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


 
  FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL 
                               YEAR 2010 

                              ----------                              


                         TUESDAY, JUNE 2, 2009

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:33 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Richard J. Durbin (chairman) 
presiding.
    Present: Senators Durbin, Tester, and Collins.

                   SECURITIES AND EXCHANGE COMMISSION

STATEMENT OF HON. MARY L. SCHAPIRO, CHAIRMAN


                 statement of senator richard j. durbin


    Senator Durbin. Good morning. I'm pleased to convene this 
hearing on the fiscal year 2010 funding request for two key 
Federal regulatory agencies within the jurisdiction of this 
Appropriations Subcommittee on Financial Services and General 
Government, the Securities and Exchange Commission (SEC) and 
the Commodity Futures Trading Commission (CFTC).
    I also want to welcome my friend and my distinguished 
Ranking Member Senator Susan Collins. We have worked together 
in many venues, and I'm glad that we're going to share the 
responsibilities of this subcommittee.
    Joining us today to present testimony on the two budgetary 
proposals are the Honorable Mary Schapiro, Chairman of the SEC, 
and the Honorable Gary Gensler, Chairman of the Commodity 
Futures Trading Commission.
    Both of these agencies enjoy unique histories, hold 
specialized and independent responsibilities and take different 
approaches to markets that serve different purposes, yet the 
CFTC and SEC both occupy pivotal positions at the forefront of 
stimulating and sustaining economic growth and prosperity.
    We are enduring an extraordinary set of circumstances in 
our Nation today. We are beginning to slowly emerge from one of 
the greatest economic crises in decades. After years of 
struggle, countless families have lost their hard-earned 
savings, seen their dreams deferred and even denied.
    Some may view the subject matter of this hearing as dry as 
dust, how much money to give to two Federal agencies, but if 
you step back for a moment and translate their work into the 
real world, realize that their oversight and their regulation 
literally protects the savings and futures of American families 
and ensures that economies in countries around the world will 
view our economy and the way we run it with respect to as to 
whether or not the rule of law is going to be followed.
    The unprecedented price volatility of our markets for 
fiscal commodities, such as energy and grains, has hurt our 
economy, in addition to the previous mention I made of some of 
the problems that we've had with savings and the like.
    Now perhaps more than ever, we need our markets to function 
transparently and be insulated from manipulation and unfettered 
excessive speculation. Much remains to be done to stabilize and 
sustain our financial system.
    Chairman Schapiro and Chairman Gensler each bring vast 
experience to their new leadership posts in this administration 
and have undoubtedly identified in their brief tenure ways to 
improve the way we approach regulating securities and futures 
markets.
    As the subcommittee prepares to make difficult funding 
decisions, I look forward to hearing about the challenges their 
agencies will face.
    In the interest of time, I am going to ask that the 
remainder of my statement be made a part of the record so that 
we will have opportunity for testimony and for questions.
    [The statement follows:]
            Prepared Statement of Senator Richard J. Durbin
    The CFTC and the SEC enjoy unique histories, hold specialized and 
independent responsibilities, and take different approaches to markets 
that serve differing purposes. Yet the CFTC and the SEC both occupy 
pivotal positions at the forefront of stimulating and sustaining 
economic growth and prosperity in our country.
    Market users, financial investors, and the U.S. economy rely upon 
vigilant oversight by these two agencies in today's evolving--and often 
volatile--global marketplace.
    We are enduring an extraordinary set of circumstances in America 
today. We are beginning to slowly emerge from one of the greatest 
economic crises since the Great Depression. After years of sweat and 
struggle, countless families have lost their hard-earned savings, 
seeing their dreams daunted, deferred, and even denied.
    When a man named Bernard Madoff can, over the span of 10 or 20 
years, lure investors into what has turned out to be a Ponzi scheme, 
causing many of them to lose millions of dollars, and his wrongdoing 
goes unnoticed by major regulatory agencies, it is clear more has to be 
done.
    When some of the major ratings agencies that gauge whether a 
company is doing well basically ignore their responsibility and fail to 
make accurate reports, everyone loses as a result of it.
    The unprecedented price volatility of our markets for physical 
commodities, such as energy and grains, has hurt our economy. Now--
perhaps more than ever--we need our markets to function transparently 
and insulated from manipulation and unfettered excessive speculation.
    The Obama administration recently announced a comprehensive plan to 
significantly regulate credit default swaps and other over-the-counter 
derivatives. Exempting these investments from regulation has proven to 
be a costly mistake--contributing to the $180 billion taxpayer bailout 
of AIG, the collapse of Lehman Brothers, and the demise of Bear 
Stearns.
    This proposal will require far more transparency and responsibility 
from derivatives traders that have long operated in the shadows.
    Things are still very fragile. Much remains to be done to 
stabilize, repair, and sustain our financial system on which we all 
depend. It will take time to redeem the lost faith of the American 
people in the government institutions they expected would protect them. 
But I believe we are moving forward with resolve toward a brighter 
economic course.
    I appreciate the fact that Chairmen Schapiro and Gensler have each 
accepted President Obama's call to be part of the economic leadership 
team to help craft a more reliable regulatory framework and guide us to 
a better future.
    Both Chairmen bring vast experience to their new leadership posts 
in this administration--and have undoubtedly identified, even in their 
brief tenures, ways to improve the way we approach regulating in the 
securities and futures markets.
    As the subcommittee prepares to make difficult funding decisions 
for the next fiscal year, I look forward to hearing about the 
particular challenges their respective agencies face in today's 
tumultuous economic environment. I welcome their input on how we can 
best help to address those needs.
    Before hearing from our panelists, I'd like briefly outline the 
missions of these agencies and their budget proposals:
    Turning first to the SEC, its three-prong mission is to protect 
investors; maintain fair, orderly, and efficient markets; and 
facilitate capital formation. The SEC is the investor's advocate.
    The SEC is responsible for overseeing more than 12,000 publicly 
traded companies, over 11,300 investment, nearly 8,000 mutual funds 
with $9 trillion in assets, fund complexes, 5,500 broker dealers with 
over 174,000 branches, 10 credit rating agencies, and close to $44 
trillion worth of trading conducted each year on America's stock and 
option exchanges.
    The strength of the American economy and our financial markets 
depends on investors' confidence in the financial disclosures and 
statements released by publicly traded companies. Investors expect the 
SEC to be the vigilant ``cop on the beat.'' Regrettably, in many 
respects, we let them down. I have faith in Chairman Schapiro's 
leadership and tenacity to turn things around.
    This subcommittee wants to make certain that the SEC has the 
necessary resources to effectively fulfill its obligatory singular 
mission: protecting shareholders.
    The SEC's budget request for fiscal year 2010 totals $1.026 
billion, an increase of $8.8 million, or 8.8 percent over the agency's 
fiscal year 2009 enacted level of $943 million. This proposed fiscal 
year 2010 budget would fund 3,692 FTE, just 40 more than the current 
year funding permits.
    Crucial to the SEC's effectiveness is its enforcement authority. 
Each year the SEC brings hundreds of civil enforcement actions for 
violations of the securities laws, such as insider trading, accounting 
fraud, and providing false or misleading information.
    Serious, thoughtful questions have been raised about whether the 
proposed enforcement budget is adequate to keep pace with the growing 
demands.
    Second, the CFTC: The CFTC is charged with protecting the public 
and market users from manipulation, fraud, and abusive practices. It is 
also responsible for promoting open, competitive, and financially sound 
markets for commodity futures.
    The CFTC helps ensure that the futures markets are equipped to 
better perform their vital function in the U.S. economy--providing a 
mechanism for price discovery and a means of offsetting price risks.
    The CFTC's oversight and enforcement mission becomes tangible when 
you consider that futures prices impact what we pay for the basic 
necessities of our daily lives: our food, clothing, shelter, fuel in 
our vehicles, and heat in our homes.
    This year--2009--marks the 35th year since the establishment of the 
Commodity Futures Trading Commission. At the time of its inception in 
1974, CFTC's 500 employees were tasked with the mission of ensuring 
fair practices and honest dealings on the commodity exchanges of 
America's then-$500 billion futures industry.
    Today it is a $22 trillion industry that looks vastly different. 
Yes, the traditional agricultural products like wheat, corn, soybeans, 
and the proverbial pork bellies are still part of the picture. But the 
landscape has been remarkably altered and diversified with novel and 
complex commodities . . . everything from grains to gold, currencies to 
carbon credits.
    In the past decade, trading volume has increased more than ten-
fold--reaching well over 3.4 billion trades in 2008, and actively 
traded contracts have quintupled--from 286 in 1998 to 1,521 in 2008. 
CFTC oversees $5 trillion of trades--daily.
    Adding to this challenge is a significantly transformed globalized, 
electronic, and round-the-clock marketplace. Moreover, the emergence of 
derivatives and hedge funds have altered the regulatory environment.
    Layered on this are new authorities added through the 2008 farm 
bill, coupled with escalating public angst about record energy and 
agricultural commodity price hikes and fluctuations, and a growing 
influx of financial funds into the futures markets.
    Further complicating the picture are transactions that the CFTC 
currently has no power to presently regulate--the vast ``shadow'' world 
of over-the-counter derivatives--like credit default swaps.
    Surprisingly, what hasn't changed is the number of staff. Despite 
the phenomenal surge in volume and activity, CFTC staffing levels have 
simply not kept pace. In fact, staffing levels have dropped by over 20 
percent. CFTC's workforce--like its predecessor over three decades ago 
in the agency's fledgling years--presently numbers only 500.
    For fiscal year 2010, the President's budget request funding for 
the CFTC of $160.6 million. This represents an increase of $14.6 
million--a 10 percent hike--above the fiscal year 2009 enacted level of 
$146 million.
    Of the $14.6 million in increased funding for next year, $7.4 
million is slated for increased compensation and benefit costs for a 
staff of 572; $0.2 million will be devoted to increased operating costs 
for information technology modernization, lease of office space, and 
other services; and $7.8 million will support the salary and expenses 
of 38 additional full-time staff.
    Last August, I had the opportunity to visit the CFTC's Chicago 
Regional Office. I met with a group of dedicated staff committed to 
doing outstanding work under challenging circumstances. I learned 
first-hand just how thin the staffing is.
    The CFTC's Chicago market surveillance staff consisted of 10 
economists who conduct daily oversight of each actively traded market 
and 6 trading specialists who process the daily reports detailing 
traders' actual positions in each market.
    These economists are responsible for surveillance of over 1,250 
different commodity futures and option contracts, of which 325 are 
active, involving 13 different commodity types. The commodities 
underlying the futures contracts the staff must monitor are highly 
diverse--including grains, livestock, lumber, currencies, Treasury 
instruments, equity indexes, single stock future, and dairy. More 
recently, weather derivatives, real estate indexes, and environmental 
products such as carbon credits and emission allowances became part of 
their portfolio.
    A single staff economist must cover many markets. For example, one 
staffer is responsible for 10 grains, one for 90 currencies, and one 
for the surveillance of over 500 hundred single stock futures. Aside 
from supervision by the chief of the Chicago surveillance section and 
Washington, DC supervisory personnel, there is limited redundancy built 
into the system. As a consequence, each one of those economists is 
critical.
    The six trading specialists maintain an extensive daily data-
gathering and verification system by collecting reports from exchanges, 
futures industry firms, and traders. As our energy debate in Washington 
throughout the last Congress demonstrated, this data collection is very 
important to the Commission's oversight and to market transparency.
    As I pledged since assuming the Chairmanship of this committee, I 
am serious about addressing the resource deficiency facing this agency.
    I will appreciate hearing from both Chairmen their honest 
appraisals about the resources they will require to achieve their 
missions, keep pace with change, and becomes as sophisticated as, if 
not more so, than the entities they monitor--while responsibly managing 
taxpayer dollars.

    Senator Durbin. And I now turn it over to my Ranking 
Republican Member, Senator Collins.

                   STATEMENT OF SENATOR SUSAN COLLINS

    Senator Collins. Thank you, Mr. Chairman.
    Let me begin by saluting you for your leadership on this 
subcommittee. I am just delighted to be your new ranking 
member.
    About two decades ago, I spent 5 years in Maine State 
government as a financial regulator overseeing the bureau of 
banking, insurance, securities administration, and I have a 
great personal interest in this area because I know that the 
decisions made by the SEC and the CFTC do, as you have pointed 
out, have such an impact not only on our economy but on the 
daily lives of most American families.
    So it's a great honor to serve with you as your ranking 
member and I very much look forward to working cooperatively 
with you throughout this Congress.
    As we begin to consider the fiscal year 2010 budget 
requests for the SEC and the CFTC, let me also salute the 
chairman for his leadership in securing significant increases 
for both of these agencies.
    Thanks to the work of this subcommittee and the chairman's 
leadership, the budget for the SEC is now nearly 9 percent 
above the fiscal year 2007 funding level and the budget for the 
CFTC is 49 percent above that year.
    These increases are extremely important, given that both of 
these agencies were woefully underfunded for years. I 
personally believe that they're still underfunded and that more 
work needs to be done.
    I want to congratulate the two chairmen for appearing 
before our subcommittee today with aggressive agendas for 
change and reform. I look forward to hearing the details about 
the budget requests.
    As the chairman has indicated, the current economic crisis 
has left our markets in turmoil and the loss of trillions of 
dollars of value in these markets has depleted family savings, 
shuttered small businesses and damaged retirement and pension 
funds.
    I am convinced that we not only need to make sure these two 
agencies have the resources necessary but that we need to 
proceed with regulatory reform, as well, in order to restore 
confidence in our markets and to prevent the root causes of the 
current financial crisis from springing up once again.
    Mr. Chairman, I am going to follow your lead and submit the 
remainder of my statement, as well, but I am delighted to be 
joining you to work on these critical issues.
    Thank you.
    [The statement follows:]
              Prepared Statement of Senator Susan Collins
    Good morning. At this first hearing of our subcommittee, I want to 
thank you, Chairman Durbin, for your leadership. This Subcommittee has 
jurisdiction over a diverse group of agencies, many of which have a 
profound impact on the financial stability of our economy and on the 
lives of most Americans. So it is an honor to serve with you as Ranking 
Member of this subcommittee, and I look forward to working 
cooperatively with you during this Congress.
    Mr. Chairman, as we begin to consider the fiscal year 2010 budget 
requests for the SEC and the CFTC, I want to salute you for your 
leadership in securing significant increases for both these agencies 
during your chairmanship of this subcommittee. Thanks to your hard-
fought efforts, the budget for the SEC is now 8.9 percent above the 
fiscal year 2007 funding level, and the budget for the CFTC is 49 
percent above the fiscal year 2007 level. These increases were 
extremely important, given that both of these agencies had been 
woefully underfunded over the years.
    Chairman Schapiro and Chairman Gensler: Congratulations and thank 
you both for appearing before our subcommittee today. I look forward to 
hearing the details of your fiscal year 2010 budget requests and the 
key efforts that you plan to undertake this year. You both have crucial 
roles in our economy: SEC, by protecting the public through enforcement 
of securities laws, and CFTC, by protecting market users and the public 
from fraud, manipulation, and abusive practices related to the sale of 
commodity and financial futures and options.
    Protecting investors is more compelling than ever since many first-
time investors have turned to the markets to help secure their 
retirements, pay for homes, and send their children to college.
    Our current economic crisis has left our markets in turmoil. The 
loss of trillions of dollars in value in these markets has depleted 
family savings, shuttered small businesses, and damaged retirement and 
pensions funds.
    Chairman Schapiro, I am troubled by reports that an environment of 
lax oversight and enforcement at the SEC was a contributing factor to 
the current financial crisis. For example, some investment banks were 
allowed to become over-extended, which led to the collapse of several 
of Wall Street's largest banks. The Bernard Madoff ponzi scheme went 
undetected for decades, resulting in $50 billion in investor losses. So 
Madam Chairman, I am pleased that you have developed an ambitious 
agenda of management reforms for the Commission, and I am interested in 
hearing what resources you need to accomplish these reforms.
    Chairman Schapiro and Chairman Gensler: You both have challenging 
tasks in front of you. You must improve transparency in our securities 
markets and uncover fraud and deception, while not over-regulating our 
markets and hindering our economic recovery. I look forward to working 
with both of you, and with Chairman Durbin to ensure that you have the 
resources and the tools you need to ensure investors are protected and 
that markets are functioning properly.
    I look forward to your testimony and I thank you for your service 
to our Country.
    Thank you, Mr. Chairman.

    Senator Durbin. Thanks a lot, Senator Collins.
    Senator Tester, would you like to make an opening 
statement?
    Senator Tester. Thank you, Mr. Chairman.
    Just to welcome Mary and Gary to the subcommittee today. I 
appreciate the work that you have done and I appreciate the 
work you are about to do. I think it's critically important 
that we have good, solid, reasonable enforcement and I think 
both of you are up to that challenge.
    So with that, we'll move on. Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Tester.
    Chairman Schapiro, the floor is yours.
    Ms. Schapiro. Chairman Durbin, Ranking Member Collins, and 
Senator Tester, thank you very much for the opportunity to 
testify today.
    In the short time that I've been at the SEC, we have taken 
on an active agenda, all with the goal of protecting investors, 
revitalizing the agency, and restoring confidence in the 
markets. We are making great strides, yet recognize that we 
have quite a distance to go.
    In the area of enforcement, we have changed our policies so 
that our investigators do not have to jump over unnecessary 
hurdles before seeking penalties or launching investigations. 
We have hired a former Federal prosecutor to lead the 
Enforcement Division, someone who is focused on bringing 
significant cases with a meaningful impact as quickly as 
possible and ensuring that the Division is appropriately 
organized to do just that.
    We have begun to update our management systems, to upgrade 
our risk assessment capabilities so that we can better detect 
fraud, and we have expanded and improved upon our training so 
that our staff will be able to keep pace with the new financial 
products and strategies created on Wall Street.
    Already we are seeing results. Since the end of January, as 
compared with the same period last year, we have filed nearly 
three times as many temporary restraining order cases, issued 
more than twice as many formal orders and opened over 20 
percent more investigations into fraud.
    Although enforcement is central, it is still just one part 
of our agency. As you know, we are tasked with overseeing 
broker-dealers, investment advisors, and mutual funds, and we 
are taking steps to improve our ability to do just that.
    For instance, we are working on a risk-based initiative to 
improve our oversight methods so that we can better identify 
and focus resources on riskier institutions. We also are 
recruiting senior professionals with new skill sets, such as 
trading, risk assessment and financial analysis, and we have 
created an Industry and Risk Management Fellows Program to 
bring top talent into the agency.

                        SEC'S RULEMAKING AGENDA

    In addition to internal management directives, we also have 
engaged in an active rulemaking agenda. Last month, the SEC 
proposed significant changes to the rules governing investment 
advisors who maintain custody of their clients' assets.
    Should the proposals be adopted, advisors with custody will 
have to undergo a surprise exam by an independent public 
accountant once a year to verify client assets and any 
custodian affiliated with an advisor would also be subject to 
custody controls reviews by an independent accountant. The goal 
is to expose Ponzi schemes and other frauds earlier.
    In the area of short selling, the Commission unanimously 
voted to propose two distinct approaches to limit short 
selling. One would impose a permanent market-wide short sell 
price test, the other approach would impose temporary short 
selling restrictions upon individual securities during periods 
of severe price declines.
    Later this month, the SEC will consider proposals to 
strengthen the money market fund regulatory regime. We will 
focus on tightening credit quality, maturity and liquidity 
standards for money market funds.
    We're also exploring whether more fundamental changes are 
necessary, such as converting money market funds to a floating 
rate net asset value to better prevent abuses and avoid runs on 
the funds.
    Additionally, I have asked the staff to undertake a 
comprehensive review of rule 12(b)(1) which allows mutual funds 
to use fund assets to compensate broker-dealers and other 
intermediaries for distribution and servicing expenses.
    In the area of proxy access, the Commission already has 
proposed rules that would enhance the ability of shareholders 
to nominate company directors and next month we will take up a 
broad packet of corporate disclosure improvements around 
compensation policies, the use of compensation consultants, and 
the interplay between risk-taking and incentive arrangements.
    But there is still more to do in the regulatory arena. We 
have been working closely with other Federal agencies to bring 
the unregulated world of credit default swaps into the 
sunlight.
    Operating under the limitations of the current legislative 
structure, we recently issued temporary orders to facilitate 
the establishment of central counterparties for clearing credit 
default swaps.
    In the coming months, we will also tackle issues related to 
municipal market reform, stock lending, trading in non-
transparent markets or dark pools, and hedge fund oversight. I 
look forward to working with Congress on these issues.

                   RESOURCES NEEDED FOR SEC'S MISSION

    The financial crisis has reminded us all just how large, 
complex and critical to our economy the securities markets have 
become. At the SEC, our 3,700-person staff now oversees more 
than 35,000 registrants, including about 12,000 public 
companies, 8,000 mutual funds, 11,000 advisors, and 5,000 
broker-dealers, and it is a number that is growing rapidly.
    Nonetheless, during this same period the SEC's resources 
have fallen. Between 2005 and 2007, the agency saw 3 years of 
flat or declining budgets and lost 10 percent of its employees. 
This has an impact.
    With support from this subcommittee during the last 2 
fiscal years, the SEC has been able to lift its hiring freeze 
and begin rebuilding its workforce, and I am very grateful for 
that support.
    But even with these important steps, the number of staff 
remains below the levels of only a few years ago. I believe 
additional resources are essential to restoring the SEC as a 
vigorous and effective regulator.
    The President has requested a total of just over $1 billion 
for the agency in fiscal year 2010, a 7 percent increase over 
this year's level. This budget request would permit us to fully 
fund an additional 50 staff positions over 2008 levels. These 
positions would help the SEC's Enforcement Program enhance its 
pursuit of tips and complaints and fully fund our new Fellows 
Program that brings in seasoned industry professionals.
    In addition to expanding our workforce, the President's 
request also would enable us to invest more in new technology, 
a budget item that has dropped by more than one-half in the 
last 4 years.
    Mr. Chairman, I came to the SEC to shape public policy in 
the interest of investors and to strengthen our Enforcement 
Program. The measures I have described today are important to 
those efforts, but what I have also discovered is that we 
cannot neglect the internal operations of the agency, the 
processes that guide our work and the agency's infrastructure.
    I am committed to a complete review of the internal 
operations to ensure that we meet the highest standards and 
that we are fully supporting the important work of our 
employees. To ensure that we do it right, I intend to bring in 
a chief operating officer to manage that process.
    I want to thank you for your continued strong support of 
the SEC and its critical mission. I believe that by 
strengthening our Enforcement Program, enhancing risk-based 
oversight, and leveraging technology, we can restore investors' 
confidence in both the SEC and in our Nation's securities 
markets.

