to announce the appointment of Federal Reserve 
Board Governor Mark W. Olson to the position of Chairman of the 
five-member Public Company Accounting Oversight Board (PCAOB) 
until 2010. Mark Olson's experience as a central banker, his 
background in securities law, his expertise gained as partner 
in a major accounting firm, his management and business 
experience as a bank president, and his national leadership as 
President of the American Bankers' Association--together with 
his demonstrated commitment to public service and protecting 
the interests of investors--will be an exceptional addition to 
the PCAOB.
    Mr. Olsen's appointment was conducted in accordance with 
the comprehensive selection procedures for the selection of 
Chairpersons and Board members of the PCAOB that the Commission 
approved last December. These new procedures are intended to 
make the selection process transparent, encourage the thorough 
consideration of all qualified candidates, ensure a thorough 
vetting of candidates, and establish timetables for the 
expeditious appointment of individuals of the highest caliber 
for this critical body.
    These selection procedures build upon the previous practice 
of the Commission, and include a timetable for the 
recommendation of candidates, background checks, Commission 
interviews, and final selection. The new procedures will apply 
whenever vacancies occur.
    Under these procedures, the SEC Chairman will lead a search 
to identify qualified candidates and will solicit nominations 
and input from each of the SEC's current Commissioners, who may 
each submit up to three nominations.
    The SEC Chairman will also consult with the Secretary of 
the Treasury and the Chairman of the Federal Reserve, as 
required by the Sarbanes-Oxley Act, and solicit recommendations 
from other executive branch, Congressional, investor, academic, 
and business community sources, and such others as the SEC 
Chairman deems appropriate.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR SANTORUM 
                      FROM CHRISTOPHER COX

Q.1. You may know that I have sponsored, along with Senator 
Allen and Senator Dole, S. 1396, a bill that would update the 
definition of eligible portfolio company (EPC) under the 
Investment Company Act of 1940. The House unanimously passed an 
identical version twice (H.R. 3170 in the 108th Congress and 
H.R. 436 in the 109th Congress).
    Does the SEC agree the use of the Federal Reserve Board 
definition of ``marginable security'' as a statutory standard 
for what Business Development Companies (BDC's) can invest in 
is outdated? If so, while the SEC has been given authority to 
establish additional categories of companies that qualify for 
treatment as an EPC, is not the only way to eliminate this 
outdated standard through legislation striking the provision, 
as is accomplished in the pending legislation? Does the SEC 
oppose the pending legislation? If the SEC believes an 
alternative approach should be considered, what is that 
alternative approach?

A.1. We agree that the use of the Federal Reserve Board's 
definition of ``marginable security'' as a means to define an 
eligible portfolio company is outdated. As you know, that 
definition was amended by the Federal Reserve Board so as to 
make most securities marginable. Consequently, many companies 
that previously met the definition of eligible portfolio 
company may have lost their status as such.
    As you know, the Commission has rulemaking authority to 
establish alternative criteria to define eligible portfolio 
company. Pursuant to that authority, the Commission proposed a 
new rule to define eligible portfolio company under the 
Investment Company Act. In developing the proposed rule, the 
Commission was mindful of Congress's intent when it established 
BDC's in 1980 that they should invest a significant percentage 
of their assets in small, developing, and financially troubled 
companies, largely defined as eligible portfolio companies. 
Accordingly, the proposed rule was intended to realign the 
definition of eligible portfolio company with that intent. The 
Commission received 36 comment letters addressing the proposed 
definition. Most commenters were concerned that the rule would 
not include many of the small public companies that 
historically would have met the definition of eligible 
portfolio company before the margin rule amendments. Commenters 
also suggested various alternative approaches. It is 
anticipated that the Commission will take final action on this 
rule in the near future.
    The Commission has not taken a position on the legislation. 
At the request of staff of the House Financial Services 
Committee and the Senate Banking Committee, Commission staff 
has provided technical assistance on the legislation. 
Commission staff expressed its view that the legislation was 
drafted very broadly. Among other things, it noted that the 
legislation, if adopted, could actually result in BDC's 
investing more of their assets in larger, well-established 
companies. Consequently, there could be less BDC capital 
available for small companies. The staff also noted its concern 
that the legislation, by permitting BDC's to invest more of 
their assets in larger, well-established companies, would make 
BDC's more closely resemble registered closed-end investment 
companies. The staff also noted that the legislation would not, 
however, provide BDC shareholders with critical investor 
protections available to shareholders of those other investment 
companies.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR STABENOW 
                      FROM CHRISTOPHER COX

Q.1. As I mentioned in my opening statement--the largest IPO's 
this year have been from foreign companies. Although U.S. IPO's 
continue to lead in total capital raised and number of deals, 
foreign markets are emerging. Not only are foreign companies 
offering larger equity deals around the world, but also foreign 
companies are also holding our debt in greater amounts.
    In your opinion, will this trend continue into the future? 
And, how will the emergence of foreign-owned debt impact 
domestic markets?

