[Senate Hearing 110-927]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 110-927
 
                  THE STATE OF THE SECURITIES MARKETS 

=======================================================================

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINING CURRENT ISSUES AND MATTERS RAISED IN PREVIOUS SECURITIES 
                                HEARINGS


                               __________

                         TUESDAY, JULY 31, 2007

                               __________

  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

               CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware           CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey          JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii              MIKE CRAPO, Idaho
SHERROD BROWN, Ohio                  JOHN E. SUNUNU, New Hampshire
ROBERT P. CASEY, Pennsylvania        ELIZABETH DOLE, North Carolina
JON TESTER, Montana                  MEL MARTINEZ, Florida

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel
                       Dean V. Shahinian, Counsel
                    Justin Daly, Republican Counsel
   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
                          Jim Crowell, Editor










                            C O N T E N T S

                              ----------                              

                         TUESDAY, JULY 31, 2007

                                                                   Page

Opening statement of Chairman Dodd...............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Menendez.............................................     5
    Senator Sununu...............................................     5
    Senator Reed.................................................     6
        Prepared statement.......................................    46
    Senator Bennett..............................................     7
    Senator Schumer..............................................     8
    Senator Allard...............................................     9
    Senator Bunning..............................................     9
    Senator Enzi.................................................    10
    Senator Crapo
        Prepared statement.......................................    47

                               WITNESSES

Christopher Cox, Chairman, Securities and Exchange Commission....    11
    Prepared statement...........................................    48
    Response to written questions of:
        Senator Dodd.............................................    59
        Senator Shelby...........................................    66
        Senator Reed.............................................    72
        Senator Carper...........................................    81
        Senator Menendez.........................................    82
        Senator Dole.............................................    85


                  THE STATE OF THE SECURITIES MARKETS

                              ----------                              


                         TUESDAY, JULY 31, 2007

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 9:48 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Christopher J. Dodd (Chairman of 
the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order.
    This morning we are going to hold an oversight hearing on 
the state of the securities markets. We are pleased to have as 
our witness Chairman Christopher Cox. Mr. Chairman, we welcome 
you to the Committee.
    The securities markets of course, as we all know, are a 
significant area of the Banking Committee's jurisdiction and 
raise a broad range of issues. This Committee has a long 
history of vigorous oversight of these markets and their 
regulators, a practice that I fully intend to continue as 
Chairman of the Committee.
    In my view, this Committee has two primary objectives with 
regard to the securities markets. One is to promote the 
efficient and effective operation of these markets so that they 
can enable individuals to invest and businesses to raise 
capital, and second to protect each and every investor from 
large institutional investors to small retail investors and 
ensure that they are treated fairly and openly by the market 
participants with which their investments are entrusted.
    The U.S. securities markets are the most efficient, liquid, 
and transparent in the world. Retail and institutional 
investors, hedge funds, private equity, public corporations, 
underwriters, brokers, exchanges and other participants are 
prospering, notwithstanding the market's performance late last 
week. These markets are key contributors to the health of the 
economy and to the welfare of our Nation.
    Therefore, I believe it is critical that the Federal and 
State securities regulators fulfill their statutory missions to 
protect investors and promote fair and efficient markets. The 
Securities and Exchange Commission's ongoing effectiveness 
promotes confidence and is a key to the future success of the 
markets.
    In this context, the Committee oversees a number of 
securities issues. A more complete list of areas of particular 
significance is contained in my formal remarks which are part 
of the record. However, in the interest of my colleagues' time, 
allow me to mention just three this morning, if I can, in my 
opening statement: the implementations of Sarbanes-Oxley, tax 
proposals affecting hedge funds, private equity firms and 
publicly traded partnerships, and the state of market 
regulation.
    Regarding Sarbanes-Oxley, last week the Commission approved 
the Public Company Accounting Oversight Board's Auditing 
Standard Number 5 which more effectively directs the 
implementation of Section 404 of the Sarbanes-Oxley Act. I 
commend Chairman Cox and the PCAOB Chairman Mark Olson and 
their colleagues for the work that they have done on that 
matter. The SEC and the PCAOB responded thoughtfully to the 
concerns of industry, including smaller businesses, while 
guarding the legitimate interests of all investors with strong 
internal controls at their companies.
    This new standard directs auditors to review those areas 
that present the highest risk and to conduct their work 
appropriate to the size and complexity of the company. It is 
expected to lower compliance cost and enable all public 
companies to comply more easily with the statutory requirement 
to have management and outside auditors attest to internal 
controls.
    Public companies which have not yet begun to comply with 
this law, which was passed 5 years ago, should begin to do so 
now, in my view. American securities markets should not list 
companies that, in effect, abide by two different standards 
regarding their financial controls. Surveys of market 
participants, including CEOs of major corporations, conclude 
that Sarbanes-Oxley is sound in achieving its goals of 
improving financial reporting, strengthening corporate 
governance, and enhancing the integrity of analysts 
recommendations. The performance of the markets since Sarbanes-
Oxley's enactment 5 years ago underscores the fact that this 
new law is strengthening our Nation's economy in my view.
    I am also pleased that Sarbanes-Oxley created the Fair Fund 
through which the Commission has distributed billions of 
dollars to investors who are harmed through securities 
misconduct. This Committee will continue to monitor Sarbanes-
Oxley and we invite ideas from both the private and public 
sectors to ways in which we can strengthen this law as we watch 
it unfold.
    Regarding tax proposals affecting hedge funds, private 
equity funds, publicly traded partnerships and others, let me 
say that as Chairman of the Banking Committee I feel a strong 
responsibility to carefully examine legislative proposals 
emanating from any Committee which may have a significant 
impact on matters within this Committee's jurisdiction, 
particularly matters affecting the capital markets.
    Recently legislation was introduced that would change the 
tax treatment of publicly traded partnerships and certain 
income called carried interest. I am concern about the 
potential adverse effects these proposals would have on capital 
formation and job creation and on institutional investors like 
pension funds and college endowments.
    I have begun to hear arguments and analysis but I am not 
prepared to support any legislation before I have thoroughly 
analyzed the full impact it is likely to have on investors and 
markets. In this regard, Senator Shelby and I have written to 
Chairman Cox and to Secretary Paulson to ask their opinions of 
the impact such proposals would have on our markets and 
investors. I look forward to your insights on that matter, as 
well.
    Again, that is not taking a position one way or another on 
this, but clearly it is in our interest in this Committee to 
have some idea what the implications could be of these tax 
proposals.
    The third and final issue I would like to briefly mention 
is the state of market regulation. A core function of this 
Committee is overseeing market regulations. On July 26th the 
SEC approved the consolidation of the National Association of 
Securities Dealers and the New York Stock Exchange regulation 
into a single consolidated self-regulatory organization. It is 
incumbent upon the SEC to devote sufficient resources to 
effectively oversee the budget, governance, and operations of 
this new regulator.
    It is critically important that as the North American 
Securities Administrators Association said, and I quote them 
``Harmonization does not compromise investor protection 
standards.'' Where the rules of the two organizations differ, 
we want to provide the strongest investor protection. The 
consolidation and regulation of securities exchanges is an 
international as well as a domestic challenge, given recent 
cross-border mergers.
    Senator Reed, my colleague from Rhode Island, has chaired 
two superb hearings on these issues as Chairman of the 
Securities Subcommittee.
    There are other important issues to be addressed that I 
will discuss in my state for the record. These include the 
regulation of investment fiduciaries and other professionals, 
disclosure and accounting in municipal securities markets, the 
partnership of the SEC and State securities regulators, the 
reposting of the SEC software tool to provide Internet links to 
SEC reports of companies disclosing business in countries that 
sponsor terrorism, shareholder proposals for access to the 
proxy including the important right to provide precatory 
proposals and many other issues.
    You have provided important leadership, Mr. Chairman, I 
would say to you in these areas and others, and I know your 
full statement includes a number of comments on these matters 
which I have gone over and will have some questions for you 
regarding several of those comments you make in your statement.
    I also want to commend you and the Commission for seeking 
to have an amicus brief with the Commission's historical view 
filed in the Stonebridge case. I am disappointed that the 
Solicitor General chose not to file the brief, depriving the 
Supreme Court of the Commission's views as it interprets the 
Federal securities laws.
    Let me say, as well, regarding this matter here that I have 
been in touch with my colleagues in the House and it is my 
intention to try and file an amicus brief in that matter, as 
well. We are a little late in terms of whether or not they will 
receive it or not, and that is true of the House matter, as 
well. But I believe it is worth submitting an amicus brief and 
we will be prepared to do that.
    I have not had a chance to talk with the Ranking Member 
about this, but if he wants to join me in that, and I will 
leave that up to him, at some point we may do it together.
    But I commend the Commission for doing so and hopefully 
they will take your views into consideration.
    I look forward to working with you, Mr. Chairman, and 
others on these issues that rise to promote efficient 
securities markets and to protect investors.
    With that, let me turn to Ranking Member, Senator Shelby, 
for any opening comments.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you. Thank you, Mr. Chairman.
    Today the Banking Committee, as you have explained, 
examines the current state of the securities markets. I would 
like to welcome Chairman Cox back to the Committee and I would 
also like to commend you, Chairman Cox, for your continued 
leadership at the Securities and Exchange Commission.
    The SEC has been quite active this year and we have been 
monitoring its work with great interest. We will continue to do 
so.
    The securities industry is undergoing rapid and dramatic 
changes for a number of reasons, none of which are probably 
more significant than increased global competition and advances 
in technology. For decades, the U.S. was the world's 
unchallenged financial center. Today, however, we must compete 
against numerous and increasingly sophisticated foreign 
markets. We cannot, I believe, reverse the tide of global 
competition or technological innovation, nor would we want to. 
We can and should, however, continually reassess and re-examine 
our approach to financial regulation in a constantly changing 
global environment.
    Although improved regulation will not inoculate the U.S. 
from global competition, I believe it is important to recognize 
that a dynamic rather than static regulatory structure gives 
the U.S. the best chance to compete.
    In the securities markets, regulation is necessary to 
protect investors, particularly retail investors, but it should 
be smart, balanced, and narrowly tailored to avoid as much as 
possible unintended consequences.
    I believe we must be careful not to regulate for 
regulation's sake. Rather, we should intervene only when market 
forces are incapable of policing conduct. When the market 
fails, we should examine whether existing regulations are being 
enforced. If a new regulation is deemed necessary, we must 
weigh carefully the benefits with the costs.
    The SEC's statutory duty to protect investors is well known 
but that duty, I believe, also extends to promoting efficiency, 
competition, and capital formation. This means that the 
benefits of any new regulation must outweigh its costs.
    For example, last week the Commission adopted a new 
standard for auditors, applying Section 404 of Sarbanes-Oxley. 
While Section 404 has provided some benefits, the costs have 
been too high and the new standard is intended to lower the 
cost of implementing the internal controls provision. This is a 
very positive development, Chairman Cox, and I encourage the 
Commission to continue this type of cost-benefit analysis 
across the SEC's regulatory spectrum.
    Chairman Cox, thank you for your appearance and thank you 
for your work at the SEC. I look forward to your testimony.
    Chairman Dodd. Let me ask my colleagues, Senator Menendez, 
do you have an opening statement?

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for calling this hearing and I 
think it is incredibly important timing. I want to welcome 
Chairman Cox, as well.
    Today entrance into the world of financial markets is open 
to anyone with extra capital who is willing to take a few risks 
in the hope of some promising returns. Roughly half of all U.S. 
households have some investments of some type, whether in 
mutual funds or individual stocks. So investors are no longer a 
singular class. Rather, they represent an increasingly diverse 
mix of Americans looking to add to their savings, save for the 
future, or build their personal wealth.
    That means more Americans are exposed to the risks that 
come with investing. As anyone who has ever invested knows, a 
certain level of risk is a given. But that risk is taken with 
some knowledge of the framework, some assurance that everyone 
is playing by the same rules, and the trust that if someone 
breaks or bends the rule they will be prosecuted.
    Often the role of the SEC is to provide some sense of 
security in the otherwise unpredictable world of financial 
markets. That security is integral to anyone involved in the 
investment market from investor, traders, brokers, and 
exchanges alike.
    One of the greatest challenges for providing that security 
is in the gray areas where regulation is not clear, where 
jurisdiction overlaps, where the guidelines may be blurred. 
This is where we turn to the SEC for what the acceptable 
standard will be, what the boundaries are, and most of all for 
what the rules of the game will be.
    There will always be winners and losers but the real 
question is whether they are winning or losing fairly. As 
investment vehicles that elude direct regulation, such as hedge 
funds, become more prevalent the issue of fairness becomes even 
more pronounced. Just as we see examples of how the market is 
working, we have all seen stories of investors who lose it all 
at the hands of unscrupulous players.
    As the hedge fund market continues to catch fire and more 
investors venture into an unregulated market, I think we have 
to carefully examine the protections that are in place and if 
they are sufficient. This is obviously an area the SEC has been 
looking carefully at and one I hope that they will continue to 
scrutinize.
    I have a series of questions when we get to that part, Mr. 
Chairman, on investor protection and I look forward to our 
witness' response.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Sununu.

              STATEMENT OF SENATOR JOHN E. SUNUNU

    Senator Sununu. Thank you, Mr. Chairman.
    I looked at this long line of Republicans and I did not 
think I would get an opportunity to provide an opening 
statement. I do not have an opening statement. But I know when 
we get to the questioning I may not be here.
    Chairman Cox, I want to raise one issue that you might 
address. I do not think it is in your testimony but in some of 
the question and answers regarding market regulation and 
oversight I hope you will address the issue of market data, 
access to market data, distribution and pricing of marketing 
data.
    About a year ago in one of the hearings we talked about it. 
You described it as a front burner issue. And I just want to 
get a sense of what you think the challenges might be to 
improving or leveling the playing field where market data is 
concerned.
    I look forward to your testimony.
    Thank you, Mr. Chairman.
    Chairman Dodd. You bet.
    Senator Reed.
    Senator Reed. Thank you. Mr. Chairman, I would like to put 
my full statement in the record and just make reference.
    Chairman Dodd. All statements will be included.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you, Chairman Cox, for joining us 
today. Thank you, Mr. Chairman, for holding the hearing.
    There is a growing concern that systematic risk may be 
creeping into our financial markets in ways that no one fully 
appreciates. Risk is being distributed more widely across 
investors, markets, and brokers, and borders.
    However, as the Wall Street Journal pointed out last week, 
because the risk gets spread so widely regulators can do little 
but watch and try to reassure everybody it is all under 
control. A system designed to distribute risks also tends to 
breed it.
    The proliferation of products such as CDOs that have not 
been tested in market downturns, the accumulation of large 
pools of capital in unregulated, highly leveraged hedge funds, 
and accounting rules that do not produce transparency in 
financial reporting seem to have created a potential for 
problems that could spill over from the financial markets to 
the general economy.
    Bear Stearns recently announced that two of its hedge funds 
are now nearly worthless after some of its investments in 
subprime mortgages went badly. Moody's and Standard & Poor's 
have significantly downgraded ratings on hundreds of subprime-
related bonds. The ABX index has hit new lows. Portions of this 
index that tracks especially risky mortgage product with junk 
grade ratings have been falling but now these declines are 
spreading to the portions of the index that tracks bonds with 
ratings of AAA or AA.
    To quote Merrill Lynch's latest manager survey, 72 percent 
of managers said that credit or default risk was the biggest 
threat to financial market stability.
    Furthermore, when we all witnessed structured mortgage 
products that were initially rated AAA at inception and now are 
trading at prices with junk bonds less than a year after 
issuance, there is a concern.
    These events, combined with the weaknesses in the markets 
last week have brought many new issues to light and raised 
significant concerns about some of the systemic risks facing 
our securities markets. I would hope, Mr. Chairman, that you 
would address these potential risks as you present your 
testimony this morning and the questions.
    Finally, let me comment about last week's SEC's 
proceedings, two distinct proposals regarding proxy access to 
shareholders. I am concerned about both the process associated 
with approving these proposals, as well as the proposals 
themselves.
    For starters, the issuance of two diametrically opposed 
proposals is unprecedented by the SEC. As Commissioner Nazareth 
pointed out, by issuing contradictory proposals the SEC has 
opened the door to the possibility of cherry picking provisions 
from each of the proposals that may result in the worst of all 
worlds.
    Additionally, while one of the proposals put out for 
comment would in theory allow shareholders access to proxies, I 
have serious concerns that the 5 percent threshold included in 
that the proposal would make any subsequent rule meaningless in 
its application. This threshold would limit the ability of even 
large long-term institutional investors such as CalPERS from 
having access to many shareholder proxies.
    I hope the Chairman will elaborate for us on the derivation 
of the 5 percent threshold and direct us to the data the SEC 
used in setting the threshold at that level.
    Clearly, there are many issues that we must address this 
morning. I appreciate your presence here, Mr. Chairman, and 
your leadership and your thoughtfulness on all of these issues. 
Thank you.
    Chairman Dodd. Thank you very much.
    Senator Bennett.

             STATEMENT OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman.
    Chairman Cox, welcome. And may I thank you for your efforts 
to try to make Sarbanes-Oxley less burdensome. You and I have 
had this conversation but I hear from the venture capital 
community that Sarbanes-Oxley is one of the main reasons why we 
have had some drop-offs in IPOs. And I hear from my friends in 
Europe that Sarbanes-Oxley is one of the things that keeps 
foreign investors from coming to America to get listed on 
American exchanges as they previously did.
    So while I think Sarbanes-Oxley has, on the whole, been 
good for the investing community, I congratulate you for your 
efforts to try to make it more sensible, particularly in terms 
of the smaller companies.
    I will have some questions for you with respect to your 
recent activities on short selling, particularly the concerns 
about naked short selling. I appreciate the very professional 
way in which your staff has interacted with my staff, come to 
my office and spent considerable time going through these 
issues. I think we are moving in the right direction there.
    So again, I thank you for your being here and look forward 
to questioning you on these particular matters.
    Thank you.
    Chairman Dodd. Thank you. Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Thank you. Thank you, Chairman Cox. Thank 
you, Chairman Dodd, for holding this hearing.
    I just want to say one of my great concerns here is as the 
world evolves we face new challenges in financial regulation. 
For a long time there was sort of an exquisite balance between 
investor protection and entrepreneurial vigor. There is always 
a tension and that is part of America and that is part of the 
good part of our system.
    The introduction of a global economy, of course, has 
challenged that because foreign countries can have different--
will have different systems of regulation. Some have very weak 
systems of regulation and all too often companies go to the 
weakest system because it is less regulation for them. It will 
hurt them in the long run but in the short run it certainly 
hurts here.
    Then there are some others, and maybe Britain is one of 
these, that have a better system of regulation, at least in 
certain aspects, not every aspect but certain. Having one 
regulator, having a results oriented regime may be a better way 
to go.
    And this puts huge challenges on us. And of course, my 
concern is both Catholic and parochial. Catholic because I want 
to see the best system for everybody. It is good for investors, 
good for everything. But parochial, because I certainly want to 
see New York stay the financial center.
    Now I think we can achieve that balance. I think we can 
adapt to the modern world and at the same time have a careful 
balance between entrepreneurialness and investor protection. In 
fact, Mayor Bloomberg and I had McKinsey do a report which had 
25 recommendations how we could improve the competitiveness of 
America and New York and at the same time not hurt investors.
    And I want to praise you because, as you know, the mayor 
and I have met with you on several occasions, as well as with 
Secretary Paulson, Chairman Bernanke, and others. We are moving 
in this direction and it is very helpful.
    We have tried to craft most of the recommendations in the 
report you can do on your own that apply to the SEC, and 
exploring mutual recognition. That is the recognition of 
comparable regulatory authority by the SEC, issuing clearer 
guidance for the implementations of Sarbanes-Oxley, as Senator 
Bennett mentioned, particularly on materiality which is an 
issue which is important. Taking steps toward recognizing 
international accounting standards so foreign companies do not 
have to totally change their books around when they come here.
    All of these are very important steps. All of these were 
recommended in our report. And I want to thank the SEC for 
moving forward in that direction.
    Having said that, we have a long way to go. The increase in 
financial service jobs in London exceeds the increase in New 
York and there are other centers that are going to be nipping 
at our heels. So we have to continue moving in this direction, 
certainly continuing investor protections. Not throwing out the 
baby with the bathwater but updating ourselves, learning the 
best of other systems, and secure in the fact that we have the 
best talent--everyone agrees with that--here in America. And 
with a good system of regulation, an updated system, based 
basically on the basic values we have had for a long time, we 
can clearly stay No. 1.
    So I thank you and thank you, Mr. Chairman.
    Chairman Dodd. Very good.
    Senator Allard.

               STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I do not have a long 
statement. I would just like to thank you for holding this 
hearing and obviously, Senator Shelby, for working with you in 
setting up this hearing.
    I also would like to welcome Chairman Cox. I appreciate 
your leadership in the SEC.
    We have seen some exciting times, I think, in the SEC where 
around the middle of this month, July 16th to be precise, we 
broke the 14,000 mark. I think that creates some challenges 
within itself. But I think it is good news. As a result of that 
we have some increased volatility that has occurred.
    I personally feel that it is impractical to expect our 
equities markets to not have to risk in it. I think risk is 
part of it, of the way our markets work, and I think we need to 
encourage an environment where people will assume some risk.
    And also, I think we have to balance. I am convinced and I 
encourage you to continue to work for a commonsense regulatory 
environment, one that is not over regulatory but obviously we 
need some protection out there for the consumer.
    I would agree with many of the comments that we got from 
our colleague, Senator Schumer, about how we are working with 
our other countries. We obviously need to work on keeping a 
competitive environment there. But we also have to be sensitive 
to the impact of Sarbanes-Oxley, the 404 provisions.
    I will be interested to see how the change in the 
accounting rules when we went from the rule No. 2 standard to 
No. 5, and see over time how that is going to work out. I think 
it might be a step in the right direction. We have to continue 
to monitor that.
    I think we have to continue to be very careful with the 
International Financial Reporting Standards. We do not want to 
have two separate standards, one for foreign investment and one 
for here. Or if we do have that, certainly our consumers need 
to understand the risk that is involved with that.
    So I commend you. I appreciate the hard work that you have 
done so far, Chairman Cox. Thank you.
    Chairman Dodd. Thank you.
    Senator Hagel.
    Senator Hagel. Mr. Chairman, thank you. I have no statement 
and look forward to the Chairman's comments this morning. Thank 
you.
    Chairman Dodd. Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Chris Cox, it is always good to see you. Thank you 
for being here. I look forward to hearing your update on what 
is going on and what we can do to make the Commission and our 
security markets work better.
    Like many members on this Committee, I am concerned about 
the competitiveness of our economy at a time when jobs can 
easily be relocated halfway around the world. Many economies 
outside the United States are growing rapidly and so are 
foreign capital markets.
    Several highly publicized reports in the last year have 
examined the growth and increases of competitiveness of these 
markets for investment dollars and jobs. The United States 
remains the leader of the financial world but our edge is not 
as great as it once was.
    Several domestic factors have affected our competitiveness 
and need to be addressed. Trial lawyers are a big part of the 
problem and the fear of litigation drives businesses overseas. 
The same is true for our tax rates. And of course, the burdens 
of regulations on our businesses are a problem.
    The United States is the gold standard for corporate 
accountability and openness and the investors around the world 
know that. But the burden of regulation must be reasonable to 
be a benefit. And this Committee and the Commission must keep a 
careful eye on that burden.
    I am glad that the Commission finally took action to make 
Sarbanes-Oxley rules more workable. I am also glad that you are 
taking the initiative to modernize other regulations. I hope 
you and the rest of the Commission will continue to keep the 
competitiveness of our markets in mind when considering any new 
regulations.
    In addition to our competitiveness, I am concerned about 
what is going on in our housing markets. The Fed bears a lot of 
responsibility for what is happening now. The low interest 
rates earlier this decade drove a credit boom and they should 
have been especially vigilant in monitoring the effect of those 
low rates. Instead they were too slow to rein in the most 
irresponsible practices and that made the situation worse than 
it could have been.
    The SEC also has an important role to play in going 
forward. You must remain vigilant that there are no abuses in 
the packaging of loans into securities or in the fallout from 
securitized loans going bad.
    As you implement last year's rating agency law, you must 
keep an eye on the role of the rating agencies and the mortgage 
mess. And you will have to decide whether any enforcement or 
regulatory actions are needed.
    I look forward to hearing your thoughts on these issues and 
your ongoing work and I thank you for being here today.
    Chairman Dodd. Senator Enzi.

