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


 
  FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL 
                               YEAR 2008

                              ----------                              


                        WEDNESDAY, MAY 16, 2007

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 3:07 p.m., in room SD-192, Dirksen 
Senate Office Building, Hon. Richard J. Durbin (chairman) 
presiding.
    Present: Senators Durbin, Brownback, and Allard.

                   SECURITIES AND EXCHANGE COMMISSION

STATEMENT OF HON. CHRISTOPHER COX, CHAIRMAN

                 STATEMENT OF SENATOR RICHARD J. DURBIN

    Senator Durbin. Good afternoon. This hearing will come to 
order.
    I am pleased to convene this session before the Financial 
Services and General Government Appropriations Subcommittee. 
Our focus today is on the President's fiscal year 2008 budget 
request for the Securities and Exchange Commission (SEC). In 
previous years funding for this agency was provided through the 
Commerce, Justice, and State, the Judiciary Subcommittee. It 
now has a new home in the Senate Financial Services 
Subcommittee.
    I welcome my colleague Senator Allard who has joined me and 
others who may arrive. Appearing before the subcommittee this 
afternoon is the Chairman of the SEC, the Honorable Chris Cox. 
Welcome, Chairman Cox. Glad to have you here, my former 
colleague from the House.
    The mission of the SEC is to administer and enforce Federal 
securities laws, to protect investors, and maintain fair, 
honest, and efficient markets. This includes ensuring full 
disclosure of financial information, regulating the Nation's 
security markets, and preventing and policing fraud and 
malpractice in the securities and financial markets.
    The administration's budget proposal for fiscal year 2008 
seeks $905.3 million for the SEC. This is a 2.7-percent 
increase, $23.7 million over the fiscal year 2007 spending 
level. The $905.3 million includes $30.3 million in carryover 
balances.
    It is interesting and important to note that the entire 
amount of the SEC budget authority is derived from the 
collection of fees, fees that are collected and deposited in 
special offset accounts, available to appropriators, not to the 
Treasury's general fund. As a result of these fee collections, 
no direct appropriations are used to fund the SEC.
    The proposed funding level of $905.3 million is similarly 
structured: $648.5 million designated for enforcement, $59.4 
million for regulatory function, $126 million directed to 
disclosure reviews and investor education, and $71.4 million 
for operations.
    I would like to invite my colleague Senator Allard, if he 
would like, to make an opening remark at this point.

                   STATEMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, thank you. I would like to 
make a brief remark if I might. I want to thank you for holding 
this hearing.
    Currently the securities and financial markets of the 
United States are thriving and investors are enjoying the 
longest bull run in over 80 years. The Dow Jones Industrial 
Average has recorded 22 record closes since the start of the 
year and the S&P 500 is 24 points below its record close it set 
in March 2000. The Dow is no longer showing lingering effects 
of the 416-point drop it suffered on February 27 and the U.S. 
economy is continuing to expand and is adding jobs.
    With more than one-half of American families investing in 
the securities market, it is vital to our Nation's economic 
health that we enjoy fairness, integrity, and efficiency in the 
marketplace.
    I would like to take this time to welcome my good friend 
and former colleague, Chairman Cox, whose responsibility it is 
to uphold the SEC's mission to protect investors, maintain 
fair, orderly, and efficient markets, and facilitate capital 
formation. I am used to seeing Chairman Cox testify before the 
full Senate Banking Committee, but I welcome him here and this 
opportunity to discuss important issues involving the SEC.
    We will be holding a hearing tomorrow, Mr. Chairman, in the 
authorizing committee on the consolidation of the National 
Association of Securities Dealers (NASD) and the New York Stock 
Exchange (NYSE) regulatory functions. I would like to thank 
you, Chairman Cox, for allowing a member of the SEC to testify 
in front of that committee on this matter.
    Again, Mr. Chairman, thank you for holding today's hearing. 
I look forward to hearing Chairman Cox's testimony and working 
with him and the SEC as a member of this subcommittee and as 
the ranking member of the Securities and Insurance and 
Investment Subcommittee.
    Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Allard.
    I want to just join in noting that the stock market has 
been doing very well and I hope there is nothing we will do 
here today that will change that.
    I turn now to Chairman Cox for your presentation. Welcome, 
Mr. Chairman.

                  SUMMARY STATEMENT OF CHRISTOPHER COX

    Mr. Cox. Thank you very much, Chairman Durbin. I know that 
Ranking Member Brownback will perhaps be here soon. Senator 
Allard. It is a pleasure to testify before you today. Thank you 
for giving me this opportunity to engage in some sharing of 
information about our budget request for fiscal 2008.
    Before I begin, I would like to congratulate you, Mr. 
Chairman, on assuming this new role. I am very, very pleased 
and looking forward to working with you.
    As you know, we are requesting $905.3 million for the SEC 
in 2008, and that represents an increase, as you noted, Mr. 
Chairman, over fiscal year 2007 that will allow the SEC to 
continue the important initiatives underway to protect and 
inform investors. These initiatives all have in common that 
they are aimed at benefiting the average retail customer, whose 
savings are dependent on healthy and well-functioning markets.
    Since I became Chairman I have worked to reinvigorate the 
agency's focus on the ordinary investor. This is the SEC's 
traditional responsibility. Back in Joe Kennedy's day, our 
first SEC Chairman could marvel that 1 in 10 Americans owned 
stocks. Today one-half of Americans own securities, and the 
median income for shareholders is a very middle class $65,000.
    When you then consider all the teachers, the Government 
employees, and the workers in other industries who have 
pensions, it becomes clear that nearly all taxpayers have a 
personal interest in fair and honest securities markets. In 
fact, when one considers the staggering growth in Americans' 
participation in the market, the enormity of the SEC's task 
becomes apparent. About 3,600 staff at the SEC are responsible 
for overseeing over 10,000 public companies, investment 
advisers that manage over $32 trillion in assets, nearly 1,000 
fund complexes, 6,000 broker-dealers with 172,000 branches, and 
the $44 trillion worth of trading conducted each year on 
America's stock and options exchanges.
    These daunting numbers make it clear that, even if the SEC 
budget were to double or to triple, the agency would have to 
carefully set priorities. That is exactly what we are doing in 
our proposed budget for fiscal 2008.
    Our risk-based and flexible approach to our examination 
program is permitting us to focus the agency's energies on the 
particular marketplace practices that are most likely to be 
high risk and on the particular investment advisers and mutual 
funds that are most likely to be sources of trouble. It also 
provides the basis for the selection of targets for 
comprehensive exam sweeps on crosscutting issues that could 
present a significant threat to investors, and it drives the 
SEC's enforcement, rulemaking, and disclosure reviews as well. 
In each case, the objective is to apply the taxpayers' 
resources in ways that make the most significant positive 
contribution to investor protection.
    If I may, Mr. Chairman, I would like to point out some of 
the major areas in which the SEC is currently focusing its 
energies. Our most important initiatives begin with our focus 
on fighting fraud against seniors. There are an estimated 75 
million Americans who will turn 60 over the next 20 years, and 
they are going to live longer than any generation before them. 
As the baby boomers turn 60, that is 10,000 of them every day 
for the next 20 years, they will need to continue to actively 
manage their investments for higher yield over their longer 
lifetimes. It was not that way with their parents.
    Rather than switching into low-yield safe investments as 
their parents did, they are going to have to be active managers 
overseeing their returns to provide for a much longer lifetime. 
That is going to have enormous consequences for our capital 
markets.
    Households today led by people over 40 already own 91 
percent of America's net worth; and, as the baby boomers 
retire, very quickly the vast majority of our Nation's net 
worth will be in the hands of our Nation's seniors. So 
following the Willie Sutton principle, scam artists are going 
to swarm like locusts over this increasingly vulnerable group 
because that is where the money is.
    Nearly every day, the SEC receives letters and phone calls 
from seniors and their caregivers who have been targeted by 
fraudsters. That is why the SEC has focused its energies in 
this area and why we have organized our fellow regulators and 
law enforcement officials at the first-ever national senior 
summit, here in Washington last July. This year's summit, the 
second annual, will integrate even more of our national 
resources, and it will take place in just a few months with our 
partners.
    We have developed a strategy to attack the problem from all 
angles. It includes aggressive enforcement, targeted 
examinations, and, very importantly, investor education. Over 
the past year the SEC's Division of Enforcement has brought 26 
enforcement actions specifically aimed at protecting elderly 
investors. Many of those were coordinated with State 
authorities.
    For example, the Commission coordinated with law 
enforcement authorities in California to crack down on a $145 
million Ponzi scheme that lured elderly victims, elderly would-
be investors, into workshops with the promise of free food and 
then bilked them out of their retirement money by purporting to 
sell them safe guaranteed notes. In another case we filed an 
emergency action to halt an ongoing securities fraud that 
targeted individuals' retirement funds.
    By focusing on free lunch seminars and dozens of other 
techniques that would-be fraudsters aim at seniors, the Federal 
Government is serving notice that there will be a special place 
in hell reserved for those who prey on the life savings of 
older Americans.
    Another important focus for the Commission is a program I 
know that is of significant interest to you, Mr. Chairman, and 
that is the agency's Office of Global Security Risk. As you 
know, this office, which is located in the Division of 
Corporation Finance, is responsible for monitoring companies' 
disclosures regarding their contacts with countries that have 
been identified by the State Department as State sponsors of 
terrorism and for coordinating with other Federal Government 
agencies to ensure the sharing of information that is relevant 
to that assessment.
    The office reviews Securities Act registration statements 
and Exchange Act filings whenever it appears that a company may 
have material contacts with countries that raise global 
security concerns, and it requires enhanced disclosure where 
appropriate.
    In the past year, the office issued comments to 
approximately 212 companies. The office conducts reviews both 
independently and in concert with the rest of the division's 
disclosure review staff. In reviewing companies' disclosures, 
the office draws upon a variety of data sources. It also 
coordinates with the Treasury's Office of Foreign Assets 
Control and Commerce's Bureau of Industry and Security.
    I appreciate the leadership of this subcommittee in 
ensuring that investors have the relevant information that they 
need to make informed investment decisions regarding the 
foreign activities of companies that they own, and I am 
confident that the Office of Global Security Risk is well 
positioned to continue fulfilling these vitally important 
responsibilities.
    Another priority for the Commission is ensuring that the 
money that is recovered in SEC settlements and court cases is 
distributed as quickly as possible to injured investors. The 
Sarbanes-Oxley Act in 2002 gave the SEC this new ``fair funds'' 
authority. Since then we have begun to develop a very 
considerable expertise in this area. When I became Chairman in 
2005, the SEC had completed the process of disbursing funds to 
investors in only a few cases. Since then we have returned over 
$1.7 billion in penalties and disgorgements to injured 
investors in significant cases, including WorldCom, Global 
Analysts Research, New York Stock Exchange Specialists, 
Hartford, and Bristol-Myers-Squibb.
    In addition, several large disbursements are pending and 
will be announced very shortly.
    To completely fulfill the vision that Congress wrote into 
Sarbanes-Oxley, however, will require a sustained effort to 
train professionals in this area. That is why I have ordered 
the creation of a new office that will work full time to return 
these funds to investors. The efforts of this new office will 
be aided by a new information system called Phoenix, that will 
more accurately track, collect, and distribute the billions of 
dollars in penalties and disgorgements that flow from our 
enforcement work. The efficiency of a dedicated tracking system 
will remove what has been a major hindrance in our efforts to 
quickly distribute fair funds.
    Another major initiative I want to bring to your attention 
holds great potential for investors. It is called interactive 
data. By using interactive data, we can give investors far more 
information in a far more useful form than anything they have 
ever gotten from the SEC before. In the very near future, 
investors will be able to easily search through and make sense 
of the mountains of financial data contained in current company 
disclosures.
    We are going to convert the SEC's current online system, 
called EDGAR (electronic data gathering analysis and retrieval 
system), from what is really now just a vast electronic filing 
cabinet into something that is truly interactive, a tool that 
lets an investor, an analyst, anyone, manage all of that 
information in ways that are truly useful to them. With a few 
clicks of the mouse, investors will be able to find, for 
example, the mutual funds with the lowest expense ratios, the 
companies within a particular industry that have the highest 
net income, or the overall trend in their favorite company's 
earnings.
    To take advantage of the capabilities of interactive data, 
the SEC is modernizing the entire EDGAR system; and, as part of 
this effort, the very new and different EDGAR will be renamed 
later in 2007. It came as a bit of a shock to viewers of the 
hit TV show ``24'' when Edgar bit the dust and it may take a 
while for people to get used to the new, improved EDGAR with a 
new name, but the effort will be supremely worthwhile.
    In all, the Commission is investing $54 million over 
several years to build the infrastructure to support widespread 
adoption of interactive data.
    Finally, I want to discuss a significant new responsibility 
that the SEC is undertaking this year to oversee credit rating 
agencies. As you know, in 2006 the Congress gave the SEC this 
new responsibility and new authority to register and inspect 
the Nation's credit rating agencies, including industry giants 
Standard and Poor's, Moody's, Fitch Ratings, and A.M. Best, as 
well as several other large, medium, and smaller current and 
potential industry participants.
    Because of congressional concern that the industry faces 
potential conflicts of interest, imposes barriers to entry for 
new rating agencies, and has failed to warn the market of such 
significant impending financial failures as Enron and WorldCom, 
even immediately before their collapse, the SEC is tasked with 
devoting significant manpower and resources to this area. Under 
the new law and the SEC's proposed implementing rules, credit 
rating agencies will be required to register with the 
Commission. In addition, they will be required to submit to 
periodic inspections to ensure that they are implementing 
policies to mitigate conflicts of interest, prevent leaks of 
material nonpublic information, and to refrain from coercive or 
unfair practices.
    The SEC takes this new responsibility very seriously. We 
remain committed to finalizing the new rules before the 
statutory deadline, and we are assembling a team of staff to 
oversee the program and begin conducting inspections over the 
next several months.
    So with that background, Mr. Chairman, that brings us to 
our requested budget increase for fiscal 2008. That level will 
permit us to continue our ongoing hiring to reach a level of 
approximately 3,600 full-time staff. This level of personnel 
strength, which as you know is 21 percent higher than in 2001, 
will permit the agency to vigorously pursue its mission and 
maintain strong regulatory, enforcement, examination, and 
disclosure review functions. It will also allow the SEC to 
continue our commitment to information technology.
    In addition to the SEC's interactive data initiative, the 
SEC is deploying new systems to better manage enforcement and 
examination programs. We are using new techniques and new 
technology to help make our existing staff more productive. 
There is absolutely no question that these technology 
improvements will make the SEC more productive and give 
investors and taxpayers more value for the money.
    Over the last 2 years, the SEC has made tremendous progress 
in improving its operations. This fiscal 2008 request will 
permit us to continue improving the agency's internal financial 
controls. The SEC has poured tremendous energy into this area 
since I have been Chairman. As you know, a few years before I 
joined the SEC, the agency began to publish audited financial 
statements. I am pleased to report that for the first time in 
its history the SEC last year received a clean opinion of its 
audited financial statements for 2006, with no material 
weaknesses in internal controls. That is vitally important, Mr. 
Chairman, because the SEC must set an example not only for 
other Federal agencies, but also for the many public companies 
whose financial statements and disclosures we review.
    For this reason, we plan to continue upgrading the agency's 
financial system and to beef up security over our information 
security.
    The largest single application of our requested budget 
increase will be to fund pay raises for SEC staff that will 
average between 5 percent and 6 percent next year. These 
healthy increases are in accordance with the SEC's pay parity 
authority and our collective bargaining agreement. I should 
point out, Mr. Chairman, the fact that cost-of-living 
adjustments, career ladder promotions, and merit pay increases 
that are essentially built into our system amount to between 5 
and 6 percent each year. That is a challenge for the SEC and 
for this subcommittee because two-thirds of our budget is 
personnel; and, if two-thirds of our budget is growing each 
year automatically by as much as 6 percent, then the agency's 
total budget has to increase by 4 percent just to maintain 
personnel at a steady state from year to year.
    The final and most important reason that the SEC needs the 
budget increase that we are requesting is to provide the tools 
that we need to address emerging risks in the Nation's capital 
markets, including not just known areas of concern, such as 
hedge fund insider trading, the safety and security of 401(k) 
plans, and fraud in the municipal securities market, but also 
threats to market integrity and investor confidence that have 
yet to emerge.

