[Senate Hearing 111-175]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-175
 
       STRENGTHENING THE SEC'S VITAL ENFORCEMENT RESPONSIBILITIES

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

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

EXAMINING THE IMPORTANT ROLE OF THE SECURITIES AND EXCHANGE COMMISSION 
 IN PROTECTING INVESTORS BY AGGRESSIVELY ENFORCING FEDERAL SECURITIES 
                                  LAWS

                               __________

                              MAY 7, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html





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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                   JACK REED, Rhode Island, Chairman

            JIM BUNNING, Kentucky, Ranking Republican Member

TIM JOHNSON, South Dakota            MEL MARTINEZ, Florida
CHARLES E. SCHUMER, New York         ROBERT F. BENNETT, Utah
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          DAVID VITTER, Louisiana
DANIEL K. AKAKA, Hawaii              MIKE JOHANNS, Nebraska
SHERROD BROWN, Ohio                  BOB CORKER, Tennessee
MARK R. WARNER, Virginia
MICHAEL F. BENNET, Colorado
CHRISTOPHER J. DODD, Connecticut

                Kara Stein, Subcommittee Staff Director

       William Henderson, Republican Subcommittee Staff Director

                      Randy Fasnacht, GAO Detailee

                                  (ii)



                            C O N T E N T S

                              ----------                              

                         THURSDAY, MAY 7, 2009

                                                                   Page

Opening statement of Senator Reed................................     1

Opening statements, comments, or prepared statements of:
    Senator Bunning..............................................     2
    Senator Dodd
        Prepared statement.......................................    27

                               WITNESSES

Richard J. Hillman, Managing Director, Financial Markets and 
  Community Investment, Government Accountability Office.........     4
    Prepared statement...........................................    28
    Response to written questions of:
        Senator Reed.............................................    61
Robert Khuzami, Director, Division of Enforcement, Securities and 
  Exchange Commission............................................     6
    Prepared statement...........................................    42
    Response to written questions of:
        Senator Bunning..........................................    62
        Senator Schumer..........................................    64
Mercer E. Bullard, Associate Professor of Law, The University of 
  Mississippi School of Law......................................     8
    Prepared statement...........................................    51
    Response to written questions of:
        Senator Reed.............................................    68
Bruce Hiler, Partner and Head of Securities Enforcement Group, 
  Cadwalader, Wickersham & Taft LLP..............................    10
    Prepared statement...........................................    58
    Response to written questions of:
        Senator Dodd.............................................    76

              Additional Material Supplied for the Record

Statement of Colleen M. Kelley, National President, National 
  Treasury
  Employees Union................................................    84

                                 (iii)


       STRENGTHENING THE SEC'S VITAL ENFORCEMENT RESPONSIBILITIES

                              ----------                              


                         THURSDAY, MAY 7, 2009

                                       U.S. Senate,
     Subcommittee on Securities, Insurance, and Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 2:34 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Jack Reed (Chairman of the 
Subcommittee) presiding.

             OPENING STATEMENT OF SENATOR JACK REED

    Senator Reed. Let me call the hearing to order.
    I want to thank you all for coming today, and particularly 
thank the witnesses and thank my colleague, Senator Bunning.
    Today's hearing examines the important role of the 
Securities and Exchange Commission in protecting investors by 
aggressively enforcing Federal securities laws.
    It is no secret that the Securities and Exchange Commission 
finds themselves in a challenging time, facing severe 
criticism--some fair, some not--for failing to prevent the 
subprime meltdown and subsequent financial crisis and, more 
recently, from its failure to detect and prevent the estimated 
$60 million Bernard Madoff Ponzi scheme. When the SEC falls 
behind on its responsibilities, these effects are seen not just 
on Wall Street but on Main Street throughout this country.
    For instance, a philanthropic foundation that donated over 
$24 million last year to nonprofits around the country, 
including $350,000 in my own home State, closed its doors in 
January because the foundation's donors funds were being 
managed by Mr. Madoff.
    As the SEC tries to restore its aggressive watchdog 
capacities, we are grateful that GAO joins us today to share 
the results of a study Senator Dodd and I requested back in 
March of last year that provides key in-depth information to 
help us consider improvements to the Securities and Exchange 
Commission. GAO's review of the SEC's enforcement division, 
which included in-depth focus group interviews with staff 
throughout the division, found that in recent years significant 
resource challenges and internal policy changes undermined the 
Agency's ability to bring enforcement actions and these 
problems occurred at the very time the SEC needed to be more 
aggressive than ever at overseeing our securities markets.
    I just want to highlight a few of the more significant 
findings in the GAO report. The SEC managers and attorneys 
throughout the Agency agreed that two corporate penalty 
policies put in place in 2006 and 2007 had the effect of 
delaying cases and producing fewer, smaller penalties, with 
penalties declining at an accelerating rate, falling 39 percent 
in 2006, 48 percent in 2007, and 49 percent in 2008.
    Staff also felt that the SEC had retreated--in their 
words--on penalties and made it more difficult for 
investigative staff to obtain formal orders of investigation 
which allow issuance of subpoenas for testimony and records. 
Formal orders decreased 14 percent since 2005.
    In addition, a burdensome system for internal case review 
has slowed cases and created a risk-averse culture.
    Finally, resources challenges have delayed cases, reduced 
the number of cases that can be brought, and potentially 
undermined the quality of some cases. Adjusted for inflation, 
the Division of Enforcement's fiscal year 2008 budget amount is 
down 8.2 percent from the fiscal year 2005 peak. Total 
enforcement staffing has declined 4.4 percent, and the number 
of front-line investigative attorneys declined 11.5 percent 
from 2004 to 2008.
    I am, however, encouraged by the SEC's steps to address 
some of these problems, most notably to change policies to 
``take the handcuffs off of enforcement staff,'' as Chairman 
Schapiro has described it. I hope today to hear what additional 
improvements the SEC is considering.
    It is clear to me that, although you can't address all of 
the SEC's challenges just by giving them new resources, GAO's 
report confirms what many of us have known for a while: the SEC 
needs more resources to effectively meet its mission of 
policing large and complex securities markets.
    Last week, I sent a letter to the Appropriations Committee, 
cosigned by 12 of my Senate colleagues, requesting an increase 
in funding for the SEC to hire more examiners and enforcement 
attorneys and invest in technology that will help get the 
Agency on the same playing field as the institutions that it 
oversees.
    I will continue to work with my colleagues to provide these 
resources and the oversight that is critical to the success of 
the Agency.
    At this time, I would like to call on the Ranking Member, 
my colleague, Senator Bunning.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman.
    I appreciate our witnesses coming out this afternoon to 
talk about the report being issued by the GAO and about 
enforcement matters in general. I think the report provides 
some useful information, such as recommendations to review and 
revise the structure and policies of the Office of Collections 
and Distributions.
    The report also adds to what we already know, there are 
real problems at the SEC. Some of those problems may be in the 
budget and resources of the Agency, but I think the much larger 
and more significant problems are in the structure and policies 
of the Agency. For example, there are too many layers in the 
chain of command. I am also concerned that the tension between 
the staff of various divisions and the Commission itself not 
only reduces the overall effectiveness of the Agency, but also 
leads each to undermine the other.
    I do think the new SEC Chairman has taken some positive 
steps, since she moved to the Commission, and her quick action 
on the recommendations of this report shows that she is willing 
to attempt to fix problems at the Agency.
    However, we should not kid ourselves that all of the Agency 
problems will be fixed by new management. After all, the last 
agency the new Chairman was in charge of did not do anything to 
stop the Bernie Madoff fraud, as my Chairman has also brought 
out.
    I also do not think just adding to the SEC's budget will 
fix all the problems. Every time this or any agency fails in 
their mission, they always claim they need more resources. In 
fact, that is what we heard after WorldCom and Enron. Yet, even 
after new laws and more staffing and funding, Madoff, Stanford, 
auction rate securities, and the whole subprime scandal, just 
to name a few, still happened under the nose of the SEC.
    I think the new management should focus on spending its 
resources more effectively rather than just increasing its 
budget. For example, as the GAO report points out, it may make 
more sense to hire administrative and support staff to help the 
investigators rather than just adding to the numbers of 
attorneys. The Agency should also be looking at hiring experts 
in the field like accounting and computers, as well as those 
who have experience in our ordered, complicated markets to 
support existing investigations rather than hiring new 
investigators.
    If the Agency truly needs more resources to accomplish 
this, Congress should consider the request, but that request 
should first explain how they will use their resources more 
effectively. One good place to start is with a flatter chain of 
reporting.
    I look forward to hearing from our witnesses and look 
forward to more hearings in the future to look into the 
problems at the SEC and how we can address them.
    Thank you.
    Senator Reed. Thank you very much, Senator Bunning.
    Let me now introduce our panel. Our first witness will be 
Mr. Richard Hillman, the Managing Director of the Financial 
Markets and Community Investment Group at the Government 
Accountability Office. Mr. Hillman has served over 30 years 
with the GAO and has recently overseen reviews of TARP, 
regulatory modernization, hedge funds, private equity funds, 
BASEL II capital standards, and sovereign wealth funds. 
Welcome, Mr. Hillman.
    Our second witness will be Mr. Robert Khuzami, the Director 
of the Division of Enforcement at the Securities and Exchange 
Commission. Before joining the Securities and Exchange 
Commission, Mr. Khuzami was a Federal prosecutor for 11 years 
with the United States Attorney's Office for the Southern 
District of New York and more recently as the General Counsel 
for the Americas at Deutsche Bank.
    Our third witness today will be Professor Mercer Bullard, 
Associate Professor of Law at the University of Mississippi 
School of Law where he teaches courses in securities, banking, 
and corporate law. He previously practiced in the SEC 
Enforcement and Investment Management Offices of WilmerHale and 
was an Assistant Chief Counsel in the SEC's Division of 
Investment Management. He is also the Founder and President of 
Fund Democracy, a mutual fund shareholder advocacy group.
    Our fourth witness is Mr. Bruce Hiler, Partner and Head of 
the Securities Enforcement Group at Cadwalader, Wickersham & 
Taft LLP. His practice focuses on securities enforcement and 
regulatory defense, corporate and regulatory counseling, 
internal investigations, and securities litigation.
    Thank you, gentleman, for joining us today. We will begin 
with Mr. Hillman.

 STATEMENT OF RICHARD J. HILLMAN, MANAGING DIRECTOR, FINANCIAL 
               MARKETS AND COMMUNITY INVESTMENT,
                GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Hillman. Chairman Reed, Members of the Subcommittee, I 
am pleased to be here today to discuss the results of our 
recent study of the Securities and Exchange Commission's 
Division of Enforcement.
    While the Division plays a key role in helping the Agency 
meet its mission by protecting investors and maintaining fair 
and orderly markets, in recent years questions have been raised 
about the capacity of the Division to manage its resources and 
fulfill its law enforcement responsibilities.
    My prepared statement discusses the results of our recent 
study and the major recommendations we made to help ensure that 
the SEC is effectively and efficiently using its resources in 
bringing enforcement actions. I would like to focus my opening 
remarks on two important areas: the first related to the extent 
to which the Enforcement Division has an appropriate mix of 
resources; and the second on recent trends and penalties and 
disgorgement ordered and the effects of adoption and 
implementation of recent penalty policies.
    Overall, enforcement resources and activities have been 
relatively level recently but the number of nonsupervisory 
investigative attorneys decreased 11.5 percent during fiscal 
years 2004 through 2008. Enforcement management told us that 
resource levels had not prevented the Division from continuing 
to bring cases across a range of violations but both management 
and staff said resource challenges had delayed cases, reduced 
the number of cases that could be brought, and potentially 
undermined the quality of some cases. Specifically, 
investigative attorneys cited the low level of administrative, 
paralegal and information technology support, and 
unavailability of specialized services and expertise.
    Also, enforcement staff said a burdensome system of 
internal review had slowed cases and that there was a culture 
of risk aversion.
    During our review, enforcement management had begun to 
examine how to streamline the case review, but their focus was 
more process oriented and did not give consideration to 
assessing organizational culture issues. To address these 
issues, we recommended that the Chairman further evaluate the 
level and mix of resources dedicated to the Enforcement 
Division and assess the impact that the Division's current 
review and approval process where investigative staff work has 
on organizational culture and the ability to bring timely 
enforcement actions.
    Regarding our work on penalties and disgorgements, we 
reported that the total penalty and disgorgements amounts can 
vary on an annual basis based upon the mix of cases concluded 
in any particular period. However, overall penalties and 
disgorgements ordered had declined significantly since the 
2005-2006 period. Specifically, total annual penalties fell 84 
percent from a peak of $1.6 billion in fiscal year 2005 to $256 
million in fiscal year 2008. Disgorgements similarly fell 68 
percent from a peak of $2.4 billion in fiscal years 2006 to 
$774 million in fiscal year 2008.
    While a number of factors can affect the amount of penalty 
or disgorgements that enforcement staff seek in any individual 
enforcement action, enforcement management, investigative 
attorneys, and others agreed that two recent corporate penalty 
policies had a significant impact. In 2006, the Commission 
adopted a policy that focused heavily on two factors for 
determining corporate penalties: the economic benefit derived 
from wrongdoing; and the effect a penalty might have on 
shareholders.
    Further, in 2007, the Commission adopted a policy--now 
discontinued--that required Commission approval of penalty 
ranges before settlement discussions. On their face, the 
penalty policies are neutral in that they neither encourage nor 
discourage corporate penalties. However, enforcement management 
and many investigative attorneys and others agreed that the two 
corporate penalty policies, as implemented, delayed cases and 
produced fewer and smaller penalties.
    Further, the Commission's handling of cases under the 
policies transmitted a message that the corporate penalties 
were highly disfavored.
    We identified other concerns, including the outward 
perception by some that the SEC had retreated on penalties, 
which made it more difficult for investigative staff to obtain 
formal orders of investigation which allows for the issuance of 
subpoenas for testimony and records.
    Our review also showed that in adopting and implementing 
the penalty policies, the Commission did not act in concert 
with Agency strategic goals calling for broad communication 
with and involvement of the staff, in particular within the 
Enforcement Division, who had limited input into the policies 
that they were responsible for implementing. As a result, 
enforcement attorneys reported frustration and uncertainty in 
applying the penalty policies.
    To begin to address these issues, we recommended that the 
Chairman determine if the 2006 corporate penalty policy was 
achieving its stated goals and any other effects that the 
policy may have in adoption and implementation.
    We also recommended that the Chairman take steps to ensure 
that the Commission, in creating, monitoring, and evaluating 
policies, adheres to its strategic goals and follows other best 
practices for communication with, involvement of the staff 
affected by such changes. The SEC Chairman agreed with each of 
these recommendations and was taking steps to implement them.
    Mr. Chairman, this concludes my prepared statement. I would 
be happy to answer any questions at the appropriate time.
    Senator Reed. Thank you very much, Mr. Hillman, not only 
for your statement, but for your very thoughtful and 
professional report, which will aid us immensely. I appreciate 
it.
    Before I move on, let me say something I should have said 
initially. Am I pronouncing your name correctly, sir?
    Mr. Khuzami. Absolutely right.
    Senator Reed. So it is Khuzami?
    Mr. Khuzami. Correct.
    Senator Reed. Well, given my Rhode Island accent, that is 
amazing. So Mr. Khuzami, would you please give your testimony.

STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT, 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Khuzami. Thank you. Thank you, Chairman Reed, Ranking 
Member Bunning, Members of the Subcommittee. Thank you for 
inviting me to testify on behalf of the Securities and Exchange 
Commission.
    I would also like to thank the GAO and its team for its 
report. I concur completely with their recommendations.
    The Division of Enforcement is the public face of the SEC, 
in many ways. Our lawsuits and legal proceedings against those 
who lie, cheat, and steal in our securities markets give the 
investing public comfort that their interests are being 
protected. We have a long and proud history of aggressively 
pursuing wrongdoers and thus helping to maintain the integrity 
of our markets.
    Now to echo the comments by Chairman Reed and Ranking 
Member Bunning in the beginning of this hearing, it is true 
that many have questioned our effectiveness in light of the 
revelations surrounding Bernard Madoff and his egregious 
misconduct. Let me be very clear, we failed in this instance in 
our mission to protect investors. Whatever explanations 
eventually surface, be they human failure, organizational 
shortcomings, or shortcomings in process, or all three, there 
are no excuses. And not a day goes by that we in the 
Enforcement Division do not regret the consequences.
    But faced with this, we have done what any responsible 
public agency should do. We have used this episode as a wake up 
call to undertake a rigorous self-assessment of how we do our 
job. As our Chairman, Mary Schapiro has said, reinvigorating 
the Enforcement Division is a top priority for the Commission.
    I am highly confident that we will succeed in this 
assessment. As a former Federal prosecutor, defense attorney 
and most recently as an in-house general counsel with a 
financial institution, I have seen the SEC from many different 
angles. But from whatever angle, I always saw integrity, 
excellence, dedication, and a passion for investor protection. 
Five weeks into the job, I can assure you and the public that 
these traits are alive and well at the SEC.
    You have asked me to address the issues of changes we are 
making, resource needs, and steps Congress should consider 
taking to assist us in helping us achieve our mission.
    With respect to changes, even before I arrived, the 
Commission began to initiate changes consistent with GAO's 
recommendations. First and foremost, with respect to the 
abolition of the penalty pilot program. That effort continues 
uninterrupted. On my first day on the job, I asked the staff to 
embrace four principles. We need to be strategic, swift, smart, 
and successful.
    To meet those goals, our self-assessment is considering the 
following: first, to reorganize the division into specialized 
groups focused on particular markets, products, entities, and 
transactions in order to build expertise to permit us to 
conduct investigations faster, more thoroughly, and with 
increased understanding in order to enable us to better spot 
patterns, trends, and motives.
    Two, to adopt a more efficient management structure that 
streamlines our processes and frees up experienced managers to 
focus on making cases and investigating fraud.
    Three, to adopt new metrics that are less about measuring 
our performance by the number of cases we file and more about 
the quality, timeliness, and deterrent impact of what we do.
    Four, to revamp our system for handling tips and complaints 
to better gather, risk analyze, and triage that information.
    And last, to expand our program to award cooperating 
witnesses who provide valuable information about wrongdoers.
    Now this self-assessment has not come at the expense of our 
ongoing investigations. In the past 2 weeks alone we have 
brought cases against those involved in the credit default swap 
markets, subprime mortgages, Ponzi schemes, and money market 
funds. And you can expect to see more of those.
    Now even with these changes, which we believe will make us 
more efficient, the fact remains that we have suffered from 
flatter, declining budgets in recent years, while at the same 
time the products, the markets, the transactions, and the 
schemes that we are duty bound to investigate become 
increasingly complex. The 7 percent increase included in the 
President's budget, released today, recognizes this fact. But 
even with that, the SEC will have significantly fewer resources 
than it had 4 years ago.
    And I am prepared to lead the Division under the current 
measures, but I would welcome additional resources. We 
sincerely appreciate the support of Chairman Reed and many 
others on this panel, who have been strong advocates on this 
front, most recently by advocating for additional 
appropriations in fiscal years 2010 and 2011.
    I also thank Senators Schumer, Dodd, and Shelby for their 
recent successful amendment to authorize additional enforcement 
funds. If we were to get those funds, we would use them in the 
following ways: first, as mentioned previously, administrative 
and paralegal support for our investigations and trials. Too 
much time is spent by lawyers and investigators on tasks more 
efficiently handled by others. On new information technology 
and databases to collect and analyze our documents. More 
lawyers in our trial unit to litigate cases. We need to have a 
strong courtroom capability to secure favorable settlements or 
win in court.
    Last, I believe there may be some legislative changes that 
could clarify our authority so that we can better enforce the 
laws. This includes legislation to broaden our jurisdiction 
over hedge funds, securities based swaps agreements, and to 
expand our whistleblower program.
    I am confident that through this self-assessment we will 
emerge stronger, bolder, and more effective in our mission. The 
source of my confidence is the men and women of the Division of 
Enforcement, since what has not changed at the Division is what 
they offer, an abundance of talent, core values of 
professionalism and fairness, and a total commitment to 
mission.
    I would like to thank you again for inviting me today and 
the opportunity to appear before you and I look forward to 
answering your questions.
    Senator Reed. Thank you very much.
    Professor Bullard.

           STATEMENT OF MERCER E. BULLARD, ASSOCIATE
 PROFESSOR OF LAW, THE UNIVERSITY OF MISSISSIPPI SCHOOL OF LAW

    Mr. Bullard. Chairman Reed, Ranking Member Bunning, Members 
of the Subcommittee, thanks very much for the invitation to 
appear before you today to discuss the SEC's enforcement 
program. It is an honor and a privilege to appear before the 
Subcommittee today.
    The GAO report that was released yesterday provides strong 
evidentiary support for what many of us have suspected for 
quite some time. The SEC's Enforcement Division's effectiveness 
has been compromised, both by a lack of resources and by poor 
leadership by the Commission itself.
    The appointment of Mary Schapiro as Chairman is a strong 
step toward solving the problem of leadership at the 
Commission. Throughout her career, Chairman Schapiro has 
demonstrated a solid commitment to a vigorous and effective 
enforcement program. In her very short tenure, she has already 
taken decisive steps to end some of the practices that have 
hindered the Commission's enforcement program in recent years.
    The problem of inadequate resources, however, remains 
unsolved. The Commission does not have the funds to provide the 
level of enforcement necessary to protect investors and promote 
efficient capital markets. I strongly recommend the Congress 
substantially increase the SEC's appropriation to enable 
Chairman Schapiro and the SEC's enforcement staff to do the job 
that they are better at than anyone else.
    This is not just a matter of adequate enforcement. It is 
also a matter of justice for investigated entities. Inadequate 
resources often have the effect of unfairly increasing burdens 
on parties defending SEC investigations.
    The importance of the SEC's enforcement program cannot be 
underestimated. The Commission is the leading voice for the 
enforcement of securities laws and the development of free 
capital markets, not only in the United States but worldwide. 
When the Commission speaks, it makes uniform law across all 50 
States that private actors can rely on to guide their business 
practices. When the Commission remains silent, the void is 
filled with the noise of dozens of regulators and courts and 
private actions creating a patchwork of rules. It is incumbent 
on the Commission to provide the coherence and uniformity in 
the securities laws that only it can provide. And it is 
incumbent on Congress to provide the Commission with the 
resources it needs to do so.
    In addition, the GAO report has highlighted certain 
problems that are internal to the Commission. First, the report 
shows that part of the SEC's resource problem may actually be 
an allocation problem. When there is inadequate administrative 
personnel or accountants or technology to support the lawyers 
working on a case, the solution may be to spend less money on 
the lawyers and more on the areas that are creating the 
resource imbalance.
    Second, the report confirms the SEC's internal review 
process and multilayered staffing hinders its effectiveness. 
The SEC should eliminate one or more supervisory layers and 
streamline its review process.
    Third, the SEC should not shy away from bringing cases 
involving industry-wide misconduct, but it does not need to 
bring every case. When industry-wide misconduct does not 
constitute a clear violation of securities laws however, no 
enforcement action should be brought. Instead, the SEC should 
clarify the law and conduct rule making as appropriate.
    The most distressing aspect of the GAO report is the 
substantial evidence that individual Commissioners were 
permitted to effectively subvert the SEC's enforcement program. 
These Commissioners may have been motivated by genuine 
ideological differences with SEC policies, but their approach, 
coupled with a well-meaning desire for consensus, materially 
damaged staff morale and the SEC's authority and undermined the 
SEC's enforcement program.
    Chairman Schapiro has indicated that she will not sacrifice 
the Agency's mission at the altar of consensus. I hope that 
future four-to-one and three-to-two votes on enforcement and 
regulatory matters will not be interpreted as a failure to 
fully consider all viewpoints on the Commission.
    I also hope the Commissioners who find themselves in the 
minority will not feel it necessary to undermine the 
Commission's authority by publicly attacking its positions even 
after they have been given a full and fair internal hearing.
    In conclusion, I would like to make a general observation 
that may relate to the friction that the GAO has identified 
between individual Commissioners and the staff. There is an 
illusion among some well-meaning proponents of free markets 
that when the SEC refrains from action, whether it be 
enforcement action or regulatory action, free markets are 
allowed to operate with greater freedom. This is not the case. 
When the SEC refrains from action, the result is often to 
impede the operation of free markets. SEC inaction creates a 
void that is filled by dozens of other private and public 
actors, all following their own conception of the meaning of 
the securities laws.
    Like many securities lawyers, I began my career reviewing 
documents pursuant to a request from the SEC's Enforcement 
Division and from a State Securities Administrator and from a 
U.S. Attorney and from 22 private litigants. There are many 
sources of law that are waiting to step in when the SEC 
abdicates its responsibilities.
    The only free market that is invigorated by SEC inaction is 
the free market for competing sources of regulatory authority, 
which for financial services firms means regulatory chaos. The 
SEC alone has the authority to establish uniform regulatory 
policy and avoid the inefficiencies of legal uncertainty.
    I hope that the proponents of free markets, among which I 
include myself, will keep this in mind.
    Thank you, and I would be pleased to answer any questions 
you may have.
    Senator Reed. Thank you very much.
    Mr. Hiler, and again, I am pronouncing your name correctly, 
I hope.
    Mr. Hiler. Absolutely.
    Senator Reed. Thank you, Mr. Hiler.