              STATEMENT OF SENATOR MICHAEL B. ENZI

    Senator Enzi. Mr. Chairman, I thank you and Chairman Cox, 
thank you for being here today. We worked together on a number 
of issues when you were in the U.S. House of Representatives, 
such as collaborating on the stock option problems and working 
on the Export Administration Act, trying to keep the economy 
going while we were still able to keep national security. And 
of course, we were both conferees on Sarbanes-Oxley in 2002 and 
I appreciate your perspective on U.S. and world markets.
    I appreciate the work that you and the PCAOB have been 
doing on Sarbanes-Oxley. I do support your final product. The 
key to successful implementation and financial controls testing 
is a risk-based top-down approach and what you have done has 
helped to reduce the skyrocketing costs and your management 
guidance and smaller company advisory panel to assist the 
Commission in developing tailored guidance for small public 
companies is a help. The scalable, as you have got it, 
streamlined process for making it scalable for smaller 
companies and I appreciate your work to continue to monitor 
that, as will I.
    Your new accounting project, of course, the new method of 
accounting for U.S. issuers, we will be watching that to see 
how that develops and how it is accepted both here and abroad.
    I appreciate the Commission's investigation of illegal 
backdating of stock options. The issue seems to be getting 
bigger as the investigations continue. I do share my support 
for Chairman Cox and the SEC Enforcement Division for your 
speed and determination with which you have been conducting 
these investigations. The PCAOB can also play an important role 
in this issue as the investigations could result in a new audit 
practice for firms auditing public companies.
    Despite the growing amount of evidence about improper 
accounting and possible fraud within the suspected companies, 
it is important to understand that stock options remain a 
legitimate and useful form of compensation. Startup companies 
and Fortune 500 companies alike use stock options to motivate 
rank and file employees and attract top talent.
    The Commission has set an ambitious agenda for the coming 
months, and I look forward to working with you and hearing your 
testimony today.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Let me just, before turning to you, Mr. Chairman, for your 
comments, we will have a markup tomorrow morning beginning at 
9:30. And Senator Shelby and I are working with your respective 
staffs on various amendments to the bills we hope to markup.
    Our hope is to be able to have an expedited markup of 
several pieces of legislation. I would just urge my colleagues, 
if they could, to come by at 9:30 so we could move rather 
quickly through the markup so we do not have to delay it or do 
it off the floor later in the morning or later in the 
afternoon.
    Your staffs are well aware of this already and we are 
working very closely with them. We just wanted to mention that 
here this morning, if I could.
    Chairman Cox, we welcome you to the Committee. Thank you 
for being here. It is good to have you back. We will take your 
opening statement.

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE 
                           COMMISSION