                           PREPARED STATEMENT

    So I appreciate, Mr. Chairman, the opportunity to discuss 
with you the SEC appropriation for fiscal 2008. I look forward 
to working with the subcommittee on the best ways to meet the 
needs of our Nation's investors. I would be happy to take your 
questions.
    Senator Durbin. Thank you very much, Chairman Cox.
    [The statement follows:]

                 Prepared Statement of Christopher Cox

    Chairman Durbin, Ranking Member Brownback, and Members of the 
Subcommittee: Thank you for the opportunity to testify today about the 
Securities and Exchange Commission's budget request for fiscal year 
2008.
    Before I begin, I would like to congratulate you, Mr. Chairman, on 
your new role as head of this subcommittee. I look forward to working 
with you and all the members of this subcommittee for the benefit of 
the nation's investors.
    As you know, the President's budget requests $905.3 million for the 
SEC in 2008. I fully support this request for increased funding over 
fiscal year 2007, which will allow the SEC to continue the important 
initiatives underway to protect and assist the average investor.
    These initiatives all have in common that they are aimed at 
benefiting the average retail customer whose savings are dependent on 
healthy, well-functioning markets. Since I became Chairman, I have 
worked to reinvigorate the agency's focus on the ordinary investor. 
This is the SEC's traditional responsibility. Back in Joseph Kennedy's 
day, our first SEC Chairman was amazed that ``one person in every ten'' 
owned stocks. But today, more than half of all households own 
securities, and the median income for shareholders is a very middle-
class $65,000. When you then consider all of the teachers, government 
employees, and workers in other industries who have pensions, it 
becomes clear that nearly all taxpayers have a personal interest in 
fair and honest securities markets.
    In fact, when one considers the staggering growth in Americans' 
participation in the markets, the enormity of the SEC's task becomes 
apparent. About 3,600 staff at the SEC are responsible for overseeing 
more than 10,000 publicly traded companies, investment advisers that 
manage more than $32 trillion in assets, nearly 1,000 fund complexes, 
6,000 broker-dealers with 172,000 branches, and the $44 trillion worth 
of trading conducted each year on America's stock and options 
exchanges.
    These daunting numbers make it clear that, even if the SEC budget 
were to double or triple, the agency would have to carefully set 
priorities. That is exactly what we are doing in this proposed budget 
for fiscal year 2008. We must continue to think strategically about 
which areas of the market pose the greatest risk, and which areas of 
potential improvement hold the greatest benefit for investors. And 
given the fast changing conditions in America's and the world's capital 
markets, we must remain agile and flexible enough to redirect our 
resources with little notice.
    This risk-based and flexible approach guides the SEC's examination 
program as we focus the agency's energies on those practices in the 
marketplace, and those investment advisers and mutual funds, that are 
most likely to be high-risk. It also provides the basis for the 
selection of targets for comprehensive examination sweeps on cross-
cutting issues that could present a significant threat to investors. 
And it drives the SEC's enforcement, rulemaking, and disclosure review 
functions as well. In each case, the objective is to apply the 
taxpayer's resources in ways that provide the biggest investor 
protection bang for the buck.
    In recent years, the SEC has professionalized the culture of risk 
assessment that informs so many of our programs throughout the SEC. 
From relatively modest beginnings as a discrete office within the SEC 
established by my predecessor, William Donaldson, the risk assessment 
function is now wholeheartedly embraced in every major functional 
division and office of the agency.
    If I may, Mr. Chairman, I would now like to discuss some of the 
major areas in which the SEC is currently focusing its energies, in 
order to provide the maximum benefit to America's retail investors.

                     FIGHTING FRAUD AGAINST SENIORS

    As you know, an estimated 75 million Americans will turn 60 over 
the next 20 years. And they will live longer than any generation before 
them. As the Baby Boomers turn 60--more than 10,000 of them every day 
for the next 20 years--they will need to continue to actively manage 
their investments for higher yield over their longer lifetimes, rather 
than switching into low-yield, safe investments as their parents did. 
This will have enormous consequences for our capital markets. 
Households led by people aged 40 or over already own 91 percent of 
America's net worth. The impending retirement of the baby boomers will 
mean that, very soon, the vast majority of our nation's net worth will 
be in the hands of our nation's seniors.
    Following the Willie Sutton principle, scam artists will swarm like 
locusts over this increasingly vulnerable group--because that is where 
the money is. And it is already occurring. Nearly every day, our agency 
receives letters and phone calls from seniors and their caregivers who 
have been targeted by fraudsters.
    That is why the SEC has focused its energies in this area, and why 
we organized our fellow regulators and law enforcement officials at the 
first-ever Seniors Summit in July 2006. This year's Seniors Summit, 
which will integrate even more of our national resources, will take 
place in just a few months. With our partners, the SEC has developed a 
strategy to attack the problem from all angles--from aggressive 
enforcement efforts, to targeted examinations, to investor education.
    Fighting fraud against seniors means taking aggressive action. Over 
the past year, the SEC's Division of Enforcement has brought 26 
enforcement actions aimed specifically at protecting elderly investors. 
Many of these were coordinated with state authorities.
    For example, the Commission coordinated with law enforcement 
authorities in California to crack down on a $145 million Ponzi scheme 
that lured elderly victims to investor workshops with the promise of 
free food--and then bilked them out of their retirement money by 
purporting to sell them safe, guaranteed notes.
    In another case, we filed an emergency action to halt an ongoing 
securities fraud that targeted individuals' retirement funds. At 
``free'' dinner and retirement planning seminars, seniors were urged to 
invest their savings in non-existent businesses with promises of 
alluringly high rates of return.
    By bringing cases like these, and dozens more like them, the 
federal government is putting would-be fraudsters on notice that they 
will be caught and punished if they prey upon seniors.
    SEC examiners are also working closely with state regulators across 
the country to stop abusive practices before seniors are actually 
injured. With our state partners, we're sharing regulatory intelligence 
about abusive sales tactics targeting seniors, and conducting focused 
examinations of any firms whose practices raise red flags.
    For example, in Florida we initiated an examination sweep of firms 
selling investments to seniors, in cooperation with the State of 
Florida and the National Association of Securities Dealers. We 
subsequently expanded the sweep to include other states with large 
retiree populations--including California, Texas, North Carolina, 
Alabama, South Carolina, and Arizona. Working together with state 
securities regulators in those states, the NASD, and the NYSE, our goal 
is to see to it that the sales people at ``free lunch'' seminars are 
properly supervised by their firms, and that the seminars are not used 
as a vehicle to sell unsuitable investment products to seniors.
    Another tool in fighting securities fraud against seniors is 
education. These efforts are aimed not only at seniors, but also their 
caregivers--as well as pre-retirement workers, who are encouraged to 
plan for contingencies in later life. The SEC is expanding our efforts 
to reach out to community organizations, and to enlist their help in 
educating Americans about investment fraud and abuse that is aimed at 
seniors. We have also devoted a portion of the SEC website specifically 
to senior citizens (http://www.sec.gov/investor/seniors.shtml). The 
site provides links to critical information on investments that are 
commonly marketed to seniors, and detailed warnings about common scam 
tactics.

                          GLOBAL SECURITY RISK

    Another important area of focus for the Commission is a program of 
significant interest to you and other members of this subcommittee--the 
agency's Office of Global Security Risk. As you know, this office, 
which is located within the Division of Corporation Finance, is 
responsible for monitoring companies' disclosures regarding their 
contacts with countries that have been identified by the State 
Department as state sponsors of terrorism and coordinating with other 
federal government agencies to ensure the sharing of relevant 
information.
    The Office reviews Securities Act registration statements and 
Exchange Act filings whenever it appears that a company may have 
material contacts with countries that raise global security concerns, 
and pursues enhanced disclosure where appropriate. In the past year, 
the Office issued comments to approximately 212 companies. The Office 
conducts reviews both independently and in concert with the rest of the 
Division's disclosure review staff.
    In reviewing companies' disclosures, the Office draws upon a 
variety of data sources. The staff considers the information in a 
company's filings and information available from other sources. In 
addition, the Office continues to coordinate with other relevant 
federal agencies, such as Treasury's Office of Foreign Assets Control 
and Commerce's Bureau of Industry and Security.
    I fully support the goals of this office and believe its efforts 
are increasing the quality of information that investors receive 
regarding companies' contacts with countries identified by our 
government as state sponsors of terrorism. I appreciate the leadership 
of this subcommittee in endeavoring to ensure that investors have the 
relevant information they need to make informed investment decisions 
regarding the foreign activities of the companies that they own. And I 
am confident that the Office of Global Security Risk is well positioned 
to continue fulfilling these vitally important responsibilities.

                  RETURNING FUNDS TO WRONGED INVESTORS

    We at the SEC work diligently to uncover fraud against investors, 
gather the evidence needed to build a case, and then prosecute cases to 
bring fraudsters to justice. But our efforts do not end at the 
courthouse door. Once we succeed in convincing a court to order a 
penalty, we must ensure that as many of those dollars as possible go 
back into the hands of wronged investors as quickly as possible.
    Since the Sarbanes-Oxley Act created ``Fair Funds,'' through which 
penalties in SEC cases can be returned directly to injured investors, 
the SEC has begun to develop a considerable expertise in using this 
important new authority. At the time I became Chairman in 2005, this 
authority was only three years old, and the SEC had completed the 
process of disbursing funds to investors in only a few cases. Since 
then, we have returned over $1.7 billion to injured investors, 
including significant distributions from cases involving WorldCom, 
Global Analysts Research, New York Stock Exchange Specialists, 
Hartford, and Bristol-Myers Squibb. In addition, several large 
disbursements are pending and will be announced shortly.
    To completely fulfill the vision that Congress wrote into Sarbanes-
Oxley, however, will require a sustained effort within the Commission 
to train professionals in this area, to develop consistent practices, 
and to routinize the execution of the Fair Funds function. Too much 
money is still undisbursed because of the complexities of the process, 
leaving investors uncompensated.
    That is why I have ordered the creation of a new office that will 
focus the efforts of all of the SEC's offices around the country, and 
work full-time to return these funds to wronged investors. The creation 
of this specialized function within the SEC will ensure that investors' 
money is returned as quickly as possible, while minimizing the costs of 
the distributions.
    The efforts of this new office will be aided by a new information 
system, called Phoenix. The system will more accurately track, collect, 
and distribute the billions of dollars in penalties and disgorgements 
that flow from our enforcement work. The efficiency of a dedicated 
tracking system will remove what had been a major hindrance in our 
efforts to quickly distribute Fair Funds.
    The agency is taking other steps in this area as well. We are 
collaborating with the Bureau of the Public Debt to invest disgorgement 
and penalty funds in interest-bearing accounts. And we are working to 
consolidate funds from related cases into a single distribution, where 
appropriate, to potentially save investors hundreds of thousands of 
dollars.
    The SEC is dedicated to doing the very best job possible for 
investors in handling this responsibility. We know that you in the 
Congress, who entrusted us with this task, expect and deserve no less.

                            INTERACTIVE DATA

    Another major initiative I want to bring to your attention holds 
great potential for investors. By using what I call ``interactive 
data,'' we can give investors far more information, in far more useful 
form, than anything they've ever gotten from the SEC before. In the 
very near future, investors will be able to easily search through and 
make sense of the mountains of financial data contained in current 
company disclosures.
    For years, ordinary investors have been stymied by the time and 
effort it takes to separately look up each SEC filing for a single 
company they might own, and then to do that again and again for every 
additional company in which they're interested. Even once the right 
forms are located, wading through all of the legal gobbledygook to find 
the right numbers has been nearly impossible for the average retail 
investor.
    That is because the SEC's online system, know as EDGAR, is really 
just a vast electronic filing cabinet. It can bring up electronic 
copies of millions of pieces of paper on your computer screen, but it 
doesn't allow you to manage all of that information in ways that 
investors commonly need.
    Not surprisingly, financial firms--who can afford it--usually end 
up getting the bulk of their information about companies not from the 
SEC filings, but from middlemen all over the world who re-key the 
information in SEC reports and put it in more useful form. This process 
is expensive and inefficient, and it also creates errors in the data. 
Worse, it feeds the notion that the rich and the highly sophisticated 
have a leg up in today's markets.
    Interactive data will let any investor quickly focus on the 
disclosure they need. With a few clicks of the mouse, investors will be 
able to find, for example, the mutual funds with the lowest expense 
ratios, the companies within an industry that have the highest net 
income, or the overall trend in their favorite companies' earnings. It 
works by giving each piece of information a unique label, written in 
the eXtensible Business Reporting Language (XBRL) computer language.
    The agency has taken a variety of steps to expand the use of 
interactive data. First, the Commission created a voluntary program for 
companies and mutual funds to submit disclosures using XBRL, and 
offered expedited reviews of disclosures if firms agree to share their 
experiences with the agency. More than 35 companies, including some of 
corporate America's biggest names, are already participating in this 
program.
    Second, the SEC is working with outside groups to develop the 
standardized computer labels for different kinds of numbers that appear 
in financial statements. The collections of these labels for each 
industry--the so-called ``taxonomies''--will be completed in 2007. With 
the taxonomies available to every SEC registrant, we will have in place 
the basic building blocks of the universal language that explains the 
components of every firm's financial statements.
    Third, the agency is modernizing the entire EDGAR system to convert 
it to one based on interactive data. As part of this effort, the SEC 
expects to rename the EDGAR system in 2007.
    In all, the Commission is investing $54 million over several years 
to build the infrastructure to support widespread adoption of 
interactive data. Companies have told us that the costs of implementing 
XBRL are minimal, while the benefits are substantial. In addition to 
providing far more useful information to investors, we believe the use 
of interactive data will be more efficient for companies' internal 
processes, for their registration and compliance reporting to the SEC, 
and for the SEC's own disclosure reviews for regulatory and enforcement 
purposes.

                         CREDIT RATING AGENCIES

    Finally, I want to discuss a significant new responsibility that 
the SEC is undertaking this year to oversee credit rating agencies. 
This new role was given to the SEC by Congress last year.
    As you know, in 2006 the Congress gave the SEC both the 
responsibility and the authority to register and inspect the nation's 
credit rating agencies, including industry giants Standard & Poor's, 
Moody's, Fitch Ratings, A.M. Best, as well as several other large, 
medium, and smaller current and potential industry participants. 
Because of congressional concern that the industry faces potential 
conflicts of interest, imposes barriers to entry for new rating 
agencies, and has failed to warn the market of such significant 
impending financial failures as Enron and WorldCom even immediately 
before their collapses, the SEC is tasked with devoting significant 
manpower and resources to this area.
    Under the new law and the SEC's proposed implementing rules, credit 
rating agencies will be required to register with the Commission. In 
addition, they will be required to submit to periodic inspections to 
insure that they are implementing policies to mitigate conflicts of 
interest, prevent leaks of material non-public information, and refrain 
from unfair or coercive practices. The SEC takes this new 
responsibility very seriously. We remain committed to finalizing the 
new rules by the statutory deadline, and we will assemble a team of 
staff to oversee the program and begin conducting inspections over the 
next several months.