                           PREPARED STATEMENT

    I look forward to answering your questions. Thank you.
    Senator Durbin. Thanks, Chairman Schapiro.
    [The statement follows:]
                 Prepared Statement of Mary L. Schapiro
    Chairman Durbin, Ranking Member Collins, Members of the 
Subcommittee, thank you for the opportunity to testify today. I 
sincerely appreciate the support this Subcommittee has shown the 
Securities and Exchange Commission, and I am pleased to have the 
opportunity to discuss with you the Commission's role in helping to 
address the financial crisis, and to discuss reforms to improve 
investor protection and restore confidence in our markets.
    The last year has been a wrenching time for the investors whom the 
SEC is charged with protecting. Trillions of dollars in wealth have 
been destroyed during the economic downturn, and millions of Americans 
have seen their retirement nest eggs and college tuition funds shrink 
dramatically as a result. The economic crisis has challenged faith in 
our system of capital formation and allocation--a system that has 
proved over the long term to be the greatest for creating wealth the 
world has seen.
    As an agency charged with protecting investors, maintaining fair, 
orderly and efficient markets, and facilitating capital formation, we 
are dedicated to understanding and learning from recent events and from 
the causes that were building in the system over the years, so that we 
can do our part to restore market integrity and investor confidence. 
The SEC must act promptly, decisively, and with resolve. We also must 
have a renewed commitment to protecting investors; they provide the 
capital used to fund the productive enterprises that create jobs and 
wealth. While we have a tripartite mission at the SEC, investor 
protection is the foundation upon which all our responsibilities are 
built.
    To that end, I've already announced several changes at the agency 
that will reinforce our focus on investor protection and market 
integrity and redirect our energies toward restoring investor 
confidence.
                     reinvigorating sec enforcement
    One of my very first actions as Chairman was to end the 2-year 
``penalty pilot'' program, which had required the Enforcement staff to 
obtain a special set of approvals from the Commission in cases where 
the staff sought fines against public companies that violated the law. 
Some enforcement staff had complained that the procedures unnecessarily 
delayed the prosecution of cases, and discouraged the staff from either 
seeking a penalty or seeking an appropriately high penalty. At a time 
when the SEC needs to send a clear message that corporate wrongdoing 
will not be tolerated, and penalties for securities violations will be 
stiff, the penalty pilot program was an unnecessary hurdle to more 
active enforcement.
    Another change I implemented to bolster the SEC's Enforcement 
program was to provide for more rapid approval of formal orders of 
investigation, which allow SEC staff to use the power of subpoenas to 
compel witness testimony and the production of documents. In 
investigations that require the use of subpoena power, time is of the 
essence; delay can be costly to an investigation. To ensure that 
subpoena power is available to the staff when needed, the agency has 
returned to a policy of timely consideration of formal orders by the 
seriatim process or, where appropriate, by a single Commissioner acting 
as duty officer.
    In addition, I have hired a new enforcement director, a longtime 
Federal prosecutor who served as Chief of the Southern District of New 
York's Securities and Commodities Fraud Task Force, charged with 
focusing our enforcement efforts on bringing meaningful, high impact 
cases quickly. We are working together on management reforms--including 
harnessing technology, improving risk assessment, and improving 
training and supervision for our line law enforcement personnel--so 
that we can maximize our resources to combat fraud and wrongdoing in 
our markets. Our Division of Enforcement has been working diligently. 
Since the end of January,
  --We have filed at least 34 emergency temporary restraining orders. 
        During roughly the same period last year, we filed 12.
  --We have opened more than 358 investigations. During roughly the 
        same period last year, we opened 292.
  --The Commission has issued at least 188 formal orders. During 
        roughly the same period last year, the Commission issued 74.
    Since January, we have brought a number of important and complex 
cases. For example, in the Reserve Fund matter filed in May, we charged 
certain operators of the Reserve Primary Fund, a $62 billion money 
market fund whose net asset value fell below $1.00 or ``broke the 
buck'' last fall, with fraud for failing to provide key material facts 
to investors and trustees about the Fund's vulnerability as Lehman 
Brothers Holding, Inc., sought bankruptcy protection. As part of this 
action, we are seeking to bring about an expedited, efficient, and 
equitable pro-rata distribution to shareholders of the Fund's remaining 
assets, including $3.5 billion originally set aside in the Fund's 
litigation reserve.\1\ We believe this will help Reserve Fund investors 
recover a larger share of their assets.
---------------------------------------------------------------------------
    \1\ SEC v. Reserve Management Company, Inc., et al., Lit. Rel. No. 
21025 (May 5, 2009).
---------------------------------------------------------------------------
    In March, we initiated a case alleging fraud in connection with a 
kickback scheme involving New York's largest pension fund. Namely, we 
charged New York's former Deputy Comptroller and a top political 
advisor with extracting kickbacks from investment management firms 
seeking to manage the assets of the New York State Common Retirement 
Fund. Since March, we have amended the complaint to add additional 
defendants, including a former New York State political party leader, a 
former hedge fund manager, a Dallas-based investment management firm 
and one of its founding principals, and a Los Angeles-based ``finder.'' 
\2\
---------------------------------------------------------------------------
    \2\ SEC v. Henry Morris, et al., Lit. Rel. No. 20963 (March 19, 
2009), Lit. Rel. No. 21001 (April 15, 2009), Lit. Rel. No. 21018 (April 
30, 2009); Lit. Rel. No. 21036 (May 12, 2009).
---------------------------------------------------------------------------
    As committed as we are to vigorous enforcement of the securities 
laws, we are also mindful that the complexity of 21st century markets, 
as well as the varied nature of frauds and scams, require that the 
sophistication and tools available to our Enforcement and Examination 
programs keep pace. Important questions have been raised concerning the 
agency's handling of tips or whistleblower information related in 
particular to the activities of Bernard Madoff. Clearly this is 
something we must learn from, and I am committed to addressing it. 
Former Chairman Cox asked the SEC Inspector General to look into what 
happened, what failed to happen, and to report back to the Commission. 
We expect to receive the IG report this summer and will promptly take 
all appropriate actions and address any remaining shortcomings.
    It is clear that, regardless of any findings of the Inspector 
General, the agency must improve its ability to process and pursue 
appropriately the hundreds of thousands of tips and referrals it 
receives annually. In February, we retained the Center for Enterprise 
Modernization which began work immediately on a comprehensive review of 
internal procedures to evaluate tips, complaints, and referrals. We are 
in the process of creating a system that will centralize this 
information so we can track it, analyze it and more effectively 
identify valuable leads for potential enforcement action and compliance 
exams.
                strengthening examination and oversight
    In addition to these changes, it is essential that we work to 
improve our risk-based oversight of broker-dealers, investment advisers 
and mutual funds. Our Office of Compliance Inspections and Examinations 
(OCIE), together with other agency staff in the Office of Risk 
Assessment, are presently working on an initiative to identify the key 
data points that would facilitate an improved risk-based oversight 
methodology to allow the staff to identify and focus on those firms 
presenting the most risk. OCIE has improved training and, under a newly 
authorized program, 268 examiners are now participating in the training 
and certification program offered by the Association of Certified Fraud 
Examiners, to identify the warning signs and red flags that indicate 
evidence of fraud and fraud risk. OCIE is also recruiting additional 
individuals with experience in different facets of the industry, such 
as trading, risk assessment and compliance. These steps taken together 
will expand the knowledge base of our inspections staff, better 
enabling them to conduct oversight of complex trading strategies and 
products that exist in our markets today.
    I have also launched an Industry and Markets Fellows Program in our 
Office of Risk Assessment. Through this program, we have begun 
recruiting fellows with extensive experience in such areas as equity 
and fixed income securities trading, structured products, complex 
derivatives, financial analysis and valuation, fund management, 
investment banking and financial services operations.
             improving transparency and investor protection
    The agency is working hard in other areas as well. In the area of 
accounting standards, the SEC staff completed a congressionally-
mandated study of fair value accounting. The staff issued guidance to 
financial institutions so that they can give fuller disclosure to 
investors, particularly with respect to hard-to-value assets. The staff 
has also continued to work closely with the Financial Accounting 
Standards Board to deal with such issues as consolidation of off-
balance sheet liabilities, the application of fair value standards to 
inactive markets and the accounting treatment of bank support for money 
market funds. FASB recently took steps to clarify treatment of off-
balance sheet items in a manner designed to increase market 
transparency.
    In the area of combating false rumors and manipulative activity in 
the marketplace, the agency initiated examinations of the effectiveness 
of broker-dealers' and investment advisers' controls to prevent the 
spreading of false information. When concluded, the results of these 
examinations will be used by regulators to assist firms in crafting and 
implementing robust policies and procedures to prevent the spreading of 
false information.
    In the wake of recent Ponzi schemes and other investment adviser 
abuses, the Commission last month proposed significant changes to the 
custody requirements for investment advisers. These proposals focus on 
the value of an independent public accountant serving as another set of 
eyes to better assure the safekeeping of investor assets. One proposal 
would require all advisers with custody or control of client assets to 
engage an independent public accountant to conduct an annual ``surprise 
exam'' to verify those assets exist. A second proposal would apply only 
to investment advisers whose client assets are not held by a firm 
independent of the adviser. In such cases, the investment adviser would 
be required to be subject to a review that results in a written 
report--prepared by a PCAOB-registered and inspected accounting firm--
that, among other things, describes the controls in place relating to 
custodial services, tests the operating effectiveness of those controls 
and provides the results of those tests. These reports are commonly 
known as SAS-70 reports. The reports would include an opinion of an 
independent public accountant issued in accordance with the standards 
of the PCAOB, which will provide an important level of quality control 
over the accountants performing this review. In addition, advisers 
would be required to publicly disclose the name of the accountant 
conducting these reviews, so that our staff can better monitor 
compliance and assess adviser compliance risks. Accountants also would 
be required to disclose the reason for any termination or resignation 
from performing these reviews, which should highlight any ``red flags'' 
for regulators and investors.
    At my request, our staff is also developing investor-oriented 
enhancements to the municipal securities area. It is time for those who 
buy the municipal securities that are critical to State and local 
funding initiatives to have access to improved quality, quantity and 
timeliness of information. On a related note, so called ``pay-to-play'' 
practices by investment advisers to public pension plans must be 
curtailed. I have asked the staff to revisit the Commission's 1999 
proposal to address harmful pay-to-play practices, and I expect that 
the Commission will consider that proposal this summer.
                    combating abusive short-selling
    In my brief tenure as Chairman, the issue of short selling has 
outpaced any other in terms of the number of inquiries, suggestions and 
expressions of concern we have received. On April 8, 2009, the 
Commission unanimously voted to propose two distinct approaches to 
short selling restrictions. One approach would impose a permanent, 
market-wide short sale price test, while the other would impose 
temporary short selling restrictions upon individual securities during 
periods of severe declines in the prices of those securities. On May 5, 
2009, the Commission held a public roundtable to solicit the views of 
investors, issuers, financial services firms, self-regulatory 
organizations and the academic community on key aspects of these 
proposals. The Commission is committed to conducting a thoughtful, 
deliberative process to determine what is in the best interests of 
investors, including examining a variety of trading and market related 
practices such as securities lending.
    We also recognize that strong rules and vigorous enforcement are 
needed to curb abusive short selling and restore confidence in our 
markets. The Commission has been focused on the issue of abusive 
``naked'' short selling since before my arrival in late January, and 
the Commission's regulatory actions have led to a significant decline 
in failures to deliver securities on time following a short sale. 
Moreover, our Division of Enforcement has a number of active 
investigations involving potentially abusive short selling in a variety 
of contexts.
                        filling regulatory gaps
    In an effort towards bringing the unregulated world of credit 
default swaps into the sunlight, the Commission, working in close 
consultation with the Board of Governors of the Federal Reserve System 
and the Commodity Futures Trading Commission (``CFTC'') and operating 
under the limitations of the current legislative structure, recently 
issued temporary orders to facilitate the establishment of central 
counterparties for clearing credit default swaps (``CDS'') by 
LCH.Clearnet Ltd., ICE US Trust LLC, and Chicago Mercantile Exchange 
Inc. The Commission is committed to increasing investor protection and 
reducing systemic risk by facilitating the development and oversight of 
central counterparties to clear CDS.
    We have also been working with the CFTC and Treasury Department to 
fill regulatory gaps in this area to help increase transparency and 
minimize risks associated with certain derivative products, including 
CDS, as well as market participants transacting in these products. I 
look forward to working with Congress to make the necessary legislative 
changes to ensure that these markets and market participants are 
appropriately regulated.
    In addition, we are closely examining the broker-dealer and 
investment adviser regulatory regimes and assessing how they can best 
be harmonized and improved for the benefit of investors. Many investors 
do not recognize the differences in standards of conduct applicable to 
broker-dealers and investment advisers. It is essential that comparable 
and effective protections be afforded to investors, whether they turn 
to a broker-dealer or an investment adviser for assistance in accessing 
the securities markets.
    Finally, hedge funds and other unregulated private pools of capital 
have flown under the radar for far too long. We are currently examining 
whether these funds, their managers or both should be subject to SEC 
registration and oversight, so that investors, regulators and the 
marketplace have more complete and meaningful information about the 
funds and their market activities. I look forward to working with 
Congress on this important issue.
                    strengthening shareholder rights
    We have launched an agenda of proxy reforms with a proposal 
approved by the Commission for public comment that would significantly 
support shareholders' rights to nominate company directors. Next month 
we will take up a broad package of corporate disclosure improvements, 
all designed to provide shareholders with important information about 
their company's key policies, procedures and practices, including 
compensation policies and incentive arrangements. With this additional 
information, shareholders will be better able to hold directors 
accountable for the decisions that they make. For example, the 
Commission will consider proposals to enhance disclosure of director 
nominee experience, qualifications and skills, so that shareholders can 
make more informed voting decisions. The Commission will also consider 
proposed disclosures to shareholders about why a board has chosen its 
particular leadership structure (whether that structure includes an 
independent chair or combines the positions of CEO and chair), so that 
shareholders can better evaluate board performance. Also, shareholders 
should understand how compensation structures and practices drive an 
executive's risk-taking. The Commission will be considering whether 
greater disclosure is needed about how a company--and the company's 
board in particular--manages risks, both generally and in the context 
of compensation. The Commission will also consider whether greater 
disclosure is needed about a company's overall compensation approach, 
beyond decisions with respect only to the highest paid officers, as 
well as about compensation consultant conflicts of interests.
           improving money market and mutual fund regulation
    Later this month, the SEC will consider proposals to strengthen the 
money market fund regulatory regime. The proposals will focus on 
tightening the credit quality, maturity and liquidity standards for 
money market funds to better protect investors and make money market 
funds more resilient to risks in the short-term securities markets, 
like those that unfolded last fall. In addition, we are exploring 
whether more fundamental changes are necessary, such as converting 
money market funds to a floating rate net asset value, in order to 
protect investors from abuses and runs on the funds.
    In addition, on June 18, the SEC and the Department of Labor will 
hold a joint hearing on target date funds. Target date funds and other 
similar investment options are investment products that allocate their 
investments among various asset classes and automatically shift that 
allocation to more conservative investments as a ``target'' date 
approaches. These funds have become quite popular, and growth in target 
date fund assets is likely to continue since these funds can be default 
investments in 401(k) retirement plans under the Pension Protection Act 
of 2006. However, target date funds have produced some troubling 
investment results. The average loss in 2008 among 31 funds with a 2010 
retirement date was almost 25 percent. In addition, varying strategies 
among these funds produced widely varying results. Returns of 2010 
target date funds ranged from minus 3.6 percent to minus 41 percent.
    These returns cause concern for investors and regulators alike. I 
can assure you that SEC staff is closely reviewing target date funds' 
disclosure about their asset allocations. In addition, in connection 
with our joint hearing with the Department of Labor, we will consider 
whether additional measures are needed to better align target date 
funds' asset allocations with investor expectations. Among other 
issues, we will consider whether the use of a particular target date in 
a fund's name may be misleading or confusing to investors and whether 
there are additional controls the SEC should impose to govern the use 
of a target date in a fund's name.
    I also have asked the staff to prepare a recommendation on rule 
12b-1, which permits mutual funds to use fund assets to compensate 
broker-dealers and other intermediaries for distribution and servicing 
expenses. These fees, with their bureaucratic sounding name and 
sometimes unclear purpose, are not well understood by investors. Yet in 
2008, rule 12b-1 was used to collect over $13 billion in investors' 
funds out of fund assets. It is essential, therefore, that the SEC 
engage in a comprehensive re-examination of rule 12b-1 and the fees 
collected pursuant to the rule. If issues relating to these fees 
undermine investor interests, then we at the SEC have an obligation to 
step in and adjust our regulations.
    In addition to these initiatives, the agency continues to annually 
review 5,000 corporate filings, over 1,000 SRO rules, and nearly 3,000 
new investment company portfolio disclosures. We establish the 
standards for 13 securities exchanges, 4 securities futures product 
exchanges, FINRA (a national securities association), the Municipal 
Securities Rulemaking Board, 10 nationally recognized statistical 
rating organizations, 10 registered clearing agencies, approximately 
600 transfer agents, and securities information processors. Despite the 
extreme volatility and uncertainty in the markets over the past year, 
transactions continue to trade at both record volumes and record speed.
                             sec resources
    The financial crisis has reminded us just how large, complex, and 
critical to our economy the securities markets have become in recent 
years. Whereas the dollar value of the average daily trading volume in 
stocks, exchange-traded options and security futures was $10 billion a 
day in February 1989, over the last 20 years it has grown to over 25 
times that size, reaching approximately $251 billion a day in February 
2009. And not only has the size of our markets exploded, the number and 
size of its participants have jumped as well. For example, since 2005, 
the number of registered investment advisers has increased by 32 
percent, and their assets under management have jumped by over 70 
percent to reach more than $40 trillion as of the beginning of this 
fiscal year. Broker-dealer operations have expanded significantly in 
size, complexity, and geographical diversity, as exemplified by the 67 
percent rise in the number of broker-dealer branch offices. In all, the 
SEC's 3,652 staff now oversee more than 35,000 registrants, including 
about 12,000 public companies, 8,000 mutual funds, 11,300 investment 
advisers, 5,500 broker dealers, and 600 transfer agents. By comparison, 
other financial regulators often have close to parity between the 
number of staff and the number of entities they regulate. For 
additional detail, attached to this testimony is an appendix, ``SEC 
Staff Levels Have Not Kept Pace with Industry Growth.''
    Yet at the same time that the securities markets have undergone 
such tremendous growth, the SEC's resources have fallen further and 
further behind. Between fiscal year 2005 and fiscal year 2007, the 
agency experienced 3 years of flat or declining budgets, losing 10 
percent of its employees and severely hampering key areas like our 
enforcement and examination programs. In the context of rapidly 
expanding markets, I believe these reductions in the SEC's staff 
seriously limited the agency's ability to effectively oversee the 
markets and pursue violations of the securities laws.
    With support from this subcommittee, during the last 2 fiscal 
years, the SEC has been able to lift its hiring freeze and begin 
rebuilding its workforce. By increasing the SEC's appropriation for 
this fiscal year, approving a reprogramming of additional resources, 
and just recently supporting emergency supplemental funds for the 
agency, this subcommittee has expressed its strong support for the SEC 
and its mission. I am very grateful for that support.
    However, even with these important steps, the number of staff with 
which the SEC can detect fraud, prosecute wrongdoing, ensure proper 
disclosure, conduct strong oversight of the markets, and take other 
actions to protect investors, is still significantly below the levels 
of only a few years ago. Under the SEC's current funding level, the 
agency's workforce still will fall about 200 staff, or about 5 percent, 
short of the fiscal year 2005 level.
    I believe additional resources are essential if we hope to restore 
the SEC as a vigorous and effective regulator of our financial markets. 
The President is requesting a total of $1.026 billion for the agency in 
fiscal year 2010, a 7 percent increase over the fiscal year 2009 
funding level. This proposal would permit the SEC to fully fund an 
additional 50 staff positions over 2008 levels, enhance our ability to 
uncover and prosecute fraud, and begin to build desperately needed 
technology.
    Specifically, these positions would help the SEC's Enforcement 
program enhance its pursuit of tips, complaints and other leads, thus 
increasing the resources the SEC can dedicate to frauds that citizens 
bring to our attention. They would also allow us to hire more trial 
lawyers and staff with specialized skills that will help our 
Enforcement program's efficiency, expertise and success. The 
Examination program would hire market experts to strengthen risk-based 
oversight of the investment management industry and expand its 
inspections of credit rating agencies. Our Division of Trading and 
Markets would strengthen its oversight of entities that play critical 
roles in our markets, such as broker-dealers, exchanges, clearing 
corporations, and other self-regulatory organizations. And the 
President's Budget would allow us to expand our Office of Risk 
Assessment by fully funding our program to bring in seasoned industry 
professionals to help uncover hidden risks to investors.
    Although expanding our workforce is a critically important step, I 
believe we also must give our staff better tools to conduct oversight 
of vast financial markets. That is why the President's request for 
fiscal year 2010 also contains funds for additional investments in our 
information systems. Investments in new systems have dropped by more 
than half over the last 4 years, and as a result the SEC has a growing 
list of technology needs that have gone unfunded. With the additional 
IT funds provided under the President's Budget for fiscal year 2010, I 
would plan to focus on several key projects:
    First and foremost, we would use additional funds to enhance our 
systems for handling tips, complaints and referrals. Although the SEC 
has a number of different processes to track this kind of information, 
there is no central repository or system through which this information 
comes together to ensure it is handled consistently or appropriately. 
Nor is there any present capability to mine the data to find 
connections, patterns or trends that would enable us to more 
intelligently focus our enforcement efforts.
    The SEC also plans to improve our ability to identify emerging 
risks to investors. We have many internal data repositories from 
filings, examinations, investigations, economic research and other 
ongoing activities. But the SEC needs better tools to mine this data, 
link it together, and combine it with data sources from outside the 
Commission to determine which firms or practices raise red flags and 
deserve a closer look.
    Finally, we would invest in our multi-year efforts to improve the 
case and exam management tools available to our enforcement and 
examination programs. These systems would give our senior managers 
better information on the mix of cases, investigations, and 
examinations, so they can apply resources swiftly to the continually 
evolving set of issues and problems in the markets. In addition, these 
tools will provide better support for line staff in these programs, so 
they can be more productive and better able to match the sophisticated 
systems used by the financial industry.
    I came to the SEC to shape public policy in the interest of 
investors and to strengthen our enforcement program. The things I have 
described in this testimony are important to those efforts. But what I 
have also discovered in the past 4 months is that much attention needs 
to be focused on the internal operations of the agency, the processes 
that guide our work, the agency's infrastructure and how we are 
organized. I have been disappointed to find that in some areas of our 
internal operations, we fall short of what the taxpayer has a right to 
expect of us, and what our employees have a right to expect of a world 
class organization. I am committed to a complete review of areas large 
and small, including FOIA operations, call centers operations, records 
management, and others, to ensure that we meet the highest standards 
and that we are fully supporting the important work of our employees in 
these operations. Doing this will take time and energy and focus. To 
ensure that we do it well and thoroughly, I intend to bring in a Chief 
Operating Officer to manage the process. Federal agencies do not manage 
themselves; we must be actively engaged in that process everyday.
    In one area, we have already made progress: we are moving to build 
an internal compliance program that is second to none. The public 
appropriately holds the SEC to a very high standard for integrity and 
professionalism, and we hold ourselves to that very high standard as 
well. That is why I have initiated several steps to guard against 
inappropriate securities trading by SEC staff, as well as to avoid any 
appearance of inappropriate trading. Among other steps, the agency has 
drafted new internal rules that would prohibit staff from trading in 
the securities of companies under SEC investigation, regardless of 
whether an employee has personal knowledge of the investigation, and 
require preclearance of all trades. The SEC also is contracting with an 
outside firm to develop a computer compliance system to track, audit 
and oversee employee trades and financial disclosures in real time. 
Finally, I consolidated responsibility for this area within our Ethics 
Office and authorized the hiring of a new chief compliance officer. To 
further enhance the SEC's financial controls, the agency also will 
continue its multi-year efforts to build an automated, integrated 
financial management system.
    I want to thank you for your continued strong support for the SEC 
and its critical mission. I believe the steps I have outlined here--
strengthening our enforcement program, enhancing risk-based oversight 
of the markets and leveraging technology--are essential for restoring 
investors' confidence in both the SEC and in our Nation's securities 
markets.
    I would be happy to answer any questions you may have.
   appendix: sec staff levels have not kept pace with industry growth
        (Tables show cumulative growth relative to 2003 levels)
    The SEC's staff of 3,652 FTE (estimate for fiscal year 2009) 
oversees more than 35,000 entities. These include:
  --11,300 investment advisers;
  --5,500 broker-dealers;
  --8,000 mutual funds;
  --About 600 transfer agents;
  --Clearance and settlement systems;
  --11 securities exchanges;
  --12,000 public companies;
  --10 credit rating agencies;
  --FINRA, MSRB, and PCAOB.
    The following charts display how various aspects of the markets 
have grown since 2003, relative to the SEC's staff:

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                    BUDGET AND WORKFORCE OF THE SEC