A.1. The opportunity for companies to access worldwide capital 
is a positive trend that reflects the health of the U.S. and 
the global equity market, and one that we expect to continue. 
IPO's in the U.S. capital markets are the largest segment of 
global IPO's, with $33 billion raised in 2005, and represent 20 
percent of the global capital market activity.
    While the number and size of IPO's in the United States has 
dipped slightly in recent years, many smaller companies 
continue to list on the NYSE and Nasdaq. In 2005, over 70 
countries hosted IPO's of over $1 billion and the largest 
offerings were conducted overseas. That so many foreign 
companies chose to list their securities in foreign markets is 
a welcome indication that the quality and liquidity of those 
markets has increased and that accounting and corporate 
governance standards are improving worldwide. However, as 
globalization provides companies with a wider choice of markets 
in which to raise capital, we have seen a decrease in multiple 
listings as companies seek to reduce their costs.
    The SEC has responded to foreign company concerns about 
compliance with Sarbanes-Oxley requirements and their inability 
to deregister with a number of initiatives intended to reduce 
their compliance burdens while maintaining our high standards 
of investor protection. Among these initiatives is a proposal 
to facilitate the ability of foreign issuers to terminate their 
SEC reporting obligations when there is relatively little 
interest in their securities among U.S. investors. Foreign 
issuers also benefit from extended Section 404 internal control 
deadlines and the SEC continued evaluation of these 
requirements. Finally, the SEC supports efforts to converge 
accounting standards, and I have stressed the SEC's commitment 
to creating a ``roadmap'' for eliminating a requirement to 
reconcile financial statements prepared using International 
Financial Reporting Standards to U.S. GAAP.
    With regard to how foreign-owned debt may impact domestic 
markets, our capital markets are based on transparency of 
information as it relates to many areas of disclosure. While 
our rules require public companies, and significant investors 
in those companies, to provide full disclosure of material 
information related to the sale, purchase, and ownership of a 
company's securities, our rules do not dictate who those 
significant investors may or may not be. Any person or entity 
that owns more than 5 percent of a public company's voting 
securities must publicly disclose certain information, 
including information regarding that person's intent in 
purchasing the securities. Our rules also require a public 
company to disclose information about that level of ownership 
of its securities.
    Other Federal and State agencies as well as U.S. exchanges 
may regulate significant investments in public companies and 
may have some policy role in whether the emergence of foreign 
companies and foreign-owned debt impacts our markets.

Q.2. Recently, I came across a report that was conducted in 
2004 by the Center for Medicare and Medicaid Services. The 
report revealed that the government was paying 9.3 percent in 
hospital overage charges. In Michigan, that percentage was even 
higher, 13.6 percent. It was my understanding that Section 404 
was intended to establish internal controls for healthcare 
benefits--however, it seems that the current accounting 
standards for employee benefits may have contributed to these 
overage charges. I am concerned that the standards are not 
being enforced or applied as intended.
    Do you have any suggestions for improvements or do you 
intend to rectify this issue in some other way?

A.2. The accounting standards related to employee benefits are 
based on the premise that post retirement health care benefits 
are part of an employee's compensation for services rendered. 
Since payment is deferred until retirement, the benefits are a 
type of deferred compensation. Under fundamental accrual 
accounting, during the years that the employee renders the 
necessary service the company accrues and reports the cost of 
providing those benefits to the employee and to the employee's 
beneficiaries and covered dependents. To estimate this cost, 
the company must make several assumptions, including an assumed 
discount rate to determine the present value of the future cash 
outflows currently expected to be required to satisfy the post-
retirement benefit obligations. The primary accounting 
standards body in the United States, the Financial Accounting 
Standards Board (FASB), currently has a two-phase project 
underway to improve the reporting of these and other related 
post-retirement benefits. The first phase involves recognition 
of the overfunded or underfunded status of defined post-
retirement plans as an asset or liability on a company's 
balance sheet. The second phase will be a more comprehensive 
reassessment of pension and post-retirement accounting. These 
accounting rules may vary, however, for government-owned 
hospitals, which are not subject to the Commission's reporting 
requirements.
    Section 404 of the Sarbanes-Oxley Act of 2002 requires 
certain public companies to report to shareholders on the 
effectiveness of their internal controls over financial 
reporting. This reporting requirement should provide reasonable 
assurance to investors that a company's financial records 
appropriately reflect the costs of health care benefits as 
calculated under the existing accounting standards. The 
Commission currently is reviewing alternatives to make this 
reporting more efficient and effective. This reporting 
requirement, however, does not apply to privately held or 
government-owned hospitals and medical facilities.
    As noted above, the Commission and FASB are reviewing how 
to improve both the accounting for health care benefits and 
reports on companies' internal controls over financial 
reporting. Although we are not aware of any direct link between 
these requirements and hospital overage charges, we will be 
alert to such issues as we proceed.
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