         STATEMENT OF BRUCE HILER, PARTNER AND HEAD OF
SECURITIES ENFORCEMENT GROUP, CADWALADER, WICKERSHAM & TAFT LLP

    Mr. Hiler. Thank you, Chairman Reed, Ranking Member 
Bunning, and Members of the Subcommittee.
    I am pleased to have the opportunity today to testify 
concerning the responsibilities of the Securities and Exchange 
Commission in policing our financial markets and protecting 
investors.
    I formerly served as an attorney in the Division of 
Enforcement, and as an Associate Director. I left the 
Commission in 1994 and since have represented clients in SEC 
and other governmental investigations, internal investigations, 
and securities litigation.
    Although recently the Commission has come under fire for 
reported lapses in detecting the activities of some individuals 
in the marketplace, the Commission has long been viewed as a 
premier regulatory and enforcement agency. If there have been 
lapses, I am confident that the Commission will evaluate those 
situations and develop new policies and procedures to avoid 
them in the future.
    In this regard, I think it's important to understand the 
effects that the vagaries of funding and resource allocation, 
the exponential expansion both of market activity and of 
sophisticated instruments and investment strategies, and the 
day-to-day pressure of operating in the glare of public 
scrutiny can have on any organization.
    With that said, there still are a number of areas I believe 
the Commission's enforcement efforts could or should be 
modified or improved on. There are three areas which I would 
like to discuss today.
    First, I believe that the efficient and speedy resolution 
of SEC investigations is important both for effective 
protection, investor protection, and enforcement efforts as 
well as for ensuring fairness and justice to the subjects of 
the investigations. In my view, these goals could be enhanced 
by having fewer layers of management between those working day-
to-day on investigations and those who ultimately must 
recommend to the Division Director whether an investigation 
should be moved forward or closed.
    Currently, in the Commission's D.C. headquarters, the 
Division has five Associate Directors indirectly supervising 
hundreds of attorneys and cases. The Associate Directors 
typically are among the most experienced professionals in the 
Division and they are looked upon internally as having the 
judgment and expertise to make appropriate case 
recommendations.
    Yet, these are also the individuals who have the least 
amount of time to be involved in the day-to-day decision making 
and the day-to-day review of facts on any particular matter as 
those facts are being discovered and analyzed. I believe there 
should be fewer layers between the Associate Directors and 
those directly working on investigations. This does not mean 
necessarily fewer management slots. Rather, I believe the 
number of senior experienced officials in the Enforcement 
Division should be dramatically increased.
    These managers should be charged with direct involvement in 
the day-to-day activities of the matters under their 
supervision and such matters should be kept to a reasonable 
caseload so that they can become familiar with the key facts 
and issues as they develop, not only at the recommendation 
stage.
    Second, efficiency must not be achieved at the expense of 
fairness or thorough evaluation. SEC investigations can involve 
sophisticated instruments and trading strategies, as well as 
complex issues such as accounting, risk analysis, and economic 
modeling, all of which fall outside the normal expertise of 
attorneys. These investigations do take time.
    But I do believe that the addition of a cadre of experts in 
a variety of fields, such as I mentioned, to assist in 
enforcement inquiries will lead to more efficient and better 
informed decision making.
    Third, I believe that the detection of fraudulent conduct 
is an extremely difficult task and that no one can expect the 
SEC or any agency will be able to anticipate specific frauds at 
specific entities. However, a regulator may be able to get an 
early warning sign of conduct which, though not illegal, on 
close examination the regulator may determine needs additional 
regulation or is not sufficiently understood that it poses 
unknown dangers to the financial system.
    To do so, to get this early warning, I think a regulator 
must reach out to and foster an open line of communication with 
those in charge of compliance and management at the relevant 
entities. It is difficult to maintain open and timely 
communication where the regulator or the regulated views the 
other in an atmosphere of suspicion. I believe that in the last 
decade, increased scrutiny by criminal authorities of 
securities law matters and public pressure on the SEC to hold 
anyone and everyone responsible for the stock market crash of 
1999, for corporate bankruptcies and defalcations, and more 
recently for the current economic turmoil have contributed to 
such an atmosphere.
    I believe that the line between civil and criminal cases 
has been blurred and that there has been a shift to an 
inappropriately low level in what authorities view as conduct 
that demonstrates sufficient scienter or ``state of mind'' to 
make even a civil securities case.
    It is possible for the Commission to adopt substantive 
internal guidelines to ensure it is making consistent, fair, 
and efficient decisions and judgments on the subjective 
judgments that are required to bring an enforcement action. I 
also believe that the Commission should have a major role in 
determining whether cases which predominantly involve Federal 
securities law issues and our capital markets should be pursued 
by criminal authorities. Efforts in these two areas, I think, 
would help promote an atmosphere of communication and openness 
that could assist the Commission in all of its regulatory 
roles.
    I am sure there are other areas that Members of the 
Subcommittee are interested in. I hope that I am able to be of 
assistance to you, and I will be happy to answer any of your 
questions.
    Senator Reed. Well, thank you very much, Mr. Hiler, and 
thank you all, gentlemen, for very fine testimony.
    Let me begin and address a question first to Mr. Khuzami, 
but also to ask everyone to respond. Inherent in the GAO report 
is a recommendation, which Chairman Schapiro has already taken, 
to take the handcuffs off the Enforcement Division. One issue 
is how hard is that to maintain, not just in the next few 
months or years, but going forward? But, second, it raises, I 
think, a more fundamental issue, which is the relationship 
between the appropriate oversight of the Commission and the 
Commissioners and the Enforcement Division. So if you have some 
thoughts about that, Mr. Khuzami, please begin, and I will call 
on your colleagues also.
    Mr. Khuzami. Thank you, Mr. Chairman. From my experience, 
since I have arrived at the Commission, which is approximately 
5 weeks now, I have seen nothing but a great deal of 
interaction, discussion, and shared views between the 
Commissioners, the Chairman, myself, and the staff of the 
Division of Enforcement. To bring it down to practicalities, we 
have been in Chairman Schapiro's office on many occasions to 
discuss cases. The Commissioners have invited me into their 
offices to discuss their views and share them with me. And I 
cannot speak to the environment that existed prior to my 
arrival, but everything I have seen since then indicates that 
any policy matters or judgments are going to be fully informed 
with the views of the enforcement staff.
    Senator Reed. Thank you. The same general question, 
Professor Bullard, about in the long term how do you have a 
balance between the Commission's appropriate role and not 
handcuffing the Enforcement Division and initiative at the 
lower level?
    Mr. Bullard. I think I can really only just echo what the 
Enforcement Director has said, but I think I would add that it 
is important that Chairman Schapiro encourage strongly the 
members of the Commission, regardless of whether there are 
ideological positions that they bring to the table, to work out 
those issues they might have in the Enforcement Division 
internally. And I would encourage the enforcement staff to be 
very aggressive in communicating with those Commissioners, 
keeping them apprised of the development of cases, to try to 
reinvigorate the internal vetting of issues within the 
Commission.
    The Commission has always had a very good practice of a 
healthy, vigorous internal debate. But as soon as that turns 
into what the GAO described as a situation where you had the 
staff cutoff not only from some key decisions but from the 
development of policies that really should have been conceived 
in the staff, then you have a staff that is working against the 
Commission and no longer can really function effectively as an 
agency.
    Senator Reed. Your comments, Mr. Hiler?
    Mr. Hiler. Yes, thank you.
    Senator Reed. Could you activate your microphone?
    Mr. Hiler. Sorry. You know, I think in every organization 
or agency there are going to be different points of view. I 
cannot say that I or my clients have felt that the Division of 
Enforcement staff has been shackled, unfortunately. But I 
wanted to go to one thing in the GAO report in this regard. I 
noted that staff members had talked about other Divisions 
hampering their enforcement activities and having to be--and 
that they did not like other Divisions having to review aspects 
of their cases. And we laugh out here in the private bar when 
people like me say, ``When I was at the Commission,'' but I 
will say it anyway.
    When I was at the Commission, I and my staff in 
Enforcement, when I was a branch chief and assistant director, 
we happily sought out the views of the other Divisions at the 
beginning of our investigation, throughout our investigation, 
and at the end of our investigation. And we did that because 
those Divisions have extreme expertise in the rules and 
regulations that we in Enforcement were trying to interpret, 
apply, and enforce. And so by the end of the investigation, we 
were probably all on the same page, and I don't recall many 
times, although there probably were some, where at the end of 
an investigation where I was trying to make a recommendation I 
felt that another Division was, you know, opposing me to some 
extent. But if they were going to oppose me, I had my view, and 
I felt completely confident that we could express our view to 
the Commission.
    So I think it is just very important that there not be a 
sense of competition in the Commission between Divisions and 
that the Division of Enforcement also should feel free and 
should consult with those other Divisions right at the 
beginning of an investigation.
    Senator Reed. Mr. Hillman, your comment?
    Mr. Hillman. I share many of the comments that have been 
discussed associated with this question. One in particular that 
I believe is very important is that there seemed to be a 
difference of view regarding the Commission's perspectives on 
penalties and that of the Enforcement Division. And in going 
forward, I think it would be very important for the Commission 
and the Division to come up with a shared set of goals and 
ideals for moving forward in the penalty and disgorgement area. 
Once that vision is established, then the Commission should 
seek out regular input from enforcement management and staff on 
policies and procedures in order to implement those goals.
    Senator Reed. Thank you very much.
    I anticipate, since we are fortunate we have three Members 
here, several rounds, but let me now yield to the Ranking 
Member for his round of questioning, and then Senator Johanns, 
and then I have other questions. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Mr.--``Khuzaman''?
    Mr. Khuzami. ``Khuzami.''
    Senator Bunning. ``Khuzami,'' I am sorry. I should pay 
attention. Let me just--on the surface, some of the worst cases 
of fraud have been hiding in plain sight. Plain sight. Madoff, 
Stanford, subprime mortgage practices, and auction rate 
securities. What are you doing differently now so that these 
things in plain sight are observed and treated quickly?
    Mr. Khuzami. Well, Senator, we are taking a number of 
initiatives. I am not sure that in many of the matters that 
have been publicly identified that they are necessarily frauds 
that are in plain sight. Some of them are fairly difficult in 
terms of attempting to investigate them. But no matter, we are 
establishing--for example, we have a series of working groups 
set up nationwide focusing on specific areas of conduct, 
including subprime, hedge funds, auction rate securities, and 
historically, options backdating and other matters so that we 
can gather the necessary expertise and target our energy and 
resources into particular areas.
    In the Ponzi scheme area, which is an area that we have 
focused our efforts on for a long period of time, you know, the 
challenge there, of course, is to make sure that you can find 
credible evidence of the wrongdoing. And, unfortunately, often 
investors are not a good source of that because they are 
receiving their out-sized returns and do not identify any 
wrongdoing. So the challenge there is to get inside the 
organizations and get credible evidence so that we can stop 
them.
    But we are, with a renewed focus across all the areas that 
you have identified, dedicating our resources and sharpening 
our tools.
    Senator Bunning. The same person, what changes are being 
implemented to allow or encourage staff to bypass the normal 
chain of command if they feel serious issues or cases are not 
being properly addressed? That is where I hear we have had a 
problem.
    Mr. Khuzami. Well, Senator, we are, as I indicated in my 
testimony, undertaking a review of the entire management 
structure, and so that will hopefully result in streamlined 
processes.
    The other thing I would point to is simply, you know, I 
have appeared before the staff on numerous occasions already 
and made it very clear to them that we are focused on these 
cases and that they should be free to raise their hand and 
bring forth any issue that they feel needs attention with 
respect to their cases.
    I do not sense any reluctance on the part of the staff to 
identify questions or issues in their cases. If anything, I 
think they feel a renewed sense of vigor and the importance of 
bringing cases in a timely manner.
    Senator Bunning. In your testimony, you mentioned that the 
Commission has filed 23 cases involving Ponzi schemes or Ponzi-
like payments. With the report just now coming out that the SEC 
received warnings back in 2002 regarding the Stanford fraud 
investigation, how long was the SEC aware of these 23 or so 
particular cases before formal filings, you know, where a 
charge was made?
    Mr. Khuzami. Senator, I would have to, in order to provide 
a thoughtful answer to you, perhaps have----
    Senator Bunning. No, a factual answer. I would rather have 
a factual answer.
    Mr. Khuzami. How about thoughtful and factual?
    I would like to be thorough in my response. I cannot tell 
you as I sit here right now what the history was, if any, with 
respect to these actions that we have brought. I will say with 
respect to the Stanford matter----
    Senator Bunning. Could you really get that to us, to the 
Chairman and myself, in writing a report on those 23?
    Mr. Khuzami. Certainly.
    Senator Bunning. I would appreciate that very much.
    Do you agree with Mr. Hiler's recommendation to increase 
the number of senior officials with smaller caseloads who can 
get more involved in individual cases--in other words, 
providing investigators with more access to key gatekeepers?
    Mr. Khuzami. As a general matter, I agree, in a streamlined 
and targeted management system that has no more managers than 
necessary and those that exist have the resources and the time 
to dedicate to properly reviewing cases early on so that we do 
not waste resources on cases that are not worth pursuing, and 
that we can focus on moving those cases that we should be 
bringing in a faster manner. Now, whether or not that means 
adding resources at the associate level or a different level, 
those details remain to be seen. But I certainly agree with the 
general principle.
    Senator Bunning. Thank you, Mr. Chairman.
    Senator Reed. Thank you very much, Senator Bunning.
    Senator Johanns.
    Senator Johanns. Mr. Chairman, thank you. And to every 
member of the panel, thank you for being here today.
    Mr. Hillman, if I could start with a few questions for you. 
I read the summary, if you will, of the recommendations from 
your report, and having been in charge of a complex Government 
organization, I have to tell you, to be very candid with you, I 
could pick up that language and I think drop it into every 
Federal department.
    Here is what I am saying to you: I think every Federal 
department would say we do not have enough resources. They 
would probably say, yes, sometimes we do not even pay attention 
to our internal goals. The right hand does not always know what 
the left hand is doing. And I am not saying that to justify it. 
I am just saying that you are findings here leave me asking the 
question: Is there a story within the story?
    And then I listened to the testimony about Mr. Madoff. You 
know, I said at the first hearing on that, ``I don't get it. I 
really don't understand it.'' You had a whistleblower that 
pretty well called this guy out, kind of laid the road map for 
what was going on, and yet there was not follow-up, and people 
really, really were hurt by that.
    So what I want to try to examine with my questions is: What 
is the story within the story? Is this a situation where you 
have a piece of the Federal government that is not getting 
along with the Commissioners? Is there a personality conflict? 
Is there a difference of opinion as to what the goals of the 
SEC are?
    Mr. Hillman, let me start with you. Is that the case here?
    Mr. Hillman. I think you raise an excellent question about 
what the real root causes are associated with the difficulties 
that we found within the Enforcement Division. We pondered that 
thought many times during the course of our review as well.
    You are absolutely correct, many of the examinations that 
we have conducted at SEC and other regulatory agencies--banking 
regulators and others--we uncovered very similar practices. 
What I think was most startling by this review, however, was 
that the unanimity of views from the enforcement management, 
from their middle management, from their investigative 
attorneys as to the problems that they were seeing within the 
Enforcement Division, which was startling and clearly in need 
of some attention to address organizational culture issues, to 
address organization communication issues, and to really set a 
tone at the top as to how penalties and disgorgements were 
going to be ordered.
    Senator Johanns. See, and here is what worries me about 
that. I think the easy answer is always, ``I need more 
resources.'' But then I kind of dig deeper into the report 
here, and on page 5 you say, you know, but the enforcement 
cases are about where they were when we talked to the attorneys 
involved, what they bring up is they need more support staff, 
the paralegals, et cetera. It is not like they are asking us to 
double the number of attorneys, although I suspect they would 
like additional help with attorneys.
    So, again, Mr.--``Kozumi''?
    Mr. Khuzami. ``Khuzami.''
    Senator Johanns. ``Khuzami.'' Everybody botches 
``Johanns,'' too. Although the Chairman got it right.
    Mr. Khuzami. My mother sometimes mispronounces it. That is 
OK.
    [Laughter.]
    Senator Johanns. Here is what I am trying to figure out 
with you. I think there is always a new energy with new people. 
There was when I went to the USDA, and I do not know that I was 
any better or worse than the person before me. But it is 
culture and processes and not necessarily building more staff, 
or whatever, that solves problems.
    Dig there with me. What is wrong with the culture? What is 
not working over there that literally you could have a 
whistleblower drop Madoff on somebody's desk and nothing 
happens? For me, as a former Cabinet member, that would have 
been a grenade. I would have been on the phone to GAO, to my 
Committee of jurisdiction, to the Solicitor General, to 
everybody I could get on the phone to, saying, ``Oh, my Lord, 
what are we going to do about this?'' And yet this just seemed 
to go on. What is wrong? What do you see?
    Mr. Khuzami. Well, Senator, due to an ongoing Inspector 
General's report, I do not have the answers yet as to the 
sequence of events and what actually happened with respect to 
the complaints regarding Mr. Madoff. I do not know if it is 
predominantly the failings of a single or small number of staff 
members, which would be one thing; whether or not it represents 
a failure in process or organization. So when we get those 
findings, we will certainly look at them closely. But we are 
not waiting for them, either.
    My sense is that there has been, you know, a certain lack 
of urgency about the mission. My sense is that, as Mr. Hillman 
has pointed out, there are policies or approaches that may not 
have been intended to be anti-enforcement or to discourage 
enforcement, but they were perceived as such or taken as such, 
and that sent a message down the line.
    I think that the Division needs to do a better job to 
maintain current with the markets and the products and the 
transactions that they are obligated to investigate. Just for a 
simple example, if the person who reviewed the Madoff complaint 
or any other complaint had specialized training in certain 
types of trading strategy, that might have resulted in a 
different result. And we do much more of that now than we did 
previously.
    But the best way I know to change culture is, as was 
mentioned, starting with a tone at the top, which the Chairman 
and the Commissioners have done, to set policies that are fair 
and appropriate and that allow the Enforcement Division to do 
its job, because those policies will live far beyond my tenure 
or the tenure of any staff attorney, but they will continue to 
pollinate the Division with the sense of urgency and mission 
that it needs to effectively do its job.
    Senator Johanns. Thank you, Mr. Chairman.
    Senator Reed. Well, thank you, Senator Johanns. And, again, 
I think we have the luxury of continuing our questioning, so 
let me initiate another series of questions.
    We have talked about this issue of resources, and I think 
there is a general consensus agreement that additional 
resources, and perhaps more appropriate with respect to 
paralegals, investigative personnel, and others is appropriate. 
There is another aspect of resources, and that is 
predictability. And given that you are subject to the 
appropriations process, that is not entirely predictable.
    There are other Federal regulatory agencies--FDIC being 
one--who have essentially a claim through their supervised 
entities on funds, and I just want your thoughts whether that 
model might be--or some form of that model might be appropriate 
for the SEC, that it would be, in fact, some type of funds that 
are always there, not subject to appropriations, that would 
provide the certainty for infrastructure improvements, 
technology improvements, hiring specialists, et cetera. So let 
me begin with, Mr. Hillman, your thoughts and then move down 
the line.
    Mr. Hillman. We had done a study earlier looking at self-
funding mechanisms of the regulators, across the banking 
regulators and securities regulators, and identified advantages 
and disadvantages of alternative approaches. The SEC, as you 
may know, is collecting fees associated with activities 
occurring within the financial markets. They receive 
registration fees for new stocks and bonds. They receive 
transaction fees paid over by national securities exchanges. 
They also have fees from proxy solicitations for mergers and 
acquisitions and the like. These fees do not come directly to 
the SEC. They are put within the Treasury's accounts, and the 
SEC has its own appropriations.
    Some of the advantages of having SEC be removed from the 
appropriations process and going to a self-funding basis, based 
off the fee income which they are receiving, would be to have 
greater control over their budgets, have an ability to plan for 
their activities over a longer period of time, 5 years or more, 
perhaps, and have a greater ability to address its challenges 
in their workload areas.
    Some of the disadvantages, however, have to do with the 
fact that a self-funding structure is not going to deal with 
all their problems that we are seeing within the SEC associated 
with, in the past, retention issues within their control, 
changing the mix of their resources and the like. It also 
significantly reduces the checks and balance systems that 
currently exist within the budgetary and appropriations 
process.
    Senator Reed. Well, thank you very much.
    Mr. Khuzami, your comments and thoughts?
    Mr. Khuzami. Well, Mr. Chairman, I agree with your point 
absolutely about appropriations and resources. I told my staff 
on the first day that the appropriations was a little like the 
cavalry. You do not know if they are going to show up, when 
they are going to show up, and how long they are going to stay. 
And that is why it was incumbent upon us to organize our own 
house as efficiently as possible to make sure that the 
taxpayers received value for their dollar.
    With respect to the issue of self-funding, I must say I 
have not spent really any time studying it. Obviously, the 
advantages are very appealing to me, but I think I will defer 
while the Chairman and the Commissioners consider those issues.
    Senator Reed. Professor Bullard and Mr. Hiler. Professor 
Bullard first.
    Mr. Bullard. I have spent a fair amount of time thinking 
about this issue, but it is not necessarily going to help you 
any because I have not really reached a firm conclusion what 
the best model is. I think the checks and balances point is 
right on the money. There is a lot of benefit to the political 
accountability. The SEC must demonstrate in contexts such as 
this one when it is going back to the hand that feeds it. On 
the other hand, having a more reliable source of income that is 
industry based has certain efficiencies.
    I am sorry I cannot give you much of an opinion on that.
    Senator Reed. That helps.
    Mr. Hiler.
    Mr. Hiler. Yes, I think that having some consistency at a 
certain level of funding is really imperative and would be 
extremely helpful for the Commission.
    In terms of the checks and balances, I assume--I am a 
securities lawyer, but I assume that Congress could deal with 
that by calling the Commission and asking them to come over, 
submit their budget, see what is going on. But I think that 
would be a very good turn of events if the Commission could 
know from year to year that at least it has some source of 
funding and it does collect fees. I think years ago it used to 
be basically a surplus to the Treasury from when you balanced 
out what it was collecting in fees and so forth and what it was 
spending.
    I think that some of the funds really, really should be 
best spent on paralegals, document control issues and document 
control assistance, IT and experts like we have all talked 
about in the GAO report and that I have talked about. I think 
that document control, knowing the size of these cases the SEC 
works on, that is one of the biggest consumers of time of an 
attorney, and they just do not have people there to help with 
that, and IT as well, and paralegals.
    Senator Reed. Can I just make the point that it might be in 
your expertise as a practitioner, on the other side the 
technology, both in the regulated industries and their 
attorneys, it must be phenomenal relative to the SEC. It is 
like, you know, sort of those Civil War militias going up 
against the 82nd Airborne.
    Mr. Hiler. Well, I will say that I do not feel that we have 
that much of an advantage. There are some very good attorneys, 
and they know their cases when we go up against them. They 
really know their cases. They know every document, and they 
have looked at it sideways and on the creases. So they make up 
for it in certain ways. But, yes, I think they are lagging 
behind in the technology, in the document control area for 
certain.
    Senator Reed. And just another point, too, and then I am 
going to recognize Senator Bunning, and we have been joined by 
Senator Schumer. In terms of understanding some of these new 
products, et cetera, the sophistication and the computer 
modeling is so significant, and I would assume even if you have 
suspicions or one of your attorneys, Mr. Khuzami, has 
suspicions, that to be able to understand what they are doing 
and feel that it is clearly wrong is a challenge without not 
only the computer technology but the market expertise that is 
on the other side. Is that a fair insight?
    Mr. Khuzami. That is correct, Mr. Chairman. The challenge 
comes in a couple of different areas. One, it is understanding 
the markets. Two, it is being able to get the kind of training 
and other information that you need, particularly in the 
unregulated markets such as hedge funds and derivatives, in 
order to get the information and have it reported in a uniform 
way so you can put the story together and see whether or not 
there is suspicious or wrongful activity. And it is then the 
resources and the technology to be able to do that. So, as you 
say, it is a technological challenge across a number of fronts.
    Senator Reed. Thank you.
    Senator Bunning, questions?
    Senator Bunning. Yes, thank you very much.
    Mr. Khuzami, I would like to just ask you, What is a better 
measure of enforcement success--the amount of fines or the 
amount of cases handled? Or whatever else might come.
    Mr. Khuzami. Well, yes, I think that would be a hard choice 
between the two of them because I think they both have some 
inadequacies. From my perspective, the best measure of both the 
performance of an individual attorney at the Commission as well 
as the overall program would be to focus less on quantity, 
although that still matters, but more on things like 
timeliness, how quickly do you bring a case. You know, the gap 
between conduct and atonement, if you will, the longer that 
stretches out, the less of a deterrent message you are able to 
send.
    Two, you want to look at programmatic priorities. If the 
Enforcement Division decides that, you know, we see a lot of 
suspicious activity and insider trading by hedge funds, then we 
should be setting that as a priority and measuring our success 
on whether or not we are achieving results in that area.
    And the third area that is of interest to me is really the 
deterrent impact, probably maybe the most important, but the 
most difficult to measure. How do you decide whether or not a 
case you bring has prevented others from doing the same thing? 
That is a big challenge. One of the ways I have seen it done 
successfully was by one of my predecessors, and it was not even 
in an enforcement case. But he announced to the Wall Street 
firms and said, ``You have to scrub your own institutions and 
your own business people and your own desks to look for 
conflicts of interest. And you better find them and identify 
them and remediate them, or we are going to come in and do it 
for you.''
    And I was at one of those financial institutions when that 
word came down, and we spent an enormous amount of time and 
money doing exactly that. We looked at our conflicts. We made 
disclosures. We cured some. We exited certain businesses.
    Now, there was never a single case that was brought. Right? 
It would not show up in anybody's statistics. But the amount of 
good and effective deterrence that that achieved is probably 
immeasurable.
    And so I would like to see us moving in some cases to more 
of a model like that where we can achieve that kind of 
deterrence, because ultimately, you know, we can sue people and 
try and get their money back, but we are all in a much better 
position if we stop it before it starts.
    Senator Bunning. To follow up, last year there were 700,000 
complaints that were sent to the SEC that were not investigated 
or followed up on. Now, how can the SEC account for that?
    Mr. Khuzami. Senator, I do not think it is the case that 
they were not followed up on. I think that is simply the raw 
number that was----
    Senator Bunning. Received.
    Mr. Khuzami. ----received by the Commission. There was, in 
fact, and is, in fact, a rigorous program for collecting, 
investigating, monitoring, and referring those complaints that 
is in place.
    Now, having said that, we all recognize that we can do a 
better job here, and one of the first things that Chairman 
Schapiro did was to order an independent vendor to study our 
processes, where we would be collecting all of these complaints 
in one area. Now it simply comes into too many different areas 
within the Commission. To collect it in one place, log it, 
analyze it, review it, look for patterns and trends across 
complaints to see if it tells a story, refer it out to the 
proper area, perhaps combine it with specialized units so that 
the people looking at these will have good eyes.
    Senator Bunning. But you have no idea how many were 
followed up on or were not followed up on out of the 700,000?
    Mr. Khuzami. I am sure many, many, many of them were. I am 
happy to get those statistics.
    Senator Bunning. OK, I would appreciate that.
    Mr. Khuzami. Sure.
    Senator Bunning. About more money and about better 
enforcement, you know, you were about to say something. I 
probably cut you off on the Stanford thing, and I did not mean 
to do that. If you have something to expand on that, now is the 
time. But a whistleblower on Madoff, and it took so long to get 
to the problem? That just--you know, to the ordinary citizen 
and to us sitting back who are watching SEC to enforce, we 
cannot imagine that happening.
    Mr. Khuzami. I understand that, Senator. I mean, in the 
particular Stanford case you are referring to, there were--we 
did receive complaints early on, not necessarily particularly 
detailed or specific, but complaints. And there were a number 
of challenges in that case having to do with the cooperation 
not only of Mr. Stanford, but the inability to obtain documents 
from offshore, the cooperation of the Antiguan authorities, and 
the lack of witnesses from the investors. And we continually, 
starting in approximately 2005, looked at that case going 
forward and continued to investigate. It was not a situation 
where someone gave us a complaint and we looked at it and 
decided there was nothing to do and moved on. We were 
continually investigating the case. It just took an 
extraordinarily long period of time in order to gather the 
evidence to bring the case. And once we did, we moved very 
quickly.
    I agree that, you know, these cases should be brought in as 
timely a way that you can, and we are focused on that. But 
sometimes it just takes a considerable period of time to make a 
case.
    Senator Bunning. Good luck.
    Senator Reed. Thank you, Senator Bunning.
    Senator Schumer.
    Senator Schumer. Thank you, and I thank the witnesses.
    My first bunch of questions may be all for Mr. Khuzami, but 
after he finishes, anyone can chime in.
    The first one is about industry experts. The SEC, known as 
``the gem of the financial regulatory world'' a long time ago, 
and the SEC's police, your Division, the Enforcement Division, 
was its public face and its iron fist. And now what we have 
seen after the financial crisis is how understaffed, 
inexperienced, and underfunded the Division of Enforcement has 
been under the previous administration. It is the idea 
Government is bad, cut it back, you know.
    To oversee 30,000 registrants, 12,000 public companies, 
4,600 mutual fund families, 11,000 investment advisers, et 
cetera, the Enforcement Division has a staff of 1,100. That is 
10 percent less in absolute numbers than the staff it had in 
2005. That is why Senator Shelby and I introduced the Safe 
Markets Act, to give the Enforcement Division the additional 
resources it needs. And Senator Reed, of course, has been a 
long-time champion of increased SEC funding.
    It is also why I fought so hard for an amendment to the 
Fraud Enforcement Act on the floor last month to ensure that 
the SEC get the funding it desperately needs. That amendment 
passed, and a version of the bill with SEC funding intact, I am 
proud to say, just passed the House yesterday. So the SEC 
should be seeing the extra $40 million we fought to get you 
pretty soon.
    Now, I want to know with some specificity how the SEC plans 
on using the $40 million, and I know Senator Bunning touched on 
this, but I would like to go a little bit further.
    The Enforcement Division is almost exclusively staffed by 
attorneys, not by investment analysts who know how to crunch 
the numbers and analyze complex financial data and trades. You 
have announced a plan to reorganize the Division into 
specialist teams and give the enforcement attorneys more 
autonomy along the line of prosecutors at the U.S. Attorney's 
Office, and I applaud that. I think that is a good idea.
    But do you plan to hire financial analysts, traders, and 
accountants with real industry knowledge and experience to help 
you investigate and oversee today's increasingly complex 
capital markets? And if so, give me some top-of-the-envelope 
idea of how many?
    Mr. Khuzami. Well, Senator, we absolutely do plan on doing 
that. One of the advantages of having specialized groups is 
that you will now have a fixed point within the organization 
where you can actually hire and assign these market specialists 
to a particular one. So if you have a structured products and 
securitization group, you can go out and hire structurers or 
traders, many of whom are currently unemployed, and bring them 
into the Division.
    The numbers that we plan on hiring, you know, I do not have 
a firm number yet, but it depends in part on, you know, which 
kind of units we set up. But we get many inquiries from folks 
who want to help, retired traders----
    Senator Schumer. But is it going to be a significant 
percentage, not one here or one there? I think there has been 
too much of a reliance on lawyers--I am not against lawyers; I 
am one--and not enough on the investigative type people who 
have had experience in the financial world.
    Mr. Khuzami. It will be a significant number.
    Senator Schumer. OK, good. When do you expect all of this 
to happen, your reorganization plan, including these new 
people?
    Mr. Khuzami. Well, it is somewhat of an execution challenge 
to roll this out, obviously, when you talk about restructuring 
a large part of the Division. But we are going to start doing 
the initial planning stages very soon. We have identified a 
small number of specialized groups that we want to start out 
with, and I suspect that we will start this process in a matter 
of weeks.
    Senator Schumer. Good. OK. The next question deals with 
sort of the siloization of investigations, which is not your 
fault. That is what Congress has done because of all our 
jurisdictional turf battles. Last year, the Enforcement 
Division received 700,000 tips, complaints, and referrals from 
the public and Federal agencies. When the Enforcement Division 
receives a tip, it now only has the ability to investigate SEC-
regulated activities or entities. Do you think this is 
sufficient in protecting our markets? Or do you think the SEC 
should also have investigative powers over currently 
unregulated entities--hedge funds and unregulated products like 
credit default swaps--to ensure the integrity of our capital 
markets?
    Mr. Khuzami. My answer to that, Senator, is a strong yes. 
My view is that we need access to hedge funds, credit 
derivatives, and other products, particularly the trading 
information, so that we can combine that with other information 
that we see in the regulated entities to make sure that we have 
a full picture of what is going on and to be able to detect 
wrongdoing.
    Senator Schumer. Good. Next one. You know, the SEC has 
limited resources, but they may not be used most effectively. 
According to the data provided by the SEC, 40 percent of 
enforcement personnel and 20 percent of examinations personnel 
are based in Washington, DC, which, until last fall, was not 
the financial center of the country, and still is not the 
financial center--will not be again soon. New York is coming 
back.
    But despite the overwhelming concentration of financial 
entities in the New York City metropolitan area, the SEC has 
stationed only 15 percent of its enforcement personnel and a 
quarter of its examination personnel there. That seems to me a 
misallocation of resources. While I think we need to put in 
certain rules and regulations to ensure that the relationship 
between regulators and the regulated does not become close or 
too close, I also think agents have a much harder time staying 
on top of what is going on in the capital markets when they are 
200 miles away.
    Do you agree? Will you consider allocating or reallocating 
some of the personnel to New York City as part of the shake-up 
of your Enforcement Division?
    Mr. Khuzami. Senator, I have not looked specifically at 
that issue, but I will certainly consider it. The one thing I 
will say is that our specialization effort will result in 
nationwide teams of investigators and attorneys looking at 
particular areas. So that in some sense, geographical location 
will become less important because you will have a team across 
the Nation focusing----
    Senator Schumer. I know, but when the team is having lunch 
in Phoenix, they do not pick up as much information as they do 
in downtown Manhattan. So I am going to ask you again. What are 
you going to do about reallocating personnel to New York City?
    Mr. Khuzami. I have not considered that in my 5 weeks, but 
I will certainly take that under advisement.
    Senator Schumer. I think the SEC should move to New York 
City, at least the Enforcement Division as a whole. I do. I 
think it would do a much, much better job.
    I also think the New York regional office is badly in need 
of permanent leadership, and soon. I would urge you to act 
quickly and consider naming someone like yourself who is a 
former Federal prosecutor with securities experience. How 
closer are you to naming someone? And are you considering the 
kind of people with the background I mentioned? I do not have 
anyone specific in mind.
    Mr. Khuzami. We are in the very final stages of that 
process, and we have an abundance of highly qualified 
candidates, including those with the profile that you mention.
    Senator Schumer. What is the likelihood one of them is 
going to be picked with that profile?
    [Laughter.]
    Senator Schumer. You are a lawyer. I can ask questions, 
too.
    Mr. Khuzami. Well, I do not want to pre-judge the process
    Senator Schumer. OK.
    Mr. Khuzami. But I hear what you are saying.
    Senator Schumer. OK, thank you. Finally--let us see. I have 
two more with the Chairman's indulgence. OK.
    Unlike the other Divisions at the SEC--this is about small 
investor protection--the Division of Enforcement does not have 
a hotline the public can call. For instance, one of my 
constituents is a victim of one of the reserve funds. You 
charged their directors with fraud this week. The constituent 
has contacted my office regularly since the fund broke the buck 
last fall because there is no other place he can turn to ask 
questions, get status updates, register complaints about the 
way the situation is being handled, and that is an unacceptable 
situation.
    I hear that the Office of Investor Education and Advocacy, 
which is charged with the mission of advising the small 
investor, has received so many calls, it maintains a database 
of investor complaints of fraud.
    Do you agree that the Enforcement Division should have a 
hotline?
    Mr. Khuzami. Senator, our entire complaint, tip, and 
referral process is under investigation. A hotline certainly 
sounds like a pretty good idea. I have no idea if that is in 
the works, but I will pass that suggestion along the line.
    Senator Schumer. Could you please? Yes, and get back to me. 
On all of these, if you could get back to me in writing--within 
5 days, is that OK? A week?
    Mr. Khuzami. Yes.
    Senator Schumer. OK, great. Can you explain to me how the 
Enforcement Division coordinates with the Office of Investor 
Education and Advocacy and other Divisions who receive calls 
about fraud and violations?
    Mr. Khuzami. Senator, the complaints, tips, and referrals 
that we get come in from many different portals within the SEC, 
and that is one of the things we are trying to consolidate. 
They come in, but they are all collected in central areas and 
are analyzed and triaged and referred. We are going to be doing 
a better job of that, but that is the current structure.
    Senator Schumer. So who receives the calls--I mean, again, 
they are all referred or triaged----
    Mr. Khuzami. Yes.
    Senator Schumer. ----and referred?
    Mr. Khuzami. Yes.
    Senator Schumer. So if you are two out of the three, you do 
not get any response?
    Mr. Khuzami. I am sorry. I do not follow.
    Senator Schumer. Well, if it is triaged, that is one----
    Mr. Khuzami. Well, by triage, I mean spam and, you know, 
kind of the nonsense----
    Senator Schumer. OK. But anyone who calls with an actual 
complaint or whatever will be given a call back.
    Mr. Khuzami. They will be referred to the appropriate area, 
and the complaint will be followed up on.
    Senator Schumer. OK, thanks.
    Finally, last but not least, rule-making consultation. The 
Divisions of Corporation Finance, Trading and Markets, and 
Investment Management are the rule-making Divisions while 
Enforcement enforces the rules. During the rule-making process, 
the industry and the public are consulted and have the 
opportunity to submit comments.
    Are you consulted, is the Enforcement Division consulted on 
the enforceability of the rules the other Divisions are 
writing?
    Mr. Khuzami. Yes, Senator. When new rules are being 
proposed, the views of Enforcement, especially with respect to 
whether or not the proposed rules have an enforcement impact, 
we are consulted and permitted to voice our views in the same 
way that these other Divisions voice their views on our 
enforcement cases.
    Senator Schumer. Permitted, but is it part of the process?
    Mr. Khuzami. Yes
    Senator Schumer. Good. And, finally, last question: Can you 
explain to me how the other Divisions train and assist the 
enforcement attorneys?
    Mr. Khuzami. Well, all of our cases--well, first of all, we 
are well aware within the Division of the expertise in our 
other Divisions. So if we have a question, we just pick up on 
the phone and call them.
    There is a more formalized process as part of our case 
review where they get to review proposed actions and comment on 
them. One of the benefits of specialization, we hope, is that 
we can get that expertise in sooner to our investigations in 
order to take advantage of it. You know, why go outside first 
when you have got some of the best experts in the country in-
house.
    Senator Schumer. OK. Does anyone else have a comment on any 
of the things I mentioned? If not, then thank you all for being 
here, and thank you, Mr. Chairman.
    Senator Reed. Thank you, Senator Schumer.
    I have two statements, one from Chairman Dodd and one from 
the President of the National Treasury Employees Union, to 
include in the record, and I have checked with the minority 
staff, and without objection, I would order these statements be 
made part of the record.
    Senator Reed. Let me just raise one question. Senator 
Schumer has highlighted a question about competition among the 
Divisions, Mr. Khuzami, and Mr. Hiler made that point, too, and 
you have responded. Is there anything else you would like to 
say about this issue of competition among Divisions?
    Mr. Khuzami. Candidly, Mr. Chairman, I have not seen 
evidence of that. We really--to some degree--my view at this 
point is that it is a highly collegial environment. We kind of 
operate in similar but different spheres, so it is not the case 
that we are focused on the same issues. We get their inputs; 
they give us their input. And, to me, it is a very 
collaborative process that works well.
    The only issues I have seen is whether--you know, sometimes 
things take too long to move through the process as you consult 
multiple Divisions, and we hope to be able to streamline that.
    Senator Reed. And let me ask another question which was 
suggested by one of Mr. Hillman's comments; that is, the 
retention of qualified attorneys. It might be easier now given 
that competing private companies are not as flush or lush, but 
that issue is always there in terms of maintaining highly 
qualified personnel.
    I think both Professor Bullard and Mr. Hiler worked for the 
Commission, and then their academic and professional challenges 
left. Your comment on what we can do--and you might even want 
to think about this and get back to us--about providing 
appropriate incentives to attract the right people and then 
keep them there, provide long-term expertise. Do you have any 
comments?
    Mr. Khuzami. Well, Senator, you know, the pay parity rules 
that were passed a few years ago that increased the salaries 
were very helpful in terms of retaining talent. We do fluctuate 
as markets fluctuate and the demand changes.
    I think that one of the great benefits of refocusing on 
enforcement and specialization and the other things we are 
considering is that the Division, I think, is just going to be 
a more attractive place for people to work, and they will stay 
longer because they are doing good cases in an active way and 
their contributions are valued. And if the gentleman to my left 
wanted to return to the Division to work, we would be more than 
happy to consider it.
    Mr. Hiler. I am surprised to hear that, actually.
    [Laughter.]
    Mr. Bullard. I do not think he has checked that with some 
of his colleagues.
    Senator Reed. I am glad we are able to have a job fair as 
well as a hearing. This is sort of doing double duty today.
    Gentlemen, thank you very much for your very insightful 
testimony. I would ask that if any of my colleagues have 
additional questions they would submit them no later than May 
13th so that we could get them to the witnesses. And I know 
some of the witnesses have suggested they will respond--is a 
week appropriate, Mr. Khuzami, given you--or we could make it 2 
weeks.
    Mr. Khuzami. Two weeks would be fine, if that is----
    Senator Reed. Let us just suggest that any requests for 
information by the Ranking Member or Senator Schumer or anyone 
on the Committee, if you could comply within 2 weeks, I would 
appreciate it very much.
    That concludes the hearing. Thank you very much, gentlemen.
    [Whereupon, at 3:53 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]