                          FISCAL 2008 REQUEST

    With all of this as background, I'll take just a moment to provide 
some useful detail about the President's budget request for fiscal year 
2008.
    As you know, the request is for $905.3 million. That will permit 
the agency to maintain its staffing levels from 2007. This level 
personnel strength, which as you know is significantly higher than five 
years ago, will permit the agency to vigorously pursue its mission and 
maintain strong regulatory, enforcement, examination, and disclosure 
review programs.
    This funding level will allow the SEC to continue its commitment to 
information technology, which has the potential both to reduce 
regulatory costs and to give investors vastly more useful information 
than what they receive today. In addition to the SEC's interactive data 
initiative, the SEC is deploying new systems to better manage 
enforcement and examination resources, to help us manage a higher level 
of enforcement activity at existing personnel and funding levels. There 
is absolutely no question that these technology improvements will make 
the SEC more productive, and give both investors and taxpayers better 
value for their money.
    Over the last two years, the SEC has made tremendous progress in 
improving its operations. The fiscal 2008 request will permit us to 
continue improving the agency's internal financial controls. The agency 
has poured tremendous energy into this area during my tenure as 
Chairman. I am pleased to say that these efforts have generated 
success: under the leadership of a new Executive Director, the SEC 
received a clean opinion on its audited financial statements for 2006 
and, for the first time, there were no material weaknesses in internal 
controls. This is vitally important, Mr. Chairman, because the SEC must 
set the example not only for other federal agencies, but for all public 
companies whose financial statements and disclosures we review. For 
this reason, the SEC will continue to upgrade its financial system, and 
to beef up security over its information systems.
    The President's budget request also will fund pay raises for SEC 
staff, in accordance with the SEC's pay parity authority and our 
collective bargaining agreement. This is a significant fact. Including 
cost-of-living increases, career-ladder promotions, and merit pay 
increases, these raises amount to between five and six percent each 
year. Given that from a budgetary standpoint the increases are 
essentially automatic, and given further that payroll represents about 
two-thirds of our budget, the agency's total budget has to increase by 
over 3.5 percent just to maintain personnel at a steady state from year 
to year.
    Finally, and most importantly, the level of funding in this budget 
request will give the SEC the tools we need to address new, emerging 
risks in the nation's capital markets--including not only such known 
areas of concern as hedge fund insider trading, the safety and security 
of 401(k) plans, and the quality of disclosure to protect against fraud 
in the municipal securities market, but also those threats to market 
integrity and investor confidence that have yet to emerge.

                               CONCLUSION

    Thank you for this opportunity to discuss the SEC appropriation for 
fiscal 2008. I look forward to working with you on the best ways to 
meet the needs of our nation's investors, and I would be happy to 
answer any questions you may have.

                   SIMPLIFYING INVESTMENT INFORMATION

    Senator Durbin. Let me ask you a few questions. Most 
Americans may come in contact with your agency when they 
receive quarterly reports on their mutual funds or stocks that 
they own, and I assume that the contents of those reports are 
monitored, regulated by the Securities and Exchange Commission. 
Is that correct?
    Mr. Cox. That is correct.
    Senator Durbin. I would dare say as an attorney with little 
business background beyond law school that I find these 
overwhelmingly boring and unintelligible. Has anyone at the 
Securities and Exchange Commission taken a look at the required 
disclosures to try to follow the model that you suggested for 
EDGAR, to bring this down to a level where it might have some 
value to the average person, to require in simple, 
understandable terms some fundamentals about mutual funds that 
we own or stocks that we own, things that we should be aware of 
in the most direct way?
    Mr. Cox. Absolutely, Mr. Chairman. You are singing our 
song; we are singing your song. You sound like the average 
American customer that the SEC is supposed to be serving. When 
I have a chance to address large audiences, I often ask them: 
When you get your proxy information or your annual report in 
the mail, the SEC-mandated disclosure for the mutual fund or 
the stock or the security that you own, do you rush to your 
comfortable chair and sit down, open it up and read it? Nobody 
raises their hand and says yes to that.
    I ask: How many of you--tell the truth--throw it away? And 
the whole room will raise their hand. I think the SEC has to be 
very concerned when the customers are throwing away the 
product.
    The whole point of this exercise is meant to serve ordinary 
investors. Now, we recognize that what is being described is 
complex, and sometimes there is some required complexity in 
fully disclosing what is going on. But there is also a lot of 
complexity that is getting in the way, that is making it hard 
for investors to understand this information. Increasingly, I 
think, as we move to web-based tools, we are going to find that 
we can layer this information so that there can be some clearly 
understandable information on top; and then, if you want to 
keep drilling down for hyper-technical detail, you can find it. 
That I think holds great promise.
    But, meanwhile, we are focused on plain English in all of 
the retail disclosures for which the SEC is responsible. We 
have a ways to go there, Mr. Chairman. I recognize that. But it 
is a top priority for the Commission in everything that we do.
    Senator Durbin. So let me ask you, do we have to change the 
law so that we can receive reports that are intelligible and of 
practical value to investors? Is it congressional 
responsibility or do you have the power at the SEC to say that 
these things that you are mailing to millions of investors all 
over America, should at least have in the first four or five 
pages in very plain English important information that they 
should know about the company that is involved in it?
    Mr. Cox. We definitely have the power to do this. We are 
doing it now very formally in rule. The executive compensation 
disclosure that investors are receiving for the first time this 
year, much more detailed information about what the boss makes 
than they have ever had before, must be by rule in plain 
English, and we are going to review these disclosures with that 
in mind.
    Senator Durbin. Good.

                         PRIVATIZING SALLIE MAE

    Now let me ask you about the proposed sale of Sallie Mae. 
This proposal suggests that it may be purchased largely by 
private entities, except for two banks. Chase and Bank of 
America, I believe, are involved in the proposed purchase of 
Sallie Mae. From the viewpoint of the public and especially 
students and their families, the current disclosures by Sallie 
Mae through SEC and other Federal agencies gives us an insight 
into how this agency is operating.
    Should we have concern that if this private sale goes 
forward there will be less information available about how the 
new entity is operating, how student loans are being handled, 
the compensation of officers, how it is being spent? What kind 
of disclosure level do you think there would be in this new 
entity that is proposing to buy Sallie Mae?
    Mr. Cox. Well, it is an excellent question. Obviously the 
Congress has a special interest and the public has a special 
interest in GSE disclosure. There has been voluntary disclosure 
that is meant to conform with the SEC requirements that apply 
to all public companies. There is nothing that would prevent 
that under any private ownership.
    Senator Durbin. But would it have to be voluntary? This is 
what I am getting to. When I have raised this question with one 
of the banks involved in the proposed sale they said: Well, we 
have so many things we are already disclosing; there will be 
more disclosure than you know what to do with. So I was trying 
to get to the bottom line. Current disclosure standards for a 
public corporation like Sallie Mae I would assume are at this 
level [indicating], and now that we have a private entity 
buying this public entity will the disclosures at least reach 
this level [indicating] of information and transparency?
    Is this something that maybe I could ask your staff to take 
a look at and give us some feedback?
    Mr. Cox. We are, as you can imagine, keenly interested 
ourselves, and I would be happy to continue to work with you on 
this.
    Senator Durbin. Good.

                            SUDAN DIVESTMENT

    Before I turn it over to my colleague here for a few 
questions, let me ask you about the situation in Sudan. I 
contacted you earlier this year about the divestment interest 
which I have in order to put pressure on the Sudanese 
government to finally respond to the genocide in Darfur, which 
has been acknowledged by this administration. After receiving 
some information from your Commission--there was a list of some 
16 companies--it turns out that that is only a fraction of the 
actual activity that goes on in Sudan.
    When we asked your staff why we did not have more 
information, we were told that the SEC can only compile such a 
list based on available information and such a list is obsolete 
almost as soon as it is created since companies shift 
operations continuously. So we are now working with Treasury 
and the State Department to create stronger reporting 
requirements to the SEC so that better information is 
available.
    Before I ask you the specific question, I would like to add 
a footnote to that. There has been a great deal said recently 
by myself and others about Fidelity, a major brokerage company 
which it has been alleged has large holdings in PetroChina, the 
largest oil company in Sudan. You may have seen some ads on 
television and in publications. We were informed today it has 
been announced that Fidelity has sold at least 30 percent of 
the $1.1 billion in Hong Kong-listed PetroChina shares held as 
of December last year. We are still looking into it to 
determine how much they have divested.
    But going back to my earlier point, if we are looking for 
companies like Fidelity and others doing business in Sudan, 
what do you recommend that we do to ensure the SEC can collect 
the kind of data that makes our effort more likely to succeed?
    Mr. Cox. As you know, Mr. Chairman, your efforts, which we 
have been assisting, I think are properly aimed at a universe 
that is larger than just U.S.-listed companies, and the 
PetroChina example that you gave--PetroChina did not appear on 
the list that we provided of our registrants for the simple 
reason that it was not a U.S.-listed company. That is, the 
subsidiary listed in the United States did not have material 
contacts in Sudan and the parent, PetroChina, is not a U.S.-
listed company. Because of the U.S. sanctions regime, not very 
many listed U.S. companies are the entities that themselves 
have the material contacts.
    So I think, if we are after the information that you seek, 
we need to broaden our horizons a little bit. Although the SEC 
can be very helpful in this regard, and I know that you are 
also working with the Treasury Department and the State 
Department, I think a multiagency effort is the best way to go.
    Senator Durbin. Well, I hope we can find that information, 
because I think at a minimum if Americans who are concerned 
about the issue are alerted to those companies that are doing 
business in Sudan and have a choice as consumers and investors 
to act accordingly that is the best we can do at this moment in 
time. We need to have a more robust effort to bring this 
information together and I will work with you to achieve that.
    I see Senator Brownback has arrived. I do not know if you 
would like to ask or let Senator Allard.
    Senator Brownback. Let Senator Allard.
    Senator Durbin. Senator Allard is recognized for 5 minutes.

                        NASD-NYSE CONSOLIDATION

    Senator Allard. Thank you, Mr. Chairman. I mentioned in my 
opening comments about the consolidation of the National 
Association of Security Dealers and the New York Stock Exchange 
regulatory function. The question I have for you, Chairman Cox, 
it is my understanding that the Division of Market Regulation 
is going to be responsible for regulation and supervision of 
the proposed consolidation. Do you feel that the SEC's budget 
request provides enough for these challenges and other 
initiatives that will modernize the national market system?
    Mr. Cox. I do. In fact, I think in some ways the 
consolidation of the regulatory functions of the NASD and the 
NYSE will make it easier to track fraud across markets. We had 
a problem heretofore with the sheriff having to stop at the 
county line. Fraud does not neatly restrict itself these days 
to one particular platform, one particular market, and, to the 
extent we have a more crosscutting view of what is going on in 
our market surveillance, we will be much more efficient at 
tracking down fraud.

                       PROGRAM ASSESSMENT RATINGS

    Senator Allard. As you will recall when we were in the 
House, the Contract with America, we worked with the Government 
Performance and Results Act (GPRA) and the way that became law 
and the way the Government agencies now is implementing it is 
the President's PART program. I am developing a reputation that 
on these Appropriations subcommittees I always ask whoever is 
testifying about how well their agency is doing in the PART 
program.
    I look here and I pulled the information off of the 
Internet on Expectmore.gov, and I see where the Securities and 
Exchange Commission, you have four programs that they refer to. 
The regulation of the investment management industry is listed 
as effective, and I congratulate you on that. The examining and 
compliance with security laws, that is characterized as 
moderately effective. Then there is a couple of agencies, what 
we call the Securities and Exchange Commission enforcement and 
then the Securities and Exchange Commission full disclosure 
program, that it says results not demonstrated, which tells me 
that they are not bothering to set objectives and try and move 
toward those.
    Now, I noticed in your comments that you referred to these 
programs and that some of the money you are requesting is to 
upgrade those programs. So my question is how are you coming 
along on getting more accountability in those two particular 
programs, where results are not demonstrated?
    Mr. Cox. First, thank you for asking about this, because it 
is something that we are very focused on from a management 
standpoint at the SEC. You are right to point out that the 2007 
PART review that focused on the Division of Investment 
Management gave the SEC the highest rating. As you know, that 
rating of ``effective'' is very rarely awarded. It is hard to 
get, and so that was cause for I think well-deserved 
celebration at the agency. We are very proud of having achieved 
that in 2007.
    Likewise, the Office of Compliance, Inspections, and 
Examinations received the next to the highest rating last year. 
Prior to the time that I came to the Securities and Exchange 
Commission, these other reviews that you mentioned were 
performed. The Enforcement Division, results not demonstrated, 
and the Division of Corporation Finance likewise, are for that 
reason very much in our focus. We are working right now with 
the Government Accountability Office (GAO), which is performing 
another management review of the Division of Enforcement, and 
we hope that, as a result of that collaboration and also our 
own internal management assessment, we will be able to develop 
additional measurable performance ratings.
    The enforcement area, as you can imagine, it is difficult. 
We are first and foremost a law enforcement agency, and it is 
the greater part of what we do. So we are very interested in 
anything that we can do to measure results.
    One of the things that we observe in the economy right now 
is that there are fewer security class actions being filed now 
than there have been in prior periods. There are a number of 
potential explanations for that, and I think only social 
scientists can parse, perhaps only to their own satisfaction, 
what the causes are for this.
    But looking for a measure of less fraud, which would be the 
ultimate performance that you would like our enforcement to 
achieve, is very difficult. So we are trying to come up with 
any way that we can measure this. We probably will not use such 
external measures for the reason that there is so much social 
science involved. But certainly we are going to develop even 
more rigorous measurements than we have used in the past so 
that we can satisfy ourselves that the taxpayers' resources are 
being put to the best use for the protection of investors.
    Senator Allard. Well, thank you for your response. Next 
year when you show up I will probably repeat that question and 
see how well we are doing.
    Now, has the GAO reviewed from the PART program 
perspective, have they reviewed all your programs, and if not 
how many more remain to be reviewed?
    Mr. Cox. Well, the GAO has on a number of occasions 
reviewed aspects of the SEC's operations. Their current ongoing 
study involves the Division of Enforcement.
    Senator Allard. Okay. So are there more programs that need 
to be reviewed yet that are not listed on here, or is this 
pretty much it?
    Mr. Cox. Well, the PART program, as you know, picks a 
different portion of the agency each year.
    Senator Allard. Right.
    Mr. Cox. And I do not know, frankly, where the Office of 
Management and Budget (OMB) will go next.
    Senator Allard. Okay. Well, we will want to follow up on 
that one too.
    Thank you for your testimony.
    Mr. Cox. Thank you.
    Senator Durbin. Senator Brownback.
    Senator Brownback. Thank you, Mr. Chairman.
    Welcome, Chairman Cox. Good to see you again. I want to 
join the chairman in his comments on Sudanese divestiture. We 
have a strong, growing campaign across the country. I am not 
sure where we are on the number of States. I do know Kansas 
just divested. We have probably between 8 to 10 States now that 
are involved in public divestiture from Sudan. I would hope you 
could help us out with that. It seems to me that is one of the 
best ways that a citizenry can express its displeasure with the 
genocide. You can say, you can conduct a genocide, we do not 
like it, and we are going to fight you every bit of the way, 
but it is certainly not going to be on our dime that you are 
going to do it. So your willingness to help is greatly 
appreciated.

