[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
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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
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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
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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.
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\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.
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\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.
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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.
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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.
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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.