    Senator Durbin. We'll have 5-minute rounds here, and I'm 
sure we'll have several questions.
    It seems to me that there are two things we're dealing with 
here just on the surface. First, the number of people working 
in your agency. It appears that over the years, as Senator 
Collins noted, we've allowed the number of professionals 
working there to decline in real terms and certainly decline 
precipitously in relation to the volume of trade that you have 
to keep an eye on.
    Between 2005 and 2007, the SEC lost 10 percent of its 
employees, if you can imagine at that moment in time, 
undermining the agency's ability to oversee the markets, and at 
the same period of time, the market ballooned in size and 
complexity.
    Registered investment advisors grew 32 percent, assets 
jumped by over 70 percent, and so we're seeing the caseload or 
at least the area that needs to be regulated is growing and the 
number of people to keep an eye on it is diminishing.
    So there is, in the first instance, the question of the 
right number of people working at the agency, and the second 
issue goes to--I don't know how to characterize it--I guess the 
internal culture of the agency.
    Bernard Madoff was a wake-up call. The fact that this man 
could swindle as many people as he did with impunity for so 
long to me is nothing short of amazing.
    According to SEC data, in fiscal year 2008, the SEC staff 
handled over 600,000 tips sent by individuals to your 
Enforcement Complaint Center. I did a calculation. I think 
that's more than 2,000 a day for every business day. People 
sending in items you ought to look at. Well, that to me is an 
overwhelming number and perhaps you could put it in some kind 
of perspective.
    Now, some have taken a look inside your agency and asked 
whether the enforcement function within the agency is a healthy 
one. Is there a risk-averse culture within the SEC to step up 
and say, you know, we ought to take a look at this Mr. Madoff 
or people like him?
    So let me ask you at the outset, number 1, what would be 
the optimal number of people that you believe you need to do an 
effective job at the SEC in light of the volume of business 
that you have to regulate, and second, do you perceive a 
cultural problem within the agency when it comes to 
enforcement?
    Ms. Schapiro. Thank you very much, Mr. Chairman.
    I think you've really summarized very well with respect to 
the staffing pressures on the SEC, the current situation.
    With over 35,000 regulated entities and 3,700 staff, it's a 
job that we really can't do in the way I think the public would 
like to believe we can do in the sense of routine onsite 
presence in many regulated entities. That's going to really 
require that we leverage third parties.
    So, for example, in the rules I discussed related to the 
custody of customer assets by investment advisors, a huge 
problem in the Madoff area, we're going to rely on PCAOB-
registered accounting firms to leverage our capability to 
ensure the customer assets are being protected by the 
custodians and by the investment advisors, and we will look for 
every opportunity we can to leverage third party resources.
    But at the end of the day, we do need significantly more 
staff, I believe, over the next several years to keep up with 
the growth and the complexity of this industry, and if there 
are additional responsibilities as a result of regulatory 
reform that accrue to the SEC in the context of hedge funds, 
credit default swaps or other areas, that, of course, will 
require sufficient additional resources because we can't 
stretch any thinner than we already are.
    So I do believe--and if you look at our 2011 budget 
request, you will see we've asked for a significant ramp-up in 
the number of full-time equivalents (FTE), close to 400 FTE and 
1,000 new positions, and I believe that if we're able to 
achieve that number in 2011 or over the course of the next 
several years, that will go a long way toward getting this 
agency to the appropriate size to handle the job that's in 
front of it.
    I don't think there's any danger that we're about to become 
too big in any event.
    I think, with respect to your second question, the Madoff 
fraud is a tremendous tragedy. It's really a tragedy of epic 
proportions and I think it really will put the onus on this 
agency to prove that it is capable of managing the 
responsibilities that it has been given under the law and it's 
really critically important for us to ensure that both our 
culture, our operations, and our procedures, our staff and our 
skill sets are up to the task.
    You pointed out, for example, that we get somewhere around 
600,000 to, in peak years, 1\1/2\ million tips a year. We can't 
manage those that come into the organization through a wide 
variety of entry points. We don't have databases that are 
connected so that we can do a trend analysis of those tips and 
complaints or connect that data to external sources of data to 
see what might be developing more broadly in the marketplace.
    Right after I started, I brought in the Mitre Corporation's 
Center for Enterprise Modernization to do a complete review of 
how we handle tips and complaints. They've concluded the first 
round of their work and we're now in the implementation phase 
of some short-term and intermediate-term remedies and processes 
to help us manage tips and complaints.
    But it's also about leadership and it's about freeing our 
Enforcement Division to do the kind of job that I know they're 
capable of doing.
    I was at the SEC 15 years ago when the agency had a really 
first-class reputation for aggressive enforcement and I know 
we're capable of that again. We have a new Enforcement Director 
who's very committed to bringing large cases in a timely way 
that have the maximum investor protection impact.
    It's about enabling our enforcement staff through 
technology and the right skill sets to bring those kinds of 
cases, that when a whistleblower presents them with 
information, as had happened in the Madoff case, they have the 
ability to understand it and pursue it. It's about being a 
little bit humble about the information that comes to us and 
appreciating that there may be real value in what's being 
presented to us.
    We're also going to seek whistleblower legislation to 
enable us to reward whistleblowers, as the Internal Revenue 
Service (IRS) and other agencies do, when they bring us well-
formed cases and documentation, a fraud that we can then 
pursue, and it's about filling the regulatory gaps, through 
such as the custody requirements I just spoke of, so that we 
are sure that the regulatory regime, coupled with aggressive 
enforcement, coupled with the tools and the skill sets, combine 
to create an agency that's absolutely committed and focused on 
investor protection.
    I'm sorry. That's a very long answer.
    Senator Durbin. No. It's a very good answer, and I thank 
you for it, and I'm going to turn to Senator Collins and return 
in later rounds.
    Senator Collins. Thank you, Mr. Chairman.
    Ms. Schapiro, you talked about the increased number of 
positions that you have requested as part of the fiscal year 
2011 budget, but in fact, the President's budget for this 
coming fiscal year does not allow you to hire any new 
positions, is that correct?
    Ms. Schapiro. That's correct, Senator. The increase in the 
2010 budget covers the annualized costs of the increases in the 
fiscal year 2009 budget that we were able to have as a result 
of the approval of our reprogramming requests and taking $17 
million of unobligated funds from prior years, dedicating those 
to staffing, additional staffing in 2009.
    The annualized costs of those additional 50 positions that 
we're bringing on this year are the increase in the 2010 
budget.
    Senator Collins. Do you need new positions for the upcoming 
fiscal year?
    Ms. Schapiro. Well, I would say that we're, first of all, 
extremely grateful to the President for the increase in the 
2010 budget and it's a meaningful increase for this agency, and 
as I pointed out, 2011 we sought a much greater increase.
    The opportunity to start to move toward that 2011 budget 
earlier would be a wonderful opportunity for us to bring that 
number of staff on over a 2-year period rather than all in 
2011, if Congress ultimately approves that number.
    Senator Collins. Because I am troubled that the current 
funding level supports a staff that is 5 percent lower than 
your peak level back in fiscal year 2005.
    If you look at the growth of regulated entities and if you 
look at the amount of money involved, if you look at the number 
of American families who now have savings in the stock market, 
the fact that these staffing levels are below what they were 5 
years ago is troubling to me.
    So are you saying that it would be helpful to be able to 
ramp up those staffing starting in the next fiscal year rather 
than waiting to fiscal year 2011?
    Ms. Schapiro. Absolutely, it would be helpful. The 
reprogramming request, in addition to allowing us to get a 
little bit of a jump on 2010, enabled us to do some technology 
investment.
    We need fundamentally more investment in technology at the 
SEC to support our Enforcement and Examination Programs and we 
can use more boots on the ground in Enforcement and 
Examination, absolutely.

                   INVESTOR PROTECTION AND EDUCATION

    Senator Collins. Aggressive enforcement is absolutely 
critical, but there's another way that's important for 
protecting investors, particularly smaller investors who may be 
less sophisticated in choosing their investments, and that is 
through a robust education effort.
    You've spoken a lot about the need to protect investors and 
I know that in my State, I've seen thousands of individuals who 
have seen their retirement nest eggs shrink, money set aside 
for their children's college education virtually disappear, and 
they're wondering what can be done about it. They're seeking 
more information.
    Several years ago, the SEC used to conduct very valuable 
educational sessions, town meetings, outreach to seniors 
groups.
    What are your plans to reach out to investors, particularly 
small investors or senior citizens, in two ways; one, to help 
them better understand risk and suitability requirements, but, 
two, to help them spot scams?
    Ms. Schapiro. It's a wonderful question, and I'm very 
committed and personally quite passionate about investor 
education and had a program at my former employer, FINRA, as 
Senator Tester knows, where we did investor forums which the 
SEC used to do years ago around the country and to great 
success and with tremendous participation all over the country.
    The SEC has a small program that does that now. 
Commissioner Walter in fact did an investor forum just last 
week with our Boston office in the State of Maine.
    My plans would be, given sufficient resources, that we 
dramatically increase that program, that we enable our offices 
around the country to provide local education in senior 
citizens centers, community centers, local high schools, and 
that we really take a leadership role in the Federal Government 
in educating investors about the kinds of questions they need 
to ask when they're being offered investment products, about 
the kinds of scams and pitfalls that they need to be on the 
alert to.
    I'm very concerned, given the current environment and the 
amount of money people have lost in their retirement plans and 
in their other investments, that they will be reaching to try 
to make that money back through some particularly risky 
investments. I have no doubt that the scam artists have already 
figured this out and are beginning to prey on people's real 
fears about their financial futures.
    I think the SEC can play a critical role here, bringing 
together other agencies of the Federal Government but also on 
its own, reaching out very directly as well as through the 
development of content put on websites and in investor forums.
    Senator Collins. Thank you. Glad to hear it.
    Senator Durbin. Senator Tester.
    Senator Tester. Thank you, Mr. Chairman.
    Chairman Schapiro, you come into an agency, the SEC, that 
has been around about 75 years and to be honest, from my 
perspective, probably come into it at a time when it's hit an 
all-time low as far as both morale and effectiveness. So you've 
got to rebuild this agency, I think, maybe not from the ground 
up but from the foundation up.
    We've talked about manpower levels. If you have the 
technology that you spoke about, do you have a figure in mind 
about what the right number of people are for this agency, 
considering the massive workload?
    Ms. Schapiro. I think it's very hard to give an exact 
number. As I said, our 2011 budget request seeks 1,000 
additional positions which would take us to just under 5,000. 
That would still be smaller, for example, than the Federal 
Deposit Insurance Corporation (FDIC) which regulates about 
5,000 to 6,000 banks.
    Senator Tester. Okay.
    Ms. Schapiro. I do think there's also practical limitation 
on how many people you can just bring on board and train----
    Senator Tester. Right.
    Ms. Schapiro [continuing]. At any given time. The faster 
that we can move toward a substantial increase like that I 
think the better.
    Senator Tester. Okay.
    Ms. Schapiro. It also depends largely on our ability of 
effectively utilized technology to save on human resources.
    Senator Tester. Right on. Consumer confidence is one of the 
things that everybody's concerned about. Nobody--you know, 
we've lost a bunch of money. People's confidence is shaken.

                     RESTORING INVESTOR CONFIDENCE

    What do you see as being two or three of the major things 
that you have to do in your agency to have consumer confidence 
back at a level that's reasonable, and, quite honestly, what do 
you see we need to do, the two or three things that we need to 
do to help re-establish consumer confidence with the groups 
that you regulate?
    Ms. Schapiro. I think it's a great question. I think 
enforcement is just a part of what we do, but it's a very 
visible part, and I think it's really critical for investors to 
see that there is a cop on the beat who's trying to ensure that 
the playing field is level, that the insiders aren't taking 
advantage of the rest of the participants in the marketplace.
    So we need to have a very timely enforcement response to 
the problems that arise in the marketplace and short of doing 
that, I think people won't have confidence. We can write all 
the rules we want, but if nobody's enforcing them, we're not 
going to restore investor confidence.
    I think investors also need to have complete confidence in 
the transparency of corporate disclosure. They need to believe 
that the companies in whose stock they are buying are getting 
then the accurate numbers and the accurate disclosure and 
information about that company's prospects so they can make 
informed decisions about where to put their money.
    And I think we have to have a focus on consumers issues, on 
mutual funds sales, on sales practices generally, on the issues 
around fees and fee structures and disclosures that investors 
really care about at the end of the day.
    We'll be announcing later this week the creation of an 
Investor Advisory Committee for the first time in many, many 
years at the SEC that will give investors a regular way to 
interact with the Commission on policy issues that are of 
interest to them.
    I think we have to reorient everything we do toward 
rebuilding the investor confidence in both the agency and in 
the fairness of our markets.
    Senator Tester. What do we need to do, Congress?
    Ms. Schapiro. I think supporting the agency, quite 
honestly, as the appropriators with sufficient resources to 
accomplish what we need to do and hold our feet to the fire 
that we're delivering on the commitments that we're making to 
the American public.
    Senator Tester. Have you been able--I mean, there's been 
talk about the future roles of the SEC, the CFTC that we'll 
hear from shortly, after a regulatory modernization has been 
done.
    Assuming that that goes forward, can you talk about the 
challenges, opportunities, possible consequences of merging 
your two agencies?
    Ms. Schapiro. Sure. And, you know, I have the unique 
position of having been Chairman of the CFTC and now Chairman 
of the SEC. So in honesty, I can tell you I've argued both for 
and against merger over the years.
    I think it's obviously a decision that's ultimately for the 
Congress about whether or not to combine the two agencies. 
Short of that, I believe that with Gary as Chairman of the CFTC 
that we can have an incredibly positive and constructive 
working relationship, to ensure that products and practices 
don't fall between the cracks of the two agencies and that we 
don't leave large swaths of the financial markets unregulated 
and unaccountable to the American public----
    Senator Tester. Do you think that would be--excuse me. Do 
you think that would be done better if you were combined?
    Ms. Schapiro. I think--in my personal view, there is a 
logic and an efficiency that can be achieved from the merger of 
the two agencies, but short of that, I also think that the two 
agencies can do a better job of working together to ensure the 
protection of investors.
    Senator Tester. My time is up, but we'll be back.
    Senator Durbin. I was just advised by my colleague that 
there's a vote on and I'm going to try to continue asking until 
someone returns, but I ask the indulgence of our witness and 
those in the audience as we try to balance a few things here.

                    ADDRESSING RESOURCE CONSTRAINTS

    The numbers of investigative attorneys at the SEC decreased 
11.5 percent between fiscal years 2004-2008 and some believe 
that that's resulted in delayed cases, reducing the number that 
can be brought to trial and potentially undermining the quality 
of cases that are pursued.
    How have resource constraints impacted the effectiveness of 
the SEC?
    Ms. Schapiro. There's no question but that--and there's a 
recent Government Accountability Office (GAO) report that 
suggests this, as well, that the resource constraints have 
hindered the ability of the Enforcement Division to pursue as 
many cases in as timely a way as I would like to see.
    In addition, there are some procedural difficulties placed 
in the path of the Enforcement Division over the last several 
years that slowed cases down and discouraged, if not 
explicitly, implicitly seeking penalties from corporate issuers 
in certain kinds of cases, and we've eliminated those hurdles 
and cases can be started much more quickly now. Investigations 
can be pursued with the approval of one commissioner, not the 
full Commission sitting in a meeting.
    We've eliminated what was called the Penalty Pilot Program 
completely and we are reorganizing the Enforcement Division 
under the leadership of our new Director in a way that we hope 
will eliminate some layers of management and some of the 
stovepiping that's existed over the years and allow us to be 
more nimble and more aggressive, pursuing much larger cases, 
particularly those arising out of the financial crisis.
    Senator Durbin. On another issue, there was a mindset for a 
long period of time that as long as the economy was expanding 
and wealth was being created, we didn't dwell and ask a lot of 
embarrassing questions, but with the downturn in the economy, 
downturn in the fortunes of many families and the investment of 
our Federal Government into many of the largest businesses in 
America, there appears to be an awakening on the part of the 
average person about how many corporations are being managed 
and particularly in the area of executive compensation.

                          CORPORATE GOVERNANCE

    I won't go into chapter and verse about bonuses given to 
executives who have nothing to show for it, other than failure, 
but let me ask you, what is the SEC currently doing to improve 
the accountability of corporate directors and enhanced 
disclosure of executive compensation?
    Ms. Schapiro. Mr. Chairman, I've made corporate governance 
one of my highest priorities in the last 4 months. We are 
engaged in a couple of things.
    First of all, in May we approved for comment a proposal 
that will facilitate the ability of shareholders to nominate on 
the company's proxy directors to serve on the corporate--on the 
company's board and it's out for comment now. It will be highly 
controversial, but if ultimately approved and not challenged in 
court, it will greatly facilitate the abilities of shareholders 
to elect nominees to corporate boards and thereby hold 
directors more accountable for their oversight of the 
corporation.
    With respect to compensation in particular, as you know, we 
already require disclosure of all plan and non-plan 
compensation by the senior-most officers of a company.
    Next month we will be considering amendments to the 
compensation disclosure rules that will simplify something 
called the summary compensation disclosure table to provide 
more information there about compensation.
    It will require disclosure about the overall compensation 
approach within the company. There will be enhanced disclosure 
about the use of compensation consultants who are sometimes in 
a conflicted position in advising both the compensation 
committee and the company's management, and we're going to 
require disclosure about the linkage between compensation plans 
and risk-taking by executives, traders and others within the 
company, so that investors will be able to understand how risk-
taking which was such an important component of the financial 
crisis has been potentially incentivized in some companies.

                         CREDIT RATING AGENCIES

    Senator Durbin. On another issue, in late 2006 the Credit 
Rating Agency Reform Act gave the SEC exclusive authority over 
rating agency registration and qualification. In the less than 
3 years since enactment the SEC has undertaken no fewer than 
five rulemakings to implement the law. These rules, which are 
all still relatively new, extend from registration and 
recordkeeping to disclosure and managing conflicts of interest.
    Yet, even though the credit rating agencies were under 
SEC's purview, rating agency performance in the area of 
mortgage-backed securities backed by residential subprime loans 
and the collateralized debt obligations linked to such 
securities has shaken investor confidence to the core.
    It used to be that credit ratings were kind of like the 
gold standard in terms of whether you could trust a business to 
be in solid financial shape. Well, I think a lot of questions 
have been raised.
    What are you doing at the SEC now to restore consumer and 
investor confidence, and what improvements are needed in the 
way that you monitor credit rating agencies?
    Ms. Schapiro. There's no question but that credit rating 
agencies played a significant role in facilitating, I guess, in 
some ways the financial crisis.
    The agency has engaged, as you point out, in many 
rulemakings, most recently the rule in 2008 which required a 
series of disclosures about performance statistics, the 
different kinds of models that were used for initial ratings 
versus surveillance ratings, documentation, disclosure of 
conflicts and so forth.
    The Credit Rating Agency Reform Act, which Congress passed 
in 2006, specifically does not allow the agency to regulate the 
substance or the procedures or the methodologies of the rating 
agencies and something we're looking at is whether we need to 
ask Congress to reopen that legislation to provide greater 
authority.
    Senator Durbin. Who does?
    Ms. Schapiro. Nobody. But nonetheless, despite the 
limitations in the law, we are looking at doing a couple of 
things.
    One is my perhaps my greatest concern in this area is 
something called ratings shopping which allows the creator of a 
structured product to get preliminary ratings from multiple 
rating agencies and then select the one they want to rate the 
product, presumably that being the highest rating they've 
gotten.
    Senator Durbin. Wish I could have had that for my report 
card in grade school.
    Ms. Schapiro. Don't we all?
    Senator Durbin. Shopping teachers.
    Ms. Schapiro. Exactly. If you'll give me an A, I'll take 
your class is what it amounts to.
    So we're looking at what we can do with respect to rating 
shopping. Removing references potentially to ratings in the 
Federal securities laws and regulations which gives an air of 
credibility and respectability to ratings that perhaps they 
don't entirely deserve, looking at whether we should require 
different symbols for rating structured products versus rating 
plain vanilla corporate debt, and we're looking at more 
detailed disclosure about how ratings have performed over time.
    So there's some things the SEC clearly can do and we are 
doing. We held a roundtable with rating agencies just about 1 
month ago to explore some of the failures of the different 
business models and some of the--not the failures of the 
different business models but the different business models, 
some of the other failures that have become clear over the last 
year.
    We're moving ahead with what we can do and we will come 
back to Congress if we believe at the end of the day we need 
more authority.
    Senator Durbin. Thank you. I'm going to ask that the 
subcommittee stand in recess for just a few moments and as soon 
as Senator Collins returns, I'm going to ask her to resume the 
hearing. I apologize, but it just so happens we have a rollcall 
vote.
    The subcommittee will stand in recess.
    Senator Collins [presiding]. The hearing will reconvene.
    In Senator Durbin's absence, he's permitting me to continue 
the hearing. I'm certain he'll be back very soon. He's just 
voting.
    Ms. Schapiro, last September the SEC's inspector general 
issued a report on its investigation of the Consolidated 
Supervised Entity Program, the CSE Program, through which the 
SEC monitored the five major investment banks.
    This inspector general report found that the SEC has 
severely understaffed its CSE Program and thus could not 
effectively manage its responsibilities to monitor or question 
these investment banks.
    As you know, I'm particularly concerned that an investment 
bank like BearStearns was allowed to have a leverage ratio of 
30:1, truly astonishing, and yet it appears that there was not 
a system in place, other than a very loose voluntary system 
that the SEC had, to monitor these banks, and in many ways this 
report was truly prescient since just a few months after it was 
issued none of these investment banks existed anymore. They all 
had either failed, been acquired or merged into bank holding 
companies.

                  REGULATION OF LARGE INVESTMENT BANKS

    Let me ask you a number of questions about this. First, 
does the SEC have the right mix of staffs to conduct the kind 
of oversight of a large investment bank? A lot of the SEC's 
employees are attorneys which is obviously very useful and 
helpful on the enforcement side, but does it need more 
auditors, more economists to have the expertise to analyze 
complex financial data and risk models? So the first question 
is the mix of expertise.
    Ms. Schapiro. I believe that we haven't historically had 
enough financial analysis experience, experience with 
structured products and complex derivative products.
    In the last couple of months that's been an area of focus 
for recruitment, not just in the Enforcement Program but also 
in the Trading and Markets Division which has responsibility 
for broker-dealer risk oversight. So that even though the CSE 
Program is discontinued, there are still a large number of--not 
maybe a large number but a number of large investment banks and 
broker-dealers for whom the SEC still has responsibility.
    That's an area that we are building and increasing our 
capability in in a very conscientious and sort of directed way 
and have been working on over the last couple of months. It's 
really important for us to have that capability.
    Even with the presence ultimately of a systemic risk 
regulator, that's the result of regulatory reform, it will be 
important for the SEC, as the day to day regulator of over 
5,000 broker-dealers, to have the capability to really 
understand the financial and operational status and condition 
of those brokerage firms.
    Senator Collins. Second, how should--I realize these large 
investment banks don't exist any more but they could reappear. 
How should they be regulated for safety and soundness?
    I cannot imagine a federally or State-chartered bank being 
allowed to have a leverage ratio of 30:1.
    Ms. Schapiro. I think the answer is they need to be 
regulated on a consolidated basis. So that, as you know, the 
securities laws are generally geared toward the protection of 
customer assets within the broker-dealer, but there are 
affiliates of the broker-dealer, there's a holding company 
structure, there are a lot of other entities where significant 
risk can be taking place, and it's important that the regulator 
of the entire entity have a view into what's going on in all of 
the related parts of the operation, so not just in the broker-
dealer but also in the holding company affiliates and 
subsidiaries.
    It is that consolidated view that will allow our regulator 
to make a judgment about whether leverage is excessive, capital 
is sufficient, the quality of management across the enterprise 
is up to the task.
    Senator Collins. Another reform that we need is the ability 
to identify and prevent what I refer to as regulatory black 
holes, and the emergence of credit default swaps or other 
exotic and poorly disclosed derivatives certainly indicates 
that the current system has not been sufficient to prevent gaps 
in regulation of products or practices that can have 
consequences for the entire financial system. That's why I 
support having a council of regulators to look at systemic 
risk.

                   ROLE OF A SYSTEMIC RISK REGULATOR

    What do you think are the advantages and disadvantages of a 
council approach versus vesting in the Federal Reserve the 
authority to be the systemic risk regulator?
    Ms. Schapiro. Well, I'm very much in agreement that the 
existing regulatory regime is riddled with holes and that there 
are large parts of the financial marketplace that were really 
not under the regulatory umbrella at all or in any meaningful 
way and credit default swaps is an example. Hedge funds and 
some other private pools of pooled funds would fall into that 
category, as well.
    As you know, I like the concept of a council, whether it's 
a stand-alone council or in conjunction with a systemic risk 
regulator, because it brings a diversity of perspective that I 
think is really important to identifying where gaps may be 
arising, where new products may be being created in the 
intricacies between regulatory authorities, so that we can 
avoid those potentially harming the system.
    And when you have a council of regulators, where you've got 
securities regulators, for example, which is very much focused 
on investor protection and transparency and bank regulators 
very much focused on prudential standards and safety and 
soundness, and insurance regulators with yet another 
perspective, I think you have a better chance of capturing the 
entire financial landscape and the potential places where those 
new products are arising, where those new gaps are being 
created.
    At the same time I think there needs to be the ability, 
whether it's a council or a single system risk regulator or a 
combination, to step in and raise standards when necessary, 
where the functional regulator may not be aggressive enough in 
requiring higher capital standards or reining in leverage, that 
there be the ability ultimately to protect the system, to force 
those kind of changes.
    Senator Collins. Thank you. Senator Tester. It's nice being 
temporarily chairman.
    Senator Tester. Thank you. Thank you, Senator Collins, and 
you're doing a fine job, I might add.

