[Senate Hearing 110-980]
[From the U.S. Government Publishing Office]





                                                        S. Hrg. 110-980


TURMOIL IN U.S. CREDIT MARKETS: EXAMINING THE U.S. REGULATORY FRAMEWORK 
                                  FOR 
                    ASSESSING SOVEREIGN INVESTMENTS

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

                                HEARING

                               before the

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

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                                   ON

    EXAMINING THE U.S. REGULATORY FRAMEWORK FOR ASSESSING SOVEREIGN 
                              INVESTMENTS


                               __________

                        THURSDAY, APRIL 24, 2008

                               __________

  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                  ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania        MEL MARTINEZ, Florida
JON TESTER, Montana                  BOB CORKER, Tennessee

                      Shawn Maher, Staff Director
        William D. Duhnke, Republican Staff Director and Counsel

                       Dean V. Shahinian, Counsel
           Roger M. Hollingsworth, Professional Staff Member
          Julie Y. Chon, International Economic Policy Adviser
              Neal J. Orringer, Professional Staff Member
                Didem Nisanci, Professional Staff Member
               David Stoopler, Professional Staff Member
                 Jayme Roth, Professional Staff Member
                  Megan Bartley, Legislative Assistant
                Brian Filipowich, Legislative Assistant

                    Mark Osterle, Republican Counsel
         Brandon Barford, Republican Professional Staff Member
          Courtney Geduldig, Republican Legislative Assistant

                       Dawn Ratliff, Chief Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor












                            C O N T E N T S

                              ----------                              

                        THURSDAY, APRIL 24, 2008

                                                                   Page

Opening statement of Chairman Christopher J. Dodd................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3
    Senator Menendez.............................................     4
    Senator Reed.................................................     5
    Senator Schumer..............................................     6

                               WITNESSES

Scott G. Alvarez, General Counsel, Board of Governors of the 
  Federal Reserve System.........................................     8
    Prepared statement...........................................    51
Ethiopis Tafara, Director, Office of International Affairs, 
  Securities and Exchange Commission.............................    10
    Prepared statement...........................................    66
    Response to written questions of:
        Senator Shelby...........................................   154
Paul Rose, Assistant Professor of Law, Moritz College of Law, 
  Ohio State University..........................................    33
    Prepared statement...........................................    71
    Response to written questions of:
        Senator Shelby...........................................   157
David Marchick, Managing Director and Global Head of Regulatory 
  Affairs, The Carlyle Group.....................................    35
    Prepared statement...........................................   135
    Response to written questions of:
        Senator Shelby...........................................   159
Jeanne S. Archibald, Director of International Trade Practice, 
  Hogan and Hartson LLP..........................................    37
    Prepared statement...........................................   141
Dennis Johnson, Director of Corporate Governance, California 
  Public Employees' Retirement System............................    39
    Prepared statement...........................................   151
    Response to written questions of:
        Senator Shelby...........................................   160

 
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING THE U.S. REGULATORY FRAMEWORK 
                  FOR ASSESSING SOVEREIGN INVESTMENTS

                              ----------                              


                        THURSDAY, APRIL 24, 2008

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:12 a.m., in room SD-538, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. Good 
morning.
    Let me first of all apologize to people, the witnesses and 
others. We had a hearing ongoing four floors down on the Food 
and Drug Administration, which I sit on that Committee as well, 
a hearing about food safety this morning as well. So we are 
trying to juggle the responsibilities of food safety and the 
responsibilities of the Committee. So I apologize to my 
colleagues and to the witnesses for being a few minutes late.
    What I would like to do is open up with a few opening 
comments on the subject matter of today's hearing, and then I 
will turn to my colleagues for any opening comments they may 
want to make, particularly Senator Shelby. And then we will 
hear from our witnesses, and we thank you for being with us.
    Today's hearing marks the sixth in a series of hearings 
examining the ongoing turmoil in U.S. credit markets. Today we 
are going to focus on a source of capital that has helped some 
of the largest U.S. financial institutions weather the storm in 
the credit markets: foreign government-controlled entities 
known as sovereign wealth funds. This is the second time the 
Committee has examined these funds. Last year, Senator Evan 
Bayh of Indiana, a member of this Committee, chaired a very 
good hearing on this subject, and we appreciate his work in 
this area.
    U.S. financial companies have raised over $60 billion in 
new equity from both foreign and domestic sources since the 
credit crunch began in July of 2007. Of that amount, 
approximately $39 billion, or nearly two-thirds, was supplied 
by sovereign wealth funds. Ninety-three percent of those bank 
capital infusions came from sovereign funds in just four 
countries: the United Arab Emirates, Kuwait, Singapore, and 
China.
    Foreign government investments in our country are not new, 
of course; however, many analysts project tremendous growth in 
this area. The International Monetary Fund estimates that more 
than 20 sovereign wealth funds, largely financed by petro 
dollars and excess foreign exchange reserves, currently manage 
$1.9 to $2.9 trillion globally. These funds, while less than 
the amount of the assets managed by pension funds worldwide, 
are up to twice the amount of assets managed by hedge funds and 
up to three times the amount managed by private equity funds.
    That amount is growing, by the way, and growing very 
quickly. Sovereign wealth fund assets are expected to grow to 
$12 trillion by the year 2012. With that kind of rapidly 
growing financial muscle, the operations of sovereign wealth 
funds in U.S. markets have raised questions generally about how 
they are run, by whom, and for what purpose. Additional 
questions have been raised about the impact of sovereign wealth 
funds on the safety and soundness of the U.S. financial system 
and the security of critical U.S. industries.
    I believe, firstly, that the United States can and must 
continue to maintain an open investment climate while still 
protecting our economic and national security interests. 
However, maintaining that vital delicate balance between 
openness and security will require continued vigilance, 
including, of course, vigilance by this very Committee.
    It was with that balance in mind that Senator Shelby and I 
authored the Foreign Investment National Security Act, which 
was signed into law last July. On Monday, the Treasury 
Department issued proposed rules to implement this law. In my 
view, these rules are consistent with our legislation's purpose 
and a very important step forward, and I commend the 
Department. These rules will not only protect our national 
security; they will also hopefully bring greater predictability 
to the investment process. But it is important to note that 
CFIUS is only one tool available to address concerns about 
certain investments in the United States.
    The United States regulates the activities of and collects 
data on sovereign investments through a host of statutes. U.S. 
banking securities, Government contracting, and other laws 
regulate the activities of both foreign and domestic investors. 
Federal officials are responsible for implementing those laws, 
including officials at the Federal Reserve Board, the 
Securities and Exchange Commission, the Treasury Department, 
the Commerce Department, and the Defense Department, among 
others.
    The purpose of today's hearing is to better understand how 
well these laws are working to protect U.S. markets and 
companies while at the same time allowing foreign investment to 
continue. For example, the SEC requires sovereign funds and 
other investors with ownership stakes exceeding 5 percent in a 
public company to file disclosure statements. Hearings held by 
this Committee in 1975 indicate that this requirement is 
directed at foreign investors in order to improve the ability 
of the Federal Government to monitor foreign investment in the 
United States. The anti-fraud provisions of the Exchange Act, 
which prohibit market manipulation and other frauds, also apply 
to sovereign funds.
    Like any laws or regulations, the effectiveness of these 
rules depends on the extent to which they are, of course, 
enforced. And here another unique challenge is posed by the 
sovereign wealth funds. SEC Chairman Cox has said it well, and 
I quote him: ``If the same government from whom we sought 
enforcement assistance were also the controlling person behind 
the entity under investigation, a considerable conflict of 
interest would arise. Another issue is the conflicts of 
interest that arise when government is both the regulator and 
the regulated.''
    I am eager to learn about how the SEC is addressing these 
and other enforcement concerns. It is imperative, in my view, 
that this Committee know whether existing securities 
requirements are adequate for the purpose of securing the 
health and stability of our Nation's markets in the face of 
increasing investment from foreign sovereign entities.
    Similarly, it is also important to examine the adequacy of 
the authority available to the Federal Reserve Board to 
maintain the safety and soundness of our Nation's financial 
system when sovereigns invest billions of dollars into our 
financial institutions. How does the Fed determine whether a 
review of an investment in a financial institution is 
necessary? Given the size and anticipated increase of sovereign 
investment in U.S. financial markets, do they pose any systemic 
risks for our country? And how does the Fed assess those risks 
if, in fact, they exist?
    Fundamentally, the Committee and the American public I 
believe must know with certainty that sovereign wealth funds 
conduct themselves according to the same standards to which 
other economic actors are held: transparency, sound governance, 
commercial purpose, and market integrity. These are critical 
issues for our economy, and they are being raised at a critical 
moment, of course, in our Nation's economic life. We cannot 
afford as a Nation to upset that vital balance that I mentioned 
earlier between openness and security. If we do, the 
consequences for our Nation I think will be dire.
    So I appreciate the willingness of our witnesses to join us 
this morning. We all look forward to hearing the thoughts and 
advice they have on the subjects I have raised in this opening 
statement on an issue that will be the subject of continued 
observation and concern to this Committee for many years to 
come. But it is important we get our arms around it, understand 
it well, and think carefully and thoughtfully about it.
    Now let me turn to Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    I strongly support this Committee's continuing examination 
of the economic and security issues surrounding the investment 
activities of sovereign wealth funds. There are many U.S. 
statutes and regulations, which Senator Dodd mentioned, which 
govern foreign investments in American companies, including 
laws pertaining to investments by individuals, private or 
publicly trade corporations, state-owned enterprises, and 
sovereign wealth funds.
    While an examination of the law is important, we should 
also be mindful of how the legal structure interacts with 
market forces which ultimately influence our economic growth 
and, on occasion, our Nation's security.
    Notwithstanding our recent economic difficulties, the 
United States remains a very attractive and accessible market. 
This may explain in part why we are the largest recipient of 
foreign investment in the world. Not only are sovereign wealth 
funds increasing the size of the investments, but they continue 
to broaden their field of interest in American companies. As 
sovereign funds acquire stakes in a wider variety of economic 
sectors, I believe we need to ensure that our national security 
is not compromised by our openness. I believe the recent 
regulations written by the Treasury Department implementing the 
revised CFIUS statute will help add clarity and certainty to 
the process.
    I look forward today to a discussion of how we regulate 
foreign investments. In particular, I am interested in hearing 
which statutes and regulations pertain to various types of 
investments and how they are applied.
    Also important is how well our regulatory and law 
enforcement agencies communicate with each other as individual 
transactions are evaluated. Sovereign wealth funds and foreign 
investment in the U.S. are projected to increase significantly 
in the years ahead. This Committee, as Senator Dodd has 
reminded you, has a responsibility to fully evaluate the 
existing legal structures and processes governing foreign 
investment. Only then can we be sure that we are protecting our 
Nation's security while maintaining an open investment climate.
    This hearing is a good step in that direction, Mr. 
Chairman. I thank you for calling it.
    Chairman Dodd. Thank you very much, Senator Shelby.
    Before I turn to Senator Menendez, let me just mention that 
there is a piece in this morning's Washington Post, ``Justice 
Department sees surge in global crime networks.'' And let me 
just say to my colleagues here, I just mentioned to staff here, 
I think this is an appropriate area for us to want to look 
into. This is the Attorney General talking about this issue, 
and gasoline prices and possibly financial services as well. I 
am not drawing any hard conclusions here, but I would like to 
invite Members of the Committee to think about this and how we 
might as a Committee here examine this issue, some of these 
questions. So I just raise it here and let you know that we are 
going to possibly conduct a series of hearings about this very 
question in terms of the jurisdiction of the Committee.
    With that, Senator Menendez.

              STATEMENT OF SENATOR ROBERT MENENDEZ

    Senator Menendez. Thank you, Mr. Chairman. I appreciate you 
calling this hearing with the Ranking Member.
    When it comes to the growing presence of sovereign wealth 
investment, I think we have more questions than we have 
answers. Sovereign investment is not a new phenomenon, and it 
is not just a phrase, and increasingly the lines are becoming 
more blurred. Instead of an open, clear stake in a company, we 
are talking about pockets of investment, capital in an 
investment bank, a stake in an equity firm, or a merged cross-
border exchange. We are not talking about a single investor but 
a fund that is backed by a foreign government. The impact is 
less clear, but the implications are far more complex. And even 
though we are often talking about a 5-percent stake here or an 
8-percent interest there, these investments add up.
    Now, Mr. Chairman, I have a little difficulty in believing 
that--I find it hard to believe that a foreign government is 
willing to invest billions and have no say. If that is the 
case, then I would like to invite them over personally at the 
end of the day.
    In the last 10 months alone, two-thirds of the equity 
raised for U.S. financial firms, some $39 billion, has been 
from sovereign wealth funds. So it is clear there is a strong 
appetite and a source for foreign capital. We need to make sure 
we know who is providing it and what, if any, motive they have 
beyond a purely financial interest. And given the volatility of 
our market, given that the need for foreign capital will only 
increase, and that sovereign investment could explode in the 
coming years, it is imperative that we ask now exactly who is 
interested in these investments and why.
    So today's hearing is an important chance to hear what is 
being done and where the cracks may be. For instance, are these 
funds trying intentionally to stay below the radar and not 
trigger a review? Do we know enough about what their interests 
may be? Do we know who their investors are? I think these are 
important questions, and if we do not have the answers, I think 
it is a cause for concern.
    The stakes are rather high, and I share the concerns of a 
number of my colleagues that we still do not know enough and 
that we may be falling short of the transparency that we should 
have for these investments. The door has swung wide open to 
sovereign investment. None of us want to close it, but we need 
to make certain checks are in place, and at the very least, we 
need to know a few basic things about who is coming through the 
door and why.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Senator Corker.
    Senator Corker. As usual, I would like to hear from the 
witnesses. Thank you.
    Chairman Dodd. Thank you very much, Senator.
    Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you, Mr. Chairman. I think this is a 
very important hearing.
    Chairman Dodd. Don't let Senator Corker intimidate you. If 
you want to say something, you go ahead.
    [Laughter.]
    Senator Reed. I want to say more than is in my statement, 
but I want to be polite, too. So I will pretend I am giving up 
my time, and then I will go on and on and on.
    No, I think the questions that have been posed by the 
Chairman, the Ranking Member, Senator Menendez, and others have 
really raised the seriousness of the issue and, I think, the 
importance of the debate. So I am looking forward to hearing 
the witnesses. It just strikes me that we have created a 
regulatory scheme based upon the culture of companies, and now 
we have a completely different player that has different 
motivations, different incentives, and has a much longer sort 
of timeframe in terms of seeing the results, whatever they may 
be, financial or otherwise. And I think we have to understand 
that, that the rules that might be working--in fact, there is a 
real question whether they are working well even for private 
entities--might not have all of the facets and all the 
dimensions necessary to fairly deal with this. The issue of 
accountability, the issue of transparency, great slogans, but 
we have to translate that into operational rules and 
procedures. And I think we have to do it seriously, and we have 
to do it, because these funds are a reality in the world 
market. They are not going to go away. In fact, the evidence we 
saw is they are getting bigger.
    One final point is that sometimes I have the impression--
and I think it is shared by a lot of people on the street--that 
we are taking our money at the gas pump, sending it over to 
many countries who now are creating sovereign wealth funds to 
buy our banks. And that might be, you know, a gross 
simplification, but there is a certain, I think, appeal and 
reality to that, and it has huge consequences. So I think we 
have to be serious about this inquiry.
    Thank you.
    Chairman Dodd. Thank you, Senator Reed.
    Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Well, thank you, Mr. Chairman, Ranking 
Member, and the witnesses, and I will apologize in advance. We 
have a markup in Judiciary, and I have a bill up, so I will not 
be able to hear your testimony. But as you know, I have been 
long involved in this issue, starting with Dubai Ports World, 
which was an anomalous situation because we were dealing with a 
key national security issue, and what applied there does not 
apply here necessarily. So I would just like to make a couple 
of points.
    First, Senator Reed talked about oil. We spend money on gas 
and oil, and the price is too high. But ultimately, in part we 
have ourselves to blame. We have not had an energy policy to 
wean ourselves away from oil for a very long time. My view is 
the administration thinks what is good for big oil is good for 
America, and big oil is happy to have the price go up and it is 
happy to be in cahoots with OPEC.
    And, second, in a broader sense, we have for now over a 
decade imported far more than we have exported. We have 
borrowed more than we have saved. We have spent or consumed 
more than we have produced. So there is a shortage of capital 
here, particularly when a crisis hits. We do not have it here 
in America because of these somewhat profligate habits that, 
again, have been allowed to just fester with no one doing 
anything about it. And then when we need capital, we have two 
choices, neither of them very good: get them from places that 
we are not particularly comfortable getting them from, or get 
no capital and have our economy contract and have tens of 
thousands, if not millions, thrown out of jobs.
    So let's face the realities here. It is easy to rail 
against sovereign wealth funds, but the alternative is even 
uglier. So what do we do?
    First, we do have to make sure there are certain--they are 
all not the same. The countries are not the same, and what they 
buy is not the same. You have to look at security. I stand by 
what many of us did--Senator Menendez was very much involved as 
well--with the Dubai Ports World, because dealing with a port 
where somebody could smuggle in a nuclear weapon--and I do not 
think the Government of Abu Dhabi wanted to do it, but who 
knows if somebody could have infiltrated, changed a freight 
manifest, and God forbid.
    On the other hand, there are some countries that seem to 
use their economic wealth for political purposes. A classic 
example is Russia. We have seen Putin do this with Europe. Who 
would want to let Putin or a Russian sovereign wealth fund buy 
an American natural gas company? I sure as heck would not. Some 
are more benign and--or less harmful, and countries in the 
Middle East, countries--Singapore--seem to be investing for 
economic purposes. And that is the one line that we have to 
assure, that the investment is for economic not political 
purposes. And that leads to transparency.
    There are a whole lot of questions such as: Do sovereign 
wealth fund officials report to an independent board of 
directors or directly to the government? Do they disclose their 
investment goals? If those goals change, are those made public? 
Are directors in the investment management team selected on the 
basis of business qualifications, not political affiliation? Is 
there a stringent code of conduct that compels boards of 
directors and management to report attempts by government 
influence of investment decisions?
    Abu Dhabi and Singapore have commendably moved in that 
direction. The IMF is putting out guidelines. But this is 
something we have to be very careful about. If you are doing 
nothing wrong, if your goals are economic, you should not mind 
transparency. And my thrust has been and will continue to be to 
make sure that there is real transparency here so that 
political decisions do not influence economic decisions.
    Mr. Chairman, thank you for having this hearing. I thank 
the witnesses, and I look forward to reviewing the testimony 
and the questions.
    Chairman Dodd. Well, thank you, Senator Schumer. There is 
the old saying that any port in a storm, and the mismanagement 
of our economy over the last number of years, leading to the 
problems of illiquidity have caused in a sense that old saying 
to be the case--any port in a storm, and so institutions 
looking for capital are out there shopping for it and are 
willing to take it in almost any place it is available. And 
that is one of the concerns that has been produced by this 
economy over the last number of years. So the questions raised 
by our colleagues here are very worthwhile ones, and we have 
two very good witnesses here this morning who can share, I 
think, some thoughts about this. There are a lot of questions, 
obviously.
    We will begin with Scott Alvarez, who is the General 
Counsel of the Board of Governors of the Federal Reserve 
System. Mr. Alvarez joined the Federal Reserve Bank in 1981 and 
has been there for 27 years, a distinguished record. He has 
held the position of General Counsel since 2004, serving as the 
chief legal officer. He advises the Board on laws such as the 
Federal Reserve Act, the Bank Holding Company Act, Gramm-Leach-
Bliley. He also assists congressional staff in drafting and 
developing legislation related to domestic and international 
banking issues. So we expect to get to know you rather well, 
Mr. Alvarez, if we have not already, in the coming months.
    Ethiopis Tafara--did I pronounce the first name correctly?
    Mr. Tafara. Absolutely.
    Chairman Dodd. Thank you. He is the Director of the Office 
of International Affairs for the Securities and Exchange 
Commission. Prior to joining the SEC in 1999, Mr. Tafara served 
at the Commodity Futures Trading Commission, known as the CFTC. 
I thank him for his years of Federal service as well. Prior to 
that, he worked for the law firm of Cleary, Gottlieb, Steen & 
Hamilton, currently oversees the SEC's regulatory policy and 
enforcement initiatives on the international front. In addition 
to working with foreign regulatory agencies and organizations, 
Mr. Tafara represents the SEC in the International Organization 
of Securities Commissions.
    Let me ask both of these witnesses to provide us with their 
statements. I would like to ask you to kind of limit your 
remarks to 5 or 6 minutes, if you could. We will accept, of 
course, your full statements and any supporting data you think 
would be worthwhile for the Committee to have. And with that, 
Mr. Alvarez, we will begin with you.

   STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF 
            GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Alvarez. Thank you, Mr. Chairman, Senator Shelby, 
Members of the Committee. I am pleased to be here today. I will 
focus my remarks on a narrow issue: the thresholds that trigger 
review by the Federal Reserve and the other Federal banking 
agencies of investments by sovereign wealth funds in U.S. 
banking organizations.
    As a general matter, investments by sovereign wealth funds 
are subject to the same statutory, regulatory thresholds and 
requirements for review by the Federal banking agencies as 
apply to investments by other domestic and foreign investors in 
U.S. banking organizations. These requirements are established 
primarily in two Federal statutes: the Bank Holding Company Act 
and the Change in Bank Control Act. The Bank Holding Company 
Act requires any company to obtain approval from the Federal 
Reserve before making an investment in a U.S. bank or bank 
holding company if the investment meets any one of three 
statutory thresholds. In particular, Board approval is required 
before a company acquires ownership or control of 25 percent or 
more of any class of voting securities of the bank or bank 
holding company; or acquires control of the election of a 
majority of the board of directors of the bank or bank holding 
company; or acquires the ability to exercise a controlling 
influence over the management or policies of the bank or bank 
holding company.
    In determining whether an investor may exercise a 
controlling influence over the management or policies of a U.S. 
banking organization and thereby trigger formal review of the 
investment, the Board considers the size of the investment, the 
involvement of the investor in the management of the banking 
organization, any business relationships between the investor 
and the banking organization, and other relevant factors.
    The Bank Holding Company Act itself presumes that an 
investor that controls less than 5 percent of the voting shares 
of a U.S. banking organization does not have a controlling 
influence over that organization.
    Chairman Dodd. Mr. Alvarez, would you move that microphone 
a little closer to you, if you don't mind?
    Mr. Alvarez. Sure.
    Chairman Dodd. Thank you very much.
    Mr. Alvarez. Based on its experience, the Board generally 
has not found that a controlling influence exists if the 
investment represents less than 10 percent of the 
organization's voting shares.
    The Bank Holding Company Act sets forth the standards that 
the Board must consider in acting on an application by any 
company, including a sovereign wealth fund, to acquire a U.S. 
bank or bank holding company. Those standards require review of 
the competitive, supervisory, convenience and needs, financial, 
and managerial effects of the transaction. The managerial 
standard includes consideration of the competence, experience, 
and integrity of the investor.
    Upon the acquisition of control of a U.S. banking 
organization, the investing company would, by statute, become 
subject to supervision by the Federal Reserve, including 
examination, reporting and capital requirements, as well as to 
the act's restrictions on the mixing of banking and commerce. 
Importantly, the restrictions of Sections 23A and 23B of the 
Federal Reserve Act, which impose quantitative and qualitative 
limitations on transactions between U.S. banks and their 
affiliates, would also apply. These statutory provisions limit 
transactions between the U.S. bank and any company, including a 
sovereign wealth fund, that controls a U.S. banking 
organization. These restrictions help assure that the U.S. bank 
does not engage in unsafe or unsound practices for the benefit 
of the parent company or its affiliates.
    Investments by sovereign wealth funds that do not trigger 
the prior approval requirements of the Bank Holding Company Act 
may, nevertheless, require review by a Federal banking agency 
under the Change in Bank Control Act. The Change in Bank 
Control Act generally applies to any acquisition of 10 percent 
or more of any class of voting securities of a U.S. banking 
organization where the transaction is not subject to review 
under the Bank Holding Company Act.
    The Change in Bank Control Act also establishes specific 
factors that must be reviewed. These standards focus on the 
competitive effects of the proposal, the managerial competence, 
experience, integrity, and financial strength of the acquirer, 
certain informational requirements, and whether the transaction 
would result in an adverse effect on the deposit insurance 
funds. Unlike the Bank Holding Company Act, the Change in Bank 
Control Act does not impose any activity limitations or any 
ongoing supervisory requirements on the owners of banks.
    The recent investments by sovereign wealth funds in U.S. 
financial institutions have remained below 10 percent, and 
often below 5 percent, of the voting equity of banking 
organizations. Consequently, these investments have not 
triggered the formal review requirements of either the Bank 
Holding Company Act or the Change in Bank Control Act.
    Sovereign wealth funds have been a beneficial source of 
capital for U.S. financial institutions. Over the past several 
months, sovereign wealth funds have provided equity capital to 
U.S. financial firms that accounts for a significant portion of 
the total additional capital raised by these financial 
companies during this recent period of stress. All of these 
investments, as well as similar investments made by U.S. 
private equity firms, have been structured as passive 
investments that do not trigger the thresholds that would 
require formal review by the Federal banking agencies under 
Federal law.
    If a sovereign wealth fund were to make an investment that 
is at a level that meets the statutory thresholds for review, 
the Federal Reserve and the other Federal banking agencies 
would carefully apply the standards established in Federal law 
for reviewing that transaction in the same manner as the 
agencies apply those standards to reviewing transactions by 
other investors.
    Thank you very much, and I would be pleased to answer any 
questions.
    Chairman Dodd. Thank you very, very much, Mr. Alvarez.
    Mr. Tafara, thank you very much for being with us.