           PREPARED STATEMENT OF SENATOR CHRISTOPHER J. DODD
    I am pleased that the Securities Subcommittee is holding today's 
hearing and commend my colleague, Senator Reed, for his work to enhance 
the performance of the Securities and Exchange Commission.
    The SEC's Division of Enforcement has a vital role in promoting 
compliance with the securities laws. It is critical to promoting the 
integrity, fairness, and efficiency of U.S. financial markets. Strong 
enforcement promotes investor confidence and participation in these 
markets, which enables companies to raise capital, grow, provide jobs, 
and create wealth. It is important that this division be strong.
    On March 20, 2008, Senator Reed and I asked the GAO to study the 
SEC's Division of Enforcement. We asked them to assess whether it has 
sufficient staff and funds to perform its mission. We also asked them 
to analyze the significant decrease in penalties and disgorgements the 
SEC has collected in recent years, and the policies which put speed 
bumps in the course of staff settlement negotiations. We asked the GAO 
to examine rumors of declining staff morale and to assess the 
Commission's progress in implementing suggestions made by a GAO study 
from August of 2007.
    Since the date of our letter, there have been additional public 
concerns raised about enforcement. They came to a crescendo with 
revelations about the failures of the SEC and the self-regulatory 
organization it oversees to discover the Bernard L. Madoff Investment 
Securities Ponzi scheme--even after the SEC received extensive and 
credible tips.
    Today's GAO study has identified several areas of concern. The 
number of attorneys responsible for primary enforcement declined 11.5 
percent between 2004 and 2008--precisely at the time that some of the 
most egregious behavior, such as the Madoff Ponzi scheme, was 
occurring. The GAO has found significant shortcomings in the SEC's data 
technology that have hampered its enforcement work.
    I am concerned about these and other shortcomings identified in the 
report, and hope that the SEC will carefully review GAO's 
recommendations and make necessary improvements. I am further 
disappointed that the SEC did not raise these problems directly with 
the Committee on any of the numerous occasions on which it appeared 
before us.
    The Congress has recently given the Commission additional resources 
and stands ready to provide more as needed. However, we also need to 
take a hard look at the way the Commission has used the resources they 
have already been given.
    While the decline in enforcement attorneys is certainly troubling, 
the GAO indicates that SEC enforcement has not effectively managed the 
staff it does have. Within one program, a Director complained that 
``most staff ostensibly in his office are in fact within the 
organizational structure of a different division.'' GAO indicates that 
complex approval procedures for investigations have led some attorneys 
to close cases rather than go through the bureaucracy needed to keep 
them open. This potentially allowed fraudsters to go unprosecuted.
    Even though I recognize that the SEC needs more enforcement 
funding, I have some concerns about how they have used some of the 
funding they have already been given. For example, the SEC Inspector 
General reported last month that the Commission spent nearly $4 million 
rearranging offices in an apparent vain effort to improve communication 
among staff members. The Inspector General concluded that it was not 
clear that this ``restacking'' project was necessary or had any 
meaningful impact on communication among the staff or productivity. GAO 
said that ``the SEC should have conducted a formal cost-benefit 
analysis of the restacking project and, had such an analysis been 
prepared, it may have led to the conclusion that the restacking project 
was not worth the costs and disruption to the Commission.''
    The Commission should assure Congress that it will manage its 
resources wisely, to promote the agency's mission.
    The need for the government to detect and prosecute fraud and other 
financial crimes has never been more crucial. The Division of 
Enforcement is vital to protecting investors. It must have the talent 
and tools needed to perform a superior job. And we must also demand 
excellence for our money. We must ensure that money is being spent on 
management, programs, and procurements that work. We must insist that 
management be more efficient and that enforcement attorneys are held to 
the highest standards. American investors deserve nothing less.
    I thank the GAO for its work and look forward to improved 
performance from the Division of Enforcement under its new leadership.

                PREPARED STATEMENT OF RICHARD J. HILLMAN
                           Managing Director,
              Financial Markets and Community Investment,
                    Government Accountability Office
                              May 7, 2009





























                  PREPARED STATEMENT OF ROBERT KHUZAMI
                               Director,
                        Division of Enforcement,
                   Securities and Exchange Commission
                              May 7, 2009
Introduction
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, thank you for inviting me to testify today on behalf of 
the Securities and Exchange Commission and its Division of Enforcement. 
I am both honored and proud to be here as the SEC's new Director of 
Enforcement. I am also extremely grateful for this Subcommittee's 
support and assistance in, among other things, efforts to increase our 
budget, meet our enforcement responsibilities, and fulfill our mission 
of protecting investors.
    I would also like to thank the GAO and its team. I truly appreciate 
the careful work that is evident in the GAO Report: Securities and 
Exchange Commission: Greater Attention Needed to Enhance Communication 
and Utilization of Resources in the Division of Enforcement (GAO-09-
358), and the extensive cooperation that our two agencies have shared 
not only with respect to this report, but with respect to others in the 
past. As our Chairman, Mary Schapiro, has noted, reinvigorating the 
SEC's Enforcement program is a top priority, and I fully concur with 
the GAO's recommendations.
    In your letter inviting me to appear, you asked me to provide my 
views on: (1) the extent to which the resource shortages and 
enforcement policies of the SEC in recent years have hampered 
aggressive enforcement of securities laws; (2) what changes are needed 
to ensure that the SEC does not once again fall behind on its 
enforcement responsibilities; and (3) what changes Congress should 
consider to ensure adequate resources and authority for the SEC to 
fulfill its vital enforcement role.
    As I will discuss in more detail, we have faced and are facing many 
challenges, including a complex and growing market and limited 
resources. It is critical not only that we do our job and do it right, 
but that in so doing, we help restore confidence in the agency and in 
the marketplace. In my testimony, I will outline for you our plan for 
addressing the challenges that we face. I will discuss some of the 
changes Chairman Schapiro has instituted since her arrival that have 
already helped our program. Additional resources in my view also would 
enhance greatly our ability to keep pace with ever-changing 
developments in a dynamic marketplace, as well as rapid advances in 
technology. Further in this regard, I will touch on some potential 
legislative changes.
    The proposed plan I will outline dovetails with the GAO report and 
its recommendations concerning an alternative organizational structure 
and reporting relationship for the SEC's Office of Collections and 
Distributions; further review of the level and mix of Enforcement 
resources and the Division's current internal processes; review of the 
2006 corporate penalty policy; and enhancing communications. And, I 
will address the GAO report and each of its recommendations in turn.
    Before I begin, however, I am mindful that this panel--and the 
public--is deeply concerned about the Division's failure to detect the 
fraud perpetrated by Bernard Madoff. I am not here today to defend the 
agency's actions, nor am I in a position yet to explain precisely what 
went wrong. I am here to say that I will be the first to admit mistakes 
when they are made and to work toward preventing them from happening 
again. But, I am also here to ask that you consider this failure in the 
context of the Division's storied history of successful enforcement and 
vigorous efforts to protect investors, and the many talented and 
committed members of the enforcement staff who work very hard every day 
on behalf of investors.
    My belief as a newcomer is that there may have been multiple things 
that contributed to the agency's failure to act timely in the Madoff 
matter. But, whatever the agency's internal investigation concludes in 
this regard, not a day goes by that I don't think about how we can stop 
the next big fraud.
    I am here to pledge my best efforts toward revitalizing the 
Division and earning back the respect of investors. I know there is 
much to do, and we've gotten a lot of things started. But all of our 
ideas and initiatives will take time and effort. I look forward to 
discussing some of these efforts with you today and in the future. We 
expect that some of our improvements will require legislative 
assistance, and your interest in a stronger SEC is greatly appreciated.
Background
    Since I am new to the SEC and this is the first time I am appearing 
before you, I hope you will permit me to tell you a little about myself 
and about the Division of Enforcement, particularly its recent 
successes. Over my career, I have been blessed to work in a wide range 
of legal jobs among some of the most talented members of the 
profession. These include positions as a judicial law clerk with the 
United States Court of Appeals for the Eighth Circuit; an associate 
with a long-established law firm in New York; 11 years as a federal 
criminal prosecutor of terrorism and white-collar criminal cases in the 
United States Attorney's Office for the Southern District of New York 
in Manhattan; and 7 years as a general counsel for a large financial 
services firm. Despite these experiences, and all that I learned from 
each one, I can say without hesitation or qualification that, to be 
asked by our Chairman, Mary Schapiro, to join the SEC, an institution 
with such a rich tradition of excellence and commitment to protecting 
investors, was the greatest day of my career.
    Although I am new as a member of the SEC staff, over the years I 
have had much experience with the agency and particularly, with the 
Division of Enforcement. As a Federal prosecutor, defense counsel, and 
most recently, in-house counsel, I have worked with the Division--and 
against the Division--and I have seen it from many perspectives. 
Through it all, I consistently saw in the Division staff integrity, 
excellence, dedication, and a passion for investor protection. I saw 
professionalism and teamwork. I saw a commitment to justice. And in my 
38 days as Director of the Division of Enforcement, I can assure you 
that despite the enormous challenges we have faced and are facing, I 
have seen these traits in abundance. They are alive and well and, in my 
view, one of the great, distinguishing safeguards of the integrity of 
our capital markets.
The Division of Enforcement and Recent Successes
    The Enforcement Division is in many ways the face of our investor 
protection agency. Ours is the Division authorized to investigate and 
bring civil charges in federal district court or in administrative 
proceedings based on violations of the Federal securities laws. These 
violations include fraud by any person or entity, whether or not such 
actor is otherwise regulated by the SEC, as long as the violation is in 
connection with the offer, purchase, or sale of securities. In addition 
to fraud, we also investigate and prosecute regulatory misconduct, 
including registration, reporting, and recordkeeping violations 
relating to issuers, broker-dealers, municipal securities dealers, 
investment advisers, investment companies, and transfer agents.
    We initiate investigations based on our own surveillance efforts, 
information from other regulators, and complaints and tips from 
investors and other members of the general public. Although we have 
delegated authority to initiate investigations on an informal basis, we 
require Commission approval in the form of a formal order of 
investigation, in order to issue subpoenas.
    When we find violations of the Federal securities laws during our 
investigation, if appropriate, we recommend to the Commission that it 
authorize us to bring an enforcement action, including seeking any 
appropriate relief, against the alleged wrongdoers. Our potential 
remedies include: injunctions, cease-and-desist orders, disgorgement of 
ill-gotten gain, financial penalties, revocations of registration, 
undertakings to maintain or improve internal procedures, and bars from 
associating with broker-dealers or investment advisers, practicing 
before the Commission as an accountant or an attorney, serving as an 
officer or director of a public company, and participating in the offer 
or sale of a penny stock. In emergency actions, we often seek temporary 
restraining orders, asset freezes, appointments of receivers, and other 
ancillary relief. Whenever practicable, we seek to return monies to 
harmed investors. In addition, we frequently work closely with the 
Department of Justice, criminal investigators, and State and Federal 
regulators, including conducting parallel and coordinated 
investigations, and cooperating with prosecutions as appropriate.
    We have brought many important and timely cases this year. Here is 
a small sample of our recent actions:

    Public trust: In March, we charged New York's former Deputy 
        Comptroller and a top political advisor with allegedly 
        extracting kickbacks from investment management firms seeking 
        to manage the assets of New York's largest pension fund, the 
        New York State Common Retirement Fund. Last month, we amended 
        the complaint to add a former New York State political party 
        leader, a former hedge fund manager, and a Dallas-based 
        investment management firm and one of its founding principals, 
        in connection with the alleged multimillion dollar kickback 
        scheme. \1\
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     \1\  SEC v. Henry Morris, et al., Lit. Rel. No. 20963 (Mar. 19, 
2009), Lit. Rel. No. 21001 (Apr. 15, 2009), Lit. Rel. No. 21018 (Apr. 
30, 2009).

    Reserve Fund: On Tuesday, we filed fraud charges in the 
        Southern District of New York against the managers of the 
        Reserve Primary Fund, a $62 billion money market fund whose net 
        asset value fell below $1.00, or ``broke the buck,'' in the 
        fall. As part of this action, the Commission is seeking to 
        consolidate the numerous lawsuits involving the Reserve Fund, 
        and bring about an efficient and equitable pro rata 
        distribution to shareholders of the fund's remaining assets, 
        including the $3.5 billion set aside in the Fund's litigation 
---------------------------------------------------------------------------
        reserve.

    Insider trading: Last week, we charged a former Citigroup 
        investment banker and seven others for allegedly engaging in a 
        widespread insider trading scheme that involved repeated tips 
        about upcoming merger deals. \2\
---------------------------------------------------------------------------
     \2\  SEC v. Maher F. Kara, et al., Lit. Rel. No. 21020 (Apr. 30, 
2009).

    Subprime mortgages: In another important case filed last 
        week, we charged two former executives at American Home 
        Mortgage Investment Corporation for allegedly engaging in 
        accounting fraud and making false and misleading disclosures, 
        including misleading disclosures relating to the riskiness of 
        the mortgages originated and held by the company, to conceal 
        from investors the company's worsening financial condition in 
        early 2007 as the subprime crisis emerged. \3\
---------------------------------------------------------------------------
     \3\  SEC v. Michael Strauss, Stephen Hozie, and Robert Bernstein, 
Lit. Rel. No. 21014 (Apr. 28, 2009).

    Auction rate securities: In February, as part of the 
        auction rate securities settlements, we announced a settlement 
        that would provide more than $7 billion in liquidity to 
        thousands of customers who invested in auction rate securities 
        before the market for those securities collapsed. \4\
---------------------------------------------------------------------------
     \4\  SEC v. Wachovia Securities, LLC, Lit. Rel. No. 20885 (Feb. 5, 
2009).

    Ponzi schemes: Also last week, we obtained an emergency 
        court order freezing assets and providing other relief against 
        a California-based financier and his two companies for 
        allegedly defrauding investors of hundreds of millions of 
        dollars by misrepresenting investments in the life insurance 
        policies of senior citizens and in timeshare real estate. The 
        complaint alleged, among other things, that investors were 
        misled by false claims that their returns would come from 
        proceeds made on their investments, when instead some of the 
        purported returns were paid out of funds raised from newer 
        investors. \5\ Since January, we have filed 23 cases involving 
        Ponzi schemes or Ponzi-like payments, in which we charged that 
        perpetrators fraudulently raised funds from new investors to 
        pay ``returns'' to existing investors. \6\ Of the 23, 19 cases 
        sought emergency relief in the form of an asset freeze to 
        prevent the possible dissipation of investor assets and, in 
        some instances, a temporary restraining order to halt ongoing 
        conduct.
---------------------------------------------------------------------------
     \5\  SEC v. Private Equity Management Group LLC, et al., Lit. Rel. 
No. 21013 (Apr. 27, 2009).
     \6\  The cases are:

      1. SEC v. Bradley L. Ruderman, et al., Lit. Rel. No. 21017 (Apr. 
29, 2009) (sought emergency relief to halt an alleged $38 million 
Beverly Hills-based hedge fund fraud that included at least one Ponzi-
like payment).
      2. SEC v. Private Equity Management Group LLC, et al., Lit. Rel. 
No. 21013 (Apr. 27, 2009) (sought emergency relief in California-based 
scheme involving hundreds of millions of dollars).
      3. SEC v. Donald Anthony Walker Young, et al., Lit. Rel. No. 
21006 (Apr. 20, 2009) (sought emergency relief to halt alleged scheme 
involving a Philadelphia-area investment adviser and its principal, who 
misappropriated more than $23 million from investors);
      4. SEC v. Maximum Return Investments, Inc., and Clelia A. Flores, 
Lit. Rel. No. 20997 (Apr. 13, 2009) (charged promoter and firm with 
allegedly operating a $23 million scheme primarily targeted at 
California's Hispanic American community);
      5. SEC v. Robert P. Copeland, Lit. Rel. No. 20994 (Apr. 9, 2009) 
(charged Georgia attorney who allegedly fraudulently raised over $35 
million from at least 140 investors in several States, including 
Georgia);
      6. SEC v. Market Street Advisors, et al., Lit. Rel. No. 20992 
(Apr. 7, 2009) (sought emergency relief against Colorado adviser for 
allegedly conducting multimillion dollar scheme);
      7. SEC v. Oversea Chinese Fund Limited Partnership, et al., Lit. 
Rel. No. 20988 (Apr. 6, 2009) (sought emergency relief to halt alleged 
$50-75 million scheme involving a Toronto-based hedge fund and 
targeting members of the Chinese American community);
      8. SEC v. Edward T. Stein, Lit. Rel. No. 20983 (Apr. 1, 2009) 
(sought emergency relief to halt alleged ongoing $55 million scheme);
      9. SEC v. Millennium Bank, et al., Lit. Rel. No. 20974 (Mar. 26, 
2009) (sought emergency relief to halt alleged ongoing $68 million 
scheme involving the sale of bogus high-yield CDs issued by Caribbean-
based bank and its Swiss affiliate);
      10. SEC v. Brian J. Smart, et al., Lit. Rel. No. 20946 (Mar. 12, 
2009) (sought emergency relief to halt alleged ongoing scheme that 
raised $1.68 million from investors, including senior citizens);
      11. SEC v. John M. Donnelly, et al., Lit. Rel. No. 20941 (Mar. 
11, 2009) (sought emergency relief in alleged scheme based in 
Charlottesville, Virginia, and involving $11 million);
      12. SEC v. Anthony Vassallo, et al., Lit. Rel. No. 20943 (Mar. 
11, 2009) (sought emergency relief in alleged $40 million scheme based 
in Northern California);
      13. SEC v. Shelby Dean Martin, et al., Lit. Rel. No. 20935 (Mar. 
6, 2009) (sought emergency relief to halt alleged $10 million scheme 
based in North Carolina);
      14. SEC v. Ray M. White, et al., Lit. Rel. No. 20925 (Mar. 4, 
2009) (sought emergency relief in alleged $11 million scheme based in 
Dallas);
      15. SEC v. Daren L. Palmer, et al., Lit. Rel. No. 20918 (Feb. 26, 
2009) (sought emergency relief in alleged $40 million scheme based in 
Idaho Falls);
      16. SEC v. Billions Coupons, Inc., Lit. Rel. No. 20906 (Feb. 19, 
2009) (sought emergency relief to halt alleged Hawaii-based scheme 
targeting deaf investors);
      17. SEC v. William L. Walters, Lit. Rel. No. 20904 (Feb. 18, 
2009) (charged former registered representative with allegedly 
operating a Ponzi scheme promising annual returns ranging from 20-40 
percent);
      18. SEC v. Stanford International Bank, et al., Lit. Rel. No. 
20901 (Feb. 17, 2009) (sought emergency relief in connection with an 
alleged $8 billion Ponzi scheme).
      19. SEC v. Craig T. Jolly, et al., Lit. Rel. No. 20890 (Feb. 9, 
2009) (alleged $40 million Internet-based Ponzi scheme based in 
Spokane);
      20. SEC v. Rod Cameron Stringer, Lit. Rel. No. 20857 (Jan. 21, 
2009) (sought emergency relief in alleged hedge fund Ponzi scheme based 
in Texas);
      21. SEC v. CRE Capital Corporation and James G. Ossie, Lit. Rel. 
No. 20853 (Jan. 15, 2009) (sought emergency relief to halt alleged 
ongoing $25 million Ponzi scheme based in Atlanta);
      22. SEC v. Gen-See Corp., et al., Lit. Rel. No. 20858 (Jan. 8, 
2009) (sought emergency relief to halt alleged ongoing affinity fraud 
scheme targeting clergy, Catholics, and senior citizens); and
      23. SEC v. Joseph S. Forte, et al., Lit. Rel. No. 20847 (Jan. 8, 
2009) (sought emergency relief to halt alleged $50 million scheme 
operating from Pennsylvania for 15 years).

