[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
CAPITAL MARKETS REGULATORY REFORM:
STRENGTHENING INVESTOR PROTECTION,
ENHANCING OVERSIGHT OF PRIVATE POOLS
OF CAPITAL, AND CREATING A NATIONAL
INSURANCE OFFICE
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
----------
OCTOBER 6, 2009
----------
Printed for the use of the Committee on Financial Services
Serial No. 111-84
CAPITAL MARKETS REGULATORY REFORM: STRENGTHENING INVESTOR
PROTECTION, ENHANCING OVERSIGHT OF PRIVATE POOLS OF CAPITAL, AND
CREATING A NATIONAL INSURANCE OFFICE
CAPITAL MARKETS REGULATORY REFORM:
STRENGTHENING INVESTOR PROTECTION,
ENHANCING OVERSIGHT OF PRIVATE POOLS
OF CAPITAL, AND CREATING A NATIONAL
INSURANCE OFFICE
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
OCTOBER 6, 2009
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-84
U.S. GOVERNMENT PRINTING OFFICE
55-810 WASHINGTON : 2010
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
----------
Page
Hearing held on:
October 6, 2009.............................................. 1
Appendix:
October 6, 2009.............................................. 85
WITNESSES
Tuesday, October 6, 2009
Abraham, Janice M., President and Chief Executive Officer, United
Educators Insurance, on behalf of the Property Casualty
Insurers Association of America (PCI).......................... 56
Atkinson, David B., Executive Vice President, Reinsurance Group
of America (RGA), on behalf of the Reinsurance Association of
America (RAA).................................................. 58
Bullard, Mercer E., President and Founder, Fund Democracy, Inc... 11
Chanos, James S., Chairman, the Coalition of Private Investment
Companies (CPIC)............................................... 45
Crawford, Denise Voigt, Texas Securities Commissioner; and
President, North American Securities Administrators
Association, Inc. (NASAA)...................................... 8
Herchel, Dennis S., Assistant Vice President & Counsel,
Massachusetts Mutual Life Insurance Company, on behalf of the
American Council of Life Insurers (ACLI)....................... 60
Houldin, Spencer M., President, Ericson Insurance Advisors, on
behalf of the Independent Insurance Agents & Brokers of America
(IIABA)........................................................ 62
Kaswell, Stuart, Executive Vice President and General Counsel,
Managed Funds Association (MFA)................................ 41
Ketchum, Richard G., Chairman and CEO, the Financial Industry
Regulatory Authority (FINRA)................................... 10
Lowenstein, Douglas, President/CEO, the Private Equity Council... 43
Maisel, Bruce W., Vice President & Managing Counsel, Thrivent
Financial for Lutherans, on behalf of the American Council of
Life Insurers (ACLI)........................................... 17
McGuire, Terry, Co-Founder and General Partner, Polaris Venture
Partners; and Chairman, National Venture Capital Association... 46
Taft, John, Head of U.S. Wealth Management, RBC Wealth
Management, on behalf of the Securities Industry and Financial
Markets Association (SIFMA).................................... 13
Tittsworth, David G., Executive Director and Executive Vice
President, Investment Adviser Association (IAA)................ 15
Vaughan, Therese M., Chief Executive Officer, National
Association of Insurance Commissioners (NAIC).................. 64
Zielezienski, J. Stephen, Senior Vice President & General
Counsel, American Insurance Association (AIA).................. 66
APPENDIX
Prepared statements:
Kanjorski, Hon. Paul E....................................... 86
Garrett, Hon. Scott.......................................... 88
Abraham, Janice M............................................ 89
Atkinson, David B............................................ 97
Baker, Hon. Richard H........................................ 104
Bullard, Mercer E............................................ 120
Chanos, James S.............................................. 126
Crawford, Denise Voigt....................................... 147
Herchel, Dennis S............................................ 161
Houldin, Spencer M........................................... 168
Ketchum, Richard G........................................... 175
Lowenstein, Douglas.......................................... 188
Maisel, Bruce W.............................................. 194
McGuire, Terry............................................... 211
Taft, John................................................... 227
Tittsworth, David G.......................................... 241
Vaughan, Therese M........................................... 273
Zielezienski, J. Stephen..................................... 280
Additional Material Submitted for the Record
Kanjorski, Hon. Paul E.:
Written statement of the Financial Services Institute........ 294
Written statement of the National Association of Insurance
and Financial Advisors (NAIFA)............................. 300
Written statement of the National Association of Mutual
Insurance Companies (NAMIC)................................ 306
Written statement of the National Association of Small
Business Investment Companies (NASBIC)..................... 314
Chanos, James S.:
Written responses to questions submitted by Representative
McHenry.................................................... 317
Tittsworth, David G.:
Written responses to questions submitted by Representative
Cleaver.................................................... 318
CAPITAL MARKETS REGULATORY REFORM:
STRENGTHENING INVESTOR PROTECTION,
ENHANCING OVERSIGHT OF PRIVATE POOLS
OF CAPITAL, AND CREATING A NATIONAL
INSURANCE OFFICE
----------
Tuesday, October 6, 2009
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:02 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Kanjorski, Waters,
Moore of Kansas, Miller of North Carolina, Scott, Green,
Cleaver, Bean, Klein, Perlmutter, Foster, Carson, Speier,
Minnick, Adler, Himes, Maffei; Bachus, Royce, Manzullo,
Biggert, Capito, Garrett, McCarthy of California, and Posey.
The Chairman. This hearing will come to order.
It is the next in a series in which I have lost count of
specific legislative hearings on pending legislation. It is a
long day. The gentleman from Pennsylvania, the chairman of the
Subcommittee on Capital Markets, and his staff, along with the
staff of the full committee, have done a great deal of work;
and there will be a great deal presented today.
I am now going to recognize the chairman of the
Subcommittee on Capital Markets for 5 minutes.
Mr. Kanjorski. Thank you, Mr. Chairman.
Today, the Financial Services Committee will examine the
three legislative discussion graphs on investor protection,
private fund adviser registration, and insurance information
that I released last week.
If we have learned anything from the financial crisis, it
is that excessive deregulation is dangerous. My three bills
work to reverse this trend by closing loopholes and fixing
problems in the broken regulatory structure, especially in our
securities and insurance markets.
As we work through these drafts and the many other pieces
encompassing financial services regulatory reform, we should
listen to commonsense ideas and seek out consensus where it
exists. I am, therefore, open to making changes in these draft
bills.
In working to enact meaningful regulatory reform, however,
we must ensure that special interests do not weaken particular
solutions to the point of becoming toothless. Looking ahead to
next year and beyond, after this round of reform is done, we
must remain diligent guardians of the public interest and of
the financial system's health as a whole. Financial innovation
and capitalism always seek to outpace the development of laws
and regulations. This is the nature of our system. To correct
this bias, vigilance is our only hope.
That said, the three draft bills before us today will no
doubt enhance regulatory authority and improve access to
information. For example, the Investor Protection Act provides
the U.S. Securities and Exchange Commission with more firepower
to perform its mandated duties. Like the Administration's
reform plan, this bill includes the requirement that all
securities professionals providing advice have a fiduciary duty
toward their customers. Through a harmonized standard, brokers,
dealers, and investment advisers will have to put investors'
interests first.
The draft Investor Protection Act also significantly
expands the ability of the Commission to reward those
whistleblowers whose tips lead to successful enforcement
actions. This legislation will further permit the Commission to
adopt rules to bar the inclusion of mandatory arbitration
clauses in securities contracts.
Additionally, this legislation significantly expands upon
the proposal put forward by the Administration by closing
loopholes identified by the Madoff and Stanford financial
frauds, updating the Securities Investor Protection Act, and
modifying the authorities of the Public Company Accounting
Oversight Board. Moreover, the bill doubles the Commission's
available funding over the next 5 years.
But enhancing the Commission's firepower and providing more
money are simply not enough. As a result, the draft bill calls
for an independent, comprehensive study of the entire
regulatory structure that oversees the securities industry by a
high-caliber body with expertise in organizational change that
will identify further improvements to the implementation of our
securities laws.
The second draft bill, the Private Fund Investment Advisers
Registration Act, requires advisers of hedge funds, private
equity firms, and others who have previously escaped direct
regulatory oversight to register with the Commission and
disclose certain vital information. Transparency has been
nonexistent in this area for far too long, and the financial
crisis revealed that our system cannot tolerate such omissions
going forward.
The third bill would create a Federal Insurance Office to
provide national policymakers with access to the information
and resources needed to respond to crises, mitigate systemic
risks, and help ensure a well-functioning financial system. The
credit meltdown highlighted the lack of expertise within the
Federal Government regarding the insurance industry, especially
during the collapse of the American International Group and
last year's turmoil in the bond insurance markets. My bill
would rectify these shortcomings and promote stability in our
insurance markets.
In closing, Mr. Chairman, our job today is to swing the
regulatory pendulum back toward the interests of hardworking
Americans. The three draft bills before us will accomplish that
objective. Billionaires on Wall Street have had their day,
egged on by a culture of greed, deregulation, and a survival-
of-the-fittest attitude that ignored the harsh effects those
things inflict upon larger society. Today's hearing advances
the effort to correct these excesses.
Thank you, Mr. Chairman.
The Chairman. The gentleman from Alabama is recognized for
3\1/2\ minutes.
Mr. Bachus. Thank you.
The catastrophic failure of AIG and the Madoff and Stanford
Ponzi schemes provide clear evidence that our current
regulatory structure is in need of reform. Republicans and
Democrats have both offered legislation to address these
concerns.
Chairman Kanjorski's draft bill, which is the subject of
today's hearing, incorporates key portions of the Republican
financial regulatory reform plan, including providing the SEC
with enhanced enforcement powers and giving victims of
financial fraud additional relief. The legislation represents a
solid foundation on which to build a bipartisan consensus on
investor protection issues.
The draft bill also contains provisions sponsored by
Representatives McCarthy, Lee, and Jenkins that have already
passed the House this year on suspension and clarify and
provide corrections to securities laws in addition to promoting
transparency and financial reporting. It includes provisions of
H.R. 2873, introduced by Representative John Campbell, to
provide the SEC with increased enforcement powers.
All these provisions enhance investor protection, modernize
our capital markets, and begin to restore investor confidence
in our markets and in the SEC; and I commend Chairman Kanjorski
for incorporating them.
Other elements of the draft bill require further study, in
my view. For example, the bill could substantially increase
dispute resolution costs for investors and compliance costs for
firms by providing the SEC with the authority to restrict and
eliminate arbitration agreements.
In addition, the discussion draft does not go far enough in
restructuring the SEC. The Inspector General's report detailed
a massive failure of the SEC and their staff to detect the
Madoff Ponzi scheme and is the best evidence for the need of
SEC reform. The Office of Compliance, Inspections, and
Examinations needs to be eliminated, in my view, and its
functions returned to the divisions from which it was created.
Chairman Kanjorski has released draft legislation to
address private pools of capital and insurance. The Private
Fund Investment Advisers Registration Act mandates SEC
registration for previously unregistered advisers of hedge
funds, private equity, and other private pools of capital.
While no private pool of capital was the source of systemic
risk or contributed to the current financial crisis, greater
transparency in this part of our capital markets could serve as
an important safeguard in the future if done right. However, we
must ensure that any new regulatory powers granted the SEC are
appropriate and do not interfere with the comprehensive due
diligence that investors already perform or discourage
innovation and capital formation.
Finally, today's hearings will examine the Federal
Insurance Office Act of 2009, which would create a new Federal
Insurance Office housed within the Treasury Department to deal
with insurance issues. This draft builds on the bipartisan
insurance legislation reported by this committee in the 110th
Congress. Judy Biggert and Chairman Kanjorski introduced that.
Thank you, Mr. Chairman.
The Chairman. I thank the gentleman.
Now the gentleman from California, Mr. Royce, for 2
minutes.
Mr. Royce. Thank you, Mr. Chairman.
Earlier this year, in an op-ed in the Washington Post,
Secretary Geithner and Larry Summers noted the importance of
international coordination among regulators; and they wrote
this in the Post. They said, ``We live in a globalized world,
and the actions we take here at home, no matter how smart and
sound, will have little effect if we fail to raise
international standards along with our own standards. We will
lead the effort to improve regulation and supervision around
the world.''
Well, with our fragmented regulatory regime over insurance,
I think it is very clear that we are lagging behind the rest of
the world. Solvency II will be implemented by the EU in the
coming months, and that will bring all of Europe under one
market for insurance. Yet the United States continues to
struggle with 50 individual markets.
Certainly, creating a Federal Insurance Office would be a
beneficial first step, but I am afraid that it will not go far
enough. The current State-based regulatory system is, as the
Treasury Department said in its White Paper when it did its
analysis, they said: ``It is highly fragmented, it is
inconsistent, it is inefficient. In short, it costs consumers,
and it makes our regulatory model weaker.''
So, as Chairman Bernanke and Secretary Geithner have stated
in previous hearings, we should consider establishing a world-
class regulatory alternative to what is currently a fragmented
State-based system.
I believe any regulatory reform effort will be incomplete
without the inclusion of a world-class Federal insurance
regulator, and I look forward to hearing from our panel of
witnesses today. I hope some of them will comment on that.
I yield back, Mr. Chairman.
The Chairman. So as not to change the subject, the
gentlewoman from Illinois is now recognized for 2 minutes.
Ms. Bean. Thank you, Mr. Chairman, for yielding and for the
time and for holding today's hearing.
I want to recognize the leadership of Subcommittee Chair
Kanjorski and the three bills before us today as part of the
broader financial regulatory reform designed to restore
investor confidence, all of which are critical to making sure
that what happened last year doesn't happen again.
I am proud to again be an original cosponsor of the
National Insurance Office Act. I believe this bill is an
important step towards addressing the lack of insurance
expertise and oversight at the Federal level. It will establish
for the first time a Federal voice for insurance matters and a
Federal official who can negotiate international agreements
that are important to the competitiveness of the U.S. insurance
industry.
However, since last Congress, much has changed in our
financial system. The collapse of AIG, the world's largest
insurer, has proven to be one of the most costly and dangerous
corporate disasters in our Nation's financial history. With
nearly $180 billion of Federal tax dollars committed to AIG,
plus billions more offered to other insurers, the Federal
Government has made an unprecedented investment in an industry
over which it has no regulatory authority.
There has never been a greater need for national insurance
regulatory oversight. Not just an office to collect
information, however. Through two Capital Markets Subcommittee
hearings this year, we have heard general agreement that there
should be a Federal role in the regulation of the insurance
industry.
The call for reform was most recently echoed 2 weeks ago
before this committee during a hearing on systemic risk. In his
written testimony and during the question-and-answer period,
former Chairman Paul Volcker advocated that establishing a
national insurance regulator was a critical component to
broader regulatory reform in order to ensure oversight of an
important pillar of the U.S. financial system.
Mr. Volker's statement follows the call for insurance
reform by the Obama Administration. The Treasury proposal
specifically cited six principles for reform, including,
``increased national uniformity,'' and recognized again our
current--
The Chairman. The gentlewoman will get 30 additional
seconds. It will come from my time.
Ms. Bean. Thank you, Mr. Chairman.
--and recognized that our current insurance regulatory
system is highly fragmented, inconsistent, and inefficient.
It supported consideration of a Federal charter. The
creation of a National Insurance Office is helpful, but without
the authority to require consistent regulatory rules
enforcement and accountability, it falls short. As we work to
modernize our financial regulatory structure, we should address
the failure of the current insurance regulatory system that
increases risks and costs to customers. Today, we have that
opportunity. I look forward to working with my colleagues on
the committee to do just that.
Thank you. I yield back.
The Chairman. The gentlewoman from Illinois for 1\1/2\
minutes.
Mrs. Biggert. Thank you, Mr. Chairman. I would like to
thank you for holding today's hearing.
First, I would like to thank a few organizations
represented on panel one--FINRA, Thrivent Financial for
Lutherans, and ACLI--for their work to promote financial
education.
As we all know, empowering consumers with financial
education and the tools they need to thrive in today's
complicated marketplace is the best kind of consumer
protection. It is also important that we crack down on fraud.
Second, I would like to thank the witnesses on the second
panel for their work to invest in America and America's
entrepreneurs who create jobs.
Lastly, I want to say a few things about proposals to
create a national insurance office, which will be the subject
of panel three and something that Congressman Kanjorski and I
are working on.
Through the last decade, it has become increasingly
apparent that our Federal Government has little or no knowledge
or understanding of the insurance industry. After 9/11, the
Federal Government had to step in and provide terrorism risk
insurance. Federal regulation lacked expertise and failed to
completely understand a multifaceted business like AIG, a
global company with savings and loan and insurance and
derivatives business.
Almost a year ago, we worked to stabilize the financial
market's treasury. Due to a lack of understanding, dismissed
proposals modeled after insurance and State guarantee funds.
And, finally, there is no in-house expertise in the Federal
Government to represent the U.S. positions on insurance during
international negotiations.
I look forward to today's discussion.
The Chairman. By the way, we have very outdated equipment.
Let me explain to people. It does not do 30 seconds. It only
does minutes. I am going to see if we can get the Legislative
Branch to spring for a more modern one. So that is why, before
the red light goes on, it may happen sometimes. But we are
working on that.
The gentleman from New Jersey is now recognized for 1\1/2\
minutes.
Mr. Garrett. Thank you, Mr. Chairman. Thank you to this
panel and all the panelists who are coming here.
The first item on the agenda, the investor protection
piece, I think really offers us an opportunity for
bipartisanship as we work forward; and I look forward to doing
so.
But I think we need to be clear about what we are doing
here today and what this panel and panels are all about and the
hearing. It is really just checking the boxes. In order to stay
in line with some artificially imposed deadline, really, the
Majority has scheduled today's hearing on a Members' travel
day. That is why we have so few people here. Today's hearing is
not one, not two, but three completely separate issues over the
course of three panels. Also, the Majority can say we have had
a legislative hearing on each one of these items and they are
fully examining these important issues.
Unfortunately, what we have here before us today is, rather
than fulfilling a good-faith commitment to a deliberative
process, some people are saying it makes a mockery of it; and
there is a risk in making a mockery of the entire hearing
process.
These witnesses, for instance, only had one business day to
review a 114-page draft before having to submit their testimony
yesterday; and witnesses won't give their due consideration
like they otherwise should to their testimony if they don't
think the committee will take it seriously.
Secretary Geithner already said that he doesn't take
seriously the testimony of independent regulators. But that is
another issue.
The issues before us today really are all very important.
In another Congress, they would each receive careful
deliberation. But not in this one. Here, we set unrealistic
politically imposed deadlines which rush the legislative
process and threaten really unintended consequences throughout
large swaths of our market and our broader economy as well.
I thank you.
The Chairman. I now recognize myself for 2\1/2\ minutes.
I apologize to the gentleman from New Jersey. We gave him
no substance to complain about, so he had to manufacture some
artificial complaints about process.
First he said, wholly inaccurately, that this was scheduled
for a travel date. When this hearing was scheduled, we did not
know that there would be no votes last night. So, no, it was
not scheduled that way.
Second, I do not apologize for telling members that we have
to have more than 2 days a week in which we can work. This
defense of a work ethic that says, oh, we can't be expected to
sit at a sensible important hearing because there aren't votes
until 6:30 leaves me wholly unimpressed. If members choose not
to--there was only recently an announcement that today would be
a no voting day.
So, secondly, as to arbitrary deadlines, in April of 2008,
George Bush's Secretary of the Treasury urged us to start
acting. Many people think we have delayed longer than we
should. We have a lot of hearings, and I guess for some members
it is a problem. They were elected to Congress. We have
legislative responsibilities. But leaving their home districts
or whatever political activity they are engaged in or specific
activity to come to a hearing to the gentleman of New Jersey is
an imposition on them. No, I think it is part of our
responsibility. Yes, it will be a day of hearings. In fact, it
will work out well, because we will not be interrupted by
votes. We will have a full day to have these hearings. These
are not new subjects.
And, again, I stress that the gentleman from New Jersey
appeared to me to be a little frustrated because he could not
find anything to disagree with. He began by saying that this
could be bipartisan. But that moment of bipartisanship
apparently unsettled him to the point where he had to then
launch into a wholly inaccurate and unjustified partisan
attack: We are having too many hearings. We are trying in a
financial crisis to adopt legislation too quickly. We have, as
he said, got a bipartisan agreement here. The gentleman from
Alabama noted that there is a great deal of bipartisan
agreement, that this bill incorporates a number of things that
had been presented by members on both sides. There is a
difference over arbitration. I think we have a very good debate
about that. We have talked about that, and we have had hearings
about it before.
So I want to say that the gentleman from Pennsylvania in
particular I think does not deserve that kind of partisan
attack. He has, as the gentleman from New Jersey knows, reached
out to try to be cooperative. The result is a product that
people say is bipartisan but I must say a very unfair attack on
the procedure by which we will move it into law.
The gentleman from California is now recognized for 1\1/2\
minutes.
Mr. McCarthy of California. Thank you, Mr. Chairman.
I look forward to the testimony of all the witnesses and
hearing their thoughts on the issues before the committee.
Specifically, I am interested in their views on harmonizing the
duty of care for all financial investors and how that would
affect the entire investment advising community and their
customers, from individuals to sophisticated institutional
investors.
Additionally, I am concerned about the draft's movement to
restrict arbitration. I look to our panelists to provide
additional comments about how this significant change will
affect the marketplace.
I also have a particular interest in the SEC's structural
issues. I see that section 304 of the Investor Protection Act
requires the SEC to hire an outside consultant to inform the
SEC on how to better organize itself. While this may be
helpful, I would like to point out that I have introduced
legislation that would solve some of the structural problems
within the SEC without additional studies.
The SEC Inspector General's Report regarding the Madoff
Ponzi scheme was a colossal regulatory failure. It is perfectly
clear to me that reform is needed now, not more studies. H.R.
2622 would move the Office of Inspection and Examinations back
to the original functional location within the Division of
Investment Management and Trading and Markets. This would
streamline operations at the SEC and reduce their current
stovepipe structure where those charged with inspecting and
examining organizations are entirely separate from those who
set the policy.
Thank you, Mr. Chairman, and I yield back.
The Chairman. We will begin with the testimony.
Our first witness is Denise Voigt Crawford, who is the
Texas Securities Commissioner; and she is here on behalf of the
North American Securities Administrators Association.
STATEMENT OF DENISE VOIGT CRAWFORD, TEXAS SECURITIES
COMMISSIONER; AND PRESIDENT, NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION (NASAA)
Ms. Crawford. Good morning, Chairman Frank, Ranking Member
Bachus, and members of the committee. I am so honored to be
here today to discuss legislative changes that are most
relevant to Americans who are looking to rebuild and safeguard
their financial security.
While the recent financial crisis was the result of many
failures, I am very proud to say that a failure of State
securities regulation was not one of them. Today, I will focus
on several proposals.
First, fiduciary duty. Financial service providers,
generally stockbrokers and investment advisers, are regulated
under two different statutes. The migration of stockbrokers to
the advisory business has fueled confusion among investors.
This is such an important issue for investors that Congress
should explicitly direct the SEC to adopt rules no later than 1
year from passage of the Act mandating compliance by broker-
dealers with the fiduciary duty standard established by the
1940 Investment Advisers Act. There should be no equivocation
in the language, And any rulemaking should be limited to simply
effectuating this requirement.
As you note, some industry groups have also called for the
imposition of a fiduciary duty. However, their ``new Federal
fiduciary standard,'' a harmonized standard, is not the 1940
Act standard.
Second, increased States' regulation of investment
advisers. As evidenced by the Inspector General's report of the
Madoff affair, the bulk of federally covered investment
advisers are examined infrequently. When examinations are
conducted, the SEC has demonstrated a lack of understanding as
to the business of these registrants. An oversight gap exists.
NASAA members, State securities regulators are fully
prepared and equipped right now to fill this gap by accepting
responsibility for the oversight of investment advisers up to
$100 million in assets under management. Investors can walk
into our offices so that proximity ensures accessibility. Plus,
NASAA members are the only regulators that actually license the
investment adviser representatives, the individuals who
actually provide the investment advice.
I would add that the lengthy experience of NASAA members in
the application of fiduciary duty sets us apart from SROs.
Third, securities arbitration. Today, virtually every
broker-dealer's customer account contains a pre-dispute
mandatory arbitration provision that forces investors to submit
all disputes to mandatory arbitration run by FINRA. The only
chance of recovery for most investors who fall victim to
wrongdoing on Wall Street is through a single securities
arbitration forum controlled by the securities industry. This
clause in brokerage accounts is inherently unfair to investors.
It is time to end mandatory industry-run arbitration.
Short of an outright congressional prohibition, section 201
of the discussion draft is a positive step. NASAA believes it
should be amended, however, to require that the SEC prohibit
this mandatory predispute arbitration and offer a meaningful
choice to investors, including civil litigation. If arbitration
really is as fair, inexpensive, and quick as its proponents
claim, then these benefits will prompt investors to choose
arbitration. If, on the other hand, arbitration does not offer
these advantages, then this mode of dispute resolution should
not be forced upon the investing public.
Fourth, establishment of a systemic risk council. Any
solution must provide enhanced communication among State and
Federal regulators. A systemic risk council would establish a
crisis management protocol with clear and regular lines of
communication among all regulators. Generally, since State
regulators are the first to identify risks and trends that
contribute to systemic risk, we really do need some State
banking insurance and securities regulators to serve on the
systemic risk council.
Fifth and last, aiding and abetting. One of the purposes of
the original securities laws was to establish higher standards
of conduct. Sections 206 and 207 of the draft further this
purpose by explicitly providing the SEC the authority to
prosecute secondary actors who aid and abet violations of these
acts. However, the interests of investors would be best served
by amending these sections to remove the language ``brought by
the Commission.'' The current language may be misinterpreted as
an explicit or implicit exclusion of private rights of action.
Certainly, this is what the defendants will argue.
Deceptive and manipulative transactions that are intended
to defraud investors really should not be classified as
ordinary business decisions, and secondary actors such as
accountants and lawyers should not be allowed to skirt
responsibility for their wrongdoing.