STATEMENT OF ETHIOPIS TAFARA, DIRECTOR, OFFICE OF INTERNATIONAL 
          AFFAIRS, SECURITIES AND EXCHANGE COMMISSION

    Mr. Tafara. Chairman Dodd, Senator Shelby, and Members of 
the Committee, thank you for inviting me to speak on behalf of 
the Commission before today's hearing on the regulatory 
framework applicable to foreign government investment in the 
U.S. economy and financial sector.
    Today sovereign wealth funds hold, by some estimates, more 
than $2.5 trillion in assets. Some projections estimate that 
their size will increase fivefold by the middle of the next 
decade. This could quite possibly make these funds, 
collectively and individually, the largest shareholders in many 
of the world's biggest companies.
    Sovereign wealth fund investments in the United States is 
not new. Sovereign wealth funds based on foreign exchange 
reserves have always tended to invest abroad since their 
capital was based on a foreign currency. What is new, however, 
is the size of their investment in the equity markets and their 
concomitant focus away from the bond markets.
    Sovereign wealth fund investment in the U.S. capital market 
offers definite benefits. Foreign investors, including 
sovereign wealth funds, can offer U.S. companies a lower cost 
of capital and a more liquid market for their securities. They 
also raise a number of potential concerns for regulators and 
other market participants. Some of these concerns mirror those 
raised by large hedge funds. By confining the foreign exchange 
reserves resulting from a thousands or millions of 
international transactions, an investment fund can wield 
enormous clout on a market. This creates opportunities for 
market manipulation and, where an entity owns enough shares of 
an issuer to control it, insider trading as well.
    But sovereign wealth funds also raise other issues. Because 
they are owned and managed by Government, the incentives that 
drive fund manager decisions may potentially be very different 
from those associated with a privately managed investment fund. 
This is an issue that Chairman Cox has touched on in the past: 
the concern that sovereign wealth funds, because they are 
national entities, may not necessarily act like ordinary market 
participants and, thus, may have a distorting effect on a 
market.
    Sovereign wealth funds may prefer not to be transparent in 
their motivations or operations. This is particularly true if a 
fund is linked to a nation's foreign exchange reserves. As you 
are aware, exchange rate policies traditionally are closely 
tied to matters relating to national sovereignty, trade policy, 
and the Nation's economy. The point here is that such sovereign 
wealth funds are not just concerned about making a profit. They 
potentially may well be willing to operate at a loss or forego 
a profit if it achieves other national objectives.
    The SEC's mandate is focused on investor protection, 
maintaining fair and orderly markets, and capital formation. 
Consequently, the SEC has in place several disclosure rules 
relevant to investments by sovereign wealth funds that address 
many of the concerns we hear voiced here and in other markets.
    First, the SEC requires that any beneficial owner holding 
10 percent or more of an issuer's securities disclose this 
ownership interest and any changes to this interest.
    Second, the SEC requires beneficial owners of 5 percent or 
more of an issuer's equity securities to disclose this 
ownership, the source and amounts of the funds being used to 
purchase the securities, and their future intentions with 
regard to this ownership interest.
    And, finally, the SEC requires fund managers who exercise 
investment discretion over $100 million or more of SEC-
registered securities to file a quarterly disclosure of the 
fund's holdings in these securities, as well as whether they 
have exercised voting authority over these shares.
    As a complementary matter, the Commission has the power to 
pursue sovereign wealth funds that violate the disclosure and 
anti-fraud provisions of the U.S. securities laws. Neither U.S. 
nor international law shields foreign countries' commercial 
activities in the United States from the jurisdiction of U.S. 
courts. The SEC staff has a strong track record investigating 
cross-border violations of our securities laws, which we do by 
working closely with our foreign counterparts. The issue that 
arises with sovereign wealth funds is the possibility that the 
same government from whom we seek assistance might also be the 
controlling person behind the entity under investigation. This 
would present a considerable conflict of interest and might 
prove challenging.
    I should note that the concerns about sovereign wealth 
funds are not just concerns in the United States. These 
concerns are shared by other jurisdictions. Currently, the 
International Monetary Fund, the OECD, and the European 
Commission are all discussing best practices for sovereign 
wealth funds that in many ways mirror our own disclosure 
requirements. I find these international developments 
comforting because I believe that, at least with regard to the 
disclosures that sovereign wealth funds should make, there 
appears to be widespread consensus that we are on the right 
track. Indeed, I would argue we are ahead of the curve on this. 
In the United States, these disclosures are not voluntary but 
mandatory, at least for any sovereign wealth fund of any size.
    Finally, sovereign wealth funds historically have been 
long-term investors. Many of their recent investments in 
troubled industries follow this trend. Given their size and the 
fact that they are owned by governments, the potential for 
politically driven investments with a concomitant effect on 
financial stability remains. But I believe that if we were to 
prohibit sovereign wealth funds from investing in our market 
for fear they might introduce market distortions, we might 
actually end up doing precisely this ourselves through the 
prohibition. A better approach is to address the underlying 
issues of transparency, independent regulation, depoliticizing 
of investment decisions, and conflicts of interest.
    Thank you for inviting me to appear today, and I would be 
happy to answer any questions.
    Chairman Dodd. That was excellent testimony by both of you, 
and we thank you. You have raised a lot of the very same 
questions you heard raised by the Members up here as well.
    Let me begin, if I can--in fact, Mr. Tafara, at several 
points in your testimony--I am going to quote your testimony 
here, but there were several places--I am reading the quote I 
am going to use here, but there were several other points where 
you sort of said very similar things, and that is about 
governments that control sovereign wealth funds and the 
particular problems raised by that. So I am going to address 
that. Let me quote you. You said, ``Governments that control 
sovereign wealth funds and sovereign businesses, because they 
are governments, can in some cases control certain economic 
events, and . . . governments routinely are privy to certain 
types of information that most private investors are not.'' You 
pose the question: ``What if the fund obtains information 
through its status as a government entity?''
    So let me ask both of you here, can we say with any 
certainty that sovereign wealth funds are operating in U.S. 
markets without access to non-public information? Mr. Tafara, 
you can start out.
    Mr. Tafara. I do not know what we can say with any 
certainty. Certainly, if there is trading activity that is 
taking place on the basis of information that is not available 
to the public generally, it usually results in anomalous 
trading patterns, which would put us in the position as an 
agency to start inquiring as to what is behind that trading and 
to begin to build an investigative record.
    So I cannot say with certainty that it is not happening, 
but I believe there are tools in place that would allow us to 
see that sort of behavior, trading on the basis of information 
that may not be available to the public, and for us to start 
going down the line to see what may be behind that trading.
    Chairman Dodd. Before you respond, Mr. Alvarez, let me add 
the element here, and that is, because I mentioned in my 
opening comments about the various agencies of our Federal 
Government that have pieces of all of this. As I was thinking 
about that last evening, that is encouraging on one level, but 
also knowing how many times there is a lack of communication 
between the various agencies of governments that are blocks 
away from each other inquiring about the same sort of 
conclusions here, to what extent when that occurs are we 
getting information from those governments about that kind of 
information so we are better aware of it, not just from looking 
at the market reactions to it but to what extent do we feel we 
are getting the full cooperation of sovereign governments that 
own these funds about that kind of information? Can you respond 
to that?
    Mr. Tafara. Well, at the SEC, anytime we have an 
investigation that has international elements to it, we 
frequently seek the assistance of a foreign counterpart. Some 
of the information that we may want and need to build that 
investigative record may be located outside the United States. 
And we have in place arrangements that date back 20, 30 years 
that basically amount to a commitment on the part of our 
foreign counterparts who provide us with the information we 
need.
    Now, I think in my testimony I indicated that when you are 
asking assistance of a government who may actually also be the 
subject of the investigation, you worry that there may be some 
recalcitrance on that government's part. But I will say two 
things that I think serve to mitigate this potential problem.
    One, generally if you are doing insider trading, 
manipulation, or some fraud of that sort, you leave a pretty 
large footprint in the United States. So as an agency, we are 
able to actually gather the information we need within the 
United States to build an investigative record.
    But, second, even if the government is associated with the 
entity that is under investigation, for reputational reasons 
they are generally inclined to provide assistance. They do not 
want to have the reputation of being an authority that--in a 
world where markets are global and investigation and 
prosecution is national, they are not willing to be part of a 
chain of a system. That is a reputation they do not want to 
have. And, second, I think they are concerned ultimately that 
if they do not provide assistance, it could have consequences 
for the ability of their companies to do business in the United 
States.
    You know, there are a number of instances--there is 
precedent here in that, for example, in Foreign Corrupt 
Practices Act cases or cases involving companies that are 
considered to be national champions, we have gotten the 
assistance necessary from the foreign governments in those 
cases, which bodes well for the possibility of getting 
assistance if the investigation involves a sovereign wealth 
fund.
    Chairman Dodd. I would feel a lot better about that answer 
if I did not also consider something Mr. Alvarez said that many 
of us, I think, on this Committee are concerned about as well, 
and that is that you see these sovereign funds structure their 
investments in many instances to avoid the thresholds that 
would trigger the kind of investigations that normally occur. 
So you get the sense that people here are doing just the 
opposite, making sure that, in fact, they are not subjected to 
the kind of investigation that would occur. And either under 
the Bank Holding Company Act or the Change in Bank Control Act, 
the case of Citi, for instance, none of the four sovereign 
funds on their own acquired more than 5 percent of ownership. 
In fact, Abu Dhabi Investment Authority came in at 4.9 percent. 
An aggregate, however, of these sovereign funds own 10 percent 
of Citi. So if you apply the law in a very strict sense, 
obviously they were under the 5-percent threshold. But, 
clearly, this was not just coincidental that it ended up being 
4.9. You are not going to convince me of that.
    So, clearly, they were trying to avoid the investigations 
that would normally occur to determine transparency on these 
other issues. So I am sitting here as the Chairman of this 
Committee concerned that, in fact, the very issues raised by 
Senator Menendez, Senator Reed, and others, Senator Bayh when 
he had earlier testimony, that we are being gamed a bit on all 
of this.
    And so, Mr. Alvarez, are you satisfied, are both of you 
satisfied, would you recommend to this Committee that we need 
more statutory authority, or if you do, that treaties are 
inadequate, we are going back to 1975 in some cases, the world 
has changed dramatically, as you point out? And, Mr. Tafara, 
you are going to maybe have three times the number of foreign 
investment funds moving around the world today. Do we need more 
authority here to better control--not to discourage, because I 
agree with you, I think if you discourage, you can also affect 
market outcomes here, but to have a better sense of balance 
between inviting these investment funds in and providing the 
kind of economic security we are looking for. Do we need more 
authority? Do you need more authority?
    Mr. Alvarez. Well, I would point out that sovereign wealth 
funds are not the only investors that structure their 
transactions in ways to take advantage of the thresholds in 
statutes. U.S. private equity funds do the same. Large 
investors do the same. And there may be a benefit to that in 
that we are bringing capital into organizations, into the 
financial organizations, without--because these are structured 
investment--without any incidence of control. They are agreeing 
to be passive investors to let their money be used by the 
current management and organization for its purposes. That I 
think is helpful and a protection.
    I think it is also helpful when you see a number of 
investors coming at the same time on relatively the same terms 
at the invitation of the target organization. That suggests 
less worry about manipulation in stock prices, less 
manipulation of the market, less likely to be trading on inside 
information. Everyone is being treated on the same terms and 
not getting special deals.
    There is quite a lot of cooperation among the banking 
agencies and the SEC in this regard, and I think we all have 
the same concerns, and we share information and we share 
concerns and work together on that. So that has also been very 
helpful. And we have been establishing at the Federal Reserve--
and I know the SEC has as well--good relationships with the 
foreign supervisors to try our best to understand their 
motives, to understand their regulatory scheme, and how they 
approach these kinds of investments.
    So we are all trying to be sensitive to these concerns. At 
this stage, I do not think we at the Federal Reserve see a 
reason to change the law yet. But we are watching carefully. We 
want to see how this will develop, and we certainly will come 
to you if we see any trouble.
    Chairman Dodd. Well, before turning to Senator Shelby, let 
me thank you for that, and we want to keep you posted on it. We 
want you to know as well that we invited the Treasury 
Department to be here this morning, and they declined to have a 
witness be here this morning, despite a very important role in 
all of this as well. And we are going to pursue the Treasury 
Department to respond as well to these questions. But I was 
disappointed that Treasury decided not to participate in 
today's hearing.
    Senator Shelby.
    Senator Shelby. Mr. Chairman, I think you should pursue, 
this Committee should pursue Treasury, because Treasury is very 
involved, as we all know, in the CFIUS and chairs the CFIUS 
Committee. We cannot let them not be present at the table when 
we are doing this. You are absolutely right.
    Senator Bayh. Mr. Chairman, they also refused to come to 
our Subcommittee hearing on this topic as well previously. 
Senator, I apologize for interrupting.
    Senator Shelby. That is OK.
    Senator Bayh. But for some reason, Treasury just refuses to 
be heard on this issue.
    Senator Shelby. Well, Mr. Chairman, you know the rules of 
the Committee. We can get them up here, and I think that I 
agree with Senator Bayh. We should not put up with that.
    Chairman Dodd. As I tell my 6-year-old, we can do it the 
easy way or the hard way.
    [Laughter.]
    Senator Shelby. I think we need to tell the Secretary of 
the Treasury that, and the Deputy Secretary, and I appreciate 
that. I agree. The easy way or the hard way, but, Mr. Chairman, 
I think you are absolutely right having these hearings. They 
are very much needed, and I hope you will continue.
    I want to pick up, if I can, on what Senator Dodd was 
talking to you about. When we passed this legislation, the Bank 
Holding Company Act, I do not know that it was contemplated by 
the Congress, and maybe by the Fed, that we would be dealing 
with such investors, like sovereign wealth, on the magnitude 
that we see today, which will be much larger in 10 years, 20 
years. And I hope that we will not and the Fed will not be 
behind the curve. Senator Dodd is absolutely right. He is 
asking you, as you know--and you are a very able attorney--do 
you need legislation. This Committee, we are going to very 
rigorously examine all these issues. But you need to be ahead 
of the curve rather than behind it. Nobody knows it better than 
you do.
    I am concerned, as Senator Dodd was, and others, let's say 
you have 10 sovereign wealth funds. There are many more, but--
and they want to buy--and we will just use Citicorp since it 
has been brought up. And they all want to buy 4.9 percent of 
Citicorp. Well, they might be different countries. They might 
be this and that, but they can act like we do as investors and 
do a lot of stuff.
    Is there anything to stop that? I do not see anything to 
stop it.
    Mr. Alvarez. That is a very good question, and both the 
Bank Holding Company Act and the Change in Bank Control Act 
allow us to look to whether folks are acting together. The Bank 
Holding Company Act----
    Senator Shelby. Let's say they are not acting together when 
they buy, but they act together as we put sort of--I mean, we 
put deals together once we are there. We all do it. It happens 
today in the board.
    Mr. Alvarez. Sure, and that is a more difficult problem to 
deal with. Once the investors have already----
    Senator Shelby. Once they are in the house, as Senator 
Menendez--they are knocking on the door. Once we let them in 
the door and they are there and enough of them are there, they 
are basically in control, aren't they? And they have enough of 
it, sure, they are.
    Mr. Alvarez. The one protection that we have there--so we 
have that same problem, not just with sovereign wealth funds, 
but with private equity funds in the United States. They often 
have their own agendas as well when they acquire a----
    Senator Shelby. Well, you are not a naive man. Now, you 
know they are going to have their own agenda. It is just not 
brand investment. I mean, sure, they want a return on their 
investment. But why would three or four large sovereign wealth 
funds invest in one or two or three of our largest banks, 
financial institutions, or other strategic things? They will 
control it, wouldn't they?
    Mr. Alvarez. Well, the----
    Senator Shelby. Sure, they would. You know they would 
control it.
    Mr. Alvarez. Well, it depends on the mechanisms and the 
relationships they have with the organization. So, for example, 
I think we would look differently at an investor who bought 
shares and then had no other relationship. We would look at 
them differently than an investor who buys shares and has 
director representation on the board of directors, has strong 
business relationships with the organization, has agreements 
about seeking approval before the organization can merge or 
make an acquisition or take various actions. And we have seen 
in the private investment world all those kinds of 
arrangements, and we look at those carefully.
    The one thing we have in our favor in the banking world 
that may be different from the rest of the world is that 
Congress has given the banking agencies authority to issue 
cease and desist orders and take other action to make sure that 
the banking organization is operated in a safe and sound 
manner. And so it is not as it might be in buying a car company 
where once an investor is in, they can do whatever they want 
and there is not any supervision. In the banking area, the 
banking agencies can examine the holding company and the bank. 
They can prevent unsafe and unsound actions from taking place. 
They can require business plans to be approved, things like 
that. We have some----
    Senator Shelby. I understand that. But they cannot stop 
them from making policy as long as that is a legitimate policy 
that might not be in the real interest of America.
    Mr. Alvarez. If they want to exercise control over the 
bank, we can stop that. They cannot--an investor cannot----
    Senator Shelby. Maybe not control. Influence. What about 
influence? If four of us had 20 percent or 19 percent or 
Citicorp, you do not think that is basic control or influence?
    Mr. Alvarez. I do not disagree with you that there is 
certainly controlling influence at certain levels, and that is 
what we have to look for, and that is the statutory standard. 
If an investor has a controlling influence, then they--before 
they have a controlling influence--they must get the Federal 
Reserve's approval. They cannot exercise--even after they have 
bought the shares--they cannot then exercise a controlling 
influence without approval.
    Now, you are exactly right, there is a gray area there. 
What is controlling influence? And that can differ from person 
to person.
    Senator Shelby. Then how do we address that? Do we need to 
address that gray area statutorily? Or does it need to be done 
through the regulator? Which you are the regulator. Or what? 
Because everybody here knows, or knows in the world, that there 
is going to be probably $10, maybe $15 trillion worth of 
sovereign wealth, and where do people want to invest it? In the 
United States of America and in Europe. I mean, that is a 
given. And with an investment of that magnitude, or let's say 
half that magnitude, it is going to change this country from 
everything we know today. Isn't it? It could change foreign 
policy. It could change a lot of things. Could it?
    Mr. Alvarez. It could, yes.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator Shelby.
    Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
I want to follow on the line of questioning that Senator Shelby 
raised. I think it is very important. But just to drill down a 
bit, when you look at one of these proposed transactions, the 
red line is 4.9 percent, so if they are 4.9 percent, below that 
then you have to look at the nature of the deal. Would you be 
looking at the transaction and, for example, if they had a put 
at any time they wanted, would that be something that you would 
say might be used and, therefore, would disqualify the 
transaction? How deeply do you go into the structure of the 
transaction, not just the ownership level?
    Mr. Alvarez. We look at all aspects of the investment. So, 
for example, we would look at convertible shares or warrants or 
the right to impose restrictions on management through a 
contract. We look at debt relationships, normal business 
relationships, attempts to fund affiliates. We look at the 
entire arrangement that they have in mind.
    Senator Reed. And you continue that observation on a 
periodic basis for sovereign wealth funds?
    Mr. Alvarez. Yes, sir.
    Senator Reed. With particular emphasis on sovereign wealth 
funds?
    Mr. Alvarez. No. For all minority investors, and the 
threshold for us is really--we look at those investments if 
they are 24.9 percent or less. Above 25 percent, there is 
statutory control.
    Senator Reed. Now, if they trigger a change in control or 
aspects of the Bank Holding Company Act, the requirement then 
would be to--and you can take me through this. They would then 
register as a Bank Holding Company?
    Mr. Alvarez. Right. So if they are in control----
    Senator Reed. Would that be the sovereign wealth fund or 
the Nation of Dubai?
    Mr. Alvarez. It would be the sovereign wealth fund. The 
sovereign wealth fund would become a bank holding company. It 
would be subject to examination, to capital requirements, to 
all the full authority of the Federal Reserve, subject to 
restrictions on mixing banking and commerce.
    Senator Reed. Now, are you prepared organizationally, 
staff-wise, to do this? I raise that question because I do not 
want to--this is a very important issue, but it is something 
like, you know, the dog chasing the bus. You catch it and what 
do you do with it? And that sometimes inhibits the tough call, 
a close call, like, well, they really do have control, but if 
we tell them they are a bank holding company, you know, that 
sets off--and it goes along the line, I think, of Senator 
Shelby's question. Do we have the legislative framework, the 
clear authority, do we have the institutional capacity to go 
and tell a sovereign wealth fund we want you to report 
everything you are doing and we do not want you to invest in 
commercial activities?
    Mr. Alvarez. I think we would have the institutional 
capacity to deal with that if it were to come up. But the 
sovereign wealth funds have tremendous incentives not to have 
that occur. They do not want to have the restrictions on mixing 
banking and commerce, for example. A sovereignty would not want 
to have to be subject to the capital rules of the United States 
in their actions or the cease and desist authority of the 
Federal Reserve or examination authority. And as a result, they 
really do try, the sovereign wealth funds, perhaps more so than 
other private equity funds, to be passive and to provide their 
funds without strings attached.
    Senator Reed. Let me raise another question for both you 
and Mr. Tafara. Senator Schumer made comments that I were very 
interesting about, you know, there are some sovereign wealth 
funds that are models of decorum and transportation, and there 
are others which are highly suspicious. Would you have the 
authority to ban a sovereign wealth fund based upon your 
determination that there is no transparency, no accountability, 
in fact, criminality? There is an interesting story in Business 
Week about Russian police authorities who basically took down 
or tried to take down through fraud an American fund, Hermitage 
Capital Management. But would you have that authority?
    Mr. Alvarez. Both the Bank Holding Company Act and the 
Change in Bank Control Act have provisions that allow us to 
deny the approval if we do not get information that we think is 
required.
    Senator Reed. Well, if there is--if you discern a pattern 
of--I guess the pattern would be illegality or you just do not 
feel that this fund is responsible, in fact, it clearly engaged 
in other areas of inappropriate activity, do you have the 
authority to say, no, you cannot invest?
    Mr. Alvarez. We have the authority to say they cannot 
control, because we are empowered to look at the experience, 
integrity, and competence of the investor. So we do have the 
authority if they wanted to breach one of the control 
thresholds based on----
    Senator Reed. But only if they are at that threshold of 5 
percent.
    Mr. Alvarez. Threshold of 24.9, or they are exercising a 
controlling influence----
    Chairman Dodd. Anything less than that, you would not have 
any authority.
    Mr. Alvarez. No, less than that, we do not have authority. 
That is correct.
    Senator Reed. Let me shift to Mr. Tafara from the SEC. From 
an investment now--not a financial institution, but a publicly 
held company in the United States, would you have the authority 
to say because of the pattern of behavior of this sovereign 
wealth fund that you are aware of, or the lack of cooperation, 
you could say no, you cannot invest?
    Mr. Tafara. We, in essence, administer a disclosure-based 
regime, so----
    Chairman Dodd. Would you raise that microphone a little?
    Mr. Tafara. I am sorry. We administer, in essence, what is 
a disclosure-based regime. So we could take action for failure 
to comply with those disclosure requirements. So we----
    Senator Reed. You could not peremptorily deny them?
    Mr. Tafara. No.
    Senator Reed. OK. Just a final, if I may, and this might be 
something you can provide later. We have been talking in the 
context of a direct investment into a publicly held company or 
a financial institution. To what extent do we know--and maybe 
we do not know--that sovereign wealth funds are using 
intermediaries, like hedge funds and private equity funds where 
they are lending tremendous amounts of money to them, and these 
funds are making the investments? Would that trip any of your--
would that lead you back to the sovereign wealth fund, at least 
knowing that they are behind the investment? Do you have any 
mechanism to do that? Yes or no.
    Mr. Tafara. Under the securities laws, if you trigger the 
thresholds, if you have 5 percent or more, part of the 
disclosure involves disclosure of beneficial owners. So----
    Senator Reed. But if you are not an owner, you are a 
lender. Do you miss that?
    Mr. Tafara. You also have to indicate the sources of your 
funds in that acquisition as well.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator. I apologize, just on 
that threshold question, I----
    Senator Reed. No, no.
    Chairman Dodd. Senator Corker.
    Senator Corker. Mr. Chairman, thank you. I think this, 
again, has been a great hearing, and thank you, witnesses, for 
your testimony.
    I am still unclear about your ability to request disclosure 
from sovereign wealth funds. There seems to be a distinction 
between requiring a corporation that is owned by a sovereign 
wealth fund and based in another country, them making 
investments here, versus just a direct investment by a 
sovereign wealth fund. And it seems to me that that has been a 
hazy area that, to some degree has been danced around a little 
bit. Mr. Tafara, there is no question that a direct investment 
by a sovereign wealth fund, you all absolutely have the ability 
to require disclosure.
    Mr. Tafara. To the extent we are talking about an 
acquisition into a U.S. public company, it is your being the 
acquirer, the investor, that triggers the disclosure. The form 
of the entity that is actually making the acquisition is of no 
relevance, so--by the way, these rules apply to anybody 
acquiring a U.S. public company, any entity acquiring----
    Senator Corker. Of any kind?
    Mr. Tafara. Of any kind.
    Senator Corker. And to both of you, what is the--they 
disclose--if you find that, in fact, thresholds have been 
broken that they have not, in fact, disclosed, what is the 
actual recourse that we have against entities that do that?
    Mr. Tafara. On our side, the Securities and Exchange 
Commission, we would potentially bring an action for failure to 
comply with the disclosure requirements of the Federal 
securities laws. The remedies----
    Senator Corker. And what would that----
    Mr. Tafara. And the remedies available to us are those that 
are available to us in any enforcement action that we bring as 
an agency. It would depend on the facts and circumstances of 
the case, but it could be a fine, a cease and desist order. We 
have a whole panoply of remedies that are available to us as an 
enforcement agency which we could bring to bear should they 
have failed to comply with the requirements of the law.
    Mr. Alvarez. In the banking area, recall that they need 
approval prior to buying control of the banking organization. 
If a sovereign wealth fund or anyone else were to acquire 
control of a bank without approval, then we could require 
divestiture of the shares; we could fine the organization, the 
acquirer; we could prevent their acquisition of other 
organizations in the United States.
    Senator Corker. I think the questions raised today have 
been very important, and, fortunately, most Members of Congress 
have not rhetorically used the fact that investments are taking 
place here to our detriment. But this is back to a serious 
issue, and I think as Chairman Dodd mentioned, there has to be 
a balance that is put in place.
    Do either of you see--I know some regulations came out on 
Monday that have been mostly well received. Do either of you 
see additional legislation of any type necessary in light of 
the very obvious and good questions that have been asked by 
other Members here today?
    Mr. Alvarez. We do not at this stage, though we are looking 
very carefully at the issues, and I think we support also the 
initiatives that the OECD and the IMF have started, which would 
increase transparency, improve governance at sovereign wealth 
funds, and we think those are positive steps. We would like to 
see how that develops as well. But then if in looking at those 
steps and our experience in the last year or so causes us to 
need more legislation, we certainly will come to you quickly.
    Mr. Tafara. And my answer would be identical to the one 
that Mr. Alvarez has given. I think this is an area that has 
raised our interest as well, and we are giving careful 
consideration to whether or not there is anything additional we 
need in terms of authority to address it.
    At this stage, I cannot say that that is the case. There is 
a fair amount of transparency that is required under the 
Federal securities laws by any investor, including sovereign 
wealth funds. But given the size of these investors and the 
nature of these investors, we are certainly giving some thought 
as to whether or not we need additional authority.
    Senator Corker. Let me just ask one final question. 
Obviously, there have been concerns about foreign governments 
having other concerns other than just direct return on 
investment, which they do. There have been concerns, other 
types of concerns that have been raised here today.
    What concerns that have not been raised by Members here are 
some of the ones that as you think about new regulations, as 
you think about other activities that ought to be taking place 
as it relates to sovereign wealth funds, what other concerns do 
you or your staffs have as it relates to huge growth in 
sovereign wealth investment here in our country?
    Mr. Tafara. I have, I think, in my testimony articulated 
the one additional concern that I have, and that is the fact 
that frequently investigation and prosecution of wrongdoing 
involving foreign entities requires the assistance of a foreign 
counterpart, and some concern that there may be some 
recalcitrance on the part of the foreign counterpart to provide 
assistance when the target is actually its government.
    Now, history has demonstrated that that has not been a 
complete impediment. We have been able to overcome that 
recalcitrance because we see it in connection with other 
investigations involving Foreign Corrupt Practices Act cases, 
involving companies that are viewed as national champions that 
potentially have fallen afoul of U.S. law. And we have gotten 
the assistance in those circumstances, so I am inclined to 
believe that we will get the assistance in connection with the 
sovereign wealth fund.
    But it is something that, in the back of my mind, is a 
potential concern which I am thinking about to determine 
whether or not there is anything additional we need to do in my 
office or as an agency.
    Mr. Alvarez. Yes, and I think the concerns that we focus on 
are actually the ones Senator Shelby focused on, what a 
controlling influence is, and what to do in that gray area, how 
to assess investments there.
    I think we also have some concern that there not be an 
overreaction. Sovereign wealth funds investments have been a 
source of useful capital to organizations in a passive way so 
far. And so far, the funds appear to have been helpful and not 
hurtful. We want to be vigilant going forward, but not 