                   ENFORCEMENT OF THE SECURITIES LAWS

    Secretary Schapiro, I'm sure you read the article yesterday 
in the Washington Post that dealt with enforcement actions of 
the SEC over the past few years. If that article's true, it is 
more than just a little bit distressing.
    You have stated the imperative to take the handcuffs off 
the Enforcement Division. That article yesterday would imply to 
me that I don't care how much money we put at the agency, if 
people on top are making arbitrary decisions about how to not 
do their job appropriately, no amount of money is going to make 
it work correctly.
    You're not going to do that, I know that. I've met you and 
long before when you were in FINRA, as you stated in your 
opening statement, in Montana and did a fine job education-wise 
and you have done a fine job in this position.
    But could you just give me a little bit of insight on how 
this budget would help you accomplish the goal of taking the 
handcuffs off the Enforcement Division?
    Ms. Schapiro. I'd be happy to. I should say that in my 4 
months at the agency, I talk a lot about enforcement. I've done 
some town halls with the staff. I e-mail with the staff.
    I will tell you that the response has been tremendous 
eagerness and enthusiasm on the part of employees to get back 
to what we do and what we can do so well and----
    Senator Tester. Good.
    Ms. Schapiro [continuing]. Particularly in the enforcement 
context.
    I think what the budget will enable us to do is have more 
people to bring the cases that need to be brought. We are not 
in danger of running out of cases. So on a very simplistic 
level, more people will enable us to do that.
    Bringing in the right skill sets so that we're not risk 
averse, so that we're not afraid to tackle the most complex 
trading strategies or the most complex products or the most 
complex frauds will be important. So we need to train our 
people better in more sophisticated methodologies. We need to 
bring in the right kinds of skill sets, as well, and we need to 
support our people with technology.
    The amount of data that comes into the agency that is 
unmanageable, even in the course of one major litigation, is 
extraordinary and we have our people wasting their times 
archiving e-mails and dealing with millions and millions of 
records when we should be able to rely almost solely on 
technology to do that.
    We need technology to help us sort out the tips and 
complaints that we get, as I spoke about earlier.
    Senator Tester. The ranking member talked about potentially 
inadequacies of this budget. In a previous line of questions, 
you said you can't bring on everybody you need because it's 
simply impossible to manage that influx of people.
    Is the budget adequate to get to where you need to go? I'm 
sure you have goals, either written or mental, where you want 
this agency to go. Is this budget adequate to get you where you 
need to be a year from now?
    Ms. Schapiro. As I said, we are genuinely grateful to the 
President for the increase the 2010 budget represents over 2008 
and 2009. We've asked for a very significant increase in 2011 
and the ability to get to that number sooner, we could handle, 
and I think it would make a difference in our ability to do our 
job.

                      REGULATION OF SHORT SELLING

    Senator Tester. Okay. Uptick rule. Can you discuss the 
Commission's effort to reinstate the Uptick rule, what's the 
likelihood, timing and opposition to that?
    Ms. Schapiro. I would be happy to do that. This is an issue 
of enormous, enormous public interest, and it's an issue of 
investor confidence, as well.
    As you know, the SEC took the Uptick rule off a couple 
years ago after careful study and evaluation. In some ways it 
was a model rulemaking to eliminate it.
    Nonetheless, that coincided with dramatic increases in 
volatility in the marketplace and investors have been clamoring 
for us to revisit this issue. In April, the Commission voted 
unanimously to seek public comment on two different approaches 
to short selling.
    One is essentially the reinstatement of the Uptick rule as 
we used to know it, with some variations. The other is a short 
sale circuit-breaker that would be kicked into effect if the 
price of a stock declined by, say, 10 percent in a day, no 
short selling thereafter for a period of time.
    We've already gotten 3,000 comment letters. The comment 
period closes in about 2 weeks, and then we will wade through 
those comment letters and hopefully bring back to the 
Commission a proposal for consideration.
    At the same time we're looking at a couple of other issues. 
There's a rule, it's a temporary rule that expires in July 
that's had a very, very positive effect on eliminating or 
diminishing the fails to deliver in securities and short sales, 
requiring them to be closed out the next day. I expect the 
Commission will make that a permanent rule this summer, and 
we're looking at some other issues, like the potential for pre-
borrow requirement.
    So we are actively focused on short selling and will 
continue to do so.
    Senator Tester. Do you anticipate that the proposal you're 
going to take back to the Commission will be voted on when?
    Ms. Schapiro. I think we're looking at August for a vote. 
The comment period closes toward the end of June. With 3,000 
comment letters at this point, I expect significantly more and 
we'll have to evaluate those, so some time this summer.
    Senator Tester. After the Commission votes on the rule, is 
it typically an immediate effective date?
    Ms. Schapiro. Generally not, if it requires technology 
changes at either exchanges or brokerage firms.
    Senator Tester. Would this?
    Ms. Schapiro. Yes, the reinstatement of the Uptick rule 
requires significantly more technology work than the circuit-
breaker would.
    Senator Tester. Okay.
    Ms. Schapiro. So it could be quite dependent upon which of 
the two approaches.
    Senator Tester. One last and it has to do with this. Who's 
opposing the Uptick rule from going back into effect?
    Ms. Schapiro. I haven't been through the comment letters, 
to be honest, but I would say historically there's certain 
kinds of algorithmic traders, some kinds of hedge funds that 
are large short sellers that oppose it. There are----
    Senator Tester. That are for the most part unregulated at 
this point in time, right?
    Ms. Schapiro. That might be right.
    Senator Tester. Okay.
    Ms. Schapiro. There are others who believe that short 
selling plays a very legitimate role in the marketplace in 
terms of adding liquidity. It has impacts on options market-
makers and others. So there is opposition to reinstatement.
    I think the pure weight of the comment letters will tell us 
that there is much more support for doing something, whether 
it's the Uptick rule or the circuit-breaker.
    Senator Tester. Thank you.

               FEE COLLECTIONS BY AND FUNDING OF THE SEC

    Senator Durbin [presiding]. Thank you. Chairman Schapiro, 
just for some perspective here, the SEC is fairly unique in 
that it collects a lot of money in fees and if I'm not 
mistaken, that number is somewhere a little north of or around 
$1.4 billion, is that correct?
    Ms. Schapiro. The 2009 expectation is, yes, about $1.35 
billion.
    Senator Durbin. Okay. And the appropriation for your agency 
is around $1 billion, a little over $1 billion.
    Ms. Schapiro. Yes, 2009 $916 billion, including the 
reprogramming request.
    Senator Durbin. So you are a cash generator----
    Ms. Schapiro. We are.
    Senator Durbin [continuing]. In terms of the revenues into 
the Treasury.
    Ms. Schapiro. And historically a very significant cash 
generator.
    Senator Durbin. And if the argument can be made that the 
industry is paying your agency to do its job and we've started 
this testimony here today arguing that you needed more people 
to do your job, it might be fair for those who are being 
regulated saying we're doing our part, in fact we're sending 
you about 40 percent more than you're actually spending in this 
agency.
    Would that be a fair comment?
    Ms. Schapiro. It might be.
    Senator Durbin. Okay. Well, this concerns me because if we 
were going in the other direction, we'd be arguing, well, we 
need to come up with some revenue source here to provide the 
regulatory structure to make sure that the Government's doing 
its job, but in fact the marketplace that you regulate is 
creating the revenue opportunity.
    Ms. Schapiro. That's correct, and actually that doesn't 
include penalties and fines that are paid into the Treasury in 
those instances where we don't create a fair fund to distribute 
back to investors. So there's actually additional funding over 
the fee generation.
    Senator Durbin. Okay. Let me go to a few more specific 
questions.
    Broker-dealers who sell stocks and bonds on commissions and 
investment advisors who offer advice are regulated under 
different Federal laws. The key difference is the rules 
governing their standard of conduct. Investment advisors held 
to a fiduciary standard which requires them to make investment 
decisions in the best interests of their clients. Brokers, in 
contrast, are held to something called a suitability standard 
under which they can sell securities as long as they are 
suitable to their clients.
    Interesting little distinction there, but the variations 
between brokers and advisors has been blurring in recent years 
and it's raised concern among some regulators that customers 
won't be able to tell the difference.
    I understand that you're taking a look at this.
    Ms. Schapiro. Absolutely. There's really no good reason for 
people not to get the same fiduciary protection and the same 
standard quality of regulation from people who are essentially 
giving them the same service but are called by different names.
    Senator Durbin. Let me ask you a question. First, let me 
preface it by saying I asked my staff this. I said, now is this 
for Chairman Schapiro or Chairman Gensler. They said, well, you 
better ask her. So here's a hedge fund issue for you.
    The Pension Protection Act of 2006. Would this be your 
jurisdiction?
    Ms. Schapiro. The Pension Protection Act is largely 
administered by the Department of Labor, but there are elements 
that intersect with the SEC.
    Senator Durbin. Okay. Let me give you the situation. You 
tell me if this is something that you think falls in your 
jurisdiction.
    This Pension Protection Act made it easier for hedge funds 
to take pension money without registering it as an ERISA 
fiduciary, meaning they don't have disclosure and other 
requirements of other pension plan managers. Is this your 
field?
    Ms. Schapiro. This is the Department of Labor, I believe.
    Senator Durbin. Okay. Let me stop at that point and save 
this for the Department of Labor then.

                       REGULATION OF DERIVATIVES

    Derivatives, contracts between two investors, betting on 
whether a stock, bond or other security will go up and down in 
value have ballooned into one of the world's largest trading 
markets, estimated to be tens of trillions of dollars, yet it's 
largely outside the regulatory umbrella. Losses, as we know, at 
AIG have led to a Government bailout of $170 billion or $180 
billion.
    On May 13, President Obama unveiled a plan to regulate this 
market which had four stated goals.
    What do you consider to be the role of the SEC in this 
regulation?
    Ms. Schapiro. This is such an important area for both the 
SEC and the CFTC and, as you point out, the Treasury letter of 
May 13 lays out some requirements that we hope will be embodied 
in legislation with respect to credit default swaps and other 
standardized over-the-counter derivatives.
    It will be very important to have standardized clearing 
mechanisms, potentially exchange trading of standardized 
contracts, promote transparency, have adequate margin and 
collateral requirements in place for these transactions and 
subject the dealers in these instruments to regulation.
    Exactly where the lines between the SEC and the CFTC fall, 
I think, are something we'll be discussing certainly over the 
next several weeks, but it is clearly my view, and I believe 
Chairman Gensler's view and the Treasury's view, that we need 
to work together to ensure that we bring credit default swaps 
and other OTC derivatives firmly under the Federal regulatory 
umbrella and how we exactly draw those lines will be something 
we'll be discussing and obviously Congress will have a deep 
interest in, as well.
    Senator Durbin. I'll ask a question that relates to last 
week it was reported that two attorneys from SEC's Enforcement 
Division engaged in suspicious trading in stocks of companies 
under SEC investigation, according to a March 3 report by the 
SEC Inspector General David Kotz.
    Mr. Kotz concluded that the SEC previously had essentially 
no compliance system in place to ensure that its employees did 
not engage in insider trading themselves. On May 22, the SEC 
issued a press release outlining how the agency would increase 
accountability.
    How will this new process impact the current SEC workload? 
Will it require additional resources or staff to implement?
    Ms. Schapiro. Thank you for asking that question. It's 
really an important area.
    When I learned about this inspector general report in 
March, I immediately set in motion--and some things were 
already underway, I should say--a number of changes to our 
process which was acceptable under the Office of Government 
Ethics rules but clearly not sufficient in my view.
    We now require all trades by employees to be pre-cleared. 
We've created a restricted list that prohibits an employee from 
trading in any stock of a company that's under investigation by 
the SEC, whether they know anything about the investigation or 
its existence or not.
    We prohibit any ownership in stocks of broker-dealers, 
investment advisors, publicly traded exchanges, and we're 
requiring employees to authorize that their brokers in 
duplicate trade confirmation statements to the SEC where they 
will be incorporated into a computerized system that will make 
monitoring compliance with all of these new rules much more 
effective, and we'll be hiring a chief compliance officer. I 
expect we'll sign the contract for the new system in the next 
several days and it should be operational in 1 to 3 months.
    The new rules requiring pre-clearance of all trades by the 
Ethics Office and the creation of the prohibited list and so 
forth are pending at the Office of Government Ethics and have 
been there for about a week. We jumped on this immediately.
    Senator Durbin. Thank you very much.
    Senator Collins.
    Senator Collins. Thank you, Mr. Chairman.

                          CONSUMER PROTECTION

    Ms. Schapiro, there is an idea that is being discussed to 
consolidate the consumer protection functions of a variety of 
regulators under a single entity and one such proposal would 
result in the SEC losing its consumer protection 
responsibilities.
    I personally don't think this makes any sense at all 
because to me, the whole reason we have an SEC is to act to 
protect consumer investors.
    What are your views on creating a single consumer 
protection entity that would include the SEC's 
responsibilities?
    Ms. Schapiro. I think that it certainly is one of the ideas 
that's being bandied about and there are many, and I think 
discussions continue to be very vigorous and ongoing throughout 
the regulatory community about the right approach here.
    I think the one thing everybody agrees on is that we must 
have a reorientation toward consumer and investor protection 
among all of our financial regulatory agencies. So whether we 
have the creation ultimately of a single entity or we just 
reheighten and refocus within the bank regulatory agencies and 
the SEC on the protection of the end users of financial 
products, we, I think, all agree that we have to go down that 
path.
    My view is that, and it's been reported that, I don't want 
to create new gaps in the regulatory system and I fear that 
moving mutual fund regulation out of the SEC and into a new 
agency has the potential to do that.
    Mutual fund--investor protection and the mutual fund 
concepts, it's about more than the end product of the sale to 
the investor. It's really about what's the governance of the 
mutual fund. What's the quality of execution that the mutual 
fund is getting when it's buying stocks for its portfolio? 
What's the quality of the disclosure of those companies that 
the mutual fund is buying? What's the quality of the disclosure 
that the mutual fund itself is making?
    These are all a piece. They're all woven together to create 
the fabric of investor protection in the mutual fund space and 
so I want to be sure we don't damage that fabric.
    That said, whatever Congress in its wisdom and the 
administration working together to create that will protect 
investors better and consumers better, we intend to, you know, 
play as strong a role as we can.
    Senator Collins. Thank you. Mr. Chairman, I'm just going to 
ask one final question, if I may, and that has to do with the 
credit rating agencies. I understand you, too, brought this 
issue up, but, unfortunately, I wasn't here. I was voting when 
you did. So I apologize if this is redundant.
    I'm very concerned about the role that was played by credit 
rating agencies in this crisis as far as their ratings of 
subprime mortgages of mortgage-backed securities.
    It seems to me that the current system has so many inherent 
conflicts of interest built into it, not the least of which is 
that the credit rating agencies are being paid by the firms 
that are marketing the securities.
    What are you looking at to improve the integrity of the 
credit ratings process?
    Ms. Schapiro. You very correctly highlight that in the 
issuer paid model where I create a security and then I ask you 
to rate it and I pay you for that rating and I pay you on an 
ongoing basis for future ratings, if I'm happy, has profound 
conflicts of interest and we are looking in particular, as we 
discussed earlier, at the rating shopping phenomenon which 
allows me to select the ratings agency that provides or 
promises to give the highest rating and we're also looking at 
more robust disclosure about fees that are paid and the 
conflicts of interest that exist in the issuer paid model.
    We held a roundtable about 1 month ago. We brought in all 
different kinds of rating agencies to talk about their 
different business models and the pros and cons of each and 
we've gotten a lot of very good ideas from that process and 
we're hoping this summer to pursue some additional rulemaking 
in this area.
    We will focus on rating shopping. We will focus on 
disclosure. We will also look at whether we need to eliminate 
references in SEC rules which creates a market for rating 
agencies and gives a certain amount of credibility and stature 
to ratings that perhaps they don't always deserve.
    Senator Collins. Thank you. Thank you, Mr. Chairman.
    Senator Durbin. Senator Tester.
    Senator Tester. Yeah. I just do want to get to the CFTC 
Chairman, but I just want to just close by saying thank you. 
Thank you for what you've done, thank you for what you're going 
to do.
    I would ask that, you know, as these budgets come forward, 
2005 to 2007 budgets were visited about here on a couple 
different occasions, somebody dropped the ball. Congress 
probably had a part to do with it. Your predecessor may have 
had a part to do with it.
    But it ended up in a disaster and we need to make sure that 
you have the resources, no more, no less, but just the 
resources you need to do your job, and I think that, as a 
friend of mine pointed out last week, we need to quit thinking 
in Government in silos, we need to start thinking about the 
consumer and whoever is consuming that product, whether it's in 
education or housing or in this case securities, and make sure 
that Government works for the betterment of everybody.
    But I really want to thank you for the work you've done so 
far. It's very impressive, and I look forward to working with 
you in the future.
    Ms. Schapiro. Thank you very much.
    Senator Durbin. Thank you very much, Senator Tester.
    Chairman Schapiro, thank you for your testimony.
    Ms. Schapiro. Thank you, Mr. Chairman.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Durbin. We'll be working closely with you and your 
agency as we put together the appropriation bill.
    Ms. Schapiro. Thank you.
    [The following questions were not asked at the hearing, but 
were submitted to the Commission for response subsequent to the 
hearing:]
            Questions Submitted by Senator Richard J. Durbin
               staying on the cutting edge of technology
    Question. With rapid acceleration of electronic innovations in the 
securities markets, the Securities and Exchange Commission faces the 
challenge of keeping abreast of advancements. In the face of aggressive 
efforts of trading firms to invest in new technology, it is critical 
that SEC investigators understand the nuances of modern trading 
operations.
    Does the SEC have sufficient resources to hire the best and 
brightest financial technologists?
    Have you identified specific gaps in SEC's workforce expertise when 
it comes to electronic trading?
    Answer. As you may know, the SEC has launched a new initiative with 
existing resources to broaden the skill sets within its workforce, 
ranging from financial analysis to complex trading strategies. As part 
of this effort, the SEC is recruiting seasoned industry professionals 
into our enforcement, examination, and risk assessment programs, 
through efforts such as the Industry and Market Fellows and the Senior 
Specialized Examiner programs. The SEC is also implementing 
enhancements to the SEC's existing training programs, in areas such as 
the examination program which is enhancing staff expertise in topics 
such as fraud detection, complex financial products, and trading and 
where more than a third of the staff have signed up for training to 
become Certified Fraud Examiners. If Congress were to approve 
additional resources for the SEC, then the agency would look to expand 
these recruiting and training efforts very significantly.
    A key repository at the SEC for expertise on trading systems is the 
Automated Review Program within the Division of Trading and Markets. 
The program conducts examinations of the trading systems of markets and 
clearing agencies, to assess the data's confidentiality, integrity, and 
availability. The program has been able to stay on top of this rapidly 
evolving field, through efforts such as the CYBER CORPS program, which 
has served as a great resource for identifying talented IT 
professionals, and through the NSA, which has provided non-commercial 
software and technical training. Over the past few years, the program 
has increased its expertise in IT security and launched new initiatives 
in the areas of cyber security, auditing intermediaries in credit 
default swaps, and international markets. The Division now plans to 
implement new source code review of trading systems and more 
sophisticated penetration testing, to the extent resources are 
available.
                  expediting fair funds disbursements
    Question. Under the ``Fair Funds for Investors'' provision (Section 
308(a) of Sarbanes-Oxley), the Securities and Exchange Commission is 
required to return money to investors victimized by securities fraud. 
Previously, disgorgements and penalties were deposited into a U.S. 
Treasury General Fund.
    Answer. The Fair Funds provisions of the Sarbanes-Oxley Act of 2002 
gave the Commission authority to increase the amount of money returned 
to injured investors by allowing civil penalties to be included in Fair 
Fund distributions. Prior to Sarbanes-Oxley, only disgorgement could be 
returned to investors.
    Question. What improvements have been realized so far from the 
creation of a specialized office on ``Fair Funds'' disbursement?
    Answer. The Commission established the Office of Collections and 
Distributions (OCD) to, among other things, expedite the distribution 
of Commission recoveries to injured investors. The Office is 
responsible for overseeing the distribution of funds to investors who 
have been injured by securities law violations, implementing the 
Enforcement 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 funds 
and provides overall case management services for the Division.
    The Office has helped streamline the distributions process and 
enhance its internal controls, and it has overseen the distribution of 
approximately $3.2 billion to injured investors to date. Among the 
Office's recent initiatives has been to issue standardized, step-by-
step guidance to enforcement staff on developing and implementing 
distribution plans in both civil actions and administrative 
proceedings. In addition, the Office has consolidated collections and 
distributions information onto the enforcement program's internal 
website so that is more accessible to staff nationwide. In 
collaboration with other SEC offices, OCD has created templates to 
standardize the reporting of periodic and final accountings for 
distributions of disgorgement funds and Fair Funds, as well as to 
facilitate the examination of administrative expenses. In order to 
manage receivership expenses, the Office also developed billing 
instructions for receivers. OCD conducts training for the staff on the 
use of both the standardized reports and the billing instructions.
    Question. SEC's financial tracking system (Phoenix) was established 
to improve management of distribution of Fair Funds to victims of 
securities law violations. Is the ``Phoenix'' system fully functional 
at this time? What remains to be done to improve its capabilities?
    Answer. To date, the Phoenix system has only been partially 
deployed. Under the functionalities that are already operational, 
Phoenix assists with tracking and recording the disgorgement and 
penalties ordered in Enforcement actions. However, the Phoenix system 
does not yet track and record distribution information. This function 
is currently performed in a limited way within CATS 2000, the SEC's 
case tracking system, which is itself slated to be replaced.
    To that end, the agency is developing business requirements for a 
new module that would record and monitor distribution-related 
information, including information reported on the newly developed 
standardized accounting reports. Once fully built, this module would 
enable the SEC to track a distribution fund's current status or phase 
in the distribution process, enhance reporting and internal controls 
over the accuracy and integrity of distribution data, and provide 
better information about the investment of Commission funds with the 
Department of the Treasury's Bureau of Public Debt. This effort also 
will support integration with the agency's core financial management 
system.
    The SEC expects to finalize and deploy the distributions module in 
fiscal year 2010, depending on the availability of sufficient funding.
    Question. I note that SEC is currently reviewing its performance 
measure of the percentage of Fair Funds and disgorgement dollars 
designated for distribution to victims within a year. What are the 
challenges? What is hampering SEC's ability to track the timeliness of 
the fund distributions and maintain accurate data?
    Answer. As noted in the Commission's fiscal year 2010 budget 
justification, this measure is currently under review and may be 
adjusted in the future. One of the primary challenges with respect to 
such a measure has been the SEC's inadequate systems to collect, 
analyze, and report on distributions (described above), which have 
hampered the Commission's ability to track the timeliness of the fund 
distributions and maintain accurate data.
    Question. What portion of this year's budget (fiscal year 2009) and 
the proposed needs for fiscal year 2010 will be devoted to the Fair 
Funds distribution project?
    Answer. The first major expense associated with Fair Funds 
distributions is information technology, most notably the Phoenix 
system. In fiscal year 2009, the SEC expects to obligate approximately 
$0.1 million in ongoing maintenance and support related to Phoenix. For 
fiscal year 2010, the agency estimates that distributions-related 
projects will cost approximately $3.2 million. These projects include 
efforts to develop new collections and distributions tracking 
functionalities, enhance the current Phoenix system, integrate Phoenix 
with the enforcement program's new HUB tracking system and the core 
financial system, and conduct ongoing system maintenance.
    A second component of the SEC's distributions-related costs is the 
expense associated with the Office of Collections and Distributions. 
OCD's costs amount to approximately $6.0 million in fiscal year 2009 
and $6.2 million in fiscal year 2010. However, it is important to note 
that the Office performs a variety of functions in addition to 
distributions, including assisting with collection of delinquent debts 
and maintenance of internal controls.
    The final element is the substantial staff time spent on 
distributions functions within other parts of the SEC. For example, 
within the enforcement program (outside of OCD), attorneys spend 
considerable time on the development, oversight, and implementation of 
distribution plan actions, while support staff perform data input for 
all cases. In addition, the SEC's Office of Financial Management aids 
with funds investment and disbursement, as well as internal controls; 
the Office of the General Counsel reviews and comments on distribution-
related documents; and the Office of Economic Analysis evaluates the 
methodologies for measuring investor loss. Although the staff time 
involved is significant, the SEC does not currently track costs at this 
level.
                                 ______
                                 