                   DECLINE IN IPOS ON U.S. EXCHANGES

    I want to target you in on two things that have been seen 
in some of the publications. One is the reduction in IPOs in 
our capital markets that have been the subject of a number of 
articles recently, the New York Times, Wall Street Journal, 
Financial Times, and Economist. There is a recent report from 
McKinsey and Company commissioned by Senator Schumer and New 
York City Mayor Bloomberg that found in the first 10 months of 
2006 U.S. exchanges attracted barely one-third of the share of 
the IPOs they captured back in 2001. They noted at the same 
time European exchanges increased their market share by 30 
percent, and Asian exchanges doubled their share.
    The study found the trend was due to non-U.S. issuers' 
concern about compliance with Sarbanes-Oxley (SOx) section 404 
and operating in what they see as a complex and unpredictable 
legal and regulatory environment.
    I would ask you, as I am sure you have seen the same 
things, do you agree with these findings and what could be done 
to stem this flow of companies going to foreign exchanges?
    Mr. Cox. Well, Senator, I think the United States always 
needs to be focused on sharpening our competitive edge in every 
way that we can. The SEC has, of course, as our statutory 
mission protecting investors, but another statutory mission of 
the Securities and Exchange Commission is promoting capital 
formation, and we are focused on that, as we are focused on our 
third statutory mission, which is maintaining orderly markets. 
All of these things I think are complementary.
    We have to be concerned, when we see that there is more 
competition in the world now than there ever has been before, 
to see that the United States of America has a regulatory 
system that is pro-competition, that is efficient, that 
achieves all the objectives of investor protection that we 
want, but that it also succeeds in our market regulatory 
objective and also our objective of----
    Senator Brownback. Do you think it is due to section 404 of 
Sarbanes-Oxley? Is that a key part of why we are losing 
competitiveness?
    Mr. Cox. We have heard from foreign private issuers who 
listed in the United States that they are very concerned about 
the operation of section 404. We have also heard that same 
complaint from U.S. issuers. Because of this, we have gone back 
to the drawing board. We are on the threshold--and it will 
occur on May 23 and May 24--of repealing in its entirety the 
audit standard that was issued shortly after the passage of 
Sarbanes-Oxley by the Public Company Accounting Oversight Board 
under SOx 404 and replacing it with one that has the benefit of 
the interim years of experience.
    It is going to be top-down, risk-based, principles-based, 
materiality-focused, and scalable for companies of all sizes. 
None of those things was really a forte of the original 
standard.
    Senator Brownback. Do you think that will get at this loss 
of the flight of companies to foreign markets?
    Mr. Cox. That is certainly a part of it. But I started with 
a reference to competition for this reason. There is more 
competition now than there used to be. In days gone by there 
simply were not the large pools of capital around the world to 
tap, nor the technological means and the commercial means that 
would offer a feasible choice for many issuers.
    Today that competition exists. I think the competition 
itself is good. It is healthy. It tends to reduce the cost of 
capital. But we want to make sure that that competition is not 
a regulatory competition that lowers standards for investor 
protection. So we are working with our counterpart regulators 
to make sure that, as we flense the blubber from the regulatory 
system and wash out any unnecessary costs, we, if anything, 
increase the level of investor protection by closer 
collaboration overseas.
    If you take a look at what is actually going on in the 
markets, while it is true that the lion's share of foreign IPOs 
went elsewhere and we did not attract them in the United States 
in recent years, this year we are on track, according to 
Thomson Financial, to add the most foreign listings on U.S. 
exchanges since 1997. That is a good development.
    It was also recently reported that foreign companies 
accounted for over 23 percent of IPO proceeds last year, and 
that is the highest since 1994. So there is every reason to 
think that the United States will maintain its lead and the 
largest market share on Earth. We are still the largest, 
deepest, most liquid pool of capital in the world. But we do 
not want to take that for granted, and regulators as well as 
marketplace participants all have to constantly sharpen our 
competitive edge.
    Senator Brownback. I appreciate you looking at that and 
considering that. I am putting in a bill today on the 
Communities First Act, that is to provide targeted regulatory 
relief for community banks--these are small banks across the 
United States--that will provide some relief on section 102 of 
Sarbanes-Oxley by exempting insured depository institutions 
with consolidated assets of $1 billion or less from provisions 
of the internal control requirements in section 404.
    I just advise you of that. In my State we have a number of 
small banks, small institutions. A number of the Sarbanes-Oxley 
provisions have been very difficult, very onerous on them, and 
this regulatory relief would be something that would be 
helpful. I want to make sure that this regulation is not 
putting the United States at a competitive disadvantage in 
global capital markets.
    I appreciate your answer and working with us on these 
topics.
    Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Brownback.

               RIGHTS AND REMEDIES AVAILABLE TO INVESTORS

    A few more questions if I might. It is my understanding, 
Chairman Cox, based on the Wall Street Journal article of April 
16 that the SEC is exploring the idea of eliminating the rights 
of investors to pursue legal remedies in court, instead 
shifting to arbitration. Inasmuch as your responsibility as 
Chairman of the SEC includes protecting investors and 
maintaining fair, orderly, and efficient markets, I would like 
to ask you a few questions if I might.
    You stated earlier there are fewer class actions that are 
being filed, which is an indication that the litigation rate is 
not increasing. But when it comes to this suggestion of moving 
the rights of investors to arbitration as opposed to the court 
system and this limitation of the legal rights of investors, 
how would you rationalize that decision against the fact that 
most of the arbitration hearings are going to be private in 
nature and some of the most dramatic information we have 
received about corporate wrongdoing, such as the Enron case, 
came in public forums, before the courts, leading to 
congressional response and perhaps a little more wariness on 
the part of investors?
    Are you not going to sacrifice some of that openness and 
transparency in this process if you move to an arbitration 
standard?
    Mr. Cox. Well, Mr. Chairman, I appreciate the opportunity 
to state very clearly, as I did to the reporter who wrote the 
story that you mentioned, that there is no pending rule or 
proposal before the Securities and Exchange Commission to allow 
corporations to mandate arbitration of shareholder claims. The 
source for the story is unclear. It was not explained to me by 
the reporter. But, as you will note, there were no other such 
stories, and I hope that I can speak authoritatively to that 
subject.
    Senator Durbin. Thank you.

                   EXPEDITING FAIR FUND DISBURSEMENTS

    Let me ask you, you have addressed this earlier, but I want 
to make sure it is clear in the record here. The fair funds for 
investors provision in Sarbanes-Oxley requires the SEC to 
return money to investors victimized by securities fraud. I 
think that your earlier statement was that you were making a 
more concentrated effort in trying to return these funds. The 
Government Accountability Office determined that as of 2005 the 
SEC had disbursed money to wronged investors in only a few 
cases--that is in 2005--and criticized the SEC for its slow 
process for disbursing more than $4.8 billion in disgorgement 
and penalties it had collected during the previous 3 years. 
While the SEC had used the fair funds provision in 75 cases, 
collecting money in a majority of those cases, the investors in 
only 3 of those cases had received any money.
    You quoted an earlier figure which I believe was $1.8 
billion. I may be wrong.
    Mr. Cox. $1.7 billion.
    Senator Durbin. $1.7 billion.
    Could you tell me, what is the status of this fair funds 
activity and whether that represents--it does not represent 
one-half, I believe, of what the GAO reported. But does it 
represent or is it an indication that this next year there will 
be even more funds to be disbursed?
    Mr. Cox. It is in fact, Mr. Chairman. The figures that you 
mentioned and the report that you mentioned from 2005, of 
course, represented the state of affairs that I found at the 
agency when I became Chairman in August 2005. That is why I 
made it an immediate priority. The $1.7 billion that we have 
distributed as of now is a substantial increase over what was 
the case in 2005.
    There is also $3.4 billion that we are very soon going to 
be able to distribute that relates to the recent mutual funds 
scandals, and that will be then the lion's share of the $3.8 
billion remaining backlog.
    Senator Durbin. Let me ask you about the WorldCom matter. 
The SEC collected $750 million in penalties and fines there. 
Could you tell me, what is the status of that reimbursement? I 
understand some $150 million should be doled out to investors.
    Mr. Cox. We have recently distributed $500 million, 
beginning this past October. There is, however, more to be 
distributed. The $750 million in total fair fund that was 
established and approved by the court in July 2004 was 
subsequently appealed to the Second Circuit Court of Appeals, 
and they then approved the lower court's decision in October 
2006.
    WorldCom also recently emerged from bankruptcy and there 
was a 9-month claims period because WorldCom was one of the 
most heavily traded stocks in the market and was widely held by 
small investors. The former Chairman of the Securities and 
Exchange Commission, Richard Breeden, is serving as our 
distribution consultant in this matter, and he has submitted a 
distribution plan that we started executing immediately after 
they emerged from bankruptcy.

                      VOLUME OF DISCLOSURE REVIEWS

    Senator Durbin. Mr. Chairman, your budget submission 
projects that the Divisions of Corporate Finance and Investment 
Management expect to review the disclosures of about 33 percent 
of all reporting companies and investment company portfolios. 
In last year's request you indicated that 44 percent of the 
disclosures would be reviewed. First, how do you select the 
disclosures to be reviewed? What is the total volume of 
filings, and why would you propose in next year's budget a 25-
percent decrease in the number of disclosure reviews?
    Mr. Cox. The basis for the selection of submissions to 
review is risk. That is true not only in the Division of 
Corporation Finance, but it is true in our Office of 
Compliance, Inspections, Examinations, and the Division of 
Enforcement.
    SOx requires now that we review all the registrants once 
every 3 years, and so we are embarking upon that approach 
separately. The volume of filings as against the risk of 
filings gives us a tradeoff, therefore, that we have to make, 
because SOx is just purely quantitative. We have got to get to 
all of them ultimately. On a risk-based approach, we can focus 
our resources where they are better used.
    The figures that we provided to you about the number that 
we expect to reach are projections; and we do not know 
precisely where we will end up, of course, until we have the 
experience.
    Senator Durbin. Why would the percentage of those reviewed 
decline by 25 percent from this fiscal year to next fiscal 
year?
    Mr. Cox. That is simply an estimate based on meeting our 
SOx obligations at the same time that we pursue a risk-based 
approach to reviewing the filings.

                      SCHEME LIABILITY LITIGATION

    Senator Durbin. Let me ask you about the issue of scheme 
liability litigation. The SEC has in the past taken the 
position in amicus curiae filings that someone who engages in 
deceptive conduct may be liable for engaging in a scheme to 
defraud even without making false statements directly to the 
public if the person undertook acts with the purpose and effect 
of creating a misleading impression. For example, in October 
21, 2004, the SEC filed a brief in the Home Store case in the 
Ninth Circuit saying that if a third party engages with an 
issuer of securities, ``in a transaction whose principal 
purpose and effect is to create a false appearance of revenues 
intending to deceive investors in the corporation's stocks, it 
may be a primary violator.''
    The Ninth Circuit relied on the SEC's interpretation in its 
ruling and said: ``We agree with the SEC that engaging in a 
transaction the principal purpose and effect of which is to 
create the false appearance of fact constitutes a deceptive 
act.''
    Has anything occurred, Mr. Chairman, in the past 3 years 
that would cause the SEC to change its position on the 
liability of third parties?
    Mr. Cox. No.
    Senator Durbin. The issue of scheme liability is going to 
be before the Supreme Court next term in the Stoneridge case. 
This is also an issue that is at the heart of the decision by 
the Fifth Circuit effectively denying the Enron victims their 
day in court against the investment banks allegedly involved in 
the fraud. The SEC has an opportunity to file an amicus brief 
on June 11 standing up for its own rule and for the integrity 
of the financial markets, as it did in the Home Store case. Can 
investors count on the commission's support?
    Mr. Cox. As you know, Mr. Chairman, the Solicitor General 
will file a brief on behalf of the United States. The SEC will, 
I believe, soon receive a recommendation from our General 
Counsel on precisely how to proceed in that particular case. 
The Commission will vote on it, and then we will make our 
recommendations to the Solicitor General.
    I expect that the net result of all of that will be that 
the United States Government will do its level best to make 
sure that injured Enron investors receive the full amount of 
recovery to which they are entitled in our legal system.
    Senator Durbin. So this matter has not been decided? It 
will be under consideration after the Solicitor General----
    Mr. Cox. Yes, this is all relatively recent in the last few 
weeks.

STUDENT LOAN REPAYMENT FOR SECURITIES AND EXCHANGE COMMISSION EMPLOYEES

    Senator Durbin. I would like to ask you one last question. 
Do you use student loan forgiveness to recruit and retain 
professional personnel?
    Mr. Cox. It is an excellent question. I do not know the 
answer. Let me see. Yes. Our Executive Director, sitting right 
behind me, tells me that we do.
    Senator Durbin. The staff just handed me a long list of 
people who have benefited from this. So it appears that you do 
use it. In fact, I would like to congratulate you for being a 
Federal Government leader in using this program. It turns out 
365 employees receive some money in student loan repayment 
benefits. This is a program which I have encouraged. I think it 
is an excellent way of attracting the best and the brightest to 
public service when they are burdened with student debt and 
might consider other careers. So I hope that you will continue 
to use that.
    Mr. Cox. We certainly will take your enthusiasm as it is 
intended.
    Senator Durbin. Thank you very much, Mr. Chairman, for 
testifying today. I thank all those who have come from the 
Securities and Exchange Commission.

                     ADDITIONAL COMMITTEE QUESTIONS

    Our record will remain open for 10 days if there are any 
written questions to be sent to you from our staff or the 
staffs of the other Senators involved.
    [The following questions were not asked at the hearing, but 
were submitted to the Commission for response subsequent to the 
hearing:]

            Questions Submitted by Senator Richard J. Durbin

                              ARBITRATION

    Question. In response to an inquiry at the hearing, you mentioned 
that a report in The Wall Street Journal that the Commission is 
considering a proposal originally described in the Capital Markets 
Study that would empower corporations to amend their bylaws to mandate 
arbitration of securities fraud class action cases was ``inaccurate'' 
although you did not specify how the article was inaccurate. What 
assurance can you provide the Subcommittee that the SEC is not 
considering any changes regarding arbitration?
    Answer. There is no pending rule or proposal before the Commission 
to allow corporations to mandate arbitration of shareholder claims. 
Corporations should not be able unilaterally to limit the rights of 
investors to sue, and I can assure you that the Commission does not 
plan to advance any proposal that diminishes investor rights.

                         MARKET COMPETITIVENESS

    Question. Three recently issued reports--the Committee on Capital 
Markets Regulation Report, the McKinsey Report, and a report from the 
U.S. Chamber of Commerce--raise concerns about the competitiveness of 
the U.S. capital markets. These reports concluded that the 
competitiveness of the U.S. markets is being hampered by our 
overzealous regulatory and litigation environment.
    All three reports relied on the same fact to support their claim--
that the U.S. share of the global IPO market dropped between 2000 and 
2006. This statistic, however, is highly misleading. In fact, since the 
implementation of the Sarbanes-Oxley Act, the number of U.S. IPOs has 
risen dramatically. According to a recent article in Barron's, IPOs in 
2006 increased 22 percent over 2005, and 170 percent over 2003. During 
that same period, the number of foreign companies listing in U.S. 
markets and the amount of money they raised here have also increased.
    Furthermore, a recent study by Craig Doidge of the University of 
Toronto and Andrew Karolyi and Rene Stulz of Ohio State University 
found that there remains a significant premium for companies that list 
in the United States, and this premium has not declined in recent 
years, despite recent regulatory developments. The professors also 
found that an exchange listing in New York still continues to provide 
significant benefits to firms.
    These facts confirm that U.S. markets are among the most highly 
competitive in the world, and suggest that we are so competitive 
precisely because of the unmatched protections we provide to our 
investors.
    What is your opinion? Do you believe that a market that provides 
such protection and transparency actually increases competitiveness?
    Answer. Yes. I agree. U.S. markets thrive because of the global 
trust we've earned. That makes the SEC itself a key part of America's 
capital markets that helps secure our global leadership, maintain our 
markets' competitive edge, and secure the benefits of robust capital 
formation for millions of Americans as well as countless people the 
world over. But the SEC can only continue in this role if we constantly 
update our rules, our policies, and our own way of operating to keep 
pace with the increasingly rapid changes in the world of finance that 
we regulate. The new global competition is good in that it tends to 
reduce the cost of capital. But we are working to make sure that that 
competition is not a regulatory competition that lowers standards for 
investor protection and ultimately undercuts America's role as the 
leading capital market in the world.