    Chairman Cox. Thank you very much, Mr. Chairman.
    I am very pleased to be here today and have the opportunity 
to speak to you, to Ranking Member Shelby, and to the rest of 
the members of the Committee, about the important work that the 
SEC is doing to protect investors, to promote efficient 
markets, and to promote capital formation.
    The initiatives that we have underway at the SEC are all 
united by a common theme and that is the protection of 
individual investors, benefiting investors whose returns 
depend, of course, on healthy, well functioning markets. This 
is the SEC's traditional responsibility.
    Back in the day of Joe Kennedy, our first Chairman, could 
marvel that one in every 10 Americans owned stocks. But today 
over half of all households own securities.
    In fact, when one considers the staggering growth in 
America's individual participation in the markets, the enormity 
of the SEC's task becomes apparent. About 3,600 staff at the 
SEC are responsible for overseeing over 10,000 publicly traded 
companies in our markets; over 10,000 dozen advisers that 
manage over $37 trillion in assets. Even in Congress, that is a 
big number. Nearly 1,000 fund complexes, 6,000 broker-dealers 
with 172,000 branches, and the $44 trillion worth of trading 
conducted each year on America's stock and options exchanges.
    Perhaps, as Senator Schumer mentioned, the most striking 
development in our market of late is that they are becoming 
increasingly interconnected globally at an increasingly 
accelerated rate. This is challenging the United States and 
securities regulators around the world to collaborate more 
closely than we ever have before. Investors have a lot to gain 
in a truly global marketplace but there are many risks and 
pitfalls as well. Not only issuers and providers of capital but 
also fraud artists have gone international.
    Mr. Chairman, many of the issues that we face are sometimes 
trivialized as disputes between business on the one hand and 
investors on the other hand, as if to be pro-investor is to be 
anti-business, or to be pro-business is to be anti-investor.
    The truth is that when people invest in a company's 
securities they are risking their own money on that company's 
success. Only if the business succeeds will their investment 
prosper. That is why the SEC's first chairman described the 
SEC's role and our relationship to business as a partnership. 
We take that to mean today, just as when Joe Kennedy was 
chairman, that if a business is investor friendly the SEC will 
be friendly to it. But anyone who seeks to drive a wedge 
between the interest of the business and the interest of 
investors in that business will face a relentless and powerful 
adversary in the Securities and Exchange Commission.
    Today the SEC's Enforcement Division is significantly 
larger than it was 5 years ago. Our staff is engaged in 
combating abuses that range from boiler rooms and Ponzi schemes 
to stock option grants made to fictitious employees. We are 
pursuing individuals and firms who have falsified corporate 
documents, engaged in self-enrichment to the detriment of their 
investors, and attempted cover ups of this sort of conduct. We 
are investigating and filing actions against perpetrators of 
Internet scams, pump and dump schemes, and prime bank frauds, 
and executives who have lied to their auditors. We are going 
after accountants, lawyers and other gatekeepers who have 
joined in those frauds themselves.
    The Commission is also making increasing use of the new 
authority that you gave us in the Sarbanes-Oxley Act to use 
Fair Funds to ensure that the monies that we recover through 
our enforcement efforts go straight back to the injured 
investors without deduction for lawyer's fees as quickly as 
possible. Through this program we have already returned over $2 
billion to investors. We are rapidly developing a considerable 
expertise in the distribution of these billions in Fair Funds, 
which I intend to accelerate through the creation of a 
dedicated office that will specialize in this area. That new 
office will be up and running by October.
    Of course, enforcement almost always comes after the fact, 
when investors have already been injured. But investors are 
best protected when securities firms have robust compliance 
programs to prevent violations. That is why the Commission has 
taken new steps to help securities firms meet their compliance 
obligations, including our CCOutreach program which helps chief 
compliance officers and mutual funds and investment advisers to 
implement strong compliance programs for the protection of 
investors.
    Beyond CCOutreach, we are publishing information about the 
common deficiencies we find in examinations to help securities 
firms improve their own compliance programs.
    Beyond the SEC's enforcement and compliance efforts, we 
have undertaken a variety of initiatives and rulemakings to 
protect investors and increase the efficiency and 
competitiveness of our markets. Perhaps the most important step 
we have taken this year is to rationalize the implementation of 
Sarbanes-Oxley. We have just approved new guidance for 
management in implementing Section 404 of the Act. Just last 
week the Commission voted to repeal the auditing standard that 
had made Sarbanes-Oxley Section 404 so expensive and replace it 
with a new standard that is half as long, written in plain 
English, and that is principles based, top-down, scalable for 
companies of all sizes and focused on what is truly material to 
the quality of the financial statements.
    These actions represent over 2 years of hard work aimed at 
addressing the problems with 404 implementation that this 
Committee has very properly focused on.
    With these improvements to 404, no longer will the auditing 
standard be the de facto rule book for management's compliance 
with our rules. For those smaller companies that have not yet 
come into compliance with Section 404, the guides will permit 
them to avoid the wasteful and unnecessary compliance efforts 
that others have had to endure. For these smaller companies we 
have once again deferred, for the fourth time, the external 
audit requirement under Section 404. So management will have 
another full extra year, until 2009, to develop its own cost-
effective compliance approach.
    When eventually these smaller companies do come into 
compliance, they will find that the new standard encourages the 
scaling of all audits. Small companies will be able to apply 
the guidance to their unique control systems rather than create 
costly and complex control systems that follow the one size all 
checklist approach that many larger companies have had to 
endure is they have struggled to comply with Section 404.
    As a result of these sweeping changes, the SEC and the 
PCAOB expect a change in the behavior of the individuals who 
are responsible for following these new procedures. To that 
end, the PCAOB's inspection program will monitor whether audit 
firms are implementing the new auditing standard in a cost-
effective way and the SEC, in our oversight capacity, will 
monitor the effectiveness of those inspections.
    The Congress has charged the SEC with making Section 404 
work both effectively and efficiently. We recognize that doing 
so will greatly benefit U.S. investors as well as the 
competitiveness of U.S. companies and financial services 
providers throughout our global capital markets.
    Another significant effort the SEC has undertaken is our 
focus on helping seniors. Last year we organized the first ever 
Seniors Summit with our fellow regulators and law enforcement 
officials from across the Nation. This September we will host 
the second annual Senior Summit which will integrate even more 
of our national resources.
    We are attacking the problem of fraud against seniors from 
all angles, from aggressive enforcement efforts to target 
examinations, and investor education. We have brought 26 
enforcement actions during the past year aimed specifically at 
protecting elderly investors. Many of them coordinated with 
State authorities.
    Beyond enforcement, education is a vitally important tool 
in fighting securities fraud against seniors. The SEC's 
education efforts are aimed not only at seniors but also their 
caregivers and the over 100 million pre-retirement workers who 
are in need of planning now for contingencies in later life.
    We are reaching out to community organizations and 
enlisting their help in educating Americans about investment 
fraud and abuse directed at seniors. We have also devoted a 
portion of the SEC website specifically to senior citizens.
    The SEC has also identified another at-risk group that is 
vulnerable to unscrupulous sales practices for financial and 
investment products, and that is the men and women of our 
military. We worked with you and the Congress to enact the 
Military Personnel Financial Services Protection Act just last 
year to prevent the sale of potentially abusive insurance and 
investment products to military personnel and we back that up 
with enforcement, examinations, and investor education to 
protect against these abuses.
    We have also initiated a coordinated approach with other 
regulators to protect America's servicemen and women.
    Today, I would like to announce another important 
initiative in the SEC's investor education and investor 
advocacy missions. We will be expanding the role of investor 
education and our focus on the needs of retail investors 
through our new Office of Investor Education and Advocacy.
    The new name connotes expanded responsibilities, including 
the appointment of a new director who will focus on the 
specific needs of individual investors such as whether the 
disclosure they receive is understandable and how they can get 
redress for problems with their retail brokerage in their 
individual investments.
    Kristin Kaepplein, who until recently was the Vice 
President for Global Compliance at Goldman Sachs, will lead 
this expanded office and two new units within it, the Office of 
Policy Investor and Outreach and the Office of Investor 
Education. The existing Office of Investor Assistance, which 
hear year has contact with tens of thousands of individual 
investors, will also come under the new Director's 
responsibilities.
    Tapping the power of new technology is key to the 
Commission's efforts to put individual investors first. Our 
recently adopted electronic proxy rules will allow individual 
investors the choice of getting their proxy materials online 
where they can search the information and also link to other 
explanatory materials as well as, in the future, gaining access 
to interactive data that will let ordinary investors sort 
through mountains of SEC mandated disclosure and turn it into 
something meaningful.
    What we are calling interactive data will provide owners of 
stocks, mutual funds, 401(k)s, far more useful information than 
anything that they have ever gotten from the SEC before.
    The SEC's current online system, known as EDGAR, is really 
just a vast electronic filing cabinet that does little to 
exploit the power of today's computers. It can bring up 
electronic pieces of paper on your computer screen but it does 
not let you do much with it. Interactive data will change that 
by allowing investors to quickly find, for example, a mutual 
fund's expense ratios or the mutual fund with the lowest 
expense ratio, the company within an industry that has the 
highest net income, or the overall trend in their favorite 
company's earnings.
    The Commission is investing over $54 million over 7 years 
to build the infrastructure to support widespread adoption of 
interactive data. Companies that are pioneering this new 
technology have told us that there are substantial benefits 
that will exceed the minimal costs. Interactive data can make 
company's internal processes more efficient and cut the costs 
of registration and compliance reporting to the SEC.
    Yet another initiative the Commission is pursuing is 
improving the way shareholders can interact with each other and 
with their companies using the Internet. In the course of 
addressing the question of shareholder access to the company's 
proxy materials, the Commission has also proposed changes to 
the proxy rules designed to remove obstacles to electronic 
shareholder communications.
    The proposal would clarify that a company or a shareholder 
who maintains an electronic shareholder forum is not liable for 
statements by any other participant in the forum and it would 
clarify that participants in electronic shareholders forum 
would not themselves be engaged in a proxy solicitation.
    Ultimately, empowering shareholders and issuers is the key 
to keeping U.S. markets competitive because capital will flow 
to where it is treated well. We are confronting the challenges 
and opportunities of more foreign listings here in the United 
States in a number of ways, not least of which is our 
consideration of International Financial Reporting Standards. 
Last week the Commission voted unanimously to publish a concept 
release for public comment on allowing U.S. issuers, including 
investment companies, to prepare their financial statements 
using International Financial Reporting Standards as published 
by the International Accounting Standards Board.
    A truly global set of standards, which is what we are 
investigating, would allow investors to draw better comparisons 
among investment options around the world. It would also 
potentially lower costs for investors and issuers who would no 
longer have to incur the cost of maintaining and interpreting 
financial statements using different sets of accounting 
principles.
    Yet another way that we are addressing the international 
character of our securities markets is exploring the merits of 
a mutual recognition approach to facilitate global market 
access. Just last month the Commission hosted a roundtable on 
mutual recognition where distinguished representatives of 
United States and foreign exchanges, global and regional 
broker-dealers, retail and institutional investors and others 
shared their views on the possibility of mutual recognition.
    Although the details of a viable mutual recognition 
approach are still in the works, any such approach would depend 
on these entities being robustly supervised and regulated in 
their home jurisdictions. And that home decision would have to 
provide substantially comparable oversight to that here in the 
United States.
    A mutual recognition regime would consider, for example, 
under what circumstances foreign exchanges could be permitted 
to place trading screens with U.S. brokers in the United States 
without full registration.
    Mr. Chairman, the final area that I would like to address 
is the way the SEC is confronting emerging risks in our global 
markets. As elsewhere, our strategy begins with enforcement 
where we have created special working groups within the 
Enforcement Division to deal with emerging risks including 
stock options backdating, microcap fraud, and hedge fund 
insider trading.
    In the past few years, the Commission has brought numerous 
enforcement actions alleging that hedge fund portfolio managers 
engaged in insider trading. The Hedge Fund Working Group within 
the Enforcement Division is coordinating with other Federal 
law-enforcement agents and self-regulatory organizations.
    In March of this year, the Commission filed cases against 
14 defendants alleging one of the most pervasive Wall Street 
insider trading rings since the days of Ivan Boesky and Dennis 
Levine. We alleged that participants in the scheme included 
several hedge funds and their portfolio managers.
    In another recent case, we charged a family insider trading 
ring with a multimillion dollar scam that they carried out by 
creating a hedge fund to conduct the insider trading and to 
disguise their identities.
    We have also brought a number of enforcement actions 
against hedge funds and their portfolio managers who, we 
alleged, made millions of dollars by trading illegally on 
inside information regarding so-called PIPE stock offerings.
    In addition, the Commission has brought cases against hedge 
fund managers that we charged with trading on the basis of 
inside information ahead of mergers and acquisitions.
    Earlier this month, the Commission voted to adopt a new 
hedge fund anti-fraud rule permitting investment advisers from 
defrauding investors and prospective investors in the funds. 
This rule will help the Commission police the hedge fund 
market. It will help us to deter misconduct and to call to task 
those who engage in such misconduct.
    Another area that we have identified as an emerging risk is 
the municipal securities market, which is now $2.4 trillion in 
size and over $6 trillion in annual trading volume. Last year 
$430 billion of new municipal bonds and notes were issued, many 
not by governments but by essentially commercial enterprises 
that structured their finances to gain the advantage of the 
tax-free borrowing rate.
    When the Federal securities laws were originally enacted 70 
years ago this was a small quiet market dominated by 
institutional investors. But today the majority of the 
investors are individuals, either directly in the form of 
households or indirectly through mutual funds, money market 
funds, and closed end funds. Despite its reputation as a buy 
and hold market, municipal trading volume, at over $16 trillion 
last year, is similar to what we see in the corporate bond 
market.
    While the SEC has anti-fraud authority, which means that we 
can come in and clean up the mess after it has happened, we do 
not have the authority in the municipal securities market that 
we have in the corporate securities market to insist on the 
disclosure of material information to investors at the time 
that the securities are being sold.
    I hope that, working with this Committee, we can consider 
ways to make disclosure information available on a more timely 
basis before the sale of municipal securities and to consider 
other ways of protecting investors, including the use of 
generally accepted governmental accounting standards, SEC 
oversight of the Governmental Accounting Standards Board, and 
clarifying the legal responsibilities of issuer officials, 
underwriters, bond counsel, and other participants in the 
offerings.
    Mr. Chairman, this is a necessarily summary description of 
just some of the most important work underway at the SEC. But 
it is a fair survey of the regulatory and enforcement landscape 
and the domestic and international challenges that we face in 
the days ahead.
    I want to thank you for the opportunity to appear before 
the Committee. I look forward to working with you and to 
meeting the needs of our Nation's investors, issuers, and 
markets.
    I would be happy to take your questions.
    Chairman Dodd. Thank you very much, Mr. Chairman.
    What I want to do, since we have a pretty good turn out 
here, Senator Menendez and Senator Reed will be back, is I will 
make it 6 minutes a round. That way we can get through a lot of 
people here quickly, maybe get one or two questions in, and we 
will try and move along so we cover as much ground as possible.
    Let me pick up, if I can, in my first question to you, a 
matter that Senator Reed raised earlier with you in his opening 
comments. And that is regarding the Commission's votes, I will 
use the word plural here, to issue for public comment on the 
two proposals that were almost the opposite of each other.
    One would have allowed shareholders who own 5 percent of a 
company for 1 year to propose changing bylaws governing how 
directors are elected. The other would prohibit all 
shareholders from putting forward the same type of election-
related proposals.
    I have been on the Committee for 26 years, Mr. Chairman. 
Correct me if I am wrong, and I am sure you have had your 
historians at the SEC go back and look at this, if there has 
ever been an example where a Chairman has voted yes on two 
absolutely contradictory proposals, carrying both of them by 
three to two margins here.
    The issues that have been raised by Senator Reed are very 
important to me, and I assumed to other members as well. One, 
explain how the reason the Commission would issue two similarly 
contradictory rules for your votes? I understand you want to 
get opinions on these matters. I understand that. But I do not 
understand why you would have two contradictory rules to get 
the opinions.
    What actions will the Commission take or not take on 
shareholder proposals on the subject prior to the Commission's 
adoption of a final rule?
    Again, the point of 5 percent ownership here, again it 
raises some questions regarding some rather large investors in 
terms of their ability to have some say. What types of 
investors would be included if the 5 percent threshold would be 
maintained?
    So I think some explanation is needed here, Mr. Chairman.
    Chairman Cox. Thank you, Mr. Chairman. You put three 
questions to me: why two proposals? What actions might we take 
prior to their implementation? And why 5 percent?
    First, with respect to why two proposals? The proposals are 
very different but they do have one essential element that is 
in common. They have the same foundation. And that is the long-
standing interpretation of the Commission's existing rule, 
under which a proposal by a shareholder to amend the company's 
bylaws concerning the procedures for election of directors 
could be excluded by a company from its proxy materials.
    Chairman Dodd. That went back to 1990.
    Chairman Cox. That goes back to 1990.
    Chairman Dodd. Prior to 1990 it was a different rule.
    Chairman Cox. From 1976 to 1990, the Commission staff 
interpreted the provision differently, although quite frankly 
we did not have much incidence of that kind of proposal at the 
time.
    But the proposal, which I will refer to for ease of 
distinction here as the longer proposal, that would permit such 
bylaw amendments to have access to the company's proxy 
materials, is based on that operating presumption of how if a 
company did not make such an election the world would work. So 
that proposal, that essential proposal, is the same in both.
    What is different, of course, is whether or not a company 
and its shareholders would have the opportunity to design a 
system that they think is right for them, whether shareholders 
would be able to propose it, whether the company would be able 
to propose it and the shareholders approve it.
    My personal view is that there is much merit in that kind 
of an approach. We do not have, among all five commissioners, a 
clear agreement on all of these issues. But we are under a very 
significant constraint, a time deadline that is imposed by the 
combination of a court decision and the upcoming proxy season.
    What I have publicly stated it, and I am happy to repeat 
here, several times is that there will be a rule in place this 
fall, this coming proxy season, so that people will know how to 
conform their conduct to the law and to the rules of the SEC.
    In order to put a rule in place, I have got to have a clear 
idea of what the commissioners want to do and which 
commissioners I am voting with, and which commissioners, by the 
way, are members of the SEC. All of these things somewhat up in 
the air right now.
    And so we will have elaborate opportunity for comment on 
these two proposals. They do have some things in common. And 
with the benefit of that I think we will be able to continue 
our discussions.
    If we were not operating under the constraint of a court 
decision and this fall deadline I think, rather than put the 
two proposals out there and let everybody see our work in 
progress, we would have just continued to consult with each 
other a little bit longer.
    With respect to----
    Chairman Dodd. The 5 percent.
    Chairman Cox. The 5 percent, what the SEC's existing role 
and existing interpretation are premised upon is that investors 
need disclosure if there is going to be a proxy contest about 
who they are dealing with and what is going on around the 
contest. I think all of the commissioners are agreed that that 
is important.
    And so in both proposals there is a sturdy mechanism to 
make sure that that disclosure is provided, that the proxy 
contest rules, for example, would apply even if a company 
adopts its own bylaw with its own procedure that might be 
different from our current rule.
    The 5 percent disclosure threshold in our existing 13(d)/
13(g) regime is what we adopted so that there is something that 
has legal precedents, that people know how to use it. Were we 
not to have done that, then the disclosure regime would have to 
have been invented from whole cloth. It would have been a much 
more significant if not daring undertaking.
    There are certainly other ways to do this. It is not 
anything in nature that requires the 13(d)/13(g) regime to be 
built upon 5 percent.
    But I will say this also, that in the aborted 14a-11 
proposal that was advanced by the Commission a few years ago 
and never finally acted upon, there was a 5 percent threshold. 
We have consulted with a number of investors and investor 
groups and there is significant support, as well as significant 
opposition, to the 5 percent threshold.
    But there is one piece of this proposal that might be being 
overlooked that I hope the comment period will help to flesh 
out. And that is electronic shareholder form that I described 
in my opening statement. The 5 percent does not need to be a 5 
percent investor. It can be a group. And one might credibly 
inquire whether if you cannot put together a group of 5 percent 
to propose a bylaw, whether you could ever get 50 percent to 
pass it. There is not any empirical evidence on this, of 
course, because this has not been attempted before.
    So we will see what the comment provides. But the 
opportunity that investors will have to speak with each other 
very freely and very inexpensively on the Internet without 
concern about the proxy rules, were this proposal to be 
adopted, would be a way to put together a 5 percent group that 
does not exist today.
    Chairman Dodd. I thank you for your answer here and I 
appreciate the time constraints you are operating under. Let me 
just say here again, speaking as Chairman but obviously as one 
member here as well, that my hope is that the Commission would 
be able to resolve this, keeping in mind the importance of 
investor rights in all of this.
    But also to say to you, Mr. Chairman, that it is something 
that the Committee might consider legislatively in dealing with 
it. I do not jump to that. As you know, I am reluctant over the 
years to have the Committee jump into matters that more 
properly belong in the regulatory framework rather than the 
legislative framework. But this is one area where I might 
express some interest legislatively if the Commission is unable 
to come to a conclusion promptly on this. So I raise that for 
you for your consideration.
    Chairman Cox. I appreciate, Mr. Chairman, the extra 
encouragement. But as I stated, we will do a rule and we will 
have it in place this fall.
    Chairman Dodd. I am glad about that.
    I have some questions about hedge funds and so forth, but 
my time has expired. Let me turn to Senator Shelby and I--if I 
can come back later on.
    Senator Shelby. Thank you, Mr. Chairman.
    Credit rating agencies. President Bush signed the Credit 
Rating Agency Reform Act into law last September, as you know, 
Mr. Chairman. My goals in drafting that legislation were to 
replace an opaque SEC staff designation process with a 
transparent registration system, promote competition in a 
highly concentrated industry, and establish a regulatory 
framework giving the SEC statutory authority to supervise 
rating agencies.
    Since the legislation was enacted, Mr. Chairman, much 
attention has focused on the role of the credit rating agencies 
and structuring subprime loans into securities, as well as the 
accuracy and quality of the ratings issued on these securities.
    In light of all the serious concerns that have been raised, 
what is the Commission currently doing to supervise the rating 
agencies? Chairman Cox, have the rating agencies followed all 
of their publicly disclosed procedures and methodologies? And 
how would you make that determination, if you can?
    It is a big concern to us when you are rating subprime 
securities or loans constituting subprime loans, securities 
constituting highly rated, and then we know they are junk. Now 
they are downgrading them. And you know what is going on in the 
subprime market. It is a concern to us.
    Chairman Cox. These are two big issues for the SEC 
colliding and mutually reinforcing one another. Congress has 
given us significant new responsibility over NRSROs which we 
are now executing upon. We have adopted rules, as you know, and 
we are devoting new resources to our responsibility to oversee 
registered ratings agencies.
    Any examinations that we conduct, I should add to clarify 
at the outset, would not in any circumstance evaluate the 
opinion that was expressed in a particular credit rating. But 
rather we would be focused upon the existence and the 
effectiveness of a rating agency's policies and practices 
regarding matters such as conflicts of interest and their 
handling of material nonpublic information.
    On the other hand, our ability to examine the NRSROs will, 
if such a thing were ever to occur, give us the opportunity to 
use the enforcement powers that we have always possessed in 
this area more effectively.
    Senator Shelby. We have given you a little more tools than 
you had, absolutely, have we not?
    Chairman Cox. Indeed.
    Senator Shelby. I hope you will use them for the benefit of 
the public.
    Chairman Cox. We are definitely using them.
    Senator Shelby. Competitiveness. We have been talking about 
this here, and you do, too. Since your last appearance before 
the Committee, a number of reports have been issued suggesting 
that excessive regulation and litigation is harming the 
competitiveness of U.S. capital markets. These are factors 
unlike globalization and technology that we have some control 
over in this country.
    I believe the next few years are a critical period, making 
it imperative for us to create a regulatory structure that can 
adapt to the rapidly changing global environment that you are 
confronted with every day.
    The SEC, I understand, has embarked on a number of 
initiatives to address some of the problems identified in these 
reports. In your estimation, Chairman Cox, what is the single 
most important action the Commission has taken or is likely to 
take that will strengthen U.S. markets as far as 
competitiveness is concerned? And what is the most important 
thing that Congress, that we could do in this regard to help, 
in your judgment?
    Chairman Cox. As you indicate, Senator, we are taking a 
number of actions. And I do not want to, by answering your 
question directly, suggest that these others are not nearly as 
important. But I do not think there is much question, 
addressing the challenge of Sarbanes-Oxley and, in specific 
Section 404, is of vital importance to the competitive position 
of U.S. markets in the world.
    I say that because even though we are all very, very 
familiar here, certainly on this Committee but also in our 
markets and across the country with the problems for example of 
Section 404, in Europe and in Asia and the rest of the world it 
starts to get a little fuzzy. People are not so focused on the 
detail as on the brand name of Sarbanes-Oxley and the 
pathologies that it is supposed to connote.
    So by directly addressing this problem and by discussing it 
in real time with our counterpart regulators overseas and with 
other market participants, I think we are going to make a big 
and a clear impression that this change, that it is going to be 
fixed, it is going to be addressed. And not only that, but it 
is going to be made to work. So we are not making it go away, 
we are making it efficient, cost effective, and getting all the 
protections for investors that Congress wanted that I believe 
and I think most of you believe undergird our markets and make 
them more competitive.
    Senator Shelby. Last week the Commission issued a concept 
release on the future role of International Financial Reporting 
Standards in U.S. markets that raises a number of questions 
including whether U.S. issuers should be permitted to prepare 
financial statements in accordance with International Financial 
Reporting Standards for purposes of complying with the 
Commission's rules and regulations and without reconciliation 
with the U.S. GAAP.
    In addition, it is my understanding that the Commission 
proposed to eliminate the requirement that foreign private 
issuers who file financial statements using International 
Financial Reporting Standards also submit a reconciliation of 
those financial statements to U.S. GAAP. This is a big 
departure but it might be where you are going.
    This transition to global accounting standards has profound 
implications for the capital markets. What is the most 
significant challenges here in the next few years? We have 
worked on this with you before but this is changing. Is it for 
the better? And will it help us compete?
    Chairman Cox. These are exactly the right questions and we 
do not have the answers right now. For that reason we have just 
voted to publish a concept release which is itself a long list 
of questions. We expect to have a good deal of public input 
from around the world and certainly from this country about 
what IFRS means for the future of U.S. markets.
    But I think we need to take a step back and recognize that 
the United States has been consistently supportive of the 
development of IFRS.
    Senator Shelby. Absolutely.
    Chairman Cox. We know that Paul Volcker was the Chairman of 
the IASB. The U.S. has been the largest financial supporter of 
the development of these standards. Europe has now mandated 
this for all of its member states starting in 2005.
    Senator Shelby. There has got to be a convergence 
somewhere, has it not, between our standards and their 
standards?
    Chairman Cox. Yes. And the U.S. participation has been 
focused on a very sturdy effort between the FASB here in the 
United States and the IASB to converge the two systems so that 
in the future this question of IFRS versus U.S. GAAP will not 
be such a consequential one. It will be much more a question of 
how we accommodate and facilitate comparisons around the world.
    I do not think there is much question in the abstract that 
if there could be such a thing that we would all agree is a 
global set of high standards that are consistently and fairly 
enforced everywhere in the world that we would all be better 
off. That is what we are trying to build toward. I do not know 
if we are there yet. And whether or not this is ripe for the 
United States in the near term is the question we are asking.
    Senator Shelby. That is equivalence. The term we are 
working at is equivalents, in a sense; right?
    Chairman Cox. At least that, yes. And I do not think there 
is much question that we are nearly there with equivalence. 
Foreign private issuers are filing their financial statements 
in the United States with IFRS already. The SEC now has a few 
years of experience in analyzing those. We have trained up all 
of our people and we are certainly capable in that respect.
    The rest of the United States, the accounting firms, 
schools of accounting, and so on, have quite a ways to go in 
this respect. So we are very much on the leading edge of these 
questions.
    Senator Shelby. Thank you. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Sununu.
    Senator Sununu. Thank you, Mr. Chairman.
    Chairman Cox, I would like to begin with the issue of 
market data. Some time ago, in a presentation before the 
Committee, you talked about the efforts of the Commission or at 
least the relative importance of the Commission dealing with 
market data revenue, access to data, and distribution of the 
revenue.
    Has the Commission come to any conclusions? And what do you 
think the issues are that stand in the way of taking action in 
this area?
    Chairman Cox. We are very intently focused on this. Since 
the last time that we discussed it in this Committee, the 
Commission has granted a petition by the Net Coalition which, 
as you know, is a trade organization of Internet companies, to 
review the staff's approval by delegated authority by NYSE Arca 
proposal to begin charging a fee for its depth of book data.
    The staff is currently preparing a new order for the 
Commission that would approve the fee primarily because NYSE 
Arca was subject to significant competitive forces in setting 
the fee.
    In addition, since the NYSE and NASDAQ have filed proposals 
for innovative reference data products that make economic sense 
for advertiser supported Internet companies like Google, Yahoo, 
and CNBC, those would be encompassed by this as well.
    Senator Sununu. You also talked about XBRL. I guess you did 
not use that language. You simplified it for us a little bit. 
But the importance of having systems in place that make it 
easier for investors and businesses to make use of the store of 
information collected by the SEC.
    In my notes, I am shown that about 40 companies right now 
are voluntarily providing data to the SEC that is tagged with 
this data format that makes the information more accessible.
    In your written testimony you spoke of $54 million that was 
going toward the implementation of this kind of data 
formatting. Have you set out any timing or milestones for 
getting more companies to use this format in order to make the 
data more accessible? You have 40 companies filing with coded 
filings to the Commission now. Out of how many total firms is 
that, that are filing? It is obviously a small percent but when 
do you expect to see more progress?
    Chairman Cox. First, let me tip my hat to the participants 
in our pilot program because what they are doing is they are 
doing it the old way and the new way. There is really not a 
whole lot of purpose, other than being early adopters and 
getting ready and helping the SEC to beta test the system in 
their doing this. You would imagine that they would stop if it 
were harmful or painful or expensive.
    But what we are finding from our test filers is that the 
amounts of money that they are spending to do this are trivial. 
And they are already seeing internal benefits to themselves in 
having this sort of automation of the preparation of financial 
information. It is more accurate. It is easier to keep track 
of. It can speed up their internal processes as well as make 
the output better.
    But it will remain for volunteers to do this in relatively 
small numbers unless and until two things happen. First, there 
is a completed cookbook or rulebook--I hate to use the word 
taxonomy, which is the favorite term of XBRL mavens--for all of 
U.S. GAAP. We are very, very close to achieving that. It should 
be completed in the third quarter of this year. That means that 
there will be about 15,000 little labels or recipes that people 
can put on their data. They will all be standardized and they 
will not have to be customized, as they are now.
    Microsoft, just as one example of a company that is a 
volunteer filer in our test program, has approximately 600 
customized extensions that it is using. Customization is sort 
of at odds with what we are trying to accomplish here because 
we want comparability and we want everybody to be able to find 
what they are looking for without a lot of prior knowledge. And 
so using the completed taxonomy for all of U.S. GAAP will 
permit them to take the next step forward.
    Assuming that this all works, I would say by the end of the 
first quarter of next year or at least by the time people file 
their 10-Qs using the new completed taxonomy, we will have a 
good idea from the test filers whether they like it and whether 
it works. They are then in a position to be evangelists to 
others and say take it on, try it, and do it.
    The second thing that will have to happen is that we will 
have to make it possible for people to stop doing it the old 
way so that there is some real benefit in people signing up for 
this, rather than filing all of your interactive data XBRL 
stuff as an exhibit to the current disclosure that is already 
required. I think when we do that, even if we were not to 
mandate it, we would get a lot of take up.
    Senator Sununu. To the second point, is there any 
information or transparency that is lost if someone were to 
convert over----
    Chairman Cox. To the contrary, there is much more 
information provided because now you have got all of the stuff 
you used. You have all of the financial statements, which now 
are susceptible to being represented on a piece of paper, and 
you have made it all interactive.
    Senator Sununu. So if we add, just hypothetically, if you 
add a system where you could file either way there would still 
be full disclosure or disclosure at least to current standards?
    Chairman Cox. Yes. And one of the things that the SEC has 
done with our modest investment is that we have built a 
software tool that will permit rendering on our own website all 
of the XBRL gibberish, the computer language that people are 
really filing in, rendering that in a way that people are used 
to so it looks like a piece of paper.
    Senator Sununu. Excellent.
    Back to the issue of timing, you think that the standard 
lexicon for tagging this data should be completed by the first 
quarter of 2008. Do you expect to have more than a handful of 
companies filing voluntarily in this format by the end of 2009? 
Or do you think that it will be about the same that we have 
now?
    Chairman Cox. By the end of 2009?
    Senator Sununu. I am sorry, 2008. But the end of 2008.
    Chairman Cox. That is a great question. I think this is 
going to be the real test of this whole opportunity. 2008 will 
be the no go or go year.
    Senator Sununu. Thank you. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Again, thank you, Chairman Cox.
    Over the last several months we have been looking in the 
Subcommittee about the mortgage securities market, CDOs, and 
have discovered that these are extremely complex instruments 
that are virtually illiquid. And rather than mark to market, 
they mark to a model or they mark to a rating by the rating 
agencies.
    How comfortable are you with this approach that these 
instruments really do not get tested by the market? In fact, 
there is a strong suggestion as when funds were given the 
choice between disposing of their assets in the marketplace or 
a parent's firm, providing resources, the parent's firm sort of 
paid up rather than trying to mark them to market.
    How comfortable are you with this situation?
    Chairman Cox. Senator, as you know, we are very much 
focused on issues such as valuation and, in particular, the 
impact of subprime lending on the CSC firms that we regulate. 
On the other hand, we are not a front-line regulator for the 
subprime lending industry. Our Division Enforcement, in 
particular, is constantly on the lookout for possible 
securities fraud involving subprime mortgage lenders.
    As I mentioned in my prepared remarks, they have formed a 
working group specifically focused on nationwide efforts in 
this area.
    The risk that you have identified, I will say, is a real 
one. And it is one about which the SEC is concerned. And so we 
will use the tools that we have and the piece of this that we 
are responsible for to go after it.
    Senator Reed. Is there an effort to coordinate your 
activities with other regulators, the Federal Reserve?
    Chairman Cox. Very much so. As you might imagine, given the 
broad market impact of this entire area, this is a subject of 
special concern to the President's Working Group on Financial 
Markets. As a participant in that group, I am sharing the SEC's 
expertise and resources with the other members, including the 
Treasury, the Fed, CFTC, as well as with other banking agencies 
that are not directly participants in the PWG.
    Senator Reed. A related question that goes to the issue of 
systemic risk which concerns all of us and it is probably the 
bottom line of what we have to worry about at the end of the 
day.
    With a tightening liquidity which is becoming more 
apparent, with higher interest rates and potentially going 
higher, and with hedge funds who are very difficult to 
understand the types of transactions and portfolios they have, 
with access to huge amounts of money, where in a day there 
could be a wrong bet that they would have significant 
repercussions in the market.
    Do you think the regulatory structure is adequate at this 
moment? Are there authorities that you lack? Is there a gap 
between what you are doing and the Federal Reserve is doing 
that has to be addressed?
    Chairman Cox. Are you asking with respect to hedge funds, 
private capital, or----
    Senator Reed. I am asking with respect to the issue--hedge 
funds being one actor or the significant actor in the 
marketplace. But looking at your course of situation of tighter 
liquidity, rising interest rates, hedge funds, private equity 
funds, some of them regulated, some not regulated. Do you feel 
you have the authority to deal with the potential systemic 
threat?
    Chairman Cox. The first way to deal with potential systemic 
threat is to be inductive and to learn what is happening. And 
in that respect, we are doing a good bit of sharing and a lot 
more than we ever used to with our international regulatory 
counterparts.
    We are also doing a much better job, I am sure, than ever 
was needed before, at sharing inside the U.S. Government. So I 
think we are increasingly getting a clearer picture of what is 
going on in terms of liquidity and the global financial system.
    The second thing that we have to do to deal with the 
potential risk in this area is to have rules and authority over 
the marketplace actors that might be violating our precepts or 
our laws. And in that respect, we do need to do more. I have 
been busy executing memoranda of understanding with our 
counterpart regulators around the world. Those MOUs typically 
begin with the enforcement piece and sharing information for 
that purpose. They then extend to, when they become more mature 
as they have with several European countries, they then extend 
to reinforcing mutually our respective regulatory regimes.
    The last thing I would point out is that if one is looking 
at the global financial system, it is impossible to do so--and 
if you are attentive to the risks posed by hedge funds, which 
tend to be black boxes, without being attentive also to the 
rise in significance of sovereign wealth funds. As you know, 
they are projected to grow over the next 8 years to potential 
$12 trillion in size. They are less transparent, significantly 
so than hedge funds.
    They also differ from hedge funds in the sense that they 
may have motives for their investment decisions that go beyond 
mere profit and loss.
    And so understanding the impact on liquidity and on the 
safety, security and soundness of markets, the efficiency of 
markets, and setting prices and allocating resources is going 
to become very, very much more difficult if the next 8 years 
really looks as has been projected.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Chairman Cox. Thank you.
    Chairman Dodd. Thank you. Senator Bennett.
    Senator Bennett. Chairman Cox, you and I have had this 
conversation but now let us have it in public.
    I understand that this is a relatively small issue when you 
take the trillions of dollars that trade every day, but I am 
talking about primarily in the pink sheets naked short selling.
    As I have spent time with this issue, I think I have put my 
finger or tried to put my finger on what the basic problem is. 
When we talk about banks, a bank takes deposits and then a bank 
makes loans. And in the process the bank loans more money than 
it has on deposit and thus creates money.
    We have the DTCC that takes deposits. In this case, it is 
not money, it is shares of stocks. And then the DTCC makes 
loans, shares of stock to be available as borrowed shares for 
those that are selling short. My concern is that the DTCC is 
beginning to act like a bank. That is, just as a bank loans 
more money that it has on deposit and creates money, the DTCC 
is loaning more shares than it has on deposit and is creating 
shares, creating phantom shares.
    Now I do not think they are doing it deliberately. I want 
to make it very clear. I think the DTCC is an essential entity 
without which the markets could not function. I do not mean to 
be listed as one who is critical of them. But I think 
inadvertently we have gotten into a position where phantom 
shares are being created.
    I salute the Commission on your June 13 statement that you 
will be eliminating the grandfather provisions of Regulation 
SHO. But I would like to know exactly when that whole situation 
will be finalized, and then get into some suggestions as to how 
we might deal with this problem.
    When does the Commission intend to publish the grandfather 
exception amendment? With what effective date?
    Chairman Cox. Senator, as you know, we have actually voted 
to repeal the grandfather. Let me inquire about the date of 
publication.
    It will be effective in October, we believe.
    Senator Bennett. I see. OK, that is helpful.
    I have three ideas that I will share with you here to deal 
with the question of phantom shares.
    No. 1, when a broker wants to make a short sale he will 
call another broker and say do you have 1,000 shares of XYZ 
stock that I might borrow to cover a short sale? And the second 
broker says yes. The first broker says well then, I will get 
back to you.
    A third broker calls and says do you have 1,000 shares of 
XYZ stock that I might borrow? Yes. OK, I will get back to you.
    Both broker one and broker three then make the short sale 
and come back to broker two and say OK, I want the shares. And 
broker two says I only had 1,000.
    Is there any way the SEC could take action to say that 
there must be an exclusive commitment on shares that would be 
loaned to cover so that you could not inadvertently create 
phantom shares in the situation I have described?
    No. 2, is there any way the SEC can say to the DTCC you 
cannot loan out any more shares than you have on deposit? If 
you have on deposit 3 million shares, you cannot loan out 3.5 
million or you cannot allow anybody to put claim on 3.5 
million. That when the total number of shares that they have on 
deposit has been loaned out to cover short sales, that is it. 
It seems to me that would be very helpful.
    No. 3, do you have the authority to say that no broker will 
receive any compensation, either in the form of cash or credits 
of any kind, until the shares have in fact been delivered? I do 
not mean delivered to cover the short. I mean delivered in the 
borrowed sense, that we really have identified the shares that 
we have sold short against. We have identified their source and 
nailed it down. And then, once that has been done, the broker 
can receive compensation.
    These are the three things that seem to me to be 
commonsense ways to prevent the creation of phantom shares. I 
am wondering if you have the authority to implement any or all 
of them?
    Chairman Cox. Thank you, Senator. In preparation for this 
hearing I inquired specifically about the proposals that you 
just described because you have described them previously and 
asked us to see what we can do in this area.
    And so at the time of our vote in the Commission on 
repealing the grandfather clause under Reg SHO, I 
simultaneously instructed the staff of the Division of Market 
Regulation to study anything and everything else that we might 
do in this area to put a halt to the maximum extent that it is 
humanly possible without disrupting the whole clearance and 
settlement system to illegal naked short selling.
    As you know, in addition to what we might do in a 
regulatory way through the Division of Market Regulation, we 
have also been bringing and will increasingly bring enforcement 
actions in this area because when it is intentional it is 
illegal.
    You have asked us also about inadvertent phantom shares 
creation and whether or not there is a way to stop the clearing 
agencies from dealing in shares that they do not have. When 
securities at DTCC are loaned from one participant to another, 
the shares have to actually be on deposit in the leading 
participant's account, even as it stands right now. They are 
moved from the lending participant's account to the borrowing 
participant's account. The lending participant at that point 
cannot relend them or cannot sell them or alienate them or 
otherwise do anything with respect to them unless and until 
they are returned by the borrowing participant.
    And of course, neither DTC or NSCC, the National Securities 
Clearing Corporation, knows or has any way of knowing whether 
or not the securities transactions that are submitted for 
clearance and settlement are related to short sales.
    Senator Bennett. The only concern I have, I have been 
brought along with an understanding of this. But I have had 
shown to me companies that have gone out of existence whose 
shares are still trading. The reason they are still trading is 
that every 13 days broker A rolls them over to broker B and 
says well see, I have covered or I have borrowed the shares. 
Then broker B, 13 days later, rolls them back and says well, I 
have borrowed the shares. And it goes back and forth.
    And there are companies, 2 years after the company ceases 
to exist, their shares are still trading.
    Chairman Cox. Those are cases where we are able to target 
our enforcement resources. Obviously, the leverage that one 
gets from illegal naked short selling is greatest in these 
thinly traded issues.
    Senator Bennett. Yes. It is a very small, small area of the 
vast amount you have to oversee. And I keep focusing on it. But 
for the people who are in it, it is very important.
    Chairman Cox. This is one of the reasons that we created a 
special task force in the Division of Enforcement focused on 
microcap fraud.
    Senator Bennett. Thank you very much.