                Question Submitted by Senator Ben Nelson
                   rule 151a, issued january 16, 2009
    Question. On January 16th of this year, the Commission issued a new 
rule regarding indexed annuities and certain other insurance contracts. 
This rule takes effect on January 12, 2011.
    What level of resources will the SEC devote in fiscal year 2010 to 
preparing to implement this rule? Can you calculate the cost to the 
Commission of the work necessary to fully implement this rule so that 
it can be operational on January 12, 2011?
    Looking ahead to the next fiscal year (fiscal year 2011), in taking 
on this additional regulatory responsibility, will additional staff be 
required? What will additional staff needs and additional regulatory 
responsibility mean for the Commission's budget?
    Answer. The release adopting this rule (Rule 151A) articulated the 
Commission's determination that investors in certain indexed annuity 
contracts are entitled to the protections of the federal securities 
laws. The rule includes a new definition of ``annuity contract'' that, 
on a prospective basis, will define a class of indexed annuities that 
are outside the scope of Section 3(a)(8) of the Securities Act, which 
provides an exemption under the Securities Act for certain insurance 
contracts. These indexed annuities will, on a prospective basis, be 
required to register under the Securities Act. With few exceptions, 
indexed annuities historically have not been registered as securities. 
The new definition will apply to indexed annuities that are issued on 
or after the January 12, 2011, the effective date of the rule.
    The staff is currently considering how to tailor disclosure 
requirements for indexed annuities. As with any other rulemaking, if 
the staff determines to recommend that the Commission propose new 
disclosure requirements, resources will be applied to develop a 
proposal, analyze public comments on the proposal, determine whether to 
recommend adoption of the proposal and consider whether and how it 
should be modified to reflect commenters' concerns.
    In addition, the Commission encouraged insurance companies, sellers 
of indexed annuities, and other affected parties to submit specific 
requests for guidance regarding the implementation of the rule. We 
anticipate that any responses to such requests will require staff 
resources.
    The Division of Investment Management also anticipates reviewing 
filings for approximately 400 new indexed annuity contracts in the 
first year.
    In all, the Division of Investment Management believes the 
implementation of Rule 151A will require an allocation of seven staff 
positions during the first year, with that number likely to decrease in 
the years following the initial implementation. The estimated cost of 
these seven positions is $1.6 million for fiscal year 2011. As 
discussed above, these staff will perform further rulemaking as 
appropriate, provide interpretive advice, and review disclosure 
filings.
                                 ______
                                 
              Questions Submitted by Senator Susan Collins
    Question. Chairman Schapiro, recently many news outlets have issued 
stories about the administration's proposal to move some consumer-
protection powers outside of the SEC. Reports state that that you are 
opposed to such a proposal. A May 20th Wall Street Journal article 
quotes you as saying that such a plan would ``. . . be hugely expensive 
and highly inefficient . . .'' Would you discuss your objections?
    Answer. I did not believe that investors would be better protected 
by separating some securities products from others, potentially 
creating gaps in the regulatory and enforcement regime. Securities 
products are different from consumer credit products: generally they 
are not guaranteed and include a number of inherent risks, including 
the loss of principal. The administration's white paper outlining its 
consumer protection plan appears to recognize this, and I do not object 
to that approach.
    Question. Secretary Geithner recently laid out a framework for 
overseeing the derivatives market including rigorous reporting 
requirements. Such a proposal would give the SEC and CFTC new 
authorities to regulate derivatives. What are your thoughts on the plan 
and the role of the SEC in the regulation of derivatives?
    Answer. I agree with the Secretary's approach. Both the SEC and 
CFTC have a role in regulating derivatives products. We continue to 
work together and make progress on how such a regime might work to best 
fill gaps in the regulatory framework and prevent regulatory arbitrage. 
I look forward to working with Congress to make the necessary 
legislative changes.
    Question. Two veteran enforcement lawyers at the SEC are currently 
under investigation for insider trading. A May 16 a Wall Street Journal 
article quotes a report by the SEC Inspector General saying that ``the 
SEC has `essentially no compliance system' to detect potential insider 
trading.'' As a result of the investigation into the trading activities 
of the two attorneys', the SEC has proposed the imposition of new rules 
on employee trades. How does this investigation affect your confidence 
in the ability of the SEC staff? In your estimation, do the recent 
troubles at the SEC signify fundamental problems within the 
organization, and if so how do you propose to rectify the issues?
    Answer. I have the utmost confidence in the ability of the SEC's 
staff and their unflagging dedication to the protection of investors. 
Time and time again, I have been impressed by the staff's talent, 
integrity, and enthusiasm for the agency's mission. However, it became 
clear to me soon after joining the agency that the SEC's system for 
ensuring compliance with employee trading rules was not sufficient. The 
report by the agency's Inspector General concerning trading activity by 
certain employees reinforced my belief that the SEC should have a 
trading compliance system that is second to none.
    I know the agency's staff shares my belief that, in light of the 
SEC's mission, it is vital that we conduct ourselves according to the 
highest standards of ethical conduct when it comes to our own financial 
holdings and transactions. To that end, we have taken several 
significant steps to strengthen the SEC's compliance system and reduce 
the potential for even the appearance of inappropriate securities 
trading:
  --We have proposed new rules concerning employee trading. These rules 
        will, among other things:
    --Require the pre-clearance of all trades.
    --Prohibit all trading in the securities of a company under SEC 
            investigation, regardless of whether the employee is aware 
            of the investigation.
    --Require all employees to authorize their brokers to provide 
            duplicate trade confirmation statements to the agency.
    --Prohibit the ownership of securities in publicly-traded exchanges 
            and transfer agents, in addition to existing prohibitions 
            against owning securities in other firms directly regulated 
            by the Commission.
    --Require employees to certify that they do not have any non-public 
            information about the company whose securities they are 
            trading.
      These rules were submitted to the Office of Government Ethics 
        (``OGE'') on May 22, 2009, and we await OGE's comments.
  --We recently retained an outside firm specializing in automated 
        compliance systems to develop a new computer compliance system 
        for the agency, which will automate and simplify the 
        transaction reporting process and make it easier to verify and 
        monitor employee trading.
  --We are creating a new Chief Compliance Officer position, and have 
        already received applications from a number of excellent 
        candidates for the new position.
  --I have consolidated responsibility for the oversight of employee 
        securities transactions within the SEC's Ethics Office and 
        devoted additional staff resources to monitor, review, and 
        spot-check these transactions.
    These measures will bolster and modernize the agency's compliance 
program, and help the talented and committed staff do its critical work 
of protecting investors without distraction.
    Question. The fiscal year 2010 budget request does not include an 
increase for the SEC Inspector General. Considering the likelihood of 
an increased workload at the IG's office, as the SEC increases 
surveillance and monitoring of employee trading, do you think that the 
IG will need additional funds?
    Answer. The Inspector General submitted a request for three 
additional positions only a few days before the publication of the 
SEC's Congressional Justification for fiscal year 2010, and therefore 
these additional positions were not reflected in the document. However, 
I have since approved the addition of these personnel, which would 
bring the OIG to a total of 19 positions. When these new staff are 
combined with the two positions approved for OIG in January 2009, the 
Office will have grown by a total of 73 percent within this calendar 
year, which is the highest growth rates of any SEC office during this 
timeframe.
    Question. Please provide a breakdown of the tips and complaints the 
SEC received in fiscal year 2007 and fiscal year 2008, to help explain 
the large decline in that year.
    Answer. As you mentioned, the number of tips and complaints 
received by the SEC's Office of Internet Enforcement declined 
significantly between 2007 and 2008, from about 1,586,000 to about 
615,000 in 2008. Unfortunately, the SEC has not had a tracking system 
that can break down those figures into their component parts or support 
rigorous analysis of underlying trends.
    The SEC's initiative to bolster its systems for tracking tips and 
complaints, working with the Center for Enterprise Modernization, will 
help the agency perform much better analyses in the future. Such 
analyses will help the SEC understand the overall statistics on tips 
and complaints and identify trends among specific firms or practices 
that can provide valuable information for potential enforcement action 
and compliance exams. The SEC also is working to streamline and 
standardize the agency's handling of tips and complaints, so they can 
be addressed more consistently and effectively. Nevertheless, for the 
2007-2008 period, the SEC is reliant on anecdotal evidence to explain 
the decline in tips and complaints during that timeframe.
    In general, the number of complaints the agency sees is related to 
the volume of spam and commercial email traffic received by investors. 
A number of factors likely affected this volume during the 2007-2008 
timeframe. First, the SEC's initiative starting in 2007 to combat spam-
driven stock manipulations was reported to have been a major 
contributor to reducing the amount of spam.\1\ Under this initiative, 
the SEC suspended trading in the securities of dozens of companies that 
had been the subject of spam stock promotions and initiated several 
spam-related enforcement actions. According to a private-sector 
Internet security report, a 30 percent decrease in stock market spam 
``was triggered by actions taken by the U.S. Securities and Exchange 
Commission, which limited the profitability of this type of spam . . 
.'' \2\
---------------------------------------------------------------------------
    \1\ ``SEC makes inroads against financial spam; Crackdown pays off 
as e-mail campaigns slow,'' by Matt Krantz, USA Today, Oct. 5, 2007 at 
p. 7A.
    \2\ http://eval.symantec.com/mktginfo/enterprise/white_papers/ent-
whitepaper_internet_security_threat_report_xii_09_2007.en-us.pdf. 
Copyright 2007 Symantec Corporation. All rights reserved. Symantec, the 
Symantec Logo, BugTraq, Symantec Brightmail AntiSpam, and Symantec 
DeepSight are trademarks or registered trademarks of Symantec 
Corporation or its affiliates in the United States and other countries. 
Apple, Mac OS, and QuickTime are trademarks of Apple Inc., registered 
in the United States and other countries. Safari is a trademark of 
Apple Inc. Microsoft, ActiveX, Windows, and Windows Media are either 
registered trademarks or trademarks of Microsoft Corporation in the 
United States and/or other countries. Sun, Java, and Solaris are 
trademarks or registered trademarks of Sun Microsystems, Inc. in the 
United States and other countries.
---------------------------------------------------------------------------
    Another major factor is the growing use and sophistication of 
commercial-grade spam email filters, blacklists, and experimental 
``data mines,'' which radically diminish the number of mass investment 
solicitations received by the average investor. Additionally, tough 
state and federal anti-spam laws, and high-profile prosecutions under 
those laws, likely helped to deter spammers.\3\
---------------------------------------------------------------------------
    \3\ See http://www.msnbc.msn.com/id/18955115/(arrest of Robert Alan 
Soloway); http://www.sophos.com/pressoffice/news/articles/2008/02/
japan-spam.html (Yuki Shiina); http://spamkings.oreilly.com/archives/
2006/03/stock_spammers_stung_by_secret.html (``g00dfellas'' spam gang).
---------------------------------------------------------------------------
    General market conditions also likely played a role in the decline 
in tips and complaints. Email stock promoters' activities lend 
themselves best to the promotion of obscure, thinly-traded stocks, such 
as the tech stocks that flourished during the late 1990s market 
``bubble.'' Since the collapse of that bubble, it seems fewer investors 
have been interested in these microcap stock promotions.
    It is important to note that, while the number of tips and 
complaints went down significantly in 2008, the figure is still 146 
percent higher than it was 5 years previously. By comparison, the 
number of full-time equivalents in the SEC's enforcement program 
increased by only 23 percent during that period. Also, while the 
quantity of complaints the SEC received decreased between 2007 and 
2008, the SEC believes that the quality of complaints has increased 
dramatically. Thus, the agency's workload from these complaints has 
actually become greater over the past year, despite the reduced number 
of complaints relating to spam.

                     ADDITIONAL SUBMITTED STATEMENT

    [Clerk's Note.--The subcommittee has received a statement 
from the Investment Company Institute which will be inserted 
into the record at this point.]
         Prepared Statement of the Investment Company Institute
    The Investment Company Institute \1\ appreciates this opportunity 
to submit testimony to the Subcommittee in support of the 
administration's fiscal year 2010 appropriations request for the 
Securities and Exchange Commission (SEC). We commend the subcommittee 
for its consistent past efforts to assure adequate resources for the 
SEC. For the reasons expressed below, we urge Congress to provide 
appropriations at least at the funding level requested by the 
President.
---------------------------------------------------------------------------
    \1\ The Investment Company Institute is the national association of 
U.S. investment companies, including mutual funds, closed-end funds, 
exchange-traded funds (ETFs), and unit investment trusts (UITs). ICI 
seeks to encourage adherence to high ethical standards, promote public 
understanding, and otherwise advance the interests of funds, their 
shareholders, directors, and advisers. Members of ICI manage total 
assets of $10.18 trillion and serve over 93 million shareholders.
---------------------------------------------------------------------------
    As SEC Chairman Mary Schapiro noted in her testimony, the recent 
financial crisis has served as a reminder of the importance and 
interconnectedness of the securities markets to our nation's economy 
and the financial health of millions of Americans. The crisis also 
demonstrated that the current regulatory system is not up to the 
challenges posed by modern financial markets and needs to be 
significantly strengthened and modernized. It has led to broad support 
for reform of the U.S. system of financial services regulation, 
including numerous calls for Congress to close regulatory and 
disclosure gaps to ensure appropriate oversight with regard to hedge 
funds, derivatives, and municipal securities. Toward these ends, it is 
critically important to provide the SEC with the resources necessary to 
assure its ability to soundly and effectively regulate securities 
offerings, market participants, and the markets themselves. And, to the 
extent that the scope of the agency's responsibilities is expanded with 
respect to hedge funds, derivatives, and/or municipal securities, it 
will be imperative that it have sufficient staffing and resources to 
effectively perform all of its oversight functions.
    More generally, the ongoing policy discussions about regulatory 
reform have highlighted why adequate funding for the SEC should 
continue to be a Congressional priority. Unlike other financial 
regulators, the SEC is specifically charged with protecting investors. 
The agency seeks to fulfill this mission in many different ways, 
including through the disclosure and substantive rules it adopts and 
administers, through examinations of regulated entities, and through 
its enforcement program, to name a few. In the wake of the financial 
crisis, it is essential to provide the SEC with the resources it needs 
to successfully pursue its investor protection mission.
    Mutual funds and other registered investment companies have a 
strong stake and vested interest in having a well-funded and effective 
SEC. Registered investment companies are an integral part of our 
economy. They represent, as a whole, the largest group of investors in 
U.S. companies, holding 27 percent of the outstanding stock in U.S. 
companies at year-end 2008. Registered investment companies also held 
the largest share of U.S. commercial paper--an important source of 
short-term funding for major U.S. and foreign corporations. In 
addition, they continue to be one of America's primary savings and 
investment vehicles for middle-income Americans. Today, over 93 million 
investors in more than 53 million U.S. households own shares of 
registered investment companies; the median household income of these 
investors is $80,000. And, since 1990, the percentage of U.S. 
retirement assets held in mutual funds and other registered investment 
companies has more than quadrupled. These millions of Americans 
continue to recognize that mutual funds are the best means of achieving 
their long-term financial goals. They deserve and benefit from 
continued vigilant regulatory oversight of mutual funds and other 
registered investment companies.
    The administration's fiscal year 2010 budget proposes SEC funding 
at a level that represents a 7 percent increase over fiscal year 2009. 
Chairman Schapiro explained in her testimony that this would permit the 
SEC to fully fund an additional 50 staff positions over 2008 levels, 
enhance its ability to uncover and prosecute fraud, and allow it to 
begin to build desperately needed technology. More specifically, 
Chairman Schapiro stated that the additional funding would allow the 
SEC to hire seasoned industry professionals and market experts to 
strengthen and expand the SEC's Office of Risk Assessment, improve its 
examination program, and bolster its oversight of the investment 
management and broker-dealer industries. We have strongly supported 
precisely these types of measures.\2\ It is essential that the agency 
have greater ability (and resources) to attract and retain professional 
staff having significant prior industry experience. Their practical 
perspectives would enhance the agency's ability to keep current with 
market and industry developments and better understand the impact of 
such developments on regulatory policy. The new Industry and Market 
Fellows Program is an encouraging step in the right direction, but we 
also believe that the agency should build strong economic research and 
analytical capabilities and should consider having economists resident 
in each division.
---------------------------------------------------------------------------
    \2\ See Letter to The Hon. Mary L. Schapiro from Paul Schott 
Stevens dated February 18, 2009 (attaching recommendations for SEC 
priorities under Chairman Schapiro's leadership). See also Financial 
Services Regulatory Reform: Discussion and Recommendations, which is 
available at http://www.ici.org/pdf/ppr_09_reg_reform.pdf. Chairman 
Schapiro also noted in her testimony that she intends to improve the 
overall management of the SEC, including by hiring a Chief Operating 
Officer to manage the organization. We also supported this idea in both 
our February 18, 2009 letter to Chairman Schapiro and Financial 
Services Regulatory Reform white paper.
---------------------------------------------------------------------------
    We are particularly pleased that a key strategic priority for the 
SEC's Division of Investment Management will be to strengthen and 
improve the money market fund regulatory regime. Last November, we 
convened a high level industry working group to study the money 
markets. In March, the group made a series of comprehensive 
recommendations that responded directly to weaknesses in current money 
market fund regulation, identified additional reforms that will improve 
the safety and oversight of money market funds and position responsible 
government agencies to oversee the orderly functioning of the money 
market more effectively.\3\ We look forward to working with the SEC on 
this critically important issue.
---------------------------------------------------------------------------
    \3\ See Report of the Money Market Working Group, submitted to the 
Board of Governors of the Investment Company Institute on March 17, 
2009, available at http://www.ici.org/pdf/ppr_09_mmwg.pdf.
---------------------------------------------------------------------------
    In conclusion, the SEC and the fund industry share a common 
objective of assuring that mutual funds remain a vibrant, competitive 
and cost effective way for average Americans to access the securities 
markets and realize their long-term financial goals. Future regulatory 
and oversight actions by the SEC will play a key part in this process. 
It is therefore critically important that the SEC have sufficient 
resources to adequately fund the staffing of the agency and to take 
other steps to fulfill its mission of protecting the nation's 
investors, including the over 93 million Americans who own mutual 
funds. Accordingly, we urge Congress to provide appropriations at least 
at the funding level requested by the President.
    We appreciate your consideration of our views.
                  COMMODITY FUTURES TRADING COMMISSION

STATEMENT OF HON. GARY GENSLER, CHAIRMAN
    Senator Durbin. I'd like to invite Chairman Gensler from 
the Commodity Futures Trading Commission to come forward.
    This year, 2009, marks the 35th year since the 
establishment of this agency. At this time of its inception in 
1974, CFTC's 500 employees were tasked with ensuring fair 
practices and honest dealings on the commodity exchanges of 
America's then $500 billion industry in 1974.
    Today, it is a $22 trillion industry and it looks a lot 
different. The traditional agricultural products are still 
there, but the landscape has been diversified with novel and 
complex commodities, from grains to gold, currencies to carbon 
credits.
    In the past decade trading volume has increased more than 
tenfold, reaching over 3.4 billion trades in 2008. Actively 
traded contracts have quintupled from 286 in 1998 to 1,521 in 
2008.
    CFTC oversees $5 trillion of trades every single day. So we 
don't want you to stay at the table too long. We want you to 
get back and keep an eye on those trades, but we invite you, 
Chairman Gensler, to give your testimony at this point.
    Mr. Gensler. Thank you, Chairman Durbin, Ranking Member 
Collins, and members of the subcommittee, Senator Tester.
    I'm pleased to be here today to discuss our budget and 
especially pleased to learn that Senator Durbin recently 
visited our Chicago office which very encouraged the staff and 
I thank you for it.
    I'm also grateful to each of you for your individual 
support on my recent confirmation. It's an honor to serve the 
country in this capacity.
    I come before you having served as Chairman just 6 calendar 
days, but with full knowledge of the failures of our regulatory 
system, failures that affected all Americans, failures that we 
must ensure do not happen again, and as Chairman, I will use 
every authority available to protect the American people from 
fraud, manipulation, and excessive speculation.
    I will also work with Congress on new authorities to bring 
much-needed transparency and regulation to the over-the-counter 
derivatives marketplace.
    I am grateful on behalf of the agency for the $146 million 
recently appropriated for this Commission. This boost has 
allowed us to get back to beginning to address the alarmingly 
low staffing levels there are at the agency. Our size, however, 
is still roughly equivalent to the Commission that was 
established 35 years ago.
    Today, the futures market is dramatically different, as 
Chairman Durbin just outlined, being some 45 times larger than 
it was 35 years ago, and much more complex as well.
    Just 10 years ago the CFTC was near its peak staffing 
levels, near 580 full-time equivalents. It's shrunk over 20 
percent in the past years, but with your help the fiscal 2009 
funding will permit us to get back to where we were in 1999.
    Since 1999, however, volumes have gone up fivefold, the 
number of contracts have gone up sixfold. The complexity, of 
course, I don't need to tell you, has gone up dramatically. 
We've gone from open outcry pits to electronic trading which is 
in some cases harder to monitor. We've also lived through the 
worst financial crisis in 80 years and seen the results of an 
asset bubble in commodity prices.
    In short, the Commission remains an underfunded agency and 
we're very grateful to the President's budget of $160.6 million 
in recognition of some of these needs. If I could just share 
with you some of the things that have been highlighted to me in 
my first 6 days. I think we still need to ensure that our 
enforcement effort is larger to ensure robust enforcement of 
our laws. Currently, we have about 141 attorneys in our 
Enforcement Division. I believe this is still quite lower than 
what's required, given the financial turmoil we've lived 
through.
    We must ensure greater transparency. I believe that 
commodity index funds did contribute to the asset bubble that 
we've just lived through. To bring greater transparency will 
require more economists. It's going to require announcements in 
our weekly commitments in traders' reports. We'll also need to 
upgrade our systems as well.
    We must ensure that position limits consistently applying 
across the board, and that we're reviewing hedge exemptions and 
no action processes in that regard.
    Our information technology (IT) systems and particularly 
our mission critical systems on positions and transactions have 
not been upgraded for quite some time and I've looked forward 
to working with this subcommittee on getting funds to try to 
upgrade these mission critical systems.
    And also, we need to ensure timely review of new products 
and rule change filings. This has lagged a great deal and just 
last year with the new farm bill, the review of significant 
price discovery contracts will be important moving forward.
    These are only a few of the funding priorities, but I 
wanted to give the subcommittee a tangible sense of some of the 
things that we're grappling with and struggling with.
    With that in context, the $14.6 million of additional 
funding, about one-half of that is to stay at current services 
and one-half of that in the President's budget, fortunately, is 
for 38 new full-time equivalents to bring us back just above 
where we were 10 years ago, to about 610 full-time equivalents. 
These positions are essential. The increase, however, still 
won't allow us to fully address these complex markets and what 
we need to do.
    Before I close, I would like to highlight that the 
additional funding needs will also accompany much-needed 
regulatory reform. I, along with other regulators, and the 
administration feel we need to broaden reforms in the over-the-
counter derivatives marketplace and bring it all under the 
regulatory umbrella. I look forward to working with this 
subcommittee and Congress for funding those new authorities to 
make sure they're properly implemented.