overreact to concerns yet.
    Senator Corker. Mr. Chairman, thank you. I do think that on 
the one hand we have been very fortunate to have liquidity 
available to us at a time when it was much needed. I think some 
of the other comments, you know, talking about our own policies 
leading to much of the need today for this investment is 
something not to take lightly. I know all of us are concerned 
and I hope this is a time of us growing stronger. Obviously, 
this liquidity, along with the tremendous mark-to-market issues 
that are taking place, hopefully will make us stronger, if you 
will, in the financial markets when this particular turmoil 
goes by.
    I hope this is not the time, on the other hand, of the 
shrinking giant because of other policies that are in place. 
And I know you will continue to examine those, and thank you 
for this hearing.
    Chairman Dodd. It is one thing to welcome sovereign wealth 
funds. It is another thing to beg for them. And the whole 
nature of whether or not I am welcoming those investments to 
come in the country or whether, because any port in a storm, 
that you are begging for them, then that equation can change 
dramatically.
    And I want to turn to Senator Bayh right now, but one of 
the things that occurs to me in response to Senator Corker's 
question, one that I asked, and Senator Reed and Senator Shelby 
have raised as well, about whether or not you think we need any 
more authority. I think the question ought to go, not just a 
question of whether or not the existing laws, but to the extent 
there is coordination.
    One of the things we did with the CFIUS legislation, as you 
will recall, was to strengthen the coordination on national 
security issues and the issue of our economic security issues, 
whether or not we need something like that.
    So it is not necessarily new laws, but requiring that there 
be better communication between the various agencies of the 
Federal Government, so that we have a better understanding of 
what is occurring when these matters arise. You are looking at 
it from a Federal Reserve perspective. You are looking at it 
from the SEC. Someone else is from Treasury and Commerce. And 
whether or not we are looking at it in a holistic way, as to 
what this means, may be something I would like to explore with 
you.
    Let me turn to Senator Bayh.
    Senator Bayh. Thank you, Mr. Chairman, and thank you for 
having this hearing today. And gentlemen, thank you.
    I apologize for not being here for your opening statements. 
We had a meeting of the Armed Services Committee on a top 
secret matter, and it was at the same time. So I am trying to 
be two places at once, and it is just always a struggle. But I 
am very interested in this topic and I am grateful for your 
presence here today.
    I wish, Mr. Chairman, that Treasury had joined them today. 
Hopefully, the hard way or the easy way, that will happen at a 
future time.
    My own thoughts on this reflect many of the others you have 
heard here today at a time when we are running tremendous 
imbalances. Our current account imbalance, particularly in the 
energy area, we have to find a way to recycle this capital. And 
it is good for our country to have it reinvested here. It 
improves productivity growth, helps to create jobs, strengthens 
our economy. There are many, many upsides. We want to be a good 
place for capital investment.
    At the same time, I think we would be naive if we did not 
appreciate the fact that governments are just sometimes 
different than private investors. And Mr. Chairman, I am struck 
by the irony of the fact that literally, in the two chairs you 
gentlemen are occupying today, seven or 8 years ago Alan 
Greenspan sat there and Secretary of Treasury O'Neill, back 
when they were willing to appear before the Committee, sat 
there. And both of them said that we should never allow our own 
government to invest in private equities because the risk of 
political interference was too great.
    And so we are now entertaining the question of whether we 
are more afraid of our own government investing and meddling in 
our affairs than we are other governments investing in our 
country and possibly having political agendas other than just 
purely profit maximization.
    So that is kind of the nub of the argument here. We want 
the capital. There are a lot of advantages. But how do we 
protect ourselves against the potential, whether our own 
government or another, has yet not realized but the potential 
of another agenda, political interference, non-economic 
motives, those kinds of things.
    And Russia has been mentioned, their thuggish behavior with 
regard to some of their neighbors certainly raises red flags. 
China, I understand the fellow who is running their sovereign 
wealth fund is a good person, he is saying all the right 
things, interested in maximizing profits, making good 
investments and that sort of thing. But the recent 
controversies regarding Tibet, for example, do raise the real 
prospect that occasionally the highest authorities in China 
have other agenda and perhaps other values that do not 
correspond with our own. And they have shown a willingness to 
pursue those agendas and values even in the face of global 
condemnation.
    As I said, we would be naive if we did not at least 
consider those possibilities.
    So, having said all of that, Mr. Alvarez, I would like to 
start with you and the banking sector. One of the things we are 
dealing with in this whole financial crisis we are currently 
trying to work our way through, and I think the Fed is, of 
course, actively involved in this is that a great deal of 
lending in our country, a great deal of banking activity over 
the last 15 to 20 years has been undertaken in what is now 
called the sort of shadow banking system or an alternative 
banking system.
    Do you have regulatory powers oversight over those 
entities? Or is it just pure banks?
    Mr. Alvarez. No, we have authority over banks and companies 
that own banks. So the lenders that are not affiliated with a 
bank are not themselves a bank.
    Senator Bayh. So the folks we have opened the discount 
window to, you have regulatory authority over them?
    Mr. Alvarez. We have opened the discount window to banks. 
That has always been the case. But we have recently opened the 
discount windows----
    Senator Bayh. I am talking about investment banks.
    Mr. Alvarez [continuing]. To primary dealers, a subclass of 
investment banks that we deal with in dealing with monetary 
policy.
    Senator Bayh. Well, these----
    Mr. Alvarez. We do not have regulatory authority over them 
by statute.
    Senator Bayh. So a 5 percent investment in one of those is 
not subject to the regulatory structure that you have outlined 
for us here today?
    Mr. Alvarez. That is correct.
    Senator Bayh. Well, this seems to me to be potentially a 
significant--I do not know if I would call it a loophole. But 
if, in fact, banking-like activity is taking place in that area 
of the economy, but your regulatory structure only applies to 
traditional banks not these new bank-like entities, is that not 
an area that we should look at possibly extending this regime 
to?
    Mr. Alvarez. Well, that certainly has a lot of 
ramifications beyond sovereign wealth funds and that is 
something we are thinking very deeply about and in consultation 
with the SEC about, because the SEC has regulatory authority 
over those primary dealers.
    So that is part of a larger program and we certainly will 
be talking to this committee about that.
    Senator Bayh. Mr. Tafara, is that----
    Mr. Tafara. That is correct.
    Senator Bayh. I understood your testimony, in response to 
very good questions from Senator Reed, to be that if an 
intermediary, a sovereign wealth fund invests in a financial 
intermediary of some kind, an investment fund of some kind, and 
that investment fund acquires more than a 5 percent stake in a 
publicly held entity, that they have to report, disclose their 
beneficial owners and also their sources of capital. Was that a 
correct understanding of your testimony?
    Mr. Tafara. Yes.
    Senator Bayh. Which leads me to the point, and I think Mr. 
Alvarez perhaps--or perhaps both of you were getting to this. 
You had both acknowledged that is control the correct notion 
for us to focus on here? It is certainly possible to exercise 
considerable influence, short of official benchmarks of 
control. In fact, that takes place in our own economy all the 
time.
    Mr. Alvarez. In the banking world, of course we straddle 
those terms. Controlling influence is what the statute looks 
for, so it is more than a simple influence but it is something 
that has--and it is less than absolute control. It is a gray 
area that is sometimes difficult to navigate.
    But if an investor has a controlling influence, they are 
subject to----
    Senator Bayh. Well, I do not want to get too semantic about 
it here, and again it is very difficult to define. And it does 
take place in our own economy. And I see my time is up, so 
maybe I will wait for a second round.
    But if, in fact, the investor can pick up the phone and 
have a material impact--maybe that is a better way to phrase 
it--on the decisionmaking of the entity to which they have lent 
money or invested, is that not the point that we are driving at 
here, as opposed to some arbitrary definition of control?
    Mr. Alvarez. The ability to do that is certainly one of the 
things we look for in any investor and making an investment in 
a banking organization. Are they going to be able to----
    Senator Bayh. So even short of 5 percent you look at that 
kind of thing?
    Mr. Alvarez. Under 5 percent, the statute presumes you do 
not have controlling influence. That is by law.
    Senator Bayh. I have exceeded my time, so I will let the 
Chairman get on with it. But my point is----
    Chairman Dodd. There are very few of us here. We do not 
have to--I am not trying to be rigid. Senator Shelby has some 
questions.
    Senator Bayh. My point is that what we are after, if there 
are sovereign entities that can have a material impact in the 
decisionmaking of our financial sector, then it seems to me 
what we are after. And it is possible to have that kind of 
material influence somewhat short of just an arbitrary 5 
percent standard. I mean, at a moment of financial crisis, 
these are growing entities, we want the capital, and it is a 
good thing that they have stepped in at this moment of 
instability to stabilize our financial market. That is a good 
thing.
    But it seems to me if that is one of the greatest sources 
of capital in the globe today, that even if you are short of 5 
percent, you are going to take that phone call, of course. And 
that person's opinion, although--they may not even have a seat 
on the board. But you are going to listen pretty carefully to 
what they have to say if you know that when the going gets 
tough this is one of the people you can turn to for additional 
capital, they are going to have some impact on your 
decisionmaking, in all likelihood, it seems to me.
    So that is how to--I know what the statute says. What we 
are asking for, we are grappling with this. We have not reached 
any conclusions. Neither have you. But it seems to me that 
something short of this arbitrary 5 percent standard, we may 
need to look for a different definition to try to handle this. 
That is the point I wanted to make.
    Mr. Alvarez. Fair point.
    Senator Bayh. Thank you, Mr. Chairman.
    Senator Shelby. Mr. Chairman.
    Chairman Dodd. Yes, in fact, this is a line of questioning 
that Senator Shelby had.
    Jack Reed has a very good question that he wants to----
    Senator Shelby. Go ahead.
    Chairman Dodd. No, go ahead.
    Senator Shelby. I defer to Senator Reed.
    Chairman Dodd. The 24 percent and the 4 percent, I want you 
to clear this up, too. Jack raised the question.
    Senator Reed. Mr. Alvarez, there are two thresholds. Could 
you just amplify the consequences of the thresholds, first the 
5 percent threshold and then the 25 percent threshold?
    Mr. Alvarez. Sure. There are a lot of different numbers 
here and different things happen at different levels, and there 
is a 5 percent threshold that the SEC worries about, which is 
different than ours.
    So there are two thresholds to worry about on numbers, 25 
percent, if you own more than 25 percent of the shares of a 
bank, you become a bank holding company, no ifs, ands, or buts 
about it.
    If you buy more than 10 percent, then you are subject to 
review under the Change in Bank Control Act. Again, that is in 
the regulations.
    There is a 5 percent threshold in the Bank Holding Company 
Act that says if you own less than 5 percent, you are presumed 
not to have a controlling influence.
    Senator Reed. Unless you have some type of arrangement 
beyond your ownership that would give you----
    Mr. Alvarez. You are presumed by law not to have a 
controlling influence unless the Federal Reserve Board, by a 
preponderance of evidence, can overcome that presumption. That 
presumption is just below 5 percent. Between 5 percent and 25 
percent, the Board could find you have a controlling influence, 
and you look at all the facts and circumstances. And we, in 
fact, have regulatory presumptions that under certain 
circumstances, you are in control. So the presumption switches 
the other way when you go above 5 percent.
    Senator Reed. If I can just follow up, and I do not want 
to--because my colleagues have questions, also.
    Are you saying, though, these transactions are specifically 
structured at 4.9 percent. So the burden of proof is on the 
Federal Reserve to say that there is something else going on 
out there that is not represented by the stock ownership?
    Mr. Alvarez. Correct.
    Senator Reed. And that is a fairly high burden of proof?
    Mr. Alvarez. That is absolutely right.
    Senator Reed. And in your review you told, you said you 
look at all the different instruments, do they have puts? Do 
they have special consultative arrangements, et cetera. But if 
you challenged this ownership and went to court or tried some 
court action, you would have a significant burden to prove if 
they stay at 4.9 percent?
    Mr. Alvarez. Yes, sir.
    Senator Reed. I think what that does, that implicates some 
of the issues that both the Chairman and Senator Bayh and 
Senator Shelby have raised, which is in this safe harbor of 
less than 5 percent, your instincts might say they have this 
influence and it could be problematic. But we really do not 
have the kind of legal authority to go in and second guess the 
investment. Is that fair?
    Mr. Alvarez. That is correct. I would add just two small 
points. One is we have not seen that so far. There has not been 
any under 5 percent investment we have been particularly 
worried about. And second, this rule applies to everyone, not 
just sovereign wealth funds. So other private investors are in 
the same position.
    Senator Reed. Thank you.
    Chairman Dodd. I just wanted to now turn to Senator Shelby. 
I asked my staff, and I have submitted a copy to my two 
colleagues to look at this. This is in my hand, the form 
required if you have more than 5 percent interest. There are 12 
questions. Are you familiar with this?
    Mr. Alvarez. Which form is it?
    Chairman Dodd. The 5 percent or less, excuse me. This is 
the--I do not know what--this is specifically----
    Mr. Alvarez. This is a Federal Reserve form?
    Chairman Dodd. It is the SEC form, excuse me. And it is a--
I filled out a form this morning for my 3-year-old to go to 
preschool over here. Believe me, I answered a lot more 
questions than this one here requires about it. And I am just 
sort of stunned. In terms of to determine whether or not 
abiding by SEC standards, it is a rather simplistic set of 
questions.
    I just wondered if you have any response to this at all. I 
am not trying to point a finger at you specifically, but it 
just seems to me at a time when we talk about an issue of this 
magnitude that we would have a questionnaire with some very 
simple responses, and that is all we get out of it.
    You are familiar with this, obviously?
    Mr. Tafara. Not intimately, but certainly there are--there 
is basic information that is sought once you have got 5 percent 
or more because that is viewed as having enough influence 
over--potentially having enough influence over a company that 
information about you should be made available to the public.
    In essence, what we get is we get the name and other 
identifying information about the beneficial owners of the 
shares, the sources and the amounts of the funds and other 
consideration used to purchase the securities, the purpose for 
which you are acquiring control, any plans or proposals you 
have with regards to future action, the number of shares 
beneficially owned, and any other shares that the purchaser has 
the right to acquire similar to the inquiry that is conducted 
by the Fed, and information about any contracts or other 
arrangements with regard to any securities of the issuer.
    That is four or five items or six items but pretty 
important piece of information that, if public, give you a 
sense of what that investor could be up to in connection with a 
particular company.
    So I am not sure that the simplicity of the form should 
necessarily indicate that there is inadequacy there. But 
certainly, if there are more things that people think we should 
be asking in this context, that is something we are prepared 
to----
    Chairman Dodd. One of the questions that has been raised by 
our colleagues here, about given the world we live in today and 
the potential influence that can exist, it seems to me there 
may be a bit more information we would want to know before 
making a determination that just--if you are at that 4.9 
percent, it seems to me there may be a bit more we would want 
to know to determine whether or not we are abiding, in effect, 
by the spirit if not the letter of the law when it comes to the 
kind of controlling influence, the language of controlling 
influence that could be important.
    Anyway, let me turn to Senator Shelby.
    Senator Shelby. Mr. Alvarez, what is roughly the market 
capitalization of your top 10 banks that you regulate, just 
roughly, all together today or in the last month? What is their 
capitalization? In other words, what are they worth together on 
the market, just roughly?
    Mr. Alvarez. I could not tell you the market 
capitalization. The assets, though----
    Senator Shelby. No, we are talking about their stock.
    Mr. Alvarez [continuing]. Something on the order of maybe a 
trillion dollars.
    Senator Shelby. What is their stock worth? What is their 
market capital?
    Mr. Alvarez. I do not know.
    Senator Shelby. It would not be a trillion dollars, would 
it, the 10 top banks?
    Mr. Alvarez. I am not certain. I would have to----
    Senator Shelby. Can you get that for the record?
    Mr. Alvarez. I can certainly get that for you.
    Senator Shelby. If these sovereign wealth funds are going 
to grow, as some people predict, to $15 trillion they are going 
to have the money as we export our wealth, buying oil and 
buying goods and so forth, to these countries who are looking 
for places to invest. You can see that we are just scratching 
the surface now on what is going to flow toward us and also 
toward Europe.
    And your challenge is going to be a lot greater than 
probably maybe you do think you are going to have. But I worry 
about it. We better worry about it. This panel is serious about 
it.
    I do not know the answer to it because we do not generate 
enough savings in this country. We do not have a surplus of 
savings to invest collectively in this country. And money, at 
the end of the day, will find its best investment. What I am 
afraid of, we are going to be owned and controlled and 
influenced by countries, sovereign wealth countries. And I 
believe it was Senator Bayh that made a good point earlier, we 
have always tried to say in this country, and I believe the 
policy has been basically, keep the government out of business. 
Let the private market work. Let the market work.
    But we are now inviting sovereign wealth funds, countries 
that own these and have got the money, to buy up and buy parts 
and a lot of times buy up whole companies. That has got to be a 
real challenge for this country, emotionally, financially, 
politically, and otherwise in this country.
    Who is going to influence this country? Will it be the 
American people? Or will it be other people that own us? We 
know what will happen. The people who own, Senator Bayh brought 
this up. If you are investing, you are not going to be a 
passive investor, not long. I mean, you know, you are 
influencing whoever is on that board some way because you have 
got the clout, you have got the money. Let us be honest about 
it.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very, very much.
    Any additional questions?
    Senator Bayh. I just had two but Senator Reed comes first.
    Senator Reed. I had just one question, if I may, excuse me.
    You indicated, in response to questions Senator Bayh and I 
both had, that you would be able to essentially track the 
lending of a sovereign wealth fund to an investor in a publicly 
held company because that investor would have to disclose their 
source of financing.
    Do you have those statistics? Could you tell us--not just 
today, but could you tell us what percentage, what activity 
sovereign wealth funds have, not just direct investment but in 
lending to investors in our economy and publicly held 
companies?
    Mr. Tafara. I certainly can inquire. I do not know how we 
would collect the information in the way you are suggesting. 
Certainly, when you are a 5 percent beneficial owner of a 
company, one of the things you are supposed to disclose is the 
sources of those funds. I will have to check back at the SEC as 
to whether or not there is a way of gathering the information 
because you are talking about lending that could be done to a 
whole host of entities----
    Senator Reed. Right.
    Mr. Tafara [continuing]. That then go on to purchase 
interest in U.S. companies. I do not have the answer for you 
now.
    Senator Reed. It would seem to me that that is something, 
that is information that I think you would want to have, we 
would want to have. And it is something that would focus more 
attention perhaps on who is lending to these investors.
    I get the sense--I do not want to trivialize this--but it 
might be sort of formulaic that they submit their forms, which 
you are in the disclosure business. They check the box, 
borrowed $2 billion from the government of X or the sovereign 
wealth fund. That does not set any bells or whistles off 
because they are disclosing it. But collectively it might set 
off lots of bells and whistles. And I think you better begin, I 
would suggest, to think about collecting the information and 
then looking at it.
    Mr. Tafara. And I think the further issue we will have to 
consider is that this could be part of a chain. In other 
words----
    Senator Reed. Exactly.
    Mr. Tafara [continuing]. Will you be able to get all the 
way back to the original, original source of the funds? I am 
not sure about that. But it is certainly something where we 
will inquire about that.
    Senator Bayh. Senator, if I could follow up on your 
question, are you getting at the point where let us say, Mr. 
Tafara, there are three or four intermediaries, investment 
banks let us say, and a lender to each of them were to acquire 
4 percent, 4 percent through intermediary A, B, C, and D. So 
through each of those entities they would be below the 5 
percent threshold. But when you aggregate them together to the 
lender, they would be well in addition to that? Is that what 
you were driving at?
    Senator Reed. Well, I think that is possible, but in 
effect, this is the question of who is influencing who. If you 
have an investor in a public company or a financial institution 
who appears to be a private investment fund something like 
this, but his sole course of--he has got $2 million in equity 
and $1 billion in borrowings, I would suspect he would be very 
responsive to his lender and that might translate.
    So again, I think at this juncture having that information 
is something as we go forward, you consciously have to think 
about doing it in a systematic way.
    Senator Bayh. Gentlemen, I just had two other quick 
questions. You are familiar with the notion of reciprocity, I 
am sure. Do you find it ironic that some of the countries 
restrict investment by U.S. private investors in some of these 
sectors in their own countries and yet seek to invest in some 
of these sectors in our own? Is that something we should 
consider as policymakers, the notion of reciprocity and asking 
if they open their markets to investment?
    Mr. Alvarez. The decision on reciprocity is clearly your 
decision to make, and there has been a conscious decision 
through the years in the banking area to focus on national 
treatment as opposed to reciprocity. So we treat foreign 
investors in the United States in the same way that we treat 
domestic investors and not based on reciprocity.
    Senator Bayh. But when it is a government entity making the 
investment and that government's policy is to restrict U.S. 
investors, is that not a fair consideration for us to take into 
our deliberations?
    Mr. Alvarez. I think it is certainly a fair consideration 
for you to take into account. I think the notion of national 
treatment, as opposed to reciprocity, is based on the idea of 
us being an open market and wanting to invite funds and 
investment opportunities as much as possible with the hope that 
success here would be an inspiration to other countries that 
they should be open, as well.
    But that is clearly a decision for the Congress to make.
    Senator Bayh. My last question, Chairman, is are either of 
you gentlemen familiar with the debate about best practices 
being defined under the auspices of the IMF on a voluntary 
basis? There is some positive movement there, and I must say 
the Gulf countries and the Singapore entity have been exemplary 
in their behavior, as far as I know. They have not pursued a 
political agenda or that kind of thing. My guess is that there 
may be some rallying around of that sort of thing.
    My questions to you--which I would view as a positive 
development.
    My question would be, just two or three related to that. 
What do we do about outliers, people who just chose not to 
participate in the best practices? No. 2, what about those who 
say they will abide by them? How do we verify that they are 
actually doing that? And No. 3, what should the consequences, 
if any, be for noncompliance?
    In other words, might we not have a bifurcated system where 
those who we can verify were abiding by the best practices 
might be subject to one regulatory regime and those that did 
not might be subject to somewhat different scrutiny?
    Mr. Tafara. As I said, I think the good news from our 
perspective is that the IMF initiative and the OECD initiative 
actually mimic the requirements we already have as a mandatory 
matter in the United States when it comes to transparency and 
disclosure. So we have a way of giving effect to what is a 
voluntary code by virtue of the requirements that are built in 
to the Federal securities laws. And in that sense, I think we 
are ahead of the curve.
    This may be a more important issue for other jurisdictions 
that are going to be relying on this voluntary code, as opposed 
to statutory requirements in place in those jurisdictions.
    Now there will be an issue as to a couple of things that 
may be in this code that are not part of our statutory 
framework, which we think are good and would like to see these 
funds abide by. We will have to see if there are any outliers 
and what the consequences could be for those outliers. It 
ultimately may end up being a decision for you.
    Senator Bayh. I am a little more concerned, Mr. Tafara, let 
us take for instance the issue of intellectual property. Some 
countries have passed intellectual property protections but 
gee, unfortunately they are just not enforced very vigorously. 
So what do we do about countries that say oh, of course we will 
abide by the practices. Don't we need to trust but verify? And 
what do we do if they are not living up to their word?
    Mr. Tafara. As I said, the good news for us is those are 
practices that are built into our laws. So we have a way, we 
have an obligation to verify and we have a way of enforcing. So 
in that respect, I think we are in a better place than some of 
our friends in other parts--in the rest of the world.
    Senator Bayh. Anything from you, Mr. Alvarez, about best 
practices or compliance and that kind of thing?
    Mr. Alvarez. I think we endorse the efforts to have best 
practices but whether a wealth fund complies with the best 
practices or not, if they need approval from the Federal 
Reserve, they are going to have to meet the informational 
requirements of the Federal Reserve to grant that approval and 
they will be subject to the same laws as everyone else.
    So we will have some mechanism to enforce compliance across 
the board. I think there will also be tremendous pressure on 
sovereign wealth funds that choose not to comply with those 
best practices to comply, because I think the worldwide 
pressure is going to build.
    Senator Bayh. Well, I agree with that, but as I observed 
with regard to the situation in Tibet, you know occasionally 
global pressure does not affect some countries' behavior 
because they have other values and agenda that they might find 
to be appropriate for themselves but we would look at and 
simply have a difference of opinion about.
    Mr. Tafara. The one thing I might add is that I suspect, 
given that this is being developed by the IMF and it is a 
membership organization, one of the means the IMF may have 
available to it for enforcing its codes would have to do with 
the administration of membership. And there is pressure that 
can be brought to bear there. I take your point that pressure 
does not always work, but there may be tools available to the 
IMF to actually give teeth to this voluntary code that they are 
coming up with. I suspect that is something that is under 
consideration by the organization.
    The one other piece of information I wanted to add, I do 
not have the numbers on the market capitalization of the 
financial sector, but we have looked at market capitalization 
in the United States generally speaking as against sovereign 
wealth funds and the capitalization is at $56 trillion to $60 
trillion now and sovereign wealth funds are at 2.5. Now that is 
going to grow, as we know, over the course of the next years. 
But that gives some context to what we are talking about here.
    Chairman Dodd. Senator, thank you very much. Excellent 
questions, by the way. And we thank both of you very much, and 
there may be some additional questions that members may have 
that were here or those who were not able to be here this 
morning.
    Senator Shelby. Mr. Chairman, I have a number for the 
record, that I would like to submit.
    Chairman Dodd. They will be submitted and we would ask both 
of you, if you could, in a timely fashion to share with us your 
observations and responses to those questions.
    And we thank both of you very much. It was very, very 
informative, very, very helpful. And it is--the Federal 
Reserve, I want to say, has been very, very responsive. 
Chairman Bernanke has been here. Don Kohn has been up to this 
Committee. We have had, over the last number of months since 
January, we have had you here a lot on various subject matters.
    The SEC, Christopher Cox was up several times before the 
Committee, as well. And we are very grateful, knowing 
everything else you have got to deal with here, to be here and 
come before the Committee.
    And I will express once again my disappointment that 
Treasury, given its important role in this subject matter, 
could not, was not willing to submit and have a witness here 
this morning. It is very disappointing to me.
    Senator Shelby. Mr. Chairman.
    Chairman Dodd. And they will be before this Committee, I 
promise them, one way or another. And it will not be a warm 
welcome either, because I am not happy about the fact they 
could not be here on a subject matter of this importance.
    Senator Shelby. Mr. Chairman?
    Chairman Dodd. Yes.
    Senator Shelby. Mr. Chairman, on the subject matter of 
Treasury not showing up today, I would hope that when you 
invite the Secretary of the Treasury, Hank Paulson, that we 
work with all the time, that he will come. But also the Deputy 
Secretary Kimmitt, because if we are going to deal in CFIUS, 
and we are, and foreign investment in the U.S., I think we need 
them both here.
    I think you would agree with that, would you not, Senator 
Bayh?
    Chairman Dodd. Very good. We thank both of you very much.
    Let me jump to our second panel, and we have got some very 
important witnesses here in the second panel. We appreciate 
their patience. Let me introduce them if I can.
    Jeanne Archibald is a partner at Hogan and Hartson--let me 
start with--let me get Paul Rose. Let me start with Paul. Paul 
Rose is Assistant Professor of Law at the Moritz College of 
Law, Ohio State University, previously a Visiting Assistant 
Professor in Securities and Finance at Northwestern University. 
Before that, he practiced law in Covington & Burling, San 
Francisco office. Professor Rose's areas of research include 
corporate governance, securities regulation, institutional 
investors, and comparative corporate law.
    David Marchick is the Managing Director and Global Head of 
Regulatory Affairs for the Carlyle Group. Prior to joining the 
Carlyle Group, Mr. Marchick was a partner in the law firm of 
Covington & Burling. In addition, he served under the Clinton 
administration for 7 years in positions within the White House. 
He was Trade Representative at the Department of State.
    Then we have as our next witness is Jeanne Archibald, as I 
mentioned, a partner at Hogan and Hartson. She currently 
directs Hogan and Hartson's International Trade Group. She 
brings with her a wealth of experience in the field of 
international trade law, having served as the General Counsel 
for the Treasury Department, where she helped draft the 
regulations governing the Committee on Foreign Investment, the 
CFIUS legislation we have been talking about, and negotiated 
the first CFIUS-related mitigation agreement. Prior to her 
service in the Treasury Department, Ms. Archibald served in the 
Office of the U.S. Trade Representative. She joined Hogan and 
Hartson in 1993.
    Dennis Johnson is the senior portfolio manager in charge of 
global corporate governance for the California Public 
Employees' Retirement System, otherwise known as CalPERS. Mr. 
Johnson is chiefly responsible for the strategy and day-to-day 
management of CalPERS' corporate governance activities. His 26 
years of experience in investment management include serving as 
the Managing Director for Citigroup Global Markets and managing 
global equity and fixed-income investment portfolios. In 
addition to his duties at CalPERS, Mr. Johnson chairs the Board 
of Directors for the National Council of Institutional 
Investors and serves on the Board of Directors of the National 
Association of Corporate Directors of Northern California 
Chapter.
    We welcome all four of you, very distinguished backgrounds 
and service to the country and to the institutions you are now 
associated with. So we thank you very much for being with us, 
and, of course, you had the wonderful opportunity to be 
enlightened by the previous witnesses here. So let me introduce 
you in the order in which I introduced you. And, again, your 
statements and supporting information will be made a part of 
the record. I would ask you to keep your remarks to 5 or 6 
minutes, if you could.
    I would tell my colleagues as well, there is at least one 
or two votes we are going to have beginning at 12:15. So we 
will try and get through your presentations, take a few 
minutes' break, and then come back for the question-and-answer 
period.
    Mr. Rose.