    Chairman Dodd. Thank you very much, Senator.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    You had mentioned in your comments about looking at further 
rules and regulations as far as municipal bonds are concerned. 
Right now municipal bonds are rated as to risk. Why isn't that 
adequate for serving the current market?
    Chairman Cox. Corporate debt is also rated. That is one 
piece of a whole system that is supposed to give the market the 
kind of information and transparency it needs to price assets.
    The truth is that the standards for municipal securities 
are nowhere near what they are in the corporate market. And 
what has happened over a period of many decades is that the 
municipal market has matured to a point where it is every bit 
as significant and, in terms of its involvement with a variety 
of financial instruments, every bit as sophisticated as the 
corporate market.
    But there is no way for investors to require or demand the 
kind of disclosure that they would routinely get for the same 
kind of debt instrument were it a corporate issue.
    Senator Allard. What types of regulation? Are you looking 
at the same type that you apply to the corporate market? Is 
that applicable to the municipal market?
    Chairman Cox. No, is the short answer. But certainly what 
we are looking for are things that we have become accustomed to 
in the capital markets more generally. But the model of 
regulation should not, and I do not believe can be, the same as 
it is for the corporate world for a variety of reasons, all of 
which proceed from the basic difference that we are dealing 
with governments and sovereigns not commercial enterprises. 
Although commercial enterprises, in many cases, are able to use 
municipal finance to accomplish their capital raising 
objectives.
    I do not think the SEC should be in the business, as we are 
with corporate issues, of reviewing mandatory filings from 
issuers. But what I do think we can do is get some consistency 
and clarity in accounting. The use of the same accounting 
standards and independent accounting standards by government 
issuers would be a big improvement. I think there is no 
question we can do much better in making what disclosure is 
available in theory available in practice by letting users have 
ready access to it. It is hard to find right now.
    And I think we can do a lot to conform the presentation so 
people know where to look for information, where to find it. In 
these and other respects, there is much that can be done.
    Senator Allard. So the rules and regulations that you are 
thinking about will help bring more a clear understanding of 
what is happening? And your interactive system that you are 
putting up, that is where you would apply that information? Is 
that what you are thinking?
    Chairman Cox. Yes. I also think we can wash a whole lot of 
cost out of the system. The evidence is that individual 
investors pay transaction costs that are about 40 percent 
higher in the municipal area than they do in the corporate 
area. A lot of that is related to, our economists believe, the 
fact that the disclosure system for municipals is substandard 
compared to the corporate system.
    Senator Allard. Thank you.
    On the International Financial Reporting Standards, I may 
show some ignorance here but we have countries that are more 
socialistic and actually own part of the company that might be 
traded. Is that possible?
    So then that happens. So when you are applying accounting 
standards like Sarbanes-Oxley, how do you evaluate a total 
country's financial standing and actions that they may take 
that would affect the value of that company? That is my 
question.
    Chairman Cox. Well, if it were ever the case that the 
parent, for securities purposes, were the government and the 
government was not amenable to conducting its finances in 
according with our norms, then I think they would not meet the 
listing standards here.
    Senator Allard. Is this not one of the dilemmas that you 
are dealing with when you are talking about an international 
reporting system or accountability system?
    Chairman Cox. Well, I think there are many potential issues 
in this area. We have not had to face them in terms of listed 
companies specifically in the United States. But when one is 
talking about what is going on in general in the world's 
capital markets, the increasing tendency for governments to 
acquire massive amounts of investable assets and then to take 
positions with those assets carries with it a great deal of 
potential for harm to markets. Because markets are premised on 
the wisdom and the results of the interaction of a multiplicity 
of individuals with their own interests and evaluations of the 
profitability or risk potential of an enterprise or an asset.
    Senator Allard. One more question I want to bring up 
quickly before my time runs out, the issue of combining the 
CFTC and the SEC. I know what happens here in the Congress. It 
ends up being a conflict between the Ag Committee and the 
Banking Committee.
    And now both of them, the financial futures is where this 
gets real cloudy. It used to be the CFTC was more commodity 
oriented. Now it is the financial futures is a big part of 
that.
    What is the position of the SEC on this?
    Chairman Cox. I do not think that the Commission has a 
formal position on this. The jurisdictional split between the 
SEC and the CFTC is, of course, legislative and it is one that 
I was very familiar with as a member. It is also one that I was 
familiar with working in the executive branch before I came to 
Congress. It has been around a long time. And one of the 
reasons it persists you alluded to.
    I do not think on the other hand, just speaking personally, 
that there would be anything but good that would come of 
rationalizing our approach to not just these two agencies but 
financial services regulation generally throughout the U.S. 
Government.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Cox, last year I asked you about the status of the 
New York Stock Exchange application to trade unlisted bonds. 
The application was finally approved in November, a year and a 
half after it was submitted. That seemed like an awful long 
time and there are many more examples of how long it takes to 
get proposals approved.
    What can be done to speed up things at the Market 
Regulation Division?
    Chairman Cox. The Director of the Division of Market 
Regulation, Erik Sirri and I are focused on precisely this, for 
the reason that the demutualization of the markets and the very 
competitive nature of being a market in the 21st century has 
made our practice, not necessarily the legislation but our 
practice under the legislation of the last many decades 
somewhat obsolete. We cannot take rule filings, sit on them for 
a very long time, think about them, and expect that the markets 
themselves can be competitive when they have to react to one 
another and, in many cases, to competition that comes from 
abroad.
    And so it is our priority to change that whole process into 
one that works with the priorities of the 21st Century.
    Senator Bunning. Quicker, I hope.
    Chairman Cox. And that means faster.
    Senator Bunning. Is there a complicated set of rules and 
regulations within the SEC that prevent it from being quicker?
    Chairman Cox. Not really. It is more the norm and the 
practice that has developed over a long period of time, in part 
because of the complexity of what is being regulated and all of 
the unforeseen consequences that might----
    Senator Bunning. Are you saying there are different 
instruments that are out there that were not out there prior 
to? And therefore the SEC has more difficulty handling that?
    Chairman Cox. As I say, I think we are going to be able to 
do this more quickly than we have in the past because there is 
a reason, and it is a very important one, to do so. But in 
explaining why it was that the system developed as it did when 
you were operating in an environment where the markets were 
more like regulated utilities, it was just--there was more time 
to consider all of the facets and so on.
    Now there is going to have to be a little bit more for the 
market to do with itself.
    Senator Bunning. Thank you.
    The second question has something to do with individual 
mortgages that have been packaged into securities are already 
held by publicly traded entities. How effectively can you track 
those at the SEC? Or do you?
    Chairman Cox. Which publicly traded entities? Which kinds 
are you----
    Senator Bunning. Those that have been--mortgages that have 
been packaged----
    Chairman Cox. I understand, securitized mortgages held by 
whom?
    Senator Bunning. Yes.
    Chairman Cox. By any public entity?
    Senator Bunning. Yes. In other words, that have a risk 
involved and some of them a bigger risk than others because of 
the type of mortgages they are.
    Chairman Cox. Well, with respect to the registration 
filings of any publicly traded company----
    Senator Bunning. That is what I am concerned about.
    Chairman Cox [continuing]. The financial statements and 
notes thereto have to draw attention to anything that is 
material. And so if it becomes material to the stability and 
the going concern aspect of any company that it has got 
something like this on its balance sheet, then our process of 
providing comments and surely our process of forcing disclosure 
about these things should bring it to light.
    Senator Bunning. The reason I asked that question is I 
asked that question, a similar question, to Chairman Bernanke. 
And he said we can only go a certain length in overseeing what 
happens to a mortgage through the bank, what the bank does 
after the fact. And that is why I asked that individual 
question. The bank actually sells it to another entity. And 
that entity is usually a secured type of entity that you are 
responsible for. So in other words, the regulation of that 
entity.
    Chairman Cox. Yes, and then you are taking it one step 
further and the securitized product ends up as a balance sheet 
risk for a publicly traded company that----
    Senator Bunning. Yes. I am trying to get to the bottom of 
where we are going.
    Chairman Cox. And that piece of it, surely, we are 
responsible for regulating. The disclosures that we require are 
absolutely, if the rules are observed, guaranteed to get at 
that.
    Senator Bunning. Are you concerned about the stability of 
our markets as lending standards are tightened for buyouts and 
other corporate borrowing?
    Chairman Cox. I am sorry?
    Senator Bunning. I will go over it one more time. Are you 
concerned about the stability of our markets as lending 
standards are tightened for buyouts and other corporate 
borrowings?
    Chairman Cox. Obviously, the credit markets have an impact 
on the equity markets and on securities trading generally. I do 
not want to, as the Chairman of the SEC, express concern in the 
sense that I am evaluating market conditions. But rather I will 
say simply that that is something that in a variety of ways the 
SEC keeps track of.
    Senator Bunning. That is as far as you want to go?
    Chairman Cox. I will go further but I want to make the 
answer as antiseptic as I can. I do not want to scare anybody.
    Senator Bunning. I do not want you to scare anybody either. 
I want the markets to do very well.
    OK, I will take that as an answer. Thank you.
    Go ahead, Mr. Chairman, I am finished.
    Chairman Dodd. Thank you very much, Senator Bunning.
    Let me, if I can, come back. First of all, I want to thank 
Senator Shelby for raising the issue about the rating agency 
issue. We were both reading an article here in the Wall Street 
Journal about how the market is reacting to rating agencies, as 
well. Some of these stocks have declined of rating agencies. 
This sort of picks up on where Senator Bunning was talking 
about to some degree here, and that is there have been those 
who have raised the issue about where the financing--obviously, 
the rating agencies are paid by the companies that they are 
then asked to rate. And there has been some concern expressed 
about to what extent some of these entities have been 
contributing rather significantly to the rating agencies and 
whether or not that has had an influence on their decisions.
    But clearly the AAA ratings of these issues are a matter of 
great concern to us here. I do not know whether we will do an 
oversight hearing on it or not.
    But share with us a little bit more. We passed this law, 
Senator Shelby actually played a very important role in the 
legislation that was adopted here giving the SEC additional 
authority. Do you need more authority in this area? Should we 
be doing more about this?
    Chairman Cox. Insofar as the Agency itself is concerned, we 
are metabolizing all of the change that you have provided. We 
have adopted a number of rules within the statutory deadline 
that you gave us to implement the law. We are commencing, 
including building a professional capacity in New York City for 
this purpose, our examination function vis-a-vis the NRSROs.
    We certainly do not know yet what we are going to learn as 
a result of all of this, but we are very busy embarking upon 
it.
    Chairman Dodd. Keep us posted. I think we would both be 
interested in knowing very early on if you thought there was 
some additional authority the SEC needed in this area.
    Let me jump, if I can, to these issues. I raised the issue, 
we have sent a letter, Senator Shelby and I, up to you and 
Secretary Paulson regarding some of these proposals by the 
other Committee dealing with regard to taxes on the issue of 
hedge funds, private equity firms, publicly traded partnerships 
and the like. I am not going to ask you to comment on tax 
policy. I realize that is not within your authority. But share 
with this Committee if you will, do you have any concerns about 
this at all?
    I cannot speak for Senator Shelby. My interest is really I 
want to know whether or not there are unintended consequences 
here. As the Chairman of a Committee that has jurisdiction over 
these matters here, should we be concerned at all about 
something that could have an adverse effect? And do you believe 
there are any adverse effects that we ought to be aware of at 
this juncture?
    Chairman Cox. You and the Congress have given the SEC the 
mission of the promotion of capital formation. So we are 
concerned to that extent. We have provided technical expertise 
upon request to the tax-writing committees in recent weeks and 
months to describe how this works from our vantage point, how 
it might work under proposed legislation.
    One of the very general things that I can observe is that 
if tax legislation discriminates against public companies it is 
entirely possible that we will have an unintended consequence 
of fewer public companies and barriers to becoming public, 
which would itself have an impact, a negative one, on capital 
formation.
    Chairman Dodd. Beyond that, any further comments on this?
    Chairman Cox. Well, I do think there is a line that I 
should not cross. I was comfortably on the other side of it 
just a few years ago, where I go to opine on tax policy. But as 
SEC Chairman, playing my position, I do think you rightly 
observe that that is not what we should be responsible for.
    Chairman Dodd. There have been several articles written 
recently about--let me just state at the outset, I think hedge 
funds perform a very, very important and valuable role in the 
capital markets. They have just been a tremendous asset in 
many, many ways.
    But there are some concerns obviously being raised by 
people. And the President's Working Group--were you a member of 
the President's Working Group?
    Chairman Cox. Yes.
    Chairman Dodd. You were. They determined that any 
additional regulation was not needed. This goes back now 
several months ago, to February I think it was. I wonder if, in 
light of The Chicago Tribune wrote a piece recently about the 
Amaranth Advisors, which again we all recognized while there 
was a lot of money involved, did not have the impact on the 
markets that many might have assumed it would.
    Yet in San Diego their retirement fund was among those 
burned and losses in its portfolio were estimated at $100 
million. On a large scale that does not seem like much. But if 
you are talking about the retirement fund in San Diego, it is a 
big deal, obviously.
    Business Week reported that smaller colleges are moving 
aggressively into hedge funds and identified colleges that had 
invested 60 to 82 percent of their endowments in hedge funds. 
They may be putting their endowments in some jeopardy was what 
one article wrote in Business Week.
    I just want to ask you here this morning whether or not you 
think any additional authority is needed? Do you need 
additional authority at the SEC? Are there any concerns that 
have been raised since February that cause you, as the Chairman 
of the SEC, to feel as though some additional authority may be 
necessary in this area?
    Chairman Cox. The pension fund risk that you mentioned is 
certainly a concern. We have been working with the Department 
of Labor to try and get at some of the data. The data is not 
reported in a way that makes it readily accessible.
    One of the changes that we hope to be able to accomplish, 
working with DOL, is to define what a hedge fund is for 
purposes of data collection and then to start learning in a 
more rigorous way how these funds that are regulated by DOL are 
actually invested.
    To the extent that we can infer it now, and that is 
possible through privately researched data as well as 
Government data, it appears that in the recent past, even 
though there is a lot of attention and discussion connected 
with pension fund investment in hedge funds, that the relative 
amounts, the relative diversification seemed to be respectively 
small and substantial so that the risk seems all to be on the 
come. The other thing that we have inferred is that there is a 
lot of fluidity here and the trend all seems to be in one 
direction, as your question describes. So I think it is a 
useful area of inquiry.
    We ourselves, as you know, have just adopted a hedge fund 
anti-fraud rule which will give us a very direct enforcement 
authority in this area, not so much enlarging upon authority 
that we never had in the past but rectifying some of the 
temporary dislocation caused by the Goldstein decision, and 
also signaling the Commission's intent to focus anti-fraud 
enforcement in this area.
    Chairman Dodd. You mentioned, in your prepared testimony 
you went on at some length and talked about the enforcement 
areas involving various hedge funds, which made me raise the 
concern about whether or not additional authority was 
necessary. But at this juncture here you are telling me the 
answer is no?
    Chairman Cox. Certainly in the enforcement area we have all 
the tools we need.
    Chairman Dodd. Beyond that, you are in the process of 
evaluating whether or not more authority would be necessary? Or 
you are satisfied at this juncture you do not need any 
additional authority?
    Chairman Cox. The two concerns that not only the SEC but I 
think all the members of the President's Working Group and 
indeed our counterpart regulators overseas persistently have 
are systemic risk and retailization, investor protection as it 
were.
    I think we have done a lot to address those challenges 
together since 1999. Market discipline in this area has really, 
really improved. And managing the credit risk is something that 
the markets themselves have become much more sophisticated at.
    Chairman Dodd. Do you buy into the notion here, and again 
you hear talk about the flight to London and elsewhere here. 
Obviously it is very much in our interest, this has been a very 
important part of our economy. We want to maintain our market 
leadership globally in this area here.
    But I get somewhat concerned that some of these arguments 
here about the flight of industries to foreign capitals here 
because of regulatory schemes. How do you feel about that? What 
is your reaction to those things in terms of these rumors or 
discussions we hear by others about companies fleeing the 
United States?
    Chairman Cox. I think the starting point needs to be not 
the state of U.S. legislation, regulation, litigation or 
anything else but rather the state of the global capital 
markets. We have to recognize that there is such a thing, that 
there is competition from all about the planet, and that there 
is nothing in nature that requires or commands that financings 
be done here. There needs to be a competitive reason and an 
advantage to do so.
    The built-in advantage that the United States has is 
twofold. First, we have a big market and a lot of retail 
participation that is very different from most other countries. 
But a big deep pool of capital that is more substantial than 
anywhere on Earth.
    The second thing that we have too is the highest standards 
on Earth, which anyone investing for the long term knows is 
vitally important because the way up is very easy but what 
happens then when things turn sour. The U.S. markets have 
proven themselves to be remarkably resilient and that long-term 
capacity of the U.S. market is our stock in trade. We need to 
make sure that we do everything possible to protect that.
    So I would say that we need constantly to sharpen our 
competitive edge, constantly scrutinize our regulatory system, 
make sure that in this world of rapidly changing technology, 
market mergers across national boundaries and all of the 
changes that we have seen in financial products that we still 
serve the needs of the 21st century.
    But we also need to make sure that we never, never lose our 
first principles: investor protection and well regulated 
markets and the promotion of capital formation.
    Chairman Dodd. Thank you for that answer.
    Senator Shelby.
    Senator Shelby. Chairman Cox, I am glad to hear you 
reiterate it. You have said this before. The integrity of our 
capital markets are paramount. We have achieved that by hard 
work, diligence, oversight, and so forth. And whether it is 
accounting standards that we talked a little bit about, go 
right to this, or whether it is bond ratings to by people, it 
all goes to this.
    I wanted to pick up on something Senator Dodd brought up 
and that is hedge funds. Sitting right here at this table 
Chairman Greenspan, that we all have a lot of respect for, he 
has said on many occasions that hedge funds brought liquidity, 
that is capital, and risk to the marketplace which is a very 
important part. Chairman Bernanke, I believe, has echoed that 
here, too.
    I think that we have to be careful in over regulating our 
hedge funds because of what it could do to the market. I know 
there is risk in the market but there is no market without 
risk, as I understand it.
    I have a couple of areas. I have a number of questions for 
the record, Mr. Chairman, that I would like to ask Chairman Cox 
but I have two that I want to----
    Chairman Dodd. We will do that for all members, by the way, 
if that is all right. We will make sure in the next couple of 
days those questions are submitted to you so they do not drag 
out, but that will be open.
    Senator Shelby. Chairman Cox, the terror web tool. In June 
the SEC added a web tool to its Internet site, it is my 
understanding here, that permitted investors to obtain 
information directly from company disclosure documents about 
their business interests in countries the U.S. Secretary of 
State has designated as state sponsors of terrorism. That is 
Iran, Cuba, Sudan, North Korea, and Syria. It worked by 
displaying a portion of a company's most recent annual report 
that discussed business activities in or relating to any of the 
five state sponsors of terrorism that I mentioned.
    In response to concerns expressed by some Members of 
Congress and some companies on the list, the Commission, it is 
my understanding, announced last week that it was temporarily 
suspending the availability of the new program while it 
``undergoes reconstruction'', whatever that means. What is your 
assessment of the quality of disclosures relating to business 
activities in the terror states? And what are you trying to get 
at by the term ``reconstruction?''
    Chairman Cox. Thank you, Senator.
    By making it possible for people to look through disclosure 
documents and find what they are looking for, the SEC just does 
a better job of serving our mission. There is no question that 
people wanted to see the portions of company disclosure devoted 
to their business in states designated by the Department of 
State as sponsors of terrorism. I say that because the site was 
up between June 25th and July 16th and it received over 150,000 
hits. This is a much more significant level of interest in 
people's 10-Ks than we have seen for a long time.
    The problem is that we have got to screen out not just to 
the maximum extent possible but just screen out completely any 
SEC involvement, any human involvement as it were, in 
qualitatively assessing this information. We want the company's 
disclosure to speak for itself.
    We attempted to accomplish that by making sure that what 
came up was exactly what the company wrote, without anything 
else from the SEC. All of the disclosures, in addition, were 
linked to the full text of the Company's annual report in which 
this disclosure appeared.
    But in order to make the tool work, human beings had to go 
through and search disclosures to find these things and link 
them to the tool that you then saw depends on the Internet. And 
that meant it was hard to keep it up currently. If someone 
filed an 8-K with more current information, let us say their 
last year's annual report said we do business in Iran, and 
subsequently because of investor pressure they left Iran and 
they filed an 8-K and said so, our tool was not capable of 
pulling that up. We would have had to wait until their next 
annual report.
    Because of the premium that the SEC places on full, 
complete, accurate disclosure, we thought it was important to 
get that tool right or not do it at all.
    Senator Shelby. Thank you. I think it is very important 
that the public know, that we all know who could be companies 
who can be aiding and abetting terrorism in countries around 
the world.
    Soft dollars, a question. You recently sent a letter urging 
the Banking Committee, our Committee here, to ban or 
substantially restrict the use of soft dollars. The letter 
asserted that the safe harbor for certain soft dollar 
arrangements ``hurts investors in the U.S. capital markets by 
protecting arrangements that involve substantial conflicts of 
interest, may contribute to higher brokerage costs, is 
difficult to administer, and may operate to impede the further 
development of efficient markets for brokerage as well as 
certain advisory services.'' Your words.
    Can you elaborate on the concerns stated in your letter and 
indicate what steps would need to be taken, either by the 
Securities and Exchange Commission, or by this Committee and 
the Congress to address the situation regarding soft dollars?
    Chairman Cox. Senator, we are focused on the disclosure 
aspects of soft dollars to the maximum extent that the SEC 
possesses that authority. But that is really the limit of what 
we can do, define it, require its disclosure and so on.
    To the extent that there are other issues associated with 
soft dollars, such as the ones that you described and I 
referred to in my letter, those are properly the purview of the 
Congress because soft dollars are enshrined in Section 28(e) of 
the 1934 Act.
    It is for that reason that I communicated with this 
Committee to let you know what we think we can do at the SEC 
and what we cannot.
    Senator Shelby. And what we can do to help.
    Thank you, Mr. Chairman. I do have these questions for the 
record, that you indicated----
    Chairman Dodd. We will submit those and we would appreciate 
it, Mr. Chairman, if you could respond.
    I will say to the members who are absent here but to their 
staffs, if they have additional questions from their members, 
let us know as quickly as possible.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    I want to go back to the soft dollars issue, I know that my 
colleague from Alabama talked about. I have always believed 
there should be a vibrant independent research industry, well-
regulated, to protect investors. So I applauded the steps you 
took when you first became Chairman to speed up the new process 
of issuing the new guidance on the appropriate use of the soft 
dollars which culminated in a unanimous SEC interpretive 
release in July of 2006.
    Soft dollars, as we know, are critical to independent 
research. And SEC's release was an important first step toward 
providing clarity on the appropriate use of soft dollar 
payments because there have been abuses but we do not want to 
throw out the baby with the bathwater.
    But this guidance by itself is not sufficient, as many 
people have pointed out. Disclosure rules are still necessary. 
And you acknowledged this when you publicly agreed to create 
new disclosure rules on soft dollars in the comments you issued 
contemporaneous with the July 2006 release.
    Disclosure rules like these, if well-crafted, would allow 
fund investors, managers, and boards to see how their 
commission dollars are spent and evaluate the value of 
independent research. Under Brandeis's admonition, sunlight is 
the greatest disinfectant. The rules would be consistent with 
the authority granted to the SEC under Section 28(e), which 
governs the use of soft dollar commissions.
    Since that time, when everyone thought we were making great 
progress, we have not heard of any new developments on SEC soft 
dollar disclosure rules. Instead, you sent, at least in my 
view, an unexpected--and I think inappropriate--letter when you 
suggested that legislative intervention to fix the abuses with 
soft dollars was required. This came as a huge surprise because 
it was unclear what evidence there was of soft dollar abuses.
    I understand you recently received a letter describing that 
virtually no abuses of soft dollars have occurred in recent 
years. Since the SEC issued a report on soft dollars in 1998, 
there have only been three SEC enforcement actions involving 
client commissions. None of them involved 28(e).
    Given all of this, what is the great need here to push 
comprehensive legislative solutions over the more easily 
available and more appropriate SEC rules?
    With this in mind, I have three questions: and they mirror 
the questions I sent you a letter on July 20th. I hope you have 
received it and had a chance to look at it.
    First, when do you expect the SEC to issue its disclosure 
guidance on soft dollar commissions?
    Second, as recently as July 2006, you supported new 
disclosure guidance for soft dollar commissions. Has your view 
changed since then?
    And third, what factors support a need for immediate 
legislation without first exploring the available options under 
the SEC's rulemaking authority?
    Chairman Cox. Taking those questions one, two, three, we 
are awaiting recommendations from the Division of Investment 
Management right now to require investment advisers to increase 
transparency. And our staff is simultaneously looking at NASD 
recommendations on this, too. But for the reasons that you 
described, and because of my own priority that I place on this, 
ASAP is the answer.
    Senator Schumer. Good. Could not be a better answer.
    Chairman Cox. Second, no, my view has not changed since 
2006 on this.
    Senator Schumer. Good.
    Chairman Cox. And third, what is the immediate need for 
legislation? In one sense, none at all since this is such a 
hoary problem. But the problem has been around for a long time. 
So the fact that we have gotten along with it for a while does 
not mean that it should not be addressed.
    The problems that I see are persistent and they are built-
in. They start with the fact that this overly complicated 
approach that is completely a regulatory construct is difficult 
to administer, probably results in higher brokerage costs for 
investors, and in any case it induces money managers to direct 
trades to broker-dealers that offer research that the money 
manager wants rather then that can best execute the advisory 
client's transactions. That is just built in to the way it 
works.
    In a purely efficient market where research was prized, 
then research would be priced according to quality and the 
efficiency of its production and its availability and 
timeliness and so on.
    We need to do everything possible to promote research. I 
think we are all square on that objective. Research is vital. 
The information that makes markets work is what we promote at 
the SEC. And so anything that would harm research is something 
that we should not just shy away from but run away from.
    I think in posing these questions and describing these 
problems, I did not presume to have the answers but I simply 
leave it at the water's edge, as it were, for the SEC because 
it is not within our statutory----
    Senator Schumer. Let me ask you this, I mentioned it 
before. Does the SEC have any knowledge of recent abuses? As 
best I understand, I have studied the issue and I certainly 
want to clear up the abuses that we heard about in the past. 
But as I said, there have only been three enforcement actions, 
none of them involved 28(e), since 1998.
    Are you aware of things that we are not in terms of abuses 
here with soft dollars in recent years?
    Chairman Cox. The abuses that have gone on in the past, we 
hope that we have gotten rid of as a result of our interpretive 
guidance.
    Senator Schumer. So what is there a need for legislation?
    Chairman Cox. People were spending it on carpeting and 
country club memberships and all this sort of thing.
    Now the problem is not abuse that we can go after legally, 
because it is legal. The problem is what is legal and whether 
or not that is good. But we are not going to bring an 
enforcement action against anybody doing something perfectly 
legal.
    Senator Schumer. But I still do not quite get why there is 
a need for legislation when about 6 months ago or a year ago 
everyone thought the disclosure rules would basically do the 
job.
    Chairman Cox. The disclosure rules and whatever we can do 
further by recommendation from the Division of Investment 
Management will take us as far as we can go. It will exhaust 
our capacity to deal with soft dollars at all.
    And so it may be that the Congress decides that 28(e) 
today, in the 21st century, makes just as much sense as it did 
when we got rid of fixed commissions and it was part of that 
legislative confluence.
    Senator Schumer. So you have no specific legislative 
recommendations to make to the Congress?
    Chairman Cox. No.
    Senator Schumer. You are just saying well, if you want to 
go further you need legislation?
    Chairman Cox. Exactly.
    Senator Schumer. You are not taking a position as to 
whether we do or not?
    Chairman Cox. I certainly have taken a position on whether 
you ought to think about it, and I want to be completely 
deferential beyond that.
    Senator Schumer. Thank you.
    Chairman Dodd. Senator.
    Senator Akaka. Mr. Chairman, and Chairman Cox, it is good 
to see you again here.
    Chairman Cox, the SEC undertook an ambitious mutual fund 
reform agenda in the wake of the mutual fund scandals in 2003. 
Mutual funds are of particular interest to me because they are 
an investment vehicle that millions of middle income Americans 
utilize and provide diversification and professional money 
management. Mutual funds are what average investors rely on for 
retirement, savings for their children's college, education, 
and other financial goals and dreams.
    At that time, I worked with Chairman Donaldson on what we 
called governance and transparency in mutual funds. I have 
advocated for strengthening the independence of mutual fund 
boards and improving relevant and meaningful disclosures for 
investors.
    In your statement, Chairman Cox, you mentioned that you are 
considering making information about funds and the brokers that 
sell them available at the point-of-sale. In addition, you 
indicate that the Commission is conducting a thorough review of 
mutual fund fees and expenses and their disclosure to 
investors.
    My question to you is when do you expect the Commission to 
move forward on mutual fund governance regulations, point-of-
sale disclosures, and fee disclosures?
    Chairman Cox. Thank you, Senator. Every single one of these 
is of interest and a priority for the Commission precisely 
because of the heavy concentration of retail investors in 
mutual funds and all of the bases of concern and interest that 
you describe in your question.
    The point-of-sale proposal is to the point now where I 
think the commissioners need to decide among ourselves what 
exactly we want to go with because the professional staff have 
just about perfected and or nearly perfected their 
recommendation to us on that.
    Likewise, all of the broader 401(k) disclosure 
improvements, the simplified prospectus for mutual funds that 
we discussed, I am hoping that we can tackle this year. That 
would make it timely as well, to consider what we are going to 
do with the comments that we most recently received on the 
economic studies in connection with the mutual fund governance 
rule.
    Senator Akaka. Will additional statutory authority be 
needed to ensure that important governance improvements and fee 
disclosures be implemented?
    Chairman Cox. I do not believe so, Senator. We are not 
asking for any at this time.
    Senator Akaka. I am concerned that the Office of Investor 
Education and Advocacy, an essential part of SEC, has been 
given additional responsibilities and duties which may hinder 
financial literacy efforts. This spring the Office of Investor 
Education was tasked with the initial review of Freedom of 
Information Act requests. Educating investors and reviewing 
Freedom of Information Act require very different technical 
expertise, skills and knowledge.
    Why were these responsibilities given to the Office of 
Investor Education? And what is being done to ensure that the 
Office of Investor Education can continue to effectively pursue 
its primary purpose of educating investors?
    Chairman Cox. Thank you, Senator. It is precisely because I 
want to place a redoubled emphasis on investor education and 
investor advocacy that I am making the changes that I announced 
today in that office. We are directing more resources to it to 
accomplish those objectives.
    The filings and information services responsibilities that 
you referred to that used to be in the Office of Filings and 
Information Services, have been redeployed about the Agency. 
Some of them are going to a new office within the Office of 
Investor Education and Advocacy that has been completely 
populated with all necessary resources. So nobody that is 
working on investor ed will be taken away from that and asked 
to do something else.
    Indeed, as a result of the changes that I announced today, 
we will for the first time have a Director of the Office of 
Investor Education, something that has never existed before, 
who will have as her only responsibility and the people who 
work for her as their only responsibility investor education.
    Up until now the way the formerly named Office of Investor 
Education and Assistance was comprised, they had to, and the 
Director in particular had to spread their attentions across a 
number of priorities, all of them related to individual 
investors but only some of them education.
    Now we will have a very sharp focus on that specific 
function and more people and more resources with which to 
discharge that function.
    Senator Akaka. Thank you for your responses.
    Mr. Chairman, I have written questions that I will submit.
    Chairman Dodd. Thank you, Senator Akaka, very, very much.
    Senator Menendez, thank you.
    Senator Menendez. Thank you, Mr. Chairman, and Chairman Cox 
for your appearance here today.
    Let me ask you, I have two fields that I particularly want 
to try to focus in on, so if you will work with me to try to 
get through them. One is on the question of regulation of hedge 
funds. The other one is about the anti-fraud rule and investor 
protection.
    I am curious and I think I came in on the tail end of 
Senator Schumer's remarks to you, so I may have missed some of 
it. But I am curious in the wake of the Goldstein decision, 
that the SEC has yet settled upon what its policy will be in 
terms of regulating hedge funds moving forward. Particularly 
last year, in your appearance before this Committee, you said 
the SEC would look at how to fill the ``gaping hole'' left in 
the wake of the Goldstein decision. Do you think the hole has 
been filled?
    And after the Goldstein decision, which effectively 
reversed the actions of the SEC that was taken in 2004 to 
increase regulation of the hedge funds, you said we were once 
again back to a situation where regulation of hedge funds was 
``inadequate.'' Do you still think we are at the inadequate 
stage? How would you characterize our current approach?
    Chairman Cox. The Goldstein Court did create a gaping hole. 
In fact, a number of punctures, as well. We have addressed the 
punctures through new action letters. We have adjusted our 
regulatory approach to conform to the decision to get things 
back to the status quo. And our anti-fraud rule specifically 
takes advantage of the way the Goldstein Court laid out the 
legal landscape so that we are not limited to frauds upon a 
client, as it was narrowly defined for one purpose in that 
decision. But rather, we have clear authority to limit fraud 
upon investors of investment pools. That is what our new anti-
fraud rule clearly permits us to do.
    I am of the view that we have essentially filled the hole 
created by the decision and also we are in a position now to 
take advantage of the thousands of registrants that we had 
under our temporary rule before it was invalidated because the 
vast majority, by far the lion's share of them, have remained 
registered with us. And so we are, through our examination and 
inspection resources, taking advantage of that fact and keeping 
an eye on the advisers.
    Senator Menendez. So are you satisfied? Are you satisfied 
in terms of the protections as to where you are? Are you 
satisfied that you have the regulatory powers to ensure the 
safety and security of investors? Or do you believe that 
Congress needs to act?
    Chairman Cox. If we take a snapshot right now, I am 
comfortable. I think, however----
    Senator Menendez. Does comfortable mean satisfied?
    Chairman Cox. Satisfied. The dynamic character, however, of 
this market, the questions of liquidity in the roles of private 
pools of capital that we discussed earlier in this hearing, I 
think require us constantly to be skeptical and to ask that 
question.
    Senator Menendez. Let me touch upon the anti-fraud rule 
that was adopted by the Commission on July 11th. I certainly 
applaud the Commission's efforts to strengthen investor 
protection.
    But I wonder, as I believe some of the commissioners did, 
whether in fact the rule went far enough. Do you think the rule 
goes far enough in protecting investors? Are there other gaps 
that the rule does not address or areas that you are exploring 
that would go beyond the anti-fraud rule?
    Chairman Cox. I think the rule does a couple of things. 
First of all, it is tailored post-Goldstein. Second, it should 
be understood to signal the intention of the SEC to use its 
anti-fraud enforcement authority in this area. I think, just as 
I responded to the last question, I think it remains to be seen 
where the market itself is going.
    Senator Menendez. Do you think the rule does anything 
beyond current law? How can you explain, for example, how does 
the rule provide investors additional protection? Doesn't 
Section 206(4) already prohibit fraudulent, deceptive, or 
manipulative practices by registered and unregistered 
investment advisors?
    Chairman Cox. It gives us no authority beyond what we had 
pre-Goldstein but it reverses the side effect of the Goldstein 
decision that the anti-fraud provisions of Sections 206(1) and 
206(2) of the Act apply only to clients as the Court defined 
them, and not to investors in the hedge funds.
    So now the rule makes it very clear on its face that the 
SEC can protect investors in the hedge fund.
    Senator Menendez. Let me ask you, are there areas that fall 
outside of the scope of the rule or the SEC's current authority 
that you still see as loopholes? For instance, how does the SEC 
protect investors from losses when negligence on the part of 
the broker is the cause?
    Chairman Cox. Our regulation of broker-dealers, I think, 
permits us to deal directly with that. I would not call that a 
loophole.
    Senator Menendez. You are satisfied that you have the 
process to pursue against those types of cases?
    Chairman Cox. Yes.
    Senator Menendez. For investors who are the victims of 
fraud, it seems they are often left without a clear person or 
entity to blame. Does that seem to be the case?
    For example, is there confusion between whether the prime 
broker or the executing broker is liable?
    Chairman Cox. I am sure that in some cases, depending on 
the fact pattern, there could be a lot of complication. And I 
would even allow, in the realm of all potential hypotheticals, 
that there are cases in which the complicated fact pattern 
bring with them complicated legal questions.
    I do not know that I am prepared to say that there is, 
perforce, a loophole without confronting the particular case.
    Senator Menendez. I am concerned--and I see my time is up, 
Mr. Chairman, so if I just may have the indulgence of the Chair 
for a moment.
    I am concerned obviously, I think the Chairman's own--your 
own statement, Mr. Chairman, about how the market has changed 
dramatically from what it was to what it is, where half of all 
Americans are now in some form invested in the market.
    I am concerned that we have the investor protections that 
are necessary. There is always risk. There is always got to be 
good information that people make judgments on. But at the end 
of the day, I am concerned that the protections that we should 
have and need to have in the marketplace are not necessarily 
there.
    So this is why I have explored--I will submit some other 
questions for the record. This is why I am concerned about it 
and look forward to hearing more about this from you.
    I have one other----
    Chairman Cox. I am sorry, Senator, and I hope we do not 
count this against your time. But just quickly I want to say 
that to the extent that we are concerned about retailization 
our concern at the SEC is in particular ordinary investors, we 
are trying to make it very clear that the accredited investor 
standards, the new ones that we are adopting, screen out the 
potential for fraud and abuse in that way.
    There is a lot about hedge funds that requires a high level 
of sophistication. And so retailization remains a concern for 
the SEC.
    Senator Menendez. Mr. Chairman, if I may just very briefly, 
on another question on market data, was it the intention under 
Regulation NMS, the National Market System, to reduce the total 
amount of market data that the exchanges distribute to their 
members? If that is not the case, was the intent to encourage 
more quoting in the market? I am trying to get a sense of what 
your purposes were and maybe some unintended consequences.
    Chairman Cox. For starters, Reg NMS affirmed the 
consolidation model of data distribution for best price 
quotations and last sale information. But in contrast, it 
adopted a primarily market-based approach for data that the 
SROs distribute individually--for example, the full depth of 
the markets limit order book--outside of NMS plans.
    In the main, we have every interest in promoting a broad 
distribution of market data and not inhibiting that.
    Senator Menendez. So is the intention to encourage more 
quoting of the market or less?
    Chairman Cox. Well, I think more.
    Senator Menendez. Are you going to be looking at how that 
regulation is being implemented?
    Chairman Cox. Yes.
    Senator Menendez. Mr. Chairman, I have some other questions 
on fee-based brokerage and whatnot but I will submit them for 
the record and look forward to the Chairman's response.
    Chairman Dodd. Thank you, Senator, very, very much. I have 
some additional questions, as well. But you have been here for 
almost three straight hours this morning but you have some 
indication of the strong interest in a wide range of subjects, 
Mr. Chairman, before your Commission.
    We probably ought to try and do this with maybe a little 
more frequency so we can cover a lot of ground that is before 
you.
    We thank you very, very much. I think I made it clear at 
the outset, I have been very impressed, Mr. Chairman, with your 
leadership at the Commission. There are some matters obviously 
that we all have some concerns about but you would expect that. 
But overall, I think there has been good leadership and we 
thank you for that.
    We will ask our colleagues to submit the questions as soon 
as possible and would hope you might be able to respond as 
quickly as possible, in turn.
    With that, the Committee stands adjourned.
    [Whereupon, at 12:15 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
                PREPARED STATEMENT FOR SENATOR JACK REED
    Thank you Mr. Chairman for holding this timely hearing on the state 
of securities markets as we witness significant changes both in our 
domestic securities markets and markets around the world. In this 
increasingly globalized financial services market, no institution can 
remain static. These institutions must continually reevaluate 
themselves to cope with dynamic and rapid change. We got a sense of 
this just last week when the SEC approved the merger of NASD and NYSE 
Regulation into a single-Self Regulatory Organization to modernize and 
streamline their regulatory functions.
    In recent months, the SEC has been addressing a number of 
regulatory reforms aimed at promoting the continued vibrancy and 
integrity of U.S. securities markets. I commend the Commission's recent 
action on Section 404 of Sarbanes-Oxley and I am interested in further 
monitoring its efforts on the mutual recognition of foreign regulatory 
regimes, international accounting standards, and delistings.
    However, with any new opportunity comes great challenges and it is 
important that any new undertakings in our regulatory regime result in 
comparable, if not better, safeguards for investors.
    There is a growing concern that systemic risk may be creeping into 
our financial markets in ways that no one fully appreciates. Risk is 
being distributed more widely across investors, markets, and borders. 
However, as The Wall Street Journal pointed out last week, ``Because 
the risk gets spread so widely, regulators can do little but watch and 
try to reassure everybody it is all under control. . . . A system 
designed to distribute risk also tends to breed it.''
    The proliferation of products, such as CDOs, that have not been 
tested in market downturns; the accumulation of large pools of capital 
in unregulated, highly leveraged, hedge funds; and accounting rules 
that do not promote transparency in financial reporting seem to have 
created a potential for problems that could spill over from the 
financial markets to the general economy.
    Bear Stearns recently announced that two of its hedge funds are now 
nearly worthless after some of its investments in subprime mortgages 
went bad; Moody's and Standard and Poor's have significantly downgraded 
ratings on hundreds of subprime-related bonds; and the ABX index has 
hit new lows. Portions of the index that tracks especially risky 
mortgage bonds with junk-grade ratings had been falling, but now these 
declines are spreading to the portions of the index that track bonds 
with ratings of AAA or AA. According to Merrill Lynch's latest fund 
manager survey, 72% of managers said that credit or default risk was 
the biggest threat to financial market stability.
    Furthermore, when I see structured mortgage products that were 
initially rated AAA at inception trading at prices associated with junk 
bonds less than one year after issuance, I wonder if there isn't a 
structural problem with the way credit agencies are doing their work. 
It is clear to me that a AAA rating obviously doesn't mean what it used 
to.
    These events, combined with the weakness in the markets last week, 
have brought many new issues to light and raised significant concerns 
about some of the systemic risks facing our securities markets. I would 
appreciate hearing about the efforts of the SEC in that regard.
    Finally, last week the SEC also issued two distinct proposals 
regarding proxy access for shareholders.
    I am deeply concerned both about the process associated with 
approving these proposals as well as the proposals themselves. For 
starters, the issuance of two diametric proposals is unprecedented by 
the SEC. As Commissioner Nazareth pointed out, by issuing contradictory 
proposals, the SEC has opened the door the possibility of cherry-
picking provisions from each of the proposals that may result in the 
worst of all worlds.
    Additionally, while one of the proposals put out for comment would, 
in theory, allow shareholders access to proxies. I have serious concern 
that the 5% threshold included in that proposal would make any 
subsequent rule meaningless in its application. This threshold would 
limit the ability of even large, long-term institutional investors, 
such as CalPERS from having access to shareholder proxies. I hope that 
the Chairman will elaborate for us on the derivation of 5% as the 
threshold and direct us to the data the SEC used in setting the 
threshold at that level.
    Clearly, there are many issues that I hope we have an opportunity 
to discuss this morning. I appreciate your presence here, Mr. Chairman, 
and I look forward to hearing your thoughts on these matters.
                                 ______
                                 