In conclusion, NASAA greatly appreciates the opportunity to
present our views today. Going forward, we are absolutely
committed to working with you as you go forward to enhance and
improve our regulatory framework. Thank you.
[The prepared statement of Ms. Crawford can be found on
page 147 of the appendix.]
The Chairman. Thank you, Commissioner.
Next, Mr. Richard Ketchum, who is the chairman and CEO of
the Financial Industry Regulatory Authority.
STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CEO, THE
FINANCIAL INDUSTRY REGULATORY AUTHORITY (FINRA)
Mr. Ketchum. Chairman Frank, Ranking Member Bachus,
Chairman Kanjorski, and members of the committee, on behalf of
FINRA, I would like to thank you for the opportunity to
testify. I commend you, Mr. Chairman, for having today's
hearing on the critically important topic of improving investor
protection in our regulatory structure for financial services.
Let me begin by saying I am deeply troubled by our system's
failures during the past 2 years and eager to see changes that
could improve the level of investor protection. When so many
investors have been harmed, it is vitally important that all
regulators take a hard look at their programs, identify
lessons, and make changes that can better prepare them for the
future.
At FINRA, that process is well under way. Already this
year, we have enhanced our examination programs, procedures,
and training in a variety of ways intended to help us better
detect conduct that could be indicative of fraud. We
established an Office of the Whistleblower to handle high-risk
tips, and last week, we announced the creation of FINRA's
Office of Fraud Detection and Market Intelligence. This new
office provides a heightened review of incoming allegations of
serious frauds, a centralized point of contact, internally and
externally, on fraud issues, and consolidates recognized
expertise in expedited fraud detection and investigation.
We will continue to develop plans to further strengthen our
programs; and we also continue to believe that the broader
financial reform that this committee is undertaking is vitally
important, especially in terms of closing regulatory gaps that
create exposure for investors.
One of the most glaring examples of this type of regulatory
gap is the disparity in oversight between broker-dealers and
investment advisers. FINRA supports the Administration's goal
of harmonizing the regulation of broker-dealers and investment
advisers. We believe that, in order to accomplish that goal,
two steps are necessary.
The first is establishing a consistent fiduciary standard
for investment advisers and broker-dealers providing investment
advice. The second is harmonizing the enforcement of that
standard and the other rules relevant to each channel to better
ensure that participants in that industry actually comply with
those obligations.
The Administration has proposed that the SEC write rules
establishing consistent fiduciary standards of care for
investment advisers and brokers providing investment advice.
FINRA stands in agreement with numerous interested parties that
the standard of care in both channels should be a fiduciary
standard for the provision of advice.
Harmonization of the standard of care is an important first
step. However, given the number of recently revealed frauds
perpetrated by investment advisers bound by the fiduciary
standard, it is clear that the existence of the fiduciary
standard of care alone is not a guarantee against misconduct.
Compliance with that standard must be regularly and vigorously
examined and enforced to ensure the protection of investors.
FINRA believes that authorizing the SEC to designate an
independent regulatory organization to augment the agency's
efforts in examining investment advisers would create a
structure that would better protect investors regardless of how
their financial profession is registered.
To put this in real terms, there are nearly 5,000 broker-
dealer firms registered with the SEC; and between the SEC and
FINRA, approximately 55 percent of those firms are examined on
an annual basis. By contrast, there are 11,000 investment
adviser firms registered with the SEC, and the agency expects
only 9 percent to be examined in Fiscal Years 2009 and 2010. No
one involved in regulating securities and protecting investors
can be satisfied with a system where only 9 percent of
regulated firms are examined each year. It is a dramatic lack
of coverage, and must be remedied.
Now, let me briefly turn to arbitration. We believe our
forum provides efficient resolution of disputes in an impartial
forum that is less costly and faster than traditional
litigation. We focus our efforts on running a fair and
efficient program, and we continually work to update and
improve it.
On the question of mandatory arbitration, I would note that
FINRA rules do not require investors to arbitrate disputes with
their brokerage firms, though they do require brokers to submit
to arbitration if their investors choose. This is a matter of
contract between firms and their customers.
FINRA has long maintained that its determination about
whether mandatory arbitration agreements should be allowable is
a decision best made by Congress and the SEC. As such, we do
not object to the proposal to authorize the SEC to restrict or
prohibit mandatory arbitration agreements.
Before I conclude, let me briefly touch on the issue of
self-funding for the SEC. I believe that any mechanism that
could provide more resources and predictability to the SEC in
support of its critical mission should be explored. Especially
now, I don't think we are in an either/or environment for
enhancing oversight of security markets. We stand ready to work
with Congress and the SEC to find solutions and fill the gaps
in our current regulatory system and create a regulatory
environment that works properly for all investors.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Ketchum can be found on page
175 of the appendix.]
The Chairman. Next, Mr. Mercer Bullard, who is founder and
president of Fund Democracy, Incorporated.
STATEMENT OF MERCER E. BULLARD, PRESIDENT AND FOUNDER, FUND
DEMOCRACY, INC.
Mr. Bullard. Chairman Frank, Ranking Member Bachus, and
Chairman Kanjorski, thank you for the opportunity to appear
before the committee today to discuss the protection of
investors. It is an honor and a privilege to appear to discuss
these issues before the committee today.
I would like to comment on certain provisions of the
October 1st draft of the Investor Protection Act of 2009.
I strongly support the Act's position that brokers should
be subject to a fiduciary duty with respect to retail
personalized investment advice. Section 103 accomplishes this
goal by requiring the SEC to adopt rules making brokers subject
to such a duty. Personalized investment advice creates a
situation in which it is likely that a retail client will rely
heavily on a broker's recommendation. The authority, therefore,
is the proper standard in that context.
Under current law, brokers are subject to a suitability
standard. Section 103 raises this standard. The duty requires,
for example, that brokers disclose conflicts of interest that
are not required to be disclosed under the suitability standard
or other FINRA rules.
I am concerned, however, about the mechanism that Section
103 uses to establish a fiduciary duty for brokers. It amends
the Exchange Act to impose the same standard of conduct for
brokers that applies under the Advisers Act and then amends the
Advisers Act to provide that standard shall be a fiduciary duty
to act in the best interest of the client.
My concern is the interplay between the amendment to the
Advisers Act and the fiduciary duty that currently applies to
the advisers under the Act. The amendment could be read to
create a new and, more importantly, different fiduciary duty
from the current Advisers Act fiduciary duty. For example, the
imposition of a statutory fiduciary duty as to retail
personalized investment advice raises the question of whether
and how the existing fiduciary duty owed to nonretail clients
survives the amendment.
If the amendment to the Exchange Act simply provided that,
with respect to retail investment advice, brokers were subject
to the same fiduciary duty that applies to investment advisers
under the Advisers Act, then no amendment to the Advisers Act
would be necessary. Brokers and investment advisers would be
subject to the same fiduciary duty with respect to retail
personalized investment advice. Advisers would still be subject
to a fiduciary duty with respect to nonretail clients as well.
Imposing a fiduciary duty on brokers and investment
advisers will amount to very little, however, if regulators
lack the capacity to enforce it. The SEC has long been
substantially underfunded, and the declining frequency of
investor adviser inspections has been one result.
Section 302 of the Act takes an important step toward
addressing the problem by creating an industry financed
mechanism for the SEC's advisory inspection program. But this
will not be enough. States also play a critical role in the
enforcement of investment adviser regulation. The cutoff amount
for State regulation of investment advisers should be increased
to return the number of advisers subject to SEC inspection to
pre-INISMIA levels.
Furthermore, the gap in inspections of advisers who are
exempt from the Act should be plugged. Bernie Madoff was such
an exempt broker for almost his entire career. The simplest
mechanism would be to repeal the solely incidental exclusion
for brokers. The SEC's overbroad interpretation of that
exclusion has left brokers who provide a significant amount of
investment advice unregulated under the Advisers Act.
Alternatively, brokers' unregulated investment advisory
activities should be regulated by their regulator, FINRA. FINRA
has argued it lacks the authority to regulate the advisory
activities of its members who are not registered investment
advisers. I believe that FINRA clearly has this authority. But
whether FINRA will not or cannot assume responsibility for its
own members' unregulated advisory activities, this situation
needs to be remedied. Brokers' new fiduciary duty with respect
to retail personalized investment advice will mean little if
their primary regulator isn't capable of enforcing it.
I recommend that the committee resolve this issue by asking
the SEC whether and to what extent FINRA lacks the authority to
inspect its members' unregulated advisory activities. If it
lacks such authority, then Congress or the SEC should take
whatever steps are necessary to fix this regulatory gap. Then,
if FINRA shows that it is capable of regulating the activities
of brokers who are not registered investment advisers, then we
can have the SRO discussion about whether FINRA might be
capable of regulating the advisory activities of brokers who
are registered investment advisers. But as long as Bernie
Madoff continues to represent the most telling example of
FINRA's oversight of brokers who are exempt from the Advisers
Act, any discussion of expanding FINRA's role would be
premature.
Thank you for your consideration of my views; and I would,
of course, be happy to take questions.
[The prepared statement of Mr. Bullard can be found on page
120 of the appendix.]
The Chairman. Thank you.
Next, we have Mr. John Taft from RBC Wealth Management, who
is testifying on behalf of the Securities Industry and
Financial Markets Association.
STATEMENT OF JOHN TAFT, HEAD OF U.S. WEALTH MANAGEMENT, RBC
WEALTH MANAGEMENT, ON BEHALF OF THE SECURITIES INDUSTRY AND
FINANCIAL MARKETS ASSOCIATION (SIFMA)
Mr. Taft. Thank you, Chairman Frank, Ranking Member Bachus,
and members of the committee. I am pleased to testify this
morning on behalf of the Securities Industry and Financial
Markets Association on this important subject.
SIFMA and its members support your efforts to reform our
financial regulatory system to provide strong and consistent
safeguards, to protect individual investors, while preserving
their ability to choose the widest range of products, services,
and advice to meet their individual investment needs.
Building upon SIFMA's testimony before this committee in
July, we support a harmonized, uniform Federal fiduciary
standard for broker-dealers and investment advisers when they
are providing personalized investment advice about securities
to individual investors. The average consumer does not know the
difference between the 1934 Act or the 1940 Act, and they
should not have to worry about different levels of protection
when they are getting the same service.
We believe that now is the time for a strong Federal
standard that should supersede the existing set of State
common-law-based fiduciary standards which have developed
inconsistently among the 50 States and which therefore are
inadequate to serve as a harmonized standard for individual
investors. At the same time, we support the important role that
States play in protecting the individual investors, and we
recommend that any new legislation clearly permit the States to
investigate or bring enforcement actions consistent with the
Federal fiduciary standard.
Mr. Chairman, we appreciate that the investor protection
discussion draft embraces the term ``personalized investment
advice'' by incorporating it into the definition of retail
customer. We believe the term ``personalized investment
advice'' is perfectly suited for clarifying the
responsibilities that are the focus of this legislation.
The term was coined in a U.S. Supreme Court case nearly 25
years ago, where the courts sought to define the business of
investment advisers. Since then, the term has been further
clarified under various Federal securities regulations. Most
recently, SEC Chairman Mary Schapiro invoked the term to define
when a fiduciary duty should apply to both brokers and
investment advisers. The SEC is well-positioned to ensure that
a Federal fiduciary standard is clear, well-defined, and
equally applied so that individual investors receive the same
protection.
It is important that the legislation appropriately define
the circumstances under which a Federal fiduciary duty would
apply and harmonize the duties under the 1934 Act with those of
the 1940 Act. The SEC should retain sufficient flexibility to
craft broker-dealer regulations without being constrained by
investment adviser rules. Such flexibility would protect
investors by appropriately respecting and preserving investor
choice, a necessary component of putting investors first. SIFMA
would like to continue to work with the committee to ensure
that the language provides the necessary flexibility from a
technical perspective.
With respect to the provisions related to predispute
arbitration clauses and the securities arbitration forum, we
would urge that the language of the Investor Protection Act:
one, be strengthened to support the fairness and efficiency of
the current securities arbitration system; and two, include
provisions consistent with the suggestion in the
Administration's regulatory reform White Paper released in June
that the SEC should study predispute arbitration clauses to
determine whether they are beneficial to investors prior to
making any changes to the current system.
For nearly 4 decades, the SEC has upheld securities rules
that require securities firms to arbitrate at the election of
the investor. Securities firms have gained the same right in
return by entering into predispute arbitration agreements with
their new customers. These agreements ensure that both sides
are treated fairly and that disputes are handled in a timely
and cost-effective manner. In addition, previous studies have
demonstrated that securities arbitration is faster and less
expensive than litigation, and it particularly benefits small
investors.
In closing, Mr. Chairman, I would like to make the
following point: Some have suggested that SIFMA's proposed
fiduciary standard is somehow inferior to what has been
described as the ``authentic fiduciary standard.'' SIFMA's
vision of a harmonized fiduciary standard is, however, stronger
and more pro-investor than any other alternative we have heard
advanced. A fiduciary puts investors' interests first, acts
with good professional judgment, avoids conflicts, if possible,
or otherwise effectively manages those conflicts through clear
disclosure and investor consent. These principles lie at the
heart of what it means to be a fiduciary. This is the standard
SIFMA endorses and that individual investors deserve.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Taft can be found on page
227 of the appendix.]
The Chairman. Next, Mr. David Tittsworth, who is the
executive director of the Investment Adviser Association.
STATEMENT OF DAVID G. TITTSWORTH, EXECUTIVE DIRECTOR AND
EXECUTIVE VICE PRESIDENT, INVESTMENT ADVISER ASSOCIATION (IAA)
Mr. Tittsworth. Thank you, Mr. Chairman, Ranking Member
Bachus, and members of the committee. On behalf of the
Investment Adviser Association, I really appreciate this
opportunity to be here today.
Our organization represents SEC-registered investment
advisers. The advisory profession serves a wide range of
clients, including individuals, trusts, and families, as well
as institutions such as endowments, charities, foundations,
State and local governments, pension funds, mutual funds, and
hedge funds. There are about 11,000 SEC-registered advisers.
Contrary to public perception, most investment advisers are
small businesses. About 7,500 employ 10 or fewer employees, and
90 percent employ fewer than 50 employees.
Our written statement addresses the Treasury Department's
proposed Investor Protection Act and related issues. Mr.
Kanjorski circulated a discussion draft at the end of last
week, and we greatly appreciate his efforts to address these
important issues as well.
In my brief time, I would like to focus on two topics that
would directly affect all investment advisers: fiduciary duty;
and SEC resources.
First, I wish to reiterate our strong support for the
Administration's recommendation to require broker-dealers who
provide investment advice to be subject to the same fiduciary
standard as investment advisers. As fiduciaries, advisers must
act in the best interests of all their clients and place their
clients' interests before their own. The Supreme Court has
stated that the Advisers Act reflects congressional intent to
eliminate or at least expose conflicts of interest related to
investment advice.
Our organization has worked closely with the State
securities regulators, consumer groups, and financial planning
organizations to ensure that the Advisers Act fiduciary duty
remains a bedrock foundation of the advisory profession.
Unfortunately, the Investor Protection Act, as drafted, would
not achieve this laudable result. Instead, it would open the
door to watering down or weakening the current fiduciary
standard by redefining fiduciary duty under the Advisers Act.
In addition, we are concerned that the proposal could
impose a fiduciary duty only with respect to retail clients,
rather than to all clients. Different standards for different
types of clients, whether individual or institutional, would
not be in the best interest of all investors. We strongly
believe it would be a mistake to alter or narrow the existing
fiduciary standard under the Advisers Act. One of the greatest
strengths of a fiduciary standard is its breadth. The standard
has allowed the regulation of advisers to remain dynamic and
relevant in changing business and market conditions.
Second, I want to underscore our strong support for the
critical missions of the SEC to protect investors, to maintain
fair and orderly markets, and to facilitate capital formation.
The SEC has the expertise and experience to regulate the
diverse advisory profession, but it clearly needs adequate and
appropriate resources to do its job. Accordingly, we believe
the SEC should be fully funded and that Congress should examine
alternatives to allow it to achieve long-term and more stable
funding, including self-funding mechanisms.
I note that Mr. Kanjorski's discussion draft includes
provisions that would authorize the SEC to collect user fees
from investment advisers for inspection activities. Frankly, we
would prefer a self-funding mechanism. But user fees may be an
appropriate option in the absence of self-funding.
In addition, we believe the SEC or Congress should increase
the $25 million threshold that separates SEC and State-
registered advisers.
Finally, we oppose a self-regulatory organization for
investment advisers. Non-governmental regulators pose serious
investor protection questions, including inherent conflicts of
interest, questions about transparency, accountability, and
oversight, and added costs. A single governmental regulator for
advisers--the SEC, operating without the confusion of
overlapping regulation and additional regulators--is directly
accountable to Congress and to the public. We particularly
oppose the idea of FINRA as the SRO for investment advisers,
given its governance structure, cost, track record, and its
stated preference for the broker-dealer regulatory model.
We look forward to working with you to ensure appropriate
and effective regulation and oversight of investment advisers,
and I would be pleased to answer any questions.
[The prepared statement of Mr. Tittsworth can be found on
page 241 of the appendix.]
The Chairman. Finally, Mr. Bruce Maisel, who is the vice
president and managing counsel, General Counsel's Office, of
the Thrivent Financial for Lutherans, on behalf of the American
Council of Life Insurers. And that doesn't come out of your
time, that title.
STATEMENT OF BRUCE W. MAISEL, VICE PRESIDENT & MANAGING
COUNSEL, THRIVENT FINANCIAL FOR LUTHERANS, ON BEHALF OF THE
AMERICAN COUNCIL OF LIFE INSURERS (ACLI)
Mr. Maisel. Thank you, Chairman Frank, Ranking Member
Bachus, and members of the committee.
Thrivent is a fraternal benefit society, a membership group
for Lutherans with a mission of helping to provide financial
security to our members and serving communities. I greatly
appreciate the opportunity to appear here before you to discuss
strengthening investor protections.
Life insurance company product distribution involves
determining customer needs and matching them with appropriate
fixed insurance and annuity products. Similarly, many life
insurance agents of affiliate broker-dealers provide essential
retail investor needs analysis and the sale of variable life
and variable annuity products.
Consistent with this needs-based approach, many of these
broker-dealers offer a variety of other types of securities to
meet the retirement, college savings, and other investment
needs of retail investors. Many of these broker-dealers are
also registered as investment advisers and offer investment
advisory services to those investors.
In short, life insurers products, functions, and
regulations fit within the scope of various initiatives that
address broker-dealer and investment advisers standards of
conduct.
As I will discuss further, while we support the
establishment of fiduciary duty for broker-dealers and
investment advisers and harmonization of their regulation, we
do have some strong concerns with the proposed Section 913 of
the Investor Protection Act and the recently released
discussion draft.
ACLI is focused on seeking to ensure that the establishment
of a harmonized standard of conduct will enhance retail
investor protection while at the same time permit ACLI member
companies to continue to meet investor needs across the broad
economic spectrum. We are also focused upon preserving the
variety of ways in which retail investors receive personalized
investment advice about securities.
Many retail investors work with broker-dealers and
investment advisers who provide personal investment advice and
offer only those proprietary and nonproprietary securities
available for distribution by the particular broker-dealer or
adviser. In other cases, broker-dealers and advisers provide
advice about proprietary securities exclusively.
ACLI does not seek to advance one distribution channel or
method as opposed to another. Instead, we believe that the
overriding goal of the establishment of a harmonized standard
must be tailored to reflect and preserve the various
relationships that exist between a broker-dealer or investment
adviser and the retail investor. By doing so, investor choice
will be preserved.
Regulators have urged that, to be effective, the imposition
of a fiduciary duty must recognize the particular role in which
a financial professional is acting. We agree. For example, SEC
Commissioner Elisse Walter has suggested that, in developing a
uniform standard, regulators should not dwell on the label to
be placed on the standard. She also noted that it is important
that any standard be accompanied by business practice rules
that provide practical guidelines regarding the standard's
parameters and that what a particular fiduciary duty requires
would depend on the functional role being performed by the
financial professional. We agree with those points as well.
As I noted, we believe certain provisions to the Investor
Protection Act and the discussion drafts are necessary to
achieve a clear, workable standard under which broker-dealers
and advisers can continue to meet the ever-increasing retail
investor needs.
First, any harmonized standard should apply only to
personalized investment advice, meaning advice that is based on
the retail investor's personal financial information.
Second, the standard should be imposed only with respect to
dealing with retail investors.
Third, the standard should require that broker-dealers and
advisers that provide personalized investment advice about
securities to retail investors act in the best interest of the
retail investors.
Finally, the hallmark of the standard should be defined
that broker-dealers and advisers make full, balanced, fair, and
timely disclosure, including of material conflicts of interest
and related information so that retail investors can make
informed investment decisions. Advisers have historically made
and currently do make such disclosures. Many broker-dealers
have voluntarily adopted similar disclosure practices.
While we support the establishment of the best interest
standard, we strongly oppose the tying of acting in the best
interest with the notion of acting without regard to the
financial or other interests of the broker or investment
adviser providing the advice. As detailed in my written
statement, that concept is at odds with the fiduciary duty to
which advisers are currently subject and could have the
unintended effect of chilling the provision of investment
advice by brokers and investment advisers which would run
counter to serving the investing public's needs.
We are also concerned that the requirement, if broadly
construed, could even require that no compensation be paid or
steps having to be taken to ensure that absolutely no disparity
in comparison exists between similar or even different
financial products.
We believe with the above-noted modifications a harmonized
standard of conduct and related rulemaking can result in
brokers and advisers enhancing their ability to meet the ever-
increasing retail needs across the broad spectrum of U.S.
retail investors while providing those investors with enhanced
protections.
Once again, I appreciate being given the opportunity to
appear before you today. The ACLI applauds the efforts of the
committee, and we are committed to working toward strengthening
investor protections.
[The prepared statement of Mr. Maisel can be found on page
194 of the appendix.]
The Chairman. Thank you.
I will begin.
The gentleman from Pennsylvania will be presiding for most
of the day, but he is meeting with some constituents now.
I did want to refer again to the question of the scheduling
of the hearing. We announced today's hearing on September 15th,
at a time when we were expecting that there would have been
votes last night. A week or 6 days later, on September 21st,
the office of the leadership announced there would be no votes
last night. So the question was, should we have cancelled the
hearing that had previously been scheduled because there were
no votes? Given the number of hearings that I think we are
obligated to have and other business, we thought that would be
a very bad idea. So, again, we scheduled this hearing at a time
when we thought there would be votes last night, and then we
accommodated. The fact is that they cancelled the votes.
I would say, by the way, in terms of having hearings on
days when there are no votes, the gentleman from Texas, Mr.
Paul, had been trying for years to get a hearing on his bill to
audit the Federal Reserve during the period when the
Republicans controlled the Congress. Not only couldn't he get a
hearing, he couldn't get the chairmanship of that subcommittee,
despite his seniority entitling him to it.
And so we did give a hearing for that. I thought it was
worthwhile. And I worked with the gentleman from Texas, and by
mutual agreement--and he thought it was a good time--we had it
on a Friday when there were no votes. The gentleman from Texas
thought the subject was important enough so that he and some
other Members on both sides did show up on that date.
Now, let me reassure Mr. Bullard and Mr. Tittsworth, I have
a phrase that I want to put on the bill keyboard: This bill
does not do what this bill does not do. Nothing in this bill
revokes any existing standard. So the question of, does it
apply to nonretail? Yes. And you reinforce the view that I
have: redundancy is preferable to ambiguity. So while the bill
doesn't do it, we will say that the bill doesn't do it.
Now, there is a question that Mr. Maisel raised, and I
talked to some people about it yesterday in my own district
office. We want to make sure who is covered and who isn't
covered. So I think it is not retail and nonretail but what
kind of activities are covered, and we will make that
distinction.
Now, let me go to Ms. Crawford.
Ms. Crawford, you are the Securities Commissioner for the
State of Texas. You were appointed by the Governor?
Ms. Crawford. No, sir, I am not.
The Chairman. Who appoints you?
Ms. Crawford. I am appointed by a board that is, in turn,
appointed by the Governor. I served for over 15 years.
The Chairman. The Governor appoints a board. How long have
you been in that position?
Ms. Crawford. Since 1993, under different Administrations,
both Republican and Democrat.
The Chairman. And the first Governor under whom you served
was?
Ms. Crawford. Ann Richards.
The Chairman. And, since 1993, you were continued by every
subsequent Governor, Governor George Bush and Governor Perry.
So you have a kind of bipartisan representation I think that is
very important to have, because I do think we do have some
bipartisanship here.
On the role of the States--not now, no one has raised it at
this point. It did came up in some of the witness statements.
But in previous Congresses, there were efforts to substantially
diminish the role of State securities administrators. Mr.
Spitzer got under some people's skin; and the securities
administrator in the State of Massachusetts, Secretary of the
Commonwealth, Bill Galvin, does a great job. What is your view
on this? Do you think that the role of States as it now--as it
exists, are you an obstacle to the harmonious enforcement of
the national securities market?
Ms. Crawford. With all due respect, Mr. Chairman and
members, we are not an obstacle. In fact, we have been filling
the gap for a number of years now. There has been less
regulation on the Federal level for a variety of reasons. You
may have read about the auction rate securities cases where we
were able to free up $60 billion and other cases of national--
The Chairman. Right. And I would say Secretary Galvin of
Massachusetts has done that as well. I think that is very
important.
Now, look, we have the Federal supremacy clause. If anyone
can show a conflict, then the Federal Government wins. But I
agree with you that you have been collectively, as States,
responsible for a significant improvement in the enforcement.
But now as to arbitration, and one of the witnesses said,
well, it is good for the small investor. Is it your experience
that small investors are so dumb that they would refuse to deal
voluntarily with something that would save them time and money?
Ms. Crawford. Mr. Chairman, arbitration is a problem that
is recognized even by the--
The Chairman. I understand that. Our bill says it should be
mutual. Nothing in this bill prevents the mutual agreement by
the investor to arbitrate dispute by dispute. It does say that
this supposed mutuality of an imposed clause in a contract,
when you have no choice, is not really mutuality.