    Other emergency actions: In addition to the 19 emergency 
        actions involving Ponzi schemes or Ponzi payments filed in the 
        last 4 months, we have also filed several emergency actions 
        related to other types of misconduct. In the last 2 weeks 
        alone, we obtained an emergency court order to freeze the 
        assets of a Connecticut-based money manager and the hedge funds 
        that he controls, alleging that he forged documents, promised 
        false returns, and misrepresented assets managed by the funds 
        to illicitly raise more than $30 million from investors; \7\ we 
        obtained an asset freeze against a Florida-based adviser for 
        allegedly misrepresenting the nature of $550 million in 
        investments; \8\ and we obtained emergency relief against a 
        Texas businessman and his company--both subjects of a previous 
        SEC enforcement action in 2001--for allegedly fraudulently 
        raising approximately $40 million from hundreds of investors 
        through a high-yield debenture offering. \9\
---------------------------------------------------------------------------
     \7\  SEC v. Ponta Negra Fund I, LLC, et al., Lit. Rel. No. 21012 
(Apr. 27, 2009).
     \8\  SEC v. Founding Partners Capital Management Co., et al., Lit. 
Rel. No. 21010 (Apr. 23, 2009).
     \9\  SEC v. Benny L. Judah, et al., Lit. Rel. No. 21009 (Apr. 22, 
2009).
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Challenges and How To Refocus the Division of Enforcement
    These are challenging times. The financial industry has grown 
dramatically over the last decade in both size and scope. As evidenced 
by the current financial crisis, our markets attract a large and 
complicated group of participants that deal in a variety of new, 
complex, and ever-changing financial products. In today's market, the 
SEC oversees more than 30,000 registrants, including more than 12,000 
public companies, 4,600 mutual fund families, 11,000 investment 
advisers, 600 transfer agents, and 5,500 broker dealers. In fiscal year 
2008, the Enforcement Division received more than 700,000 complaints, 
tips, and referrals regarding potential violations of the Federal 
securities laws. Yet, our entire Enforcement staff nationwide--
including lawyers, accountants, information technology staff, and 
support staff--is just above 1,100. Our mandate is broad, including not 
only regulatory misconduct by registered entities and persons but also 
fraud by any entity or person, whether registered or not, in connection 
with the purchase or sale or in the offer or sale of securities or 
security-based swap agreements. The challenge of our mandate grows as 
new financial products emerge that may fit the definition of a 
``security.''
     In the face of these growing challenges, the Division needs 
sufficient resources to meet its mandate. Yet, because of several years 
of flat or declining SEC budgets, the SEC has faced significant 
reductions. As a result, even after receiving a much appreciated budget 
increase in 2009, the SEC's workforce still will have significantly 
fewer staff than in 2005. As noted in the GAO Report, this decline is 
reflected in Enforcement's staffing levels as well. And our budget for 
new technology investments is still more than 50 percent lower than the 
2005 level. If the SEC were to receive additional Enforcement 
resources, we would be able to continue rebuilding our staff and 
technology investments, which would reinvigorate the Enforcement 
Division and help restore investor confidence.
    We have a talented and dedicated staff and the support of a 
Chairman and Commissioners who are committed to a strong Enforcement 
program. And, I am reminded daily that a change in culture within the 
division has already started to occur. The staff has redoubled their 
efforts to meet the challenges of this ongoing financial crisis. By way 
of comparison, since the end of January:

    We have filed at least 27 emergency temporary restraining 
        orders. During roughly the same period last year, we filed 7.

    We have opened more than 287 investigations. During roughly 
        the same period last year, we opened 217.

    The Commission has issued at least 138 formal orders. 
        During roughly the same period last year, the Commission issued 
        57.

    Chairman Schapiro also has begun to implement changes in our 
policies and procedures. For example, she streamlined the formal order 
approval process. As the Chairman has noted, in investigations that 
require the use of subpoena power, time is of the essence, and delay 
can be costly. To ensure that subpoena power is available to the staff 
when needed, the Chairman returned the SEC to a policy of faster 
consideration of formal orders, where appropriate, by a single 
Commissioner acting as duty officer. Another change, discussed more 
fully below, is the Chairman's abolition of the ``penalty pilot'' 
program, which had required Enforcement staff to obtain full Commission 
approval before the staff could begin settlement negotiations regarding 
civil penalty amounts with public issuer defendants.
    But there is more to be done. With what I have already learned--and 
am still learning--as Division Director, I am prepared to make changes 
to the structure of the Division, how we conduct business internally, 
how we view the world, and most importantly, how we can rise to the 
challenge and fulfill our critical mission of enforcing the Federal 
securities laws, pursuing violators, and protecting investors, in a 
timely and effective way. We have heard the criticisms and the 
commentary, and we are doing what any responsible trustee of the public 
faith should do--we are using it to conduct a serious self-assessment 
to determine what we can do to improve and move forward, and be all the 
better for the adversity. We are learning as many lessons from the few 
things we have handled less effectively as we have learned from the 
many we have handled highly effectively. We need to do this so that we 
can restore investor confidence and send a strong message to would-be 
violators that the SEC is on the beat. As our Chairman noted before the 
full Banking Committee, the SEC is the only agency focused primarily on 
the protection of investors. As the agency's most public face in its 
efforts to protect investors, a strong Division of Enforcement is 
critical to the investing public's confidence in the integrity of our 
markets.
    I met with Division staff my first day on the job and I asked the 
staff to embrace four principles:

    First, we have to be as strategic as possible. We need to 
        use our resources as efficiently as possible and in a manner 
        that achieves the greatest impact. This means a focus on cases 
        involving the greatest and most immediate harm and on cases 
        that send an outsized message of deterrence.

    Second, we have to be as swift as possible. A sense of 
        urgency is critical. If cases are unreasonably delayed, if 
        there is a wide gap between conduct and atonement, then the 
        message--to the investing public that the SEC is vigilant and 
        effective, as well as the message to those who might themselves 
        be considering a step outside the law--is diluted. Timeliness 
        is critical. Corporate institutions are dynamic and ever-
        changing. People come and go. When a case is brought years 
        after the conduct, the fines and the penalties still hurt, but 
        the opportunity to achieve a permanent change in behavior and 
        culture is greatly reduced.

    Third, we have to be as smart as possible. Investigating 
        cases or individuals past the point of diminishing returns is 
        as inefficient as choosing the wrong case to investigate up 
        front. This means a constant focus on investigative plans. We 
        need to have regular decision points during the life-cycle of a 
        case, where we determine on an informed basis how to shape the 
        investigation and charge the case. We also need other tools to 
        help us better track and analyze case progress, or lack 
        thereof.

    And last, we have to be as successful as possible. We need 
        to win. This means building strong cases so that defendants 
        settle quickly on the Commission's terms or face a trial unit 
        armed with compelling evidence.

    There was, and is, little dispute over these goals. The challenge, 
as always, is one of execution. But I assure you that I am committed to 
implementing the changes necessary to achieve our goals. To that end, 
10 days into the job, I assembled approximately nine advisory groups 
within the Division, staffed by senior personnel to assess and propose 
changes to virtually all significant aspects of our work and processes. 
The advisory groups looked at issues relating to, among other things, 
Division structure, case management and handling, streamlining, and 
better training. The marching orders in this top-to-bottom review were 
simple--in each context, ask yourselves, what works better? These 
advisory groups then gathered and presented their preliminary findings 
just 2 weeks later to a group of approximately 175 managers in the 
Division. The result was 2 days of commentary, feedback, and 
brainstorming. We also had the aid of a management consultant who has 
analyzed and restructured law firms and law departments in both the 
public and private sectors. The discussions were free-flowing and 
highly constructive.
    The result of this exercise is that we have recognized critical 
items that need to be addressed if we are to improve our protection of 
investors. Consistent with the GAO's recommendations, I propose 
allocating additional resources to the following categories:

    Administrative and paralegal support: The Division's 
        lawyers and accountants spend too much time doing document or 
        organizational tasks that are better handled by 
        paraprofessional personnel. This includes document collection, 
        organization, uploading, and indexing, as well as tasks related 
        to the collection and distribution of disgorgement and 
        penalties. It would be much more efficient, and free-up much 
        more time for high-value investigative tasks, if these efforts 
        were transferred to administrative and support staff.

    Information technology support: The SEC is working on a 
        number of technology initiatives designed to bolster its 
        ability to detect, investigate, and prosecute wrongdoing. These 
        initiatives include a review of how the SEC handles tips, 
        complaints, and referrals; the improvement and expansion of the 
        Division's document management, reporting, and case management 
        capabilities; and the improvement of the SEC's ability to 
        identify, track, and analyze data to identify risks to 
        investors better.

    Trial lawyers: It is important that the Commission maximize 
        the capacity and ability of its trial unit. Simply stated, we 
        must convey to all defendants in SEC actions that not only do 
        we assemble winning cases against them, but also we are 
        prepared to go to trial and we will win. Only then can we 
        expect to secure the type of settlements that both achieve 
        justice for investors and save resources to be used in pursuing 
        the next case. Without that credible threat, we are at a severe 
        disadvantage. Our trial unit does an admirable job, but given 
        the increased caseload, particularly the great increase in the 
        number of emergency actions such as temporary restraining 
        orders and asset freezes, it needs to grow.

    Hiring a Chief Operating Officer/Business Manager: the 
        Division lacks a business manager or COO who can manage 
        administrative, information technology, project management, and 
        human resource issues. Additional staffing in the Office of 
        Collections and Distributions would be welcome, as our 
        attorney-investigators spend a significant amount of time doing 
        collection and distribution work--approving distribution plans 
        and distribution service providers--when they could be 
        investigating cases.

    Resources are critical, and I believe there is a compelling need at 
the Division for greater assistance. An increased budget would enhance 
significantly our ability to make the changes I believe we need to do 
our job to the best of our abilities. But as I told the SEC staff who 
gathered on my first day on the job, relying on new resources is a 
little like waiting for the cavalry--you don't know if they will come, 
you don't know when they will come, and you don't know how long they 
will stay. So it is our obligation--to those who are evaluating whether 
we should be afforded additional resources as well as to the taxpayer--
to efficiently use the resources we already have.
    To that end, our self-assessment effort is underway, in which we 
are asking ourselves a number of pointed questions to identify those 
changes that will allow us to be more efficient and successful. These 
questions include:

    Specialization: Should we increase our use of specialized 
        groups organized along product, market, or transactional lines, 
        in order to understand better the areas we investigate and to 
        see patterns, links, trends, and motives? Would such a 
        structure permit us to better gather in one place and harvest 
        the accumulated expertise that exists throughout the Division, 
        to target focused training at such a group, and to utilize 
        outside market specialists better?

    Management: Would a different management model enable us to 
        do our job with fewer managers, thus freeing up those 
        managers--including many highly talented and experienced 
        investigators--to conduct more investigations and bring more 
        cases?

    Approvals and Procedures: The Division has a number of 
        processes by which approvals must be secured at the highest 
        level of the Division. Are these approvals necessary or can 
        they be delegated to those running the investigations day-to-
        day? We are also considering whether changes to agency-wide 
        procedures will help make our processes more efficient.

    Metrics: Can we de-emphasize the current quantitative 
        metrics used to evaluate personnel and programs--the number of 
        cases opened and the number of cases filed--in favor of a more 
        qualitative standard, which includes concepts like timeliness, 
        programmatic significance, and deterrent effect of a case?

    National Program: Can we undertake efforts to break down 
        the roles that naturally exist when one is organized along a 
        regional basis and think of ways to encourage and incentivize 
        more collaboration across regions? (Specialization, in which 
        groups are created that are staffed nationally, could be one 
        way to do this.)

    Complaints, Tips, and Referrals: As Chairman Schapiro has 
        previously noted, we have retained Mitre, a Federally Funded 
        Research and Development Company, to advise us on how we can 
        better collect, record, investigate, refer, and track the 
        hundreds of thousands of complaints, tips, and referrals that 
        we receive each year. How can we analyze them better in order 
        to reveal links, trends, statistical deviations, and patterns 
        that might not be observable when they are examined on a less-
        than-comprehensive basis?

    Rewards: Would it improve our program to use tools that we 
        either already have, or would like to have, to reward persons 
        for coming forward with information about wrongdoers before it 
        is too late? Such tools include a whistleblower program and a 
        greater use of benefits--reduced sanctions, immunity, or 
        agreements similar to a deferred prosecution agreement--for 
        persons who come forward to identify and provide evidence 
        against those who violate the law. Some of the most credible 
        and valuable evidence is gathered in this manner by criminal 
        and other authorities, and we seek to determine if we are 
        taking full advantage of this opportunity. As Chairman Schapiro 
        has stated, we are actively considering coming to Congress soon 
        with a request for authority to compensate whistleblowers who 
        bring us well-documented evidence of fraudulent activity.

    Cooperation: Could we cooperate further with other law 
        enforcement agencies and regulators to leverage resources more 
        effectively? The Commission staff works closely with other 
        authorities, for example, in securities-related criminal 
        actions. The nature and extent of the cooperation varies from 
        case to case and can include referrals, the sharing of 
        information in parallel investigations, simultaneous actions, 
        and staff assistance on criminal cases. Additional cooperation 
        and coordination with criminal and other authorities may yield 
        even better results.

    These are, in broad strokes, some of the questions we are asking 
and changes we are considering. The focus, as I said, is on being more 
strategic, swift, smart, and successful in our job--protecting the 
investor.
Potential Legislative Changes
    As I discussed earlier, I believe that an increased budget would 
enable us to address our resource concerns better, both in terms of 
staffing and technological support. We greatly appreciate the support 
we have received time and again from you, Chairman Reed, as well as 
Chairman Dodd, Ranking Member Shelby, and many others on the Banking 
Committee who have advocated for the SEC on this front.
    With regard to specific legislative changes, there are a number of 
ways to broaden or clarify our authority so that we can better enforce 
the Federal securities laws and protect investors. I have discussed a 
number of items with Chairman Schapiro that would aid our enforcement 
efforts, including a whistleblower program, additional aiding and 
abetting authority, and legislation in areas such as swap agreements 
and hedge fund regulation. I understand that she will be providing some 
of these legislative recommendations to you very soon. These proposals 
will be aimed, in part, at ensuring we have sufficient authority and 
reach to combat fraud and other market misconduct.
    We also expect to request other legislative measures we have 
discussed with you in the past, which would provide important 
substantive and procedural tools to the Enforcement Division. Some of 
those include giving the Commission the authority to seek penalties in 
cease-and-desist proceedings and authorizing civil money penalties 
against aiders and abettors under the Investment Advisers Act. We also 
believe providing for nationwide service of process in civil actions 
filed in Federal courts would afford significant savings of travel 
costs and staff time through the elimination of duplicative depositions 
and adds the benefit of having live witnesses and party testimony 
before the trial court.
The GAO Report
    Let me now turn to the GAO Report. As Chairman Schapiro has noted, 
reinvigorating the SEC's enforcement program is a top priority for the 
Commission, and I welcome the GAO's report and recommendations. The GAO 
report and its recommendations are timely and dovetail with our 
proposed initiatives to strengthen our Enforcement Division, maximize 
our resources, and meet the challenges that lay ahead.
    The GAO's report has identified four specific recommendations for 
actions that the SEC can take to enhance the operations of our 
enforcement program. I agree with each of the recommendations.
To consider an alternative organizational structure and reporting 
        relationship for the Office of Collections and Distributions
    The Commission in September 2007 established a new centralized 
office, the Office of Collections and Distributions, to expedite the 
distribution of Commission recoveries to injured investors. The Office 
is responsible for overseeing the distribution of billions of dollars 
to investors who have been injured by securities laws violations, 
implementing the Division's collections and distributions programs, and 
conducting litigation to collect disgorgement and penalties imposed in 
certain Enforcement actions. In addition, the Office tracks, records, 
and provides financial management assistance with respect to the 
distribution funds, and provides overall case management for the 
Division.
    The GAO's review has identified the need for improvements to the 
Office's organizational structure. The SEC agrees with this 
recommendation and is working to identify and evaluate various 
alternatives for reforming the Office's organizational structure. We 
are considering how best to improve the administration of the Office of 
Collections and Distributions and to make sure that the Office's 
workflows and processes are run efficiently. By making the necessary 
changes, we hope to enhance the Commission's ability to collect 
disgorgement and penalties and swiftly and efficiently distribute the 
monies to harmed investors.
To further review the level and mix of resources dedicated to 
        Enforcement, and assess the impact that the Division's current 
        review and approval process for investigative staff work has on 
        organizational culture and the ability to bring timely 
        enforcement actions
    Declining staffing levels have had an impact on the SEC's ability 
to pursue an aggressive enforcement program. The GAO report notes that 
the total number of staff who work in the enforcement program is down 
4.4 percent since 2005, and the total number of nonsupervisory 
investigative attorneys is down even more significantly, by 11.5 
percent, since 2004. The report also identifies the need for additional 
resources in Enforcement devoted to administrative and paralegal 
support, information technology support, and specialized services and 
expertise.
    I concur with GAO's recommendation. Given the number of Enforcement 
Division staff as compared with the broad area that is potentially 
under our purview, it is clear that smart and strategic use of 
resources is critical to the success of our mission to protect 
investors. I have consulted at length with Division staff, as well as 
with the Chairman, to find ways to work smarter with our current 
resources and to identify the highest impact use of any additional 
funds that Congress may provide. As described above, I believe we need 
to allocate more resources to administrative and paralegal support, 
information technology, trial lawyers, and to hiring a COO/business 
manager. With regard to specialized services and expertise, as outlined 
above, I am also exploring the increased use of specialized groups as a 
way to enhance our understanding of the areas we investigate and our 
ability to see patterns, links, trends, and motives. Such groups may 
also provide a better forum in which to hire persons with specialized 
expertise in various aspects of the securities industry to improve our 
collective ability to detect fraud and prosecute violators. Similarly, 
a national program that reaches across the current regional lines may 
enable us to share information and expertise better.
    The GAO report also identifies the need to ensure efficiency in the 
internal case review process so that Enforcement staff can bring 
enforcement cases more quickly and spend more time on investigations. I 
concur with this recommendation. To this end, as outlined above, we are 
exploring changes in management structure and whether certain 
procedures and processes are necessary or can be improved.
To examine the effects of the 2006 corporate penalty policy to 
        determine whether the policy is achieving its stated goals, and 
        any other effects the policy may have had in adoption or 
        implementation
    In January 2006, the Commission issued a Statement Concerning 
Financial Penalties. The Statement identified two key considerations 
and seven additional factors to be considered in determining whether to 
impose a penalty. The two key considerations are (1) the presence or 
absence of a direct benefit to the corporation as a result of the 
violation; and (2) the degree to which the penalty will recompense or 
further harm the injured shareholders. The other factors are the need 
to deter the particular type of offense, the extent of the injury to 
innocent parties, whether complicity in the violation is widespread 
throughout the corporation, the level of intent on the part of the 
perpetrators, the degree of difficulty in detecting the particular type 
of offense, the presence or lack of remedial steps by the corporation, 
and the extent of cooperation with Commission and other law 
enforcement. The purpose of the guidelines was to provide ``clarity, 
consistency, and predictability'' to the issuer penalty process.
    I concur with the recommendation in the GAO Report that the 
Commission examine whether the 2006 corporate penalty policy is 
achieving its intended goals. Although my tenure has only recently 
begun, I have already initiated discussions with various members of the 
staff and will report back to the Commission with findings and 
recommendations. To me, however, the focus of any penalty policy should 
be assurance that malefactors get appropriately severe sanctions to 
sufficiently deter them and others from engaging in similar misconduct 
in the future.
    The GAO Report also raised concerns about the Commission's 2007 
``penalty pilot'' program. Before I arrived, Chairman Schapiro ended 
the 2007 ``penalty pilot'' program, which had required Enforcement 
staff to obtain a special set of approvals from the Commission in cases 
involving civil monetary penalties against public companies as 
punishment for securities fraud. I believe this decision has had a 
positive effect on Enforcement staff.
To take steps to ensure that the Commission, in creating, monitoring, 
        and evaluating its policies, follows the agency strategic goal 
        and other best practices for communication with, and 
        involvement of, the staff affected by such changes
    Finally, the GAO recommends that the SEC take steps to ensure that 
the Commission better involves, and communicates with, Enforcement 
staff in its decision-making process relating to the management of the 
Enforcement program. Again, I concur with this recommendation. 
Communication is a top priority and critical not only to the effective 
performance of our jobs but to one of our most important intangibles--
the morale of our staff on the ground. I am a strong believer that all 
constituencies should be heard. Since my arrival at the SEC, I have 
conducted Enforcement-wide Town Hall meetings, I have met individually 
and in groups with many members of the staff and with the management of 
the Division, I have solicited commentary and feedback and brainstormed 
with Division managers on the restructuring of the Enforcement Division 
and other issues, and I have asked and will continue to ask for input 
from Enforcement staff and others. I intend to keep the lines of 
communication open not only within Enforcement, but with other SEC 
Divisions and Offices and with the Chairman and the Commissioners.
Conclusion
    I would like to thank you again for the privilege and opportunity 
to appear before you today, and to thank the GAO and its staff for 
their hard work and cooperation. I would be happy to answer any 
questions you might have.