  STATEMENT OF PAUL ROSE, ASSISTANT PROFESSOR OF LAW, MORITZ 
             COLLEGE OF LAW, OHIO STATE UNIVERSITY

    Mr. Rose. Chairman Dodd, Ranking Member Shelby, and Members 
of the Committee, thank you for the opportunity to speak to you 
today on the regulatory framework for sovereign investments and 
how such investments impact U.S. financial stability.
    Sovereign investment takes many forms, including 
stabilization funds, endowment funds, pension reserve funds, 
development funds, and sovereign wealth funds. Sovereign wealth 
funds may be narrowly defined as ``government investment 
vehicles funded by foreign exchange assets and managed 
separately from official reserves.''
    SWFs are increasingly important players in our capital 
markets. The size and impact of SWFs may be given context 
through comparison with other major investment vehicles such as 
institutional funds, private equity funds, and hedge funds. If 
we assume on the high side approximately $3 trillion in 
sovereign wealth fund assets, sovereign wealth funds manage 
roughly one-seventh the amount managed by pension funds, one-
sixth the amount managed by mutual funds, and one-sixth the 
amount managed by insurance company funds. On the other hand, 
as Chairman Dodd mentioned, sovereign wealth fund assets under 
management are approximately twice that of hedge funds, and 
roughly three times that of private equity funds. Furthermore, 
as noted by Treasury Under Secretary David McCormick, SWFs 
``are set to grow at a much faster pace'' than these other 
investment vehicles.
    SWFs also often control relatively larger concentrations of 
wealth. For example, the largest SWF, the ADIA fund, is more 
than twice as large as the ten largest hedge funds combined.
    Since July 2007, sovereign wealth funds have made a number 
of investments in U.S. financial institutions, most of which 
occurred since the Committee's hearings in November. These 
investments alone provided approximately $39 billion in much 
needed capital for the financial institutions. The investments 
involve less than 10 percent, and typically less than 5 
percent, of the banks' outstanding capital, with no control 
rights. Each investment was designed to be a passive 
investment, and the sovereign funds and banks have made a point 
of reassuring the public, other investors and regulators that 
these are stable, long-term investments.
    Three sets of regulations governing SWF investments in 
financial institutions have shaped the structure of these 
investments.
    The first set of regulations governs the CFIUS process, 
which, among other things, targets transactions in which a 
sovereign wealth fund would gain the ability to exercise 
functional control over a target company.
    The other two set of rules are the Bank Holding Company 
Act, the Change in Bank Control Act, which has been discussed, 
and also the SEC's disclosure scheme under Section 13(d) of the 
Exchange Act.
    While this framework encourages commercial, non-political 
investment by SWFs, there are some limitations to the 
framework.
    With respect to SEC enforcement, SEC Chairman Christopher 
Cox has expressed concern that the SEC may not be able to 
regulate SWFs as it does other investors, and that considerable 
conflicts of interest might impair SEC efforts to obtain 
cooperation from the sovereign that controlled a fund under 
investigation.
    Additionally, sovereign wealth fund investment in financial 
institutions may create unique systemic risks. For example, 
sovereign wealth funds could cause significant turmoil if, for 
reasons of national exigency, a sovereign wealth fund was 
required to liquidate its positions. Given the importance of 
financial institutions to the overall economy, the risks 
created by quick divestment by sovereign wealth funds, although 
perhaps not likely, could be especially acute.
    Another concern with sovereign wealth fund investment that 
may be amplified by investment in financial firms is the 
potential for abuse of informational disparities. Easier access 
to financial firms, which are awash in material, non-public 
information, enhances the risk of exploitation of unfair market 
advantages.
    While recognizing that the concerns with sovereign 
investment in financial firms are significant, I do not believe 
that these concerns need be answered by adding to or amending 
existing statutes and regulations. First, as Deputy Treasury 
Secretary Robert Kimmitt has noted, SWFs ``have not caused 
significant financial market disruption and . . . even for 
investments that do involve control, there is little evidence 
of any ulterior foreign policy motives in practice.'' Second, 
imposing additional regulations on SWFs beyond the reasonable 
framework now in place may create other, more significant 
problems, such as a shift in sovereign wealth fund investment 
away from the U.S. The result of such a shift would be 
detrimental both because U.S. firms would miss the capital 
investments, and because the funds may flow to other 
jurisdictions that may be underregulated. Arguably, this could 
increase the danger that sovereign wealth funds would be used 
as political tools to harm our national interests and make it 
less likely that our regulators could effectively work against 
such activities.
    In balancing these concerns, I believe the Treasury has 
ably worked to buttress our regulatory framework by promoting 
voluntary standards by working directly with sovereign wealth 
fund, in the case of Abu Dhabi and Singapore, and by 
encouraging efforts by the IMF to work with sovereign wealth 
funds on a set of best practices. The IMF's efforts are also 
supported by the Financial Stability Forum, which is 
particularly focused on the health of financial institutions 
and markets.
    A robust set of best practices essentially encourages 
sovereign wealth funds to act like institutional investors: to 
operate transparently, to maintain adequate risk management 
structures, to provide adequate disclosures, and to create 
accountability to regulators, and, we should hope, the citizen 
beneficiaries of sovereign wealth funds.
    The primary limitation of voluntary best practices is, of 
course, the lack of an enforcement mechanism--other than the 
possibility of retaliatory economic and political responses, 
which is, I believe, a quite significant enforcement mechanism. 
On the other hand, it is not realistic to hold out for the 
successful negotiation of a multilateral foreign investment 
agreement that might provide a formal dispute resolution 
mechanism. Sovereign wealth fund are investing now, and they 
are here to stay. I believe we can rely on the regulatory tools 
currently at our disposal while continuing to encourage the 
creation of best practices for sovereign wealth funds and long 
term continuing to work on domestic and international 
initiatives that will ensure the stability of financial 
institutions and the capital markets.
    Thank you.
    Chairman Dodd. Thank you, Mr. Rose.
    Mr. Marchick.