But if in fact you were to have a situation where you could
have that agreement, that you would have a choice, if in fact
there was a form of arbitration that was better for the
investor, do you think they would refuse voluntarily to accept
it?
Ms. Crawford. Of course not. I think that investors want
choices. They don't want to be captive to an arbitration board.
The Chairman. All right, let me take the last question. We
are told while they have a choice, they can sign a contract
that requires it in advance or not. If they decide they want to
invest and they don't want arbitration, what options are open
to them?
Ms. Crawford. They have no options. They cannot go to
court, even small claims court, nor can they go to an
arbitration forum that is not industry-run. So they are
essentially out of luck.
The Chairman. Thank you, Commissioner.
The gentleman from Alabama.
Mr. Bachus. I thank the chairman.
I want to acknowledge Joe Borg, who is the past president
of the State Securities Commissioners. He also, like Texas, has
done a tremendous job in Alabama on protecting consumers. I
think there is bipartisan agreement, at least between the
chairman and I, that State securities commissioners do a very
good job of protecting consumers, and often when there has been
a failure on the Federal level, there has not been at the State
level.
I also believe that a lot of the questions will probably be
on what standard. Let me start with a very elementary question
that I am struggling with, because when I read the testimony
and people visit my office from various associations, I can't
even get them to say which is a stronger standard, fiduciary or
suitability.
Just starting with you, Commissioner Crawford, tell me what
you think the difference in the standards is?
Ms. Crawford. Mr. Bachus, there is no question but that the
fiduciary standard is the more stringent standard. It is simply
a standard to put the clients' best interests first. Whereas
suitability is a standard that focuses on whether or not the
investment at issue is suitable for the investor.
Mr. Bachus. All right.
Mr. Ketchum. From our standpoint at FINRA with experience
over the last 10 to 15 years, a standard that clearly provides
a requirement to put the investors' best interest first is the
right standard. There is great value for some specific
rulemaking that provides guidance as to how you handle
advertising, communication with customers and the rest, but
there should be no question that the requirement should be to
put the customer first, and we believe that a fiduciary
standard is the right way to do that.
Mr. Bachus. And you think the fiduciary is a higher
standard?
Mr. Ketchum. I believe the fiduciary is a clearer and
higher standard. It is not enough in this environment to just
determine a product is okay. The product needs to be in the
best interest of the customer. That standard shouldn't make
decisions from the standpoint of what type of business model
should be okay. The standard should be business model neutral.
It should encourage disclosure of conflicts. But the right
question for anyone involved in providing advice to customers
is, is this advice in the best interest of the customer.
Mr. Bachus. All right.
Mr. Bullard. I would essentially agree with Mr. Ketchum
that the fiduciary duty for some purposes is clearly a higher
example. An example is precisely the disclosure of conflicts of
interest I think is of greatest interest to investor advocates.
For example, when a broker is paid differential amounts of
compensation for selling mutual funds, the fiduciary duty would
require that be disclosed. The suitability standard, while it
goes a long way towards protecting investors, would not protect
the investor.
Mr. Taft. No question, the fiduciary standard represents a
raising of the bar in terms of the standard under which
brokerage activities would be conducted, and we are proposing
fiduciary standard with the intention of raising the bar. If I
might elaborate on that for a minute.
Firms like mine, most brokerage firms are duly registered
under the 1940 Act and as broker-dealers. We operate every day
as investment fiduciaries under the investment advisory
fiduciary standard. But unlike the businesses of registered
investment advisers, those activities regulated by the 1940 Act
only constitute a small part of what we do for retail investors
and only constitute a small part of what our clients ask us to
do for them.
We are not proposing to water down or narrow the fiduciary
standard. Quite the opposite. What we are proposing to do is
extend its reach from the small set of activities it applies
to, investment advisory activities, to all the activities and
services we provide to individual investors. And doing that
will require work if we want to preserve the ability of
customers to retain the breadth and range of services they
receive today.
Mr. Bachus. Thank you.
Mr. Tittsworth. Fiduciary standard is well established
under the Advisers Act and is a higher standard than
suitability.
Mr. Maisel. Fiduciary standard is a higher standard, but I
think it brings up an issue of it becomes an argument of the
labels. Investment advisers as fiduciaries have to make
suitable recommendations just like registered reps, and there
are obviously a slew of rules, including SRO rules for broker-
dealers on the suitability side. And behind the label of
fiduciary and acting in good faith and several others, there is
not a lot of ``there'' there. So I think starting from the best
interest point on both sides and following would be the way to
go.
The Chairman. The gentleman from Kansas.
Mr. Moore of Kansas. Thank you, Mr. Chairman.
My first question is to my fellow Kansan, Mr. Tittsworth. I
appreciate the point you made on page 2 of your written
testimony that while the SEC's regulatory inspection and
enforcement efforts should be fully funded, Congress should
``examine alternatives to allow the agency to achieve longer
term and more stable funding, including self-funding mechanisms
and user fees.''
Do you have specific suggestions on how Congress should
guard against regulatory capture, sir?
Mr. Tittsworth. Thank you, Congressman Moore. We do have
several suggestions. The goal should be giving the SEC the
resources it needs to do its job. Our first preference would be
self-funding, which has received a fair amount of attention
lately, tying the SEC in to a dedicated revenue stream.
Secondly, as Commissioner Crawford and Mr. Bullard have
indicated, we strongly believe that the $25 million line that
was established by Congress in 1996 and that has never been
increased should be increased. I believe Commissioner Crawford
suggested a level of $100 million. That would shift 4,200
advisers to State regulation from SEC regulation and basically
put us back where we were when NSMIA was enacted in 1996.
Finally, Congressman, Mr. Kanjorski has put a provision in
his draft bill, section 302, on user fees for investment
advisers. If those are properly structured and if it is clearly
in lieu of a self-regulatory organization, we would be happy to
work with you on that funding source as well.
Mr. Moore of Kansas. Thank you very much.
There seems to be a lot to learn from the Madoff scandal
and other Ponzi schemes that have been exposed in the financial
crisis. For example, the Inspector General for the SEC recently
issued a sweeping report and the draft investor protection bill
includes language authorizing an independent, comprehensive
study of how to improve securities regulation.
Mr. Taft, does the draft bill we are considering today
answer all of the concerns raised by the Madoff and other
investor fraud cases, in your opinion?
Mr. Taft. Congressman, I would like to speak in support of
the comments that Mr. Ketchum made earlier. The imposition of
or creation of a fiduciary standard for brokers and investment
advisers, a harmonized standard, is a first step towards
preventing Madoff-like events from happening in the future. I
think though you have to marry that first step with an
acceptable and appropriate enforcement regime, and I think Mr.
Ketchum spoke very articulately to that point, and that is a
necessary second step if you want to prevent future Madoffs.
Mr. Moore of Kansas. Mr. Tittsworth or other witnesses, do
you have any comments in response to this question?
Mr. Tittsworth. Well, I assume what Mr. Taft is referring
to is the creation of an SRO or, as Mr. Ketchum, my good
friend, has argued, extending FINRA's reach over investment
advisers. We are strongly opposed to that suggestion,
Congressman.
I certainly agree that enforcement is absolutely key to any
appropriate regulatory structure, but we believe that the SEC
has the expertise, the experience to do the job. What it needs
is to have appropriate resources, and in my previous response,
I hope I gave you some of our ideas on that subject.
Mr. Moore of Kansas. Do any other witnesses have comments?
Mr. Ketchum. Congressman, if I could just briefly say, I do
believe that there is a choice here between one way or another
ensuring that there are enough boots on the ground and
providing the SEC resources is absolutely critical if the
determination is not to have an additional independent
regulator with responsibility on the investment adviser side.
I suggest moving back to the NSMIA standard that perhaps
moves the SEC from 9 percent to 15 to 20 percent is not even
close to enough. So there needs to either be a realistic
expectation of a huge increase from the standpoint of SEC
resources or considering other alternatives.
Mr. Moore of Kansas. Ms. Crawford, do you have a comment?
We are just about out of time.
Ms. Crawford. With all due respect to my friend Mr.
Ketchum, I would say that the dividing line, if you raise that
dividing line from $25 million to $100 million, you immediately
address the bulk of the problem, because the SEC is left with
the giant money managers, those more complex firms that need to
be looked at by the Federal Government with their expertise,
while the States take on those smaller shops, and that way you
have governmental accountability, you have local
accountability, and it would not cost the Federal Government
more money.
Mr. Moore of Kansas. Thank you very much.
The Chairman. The gentleman from California, Mr. Royce.
Mr. Royce. Thank you, Mr. Chairman.
I remember talking to a British regulator and asking him,
how do you think the SEC missed this? He said, how did you miss
it? How did we miss some of the things we missed? He said, with
the financial services authority, the first thing we need to do
is fire half the lawyers and hire somebody who knows something
rudimentary about the market in Britain.
That brings me to the question, because as we look at the
regulatory reform proposal issued by the Treasury Department, I
think it is important that we fully understand the events of
the past year, and I think one of the things that looking back
is the most troubling is the SEC's handling of the Ponzi scheme
of Bernie Madoff, the Ponzi scheme of all Ponzi schemes. And
before we look at increasing the regulatory responsibilities of
the SEC, we should make sure some of the systemic problems are
addressed.
That takes me to the theme of Harry Markopolos' testimony
here that I think riveted everyone when he said that it was his
belief that the SEC was over-lawyered. He noted, and then
subsequently the SEC officials affirmed it, he noted there was
a fundamental lack of understanding of the more intricate
aspects of our financial markets within the SEC which prevented
the SEC year after year from uncovering the Madoff incident.
I would like each of you to comment on the idea of the SEC
being over-lawyered and what else can the SEC do to address
this problem, in your opinion. Maybe we can start with Mr.
Taft.
I do think Mr. Markopolos is on to something inasmuch as
the British seem to feel that part of their problem was the
same lack of understanding of how the market works by the
people who are supposed to regulate it.
Mr. Taft?
Mr. Taft. Congressman, I have to say that I really have no
informed opinion on that subject, and, more importantly, I am
here speaking on behalf of the SIFMA, and it would be far
beyond my ken if I spoke to that.
Mr. Royce. Well, that is all right. We will go down the
line and see if any of the other witnesses would like to
comment on it.
Ms. Crawford. Congressman, I have an opinion. I think that
the point was very well taken. The SEC has, no question about
it, brilliant lawyers. They are very good at writing rules,
they are very good at interpreting statutes, they are good at
bringing complex cases, appeals, that sort of thing.
However, they are not what I would call nimble and scrappy.
They don't have people on staff who really have the will to
burrow into the facts and circumstances and analyze the
numbers. They need more MBAs, they need more accountants.
Mr. Royce. Well, I am told by someone who has expertise in
this area, and Harry Markopolos would certainly be one, that it
doesn't take that much burrowing in to find a classic Ponzi
scheme, especially of this magnitude. The question is, did they
have anybody?
Well, as a matter of fact, we now know that the SEC did
have someone who understood the market. He was in the Boston
office. He had been a former portfolio manager and trader, and
he was constantly trying to alert the New York office, he was
trying to alert the home office, as to the nature of that
particular scam, and he was constantly being ignored, because
in that corporate culture, anybody with that background wasn't
an attorney and wasn't to be listened to. At least that was Mr.
Markopolos' summation of the problem.
Ms. Crawford. There is a question of accountability. One of
the differences between State and Federal regulation is when
you have people literally walking in off the street, defrauded
investors that you have to sit across the table from and talk
with one-on-one and try to address their problem, it changes
your sensibility, it changes your culture.
I think oftentimes the SEC, based as it is in Washington,
doesn't have those types of encounters on a day-to-day basis.
If you actually looked at the lawyers there--
Mr. Royce. Ms. Crawford, let me just stop you there. If we
had somebody in the Boston office who understood it, why
wouldn't you just change the equation so that you have people
who understood the problem. Rather than arguing well, if down
in Texas somebody walks into the office, it might be a lawyer,
it might not, at least we would have more empathy, why not
acknowledge, and maybe having somebody who understands the
nature of the problem would be something of an assist here.
I think that is the bottom line. And changing that
corporate culture is going to be necessary, I think, in order
to get the kind of expertise necessary the next time to spot a
Ponzi scheme. I don't think it is empathy. I think it is a
question of having somebody on board who understands the basic
rudimentary nature of a Ponzi scheme.
Ms. Crawford. Well, in addition to empathy, I absolutely
agree with you. You need those MBAs, you need those
accountants, you need people with solid business experience
employed at the SEC.
Mr. Bullard. I would say, having worked at the SEC, Ms.
Crawford is correct. I wouldn't necessarily call it over-
lawyered, I would call it maybe under-quantified, and the staff
needs to hire more experts in those quantitative areas, and it
is my understanding that is Chairman Schapiro's intent.
Mr. Ketchum. Congressman, if I could also say, having spent
a large number of years at the SEC and then working closely
with the SEC in time, I would just leaven that. I do believe
that the SEC needs a broader diversity of capabilities. They do
have a lot of MBAs, they do have a lot of accountants, they
have a lot of people who know reverse conversions and
conversions and understand the arbitrage. They failed in this
particular case because of a stovepipe mentality and problem
that needs to get fixed.
I think that Chairman Schapiro, and I would also note
somebody who hasn't been mentioned so far, Robert Khuzami, is
exactly the junkyard dog with the right type of experience to
be able to cut through that. So I think you can feel that the
SEC has already taken significant steps to move in the right
direction.
Mr. Kanjorski. [presiding] The gentleman's time has
expired.
There is a choice now; the issue came up that I am
particularly interested in. I was going to go to Mr. Green, but
I am going to hold off for a second, Mr. Green, and take my 5
minutes, if I may.
In putting the Investors Protection Act together, we were
particularly struck by some of the material that came out in
the latter part of September in regard to the IG's report on
the Madoff and Stanford frauds, and it seemed to me that any
fair impartial reading of the IG report indicated that we were
now dealing with a totally dysfunctional agency. We can all be
sensitive as to whether when we use that word, folks will be
embarrassed, but I do not use the word for the purpose of
embarrassing either the agency or its leadership, present or
past. The fact of the matter is it does not really matter what
the Congress does in passing new laws and encouraging new
regulations at the securities level if the cop is incapable or
not inclined to carry out those new laws. And that is what we
have, we have a blockage of implementation, and it is so very
clear.
So it became apparent to me that, unfortunately, we did not
have all of the diagnosis in place to make recommendations or
create authorities that are necessary to straighten that agency
out, but it was with the understanding and the perception that
we have a regulator now that is sensitive to what is necessary
and desirous of removing a dysfunctional agency into a
functional agency.
That being the case, she will need assistance and help, and
it is my intention that our subcommittee and committee give
that assistance and help as necessary. But in order to
adequately accomplish that, a very thorough study is necessary,
unless we are going to go down this path of acting like blind
men, not knowing quite what we are doing, because that is what
we are. We are not experts in securities or securities laws or
the experiences of the SEC, but we do have the legal authority
and ability to give experts better tools in which to accomplish
a functional agency, and that we intend to do.
So we are asking basically for a total and complete study
of not only the SEC, but its related agencies, so that we can
get an entire picture of what the securities requirements of
the United States are vis-a-vis 2010 and then from there do the
necessary adjustments and implementation of new laws to equip
them with the capacity to perform at a much higher rate.
I have to be honest to say that I was shocked because I
heard a little of the discussion here in response to Mr. Royce
about the need for lawyers, junkyard lawyers, MBAs, etc. I
don't know what we need over there, but we don't need blind men
leading the blind.
A very simple question in the Madoff case would have
resolved the whole problem when they were doing some of the
examinations that they were doing. They just asked the one
question, where are the securities, and they totally failed to
ask what I think is the most obvious question that should have
been hornbook law for any lawyer or investigator or Master's of
Business Administration. They just didn't know what to ask.
Having not asked the proper question, they got not only
inaccurate, but incredibly wrong answers, and they relied upon
them and cost victims an awful lot of money, and I think
brought somewhat of a disgrace to the agency.
That is in the past. We cannot change that. But we sure can
change the future. And it is the clear intent of the
subcommittee, while I am chairing it with its jurisdiction, and
I believe there is no question that under Mr. Frank, the full
committee, we are going to do everything necessary to give the
tools to the leadership of the Securities and Exchange
Commission to accomplish our end of good administration with a
strong cop on the beat. That is going to be done.
Now, what I wonder about, is why we do not hear more as the
committee and the Congress about inadequacies such as existed
for years in the SEC? Is there something we should do? We have
the whistleblower implementation in the Act. But how about
internal whistleblowers? What is wrong with people working in
government who are observing what is happening. What is wrong
with people who are clients of the agency who see what is
happening?
I do not get the calls. Every now and then, if I have a
long involved conversation with a regulated individual, after
several drinks or some other sort of relaxation, they will
break down and start talking the truth. But when they are in
their formal mode, they just do not respond the same, saying
you have a problem over there, stovepiping, we have all heard
of those things, here is what happened to me and here is how
bad it is. Now, I have to be honest, recently, some have come
forth that way and it has been very, very helpful.
The reason we selected the witnesses here today, we know
you have the expertise, the insight and the capacity to help us
along this mode. May I urge you to grab the telephone, even in
these processes, even in examining this draft legislation, if
you see some ways we can strengthen it and make it fairer. We
are not trying to just come down with a hard club. We are
trying to do what is rational and reasonable, but at the same
time not to dodge the responsibility of the Congress to
oversight these areas of the government.
So please feel free, I see my time has expired, but please
feel free to call us to talk to us. I know you all know our
staff very well. Get to know them even better if you will. We
will appreciate it.
Thank you.
I now recognize my friend, the gentleman from New Jersey,
Mr. Garrett, a frequent visitor on CNBC. That just proves I was
up at 6:30 this morning watching Mr. Garrett.
Mr. Garrett, you are recognized for 5 minutes.
Mr. Garrett. I thank the chairman. Just to clarify my
opening comments, I do appreciate the work that you have done
on all of these areas we are talking about today. I guess my
only wish is that they do just merit a subcommittee look, in my
opinion, and probably the chairman might concur with me on that
approach to doing these things so we can really delve into all
the issues we look at. I do appreciate the hearing, the work
you have done, and the information that we are learning today.
I thank you.
The ranking member went through the panel before with
regard to the issue of the difference between the two
standards. All right, let me just throw out to the panel a
couple of questions.
One is, there is talk about harmonization. Would someone
just like to answer this question? When we talk about
harmonization, does that always mean, maybe Mr. Maisel, does
that necessarily mandate, require, that we get exactly the same
standards?
Mr. Maisel. I would suggest that for the same functions,
regardless, for example, of how the customer pays for the
service or the choice or the way they are served, that there be
the same regulation, whether you are under the Advisers Act or
the broker-dealer rules, and that is not the case today.
Mr. Garrett. But how about this? Most of the panel here is
talking about raising the standard to a higher standard,
fiduciary standard. Could you, I will just throw this out, to
say allow for different standards, fiduciary standard or the
current standard for broker-dealers, but on this side of the
broker-dealers simply change it in a way as far as additional
disclosure requirements and ``transparency,'' and would that
then get to some of the points that some of the other members
on the panel addressed as far as what me as the personal client
would be able to look at and say, well, now I know what I am
dealing with here, but because the broker-dealers'
responsibilities are slightly different, they are selling some
of their products, they are getting commissions, and that sort
of thing, could that address the problem?
I will start there.
Mr. Taft. Congressman, if your question is would there be
other ways to raise the bar with respect to the products and
services we provide to retail investors, other ways than
harmonizing the fiduciary standard, the answer is yes, you
could do that differently.
Mr. Garrett. But still with a good result?
Mr. Taft. Well, it depends what you do, but you could
certainly engineer a good outcome.
The other thing you can do, and it was picked up actually
in Mr. Maisel's comments, is that, and I think this is the
intention of a harmonized fiduciary standard, is have the same
umbrella standard applying to all activities, but then tailor
the duties and responsibilities when it comes to fulfilling
that standard in a way that matches with the specific service
being provided, okay?
So, for example, you have heard unsolicited orders to sell
or buy stocks should not be necessarily subject to the same
requirements as the continuous discretionary management of a
portfolio.
Mr. Garrett. Mr. Maisel?
Mr. Maisel. I would say that I agree with Mr. Taft. I think
there are several ways to get there. At the end of the day, the
basic consumer protections should be in place for similar
services and functions that are provided, and the same
obligations of the firm should be in place as well.
Mr. Tittsworth. Mr. Garrett, I would just reiterate a
couple of points. Number one, I totally agree, similar
functions, activities, should be regulated the same way. I
think everybody would agree that is fundamental fairness.
I think the Administration's proposal to say brokers who
are providing investment advice should have the same fiduciary
standard under the Advisers Act as investment advisers, that
makes sense. If they are doing what investment advisers are
doing, let's treat them the same way.
But I would also agree with Mr. Taft, not all broker-dealer
activities are giving advice, and we are not suggesting that
the fiduciary standard should apply to execution of securities
transactions, underwriting or other important activities that
broker-dealers are engaged in.
Mr. Garrett. My time is going by quickly.
Mr. Tittsworth, Mr. Royce was raising the issue as far as
the problems and the chairman is also raising the problems that
we have had at the SEC in the past. I know FINRA was out there.
They would say, hey, we can handle this all. Some would argue
on the other side of that the SEC hasn't done such a great job
in what they have done and as far as the personnel necessary.
How do we actually get that done with an entity that so
many people have pointed to the legitimate mistakes in the past
to handle that huge broad authority if you have them sweep in
all of this larger number?
Mr. Tittsworth. I guess I may not be able to give you all
the answers you want, but I would suggest that the SEC missions
are absolutely right. So whether you put them with the SEC or
establish some new regulator or whatever, I think you must
have: that protection of investors; maintaining fair and
orderly markets; and facilitating capital formation. Those are
the right missions. And I think it is partly a question of
giving it the resources to do its job as fully as it can.
Ms. Crawford. I would respectfully disagree. Resources are
always important. You have to have them. But more important
than that, you have to have a will to regulate.
Just as the gentleman previously indicated, you can make
all the rules and laws in the world, but if you don't have
people who are willing to enforce them, then you have a problem
that you haven't solved. And what we have seen at the SEC for
the past few years is a lack of will to regulate. There are
some things that can be done about that, but the SEC won't like
it.
Mr. Garrett. Thank you.
Mr. Kanjorski. The gentlelady from California is recognized
for 5 minutes.
Ms. Waters. Thank you very much, Mr. Chairman.
I am interested in the testimony that was filed with us
from Ms. Crawford.
Ms. Crawford, your testimony mentioned aiding and abetting
liability. When the Stoneridge case was before the Supreme
Court in 2007, Chairman Frank and Chairman Dodd filed amicus
briefs supporting the plaintiff's position that third parties
could be held liable for their participation in fraudulent
financial disclosures to the SEC. The Supreme Court ruled
adversely to the shareholders, removing any private right of
action against so-called secondary actors.
As you mentioned, the proposal before us clarifies aiding
and abetting liability for the SEC, but does not create any
private right of action for investors. Can you provide us with
some additional information about secondary actors? You
mentioned they are lawyers and accountants. How large a role do
they play in corporate fraud when such fraud occurs? Why is it
important that we allow investors to have private right of
action? And what was the Stoneridge case's impact on investors?
How much money or wealth is lost each year, now that investors
are prevented from filing their own lawsuits against secondary
actors?
Ms. Crawford. You have asked a number of questions and I
will take them in order.
The first one is the role that accountants and others,
lawyers, play in connection with the entire process. Their role
is unbelievably large and unbelievably important. The
transparency that is required to make our markets operate
effectively really boils down to two things: transparency and
the verbiage that is in the disclosure documents; as well as
transparency and the numbers that are put before the investors.
Accountants and lawyers are critical to that process.
So to the extent there is wrongdoing on the part of an
accountant or a lawyer who is engaged in that process, it is
very unfortunate that they are not held liable for that
wrongdoing.
Why do we need aiding and abetting liability and why isn't
it enough just to give this to the SEC? Because the SEC can't
bring all of these cases. The SEC can't be everywhere at once.
You in this room today are demanding a lot of the
Securities and Exchange Commission, as you should. But the
Securities and Exchange Commission cannot be the private lawyer
for every defrauded investor in the United States. The only way
that an investor can effectively enforce his or her claims
against a secondary actor would be remove that language in the
draft so that it is not restricted just to the SEC's
enforcement.
With regard to the decision in the Stoneridge case, we too
at NASAA filed a brief and we were very dismayed at the outcome
of the case, at the opinion of the Supreme Court, and it is
extremely difficult to put a dollar figure on the amount that
investors might have been able to recover had the case been
decided differently. But I can tell you that it was a lot. We
can try to provide numbers for you as best we can.
Ms. Waters. Would it be safe to suggest that when many of
these fraudulent schemes are being enacted, that it would be
almost impossible to do them without some of the supporting
actors such as lawyers and accountants? How do you present
something? How do you record something? How do you report
something? How do you document it? And those people have to
know what is going on. Is that what you are suggesting?
Ms. Crawford. Absolutely. It is impossible to conceive of
CEOs and upper level management actually sitting down and
putting these disclosure documents together. They of necessity
must rely upon their accountants and lawyers to do that for
them. Of course, they need to oversee the process, but the
nitty-gritty details are left to the professionals. Those
professionals need to be held accountable for any wrongdoing
that they engage in.
Ms. Waters. So you consider a private right of action
extremely important?
Ms. Crawford. Yes, ma'am.
Ms. Waters. Thank you very much. I yield back.
Mr. Kanjorski. The gentleman from California, Mr. McCarthy.
Mr. McCarthy of California. Thank you, Mr. Chairman.
In listening to the chairman's comments and also the
questioning from Mr. Royce and Mr. Garrett, I would like to
follow up a little on the SEC.
I know in this bill it provides more money, but also just
provides another study, and I am a little concerned by that. I
am one who believes that structure dictates behavior. Mr.
Ketchum, in part of the questioning you brought up stovepiping,
the idea that you have people who set policy in one place and
those inspectors in a whole other place.