                PREPARED STATEMENT OF MERCER E. BULLARD
                      Associate Professor of Law,
              The University of Mississippi School of Law
                              May 7, 2009
    Chairman Reed, Ranking Member Bunning, Members of the Subcommittee, 
thank you for the opportunity to appear before you to discuss the SEC's 
enforcement program. It is an honor and a privilege to appear before 
the Subcommittee today.
    I began my career working on SEC investigations at WilmerHale, 
served as an Assistant Chief Counsel in the SEC's investment management 
division, and more recently have provided expert witness services in 
plaintiffs and defendants in private securities cases and public 
enforcement matters. I am currently an Associate Professor of Law at 
the University of Mississippi School of Law, the Founder and President 
of Fund Democracy, a nonprofit advocacy group for mutual fund 
shareholders, and a senior adviser with the financial planning firm 
Plancorp, Inc. I am testifying today based on my general securities law 
experience, rather than in my advocacy capacity.
Introduction
    The GAO Report, SEC: Great Attention Needed to Enhance 
Communication and Utilization of Resources Within the Division of 
Enforcement, provides strong evidentiary support for what many have 
known for quite some time. The SEC enforcement division's effectiveness 
has been compromised, both by a lack of resources and poor leadership 
by the Commission itself. The appointment of Mary Schapiro as Chairman 
is a strong step toward solving the problem of leadership within the 
Commission. Throughout her career, Chairman Schapiro has demonstrated a 
solid commitment to a vigorous and effective enforcement program. In 
her very short tenure, she has already taken decisive steps to end some 
of the practices that have hindered the Commission's enforcement 
program in recent years.
    The problem of a lack of resources, however, remains unsolved. The 
Commission does not have the funds necessary to provide the level of 
enforcement necessary to protect investors and promote efficient 
capital markets. I strongly recommend that Congress substantially 
increase the SEC's appropriation to enable Chairman Schapiro and the 
SEC's enforcement staff to do the job that they are better at than 
anyone else. This is not just a matter of adequate enforcement; it is 
also a matter of justice for investigated entities. Inadequate 
resources often have the effect of unfairly increasing burdens on 
parties defending SEC investigations.
    The importance of the SEC's enforcement program cannot be 
underestimated. The Commission is the leading voice for enforcement of 
securities laws and the development of free capital markets not only in 
the United States, but worldwide. When the Commission speaks, it makes 
uniform law across all 50 States that private actors can rely on to 
guide their business practices. When the Commission remains silent, the 
void is filled with the noise of dozens of regulators and courts in 
private actions creating a patchwork of rules. It is incumbent on the 
Commission to provide the coherence and uniformity in the securities 
laws that only it can provide. And it is incumbent on Congress to 
provide the Commission with the resources it needs to do so.
    The remainder of this testimony is divided into two parts. The 
first part discusses some of the findings of the GAO Report and 
recommends reforms that the Commission should consider in the process 
of revitalizing its enforcement program. The second part discusses 
other issues that relate to a number of occasions on which the 
Commission has failed to take action in the face of known industry 
abuses, and proposes two analyses of what might be the causes of this 
problem.
GAO Report
    The GAO Report provides useful insight regarding how the Commission 
can most effectively and efficiently fulfill its enforcement role. The 
input provided to the GAO by SEC staff draws a very clear picture of 
potential areas of improvement, as discussed further below.
    Consensus Management. The most striking aspect of the GAO's Report 
is the picture it presents of the apparent subversion of the SEC's 
enforcement program through the efforts of individual Commissioners. 
The GAO reported that individual Commissioners blamed ``the quality of 
management'' in the enforcement division for declining amounts of 
penalties and disgorgement, even while the same Commissioners 
apparently spearheaded efforts to require pre-approval of penalties. 
Individual Commissioners claimed that ``the staff elect[ed] on its own 
to retreat from penalties,'' although the GAO found that staff 
consistently interpreted Commission positions to have been intended to 
have this effect. In a very revealing admission, an individual 
Commissioner emphasized that it was ``important to understand that the 
division worked at the direction of the Commission, not as an 
independent entity.'' This apparent desire by individual Commissioners 
to ``remind the staff who's boss,'' coupled with Chairman Cox's 
publicly expressed preference for consensus on the Commission, was a 
recipe for disaster and explains much about the recent deterioration in 
the Commission's enforcement program. The GAO reports that penalty pre-
approval policy was developed without input from the enforcement 
division when it should have been the division that produced the first 
draft of such a policy. The GAO reports that controversial cases were 
frequently re-calendered. The seriatim approval of investigations was 
suspended. As a whole, these findings paint a troubling picture of a 
concerted effort to impede the enforcement of the securities laws from 
within the Commission itself. \1\
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     \1\  There is strong evidence of similarly subversive intent with 
respect to various Commission rule makings where a number of public 
dissents seemed to have been written more for the purpose of aiding and 
abetting challenges to the Commission's authority than documenting 
constructive grounds of disagreement.
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    This should not be read as a critique of the ideological views or 
motives of certain Commissioners, who may have had well-meaning 
intentions to introduce newer ideological perspectives to the 
Commission's enforcement culture. Indeed, I agree with their general 
ideological misgivings regarding the efficacy of certain corporate 
penalties and encourage the Commission to continue to work through the 
problem of promoting corporate deterrence without harming innocent 
shareholders. But there is a right way and a wrong way to seek to 
influence the culture of an organization. The GAO Report provides a 
roadmap of how the wrong approach taken by individual Commissioners, 
especially when coupled with the enabling effect of the Chairman's 
desire for consensus, can have disastrous consequences.
    The Commission appears to be well on its way to correcting this 
situation. Chairman Schapiro has wasted no time in suspending the 
``penalty pilot'' program and ordering a review of the 2006 corporate 
penalty statement; reinstating seriatim or individual approval of 
formal orders of investigation; and ending the re-calendaring process. 
These are important steps, but misguided, subversive interference by 
individual Commissioners will not cease unless the Chairman is willing 
to prosecute cases without reaching a consensus. Chairman Schapiro's 
March 25, 2009, letter to the GAO, in which she specifically noted that 
the re-calendaring resulted from a perceived need for ``consensus,'' 
seems to signal that she will not tolerate the undermining of the 
Commission's enforcement program from within.
    Disfavoring Cases Involving Industry-wide Practices. The GAO Report 
refers to a single statement by an enforcement manager that the 
Commission disfavors industry-wide ``issues,'' preferring instead to 
handle these issues through the rule-making process. Certainly a single 
statement is not necessarily representative of an office-wide position, 
but it echoes sentiments frequently expressed in the securities bar and 
should be considered carefully. The statement raises two issues.
    First, to the extent that ``issues'' is a euphemism for clear 
violations of the securities laws, then industry-wide cases are the 
most important cases for the enforcement division to bring. When clear 
misconduct has become pervasive, public confidence in the capital 
markets is undermined. A strong enforcement response is critical. That 
being said, an enforcement response to industry-wide violations need 
not include enforcement actions against every violator. As discussed in 
greater detail in the second part of this testimony, the Commission 
does not add value by investing resources in bringing dozens of cases 
involving the same misconduct once it has clearly established its 
position. Rather than pursuing the 15th or 20th mutual fund market 
timing case, the Commission should invest those resources in 
identifying other areas of misconduct before they becomes industry-
wide. Chairman Schapiro's recent statement that the Commission has 
``150 active hedge fund investigations'' \2\ raises the question of 
whether the incremental benefit from the 20th, 50th, or 100th hedge 
fund investigation is greater than the incremental benefit that could 
be gained by assessing risks and identifying cases in other areas.
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     \2\  Comments of Mary Schapiro, Chairman, Securities and Exchange 
Commission, before the Society of American Business Editors and Writers 
(Apr. 27, 2009) available at http://www.sec.gov/news/speech/2009/
spch042709mls.htm.
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    Second, if the term ``issues'' is a euphemism for misconduct that 
the law does not clearly prohibit, then no enforcement actions should 
be brought. This is the ``gotcha'' problem about which defense lawyers 
often complain. A small number of industry participants may seek a 
competitive advantage by engaging in questionable practices, and, when 
the Commission does nothing in response, an industry-wide issue is 
created when the practices become widespread. Enforcement cases should 
not be used to correct such misconduct. In this case, good enforcement 
practice is to ensure that the SEC's operating divisions act promptly 
to provide public clarification of industry members' legal obligations, 
including rule making as necessary.
    Resource Allocation. Many of the complaints expressed by SEC staff 
may reflect a failure to balance priorities rather than inadequate 
resources. For example, assume that an office of 12 attorneys needs two 
administrative staff, one accountant, and a $1,000 technology 
investment, but it has only one administrative person. The best 
solution may be to fill the next attorney vacancies with an 
administrative person and accountant and to spend the remaining funds 
on the technology. As noted in the GAO Report, however, the Commission 
may have a tendency to overhire lawyers. \3\ This means that increasing 
the SEC's budget could actually exacerbate the complained about 
shortages. If, in the foregoing example, the Commission used additional 
funding to hire another 12 attorneys, the funding would actually make 
the resource shortfall worse. The shortfall of administrative staff, 
accountants, and technology would be increased. Thus, it may be top-
heavy staffing that creates scarcity, not a lack of funding. The 
Commission should ensure that, regardless of funding levels, resources 
are allocated efficiently so as not to create unnecessary imbalances.
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     \3\  See GAO Report at 29.
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    Internal Review. Another example of internally created resource 
constraints is what the Report describes as ``the burden of the 
division's internal review.'' \4\ As reported by the GAO, Commission 
action memoranda may be subject to five or six layers of overlapping 
review before being presented to the Commission. There are many legal 
offices in the Federal government that manage with a substantially 
flatter structure than the SEC. It is not unusual for a single attorney 
to supervise dozens of senior lawyers. In contrast, the Commission (not 
just the enforcement division) uses multiple supervisory layers that 
create inevitable backlogs. The Commission should flatten its reporting 
not only in the enforcement division, but throughout the Commission. 
The first step would be eliminate branch chief positions across the 
Commission and replace them with a kind of senior staff designation. 
Case supervision should be provided by an Assistant Director or 
Associate Director, but not both. Similarly, work product such as 
action memoranda should be reviewed by an Assistant Director or 
Associate Director, but not by both, before being reviewed by the 
Director. Many matters should be able to taken to the Commission 
without the Director's direct involvement. In addition, the Commission 
should also consider limiting more senior review to a summary document 
that is most likely to receive the most attention from the Commission. 
Conversely, Commissioners should not be expected to flyspeck every 
detail of every enforcement action, an expectation that, based on 
recent experience, may need to be expressly enforced by the Chairman.
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     \4\  See GAO Report at 28.
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Other Issues
    One important SEC management issue that is not addressed by the GAO 
Report, or least this GAO Report, is the SEC's recent record of 
inaction with respect to known abuses in the securities industry. In a 
number of areas, the Commission has abdicated its policymaking 
responsibilities to State regulators and private litigants. The result 
has been a decline in public confidence in the markets, a reduction in 
investor protection, and an increase in uncertainty regarding 
applicable legal standards. This part of this testimony provides 
examples of this problem and proposes two analyses of its potential 
source and possible solutions.
    For example, in the early part of the decade a number of States 
initiated enforcement actions relating to mutual fund trading practices 
and analysts' conflicts of interests. The problem of stale pricing by 
mutual funds and accompanying trading abuses had been well-known to the 
Commission for years. The Commission took no action to address these 
abuses which expanded to cover a large segment of the fund industry. 
Ultimately, whistleblowers took their cases to State regulators (in one 
case after having been rebuffed by the SEC), who then brought 
enforcement actions against dozens of fund managers, traders and 
salespersons.
    State actions relating to analysts' conflicts of interest reflect a 
similar pattern. The problem of analysts' recommending securities in 
order to attract and retain investment banking business was well-known 
before the New York Attorney General began his investigation. The 
investment banking industry complained that State prosecutions 
threatened to create a 50-State patchwork of regulatory standards, a 
situation that could have been avoided if the Commission had previously 
established uniform standards governing analysts' conflicts. There has 
never been a more obvious or greater risk of analysts' conflicts than 
during the Internet boom of the late 1990s, yet the Commission was 
unable to provide effective oversight and address conflicts of interest 
before they became systemic.
    The Commission has continued to allow States to take the lead on 
other known abuses in the securities markets. Massachusetts, New 
Hampshire, and California have brought cases relating to the 
nondisclosure of conflict of interest payments in connection with fund 
sales. For years, the Commission was aware that funds were compensating 
brokers for selling fund shares by directing brokerage to the brokers' 
firms. It banned this practice only after State enforcement actions 
directed attention to the problem. The Commission also was aware that 
funds had been making undisclosed revenue sharing payments to brokers. 
The Commission has yet to establish a clear legal standard for the 
disclosure of such payments, leaving it to State regulators and the 
plaintiffs' bar to protect investors from such abuses.
    Most recently, States have brought a slew of cases in connection 
with mutual funds in 529 plans that improperly allocated assets to 
high-risk investments. These plans offered investment options with 
substantial equity components for children who were expected to begin 
college in 1 to 2 years. Once again, the Commission is sitting on the 
sidelines, apparently willing to leave the solution to a national 
problem to the States. The result is likely to be a patchwork of 
conflicting court decisions on the disclosure obligations of mutual 
funds. In the meantime, investors who simply wanted an easy way to 
invest for their children's college education have been left wondering 
what is the purpose of securities regulation that can be so fatally 
inadequate. (I note that just prior to the finalizing of this 
testimony, Chairman Schapiro made remarks regarding target-date funds 
that may indicate a change in the SEC's approach to this area. \5\)
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     \5\  See Remarks of Mary Schapiro, Chairman, Securities and 
Exchange Commission, before the Mutual Fund Directors Forum Ninth 
Annual Policy Conference (May 4, 2009) available at http://www.sec.gov/
news/speech/2009/spch050409mls.htm.
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    In other areas, the Commission has abdicated its responsibility to 
establish uniform standards to private litigants and Federal courts. 
The most glaring example is excessive fee claims under section 36(b) of 
the Investment Company Act. That provision was enacted in 1970 
specifically at the behest of the Commission in order to establish an 
express fiduciary duty for advisers with respect to compensation 
received from mutual funds. It granted express enforcement authority to 
the SEC, but the agency has never brought an excessive fees case. In 
contrast, the New York Attorney General extracted a number of 
settlements from funds that charged excessive fees and initiated 
litigation for charging excessive fees against at least one fund 
manager. Remarkably, the Commission criticized the NYAG for bringing 
these cases even while the Commission itself had never taken any steps 
to establish standards for excessive fees.
    Not surprisingly, in the absence of clear regulatory guidance not 
one private claim under section 36(b) has prevailed in a litigated 
action (there have been substantial settlements). A U.S. Court of 
Appeals panel recently held that, in effect, a mutual fund fee set in a 
``free'' market cannot be excessive. The Supreme Court has granted 
certiorari in that case, yet there is still no sign that it will have 
the benefit of any guidance from the agency responsible for creating 
and administering this Federal claim. The Commission remains silent. 
The Commission apparently believes that there is no such thing as an 
excessive mutual fund fee and that it has no responsibility to give 
content to statutory standards for which it is primarily responsible. 
It is likely that, even after the Supreme Court establishes a new 
standard for excessive fees cases, the industry and plaintiffs' lawyers 
will spend millions of dollars litigating its meaning, fund directors 
will continue to flounder when reviewing fund fee arrangements, and the 
Commission will sit by doing nothing.
    Each of these cases involves an open and notorious problem in the 
securities markets that the Commission has ignored until forced to act 
under public pressure. This is not a complete list. One could add the 
failure of the auction-rate securities market and the options 
backdating scandal, among others. Indeed, the current liquidity crisis 
in fixed income instruments is partly the result of the SEC's failure 
to push more aggressively for the development of liquid debt markets. 
Somehow a division of the Commission that exists for the purpose of 
enforcing the securities laws has demonstrated willful blindness until 
abuses became so widespread that they were impossible to ignore. What 
enables or motivates State regulators with fewer resources and less 
depth of expertise than the Commission to bring these cases? Why does 
the Commission wait until misconduct reaches epic proportions before 
taking action?
    There are no definitive answers to these questions. The following 
discussion provides two analyses of the SEC's enforcement program that 
are intended to foster debate and prompt action. The first analysis 
posits that a misapplication of the principle of deregulation has 
caused a kind of regulatory paralysis at the Commission that has 
resulted in the delegation of the SEC's enforcement responsibilities to 
less efficient, State and private legal mechanisms. The second analysis 
posits that the dominant metrics used to measure the SEC's enforcement 
success has resulted in an inefficient and ineffective allocation of 
resources.
The Myth of Deregulation
    One answer may be that the SEC staff as a whole has become 
paralyzed by a misapplication of deregulatory principles. One of the 
positive developments of the 1990s was the introduction of deregulatory 
thinking at the SEC. In its positive form, deregulation refers to 
regulation that seeks to maximize societal gain while minimizing 
societal cost. Deregulation, properly understood and applied, 
strengthens investor protection and capital markets. But the principle 
of deregulation as understood and applied by the Commission has long 
since devolved into a reductive version that equates deregulation with 
the simplistic mantra of ``let free markets decide.'' The problem with 
this populist version of deregulation is that, in the absence of SEC 
action, the free markets are likely to have less influence, not more.
    Effective deregulation does not mean nonregulation or inaction in 
the face of change. Deregulation refers to a kind of affirmative 
regulation. When the SEC's position on the law regarding an area of 
legal duties is unclear, deregulation does not always mean it should 
leave it to ``free markets'' to resolve the uncertainty. The idea that 
the markets in this sense are the ``markets'' of privately contracted 
arrangements is an illusion. In the absence of clear SEC guidance, the 
``markets'' that guide the conduct of private actors are the panoply of 
alternative policymaking and dispute resolution structures that 
naturally fill in the void created by SEC inaction. They are the 50 
State attorneys general; hundreds of State securities enforcement 
staff; thousands of State courts; hundreds of Federal bankruptcy 
courts, district courts, and courts of appeal; State and Federal 
banking regulators; the Department of Labor; the Department of Justice; 
and others. The list is a long one, but no one on it has the 
expertise--the capital markets expertise--and the ability to establish 
efficient, uniform capital markets standards as the SEC. When the 
Commission fails to establish standards of conduct, the standards will 
be established by other regulatory means. The result of this populist 
version of ``deregulation'' actually leads to more costly, less 
efficient regulation. This kind of ``deregulation'' leads to regulatory 
anarchy, not regulatory efficiency. It should be kept caged in the 
academic zoo where it was conceived and can do no real harm.
    The operation of an efficiently ``deregulatory'' regime is not 
reflected in bureaucratic paralysis, but in decisive action that is 
based on full consideration of the costs and benefits of regulation. 
The view that ``deregulation'' means a kind of regulatory neutrality 
consigns the financial services industry to being whipsawed back and 
forth between periods of inaction and a convulsive overreaction This is 
not merely a problem with SEC enforcement. It is a problem across the 
full spectrum of financial services regulation. An extended period of 
populist deregulation (as opposed to productive deregulation) has left 
glaring problems unaddressed for years, and the current regulatory 
response in some areas has initiated some of the most excessive over-
regulation this country has ever seen.
    In short, the problems experienced in the SEC's enforcement program 
may reflect not industry capture, but deregulatory capture. The 
Commission was aware of, and ``working'' on, many of the problems 
underlying these enforcement matters before they surfaced as State and/
or private claims. But the Commission was unable to resolve them. In 
this ``deregulatory'' era, the staff has become so paralyzed that it 
has become unable to take definitive policy positions or bring 
enforcement actions. This is consistent with the enforcement staff's 
statements that internal case review roadblocks ``created a risk-averse 
culture.'' In many instances, this paralysis has not resulted in less 
regulation, but more. The SEC's failure to take definitive policy 
positions handcuffs its own enforcement efforts, \6\ creates legal 
uncertainty, and increases private and State litigation.
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     \6\  The GAO reported that a number of SEC enforcement staff 
perceived ``that other divisions have become too influential in 
effectively controlling Enforcement activities.'' GAO Report at 28. 
This is not surprising because the SEC's operating divisions are far 
more risk averse and susceptible to outside influence than the 
enforcement division.
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    The SEC's failure to correct stale pricing by mutual funds, 
commission overcharges by brokers, options backdating by executives, 
conflicted recommendations by analysts and similar misconduct early on 
in its evolution, and its continuing failure to establish standards for 
the disclosure of revenue sharing and excessive mutual fund fees, for 
example, impose costs not only on investors, but also on the financial 
services industry. When known misconduct becomes widespread, it becomes 
difficult for compliance officers and legal counsel to persuade their 
clients that the misconduct is illegal. Firms that seek to compete in a 
free enterprise market are undercut by those who compete by breaking 
the rules. In some cases, the internal tension created by the 
misconduct escalates until it reaches crisis levels and public pressure 
forces the Commission to act. The inefficiencies and competitive 
distortions created by ignored misconduct are resolved in an expensive, 
time-consuming spasm of litigation and over-regulation. In cases that 
never escalate to this level, the regulatory void created by SEC 
inaction operates as a permanent tax on financial services. Mutual 
funds are left defending revenue sharing and excessive fee cases 
brought by States and private litigants largely because the Commission 
has not established clear regulatory guidance.
    The SEC's position on target-date funds provides another 
illustration. A number of target-date 2010 funds (intended for workers 
retiring around that year) have invested far more in equities than 
would normally be considered prudent. When Congress asked the 
Commission about this problem, the SEC's response was as follows:

        Given that there is variation among investment professionals 
        regarding the appropriate allocation of assets as investors 
        age, our review of target date funds has generally focused upon 
        ensuring that prospectuses provide full disclose of the asset 
        allocations in the funds and the corresponding strategies and 
        risks related to these allocations. By ensuring [that] funds 
        provide full disclosure, plan fiduciaries and investors are 
        then able to assess the appropriateness of these funds as 
        investment options.

This response is wrong as a matter of law and gratuitously provides 
litigation support to funds that use misleading names. But this 
critique is, admittedly, a policy critique. The deeper problem is that 
it is completely unresponsive. It does not address the fact that many 
investors will expect a target date 2010 fund to invest according to a 
typical allocation for someone very near retirement--regardless of what 
the prospectus says or how clearly it says it. Like the sponsors of 
these funds, the Commission is hiding behind the prospectus language 
that it permits to directly contradict the impression created by the 
fund's name, although recent statements appearing in press reports. And 
the lack of legal clarity on this issue will result in unnecessary 
losses for investors and unnecessary litigation for all concerned.
    I believe that the Commission should require that a ``Target-Date 
2010 Fund'' should be required to invest consistent with a conventional 
asset allocation for someone at the brink of retirement. But again, 
that is one viewpoint. The point here is not that the Commission should 
take a particular policy position, but that the Commission has no real 
policy on the issue at all. Even if the Commission were to take the 
position that the fund's name could not be inherently misleading--no 
matter how strongly suggestive it was--if the impression created by the 
name was corrected by fund disclosure (essentially codifying a kind of 
bespeaks caution analysis), investors and the industry would be better 
off than they are with the SEC's ``deregulatory'' pablum quoted above. 
The SEC's guidance regarding ``full disclosure'' is the functional 
equivalent of a prescription to go forth and litigate and let us know 
how it all comes out. (I note that just prior to the finalizing of this 
testimony, Chairman Schapiro made remarks indicating that the 
Commission was reconsidering a disclosure-only approach to the issue of 
target-date funds. \7\)
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     \7\  See supra note 5.
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The Metrics of SEC Enforcement
    Another answer may be that the Commission has become captured by 
its own metrics. The most common measure of the enforcement division's 
performance has become the number of investigations it opens and cases 
it files in a fiscal year. \8\ It is no coincidence that this metric 
matches up with the kind of epic investigations that the Commission 
often launches under public pressure. After bringing a few enforcement 
cases based on similar fact patterns, the deterrence benefit rapidly 
diminishes, but the efficiency with which the Commission can rack up 
additional settlements increases. The Commission uses a metric that 
provides an incentive to bring dozens of cookie cutter cases where it 
can spread the fixed costs of the investigation over a large caseload.
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     \8\  See GAO Report at 21-22 (``Enforcement officials said they 
focus on two process-oriented performance indicators to track the 
division's activities: number of investigations opened annually, and 
number of enforcement actions filed annually.'').
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    For example, consider the most recent settlement in the never-
ending mutual fund trading scandal. The most recent of these cases was 
settled just 2 weeks ago. The alleged misconduct took place between 
2000 and 2003, it was very similar to misconduct alleged in dozens of 
previous cases, and the charge was mere negligence. If this prosecution 
was typical, it involved numerous, often redundant and expansive 
document requests demanding immediate compliance followed by extended 
periods of SEC inactivity and silence. The individuals remained under 
the cloud of the investigation throughout this period with no 
indication as to the SEC's position on their culpability. At the end of 
the investigation, the settlement broke no new ground, provided no 
additional general deterrence, and did not even finalize the amount to 
be disgorged, that process having been left to a distribution 
consultant to be retained well into the next decade. Remarkably, most 
of the rule-making initiatives arising out of the mutual fund scandal 
were developed, proposed, and adopted long before many cases were 
closed. Most lawyers who defend SEC investigations probably would agree 
that the process leading to a settlement is usually far more costly and 
burdensome than the penalties ultimately imposed.
    But bringing large numbers of cases in a limited number of areas of 
misconduct matches the metric of producing the largest number of 
settlements. By analogy, if the Center for Disease Control's success 
were measured by the number of swine flu victims who were cured after 
an outbreak had been identified, it would have an incentive to invest 
in curing large numbers of victims rather than in detecting the 
earliest signs of an epidemic and preventing its spread. While the 
Commission is developing its 50th mutual fund trading case, the staff 
working on that case is not seeking to identify the seeds of the next 
enforcement problem. When those seeds germinate and bloom into a 
systemic crisis, the Commission will shift resources to another endless 
series of cases while other problems begin to take root.
    The BISYS case provides a current illustration of the likely 
overcommitment of resources to stale matters. In September 2006, the 
Commission reached a settlement with BISYS Fund Services, Inc., that 
was based on BISYS's payments to 27 unnamed fund managers in return for 
their recommending that their funds use BISYS as the fund's 
administrator. The arrangements were in place from June 1999 and July 
2004, which means that more than 2 years already had passed before the 
Commission settled with BISYS. Since then, the Commission has settled 
with only one of the 27 fund managers, and that occurred another 2 
years after the BISYS settlement, in September 2008. \9\ The fund 
managers' arrangements with BISYS had already been terminated for over 
4 years. Many of the funds have reached private settlements with the 
fund managers who were involved in the scandal. But the fate of the 
other 26 fund managers appears to remain unresolved. The investigations 
regarding the unlucky 26 are probably ongoing, with some inching toward 
a resolution and others floating motionless in an investigation 
purgatory awaiting a final decision on their fate. \10\
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     \9\  See In the Matter of AmSouth Bank, Admin. Proc. No. 3-13230 
(Sep. 23, 2008) available at http://www.sec.gov/litigation/admin/2008/
ia-2784a.pdf.
     \10\  The GAO reports a 264 percent increase in case closings from 
2007 to 2008, which officials attributed, in part, to new quarterly 
reports that list cases that are 5 or more years old. See GAO Report at 
14. On the one hand, the staff should be applauded for this dramatic 
increase in case closing. On the other hand, cases should be considered 
old long before they reach the 5-year mark. In a real-time enforcement 
environment, any case older than 2 years should carry a rebuttable 
presumption that it should be closed.
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    In lieu of the staff time invested in settling cases based on 
ancient misconduct, the Commission could have been looking for 
developing problems in other areas. This approach to the allocation of 
staff resources would result in a smaller number of settlements, 
however, and current indications are that the Commission is committed 
to keeping its numbers up. The SEC Chairman recently stated, for 
example, that the Commission has ``150 active hedge fund 
investigations,'' ``two dozen active municipal securities 
investigations,'' and ``50 current investigations involving Credit 
Default Swaps, [CDOs] and other derivatives-related investments.'' \11\ 
That totals 224 investigations, all of which are, not surprisingly, in 
areas that have recently received a great deal of public attention. 
While these matters should be investigated, is it prudent to commit the 
resources necessary to investigate 150 hedge funds? Why not only 20, or 
50, or even 100? Are these investigations triggered primarily by 
allegations of alleged misconduct or by simply being a large hedge 
fund? Hedge funds and credit default swaps are generally purchased by 
sophisticated investors. What about investigations of the losses 
suffered in 529 plans by investors who will not be able to afford to 
send their children to college? Or in target-date 2010 funds by 65-
year-old investors who will not be able to retire? Like the dozens of 
mutual fund trading, options backdating, and other massive 
investigations, the current slew of topical matters will take years to 
resolve.
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     \11\  Comments of Mary Schapiro, Chairman, Securities and Exchange 
Commission, Before the Society of American Business Editors and Writers 
(Apr. 27, 2009) available at http://www.sec.gov/news/speech/2009/
spch042709mls.htm.
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    The Commission needs to bring a smaller number of targeted 
enforcement cases covering a wide range of activities in real-time, not 
develop a massive caseload of factually similar cases in a narrow set 
of circumstances over a 5- or 10-year period. To do this, the 
Commission needs to develop new metrics, which will require new 
settlement strategies. For example, it should develop a self-reporting 
approach to suspected widespread misconduct. The company internal 
investigation that is conducted promptly (within 4 months) and credibly 
and accompanied by a fair resolution for injured parties should be 
rewarded; the laggard that produces a half-hearted investigation 
without any clear resolution should be penalized and considered for 
formal prosecution. Entities do not engage in wrongdoing, people do, 
and those people generally do not include independent directors. If the 
Commission promises to reward shareholders whose independent directors 
engage in prompt investigation, cooperation, and mitigation, the 
shareholders and their boards will have a strong incentive to conduct 
an expedited, impartial investigation, leaving a smaller number of more 
egregious cases on which the SEC staff can focus. (Admittedly, the 
efficacy of this approach is undermined when the chairman is also the 
CEO whose oversight and individual conduct are inevitably the subject 
of investigation.)
    Once these potential enforcement targets have been identified, the 
Commission should establish real-time enforcement guidelines that are 
designed to produce a settlement or a complaint within 18 months. This 
will often mean winnowing out the less egregious or more complex cases, 
even where there is known misconduct. But it is not the SEC's role to 
bring enforcement actions against every wrongdoer. It is the SEC's duty 
to use its unique position to deter misconduct, communicate and set 
uniform standards, and inspire confidence in the rules governing the 
financial markets. A small number of targeted enforcement actions 
brought (and section 21(a) reports issued) on a real-time basis will 
allow the Commission to invest resources in identifying abuses before 
they become systemic while sending strong signals to compliance 
officers about what kinds of conduct will not be tolerated.
    This approach cannot succeed, however, without the development of 
explicit metrics against which the Commission publicly measures its 
performance that are keyed to fewer cases brought across a wider 
spectrum of misconduct. If the SEC's performance continues to be 
measured by the number of cases that it brings, it inevitably will, 
consciously or otherwise, tend to strategies that produce more cases. 
New metrics must be explicitly adopted and past performance re-
evaluated in light of those metrics. The first step might be to 
determine the range of types of cases brought in the previous fiscal 
year and actively promote this measure as an alternative benchmark to 
gross numbers of enforcement actions. Whatever alternative metrics are 
developed, they must be accompanied by repeated reminders by the 
Commission and senior staff that the Commission cannot and does not 
seek to bring every case. Calls for ever more enforcement staff create 
an impression that if the Commission only had enough staff it could 
detect every fraud and bring every case. The Commission needs more 
staff, but the staff needs clear direction that is consistent with its 
limited but critical role in a broad spectrum of regulatory mechanisms.
                                 ______
                                 