                           PREPARED STATEMENT

    And with that, I thank you very much and I look forward to 
answering your questions.
    I hope my written testimony can be entered into the record.
    Senator Durbin. Of course. It will be.
    [The statement follows:]
                   Prepared Statement of Gary Gensler
    Thank you, Chairman Durbin, Ranking Member Collins, and other 
members of the Subcommittee. I am pleased to be here to testify on 
behalf of the Commodity Futures Trading Commission, and I appreciate 
the opportunity to discuss issues related to the Commission's 2010 
Budget. I am also grateful to have had each of your individual support 
for my recent confirmation. It is a great honor to serve my country in 
this capacity.
    I come before you today having only served as CFTC Chairman for 6 
calendar days, but with the full knowledge of the failures of our 
financial regulatory system; failures that affected all Americans and 
failures that we must ensure never occur again.
    The last decade, and particularly the last 21 months, has taught us 
much about the new realities of our financial markets. We have learned 
the limits of foresight and the need for candor about the risks we 
face. We have learned that transparency and accountability are 
essential and that only through strong, intelligent regulation can we 
fully protect the American people and keep our economy strong.
    As Chairman of the CFTC, I will use every tool and authority 
available to protect the American people from fraud, manipulation and 
excessive speculation. I also look forward to working with Congress to 
establish new authorities to close the gaps in our laws and bring much-
needed transparency and regulation to the over-the-counter derivatives 
market. I firmly believe that doing so will strengthen market 
integrity, lower risks, protect investors, promote transparency and 
begin to repair shattered confidence in our financial markets.
    I would like to thank the Committee for the $146 million recently 
appropriated for the CFTC for the 2009 fiscal year and special thanks 
to Chairman Durbin for visiting our Chicago office last year. As a 
result of this much needed boost in funding, the Commission has begun 
to address our alarming staffing levels; levels that recently reached 
historic lows.
    At present, the Commission employs about 500 career staff--roughly 
equivalent to when the Commission was created in 1975. Three decades 
later, the futures market has changed in every way: with respect to 
volume, complexity, risk and locality. What was once a group of 
regional domestic markets trading a few hours 5 days a week is now a 
global market trading 24/7, and what was once just a $500 billion 
business has exploded to a $22 trillion annual industry.
    Ten years ago, the CFTC was near its peak staffing level at 567 
employees, but shrunk by 20 percent over the subsequent 8 years before 
hitting a historic low of 437.
    With the increase in fiscal year 2009 funding the CFTC can reach 
572 employees.
    While this is a start, I believe that merely raising our staffing 
levels to the same as a decade ago will not be enough to adequately 
fulfill all of the agency's missions. In the last 10 years, trading 
volume went up over five fold. The number of actively traded futures 
and options contracts went up over six fold, and many of these are 
considerably more complex in nature. We also moved from an environment 
with open-outcry pit trading to highly sophisticated electronic 
markets.
    In addition to the dramatic evolution of the futures industry, we 
have experienced the worst financial crisis in 80 years. We also 
experienced, in my view, an asset bubble in commodity prices. The staff 
of the CFTC is a talented and dedicated group of public servants, but 
the significant increase in trade volume and market complexity, as well 
as rapid globalization, commands additional resources to effectively 
protect American taxpayers.
    For all of these reasons, I feel it is appropriate for our staffing 
levels and our technology to be further bolstered to more closely match 
the new financial realities of the day.
    In short, despite the recent increase in funding, the Commission 
remains an underfunded agency. The President's Budget recommendation of 
$160.6 million is recognition of this need. Specifically, the 
Commission needs more resources to hire and retain professional staff 
and develop and maintain technological capabilities as sophisticated as 
the markets we regulate.
    I'd like to identify some of my priorities and provide some 
illustrations of how resource limitations have constrained the 
Commission. Among my priorities will be to:
  --Ensure robust enforcement of our laws. Currently, the Commission's 
        enforcement program consists of 122 employees--the lowest level 
        since 1984. Though fiscal year 2009 funding will get us back to 
        141 enforcement employees, this is still below the agency's 
        peak of 167 and well below what we need given the current 
        financial turmoil. Any financial downturn reveals schemes that 
        could only stay afloat during periods of rising asset values. 
        Our current, and much larger, downturn is exposing more leads 
        than the Commission can thoroughly and effectively investigate. 
        This is true both as it relates to fraud and Ponzi schemes as 
        well as staff intensive manipulation investigations. The 
        regulations we enact to protect the American people are 
        meaningless if we do not have the resources to enforce them;
  --Ensure greater transparency of the marketplace. Also, I believe 
        that commodity index funds and other financial investors 
        participated in the commodity asset bubble. Notably, though, no 
        reliable data about the size or effect of these influential 
        investor groups has been readily accessible to market 
        participants. The CFTC could promote greater transparency and 
        market integrity by providing further breakdowns of non-
        commercial open interests on weekly ``Commitments of Traders'' 
        reports. The American public deserves a better depiction of the 
        marketplace. The temporary relief from higher prices does not 
        negate this need, especially given that a rebounding of the 
        overall economy could lead to higher commodity prices;
  --Ensure position limits are consistently applied. The CFTC has begun 
        a review of all outstanding hedge exemptions to position 
        limits. This review will consider the appropriateness of these 
        exemptions and look for ways to institute regular review and 
        increased reporting by exemption-holders. The Commission also 
        has begun a review of the process and standards through which 
        no-action letters are issued. As part of these reviews, CFTC 
        staff will consider the extent to which swap dealers should 
        continue to be granted exemptions from position limits;
  --Ensure the Commission has the tools to fully monitor the markets. 
        We must upgrade the Commission's mission critical IT systems 
        for the surveillance of positions and trading practices. 
        Neither is robust enough nor have they been upgraded to reflect 
        the vast increase in volume and complexity. Our systems must 
        begin to produce the surveillance reports needed to meet the 
        analytical needs of our professional staff and the transparency 
        needs of the public; and finally
  --Ensure timely reviews of the many new products and rule change 
        filings of the futures markets. These have lagged due to the 
        growth and complexity of markets and the added responsibilities 
        extended to the Commission in the 2008 Farm Bill. The Farm Bill 
        requires staff to review all contracts listed on Exempt 
        Commercial Markets (ECMs) to determine if they are significant 
        price discovery contracts--if they are, then any ECM that lists 
        such a contract must also be reviewed to determine compliance 
        with a stringent set of core principles under the Commodity 
        Exchange Act.
    Other examples that I believe are illustrative of the difficult 
tradeoffs caused by resource constraints are:
  --The Commission does not conduct annual compliance audits of every 
        Designated Contract Market (DCM)--rather only periodic reviews 
        on average, every 3 years;
  --The Commission does not conduct annual compliance audits of every 
        Derivatives Clearing Organization (DCO)--rather periodic 
        reviews are conducted of selected core principles that are 
        rotated and completed every 3 years; and
  --The Commission does not conduct routine examinations of Commodity 
        Pool Operators, Commodity Trade Advisors, and Futures 
        Commission Merchants--a function currently performed by Self 
        Regulatory Organizations. If the Commission were to perform 
        direct periodic audits our staff would better understand the 
        operations of brokers and managed funds and could better assess 
        compliance with the law and regulations.
    These are only a few of our important funding priorities and the 
workload challenges imposed by resource limitations. There are, of 
course, others. I hope that this helps the Committee to understand, in 
a tangible way, the challenges the Commission faces in regulating the 
futures markets the way the Nation requires.
    Although the work of the Commission can be highly technical in 
nature, the mission of the agency is quite straightforward. The CFTC is 
charged with:
  --Protecting the public and market users from manipulation, fraud, 
        and abusive practices and
  --Promoting open, competitive and financially sound futures markets.
    With that context, I would like to address the specifics of the 
fiscal year 2010 Budget request. The fiscal year 2010 Budget proposes 
an increase of $14.6 million. Approximately half of the increase is 
needed to maintain our fiscal year 2009 level of operations into fiscal 
year 2010. The balance would fund an additional 38 positions.
    Twenty-six of the 38 staff would be allocated to principal program 
areas. Specifically, we would allocate 11 positions to Enforcement, 8 
to Market Oversight, 6 to Clearing and Intermediary Oversight, and 1 to 
the Chief Economist's office. The remaining 12 positions will provide 
critical mission support in the areas of legal analysis and counsel, 
technology support, international coordination, legislative and public 
outreach, and human capital and management support.
    The additional 38 positions are essential to addressing some of the 
limitations I mentioned earlier. This increase, however, will not 
provide the Commission with the critical mass of professional and 
technical expertise needed to ensure that the growing markets remain 
free of manipulation and fraud.
    For example, our enforcement staff needs to be significantly 
expanded to:
  --Ensure that crimes are punished to the fullest extent of the law;
  --Develop strategies aimed at quickly identifying and eradicating 
        fraudulent schemes, such as Ponzi and foreign exchange ``boiler 
        rooms''; and
  --Importantly, pursue resource-intensive investigations and 
        litigations involving manipulation, including energy-related 
        market abuses, so wrongdoers will not believe they are immune 
        from enforcement simply due to the complexity of an enforcement 
        action.
    Insufficient resources in the enforcement division force it to be 
too selective in the matters it investigates.
    Our market oversight operation needs additional highly-skilled 
economists, investigators, attorneys and statisticians to:
  --Analyze trading reports quickly and thoroughly, identify potential 
        market problems or trader violations promptly, and avoid market 
        disruptions and pricing anomalies;
  --Conduct timely and complete reviews of regulated entities to ensure 
        compliance with all core principles;
  --Examine exchange self-regulatory programs on an on-going and 
        routine basis with regard to trade practice and market 
        surveillance; and
  --Ensure their compliance with disciplinary, audit trail, record-
        keeping and governance obligations.
    Our clearing and intermediary oversight program needs additional 
auditors, analysts, and attorneys. This would allow us to:
  --Ensure clearing systems protect against a single market becoming a 
        systemic crisis;
  --Protect investors' funds from being misused or exposed to 
        inappropriate risks of loss; and
  --Guard against abusive sales practices that harm customers and 
        undermine market integrity.
    Our economic research program needs more economists to review and 
analyze new market structures and off-exchange derivative instruments, 
especially in light of novel and complex products and practices that 
call for state-of-the-art economic analysis. Further, additional 
resources would enhance our economic and statistical analysis, 
improving transparency of markets and better supporting the 
Commission's enforcement and surveillance programs.
    We also need to transform the current legacy information technology 
systems into robust systems capable of efficiently receiving and 
managing massive amounts of raw data as well as transforming them in to 
useful analytical and research tools.
    The Commission has made a substantial investment in technology over 
the past 2 years--focusing first on upgrading obsolete computer 
hardware to industry standards. We need technology, however, that is as 
modern and dynamic as the technology-driven markets we are charged with 
overseeing. Our investment in technology must be more than just 
periodic equipment upgrades and maintenance. The Commission must 
leverage resources by employing 21st century technology to protect the 
American people.
    As the Commission informed this Committee in February of this year, 
the agency believes it needs $177.7 million for fiscal year 2010 to 
perform its present duties. I look forward to working with this 
Committee to secure the funding necessary to meet our current 
regulatory responsibilities.
    Before I close, I would like to briefly highlight funding needs 
that might go along with much needed regulatory reform. The CFTC along 
with the administration and other financial regulators is committed to 
working with Congress on broad regulatory reform. This is particularly 
true for the markets that the CFTC currently regulates and the markets 
that may soon come under our regulation.
    Specifically, we must urgently regulate the over-the-counter 
derivatives market and address excessive speculation through aggregated 
position limits.
    President Obama has called for action by the end of this year to 
strengthen market integrity, lower risks, and protect investors. The 
future of the economy and the welfare of the American people depend on 
a vibrant Commission to assist in leading the regulatory reform ahead. 
Additional funding will be necessary to properly implement these 
reforms.
    I look forward to working with the Members here today and others in 
Congress to accomplish this goal.
    Thank you very much. I would be happy answer any questions you may 
have.

                                STAFFING

    Senator Durbin. Chairman Gensler, thank you for being here 
and we're glad that you're on the job, and it strikes me that 
if we look at your recent arrival and the recent arrival of a 
lot of money into your agency, that you're really going to be 
tested quickly in terms of whether or not you can gather 
together the professional staff to do your job and the added 
responsibilities that you mentioned in the farm bill. I don't 
know if you have had a chance to look at the inspector 
general's report on your agency but that was, I think, one of 
the major points made by that report, as to whether or not you 
would have the human capital necessary to monitor the complex 
situations that you face.
    Now, there's been some problems in the past at CFTC when it 
comes to Federal pay parity, where the Government basically 
said let's start treating all the professionals in our agencies 
alike and CFTC seemed to be lagging in the past in bringing the 
income levels up to meet the pay parity standard.
    You mentioned my visit to the office in Chicago and I'm 
glad I did it. I don't know how many other Congressmen or 
Senators have been there, but it's an eye-opener. It's a small 
staff but it's an amazing staff and I was very impressed. There 
are some people we have working for our Government in that 
office who do such exceptional work.
    One man they introduced me to, I've forgotten his name 
unfortunately, and they told me what his responsibility was 
each day and they said he is the go-to guy. He watches all of 
these transactions going and he's the one who monitors them and 
if he weren't here, you know, I'm not sure how good a job we'd 
do. It would take a lot more people to try to do what he does 
every day. I said, ``Does this man take a vacation?'' They 
said, ``Yes, he does and we try to hang on until he gets 
back.''
    It's that kind of person and that kind of responsibility 
which leads me to ask, now that we've sent you a substantial 
amount of money in this year's fiscal year bill, in the omnibus 
bill, and now that we've told you you need more professional 
people and now that you're looking at this pay parity issue, 
how are you trying to fit these pieces together into some 
coherent way of expanding your agency in a manner that is 
consistent with rewarding the good performance of people there 
and bringing onboard the kind of folks that you need to meet 
these new electronic markets?
    Mr. Gensler. Senator, I think you're right in these are 
important challenges. Just being in the job for 6 days, what I 
see are talented staff facing significant challenges ahead.
    Senator Durbin. Incidentally, you're new to this, but it's 
always great to start your answer with Senator, you're right. 
Please proceed.
    Mr. Gensler. Senator, you're right. As I understand it, the 
agency's been able to fulfill all of the job postings--about 95 
job postings. There's confidence, at least within the staff, as 
to what might be achieved by September 30. We all know there's 
a summer and August and so forth, but all the postings are up. 
Some of the recruiting has already occurred and people have 
been coming in.
    But I also agree with Chairman Durbin that this agency, 
which was so sorely underfunded and actually shrank over 20 
percent in the face of this complexity during the last 8 years, 
has too many jobs that are being done by one person or not 
enough. As an example, when I asked, well, how large is the 
group that oversees clearing, this really important function in 
futures. I was told that there is a nine-person staff out in 
Chicago, which is part of that larger staff, I said, ``Is that 
enough?'' Well, you know, everybody said, ``Well, that's what 
we have. We've had to make tough choices.''
    So I think that's very important. I'm committed to make 
sure that taxpayer dollars are put to work most appropriately 
and efficiently, but I do have confidence in what I've seen in 
6 days, that there's a plan of action for these hires.
    Senator Durbin. What about the pay parity issue?
    Mr. Gensler. On pay parity, as I understand it, we've been 
able to bring up to a figure of about $4 to $4.5 million.
    Senator Durbin. I might say that there----
    Mr. Gensler. I'm sorry Senator, let me just correct this. 
There is $1.4 million in the fiscal 2010 budget specifically 
with regard to that.

                         STUDENT LOAN REPAYMENT

    Senator Durbin. One obscure little thing which I 
accomplished when Senator Collins was chairing the Governmental 
Affairs Committee.
    Senator Collins. Governmental Affairs.
    Senator Durbin. Governmental Affairs Committee, when it 
started, was the whole question of student loan repayment as an 
incentive to bring in professionals to Federal agencies.
    The SEC is one of the best agencies in Government on this 
front, 385 of their staff, 181 of whom are attorneys have used 
the student loan repayment, and I believe this brings them into 
Federal Government where their services are very valuable. 
Otherwise they might not be able to consider it.
    CFTC has not instituted such a program, probably for lack 
of money, and I'm wondering if you expect to be able to provide 
that benefit as part of recruitment in the future.
    Mr. Gensler. The answer is yes, sir, I think that we tried 
to do--I think it was just a small amount this year, $200,000 
in this fiscal year.
    Senator Durbin. I see.
    Mr. Gensler. In fiscal 2009, actually.
    Senator Durbin. Well, I think it can be a major part of 
attracting really talented college graduates who otherwise 
would be lured to something that may pay a little more just to 
defray their costs.
    Mr. Gensler. The agency shares that view.
    Senator Durbin. Thank you.
    Senator Collins.

                              UNDERFUNDING

    Senator Collins. Thank you, Mr. Chairman.
    Mr. Gensler, Senator Lieberman and I, as the chairman and 
ranking member of the Homeland Security and Governmental 
Affairs Committee, held three hearings last year looking at 
speculation in the commodities markets, and I want to talk 
about some of our findings as a result of those hearings.
    The first we've already discussed at some length and that 
is that the CFTC has been woefully understaffed. We were told 
by the Commission that there were more than 3 billion futures 
and options contracts that were traded last year, I guess it 
would have been the year before last, and that was up from 37 
million in 1976 when the Commission was first created, so 37 
million to 3 billion contracts, and yet the Commission was 
operating with fewer employees than it had 30 years ago. Just 
an untenable situation.
    Now, the Acting Chairman of the Commission in February 
wrote to the Office of Management and Budget (OMB) Director in 
protest of the budget that had been handed down by OMB of 
having a budget of $160.6 million and he described it as 
perilously inadequate. He went on to say that it would not 
allow the Commission to implement all of its responsibilities. 
That is the budget that we're talking about today.
    Do you disagree with the letter that was written by the 
Acting Chairman or do you share his concerns?
    Mr. Gensler. I share the concerns that this agency is both 
underfunded, as you and Senator Lieberman's panel determined 
last year. I think, as the Acting Chairman Mike Dunn did an 
excellent job these past 4 months laying out that this agency 
needs more. We're very appreciative of the President's budget 
and the 38 additional employees, but I don't think it's really 
yet up to the task that the American people expect or how we're 
going to protect against fraud, manipulation, and, as your 
hearings looked at, the burdens of excess speculation in these 
markets.

                              SPECULATION

    Senator Collins. Let me turn to the speculation issue. As a 
result of the hearings that we held, Senator Lieberman and I 
introduced a bill that directed the CFTC to establish position 
limits that would apply to an investor's total interests in a 
commodity, regardless of whether they originate on a regulated 
exchange, the over-the-counter market or on foreign boards of 
trade that deal in U.S. commodities.
    Do you support establishing position limits, having the 
Commission do it rather than the exchanges?
    Mr. Gensler. I think, Senator, that it's important that we 
bring a broader view of this even than was being discussed 
then, that we have the over-the-counter derivatives marketplace 
under regulation, but, in addition, that the position limits 
that are set--for instance, if it was for crude oil, that it 
would look across markets and aggregate not only 
internationally, as you were discussing, but also with the 
over-the-counter derivatives marketplace. There may be 
contracts that are really quite similar, as you addressed in 
the farm bill, but more broadly as we work with Congress later 
this year and try to get aggregate position limit authority for 
Federal regulators to look across markets and across futures 
and swaps.

                             INDEX TRADERS

    Senator Collins. What our hearings demonstrated was that 
speculation in the commodities markets by noncommercial 
investors, not individuals or entities that are actually taking 
possession of the commodity at some point, but entities, like 
pension funds, university endowments and other institutional 
investors, has grown enormously from 2003 to 2008.
    In just that 5-year period the total value of their futures 
contract and commodity index funds investments soared from $13 
billion to $260 billion. So you have this influx of money from 
speculators. There's always been speculation in the commodities 
futures markets.
    I understand that and I understand that speculation is 
useful for hedging risk, but we're talking now about 
speculation from individuals who are not the traditional buyers 
and sellers of the commodity, and I understand that those 
investors' intention is to provide good returns as a hedge 
against inflation, asset diversification, but the effect of 
that activity cumulatively appears to drive up the price for 
some of the traditional users of the commodity markets.
    Just a week ago Maine's fuel dealers were in my office 
saying that they believe excessive speculation by noncommercial 
players is once again driving up the cost of oil. That's a 
tremendous issue in a State where 80 percent of the families 
use home heating oil to stay warm.
    So two questions. First, what is your general opinion on 
whether the influx of funds from nontraditional players is 
putting artificial price inflation or causing prices to go up 
beyond what they otherwise would, and second, what, if 
anything, should we do about it?
    Mr. Gensler. Two excellent questions. I do think that, 
looking back, in that period that you named and when oil prices 
peaked last summer, that a contributing factor, not the only 
factor because there were many factors, but a contributing 
factor to the commodity asset bubble was index investors and 
other financial investors.
    We have also lived through other asset bubbles in housing, 
unfortunately, in the stock market in the late 1990s and then 
again maybe last year. So in a similar way, I think financial 
actors contributed to this but were not the only cause.
    I do think that the Commodity Futures Trading Commission, 
at its core and has been for 70 plus years, one of its missions 
is to make sure that markets' integrity is sound, that there's 
not manipulation and fraud but also that the burdens of 
excessive speculation be guarded against through position limit 
authority.
    So in terms of that mission, the Commodity Futures Trading 
Commission is not a price-setting agency, but it is an agency 
that has to guard to make sure that the markets are operating 
free of manipulation, free of fraud, and that through the 
position limit authority the Congress first granted back in the 
1930s, that there's some limit to the actors within the 
marketplace.
    Senator Collins. Thank you.
    Senator Durbin. Senator Tester.
    Senator Tester. Thank you, Mr. Chairman, and thank you for 
those questions, Senator Collins.
    I've just got a follow-up that goes right under her 
question and that is, do you think the marketplace right now is 
being impacted by--I'm talking about the oil marketplace is 
being impacted by trading of nontraditional traders?
    Mr. Gensler. Senator Tester, again I've only just been in 
the job for 6 days and mostly been preparing for this 
Appropriations hearing and a hearing for Thursday on other 
matters, so I haven't formed a view.
    I do think that, just as the asset bubble broke last year 
with this financial crisis, that part of what we're seeing is 
with some confidence coming back in the stock market and in 
other investment markets, just as Senator Collins mentioned, 
some investments of firms and others are having more confidence 
in the value in the commodities marketplace.
    But again, I've only been there 6 days and haven't, you 
know, been able to meet with economists and sort through the 
specifics of this market.
    It is likely that, as economy--if we're able to get out of 
this recession and get away from the financial crisis, the 
commodity prices will move and I'm not saying where, but a lot 
will change in the economy, as well.
    Senator Tester. Being a farmer, I don't mind having 
commodity prices go up. I can tell you that the price of 
gasoline at the pump in Montana over the last 6 weeks has 
probably went up a buck a gallon. I don't see that kind of 
increase at the barrel level. I can still hear about ships 
floating around out in the ocean full of oil.
    I can't make any sense of what's going on and what further 
frustrates me is that last year, during the last Congress, we 
had people in, and you're right, it was a multifaceted thing, 
but very, very few people would step up to the plate last year 
and say part of this--a good part of this is caused by 
speculation in the marketplace.
    It was all supply and demand, supply and demand, supply and 
demand, and that was part of it, but I think a good part of it 
was just flat speculation and greed.
    Mr. Gensler. Senator Tester, as I just mentioned to Senator 
Collins before you arrived, I believe that index investors, 
hedge funds, and other pension and financial investors were a 
contributing factor in this asset bubble of last year. I just 
haven't been able to tease out exactly what's happened in my 
first 6 days.
    Senator Tester. I look forward to further communication, 
either in committee or outside the committee, on that issue 
because I think it's really important. I think it's really 
important that we make sure that we have honest markets here.
    Mr. Gensler. I fully agree with that.

                                 MERGER

    Senator Tester. Okay. I asked a question to Secretary 
Schapiro about the discussions of future roles of your agency 
and the SEC as we conduct a regulatory modernization effort, if 
they were combined, if CFTC were combined with SEC.
    Can you just tell me some of the challenges, opportunities, 
possible consequences?
    Mr. Gensler. You said if.
    Senator Tester. That's right.
    Mr. Gensler. Well, thank you for your question, Senator. I 
think whether it's in Government or in commerce, it's important 
to consider that a merger just for merger's sake is probably 
not much reason to do that, whether it's in Government or in 
commerce.
    Senator Tester. Yeah.
    Mr. Gensler. I think some of the challenge is that each of 
these agencies, agencies that date back to the 1930s, have a 
mission to protect against fraud manipulation but with 
different missions.
    At the CFTC, its core was around farmers and ranchers, 
which you know a great deal about, to protect their markets so 
they can hedge a risk, buy the seed and plant a crop knowing 
that the market pricing mechanism is honest.
    That's at the core of the CFTC and if, for any reason, 
Congress and the President working together wanted to merge 
these agencies, which again I'm saying merger for merger's sake 
probably isn't it, we'd have to really protect that root 
mission, that we're protecting the pricing mechanism for 
farmers, ranchers, commercial users, all the users of the 
futures and derivatives marketplaces that the CFTC oversees.
    Senator Tester. Okay. If the President's working group 
recommends combining the two agencies, if again, and you 
believe that they should be separated, would you support the 
working group's regulatory modernization proposal?
    Mr. Gensler. I chair an independent regulatory agency. My 
responsibility, I think, to the American public would be to 
tell you what I believed at that time. So I think I would speak 
out openly and share with this subcommittee and the rest of the 
Congress what I thought.

                         DERIVATIVES REGULATION

    Senator Tester. All right. Good. Derivatives. You've been 
involved in a conversation on regulating or deregulating 
derivatives for over a decade in past positions that you've 
held.
    Could you give me a quick synopsis, because I'm already out 
of time, on how your opinion of derivatives and the regulation 
has evolved over the last 5 to 10 years?
    Mr. Gensler. It has evolved, Senator. I think now that we 
must bring under regulation the over-the-counter derivatives 
marketplace through two complementary schemes.
    One is the dealers or institutions that actually deal in 
these swaps, if I may call them, and that's nearly 100 percent 
of the market, probably in 20 or 25 big institutions. We know 
their names and you're familiar with them.
    We should police for fraud manipulation. We should get 100 
percent of the record, both for standardized and customized 
swaps and set capital standards at the Federal level and margin 
requirements through the dealer side.
    But, in addition, in an additive way, also regulate the 
markets and then we can lower risk, we can lower risk if we 
have standard products go through central clearing and we can 
promote transparency and this is critical that we promote 
transparency through having regulated exchanges, as well.
    Senator Tester. Okay. Thank you very much, Mr. Chairman.
    Senator Durbin. Chairman Gensler, as you look at the volume 
of work that you're faced with, the new responsibilities, what 
do you think is the--let me state it this way.
    What would you recommend as the optimal number of people 
that you need in your agency to do that job effectively?
    Mr. Gensler. Under the current authorities, because, of 
course, we'll work together with Congress and with the rest of 
the administration on new authorities,--thank you, Senator 
Tester.
    Under the current authorities, the agency put forward, as 
Senator Collins said, an appeal letter in February that was 
speaking to--I think it was about 650 full-time people under 
that $177 million.
    I don't know yet, again through just 6 days, whether that's 
going to allow us to fully cover, but I agree with Acting 
Chairman Dunn that it's more toward that number of people and 
it may be as high as some figures I've seen inside that are a 
little higher than that, closer to the 700-person figure.