I guess my question, and I would like to start with Mr.
Ketchum and go down the line, is does this really get the job
done in the SEC? But specifically, what are some fundamental
changes without waiting for a study that we can change to
change the structure to actually perform better?
Mr. Ketchum?
Mr. Ketchum. Well, it is a great question, Congressman. I
think points have been made with respect to diversity and skill
sets. I think the point that you emphasized in your opening
statement with respect to the bill, I wouldn't be pretentious
enough to say I know exactly how to design the SEC. But I do
know that the present environment in which the examination
function doesn't have a direct accountability and in which the
level of communication between that function and the two policy
divisions from the standpoint of Trading and Markets and
Investment Management is not good and should change.
There should be greater accountability between the three
divisions. Perhaps there should be a single person with
responsibility for all three. But, one way or another, there
needs to be the assurance that there is effective communication
between the persons interacting with those industry sectors on
a daily basis and the exam program.
Mr. McCarthy of California. Should we wait until the study
is done to make that move, or do you see any negative? I know I
have H.R. 2622 that takes the office of inspection and
examination and moves it back to the original function,
location and division of investment management, trading and
markets.
Should we wait to have a study done, or could we not make
that move now? Don't you think it would be more important to
have that done?
Mr. Ketchum. Well, Congressman, I have a great deal of
faith in Chairman Schapiro. I think, as mentioned by Chairman
Kanjorski before, she brings a very different focus and
commitment to the SEC. I think she is looking very closely at
organization now. I think you should definitely demand that
there should be a conversation between Chairman Schapiro and
this committee and subcommittee.
I believe that a study may be useful, but I would give
Chairman Schapiro a chance to work through, make her personnel
decisions and make her organization decisions, and evaluate it
after that has occurred.
Mr. McCarthy of California. I would like to go down the
row, if there are any ideas specifically as to what the SEC can
do for a structural change, be it small or not, to make sure
that we make a fundamental change there, not a study.
Ms. Crawford. Congressman, I would just mention that one of
the overarching problems at the Commission is regulatory
capture. There is so much interplay with the top people on Wall
Street, and many, many of the employees of the SEC go there to
get the necessary experience to then get jobs on Wall Street.
And I think that it has a chilling effect sometimes at the
agency in terms of the staff's willingness to vigorously pursue
wrongdoers.
To the extent that you could address that, perhaps by
limiting--or saying that an attorney who works for the SEC
cannot go to work for a Wall Street firm for 1 year after
departing the agency, or something like that, so that you don't
have so much of a revolving door, that might go a long way
toward addressing this regulatory capture problem.
Mr. McCarthy of California. Thank you. Mr. Bullard?
Mr. Bullard. I would reinforce Mr. Ketchum's point about
leaving it to Chairman Schapiro. Just to give you an example of
why, having lived under the problems of OC being separate from
the Division of Asset Management, where I was, if you move that
function into investment management, which is responsible for
regulating investment advisers, and you also move the broker
function to the Trading and Markets Division, you have
separated what are functionally similar, as Mr. Taft pointed
out, because many of those people are dual registrants.
I think that there has to be a two-step process, and that
is a major reorganization that is reflecting the actual
functional and regulatory lines that the law draws, and those
are generally kinds of retail sales issues. And I can tell you
in investment management, the hardest thing to get done was
something that we had to get sign-off on trading markets. Of
course, it was always trading markets' fault. They might see
the issue differently.
The other recommendation I would make is that not only
structure, but also money drives behavior, and I was greatly
disappointed to see that the increased compensation being paid
to SEC staff as of a few years ago went to salaries rather than
bonuses. If you really want to change the behavior of the
staff, then provide for an enforced mechanism of rewarding
quality, rather than simply giving automatic salaries and
increases to staff who may not be as productive as others.
Mr. McCarthy of California. Mr. Taft?
Mr. Taft. I have no comment, Congressman.
Mr. Tittsworth. Congressman, I agree with my good friends
Mr. Ketchum and Mr. Bullard. I would leave it to Chairman
Schapiro. I think in her testimony before this committee on
July 14th, she bullet-pointed seven or eight different things
that she is doing that could enhance the SEC's ability to
prevent future Madoffs from occurring.
Mr. Maisel. The only comment I would have is I believe the
harmonization work that has been discussed earlier could
certainly contribute to moving away from a false demarcation
about one activity versus another and I think would be a factor
in some of these improvements.
Mr. McCarthy of California. Thank you, Mr. Chairman. I
yield back.
Mr. Kanjorski. Thank you, Mr. McCarthy.
We will now hear from the gentleman from Texas, Mr. Green.
Mr. Green. Thank you, Mr. Chairman, and I thank the
witnesses for appearing. I especially would like to thank Ms.
Crawford, a fellow Texan. Thank you for being here today. I am
honored to know you have been appointed and reappointed as many
times as you have.
Ms. Crawford, I think that you are eminently correct. I
really do believe that it is willpower that we are talking
about. Mr. Ketchum, you spoke of a junkyard dog, a highly
technical term. I understand it. But the unfortunate
circumstance is that we have a lot of front yard dogs. When you
have a front yard dog, you need a junkyard dog. Then you would
need a system. You need something that is going to cause a
front yard dog to behave like a junkyard dog.
There is no question that the empirical evidence was before
the SEC. Mr. Markopolos provided not only the evidence, he also
provided the questions. He provided everything that a
whistleblower could have provided. And the unfortunate
circumstance is there was no one there who actually picked up
on it and moved with it.
I think, Ms. Crawford, what you said about allowing the
private right of action to exist would have made a difference
if Mr. Markopolos had the right to sue. If he could have sued,
I think we would not have had the same ending that we are
currently confronted with.
Ms. Crawford, would you give me a brief response with
reference to the right to sue as it would have related to Mr.
Markopolos?
Ms. Crawford. Well, it would have been extremely fraught
with difficulty, and your assessment is correct. At the end of
the day, he would not have been able to maintain a lawsuit.
What we are talking about right now is the aiding and
abetting of these frauds by others who were involved, these
secondary actors. And what we believe would be very helpful
would be to not just limit these types of actions to the SEC,
but to allow private individuals to bring these suits.
Mr. Green. Give me an example of a private individual.
Would Mr. Markopolos have been a private individual?
Ms. Crawford. He may well have been.
Mr. Green. If he had the right to sue, what impact would
that have had?
Ms. Crawford. Well, it would have had a major impact, for a
number of reasons. For one thing, it would have been a very
public action that would have put pressure on the regulators to
perhaps take another different look at the activities of Bernie
Madoff, and of course if he recovered, we would not have had as
many wasting of assets, although there would have been huge
losses, no question about that.
Mr. Green. Now, if we couple that with a stronger, more
expanded whistleblower requirement, how would you see the
whistleblower, expanding the power of someone who is within who
is blowing the whistle, who is giving us intelligence, how
would that be much more effective, if you could have your way
with this?
Ms. Crawford. Well, the problem isn't that people weren't
coming to the Securities and Exchange Commission. They receive
I think about 750,000 complaints a year. The problem is that
they were ignoring them or at least not making good
determinations with regard to those complaints that really
needed to be followed up on.
So, the whistleblower provisions are very good and helpful,
but the problem is not with people who are reticent to
complain. The problem is more that they are not getting the
response of the agency presently.
Now, I will say with regard to this question of the ability
to file lawsuits, it is my understanding that while this has
not yet been introduced in the House, there is a Senate
provision, Senate 1551, called the Liability for Aiding and
Abetting Act, that was recently introduced. State securities
regulators support that Act, and it has many of the types of
things you are concerned about, Congressman Green. So I would
commend it for your consideration.
Mr. Green. I thank you. I thank Chairwoman Waters for
broaching the issue initially, because there is no question in
my mind that the lack of willpower, coupled with the fact that
there really weren't any penalties for failure to act, it is
not that persons were necessarily engaged in aiding and
abetting as much as it was that there was no penalty for those
who decided that well, this really can't be the case. Assuming
they were acting with the best of intentions, there were just
no penalties. So if we don't have penalties, we obviously have
to have some way to force the agency to look into these issues.
Thank you, Mr. Chairman. I know that my time is up. I yield
back.
Mr. Kanjorski. Thank you.
We will now hear from the gentlelady from Illinois, Mrs.
Biggert.
Mrs. Biggert. Thank you, Mr. Chairman. I will move down
here.
Mr. Maisel, are there any outstanding issues, and we have
had this discussion, in the latest draft bill that would place
consumers in a worse position or might cause them more harm
than they have today?
Mr. Maisel. Yes. I believe in particular the language about
without regard, acting in the best interests, we support on
both investment adviser and broker-dealers. But tying it to
without regard to the interest of the firm or the
representative, is contrary to the Advisers Act, and I think
one of the things that does work very well on the Advisers Act
side and I think would be replicated somewhat as a result of
this harmonization would be full and timely disclosure of
information, including potential conflicts of interest,
material conflicts of interest.
So I think that I worry about the potential and we worry
about a chilling. People would be afraid to provide investment
advice if the point was so rigid or could be construed so
rigidly that no other regard could be taken into account the
other than the customers. There are always going to be
different factors, and I think the key is to get information in
the place of consumers at the right time so they can make
informed investment decisions.
Again, that would fall in the long-standing Adviser Act
process, which I think is a very good and full disclosure
regime.
Mrs. Biggert. Thank you. We have been talking about the
willpower and everything. Nobody has really mentioned the
technology, and I think we had a hearing in the Oversight
Subcommittee to talk about technology. I also serve on the
Science Committee, and we now have the fastest computers in the
world, and it just seems like maybe more investigations could
have been done in a more timely fashion, instead of the 9
percent a year or whatever it is. Is that a factor that should
be addressed?
Mr. Ketchum?
Mr. Ketchum. Congresswoman, I think you make a great point.
I know Chairman Schapiro has spoken quite strongly about the
need to upgrade technology at the SEC. It is a focus at FINRA.
We need to be in an environment where we effectively can manage
the records of a broker-dealer and do as much preparation as
possible away from site, and also ensure that all regulators
are effectively communicating together.
I know this is a point that Ms. Crawford is concerned with
as well. We can't have situations where complaints are coming
in to one of us and the rest of us are not aware of it. We
can't have situations where we are identifying problems with
respect to a particular firm and others are not aware of it. We
need to find ways to ensure our technology systems share better
and our technology systems are better able to mine information
with respect to the industry.
So I think your point is a great one.
Mrs. Biggert. I have heard about the big stacks of paper
that are around everywhere. We try in our office to be a
paperless office, but it is not possible. As you see on all
these desks, all the paper.
But the other thing is the need to have technology that
talks to each other. That seems to be the hardest thing to deal
with.
Mr. Ketchum. I think it is a great point. It is really
critical for us to be able to talk and effectively work through
information that exists from a record standpoint from the
brokers and investment advisers, and similarly to be able to
have technology that is more transparent between regulators.
Your point is really well taken.
Mrs. Biggert. Is there any concern then with the
transparency, that there might be people who would get into any
proprietary information?
Mr. Ketchum. You always have to be concerned from an
information security standpoint. This should be sharing of
information between regulators who both have responsibility to
protect that information from a confidential standpoint, if it
is public customer information, and have the responsibility to
protect all information with respect to investigations of other
regulators. Absolutely.
Mrs. Biggert. Thank you. Just one other question. Is there
a need for the industry and the SEC to really increase
financial literacy and education to consumers, and do you have
a quick way to do that? I know we have worked on it here. But
it still seems like there is such a need.
Ms. Crawford. Congresswoman, we work on that all the time.
In fact I am very pleased to say, and I say this every time I
have the opportunity, financial literacy and investor education
programs begin with State securities regulators. Now it has
been embraced by everyone from the President of the United
States out, and that is a very good thing.
The question for us today is to make sure that what we are
doing is working, and we would love to talk with you about that
going forward.
Mrs. Biggert. Thank you very much. I yield back.
Mr. Kanjorski. Thank you very much.
Now, we will hear from Mr. Cleaver.
Mr. Cleaver. Thank you, Mr. Chairman, and thank you for
your work on this legislation.
Ms. Crawford, thank you for being here. I want to chat with
you just for a minute about State regulations.
What size or the amount of assets under management by an
investment adviser is currently under the responsibility of the
State securities regulator?
Ms. Crawford. Right now, it is $25 million assets under
management or less. And what we are proposing to do,
Congressman, and we hope that you will give this serious
consideration, is raising that to $100 million. We have the
infrastructure in place, we have the experience, and we are
certainly willing to take that on.
Mr. Cleaver. I am very much interested in that. In fact, I
am going to chat with the chairman and the sponsor of the
legislation, about perhaps some kind of an amendment. But I
want to make sure that $100 million is in harmony with the
inflationary rise over the time that was set and today. Was
that a figure that you just came up with, or was it based on
inflation?
Ms. Crawford. Actually, Congressman, it wasn't so much
based upon inflation as it was counting up the number of firms
that fell within that group, the size of that universe. What we
are seeking to achieve is to leave the SEC to address the big,
big money managers, the big investment advisers, while we will
take the bulk of the smaller ones. I know it is hard to
believe, it is hard for me to believe sometimes, but $100
million assets under management is actually pretty small.
Mr. Cleaver. Yes, very small. I agree with you, and thank
you.
Mr. Tittsworth, to hang out a shingle that one is a
financial planner requires what?
Mr. Tittsworth. Nothing, as far as I know.
Mr. Cleaver. Yes. Therein, said Shakespeare, lies the rub.
David Letterman could just say I am a planner and go out and
get clients and handle their money, and nothing is required.
Mr. Tittsworth. There are no Federal competency standards
for investment advisers, if that is what you are getting at.
Mr. Cleaver. That is what I am getting at.
Mr. Tittsworth. I would point out that certainly with the
vast majority of people, you still have the question of who is
going to give their money to David Letterman or to me if I hang
out my shingle, and the vast majority of people that I know in
our industry, in our profession, are highly educated. There are
a number of designations, including chartered financial
analysts.
Mr. Cleaver. I understand that. But you would agree, and I
want Ms. Crawford to respond to this, you would agree that
there are some bad people in the world?
Mr. Tittsworth. Yes, sir, I would agree with that.
Mr. Cleaver. All right. So you are talking about the people
who, like you, are trying to function inside some kind of moral
code or ethical code, but you will also agree with me that
there are people who with great intentionality would go out and
do just the opposite in order to make money?
Mr. Tittsworth. I agree with you, Congressman. And not to
change the subject necessarily, but I would point out that
Bernard Madoff certainly had a Series 7 stockbroker license; he
had taken an examination. So that in and of itself does not
necessarily prevent the wrongdoers from doing what they want to
do.
Mr. Cleaver. Yes, I know. I agree. Except that when we know
that nothing is required to be a financial planner--there is a
guy in Kansas City, Missouri, the district that I represent,
and I couldn't believe it. I am driving by a little strip
shopping mall and I see his sign out doing financial planning,
real estate development. He doesn't even have his GED, but he
probably has a bachelor's in ``crooktivity'' or something. But
this guy is cleaning up, and it just troubles me.
Ms. Crawford? I am not even sure he is being prosecuted. He
is out of business now because so many people reported him when
the real estate market crashed.
Ms. Crawford. I just want to clarify that the term
``financial planner'' doesn't really mean anything, just as you
indicated, but if that person is giving investment advice and
is receiving compensation for doing so, that person does have
to be registered. A few years ago, the State securities
regulators came up with an entry level competency exam for
those folks. So if they are investment advisers, they fall
within the regulatory regime.
But you are so correct, Congressman. If they are just out
there calling themselves a financial planner, sometimes it is
difficult to get to them, depending on precisely what it is
they are doing.
Mr. Cleaver. Thank you. Mr. Maisel?
Mr. Maisel. My comments don't relate to the bad actors, but
I also do want to say that I also raise the point that if
financial planning somehow is separated, financial planning is
one of various investment advisory services today, and I think
it could be counterproductive to the harmonization discussion
if somehow financial planning or financial planning client gets
some kind of uber protections.
Again, I think it goes back to the point it shouldn't
matter regardless of the type of broker-dealer service or
investment advisory service, hopefully will be there a
harmonized standard with the best interests and the rules of
the road that we talked about, but not separating out one part
of the industry.
Mr. Cleaver. Yes. Thank you, Mr. Chairman.
Mr. Kanjorski. Thank you. The gentleman from Colorado, Mr.
Perlmutter.
Mr. Perlmutter. Thank you, Mr. Chairman.
I guess I just have more general questions. Mr. McCarthy
from California has some general changes to the structure
within the SEC that he thinks will assist in enforcement and
review and things like that. And I think that is great. I think
it also starts at the top. If you have an Administration that
says let the market take care of it, and buyer beware and the
regulatory agencies don't really have a rule, they just get in
the way, well, then you have, in my opinion, a lot of the fraud
that was committed over the last 8 years by Stanford and by
Madoff.
Soon we have people who really do believe that regulation
boosts certainty and trust in the marketplace, which I think we
have with President Obama. My question to you is this, all the
people who lost a bunch of money, either to Madoff or to
Stanford or to some other of the Ponzi schemes, what recourse
do they have now, or is there any?
So I know SIPC is part of the conversation here. And I am
not looking for an education on this, but are we making it any
better for the people that we are investing in the feeder funds
to have some protection here?
I will start with you, ma'am. Does this bill help those
folks in any way?
Ms. Crawford. I am not familiar with any provisions in the
bill that would address your question, Congressman. However, I
will point out that in some jurisdictions, States are looking
at the feeder funds, trying to determine whether or not they
contributed to this problem and recoveries may be possible
there.
But I wouldn't want to mislead you into assuming that there
is a magic bullet to the problem of the defrauded investors,
because I personally think that there is not going to be a lot
of money there and wouldn't want to lead you to think
otherwise.
Mr. Perlmutter. Mr. Ketchum?
Mr. Ketchum. I would agree with Ms. Crawford. To your
specific question, no. I don't believe there is anything in
this bill that looks backward and addresses that issue. I would
say that the SIPC provisions that are built in here are
important steps to ensure the flexibility of how SIPC covers
and its ability to cover investors going forward and it is a
good thing.
Mr. Perlmutter. Do you think we should have something in
this bill that protects secondary and tertiary investors, if I
invest in this guy over here in Boulder, Colorado, who then
invests in something here that then invests in Madoff, should
they have any protection or how are they protected? Those are
the guys who are getting clobbered in this thing.
I appreciate, we have to have better up-front watchdog kind
of enforcement. But how do I, how do I help those guys at the
back end of this thing? They are the little guys who were just
wiped out?
Mr. Ketchum. Well, I think where you can, as Ms. Crawford
indicated, where you find complicity and serious failures by
entities like feeder funds, they should be held accountable and
they should be held actable monetarily. The key thing for all
of us is to find these things more quickly before customers are
exposed as they were in those tragic instances.
Mr. Perlmutter. Thank you. Mr. Bullard, do you have any
thoughts?
Mr. Bullard. There are clearly a wide range of private
claims that can be brought against Madoff, both Madoff feeder
funds. And I think, to a large extent, they are fairly
adequate. The concern I have had with CPIC, is that I think
they are taking a position on what constitutes a loss, which is
both unreasonable and not consistent with fundamental financial
theory. But that doesn't seem to raise anyone's eye, and it is
clearly addressed by the bill.
I would say, though, that as far as this bill goes, Mr.
Taft has suggested that it preempt State causes of action. That
would significantly reduce the ability of investors to bring
claims against investment advisors. I don't know whether he
sees that as an implied preemption in the bill, in which case
the committee certainly should make it clear in the legislative
history that it does not preempt State law or if it is wishful
thinking. But that would give a substantial hit to State
claims.
Mr. Perlmutter. Okay. Let me ask Mr. Taft, what do you
think?
Mr. Taft. Well, as I said in my testimony, we believe there
is tremendous merit to having a harmonized Federal fiduciary
standard that applies to everyone providing investment,
personalized investment advice to individuals, so that no
matter which door an individual investor walks into, they can
be assured that they are going to receive the same protections
they would receive if they walked in a different door.
As to a Federal standard, the consistency, the clarity that
it brings, we are not suggesting that exist to the detriment of
the ability of State regulators to enforce that law. So I want
to make it clear that we think State regulators play an
important role, and they would have the ability to pursue
wrongdoers who violate fiduciary standard.
Mr. Perlmutter. Thank you. Thank you, Mr. Chairman.
Mr. Bullard. To clarify, my point was about private claims,
not State regulators claims. I didn't hear a response to that,
but that is what I was getting at.
Mr. Kanjorski. Thank you, Mr. Perlmutter. Now we will hear
from the gentleman from Illinois, Mr. Manzullo.
Mr. Manzullo. I have been going in and out and I am sorry I
have missed most of the testimony. I had an opportunity to read
it.
I have some people in northern Illinois who got caught up
in some of these Ponzi scams, and we are always interested in
knowing what, if anything, can be done to protect sophisticated
investors from getting caught in something like that, and what,
if anything, the Investor Protection Act of 2009 could do to
help people who are sophisticated investors. Does anybody want
to take a stab at that one?
Ms. Crawford. Well, I will say this, and the statement has
been made by Chairman Frank that the accredited investor
standard is not working or, I am paraphrasing, but he said
words to that effect.
And when you look at the universe of people who were where
defrauded by Bernie Madoff as well as Robert Stanford, they
were so-called accredited investors, which means that they have
a very large net worth and/or a very large income and are
presumed to be, because of that, sophisticated.
At some point, it may make good sense for the United States
Congress to look at that concept. Should someone be presumed to
be sophisticated simply by virtue of his or her wealth or
income? That standard did not service very well recently, and
there really is no reason to think that it will service very
well going forward.
Mr. Manzullo. Does anybody else want to take a stab at
that? I know it is a little bit off the context, but it really
is tied into it.
Mr. Bullard. I will do it. I think there may be reluctance,
to be really frank, about the question of sophisticated
investors investing with someone like Madoff. But in my
position, I can perhaps afford to be more frank.
And my view is that in light of the Madoff scandal, a truly
sophisticated investor would not have invested with Madoff.
There were fundamental steps that any truly sophisticated
investor should have made that would have led them not invest
at least a substantial amount of their assets with Madoff. I
think Madoff is ultimately a question of how we regulate those
who don't take the steps, to some extent, to protect
themselves. Exactly the same thing could be said of Stanford
with respect to CDs being issued from a very small island in
the middle of the Atlantic.
So I think that is really the answer, and as my testimony
suggests, I think the focus should be on retail investors,
personalized advice and there has to be a point at which you
draw the line and sophisticated investors would have to rely on
the private claims that they have.
Mr. Manzullo. The reason that I asked--
Mr. Ketchum. I am sorry, I just agree with Professor
Bullard. Two things to note. First, fraud standards remain the
same no matter what the sophistication of the investor.
Secondly, you are absolutely right. I think it deserves a
careful analysis from a suitability standpoint at a minimum and
perhaps from a fiduciary standpoint, with respect to what
obligations are with regard to a range of institutional
investors that don't have the level of sophistication that many
other institutional investors do.
And time and time again, there are instances in which those
persons who are categorized by standards that have been built
for other reasons by the SEC are brought into schemes where
they suffer serious harm. So I think your point is correct. I
think it deserves some careful look and study and perhaps a
valuable part of the study that is a part of this bill.
Mr. Manzullo. The fact that the SEC had actually looked at
Mr. Madoff, given him a clean bill of health on a couple of
occasions, wouldn't that lend credence to a sophisticated
investor that the Madoff investment was solid?
Mr. Bullard. It might. I would say it should not, given
that would be nearly a floor. But just to give you a concrete
example of steps that any sophisticated investor should take,
one of the rules that I suggest for any investor is never send
the check to the person who is making the decision about the
check, and what that means is you always have to make sure that
there is a separate third party who has custody, who is a
different person from the one who is making decisions about the
account.
Mr. Manzullo. But there were people who had contacted
independent brokers, and investment advisers, who said the best
place to invest your money is with Mr. Madoff.
And so I guess at what point, does the government get
involved, when even the people who are supposed to be really
sophisticated also may have relied upon some very poor
information and gotten stung? Maybe I should just leave that as
a rhetorical question and let it go at that and thank you.
Ms. Crawford. Congressman, you might want to direct that
question to the SEC.
Mr. Manzullo. Well, they didn't even know about it. Their
own internal investigation showed that when the whistleblower
had contacted the lower echelon at the SEC, that it never made
it all the way to the top. I guess my thought is, why didn't
that man who testified here contact a Member of Congress or
somebody in the Banking Committee, because we could have kicked
it upstairs right away and worked on it. Thank you.
Mr. Kanjorski. Thank you very much, Mr. Manzullo. Now we
are faced with a problem. The problem is we could continue with
this panel or take a break for lunch and come back and catch
panel 2 and panel 3, and I see all the disappointed faces of
this panel to get excused now and I would not want to
disappoint them. But since we are down to three members here,
four members, it probably is a good chance to take a break. So
what I want to do is express the thanks of the committee and
the subcommittee for this panel's participation. We appreciate
it. I was particularly interested with the flow of some of the
testimony and the comments. We will not refer to the gentlelady
from Texas at all, so we cause her no embarrassment.
But all of you really were rather forthcoming, gave some
very good insight in assisting us and coming up with
conclusions, and, of course, you were willing to give critiques
and criticism to the existing legislation, which you are always
welcome to do.
Again, you are not discharged from your responsibilities to
communicate some of your hesitations with the legislation or
how we can improve it, but we do want to give you our
tremendous thanks for having participated.
And at this point, we will discharge the panel. Thank you.
We are going to recess the hearing until 1:00, when we will
take panel number 2 and then shortly thereafter, panel number
3. So no one try and escape from the committee room. Thank you,
they are discharged. The committee stands in recess.
[recess]
Mr. Kanjorski. The full committee will reconvene, and I
will introduce our second panel, which will discuss enhancing
oversight of private pools of capital. Thank you for appearing
before the committee today and without objection, your written
statements will be made a part of the record. You will each be
recognized for a 5-minute summary of your testimony.
First, we have Mr. Stuart Kaswell, general counsel of the
Managed Funds Association.