                   PREPARED STATEMENT OF BRUCE HILER
           Partner and Head of Securities Enforcement Group,
                   Cadwalader, Wickersham & Taft LLP
                              May 7, 2009
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee: I am pleased to have the opportunity today to testify 
concerning the responsibilities of the Securities and Exchange 
Commission and its Division of Enforcement in policing our financial 
markets and protecting investors. I formerly served as an attorney in 
the Division of Enforcement and as an Associate Director of the 
Division. I left the Commission in 1994 and have since been a partner 
in two different law firms, where I have represented clients in SEC and 
other governmental investigations, internal investigations, and 
securities litigation.
    Although recently the Commission, and particularly its enforcement 
efforts, have come under fire for reported lapses in detecting or in 
quickly reacting to the activities of some individuals in the 
marketplace, the Commission has long been viewed as a premier 
regulatory agency and, through its Division of Enforcement, a premier 
civil enforcement agency. If there have been lapses, I am confident 
that the Commission will evaluate those situations and develop new 
policies and procedures to avoid them in the future. In this regard, I 
think it is important to understand the effects that the vagaries of 
funding and resource allocation, the exponential expansion both of 
market activity and of sophisticated instruments and investment 
strategies, and the day-to-day pressure of operating in the glare of 
public scrutiny can have on any organization.
    Nevertheless, from the standpoint of a private practitioner who 
also served in the SEC's Division of Enforcement, I have seen a number 
of areas in which I believe the Commission's enforcement efforts could 
or should be modified or improved. In particular, there are three areas 
which I would like to discuss briefly today: the management structure 
of the Division of Enforcement; the availability of specialized 
resources to enforcement attorneys; and the relationship between the 
Commission and the market participants it regulates.
    First, I believe that the efficient and speedy resolution of SEC 
investigations is important both for effective public protection and 
enforcement efforts, as well as for ensuring fairness and justice to 
the subjects of the investigations. In my view, both the speed of 
resolution of enforcement investigations and the consistency and 
fairness of outcomes of those investigations could be enhanced by 
having fewer layers of management between those working day-to-day on 
investigations and those in the Division of Enforcement who ultimately 
must recommend to the Director of the Division whether an investigation 
should move forward or should be closed without action. However, this 
does not necessarily mean fewer management slots. Rather, in my view, 
it requires more positions for experienced, senior managers.
    Currently, in the Commission's D.C. headquarters offices, the 
Division has two deputy directors and five associate directors. Through 
assistant directors and branch chiefs, the associate directors 
indirectly supervise hundreds of investigative attorneys, and they may 
be supervising dozens, if not scores, of investigations and active 
litigations, in addition to fulfilling other management 
responsibilities. The associate and the deputy directors typically are 
among the most experienced professionals in the Division, and they are 
looked upon internally as having the judgment and expertise to make 
appropriate case recommendations. Yet, these are also the individuals 
who have the least amount of time to spend on any one matter, and who 
are relatively infrequently involved in any one particular matter on 
the day-to-day decision making or day-to-day review of facts, as they 
are discovered or analyzed by those directly involved in the 
investigations.
    In my view, there should be fewer layers between these senior 
individuals and those directly working on investigations. To best 
achieve this result, I believe the number of senior, experienced 
officials should be dramatically increased. These senior managers 
should be charged with direct involvement in the day-to-day activities 
of the matters under their supervision, and such matters should be kept 
to a reasonable case-load so that they can become familiar with key 
facts and issues as they develop, and can spend time directly reviewing 
the factual records.
    Second, efficiency must not be achieved at the expense of fairness 
or thorough evaluation. The SEC has a long history of careful 
evaluation of important and complex issues and constantly must guard 
against public pressure to act too quickly or to be rushed to 
enforcement resolutions which may have significant policy implications. 
The matters which the SEC investigates can be extremely complex, and 
some conduct may easily be made to appear nefarious to the public and 
in media reports because of its novel or complex nature. SEC 
investigations can involve sophisticated instruments and trading 
strategies, as well as complex issues, such as accounting, risk 
analysis, and economic modeling, that fall outside of the normal 
expertise of attorneys. Although there are individuals at the SEC with 
expertise in some of these areas, their numbers should be increased and 
the Commission should organize these individuals by expertise outside 
of the Division of Enforcement. These experts should be available to 
consult and to work day-to-day on enforcement investigations. I believe 
that the addition of a cadre of experts in a variety of fields to 
assist in enforcement inquiries could lead to more efficient and better 
informed decision making, and may assist in determining when issues are 
better resolved by way of considered regulatory or policy judgments.
    Third, I believe that the detection of fraudulent conduct is a 
difficult task, and no one can expect that the SEC or any agency will 
be able to anticipate specific frauds at specific entities. However, a 
regulator may be able to get early warning signs of conduct which may 
have become acceptable due to macroeconomic or social events, but 
which, on close examination, the Commission would like to halt or 
believes is not sufficiently understood such that it poses unknown 
dangers to the financial system. In order to get early warning signs of 
such conduct, I believe a regulator must maintain and foster an open 
line of communication with those in charge of compliance and management 
at the relevant entities. It is difficult to maintain open and 
sufficiently timely communication where the regulator or the regulated 
views the other with suspicion and where the regulated has reason to 
question the process by which its conduct is or will be judged. I 
believe that such an atmosphere of mutual suspicion began to develop in 
the last decade between the Commission and some of the entities with 
which it interacts.
    I believe that the causes of this mutual suspicion are varied. 
However, I believe that increased scrutiny by criminal authorities of 
securities law matters and public pressure on the SEC to hold anyone 
and everyone responsible for the stock market crash in 1999, for 
corporate bankruptcies and defalcations, and, more recently, for the 
current economic turmoil have contributed to this atmosphere. Increased 
attention to securities cases by criminal prosecutors is not in and of 
itself a cause for concern, but I believe that the line between civil 
securities cases and criminal securities-based fraud cases has been 
blurred, and that there has been a shift to an inappropriately low 
level in what authorities view as conduct that demonstrates sufficient 
scienter or ``state of mind'' to make even a civil securities case.
    The Commission should develop internal guidelines that set forth 
its views on the standards that should be applied in determining what 
constitutes ``fraud'' under the Federal securities laws. A starting 
point, for example, could be guidelines concerning permissible 
inferences that can be drawn in cases to support such a charge. The 
U.S. Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 
U.S. 308 (2007), recently held that, in determining whether the pleaded 
facts in a private securities fraud case give rise to the required 
``strong'' inference of scienter under applicable pleading standards, a 
court must take into account ``plausible opposing inferences.'' Id. at 
323. In other words, the court must consider ``plausible, nonculpable 
explanations for the defendant's conduct,'' and the case should be 
permitted to proceed ``only if a reasonable person would deem the 
inference of scienter cogent and at least as compelling as any opposing 
inference one could draw from the facts alleged.'' Id. at 324. It thus 
is possible for the Commission to adopt reasonable internal guidelines 
to ensure it is making consistent and fair decisions on the subjective 
judgments of whether to bring enforcement actions or continue to pursue 
investigations. I also believe that the Commission should have a major 
role in determining whether cases which predominantly involve Federal 
securities law issues and our capital markets structure should be 
pursued by criminal authorities. I believe that efforts in these two 
areas would help promote an atmosphere of cooperation and communication 
that could help assist the Commission in all of its regulatory roles.
    There are other areas in which I know the Members of this 
Subcommittee are interested. I also believe that the SEC historically 
has responded positively to constructive assessment of its operations 
and programs. I hope that I am able to be of assistance to you, and I 
will be happy to answer your questions on this important subject.
         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                    FROM RICHARD J. HILLMAN

Q.1. As the Bernard Madoff case clearly illustrated, the SEC 
fell short in responding adequately to what were clear signs of 
fraud. It's not clear that this was a problem of a lack of 
resources. Do you have suggestions on steps the SEC could take 
to improve its oversight in this area? What information would 
better assist the SEC in identifying and acting upon problems 
such as market manipulation, insider trading, and other 
misconduct? What surveillance tools would help this effort?

A.1. Since we did not review SEC's oversight of Madoff's firm 
or the agency's actions regarding tips received about the 
fraud, we cannot specifically comment on the circumstances or 
any deficiencies SEC may have in handling this fraud case. 
However, in several GAO reports where we reviewed SEC's OCIE 
and Enforcement functions, we have made a number of 
observations and recommendations for improvement in its 
examination and surveillance-related effort.
    SEC's routine examinations are risk based and as such, 
relatively low-risk areas are generally not examined. For 
example, in our 2005 report on mutual fund trading abuses, we 
noted that SEC staff did not examine for market timing abuses 
or assess company controls over that activity because they 
viewed market timing as low risk and determined that mutual 
fund companies had financial incentives to establish effective 
controls over frequent trading. We observed that SEC could 
strengthen its ability to detect market timing activities by 
conducting independent assessments of controls (through a 
variety of means including interviews, reviews of compliance 
reports or internal audit reports, and transaction testing as 
necessary) at a sample of companies to verify assessments about 
risks and the adequacy of controls in place to mitigate those 
risks. SEC could apply this process to other perceived low-risk 
areas.
    In a 2007 report, we noted that since the detection of 
mutual fund trading abuses, OCIE has shifted its approach to 
examinations of investment companies and advisers from one that 
focused on routinely examining all registered firms, regardless 
of risk, to one that focuses on more frequently examining those 
firms and industry practices at higher-risk for compliance 
issues. The effectiveness of OCIE's revised approach largely 
depends on OCIE's accurately assessing the risk level of 
investment advisers. Since many firms rated lower-risk are 
unlikely to undergo routine examinations within a reasonable 
period of time, if at all, harmful practices could go 
undetected if firms are inappropriately rated as lower-risk. We 
noted that the method that OCIE employs to predict the level of 
risk for the majority of advisers has some limitations, 
particularly in that this method relics on proxy indicators of 
compliance risks without incorporating information about the 
relative strengths of a firm's compliance controls. We continue 
to believe May 7, 2009, that using compliance reports from 
firms could potentially help OCIE better identify higher-risk 
firms. In some cases, SEC will have to test the quality of the 
firm's internal audit function before relying on its 
assessments.
    Self-regulatory organizations (SROs), rather than SEC, are 
responsible for the surveillance of the trading activity on 
their markets. As a result of a 1985 study, SEC determined that 
SROs had created a viable intermarket surveillance program, and 
terminated its then tentative Market Oversight and Surveillance 
System project by determining not to develop the direct 
surveillance capabilities the system would have allowed. SROs 
employ electronic surveillance systems to monitor market 
participants' compliance with SRO rules and Federal securities 
laws. One of the key surveillance systems employed by SROs 
monitors the markets for insider trading. Since SROs only have 
jurisdiction over entities and individuals that are part of 
their membership, any suspected violations on the part of 
nonmembers are referred directly to SEC's Enforcement Division. 
In a 2007 report, we noted that Enforcement's referral receipt 
and case tracking systems do not allow Enforcement staff to 
electronically search all advisory and referral information, 
which may limit their ability to monitor unusual market 
activity. We recommended that SEC considers system 
improvements.
    Finally, as we noted in our 2009 report, some Enforcement 
attorneys felt that the division's in-house expertise in a 
range of areas was inadequate. These include forensic 
accounting, complex trading, and complex financial instruments. 
Several attorneys also said that the investigative staff do not 
have access to real-time trading information, which can be 
pivotal to bringing certain cases such as pump and dump 
schemes. Getting access to such specialized services and 
expertise would aid in case development. We recommended that 
SEC review the level and mix of Enforcement resources.
                                ------                                


        RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
                      FROM ROBERT KHUZAMI

Q.1. In your testimony, you mentioned that the Commission has 
filed 23 cases involving Ponzi schemes or Ponzi-like payments. 
With the report just now coming out that the SEC received 
warnings back in 2002 regarding the Stanford fraud 
investigation, how long was the SEC aware of these 23 or so 
particular cases before formal filings where a charge was made?

A.1. Of the 23 cases involving Ponzi schemes or Ponzi-like 
payments referenced in the written testimony, we investigated 
and filed 18 of them, or 78 percent, within 6 months of the SEC 
becoming aware of possible misconduct through a complaint, tip, 
referral, or staff surveillance. Fifteen of the 18, or 83 
percent, were filed within 2 months of the complaint, tip, 
referral, or surveillance. In three of those cases, or 16 
percent, we filed charges within 2 weeks of becoming aware of 
the possible misconduct.
    Of the remaining five cases, more time was needed to 
develop each case. As an initial matter, I note that 
complaints, tips, or referrals often lack specific, admissible 
evidence of wrongdoing; rather, further investigation must be 
undertaken before charges can be filed.
    Turning to the remaining five cases, one was the Stanford 
matter that I referred to in my oral testimony. In that case, 
there were various impediments to filing charges, most notably 
the absence of sufficient evidence of wrongdoing, due in part 
to the lack of cooperation from Stanford and the Antiguan 
authorities. For a variety of reasons, the remaining four cases 
in this category were brought more than 1 year after the 
complaint, tip, or referral. In two of the remaining cases, the 
staff learned that the conduct had ended and that significant 
assets did not exist which might justify emergency action. 
Thus, the investigation continued to allow for evidence to be 
collected upon which the wrongdoers could be charged. In the 
third case, there was initially a lack of credible evidence of 
wrongdoing, since none of the victims complained, there was no 
investor list, and there was an absence of affirmative 
misstatements of fact. Subsequently, the staff worked 
diligently and ultimately obtained bank records to trace 
investor funds, an independent third party receiver was 
retained to marshal any remaining assets, and the case was 
filed. In the final case, once the staff became aware of the 
true nature of the conduct, the staff investigated and brought 
the action in an expeditious manner--moving from a formal order 
of investigation to filing in Federal district court in less 
than 2 months.

Q.2. Out of the 700,000 complaints, tips, and referrals 
received last year, how many were followed up on?

A.2. There are a variety of ways that complaints, tips, and 
referrals come into the SEC, including through various 
divisions and the agency's eleven regional offices. By volume, 
the Enforcement Division's Complaint Center (ECC) and the 
Office of Investor Education and Advocacy (OIEA) receive the 
vast majority of such contacts.
    In Fiscal Year 2008, the Division received approximately 
615,000 submissions through the ECC, an online mailbox of the 
Division of Enforcement that receives e-mail tips and 
complaints from investors and other members of the public. 
Every complaint received through the ECC is reviewed by a 
member of Enforcement staff, and passes through a multistage 
triage process. At each stage, some complaints are eliminated, 
either because they fall outside the agency's jurisdiction, 
or--later in the process--because they do not present 
compelling facts, do not establish the potential for a Federal 
securities law violation, or are judged not to be an efficient 
use of resources. In the later stages of this triage, reviewing 
staff may also forward a higher-quality complaint to 
Enforcement staff as a ``referral'' to be considered for 
further investigation or action. Even if e-mails are not 
formally referred, they are archived and can be researched 
should a future investigation be opened. Given the multilayered 
review and referral process, together with current 
technological and resource limitations, there does not 
currently exist a capability for specific tracking of each e-
mail throughout its review and triage.
    During that same time period, OIEA received approximately 
81,000 investor complaints, questions, or other contacts. OIEA 
reviews the contacts received and decides whether to refer it 
to the Division of Enforcement, another SEC Office, or another 
regulator. A relatively small number of the contacts received 
by OIEA are tips or complaints referred to Enforcement for 
further action. The remaining contacts (questions, requests for 
information, comments, etc.) are handled by OIEA directly or 
sent to the appropriate SEC Office or Division for disposition.
    In addition, the Division of Enforcement receives 
complaints, tips, and referrals from self-regulatory 
organizations, other regulators, other Divisions and Offices of 
the SEC, and correspondence from the public not routed through 
these other sources. Enforcement staff members also find 
matters to investigate through their own surveillance.
    Last fiscal year, 1,224 matters under inquiry were opened 
based on information received from all sources.
    On March 5, 2009, Chairman Schapiro announced that the 
agency is undertaking a comprehensive review of the process by 
which all complaints, tips, and referrals are handled. As part 
of that review, we are considering new processes and systems 
for receiving, tracking, analyzing, and acting upon the tips, 
complaints, and referrals from outside sources. The team 
overseeing this initiative expects to present to the Chairman 
in the near future recommendations regarding how to improve the 
efficiency, effectiveness, and overall management of how the 
agency addresses tips, complaints, and referrals, and how SEC 
staff utilizes the information received to protect investors.
                                ------                                


        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER
                      FROM ROBERT KHUZAMI

Q.1. How does the SEC plan to use the additional $40 million in 
funding that it may be receiving? Do you plan to hire financial 
analysts, traders, and accountants with real industry knowledge 
and experience to help you investigate and oversee today's 
increasingly complex capital markets? If so, how many?

A.1. We intend to hire staff with specialized expertise in 
financial services and other related areas, including product 
specialists, traders, and others. The exact numbers of these 
specialized hires will depend, among other things, on 
availability and competing demands for resources. For example, 
we also need to hire more trial lawyers, which will enable the 
SEC successfully to litigate increasingly complex cases and 
demand tough sanctions. We need additional support staff, since 
attorneys and others currently spend far too much time doing 
tasks more efficiently undertaken by paraprofessionals. 
Finally, we require improved information technology systems, 
including document management systems, so that cases can be 
investigated and brought more quickly and efficiently.

Q.2. When do you expect the reorganization, including the 
hiring of new staff, to occur?

A.2. Various workstreams have been examining different aspects 
of our structure and operation. Some recommendations, primarily 
those dealing with internal procedures and process, have 
already emerged from that process, and we are preparing to 
discuss those recommendations with other SEC divisions and 
others within the SEC, and then to commence implementation. 
Other aspects of our initiative, including recommendations as 
to specialized groups and management restructuring, will be 
forthcoming on a rolling basis starting in June 2009. The 
hiring of new staff is also conducted on a rolling basis, and 
we have already begun the task of reviewing resumes from 
various market specialists. We have also closed out the posting 
for a new Business Manager for the Enforcement Division and 
expect to commence interviews immediately.

Q.3. Should the SEC have investigative powers over currently 
unregulated entities, including hedge funds, and unregulated 
products, including credit default swaps, to ensure the 
integrity of our capital markets?

A.3. I believe that it is critical to have investigative powers 
over unregulated entities, particularly hedge funds, and 
unregulated products, including credit derivatives. Although 
the SEC has antifraud authority in many of these areas, my view 
is that we need significant additional access to information 
regarding those entities and products. In particular, we need 
access to trading information to enable us to combine that 
information with information obtained from regulated entities 
to make sure that we have a full picture of the financial 
markets and to be better able to detect wrongdoing.
    Hedge Funds: Unregistered and unregulated private funds, 
such as hedge funds, represent a significant segment of the 
financial markets that is predominately below the radar. The 
Commission currently lacks basic data about private funds and 
thus, lacks significant knowledge concerning an important 
segment of the market. It is essential that we have better 
knowledge of who these private funds and their managers are, 
how they meet their obligations to their investors, and the 
impact their investment activities have on the overall 
financial markets. Currently, without specific SEC authority to 
register and oversee private funds and their advisers, our 
access to this information is limited, which makes it much more 
difficult for the Commission to identify misconduct.
    Registration of private funds will accomplish two important 
objectives. First, it will enable us to gather and compile 
comprehensive information about the entire private fund 
industry--permitting us to measure the size, influence, and 
impact of the industry in a manner currently unavailable to the 
Commission. Second, registration and rule-making authority over 
private funds will permit us to ensure that individual hedge 
funds are maintaining information, especially trading records, 
across financial instruments in a uniform manner. With uniform 
reporting and recordkeeping standards, we can then more 
effectively examine and investigate whether hedge funds and 
other institutional traders are engaging in manipulative 
conduct across financial instruments.
    Security-Based Swap Agreements: Although the SEC has 
antifraud jurisdiction over security-based swap agreements, 
including credit default swap agreements, the agency does not 
have authority to promulgate rules related to reporting or 
recordkeeping in this area, which would provide the type of 
information we typically would use to identify suspicious 
trading patterns. This information gap substantially inhibits 
our enforcement efforts in this area. Although efforts to 
provide central clearing for credit default swaps will bring to 
this market much-needed transparency, providing the Commission 
with authority to impose uniform recordkeeping and reporting of 
derivative transactions, particularly by hedge funds and 
broker-dealers, will bring significantly more transparency to 
our complex financial markets. For example, with this 
authority, staff can more easily pinpoint where manipulative 
credit derivative trading occurs in tandem with other trading 
strategies, such as short selling, that put selling pressure on 
particular securities. With enhanced regulatory authority over 
certain derivatives, SEC staff, particularly its examination 
and enforcement staff, can better surveil, examine, and uncover 
deceptive or manipulative conduct across both standard and 
complex financial instruments.

Q.4. Will you consider allocating or reallocating some of the 
personnel to New York City as part of the shake-up of your 
Enforcement Division?

A.4. We will undertake to review the allocation of resources to 
the New York Regional Office. Having said that, we are at the 
same time attempting to break down the silos that can flow from 
a regional structure, and to create a truly national program in 
which the connectivity amongst staff and offices is increased, 
thus facilitating the sharing of knowledge and efficient use of 
resources.

Q.5. How close are you to naming someone to lead the New York 
Regional Office? Are you considering naming someone who is a 
former Federal prosecutor with securities experience?

A.5. We are in the very final stages of the hiring process. We 
have an abundance of highly qualified candidates, including 
those with the profile you mention. We anticipate making an 
announcement shortly.

Q.6. Should the Enforcement Division have a hotline the public 
can call?

A.6. Although the public has a variety of ways it can contact 
the SEC, including phone lines, the establishment of an 
Enforcement hotline number is one item under consideration as 
part of the Commission's current assessment of its handling of 
complaints, tips, and referrals.
    On March 5, 2009, Chairman Schapiro announced that the SEC 
enlisted the services of the Center for Enterprise 
Modernization, a federally funded research and development 
center operated by The MITRE Corporation. The MITRE Corporation 
is currently working with the SEC to (1) conduct a 
comprehensive review of internal procedures used to receive and 
evaluate tips, complaints, and referrals, (2) identify ways to 
improve the quality and efficiency of the agency's current 
procedures, and (3) recommend potential technology solutions 
that can assist the SEC staff in more effectively managing and 
utilizing tips, complaints, and referrals. This priority 
initiative is moving forward swiftly.

Q.7. How does the Enforcement Division coordinate with the 
Office of Investor Education and Advocacy and other Divisions 
who receive calls about fraud and other securities law 
violations? Do individuals who call with an actual complaint 
get a call back?

A.7. The complaints, tips, and referrals Enforcement receives 
come in from many different portals within the SEC. Complaints 
are routed to different groups in Enforcement for handling, and 
each group has developed its own protocol regarding how to 
process, review, and retain information regarding the referral 
or complaint. For example, online complaints and referrals from 
the Office of Investor Education and Advocacy are processed 
through Enforcement's Office of Internet Enforcement, and SRO 
referrals are processed through the Office of Market 
Surveillance.
    Complaints by individuals taken over the phone are referred 
and followed up on as appropriate. For example, the Office of 
Investor Education and Advocacy receives tips and complaints 
from individuals who call the Office's investor information 
number and refers these tips and complaints to Enforcement's 
Office of Internet Enforcement as appropriate.
    This structure is currently under review. We are 
undertaking a comprehensive review of our processes and systems 
for receiving, tracking, analyzing, and acting upon the tips, 
complaints, and referrals from outside sources. The goal of the 
review is to improve the efficiency, effectiveness, and overall 
management of how the agency addresses tips, complaints, and 
referrals, and how SEC staff utilizes the information received 
to protect investors. In this regard, the Commission is seeking 
to establish a more centralized process that will more 
effectively identify valuable leads for potential enforcement 
action as well as areas of high risk for compliance 
examinations.

Q.8. Is the Enforcement Division consulted on the 
enforceability of the rules the other SEC Divisions are 
writing? Is it part of the process?

A.8. Enforcement does comment on SEC rule making, especially 
with respect to whether or not proposed rules have an 
enforcement impact. There is a process, although not 
formalized, by which Enforcement is consulted and reviews and 
comments on proposed rule making.

Q.9. How do the other Divisions train and assist the 
Enforcement attorneys?

A.9. We have a wealth of in-house expertise. During the course 
of any given inquiry or investigation, Enforcement staff can 
consult with staff of the other Divisions and Offices. Some 
cases--because they are more difficult, novel, or technical--
may require more consultation than others. Topics can run the 
gamut from technical expertise on the specific requirements of 
a particular rule to broader questions of industry practice, 
how to charge a case, or how a contemplated case may impact the 
industry.
    There is also a formalized process as part of our case 
review whereby the other Divisions and Offices review and 
comment on proposed Enforcement recommendations before 
Enforcement staff presents the recommendations to the 
Commission. The other Divisions and Offices may also comment on 
Enforcement recommendations when they are being presented to 
the Commission.
    Part of our training for new hires includes presentations 
from the other Divisions and Offices about their areas of 
expertise and how they can be of assistance to Enforcement 
staff. In addition, the other Divisions and Offices may offer 
training sessions for their own staff, to which Enforcement 
staff is invited.
    Finally, we hope that one of the benefits of specialization 
is having more in-house Enforcement expertise that our staff 
can turn to earlier in their investigations and more often.
                                ------                                


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
                     FROM MERCER E. BULLARD

Q.1. As the Bernard Madoff case clearly illustrated, the SEC 
fell short in responding adequately to what were clear signs of 
fraud. It's not clear that this was a problem of a lack of 
resources. Do you have suggestions on steps the SEC could take 
to improve its oversight in this area?