STATEMENT OF DAVID MARCHICK, MANAGING DIRECTOR AND GLOBAL HEAD 
            OF REGULATORY AFFAIRS, THE CARLYLE GROUP

    Mr. Marchick. Thank you very much. Mr. Chairman, Senator 
Shelby, it is great to be back here before the Committee. I am 
going to be very brief because I think there has been a 
thorough discussion. I am just going to address three or four 
points. I know how busy you are.
    Let me start by complimenting the two of you for your 
leadership on the FINSA. Senator Shelby, you were all over this 
issue well before Dubai Ports, focused on the importance of 
having a robust foreign investment screening process for 
national security. And if you think about the number of pieces 
of legislation that have passed the Congress in the last few 
years that affect billions of trillions of dollars of economic 
activity that were done in a bipartisan way, you can count them 
on your hands, and you all were really at the forefront of 
that. So I congratulate you.
    Just a few points. The first is I think we need to keep the 
size of sovereign wealth funds in perspective. One can say that 
they are large by comparing them to certain things or say that 
they are small by comparing them to other funds; $3.2 trillion 
is a huge amount of money, but compared to the combined size of 
pension funds and mutual funds, which is about $55 trillion, it 
is fairly small. Second, even though the investment activity 
coming from sovereign wealth funds has grown significantly, it 
still represented about 1.5 percent of overall global M&A last 
year, so it is fairly small.
    Second, I think that there is consensus on the Committee 
that basically we want this investment in the United States, as 
opposed to elsewhere, so long as there is not a problem with a 
particular investment. So we want the investment if it is made 
for commercial purposes, if it is not going to compromise our 
national security, if it is not going to compromise our banking 
system, et cetera. So then the question is: If we want the 
investment, are our laws adequate to address any government 
interests that we have with particular investments? So if a 
sovereign investment fund invests in a Play-Doh factory for our 
6- and 4-year-olds or 3-year-olds, you know, who really cares? 
If they invest in something that affects national security, we 
have FINSA, which was strengthened under your leadership. If 
they invest in a defense company, you not only have CFIUS, you 
have defense regulations that protect the defense supply chain 
and protection of classified information. If they invest in the 
chemical sector, there are more than a dozen chemical statutes 
that govern and five Federal regulatory agencies that govern 
chemical safety, security, et cetera. And so from my 
perspective, there is a robust regulatory structure that is 
adequate to deal with any legitimate government interest.
    Third, I think the professor highlighted the importance of 
the transparency initiatives. I think that you are familiar 
with those. I hope that you would support those.
    Fourth, equally important is just as there is 
responsibility for the sovereign wealth funds to have a code of 
conduct and behave appropriately, it is equally, if not more 
important, that recipient countries remain open to investment, 
unless there is a particular problem with a particular 
transaction.
    There is cause for concern. If you look at in the last 2 
years alone, countries that represent 40 percent of the--that 
are the recipients of 40 percent of global investment have 
either passed or are debating laws that limit investments. Some 
of this is narrowly tailored on national security, like the law 
that you passed. Some of it goes beyond. But China now 
regulates investment in a number of sectors. Russia regulates 
investment in 43 sectors. France regulates investment in 19 
sectors, including gambling. Hard to see how that is a national 
security issue. And there is danger of a downward spiral.
    Finally, let me just reflect on Carlyle's experience with 
sovereign wealth funds or with funds affiliated with government 
institutions. We have two investors that own a piece of the 
Carlyle partnership: one is CalPERS, which in 2000 bought 5.5 
percent of Carlyle; and last year a fund based in the UAE 
called Mubadala Development Corporation bought 7.5 percent. 
Both of these investments are structured exactly alike--
completely passive, they wrote us, they made a big investment 
in us. We work hard to provide an adequate return, strong 
return. So far we have done fairly well for CalPERS, and 
hopefully we will continue to do so. They have no control or no 
influence over what investments we make. They have no control 
or influence over how we manage our investments. And they have 
no control or influence over when we exit. So they are 
completely passive. We control all our investment decisions.
    So that is an example in my view of a positive experience 
with two different entities affiliated with either the State of 
California or the state of the UAE in Abu Dhabi. And we are 
grateful for the confidence that CalPERS and Mubadala has shown 
us, and hopefully we will be good stewards of their money.
    So thank you very much.
    Chairman Dodd. Thank you very much.
    Welcome to the Committee, Ms. Archibald.

  STATEMENT OF JEANNE S. ARCHIBALD, DIRECTOR OF INTERNATIONAL 
             TRADE PRACTICE, HOGAN AND HARTSON LLP

    Ms. Archibald. Thank you, Chairman Dodd, Senator Shelby. 
Let me begin by saying that I am not here appearing on behalf 
of any client. I am here in my personal capacity sharing views 
that are based on 20 years or more of having looked at the 
issue of national security with respect to foreign direct 
investments, either in the Government or in the private sector. 
And let me just cut right to the chase. I think the issue has 
been framed well in this hearing so far this morning. People 
recognize the benefits to the U.S. of an open investment 
policy, but at the same time, they are trying to ensure that 
such investments, particularly from foreign government 
entities, are done in a way that does not endanger national 
security.
    And so the question is: Do we have the tools to give 
ourselves that assurance? And let me run through some.
    CFIUS is obviously a clear one. I do not need to tell 
anybody sitting in this room today what CFIUS has done in the 
past and also what it is going to be doing in the future in 
light of the strengthened statute that was put into place last 
year. But let me talk about some of the other regulatory 
schemes that are out there. Mr. Marchick has already referred 
to a few of them.
    Consider, for example, acquisitions in the 
telecommunications sector. The Communications Act of 1934 
absolutely prohibits any foreign government or representative 
of a foreign government from holding a broadcast or common 
carrier radio license. The act also imposes an absolute limit 
of 20 percent on direct holdings by any foreign company, and it 
has a waivable limit of 25 percent on indirect holdings by 
foreign companies. In other words, if they establish a 
subsidiary in the U.S., they can own 25 percent. They can even 
own above that if there is an approval from the FCC.
    Now, it is true that broadcast and radio common carrier 
licenses are not as important today as they were in the past. 
But the SEC now has a practice--it is not codified, but it is a 
consistently applied practice with respect to any application 
involving telecommunications services by a foreign entity, but 
they do not approve the application without having it first 
looked at by the Team Telecom agencies--the Department of 
Justice, the FBI, the Department of Homeland Security, and, as 
appropriate, the Department of Defense.
    Investors are aware of this practice, and, in fact, with my 
clients when they are investing in telecommunications, we know 
that we have to talk to Team Telecom and make sure that if they 
have any national security or law enforcement concerns, we need 
to work those out. And typically we attempt to do that before 
we even approach CFIUS with respect to their review because 
they will help make the CFIUS process go more smoothly.
    Another example, companies that have facility security 
clearances. Essentially, any company that is doing classified 
work for the U.S. Government, there is an obligation on the 
part of the U.S. entity that has a facility security clearance 
if it is, in fact, negotiating with a foreign entity and that 
entity is going to obtain foreign ownership, control, or 
influence over that facility security clearance holder to 
notify the Department of Defense and, indeed, they will have to 
work out a plan to mitigate the impact of that foreign 
ownership control or influence. And if they do not do so, then 
the facility security clearance will be suspended, and that 
company will not be able to bid on further classified 
contracts.
    Now, the requirements that are imposed by the Defense 
Department can be pretty significant. You either enter into a 
special security arrangement which would allow the foreign 
entity to have perhaps board representation, but would put in 
very strict controls to protect the security of the classified 
work. In other types of cases, when the contracts involved 
prescribe information, there is a requirement to establish a 
proxy agreement. And essentially the foreign entity can have an 
economic interest in the U.S. company, but it can have no 
management involvement in the company. The company is turned 
over to a proxy board that is made up solely of U.S. citizens 
whose appointment is approved by the Department of Defense.
    Similar types of restrictions apply in the nuclear power 
industry. Manufacturers of goods or technology that are made 
for military purposes require--the manufacturer is required to 
have a registration under the International Traffic in Arms 
Regulations. In those instances, if someone is going to take 
ownership or control, a foreign entity is going to take 
ownership or control of such a company, again, they are going 
to have to work with the State Department to ensure that ITAR 
registration is either amended as necessary or is going to be 
continued.
    I would also note that under the International Investment 
and Trade in Services Survey Act, there is a requirement for 
all foreign investments in U.S. business enterprises with 
assets of $3 million or more--a very small threshold--in which 
a foreign person owns a voting interest of 10 percent or more, 
they are subject to a reporting requirement and have to submit 
information about that investment within 45 days of the 
completion of the investment.
    This is just a very small sampling of what is out there. 
There could be a much longer list developed. But I think the 
point is that there are many aspects of U.S. regulation in 
industries particularly that are sensitive for national 
security purposes where there are very clear rules and clear 
opportunities for the U.S. Government to pay close attention to 
what is happening by way of foreign investment.
    I will stop there. Thank you.
    Chairman Dodd. Thank you very, very much.
    Mr. Johnson, thank you for being with us.

STATEMENT OF DENNIS JOHNSON, DIRECTOR OF CORPORATE GOVERNANCE, 
         CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM

    Mr. Johnson. Chairman Dodd, Senator Shelby, I am pleased to 
provide the perspective of an institutional investor on the 
virtues of transparency and the principled practices of the 
California Public Employees' Retirement System, which I 
represent.
    CalPERS is the largest public pension plan in the Nation 
with more than $244 billion in assets under management. We 
provide retirement and health benefits to 1.5 million members 
who work in State and local government.
    Given our responsibility as a trustee and the fact that our 
investments span domestic and international markets, not only 
do we require transparency from our portfolio companies, we 
believe that we should lead by example in providing 
transparency into the activities related to our investment 
portfolio.
    We also believe it is crucial to have a principle-based 
approach for exercising our rights as shareowners in over 8,000 
publicly traded companies around the world.
    That is why the CalPERS Board of Administration annually 
reviews and approves the CalPERS' Global Principles of 
Accountable Corporate Governance.
    Our principles create the framework by which CalPERS 
executes its proxy voting responsibilities in addition to 
providing a foundation for supporting the system's corporate 
engagement and governance initiatives. To promote transparency, 
the CalPERS Policy Subcommittee and Investment Committee 
discuss and approve the principles in open public sessions. In 
addition, we maintain a current edition of our principles on 
the CalPERS website.
    There are numerous ways that CalPERS provides transparency 
for its investment and related activities. Some of the methods 
for promoting transparency include but are not limited to the 
following:
    The CalPERS Board of Administration has a fiduciary duty to 
employees, contracting public agencies, and retirees of the 
pension fund. As a public government entity, this stewardship 
entails public reporting.
    The California Constitution and case law clearly 
establishes that the CalPERS Public Employees' Retirement Fund 
is a trust and that the board acts in a fiduciary capacity as 
the body responsible for managing and administering that trust. 
Article XVI, Section 17, of the California Constitution 
provides that the assets of a public pension and retirement 
system are trust funds and that the retirement board 
responsible for administration of the retirement system has the 
sole and exclusive fiduciary responsibility for those assets.
    The 13 members of the Board of Administration are either 
elected by members of the system, appointed, or are designated 
by law to be on the CalPERS Board of Administration. The board 
has established various committees that review issues and 
recommend actions to the full board. The board meets monthly in 
Sacramento, but holds one meeting a year in Southern 
California. Each CalPERS trustee is identified on the CalPERS 
website.
    The Constitution requires that CalPERS assets are held in 
trust for the exclusive purposes of providing benefits to 
system members and their beneficiaries, and to defray 
reasonable expenses of administering the system.
    Board members, individually, are responsible for maximizing 
investment returns to the pension fund, thereby minimizing 
contributions required of active State, public agency, and 
school employees and California taxpayers who support employer 
contributions to the fund. As of June 30, 2007, CalPERS assets 
included $3.3 billion in employee contributions, $6.4 billion 
in employer contributions, and investment returns on all such 
contributions through the 2006-07 fiscal year. Investment 
income pays 75 cents of every pension dollar received by 
CalPERS retirees.
    CalPERS also posts its investment portfolio in public 
printed reports and on-line on its website. CalPERS records are 
readily accessible.
    Investment performance results are made available to the 
public on-line and in printed materials. This includes a 
Comprehensive Annual Financial Report, the annual Investment 
Report, monthly Consolidated Investment Activity reports, a 
Total CalPERS Fund Quarterly Report, and detailed quarterly 
reports of sub-asset classes, monthly activity reports, and all 
investment transactions. The CalPERS website also has a 
complete report of our Alternative Investment Management 
Program showing investments in hundreds of private equity 
funds, and their performance.
    Proposals to contract with external portfolio managers are 
also publicly reported, as are investment allocations, 
commitments, and deployment of capital into the market.
    The CalPERS Investment Committee meets in open session, and 
all policies are presented first in the Policy Subcommittee, 
then in the full committee, which comprises all 13 board 
members. Agendas are made available for the public prior to 
open session meetings. Minutes from the previous meeting are 
also included in the agenda package.
    We appreciate the opportunity to share our experience as a 
major investor. We hope that this account of our practices 
regarding transparency, accountability, and our unique 
fiduciary responsibility to our members will help in addressing 
the difficult questions that are before this Committee.
    Thank you.
    Chairman Dodd. Thank you very, very much, and I am going to 
turn to Senator Shelby for some questions. Then Senator Reed 
will be coming back, and I will have a few questions myself. 
And we will find we will not have to delay too long as a result 
of these votes.
    Senator Shelby. Thank you, Mr. Chairman.
    Ms. Archibald, in your testimony you write that some 
regulatory regimes can, and I quote you, ``provide an avenue by 
which the U.S. Government can be made aware of a contemplated 
or completed investment.'' Would you give the Committee an 
example of how this would occur specifically in the financial 
services sector we are focusing on today? And do you think that 
the regulatory agencies often find out about sovereign 
investments in this manner? Or in your experience, did most 
potential investors come directly to CFIUS?
    Ms. Archibald. Let me try to answer both those questions. 
An example of how agencies can learn about investments either 
before or after the fact, one was the Investment Survey Act 
that I mentioned, where within 45 days of making the 
investment, there is a requirement to fill out a form notifying 
the Department of Commerce. You heard the witnesses this 
morning talk about the requirements when certain thresholds are 
triggered to notify, for example, the SEC in the acquisition of 
a public company when it is a percent holding. So there are 
these various statutes out there that do require disclosure.
    In my own experience, I have found that most of the foreign 
companies that I represent in U.S. acquisitions, in fact, do 
want to make a CFIUS filing, and they do that in part because 
if they are planning on making more than one acquisition, or if 
even the single acquisition is likely to get public attention, 
they want to be seen as good corporate citizens who are 
following through on the regulatory structures of----
    Senator Shelby. So transparency is very important here, is 
it not?
    Ms. Archibald. I think being seen as cooperative and 
wanting to abide by the regimes that the U.S. Government is 
setting up is important to them.
    Senator Shelby. OK. Mr. Johnson, your CalPERS, as we all 
know--and you represent them here--is a huge investor. But do 
you believe as the Director of Corporate Governance for your 
pension fund, do you feel that your fund has a level playing 
field in its competition with sovereign investors?
    Mr. Johnson. Senator, I am not in a position to say, but I 
would just indicate that we obviously have a fiduciary duty to 
our members to maximize the returns for our portfolio, and our 
board works very vigorously----
    Senator Shelby. When you speak of your members, it would be 
the members of the California pension fund.
    Mr. Johnson. That is correct.
    Senator Shelby. State pension fund.
    Mr. Johnson. That is correct.
    Senator Shelby. OK. Mr. Marchick, do you have concerns 
about the increasing size of the sovereign wealth funds and the 
ability of our current regulatory system which we talked about 
here today to be able to effectively monitor their activities? 
You heard the questions earlier, and you are very familiar with 
them.
    Mr. Marchick. I guess my concern about the size of the 
sovereign wealth funds----
    Senator Shelby. Turn your microphone on. Is your microphone 
on?
    Mr. Marchick. Sorry, sir. I think my concern focused on 
less the fact that they are getting larger and more--it is 
indicative of some fundamental problems in the U.S. economy 
with our deficit going through the roof, current account 
deficits in China and elsewhere.
    Senator Shelby. Lack of savings?
    Mr. Marchick. Lack of savings. And so when you have oil 
prices that are so high and you have China and a few other 
countries with huge external surpluses, they have to do 
something with the money. And so, you know, they are growing. I 
guess my focus is that if they are going to invest the money, I 
would rather have it invested in the United States than 
anywhere else, so long as a particular investment does not 
present a problem.
    Senator Shelby. OK. Professor Rose, in your testimony you 
quote Under Secretary McCormick's statement that sovereign 
wealth funds are set to grow at a much faster pace than other 
investment vehicles. Do you believe that the growth in size of 
sovereign wealth funds are a greater policy challenge than the 
fact that they are government owned? Or how do you 
differentiate here?
    Mr. Rose. Well, the growth certainly does worry me. When 
you look at present investment levels, I feel comfortable with 
the regulations that we have in place. I think that the hearing 
today and the witnesses have done a good job of spelling those 
out. And if we are thinking about, say, banking, financial 
services, the testimony seems to have been, well, right now we 
feel comfortable. If they keep growing, they keep investing, we 
start to have not just one 5-percent shareholder but, as you 
mentioned, a number of them, well, then I think maybe the 
ability to monitor those is diminished and we may need to 
revisit the regulations that are in place. And I think this 
Committee is obviously attuned to that issue and is prepared to 
continue to make sure that the Federal Reserve Board and the 
SEC are doing their jobs and monitoring it.
    Senator Shelby. And this Committee?
    Mr. Rose. Yes, this Committee.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    You know, I raised the issue before just as a thought. You 
mentioned the CFIUS legislation. What did you call it, Ms. 
Archibald? Team----
    Ms. Archibald. Team Telecom.
    Chairman Dodd. Team Telecom, sort of an example where 
instead of talking about new authority per se, you get a sense 
of at least requiring some coordination that goes on, and done 
expeditiously. One of the things we have tried to do--and I 
appreciate, Mr. Marchick, your kind comments about the efforts 
on the CFIUS legislation; Senator Shelby and I were deeply 
involved in that here--is to make sure that we structured that 
in a way that would allow you to get answers but do it quickly, 
and so you do not end up becoming a drag in terms of that very 
welcomed investment to occur in the country.
    It occurs to me here, as I was looking at the various 
Federal agencies and departments that have some piece of all of 
this, that we might want to structure something similar to 
that. If this is going to be a growing issue and you end up 
with an example that will happen, a Dubai Ports that provokes 
the kind of public reaction without understanding the issue 
maybe as thoroughly as we should have at the time, but, 
nonetheless, it certainly provoked us taking a harder look at 
CFIUS and structuring it in a way, I think, that satisfied 
everyone involved. There may be an anticipation of something 
like that occurring, which may not always be fair, but, 
nonetheless, provokes the kind of public response, where the 
pendulum can swing, as we have seen, periodically, that we 
might want to look at something like Team Telecom or the CFIUS 
structure.
    I wonder if any of you have any particular comments on that 
idea. Mr. Marchick?
    Mr. Marchick. I think it is a very good idea for the 
following reasons: First, there were two major problems with 
Dubai Ports. One was just the facts and the politics, and the 
second was that, notwithstanding Senator Shelby's great efforts 
when he was the Chairman and he had a hearing on this before 
anybody else frankly cared about it, there was not enough 
communication with the Congress so that when a hard case came, 
nobody had visibility into the process and nobody had 
confidence in it. And so when you have bad facts and lack of 
transparency, the system broke down.
    So it seems to me that there could be some type of 
interagency coordination among all the agencies that have any 
relationship with sovereign wealth fund activity to monitor it, 
to make sure that they look to see that every government 
concern is addressed adequately, and if not, they should 
communicate with you.
    So, to my knowledge, there has not been a sovereign wealth 
fund investment in the United States that has been problematic 
in 50 years, and some of these funds have been around for 50 
years. Does that mean that there are not holes in the system? 
You know, nobody knows, but they need to be vigilant in this 
type of coordination and communication not only internally but, 
equally important, with you and your colleagues so that people 
up here have confidence in what is going on down there. That is 
a good idea.
    Chairman Dodd. Ms. Archibald? Anybody else?
    Ms. Archibald. I agree with that, and one thing I would add 
to it is perhaps it would be worth considering whether or not 
one structure to use for that would be to look at this on an 
industry basis, because sometimes the national security issues 
will vary industry by industry. So perhaps in the banking and 
finance industry, you want to get the agencies--and there are 
many of them in the banking area--to be working together and, 
in fact, sharing knowledge with each other about these 
investments.
    I do note that one of the changes I have seen in the 
proposed regulations on CFIUS for foreign government 
acquisitions, which would include sovereign wealth funds, is 
the requirement to talk about agreements that the investor may 
have with others that would get at one of the issues that I 
know was of concern to Members here, which is the idea of 
cooperation and acting in concert to beat a particular 
threshold.
    So I think you have got mechanisms in place, and if you 
just applied them in a couple of other areas, even in an 
informal way, you will have a much greater sense of confidence 
that the investments are being monitored in a way that will 
properly protect national security.
    Chairman Dodd. Professor Rose.
    Mr. Rose. Well, I agree with both of those comments. I 
think one argument for a quite broad interagency communication 
framework would be that, you know, if you have a sovereign 
wealth fund investor in financial services that starts behaving 
badly, then certainly the telecommunications folks should know. 
These are going to be diversified investors with investments 
all over companies in the United States and, frankly, I think 
that having that made public will also help investors in--or, 
rather, regulators in other countries become aware of this 
problem. And I think this is part of the important policing 
effect, I think, that this kind of interagency communication 
could have.
    Chairman Dodd. Mr. Johnson.
    Mr. Johnson. Chairman Dodd, this is an interesting idea, 
and CalPERS would welcome the opportunity to support you and 
this Committee in this effort in any way.
    Chairman Dodd. Well, thanks. Let me ask about the 
definitions. Treasury Deputy Secretary, despite the fact they 
are not here today, which we will constantly remind them of 
this, they defined--Bob Kimmitt defines ``sovereign wealth'' as 
``government investment vehicles funded by foreign exchange 
assets and managed separately from other reserves.'' Mr. 
Alvarez in the first panel defines ``sovereign wealth'' as ``an 
investment fund that is owned by a national or state 
government.''
    Is CalPERS a sovereign wealth fund?
    Mr. Johnson. CalPERS is not a sovereign wealth fund, 
Chairman Dodd. As I stated in my testimony, we receive assets 
from the members that we represent, and only a small percentage 
of----
    Chairman Dodd. So you are not owned by the State of 
California?
    Mr. Johnson. We operate under the Constitution of the State 
of California.
    Chairman Dodd. But you are not owned by them?
    Mr. Johnson. That is correct.
    Chairman Dodd. Distinguish for me, if you can, these two 
definitions. Is there something that we as a Committee ought to 
be--our ears ought to be particularly sensitive to? Is it the 
last part of this thing, that it is managed separately from 
official reserves in the Treasury definition as opposed to the 
Federal Reserve definition? Or is it a distinction without a 
difference?
    Mr. Rose. Well, I think the Treasury--you know, that was 
his definition. I do not know if the Treasury has an accepted--
if this is their accepted----
    Chairman Dodd. I do not know either.
    Mr. Rose. I know that the European Union defines 
``sovereign wealth funds'' quite broadly, and they will include 
these other categories that I mentioned in my statement in 
there.
    I think that the reason why these distinctions can matter 
is because the different funds may perceive risk differently. 
They may have different kinds of investment strategies. And for 
regulators, those differences could matter.
    Mr. Marchick. The first thing I will do is agree with 
CalPERS since they are a good investor in Carlyle.
    The second thing I would say is I think you have to look at 
control and who controls the decisions. So if you have an 
organization like CalPERS, which I think the majority of the 
board members are not government officials, but they are 
elected or appointed by their members, that control is not with 
the government. There are other pension funds where the 
government in Canada and elsewhere appoints all the members or 
a majority of the members. So, therefore, you know, you have 
control.
    So sovereign wealth funds have been--you know, SWFs, they 
are almost like a four-letter word now, even though it is just 
three. I think the key thing is, you know: Is there control? Is 
there government direction? Are they making decisions for 
economic reasons or for non-economic reasons? If they are non-
economic reasons, how do we react? When an investor invests in 
the United States, the United States is sovereign, not them. 
And are our laws and regulations adequate?
    Chairman Dodd. Let me ask you----
    Senator Shelby. Mr. Chairman, can I ask him one thing along 
that line?
    Chairman Dodd. Certainly.
    Senator Shelby. Excuse me.
    Chairman Dodd. No. Go ahead.
    Senator Shelby. What if they are both? In other words, you 
are investing for a return, obviously, but you are also going 
to influence how that institution is run. Two different things, 
aren't they?
    Mr. Marchick. It is a very good question----
    Senator Shelby. One is benign, one is not.
    Mr. Marchick. Right. You take Norway. OK? Everybody is 
saying Norway is the panacea of transparency. Norway does make 
some decisions--this is their oil fund--for non-pure economic 
reasons. They invest in, for example, broadband in Norway, and 
they say we are doing this because we want broadband to be 
ubiquitous in Norway. Is that a problem? I do not know. If they 
invested in the United States and were making investments for 
reasons that were not perfectly economic, as long as it did not 
undermine important government interests or trigger any 
particular regulation or law that does not create problems--you 
know, that indicates a problem, I guess I would rather--I would 
love to have their investment in the United States.
    Chairman Dodd. Well, you raise an interesting point. Let me 
raise this question with you. It might require a longer answer 
than the time will permit us at this juncture. But Carlyle is 
both a recipient of foreign investment funds and an investor, 
benefiting from----
    Mr. Marchick. Absolutely.
    Chairman Dodd [continuing]. Those protections and from the 
protections of the U.S. securities laws. How would you 
recommend addressing the conflicts cited if they limit the 
ability of U.S. authorities to investigate or prosecute insider 
trading, for example, market manipulation, or other misconduct 
by rogue sovereign funds?
    Mr. Marchick. That is not my area of expertise, securities 
law. I would say that in our case, all of our investors are 
completely passive, so there is no real issue in terms of how 
they impact any decisions that Carlyle makes because our 
investment professionals, whether they are in the United States 
or Europe or Asia, make their investment decisions based on 
what they believe is the best opportunity for increasing return 
for our investors. And if we do a good job, hopefully our 
investors will keep investing. But I do not have a particular 
answer to your----
    Chairman Dodd. Well, I would like you to raise that with 
folks at your shop.
    Mr. Marchick. Sure, absolutely.
    Chairman Dodd. Because it raises that issue for us on this 
side of the panel here.
    Do you have any comment on that question?
    Ms. Archibald. Not that I am in the business of trying to 
encourage lots and lots of mitigation agreements in the context 
of a CFIUS review, because there are places where they are 
proper and useful, and you could get carried away. But if there 
is an area where you are really concerned about a sovereign 
investor in a particular industry and where there may be a 
concern about willingness to work cooperatively with law 
enforcement when issues do arise, you know, that could always 
be something that is included as part of a mitigation agreement 
which is imposed as a condition of agreeing to the investment.
    So, again, I think there is a tool--not that it would be 
used in every case, but there is something that is available 
there.
    Chairman Dodd. And, of course, the ideal situation would be 
to know that in advance to be talking about it, rather than 
have something come up after the fact.
    Ms. Archibald. That is exactly right. But, again, this may 
be an area where it is worthwhile getting a little bit of 
experience. Certainly once there ever were such an issue, I 
think someone mentioned before the agencies should share this 
kind of information. It could certainly become a requirement 
thereafter.
    Chairman Dodd. Professor Rose, any comments on this?
    Mr. Rose. No. I agree with those comments. It certainly is 
a problem, I would imagine--I would hope--that the banks would 
be aware of this and that they might just as a sort of market 
mechanism structure deals so that they would prevent this kind 
of activity.
    Chairman Dodd. Mr. Johnson.
    Mr. Johnson. No comment, Mr. Chairman.
    Chairman Dodd. Well, there will probably be some additional 
questions I may have for you. We are going to take a slight 
recess here. Senator Reed is coming back to complete his 
questioning. He will be a few minutes because there are two 
votes here. I want to make the first vote and the second vote. 
But I am very grateful to all of you for being a part of this 
discussion. And when I said at the outset of my comments--and, 
that is, striking the balance here, again, I think your point, 
Mr. Marchick, again, is this is a large amount of money. It 
depends how you look at it in the context of other resources. 
And, of course, particularly now because we find ourselves 
vulnerable with our economy being what it is, the foreclosure 
issues, the seizing up of capital and credit, and so they are 
going out and seeking capital elsewhere. And there are 
different motivations that are involved here, and as a result, 
that is raising some additional concerns that otherwise 
probably would not be present, at least at this juncture.
    So it is important to understand the context in which we 
are talking about this, not so much the size of it at this 
juncture, although that is a legitimate issue to raise, but the 
potential ability for those funds to have a greater influence 
than they might otherwise have since your ability to shop 
elsewhere has been limited by what we are dealing with. And 
that is a concern I have as Chairman of the Committee.
    So I thank you all very, very much. You gave excellent 
testimony, and it is tremendously helpful.
    The Committee will stand in recess for a few minutes.
    [Recess.]
    Senator Reed [presiding]. Chairman Dodd has asked me to 
reconvene the hearing and, on my behalf, thank you for your 
testimony and participation. And let me ask a few questions. 
The Chairman is returning, I assume in a few minutes, and he 
will ask other questions and wrap up. But thank you very much.
    Mr. Marchick, you explained that Carlyle Group has received 
investments from two government-affiliated entities--a State 
employees' pension fund and a sovereign wealth fund. Can you 
describe the extent of information that is available to you 
about these funds? And would it be useful to you as a company 
to have additional information that is readily accessible?
    Mr. Marchick. Thank you for your question. I will call you 
``Mr. Chairman'' for the moment. We are very comfortable with 
the level of information that we have. Obviously, before taking 
an investment, we spend a lot of time doing due diligence on 
the investors, and they spend a lot of time doing due diligence 
on us, and we get to know each other. We get to know their 
culture, their goals. Obviously, CalPERS is very well known. 
They have a phenomenal track record of being good investors and 
responsible stewards for the pensioners of California. And we 
have enjoyed that relationship for many, many years, and the 
investment they have made has been a fantastic investment. When 
that is realized, it is going to be worth quite a bit of money 
for the pensioners of California. So we are pleased with it, 
and hopefully they are pleased with it.
    With respect to Mubadala, we did not know much about them. 
We got to know them last fall, and we are very impressed with 
them. We got to know their business, their people. What was 
interesting to us is that most of their leadership are people 
that either grew up in the United States that are of origin in 
that region or were trained in the United States, you know, at 
some of our best institutions--Harvard, Stanford, and others, 
either for undergrad or business school. And most of the senior 
leadership at Mubadala spent a number of years at some of our 
finest institutions, you know, Citibank and Goldman Sachs and 
others.
    So we have a good comfort level with both of our investors 
and feel very good about their investments and are grateful 
that they have confidence in us, and hopefully we can continue 
to enjoy their confidence.
    Senator Reed. In line with the questions I was addressing 
to the SEC, just trying to get a handle on the amount of either 
equity or debt that a sovereign wealth fund is investing in a 
private equity fund or a hedge fund, that then in turn invests 
in any publicly held company or financial institution, is that 
something that you think would be easily obtained or willingly 
given?
    Mr. Marchick. It is a good question. We have a number--if 
you look at the typical investors in private equity funds, the 
biggest chunk by far are public pension funds like CalPERS and 
Rhode Island Pension and others. There are also institutional 
funds, say insurance companies, other private pension funds, 
pension funds endowments, foundations, et cetera. Then there 
are individual investors, oftentimes wealthy individuals who 
either invest directly or invest through aggregators like a 
Merrill Lynch will raise money from a hundred different wealthy 
individuals and invest in Carlyle or Blackstone or others. And 
then, finally, you know, a sovereign wealth fund.
    Most of our clients, most of our investors prefer or demand 
confidentiality. Some of our investors do not. CalPERS for 
their own purposes discloses every investment they make, and if 
they are comfortable disclosing it, then we are comfortable 
disclosing it.
    In certain regulatory instances where there is a sensitive 
investment, some regulators have asked us for a list of 
investors, and we obviously comply with that if there is a 
reason for them to be focused on the list of investors. In my 
view, it does not really matter because all of our investors 
are completely passive. So it is just like when you invest in 
your 401(k) or TSP, you put your money in, someone else manages 
it, and hopefully they do a good job for you. In our case, they 
invest with us. We hopefully will do a good job. We have a 
pretty good track record, and if we are good shepherds of their 
money, then they will keep investing with us.
    But who invests with us does not matter in terms of, you 
know, how the investments are made. When we invest in a 
particular sector, we are subject to the regulations in that 
sector. So a telecom company, we are under FCC jurisdiction.
    Sorry for going on.
    Senator Reed. No, no. It is quite helpful. Thank you.
    Mr. Johnson, from your perspective, this issue of the level 
and identity of investors, sovereign wealth funds in 
particular, any comments?
    Mr. Johnson. Senator Reed, I would just promote the point 
that CalPERS advocates disclosure and transparency by investors 
at large. We try to lead by example. We try to advance this in 
the marketplace with the development of our own principles in 
this area.
    Senator Reed. Thank you.
    Let me shift gears for a moment. Professor Rose and Ms. 
Archibald, we have talked a lot about the Federal securities 
laws, the Change in Bank Control Act, the Bank Holding Company 
Act, but there are State laws which are implicated at certain 
times. Can you comment, Professor, first on any implications 
that State laws have with respect to these sovereign funds, or 
either what they are doing now or what they may do?
    Mr. Rose. Well, the only thing that I could offer that I 
think would be of value is if you were thinking about a 
sovereign wealth fund and worrying that they would be 
controlling a company--maybe it is at a level that falls under 
4.9 percent--I frankly would be concerned about whether 
fiduciary duties would be implicated, frankly, if they are 
acting as a controlling entity and, I suppose, pushing around a 
board. So from that angle, conceivably you could have State 
laws implicate. As far as perhaps insurance laws or other State 
regulations, I do not have as much experience, and I cannot 
offer any comments on those.
    Senator Reed. Thank you.
    Ms. Archibald, your perspective?
    Ms. Archibald. Yes, I would have to say the same thing. I 
am not aware of any specific State law that is directly aimed 
at sovereign wealth funds. Certainly for some of the sectors 
that we have talked about this morning that are subject to 
regulation generally, there are State regulations that must be 
adhered to at the time of a change in control or an acquisition 
by a foreign entity. But I am not aware of any that are 
specific to sovereign wealth funds.
    Senator Reed. Shifting back again to the Federal forum, 
last year we took action on the Foreign Investment and National 
Security Act, and it requires that Treasury propose new rules, 
which also talks about the definition of ``control.'' And under 
these regulations, the presumption is that 10 percent would be 
considered a controlling stake. Is that your view, Ms. 
Archibald? Or I do not want to--this is not a final exam.
    Ms. Archibald. No. Actually, I am glad you asked this 
question. I was discussing during the break that there has been 
a misunderstanding, I think, about the regulations that have 
been in effect for some time.
    It is not quite correct to say that there is a presumption 
that anything that is over 10 percent is controlling or that 
everything under 10 percent is not controlling. The test that 
has always been in the regulations but I think is clarified to 
a much greater degree in the proposal that was issued this week 
is that where an investment is at or below 10 percent and is 
purely for passive purposes, then the presumption is that there 
is not control.
    Now, the proposed regulations go on to make very clear that 
in order to be purely for passive purposes, there can be no 
action that is taken by the investor that would be inconsistent 
with a purely passive investment. And so, for example, it would 
appear that having a single board seat, even if there are no 
minority shareholder protections, even if there is no special 
class voting, et cetera, that that is an action that is 
considered inconsistent with a passive investment. That simply 
means then that the transaction is appropriate for review by 
CFIUS. They may still determine that it is not a controlling 
share, but it is certainly a reviewable transaction.
    Senator Reed. Well, that circles back to the point that 
Professor Rose suggested, that on the other side of the 
transaction, if, in fact, an investor disregards the passive 
nature, there would be a duty by the directors and the 
management to resist any measures like that to publicize them. 
Do you think that would be, you know, under standard corporate 
law where the fiduciary duty is to ensure--or is there no duty 
on the other side of the transaction?
    Ms. Archibald. I do not want to hold myself out as an 
expert on all the rules that apply to public corporations, but 
certainly in any instance in which an investment was made with 
the approval of the other shareholders of the company that was 
purely for passive purposes and there is behavior that is 
inconsistent with that, I would certainly expect the management 
of the company to share that information with the rest of the 
board and to determine what action, if any, was appropriate and 
available.
    Senator Reed. I have exhausted my questions, but I do not 
see the Chairman. So I hesitate to stand in recess for a 
moment.
    We are trying to clarify his--I have guidance that we 
should stand in recess for a moment. But don't mill around. 
Hopefully he will be here in a moment. Thank you. The Committee 
stands in recess.
    [Recess.]
    Senator Reed. Just if I may for a moment reconvene the 
hearing, Senator Dodd has just informed the staff that he is 
unable to return. So I want to thank all of you on behalf of 
the Chairman and the Ranking Member, Senator Shelby, and all of 
my colleagues for your testimony and for your participation 
today and for your good work outside this hearing room. Thank 
you very, very much.
    The hearing is adjourned.
    [Whereupon, at 1:01 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ETHIOPIS 
                             TAFARA

                 CONCERN OVER SWF SIZE AND SEC CAPACITY

Q.1. Mr. Tafara, there is a wide range in market participants 
from the small single investor all the way to multi-billion 
dollar sovereign wealth funds.
    Does the SEC take any particular steps to address this 
broad range and do you have any concerns that, as sovereign 
investors grow larger, the task of policing the markets will 
grow more difficult?