                    INVESTOR FRAUD TARGETING SENIORS

    Question. Chairman Cox, in your prepared statement you discuss the 
SEC's initiatives to combat investor fraud schemes which particularly 
target seniors. I understand that the SEC recently teamed with the 
University of Illinois College of Law and the Federal Reserve Bank of 
Chicago to host a symposium focusing on this issue in Chicago.
    Are there certain schemes that are aimed at older Americans?
    What recommendations do you have for older Americans to better 
guard their retirement funds? What is the SEC doing to inform and 
educate consumers?
    What specific actions has the SEC taken to reduce the prevalence of 
these unscrupulous practices? What remedies have been the most 
effective?
    Answer. It was a great pleasure to be in Chicago on May 18 for the 
Senior Symposium the Commission hosted with the Elder Law Journal of 
the University of Illinois College of Law and the Federal Reserve Bank 
of Chicago. The Symposium featured a distinguished panel of 
representatives from the business, law, regulatory and academic 
communities with significant experience tackling the issues facing 
seniors as they prepare for and enjoy their retirement. The panelists 
discussed how older Americans can protect themselves from investment 
fraud while financially preparing for the future. It was a very 
instructive and successful event.
    As you know, fighting fraud against seniors requires aggressive 
action. That's why last year I launched the SEC's ``Seniors 
Initiative,'' which is designed to better coordinate the work of the 
SEC's various offices and divisions and with state securities 
regulators when it comes to prosecuting and preventing securities fraud 
aimed at swindling senior citizens.
    Educational efforts are an important of the Commission's strategy 
for seniors and we are dedicated to putting better information in their 
hands so they can make informed investment decisions. We are conducting 
a series of seniors events around the country and will hold the second 
Senior's Summit this fall.
    We know that many seniors, and many children and caregivers of 
seniors, use the Internet to search for information on investing. That 
is why we created a section on our website (http://www.sec.gov/
investor/seniors.shtml) aimed specifically at senior investors.
    The information on this website can help seniors fend off high 
pressure sales pitches for legitimate, but arguably unsuitable 
products. After reading our materials on equity-indexed annuities, for 
example, seniors will know to avoid any salesperson claiming that 
individuals ``can't lose money'' in that product. Investors can lose 
money buying an equity-indexed annuity, especially if the investor 
needs to cancel the annuity early.
    In addition to providing critical information on other investments 
commonly marketed to seniors, such as variable annuities, promissory 
notes, and certificates of deposit, the website also provides key 
information about how to detect and avoid fraudulent schemes.
    This is also a top enforcement priority for the SEC. Since many of 
the scams targeted at seniors involve ongoing fraud or Ponzi schemes, 
time is often of the essence--both to stop the ongoing fraud and to 
recover lost investor funds. In these instances, the staff may move 
very quickly and seek emergency relief in the district courts. Once 
emergency relief is obtained and the status quo is preserved to the 
extent possible, the Enforcement staff generally goes through the same 
detailed process it would in any investigation, which include 
interviewing witnesses, requesting and reviewing documents, and taking 
formal testimony.
    The existing statutory penalties provide a broad range of available 
sanctions, including cease-and-desist orders, censures, injunctive 
relief, disgorgement, civil penalties, and industry bars. Moreover, 
civil monetary penalties may be imposed in cases involving repeat 
violations and severe frauds. I believe that the Commission's full 
range of existing remedies allows enough flexibility to ensure that the 
Commission can effectively prosecute cases involving fraud against 
seniors. This is particularly true given the SEC's ability to make 
criminal referrals in the most egregious cases.

               STOCK OPTION BACKDATING AND SPRINGLOADING

    Question. Numerous media accounts in recent months have reported 
that many companies may have bent our securities laws by engaging in 
stock option backdating and springloading as a way to provide senior 
corporate management with manufactured gains.
    Do you view the proliferation of this practice as a serious threat 
to the integrity of the securities laws which you oversee?
    If so, how many cases has the SEC brought in this area in the last 
year?
    Does the SEC need greater enforcement resources to combat 
compensation practices such as these?
    Answer. The SEC's Division of Enforcement is currently 
investigating more than 140 companies for possible fraudulent reporting 
of stock option grants. The companies under investigation are located 
across the country, are of various sizes, and span multiple industry 
sectors. All of the SEC's regional offices are currently involved in 
these investigations.
    Longstanding SEC policy precludes the disclosure of any information 
about these ongoing investigations; however, enforcement actions have 
been filed against former executives of Symbol Technologies, Peregrine, 
Brocade, Comverse Technology, McAfee, Monster Worldwide, TakeTwo 
Interactive Software, Engineered Support Systems, Apple Inc. and 
Mercury Interactive. To date, the Commission has brought enforcement 
cases against 4 issuers and 19 former executives. These cases involved 
alleged misconduct of chief executive officers, general counsels, chief 
financial officers, and other accounting and human resources employees. 
The Department of Justice has also brought parallel criminal actions 
against 10 of the 18 former executives charged by the Commission.
    The SEC has taken many steps to ensure clear, full, and fair 
disclosure about executive compensation, including that relating to 
employee stock options. The revised executive compensation disclosure 
rules the Commission adopted in July 2006 include a number of 
provisions that directly or indirectly address backdating of options. 
For example:
  --A company must now disclose how it determines when it will make 
        equity awards. This will require a company to disclose how, and 
        why, it backdates for its executives.
  --A company must disclose the grant date of equity awards. If the 
        grant date is different than the date on which the board took 
        action, the company must disclose the date of the board's 
        action.
  --A company must disclose the exercise or base price of an option if 
        it is less than the market price of the underlying security on 
        the grant date. If it is less than the market price on the 
        grant date, the company must disclose the market price on the 
        grant date. This disclosure is intended to provide an investor 
        with a complete picture of the true terms of each option award 
        by allowing the investor to compare the grant date market price 
        to the in-the-money exercise price.
  --Further, if the exercise or base price of an option grant is not 
        the closing market price per share on the grant date, a company 
        must describe its methodology for determining the exercise or 
        base price.
    In addition, the Sarbanes-Oxley Act of 2002 tightened up a 
company's obligation to report stock option grants. Before Sarbanes-
Oxley, officers and directors were not required to disclose their 
receipt of stock option grants until after the end of the fiscal year 
in which the transaction took place--which meant that an individual, in 
some cases, had more than a year to disclose a grant. In August 2002, 
the SEC issued rules requiring officers and directors to disclose 
option grants within two business days.
    In combination, these steps are an important contribution to 
preventing backdating abuse. They have effectively eliminated easy 
opportunities for companies to secretly grant options. Companies are 
beginning to file reports with disclosure of executive stock option 
grants in accordance with the Commission's new rules. Staff from the 
Commission's Division of Corporation Finance will selectively review 
these reports for compliance with the new rules, including those 
relating to stock option awards. Where the disclosures indicate 
possible violations of the federal securities laws, appropriate 
referral of the matter will be made to our Division of Enforcement.

                COMMISSION APPROVAL FOR SETTLEMENT TALKS

    Question. On April 13, 2007, the Washington Post reported that SEC 
had made a change in procedures such that your enforcement lawyers must 
seek approval from the Commission before they begin settlement talks 
that involve fining corporations, including seeking ranges for possible 
fines. It has also been reported that this action may lead to lower 
penalties.
    Please comment on whether this report is accurate and whether you 
believe it will lead to lower penalties and if so, was that its intent?
    Answer. The Commission's procedures for authorizing settlement 
negotiations in cooperate penalties cases are not designed to increase 
or decrease the amount of monetary penalties paid by companies or to 
make penalty payments more or less frequent. Rather, they are intended 
to strengthen the negotiating position of our Enforcement Division in 
settlement negotiations involving corporate penalties and streamline 
the approval process for those cases. The implementation of the 
procedures will be carefully monitored, and the procedures will not be 
continued if they do not achieve these key objectives.
    The process is designed to ensure that the laws are vigorously 
enforced by giving the professional enforcement staff the full backing 
of the Commission in the staff's settlement negotiations.
    The pilot streamlines the settlement process by shortening final 
Commission review and approval when the staff reaches a settlement 
within the range authorized by the Commission.
    The staff may always return to the Commission to recommend a higher 
or lower penalty range if their recommendation changes based on new 
information or a development that occurs during the settlement 
negotiations.

              WEAKNESSES IN INFORMATION SECURITY CONTROLS

    Question. In carrying out its mission to ensure that securities 
markets are fair, orderly, and efficiently maintained, the SEC relies 
extensively on computerized systems. Integrating effective information 
security controls into a layered control strategy is essential to 
ensure that SEC's financial and sensitive information is protected from 
inadvertent or deliberate misuse, disclosure, or destruction. In fact, 
one of SEC's four strategic goals is ``maximizing the use of SEC 
resources,'' which expressly includes ``enhancing internal controls.''
    A recent GAO study acknowledged that the SEC has made progress 
toward correcting previous weaknesses in information systems security, 
and attributed progress to active engagement by SEC senior management 
in implementing reforms. However, GAO emphasized that despite progress, 
the SEC has not consistently implemented key controls to effectively 
safeguard the confidentiality, integrity, and availability of its 
financial and sensitive information and systems.
    GAO recommends that the SEC Chairman improve the implementation of 
its policies and procedures, control tests and evaluations, and 
remedial action plans as part of its agency-wide information security 
program.
    Chairman Cox, what is the SEC actively doing to implement GAO's 
recommendations to correct information security control weaknesses?
    Answer. The SEC now devotes about 7 percent of the agency's 
information technology budget on technology security--a significantly 
greater share of overall information technology resources than many 
other agencies. Our efforts run the gamut from highly technical 
initiatives such as server configuration management, to equally 
critical but ``softer'' programs such as user awareness training.
    In one major improvement initiative, the SEC has invested over $2 
million during fiscal year 2006 to enhance our core financial 
management system. These upgrades include new hardware and software, as 
well as implementing a more secure database. As part of this upgrade, 
the SEC will continue to make enhancements to business processes and 
automated workflows that will improve internal controls, eliminate 
traditional financial management paper processes, and enhance reporting 
capability and efficiency. Beyond these benefits, the updated hardware 
and software will provide much greater assurance that the system 
complies with modern information security standards.
    We have also taken significant steps to upgrade physical security 
throughout SEC buildings. Specialists have evaluated the structures and 
installed computerized identification card authentication systems, 
cameras, and alarms in key facilities. The number of entrances at our 
data operations center has been reduced. Guards have been redeployed 
and retrained. We have also put in place new technology and changes in 
procedures to restrict access to sensitive rooms on SEC premises, such 
as data centers and network closets.
    We are continuing our efforts to tighten access controls that 
prevent, limit, or identify inappropriate access to data, equipment, 
and facilities. All of these controls are designed to prevent 
unauthorized disclosure, modification, or destruction of sensitive 
information.
    While the SEC has strong access control policies, a number of 
issues identified during the audit were related to inadequate 
compliance with existing agency policies by individuals responsible for 
the system and technical staff. To address this concern, the SEC has 
stepped up educational and enforcement efforts. System owners--
individuals responsible for the system--have been presented with all 
agency information technology policies and have been directed to sign 
documentation showing that they have reviewed those policies. Beyond 
developing an educated population, we are also focused on errors that 
can happen through inattention. To address such issues, the SEC is 
implementing a systemic scanning program administered by teams that are 
organizationally separate from the system owners. System owners will be 
presented with the results of those scans and directed to correct any 
vulnerabilities and mitigate risks on systems that do not comply with 
SEC policies. By implementing a continuous scanning approach, the 
agency expects to achieve dramatic cost savings. These savings can be 
achieved because configurations will be corrected early on, before they 
can have a negative effect on operations. Such practices will also 
reduce the amount of resources and time required to correct problems in 
the future.
    The SEC also is making efforts to address weaknesses in its IT 
``change management'' processes. These are the processes and procedures 
that govern the way that software and other technologies are deployed 
into the SEC's environment. The GAO has recommended a number of 
improvements to ensure that such deployments do not introduce security 
weaknesses, whether inadvertently or as the result of an insider with 
malicious intent. Therefore, we are taking steps to better oversee our 
environment through such measures as weekly change control board 
meetings, better communication between the involved groups, improved 
version management procedures, and an enhanced test environment.
    As Chairman, I am committed to implementing all of the GAO's 
recommendations. I anticipate that we will again see significant 
improvements in our information security posture at the conclusion of 
this year's audit.

              RISK-BASED EXAMINATIONS--TARGETED ACTIVITIES

    Question. In your budget justification document for fiscal year 
2008, in the section covering the Office of Compliance Inspections and 
Examinations and your risk-based examination program, you explain that 
SEC's resources will be focused on those firms and practices that have 
the greatest potential for violative conduct that can harm investors.
    You state that ``higher-risk activities'' include those that 
``create significant conflicts of interest where compliance policies 
and procedures are insufficient to mitigate those conflicts.''
    Please explain in greater detail what these ``higher risk 
activities'' include, and how you target them.
    Answer. Higher risk activities at adviser, funds, and broker-
dealers include business practices that create significant conflicts of 
interest that, if not monitored and mitigated in some fashion, may 
result in harm to clients or investors, such as: soft dollar 
arrangements; directed brokerage; performance advertising; custody and 
possession of client funds and securities; difficult-to-value 
securities; access to non-public information; and significant personal 
trading by employees of the firm. In examinations of broker-dealers, 
our risk-based focus is on areas such as: compliance with capital 
requirements and operational issues; sales practices including 
suitability, churning, and unauthorized trading; supervision; new 
products; order handling and trading rules; and anti-money laundering 
rules.
    The Office of Compliance Inspections and Examinations (OCIE) has 
implemented a risk-based approach to examinations. OCIE's goal is to 
identify emerging areas of compliance risk, conduct examinations and 
take steps to remedy identified problems. Given the number of firms 
registered with the SEC and the breadth of their operations, the staff 
continues to focus examination resources on those registrants and 
activities where the investing public or market integrity is most at 
risk.
    In recent years, the examination program has enhanced its efforts 
to proactively detect and address potential risks, and provide 
balanced, cost-effective and reasonable oversight of the regulated 
community. Many of these higher risk activities have been identified 
through years of experience with examinations and enforcement 
activities at registered firms. However, we are continually searching 
for areas of risk that are new or unique to the investment management 
community. To assist the staff in identifying risks warranting 
examination follow-up, OCIE utilizes a risk-identification and risk-
assessment methodology. This methodology uses an internal database to 
identify and prioritize risks, consider mitigating and aggravating 
conditions, and recommend regulatory or other actions to be taken to 
remove or mitigate the risks. As part of this risk assessment process, 
examination staff nationwide provide feedback about where risks may 
exist in the industry and to propose possible solutions. This risk-
assessment process is used to identify risks requiring regulatory or 
examination follow-up and to build a culture of risk-assessment within 
the examination program.
    Higher risk activities are targeted primarily through our 
examination process. All of our routine examinations will focus on 
those activities and areas presenting the greatest concern to investors 
(many of which are identified above). In addition, exam staff may 
specifically conduct focused risk targeted examination sweeps to 
determine the extent and interpret emerging risks in the regulated 
community. In such examinations, examiners review risk conditions and 
responsive controls for a particular compliance risk at a sample of 
firms. This approach allows the staff to obtain a more comprehensive 
view of the particular risk, assess the gravity of the risk, evaluate 
the compliance performance of individual firms compared to that of 
their peers, and suggest regulatory solutions. These examinations may 
often identify specific areas of interest and risk that are 
incorporated into our regular examination process.
                                 ______
                                 