A.1. I agree that the failure to detect Madoff's fraud was not 
the result of inadequate resources. I have described below the 
regulatory causes of the Madoff scandal, in order of 
importance, and suggested steps that the SEC could take to 
improve its oversight with respect to each cause.
    Cause 1: The principal regulatory cause of the scandal was 
the failure of Madoff's primary regulator, the Financial 
Industry Regulatory Authority (FINRA) to detect his fraud. 
During the entire period of his fraud, Madoff was a broker-
dealer regulated primarily by FINRA. Until 2006, when Madoff 
registered an investment adviser, FINRA was Madoff's sole 
Federal regulator.
    FINRA's oversight responsibilities would have included 
confirming that client assets custodied with Madoff were 
actually in the possession of his broker-dealer firm. FINRA 
also is responsible for overseeing advisory activities of 
registered representatives of a broker-dealer provided away 
from the firm. It is not clear how FINRA could have been 
ignorant of Madoff's advisory activities. It appears he was 
widely known and sought after as a money manager. When 
interviewed by FINRA personnel in the course of inspections, 
did Madoff and his employees state that the firm and Madoff 
provided no money management services? If FINRA knew about his 
money management activities, it should have confirmed the 
firm's custody of client assets. In any case, Madoff's 2006 
investment adviser registration stated that his broker-dealer 
was the custodian for client assets. This should have been a 
red flag for FINRA.
    The SEC should take a number of steps to address the 
problems exposed by the Madoff scandal. \1\ First, it should 
order FINRA to conduct an investigation of its failed oversight 
and report its findings to the SEC and your Committee. Second, 
it should revise its policies that improperly permit brokers 
such as Madoff who provide individualized investment advice to 
avoid regulation as investment advisers. Third, the SEC should 
abandon its plan to recommend legislation that would enable 
FINRA to become the primary regulator for investment advisers 
pending the completion of the two suggestions provided above. 
Fourth, Chairman Schapiro and Commissioner Walter should recuse 
themselves from any role in any of the three matters discussed 
above on the ground that their prior employment at FINRA 
creates at least the appearance of a conflict of interest.
---------------------------------------------------------------------------
     \1\  The SEC recently proposed new custody rules, but these rules 
would have not have applied to Madoff prior to 2006 because he was not 
a registered investment adviser prior to that date.
---------------------------------------------------------------------------
    Cause 2: A second regulatory cause of the scandal was the 
SEC's policy of permitting brokers who provide nonincidental 
investment advice to evade regulation as investment advisers. 
If Madoff had registered as an investment adviser in the early 
1990s when his fraud began, it is highly likely that an 
investment adviser inspection would have uncovered his fraud 
many years ago.
    The definition of investment adviser under Federal law does 
not apply to a broker who does not receive special compensation 
and whose advice is solely incidental to his brokerage 
services. The SEC has adopted an absurdly broad definition of 
``solely incidental'' that until just recently allowed advisers 
who exercised discretionary authority over client assets but 
charged only commissions (such as Madoff) to evade registration 
as investment advisers. There is no and never has been a 
rational basis for believing that the exercise of discretionary 
oversight could be consistent with ``solely incidental'' 
services. The SEC conceded this only recently. The SEC's 
belated recognition of this fact will not prevent the next 
Madoff, however. Under SEC positions, it will be easy for a 
broker to claim not to exercise discretion while exercising 
effective control over client accounts and thereby run an 
unregistered advisory program that is exempt from adviser 
inspections. The SEC takes the position that any services 
provided ``in connection with and reasonably related to'' 
brokerage services can be considered ``solely incidental.'' 
Under this interpretation, it is difficult to imagine any 
broker being unable to rely on the ``solely incidental'' 
exclusion. Any broker that wishes to ensure that only FINRA 
oversees its advisory operations can continue to do so.
    The steps that the SEC should take in this respect are 
simple. It should apply the plain meaning of the broker 
exclusion's ``solely incidental'' trigger. Most ``brokerage'' 
services have become advisory in nature and should be regulated 
accordingly. When investors received personalized investment 
advice, they are entitled to--and intuitively expect--that the 
advice will be subject to the same fiduciary duties that apply 
to similar professional advice provided by lawyers and doctors. 
Under current SEC positions, brokers can create the appearance 
of acting as the client's agent while enjoying the benefit of a 
salesman's nonfiduciary status. This is not to say that the 
Madoff scandal reflects the failure to apply a fiduciary 
standard to his conduct. Rather, it is to say that the Federal 
securities regulatory scheme for retail services is designed 
and should be applied so as to provide additional investor 
protection as the relationship increasingly engenders trust and 
confidence in the regulated professional. Madoff's business 
model depended on a high level of client trust and confidence, 
but because of lax SEC positions that relationship was not 
subject to the heightened regulatory standards that would have 
caught his fraud much sooner, if not prevented it altogether.
    Cause 3: A third regulatory cause of the scandal was the 
SEC's failure to act on tips from Harry Markopolos. This cause 
is only third in this discussion for two reasons. First, the 
tips did not begin until 1999, whereas the fraud had been 
perpetrated under FINRA's nose since the early 1990s, as 
discussed above. Second, earlier registration as an investment 
adviser also would have stopped Madoff's fraud long before 
1999. Both failed FINRA oversight and Madoff's delayed 
registration as an adviser are far more significant factors in 
the scandal than the breakdown in the SEC's whistleblower 
procedures.
    Indeed, whistleblower tips are an inherently inefficient 
means of achieving enforcement goals. It would be impossible 
for the SEC to conduct a complete investigation of every one of 
the hundreds of thousands of complaints that it receives each 
year. If it did so, it would do nothing else. The most 
efficient means of detecting fraud is through inspections and 
market monitoring.
    That being said, whistleblowers can be a useful source of 
information, provided that it is understood and accepted that 
some credible allegations of violations inevitably will slip 
through the system. There is no mechanical system that will 
catch every credible complaint, and no system based on human 
judgments can eliminate the possibility of human error. We 
should expect and accept that there will be significant frauds 
that are revealed in complaints but not fully investigated. The 
costs of a system designed to investigate fully all such 
complaints would far outweigh the benefits.
    Any system that failed to surface Markopolos's tips, 
however, could not have been reasonably designed to provide an 
effective means of reviewing complaints. In that case, the 
failure exposed a flawed system of reviewing complaints. 
Chairman Schapiro's proposed whistleblower reforms are the 
right way to address this problem. The SEC has enlisted the 
Mitre Corporation to assist it in developing an efficient 
system for managing and utilizing tips, complaints, and 
referrals. The SEC appears to recognize that the importance of 
applying modern information management systems in this context 
while avoiding promises of a perfect process.
    Cause 4: A final cause of the scandal was the SEC's failure 
to inspect Madoff once he registered as an investment adviser 
in 2006. An SEC inspection would have included verification of 
custody of client assets, which would have uncovered his fraud. 
It should be noted, in this respect, that Madoff's fraud had 
been underway since the early 1990s, when he was subject only 
to FINRA's oversight, and Markopolos first provided information 
to the SEC in 1999. The failure to inspect Madoff was only a 
regulatory cause of the scandal to the extent that it operated 
from 2006 to 2008. It should also be noted that Madoff's 
registration occurred at the time when thousands of firms were 
newly registering in response to the SEC's new requirement that 
hedge fund managers register, but this does not excuse the 
failure to inspect Madoff in a timely manner.
    At the time that Madoff registered, he claimed to have $17 
billion in client assets under management. Although the failure 
to conduct inspections may, in some cases, be attributable to a 
lack of resources, the failure to inspect Madoff was not. When 
an advisory firm of that size files its initial registration, 
an inspection should be immediate. In other words, resources 
that are available should be devoted first to this kind of 
inspection. The failure was one of allocating resources, not a 
lack of resources.
    The improvement that needs to be made to address this 
oversight is to ensure that certain filings automatically 
trigger an inspection, such as the new registration of an 
investment adviser with more than a certain amount of assets 
under management. Lori Richards, Director of the SEC's Office 
of Compliance Inspections and Examinations, spoke recently 
about the SEC's surveillance in which it analyzes data in 
investment adviser registration forms to assess their relative 
compliance risks. \2\ This is the kind of program that should 
trigger an immediate inspection for a new registrant such as 
Madoff. Richards stated that this analysis is run only once 
each year (in September), however. It should be run on a 
continuous basis with respect to all new registrations and 
certain types of registration amendments.
---------------------------------------------------------------------------
     \2\  Her speech is available at http://www.sec.gov/news/speech/
2008/spch121608lar.htm.

Q.2. What information would better assist the SEC in 
identifying and acting upon problems such as market 
manipulation, insider trading, and other misconduct? What 
---------------------------------------------------------------------------
surveillance tools would help in this effort?

A.2. The SEC generally has an effective system for identifying 
problems such market manipulation, insider trading, and other 
misconduct. The question of what information would better 
assist the SEC in acting upon problems once they have been 
identified is discussed below.

Q.3. The Enforcement Division faces key challenges in targeting 
its resources among a large and constantly changing universe of 
potential fraud. The SEC must act decisively to address new 
activities, while conserving precious resources for other 
important areas. How can the SEC most effectively target its 
resources to oversee a broad and changing set of issues?
    What are the key factors the SEC should be identifying and 
considering to determine if and how to take action?
    You note in your written testimony that the SEC does not 
add value by investing resources in dozens of cases involving 
the same misconduct once it has clearly established its 
position. Please elaborate on this statement.

A.3. I have combined my answers to these three questions 
because they are essentially interrelated.
    The mission of the SEC's enforcement program should be to 
prevent, detect, and deter securities fraud, and to play the 
leading role in securities enforcement. Toward this end, the 
SEC has developed an effective strategy for efficiently 
allocating its resources, responding to a quickly changing 
business environment, and deciding when and how to take action 
in response to fraud. As noted in my testimony, however, the 
SEC may have a tendency to overinvest resources in multiple 
cases involving the same underlying conduct. This tendency 
results in an inefficient allocation of resources and diverts 
attention from developing problems in the financial services 
industry. It also undermines the SEC's leadership role in 
securities enforcement. The SEC should be more strategic in 
deciding when and how to take action in response to widespread 
fraud.
    In a number of instances, the SEC has brought dozens of 
cases involving essentially the same kind of misconduct. In 
some of these cases, it has done not on its own initiative, but 
following the lead of State enforcement agencies and private 
litigants. In other areas of misconduct, it has not brought any 
enforcement actions, choosing to allow the law to be determined 
by multiple State actors and State and Federal courts without 
the uniformity that only the SEC can provide. The result is 
less effective protection for investors and more costly 
compliance for regulated entities.
    The SEC should seek to identify potential areas of fraud, 
investigate them, and prosecute misconduct in a way that 
exploits the potential benefits of overlapping jurisdiction and 
efficiently manages its resources. There are many actors on the 
securities enforcement stage, but only one actor can provide 
the centralized leadership and uniformity that optimizes 
efficient and effective national securities enforcement. The 
SEC is uniquely situated to gauge the significance of potential 
areas of fraud across the country, uniquely skilled in 
understanding the ideal balance between investor protection and 
free markets, and uniquely equipped to coordinate enforcement 
activities across a wide spectrum of actors.
    The SEC should respond to widespread abuses by using the 
full range of mechanisms that are available to accomplish its 
enforcement goals. For example, one might roughly organize 
potential mechanisms and the related investment of SEC 
resources for widespread misconduct, such as mutual fund market 
timing or options backdating, as follows:

    Federal and State criminal action followed by SEC 
        administrative action,

    SEC administrative action,

    Joint SEC/State administrative Action,

    Section 21(a) investigation report,

    State administrative action,

    Private lawsuits,

    Nonlitigation private resolution (e.g., board 
        action),

    Private voluntary remediation pursuant to internal 
        investigation,

    Rule-making/interpretive guidance, and

    Commission/Director speeches.

    Each of these mechanisms can provide significant prevention 
and deterrence benefits, in many cases with a much smaller 
expenditure of SEC resources than would be incurred in a full-
blown investigation. In cases of widespread misconduct, the 
egregiousness of the misconduct typically varies greatly. Some 
cases will militate for criminal penalties and administrative 
proceedings--the highest investment of SEC resources. At the 
other end of the spectrum will be marginal misconduct that can 
be addressed, for example, through Commissioner speeches 
reminding regulated entities of their responsibilities.
    For the cases that warrant administrative action, the SEC 
does not need to bring every case itself. State securities 
commissioners and attorneys general have demonstrated their 
interest in securities enforcement. The SEC should not hesitate 
to refer cases for prosecution solely by State authorities, or 
to bring joint proceedings where the SEC's investment of 
resources can be reduced through a sharing arrangement. When 
misconduct is the subject to private litigation, the SEC should 
consider whether that mechanism will serve an adequate 
enforcement function in lieu of an SEC action. In some cases, 
the SEC may wish to intervene in such cases, which would still 
place less strain on SEC resources than a full-blown 
administrative proceeding. In other instances, a fund board or 
board of an operating company may negotiate a settlement and 
airing of the facts that is adequate. A self-reported internal 
investigation with follow-on remedial measures can serve a 
similar purpose. The SEC's evaluation of its enforcement 
program should integrate all of these mechanisms, especially in 
view of the SEC's role in the administration of the FAIR Fund 
program.
    The following discussion provides three illustrations of 
these principles. The first illustration is the mutual fund 
market timing scandal in which the SEC brought dozens of cases. 
The scandal was based partly on arbitrageurs' exploitation of 
mispriced fund shares, a problem that was known to the SEC and 
about which it had done nothing. Not surprisingly, a State 
attorney general brought the first market timing cases, with 
the result being that it, rather than the SEC, played the 
leading role in establishing standards in certain respects for 
mutual fund operations, governance and fees. To this day, the 
SEC has not brought an enforcement action for stale pricing. 
The same attorney general also took the lead in establishing 
standards for addressing analysts' conflicts in yet another 
problematic area of which the SEC was fully aware but 
inexcusably inactive.
    The mutual fund scandal also illustrates the inefficient 
use of SEC resources by bringing dozens of cases even after the 
SEC's position has been clearly established in the area. The 
SEC should not bring every case when it discovers widespread 
abuses such as mutual fund market timing, analyst conflicts, 
and backdating options. Market timing cases are still being 
resolved today, more than five years after the scandal began. 
As discussed above, the SEC should evaluate the egregiousness 
of the conduct involved and take a range of actions that are 
matched to the conduct. In cases of widespread fraud, many of 
the implicated parties will not represent inherently bad 
actors, but rather firms whose well-meaning compliance 
procedures were not adequately designed to prevent abuses. When 
many industry participants engage in certain types of 
misconduct, the line between legal and illegal conduct becomes 
blurred and it becomes more difficult for compliance 
departments to take strong positions against the natural 
pressures of competition. In many cases, there is little gained 
by bringing an enforcement action rather than seeking a 
resolution through less resource-intensive approaches.
    I have conducted an extensive review of the enforcement 
actions brought in the market timing scandal, and it is my 
opinion that the SEC brought far too many cases. It is likely 
that the options backdating cases reflect a similar problem. 
The SEC should more aggressively pursue alternative approaches 
to many of these cases, including handing off more 
investigations to States, issuing section 21(a) reports, and 
monitoring private resolutions and internal investigations. The 
SEC must be willing not to bring cases number 10 through 20 in 
one area in order to redirect those resources to bringing cases 
number 1 through 5 in areas that otherwise would go untended. 
SEC resources are finite, and every additional market timing or 
options backdating cases reflects an investment in resources 
that are not invested somewhere else.
    The BISYS case provides a current illustration of the 
likely overcommitment of resources to stale matters. In 
September 2006, the Commission reached a settlement with BISYS 
Fund Services, Inc., that was based on BISYS's payments to 27 
unnamed fund managers in return for their recommending that 
their funds use BISYS as the fund's administrator. The 
arrangements were in place from June 1999 and July 2004, which 
means that more than 2 years already had passed before the 
Commission settled with BISYS. Since then, the Commission has 
brought cases with respect to only one of the 27 fund managers, 
the earliest occurring another 2 years after the BISYS 
settlement, in September 2008. \3\ The fund managers' 
arrangements with BISYS had already been terminated for over 4 
years. The fate of the other 26 fund managers appears to remain 
unresolved. The investigations regarding the unlucky 26 are 
probably ongoing, with some inching toward a resolution and 
others floating motionless in an investigation purgatory 
awaiting a final decision on their fate. \4\
---------------------------------------------------------------------------
     \3\  See In the Matter of AmSouth Bank, Admin. Proc. No. 3-13230 
(Sep. 23, 2008) available at http://www.sec.gov/litigation/admin/2008/
ia-2784a.pdf.
     \4\  In the latest twist in the BISYS scandal, BISYS (now a 
Citigroup subsidiary) has submitted to the SEC a proposed plan to 
distribute settlement amounts to the 27 fund families that had 
marketing arrangements that were subject to original enforcement 
action. None of the fund families is named, notwithstanding the strong 
implication that each fund manager engaged in wrongful conduct and the 
distributions' indirect reflection of a finding that each fund manager 
engaged in wrongdoing.
---------------------------------------------------------------------------
    The types of relationships involved in the BISYS case 
trigger complex regulatory issues. Every attentive mutual fund 
lawyer would have read the BISYS settlement with an eye to 
future settlements that would clearly delineate appropriate 
from questionable conduct. It is not the plain vanilla bribery 
case that needs further explication--there, severe punishment 
and the deterrence it creates should be the SEC's primary goal. 
No guidance is necessary. But among the 27 fund managers with 
whom BISYS had a relationship there are undoubtedly borderline 
cases, i.e., fact patterns that compliance personnel might not 
immediately recognize as being questionable or crossing the 
line into illegality. Yet no such guidance has been 
forthcoming. The BISYS scenario remains an area of legal 
uncertainty. The SEC should bring more cases to clarify the 
contours of what it considers to be illegal conduct. (Many of 
the funds have reached private settlements with the fund 
managers who were involved in the scandal which may reflect an 
adequate enforcement resolution in those cases.)
    A final illustration is the SEC's recent enforcement action 
for a violation of section 15(c) of the Investment Company Act. 
\5\ The SEC settled charges with a fund manager for violating 
section 15(c)'s requirement that it provide material 
information to the fund's board that was necessary to for the 
board to evaluate the fund manager's fee. The SEC also found 
that the fund manager's actions constituted willful fraud under 
the Investment Advisers Act. These facts also would have formed 
the basis for liability under section 36(b) of the Investment 
Company Act, which creates a private and public cause of action 
against a fund manager that violates its fiduciary duty to the 
fund with respect to the fees it receives. \6\ While the SEC 
has developed no precedent under section 36(b), private 
litigants have brought numerous cases over many decades that 
have generated various interpretations by dozens of judges. \7\ 
Conflicts among these judges' positions recently led the 
Supreme Court to take a section 36(b) case (Jones v. Harris 
Associates). The Court will be left to make this determination 
with virtually no guidance from the SEC.
---------------------------------------------------------------------------
     \5\  See In the Matter of New York Life Investment Management LLC, 
Admin. Proc. No. 3-13487 (May 27, 2009).
     \6\  It is not possible for someone not involved in the 
negotiation of this section 15(c) settlement to know definitively 
whether this particular case was the right opportunity to bring a 
section 36(b) claim (e.g., perhaps the factual basis was not as strong 
as the record suggests and the defendant refused to agree to a finding 
under section 36(b)). The point here is that the SEC's enforcement 
program should be designed so that the potential strategic benefits of 
bringing a section 36(b) claim in such a case would be thoroughly 
reviewed. The fact that the SEC has failed to provide guidance as to 
what constitutes a violation of section 36(b) illustrates a failure to 
apply this approach.
     \7\  In connection with the mutual fund market timing scandal, the 
New York State Attorney settled a number of claims for excessive fees 
in which the fund manager agreed to reduce its fees for a certain 
period. Remarkably, the SEC criticized the NYAG for bringing these 
claims, notwithstanding the SEC's own failure to establish any standard 
for excessive fees.
---------------------------------------------------------------------------
    The 15(c) case cited above illustrates the kind of 
opportunity that the SEC has failed to take to clarify the law 
and create efficiencies for shareholders and fund managers 
alike. The only beneficiaries of the uncertainty created by the 
SEC are litigators. After the Supreme Court decides Jones, the 
situation is likely to be exacerbated. The Court will provide 
guidance as to the standard for excessive fee cases, and 
Federal trial and appellate courts will spend years defining 
the precise contours of the new standard. This situation could 
have been avoided if the SEC had established clear standards 
under Section 36(b). Its failure to do so has imposed and 
continues to impose a heavy tax on investors.
    The Commission is under pressure to generate a large number 
of enforcement actions, which can undermine its effectiveness 
as an enforcement agency. Chairman Schapiro stated recently 
that the SEC has ``approximately 150 active hedge fund 
investigations . . . about two dozen active municipal 
securities investigations . . . and more than 50 current 
investigations involving Credit Default Swaps, Collateralized 
Debt Obligations and other derivatives-related investments.'' 
How will these investigations be winnowed to a group of 
enforcement actions? If the SEC finds a common type of fraud in 
these cases, will it feel compelled to bring an enforcement 
action in every case? If 120 cases can be made in the 150 hedge 
fund investigations, will the SEC bring all of them, thereby 
adding 120 actions to its headcount for the year? If it does, 
will that prevent it from committing additional resources 
necessary to supporting a handful of criminal prosecutions? 
What would the resources being invested in hedge fund 
investigations number 10 through 150 be invested in if not in 
those cases? What are the opportunity costs?
    The enforcement division should develop a structure for 
conducting an opportunity cost analysis for every area in which 
the staff is investing resources. This structure would identify 
alternative areas of inquiry in which those same resources are 
not being invested and provide a cost-benefit analysis to 
determine whether prevention, detection, and deterrence goals 
continue to be best served by prosecuting multiple cases 
involving similar misconduct. Metrics should be developed to 
recognize and quantify the value of an enforcement program that 
prizes efficient utilization of resources rather than brute 
case totals. Securities enforcement is not a business activity, 
but the application of business principles can help the SEC 
greatly improve its process of deciding if and how to take 
action.
                                ------                                


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR DODD
                        FROM BRUCE HILER

Q.1. It is important that the SEC continually strive to have an 
Enforcement staff with the expertise and industry experience to 
properly police the markets. You noted in your written 
statement that although there are individuals at the SEC with 
expertise outside of the normal expertise of attorneys 
(sophisticated financial instruments, trading strategies, 
accounting, risk analysis, economic modeling), it should expand 
the number of such experts. Please elaborate on this statement.

A.1. As I noted in my written statement, there already are 
individuals at the Commission with expertise in areas outside 
of the legal field. Many of these individuals are not in the 
Division of Enforcement. For example, members of the Office of 
Economic Analysis are available to perform market and economic 
analyses relevant to certain types of investigations. Members 
of the Office of the Chief Accountant, the Office of the 
General Counsel, the Division of Trading and Markets and the 
Division of Investment Management similarly are available to 
assist in analysis and interpretation of the rules which they 
have drafted for adoption by the Commission, and to provide 
input on the operation of the markets and market participants 
in the areas which those offices cover, e.g., accounting 
issues, broker-dealer firms, mutual funds, clearing agencies, 
and transfer agents.
    However, individuals in these other offices and divisions 
have other duties, and they are not regularly available to 
assist in the day-to-day investigative work of the Division of 
Enforcement. They also may not be readily identifiable by 
Enforcement personnel, and some Enforcement personnel may be 
reluctant to seek the advice of these individuals. For example, 
as noted in the GAO Report which was a topic of the May 7 
hearings, some personnel in Enforcement who were interviewed 
expressed the view that other offices and divisions at the 
Commission ``had become too influential in effectively 
controlling Enforcement activities.'' GAO Report at p. 28. As I 
noted in my oral response to a question from Senator Bunning, I 
believe that in fact it is important for members of the 
Division of Enforcement to consult with individuals in other 
offices and divisions on issues within the expertise of those 
offices early in an investigation and throughout an 
investigation. It is members of those offices who have drafted, 
proposed, analyzed the public comments on, and presented the 
rules and regulations being enforced to the Commissioners for 
consideration and adoption. The Commissioners do and should 
value the input of those offices. This type of in-depth 
consultation by the Division of Enforcement, if fully 
effectuated, however, would place an additional burden on the 
resources of those other offices and divisions.
    In my view, to deal with the expertise issue, the 
Commission should either add experts in various fields to 
special units within the existing offices and divisions and 
assign them to be readily available to the Enforcement 
Division, or form a new office in which it could group experts 
who would be available to assist the Division of Enforcement on 
a regular, day-to-day basis with investigations. These experts 
also could work with divisions other than the Division of 
Enforcement on special projects within their expertise. I think 
the areas of expertise most needed involve (i) knowledge of the 
structure of new, complex financial products, which are ever-
evolving, and of the market forces driving the creation of 
those products, (ii) the ability to analyze risk associated 
with, and the reasoning behind, complex trading strategies and 
positions, (iii) knowledge of corporate treasury and earnings 
management strategies, and (iv) knowledge of various types of 
economic modeling.
    It will be difficult to attract such individuals without 
something approaching pay parity with the private sector. I 
also believe that having a separate office of such experts will 
increase the likelihood of attracting well-qualified 
individuals. Having a separate office and title structure will 
allow the work of these individuals to be, and to be viewed as, 
more objective, and would give them additional prestige within 
the Commission. I believe that experts who are not ``tied'' to 
the Enforcement Division, will view the opportunity for broader 
exposure to the work of the other offices and divisions of the 
SEC, and for being able to interact more closely on a daily 
basis with colleagues with similar expertise and experience, as 
pluses in terms of recruiting.

Q.2. As the Bernard Madoff case clearly illustrated, the SEC 
fell short in responding adequately to what were clear signs of 
fraud. It is not clear that this was a problem of a lack of 
resources. Do you have suggestions on steps the SEC could take 
to improve its oversight in this area? What information would 
better assist the SEC in identifying and acting upon problems 
such as market manipulation, insider trading, and other 
misconduct? What surveillance tools would help this effort?

A.2. I am not in a position to comment on the Madoff situation. 
In addition to the fact that my law firm has clients who 
invested with Mr. Madoff, I simply am not privy to sufficient 
facts to make a judgment about the SEC's conduct in that 
matter. In my experience, however, it certainly is not the 
usual course of conduct for the SEC to fail to respond 
appropriately if there are ``clear signs of fraud.'' Indeed, I 
and many in the private securities bar are more concerned over 
the SEC being pushed to act precipitously or to expand its view 
of what is fraudulent conduct in response to criticisms that it 
has ``missed'' frauds or has come late to the investigative 
party. I speak more to this below, in response to the third 
question presented to me.
    In terms of resources and oversight relevant to discovery 
of situations like that alleged in the Madoff matter, the SEC 
does employ market and financial analysts who are available to 
assist on enforcement investigations, and many staff attorneys 
have experience in dealing with Ponzi schemes and misuse of 
investor funds by advisors. In my experience, the SEC presently 
relies on at least four sources for information about possible 
market manipulations and insider trading. I lump these two 
types of conduct together, because they are trading-based 
frauds, and thus have common sources of surveillance. First, 
and foremost, the stock and option exchanges and the Financial 
Industry Regulatory Authority (FINRA) utilize sophisticated, 
computer-based systems for identifying possible manipulative 
trades or trades that may be indicative of trading on inside 
information. These entities compile and review this information 
and forward it to the SEC for investigation, though in certain 
cases, where they have ``jurisdiction,'' they also investigate 
the matter themselves. Second, the SEC's Office of Compliance, 
Inspections and Examinations (OCIE) conducts inspections of 
regulated market participants, and attempts to identify 
possible illegal trading either by the participants or their 
customers. Third, the SEC relies on tips from members of the 
public who may have heard of possible manipulative or insider 
trading. Finally, SEC staff members monitor the markets and the 
press to spot irregular trading patterns that may be indicative 
of such conduct.
    In terms of ``other misconduct'' mentioned in your 
question, there are numerous types of possible misconduct which 
the SEC regularly investigates, which differ significantly from 
the conduct alleged in the Madoff matter. These types of 
conduct sometimes involve different regulatory regimes or 
statutes within the SEC's responsibility. The sources of 
information used by the Division of Enforcement to uncover 
misconduct differ depending on the type of conduct or the 
entity engaging in the conduct--For example, OCIE examines 
registered investment advisers, broker-dealers and other 
regulated entities, and may uncover misconduct involving an 
adviser or broker-dealer vis-a-vis their customers. Those 
customers can include individuals, institutions and mutual 
funds. The Division of Trading and Markets or Investment 
Management may notice suspect activity in reviewing reports 
filed by the market participants with which they are generally 
involved. The Division of Corporation Finance may uncover 
misconduct in reviewing and commenting on public filings by 
issuers. An outside auditing firm or an insider at an entity 
also may uncover misconduct and report it to the Commission 
staff.
    Despite the SEC's pursuit of and access to the above 
sources of information, as I noted in my written statement, it 
can be difficult for any agency to detect fraud at anyone of 
the thousands of entities over which an agency such as the SEC 
has some jurisdiction. Individuals who commit frauds generally 
try to hide them, and some conduct which may appear suspicious 
or ``unusual'' at first look, may be entirely legal, though 
novel or complex. Where an individual or individuals are 
determined to falsify books and records and where third parties 
who may review or be provided copies of those records fail to 
notice irregularity, it can be difficult for the SEC quickly to 
obtain credible evidence of that irregularity. The SEC's 
statutory authority also provides various surveillance tools, 
such as those mentioned above: regulated market participants 
are subject to inspection by the SEC and by self-regulatory 
organizations; independent audits are required of certain 
entities; financial condition filings and reports by certain 
entities are required and are available for review by the SEC, 
institutional investors and the public generally, and the 
exchanges and FINRA have sophisticated computer-based market 
surveillance systems. Despite all of this, an organization can 
only get through so much data per employee in a disciplined 
fashion, and fraud can be difficult to detect even by auditors 
who have on-site and extensive access to the books and records 
of the entities which they audit.
    In light of the above, I am not aware of additional, 
realistic surveillance tools which could assist the Commission. 
I am afraid that the best suggestion I can come up with to 
increase detection and prevention of fraud is a ``boots on the 
ground'' approach, and the suggestion I made in my written 
statement, and which I discuss below, concerning nonadversarial 
contact by regulators with market participants.

Q.3. In your statement you said that the SEC might be more 
successful at getting early warning signs of problems if it 
maintained more of an open line of communication with regulated 
firms, and moved away from the current atmosphere of suspicion 
that exists today. Can you expand on your thoughts? Does this 
present risk of regulatory capture?