Mr. Kaswell.
STATEMENT OF STUART KASWELL, EXECUTIVE VICE PRESIDENT AND
GENERAL COUNSEL, MANAGED FUNDS ASSOCIATION (MFA)
Mr. Kaswell. Thank you, Chairman Kanjorski, Ranking Member
Bachus, and members of the committee.
I am Stuart Kaswell, executive vice president and general
counsel of the Managed Funds Association. As you know,
Congressman Richard Baker was invited to testify on behalf of
MFA today, but weather-related delays in Baton Rouge kept him
grounded. He sends his deep apologies for not being able to
appear and sends his thanks to the committee for its
invitation.
MFA is the voice of the global alternative investment
industry and is the primary advocate for sound business
practices and industry growth for professionals in hedge funds,
funds of funds and managed futures funds, as well as industry
service providers. Hedge funds provide liquidity and price
discovery to markets, capital to allow companies to grow or to
improve their businesses and sophisticated risk management to
investors, such as pensions, to allow those pensions to meet
their obligations to their beneficiaries. MFA appreciates the
opportunity to provide its views on the registration and
investor protection legislative proposals from this committee
and the Obama Administration.
MFA is committed to playing a constructive role as the
regulatory reform discussion continues. As investors, hedge
funds have a shared interest with other market participants and
policymakers in seeking to restore investor confidence in a
stable and transparent financial system. These important
objectives can, in part, be accomplished through a thoughtful
approach towards the goal of establishing a smarter financial
regulatory system, a system that enhances investor protection
and market efficiencies through strong but fair oversight,
regulation and enforcement, and the promotion of industry best
practices like MFA's sound practices.
With regard to the registration issue, MFA and its members
support the general approach of requiring investment advisers,
including those to all private pools of capital, to register
under the Investment Advisers Act, which provides a
comprehensive regulatory framework for investment advisers.
In considering the appropriate regulatory framework, we
believe it is important to establish a narrowly tailored
exemption from registration for the smallest investment
advisers that have a de minimis amount of assets under
management and coordinate with, and not duplicate, State
regulation of investment advisers.
MFA believes that the approach taken in the draft
proposals, notably requiring registration under the Advisers
Act, is consistent with an intelligent approach to a complex
issue. We also welcome the fact that the committee and
Administration drafts both seek to preserve a de minimis
exemption from Federal registration for advisers to all but the
smallest of funds and would provide for confidentiality with
regard to reporting systematically relevant information about a
firm to the appropriate regulator.
While MFA supports the general thrust of the draft
proposals, I would like to spend a few minutes discussing some
areas of concern where we believe the draft proposals can be
improved.
We believe that the proposed bills by imposing unnecessary
overlapping regulatory requirements for commodity trading
advisors, who are already registered with, and well regulated
by, the Commodity Futures Trading Commission, is inconsistent
with the goal of improving the current system of regulation.
As I noted, while we appreciate that the proposals provide
for the confidential treatment of certain reports, we would
encourage Congress to consider the Federal Reserve's model of
protecting bank information.
We recognize and strongly support the fiduciary obligations
that investment advisers owe their clients. We further
recognize the SEC's challenges following the Goldstein decision
and the need for additional legislation to clarify the SEC's
authority.
We believe there are different ways to address those
concerns without expanding the definition of client so broadly
that advisers would become subject to the irresolvable
conflicts that would result if an adviser were required to
manage a pooled investment in the interest of each individual
investor.
We support strong disclosure between counterparties, but we
believe that there should be limitations on the information
that an adviser is required to disclose to other market
participants. For example, we believe that an investment
adviser should not be required to reveal its proprietary
trading strategies or other trade secrets.
We believe that Congress should provide an appropriate
transition period to implement the registration requirement.
MFA also supports efforts to enhance investor protection
and strengthen the authority of the SEC to enforce the Federal
securities laws. I have a few suggestions. I will try to cover
them quickly. We support giving the SEC authority to prohibit
individuals who engage in improper conduct while associated
with a broker-dealer or investment adviser, from being
associated with any other securities industry participant.
Investment advisers are subject to an existing, robust
fiduciary standard with respect to their clients. We support
extending that standard to broker-dealers and believe it is
unnecessary for Congress to establish a new standard.
I see I am just about out of time. We have a few additional
points that are included in our written statement. Thank you,
Mr. Chairman.
[The prepared statement of the Honorable Richard Baker,
president, Managed Funds Association, can be found on page 104
of the appendix. ]
Mr. Kanjorski. Thank you, Mr. Kaswell.
Next, we have Mr. Douglas Lowenstein, president of the
Private Equity Council. Mr. Lowenstein?
STATEMENT OF DOUGLAS LOWENSTEIN, PRESIDENT/CEO, THE PRIVATE
EQUITY COUNCIL
Mr. Lowenstein. Thank you, Mr. Chairman, and members of the
committee. I appreciate being back here to testify and discuss
the Private Equity Council's views on the proposed Private Fund
Investment Advisers Registration Act of 2009. As I had
previously testified before this committee, when applying the
Obama Administration's systemic risk factors to private equity,
it is hard to see how any particular PE fund could be
considered to present a systemic risk.
Indeed, in testimony last week before this very committee,
Federal Reserve Board Chairman Ben Bernanke said he would not
think that any hedge fund or private equity fund would become a
systemically critical firm individually. Though he did add that
it remains important for the systemic risk regulator to monitor
the industry as a whole, and we agree. Precisely for that
reason, and notwithstanding the lack of a nexus between private
equity and systemic risk, we are genuinely supportive of
requiring registration of advisors to private pools of capital.
With respect to the specifics of the draft bill circulated
last week, I have a few comments that I want to share with you
and we covered in some detail in our written testimony. Section
204(b)(7) of the draft would add to the Investment Advisers Act
the requirement that registrants provide reports, records, and
other documents to investors, prospective investors,
counterparties, and creditors if the SEC determines such
disclosure is necessary.
We take no issue with requiring PE fund managers to
disclose any and all information to the SEC regarding systemic
risk, but this section's added authorization for the SEC to
require registrants to make broad disclosures to third parties
is unnecessary, problematic and will do little to advance the
underlying objectives of the regulatory system. It is
unnecessary because the Securities Acts of 1933 and 1934
already impose a series of requirements obligating PE funds to
make extensive disclosures to their investors.
Additionally, the contracts that PE funds negotiate with
their investors typically require the funds to provide even
more information than is required by the 1933 and 1934 Acts.
In short, given the highly sophisticated nature of our
investors and our dependence on them for funding our
investments, they have both the knowledge and the leverage to
obtain the information they need to ensure they are fully
protected. While the proposed law protects information provided
to the SEC from disclosure under the Freedom of Information
Act, the section has the perverse effect of neutering these
critical confidentiality provisions by allowing the agency to
compel disclosures to counterparties, creditors, and others.
These disclosures could result in exposure of proprietary
information and trade secrets to those with whom we compete.
For example, this provision could easily result in the
disclosure of highly sensitive material, nonpublic information
about our valuation of a current or prospective investment,
information that creates the potential for the counterparty to
trade on that information or pass it along to another client.
There is no public or systemic risk interest served, as far as
we can tell, by this additional disclosure section, and we hope
that you will consider removing it from the draft.
We are also concerned about section 204(b)(3) of the draft
which creates what we believe is a rather sweeping optional
information-gathering authority for the SEC above and beyond
the already extensive disclosures that are required by the
Investment Advisors Act itself.
Given the fact that the prior section of the draft already
authorizes the SEC in consultation with the Fed to collect such
information as it deems necessary or appropriate in the public
interests for the protection of investors or for the assessment
of systemic risk, it would seem that should be sufficient to
carry out the goals of the statute.
Finally, section 6 creates a venture capital exemption. I
sympathize with the intent to offer relief to certain funds
that may not have the resources or the infrastructure to absorb
the administrative costs of a company registration, and which
are also too small to create systemic risk individually or
collectively. However, I think it will prove very difficult to
define a venture capital firm and to distinguish these from
most other investment firms. So I would suggest a simpler and
perhaps even fairer approach would be to raise the threshold
above which registration is required from $30 million to a
level that Congress believes is appropriate.
This would ensure the registration requirement captures the
larger firms more likely to pose the systemic risk, regardless
of whether they are classified as a venture capital fund or
private equity fund or some other investment advisor. And it
has the virtue of treating all small advisers in the same way.
And, most importantly, it will help ensure the SEC can
focus its scarce resources on overseeing those very firms,
including those who are members of the Private Equity Council,
that are most relevant to the public policy objectives that
bring us here today.
Thank you for inviting me. I look forward to answering any
questions you may have.
[The prepared statement of Mr. Lowenstein can be found on
page 188 of the appendix.]
Mr. Kanjorski. Thank you, Mr. Lowenstein.
Next, we have Mr. James S. Chanos, chairman of the
Coalition of Private Investment Companies. Mr. Chanos?
STATEMENT OF JAMES S. CHANOS, CHAIRMAN, THE COALITION OF
PRIVATE INVESTMENT COMPANIES (CPIC)
Mr. Chanos. Thank you, Congressman Kanjorski, Congressman
Bachus, and members of the committee.
My name is Jim Chanos, and I am testifying today as
chairman of the Coalition of Private Investment Companies. I
also run a $6 billion hedge fund. Thank you for the opportunity
to testify.
As I testified before at your Capital Markets Subcommittee
earlier this year, CPIC supports legislation to provide
increased Federal regulation of private investment funds. We
support the draft legislation before the committee today with
some additional enhancements that I will outline briefly.
As this committee is aware, hedge funds and private pools
of capital were not the source of the recent near meltdown in
our financial system. The greatest threats to the world economy
came from large, highly regulated, diversified investment and
commercial banks, insurance companies, and the GSEs.
Nonetheless, we recognize that you are working to expand and
improve Federal oversight over the financial markets in which
private funds play an important role. All significant market
participants should participate in a regulatory framework that
promotes transparency and accountability.
The benefits and risk mitigating features of private funds
for investors in our economy are well-known at this point.
There, of course, are risks associated with private funds.
These risks center on relationships among fund managers,
investors and individual counterparties. In rare cases, like
Long-Term Capital Management in 1998, a fund may grow to a
size, amount of leverage, and interconnectiveness that presents
systemic risks.
CPIC has advocated that Congress develop a special stand-
alone private investment company act tailored to the unique
characteristics and risks of private funds. In our view,
statutes like the Investment Company Act and the Investment
Advisers Act were designed to protect retail investors and are
not the right fit for private funds.
That said, the Administration's proposal and this
committee's draft have chosen to develop private fund
regulation oversight through amendments to the Adviser's Act.
These proposals offer a way forward but only if they are
sufficiently strengthened and tailored to private funds. To
begin, both proposals require that private fund advisers
register with the SEC under the Advisers Act and subject both
the fund manager and the fund to SEC examination.
The committee's draft, however, exempts advisers to venture
capital funds from registration. We question whether a category
of private funds should be relieved of SEC registration,
recordkeeping and inspection, solely by virtue of its self-
proclaimed investment strategy. Indeed, Ponzi schemes and
frauds can be run with any asset class, and the lines between
different categories of private funds have tended to blur over
time.
Leaving the operations of some funds outside the regulatory
purview based upon a stated investment strategy is an
invitation for the growth of bubbles and frauds. The draft
proposals grant broad general authority of the SEC to write
rules in several areas, including disclosure to investors,
counterparties, and creditors.
We recommend providing more specificity such as requiring
disclosures for a fund's valuation methodologies, the type of
assets it holds, the existence of side arrangements and trade
allocation policies. We also believe that Congress could help
combat fraud and theft by statutorily requiring managers to
keep all client assets with qualified custodians and requiring
audits by public accounting firms overseen by the PCAOB.
We commend the decision to explicitly direct the SEC to
write rules relating to assessments of systemic risk. We
support these provisions and also believe that any broader
systemic risk regulation the committee develops should include
private funds, depending upon their size, level of leverage,
and interconnectedness.
With respect to systemic risk oversight, private funds
should not be subject to the same type of regulation as is
necessary for a Bank of America, Citigroup or Goldman Sachs.
But what is fundamentally important is that systemic risk
entity has the overarching authority to obtain information from
any market participant when necessary and without the predicate
of an enforcement action.
We would also urge the committee to consider whether it
wants this new systemic risk regulator to apply the same
disclosure contemplated in the Private Investment Act to the
proprietary trading functions of all regulated financial
institutions.
Proprietary trading resembles many of the same features as
hedge funds using high levels of risk and leverage. The metrics
used to assess risk stemming from private fund activity can
also be used to better understand the risks being taken by
significant taxpayer-backed financial institutions.
All of these provisions will benefit investors and private
funds by enhancing regulators' ability to combat abuses while
reducing systemic risk. CPIC is committed to working with you
to build a better regulatory framework that will best serve all
investors' interests.
Thank you very much for this opportunity.
[The prepared statement of Mr. Chanos can be found on page
126 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. Chanos.
Next, we have Mr. Terry McGuire, co-founder and general
partner of Polaris Venture Partners, and chairman of the
National Venture Capital Association.
STATEMENT OF TERRY McGUIRE, CO-FOUNDER AND GENERAL PARTNER,
POLARIS VENTURE PARTNERS; AND CHAIRMAN, NATIONAL VENTURE
CAPITAL ASSOCIATION
Mr. McGuire. Chairman Kanjorski, Ranking Member Bachus and
members of the committee. On behalf of the venture capital
industry, I would like to thank you for the opportunity to be
part of this important process. We understand the need to
address the causes of the recent financial crisis, as well as
eliminate regulatory gaps, so that our country is never
surprised by massive financial failures again.
Last week, the Capital Markets Subcommittee, chaired by
you, Chairman Kanjorski, released a discussion draft focusing
on risk related to private pools. We would like to express our
sincere appreciation for the work of the subcommittee under
your leadership and the leadership of Chairman Frank in
drafting legislation that recognizes that venture capital firms
do not pose systemic risks.
We also appreciate your understanding that registering
under the Advisers Act would place an undue burden on our
industry. The legislative draft recognizes the important
difference between entrepreneurial risks, which we take all the
time, and financial systemic risks, which we do not.
Our investment model is simple. We invest in startup
companies run by entrepreneurs using capital from ourselves and
our investors. We invest cash to purchase equity and hold that
equity, working side-by-side with the management for 5 to 10
years until the company is sold, goes public or fails. In the
latter case, there is no multiplier impact of these losses.
While we lose our capital, there are no derivative
transactions or leverage that would lead to a ripple effect.
The elements identified by the Treasury Department as
contributing to systemic risks are not part of the venture
capital model.
We do not actively trade in the public markets. Our funds
are not directly available to retail investors. While some of
our investors are pension funds, under many State laws they are
limited to the amount of money they can invest in venture
capital. The number is often less than 5 percent in investable
assets.
We do not use long-term leverage or rely on short-term
funding. We do not create third party or counterparty risks.
Lastly, the venture capital industry is small, just a fraction
of other pool investment funds. But, for more than 50 years,
our collective wins have far outpaced our losses.
Tremendous economic value has been created. Venture-backed
companies say it counts for 12.1 million jobs and approximately
21 percent of the U.S. GDP. Entire industries, including
biotechnology, semiconductors, and now clean tech have been
built upon venture capital. By exempting venture capital funds
from registering under the Advisors Act, this committee has
eliminated a significant burden on our industry.
As you may know, the average venture capital firm employs
less than 10 professionals, and the administrative staff is
often a fraction of that. Registration could easily cost our
firms hundreds of millions of dollars, which should be directed
to growing new companies, rather than unnecessary compliance.
Finally, venture capital registration would not provide the
government with meaningful insight into systemic risks and
would divert government resources. With that said, we do
recognize the ongoing need for ongoing transparency.
Today, venture capital firms provide information to the SEC
that is publicly available when we seek to raise a new fund.
This filing process, which involves the completing of a form
which is known as form D, could easily be enhanced to include
information that would provide greater comfort regarding
systemic risks. An enhanced form D, let's call it form D-2, for
venture firms could answer questions annually on the use of
leverage, trading positions and counterparty obligations,
allowing regulators to continue to exempt firms that pose no
systemic risks.
The D-2 solution could be a viable option because it does
not require a lengthy regulatory process to test the definition
of venture capital. It would cause firms to annually confirm
that they are safe from systemic risks by responding to
questions that reveal the nature of their investing activity.
This would enable the SEC to quickly identify firms that do not
meet the standard.
This process would also accomplish the Administration's
goals of providing transparency and eliminating regulatory
gaps. It would do so without unnecessarily burdening the
venture industry or the SEC. We look forward to discussing
these recommendations further.
We applaud the committee's intent to protect
entrepreneurship and innovation. We stand ready to work with
you to gain transparency as you require, without hurting our
industry and the startup companies we support.
I thank you for your consideration today, and I am happy to
answer any questions.
[The prepared statement of Mr. McGuire can be found on page
211 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. McGuire.
And thank you all, gentlemen, for your testimony. Notice I
said ``gentlemen.'' There should be some young ladies sitting
at that table too, so one of these days, we have to think about
equality here.
No, all things being said, I take it for granted that
nobody really has concluded that the bill as presented is too
harsh for acceptance, but you would like to sit in a role of
being an assistant and helping us to protect even a finer bill;
is that correct?
Mr. Kaswell. That is correct. We applaud your efforts. We
think there are opportunities for further enhancement, but we
agree with the general thrust, that is right.
Mr. Kanjorski. That is very good. The Congress doesn't hear
that very often, so I thank you on behalf of the entire
Congress.
I have been trying to propel an idea to the industry that
is we regulate or sit in judgment of and create regulatory
implementation for, and that is that too often we miss the
advice of the experts and do not recognize very clearly that we
all, Members of Congress and members of this committee, are
generalists.
If I can extend to you--we all actually have telephones. If
you call the gentleman from Alabama, he will get on that line
and talk to you. Then he, in turn, will relate to us some of
the objections you may have stated or, actually, make your
argument a little more understandable.
Mr. Bachus. Or not.
Mr. Kanjorski. Or not. No, I have known Mr. Bachus for a
long time, and he is going to be a very major player in trying
to put this together. What this is, is an open invitation to
you and your colleagues and your association members, etc., to
please participate.
If we have done something that can be improved and
corrected upon, do not hesitate to do that. That is what we are
here for. We are not here to play ``gotcha.'' We are not here
to cost you a lot of money. Mr. McGuire, you mentioned it
costing hundreds of millions of dollars to comply. That is the
last thing we want to do.
We do really want you to take those hundreds of millions of
dollars out there and invest in companies, those that are north
of Philadelphia by 100 miles and east of Pittsburgh by 200
miles. If you get my measure, you can tell exactly where I am
looking at that investment to occur.
We spent actually a lot of time trying to put this together
so we could accomplish something. I take for granted that we
have been partially at least successful. We want to work as
this process goes forward, and we think it can go forward in a
relatively reasonable period of time to get this done.
So without taking my full time, I am going to recognize the
ranking member from Alabama to give his comments.
Mr. Bachus. I thank the chairman.
Venture capital, hedge funds, private equity, all of those,
I guess, private pools of capital or whatever you call them, I
think have served the country well, and they have been a
valuable cog in our economy, and it is an economy that is 3
times larger than the next biggest economy, which is the
Japanese economy.
I think it was this diversity and different approaches to
adding wealth creating jobs is a strength of the American
economy. And we don't, in America, take the one-size-fits-all.
And as the chairman said, as we move forward on protecting
investors, we do want your advice and input, because we don't
want to put some restriction on what you do that is unnecessary
and also limits your ability to aid the economy.
Our economy--I go to high school students and I ask them
what the largest economy in the world is. Most of them today
say China. Yet our economy is bigger than the Japanese, the
German, the British, the French, the Chinese, and the Japanese
economy put together.
We got there through choice and innovation and different
approaches, and letting the market come up with, really,
solutions. And our capitalistic market, it turned into a bad
word, that and profits today, but I think they have generated
tremendous wealth for the American people. Despite what we
witnessed last year, I think we got ahead of ourselves on some
of them.
The securitization, the different derivatives, all those
things were actually, I think, good products that were just
abused. But there is nothing fundamentally unsound or
fundamentally wrong with the product itself, but you can abuse
anything.
So I am just going to--I guess I will ask this, is
registration with the SEC properly done, would that be a
problem with any of the industry or you?
Mr. McGuire. If I could make a comment, the truth of the
matter is that the venture capital industry has been around for
50 years. We certainly submit SEC forms, form D, as I
mentioned. We are prepared to do additional disclosure.
I do think, though, that the burden of the Advisers Act
would be substantial and would be difficult for some of our
members. Some of our members are very small places in districts
such as yours. As I mentioned, the average has nine
professionals. There are some, though, with two and three
professionals.
By the way, they are doing incredibly important work in
companies that are coming from technologies generated from your
local universities. And I think having an additional burden,
the SEC burden, would not be helpful. In fact, over 50 years we
have proven that, in fact, we are good citizens.
Our model is pretty simple. It is old-fashioned. We invest
in companies. We expect to have our equity in those companies
for up to a decade, and we work hand-in-hand with those
companies. So I think we have proven to be good citizens. We
have proven that our model works. As you point out, it has made
an enormous contribution to the competitive positioning of the
United States.
So I think it would be unfortunate if there was undue
regulation. I don't think it would provide any particular
insight into systemic risks. Things haven't changed in our
business.
It is true that technology is unrelenting, and it is always
changing. But the way we practice venture investing has really
been tried and true for over 50 years. We would hate to lose
some of these venture capital investors because of these undue
burdens.
Mr. Bachus. I think you make a good argument. I think the
burden ought to be on us to prove that there is a reason for--
even registration.
Mr. Lowenstein?
Mr. Lowenstein. Yes, I think that for anybody, even the
largest private equity fund, to suggest that registration isn't
in some ways burdensome is not reasonable. It clearly is
burdensome. That is distinguished--in fact, for even the
largest funds, that might requiring hiring 7 to 10 compliance
people at a cost of several million dollars. But that is a
reasonable cost to impose on the members we represent in the
private equity world.
I do think it is important and appropriate though to, as
you go further down into the smaller firms--and there are about
2,000 private equity firms, and most of us all know the big
names in private equity--but there are small private equity
firms all around this country. And imposing, in the same way
that the VC funds have, would be a burden, I think would apply
to virtually any small fund regardless of what it does. And
that is why we suggest in our testimony, the touchstone for
whether registration is there, isn't what you say you are, it
is a--an assessment of your size and what you do and whether
you create systemic risk.
That is a reasonable standard. That is what this statute is
all about. And so tying the registration to a reasonable
targeting of registrants who actually are relevant to the
underlying policy goals, I think, makes no sense. Just in the
final point, as we say in our testimony, the characteristics of
PE and the reality of what's happened would suggest that
private equity wasn't relevant at all to the crisis.
I could make a case that we shouldn't have to register. I
think it is entirely reasonable to require us to register and
then to calibrate that registration so that it is most tied to
what we do and what is necessary for the SEC to carry out its
oversight responsibilities.
Mr. Bachus. And I don't think venture capital, in any way,
contributed to the events of last year, did it?
Mr. Chanos. If I could take a stab also, I would just point
out as a practitioner, as someone who runs a fund day-to-day,
much of what we are talking about here in the form of so-called
burdensome compliance issues to register, if you are accepting
pension fund money in large pools of capital, which almost all
the reasonably large members of our different groups do, you
are already doing most of that which is necessary for
compliance under registration.
So it would not be necessarily additive to what you should
already be doing in your internal workings of your fund if you
take pension fund money, ERISA money. That is something that is
often lost in these discussions.
Number two, we can talk about various different types of
self-described funds and whether or not they were the source of
systemic risk. And the hedge fund industry, I think was a model
of actually warning people about systemic risk back in 2006 and
2007.
But we also understand that markets look forward. And who
is to say which group of funds is not going to be issued
prospectively as opposed to retrospectively. And I know that we
can all hold ourselves out to be paragons, I think, in the
investing world--but for the purpose of the public good, I
think that our group, CPIC, says don't make many exemptions.
Make it comprehensive, set minimum standards for capital or
risk standards as Mr. Lowenstein said. But when a lot of people
opt-out through self-description, you also open up the door to
the less than 1 percent of the actors out there that may take
advantage of that.
Mr. Bachus. Mr. McGuire?
Mr. McGuire. Yes. Let me comment on that. Let me be very
specific. In my opening statement, I made the comment that
there are essential criteria which have been defined by
Treasury which define what are systemic risks. They include the
use of leverage, they including public trading positions, they
include counterparty transactions.
Our model doesn't use any of those. Therefore, I am making
an argument which is that any models that don't use those
criteria which have been defined by Treasury are adequate for
exception. Now I am not here to tell you which of these other
organizations should be regulated. They, earlier on, said that
they are happy to register. That is fine.
We have never taken a position that registration works for
our industry because, in fact, as defined by these risks, none
of these apply to us. So why should we now start registering
just because the others are registering?
Mr. Kaswell. We also feel that there should not be
regulatory gaps, that registration should apply to advisers to
all private pools of capital with the exemption for only the de
minimis based on the size of assets under management, not the
nature of the operation.
We are afraid it will create regulatory gaps, which we know
has been one of the touchstones of the Administration's
concerns here, and also we are concerned about the
opportunities for regulatory arbitrage.
One of the things we are worried about in the bill, and I
mentioned this in my statement, is that it creates the
possibility of overlapping regulation, if you are principally
engaged on the future side and registered with the CFTC, the
bill would take away an exemption that exempts you from the
Advisers Act. We think that just creates duplication and is not
warranted. Thank you.
Mr. Bachus. Thank you.
Mr. Kanjorski. The gentleman's time has expired. We will
now hear from the gentleman from Missouri, Mr. Cleaver.
Mr. Cleaver. Thank you, Mr. Chairman, thank you, Mr.
Chanos. Thank you for being here. Thank you all for being here.
In your testimony on pages 11 and 12, you say, ``In my
view, one of the most important recommendations of the report,
of the asset manager's committee, is that managers should
disclose more details going beyond the Generally Accepted
Accounting Principles regarding how their funds derive income
and losses from financial accounting standards.''