A.1. In general, the federal securities laws do not distinguish 
among investors due to their size, but rather offer the same 
protections to and impose the same obligations on each 
investor, regardless of the amount of assets it has or its 
sophistication.

Holdings in relation to an issuer

    The federal securities laws impose disclosure requirements 
on investors once their interest in a given issuer reaches a 
certain size. For example, beneficial owners of more than 5% of 
a voting class of an issuer's registered equity securities are 
required to file a Schedule 13D. This disclosure schedule must 
be filed within 10 days of the purchase and is designed, among 
other things, to disclose possible takeover attempts of an 
issuer. Schedule 13D also requires the beneficial owner of the 
securities to disclose the source and amount of funds being 
used to purchase the shares, and announce whether the purpose 
of the purchase is to acquire control as well as any plans or 
proposals with regard to future actions by the purchaser.
    Instead of reporting beneficial ownership of more than 5% 
of a voting class of an issuer's registered equity securities 
on Schedule 13D, certain types of beneficial owners are 
eligible to report their holdings on the abbreviated ``short-
form'' Schedule 13G. These investors are commonly referred to 
as Qualified Institutional Investors or Passive Investors. When 
filing a Schedule 13G, an investor must certify that the 
securities were not acquired and are not held with the purpose 
or with the effect of changing or influencing control of the 
issuer. Depending on the facts and circumstances, beneficial 
owners who report their holdings on Schedule 13G must file that 
disclosure schedule in as few as 10 days from the date of 
acquisition or as many as 45 days at the end of the calendar 
year to the extent their holdings exceeded 5% on the last day 
of that calendar year.
    The federal securities laws also require beneficial owners 
of more than 10% of a voting class of registered equity 
securities to file a Form 3 to disclose their share ownership, 
and a Form 4 if the amount of share ownership changes. Form 3 
is due within 10 days of becoming a 10% beneficial owner and 
Form 4 is due within 2 business days after the transaction that 
causes a change in beneficial ownership.

Holdings in relation to the market

    Investors in U.S. exchange-traded equities are required to 
file Form 13F reports once the size of their discretionary 
assets under management reaches a certain amount. Exchange Act 
Section 13(f) requires institutional investment managers that 
exercise investment discretion over accounts holding registered 
securities, the aggregate fair market value of which is $100 
million or more, to file quarterly reports of their holdings in 
SEC-registered securities within 45 days of a quarter's end.

Enforcement

    With regard to whether policing the markets will become 
more difficult as sovereign wealth funds grow larger, the SEC 
has a variety of tools with which to enforce the federal 
securities laws that allow it to be an effective regulator 
despite constant evolution in the capital markets. These tools 
include strong ties with securities regulators around the world 
that facilitate gathering evidence located abroad, thus 
allowing the Commission to pursue wrongdoing even if the 
perpetrators are outside U.S. borders. Even if another 
government is recalcitrant in its cooperation, illegal 
activities such as market manipulation and insider trading 
generally leave sufficient evidence in the United States that 
the SEC can proceed with its enforcement duties.

         SWF HOLDINGS OF U.S. EXCHANGE-TRADED EQUITY SECURITIES

    Mr. Tafara, in your testimony you point out that 
institutional investment managers who control more than $100 
million of U.S. exchange-traded securities must file Form 13F 
at the end of each calendar quarter, which requires a manager 
to disclose the name of each reportable issuer, the number of 
shares, and the market value of the manager's portfolio.
Q.2.a. How active is the SEC's oversight with respect to 
ensuring adherence to the disclosure requirements of the 
Securities Laws?

A.2.a. There are over 12,000 companies that are registered with 
the SEC. SEC staff regularly reviews the filings of those 
companies, as mandated by the Sarbanes-Oxley Act. SEC staff, 
primarily in the Division of Enforcement and the Division of 
Corporation Finance, relies on a variety of public sources of 
information about registered companies for purposes of 
conducting surveillance for compliance with the US federal 
securities laws. In addition, the staff receives, on a 
continuous basis, information provided from nonpublic sources, 
such as investor or issuer complaints and tips from purported 
insiders or other sources. For example, in the context of proxy 
contests or hostile tender offers, issuers and other investors 
are the Commission's most common source of information about 
undisclosed shareholdings. Information indicating a material 
non-compliance with SEC disclosure requirements could become 
the basis of an SEC investigation. Once the SEC undertakes an 
enforcement action, depending on the facts and circumstances, 
it can seek various remedies, including enjoining further 
violations of the federal securities laws and imposing fines.
    The SEC has taken action against institutional investment 
managers for not complying with Section 13(f) disclosure 
requirements. In 2007, the SEC brought actions against two 
funds for not complying with Section 13(f) reporting 
requirements, among other things. In August 2007, the SEC filed 
an administrative action against Quattro Global Capital LLC, a 
registered investment adviser that failed to file Form 13F 
reports for a period of five years.\1\ This failure to file was 
discovered as a result of an inspection of Quattro by the SEC's 
Office of Compliance Inspections and Examinations. Quattro 
agreed to a cease-and-desist order against further violations 
of the federal securities laws, as well as to pay a fine of 
$100,000. In a separate matter, also in 2007, the SEC filed a 
claim against two persons, Scott Sacane and J. Douglas Schmidt 
for their failure to file Form 13F reports and other disclosure 
documents in connection with their alleged fraudulent schemes 
concerning the purchase and sale of the common stock of two 
biotechnology companies.\2\

    \1\ In the Matter of Quattro Global Capital, LLC, ADMINISTRATIVE 
PROCEEDING File No. 3-12725; 2007 SEC Lexis 1807 (August 15, 2007). The 
SEC administrative proceeding release on this matter is located at 
http://www.sec.gov/litigation/admin/2007/34-56252.pdf. 
    \2\ SEC v. Scott R. Sacane, et al., Civil Action No. 3:05cv1575-SRU 
(D. Conn., filed October 12, 2005); 2007 SEC Lexis 1929 (August 19, 
2007). The SEC litigation release on this matter is located at http://
www.sec.gov/litigation/litreleases/2007/1r20258.htm. 

Q.2.b. Are there any sovereign investors, either sovereign 
wealth funds or state-owned enterprises, which file a form 13F 
---------------------------------------------------------------------------
and if so, which entities are they?

A.2.b. Through the SEC's Electronic Data Gathering and 
Retrieval system (EDGAR), a search can be conducted on any 
identified sovereign wealth fund or state-owned enterprise. 
This search would show all of the public filings that each 
entity has made, including Form 13F reports. We are aware of 
some sovereign wealth funds that have filed Form 13F reports, 
including the following:

      Norges Bank (Norway)

      Temasek Capital (Private) Ltd. (Singapore)

      Temasek Holdings (Private) Ltd. (Singapore)

    Please note that this list may not be complete for the 
following reasons: (1) There is no SEC requirement that 13F 
filers identify themselves either as sovereign wealth funds or 
state-owned enterprises. (2) Sovereign wealth funds and state-
owned enterprises would be required to file Form 13F only if 
they manage their assets themselves. If they hire other 
entities to manage their assets, those entities would be 
required to file Form 13F if they meet the criteria of Section 
13(f) of the Exchange Act. However, those entities are not 
required to name their clients. (3) There are a large number of 
entities that have filed Forms 13F, most of which are not 
sovereign wealth funds or state-owned enterprises. Because Form 
13F filers identify themselves only by name and address, a 
systematic search of EDGAR's Form 13F database for sovereign 
wealth funds, state-owned enterprises, or any other category of 
filer is impracticable.
    In the past, the SEC staff has undertaken efforts to 
contact large private funds with US investments that had not 
filed Form 13F reports. The purpose of this exercise was to 
determine whether these funds should be filing Form 13F 
reports, and, if so, to bring them into compliance. Based on 
the staff's experience with these funds, we believe it is 
possible that some sovereign wealth funds may not be aware of 
their Form 13F reporting obligation. SEC staff is weighing 
various options for addressing sovereign wealth funds' 
compliance with Form 13F reporting requirements.

              RECORD OF SETTLED SOVEREIGN INVESTMENT CASES

Q.3. Mr. Tafara, the Committee is aware of the inability of SEC 
staff to comment on the substance of any issue where there may 
be an ongoing investigation or enforcement action. I would like 
to ask however, about completed and settled cases.
    Do you know of examples of any sovereign investor or state-
owned enterprise that has been implicated in an enforcement 
action in the past?

A.3. We cannot report any recent SEC enforcement action against 
a sovereign investor or state-owned enterprise. Below are two 
matters in which the SEC brought actions against state-owned 
enterprises for making unregistered offers of bonds in the 
United States:

      In 1992, the SEC brought an administrative 
proceeding against the State Bank of Pakistan in In the Matter 
of State Bank of Pakistan \3\ for violations of Section 5(c) of 
the Securities Act of 1933. The State Bank of Pakistan had 
offered bearer bonds in the United States without registering 
them with the Commission. This action was settled after the 
State Bank of Pakistan withdrew the offer and the SEC 
instituted a cease-and-desist order against further violations 
of Section 5 of the Securities Act.
---------------------------------------------------------------------------
    \3\ Securities Act of 1933 Release No. 6937; 1992 SEC LEXIS 1041; 
50 S.E.C. 980 (May 2, 1992).

      In 2001, the SEC brought an administrative 
proceeding against the State Bank of India in In the Matter of 
The State Bank of India and Citibank, N.A.,\4\ also for 
violations of Section 5(c) of the Securities Act. This action 
was in response to an unregistered US offering of bonds made by 
the State Bank of India in 1998. In a settled action, the 
Commission ordered the State Bank of India to cease and desist 
from further violations of Section 5 of the Securities Act.
---------------------------------------------------------------------------
    \4\ Securities Act of 1933 Release No. 8036; 2001 SEC LEXIS 2430 
(Nov. 19, 2001). The SEC administrative proceeding release on this 
matter is located at http://www.sec.gov/litigation/admin/33-8036.htm.
---------------------------------------------------------------------------
                                ------                                


 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM PAUL ROSE

             U.S. APPROACH TO REGULATING FOREIGN INVESTMENT

Q.1. The U.S. Government has pursued a transaction and sectoral 
based system of regulation for sovereign investment, rather 
than regulating types of investors.
    I would like each of the witnesses to comment on the merits 
of this approach and any concerns you may have.

A.1. I believe that the general transaction and sectoral based 
system of regulation, as applied to all types of investors, has 
provided a strong framework that has served companies, 
investors and consumers well. However, sovereign investments do 
not fall neatly into the regulatory framework and often present 
risks that are not present with most other types of investment. 
Nevertheless, it is my opinion that the existing regulatory 
structure, as recently buttressed through the Foreign 
Investment and National Security Act, is flexible enough to 
address these risks. However, improvements could be made in the 
implementation of the existing regulations. For example, I am 
concerned that the sectoral focus does not provide a holistic 
view of a sovereign's investment in U.S. enterprises. The 
judgment of an agency with regard to a particular transaction 
could be affected if the agency were aware of the various 
investments that were approved by other agencies. To my 
knowledge, there is no formal mechanism (except to the extent 
certain agencies coordinate through CFIUS) to ensure that 
information is shared between all agencies, and that this 
information is relied upon in making judgments about the 
propriety of particular sovereign investments. At a minimum, a 
central repository of such information would be helpful for 
agencies, CFIUS and Congress in regulating sovereign 
investment.
    With respect to regulating types of investors rather than 
regulating transactions, I have two concerns specific to the 
application of such a system to investment by sovereign wealth 
funds. First, sovereign wealth funds vary widely in their 
investment objectives, risk management systems and 
transparency. Regulating all investors of a given type in the 
same way would seem to apply blunt force where precision is 
needed; that precision is more likely achieved through a 
transaction-by-transaction approach.
    Second, there are real risks that investor-specific 
regulation would raise the regulatory burden on sovereign 
wealth funds without correspondingly increasing the benefits of 
regulation beyond those provided by the existing framework. For 
example, imposing rules for fund governance (which would most 
likely be a feature of sovereign wealth fund-specific 
regulation) would likely drive funds to less-regulated 
jurisdictions where we would have even less information on and 
regulatory authority over their activities than we do under our 
present regulatory system. A useful illustration of this 
possibility is California's recent efforts to regulate hedge 
funds. Proposed legislation in California would have required 
registration of hedge funds if the funds were not already 
registered with the Securities and Exchange Commission. 
California abandoned the proposed legislation earlier this 
month for a variety of reasons, but certainly among them was 
the fact that California's legislators ultimately recognized 
that hedge funds would simply move to other jurisdictions like 
Connecticut and New York, and that California would lose the 
benefits of the hedge funds' operations within its borders.
    For these reasons, I believe that we should address 
concerns in the present system not by replacing regulation, but 
instead continuing to ensure that the existing regulation works 
as intended by Congress. As noted above, this effort should 
include inter-agency information-sharing and coordination.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM DAVID 
                            MARCHICK

             U.S. APPROACH TO REGULATING FOREIGN INVESTMENT

Q.1. The U.S. Government has pursued a transaction and sectoral 
based system of regulation for sovereign investment, rather 
than regulating types of investors.
    I would like each of the witnesses to comment on the merits 
of this approach and any concerns you may have.

A.1. This answer is partially drawn from a paper that Matt 
Slaughter, Assistant Dean of the Tuck School of Business, and I 
have written for the Council on Foreign Relations.
    Based on my experience, CFIUS examines a number of factors 
when evaluation the national security threats (or lack thereof) 
associated with a particular investment. CFIUS considers the 
origin of the investment, the individuals that control the 
foreign entity, past compliance with U.S. laws and regulations 
by the foreign investor, the sensitivity of the asset being 
acquired and the ability of the U.S. government to mitigate any 
national security concerns.
    Some countries, including the United States and (if it 
adopts its new draft law) Germany, use broad-based national 
security review mechanisms without identifying specific sectors 
for which reviews are required. Other countries, including 
France and Russia, have chosen a sector-based approach in which 
they identify the sectors that require government approval for 
foreign takeovers.
    There are benefits and drawbacks to each approach. Sector-
based lists can provide a measure of clarity and predictability 
for foreign investors because they know with certainty whether 
an investment requires pre-approval. In the United States, the 
lack of a sector-based list leaves some investors and their 
advisors guessing as to which transactions should be filed with 
CFIUS. FINSA, the new statues governing CFIUS, makes clear that 
foreign investments in ``critical infrastructure'' are within 
the scope of CFIUS reviews. Yet the statute does not define 
critical infrastructure, and in four different reports in 
recent years the Department of Homeland Security has used four 
different definitions. On the other hand, publishing a sector-
based list is very difficult for regulators because the facts 
and circumstances in which a foreign investment may raise 
national security issues vary significantly. Moreover, the 
ever-increasing complexity of global business structures makes 
it very hard to apply clear ex-ante lists to actual 
transactions. In practice, then, a list that is intended to 
boost investor certainty can end up actually reducing it. 
Overall, the possible investor-certainty benefit of sector-
based lists is outweighed by the practical implementation 
problems of sensibly creating and applying these lists. 
Accordingly, a better approach is for countries not to create 
such lists. If a government does choose to create a sector-
based list, however, it should be tailored to those 
transactions that are at the core of a government's national 
security interests. When drafting a sector-based list, 
regulators--who tend to be cautious and conservative in the 
first place--may be inclined to draft an extremely broad list 
that covers every conceivable transaction that could raise 
national security issues. This tendency should be resisted. For 
example, while foreign investments in energy have become more 
sensitive and of greater interest to governments in Europe, 
Asia and North America, not all energy investments are 
sensitive. A government has a keen and legitimate interest in 
regulating nuclear energy, including who owns a nuclear energy 
company. Alternatively, it is hard to see how a foreign 
investment in, for example, a wind farm could raise national-
security issues. Thus, instead of deeming energy as a broad 
sector of interest to government regulators, it would be better 
to identify, as narrowly as possible, those specific subsectors 
that raise national security concerns.
                                ------                                


  RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM DENNIS 
                            JOHNSON

             U.S. APPROACH TO REGULATING FOREIGN INVESTMENT

Q.1. The U.S. Government has pursued a transaction and sectoral 
based system of regulation for sovereign investment, rather 
than regulating types of investors.
    I would like each of the witnesses to comment on the merits 
of this approach and any concerns you may have.

A.1. CalPERS does not have a policy position on the U.S. 
Government's system of regulating sovereign investments.
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