              Questions Submitted by Senator Sam Brownback

    Question. As I mentioned in my statement, recent articles in the 
``New York Times,'' ``Wall Street Journal,'' ``Financial Times'' and 
``The Economist'' have all suggested that tenets of Sarbanes-Oxley are 
cause for a decrease in American-listed public companies compared to 
foreign exchanges such as London and Hong Kong, because the Act takes 
away incentives to list on an American exchange. Do you agree with this 
assessment?
    A recent report by McKinsey & Company commissioned by Senator 
Schumer and New York City Mayor Bloomberg found that over the first ten 
months of 2006 U.S. exchanges attracted barely one-third of the share 
of IPOs they captured back in 2001. During that same time, European 
exchanges increased market share by 30 percent and Asian exchanges 
doubled their share. Most importantly, the study found this trend was 
``due to non-U.S. issuers' concerns about compliance with Sarbanes-
Oxley Section 404 and operating in what they see as a complex and 
unpredictable legal and regulatory environment.'' Do you agree with 
these findings? What can we do to stem the flow of companies to foreign 
exchanges?
    Answer. Over the past year, a number of reports have been published 
which advise the SEC and Congress on how to deal with increasingly 
global capital markets. They have offered the Commission and 
policymakers in Congress and the Executive Branch many recommendations. 
These reports, including the report by McKinsey & Company commissioned 
by Senator Schumer and Mayor Bloomberg frequently cite the increase in 
foreign-listed IPOs as cause for concern about the competitiveness of 
U.S. markets, and cite the Sarbanes-Oxley Act as a contributor to 
capital flight from the United States.
    I agree that Sarbanes-Oxley is a factor in the decision of some 
issuers to list overseas. I am comfortable stating this because several 
issuers, underwriters, accountants, and attorneys have shared the 
reasons behind their decisions to list overseas with me and have cited 
SOX as a reason. But despite this kind of unfiltered, episodic 
information much more is at work here. We need to recognize that our 
capital markets are changing at an accelerating pace and that we are 
living in a very dynamic, much more competitive world. There are more 
opportunities to raise money and deeper, more varied pools of capital 
in other countries than ever before. Even if SOX were provably and 
quantifiably a determinant in the increase in foreign market IPOs--and 
sound science does not permit such neat conclusions--the fact is there 
are simply greater competitive challenges than ever before to the 
United States' leading position in the world as the largest, deepest, 
and most liquid markets.
    Our continued global market leadership is not America's birthright. 
We have to constantly earn it. That is true for our private sector and 
it is true for our regulatory system. As regulators, we must constantly 
work to sharpen our competitive edge as well. When it comes to SOX, 
that has meant completely overhauling the expensive, inefficient 
auditing standard that was used to implement section 404. We recently 
repealed it and replaced it with a new standard that is clearly written 
in plain English, is less than half as long, and is risk-based, 
materiality-focused, and scalable for companies of different sizes. We 
expect it to dramatically reduce the costs of SOX 404 compliance.
    That said, the evidence of some high profile foreign IPOs no longer 
listing in the United States may simply be an indication that other 
markets have improved, not that the United States has become 
unattractive. A steady stream of foreign companies continues to tap the 
U.S. markets. In fact, according to Thomson Financial, this year is on 
pace to add the most foreign listings on U.S. exchanges since 1997. It 
was also recently reported that foreign companies accounted for 23.4 
percent of IPO proceeds last year--the highest amount since 1994.
    Question. Chairman Cox, the press has reported that the SEC intends 
to put forward its management guidance in the next few weeks. Can you 
comment on the timeline to putting forth this guidance and the process 
for its adoption?
    Answer. On May 23, 2007, the Commission unanimously approved 
interpretive guidance to help public companies strengthen their 
internal control over financial reporting while reducing unnecessary 
costs, particularly at smaller companies. The new guidance will enhance 
compliance under Section 404 of the Sarbanes-Oxley Act of 2002 by 
focusing company management on the internal controls that best protect 
against the risk of a material financial misstatement. It is currently 
in effect.
    The Commission also approved rule amendments providing that a 
company that performs an evaluation of internal control in accordance 
with the interpretive guidance satisfies the annual evaluation required 
by Exchange Act Rules 13a-15 and 15d-15. The Commission also amended 
its rules to define the term ``material weakness'' as ``a deficiency, 
or combination of deficiencies, in internal control over financial 
reporting, such that there is a reasonable possibility that a material 
misstatement of the company's annual or interim financial statements 
will not be prevented or detected on a timely basis.'' The Commission 
also voted to revise the requirements regarding the auditor's 
attestation report on the effectiveness of internal control over 
financial reporting to more clearly convey that the auditor is not 
evaluating management's evaluation process but is opining directly on 
internal control over financial reporting. These changes, too, are now 
in effect.
    In addition, the SEC in July 2007 repealed the costly Auditing 
Standard No. 2, which had made Sarbanes-Oxley compliance so difficult, 
and replaced it with a completely new standard that is top down, risk-
based, materiality focused, and scalable for companies of all sizes. 
The replacement standard, Auditing Standard No. 5, is now in effect.
    Question. The data shows that smaller public companies have 
experienced a disproportionate burden from Sarbanes-Oxley. Given that 
you are re-writing the rule-book for management, are you going to do 
anything to grant further relief for the non-accelerated filers? Some 
of my colleagues (Sen. Snowe and Sen. Kerry) have called for delayed 
implementation of the Sarbanes-Oxley Section 404 requirements for small 
public firms to ease the burden on complying with the expected new 
auditing standards.
    Answer. The question of further deferral for non-accelerated filers 
is still open. The SEC has, however, already deferred compliance for 
non-accelerated filers four times in an effort to ensure that the 
burden of compliance did not unduly impact smaller companies. The very 
positive result of our determination to phase in 404 for smaller 
companies is that we and they have had the opportunity to field test 
the requirements so that smaller companies have the benefit of learning 
from the experiences of larger firms.
    These experiences have deeply informed the SEC's new Interpretive 
Guidance and the PCAOB's new auditing standard. The continued phased 
implementation will allow smaller firms to start complying with section 
404(a) of SOX starting in 2008, while the first audit under section 
404(b) won't be due until 2009.
    The SEC's new guidance is intended to be of significant help to 
small companies. Completing the implementation of Section 404 is 
important to further enhancing the quality of reporting and increasing 
investor confidence in the fairness and integrity of the securities 
markets. The Commission and the PCAOB will continue our ongoing 
outreach efforts over the coming months to ensure that the changes 
recently made in the implementation of section 404 live up to our 
expectations for a more effective and efficient system for all filers. 
In particular, we will focus on the extent of the expected cost 
reductions for first-time accelerated filers during 2008 under the new 
Auditing Standard No. 5 and our new Interpretive Guidance.
    Question. The majority of the problems with Sarbanes-Oxley have 
been the implementation--not the language itself. What is the SEC going 
to do to ensure that the fixes put forward in its new guidance are 
successfully implemented in order to bring the cost-benefit back into 
alignment?
    Answer. With new guidance that allows management to scale and 
tailor evaluations to focus on what matters most--and with a new 
auditing standard that enables auditors to deliver more cost-effective 
audit services--one final step remains. The SEC and the PCAOB expect a 
change in the behavior of the individuals who are responsible for 
following these new procedures. To that end, the PCAOB's inspection 
program will monitor whether audit firms are implementing the new 
auditing standard in a cost-effective way that is designed to achieve 
the intended results. And the SEC, in our oversight capacity, will 
monitor the effectiveness of the PCAOB's inspections. So both the SEC's 
and the PCAOB's inspectors will be focused on whether audit firms are 
achieving the desired audit and cost efficiencies in the implementation 
of 404. The SEC staff will also conduct an economic analysis--using 
real-world information--to evaluate whether the costs and benefits of 
implementing section 404 are in line with our expectations.
    Question. I understand that, due to concerns about the burdensome 
effects of section 404 of Sarbanes-Oxley, the Chamber of Commerce has 
asked that you delay 404 compliance for smaller public companies. Do 
you plan to delay 404 compliance? How can you limit the burden of 
section 404 on small companies?
    Answer. With respect to the potential for a further delay of 404 
compliance for smaller public companies, see the answer to Question 4, 
above. With respect to other ways that the SEC can reduce the burden of 
section 404 on small companies, we have very recently approved 
Interpretive Guidance recognizes that smaller public companies 
generally have less complex internal control systems than larger public 
companies.\1\ The new Interpretive Guidance is intended to assist 
management of smaller companies in scaling and tailoring their 
evaluation methods and procedures, recognizing that what is necessary 
in a large company may not be appropriate for smaller companies with 
less complex internal controls systems.
---------------------------------------------------------------------------
    \1\ Final Report of the Advisory Committee on Smaller Public 
Companies to the United States Securities and Exchange Commission (Apr. 
23, 2006) at 39-40, (``Advisory Committee Report'') available at http:/
/www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf.
---------------------------------------------------------------------------
    The Interpretive Guidance is intended to allow management 
sufficient and appropriate flexibility to design an evaluation process 
that fits its facts and circumstances. We are encouraging smaller 
public companies to take advantage of the flexibility and scalability 
afforded in the guidance to conduct an evaluation of internal controls 
that is both efficient and effective at identifying material 
weaknesses.
    In order to help smaller companies understand how they can tailor 
their evaluation efforts, the guidance specifically highlights some of 
the key areas where the evaluation at a smaller company might be 
different than for a larger company. For example, three key points 
within the evaluation process are the overall determination of 
effectiveness of the design of controls, the testing of the operating 
effectiveness, and the documentation needed to sufficiently support 
both. The Interpretive Guidance includes guidance on each of those 
points indicating how a smaller company may accomplish those 
requirements of the evaluation process.
    The guidance explains how a small company might approach 404 
differently than a large company. For example:
  --A smaller company would probably follow fewer and different steps 
        in evaluating whether its controls will provide reasonable 
        assurance about the reliability of its financial reports.
  --Management in a smaller company can go about obtaining information 
        on whether its controls operate as designed in different and 
        less elaborate ways than would be necessary in a large company.
  --The documentation needed to provide reasonable support for a 
        smaller company's controls will normally be less than what's 
        required in a larger company.
    Question. The Chamber of Commerce has asked that you clarify a 
number of defined terms so that companies have better guidance about 
what is required of them to comply with section 404. These terms 
include ``material weakness,'' ``significant deficiency,'' and 
``materiality.'' Have you further clarified the use of these terms?
    Answer. On May 23, 2007, the Commission adopted amendments to its 
rules to define the term ``material weakness'' as ``a deficiency, or 
combination of deficiencies, in internal control over financial 
reporting (ICFR), such that there is a reasonable possibility that a 
material misstatement of the company's annual or interim financial 
statements will not be prevented or detected on a timely basis.'' Our 
intention is to re-focus 404 compliance on the specific problem that 
Congress had in mind: material risks to reliable financial reporting. 
In that way, we will better protect investors and companies can more 
wisely spend their money on meaningful evaluations of internal 
controls. In addition, the definition of material weakness, including 
the indicators of material weakness, has been aligned between the 
Commission's management guidance and the PCAOB's Auditing Standard No. 
5 to promote consistency in the considerations made by management and 
auditors in evaluating deficiencies.
    In addition, on June 20, 2007, the Commission issued a release 
seeking additional comment on a proposed definition of a ``significant 
deficiency.'' The proposal defines ``significant deficiency'' as ``a 
deficiency, or combination of deficiencies, in internal control over 
financial reporting that is less severe than a material weakness, yet 
important enough to merit attention by those responsible for oversight 
of a registrant's financial reporting.'' In drafting the proposed 
definition, we considered comments received by the PCAOB in response to 
its proposed auditing standard. We believe that the proposed definition 
reflects the Commission's belief that the focus of the term 
``significant deficiency'' should be the underlying communication 
requirement that results between management, audit committees and 
independent auditors. The comment period on this proposal ends on July 
18, 2007 and we will evaluate comments received to ensure that the 
final definition effectively communicates the Commission's objectives.
    With regards to materiality, both the SEC and PCAOB received a 
number of comments, including those received from the Chamber of 
Commerce, suggesting that more guidance should be issued related to 
materiality and how it applies to the evaluation and assessment of 
ICFR. For management, judgments regarding materiality often must 
consider many factors that can vary based on each company's individual 
facts and circumstances. These areas are frequently complex and involve 
significant judgment, which makes providing ``bright-line'' guidance 
and examples difficult and presents the risk of unduly restricting 
management's ability to effectively utilize and apply its informed 
judgment. Nonetheless, we are continuing to seek feedback on the more 
challenging issues relative to materiality considerations and the 
appropriateness of providing additional guidance.
    Question. Past chairman of the National Venture Capital 
Association, Robert Grady, wrote a few weeks ago that section 404 is 
causing an outcry because it requires ``tiny companies to provide shelf 
after shelf of process-oriented paperwork, at the cost of millions of 
dollars, that no investor is even likely to read.'' Do you agree with 
this assessment? How can we--as Grady says--``bring sanity to this 
process?''
    Answer. The SEC is keenly attuned to making sure that the U.S. 
capital markets remain robust and competitive, and to helping small 
businesses remain competitive in the global marketplace. To date, no 
tiny company--this is, no company with public float of less than $75 
million--has had to comply with section 404.
    To ``bring sanity to this process,'' as Mr. Grady suggests, the SEC 
is working to make sure that its regulations are scalable and that they 
do not impose an undue burden on small businesses. In May 2007, the SEC 
proposed and adopted a number of changes--in the way private offerings 
are conducted in the United States, and in the section 404 internal 
controls reports that companies are required to file with us--that 
address both scalability and competitiveness.
    We continually review our regulations with a view towards reducing 
the burdens of being a public company and to remove obstacles to 
raising capital, consistent with investor protection. On May 23 the 
Commission approved an entire package of rule change proposals designed 
to modernize and streamline capital raising and reporting requirements 
affecting small business. The small business improvements that the SEC 
recently proposed include:
  --Giving small businesses access to the expedited ``shelf'' 
        registration process for their own securities offerings, which 
        previously was available only to big companies.
  --Cutting paperwork for thousands of small businesses, by allowing 
        them to raise capital in a private offering after filing a 
        simplified Form D online.
  --Establishing shortened holding periods for restricted securities, 
        making it easier for small business shareholders to put their 
        securities on the market sooner and hopefully reducing the 
        discount that small businesses must absorb to sell restricted 
        securities.
  --Giving issuers the benefit of a new, limited offering exemption 
        from Securities Act registration requirements for offerings and 
        sales of securities to a newly defined category of ``qualified 
        purchasers'' in which limited advertising would be permitted.
  --Eliminating the limit on the number of employees who can receive 
        stock options from their fast-growing private firms, improving 
        the ability of emerging growth companies to attract and retain 
        talent without prematurely triggering the requirements of the 
        Exchange Act.
  --Providing a simplified system of disclosure for almost 1,600 
        additional smaller public companies, an increase of over 45 
        percent in the number of small companies that are currently 
        eligible.
    Many of these rule proposals address key recommendations made by 
the Commission's Advisory Committee on Smaller Public Companies. We 
look forward to further input from the small business community as we 
receive the public comments on those proposals. We will continue to 
consider additional recommendations made by the Advisory Committee.
    Question. A new undertaking of the SEC is the oversight of credit 
rating agencies. Could you please tell me a little bit more about this 
and what led the SEC to begin this new project?
    Answer. On May 23, 2007, the Commission voted to adopt final rules 
to implement provisions of the Credit Rating Agency Reform Act of 2006, 
which was enacted into law in September 2006. The Credit Rating Agency 
Reform Act defines the term ``nationally recognized statistical rating 
organization'' (NRSRO), provides authority for the Commission to 
implement registration, recordkeeping, financial reporting, and 
oversight rules with respect to registered credit rating agencies. The 
Commission acted well in advance of the statutory deadline to establish 
the regulatory regime for rating agencies and to lower the barriers to 
entry into this market.
    The goal of this new law is to improve credit ratings quality by 
fostering competition, accountability, and transparency in the credit 
rating industry. The heart of the Act calls on the Commission to 
replace the barriers to entry that had previously existed. The 
replacement is a transparent and voluntary Commission registration 
system that favors no particular business model. The SEC adopted rules 
in each of these areas that would implement the Credit Rating Agency 
Reform Act.
    Question. What are the methods of enforcement used against 
violators of federal securities laws?
    Answer. Investigations begin when the staff obtains information 
from any of a wide range of sources about a possible violation of the 
securities laws. Sources include the surveillance units at the 
exchanges, examinations of regulated entities, issuer filings, news 
reports, and investor complaints. When the staff first obtains a lead, 
it conducts a preliminary inquiry. If the lead seems promising, the 
staff opens an informal investigation and requests voluntary submission 
of documents and sworn testimony from witnesses. If the staff cannot 
obtain documents or testimony voluntarily, the Commission can issue a 
formal order of investigation, which authorizes the staff to issue 
subpoenas for testimony and the production of documents. If an 
investigation uncovers evidence of wrongdoing, the staff meets with the 
Commission, presents a description of the case, suggests what action is 
appropriate and discusses various alternatives. The Commission may then 
authorize the staff to begin public enforcement action in a federal 
district court or before a Commission administrative law judge. The 
Commission may also accept proposals submitted by the alleged violated 
to settle the proposed charges.
    The securities laws provide for a broad range of sanctions, 
including: cease-and-desist orders, censures, injunctive relief, 
disgorgement, civil penalties, and industry bars. Moreover, civil 
monetary penalties may be imposed in cases involving repeat violations 
and severe frauds. The Commission's full range of existing remedies 
ensure that the Commission can effectively prosecute cases. This is 
particularly true given the SEC's ability to make criminal referrals in 
the most egregious cases.
    Question. Commissioner Cox, would you please explain how the SEC 
cooperates with foreign authorities especially regarding cross-border 
enforcement?
    Answer. Because fraudsters take advantage of borderless capital 
markets, the SEC requests assistance from foreign counterparts in all 
types of investigation--from fraud committed by investment advisers, to 
market manipulation schemes, to account intrusion cases, to 
international insider trading rings. To promote information sharing in 
cross-border securities investigations, the SEC was a founding member 
of the International Organization of Securities Commissions (IOSCO), 
and supported IOSCO's endorsement of the Multilateral Memorandum of 
Understanding (MMOU) in 2002. The MMOU requires signatories to meet 
international standards for international enforcement cooperation. The 
growing number of signatories to the MMOU is strong evidence of the 
increasing ability of our foreign colleagues to assist in international 
investigations. In fact, a number of foreign counterparts have 
strengthened their laws in order to be able to meet the international 
standard required to join the MMOU and thus be considered among the 
responsible members of the international enforcement community. As of 
September 2006, 34 securities and derivatives regulators had become 
signatories to the MMOU, and 9 additional IOSCO members had expressed 
their commitment to become signatories.
    We are also witnessing an increase in the number of investigations 
(and, consequently, the number of requests for assistance) in major 
capital markets, such as Canada and Australia, with enforcement 
programs similar to our own. We are also seeing fervent enforcement 
efforts in other less developed markets. Some of the nations whose 
markets are emerging, whose enforcement laws are newly minted or 
strengthened, or whose regulatory agencies are recently established are 
keen to establish robust enforcement programs. The tremendous demand 
for the SEC to send staff to train foreign investigators demonstrates 
our counterparts' interest in effective enforcement and in combating 
securities fraud. In response, the SEC conducts technical assistance 
and training which, over the course of close to 20 years, has resulted 
in more effective enforcement programs around the world.
    The most prominent type of illegal activity as to which our foreign 
counterparts seek assistance is in the area of insider trading. In the 
past 13 months, the SEC has received over 50 requests from our foreign 
counterparts to assist in insider trading investigations. During this 
same time frame, we have also received a substantial number of requests 
from abroad seeking assistance in market manipulation investigations 
(that is, cases where fraudsters may have manipulated the market price 
of a company's stock by false representations about the company or by 
illegal trading in the stock.)