                PREPARED STATEMENT OF SENATOR MIKE CRAPO
    Our capital markets are at a crossroads and there are major 
regulatory, tax, and liability questions which need to be addressed in 
order to ensure that U.S. capital markets remain competitive. The 
competitiveness of our capital markets has a very significant impact on 
the health and growth of our economy.
    Several recent reports have concluded that American hegemony over 
global capital markets has been broken. For instance, the City of 
London has a leadership position in the OTC derivatives markets, and 
has become a domicile of choice for Hedge Funds.
    Although this has resulted from a number of factors, certainly one 
important factor contributing to this trend is the growth of U.S. 
regulatory compliance costs and liability risks compared to other 
developed and respected market centers.
    I am very interested in the way that the United Kingdom and Japan 
have gone to a single regulator, which is more principles based. It 
seems to me that we could make significant progress in the United 
States in continuing to have strong customer and investor protection 
and strengthening our market integrity and achieving effective 
regulatory compliance but still move toward a more principles based 
regulatory system.
    I look forward to working the members of this committee and we work 
to bolster the competitiveness of this essential sector of the U.S. 
economy.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD FROM CHRISTOPHER 
                              COX

Q.1. Last year, the Second Circuit Court of Appeals ruled 
``that a shareholder proposal that seeks to amend the corporate 
bylaws to establish a procedure by which shareholder-nominated 
candidates may be included on the corporate ballot . . . [and] 
cannot be excluded from corporate proxy materials'' under the 
Commission's shareholder proposal rule. Last week, the 
Commission issued two proposals regarding shareholder proposals 
on proxy access, one of which could allow investors to nominate 
independent directors to corporate boards and one of which 
would not. Both proposals will be published for public comment. 
In light of the Court's ruling, will the Commission staff 
continue its current practice of refusing to issue no-action 
letters on shareholder proposals for proxy access until the 
Commission considers public comments and adopts a final rule?

A.1. We fully intend to have final rules in place this fall, in 
time for the coming proxy season. Accordingly, we do not 
believe that it will be necessary for the staff to address the 
situation about which you inquire. As discussed at the open 
meeting on July 25, in the unlikely event that the Commission 
has not issued final rules before next proxy season, the staff 
will continue to analyze requests for no-action relief 
concerning shareholder proposals to establish procedures for 
shareholders to include their nominees in company proxy 
materials in the same manner that it did in the 2006-2007 proxy 
season. Any no-action request is fact specific and there may be 
any number of bases on which a company may rely to exclude a 
proposal. Accordingly, there is no way to predict what response 
the staff may provide to any specific proposal.