Now I agree with the need to disclose more details, but can
you be a little more specific on the change, what kind of
change will take place with the overall risk to the financial
system?
Mr. Chanos. I helped write that section for the President's
Working Group and the manager's report, so I am familiar with
it.
What we suggested, and what my organization, CPIC, is
embracing, is a level of disclosure beyond what we have right
now under GAAP for the so-called level 1, level 2 and level 3
assets. And these are the various classifications of financial
assets under the accounting standards. Very briefly, level 1
are things that have a very liquid national market, 100 shares
of IBM, for example.
Level 2 assets are those assets which are priced off
something else, which uses the term observable inputs. So,
typically, a bond that might trade at a spread to Treasuries
would be, in some historical pattern, would be a level 2 asset.
Level 3 assets are those which are the oxymoronic phrase
unobservable inputs, and those are really subject mostly to
management judgment and best guesses, quite frankly.
And what we advocated--and I think is good policy for every
financial institution, not just hedge funds, by the way, would
be not only a disclosure of the various levels of assets at a
point of time on the balance sheet, but also how much of your
profits and losses, both realized and unrealized, in your
financial statements, have come from the three classifications.
That goes well beyond the current accounting standards, but
that would have helped us in 2006 and 2007 in seeing just how
much of the profitability of various different actors on the
stage were dependent on hard-to-value assets or assets in which
management had large discretion over the valuation.
So, the President's Working Group committee, the managers,
really, we did argue over that, exactly the point you
highlighted. But we felt it was in the best interests of not
only the hedge fund industry but the markets as a whole and
regulation to shine more light in this area.
I really applauded the President's Working Group committee
to take that step and go beyond what we are doing now.
Mr. Cleaver. I do as well. I am requesting a subjective
response, probably, but whenever we begin to discuss in this
committee requiring more detail, we run into very, very rigid
resistance.
You can predict it, it is coming, and it is going to, if we
are told, if we do, that the Statue of Liberty will fall and
the Washington Nationals would win the series, or all kinds of
just unbelievable things will happen. Give me a response to
what we have heard in here over and over again.
Mr. Chanos. Well, I think that I would make the distinction
between giving the information that your investors need to make
good decisions about, for example, my fund, and that the
industry feels that we could go a little bit further to telling
our investors where we are making our money, how we are making
our money, and also to tell regulators and enforcement
individuals what they need to do to do their market policing
and their market regulation.
We do draw the line in telling the broad public, because
you then do cross over into the proprietary trading
information. And if I have to disclose my whole portfolio to
the public every 90 days, I really don't have a business
because, that is what I charge people for.
But to regulators, to enforcement, and to our own
investors, who have put their money in the fund, we think we
should be as broad as possible and as detailed as possible. And
I think that is just sound business and sound regulation. It
doesn't necessarily compromise my ability or our members
ability or members of these organizations' ability to make
money as long as they know they have some safeguards over that
information, that it stays in the proper regulatory framework.
Mr. Cleaver. I agree. I think that is what the American
public wants too. Mr. Kaswell?
Mr. Kaswell. Yes, I just wanted to note that these
principles are--as part of the President's Working Group
recommendations--reflected in the MFA sound practices that we
recommend as something for our members to consider. So I think
we are not necessarily saying it should be a regulatory
requirement--I am not sure we are going that far--but as far as
what we think are sound practices for the hedge fund industry,
we are very much on board.
Mr. Cleaver. But you are not saying that they should be
included in any regulatory form?
Mr. Kaswell. Right, not at this stage. But we are saying
this is something our firm should seriously consider doing, and
we have it as an industry sound practice that we commend to our
members.
Mr. Cleaver. Thank you. My time has about run out.
Mr. Kanjorski. Thank you very much, Mr. Cleaver.
Now, the gentleman from New Jersey, Mr. Garrett.
Mr. Garrett. I thank you, Mr. Chairman, and I thank the
panel.
Well, Mr. McGuire, you convinced me, although I was easy to
be convinced, public coming in on this, as to why, as you
described it, you would not be what this type of legislation is
adept at trying to get at, which is systemically risk the
institutions and, of course, you said a 50-year track record
that we have before us.
But I think those points that you make also seem to apply
to your colleagues on your right, to an extent, well, going to
the issue of--the one seminal issue which I always bring up is
how do we get here in the first place. Mr. McGuire, you would
argue that it was not venture capital firms. I would think
others would argue that it was not the hedge fund industry as
well. And if anyone disagrees with that--no.
So, part of the problem, then--and I found some of the
testimony quite interesting--part of the problem is, can you do
sometimes more good, more harm than good, and can you sometimes
be adding disclosure that may actually open it up if it is not
crafted in just the right way as far as, Mr. Chanos, your
comments, as far as disclosing your practices and your
portfolio, what have you?
So, that is one element that is a problem. And the other
element, of the problem I guess, is that if you disclose
information that becomes what someone indicated is duplicative,
it is already out there anyway.
And I guess the third problem, as far as disclosure is, if
you do disclose, and maybe it is not duplicative--and that
would be one of my questions to you is what information would
you be receiving potentially that is not duplicative--that is
just overwhelming to the system. I am sitting here thinking on
the personal level as far as all of the information that we
require in Congress as far as the disclosure on credit cards
and what have you--and no one ever reads that--all of us who
are involved in mutual funds and what have you--and we get the
reports every 6 months and no one ever reads that.
I am wondering we can--these aren't individuals here, but
the Fed and the other regulators who look at this can, we would
be giving them something they already have or information that
is already overwhelming towards them. So if you would address
those two points, duplicative information, new information, and
whether there is an overwhelming factor. That is three points.
Mr. Lowenstein. Let me take a quick crack at that and also
link it back to the prior discussion.
I think if you actually take a look at the draft
legislation, it provides the SEC with a pretty broad mandate
beyond even what's in the existing Advisers Act to collect
information, as is necessary, appropriate, in the public
interest for the protection of investors or for the assessment
of systemic risk as the committee determines in consultation
with the Board of Governors of the Federal Reserve. That is a
pretty sweeping grant of authority to the agency and could, in
fact, compel considerably more disclosure than we have today.
I think the point that we have made all along, in answer to
your question, is that what is helpful here is for the agency
to be directed to calibrate the disclosure it requires based on
the nature of what level of systemic risk you might present.
So it is less about a one-size-fits-all regulation and more
about a more focused effort to look at what are the differences
between different private pools of capital; and are there
differences, therefore, in the kinds of information we need to
carry out the responsibilities under this Act, which I think
are important and reasonable.
Mr. Garrett. And part of those requirements is fixed
criteria that they are looking at for someone who has capital,
someone who is leveraging. But in this industry, you are really
not looking, actually, at an industry that is overly leveraged,
certainly not in comparison to where the problems come,
certainly not in comparison to what we do in the government
with GSEs.
So, really, what are we looking at here, as far as a class
of industry, a class of business that is potentially a problem
area? Or, as one of you said in your statement, do we want to
make sure that the SEC's resources are focused on those areas
where they should be focused on. Is this an area we want them
to be focused on? Or are there other, better places for them to
focus on?
Mr. Lowenstein. If I could comment, again, our practice is
very simple--
Mr. Garrett. Yes, well, yours shouldn't be. But I am
wondering if they shouldn't be focused on at all. I am right
there. I am also right there maybe to further than where the
panel is, saying that maybe we should be focusing on some other
area.
I am down to my last 30 seconds.
Mr. Kaswell. In some areas, we think there are
opportunities for more disclosure. For example, amending ADV
Part II, the information that goes to investors, we support
providing information to investors on prime brokers,
accountants, and custodians. We think that would be useful.
We are supportive of providing reasonable information to
the regulator. We get concerned about public disclosure. We
don't want to have to disclose our trading strategies. We are
concerned about providing too much information in the way of
trade secrets to counterparties.
We only deal with sophisticated investors. It is a very
different market than the retail marketplace, and we want to
keep it that way. We also favor raising the level of investment
permitted so that we don't inadvertently become a retail
product.
Mr. Garrett. Can I go a little further?
On another note, for 30 seconds, Mr. Lowenstein, I thought
you made some sort of comment with regard to the auditing
requirements--I think it was you, I made in my notes--with
regard to making sure that the firms are audited by a PCAOB.
Oh, I am sorry, Mr. Chanos. Okay.
Mr. Chanos. We said that, too.
Mr. Garrett. There you are. Everybody but Mr. Lowenstein.
Okay.
Mr. Kaswell. Funds should be audited by a PCAOB-regulated
auditor.
Mr. Garrett. Now, here is the problem, potentially, with
that. Let me see what your response is.
That is okay for the big guys who are probably already in
that mix already. But if we are going to either carve out
exemptions by class or if we are going to carve out exemptions
by size, doesn't--or, class and not size, doesn't that cause a
problem, then, for those industries that are just now going to
look for higher-priced audits being done? And, really, the
benefit of that is just marginal?
Mr. Kaswell. Well, we favor a de minimis exemption for the
truly small. But after that, when you are taking the
investments from pension plans and so on, we think that a PCAOB
audit is the appropriate thing to do.
Mr. Garrett. What are the requirements right now if you are
already doing a pension fund--handling a pension fund? What are
the requirements, as far as any audits?
Mr. Kaswell. I don't believe it is required.
Mr. Chanos. It is not required. But you will get very
little pension fund money unless you do it. It is a
practicality.
Mr. Garrett. It is standard practice, is what I thought,
already. So maybe, once again, we might be adding something on
that is actually--for those industries that are already doing
it, we are not really adding it on, but we are just creating
all that murky middle ground as to where that exemption lies.
Is this for a class of business or size of business as you
folks would have to do? And all we are doing is just adding
more uncertainty. But the best practices out there--or the real
practices out there, it is already being done.
Am I right, understanding--
Mr. Kaswell. I think that is true. We think that, in this
environment, you should have a PCAOB audit. We think that is a
threshold issue at this juncture.
Mr. Garrett. Okay.
Mr. Kanjorski. Thank you very much, Mr. Garrett.
The overwhelming attendance on your side of the aisle there
is--
Mr. Garrett. They are all in the back room having coffee,
waiting for--
Mr. Kanjorski. Just going to run out here suddenly.
Mr. Garrett. Suddenly, yes.
Mr. Kanjorski. All right. Mr. Cleaver, do you have any
further questions?
Mr. Cleaver. No, Mr. Chairman.
Mr. Kanjorski. Okay. Well, then we are going to give this
panel a break.
Thank you very much for coming by and giving us your
observations. We thank you very much and appreciate it.
And may I extend to you what I said before? If, as this
process moves on over the next several weeks and couple of
months and you have some more insights, please feel free to
share those insights with the staff or myself or Mr. Garrett.
Thank you very much for appearing.
The committee will reconvene. I now introduce the third
panel, which will discuss creating a Federal Insurance Office.
Thank you for appearing before the committee today. And,
without objection, your written statements will be made a part
of the record. You will each be recognized for a 5-minute
summary of your testimony.
First, we have Ms. Janice Abraham, president and chief
executive officer of United Educators Insurance, on behalf of
the Property Casualty Insurers Association of America.
Ms. Abraham?
STATEMENT OF JANICE M. ABRAHAM, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, UNITED EDUCATORS INSURANCE, ON BEHALF OF THE PROPERTY
CASUALTY INSURERS ASSOCIATION OF AMERICA (PCI)
Ms. Abraham. Thank you, Chairman Kanjorski, and Ranking
Member Bachus. I am Janice Abraham, president and CEO of United
Educators, a reciprocal risk retention group. We are owned and
governed by 1,200 educational institutions that we insure,
including colleges and universities, public and independent
schools, educational associations, foundations, and cultural
institutions.
I am testifying today on behalf of Property Casualty
Insurers Association of America, PCI, the leading P and C
insurance trade association in the United States, representing
more than 1,000 members.
The home, auto, and business insurance industry is healthy
and competitive, and the current system of regulating the
industry is working relatively well. In the past 5 years, our
insurance companies have weathered Hurricanes Katrina, Rita,
and Ike, in addition to handling our regular claims, without
having to ask for a government bailout. We are not broke, we
didn't cause the current financial crisis, and we don't need a
duplicative system of Federal oversight that may ultimately
increase costs to consumers.
PCI supports responsible regulatory reforms that reflect
principles of good insurance regulation. We understand the need
for a Federal insurance office with three primary roles: first,
to support harmonization of State insurance regulations;
second, to have a seat at the table during international
negotiations regarding insurance issues; and third, to develop
an expertise within the Federal Government to advise both
Congress and the Administration on insurance issues.
While PCI has not taken a position on the Federal Insurance
Office, our members have a number of questions and concerns
about the ONI and FIO discussion drafts. PCI appreciates some
of the changes made in the FIO draft. However, the proposed
Federal Insurance Office still goes far beyond the limited
scope of the original bipartisan congressional bill by you,
sir, and Representative Biggert and several other committee
members. Instead, it creates an office with extremely broad
scope and powers that could lead to very costly duplication of
State insurance oversight.
I will underscore four critical concerns that are more
fully detailed in my written testimony.
First, there are virtually no limits in the bill on the
types or volume of information the FIO may demand. While
gathering information might sound like an innocuous activity,
it can impose extraordinarily high costs and burdens on
insurers, especially small insurers who must comply with data
requests.
State regulators have some accountability in the
information that they gather since they do so in pursuit of a
regulatory function with the responsibility of insuring the
solvency and stability of the marketplace. The FIO has no such
balancing accountability or mission. Instead, the proposed
language directs the FIO to require mandatory information
reporting to ``monitor all aspects of the insurance industry.''
This is an incredibly broad directive, duplicating what the
States already effectively implement.
PCI appreciates your leadership, Representative Kanjorski,
in dropping the explicit grant of subpoena authority from the
ONI proposal. This is a significant improvement. However, to
avoid inefficient duplication of reporting requirements, the
FIO should look to State insurance regulators or other public
sources to obtain information it needs for its analysis. If the
information needed is not available through these public
sources, we suggest the data requests be voluntary, not
mandatory.
Second, the FIO may exclude small insurers from its
mandatory reporting requirements, but the exclusion is
discretionary and undefined.
Third, the FIO proposal dropped critical due process
protections that are standard administrative procedures and
included in your congressional bipartisan bill, although we do
appreciate that it reflects an improvement on the ONI proposal.
Fourth, and perhaps the most important concern, the scope
of FIO goes far beyond the bipartisan congressional bill, with
the potential to lead to mission creep and greater duplicative
and costly oversight. Specifically, the new proposal would have
the officer monitor all aspects of the industry and to have any
additional related authority that Treasury wants to give it. We
recommend refocusing the Federal Insurance Office on its unique
role in international trade issues, liaison, and advisory to
the Federal Government, as specified in the bipartisan
congressional bill, as well as coordination to harmonize State
insurance regulations.
In conclusion, PCI appreciates the committee's hard work
and diligent consideration of this issue, especially the joint
leadership of Representatives Kanjorski and Biggert on the
original, widely supported, bipartisan proposal. PCI has strong
concerns about the current legislative FIO draft but
appreciates the improvements on the ONI proposal and looks
forward to working with the committee on addressing the
remaining concerns consistent with the past committee
leadership.
Thank you very much, sir, for your consideration.
[The prepared statement of Ms. Abraham can be found on page
89 of the appendix.]
Mr. Kanjorski. Thank you, Ms. Abraham.
Next, we will have Mr. David B. Atkinson, executive vice
president and vice chairman of RGA Reinsurance Company, on
behalf of the Reinsurance Association of America.
STATEMENT OF DAVID B. ATKINSON, EXECUTIVE VICE PRESIDENT
REINSURANCE GROUP OF AMERICA (RGA), ON BEHALF OF THE
REINSURANCE ASSOCIATION OF AMERICA (RAA)
Mr. Atkinson. Thank you, Mr. Chairman. As you said, my name
is David Atkinson. I am testifying today on behalf of not only
my company, Reinsurance Group of America, Integrated (RGA), but
also the Reinsurance Association of America, or RAA, a trade
association representing life, property, and casualty companies
that specialize in reinsurance.
Simply put, reinsurance is insurance for insurance
companies. By spreading risk among many companies around the
world, reinsurance plays a critical role in maintaining the
financial health of the insurance marketplace and ensuring the
availability of insurance for U.S. citizens and businesses. My
company, RGA, is the largest U.S.-based life reinsurer, the
second-largest life reinsurer in North America, and the third-
largest in the world.
I am pleased to appear before you today to provide the
RAA's perspective on Congressman Kanjorski's legislation to
create a Federal Insurance Office. We applaud the committee's
interest in and we strongly support this legislation, and are
especially grateful for Congressman Kanjorski, his leadership
on this important issue.
We also applaud the Administration's acknowledgement that
international aspects of the reinsurance business require
Federal involvement to address the needs of the U.S. market as
well as to assist and support U.S. companies doing business
abroad. Encouraging the participation of global reinsurers in
the U.S. market is essential, because reinsurance provides the
much-needed risk-sharing capacity for life, property, and
casualty risks in the United States. Without reinsurance,
insurance prices would increase and the availability of
insurance would decrease.
The current State-based system is primarily focused on
regulating market conduct, contract terms and rates, and
protecting consumers. None of these objectives apply to
reinsurance, which is purely a business-to-business
transaction. Instead, reinsurance regulation focuses mainly on
financial solvency so that reinsurers can meet their
obligations to their insurance company customers.
The RAA supports a reinsurance regulatory system that would
create a single national regulator with a single set of rules
focused on efficient and effective solvency regulation. We also
support a process for the national regulator to evaluate and
recognize non-U.S. regulatory regimes to boost international
reinsurance transactions.
We believe a Federal Insurance Office is necessary to
assist Congress and the Federal Government in making better
decisions regarding international insurance policy and in
enforcing international reinsurance agreements uniformly across
the United States. Public policy issues are frequently raised
at the Federal level which could have a significant impact on
the reinsurance business, yet there is no Federal agency tasked
with understanding the insurance industry. The Federal
Insurance Office would fill this void.
The RAA believes it is critical that the Federal Insurance
Office coordinate Federal efforts and establish Federal policy
regarding global standards for international insurance matters.
Currently, the U.S. voice is marginalized because of the
fragmented nature of the current State system and the lack of a
single national regulator with authority to speak on behalf of
the United States. As a consequence, global insurance standards
are evolving with minimal U.S. input. Furthermore, uniform
application of these global standards in the United States is
unlikely, since identical regulations would have to be adopted
in each individual State. We suggest that the legislation be
amended to make it clear that the Federal Insurance Office has
the authority to represent the United States in all relevant
international organizations on insurance issues.
The RAA also strongly supports the authority of the Federal
Insurance Office to preempt State insurance measures that are
inconsistent with international insurance agreements and that
disadvantage non-U.S. reinsurers. It is critical that the
Federal Insurance Office be empowered to ensure these
international agreements are uniformly upheld throughout the
States and that companies are not subject to dual and perhaps
conflicting regulation. This is a significant step forward in
creating a more efficient and effective regulatory system in
the United States and enhancing U.S. dealings with foreign
governments and regulatory bodies.
Now, in our drive to open the U.S. market to non-U.S.
reinsurers, it will be important to not put U.S. reinsurers,
such as my company, at a disadvantage in their home market.
Preserving a U.S. presence in the U.S. reinsurance market
should be a guiding principle of the Federal Insurance Office
legislation.
Finally, the Federal Insurance Office must ensure a level
playing field in the United States for both U.S. and non-U.S.
reinsurers alike.
Thank you for the opportunity to testify. The RAA looks
forward to working with members of the committee on this very
important issue.
[The prepared statement of Mr. Atkinson can be found on
page 97 of the appendix.]
Mr. Kanjorski. Thank you, Mr. Atkinson.
Next, we have Mr. Dennis Herchel, assistant vice president
and counsel of Massachusetts Mutual Life Insurance Company, on
behalf of the American Council of Life Insurers.
Mr. Herchel?
STATEMENT OF DENNIS S. HERCHEL, ASSISTANT VICE PRESIDENT &
COUNSEL, MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY, ON BEHALF
OF THE AMERICAN COUNCIL OF LIFE INSURERS (ACLI)
Mr. Herchel. Thank you.
Mr. Chairman, Ranking Member Bachus, and members of the
committee, on behalf of the American Council of Life Insurers,
I would like to thank you for the opportunity to appear here
today to discuss the industry's position on the newly proposed
Federal Insurance Office.
We support creating this office in the Department of the
Treasury. As we testified last year on the Office of Insurance
Information proposal, we believe this office would be
enormously beneficial to Congress as it considers issues that
are vitally important to our business and would facilitate the
handling of international insurance matters and would provide a
means for--
Mr. Bachus. Mr. Herchel, could you pull the microphone up a
little closer? Just grab it and pull it up. And I guess it is
on. You have to turn them on.
Mr. Herchel. It was on. I am sorry.
The events of the last 12 months have only heightened the
need for this office. The financial crisis illustrated the
problems associated with the lack of insurance industry
expertise at the Federal level.
As you know, for some time now, the ACLI has advocated for
the creation of a Federal regulatory presence. In light of the
recent crisis and the legislative proposals and response, and
short of Congress enacting an optional Federal insurance
charter, we believe it is imperative that Congress establish
this office.
As proposed, the office would be the Federal Government's
repository of insurance industry information and expertise and
also act as the U.S. international representative on insurance
issues. It would not have any supervisory or regulatory
authority.
In addition, we believe the office should be elevated in
status so it can participate actively and effectively with
Federal financial industry regulators, including the systemic
risk regulator, under any new systemic risk regulatory
structure. This will ensure that actions affecting insurers are
taken only after a systemic risk regulator has had direct
consultation and coordination with the office.
The Administration's systemic risk regulation proposal
places the Federal Reserve Board in the position of ultimate
systemic risk regulator. The Board would be given broad
authority to determine which companies pose systemic risk,
designate them as Tier 1 financial holding companies, and
exercise sweeping regulatory powers over those companies and
their subsidiaries. This includes authority to require
increased capitalization and changes in management activities.
This power is tempered only slightly, as the Board is
required to consult and coordinate with the Federal functional
regulator of a Tier 1 company or its subsidiary before
instituting any action or proceeding against it. Since there is
no Federal functional insurance regulator, there would be no
equivalent consultation or coordination when it comes to Board
decisions affecting Tier 1 companies that are insurers or
insurance subsidiaries.
Since the Board is a banking regulator and has virtually no
insurance regulatory expertise, we believe this is an
inappropriate result. The Board is required to coordinate with
other banking regulators even though it has strong expertise in
that area. The fact that it would not be required to act
similarly when it comes to insurers is a contradiction of sound
regulatory policy.
Insurance is a highly regulated industry. Insurers that do
business in more than one State are supervised by a functional
regulator in each one. Insurers are subject to a strict
financial solvency regime. Establishing a systemic risk
regulatory system that ignores this is an imprudent approach
for the Federal Government to take and will result in
unintended negative consequences.
We believe one solution is to give the office a role
equivalent to that of Federal functional regulators when it
comes to dealing with the Board on all aspects of systemic
regulation. The Board should be required to coordinate and
consult with the office whenever Board supervisory or
enforcement action is directed at an insurer. The office should
be required to act as an intermediary between the Board and the
insurer's domestic State regulator regarding any proposed Board
action. And the office should be given a seat on the proposed
Financial Services Oversight Council. These and other changes
in the office's status will vastly improve any regulatory
regime ultimately enacted by Congress.
We also support amending the proposal in a number of ways
to effectuate the role originally envisioned by the office.
First, it should be made clear that the office's preemption
authority will never be used in a way that results in a
solvency regulation gap, nor should preemption result in any
material, unfair discrimination against any U.S. insurer. While
we do not believe use of preemption should be withheld if it
can't be used to realize the benefits provided under mutual
recognition agreements, it should not be used to disadvantage
domestic U.S. companies. We support a clear administrative due
process to any preemption action to ensure prevention of these
undesirable outcomes.
Second, it is important that a report of the funds
appropriated to the office be used to secure and retain
personnel with insurance industry experience and expertise. In
order for the office to be successful, it will be necessary to
staff it with personnel who are well versed in the workings of
the industry.
Third, clarification that the office has no general
supervisory or regulatory authority over insurance companies is
important. As drafted, the proposal contains ambiguous language
that could cause confusion on this issue, so a clear statement
of this intent should be included in the final bill.
There are some additional recommended changes outlined for
you in my written testimony, so I won't take the committee's
time listing them again here.
Mr. Chairman and members of the committee, we believe the
need to establish this office is self-evident and, with the
addition of these changes we have outlined, fully support
enactment of the proposed substitute to H.R. 2609. Thank you
for giving us the opportunity to present our views, and we look
forward to working with you as this legislation moves forward.
[The prepared statement of Mr. Herchel can be found on page
161 of the appendix.]
Mr. Kanjorski. Thank you, Mr. Herchel.
We will now hear from Mr. Spencer Houldin, president of
Ericson Insurance Advisors, on behalf of the Independent
Insurance Agents and Brokers of America.
Mr. Houldin?
STATEMENT OF SPENCER M. HOULDIN, PRESIDENT, ERICSON INSURANCE
ADVISORS, ON BEHALF OF THE INDEPENDENT INSURANCE AGENTS &
BROKERS OF AMERICA (IIABA)
Mr. Houldin. Thank you, Mr. Chairman.
Good afternoon. My name is Spencer Houldin. I am pleased to
be here today on behalf of the Independent Insurance Agents and
Brokers of America. Thank you for the opportunity to provide
our association's perspective on proposals to create a Federal
Office of Insurance.
IIABA has long supported State regulation of insurance.
And, especially during this difficult economic time, State
insurance regulators have effectively ensured that insurers are
solvent, that claims are paid, and that consumers are
protected. State insurance regulation has a long and stable
track record of accomplishment, especially in the areas of
solvency regulation and consumer protection, but its benefits
and merits have never been more apparent.
While State regulation is certainly in need of improvement,
the economic crisis has highlighted serious deficiencies
associated with creating an optional Federal insurance
regulatory system. When financial services entities are
permitted to select a regulator of their choice, they will
select the path of least resistance and what best serves their
business interests. That choice may not be what is in the best
interest of the consumer.