                         CONCLUSION OF HEARINGS

    Senator Durbin. This meeting of the subcommittee will stand 
recessed.
    [Whereupon, at 3:58 p.m., Wednesday, May 16, the hearings 
were concluded, and the subcommittee was recessed, to reconvene 
subject to the call of the Chair.]


             Material Submitted Subsequent to the Hearings

                 FEDERAL DEPOSIT INSURANCE CORPORATION

 Prepared Statement of Jon T. Rymer, Inspector General, Office of the 
                           Inspector General

    Mr. Chairman and Members of the Subcommittee: I am pleased to 
present the fiscal year 2008 budget request totaling $26.8 million for 
the Office of Inspector General (OIG) at the Federal Deposit Insurance 
Corporation (FDIC), the first budget request since I took office on 
July 5, 2006. This request will allow us to continue meeting our 
statutory responsibilities and assist the FDIC in effectively carrying 
out its mission.
    As you know, the Congress created the FDIC in 1933 as an 
independent executive agency, during the Great Depression, to maintain 
stability and public confidence in the nation's banking system. Our 
nation has weathered several economic downturns since that era without 
the severe panic and loss of life savings unfortunately experienced in 
those times. The federal deposit insurance offered by the FDIC is 
designed to protect depositors from losses due to failures of insured 
commercial banks and thrifts. The Congress enacted deposit insurance 
reform legislation that will maintain insurance coverage for individual 
accounts at $100,000, but provides for inflation indexing every 5 years 
beginning in 2011. Also, as of April 1, 2006, coverage for certain 
retirement accounts increased to $250,000 from $100,000, with similar 
inflation indexing. According to most recent FDIC data, as of December 
31, 2006, the FDIC insured $6.6 trillion in deposits for 8,693 
institutions, of which the FDIC supervised 5,220. The FDIC promotes the 
safety and soundness of these institutions by identifying, monitoring, 
and addressing risks to which they are exposed.
    The Corporation reports that industry earnings are at record-high 
levels, bank capital is historically high, and loan performance has 
slipped only slightly from record levels. Currently, there are 50 
institutions on the ``problem list''--one of the lowest numbers in the 
history of the FDIC. Unfortunately, the 31-month streak of no 
failures--the longest in FDIC history--ended in February 2007, when one 
small institution, Metropolitan Savings Bank, failed. Still, the 
financial health of the banking industry remains very good overall. As 
for the economy, it is now in a sixth year of expansion; however, U.S. 
economic growth appears to be slowing significantly and some negative 
trends are emerging in the banking sector. They include a narrowing of 
net interest margins; increasing concentrations of riskier commercial 
real estate loans; and signs of credit distress in subprime mortgage 
portfolios. As economic conditions shift, the OIG is poised to focus 
its work on the challenges facing the FDIC in monitoring and assessing 
various existing and emerging risks to insured depository institutions 
and the Deposit Insurance Fund.
    The FDIC OIG is an independent and objective unit established under 
the Inspector General Act of 1978, as amended. The OIG's mission is to 
promote the economy, efficiency, and effectiveness of FDIC programs and 
operations, and protect against fraud, waste, and abuse to assist and 
augment the FDIC's contribution to stability and public confidence in 
the nation's financial system.
    Before discussing our budget needs for fiscal year 2008, I would 
like to highlight some of our accomplishments from the past fiscal 
year, our assistance to FDIC management, our planning and internal 
initiatives to improve the OIG, and the management and performance 
challenges facing the FDIC.
      a review of the fdic oig's fiscal year 2006 accomplishments
    As in past years, during fiscal year 2006, our work in audits, 
evaluations, and investigations resulted in a number of major 
achievements, as follows: $44.9 million in actual and potential 
monetary benefits; 26 audit and evaluation reports issued; 82 non-
monetary recommendations to FDIC management; 49 referrals to the 
Department of Justice; 42 indictments/informations; 26 convictions; 1 
employee/disciplinary action.
    More specifically, our accomplishments included investigations that 
led to the above indictments and convictions as well as fines, court-
ordered restitution, and recoveries that constitute slightly over $39 
million in actual and potential monetary benefits from our work. Our 
audit and evaluation reports included about $3.4 million in questioned 
costs and $1.5 million in recommendations that funds be put to better 
use. The audit and evaluation reports contained non-monetary 
recommendations to improve FDIC policies, operations, and controls that 
ultimately are designed to improve the FDIC's ability to effectively 
and efficiently accomplish its mission.
    On the whole, the OIG accomplished all of its organizational goals 
during the fiscal year, as outlined in our annual performance plan. Our 
2006 Performance Report shows that we met or substantially met 100 
percent of our goals. In a measurable way, this achievement shows the 
progress we continue to make in adding value to the Corporation with 
our audits, investigations, and evaluations in terms of impact, 
quality, productivity, and timeliness.
    The following audit, evaluation, and investigative work illustrates 
some of the OIG's accomplishments in fiscal year 2006:
  --Audit reports addressed significant issues. For example, one report 
        contained recommendations to ensure that the FDIC periodically 
        validates key assumptions, estimates, or other components that 
        factor into the calculation of the reserve ratio, which is the 
        ratio of the balance in the Deposit Insurance Fund to estimated 
        deposits in the banking system. In connection with corporate 
        governance practices, this report also recommended improved 
        communication of information relevant to deposit insurance 
        assessment determinations and other corporate matters and 
        activities to the FDIC Board of Directors. Several reports 
        dealt with various consumer protection and community 
        reinvestment issues, including predatory lending, use of Home 
        Mortgage Disclosure Act data to identify and assess instances 
        of potential discrimination in FDIC-supervised institutions, 
        and the FDIC's process for addressing the violations and 
        deficiencies reported in compliance examinations. Our Federal 
        Information Security Management Act-related audits have 
        contributed to the FDIC making significant progress in the past 
        several years in improving security controls and addressing 
        current and emerging information security requirements.
  --Evaluation reports focused on a number of important corporate 
        issues, including the industrial loan company application 
        process, the FDIC's safeguards over personal information, 
        contract administration, and the FDIC's emergency response 
        plan. The reports have generally contributed to strengthened 
        program controls and improved corporate governance of FDIC 
        operations.
    Successful investigative outcomes included the following:
  --The former president and chief executive officer of Hawkeye State 
        Bank (HSB) was ordered to pay $3.7 million in restitution based 
        on his stipulating to having caused $4.9 million in losses to 
        HSB. He was sentenced to 65 months of incarceration and 5 years 
        of supervised release.
  --The former president of the First National Bank of Blanchardville 
        was sentenced to 9 years' incarceration and ordered to pay 
        restitution of $13 million to the FDIC.
  --The former chairman of the board and chief executive officer of 
        Hamilton Bank was sentenced to 30 years of incarceration and 36 
        months of supervised released. He had earlier been convicted on 
        all 16 charges of making false filings to the Securities and 
        Exchange Commission and to bank examiners, making false 
        statements, wire fraud, bank fraud, securities fraud, 
        obstruction of a bank examination, and conspiracy. He, along 
        with two other convicted Hamilton Bank officers, was ordered to 
        pay $32 million in total restitution for bank and securities 
        fraud, $16 million of which is payable to the FDIC.
  --The former chief executive officer (CEO) of the now defunct Sunbelt 
        Savings and Loan of Dallas, Texas, an institution whose 
        insolvency cost taxpayers approximately $1.2 billion, was 
        sentenced to 15 years' imprisonment and ordered to pay a 
        criminal forfeiture of $2 million to the United States 
        Government and restitution in the amount of $312,828 to the 
        FDIC. The former CEO was convicted on 27 counts involving 
        defrauding the FDIC of its payments of $7.5 million and $8.5 
        million in a civil judgment resulting from his 1990 guilty plea 
        to federal fraud charges in connection with the collapse of 
        Sunbelt.

                     ASSISTANCE TO FDIC MANAGEMENT

    In addition to audits, investigations, and evaluations, the OIG 
made valuable contributions to the FDIC in several other ways. Among 
these contributions were the following activities:
  --Reviewed 14 proposed corporate policies and offered comments and 
        suggestions when appropriate (e.g., Employee Rights and 
        Responsibilities under the Privacy Act of 1974, Encryption and 
        Digital Signatures for Electronic Mail, Protection of Privacy 
        Information, the FDIC's Software Configuration Management 
        Program, and Enterprise Risk Management);
  --Participated in division-level conferences and meetings to 
        communicate our audit, evaluation, and investigation work and 
        processes;
  --Provided technical assistance and advice to several FDIC groups 
        working on information technology issues, including 
        participating at the FDIC's information technology security 
        meetings;
  --Reviewed and/or commented on four draft legislative documents and 
        regulations.
    We are committed to continuing to demonstrate to the Congress, the 
public, the FDIC, and the banking industry that the OIG is doing the 
right things and generating results that are a worthy return on the 
investment made in us.

                 OIG PLANNING AND INTERNAL INITIATIVES

    In fiscal year 2006, we undertook a comprehensive and integrated 
approach to planning OIG audits, evaluations, investigations, and 
internal activities, resulting in a Business Plan that captures our 
strategic goals, performance goals, and key efforts. We have been 
planning, conducting our work, and reporting our results in the context 
of these strategic goals since that time and will continue to do so in 
fiscal years 2007 and 2008. The OIG's work is centered on five 
strategic goals that link directly to the FDIC's mission, principal 
business lines, and significant challenges: Supervision, Insurance, 
Consumer Protection, Receivership Management, and Internal Resources 
Management. To these, we added a goal related to our internal processes 
in the interest of continuing to build and sustain a high-quality OIG 
work environment. We are pursuing that goal intently through a number 
of operational improvement projects.
    These projects include professional development; human capital 
management and leadership development; client, stakeholder, and staff 
relationships; quality and efficiency of OIG work; strategic and annual 
performance planning and measurement; and information technology. These 
initiatives are important for the OIG to ensure that we build and 
sustain the quality of our work and remain a results oriented high-
performance organization, use our resources wisely, and stay abreast of 
the significant and ever-changing challenges facing the FDIC and the 
financial services industry.
    The complete 2007 Business Plan can be found on our Web page at 
http://fdicig.gov or obtained by contacting our office. Consistent with 
our working Business Plan, we are currently developing performance 
goals and key efforts for fiscal years 2008 and 2009, which will 
continue building on our six strategic goals. We will also continue to 
coordinate closely with the Congress, FDIC management, financial 
regulatory OIGs, others in the IG community, the U.S. Government 
Accountability Office, and law enforcement agencies as we plan and 
conduct our upcoming work.

      MANAGEMENT AND PERFORMANCE CHALLENGES FACING THE CORPORATION

    As part of our planning and budgeting process, the OIG annually 
assesses the most significant management and performance challenges 
facing the Corporation, in the spirit of the Reports Consolidation Act 
of 2000. In identifying those challenges, we consider the FDIC's 
strategic goals and the Chairman's corporate priorities and objectives. 
Identifying these challenges helps guide our work. In February 2007, we 
identified the following management and performance challenges facing 
the Corporation for inclusion in the Corporation's Performance and 
Accountability Report: addressing risks in large banks; maintaining 
strong regulatory capital standards; implementing deposit insurance 
reform; maintaining an effective examination and supervision program; 
granting insurance to and supervising industrial loan companies; 
guarding against financial crimes in insured institutions; safeguarding 
the privacy of consumer information; promoting fairness and inclusion 
in the delivery of information, products, and services to consumers and 
communities; ensuring compliance with consumer protection laws and 
regulations and follow-up on violations; being ready for potential 
institution failures; and promoting sound governance and managing and 
protecting human, financial, information technology, physical, and 
procurement resources.
    FDIC Chairman Bair recently expressed her views on several 
challenges that the Corporation is facing and that she believes will 
continue to warrant attention over the next few years. The Chairman 
highlighted the following challenges as ``front-burner'' issues:
  --Making sure the FDIC has a strong, vigilant supervisory program and 
        creating a strong interrelationship between compliance and risk 
        management;
  --Implementing deposit insurance reform to help ensure a deposit 
        insurance pricing system that reinforces the supervisory 
        program;
  --Maintaining strong regulatory capital standards under Basel II;
  --Granting insurance to and supervising industrial loan companies;
  --Promoting fairness and inclusion in the delivery of information, 
        products, and services to consumers and communities; and
  --Promoting sound governance and managing resources.
    In addition to these priorities, Chairman Bair recently testified 
before the House Subcommittee on Financial Institutions and Consumer 
Credit of the Committee on Financial Services regarding other 
management and performance challenges facing the Corporation. Chairman 
Bair focused on the following:
  --Strengthening protections available to borrowers in the subprime 
        mortgage market; and
  --Ensuring that predatory lending practices do not take root in the 
        banking system.
    Clearly, our assessment of corporate challenges and the Chairman's 
articulation of priority issues are closely aligned. We look forward to 
continuing to work with the Congress and corporate officials to address 
all of these challenges successfully.