         ENFORCEMENT PENALTIES: AMOUNT, RECOVERY AND DETERRENCE

    Senator Durbin. When Chairman Schapiro was here, I noted 
that the fees collected by her agency within the marketplace 
generated about 40 percent more than the annual appropriation 
for her agency.
    Similarly, in your situation, the penalties that have been 
assessed for wrong-doing and the amounts collected, I've seen 
varying estimates of this amount, but they appear to be over 
the last 8 years somewhere between $1.5 and $2 billion your 
annual appropriation, for last year $146 million, in comparison 
there.
    So could you say to me, I mean, or could we say to those 
who are observing this hearing that when your agency does its 
job and ends up with a trustworthy marketplace, it also is 
engaged in enforcement actions which bring in more revenue than 
the actual budget of the agency?
    Mr. Gensler. I think, Mr. Chairman, that the agency--we 
could say to those looking at this is a sound investment of a 
$160 million for the next year of taxpayer money because in 
helping police these markets, enforcing these markets, bringing 
integrity to the markets, making sure that they're fairly 
priced in the marketplace is the crucial thing.
    But in addition, you're right, there are enforcement 
actions that have penalties. The penalties are at least greater 
than the budget. The collections tend to be a little less than 
that, as you know.
    Senator Durbin. How well is the CFTC able to measure the 
deterrent impact of these enforcement actions?
    Mr. Gensler. It's a challenge to measure the results, but 
we believe that the stronger we are in enforcement, just as 
Chairman Schapiro said, in finding some of those cases that you 
can really bring the wrong-doers to bear is critical to make 
sure that the markets operate better.
    Senator Durbin. What is your recovery rate?
    Mr. Gensler. As I understand it, the collections on the 
large manipulation cases are very high. The collection on the 
Ponzi schemes and fraud cases, unfortunately, is very low 
because so often those individuals behind those cases don't 
have any money, but I believe it's somewhere in the 30 to 40 
percent when you average out high recoveries on complex 
manipulations and low recoveries on these Ponzi schemes.
    Senator Durbin. I'd like your thoughts, and maybe you can 
share them with me in separate communication, about whether the 
current penalty structure is in fact at a level consistent with 
creating a deterrent and what additional remedies or 
instruments you may need for that recovery rate to improve, and 
I understand that, as you said, some recovery is going to be 
extremely difficult.
    But if you would take a step back and look at those two 
aspects, the deterrence and recovery, and give us your thoughts 
on that, I would appreciate that very much.
    Mr. Gensler. We will follow up with you, Mr. Chairman.
    Senator Durbin. Thank you.
    Senator Collins.

                         DERIVATIVES REGULATION

    Senator Collins. Thank you, Mr. Chairman.
    Just two final questions from me. Senator Levin and I have 
introduced a bill that would repeal the language that prohibits 
the Commodity Futures Trading Commission from regulating 
derivatives, and I understand that the administration's new 
proposal would give both the SEC and the CFTC new authority to 
regulate derivatives.
    What are your thoughts on this plan and the role of the 
CFTC in the regulation of derivatives?
    Mr. Gensler. I wish to applaud you and Senator Levin on 
that bill. I believe that we have to have, working with 
Congress, significant amendments to the Commodities and 
Exchange Act and seeking the same goal, to bring all the over-
the-counter derivatives marketplace under regulation.
    I think the Commodity Futures Trading Commission has the 
lead expertise on derivatives. Futures are a form of 
derivatives and these things that are now called over-the-
counter swaps are another form of derivatives.
    Working with Chair Schapiro, I'm hopeful that we can 
present a unified front and, as she said, you know, there's the 
boundary issues are important.
    I think it's critical that we not have any gaps in 
regulation, but we believe at the CFTC and I believe interest 
rate swaps, currency swaps, commodity swaps, equity swaps, 
credit default swaps and any swaps invented in the future that 
are just a blip on the radar need to come under this regulatory 
regime.
    There may be areas where a swap is more security-like, like 
a single issuer credit default swap, where, of course, we need 
multiagency work, insider trading and SEC, you would want very 
much involved in things like that.
    Senator Collins. Actually, I would argue that the credit 
default swaps were more like an insurance product and yet they 
were not regulated by State insurance agencies either.
    Mr. Gensler. They had many insurance attributes. There were 
many lessons, unfortunately, out of this crisis. You were 
earlier asking Chair Schapiro, but I think one of the great 
lessons of AIG was that there was unregulated institutions. 
That's why I am for regulating all derivative dealers, whether 
they're affiliated with banks or not.
    But then these products, as you say, credit default swaps, 
have attributes of insurance, like monoline insurance. They 
have attributes of securities.
    Senator Collins. Exactly.
    Mr. Gensler. They have attributes of derivatives that the 
CFTC is the expert on.
    Senator Collins. Which is why we need this council of 
regulators approach because the problem now is the marketplace 
is always going to be innovating and we want it to be 
innovative and producing new kinds of products and we need a 
system where just because a product is new does not mean that 
it falls into a regulatory black hole and no regulator ends up 
having responsibility and no regulator or regulators is looking 
at the impact across the financial system.
    When you think of a credit default swaps situation, here we 
have a new product that grows into the trillions of dollars, 
jeopardizes the entire financial market, and yet it doesn't 
fall under securities, it doesn't fall under insurance, it 
doesn't fall under the Consumer Product Safety--I mean the 
Commodity Futures Trading Commission. So clearly, we need to 
resolve that.
    Let me just turn to another loophole that our hearings took 
a look at and that's the so-called swaps loophole that allows 
financial institutions to evade position limits on commodity 
contracts that regulators are using to prevent unwarranted 
price swings or attempts at manipulation.
    What should be done to close that loophole?
    Mr. Gensler. I think that explicit authority should be 
given to the Federal regulators, with the CFTC taking the lead 
on position limits, to bring the over-the-counter derivatives 
marketplace under a regulatory regime: that we regulate all of 
the dealers to make sure that they are not manipulating, that 
we're policing fraud, that we're policing position limits, 
aggregate position limits, as I referred to earlier, that we, 
amongst the regulators, have an enormous opportunity to see 100 
percent of the transactions.

                             INTERNATIONAL

    Senator Collins. Finally, do you have sufficient funds to 
pursue your international responsibilities?
    What I'm thinking of is there is a problem with foreign 
exchanges and what rules they're going to play by, particularly 
if they're dealing with U.S. commodities which they are, and 
particularly when they have a presence in the United States.
    I don't know whether that's an issue you've looked at yet, 
but the SEC seems to be far more active in that area than the 
CFTC is.
    Mr. Gensler. Well, Senator, you're right that we've had to 
make as an agency tough trade-offs, an agency that shrunk 20 
percent in the last years, but thankfully with this year we'll 
start to move back.
    There's a small Office of International Effort but it's 
very small, I think four or five people at the CFTC. We do 
share your concern and share the view that we have to make sure 
that foreign boards of trades that are influencing these 
markets and are in our markets have consistent regulation, come 
under the position limits and other authorities here.
    Though the CFTC has moved forward in this regard, we do 
think that it's important to work with Congress to embed in 
statutes some additional authorities with regard to foreign 
boards of trade.
    Senator Collins. Thank you. Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Collins.

                     ADDITIONAL COMMITTEE QUESTIONS

    Chairman Gensler, thanks for your testimony. We're going to 
keep the hearing record open until next Wednesday, June 10, at 
12 noon for subcommittee members to submit statements and/or 
questions, and we ask that the information we requested you do 
your best to comply with at a convenient time.
    [The following questions were not asked at the hearing, but 
were submitted to the Commission for response subsequent to the 
hearing:]
            Questions Submitted by Senator Richard J. Durbin
   most serious management challenges identified by inspector general
    Question. The Reports Consolidation Act of 2000 requires the 
Inspector General to summarize the ``most serious'' management and 
performance challenges facing the Commodity Futures Trading Commission 
(CFTC). In the Inspector General's assessment report of November 14, 
2008, the Inspector General identified two management challenges for 
fiscal year 2009.
    The first concern is with the Modernization of Electronic Market 
Surveillance. The Inspector General explains that while market 
surveillance has always been an integral part of CFTC operations, the 
past years have witnesses the transformation of futures trading from an 
open outcry trading floor based system to an electronic system. In 
fact, in 2008, electronic trading accounted for 84 percent of total 
exchange traded derivatives.
    The second area is the Efficient Acquisition and Integration of 
Skilled Human Capital. The Inspector General cites the fact that recent 
economic turbulence has simulated an interest in applying the 
historically successful centralized clearing mechanism to the bilateral 
and complex swap markets. The Inspector General expressed skepticism 
that the CFTC currently has the human capital to monitor these complex 
markets and that situation may demand review of existing hiring 
procedures.
    Chairman Gensler, have you had an opportunity to review the 
Inspector General's analysis?
    What is your reaction?
    What is your plan for prioritizing these two key items in your 
management agenda?
    Answer. Yes, certainly the need to modernize electronic market 
surveillance will require additional technological capabilities. It is 
also apparent that if the Congress entrusts the Commission with 
significant additional responsibilities, the Commission will need to 
expand its staff and pay particular attention to needed skill sets. The 
Congress provided the Commission with substantial additional funds for 
fiscal year 2009. At this point we have almost completed hiring the new 
staff funded for this year. I asked the staff to provide the following 
information on the modernization of electronic market surveillance:
    In late 2008, the CFTC contracted with the Promontory Group to 
review the market surveillance program. Commission staff is finalizing 
its assessment of the Promontory report and preparing recommendations 
for the Commission. The objective is to ensure that the CFTC has an 
effective approach to surveillance, from both a programmatic and 
operational perspective.
    The CFTC also is in the process of modernizing its trade 
surveillance system in order to perform its statutorily mandated 
oversight functions and to keep pace with the explosive growth in 
electronic trading. In 2007, the CFTC's Division of Market Oversight 
(``DMO'') and Office of Information and Technology Services (``OITS'') 
embarked on a multi-year plan to develop a new trade surveillance 
system (``TSS''), to replace the Commission's antiquated system. TSS is 
designed as a database of exchange data maintained by the Commission 
which can be evaluated with off-the-shelf alert and analysis tools. A 
contract was awarded to Actimize in 2008 to deliver such a product. 
OITS expects to have all of the exchanges connected to the Actimize 
tool by the end of the first quarter 2010.
    A challenge to the Commission in implementing TSS has been a lack 
of data uniformity. To resolve this problem, in May 2007, DMO formed a 
subcommittee through the Joint Compliance Committee to discuss and 
formulate a plan for using ``FIXML'' as a standardized format for trade 
data submitted to the Commission and to formulate a FIXML transition 
plan. In December of 2008, a schedule was presented to all exchanges 
for submission of trade data in FIXML by the end of 2009.
    The Commission has also been working to better link its trade 
surveillance and market surveillance systems. Currently, the Commission 
is unable to connect accounts identified by large traders with their 
intra-day transactions. To resolve this problem, the Commission has 
issued an advanced notice of proposed rulemaking to solicit comments on 
the collection of account ownership and control information from 
exchanges. Such information would be used to improve DMO surveillance 
by serving as an adjunct to the CFTC's ISS (large trader position data) 
and TSS databases.
                adequacy of funding to permit pay parity
    Question. In response to the 1980s banking crisis, Congress passed 
the Financial Institutions Reform, Recovery, and Enforcement Act of 
1989 (FIRREA) (Public Law 101-73) which provided for pay parity among 
federal financial regulatory agencies.
    The Commodity Futures Trading Commission was granted comparable pay 
authority (Public Law 107-171) with other financial agencies to level 
the playing field with a goal of attracting the best and brightest 
talent. Despite the authorization, the CFTC has not been fully funded 
to the level of comparable agencies covered under the law.
    During recent years, the Commodity Futures Trading Commission's 
budget situation has resulted in hiring freezes and has not permitted a 
meaningful review by the IG to determine its effect on employee 
retention and whether new hires are appreciably more experienced or 
better qualified.
    Chairman Gensler, what has been the practical impact of the CFTC's 
not having sufficient annual budget authority to accomplish pay parity 
for your workforce?
    Answer. The Commission is currently near pay parity with the other 
FIRREA agencies with regard to pay, having implemented merit pay and 
new pay ranges. There are several areas where we need to align the 
Commission with the FIRREA agencies; these include personnel benefits 
and possibly some job reclassification.
    The implementation of pay parity without sufficient budget 
authority has had the same practical effect as meeting all other 
resources challenges without sufficient budget authority--the 
Commission froze and/or restricted hiring and deferred investment in 
Information Technology. These steps were taken after exhausting all 
other savings from administrative efficiencies.
    Question. To what extent has the CFTC's inability to compensate 
staff at comparable levels led to departures of experienced personnel 
to positions in other Federal financial regulatory agencies?
    Answer. Since the Commission is currently comparable with other 
FIRREA agencies with regard to pay, and nearly comparable with regard 
to benefits, the Commission is no longer losing, as it once did, a 
significant number of staff to other financial regulatory agencies as a 
result of inadequate compensation. However, those past losses tell us 
it is important that the Commission maintain comparability with these 
agencies.
    Question. What funding level would permit the CFTC to move toward 
providing pay parity?
    Answer. The fiscal year 2010 budget includes approximately $1.4 
million that would permit the Commission increased contribution to 
personnel benefits package thereby making it more comparable to FIRREA 
agencies. Funding would also permit the Commission to reclassify 
selected positions if an ongoing review concludes that is appropriate 
to support parity and to improve recruitment and retention.
    Question. As CFTC Chairman, what are your goals in this area?
    Answer. As a new Chairman I look forward to reviewing the findings 
and recommendations of the Commission Pay Parity Governance Committee 
before advancing any new goals of my own. However, I am committed to 
ensuring that the Commission receives adequate funding to stay 
comparable with our fellow financial regulatory agencies.
    Question. When does the CFTC plan to institute a student loan 
repayment program as a recruitment and retention tool?
    Answer. Our goal is to implement a student loan repayment program 
by the end of the year.
    Question. What resources would that require?
    Answer. We have initially set aside $200,000 for the implementation 
of this program.
                  derivatives market regulatory reform
    Question. Derivatives--contracts between two investors betting on 
whether a stock, bond, or other security will go up or down in value--
has ballooned into the world's largest trading market, estimated to be 
in the tens of trillions of dollars. Much of the activity is not 
currently under a regulatory apparatus.
    This market has also helped catalyze the current economic crisis. 
Losses on one type of derivative known as credit-default swaps helped 
topple American International Group (AIG), prompting a government 
bailout that has grown to $180 billion.
    On May 13, President Obama unveiled a plan to regulate the 
derivatives market. This proposal includes new rules to restrict banks, 
hedge funds, and other investors, and has four goals: (1) force the 
trade of most derivatives through a regulated clearinghouse and require 
traders to report activities and hold a minimal level of capital to 
cover losses; (2) improve oversight by ensuring clearinghouses and 
firms dealing in derivatives provide copious information to regulators 
about their trades; (3) empower regulators to force traders to submit 
detailed information and pursue cases of fraud and manipulation; and 
(4) prevent derivatives from being marketed to groups that may not 
understand their complexities.
    How would expanded derivatives regulation impact the CFTC workload? 
What budgetary considerations need to be considered?
    Answer. We must establish a comprehensive regulatory regime to 
cover the entire over-the-counter derivatives marketplace. This will 
help the American public by: (1) lowering systemic risk; (2) providing 
transparency and efficiency in markets: (3) ensuring market integrity 
by preventing fraud, manipulation, and other abuses; and (4) protecting 
the retail public. I envision this will require two complementary 
regimes--one for regulation of the dealers and one for regulation of 
the market functions.
    The Department of the Treasury, on behalf of the Administration, 
has submitted legislation to Congress to regulate the over-the-counter 
(OTC) markets. Although some improvements are appropriate to ensure 
that we best meet the goals stated above, the Administration's 
comprehensive proposal is consistent with regulatory reforms that the 
CFTC has proposed in testimony to Congress. The Administration's 
proposal will lower risk by requiring capital and margin on dealers and 
mandatory clearing of all standardized products. It will enhance market 
integrity by protecting against fraud, manipulation, and other abuses 
and establishing new authorities to set aggregate position limits. It 
will promote transparency and market efficiency by requiring 
recordkeeping and reporting for all derivatives and requiring that 
standardized derivatives be traded on transparent trading platforms.
    Of course there would be a need for some additional resources at 
the CFTC to handle this expanded regulatory obligation. Until the 
nature and scope of the regulation of OTC derivatives markets is 
determined by the Congress, the resources necessary for implementation 
cannot be predicted with certainty.
    Whatever the cost of regulation, it will pale in comparison to the 
cost of doing nothing. If the current financial crisis has taught us 
anything, it is that that the derivatives trading activities of a 
single firm can threaten the entire financial system. The costs to the 
public from the failure of these firms has been staggering, $180 
billion of American taxpayer financial support for AIG alone. The AIG 
subsidiary that dealt in derivatives was not subject to any effective 
federal regulation.
            memorandum of understanding between cftc and sec
    Question. Last year (March 11, 2008), then-Commodity Futures 
Trading Commission (CFTC) Acting Chairman Walter Lukken and then-
Securities and Exchange Commission (SEC) Chairman Christopher Cox 
entered into a formal ``Memorandum of Understanding'' (MOU) setting 
forth several principles designed to guide inter-agency collaboration. 
The premise of this agreement was to seal some of the regulatory gaps 
and better accommodate new products that blur the lines between the 
futures and the securities worlds.
    The MOU establishes a permanent regulatory liaison between the CFTC 
and SEC; requires quarterly joint meetings of staff; sets up a 
framework for extensive information sharing and exchange confirms 
existing enforcement policies; creates guidelines for new financial 
products that combine elements of securities, futures, or options; and 
addresses jurisdictional overlaps.
    Chairman Gensler, can you describe some of the benefits to the CFTC 
since entering into the MOU with the SEC in March 2008?
    Answer. The MOU has provided a formal mechanism to assure dialogue 
among senior staff of the two agencies regarding the treatment of novel 
derivative products and other issues of mutual regulatory interest. In 
addition, following on the MOU, the CFTC and SEC Divisions of 
Enforcement undertook efforts to improve coordination and cooperation. 
Specifically, in the summer of 2008, the CFTC and SEC Divisions of 
Enforcement appointed senior staff to serve as liaisons for their 
respective agencies, and also established quarterly meetings to discuss 
issues related to investigation and litigation dockets for matters of 
common concern. The enhanced cooperation between the CFTC and SEC 
Divisions of Enforcement is also reflected in the May 2009 joint 
training session for enforcement staff in which experts from both 
agencies discussed strategies regarding the agencies' coordination, 
investigation and prosecution of several recent Ponzi fraud matters.
    Question. What impediments hinder CFTC's ability to oversee and 
regulate new products that have mixed characteristics of futures and 
securities?
    Answer. Neither the CFTC nor the SEC currently has regulatory 
jurisdiction with respect to OTC derivatives transactions, some of 
which are relevant to both the futures and the securities markets. In 
areas where jurisdiction does exist, further enhanced communication 
between the CFTC and SEC staff--specifically, ongoing communications 
regarding whether activity detected by one agency implicates the 
jurisdiction of the other agency--will improve the CFTC's ability to 
oversee and regulate such new products.
    Question. How do intend to collaborate with SEC Chairman Schapiro 
in advancing the goals of this MOU?
    Answer. In addition to direct communications with Chairman 
Schapiro, as we have done in discussing regulatory reform with respect 
to OTC derivatives, I anticipate that Chairman Schapiro and I will 
actively direct and guide our respective staffs to fulfill the 
objectives of the MOU. We will work cooperatively and collaboratively 
to remove unnecessary duplication and other regulatory roadblocks to 
innovative market developments, while assuring that there are no 
regulatory gaps that endanger the public interest. The agencies' focus 
on this goal is currently reflected in our joint harmonization project, 
including the unprecedented joint meetings recently held by our two 
Commissions.
    Question. Do you envision the need for any modifications to the 
agreement to strengthen the current interagency relationship?
    Answer. The MOU was intended to be a ``living'' document. Just as 
the agencies have entered into an Addendum to the MOU with respect to 
novel derivative products, additional Addenda may be considered as the 
agencies address new issues and harmonization on a going-forward basis.
  enforcement actions to preserve market integrity and protect market 
                                 users
    Question. Detecting and deterring against illegitimate market 
forces requires CFTC's steady vigilance and swift response. Over the 
past 8 years, CFTC has assessed over $2 billion in civil penalties 
against perpetrators of various fraud schemes. For instance:
  --To address manipulation, attempted manipulation, and false 
        reporting in the energy arena, the CFTC filed 43 enforcement 
        actions against 73 entities or individuals in the December 2001 
        to September 2008 period resulting in $445.5 million in 
        assessed civil penalties.
  --To address misconduct in connection with commodity pools and hedge 
        funds by unscrupulous and unregistered operators and advisors, 
        from October 2000 and September 2008, the CFTC filed 73 
        enforcement actions against 24 entities, with $564.13 million 
        in penalties assessed.
  --To combat the problem of foreign currency (forex) fraud, between 
        December 2000 and September 2008, on behalf of nearly 26,000 
        affected customers, the CFTC has filed 98 enforcement actions, 
        charging 374 entities or persons, culminating in over $562 
        million in civil monetary penalties and $454 million in 
        restitution.
    How well is the CFTC able to measure the deterrent effect of these 
enforcement actions?
    Answer. Measuring the deterrence effect of enforcement actions 
remains a challenge to the CFTC and other law enforcement agencies. The 
CFTC has undertaken a number of actions to increase deterrence as noted 
below by staff:
  --The CFTC maximizes the deterrent effect of its enforcement program 
        through: the filing of enforcement actions, cooperative 
        enforcement, public outreach and investor education. In cases 
        of ongoing fraud, the CFTC's objective is to bring its 
        enforcement action as quickly as practicable in order to stop 
        the fraud, freeze assets, and preserve books and records. The 
        CFTC also leverages the impact of its enforcement actions by 
        working cooperatively with federal and state criminal and civil 
        authorities who often bring their own actions based upon the 
        conduct that violates the Commodity Exchange Act and CFTC 
        Regulations. Whenever the CFTC files an enforcement action and 
        obtains a final judgment in one of its enforcement actions, it 
        publicizes these events through press releases and media 
        interviews. To alert market users and the public to the dangers 
        of fraud, the CFTC has issued a number of Consumer Advisories 
        warning the investing public of potential risks and scams, and 
        has posted these Advisories on its website. The CFTC also seeks 
        to maximize the deterrent effect of its enforcement program by 
        tracking industry trends. For example, the CFTC's Acting 
        Director of Enforcement gave Congressional testimony in June 
        2009 regarding the observed uptick in fraud involving 
        solicitation of retail customers for purported off-exchange 
        transactions in precious metals, and certain energy and 
        agricultural products. The fraudsters appear to have drafted 
        customer agreements to make them appear to be spot contracts 
        outside of CFTC jurisdiction and not futures contracts covered 
        by the Commodity Exchange Act.
  --The CFTC remains committed to developing improved performance 
        measures to reflect the deterrence effect of its enforcement 
        program. For example, the CFTC has requested funds every year 
        since the fiscal year 2007 OMB budget request thru fiscal year 
        2010, to study the performance measurement issue, however, 
        funds, to date, have not been approved.
    Question. How rapidly are you able to collect restitution, 
disgorgement of ill-gotten gains, and civil monetary penalties imposed 
against violations of the federal commodities laws?
    Answer. When the CFTC files enforcement actions that include 
allegations of fraud, its general practice is to seek a statutory 
restraining order to immediately freeze the defendants' known assets, 
including trading and bank accounts, homes and other real property and 
cars. These assets are then preserved for purposes of customer 
restitution or disgorgement at the conclusion of a successful 
prosecution. The CFTC Division of Enforcement may also request that the 
federal district court order defendants to make an accounting, which 
assists the CFTC in tracking money flows and identifying additional 
assets for recovery. The CFTC also names as relief defendants in its 
enforcement actions persons known to have received funds derived from 
the fraud and to which they have no legitimate claim, and seeks to 
freeze and recover these funds for return to customers as well. At the 
conclusion of litigation, and in the event of a remaining judgment, the 
Commission follows an established protocol to ensure that matters are 
appropriately referred to the Department of Justice and Department of 
the Treasury for collection.
    Question. What is the annual recovery rate?
    Answer. Staff has supplied the following information:
    Below is a table that sets out the CFTC's annual recovery rate for 
civil monetary penalties assessed for fiscal years 1992 through 2008.