Although we strongly support State insurance regulation and
would oppose any effort to undermine that system, we recognize
the benefits that can achieved by establishing a nonregulatory,
informational office at the Federal level. It is imperative,
however, that any statute authorizing the establishment of an
insurance information office be designed carefully and with the
proper safeguards and not set the stage for Federal insurance
regulation.
We support the Insurance Information Act as introduced in
May but have significant concerns with several of the revisions
unveiled in a recent discussion draft. The OII legislation
introduced just several months ago was a carefully constructed
and thoroughly vetted, bipartisan proposal with broad support
in what is often a highly splintered insurance market. We
strongly hope any legislation adopted by this committee will
closely resemble the original bill.
There are several critical elements of the original version
of OII that are, at a minimum, essential to any legislation
that creates a Federal insurance information office.
Specifically, any proposal should make clear that the office
does not possess supervisory or regulatory authority over the
business of insurance. We also believe the information
gathering provisions of any proposal should ensure that the
office does not collect information available elsewhere, and
include important protections governing how certain data maybe
obtained and utilized.
In addition, the discussion draft would have the unintended
effect of enabling this office to require Main Street insurance
agents to produce data and information upon demand. We,
therefore, urge the committee to revise the definition of
``insurer'' so that it applies, as it should and is likely
intended, only to insurers and reinsurers and not small
businesses.
At the very least, we believe that this office should be
required to establish an exemption to the submission
requirements for all covered entities meeting the minimum size
threshold, instead of only permitting the office to do so.
Explicitly requiring such an exemption would ensure that small
agencies and insurers are not unduly burdened by informational
demands.
Any legislation should also include clear and meaningful
administrative provisions for handling preemption, and we urge
the committee to establish safeguards that would apply in those
instances when the office is considering whether a State law
should be preempted. We believe that these changes would ensure
that the scope and power of this office are limited in focus
and would eliminate any concern of regulatory mission creep.
Our main concern and focus is ensuring that the office does
not operate as a de facto Federal insurance regulator or serve
as a precursor to Federal insurance regulation. It has
repeatedly been stated that such an office is not meant as a
step towards Federal regulation. Our conditional support for
this concept is tied directly to these commitments. Therefore,
any overt or subtlest efforts to make the insurance office look
more like a regulatory body or set it up to become a forerunner
to Federal regulation would force us to vigorously oppose any
such proposal.
State insurance regulation has a strong track record of
regulating insurers and protecting consumers, and it has been
particularly successful over the last year. Using targeted
legislation to establish a nonregulatory insurance information
office with limited and defined responsibilities would
strengthen State regulation while also filling the void of
insurance expertise that currently exists at the Federal level
and remedy many of the problems faced by the insurance industry
participants in the global economy.
Thank you.
[The prepared statement of Mr. Houldin can be found on page
168 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. Houldin.
We will now hear from Ms. Therese Vaughan, chief executive
officer of the National Association of Insurance Commissioners.
Ms. Vaughan?
STATEMENT OF THERESE M. VAUGHAN, CHIEF EXECUTIVE OFFICER,
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (NAIC)
Ms. Vaughan. Thank you, Chairman Kanjorski, Ranking Member
Bachus, and members of the committee. Thank you for inviting me
to testify today.
My name is Terri Vaughan, and I am the CEO of the National
Association of Insurance Commissioners. Prior to joining the
NAIC, I was a professor of insurance and actuarial science at
Drake University. I also served as the Iowa Insurance
Commissioner from 1994 to 2004 and as the NAIC president in
2002. I am pleased to be here today to offer the NAIC's
perspective on establishing a Federal Insurance Office.
To address a Federal Insurance Office, we must first offer
this context: State regulation of insurance has a proven track
record of stability and effectiveness even in the face of great
financial strain, having shepherded the U.S. industry through
the recessions of the 1890's, the bankers panic of 1907, the
Great Depression, and the dramatic credit crisis of the past
year.
In light of this track record, particularly when compared
to other aspects of the financial services industry, we
strongly urge that any efforts to improve insurance regulation
build on the proven legacy of State oversight and tread
carefully when considering any amount of Federal preemption.
Having said that, certain fundamental improvements to
State-based regulation may require targeted Federal assistance,
and we are not adverse to this when appropriate. We worked
closely with Congressman Kanjorski, Congresswoman Biggert, and
others on H.R. 2609, which would create an Office of Insurance
Information. That proposal was carefully crafted to protect
effective State supervision while achieving two fundamental
goals: first, increasing insurance knowledge and access to
insurance sector information at the Federal level; and, second,
enhancing international cooperation on insurance regulatory
issues.
The proposed Federal Insurance Office Act generally
preserves those two goals but has discarded a number of the key
provisions from the original OII proposal that are critical to
preserving the strong State regulatory system and, therefore,
critical to our support.
In particular, we urge that any Federal Insurance Office
not be empowered with day-to-day supervisory authority over
insurance. Additionally, we have recently offered members of
this committee a number of substantive suggestions which
restore the protections embedded in the original OII
legislation. Our written statement goes into greater detail,
but today I will focus on a few key points.
While insurance regulatory information and expertise has
always been available directly from the States and collectively
through the NAIC to those in Washington, a formal Federal
interface is appropriate. However, this interface should
provide a two-way, reciprocal flow of information, enabling
insurance regulators to have equal standing with our Federal
counterparts and access to information on federally regulated
parents and partners of State-regulated insurers.
To avoid unnecessary expense and resources, any Federal
Insurance Office should serve as a conduit for, and not a
replacement of, the extensive information collected by the
States, both individually and nationally through the NAIC. The
recent financial crisis and our experience with AIG illustrates
the need for financial regulators, whether State or Federal, to
have in place a clear system for sharing information about
complex institutions.
A key goal of legislation to create a Federal Insurance
Office should be to enhance international cooperation on
insurance regulatory issues without displacing the existing
critical role of the States as the functional regulators in
these discussions. Any binding discussion at the international
level should respect and reinforce the States' authority to
regulate insurer solvency and protect insurance consumers and,
therefore, should be limited to agreements of regulatory
equivalence or mutual recognition. These types of agreements
serve to level the playing field for U.S. and non-U.S. insurers
without preempting States' ability to prescribe the rules of
the game for solvency and consumer protection.
Such equivalence seeks to harmonize treatment of insurers
operating globally, but it does not require jurisdictions to
give up sovereignty over their standards over minor
differences. As such, any preemption of a State law stemming
from an international agreement should be limited to
reconciling material or substantive differences in treatment.
Strong capital and solvency protections have been embedded
in State regulation of insurance and are a critical reason that
insurers have weathered the financial downturn relatively
better than other types of financial institutions. Our solvency
system is national in scope. All 50 States are now accredited
by the NAIC utilizing the same risk-based capital and baseline
solvency standards. As such, State solvency regulation should
be excluded from any possible preemption by a Federal Insurance
Office.
Mr. Chairman, we support the goal of creating a National
Insurance Office to serve as a resource for the Federal
Government and a conduit for the States. But we will continue
to strongly oppose any efforts to use such an office as a
precursor to establishing a Federal insurance regulator, and we
continue to have significant concerns with the current proposal
before this committee.
We have offered substantive changes in good faith to
improve the proposal, and we look forward to continuing to work
with you on this effort and on the many other critical issues
before this committee.
Thank you for the opportunity to testify, and I would be
happy to answer your questions.
[The prepared statement of Ms. Vaughan can be found on page
273 of the appendix.]
Mr. Kanjorski. Thank you, Ms. Vaughan.
And finally, we will hear from Mr. J. Stephen Zielezienski,
senior vice president and general counsel of the American
Insurance Association.
Mr. Zielezienski?
STATEMENT OF J. STEPHEN ZIELEZIENSKI, SENIOR VICE PRESIDENT &
GENERAL COUNSEL, AMERICAN INSURANCE ASSOCIATION (AIA)
Mr. Zielezienski. Thank you, Chairman Kanjorski, Ranking
Member Bachus, and members of the committee. I appreciate the
opportunity to be here today to discuss the establishment of a
Federal Insurance Office, as contemplated in Chairman
Kanjorski's discussion draft.
While the discussion draft does not create the national
regulatory option AIA has long advocated, we support the
Federal Insurance Office because it accomplishes two major
goals that I would like to explore today: increasing Federal
insurance expertise; and empowering the United States in
international negotiations on prudential insurance matters.
First, the important role of insurance in our economy
compels the need for Federal insurance expertise. Insurance
contributes 2.4 percent to the annual GDP and directly or
indirectly employs 1.5 million hard-working Americans. And the
unique focus of property casualty insurers on reducing societal
risk has saved many lives, prevented countless injuries, and
avoided billions of dollars in economic losses.
We believe that the Federal insurance office should be led
by an assistant secretary appointed by the President and
confirmed by the Senate. By having this position filled by a
presidential appointee, the head of the office will be
recognized here and abroad as an important senior government
official with insurance sector responsibilities.
In its role as Federal insurance expert, the discussion
draft also envisions that the office will identify regulatory
gaps that might contribute to systemic risk and recommend
whether any insurer should be subject to additional regulatory
scrutiny. We agree that these are key functions.
The office should start from the premise that the property
casualty sector has weathered the current crisis and remains
strong overall today primarily because these are generally low-
leveraged businesses, with lower asset-to-capital ratios than
other financial institutions, more conservative investment
portfolios, and more predictable cash outflows that are tied to
insurance claims rather than on-demand access to assets.
Given this dynamic, the office should facilitate
understanding of the insurance regulatory model and ensure that
the industry and its customers are not adversely affected by
the application of inappropriate bank-centric regulatory
standards.
I don't mean to imply that our insurance regulatory system
is perfect. In fact, Treasury has called it ``highly
fragmented, inconsistent, and inefficient.'' Despite the best
of regulatory intentions, States are inherently limited in
their ability to resolve issues that go beyond their borders.
But until Congress decides to establish a national regulatory
alternative, a result the AIA would welcome, the expertise
promised through the Federal Insurance Office is essential to
prevent unintended consequences.
We would also urge the office to focus its monitoring
activities on unregulated or lightly-regulated products or
activities that could present broader systemic risk. This
approach would allow the office to analyze the industry through
the prism of risk aggregation and counterparty exposure
generated by nontraditional products or activities rather than
simply by company size.
We also strongly urge this committee to provide a seat for
the Federal Insurance Office on any systemic risk council that
is established so that the council gains a Federal stakeholder
offering a national perspective on insurance issues.
Second, the discussion draft grants the Federal Insurance
Office authority to set national policy on prudential aspects
of international insurance matters and to represent the United
States before the IAIS. The office's international authority
complements separate power given to the Treasury Secretary to
negotiate international insurance agreements.
These are critical functions, given that the U.S.
Constitution grants the Federal Government exclusive power to
conduct foreign affairs. Both the discussion draft and the
Treasury White Paper document ongoing frustrations with the
inability of the United States to negotiate authoritatively
with foreign counterparts on pressing insurance issues.
The most oft-cited example of the need for robust U.S.
involvement is the EU Solvency II initiative. Solvency II is
moving forward, while the current U.S. insurance regulatory
system remains fragmented among 57 separate jurisdictions. The
ability of U.S. insurers to remain globally competitive may
well rest on Federal engagement on this prudential issue in
every relevant forum as it evolves and to have our financial
regulatory system deemed equivalent on a national level.
Indeed, we believe that the discussion draft compels the
conclusion that the office can preempt State insurance measures
that are inconsistent with international agreements concluded
on behalf of the United States to the extent those agreements
involve financial supervision.
Let me close by thanking the committee again for
circulating Chairman Kanjorski's discussion draft and for
engaging in an open dialogue on the substantial merits of a
strong Federal Insurance Office. Establishing such an office,
properly empowered, represents a key step in ensuring that the
critical role of insurance is recognized at the national level
and that the Federal Government retains the ability to preserve
a viable private insurance market and maintain U.S.
competitiveness in a changing global economy.
Thank you.
[The prepared statement of Mr. Zielezienski can be found on
page 280 of the appendix.]
Mr. Kanjorski. Thank you, Mr. Zielezienski.
I thank the panel for their testimony. We have a few
questions. I will take mine initially to begin with, and then
we will get the other members in.
If I had to summarize what I have just heard in the opening
statements, 50 percent of you love it and 50 percent of you
hate it. I could concede that maybe that means we should do it.
I think it is fair to say it has stiffened considerably
from its original introduction. It has also changed its name
from ``National'' to ``Federal.'' It is not intended to do
anything that is regulatory in nature; I think that should be
made clear to everyone. It is, however, something that has been
requested for various reasons from the Administration and
others that we make the changes.
But I want you all to know that they manufacture that thing
called a telephone that allows you to every now and then ring
us up, either myself or the staff or even the other side of the
aisle, if you will, to give us some good critiques of what is
in there, how it could be changed in a better light.
On the other hand, do not just call to make a compelling
argument to tone it down or dumb it down because that won't be
very successful. I think it is already dumb enough, so what we
really want to do is try to smarten it up. And that is where we
will ask members of the panel to participate with us.
I, quite frankly, thought that it was going to be so great
today that we would just have a roar from the panel, no
statements necessary, and we would go on to unanimous passage.
I expected my colleague on the right here to just announce his
bipartisan support of the legislation, that it would be all
over and we would lock hands and sing. But I think I am now
looking at the gentlelady from Illinois, and she is not too
happy. Now I am in trouble. So we will go down and take the
legitimate criticisms that are there and see what has happened.
Actually, if I had to ask a question now, those who think
they can favor the legislation as is, could you show your
hands?
Thank you, Mr. Cleaver.
And those who are absolutely abject opponents of the
legislation as it presently is?
Okay. And we have two neutrals. Is that it? Maybe yes and
maybe no?
Ms. Abraham. I am not sure where you counted, whether--in
your 50 percent.
We think there are good reasons to have a Federal Insurance
Office. I articulated those: a seat at the table on
international issues; and harmonization of State regulations.
We think there needs to be expertise. We are concerned about
the breadth, the scope, and the potential for mission creep.
And those are concerns. And we think there can be areas where
your stated goals can be articulated. I am concerned about
small insurance companies, small to mid-sized companies.
So we understand why this is needed. We think the intent is
strong. But there are very specific issues and concerns that we
have that we think can be addressed. And I articulated those in
my testimony, my written testimony. So I am not agnostic, not a
flag bearer, but very willing to work with you on making
improvements to this, sir.
Mr. Kanjorski. We do appreciate that. And, believe me, we
do want to work on that, and we will.
Ms. Abraham. Thank you.
Mr. Kanjorski. But you have to admit that we are
successful--did somebody say--oh, yes, your testimony said that
50 of the States have now joined in. That is amazing. We are
getting some people to stand up and be counted, are we not? So
we are slightly successful there. Maybe we can get some other
activity and finding out what can happen both in State
regulation as it impacts on potential Federal regulation. That
would be very healthy.
But we are not trying to sneak an end run here. We are
really--and I think everybody agrees with at least this whole
idea that a Federal Government devoid of adequate information
on the insurance industry, as large as it is, is really a great
risk to our system of systemic risk in the future if we do not
have: one, an understanding; and two, a methodology to handle
it.
Right now, it almost was a complete disaster with AIG
insofar as it was not the insurance part of the business that
went awry, it was the financial products part of the business,
but the insurance part almost got dragged in. Because, as you
recall, there was a request to allow the utilization of about
$30 billion in assets to support the counterparty positions of
AIG in Europe, and the regulator in New York actually gave the
authority for that to happen. Luckily, circumstances and events
passed beyond the authority being exercised. But if it had been
exercised, it probably would have precipitated the largest
financial disaster for the insurance industry in the history of
the country. And whether it could have been stopped is an open
question when I discuss with people.
And now, Professor, if you will give us a shot on that?
Ms. Vaughan. Well, thank you, Chairman Kanjorski.
I was not around at the time. I was safely ensconced in Des
Moines, Iowa. But my understanding is that there were extensive
discussions among the regulators. And, actually, I think the
story around AIG is a very positive one, because the States got
very organized. They had constant communication, regular
conference calls. They had a game plan for what was going to
happen so that there was going to be action taken by all States
at the same time if it was necessary. They agreed on what that
was going to be.
And in terms of the request by New York to use the money,
my understanding is that it still had to go through some
approval processes in other States and that had not yet--they
hadn't agreed to that.
So it is not entirely clear to me that would have happened.
In fact, I like to use that as an example of the strength of
our system, in that New York, I do not believe, could have
unilaterally taken that money. I think they would have had
others that would have had to look at it and decide whether
that was a good idea or not. And that is a good thing.
Mr. Kanjorski. I would hope that in the future--and I know
I am over my time--that we don't have little entities in far-
off countries like London carrying on adventures in the
insurance industry that, in my estimation, were never intended
to be engaged in by insurance companies.
But to the tune of, I think, your testimony is that the
counterparty positions held by AIG Financial Products in London
was $7.8 trillion. How that ever happened, to that size and
magnitude.
And the fact that we obviously now know that we have not
had a sufficient system to have that disclosed within the
system, whether we could call that systemic risk or for some
other purposes, we just cannot afford to continue or to allow
that to happen in the future. Luckily, it did not precipitate
the type of disaster, perhaps, that could have occurred, but I
do not know how we meet that challenge.
Anyway, I have exhausted my time, and I guess I will move
to my friend from New Jersey--incidentally, a recent television
star in his own right.
Mr. Garrett. If you were up at 6:00 this morning.
Mr. Kanjorski. That is right. I was viewing it at 6:30 in
the morning. That is the point. I have just been mentioning
that so that everybody knows I was up at 6:30 in the morning
watching Mr. Garrett on TV.
Mr. Garrett. Thank you.
To the panel, Ms. Abraham, one of your opening comments
just struck me when you read it. It said, ``We are not broke,
we didn't cause the current financial crisis, and we don't need
a new Federal oversight that may ultimately increase the costs
for consumers.''
I don't know if you were sitting in the rows before the
other panel who was here. They could probably have said the
same things, the hedge funds and the venture capital: They
weren't broke, they didn't cause a problem, and they don't need
any oversight. But, gee, almost everybody, except for a man
there, sitting at the panel said they were all willing to have
the Federal Government step in and oversight them anyway.
Ms. Abraham. Well, I didn't mean to say we didn't need
oversight. What I said is, we already have oversight. We have
good oversight in the State system. And what we are concerned
about is duplicative oversight or conflicting oversight, so
that the Federal Government is asking for information that is
already produced, already given to the State regulators. So
that is what I meant by ``we have oversight.'' I think we have
extensive oversight.
Mr. Garrett. Actually, I was going to jump to that in a
minute, but you brought it up, so I will raise it out to other
people, as far as the duplication of information.
And, Ms. Vaughan, you can chime in here, or others.
The information as far as that is already being collected
by the States and then through the NAIC, is there other
information that would be going to this new entity that is not
going to the NAIC or not going to--yes, not going to the NAIC
right now? And, if so, what?
Ms. Vaughan. I would say that is a good question to ask the
Treasury, is what other information they might envision in
this. I have a hard time imagining that there would be issues
that are needed in order to understand the risk posed by the
insurance industry that the insurance regulators wouldn't
already be asking and gathering information about.
We periodically go to our companies and say, give us
information on this. Because of the environment that we are in
right now, there is a new thing that we highlighted that we
want to gather information on. I would say we could certainly
do the same thing in working for a Federal insurance office, if
they want to work through us.
What we would really like to get to is a partnership, where
they come to us, we go to them, we have good communication. We
think we can make something like that work.
Mr. Garrett. Thank you.
I only have a couple of minutes.
Another question that you brought up that raised a point--I
will let you chime in on this. Maybe you can answer this
question as well. She also said, we ultimately don't want to
increase costs for the consumers, so maybe this goes to the
question of collecting information and more information.
Has anybody on the panel--are there are groups or entities
that have gone out there and looked to see, if we do do this,
either in this version or the other version, whether or not
this actually raises costs to the consumers?
Ms. Abraham. I think one of the concerns--just to jump in
quickly--to Dr. Vaughan is, because the scope is so broad, we
don't know what we would be asked for. We already supply to 50-
plus different regulators information. I have no doubt that if
we would require additional information, we would have to hire
additional staff in order to compile the information and send
it in, in addition to what we already do. So it is the broad
scope. It is the unlimited mandate that is of deep concern to
us.
Mr. Garrett. Does anybody know of information on the
studies as far as whether this raises costs or maybe lowers
costs? I can see that argument being made.
No? Okay.
Just another general--Mr. Atkinson?
Mr. Atkinson. If I could just comment on that.
If we get into international negotiations with foreign
regulators, they may well come up with some items of
information they require from U.S. companies to get comfortable
with our situation. So that is one area we don't know about,
but it is a possibility.
Mr. Garrett. Mr. Herchel?
Mr. Herchel. Thank you.
One point that was made about oversight, I think of this
office as not just being one of oversight but also one of
gathering information and developing expertise at the Federal
level. So not to say that there won't be some oversight that
will be taking place, but I think there is a dual purpose
there.
Mr. Garrett. On that line as far as oversight, one question
is the issue of solvency, which to me is the issue when it
comes to insurance regulation. Everything else is secondary to
that.
Does anyone want to chime in on the thought that this
language is tight enough or too broad as to giving the Fed the
authority to get into the area of solvency? A, should we--and I
can imagine your answers--and, B, whether the language is on
point or goes in different directions?
Ms. Vaughan. I would say the concern--one of the concerns
we have about the language is the ability of the office to
enter into international insurance agreements is not
constrained in the sense that it should be focused on the kinds
of agreements that reflect our own solvency system. That is one
of the things we want. We have a system that works. Let's not
go out and make agreements and let people come in under weaker
solvency systems.
Mr. Garrett. For the folks who are proponents of this,
generally speaking, on the other side--I will close on this--do
you see that as an issue? Do you see the language could be
tightened up to address those concerns? Or shouldn't it be
tightened up?
Mr. Herchel. We have concerns about making sure that our
solvency regime stays intact so that we can withstand the
trials and tribulations as we go through. However, we think
there probably has to be some type of flexibility there for
this Federal insurance office to be able to sit at the table
and try to understand different issues on an international
solvency basis.
But in our testimony, you will see that we have caveats in
there about making sure that we don't create any type of
solvency gap. We don't want to have any unfair discrimination
amongst foreign insurers and domestic insurers and things of
that nature. Maybe we are saying it in a little different way
than the NAIC today, but we recognize that is an important
issue. But we don't want to necessarily completely take the
whole discussion off the table for this Federal office.
Mr. Zielezienski. I think we read the language ``prudential
measures'' to be coextensive with the term ``financial
regulation.'' I think if you look at other titles of the
Administration proposal, particularly title II, which deals
with stricter capital standards on so-called Tier 1 financial
holding companies, all of the measures that are identified as
prudential standards are things that you would expect in a
solvency regulatory regime.
So if one of the purposes of this legislation is to help
the United States engage effectively at the international level
and be at the table when Solvency II discussions evolve to make
sure that not only are we well-represented but that, when the
equivalency determinations get made--and European spokespersons
have said they are going to be made at a national level, not a
State-by-State level--that they have the ability to carry that
out.
Mr. Garrett. Okay. I thank the panel.
Thanks, Mr. Chairman.
Mr. Kanjorski. Thank you, Mr. Garrett.
Now we will hear from the gentleman from Missouri, Mr.
Cleaver. I am sorry--Mr. Scott. I avoided an assault there.
Mr. Scott. That is okay. When you get me confused with Mr.
Cleaver, you have gotten me confused with a tremendous
gentleman, a scholar, and a great American. Thank you.
Allow me to pose a few questions here, because I just want
to make sure we are clear here.
Is this a Federal Office of National Insurance we are
proposing? Is it a Federal Office of Insurance Information or
is it a Federal Insurance Office?
There are a variety of different terminologies that we have
been throwing around with what this is. But, most definitely, I
hope that we will come to the conclusion that this is not a
precursor to a Federal charter for insurance.
What disturbs me about the plan also is the words in this
as I read it that states there will be preemption power over
State insurance matters in this. So I think we ought to really
make sure we are moving down a road that we have fairly clearly
mapped out and that we don't have unintended consequences.
Let me start with you, Mr. Houldin, if I may. You are with
the Independent Insurance Agents & Brokers of America. You have
consistently been a strong supporter of State regulation of
insurance and an opponent of Federal regulation, optional or
otherwise, is that correct?
Mr. Houldin. That is correct.
Mr. Scott. Do you see a danger here? We all know that
everything is not perfect. Let me ask you, how would you
propose modernizing or reforming the State system for the
benefit of the consumer?
Mr. Houldin. That is a great question, Congressman. Thank
you.
The State system has proven to be extremely efficient; and,
using targeted Federal legislation, I think we can make that
State system better. We look at the surplus bill that recently
passed the House, the NARAD bill which you have recently
introduced, which would make agent licensing more efficient.
And the original OII bill from Chairman Kanjorski is a good
piece of legislation. It brings data and information to the
Federal Government, and it does solve some preemption problems.
This current draft legislation goes a little bit further than
that and starts to bring in regulation and supervision of the
industry, so we have a problem with that. But using targeted
Federal legislation to enhance the State system in our opinion
is the best of both worlds.
Mr. Scott. Let me ask you, are you familiar--I am sure you
have read this--with the preemption language in this?
Mr. Houldin. Yes.
Mr. Scott. How do you interpret this? If this new Federal
insurance office is granted broad preemption authority, and
let's say foreign insurers are able to operate under different
rules, would this create a potential harmful environment for
the consumer?
Mr. Houldin. We certainly have concerns that the preemption
in the new draft goes a little bit further and may put the
foreign companies in different consideration than the domestic
companies. The original draft or original OII only treated when
there was a difference and put everybody on a level playing
field. We are afraid this new language may have gone too far
and made it unlevel.
Mr. Scott. And with this new preemption authority, is there
a real concern that all of the insurance companies domiciled,
let's say, in a certain State would be significantly
disadvantaged by these international companies?
Mr. Houldin. It certainly could happen when the
international companies are going to be given different
treatment and play by different rules. Certainly.