Q.2. Hedge funds have been a tremendous wealth-creation vehicle 
in our capital markets. However, there are concerns about the 
potential for investors who lack appropriate sophistication to 
invest in hedge funds. Recently, the Commission adopted a new 
anti-fraud rule to protect investors from hedge funds advisers 
who make false or misleading statements and also proposed to 
increase the amount of wealth required for a person to be 
deemed to be an ``accredited investor'' who can invest in hedge 
funds. When do you expect the Commission to act on the proposed 
rule to revise the definition of ``accredited investor''?

A.2. The comment period on our rulemaking to revise Regulation 
D to include a new category of investor--the ``accredited 
natural person,'' which would be defined to be a natural person 
who owns at least $2.5 million of investments, closes on 
October 9, 2007. As part of this rulemaking, we also proposed 
additional amendments to Regulation D that would affect all 
issuers offering their securities under Regulation D, and not 
just hedge funds.
    I hope to move quickly on the proposals. Nevertheless, we 
anticipate that the Commission will receive many insightful 
comments on the proposals, and particularly on the proposed 
definition of accredited natural person, which the Commission 
will fully and carefully evaluate before moving ahead. 
Accordingly, it is difficult to predict the timing of any 
action by the Commission on the proposals.

Q.3. The Commission has promulgated new rules which require 
disclosure of executive compensation. On March 24, 2006, in a 
speech before the Consumer Federation of America, you stated, 
``I've often been asked whether all of this will be enough to 
rein in the abuses of excessive compensation in some companies. 
And the truth is, we won't know until we try.'' Since then, 
public companies have given their shareholders disclosures 
under the new rules. What are your perceptions about the impact 
of the new disclosures on executive compensation? What other 
types of actions might serve ``to rein in the abuses of 
excessive compensation in some companies''?

A.3. The new executive compensation rules were effective in 
December 2006, and the first disclosures provided under these 
rules were made in the 2007 proxy season. The Division of 
Corporation Finance has been reviewing these disclosures and 
plans to issue a report regarding the new disclosures in the 
near future. As this is the first year in which disclosures 
have been provided under these rules, it is too early to tell 
what impact the rules have had, or ultimately will have, on 
executive compensation. We are confident, however, that these 
rules provide investors with clearer, more detailed and more 
comprehensive disclosure about companies' executive 
compensation plans, policies and decisions. In terms of what 
other types of actions might ``serve to rein in the abuses of 
executive compensation in some companies,'' we believe that, 
consistent with the underlying purpose of the federal 
securities laws, the new rules will provide investors with the 
information that they need in order to assess the 
appropriateness under state corporate law of the levels and 
form of executive pay. In addition, strong enforcement efforts 
where there has been wrongdoing, such as in the options 
backdating area, will play an important role in reining in 
abuses. Effective board oversight also will be critical in this 
area.

Q.4. During this proxy season, a sizeable number of shareholder 
proposals requested advisory votes on executive cash 
compensation. What is your analysis of the significance of this 
type of proposal to investors? Have you been able to identify 
any impacts of such proposals on executive compensation 
practices?

A.4. Based upon the large number of no-action requests we 
received relating to these types of shareholder proposals, it 
is evident that executive compensation continues to be an area 
of interest for shareholders. In this regard, we have heard of 
five shareholder proposals in this area that were approved by 
shareholders during this past proxy season. Our involvement in 
the shareholder proposal process is not designed to identify 
the impact that certain proposals have on companies. However, 
we continue to monitor changes in companies' disclosures as a 
result of the new executive compensation rules. The new rules 
should provide investors with a clearer picture of how 
companies in which they invest compensate their executives and 
increase transparency of companies' executive compensation 
practices.

Q.5. Last week, you sent me a letter urging legislative action 
relating to the municipal securities. You stated, ``I believe 
that investors in municipal securities . . . deserve the same 
level of current, high-quality disclosure and protection in the 
municipal market as they do in other capital markets.'' What 
impacts do you predict your recommendations regarding municipal 
issuer accounting and disclosure standards would have on 
municipal securities issuers and investors?

A.5. If implemented through legislation, I would expect my 
recommendations to improve municipal issuer disclosure and 
accounting standards to the benefit of municipal securities 
investors, as well as issuers and other market participants. 
History has shown that capital markets benefit from disclosure. 
Improved disclosure practices, greater availability of 
disclosure documents, and more uniform accounting standards 
should enhance the desirability of investing in this market, 
and may lower costs to issuers. Clarification of the disclosure 
responsibilities of market participants could reduce the costs 
to taxpayers, issuers, and their professional consultants that 
arise because of today's uncertain liability environment.

Q.6. You have said, ``our state partners in securities 
regulation are doing an outstanding job in this area. We're 
proud to be their partners'' and observed that ``the SEC and 
state regulators have . . . achieved some spectacular results 
in a number of high profile cases.'' I share your respect for 
the good work of State securities regulators. Please describe 
how this partnership is working. What do you see as the future 
role of the States in securities regulation?

A.6. The Securities and Exchange Commission has a long history 
of working together with our state counterparts. We share a 
common mission--to protect investors. It simply makes sense for 
regulators to work together and where possible, to leverage our 
respective resources.
    Cooperation between the SEC and the state securities 
commissions takes many forms. During the past several years, 
the SEC has granted hundreds of requests from state and local 
government entities for access to our investigative files. The 
Commission also has referred thousands of investor complaints 
to state regulators. Similarly, when appropriate the states 
forward potential enforcement leads to the SEC for its 
consideration.
    In addition, the SEC and the states take advantage of a 
number of regularly scheduled joint conferences, panels, and 
meetings to share information and work together to set 
enforcement priorities for issues that have both state and 
federal implications. The Commission also sponsors annual 
enforcement training for state regulators and criminal 
authorities.
    Specific examples of recent cooperative enforcement efforts 
with state regulators include:

      A joint investigation involving the SEC's Salt 
Lake Regional Office, the Utah Division of Securities, the FBI 
and the local United States Attorney's Office which resulted in 
an emergency civil action filed by the Commission in an alleged 
$30 million offering fraud by Novus Technologies;

      A joint investigation by the SEC's Los Angeles 
Regional Office and the Oregon Department of Consumer and 
Business Services of Rhodes Econometrics, an investment adviser 
that allegedly fraudulently raised millions of dollars from 
individual investors, including many senior citizens. The 
action resulted in settled enforcement actions filed by both 
the SEC and the State of Oregon;

      A joint investigation by the SEC's Boston 
Regional Office and the Massachusetts Securities Division of 
Lydia Capital, a Massachusetts-based registered hedge fund 
adviser whose principals were allegedly misappropriating 
investor funds from a $33 million hedge fund. Both the 
Commission and the State of Massachusetts filed enforcement 
actions against Lydia and its principals;

      A successful enforcement action filed by the 
Commission's Atlanta Regional Office, with the cooperation of 
the Georgia Securities Division, against Geoffrey Gish (an 
alleged $30 million prime bank scheme); and

      An emergency enforcement action filed by the 
Commission's San Francisco Regional Office, with the 
cooperation of the California Department of Corporations and 
the U.S. Attorney's Office for the Eastern District of 
California, to shut down an alleged $25 million Ponzi scheme 
that victimized hundreds of seniors and other investors 
nationwide who bought fractional ownership interests I in life 
insurance policies. The action was instituted against Donald 
Neuhaus, his daughter Kimberly Snowden, and their company 
Secure Investment Services, Inc.

    Our examination staff meets regularly with their state 
counterparts across the country in National and Regional Exam 
summit meetings to discuss areas of common concern, trends in 
compliance, priorities in examinations and other issues. One 
particularly successful joint effort is the Annual Joint 
Regulatory Training program at which state, SEC and SRO 
examiners receive training from experienced examiners in each 
organization about examination strategies and techniques, 
emerging compliance problems and other issues.
    One of the more recent joint initiatives in which the SEC, 
the states, and the SROs have participated is our effort to 
protect our nation's seniors from being victimized by promoters 
of various kinds of investment frauds. This initiative has 
three major components: aggressive enforcement against those 
preying on seniors, targeted examinations, and investor 
education. Progress already has been and continues to be made 
in all three of these areas.
    As mentioned previously, it is critical that the SEC and 
the states continue to maintain a strong partnership in 
addressing the enforcement and regulatory challenges 
confronting our organizations. The Commission remains committed 
to building on these joint efforts to maximize our respective 
resources.

Q.7. Last year, at the Banking Committee's hearing on ``Stock 
Options Backdating,'' we heard testimony from Professor Erik 
Lie, whose research published in The Wall Street Journal led to 
vigorous enforcement actions. Professor Lie has said his 
research indicates that ``almost 30% of firms that granted 
options to top executives between 1996 and 2005 manipulated one 
or more of these grants in some fashion. This amounts to more 
than 2,000 firms.'' Please update us on the Commission's 
investigation involving improper backdating of stock options. 
What is your reaction to Professor Lie's research, particularly 
with respect to the number of firms that may have improperly 
backdated stock options?

A.7. The Commission's Division of Enforcement is currently 
investigating more than 100 companies related to possible 
illegal backdating of stock options. The companies are located 
throughout the country, and include Fortune 500 companies as 
well as smaller cap issuers. They span multiple industry 
sectors. As of October 1, 2007, the Commission has filed 
enforcement actions against seven public companies and 26 
former executives (associated with 15 companies) alleging 
securities law violations in connection with backdating stock 
options, and parallel criminal charges have been brought 
against 14 former executives. The executives charged include 
former CEOs, general counsels, chief financial officers and 
other accounting personnel, human resources personnel, and a 
former compensation committee member.
    The research of Professor Erik Lie draws information from 
publicly available data concerning stock option awards to top 
executives from 1996 through 2005. (Erik Lie and Randall A. 
Heron, ``What fraction of stock option grants to top executives 
have been backdated or manipulated?'' (November 1, 2006).) The 
research suggests that patterns of potential backdating 
significantly decreased after 2002, when the Sarbanes-Oxley Act 
shortened the time for reporting option grants to two business 
days. While Dr. Lie's data suggest a large number of companies 
chose grant dates that coincided with low stock prices, whether 
a particular company engaged in illegal backdating depends on 
the facts and circumstances of each case.

Q.8. Yesterday marked the five-year anniversary of the 
enactment of the Sarbanes-Oxley Act. What is your assessment of 
the impact of the Act on accounting, corporate governance, 
corporate disclosure and securities recommendations?

A.8. The Act has had its intended effects. It may not be 
perfect in every respect but the vast majority of its 
provisions are net contributors to the nation's economic 
health. Investor confidence has recovered. There is greater 
corporate accountability. Financial reporting is more reliable 
and transparent. Auditor oversight is significantly improved.
    The success of the Act is highlighted by the fact that many 
of the tenets of Sarbanes-Oxley have been taken up by 
regulators in foreign countries. Governments in the major 
markets around the world have established independent auditor 
oversight bodies like the PCAOB. Other major capital markets 
also have recognized the conflicts of interest that some non-
audit services create, and the need to place restrictions on 
these services to improve audit quality. A number of countries 
have even adopted requirements similar to provisions of Section 
404 of the Sarbanes-Oxley Act. Several countries, including the 
United Kingdom, Australia, and Hong Kong, have adopted a 
comply-or-explain approach to a management assessment. Japan, 
France, and Canada all now have legislation or regulations 
requiring a management assessment of internal controls. Still 
others, such as Mexico, have corporate governance codes that 
recommend having a management assessment of internal controls.

Q.9.a. You testified that the Commission is exploring the 
possibility of mutual recognition of foreign securities 
regulatory regimes. Such a practice could profoundly impact the 
protection of U.S. investors, depending on the regime, and 
raises questions and concerns. This possibility requires 
cautious and comprehensive analysis of a variety of factors, 
including a comparison of the resources, rigor, culture and 
values of the foreign legal, enforcement and examination 
regulatory schemes with those of the United States. How would 
the Commission assess whether a foreign securities regulatory 
regime is comparable to United States regulation?

A.9.a. In determining whether a foreign securities regulatory 
regime is comparable, the Commission would have to consider 
both the letter of the law, and how it is applied, particularly 
the rigor of examination and enforcement. Specifically, 
assessing comparability would require review of the foreign 
jurisdiction's regulatory standards, examination efforts and 
surveillance systems, and enforcement activities. This would 
entail consultation between the Commission and the foreign 
regulatory authority to determine areas comparably addressed by 
the foreign regulatory scheme, and possibly areas in which 
greater levels of harmonization between the two regulatory 
regimes would be needed to permit recognition. While the manner 
in which a foreign securities regulatory regime carries out 
certain regulatory functions might differ between 
jurisdictions, the overall regulatory arrangements in a 
jurisdiction would need to be adequate for the protection of 
U.S. investors that would be utilizing applicable services 
before a regime could be found to be comparable.

Q.9.b. How would the Commission assure U.S. investors that they 
will receive the same degree of protection and transparency 
when buying a foreign security under a mutual recognition 
scheme as they receive today?

A.9.b. As noted above, the Commission would need to make a 
determination regarding whether a foreign regulatory regime is 
comparable before U.S. investors would be able to buy a 
security under a mutual recognition scheme. Any mutual 
recognition regime initially could be limited to certain large 
U.S. investors, which should be more capable of understanding 
and bearing the risks of dealing with foreign broker-dealers 
that are subject to different, though comparable, regulatory 
requirements. Starting with such investors would also afford 
the Commission the opportunity to review how mutual recognition 
works in practice before considering whether to extend it to 
other U.S. investors. Furthermore, U.S. investors under a 
mutual recognition regime would be provided with notice before 
transacting with a foreign broker-dealer and before having 
orders executed in foreign markets. Moreover, the antifraud 
provisions of the federal securities laws would remain 
applicable to all transactions under a mutual recognition 
approach, including the fair dealing standards that have 
evolved under these provisions.

Q.10. We understand that the cost of capital in the United 
States is lower than that of other major markets. Please 
discuss the significance of this factor for the competitiveness 
of United States markets.

A.10. The low cost of capital that companies face in the U.S. 
is a good measure of the competitiveness of U.S. markets. 
Access to deep and liquid securities markets has long attracted 
many companies, domestic and foreign, to our markets. There 
appears to be a strong link between the strength of U.S. 
regulatory institutions and this ability of companies to raise 
capital on such favorable terms in the U.S. Strong regulatory 
institutions promote investor confidence, so that investors are 
willing to provide capital on relatively favorable terms, which 
in turn brings companies to our markets for low-cost capital.
    According to the Commission's Office of Economic Analysis, 
the evidence from recent research is consistent with this view. 
A recent study \1\ examines the relation between cost of 
capital and strength of regulatory institutions in across-
section of 40 countries globally. The evidence from this study 
is that the countries with the lowest costs of capital were 
also the countries with the strongest regulatory institutions, 
as reflected in the strength of the legal and regulatory 
protections for investors. The evidence is that the 
competitiveness of the U.S. is reflected in both the low cost 
of capital to companies and its strong regulatory protections 
for investors.
---------------------------------------------------------------------------
    \1\ Luzi and Leuz, Christian, ``International Differences in the 
Cost of Equity Capital: Do Legal Institutions and Securities Regulation 
Matter?'' Journal of Accounting Research, Vol. 44, No. 3. (June 2006), 
pp. 485-531.
---------------------------------------------------------------------------
    As financial markets have evolved globally, other countries 
have tended to strengthen their regulatory and market 
institutions. To the extent other countries follow the 
leadership of the U.S. in maintaining strong regulatory 
institutions, we anticipate a natural narrowing of the gap 
between the competitive strengths of the U.S., and other 
markets over time, even while the absolute strength of the U.S. 
markets remain.

Q.11. In the research on competitiveness, there has been 
discussion of a premium valuation for stocks listed in the 
United States markets versus other markets. Please explain 
whether there is a U.S. listing premium, explain the factors 
which contribute to such a premium and comment on whether this 
enhances the competitiveness of U.S. markets.

A.11. Foreign companies that list in the U.S. have historically 
traded at a premium above comparable companies that did not 
cross-list. This premium is a good reflection of U.S. market 
competitiveness, and can be traced to several advantages of 
cross-listing. Those advantages include the lower cost of 
capital, greater liquidity, higher level of visibility, and 
improved governance that companies and their investors may 
directly and indirectly achieve from the decision to cross-
list. Enhancements to U.S. market competitiveness are achieved 
by strengthening the U.S. regulatory and market institutions 
that give rise to these advantages of cross-listing. The cross-
listing premium is thus not itself an enhancement to 
competitiveness, but rather a reflection of the competitiveness 
of U.S. markets and the value they create for investors.
                                ------                                


     RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM 
                        CHRISTOPHER COX

Q.1. The Commission has established a new process for 
negotiating monetary settlements with investigated entities. It 
is my understanding that Enforcement Division staff can no 
longer commence discussions of penalties without prior approval 
from the Commission. This change followed criticism by some 
that large corporate fines were essentially penalizing 
shareholders twice. Can you provide additional information 
regarding this process and tell the Committee why you made this 
change?

A.1. As a matter of law and good practice, the Commission is, 
and always has been, the decision maker on whether to bring an 
enforcement proceeding and on what terms to settle a case. The 
Commission is the designated authority and the Commissioners 
are the ones accountable to the Congress and the public for 
each enforcement decision.
    Against the backdrop of the Commission's over 70-year 
history, the current process for consideration of enforcement 
matters at closed meetings allows for more staff discretion and 
for less Commission oversight than has been the traditional 
norm. As recently as the 1970s, all cases of all kinds were 
submitted for Commission consideration prior to the initiation 
of settlement discussions. The recently initiated pilot 
procedure, in contrast, applies only to the very small number 
of corporate penalty cases each year, in which early 
implementation of the Commission's recent and unanimous penalty 
guidelines is of exceptional precedential importance. Moreover, 
the procedure maintains the collaborative process between the 
Commissioners and the staff--with the staff providing 
invaluable advice to the Commission, and the Commissioners 
supplying their views and general settlement guidance to the 
staff. The procedure does not replace the independent judgment 
of the SEC staff. Rather, it provides a means for the staff to 
discuss cases and possible resolutions at a more meaningful 
point, before the negotiation of the settlement and its terms 
is concluded.
    The pilot program has the following objectives:

      Provide clarity, consistency, and predictability 
in the imposition of monetary penalties. In January 2006, the 
Commission unanimously agreed on a statement concerning 
financial penalties against corporations. With SEC offices 
across the country handling cases of this type the Commission 
must work diligently to ensure that these Commission-
enforcement principles are applied consistently. Providing 
horizontal equity in a nationwide program sends a clear message 
to the markets about the costs of engaging in illegitimate 
behavior, and the importance of compliance with legal norms.

      Strengthen the Commission's enforcement program. 
By providing the views and recommendations of the staff to the 
Commission at a time that settlement negotiations are to begin, 
the procedure will allow the staff to enter upon those 
negotiations with the full support of the Commission. When 
enforcement lawyers in settlement discussions sit across the 
table from outside counsel, we want them to know they will not 
be second-guessed by the Commission at a later stage.

      Streamline the settlement process. By shortening 
final Commission review and approval if the staff reaches a 
settlement within the guidelines set with the Commissioners, 
the procedure is intended to make the entire enforcement 
process speedy and more efficient.

      Maintain fairness to potential defendants and 
respondents. By providing an opportunity to provide written 
submissions on potential enforcement actions prior to 
Commission consideration, the procedure guarantees due process 
to those who are subject to Commission enforcement action.

    Because the pilot procedure takes effect at the end of the 
normal investigation process, the entirety of the process 
continues unchanged. The procedure provides the Commission with 
the benefit of a staff recommendation, and a submission by the 
subject of an investigation, after a case has been fully 
developed. If the staff believes it is likely to recommend an 
enforcement remedy that includes a corporate monetary penalty, 
the staff first informs the company of a possible proceeding, 
and provides it with an opportunity to make a written 
submission about the case and the possibility of monetary 
penalties (in accordance with section 202.5(c) of Commission 
rules). The company, as in other cases, is free to choose 
whether to make a submission. The staff then prepares an 
enforcement recommendation for the Commission to consider, 
which will include possible charges, sanctions, monetary 
penalties, and any written submission by the company.
    The Commissioners then have the opportunity to discuss the 
case with the Enforcement staff, and to learn their views about 
ranges of outcomes that should be acceptable if the company 
decides to settle. If the Commissioners agree that an 
enforcement proceeding seeking a corporate monetary penalty is 
warranted, the Commission will authorize a proceeding and 
settlement discussions to reach a settlement consistent with 
the Commission's theory of the case, within the range of 
settlement guidelines the
    Commissioners have identified. If the staff reaches such a 
settlement, final Commission approval of it generally will 
occur on an expedited basis without the need for a further 
closed meeting. The staff may always return to the Commission 
to recommend a higher or lower penalty range, or lesser or 
greater charges or non-monetary sanctions, if their 
recommendation changes based on new information or a 
development that occurs during the settlement negotiations.
    There are several benefits to this procedure. When the 
staff presents fully negotiated settlement terms to the 
Commission for approval, without prior consultation, the 
Commissioners' exercise of judgment and discretion in 
determining the appropriate outcome for a case can be limited. 
Modifying the terms of a fully negotiated settlement can often 
be challenging. Moreover, when the Commission votes to upset a 
settlement reached independently by the staff, this could 
undercut the bargaining power of the staff in the agency's 
nationwide program in future negotiations. A further 
disadvantage to reopening completed settlements is that the 
enforcement process is prolonged and delayed. In these 
circumstances, potential defendants and their shareholders face 
new uncertainty, and limited government resources are used 
inefficiently.
    The pilot procedures are not designed to increase or 
decrease the amount of monetary penalties paid by companies or 
to make corporate penalty payments more or less frequent. 
Nevertheless, the pilot program is likely to increase the 
staff's negotiating leverage because the staff will now be 
engaging in settlement discussions with the backing of the 
Commission. Thus, the new approach could lead to superior 
settlements because the staff will not need to hedge in 
settlement discussions, wondering whether the Commission will 
back them up or disagree. Ultimately, this approach should 
increase investor protection by strengthening the position of 
the staff to obtain results that the Commission believes are 
appropriate and by bringing clarity and consistency to the 
imposition of monetary penalties.
    On an ongoing basis, we will evaluate the pilot program to 
determine whether the objectives set forth above are being 
achieved. If, as intended, this approach to settlement 
authorization makes the Commission's enforcement program more 
effective while preserving fairness to potential defendants, it 
will be made permanent. If not, it will be redesigned or 
rejected entirely.

Q.2. A recent decision by the U.S. Court of Appeals for the 
District of Columbia Circuit, FPA v. SEC, invalidated a rule 
adopted by the SEC to define the boundary line between 
brokerage accounts and investment advisory accounts. Some 
assert that as a result of the decision, approximately one 
million accounts that previously were regulated as brokerage 
accounts could be reclassified as advisory accounts. Could you 
explain the regulatory implications of this decision, in 
particular its impact on the role of self-regulatory 
organizations?