                     OIG'S FISCAL YEAR 2008 REQUEST

    Our fiscal year 2008 budget request seeks the resources necessary 
to allow the OIG to continue its efforts in audit, investigative, and 
evaluation work. In addition, our funding allows us to continue to 
enhance knowledge capacity, employee programs, and operational 
improvement projects. These funds are essential to helping us remain 
prepared to meet the complex issues and challenges confronting the 
FDIC. The funds are critical to ensure that OIG can continue to provide 
our clients with timely, objective, and reliable information on how 
well FDIC programs, operations, and policies are working, and, when 
needed, recommendations for improvement. The OIG is an invaluable tool 
for helping the FDIC protect against fraud, waste, and abuse to assist 
and augment the Corporation's contribution to stability and public 
confidence in the nation's financial system.
    At this time, we anticipate handling a 2008 investigative workload 
comparable to that of 2007. With respect to 2008 audit and evaluation 
work, we also anticipate a similar level of effort, with sustained 
attention to many of the Chairman's corporate priorities. Some key 
efforts begun in fiscal year 2007 will carry over into fiscal year 
2008. To remain responsive to ever-changing priorities and emerging 
issues, we will keep close track of our planned work and make 
adjustments, as needed, to maximize the value that we add.
    After 11 years of consecutive budgetary decreases, our fiscal year 
2008 budget request in the amount of $26,848,000 represents a modest 
increase of $592,000 (or 2.2 percent) over our fiscal year 2007 funding 
level. This budget request reflects a stabilized OIG operating 
environment and will support a full-time equivalent staff of 127, down 
3 from fiscal year 2007. Even with the reduction in staffing, the 
slight increase in budget is required to help absorb higher projected 
expenses for employee salaries and benefits costs and non-personnel 
related expenses. As in past years, funds for the OIG budget would be 
derived from the Deposit Insurance Fund and the Federal Savings and 
Loan Insurance Corporation Resolution Fund.

                           CONCLUDING REMARKS

    I appreciate the support and resources we have received from this 
Subcommittee, the Congress, and the FDIC. As a result, the OIG has 
continued to pursue successful investigations and to make a difference 
in FDIC operations in terms of financial benefits and improvements and 
strengthened internal operations and efficiency. I look forward to 
continue working with this Subcommittee in years to come. I believe our 
fiscal year 2008 budget strikes an appropriate balance between the 
mandate of the Inspector General Act, other legislative requirements, 
our judgments of OIG workload needs, and the changing conditions in the 
banking industry. We continue to seek your support so that we will be 
able to effectively and efficiently conduct our work on behalf of the 
Congress, the FDIC, and the American public.
                                 ______
                                 

                        NONDEPARTMENTAL WITNESS

                Prepared Statement of Independent Sector

    Mr. Chairman and Members of the Committee: Independent Sector 
appreciates the opportunity to comment on fiscal year 2008 federal 
appropriations for Internal Revenue Service activities.
    Independent Sector is a nonprofit, nonpartisan coalition of 
approximately 575 charities, foundations, and corporate philanthropy 
programs, collectively representing tens of thousands of charitable 
groups in every state across the nation. Our mission is to advance the 
common good by leading, strengthening, and mobilizing the charitable 
community. We have worked since our inception to help our member 
organizations meet the highest standards of ethical practice, 
accountability, and effectiveness.
    We support increased funding of the Internal Revenue Service's 
fiscal year 2008 budget and write today to urge you to appropriate the 
level recommended by the IRS Oversight Board: $11.406 billion, $310.1 
million above the President's budget request.\1\ The increased funding 
is necessary to develop more effective oversight and enforcement of the 
laws regulating charities and foundations as well as comprehensive 
education of nonprofit organizations about their obligations under 
those laws.
---------------------------------------------------------------------------
    \1\ IRS Oversight Board, ``Fiscal Year 2008 IRS Budget 
Recommendation, Special Report,'' at 13 (April 2007).
---------------------------------------------------------------------------
An Ethical, Accountable Nonprofit Community is Essential to Nonprofits' 
        Ability to Improve Lives
    Our country's growing nonprofit community works to improve lives in 
communities across America and around the world. It provides vital 
services in such fields as health, education, social assistance, 
community development, and the arts.
    Crucial to fulfilling our missions is our ability to demonstrate to 
our stakeholders--donors, beneficiaries, volunteers, and policymakers--
that we operate ethically and accountably. Only if we earn and maintain 
their trust will we receive their continued support. Preservation of 
that trust depends upon a combination of vigorous self-regulation by 
charitable organizations and effective enforcement of the law.
    In recent years, media stories have revealed a number of instances 
of abuse by taxpayers using charitable organizations for personal gain 
and individuals claiming excessive contributions. Former IRS 
Commissioner Mark Everson encapsulated this threat in testimony before 
Senate appropriators in April 2005, ``[i]f we do not act expeditiously, 
there is a risk that Americans will lose faith in our nation's 
charitable organizations. If that happens, Americans will stop giving 
and those in need will suffer.'' \2\
---------------------------------------------------------------------------
    \2\ Hearing on Internal Revenue Service Fiscal Year 2006 Budget 
Request Before the Senate Comm. on Appropriations, Subcommittee on 
Transportation, Treasury, the Judiciary, Housing and Urban Development, 
and Related Agencies, 109th Cong. 8 (2005) (statement of Mark W. 
Everson, Commissioner, Internal Revenue Service).
---------------------------------------------------------------------------
    Concerned about the cumulative impact of abuse and convinced of the 
need for better enforcement, in 2004, at the encouragement of the 
Chairman and Ranking Member of the Senate Finance Committee, 
Independent Sector brought together leaders from all corners of the 
nonprofit community to create the Panel on the Nonprofit Sector. The 
Panel was charged with considering and recommending actions to ensure 
that charities and foundations maintain the highest possible ethical 
standards. It submitted its Final Report to Congress and the Nonprofit 
Sector \3\ in June 2005 proposing more than 120 actions to be taken by 
charitable organizations, Congress, and the IRS.
---------------------------------------------------------------------------
    \3\ Panel on the Nonprofit Sector, ``Strengthening Transparency, 
Governance, and Accountability of Charitable Organizations: A Final 
Report to Congress and the Nonprofit Sector,'' available at http://
www.nonprofitpanel.org/final/Panel_Final_Report.pdf (June 2005).
---------------------------------------------------------------------------
    A key recommendation of the Panel is to increase resources 
allocated to the IRS for oversight of charitable organizations as well 
as overall tax enforcement. As noted by the Panel, effective oversight 
of the nonprofit community requires vigorous enforcement of the law. It 
continued, ``without adequate resources for oversight and enforcement, 
those who willfully violate the law will continue to do so with 
impunity.'' \4\
---------------------------------------------------------------------------
    \4\ Id. at 25.
---------------------------------------------------------------------------
    Comptroller General David Walker echoed the Panel's recommendation 
in congressional testimony in 2005: ``Oversight can help sustain public 
faith in the sector and ensure that exempt entities stay true to the 
purposes that justify their tax exemption. It also can help protect the 
entire sector from potential abuses initiated by a small minority.'' 
\5\
---------------------------------------------------------------------------
    \5\ Tax-Exempt Sector--Governance, Transparency, and Oversight are 
Critical For Maintaining Public Trust: Hearing on an Overview of the 
Tax-Exempt Sector Before the House Comm. on Ways and Means, 109th Cong. 
1 (2005) (statement of David M. Walker, Comptroller General of the 
United States, Government Accountability Office).
---------------------------------------------------------------------------
Additional Resources are Needed to Restore and Grow IRS Enforcement 
        Capacity
    Following a dramatic decline in IRS enforcement resources during 
the 1990s, Congress has in recent years enacted targeted increases to 
the IRS budget. We applaud and appreciate these investments, which have 
enabled the IRS to initiate critical investigations into potential 
areas of noncompliance, including political intervention by nonprofits, 
executive compensation practices, and abuses by credit counseling 
agencies.
    However, the IRS's enforcement capacity has not yet fully 
rebounded. As the Government Accountability Office noted in a recent 
statement before this subcommittee, ``[a]lthough IRS has increased 
direct revenue collected through its enforcement programs in recent 
years, enforcement continues to be included on our list of high-risk 
federal programs.'' \6\
---------------------------------------------------------------------------
    \6\ Internal Revenue Service, Assessment of the 2008 Budget Request 
and an Update of 2007 Performance: Hearing on the Department of 
Treasury's Budget Request and Justification for Fiscal Year 2008 Before 
the Senate Comm. on Appropriations Subcommittee on Financial Services 
and General Government, 110th Cong. 1 (2007) (statement of James R. 
White, Director, Strategic Issues, Government Accountability Office and 
David A. Powner, Director, Information Technology Management Issues, 
Government Accountability Office).
---------------------------------------------------------------------------
    IRS enforcement resources have not kept pace with the dynamic 
growth of the nonprofit community. Over the past 20 years, the number 
of charities and foundations has nearly doubled in size, with 
applications for tax-exempt status increasingly steadily. During that 
time period, the number of staff within the IRS Tax Exempt and 
Government Entities Division has remained essentially unchanged.\7\ In 
fiscal year 2006, the most recent year for which data is available, the 
IRS examined 34 percent fewer tax-exempt returns than it did in fiscal 
year 1997.\8\
---------------------------------------------------------------------------
    \7\ Statement of David M. Walker, supra note 5, at 17.
    \8\ Internal Revenue Service, ``Fiscal Year 2006 Enforcement and 
Service Results,'' at 7 (November 20, 2006).
---------------------------------------------------------------------------
    The recent enactment of the Pension Protection Act of 2006 (Public 
Law No. 109-280) has put yet additional pressure on the IRS, making the 
need to strengthen the IRS more urgent. The Pension Protection Act 
(PPA) included what one IRS official has categorized as the most 
``significant, comprehensive legislation'' affecting tax-exempt 
organizations since 1969.\9\ It contained various provisions, many of 
which reflected the recommendations of the Panel on the Nonprofit 
Sector, designed to deter individuals who would use charitable 
organizations for personal benefit and to ensure that donations are 
used for charitable purposes.
---------------------------------------------------------------------------
    \9\ Christopher Quay, IRS Focusing on Forms, Education Issues 
Related to Pension Act, Official Says, Tax Analysts, March 14, 2007, at 
Doc 2007-6377.
---------------------------------------------------------------------------
    Since enactment of PPA, the IRS has issued several pieces of 
guidance implementing and explaining the new law. However, much more 
has yet to be done. For example, PPA mandated that the IRS complete a 
study on supporting organizations and donor-advised funds by August 
2007. The IRS has additionally pledged to develop guidance on a number 
of issues in the coming year as well as to continue efforts to overhaul 
the Form 990, the annual Return of Organization Exempt From Income Tax, 
to reflect new filing requirements enacted as part of PPA as well as 
other much-needed modifications.
    Recognizing the importance of building staff capacity and stronger 
enforcement mechanisms, the Administration requested in its fiscal year 
2008 budget funding to support 12 IRS enforcement initiatives, 
including a program to increase tax-exempt entity compliance. Echoing 
the IRS Oversight Board, we applaud the President's commitment to 
restoring and strengthening the oversight capacity of the IRS. However, 
we urge you to fund the initiatives at the level recommended by the 
Board--$351.4 million, or $105 million above the President's 
request.\10\ Increased funding will better equip the IRS to serve its 
enforcement functions--to ensure nonprofits meet the requirements of 
the tax laws, in particular the new mandates included in PPA, and help 
to protect charitable organizations from unscrupulous individuals 
looking to exploit them for personal gain.
---------------------------------------------------------------------------
    \10\ IRS Oversight Board, supra note 1, at 17-19.
---------------------------------------------------------------------------
Education and Outreach are Needed to Enhance Voluntary Compliance
    As articulated in its guiding principle--``service plus enforcement 
equals compliance''--the IRS will only achieve maximum compliance with 
our nation's tax laws if it balances its oversight activities with a 
strong program of education, outreach, and accessibility.
    Recent increases in the IRS budget have enabled the agency to 
develop myriad new educational tools for charitable organizations, 
including issue-specific teleconferences and web forums; an online 
training workshop, www.stayexempt.org; and numerous fact sheets and 
notifications. As in the enforcement arena, however, the passage of PPA 
makes additional IRS education crucial.
    PPA increased the complexity of laws governing charitable 
organizations. Nonprofits will look to the IRS for explanation and 
guidance as they attempt to comply with these important new mandates. 
Tax practitioners too will turn to the IRS for technical guidance to 
ensure that they accurately and effectively advise their nonprofit 
clients.
    The large number of small organizations within the nonprofit 
community magnifies the need for stronger education. The majority of 
nonprofit organizations are community-based groups, many of which rely 
entirely on voluntary staff. Of the one million 501(c)(3) organizations 
registered with the IRS in 2004, approximately 63 percent had annual 
revenues of less than $25,000 and were not required to file with the 
IRS. Of those obligated to file with the agency, nearly 63 percent 
reported total budgets of less than $200,000.\11\
---------------------------------------------------------------------------
    \11\ Independent Sector analysis of the National Center for 
Charitable Statistics Core Data Files for Public Charities and Private 
Foundations. Analysis run on May 16, 2007. Internal Revenue Service, 
``Internal Revenue Service Data Book, 2006,'' at 56.
---------------------------------------------------------------------------
    PPA mandates a new reporting requirement for the smallest 
organizations, those with annual receipts of less than $25,000. Failure 
to comply for three consecutive years will result in revocation of tax-
exempt status. Oversight alone will not ensure these organizations--
some 600,000 groups, the majority of which do not have access to tax 
and accounting advisers--comply with the law. It will be incumbent upon 
the IRS to find and notify these organizations of their new 
responsibility. The IRS Oversight Board's budget recommendation would 
enable the IRS to meet these service needs--to reach out to and educate 
nonprofit organizations that want to comply with the law but may not 
know how--while balancing its enforcement responsibilities.

                               CONCLUSION

    Following a significant decline in resources, the Internal Revenue 
Service has made great strides toward restoring its tax enforcement 
program while maintaining adequate taxpayer services. This achievement 
is due in large measure to recent investments by Congress. We applaud 
and appreciate these efforts.
    However, we concur with the recommendations of former IRS 
Commissioner Everson, the GAO, and others that additional resources are 
necessary to enable the IRS to continue to ensure effective oversight 
of the charitable sector and enforcement of our tax laws, while also 
maintaining taxpayer service. In order to help preserve and grow public 
trust in the nonprofit community's ability to improve lives and 
strengthen communities, we urge you to fund the IRS in fiscal year 2008 
at the level recommended by the IRS Oversight Board: $11.406 billion.
    We thank you for your consideration of these comments. If you have 
any questions, please feel free to contact Patricia Read, Independent 
Sector's Senior Vice President of Public Policy and Government Affairs, 
by phone at (202) 467-6100 or by email at [email protected].