                      CIVIL MONETARY PENALTIES \1\
                   [Fiscal year 1992-fiscal year 2008]
------------------------------------------------------------------------
                                           Penalties        Penalties
              Fiscal year                   imposed         collected
------------------------------------------------------------------------
1992..................................       $3,207,277       $2,285,664
1993..................................        3,313,100        3,514,715
1994..................................        4,112,407        3,134,266
1995..................................       11,201,100        9,430,239
1996..................................        1,335,000        1,526,000
1997..................................        4,532,000        1,752,636
1998..................................      132,623,756      125,803,781
1999..................................       85,863,311       22,165,368
2000..................................      179,811,562        3,299,362
2001..................................       16,876,335        3,170,252
2002..................................        9,942,382        5,922,387
2003..................................      110,264,932       87,699,077
2004..................................      302,049,939      122,468,925
2005..................................       76,672,758       34,163,077
2006..................................      192,921,794       12,364,509
2007..................................      345,614,139       12,137,848
2008..................................      234,835,121     140,745,252
------------------------------------------------------------------------
\1\ The discrepancy between the amount of civil penalties imposed and
  the amount collected is accounted for by the following factors: (1)
  when courts order the defendants to both pay restitution to victims
  and a civil monetary penalty to the Government, established Commission
  policy directs available funds to satisfy restitution obligations
  first; (2) in fraud actions, it is not uncommon that the proceeds of
  the fraud have been dissipated and/or that the penalty far exceeds the
  defendants' represented financial ability to pay; (3) delinquencies
  assessed in default proceedings against respondents who are no longer
  in business and who cannot be located or are incarcerated; (4)
  penalties imposed in one year may not become due and payable until the
  next year; (5) a penalty may be stayed by appeal; (6) some penalties
  call for installment payments that may span more than 1 year; (7)
  penalties have been referred to the Attorney General for collection;
  and (8) collection may still be in process.

    Question. What has been the impact of more sophisticated 
information technology to monitor and detect fraud more readily?
    Answer. In the enforcement arena for fraud cases, information 
technology assists in asset tracing, account reconstruction, and 
electronic data recovery of financial records. Improvements in 
information technology have improved the CFTC's search capability for 
evidence of illegal activity involving Internet websites, instant 
messages, e-mail and audio.
    In the regulatory arena, as discussed above, the CFTC is currently 
implementing its new trade practice surveillance system (TSS). TSS is 
designed as a database of exchange trade data maintained by the 
Commission upon which off-the-shelf alert and analysis tools can be 
connected. A contract was awarded to Actimize in 2008 to deliver an 
alert and analysis tool that has the capability to perform 
sophisticated pattern recognition and data mining to automate basic 
trade practice surveillance, and to detect novel and complex abusive 
practices. TSS also will fill a vacuum in inter-market surveillance 
which only the Commission can address, e.g., where NYMEX and NYSE Liffe 
both list metals contracts.
    Question. Are there any statutory or administrative impediments 
that prevent the CFTC from doing more to combat fraud?
    Answer. As noted above, the CFTC has observed an upswing in retail 
customer complaints regarding potential fraud involving off-exchange 
transactions in precious metals, energy products and agricultural 
commodities. It appears that fraudsters are drawing upon the adverse 
precedent of a line of cases under CFTC v. Zelener, 373 F.3d 861 (7th 
Cir. 2004), in which the Seventh Circuit held that certain contracts 
were spot transactions beyond the jurisdiction of the CFTC. Congress 
addressed this problem in the CFTC Reauthorization legislation included 
in the 2008 Farm Bill with respect to Zelener-type foreign currency 
transactions. A similar fix is needed if the CFTC is to effectively 
prosecute boiler rooms offering Zelener-type contracts in metal, 
energy, and other commodity contracts to retail customers (and is 
included in the Administration's proposed OTC derivatives reform 
legislation).
    In addition, in the wake of the decision in CFTC v. Wilshire, 531 
F.3d 1339 (11th Cir. 2008), defendants in fraud cases increasingly are 
asserting that federal courts lack authority under the Commodity 
Exchange Act to award restitution based on customer losses suffered as 
a result of the fraud. Wilshire held that the proper measure of 
restitution is the gain to the wrongdoer, rather than the losses 
suffered by customers. In cases where the fraudster retains only a 
small portion of the monies fraudulently induced from customers, this 
limit on restitution threatens the CFTC's ability to obtain make-whole 
relief for defrauded customers.
    Staff advises that additional statutory measures that may increase 
the CFTC's ability to combat fraud include, among others, the 
following:
  --Amendment of the Privacy Act to clarify that CFTC investigators may 
        seek promotional material and verbal sales solicitations 
        without identifying themselves as CFTC employees or providing 
        personal information as to their true identity.
  --In Section 4n of the Commodity Exchange Act, provide authority to 
        require accountants to maintain records of audit activity 
        concerning commodity pools that would be available for 
        inspection by the CFTC.
  --Clarify that the CFTC need not show criminal intent in actions 
        based on conversion under Section 9(a)(1) of the Commodity 
        Exchange Act.
    Question. Is the current penalty structure designed to serve as an 
effective deterrent?
    Answer. Yes. Commission staff supplies the following background:
  --Section 6(e) of the Act, 7 U.S.C.  13a-1(d), instructs the 
        Commission to impose a civil monetary penalty that is 
        appropriate to the gravity of the violation. Commission 
        precedent has long recognized the importance of deterrence in 
        preventing violations, most recently in In re DiPlacido 
        [Current Transfer Binder] Comm. Fut. L. Rep. (CCH)  30,970 
        (CFTC Nov. 5, 2008) (``[g]iven the gravity of DiPlacido's 
        offenses and potential maximum fine, the focus of the 
        Commission's analysis shifts to assessing a specific penalty 
        appropriate to the level of gravity and suitable to deter 
        future violations''). Indeed, the Commission signaled the 
        paramount role that deterrence plays when it emphasized that 
        ``[i]n imposing monetary sanctions, the primary focus of the 
        Commission's analysis has been deterrence.'' In re Murlas, 
        [1987-1990 Transfer Binder] Comm. Fut. L. Rep. (CCH)  24,440 
        at 35,929 (CFTC Apr. 24, 1989) (emphasis added).
  --Also, in last year's CFTC Reauthorization legislation, Congress 
        increased the maximum civil monetary penalty for manipulation, 
        attempted manipulation, and false reporting to $1 million per 
        violation. See Title XIII of the Food, Conservation and Energy 
        Act of 2008, Pub. L. No. 110-246, 122 Stat. 1624 (June 18, 
        2008); 7 U.S.C.  13(a).
    Question. What additional remedies or authorities might be useful 
to boost your recovery rate?
    Answer. Staff has advised that additional statutory measures that 
could potentially boost the CFTC's recovery rate include, among others, 
the following:
  --Similar to provision for non-payment of penalties imposed in CFTC 
        administrative enforcement actions (see Section 6(e)(2) of the 
        Commodity Exchange Act), provide that a defendant's non-payment 
        of civil monetary penalties imposed in enforcement actions in 
        federal court shall result in the non-paying defendant 
        automatically being prohibited from trading and automatically 
        suspending any applicable registration until the defendant pays 
        the full amount of the penalty, with interest to the date of 
        the payment.
  --Provide that collection of judgments and orders in fraud actions 
        shall not be subject to State homestead exemptions or other 
        State or local impediments to collection.
  --Provide that disgorgement and restitution awarded in CFTC 
        enforcement actions are non-dischargeable in bankruptcy.
  --Add disgorgement as an available sanction in administrative 
        enforcement proceedings.
                  performance goals/measuring outcomes
    Question. The Commodity Futures Trading Commission (CFTC)'s 
performance-based budget for fiscal year 2010 delineates four specific 
goals tied to the agency's overall mission. For each of the goals, 
several outcomes are specified.
    First Goal.--Of the $160.6 million in appropriations requested for 
fiscal year 2010, the CFTC would designate $48.2 million (or 30 percent 
of the total funding) and 185 FTE to meet the first goal--to ensure the 
economic vitality of commodity futures and options markets.
    The outcomes to be achieved as a result of the investment made 
related to this goal are markets that accurately reflect the forces of 
supply and demand for the underlying commodity, are free of disruptive 
activity, and are effectively and efficiently monitored to ensure early 
warning of potential problems or issues.
    How does (or will) the CFTC measure whether and how well these 
outcomes are achieved?
    Answer. The Commission has developed nine performance measures 
intended to measure progress in achieving the stated outcome objective. 
The performance results along with an annual performance analysis and 
review are included in pages 46-55 of the Fiscal Year 2008 Performance 
and Accountability Report available on the CFTC website at: 
www.cftc.gov/aboutthecftc/cftcreports.
    Question. How does the CFTC intend to meet a performance goal of 
``no price manipulations or other disruptive activities that would 
cause loss of confidence or negatively affect price discovery or risk 
shifting''?
    Answer. This goal is fundamentally tied to the Commission's mission 
and is a priority of the Commission market surveillance and enforcement 
efforts as noted by staff below:
  --Continuous monitoring of market activity is the principal way the 
        Commission seeks to protect the economic function of the 
        markets. Effective market surveillance requires sufficient 
        staff with expertise in each of the diverse markets under the 
        Commission's jurisdiction. The Commission takes preventive 
        measures to ensure that market prices accurately reflect 
        fundamental supply and demand conditions, including the routine 
        daily monitoring of large trader positions, futures and cash 
        prices, price relationships, and supply and demand factors in 
        order to detect threats of price manipulation.
  --As discussed above, the CFTC maximizes the deterrent effect of its 
        enforcement program through: the filing of enforcement actions, 
        cooperative enforcement, public outreach and investor 
        education. The CFTC also leverages the deterrent impact of its 
        enforcement actions by working cooperatively with other federal 
        criminal authorities who often bring their own actions based 
        upon the conduct that violates the Act and CFTC Regulations.
    Question. When it comes to a performance goal of ``improving 
effectiveness and efficiency of market surveillance'' what indicators 
will be used to determine if you have indeed reached this goal and how 
well? What is the baseline from which progress is to be measured?
    Answer. A strategic priority of the Commission is to enhance the 
Commission's technological capability, improve data standards, and 
enhance in-house human analytical and decisionmaking capability--each 
in order to recognize, understand and adapt to market changes early on. 
Indicators of success will be progress in achieving the following 
tasks: upgrading ISS to get more timely market position information and 
to integrate trading data with position data; developing capability to 
provide real-time margin and settlement information; promoting data 
standards throughout the industry; developing and implementing 
sophisticated trade surveillance systems; developing automated 
capability to analyze and integrate off-exchange data as it relates to 
surveillance and investigations; developing a recruitment plan to 
address required skills; identifying needed competencies and developing 
a training plan that empowers employees to react quickly in 
understanding and resolving regulatory matters. Each of these tasks 
represents a strategic need of the Commission that is not currently 
being met adequately.
    Question. Second Goal.--Of the $160.6 million in appropriations 
requested for fiscal year 2010, the CFTC would designate $42.9 million 
(or 27 percent of the total funding) and 160 FTE to meet the second 
goal--to protect market users and the public. The three outcomes to be 
achieved as a result of the investment made related to this goal are 
better detection and prevention of violations of commodities laws, high 
standards for professionals, and expeditions handling of customer 
complaints.
    How does the CFTC plan to increase the probability of violators 
being detected and sanctioned?
    Is this readily measurable?
    What is the baseline against which future performance will be 
gauged?
    Answer. Having sufficient resources to pursue violations is key to 
increasing the probability of violators being detected and sanctions. 
The Commission has developed four performance measures to assess 
progress in detecting violators. The performance results along with an 
annual performance analysis and review are included in pages 58-63 of 
the Fiscal Year 2008 Performance and Accountability Report available of 
the CFTC Web-site at: www.cftc.gov/aboutthecftc/cftcreports.
    Like all enforcement programs, we face a challenge in establishing 
overall performance measures that indicate the percentage of violative 
activity deterred, since no way has yet been devised to measure the 
total universe of violative activity that exists. The Commission keeps 
extensive records on the number of investigations opened and cases 
filed during the year, the number and amount of sanctions obtained, as 
well as the number of cases filed by criminal and civil law enforcement 
authorities that included cooperative assistance from the Commission. 
However, these statistics do not measure complexity of the matters 
opened and filed. For example, the Commission met its performance 
target in fiscal year 2008 with regard to the number of enforcement 
investigations opened. However, commencing in 2002, the complexity of 
Commission investigations has increased substantially over prior years 
(including the Commission's investigation of alleged energy market 
manipulation). As a result of these investigations, the complexity of 
the Commission's cases filed and litigated also has increased 
substantially since 2002. The Commission's performance target tries to 
take into account both of these factors but they cannot be predicated 
with precision.
    Question. How will the CFTC ensure there are ``zero unregistered, 
untested, or unlicensed commodity professionals (unless they are exempt 
from registration)''?
    Answer. There are several complementary aspects to the Commission's 
program that ensure compliance with registration requirements as 
summarized by staff below:
  --Registration and NFA Membership.--Under Section 17 of the Commodity 
        Exchange Act (``CEA''), the National Futures Association 
        (``NFA'') performs registration functions on behalf of the 
        CFTC. NFA registers members through its Online Registration 
        System (``ORS'') a web-based registration and membership filing 
        and processing system. With certain exceptions, all persons and 
        organizations that intend to do business as futures 
        professionals must register under the CEA. The primary purposes 
        of registration are to screen an applicant's fitness to engage 
        in business as a futures professional and to identify those 
        individuals and organizations whose activities are subject to 
        federal regulation.
      In addition, all individuals and firms that wish to conduct 
        futures-related business with the public must apply for NFA 
        membership or associate status. Mandatory membership serves an 
        important function: NFA Bylaw 1101 prohibits members from 
        conducting customer business with non-NFA members.
  --Testing.--Individuals who are applying for NFA membership as a sole 
        proprietor FCM, IB, CPO, CTA or for registration as an AP of 
        any of these categories must satisfy proficiency requirements. 
        Applicants generally must have passed the National Commodity 
        Futures Examination (NCFE or Series 3) within the 2 years 
        preceding their application.
  --Ethics Training.--The CFTC Statement of Acceptable Practices (see 
        Appendix B to Part 3 of the Commission's regulations) for 
        ethics training allows flexibility, permitting firms to tailor 
        their training programs to best suit their particular 
        operations. In an Interpretive Notice to its Compliance Rule 2-
        9, NFA states that good business practice dictates that 
        employees receive periodic training to keep them cognizant of 
        new developments in technology, commercial practices and 
        regulations, and their ethical implications.
  --Oversight.--NFA conducts ongoing audits of its registrants for 
        compliance with NFA rules. In turn, Commission staff pursues 
        formal and ongoing oversight of NFA's compliance and 
        registration programs. Formal oversight activities involve 
        periodic reviews of NFA programs and inspection of records and 
        interviews with NFA staff.
      NFA pursues statutory disqualification and other disciplinary 
        matters through Registration, Compliance & Legal Committee 
        (``RCLC'') cases. On a quarterly basis, Commission staff meets 
        with NFA to provide guidance on registration issues generally, 
        and to review the past quarter's RCLC cases.
    These oversight activities are designed to protect market 
participants and the public interest by ensuring that persons who deal 
with customers and those who handle customer orders and funds meet the 
standards for fitness and integrity established under the Commodity 
Exchange Act.
    Question. What type of tracking system is in place to demonstrate 
that this outcome has been achieved?
    Answer. Currently, there are more than 67,000 individuals and 
companies registered with the CFTC in some capacity. Although it would 
be impossible to track the negative (i.e., that there are unregistered 
individuals conducting business), through its oversight of NFA's 
registration program, the Commission ensures both that qualified 
applicants are properly registered, and that unqualified applicants (or 
registrants) are denied registration (or have their registration 
revoked). Through the quarterly meetings of the Registration Working 
Group involving CFTC and NFA staff, the Commission ensures that 
standards for such actions are applied consistently, and gives guidance 
when questions arise.
    Question. With regard to meeting timeframes for resolution of 
customer complaints, how does the CFTC track disposition of complaints, 
proceedings, and appeals in order to show that the targets are achieved 
in the caseload?
    Answer. The various Divisions at the CFTC (Enforcement, Clearing 
and Intermediary Oversight, Market Oversight, and General Counsel's 
Office) each operate an ``officer of the day program'' to receive, and 
address or refer, inquiries (including complaints) from members of the 
public. The Office of Proceedings handles and tracks the disposition of 
adjudicatory matters at the hearing level. With respect to adjudicatory 
appeals to the Commission, pending cases are maintained with the 
Secretariat, with monthly status reports issued by the Office of 
General Counsel.
    Question. Third Goal.--Of the $160.6 million in appropriations 
requested for fiscal year 2010, the CFTC would designate $38 million 
(or 24 percent of the total funding) and 144 FTE to meet the third 
goal--to ensure market integrity in order to foster open, competitive, 
and financially sound markets
    The outcomes to be achieved as a result of the investment made 
related to this goal are that clearing organizations and firms holding 
customer funds have sound financial practices, commodity futures and 
options markets are effectively self-regulated, markets are free of 
trade practice abuses, and the regulatory environment is flexible and 
responsive to evolving market conditions.
    How will the CFTC work to ensure zero loss of customer funds as a 
result of firms' failure to adhere to regulations and ensure that no 
customers are prevented from transferring funds from failing firms to 
sound firms?
    What mechanisms does the CFTC have to monitor self-regulatory 
organizations to ensure that no funds are lost as a result of the 
failure of SRPs to comply with their rules?
    Answer. Again, the Commission has several complementary programs 
that address the protection of customer funds held by FCMs) and 
derivatives clearing organizations (``DCOs''). They are summarized by 
staff below:
  --Protection of Customer Funds--Statute and Regulations.--The 
        Commodity Exchange Act and Commission regulations require each 
        FCM to segregate from its own assets all money, securities or 
        property deposited by customers to margin or secure futures and 
        option on futures positions traded on designated contract 
        markets or funds that accrue to customers from these open 
        positions. Each FCM also must set aside in accounts (i.e., 
        ``secured accounts''), separate from its proprietary accounts, 
        sufficient funds deposited by customers trading on non-United 
        States futures markets to meet its obligations to customers 
        trading on foreign markets.
  --Notification.--Commission regulations also require each FCM to 
        perform daily calculations demonstrating compliance with the 
        segregation and secured amount requirements. Any FCM that does 
        not maintain sufficient funds in segregated accounts or in 
        secured accounts, as applicable, to meet its obligations to its 
        customers (i.e., is ``under segregated'') is required to 
        provide immediate telephone notice, confirmed immediately in 
        writing, to the Commission and to the FCM's self-regulatory 
        organization (``SRO'') that conducts financial surveillance 
        over the firm.
  --Commission and SRO Responsive Action (Direct Examinations).--Upon 
        receipt of a notice, Commission staff work with the applicable 
        SRO to determine the facts and to assess whether the situation 
        is a temporary under segregation that can be immediately 
        rectified by the FCM infusing additional funds into segregated 
        or secured accounts, or indicative of a more serious issue that 
        may require prompt SRO or Commission action to protect customer 
        funds. In certain situations, Commission and/or SRO staff may 
        conduct an immediate onsite examination of the firm's books and 
        records to assess the FCM's compliance with its financial 
        requirements.
  --SRO Oversight.--The Commission conducts periodic reviews of SROs' 
        financial surveillance programs. The SROs' financial 
        surveillance programs include routine examinations of FCMs to 
        assess their compliance with Commission and SRO minimum 
        financial requirements and related reporting requirements, 
        including minimum capital requirements and compliance with the 
        segregation and secured amount requirements. The Commission and 
        SROs also may conduct an examination of an FCM on an exigent 
        basis in response to an FCM filing a notice that it is not in 
        compliance with the customer funds segregation or secured 
        amount requirements. Experience has demonstrated that if the 
        Commission and SROs can react promptly at the initial signs of 
        weakness in the financial condition of an FCM, it is more 
        certain that customer funds will be protected. In this regard, 
        open futures and options on futures positions may be 
        expeditiously transferred to another FCM if the FCM that is 
        experiencing financial difficulties has properly segregated and 
        secured customer funds.
  --Communication With SROs.--Commission staff hold periodic meetings 
        with the financial surveillance staff of the SROs for the 
        purpose of discussing emerging issues and to coordinate 
        examination procedures and policies. This includes an annual 
        review of the detailed SRO audit programs, which are submitted 
        to the Commission for review.
      The resources requested by the Commission for the protection of 
        customer funds would allow Commission staff to conduct more 
        frequent assessment of the SROs' execution of their financial 
        surveillance programs. Additional resources would also allow 
        the Commission to conduct more frequent direct examinations of 
        FCMs for compliance with financial and other requirements, 
        including the segregation of customer funds.
  --Risk Surveillance Program.--The Commission's risk surveillance and 
        DCO review programs also serve to protect customer funds by (i) 
        identifying traders that pose risks to firms and firms that 
        pose risks to DCOs, and (ii) taking steps to mitigate those 
        risks thereby decreasing the likelihood of default. Additional 
        resources would allow the Commission to enhance these programs.
    Question. What are the advantages and disadvantages of ``regulatory 
restructuring'' from the perspective of the CFTC?
    Answer. Exchange traded futures and options contracts are 
derivatives relied upon by the nation's businesses for price discovery 
and risk management. The CFTC's mission is to protect market users and 
the public from fraud, manipulation, and abusive practices related to 
the sale of commodity and financial futures and options, and to foster 
open, competitive, and financially sound futures and option markets. 
Like exchange traded futures, OTC swaps and similar transactions are 
derivatives. Like futures, OTC derivatives are used for risk shifting 
purposes. In recent years the OTC market has grown to far exceed the 
exchange traded market in size. Bringing OTC dealers and markets under 
CFTC regulatory oversight will greatly enhance the ability of the 
Commission to fulfill its mission and to protect the price discovery 
and risk shifting functions of derivatives markets. Additionally, 
bringing the OTC dealers and markets under federal regulation will 
significantly improve financial integrity and transparency, qualities 
that were lacking in the collapse of firms like AIG and Lehman 
Brothers.
    Question. Fourth Goal.--Of the $160.6 million in appropriations 
requested for fiscal year 2010, the CFTC would designate $31.5 million 
(or 19 percent of the total funding) and 121 FTE to meet the first 
goal--to facilitate agency performance through organizational and 
managerial excellence, efficient use of resources, and effective 
mission support.
    Among the outcomes to be achieved as a result of the investment 
made related to this goal are a productive, technically competent, 
competitively compensated and diverse workforce, a modern and secure 
information system, and an organizational infrastructure that 
effectively and efficiently responds to and anticipates both the 
routine and emergency business needs of the agency.
    How does the CFTC intend to measure progress and the extent to 
which these outcomes have been achieved?
    Answer. The Commission has developed 18 performance measures 
intended to measure progress in achieving the stated outcome objective. 
Of the 18 measures 11 results were determined to be effective, one was 
determined to be moderately effective, and six were determined to be 
adequate. The performance results along with an annual performance 
analysis and review are included in pages 91-110 of the Fiscal Year 
2008 Performance and Accountability Report available of the CFTC Web-
site at: www.cftc.gov/aboutthecftc/cftcreports.
                                 ______
                                 
              Question Submitted by Senator Susan Collins
    Question. Excessive speculation in the commodities market is 
prohibited under CFTC's statutes. However, determining what constitutes 
excessive speculation is a thorny question. Last year, as oil and other 
commodities skyrocketed on the futures market, many in Congress became 
concerned that these market prices were more reflective of the activity 
of speculators than commercial interests in the underlying product. 
Last year, under the leadership of Chairman Lukken, the CFTC stated 
that despite the rapid increase in prices, the data did not reflect 
manipulation by speculators. Critics, however, contend that in this 
arena, the CFTC is simply outmatched. It lacks the manpower and 
resources to effectively collect the large volume of data in the 
commodities markets and to effectively analyze that data. Do you 
believe the CFTC needs more resources to gather relevant data and 
effectively analyze it to better understand the role and the effects of 
speculators?
    Answer. The Commission examines markets by studying the behavior of 
commercial and non-commercial traders. In determining the status of 
traders, the Commission has traditionally accepted their self-
classification. The Commission has begun to examine trader patterns to 
ascertain the general accuracy of these classifications. Commission 
assessments of the self-classifications are staff intensive and in 
order to accomplish them expeditiously and on a sustained basis, 
additional resources will be required.
    On another front the Commission relies on market positions 
information that is updated daily. Without intraday position 
information, the Commission cannot examine any price effect occurring 
on the same day as a position change. This problem could be addressed 
were position information available throughout the trading day. 
Obtaining and processing such information will require additional 
resources for both staff and data processing capacity.

                          SUBCOMMITTEE RECESS

    Senator Durbin. Thank you very much for coming in.
    Mr. Gensler. Thank you, Mr. Chairman, Ranking Member 
Collins. Thank you so much.
    Senator Durbin. Thank you very much.
    The subcommittee hearing is hereby recessed.
    [Whereupon, at 12:27 p.m., Tuesday, June 2, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