A.2. As a consequence of the court's decision in FPA v. SEC, 
broker-dealers offering fee-based brokerage accounts became 
subject to the Investment Advisers Act of 1940 with respect to 
those accounts and the client relationship became fully subject 
to the Advisers Act. Investors holding approximately one 
million accounts with $300 billion in assets must decide 
whether they will convert their accounts to fee-based accounts 
that are subject to the Advisers Act or to commission-based 
brokerage accounts. Only the Commission, and not FINRA, 
regulates the activities of broker-dealers with respect to 
their advisory customers.
    Firms are considering how to transition fee-based brokerage 
accounts to other types of accounts by October 1, 2007. Firms, 
however, consider the restrictions on an adviser trading as 
principal (pursuant to section 206(3) of the Advisers Act) to 
pose a significant impediment to providing fee-based brokerage 
customers the same services in advisory accounts as those 
customers received when the accounts were fee-based brokerage 
accounts. In order to address this impediment in a manner that 
is consistent with the protection of investors, the Commission 
recently adopted a temporary conditional exemption from the 
Advisers Act's principal trading restrictions to enable firms 
to sell securities to investors out of inventory more easily. 
The temporary rule will expire on December 31, 2009. The 
principal trading exemption would also be available for all 
other nondiscretionary advisory accounts, thus addressing 
firms' concern that any exemption should not distinguish among 
accounts.
    A key condition for using this principal trading exemption 
would be that firms must treat these accounts as both advisory 
and brokerage accounts. The purpose of this condition is to 
ensure that the sales practice rules applicable to broker-
dealers--primarily through FINRA rulemaking--continue to apply. 
These rules specifically address, among other areas, 
suitability of securities recommendations, product disclosures, 
customer communications and advertising, and product sales 
charges. Therefore, the FPA decision should not have any impact 
on the role of FINRA during the next two years.
    Longer term, the Commission is considering the implications 
of two separate regulatory regimes--broker-dealer and 
investment adviser regulation--for the delivery of similar 
financial services. We are awaiting a report being prepared 
RAND Corporation comparing how the different regulatory systems 
that apply to broker-dealers and advisers affect investors (the 
``RAND Study''). The Commission commissioned a study comparing 
the levels of protection afforded customers of broker-dealers 
and investment advisers under the federal securities laws. The 
Commission will have another opportunity to assess the 
operation and terms of the rule when it receives the results of 
the RAND Study, which is expected to be delivered to the 
Commission no later than December 2007, several months ahead of 
schedule. The results of the RAND Study are expected to provide 
an important empirical foundation for the Commission to 
consider what action to take to improve the way investment 
advisers and broker-dealers provide financial services to 
customers. One option then available to the Commission will be 
making the RAND Study results available to the public and 
seeking comments on them and their bearing on the terms of this 
rule.

Q.3. Last year the Banking Committee held a hearing to examine 
whether shareholder-owned exchanges can effectively manage the 
conflicts of interest that arise in their role as regulators. 
Since the hearing, concerns have been raised that exchanges may 
be improperly benefiting from their access to market data. Can 
you tell the Committee whether it is permissible for an 
exchange to use data collected for regulatory purposes in order 
to create proprietary products? Would you be concerned if an 
exchange was essentially profiting from this dual role of 
regulator and publicly traded company?

A.3. The Securities Exchange Act of 1934 sets forth a 
regulatory model that combines both industry and governmental 
responsibility, and national securities exchanges have a 
critical ``front-line'' responsibility for overseeing their 
markets. In recent years, many national securities exchanges 
have demutualized and become shareholder-owned, with a number 
of them becoming publicly traded entities. As you note, your 
committee and the Commission have closely examined the new 
ownership structures of these exchanges, given the potential 
conflicts that may arise as they have become for-profit 
entities while maintaining their self-regulatory roles. The 
Commission is currently considering proposals by several 
national securities exchanges to establish and charge fees for 
their real-time, last sale data, as well as proposals relating 
to information regarding the limit order books of certain 
exchanges. These proposals have generated significant comment 
and raise important and complex questions, including the level 
of fees that a market may charge for a variety of market data 
products, how those fees should be established, and the 
Commission's role in reviewing those fees. The Commission 
considers these issues to be of great importance and is 
carefully weighing the merits of the proposals, as well as the 
comments it has received regarding them from interested 
parties.

Q.4. Last week the Commission considered changes to the federal 
proxy rules governing shareholder proposals and shareholder 
communications. The most significant proposed change concerns 
the question of a shareholder's ability to propose procedures 
in a company's bylaws for the nomination of directors. As you 
have noted, two ``very different'' proposals were adopted, each 
on a 3-2 vote. The first proposal would codify the Commission 
staff's interpretation of the election exclusion since 1990, 
permitting the exclusion from the company's proxy materials of 
shareholder-proposed bylaws concerning director nominations. 
The second approach would permit shareholders who own more than 
five percent of the company's shares to propose bylaws relating 
to director nominations in the company's proxy materials. Given 
last year's federal appeals court decision, I understand that 
you want to have new rules in place for the next proxy season. 
Is there a way to move forward in a consensus fashion?

A.4. Our starting point on both proposals is the long-standing 
interpretation of the existing rule under which a proposal by a 
shareholder to amend the company's bylaws concerning the 
procedures for election of directors could be excluded by a 
company from its proxy materials. Pursuant to its authority 
under the Exchange Act, the agency adopted rules so that 
shareholders receive full and fair disclosure in connection 
with proxy contests. A number of Exchange Act rules govern the 
disclosure required in proxy contests, and allowing the use of 
current rule 14a-8 to establish procedures for the election of 
directors would circumvent the proxy contest rules. We all 
agree that it is of the utmost importance that any rule we 
adopt gives shareholders full disclosure upon which to make an 
informed decision on a matter as important as the election of 
directors. With that basic premise in mind, we will continue to 
evaluate the available alternatives and take full advantage of 
the public comments that we receive in response to both 
proposals when formulating and adopting any final rule.

Q.5. Under the Commodity Futures Modernization Act of 2000, the 
exchanges supervised by the Commodity Futures Trading 
Commission operate under a self-certification process for 
exchange rules. Self-certification permits futures exchanges to 
respond in a timely fashion to the changing needs of their 
customers. The Securities and Exchange Commission, in contrast, 
only approves substantive changes to exchange rules after 
proposals have gone through an informal negotiation process 
with Commission staff and a formal public comment period. The 
informal negotiations are not subject to any time limit and 
could begin months or even years after a rule is submitted. Is 
the Commission exploring ways to streamline the exchange rule 
approval process? If so, when would you expect the Commission 
to act?

A.5. I have asked the staff to develop a proposal that would 
permit more SRO trading rules to become immediately effective, 
and would expect the Commission to consider it later this year. 
Over the years, the Commission has continued to evaluate and 
adjust the SRO rule filing process, in a manner consistent with 
the framework established by the Exchange Act, in response to 
changes in the financial marketplace, including recent changes 
to SRO market structure and trading system technology, to 
ensure that rule proposals are processed efficiently and 
expeditiously in a manner that facilitates the Commission's 
oversight of the SRO rule-making process.
    National securities exchanges are subject to various 
requirements under the Securities Exchange Act (``Exchange 
Act''), including the requirement in Section 19(b) and Rule 
19b-4 thereunder to file their proposed rule changes with the 
Commission, which are published for notice and comment. A 
proposed rule change may not take effect unless it is 
thereafter approved by the Commission or is otherwise permitted 
to become immediately effective under Section 19(b) of the 
Exchange Act. By providing for Commission review of proposed 
rule changes and allowing for public notice and comment from 
interested parties, this requirement is designed to ensure that 
each exchange carries out the purposes of the Exchange Act and 
exercises its regulatory authority appropriately.
    The Commission has periodically revised the rule filing 
requirements over the years to meet the changing needs of the 
exchanges in a competitive financial marketplace, while at the 
same time maintaining appropriate oversight of the SRO rule-
making process. For example, in 1994, the Commission adopted 
amendments to Rule 19b-4 to allow certain non-controversial 
filings and minor systems changes to become immediately 
effective.\2\ In 1998, the Commission again amended Rule 19b-4, 
to allow for the listing and trading of certain derivative 
securities products without first having to submit a proposed 
rule change under Section 19(b), which helped speed the 
introduction of new derivative securities products and, enable 
exchanges to remain competitive with foreign and OTC 
derivatives markets.\3\ In 2004, the Commission established an 
electronic filing system for proposed rule changes to improve 
the rule filing process by eliminating paper submissions.
---------------------------------------------------------------------------
    \2\ See Securities Exchange Act Release No. 35123 (December 20, 
1994), 59 FR 66692 (December 28, 1994).
    \3\ See Securities Exchange Act Release No. 40761 (December 8, 
1998), 63 FR 70952 (December 22, 1998).
---------------------------------------------------------------------------
    The staff is once again considering options that the 
Commission could adopt to streamline the SRO rule filing 
process, particularly with respect to proposed changes to the 
trading systems operated by exchanges. The ability of SROs to 
designate a proposed rule change for immediate effectiveness in 
compliance with Rule 19b-4 represents the most direct way in 
which exchanges can expedite their proposed rule changes within 
the framework established by the Exchange Act, and it is this 
provision under which the staff is currently considering ways 
to streamline the rule filing process. Approximately half of 
the proposed rule changes submitted by SROs in 2005 and 2006 
were designated for immediate effectiveness, and the staff is 
evaluating ways to increase that percentage even further. As 
SROs increasingly utilize the availability of immediately 
effective filings, it should proportionately reduce the number 
of filings that must be approved by the Commission, thereby 
allowing the Commission to devote more attention to those 
filings that raise novel issues or warrant closer regulatory 
scrutiny.
                                ------                                --
----


RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM CHRISTOPHER 
                              COX

Q.1. Credit, CDOs, and CLOs: When there are structured mortgage 
products that were initially rated AAA at inception trading at 
prices associated with junk bonds less than one year after 
issuance, it raises the question as to whether there isn't a 
structural problem with the way credit agencies are doing their 
work. Is the SEC monitoring this situation, and what is the SEC 
doing to address this problem?

A.1. In recent months, some have criticized rating agencies for 
the accuracy of their ratings of certain structured finance 
products, including residential mortgage-backed securities 
(RMBS). Critics fault the rating agencies for not taking rating 
actions sooner on those securities as the performance of 
underlying assets deteriorated, and for not maintaining 
appropriate independence from the issuers and underwriters of 
those securities.
    Given recent events in the subprime mortgage and credit 
markets, the Commission staff has begun a review of NRSRO 
policies and procedures regarding ratings of RMBS and CDOs, the 
advisory services they may have provided to underwriters and 
mortgage originators, their conflicts of interest, disclosures 
of their rating processes, the agencies' rating performance 
after issuance, and the meanings of the assigned ratings. As 
described in the Commission's adopting release in June 
regarding the NRSRO rules, the Commission is studying whether 
it would be appropriate to require additional types of 
performance statistics be disclosed as an alternative, or in 
addition, to historical default and downgrade rates, which are 
required to be disclosed under the rules adopted.

Q.2. As a member of the President's Working Group on Financial 
Markets, is the SEC aware of the amount of existing credit 
default contracts written on structured products, like MBS and 
CDOs? In case of a credit event, are you concerned about a 
situation in which the pay out will far exceed the payments 
made for these contracts?

A.2. As a preliminary matter, the Commission has very limited 
authority over credit default swaps. In the Commodity Futures 
Modernization Act of 2000, Congress specifically prohibited the 
Commission from promulgating, interpreting, or enforcing rules, 
or issuing orders of general applicability, in a manner that 
imposes reporting or recordkeeping requirements, procedures, or 
standards as prophylactic measures against fraud, manipulation, 
or insider trading with respect to any security-based swap 
agreement.
    Thus, the Commission has limited ability to monitor the 
amount of existing credit default swap contracts written on 
structured products like MBS and CDOs, except those held at 
broker-dealers or consolidated supervised entities. The 
Commission has little insight into the overall amount of 
exposure across the markets. Even if all systemically important 
dealers were to provide exposure information to a single 
supervisor, this would only produce the gross exposure. This 
measure would materially overstate actual exposure and provide 
few clues regarding the distribution of exposure as many 
institutions hold contracts that effectively offset the 
economic risk of other contracts in their portfolios. Of note, 
many financial contracts, including options, involve potential 
payouts that exceed the amounts received under the contract. 
Sophisticated institutions manage the risks of this type of 
exposure, including those related to CDOs, etc.

Q.3. Are you focused on the potential systemic downsides for 
financial institutions that have double exposed themselves by 
writing the default derivatives and owning the CDOs?

A.3. In supervising the systemically important U.S. securities 
firms, termed consolidated supervised entities (``CSEs''), 
Commission staff monitors concentration and correlations of 
risks across various instruments and business areas. Further, 
Commission requirements ensure that adequate capital is held at 
the parent company against these risks.
    A large financial institution may face potential conflicts 
when, through its various businesses and client activities, it 
engages in originating or selling CDOs while also being long 
the CDO, its underlying assets, or related default protection. 
Management at the complex financial institutions have processes 
to identify and review transactions that present conflicts, and 
utilize procedures, such as information barriers within each 
subsidiary, to mitigate the legal and compliance risks. 
Businesses involving CDOs are only one place of many where such 
conflicts must be actively managed.

Q.4. Can you comment on the current quality of underwriting 
standards for corporate borrowing and the likeliness of tighter 
credit in the near term? Are you comfortable that risk is 
contained and we don't have issues in the CLO market similar to 
issues in the CDO market? Are CLOs structured to allow you to 
identify and monitor risks?

A.4. The federal securities laws administered by the Commission 
are aimed at providing full and fair disclosure to enable 
investors to make informed investment decisions. The federal 
securities laws do not regulate corporate borrowings, including 
the underwriting standards used by banks and other lenders in 
corporate borrowings. In addition, certain securities offerings 
can be made without complying with the disclosure requirements 
of the federal securities laws because an exemption from 
registration is available.
    Sales of collateralized debt obligations and collateralized 
loan obligations, for instance, are often sold to sophisticated 
investors in transactions that are not registered with the 
Commission. Because sales of these securities are typically 
exempt from registration, the information available to the 
Commission and the public about these securities and their 
issuers is limited. It would appear, however, that to the 
extent that the CDO market and the CLO market are closely tied 
together and are impacted by the significant contraction in 
liquidity, concerns about the sub-prime mortgage market may be 
relevant to, and could impact, both markets.
    If a company is required to file periodic reports with the 
Commission, the company is required to provide narrative 
disclosure about its borrowings and other liabilities. Such 
disclosures may include a discussion of liquidity and off-
balance sheet arrangements, including any contingent 
liabilities. Filings made with the Commission are subject to a 
17 legal and accounting review and, notwithstanding any 
exemption from registration, the anti-fraud provisions of the 
federal securities laws apply to all issuances of securities.
    Also, as leveraged lending has become a material business 
for CSE firms in the last few years, the Commission staff has 
been focusing on the risk management implications for the 
systemically important CSE firms of such pipeline businesses. 
While Commission staff does not opine on the terms of the 
individual deals negotiated by CSE firms, the CSE program 
requires and has the tools to determine whether the potential 
risks presented by activities such as leveraged lending are 
measured and that adequate capital is held by the parent 
company for such potential funding obligations.

Q.5. Global Trends: Recent news reports from China and Russia 
suggest that the governments of those countries may be 
pressuring accounting firms to step back from financial audits 
that come into conflict with governmental goals. This is of 
particular concern given the SEC's ongoing consideration of 
accepting international financial reporting standards without 
reconciliation to U.S. GAAP, as well as its recent concept 
release on allowing U.S. firms to use the international 
standards. Is the SEC concerned about the issues raised by 
these instances in Russia and China, namely the ability to 
ensure that foreign firms will be filing accurate financial 
statements without government intervention? What steps is the 
SEC taking to ensure the integrity of information reported to 
U.S. investors from abroad?

A.5. The Commission's Office of International Affairs promotes 
investor protection and cross-border securities transactions by 
advancing international regulatory and enforcement cooperation, 
promoting the adoption of high regulatory standards worldwide, 
and formulating technical assistance programs to strengthen the 
regulatory infrastructure in global securities markets. To 
these ends, the Commission and the China Securities Regulatory 
Commission agreed to a bilateral dialogue in 2006.
    Currently, foreign private issuers that do not file using 
U.S. GAAP are required to reconcile local country financial 
information, which may be reported in accordance with IFRS, to 
U.S. GAAP. Any financial information that is treated 
differently in home country accounting standards from U.S. 
GAAP, including differences resulting from government 
intervention, would result in a U.S. GAAP reconciling item. As 
proposed in the Commission's July 2007 Proposing Release, 
acceptance from foreign private issuers of IFRS financial 
statements without reconciliation to U.S. GAAP would occur only 
if the foreign private issuer prepares its financial statements 
in accordance with the English language version of IFRS as 
published by the IASB. The auditor also must opine that the 
financial statements comply with IFRS as published by the IASB. 
If financial statements are prepared using a deviation from 
IFRS as published by the IASB (i.e., as a result of government 
intervention or otherwise), the foreign private issuer would be 
required to reconcile its financial statements to U.S. GAAP.
    The periodic reports of both U.S. issuers and foreign 
private issuers are subject to the same review process of the 
Commission's Division of Corporation Finance. As of the end of 
2006, five companies filing reports with the Commission 
indicated that they are incorporated or organized in Russia and 
eleven indicated that they are incorporated or organized in 
China. In accordance with the Sarbanes-Oxley Act, the Division 
of Corporation Finance must review each reporting company at 
least once every three years. Many companies are reviewed more 
frequently. The correspondence between the Division and the 
reporting company is made available to the public on the 
Commission's EDGAR website. Additionally, the antifraud rules 
apply to all filings with the Commission, and the Commission's 
Division of Enforcement may investigate management and the 
auditors of U.S. issuers as well as foreign private issuers.
    Auditors of U.S. issuers and foreign private issuers are 
subject to similar oversight as well. Auditors, whether for 
U.S. issuers or foreign private issuers, must register with the 
PCAOB, perform audits of public companies in accordance with 
PCAOB standards and comply with SEC and PCAOB standards. 
Registered public accounting firms are required to be inspected 
by the PCAOB at least triennially and audit firms that provide 
audit reports to more than 100 issuers must be inspected at 
least annually.

Q.6. Mutual recognition would involve the SEC permitting 
certain types of foreign financial intermediaries to provide 
services to U.S. investors provided those entities are 
supervised under a regulatory regime substantially comparable 
to that in the U.S. How will the SEC continually evaluate the 
regulatory regimes of countries with which they agree to mutual 
recognition to ensure that those regimes remain comparable to 
the U.S.? Have you considered a process for derecognition if a 
country's regime is no longer deemed comparable to that of the 
U.S.?

A.6. As currently contemplated, the Commission would conduct 
periodic reviews of the foreign regulatory regimes that have 
been recognized as comparable to the U.S. Such reviews could be 
scheduled regularly and would give the Commission an 
opportunity to reassess the recognized foreign regulatory 
regime's compliance with all of the requirements and conditions 
for a comparability finding. The Commission could also conduct 
intermittent reviews when necessary (for instance, upon a 
material change to the recognized foreign regime's regulation). 
Upon the completion of either a periodic or intermittent 
review, the Commission could either reaffirm its comparability 
approval or withdraw its comparability approval, if it finds 
that a foreign regulatory regime is no longer comparable to the 
U.S. A finding that a foreign regime is no longer comparable 
would, in turn, provide a basis upon which the Commission could 
rescind, in an orderly manner, the approval of any exchanges or 
broker-dealers regulated under that regime that are operating 
in the U.S. under the mutual recognition framework.

Q.7. Shareholder Access: Would you clarify for us the 
Commission staff's approach, absent a final rule, to 
considering no action letters on proxy access proposals?

A.7. As is explained more fully in response to Senator Dodd's 
question, we intend to adopt final rules this fall, so we do 
not anticipate that we will be faced with this situation. 
However, in the event that the Commission does not issue final 
rules before next proxy season, the staff will, as discussed at 
the open meeting on July 25, continue to analyze requests for 
no-action relief concerning shareholder proposals to establish 
procedures for shareholders to include their nominees in 
company proxy materials in the same manner that it did in the 
2006-2007 proxy season.

Q.8. Approximately how many institutional investors currently 
sponsor shareowner resolutions? How many of those investors own 
more than 5% of a company's shares and, therefore, would 
qualify to submit a proxy access proposal under the SEC's 
proposal? Has the SEC performed any analysis about how 
difficult it would be for state and local pension funds to meet 
the 5% threshold contained in your proxy access proposal?

A.8. For a number of reasons, we are unable to track the number 
of institutional investors that sponsor shareholder proposals. 
First, institutional investors--and individual investors for 
that matter--decide for themselves whether or not to submit a 
proposal to a company and whether to submit a proposal 
individually or as a group. Second, investors submit their 
proposals directly to companies and do not have to notify the 
Commission of such submissions. Therefore, a shareholder 
proposal may be submitted by a single institutional investor or 
by a number of institutional investors co-sponsoring a 
proposal. Third, the Commission staff gets involved in the 
shareholder proposal process only when a company seeks a no-
action position from the staff to gain assurance that it will 
not recommend enforcement action if the company omits the 
proposal from the proxy materials based on one of the 
exclusions in Rule 14a-8. Occasionally, a shareholder may 
submit a proposal to a company and then engage in negotiations 
with the company regarding the proposal. As a result of the 
negotiations, the shareholder and the company may reach a 
mutually agreeable solution on the matter resulting in the 
shareholder withdrawing the proposal and request. In other 
instances, a company simply may agree to include the 
shareholder proposal in the company proxy materials. We 
encourage this type of dialogue between a company and its 
shareholders.
    As to how many institutional investors hold 5% of a 
company's shares and would be able to submit a proposal for a 
bylaw amendment regarding director nominations, our proposed 
rulemaking requests data regarding this threshold and whether 
an alternate threshold would be more appropriate. In this 
regard, it is important to note that under the proposed rule, a 
group of shareholders could join together to meet the 5% 
threshold. We encourage commenters to respond to our request 
for comment regarding the appropriate threshold so that we, 
along with our Office of Economic Analysis, can conduct a 
thorough analysis regarding the ability of institutional 
investors, individual) or as a group, to submit a shareholder 
director nomination bylaw amendment.

Q.9. How many of those investors would have to combine their 
holdings in order to meet the 5% threshold for filing proxy 
access resolutions required by your proposal?

A.9. The number of institutional investors that would have to 
co-sponsor a proposal and combine their holdings in order to 
meet the 5% threshold for filing a proposal for a shareholder 
director nomination bylaw amendment would depend on a number of 
factors, including the size of each institution's holdings and 
the size of the company. Because of these variables it would be 
difficult to provide an estimate in this regard, even if we 
were able to track submissions by institutional investors. We 
are hopeful that we will receive useful comment in this general 
area, including personal experience by investors and specific 
data to the extent available.

Q.10. The SEC's proxy access proposal seeks comment on issues 
relating to precatory shareholder proposals? Do you agree that 
precatory shareowner proposals have, in a number of cases, led 
to improvements in corporate governance practices that have 
benefited investors and the U.S. capital markets? Are you 
concerned that the SEC's proposal could make it more difficult 
for shareowners to submit precatory proposals?