Mr. Scott. Now, so that we know for sure, what is your
major concern? What is your major concern with Federal
regulation?
Mr. Houldin. Well, with Federal regulation on this
particular bill and where it goes, our major concern is that
the bill goes beyond just information and preemption and it
gives regulatory authority to Treasury.
We also have a concern in that the definition of insurer in
the bill is anybody who engages in the business of insurance.
That would bring mainstream agents like myself, mom-and-pop
shops, into the fold. So we think there should be some
exemptions to exempt smaller businesses and insurers.
Mr. Scott. I just want to note for the record in the White
Paper that the President submitted, he says in the last
sentence here, ``Given the importance of a healthy insurance
industry to the well-functioning of our economy, it is
important that we establish a Federal Office of National
Insurance.''
Do you worry that this kind of language would be a
precursor to Federal control? Especially when it says within
Treasury and that we develop a modern regulatory framework for
insurance.
Mr. Houldin. Certainly, that concerns us. It was nice to
see that the Blueprint left out Federal regulation of insurance
completely and just talked about this particular office. We do
need to make sure we don't have mission creep through this
bill. That is exactly what the original OII was intended to do.
Mr. Scott. Thank you very much, Mr. Houldin.
I yield back the balance of my time. Thank you.
Mr. Kanjorski. Now, we will hear from the gentleman from
Alabama, Mr. Bachus.
Mr. Bachus. Thank you, Mr. Chairman.
Normally, I would not ask you all to give me a yes-or-no
answer, so I am going to give you another choice, and that is,
you can answer ``yes,'' ``no,'' or ``I don't have an opinion.''
How about that?
My first question is, State regulation--this is just a
statement. You tell me whether you agree or disagree with this
statement, or you don't have an opinion.
State regulation of insurance functions is significantly
better than Federal regulation of securities and banking over
the past 5 or 10 years. How many think it did a better job of
regulating the State--okay.
How many of you think it did a worse job?
How many of you don't have an opinion?
Okay. To the three who said that you don't have an opinion
on whether State regulation of insurance was better than
Federal regulation of, say, securities or financial services,
what were the failures of State regulation of insurance?
I will start with Mr. Atkinson. What do you see as the most
significant failure? I can give you 100 failures of Federal
regulation of banking and securities.
Mr. Atkinson. I wouldn't say they are failures. They are
probably inefficiencies and frustrations and so forth. It is
not a very fast system. Things evolve very, very slowly. We are
30 years behind most developed countries in our regulations.
Mr. Bachus. The bottom line, how did that affect customers?
Was it increased--
Mr. Atkinson. Increased price is probably the main thing.
Mr. Bachus. Was it increased over what the costs were, like
the insurance in other countries?
Mr. Atkinson. The products are not too comparable between
countries. Each country has their own regulations which dictate
what kind of products are available.
Mr. Bachus. I can't think of any instance where someone
didn't have an insurance contract, they contracted for
insurance, and it paid off. Were there any instances where that
didn't happen?
Mr. Atkinson. There have been insolvencies. We do have a
State guarantee system that backs up--
Mr. Bachus. So there were no losses?
Mr. Atkinson. Insolvency regulation has worked well. It has
been a success.
Mr. Bachus. They didn't in banking and securities?
Mr. Atkinson. I am not that close to banking, but
certainly, reading the papers, there have been huge problems in
banking and securities.
Mr. Bachus. We talk about inefficiencies in insurance,
driving up the cost to consumers. National regulation in
banking, has that brought down the cost to consumers of
different banking fees? Does anybody have an opinion?
Okay. Do you think that national regulation of financial
services products or securities, do you think that offered the
type of protection it should have? Anybody?
It was a pretty profound failure, wasn't it?
I am just trying to figure out how, after what we witnessed
the last 10 years, we would want to say that national
regulation would do a better job than State regulation. To me,
clearly, the answer to that first question was that the States
did a much better job of regulating insurance than the Federal
Government did of regulating securities, investments, and
banking.
Let me say this--and I appreciate those who came down on
both sides. Maybe you all would elaborate in a letter to me why
you don't have an opinion as to which worked best.
Mr. Atkinson. I am just not that familiar with Federal
regulation of banking.
Mr. Bachus. But you read the papers.
Mr. Atkinson. But there is also State regulation of
banking, and I don't know where the failure lies, perhaps it is
at both levels.
Mr. Bachus. We were talking about State regulation of
insurance.
Mr. Atkinson. Right. So I don't know that either has a
license to be better than the other.
Mr. Bachus. Let me ask you this: International insurance
agreements, that has quite an appeal to me, that we need an
office that can negotiate those. But does the Federal
Government have better expertise to know whether those
agreements will protect insurance customers in those States?
Ms. Abraham. One of the issues that we are concerned about
on this is to ensure that, if preemption does occur, that there
is due process associated with it. So there can be a full
hearing through the judicial process to understand what the
preemption means, the impact on the States and the consumers,
obviously. So we are concerned that preemption can occur. And
as the draft proposal currently stands, there isn't that due
process. We think that is very important. So we would encourage
as this evolves, that is built into any final legislation that
is put forward.
Mr. Bachus. I would think there is something worse than not
having an international insurance agreement, and that would be
having a bad one that impacted customers negatively.
Mr. Atkinson. The whole reason for this measure is to build
expertise at the Federal level, and it may take years; and it
may also take more than a few years to negotiate our first
international insurance agreement, and probably prudently so.
Mr. Bachus. I am really asking questions. I am seeking to
better educate myself. Thank you.
Mr. Kanjorski. Mr. Zielezienski wanted to respond.
Mr. Zielezienski. There are a couple of responses, one in
the context of international insurance agreements. The U.S.
Government is the only one that can do that, vested solely with
the foreign affairs power by the Constitution. The fact of the
matter is these international agreements are being concluded
between other countries every day, and every day we don't sit
at the table is another day lost.
Mr. Bachus. A lot of those international agreements have
turned out fairly badly for some of our companies.
Mr. Zielezienski. And, to date, there has been no ability
or authority on behalf of the Federal Government to conclude an
agreement on insurance matters.
Mr. Bachus. I am not sure that is all bad. I understand it
is bad on occasion. I give you that. There are legitimate
cases. With reinsurance, there have been some tremendous
problems. I do think last year's legislation went about where
it should have, and I am afraid that this year's legislation
may be an overreach.
Thank you.
Mr. Kanjorski. Thank you very much.
Now, we have the gentleman from Missouri, Mr. Cleaver.
Mr. Cleaver. Thank you, Mr. Chairman.
Let me thank all of the witnesses for being here, but
particularly Mr. Atkinson. Thank you for being here.
I will just restate something that the chairman stated
earlier. You are from the Reinsurance Group of America, RGA.
The business journals, which actually was started in Kansas
City by Mike Russell and ``Doc'' Worley, Bill Worley, but now
they are all over the country and one is in St. Louis, the St.
Louis Business Journal said that people get you confused with
the RCGA as well, which is a civic, economic development
oriented organization; and if you come near the Potomac, the
RGA is the Republican Governors Association. I am not mad or
anything. I am just saying that is what people think,
particularly on this side. So it may be of some value for you
to help us clear up some things, particularly about
reinsurance.
How would your member organizations differ from some major
company like AIG?
Mr. Atkinson. Well, first of all, we are specialists in
life reinsurance, so we pay money when people die. We only pay
life insurance companies, and all of our negotiations and
dealings are with life insurance companies. We also are a buyer
of reinsurance ourselves. We deal with other life insurance
companies behind us. The net effect of all this is, when
someone famous with a lot of insurance dies, no single company
is put in jeopardy. The claim is spread around, with sometimes
as many as 40 or 50 companies paying a share of a large claim.
On top of that, we work with a lot of companies on new
products, new ideas in the industry, and help to further the
process, speed up the process of innovation and lower the price
of insurance over time because of that.
Mr. Cleaver. So AIG, which is ``too-big-to-fail,'' would
not be in any way or should not be confused with your group.
You are not ``too-big-to-fail?''
Mr. Atkinson. We do insure AIG. But one thing to note about
our business, too, we charge premiums each year, and we pay
claims each year, and those largely offset. So there is not a
lot of money tied up somewhere that could evaporate.
Mr. Cleaver. You said that right now, the multi-State
system of insurance regulation is cumbersome.
Mr. Atkinson. Yes, it is.
Mr. Cleaver. And extremely inefficient.
Mr. Atkinson. Look at things like new product
introductions. You have to file your product in every State.
Every State has different things they want changed on your
application and your policy wording. It is a nightmare. It
takes up to a year sometimes to get 1 product approved in all
50 States.
Mr. Cleaver. So you would be opposed to a 50-State system?
Mr. Atkinson. That is just the way it is today. I think
U.S. companies are used to dealing with that. It is a
frustration. It is an inefficiency, but it is livable.
Mr. Cleaver. What would you do to correct it? To make it
more livable?
Mr. Atkinson. I don't know that you can do anything. When
you have insurance regulated at the State level, you are going
to have at least 50 different voices with different ideas, and
sometimes they can come together and adopt a uniform
regulation. Even there, there are usually some tweaks in each
State.
Mr. Cleaver. I got a BlackBerry message a few minutes ago
from someone who said to me, you guys should not do anything to
help AIG, assuming that is what is going on here. That is why I
wanted to get some clarity.
I have no other questions, Mr. Chairman. Thank you.
Mr. Kanjorski. Thank you very much, Mr. Cleaver.
Next we will hear from the gentleman from California, Mr.
Royce.
Mr. Royce. Thank you. Thank you, Mr. Chairman.
Well, one of the biggest failures I think was AIG in our
recent history, and the securities lending division was
overseen by the various State insurance regulators. Now, that
portion of AIG has cost the taxpayers dearly, and no one here I
don't think is arguing that there aren't problems with State
regulations or Federal regulations. We understand there are
problems with both, and it is getting to a solution of this I
think we are focused on.
One of the particular problems with AIG in terms of their
insurance contracts over the Government-Sponsored Enterprises,
Fannie Mae and Freddie Mac, was the government intervention
directly in the market, in the sense that we prevented
regulators from regulating Fannie and Freddie for safety and
soundness.
I carried legislation on the behalf of the Federal Reserve
to try to do something about this, but it was defeated over an
argument that it would be injurious to affordable housing if we
didn't have those zero down payment loans, if we didn't have
those 50 percent requirements for Fannie and Freddie to hold
that much subprime in their portfolios, and it was AIG that
made the bet or insured this. So when Fannie and Freddie went
down, when that $1 trillion was lost, AIG lost that money as
well. But a lot of that money, again, was the securities
lending division over seen by the various State insurance
regulators, so they miss THAAD too.
As I mentioned in my opening statement, the European Union
continues to move closer to passing the Solvency II directive
which will create one market for insurance throughout all of
Europe. Another aspect of Solvency II is meant to increase the
global cooperation effort by bringing equivalent regulators
from around the world into closer consultation with each other.
Unfortunately, we have not held up our end of the bargain.
The various State insurance regulators simply do not have the
authority to negotiate with foreign regulatory bodies on behalf
of the U.S. market. As a result, the regulators in the EEU will
not recognize U.S.-based firms under the oversight of the
various State regulators.
So I would ask Mr. Atkinson, are you concerned that our
regulatory model will punish U.S.-based institutions trying to
operate overseas, and what are steps likely to be taken by EEU
regulators against U.S. firms should they follow through on our
violation of that agreement?
Mr. Atkinson. I wouldn't use the word ``punish,'' but we
have been disadvantaged by our situation for some years now in
many of the leading countries that we operate in. We have had
to set up subsidiaries and capitalize those subsidiaries,
rather than deal directly from our U.S. base. So that has
created a lot of extra costs.
Mr. Royce. If I could interrupt, Mr. Atkinson, that was in
a situation where we as a Nation have 50 separate regulators,
but France didn't have 50 regulators for every province, so
they took some decisive action then. But now the EEU is all one
market, because they have decided instead of having 50
regulators, they are going to have one world-class regulator.
But they are looking at the United States and saying we have an
agreement for equivalency on regulation, and you are going to
be in violation of it unless you figure out a way to have a
regulator that can effectively regulate and stop things like
AIG from happening in the future. So your observation on that?
Mr. Atkinson. Well, the way around that is you set up
another company in another jurisdiction and operate it in
harmony with the local laws. Like I said, it is not a good way
to do business, but it is a way to do business.
Mr. Royce. As I noted in my opening statement, the current
State-based regulatory system is highly fragmented, it is
inconsistent, and it is inefficient. That is the judgment of
the Treasury Department. It costs consumers and makes our
regulatory model weaker.
What will a Federal insurance regulator do that the
proposed Federal insurance office cannot? Could I ask if Mr.
Herchel has any observation on that?
Mr. Herchel. Yes, Congressman. I think there is a big
difference between the legislation that is in front of this
committee today and an optional Federal insurance charter would
call for. What we are just talking about here today is about a
Federal insurance office that is going to have information
gathering potential and expertise so they can consult with the
systemic regulator or other Members of Congress to make sure
that there is a knowledge base about the insurance business and
also on the side with reinsurance, as an example, with respect
to international agreements.
You are correct that these rules will not have any way of
regulating the business of insurance in the United States. This
office would not have any role in taking care of product
development or product approvals, which is some of the issues
that national insurance companies, insurance companies that do
business across the country do; have nothing to do with market
conduct requirements; have nothing to do with agency licensing
issues, making sure that products are distributed appropriately
throughout the States; and also the financial standards that
are applicable to those companies, what reserves they have to
have in place and how they invest their assets that they take
in.
Mr. Royce. Mr. Zielezienski, you wanted to comment on this?
Mr. Zielezienski. Yes. You have heard today, I think, from
a variety of panelists that the Federal insurance office won't
be a regulatory body. Adopting an optional Federal charter
would create that national regulator that we lack today.
On the issue of the fragmentation and inconsistency and
inefficiency that pervades the State system today, that would
be eliminated in favor of a strong set of uniform national
standards that would apply to those who were federally
chartered.
If the bill follows your legislation, that focus would be
squarely on financial solvency and market conduct, where it
ought to be. And I have no doubt that under such a system, even
if it replicated the standards that are at the State level
today on financial solvency, that would be judged to be
equivalent.
Mr. Royce. Thank you, Mr. Zielezienski.
Now, we will hear from the gentlelady from Illinois, Ms.
Bean.
Ms. Bean. Thank you, Mr. Chairman, and to all of the
witnesses who are testifying before us today.
First, I just want to point out in reference to my
colleague from Alabama's questions about State versus Federal
oversight, my colleague from California did point out some of
the failures at the State level relative to AIG. I would like
to add to that McKenzie & Company found that State regulation
creates an added cost of over $13 billion in inefficiency to
the industry, which does get passed on to the consumers.
Also relative to banking oversight that came up as part of
his questions to the panel, two-thirds of the subprime loans
that were originated came from nonbanking, State-regulated loan
originators. So, that clearly had a lot to do with the overall
financial crisis.
But moving forward, I have a question for the NAIC. As you
know, the National Insurance Office Act was included in the
Obama Administration's June proposal for regulatory reform. The
Treasury proposal further called for modernization of our
insurance regulatory structure, stressing the need for
``increased national uniformity through either a Federal
charter or effective action by the States.'' The Treasury also
recognized the failures of the State-based system, stating,
``Our current insurance regulatory system is highly fragmented,
inconsistent and inefficient.''
My question to you is, since June, what actions have the
State commissioners and the NAIC taken to create a uniform
system of insurance regulation?
Ms. Vaughan. Thank you very much, Congresswoman Bean.
First of all, let me say that I have to respectfully
disagree with Treasury's statement that the structure is highly
fragmented, inconsistent, and inefficient. In fact, we have a
highly coordinated system, and we work very hard through the
NAIC to be coordinated. And I think history demonstrates that
we have been coordinated and have done a pretty good job,
certainly in the environment we are in.
We do recognize that there are things--
Ms. Bean. Specifically what have you done?
Ms. Vaughan. Specifically what we have done, in September
we adopted, we came up with a new proposal for modernizing our
reinsurance regulatory structure. That is something that--
Ms. Bean. So a proposal. Anything else?
Ms. Vaughan. Boy, I would have to go back and look at all
of the various things. We work constantly, and I would be happy
to answer your question in more detail in writing.
Ms. Bean. Okay.
Ms. Vaughan. After I have a chance to--
Ms. Bean. And what authority does the NAIC or any State
commissioners have to enforce, number one, the collection of
information from non-insurance affiliates like an AIG, or to
enforce any kind of commitments out of a proposal towards
consistency in rules?
Ms. Vaughan. What authority does the NAIC have, or does the
State have?
Ms. Bean. Or does any individual State commissioner have to
actually make sure that: number one, collection of information
happens; or, number two, that there is commitment to consistent
rules that States will follow through?
Ms. Vaughan. Yes. We have laws in the States that call for
companies to report information to the NAIC, so we collect that
information and that is grounded in State law.
Ms. Bean. So some States?
Ms. Vaughan. Normally, all States require that the
companies file. That is one of our accreditation requirements,
that companies file their financial information with the NAIC,
and that is what creates our financial database.
Second, the interpretation and enforcement of laws in the
States are the responsibility of the State insurance
regulators.
So I am not sure that I understand the question exactly.
Ms. Bean. Okay, let me move on to some other questions with
some other folks.
We just heard the NAIC say they have a proposal to create
further coordination. I guess I would ask Mr. Herchel and Mr.
Atkinson, do you believe or should anyone here have any
confidence that after 140 years of efforts by the NAIC to
create uniform rules and their failure to actually have that
happen, that a new proposal was going to change that?
Mr. Herchel. Congresswoman, I have been working in the
insurance arena for decades now, and I have been working with
the NAIC, and I have a lot of respect for the insurance
regulatory community. They are very dedicated and work very
hard.
But what we found is that there are constraints on how far
they can go. The NAIC is a great organization, puts together
great proposals and model laws and model regulations.
Ms. Bean. To shorten up your answer so I can get to other
questions, you don't have a lot of confidence that anything is
going to be any different than it has for 140 years?
Mr. Herchel. I hope we move on, but it is going to be a
tough road for them.
Ms. Bean. Mr. Atkinson?
Mr. Atkinson. I would add, it is hard. As diligent and
dedicated as the NAIC and its members are, how do you get
unanimous agreement from so many players?
Ms. Bean. From 50 different bodies.
Mr. Atkinson. But we are encouraged that they are trying
hard. In fact, their latest proposal recognizes the need for a
Federal role in international reinsurance matters.
Ms. Bean. I would like to ask Mr. Zielezienski as well?
Mr. Zielezienski. We have said this pretty often, it is not
the fault of the State regulators, but the fact is you have to
navigate 50 different political environments. If the NAIC
produced a perfect model law, you still have to go to the State
legislatures and get it passed, and our experience has been
there is always going to be those inconsistencies, and, again,
it is not their fault. That is just the way it is.
Ms. Bean. Again, you don't have confidence that this is
going to change that. I appreciate that.
I would like to ask Mr. Zielezienski another question,
which is essentially that the Treasury proposal included six
principles of reform for insurance reform. It included, and I
will just summarize: effective systemic risk regulation; strong
capital standards that specifically matched capital allocation
with liabilities; meaningful and consistent consumer
protections for insurance products and practices; increased
national uniformity, which we just spoke about; to improve and
broaden regulation of insurance companies and their affiliates;
and international coordination.
Specifically, you have already said that we don't have
confidence that what we are doing today addresses the national
uniformity issue. Does it provide meaningful and consistent
consumer protection for insurance products and practices
nationally?
Mr. Zielezienski. I think ``meaningful'' is subject to
interpretation. But consistent, I think the answer is no. One
of the frustrations for companies is that you have to deal with
requirements that may differ and different definitions of
consumer protection. Some may view different aspects of
regulation as providing consumer protection, when actually they
are inhibiting solvency regulation.
Ms. Bean. If I could ask another question, do you believe
the National Insurance Office can potentially monitor systemic
risk within the insurance industry without a seat on the
Financial Services Oversight Council?
Mr. Zielezienski. No.
Ms. Bean. Given the significance of the insurance industry
in our financial system, do you think this office would be
better served by an individual that is appointed by the
President and confirmed by the Senate to serve a set term in
office, compared to serving more or less as a subordinate to
the Treasury Secretary?
Mr. Zielezienski. Yes, I have testified to that, that I
believe the person ought to be viewed as much as an equal,
absent the regulatory responsibilities that the discussion
draft doesn't provide.
Ms. Bean. Thank you. I yield back.
Mr. Kanjorski. The gentlelady from Illinois, Mrs. Biggert.
Mrs. Biggert. Thank you, Mr. Chairman.
I do have some concerns with the discussion draft that was
circulated late last Thursday. Obviously, it has been mentioned
that it is almost identical to the Administration's proposal,
except the subpoena power has been removed. I am afraid that
the new draft moves away from what I thought was really a great
bipartisan bill that I worked on with you, Mr. Chairman. So, I
just have a few questions and a few comments.
The new discussion draft requires that insurers provide
that the new Federal Insurance Office with any information that
it requests, and our bill sets up an Office of Insurance
Information that made providing information beyond what is
already provided to the State regulator voluntary. So there is
a mandate versus voluntary.
Then I really worry about the mandatory requirement
unfairly imposing significant costs and burdens, particularly
on the smaller and medium-sized insurers.
Also, the draft could allow agreements entered into the
USTR, and this concerns me that the head of the Federal
Insurance Office would be able to preempt State law. We have
already had agreements under GATT and worked with the WTO, and
insurance was included in some of these agreements and there
has been a carve-out of domestic laws to protect the consumer
and the policyholder. The Treasury has an international office
now that is already engaging in talks with trading partners,
aimed at beefing-up the insurance part at the market, informed
markets. Some have been informal, like the U.S.-China Joint
Commission. Others are a little more formal.
My question would be, I believe there are existing trading
agreements, both bilateral and multilateral, that involve
insurance. Am I correct in that? Does anyone say no to that?
Well, then, would this new office require States to comply
with these agreements and could States opt out? Anybody willing
to take a shot at that? Mr. Atkinson?
Mr. Atkinson. Where we are today, the U.S. Government can
negotiate, but they can't follow through on any agreement
because they have no power. There is no credibility for a U.S.
negotiator where we are today. The EEU knows that no matter
what the United States says, the States control the outcome. So
there is no way to implement it.
Ms. Abraham. One of the issues, I agree with your statement
that there is potential for preemption. I did mention earlier
the need for due process to hear that. One issue I was
specifically concerned about, Representative Biggert, is the
collateralization issue. We are quite concerned about that,
because this allows particularly small to medium-size insurance
companies to be able to be confident that when they have claims
to pay, when they have a judgment, that the collateral be
there, the payment will be there from the reinsurance companies
that are not U.S. reinsurance companies. These are foreign or
non-domestic reinsurance companies.
We would be very concerned that there would be a preemption
of the State collateral rules, and that particularly small-to-
medium companies would be left disadvantaged, unable to collect
on the collateral if that would go away.
So it is a concern we have, and one we appreciate your
attention to.
Mrs. Biggert. Okay. Because it could erode consumer
protections and decrease competition and really harm U.S.
insurers or the reinsurers or raise the cost of insurance for
consumers. Let me go on to one other thing I wanted to get to,
and my time is running out.
If you could just give me one or two or two or three issues
that are different in this draft versus the Office of Insurance
Information that you have concerns about. I will start down
here.
Mr. Zielezienski. I will highlight one which I think we can
all agree on, and that is to the extent there is an information
collection function by the office, that it needs to ensure that
data is gathered from existing sources. I think we can all
agree that the best thing to do is create an efficient system
of collecting that information, and protecting that information
is also key as well. I think my concern is that should be a
little bit tighter.
Mrs. Biggert. Ms. Vaughan?
Ms. Vaughan. Yes. First, the language that would limit the
scope of international agreements to those that are
substantially equivalent to regulation in the States, we think
that is very important; second, the possible stay of
preemption; And, third, the two-way information sharing,
including sharing information through the NAIC.
Mrs. Biggert. Mr. Houldin?
Mr. Houldin. Two things. One, the definition of
``insurer,'' not to include everybody engaged in insurance,
including Main Street agents. Secondly, just the overstep of
their regulatory and supervisory authority that it gives the
office.
Mrs. Biggert. Thank you.
Mr. Herchel. A couple of things that we want to make sure
are part of this process is making sure that the Federal
Insurance Office is a member of the council, and the other
thing is to make sure that they are on parity with other
Federal regulators with respect to consulting and coordinating
with the systemic risk regulator.
Mrs. Biggert. So that would be either the FOI or the OII?
Mr. Herchel. The FOI.
Mr. Atkinson. I think the current proposal also works
pretty well for the reinsurance market. As part of that, I
think we do want to be at the table talking about collateral
requirements, talking about capital requirements, talking about
reserving requirements, all of the factors that enter into
solvency. But I would just like to emphasize, the ability to
preempt State laws when needed is absolutely necessary because
you cannot negotiate in good faith unless you can actually
follow through.
Mrs. Biggert. Ms. Abraham?
Ms. Abraham. Retrieving information from established
sources, from the existing State regulators or other public
sources; voluntary submission of information, not mandatory;
and a very distinct carve out for small insurance companies are
things that are very important to us.
Mrs. Biggert. Thank you.
Thank you, Mr. Chairman. I yield back.
Mr. Kanjorski. Thank you very much.
I see no other questions are pending or members present. So
that being the fact, I am going to thank the panel for having
been here and call to the panel's attention that some members
may have additional questions for this panel which they may
wish to submit in writing.
Without objection, the record will remain open for 30 days
for members to submit written questions to today's participants
and to place their responses in the record.
Before we adjourn, the following written statements will be
made part of the record of this meeting: The National
Association of Mutual Insurance Companies; the National
Association of Insurance and Financial Advisers; the Financial
Services Institute; and the National Association of Small
Business Investment Companies. Without objection, it is so
ordered.
The panel is dismissed and this meeting is adjourned.
[Whereupon, at 3:32 p.m., the hearing was adjourned.]
A P P E N D I X
October 6, 2009
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