A.3. In my experience, one of the best sources of information 
about risky conduct or possible misconduct may be someone with 
experienced-based knowledge of a particular industry or of an 
organization and its practices. This does not have to be an 
actual insider of the organization, and it does not mean that 
anything an insider or former insider says should be accepted 
at face value. Indeed, in my experience the Commission staff 
is, and should be, cautious about statements made by a 
potentially disgruntled employee or former employee of an 
entity, or by a competitor of an entity. And, of course, once 
an insider decides to expose possibly violative conduct, it has 
been ongoing for at least some period of time.
    I believe that first-hand experience of SEC staff personnel 
with market participants, outside of an Enforcement inquiry or 
an inspection, is one of the best ways for the staff to assess 
the credibility of and the risks associated with a business 
organization. The SEC often forms advisory groups with which it 
consults on various issues, but it also is important to 
establish an open line of communication on a more regular basis 
with market participants and issuers and for the SEC to reach 
out to business leaders regularly to discuss business and 
regulatory issues informally. It is through such contact that 
the SEC can gain a more up-to-date understanding of the issues 
facing the markets and the risks associated with certain 
strategies. Through these communications the SEC can also move 
more quickly to give public guidance in areas involving complex 
or emerging issues, and to avoid after-the-fact review of 
conduct and situations which may develop in a fashion which the 
SEC later determines is not appropriate.
    I do not believe that such contact will result in 
``regulatory capture.'' Those who work at the SEC are 
professionals who make certain sacrifices in choosing public 
service, and, though they are not immune from normal human 
reactions to more frequent contact between individuals, the 
context of the contact, the relative infrequency of it even if 
an open line of communication is established, the sensitivity 
on both sides to the interests which each participant 
ultimately serves, and the close monitoring of the SEC by 
Congress, the media and the public in general, I believe will 
provide sufficient protection from regulatory capture.
    An open line of communication must be a two-way street to 
be effective. The regulated must be willing to respond. As I 
noted in my written statement, I believe that in the last 10 
years, an atmosphere of suspicion has developed between the SEC 
and market participants and issuers in some cases. In my 
written statement I briefly noted my thoughts on the sources of 
this tension. One source is, that in stark contrast to the 
picture of weak SEC Enforcement efforts painted in the media, I 
believe that many market participants and issuers view the 
SEC's Enforcement efforts in this decade as very aggressive 
across the board. In the last 5 years, the SEC has conducted 
numerous market ``sweeps,'' in which it sends requests for 
voluminous information to many market participants or issuers 
at the same time regarding different areas of concern or 
interest. The sweeps call for extensive document production as 
well as provision of written statements or information, and are 
very time consuming and expensive. Regulatory inspections have 
been often lengthy and may overlap with other regulatory bodies 
or even other offices within the SEC.
    In addition, as expressed in the Report on the Current 
Enforcement Program of the Securities and Exchange Commission, 
issued by the U.S. Chamber of Commerce in March 2006 (Chamber 
of Commerce Report), it seems that ``the current pro-
enforcement atmosphere and criticisms of the Commission's 
enforcement program . . . have encouraged the Commission to 
advance aggressive theories through enforcement actions, where 
the relevant facts are far from clear.'' Chamber of Commerce 
Report at page 17. I and my law firm were counsel to David 
Andrews, who was engaged by the Chamber of Commerce to develop 
the Report, and I refer to it because of my participation in 
authoring it and because the views expressed in the Report are 
consistent with mine. The Commission relies extensively on the 
Staff to interpret facts discovered in an investigation and to 
recommend enforcement actions. This often requires evaluation 
of difficult factual issues and determination of whether 
malleable standards like ``recklessness'' or ``materiality'' 
are met. As noted in the Chamber of Commerce Report, although 
no one disagrees that clear cases of fraud should be pursued 
aggressively, there is a feeling ``that there is a lack of 
appropriate consideration by the Commission of the difficulties 
with which executives are faced in interpreting complex 
disclosure, accounting and legal issues and in uncovering 
fraud.'' Chamber of Commerce Report page 17. As former SEC 
Chairman Donaldson cautioned in a speech in September 2003, 
``enforcement of the laws can, in some circumstances, become a 
vehicle for changing the rules . . . an enforcement proceeding 
can realign an industry standard in much the same way as a new 
rule, at times, making the line between rule making and 
enforcement unclear.'' \1\ This issue also extends to 
consideration by criminal prosecutors dealing with securities 
law cases, and can be much more acute in such instances. See 
Chamber of Commerce Report at pp. 23-24.
---------------------------------------------------------------------------
     \1\  William H. Donaldson, Speech by SEC Chairman: Speech to NASAA 
Annual Conference (Sep. 14, 2003) (available at http://www.sec.gov/
news/speech/spch091403whd.htm).
---------------------------------------------------------------------------
    Another source of tension between the Commission and 
industry participants and issuers is the Commission's use of 
its penalty powers. The GAO Report which was a topic of the May 
7, 2009, hearings, spent some time reporting its findings on 
the SEC's penalties program, and concluded, among other things 
that recent SEC policies ``have had the effect of making 
penalties less punitive in nature . . . '' and that there is 
``a perception that the SEC has retreated on penalties,'' GAO 
Report at page 7. I agree that the SEC's recent pilot program 
requiring that the Commission approve a range of possible 
penalties before the Enforcement staff was allowed to begin 
negotiating a settlement with an entity that is the subject of 
a possible enforcement action slowed the process. However, I 
disagree with the implication that penalties serve a deterrent 
purpose on corporate or other entities, and that penalties must 
be ``punitive'' and must ``punish'' entities for the misdeeds 
of their employees, at least where the entity itself is not an 
entirely corrupt organization. Rather, I believe that the 
publicity and cache given to the size of penalties in the 
public eye encourages the SEC to seek larger and larger 
penalties and discourages entities from engaging in a dialogue 
with the Commission staff about uncertainties over trading 
strategies or other activities. When coupled with an aggressive 
interpretation of standards for fraud liability, a move toward 
large corporate penalties only exacerbates tensions between the 
Commission and those it regulates.
    One might not be concerned about such tension if penalties 
on entities truly did deter future conduct. However, 
corporations do not commit fraud; individuals who work for them 
do so. And I do not believe that monetary penalties appreciably 
increase the incentive of corporate boards or executives to 
attempt to prevent and detect fraudulent conduct. Honest 
corporate boards, executives and employees already have 
adequate incentive, and indeed, legal requirements, to police 
themselves and those who work around them. Corporations are 
required by the Federal securities laws, including recent 
additions under the Sarbanes-Oxley Act of 2001, to take 
extensive steps to set internal controls and to monitor and 
attempt to prevent and detect fraudulent conduct by employees. 
In addition, the monetary costs incurred by an entity which 
becomes involved in an SEC investigation are in effect a 
penalty, and are potentially enormous. The cost to the entity 
to retain counsel and experts to conduct an internal review, to 
defend the corporation in an investigation and often to provide 
separate counsel to its Audit Committee and employees can be in 
the tens of millions of dollars. Many of these direct costs may 
be defrayed by D&O insurance, depending on the amount that had 
been purchased, but insurance policy amounts run out and 
increased insurance costs in the future are real. Also, there 
is inevitable shareholder litigation which may take multiple 
forms and which requires additional counsel and experts to be 
retained. Settlements of shareholder actions can run into the 
hundreds of millions of dollars in egregious cases. The cost in 
person hours, morale, and loss of goodwill and good employees 
also can be very high, especially in light of more recent media 
and shareholder sophistication and attention to such issues. 
When conduct of some at a corporation begins to make headlines, 
whether or not involving egregious misconduct, the jobs of even 
those executives who were not involved in the conduct are at 
risk and their reputations are severely damaged. All of this 
provides adequate deterrence and incentive to the honest 
employees of a corporation or other entity to take strict 
measures to prevent and detect improper conduct.
    Finally, I have never accepted that an individual who is 
brazen and self-interested enough to engage in a fraud at a 
public company or a regulated entity would be deterred, let 
alone punished, by the idea that if they are caught a penalty 
may be levied against his or her employer. Indeed, by the time 
the fraud is discovered and gets to a penalty stage, the 
offending employee(s) most certainly are gone and their last 
concern is about what happens to the entity.
    I have heard the argument that if penalties do not deter, 
then why is there so much concern over them? Despite their best 
efforts, honest boards of directors, executives, and employees 
cannot be certain that they are preventing fraudulent 
activities by even senior executives. Thus, the concern over 
penalties and over an apparent race to satiate the public 
appetite for ever larger penalties is that an entity will 
someday be caught in the vise of public outcry and the 
practical need to resolve a matter in which the government is 
calling for a very large penalty as a result of conduct which 
honest executives or board members were unable to prevent. I 
also believe that the push for greater penalties and the 
publicity which it generates helps to advance the growing, 
inaccurate, and very unhelpful public perception that corporate 
America is corrupt or tends toward corruption, and that huge 
penalties are the only thing standing between honest investors 
and corrupt executives.
    I believe that the above factors combine to create a 
perception among some issuers and regulated entities that 
increased dialogue and contact with Commission staff may only 
lead to second-guessing based on a lack of understanding, and 
possibly an investigation and a wide net being cast over almost 
anyone near some conduct that is deemed inappropriate or 
improper. Although this view may not be entirely justified, 
especially with rule-making divisions within the Commission, 
the trifecta of (i) the Commission being widely criticized and 
pushed to be more aggressive in the enforcement area; (ii) 
public pressure for ever-increasing entity penalties, and (iii) 
the case with which complex factual situations can be 
misinterpreted and read to infer misconduct under malleable 
legal principles, combine to put pressure on both the 
Commission and those whom it regulates and monitors to interact 
only in an adversarial or semi-adversarial setting.

Q.4. You noted in your testimony that the line between civil 
and criminal securities cases has been blurred. Can you share 
your thoughts on the role of the SEC with respect to criminal 
securities fraud cases?

A.4. As to the role of the SEC in criminal securities cases, I 
believe that the SEC should have a major, consultative role and 
should be intimately involved in decision making with criminal 
authorities where a case is predominately a securities law case 
or is a case that affects a regulated entity under SEC 
supervision. The SEC administers, enacts rules under, and 
interprets a number of statutes covering a variety of 
businesses and business organizations, including public 
companies, broker-dealers, investment advisers, and mutual 
funds. These statutes and related rules are often complex and 
reflect long-reviewed and thought-out policy considerations. 
The SEC is charged with consistently applying these statutes 
and rules to the activities of individuals and entities to 
provide uniformity across all such activities in the areas of 
the SEC's expertise, no matter in what jurisdiction the 
individuals or entities operate in the United States. Indeed, 
the SEC's jurisdiction can reach to entities that are not 
predominately U.S. organizations.
    Although some frauds are clear or brazen, the above 
considerations still apply to cases brought as ``straight-
forward frauds,'' which may not on their face involve any 
complex rule or regulation. Indeed, recent criminal securities 
``fraud'' cases still involved interpretation of esoteric 
accounting principles or required the criminal authorities to 
pursue theories which involve those authorities advancing what 
they believe was or was not a proper business purpose for a 
transaction.
    In an atmosphere where even a threatened criminal action or 
a threat by a State to shut down a major brokerage firm can 
have a dramatic and swift effect on that organization and the 
market as a whole, I believe that the agency charged with the 
strong public policy interests expressed in the Federal 
securities laws should have a major role in determination of 
whether actions involving conduct or entities directly within 
its jurisdiction should be criminally prosecuted under any 
particular set of facts. For a further discussion of issues 
relating to criminal enforcement of the Federal securities 
laws, I refer you to the Chamber of Commerce Report, pp. 22-24 
and note 82 therein.
    Once again I thank you for the opportunity to appear before 
the Subcommittee and to provide information on the important 
work which you are doing in the area of SEC enforcement. I hope 
that my comments are helpful, and I look forward to assisting 
you in the future if called upon.
              Additional Material Supplied for the Record

                PREPARED STATEMENT OF COLLEEN M. KELLEY
                          National President,
                   National Treasury Employees Union
                              May 7, 2009
    Chairman Reed, Ranking Member Bunning, and Members of the 
Subcommittee, I greatly appreciate the opportunity to provide testimony 
to this distinguished Subcommittee.
    These are challenging times for the United States Securities and 
Exchange Commission and for its Division of Enforcement in particular--
but these times also present a unique opportunity to engage SEC 
leadership to recognize and utilize what is best about government 
service to make the agency more responsive to our Nation's needs. 
During our Nation's current financial crisis, I am confident that the 
talents and expertise of front-line SEC employees, many of whom have 
been too often overlooked, can and will be tapped to help restore 
confidence in our Nation's capital markets achieve the fundamental goal 
of protecting our Nation's investors. As President of the National 
Treasury Employees Union (NTEU), representing more than 150,000 Federal 
employees in over 31 different agencies and departments throughout the 
government, including the over 2,500 bargaining unit employees at the 
SEC, I look forward to working with you to help the SEC succeed in its 
fundamental mission.
    The challenges that we face as we work together to revive our 
economy and ailing financial institutions are complicated and broad 
ranging. But much has happened in the past several months. We have a 
new president and a new SEC chairman who see government as part of the 
solution to our Nation's challenges, rather than as the problem. We are 
hopeful that in this new era, the SEC will begin the work of restoring 
the morale of the SEC's front-line staff and rededicating the agency to 
its mission as the investor's advocate, rather than as an arbiter 
between those who favor a smart, efficient regulatory landscape and 
those who oppose it.
    Indeed, a renewed dedication to public service has never been more 
important. I was proud that NTEU's award-winning public service 
campaign, ``Federal Employees . . . They Work for U.S.,'' was well 
received throughout the country. We were proud to air radio spots on 65 
stations, in 50 markets nearly 17,000 times, and TV spots that resulted 
in 14 million impressions. These ads reminded the public of the 
important work Federal employees do in an array of agencies and 
communities throughout the Nation.
    NTEU believes that fundamental improvements to the SEC's 
Enforcement Division are long overdue. We support the new Director of 
the Division of Enforcement, Robert Khuzami, and his basic goal of a 
smart, swift, strategic, and successful enforcement program. In our 
view, Enforcement Division reforms should be carefully considered and 
based upon lessons learned about the Division's strengths and 
weaknesses over the past several years. And I think it is important to 
note, that whether in connection with market timing, options 
backdating, the subprime mortgage crisis, or the Madoff Ponzi scheme, 
the common thread among these failures has not been a failure of the 
front-line investigative staff, but rather a failure of past SEC 
management to acknowledge or respond swiftly to significant allegations 
of improper conduct and inordinately high systemic risks.
    The extent to which the SEC's Division of Enforcement will be 
successful in its mission rests in large measure with the Federal 
employees charged with carrying out the agency's fundamental mission of 
enforcing the Federal securities laws to protect our Nation's 
investors. In the final analysis, a great country is the sum of the 
actions of its people--and in few, if any endeavors, does that hold 
more truth than in the work of the attorneys, accountants, and support 
staff who are employed in the SEC's Division of Enforcement. These 
highly skilled women and men have dedicated themselves to answering the 
call to public service. The change in administrations clearly provides 
a window of opportunity not only for improvements in the Division of 
Enforcement and the way it conducts itself--and thus how it serves the 
public--but in the way it attracts and retains those who perform the 
people's work.
Improving the Organizational Structure of the Enforcement Division
    The primary challenge currently faced by the front-line SEC 
enforcement staffers that NTEU represents is the existence of a 
multilayered and redundant management structure within the Division of 
Enforcement. Every four or five front-line enforcement employees 
currently report to a ``Branch Chief,'' who reports to an Assistant, 
who reports to an Associate. The vast majority of these front-line 
enforcement staffers are highly qualified, skilled, and motivated 
attorneys and accountants who are fully capable of handling their 
investigations independently, without the level of constant supervision 
that flows naturally from this ratio of managers to staff persons.
    As a result of this structure, it often takes as long to determine 
what to do about a violation as it does to determine whether there was 
a violation in the first instance. This robs the Division of its 
ability to have a swift and timely regulatory impact.
    NTEU generally supports President Obama's laudable reform goal of 
flattening management layers in the Federal government, as well as 
recent remarks by Enforcement Director Khuzami indicating a willingness 
to consider such changes. The SEC's Enforcement Division is an example 
of an entity that would be well served by a reduction in the number of 
redundant management layers. Such a flattening of the structure would 
improve the speed and efficiency of the enforcement program, while, 
simultaneously increasing front-line employee morale, engagement, and 
empowerment. Re-designating unnecessary enforcement managers would also 
result in a substantial increase of up to 20 percent in the number of 
front-line investigative enforcement staff who are actually 
investigating cases, without requiring an increase in funding from 
Congress.
Need for Additional Market, Financial, and Accounting Expertise
    Mr. Khuzami has recently expressed the view that the SEC's 
enforcement program might benefit from hiring additional experts to 
assist the front-line staff in conducting their investigations, as well 
as by more effectively leveraging the experts that it already employs. 
NTEU supports this recommendation. The SEC's front-line enforcement 
attorneys are highly skilled experts at what they do--that is, 
identifying and developing evidence critical to evaluating possible 
violations of the Federal securities laws. However, in an increasingly 
complex global financial marketplace, those attorneys would benefit 
greatly from more readily available technical and analytical support 
staff. In recent years, the SEC has failed in providing this type of 
support.
    As an example to place this issue in perspective, the Enforcement 
Division today employs approximately 500 nonmanagement investigative 
attorneys, but it has only nine bargaining unit ``market surveillance'' 
experts nationwide. Increasing the staff of market, accounting, and 
financial analysts and other investigative support staff available to 
work with SEC attorneys would be an efficient improvement that would 
help to achieve the Director's goal of smart, strategic, swift, and 
successful results.
Reorganization of Enforcement into Specialist ``Silos''
    During his first few weeks at the SEC, Mr. Khuzami has suggested 
that the agency might perhaps more effectively fight securities fraud 
by radically reorganizing its enforcement staff into a number of 
``specialist'' groups that would target specific types of cases. 
Employees would shift in and out of particular specialty areas every 
couple of years. This type of specialist, or ``silo,'' model would 
constitute a historic and fundamental sea change in the organization of 
the Division of Enforcement. It therefore requires extremely careful 
consideration and deliberation before implementation.
    It is important to carefully consider the inherent logistical 
problems raised by attempting to shift to such a model. If employees 
are reassigned en masse into specialist ``silos,'' will the agency 
transfer their cases to other employees if those cases do not fall 
under their current specialty? If so, how would it be an efficient use 
of agency resources to transfer numerous cases from staff possessing 
historical knowledge of those cases to staff having no such knowledge? 
If not, then what will specialization really mean? How long will 
employees be expected to stay in a particular specialty area? When 
their ``tour of duty'' in a particular specialty ``silo'' is over, will 
they transfer their uncompleted cases to other employees? Will this be 
efficient for the agency? If not then what will specialization really 
mean? To deal with these problems, will employ be expected to stay in 
certain specialty areas for extended periods of time, without the 
ability to work in other areas of the Federal securities laws? Who will 
decide which employees are reassigned to which groups, and what will be 
the criteria for such reassignments? What will be the long term impact 
of such decisions upon employee morale, and upon recruitment and 
retention?
    Even beyond these logistical difficulties, there are fundamental 
questions about the efficacy of such a ``silo'' model that should be 
carefully considered by the SEC. Most of the highly skilled SEC 
enforcement lawyers and accountants that NTEU represents are organized 
into groups which handle all of the types of cases brought by the 
agency--most notably cases enforcing the Securities Act of 1933, the 
Exchange Act of 1934, the Investment Company Act of 1940, and the 
Investment Advisers Act of 1940. All of these types of cases have basic 
similarities, and a great many investigations involve violations under 
more than one provision. For this reason, the agency has traditionally 
believed that it is important for the front-line enforcement employees 
to possess a relatively broad knowledge of all of the securities laws, 
even if in some cases that knowledge is not particularly deep.
    In fact, it is not at all unusual for one enforcement investigation 
to present issues that touch upon almost all aspects of the Federal 
securities laws. A hedge fund investigation may involve, among other 
things, insider trading, offering fraud, market manipulation, and 
accounting fraud, as well as violations of the Investment Advisers Act. 
This may be one reason why the SEC's historical experience with 
specialized groups has often resulted in such groups dissolving back 
into general enforcement. Cases frequently contain too many parts to 
classify easily. In addition, while the SEC has used task forces in the 
past, they have only existed for limited durations.
    Thus, although there is some natural appeal to the broad concept of 
``specialization,'' the SEC's enforcement attorneys and accountants are 
already highly specialized by focusing on enforcement of the Federal 
securities laws. In this regard, the Division of Enforcement is 
different from the Department of Justice, where law enforcement is 
divided into specialist groups. Federal securities law is already a 
fairly narrow area of the law. By contrast, a typical U.S. Attorney's 
Office is divided into a number of different groups dealing with 
unrelated criminal activities. Even a small white collar crime group in 
a U.S. Attorney's Office, for example, deals with a broader class of 
investigations than just the violations of the Federal securities laws 
currently handled by the SEC's Enforcement Division.
    By creating ``specialized'' groups, the SEC would in reality be 
creating microspecialized groups. This could be akin to transforming 
SEC enforcement attorneys into assembly line workers who only attach 
one part during an assembly process. Although, perhaps, some simpler 
types of securities fraud cases could be completed more quickly in such 
an environment, the cost could very well be increased staff alienation 
and balkanization, and a generally less effective enforcement program, 
particularly with respect to larger, more complex cases.
    NTEU shares Mr. Khuzami's ultimate objective, which we believe is 
to empower front-line enforcement investigators with the expertise and 
resources necessary to regulate increasingly complex financial markets. 
We believe, however, that the SEC should proceed very carefully with 
any plans to fundamentally shift the organization of the Enforcement 
Division toward a higher degree of specialization. In this regard, 
Federal labor law and the collective bargaining agreement between NTEU 
and the SEC set forth the negotiating process that is required before a 
large scale reorganization of the Division could occur. NTEU leaders 
look forward to engaging in a respectful and constructive dialogue 
regarding these issues with SEC management.
Improved Enforcement Prioritization Metric
    NTEU supports Mr. Khuzami's call for the introduction of an 
improved Enforcement Division prioritization metric which would allow 
every front-line employee to effectively evaluate potential enforcement 
matters.
    Walter Ricciardi, a Deputy Director in the Enforcement Division 
from 2005 to 2008, recently remarked in an April 1 speech in New York 
that SEC enforcement offices are evaluated on the number of cases, or 
``stats,'' that they bring in, rather than on the regulatory impact of 
those cases. This system, in which every case receives the same one-
size-fits-all ``stat,'' is woefully inadequate. Bringing an enforcement 
action against Enron yields one ``stat,'' but an office could receive 
100 ``stats'' for delisting 100 defunct companies for failing to file 
annual reports.
    All cases are not the same, and treating them as though they are 
has the potential to create perverse incentives, as well as to devalue 
the important work of front-line employees. Most importantly, the SEC's 
prioritization metric should reflect actual harm to investors, current 
or potential.
Empowering Front-Line Investigative Staff
    Over the past year, there have been a number of press reports 
regarding inquiries by Congress and the Office of the Inspector General 
concerning SEC investigations in which senior managers allegedly met 
with defense counsel outside the presence of the front-line staff 
assigned to those investigations. These reports led one Senator to 
comment in the press on what he perceives to be a ``culture of 
deference'' toward ``big players'' on Wall Street.
    A renewed public commitment by Enforcement Division management to 
ensuring that front-line enforcement staff will be permitted to attend 
all meetings between management and defense counsel on the matters that 
those staffers are investigating would readily dispel such perceptions, 
while simultaneously reinforcing the important role of the front-line 
staff in enforcement investigations.
Reducing Bureaucratic Tasks
    Today, front-line employees in the Enforcement Division expend a 
great deal of time on bureaucratic tasks such as the updating various 
internal databases and providing repetitive reports on their cases up 
the management chain. Simply reducing these types of activities would 
be an important step toward streamlining the enforcement process.
Expanded Regulatory Authority
    NTEU supports increased regulatory authority for the SEC over 
unregulated investment instruments and entities, including explicit 
statutory authority to regulate hedge fund advisers as investment 
advisers and to require hedge funds to disclose the contents of their 
portfolios, leverage amounts, and counterparties.
Funding and Staffing
    Any consideration of ways to strengthen the SEC's vital enforcement 
responsibilities should include a discussion of the important human 
capital issues currently facing the SEC. As the agency deals with what 
is perhaps the most challenging period in its history, its single most 
important asset continues to be its human capital--the stock of skills 
and knowledge embodied by the talented group of front-line employees 
who work at the agency and carry out its complex mission every day. For 
that reason, maintaining a sound strategy to both attract and retain 
the best possible work force will be critical to the long term success 
of the SEC's enforcement program.
    During the previous administration, however, the SEC displayed what 
could only be viewed as a marked indifference to human capital issues. 
Far too often, the agency was hamstrung, understaffed, underfunded, and 
led by political appointees who were at best ambivalent about the 
agency's mission. By actively engaging the SEC's workforce and 
refocusing its mission, the agency's new management can take a 
fundamentally different path which will assist it in more effectively 
tackling our Nation's problems while simultaneously restoring vitality 
to the SEC, including its Division of Enforcement.
    Last year, NTEU pressed the case in Congress for additional SEC 
staffing and an increase in the performance based pay budget requested 
by the agency, even as the prior administration was asserting that the 
SEC did not need any additional funds and that it expected substantial 
staff attrition in FY2009. In hindsight, it is now abundantly clear 
that permitting attrition to shrink the size of the SEC's staff, 
including its enforcement staff--a strategy which was actively pursued 
by the agency's previous management--could not have been more gravely 
off the mark. For that reason, I am heartened by the fact that current 
SEC Chairman Mary Schapiro has signaled a change in direction with 
respect to staffing issues. I strongly support additional funding to 
increase the agency's front-line staff.
    But more needs to be done with respect to human capital issues at 
the SEC. For example, the agency should deliver on its agreement, made 
more than 2 years ago during its 2006 compensation negotiations with 
NTEU, to provide a 2 percent increase in its retirement match for SEC 
employees. In addition, SEC management should reverse the prior 
administration's approach of repeatedly slashing the funding for its 
performance based pay system.
    The SEC's performance based pay system has had many flaws, both in 
its implementation and execution. This was clearly evidenced by NTEU's 
national arbitration victory against the agency in late 2007, which 
ultimately resulted in a $2.7 million monetary settlement after an 
arbitrator found that the system had had a discriminatory impact on 
hundreds of SEC employees. The most glaring problem with the merit pay 
system, however, has been past management's conscious decision to 
inadequately fund it. For fiscal years 2007, 2008, and 2009, the agency 
slashed its performance based pay budget, culminating in its most 
recent request to Congress for only a 1.5 percent increase for FY2009. 
This amount represented only half of the historic merit pay budget of 3 
percent. Without SEC management support for adequate funding, the merit 
pay system will never work as intended.
    NTEU is looking forward to working closely with new SEC Chairman 
Schapiro to alter the course of the misguided human capital policies of 
the past administration. Without fundamental change in the agency's 
approach to these issues, employee morale will continue to suffer, 
which will have a concomitant negative impact upon recruitment and 
retention--and ultimately upon the agency's ability to effectively 
enforce the Federal securities laws.
    Finally, NTEU supports a self-funding mechanism for the SEC to 
ensure its independence in establishing its budget and staffing needs 
from the fees that it collects. Currently, as you know, fees collected 
by the SEC go into the General Treasury and the agency is funded and 
staffed through appropriations. Other financial regulatory agencies 
represented by NTEU, however, such as the Federal Deposit Insurance 
Corporation, the Office of the Comptroller of the Currency, and the 
National Credit Union Administration, all have such control over the 
funds that they collect. The SEC should be afforded the same 
independence and discretion.
Conclusion
    The challenges facing the SEC's Division of Enforcement in our 
Nation's current financial crisis are large and historically important. 
I think that it is important to remember in this context that the 
Chinese symbol for ``crisis'' contains both the symbols for ``danger'' 
and for ``opportunity.''
    It is truly a new day for us all. The SEC has been through a lot in 
recent years, suffering from depleted resources and staffing, as well 
as poor judgment by prior management. But it also enjoys a deep 
reservoir of highly skilled, resilient, and capable employees who will 
continue to play a critically important role as we move ahead together 
to address the problems that we face.
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