A.10. There has been a great deal of discussion in this area 
following the Commission's roundtables on the proxy process and 
subsequent rule proposals. We recognize the role that non-
binding proposals play in enabling shareholders to advise 
management and other shareholders of corporate governance and 
other concerns. The rule proposals do not make any changes to a 
shareholder's ability to submit non-binding proposals. Rather, 
the Commission requested public comment on procedures for 
inclusion of such proposals in company proxy statements, 
including individualized procedures adopted for a particular 
company, as well as alternatives to their inclusion in the 
proxy statement, such as the use of an electronic forum. In 
considering any rulemaking in the proxy area, we believe that 
it is important to be respectful of the preeminent role of 
state law in determining shareholder rights. Therefore, our 
release requests comment regarding non-binding proposals and 
whether our proxy rules are properly aligned with, or can be 
better aligned with, shareholder rights under state law.

Q.11. Most shareowner proposals are issued by state and local 
pension funds, the ten largest of which combined own less than 
4% of the entire U.S. equity market. Has the SEC performed any 
analysis about how difficult it would be for state and local 
pension funds to meet the 5% threshold contained in your proxy 
access proposal?

A.11. The ability of an institutional investor or a group of 
institutional investors to meet the proposed 5% threshold would 
depend on the size of the institution's or groups' holdings and 
the size of the company. We have heard from various interested 
parties regarding the 5% threshold, and there is both support 
for, and opposition to, the 5% threshold. We have requested 
public comment regarding the proposed threshold and are hopeful 
that the public will provide us with commentary that will 
enable us to more thoroughly evaluate whether 5% is the 
appropriate threshold.

Q.12. How many shareowner proposals were submitted by mutual 
funds during the last proxy season? Isn't it true that if 
mutual funds fail to support shareowner proposals it will be 
extremely difficult for other institutional investors to meet 
the 5% threshold contained in your proxy access proposal?

A.12. We do not have a mechanism for tracking the number of 
shareholder proposals submitted to companies, so we do not have 
information regarding the number of proposals that may have 
been submitted by mutual funds. Our rule proposals are out for 
public comment and we have heard from interested parties that, 
absent support from mutual funds, it would be difficult to 
achieve the proposed 5% threshold; however, others have 
expressed a contrary view. In this regard, we do not have 
specific data supporting either point of view, but are hopeful 
that we will receive comments in this area.

Q.13. Private Equity: There has been a lot of talk in recent 
weeks about a change in the credit cycle that appears to be 
occurring, and the impact that change may have on private 
equity deals in particular. Published reports indicate that in 
recent weeks, debt offerings for major private equity deals 
have been delayed or altered because of market conditions. 
Investors have apparently balked at the terms of these deals, 
leaving the banks on the hook to the private equity firms that 
are buying these companies. With so much private equity deal 
activity in the pipeline, and with banks on the hook for debt 
offerings of over $200 billion to fund these transactions, 
would you please comment on the systemic risk that this volume 
of pending debt poses to the banks, the debt and equity 
markets, and to the economy overall.

A.13. The systemically important Consolidated Supervised 
Entities (``CSE'') provide significant funding to sponsors of 
private equity deals, often in the form of loan commitments. 
The risk faced by the originating institution is that the loans 
will not be purchased by investors, or an issuance of debt or 
equity intended to repay a loan will not be successful. In such 
cases, the loan commitments may fund and then remain on the 
firm's balance sheet.
    Under current market conditions, this has occurred with 
some deals and may well occur with still others. Securities 
firms supervised by the Commission as CSEs are required to 
maintain adequate liquidity at the parent, measured against a 
stress scenario intended to incorporate those funding demands 
that would occur during a period of market dislocation. Lending 
commitments are incorporated into this stress scenario, and 
represent a significant potential use of funding capacity 
against which liquidity is held.

Q.14. Conflicts of Interest: Many are concerned about the 
potential for conflicts of interest in the securities markets. 
I would ask you to focus in on one particular type of conflict, 
and that is when the CEO or chairperson of a public company 
participates in a private equity buyout of his or her company. 
How do these competing interests get reconciled? The current 
mechanisms are through fairness opinions, ``go shop'' 
provisions, special committees of the board, and shareholder 
votes. Are these mechanisms sufficient to protect the integrity 
of the markets? Some commentators have suggested that fairness 
opinions and special committees are fig leaves, ``go shop'' 
periods are too short to allow other potential buyers a real 
chance to value the company, and that shareholders often have 
little real choice, and much less information, than insiders 
and private equity firms on which to base their voting 
decision. What is your view about these conflicts and how best 
to ensure that shareholders' interests are protected when the 
fiduciaries they have entrusted to maximize the value of their 
shares make an offer to buy their company in concert with 
private equity?

A.14. The rules and regulations administered by the Commission 
recognize the potential conflicts that could arise when 
affiliates of an issuer, including management, participate in 
an offer to buy an issuer. Therefore, in addition to the 
disclosures generally required to be made to security holders 
about a takeover offer, certain specific disclosure 
requirements exist for affiliated transactions. Those specific 
disclosure requirements include, among other things, 
information about whether the issuer and any affiliates 
reasonably believe the transaction to be fair to the 
unaffiliated security holders; information about the 
negotiations and material contacts between the issuer, its 
affiliates and third parties; the effects of the transaction on 
the issuer, its affiliates, and unaffiliated shareholders; and 
the alternative transactions or bidders considered and why any 
such alternative transactions and bidders were rejected. Any 
information sent to the security holders of a public company 
regarding an affiliated takeover offer is required to be filed 
with the Commission and is subject to staff review.
    The Commission and its staff continue to monitor whether 
the disclosures required by the federal securities laws provide 
security holders with the information necessary for them to 
make informed voting and investment decisions. When deemed 
necessary, the Commission may amend the rules and regulations 
it administers or advise that new laws be adopted by Congress.
    In addition to the Commission's disclosure requirements 
regarding a proposed affiliated takeover offer, state law 
imposes duties on issuers and their boards of directors and 
management when structuring transactions, entering into 
acquisition agreements and considering whether to advise 
security holders to approve affiliated transactions. Violations 
of these duties subject directors to state law liabilities. 
Whether a special committee of the board is used to consider an 
affiliated transaction, the board wants to obtain a fairness 
opinion and certain procedural provisions--such as a ``go 
shop'' provision--are included in an acquisition agreement is 
generally determined by those state law duties and other 
commercial concerns.

Q.15. An upcoming study by Professors James Westphal and 
Michael Clement found that executives influence ratings by 
withholding favors from analysts. According to the study, 
analysts that were aware of an executive who retaliated for 
being downgraded by not responding to phone calls or refusing 
to answer questions 7- were less than half as likely as their 
peers to downgrade that executive's firm after an earnings 
report came in 50% below forecasts. Is the SEC aware of the 
conflicts outlined in the study and are there additional 
measures the Commission should take to address such conflicts?

A.15. We are aware of the study by Professors Westphal and 
Clement. In fact, we contacted Professor Clement in early 
August and he informed us that he was in the process of 
revising the paper based on recent feedback from an academic 
journal.
    We believe that issuers should be fair and consistent in 
determining what level of access to company management should 
be provided to analysts. We will consider the revised study by 
Professors Westphal and Clement as we continue our 
consideration of the impact of issuer retaliation against 
research analysts.

Q.16. Executive Compensation: Last July, the SEC unanimously 
adopted new executive compensation disclosure rules. In 
addition to requiring the disclosure of the total annual 
compensation for senior corporate officers and directors, the 
rule requires each company to file a Compensation Discussion 
and Analysis (CD&A). I would like you to comment on your 
reaction to the first year disclosures and how would you rate 
the usefulness of the initial CD&A filings?

A.16. Overall, companies have made a good faith effort to 
comply with the new rules, including the Compensation 
Discussion and Analysis, and have provided investors with 
clearer, more detailed and more comprehensive disclosure about 
a company's executive compensation plans, policies, and 
decisions. There have been some instances, including some 
CD&As, where companies have not provided as complete or clear 
narrative disclosure as we would have liked to see in response 
to the new rules. In light of the significant changes required 
in executive compensation disclosure, however, we were not 
surprised by this result. Rather, we believe that this has been 
a learning experience for companies. To assist companies in 
that process, the Division of Corporation Finance is currently 
completing a special review project of executive compensation 
disclosures from the 2007 proxy season. The Division is 
providing public companies with specific feedback about 
compliance with the rules that they will be able to use in 
drafting their next year's proxy disclosures. As a result, we 
are optimistic that we will see even further improved 
disclosures next year.

Q.17. Backdating Stock Options: I know that the Commission has 
been concerned about the practice of backdating stock options. 
It's my understanding that the Commission has issued sanctions 
against four companies. Recognizing that there are literally 
hundreds of companies that could be suspected of backdating 
stock options and over 250 companies that have been identified 
as having backdated options, how would you evaluate your 
ability to investigate and take action against further 
corporations?

A.17. The Commission's Division of Enforcement is currently 
investigating more than 100 companies related to possible 
illegal backdating of stock options. The companies are located 
throughout the country, and include Fortune 500 companies as 
well as smaller cap issuers. They span multiple industry 
sectors. As of October 1, 2007, the Commission has filed 
enforcement actions against seven public companies and 26 
former executives (associated with 15 companies) alleging 
securities law violations in connection with backdating stock 
options, and parallel criminal charges have been brought 
against 14 former executives. The executives charged include 
former CEOs, general counsels, chief financial officers and 
other accounting personnel, human resources personnel, and a 
former compensation committee member.
    The Commission also has a variety of information available 
that makes it harder for lawbreakers to conceal possible 
illegal stock option grant manipulations by public companies. 
Among other things, the Commission's new executive compensation 
rules adopted in July 2006, which have since taken effect, were 
specifically designed to give investors far better disclosure 
about every public company's option practices. In addition, 
since 2002, officers and directors have been required to 
disclose their option awards within two business days. This 
requirement, which the SEC adopted in August 2002 to implement 
Section 403 of the Sarbanes-Oxley Act, has made it more 
difficult for companies to backdate option grants, and it has 
also helped to enhance the transparency of companies' option 
plans and practices.
    The Commission has made a significant commitment of 
resources to address the problem of stock option grant 
manipulation. As I testified before the Senate Banking 
Committee last year and to the Senate Financial Services 
Appropriations Subcommittee in May of this year any additional 
resources from Congress would be put to good use, and could be 
used to further strengthen our enforcement program.
                                ------                                --
----


     RESPONSE TO WRITTEN QUESTIONS OF SENATOR CARPER FROM 
                        CHRISTOPHER COX

Q.1. Our current bifurcated regulatory system sets up 
burdensome hurdles to the introduction of new derivatives 
products. A good example would be the credit default products 
that both the CME and CBOE recently began to trade. It took the 
SEC and CFTC 9 months to determine how to approve these 
products in a way that is consistent with the jurisdiction of 
both agencies. Meanwhile, Eurex, a European exchange, was able 
to introduce a competitive product within weeks of announcing 
its intention to do so. Another example would be the gold-ETF 
options contracts submitted by the CBOE for SEC approval. In 
this case, the SEC has not acted on this application for more 
than two years. Can any steps, short of merger, be taken to 
improve this process? Should there be a time limit related to 
rules approval which will ensure that new products can be 
introduced to the market by a date certain?

A.1. The Commission is keenly aware of the importance to 
exchanges of being able to begin trading new derivative 
products in a timely manner. To this end, in 1998, the 
Commission amended Rule 19b-4 to allow for the listing and 
trading of certain derivative securities products without first 
having to submit a proposed rule change under Section 19(b), 
which helped speed the introduction of new derivative 
securities products and enable exchanges to remain competitive 
with foreign and OTC derivatives markets.
    The staff has also been considering additional steps to 
further streamline the process to list and trade new products, 
including streamlining the process by which exchanges trade new 
products pursuant to unlisted trading privileges (when new 
products have already been listed by another exchange) and 
permitting certain new products-related rule filings to be 
immediately effective upon filing.
                                ------                                --
----


    RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM 
                        CHRISTOPHER COX

Q.1.a. Regulation of Hedge Funds: What is the threshold you use 
to gauge whether or not more regulation of hedge funds is 
needed? Is there a point where systemic risk could become 
enough of a concern that either the SEC would take further 
action or you would urge Congress to do so?

A.1.a. The Commission is part of an ongoing Presidents Working 
Group (``PWG'') process to evaluate the impact of hedge funds 
on the markets and market participants. The growth of hedge 
funds and the important role in the markets has clearly 
influenced this effort. We believe the PWG process is the best 
way to proceed on this issue.

Q.1.b. Should we be more concerned about systemic risks given 
that hedge funds constitute a much larger percentage of trading 
volume?

A.1.b. With regard to potential systemic risks presented by 
hedge funds, the Commission focuses on the adequacy of capital 
and risk management at the largest banks and securities firms 
under its CSE program. Because of this program and its emphasis 
on risk management at firms that, due to their large size, are 
of systemic importance, the growing importance of hedge funds, 
therefore, is a secondary issue.
    However, with regard to the potential systemic risks 
presented by hedge funds themselves, market discipline by 
creditors, counterparties, and investors is the most effective 
mechanism for limiting systemic risk. To date, information 
gathered from CSE firms indicates hedge funds have reduced 
their exposures in an orderly manner. This reduction of 
positions (and reduction in trading volume) under current 
market conditions would appear to reflect discipline by hedge 
funds.

Q.1.c. You said in response to my questioning that you felt we 
have essentially filled the hole left by the Goldstein 
decision. Is there additional action or areas you think still 
need examining by the SEC? Does the SEC need increased 
authority? Do you think Congress needs to step in?

A.1.c. The Commission and our staff, as a matter of routine 
practice, review developments in the securities industry, 
including those relating to hedge funds and other significant 
market participants. Recently, we resolved, in a new rule, the 
uncertainty created by the opinion of the Court of Appeals for 
the District of Columbia Circuit in Goldstein v. SEC regarding 
our authority to bring enforcement actions against hedge fund 
advisers. The rule, which became effective on September 10, 
2007, clarifies our authority to bring enforcement actions 
where an investor in a hedge fund or other pooled investment 
vehicle is defrauded by the fund's adviser.
    The Commission plans to use the new rule, and the authority 
already granted to us by Congress, to monitor developments with 
respect to hedge funds and other significant market 
participants and to address abuses that warrant further action. 
We also coordinate with other Federal agencies to monitor hedge 
fund practices, as well as other industry developments.
    The Agreement among the Presidents Working Group and Agency 
Principals regarding guidelines on Private Pools of Capital was 
signed earlier this year. That agreement, to which I was a 
party, recognizes that private pools of capital, such as hedge 
funds, bring significant benefits to the financial markets. It 
also endorsed:

      limiting the offering of private pools only to 
investors with the sophistication to identify, analyze, and 
bear the risks associated with them; and

      ensuring that investors in those pools obtain 
accurate and timely historical and ongoing material 
information.

    As you can see, we and our staff have many options for 
monitoring developments with respect to hedge funds, within the 
authority already granted to the Commission. To the extent that 
we were to determine that this authority is inadequate to the 
task, we would submit to Congress a request for additional 
authority, as well as a full explanation for why we believe a 
further grant of authority is warranted.

Q.2.a. Market Data: Before Regulation NMS, the market data 
revenues allocated to each Exchange were based simply on the 
number of trades reported by that Exchange. As part of 
Regulation NMS (``national market system''), the SEC has 
changed that allocation to be based on quotes and trades. While 
I understand these changes are still being rolled out, it seems 
that this change has had some unintended consequences. Would 
you agree there have been some unintended consequences? Was it 
the intention of the SEC to reduce the total amount of market 
data that Exchanges distribute to their members? Can you 
describe what the intent was?

A.2.a. The market data revenue allocation formula adopted as 
part of Regulation NMS was designed to address certain 
weaknesses associated with the previous allocation formulas, 
including: (1) the absence of any allocation of revenues for 
the quotations (as opposed to the trade reports) contributed by 
a self-regulatory organization (``SRO''); (2) an excessive 
emphasis on the number of trades reported by an SRO that had 
led to substantial and ongoing distortive trading practices, 
such as wash sales and trade shredding (the splitting of large 
trades into multiple 100-share trades); and (3) a 
disproportionate allocation of revenues for a relatively small 
number of stocks with extremely high trading volume, with a 
much smaller allocation to the stocks, typically those issued 
by smaller companies, with less trading volume.
    The market data allocation formula was not adopted with the 
goal of reducing the amount of market data revenue, but was 
designed to eliminate the trade shredding and other distortive 
trade reporting practices associated with the previous 
allocation formula, and to allocate revenues to the SROs that 
produced the market data that was most useful to investors. The 
SEC believes that the formula adopted in Regulation NMS is less 
subject to any particular type of gaming and distortion because 
it incorporates a more broad-based measure of the contribution 
of each SROs' quotes and trades. Generally speaking, the 
formula allocates revenues among the SROs based on measures of 
the usefulness to investors of an SROs' trades and quotes in a 
security. The Commission will continue to monitor the operation 
of the new formula to asses whether it achieves its goals and 
would welcome feedback as to its success in that respect, as 
well as insights into any unintended consequences the new 
formula may be having.

Q.2.b. In response to my question at the hearing, you said the 
SEC plans to take another look at how the Regulation NMS is 
being implemented. Can you provide any details? Is there a 
timeline for any follow up actions you expect the SEC to take?

A.2.b. The implementation of a number of key rules of 
Regulation NMS, namely the order protection and fair access 
rules, has been phased in over the past half year, and 
Regulation NMS will be completely implemented in early October 
2007. During this time, the staff has been working closely with 
national securities exchanges, broker-dealers, industry trade 
groups and other market participants to monitor each 
implementation phase. As part of this effort, the Commission 
has provided where appropriate a number of tailored exemptions 
from Regulation NMS, and the staff has provided responses to 
frequently asked questions regarding the new rules. In 
addition, Commission staff has been coordinating efforts to 
review the compliance with Regulation NMS by market 
participants going forward.

Q.2.c. You also stated at the hearing that the SEC would be 
ruling on the proposals by the NY Stock Exchange that are 
pending before the SEC. Is there any timeline for this?

A.2.c. The Commission is currently considering proposals by 
several national securities exchanges, including NYSE, Nasdaq, 
and Amex, to establish and charge fees for new proprietary 
real-time last sale data feeds. In addition, the Commission is 
also considering a proposal by NYSE Arca to charge fees for 
ArcaBook, a compilation of all limit orders resident on the 
NYSE Arca limit order book which is currently free of charge. 
These market data proposals have generated significant comment 
and raise important and complex questions, including the level 
of fees that a market may charge for its proprietary market 
data products, how those fees should be established, and the 
Commission's role in reviewing those fees. The Commission 
expects to act on these proposals in the near future.

Q.3.a. Fee-Based Brokerage: Earlier this year, the D.C. Circuit 
Court reversed a 2005 SEC rule on fee-based broker-dealer 
services. Since this court decision will have the effect of 
changing the broker arrangements for more than a million 
customers who utilize these services, I would like to hear what 
the SEC's plans are to address this shift that will occur for 
these accounts. Is the SEC working on a plan to address this 
issue through regulations or other action? Can you comment on 
the SEC's plans? As the October 1 court deadline for enacting 
these changes is fast approaching, does the SEC plan to release 
any guidance before then?

A.3.a. We are devoting substantial attention to the difficult 
issues that have arisen as a result of the Court's decision in 
Financial Planning Association v. SEC. As you are aware, we 
requested a 120-day stay of the ruling, which the Court 
approved and which expired on October 1, to work with the firms 
on transition issues and to consider further action by the 
Commission with respect to the application of the Investment 
Advisers Act to the affected accounts. I have met with 
representatives of the brokerage industry, and other members of 
the Commission's senior staff have had multiple meetings with 
representatives of all groups affected by the Court decision. 
We are working hard to arrive at a solution with respect to 
these accounts that protects investors, facilitates investor 
choice, and is within our statutory authority.
    On September 19, 2007, the Commission approved two 
rulemaking initiatives addressing the FPA decision. One is a 
proposal for an interpretive rule under the Investment Advisers 
Act that would clarify the application of the Advisers Act to 
certain activities of broker-dealers. The other is a temporary 
rule that the Commission adopted on an interim final basis that 
provides investment advisers who also are registered broker-
dealers an alternative means of compliance with the principal 
trading restrictions of Section 206(3) of the Investment 
Advisers Act.

Q.3.b. I understand the SEC has commissioned a study by the 
Rand Corporation to determine what additional legislative and 
regulatory steps may be needed to improve regulation in this 
area. Can you provide any details on the scope of this report? 
Do you think that this issue will require legislation?

A.3.b. The results of the study by the RAND Corporation are 
expected to be delivered to the Commission no later than the 
end of December 2007, several months ahead of schedule. This 
study is focusing on the marketing, sale, and delivery of 
financial products and services to investors by investment 
advisers and broker-dealers. The results of the study are 
expected to provide an important empirical foundation for 
considering improvements in regulatory and legislative rules 
that date back to the 1930s. One option available to the 
Commission will be making the RAND Study results available to 
the public and seeking comments on them.
                                ------                                


RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE FROM CHRISTOPHER 
                              COX

Q.1. Many medium to small financial institutions are dedicated 
to traditional banking services. These banks do not engage in 
the global and diversified non-banking businesses that the 
nation's largest banks do. Given the differences between banks 
and typical non-banking corporations, I ask you whether 
requiring non-diversified, non-global banks to comply with 
Section 404 serves the shareholders of these banks and public 
investors in general? Why should already highly regulated banks 
be subjected to the additional cost and regulatory burden of 
Section 404 compliance.

A.1. The importance of having adequate internal controls, which 
provide reasonable assurance regarding the reliability of 
financial reporting, is long-recognized and was reinforced back 
in 1977, under the Foreign Corrupt Practices Act, for companies 
of all types and sizes. Then, in 1991, in response to a 
financial institution crisis following many savings and loan 
association failures, Congress also enacted the Federal Deposit 
Insurance Corporation Improvement Act. That Act includes an 
internal control provision that is similar to section 404 of 
the Sarbanes-Oxley Act.
    Neither section 404 nor the SEC's implementing rules 
prescribe the way in which management must design the necessary 
controls in order to achieve reliable financial reporting. 
Instead, the SEC's implementing rules simply require annual 
disclosures to investors about the effectiveness of a company's 
internal controls as was mandated by Congress. The only 
exemption from reporting on internal controls provided for by 
Congress is for registered investment companies.
    It is also noteworthy that smaller, less complex companies, 
including non-diversified, non-global banks, generally require 
less complex internal controls than larger, more complex 
companies. As a result, management of such companies can 
evaluate the effectiveness of their internal controls with less 
effort and cost than is required of larger, more complex 
companies. The SEC's recently adopted interpretive guidance for 
management and the Public Company Accounting Oversight Board's 
recently adopted new auditing standard were both specifically 
developed with this point in mind, so that management 
assessments and auditor attestations can be tailored to the 
facts and circumstances of companies of all types and sizes 
without being unduly burdensome.
    Finally, the Commission has on four separate occasions 
delayed the implementation of section 404 for smaller companies 
(non-accelerated filers). These extensions have not only 
allowed time for these smaller companies to more gradually 
prepare to comply with the requirements of section 404, but 
these extensions have also allowed smaller companies to benefit 
from the significant improvements that the Commission and the 
PCAOB have made to the implementing rules based upon the 
initial three years of experience with the implementation for 
larger companies.
