    [Senate Hearing 112-238]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 112-238

            ENHANCED INVESTOR PROTECTION AFTER THE FINANCIAL CRISIS

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

                                    HEARING

                                   before the

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

                          ONE HUNDRED TWELFTH CONGRESS

                                 FIRST SESSION

                                       ON

      SURVEYING THE INVESTOR PROTECTION PROVISIONS CONTAINED IN THE DODD-
    FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT ONE YEAR AFTER ITS
                                 IMPLEMENTATION

                                   __________

                                 JULY 12, 2011

                                   __________

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

                     Available at: http: //www.fdsys.gov /

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      TIM JOHNSON, South Dakota, Chairman

    JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
    CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
    ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
    DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
    SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
    JON TESTER, Montana                  MIKE JOHANNS, Nebraska
    HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
    MARK R. WARNER, Virginia             MARK KIRK, Illinois
    JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
    MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
    KAY HAGAN, North Carolina

                         Dwight Fettig, Staff Director

                  William D. Duhnke, Republican Staff Director

                           Charles Yi, Chief Counsel

                         Dean Shahinian, Senior Counsel

                         Laura Swanson, Policy Director

                     Levon Bagramian, Legislative Assistant

                     Andrew Olmem, Republican Chief Counsel

                    Hester Peirce, Republican Senior Counsel

                  Michael Piwowar, Republican Senior Economist

                           Dawn Ratliff, Chief Clerk

                         William Fields, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)

                                C O N T E N T S

                                  ----------

                             TUESDAY, JULY 12, 2011

                                                                       Page

    Opening statement of Chairman Johnson............................     1

    Opening statements, comments, or prepared statements of:
        Senator Shelby...............................................     2

                                   WITNESSES

    David Massey, NASAA President and North Carolina Deputy
      Securities Administrator.......................................     3
        Prepared statement...........................................    33
        Response to written questions of:
            Senator Moran............................................    85
    Lynnette Hotchkiss, Executive Director, Municipal Securities
      Rulemaking Board...............................................     5
        Prepared statement...........................................    37
        Response to written questions of:
            Senator Reed.............................................    87
    Harvey L. Pitt, Former Chairman, Securities and Exchange
      Commission.....................................................     6
        Prepared Statement...........................................    48
    Barbara Roper, Director of Investor Protection, Consumer
      Federation of America..........................................     9
        Prepared Statement...........................................    55
        Response to written questions of:
            Senator Reed.............................................    89
            Senator Menendez.........................................    92
    Anne Simpson, Senior Portfolio Manager, Global Equities,
      California Public Employees' Retirement System.................    10
        Prepared Statement...........................................    66
        Response to written questions of:
            Senator Shelby...........................................    93
            Senator Hagan............................................    94
    Paul S. Atkins, Visiting Scholar, American Enterprise Institute
      for Public Policy Research.....................................    12
        Prepared Statement...........................................    71
        Response to written question of:
            Chairman Johnson.........................................    94
    Lynn E. Turner, Former Chief Accountant, Securities and Exchange
      Commission.....................................................    14
        Prepared Statement...........................................    78

                  Additional Material Supplied for the Record

    Prepared statement of the American Bankers Association, the
      Financial Services Roundtable, Financial Services Institute,
      Insured Retirement Institute, and National Association of
      Insurance and Financial Advisors...............................    97
    Prepared statement of the Center on Executive Compensation.......   111

            ENHANCED INVESTOR PROTECTION AFTER THE FINANCIAL CRISIS

                                  ----------

                             TUESDAY, JULY 12, 2011

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 10:02 a.m. in room SD-538, Dirksen
    Senate Office Building, Hon. Tim Johnson, Chairman of the
    Committee, presiding.

               OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

        Chairman Johnson. The Committee will come to order.
        Today, the Committee will examine ``Enhanced Investor
    Protection After the Financial Crisis.'' This hearing will
    survey the investor protection provisions contained in the
    Dodd-Frank Wall Street Reform and Consumer Protection Act as we
    approach its 1-year anniversary.
        About one-half of American households are invested in the
    securities markets, directly or indirectly. During the
    financial crisis, retail as well as institutional investors
    suffered financial harm when their retirement and other
    securities accounts lost value. Some had invested in companies
    with compensation systems that encouraged executives to take on
    unmanageable risks. Some had bought asset-backed securities
    based on inflated credit ratings. Many were victims of the
    market decline when the public lost confidence in the markets
    and their regulators.
        This last financial crisis highlighted the need for
    stronger investor protections to mitigate the negative impact
    of future crises.
        Congress responded by passing the Wall Street Reform Act,
    which contains robust investor protection provisions and other
    new reforms. These provisions sought to strengthen the
    financial system by improving the accuracy of credit ratings,
    better aligning the economic interests of securitizers and
    investors, boosting the effectiveness of the SEC, giving
    shareholders a greater voice over compensation, regulating
    municipal advisors and hedge fund advisors, and encouraging
    credible whistleblowers to come forward and report fraud and
    abuse by providing them enhanced protections and incentives.
        As we approach this 1-year anniversary, it is timely for us
    to survey investor protection provisions in the Wall Street
    Reform Act, many of which are still in the process of being
    finalized. While some have criticized reforming Wall Street, I
    believe we must give these provisions a chance to work to
    protect investors and American families who depend on our
    financial system.
        I remember the economic nightmare we lived though 3 years
    ago and am proud that the Senate could act to pass these
    historic reforms last year. I take my responsibility as
    Chairman of the Banking Committee to oversee implementation of
    this new law seriously and look forward to hearing from the
    witnesses about these investor protections.
        Now I will turn to Ranking Member Shelby.

                 STATEMENT OF SENATOR RICHARD C. SHELBY

        Senator Shelby. Thank you, Mr. Chairman. Thank you for
    calling this hearing.
        Mr. Chairman, I noted with interest we have the former
    Chairman, Mr. Harvey Pitt, among the panelists--all of them are
    welcome--and also Paul Atkins, former Commissioner. A good
    panel.
        The title of today's hearing is ``Enhanced Investor
    Protection After the Financial Crisis.'' The reality, however,
    is that the passage of Dodd-Frank did little to improve
    investor protection. Instead, the act codifies a series of
    special interest provisions of questionable value to the
    average investor. In fact, several of these provisions threaten
    to harm investors.
        For example, under the proxy access provision, the SEC
    adopted a rule that would grant shareholders with a mere 3
    percent of a company's shares the special right to have their
    board of director nominees include in a company's proxy
    material. Three percent.
        Special interest groups, like unions, State pension funds,
    and hedge funds will now have the leverage to force companies
    to adopt politically motivated agendas, regardless of whether
    doing so would benefit all shareholders.
        As a result, Dodd-Frank's corporate governance provisions
    could move control of corporations away from average investors
    to special interests with minority positions and political
    clout.
        Another troubling Dodd-Frank provision is that the mandate
    that the SEC pay whistleblowers. Although encouraging people to
    inform the SEC of corporate misdeeds I believe is a good idea,
    the whistleblower provision in Dodd-Frank is drafted in a way
    that could actually harm investors. Whistleblowers, even those
    who are part of the scheme, will receive 10 to 30 percent of
    fines that the SEC collects as a result of their tips. Rewards
    in a single case could run into tens of millions of dollars.
    This will be a huge windfall for whistleblowers and their
    attorneys. It would also be far in excess of the amount needed,
    I believe, to encourage whistleblowers.
        Recent history has demonstrated that the problem has not
    been a lack of tips but, rather, the SEC's failure to follow up
    on tips. Perhaps the millions that will go to whistleblowers
    under Dodd-Frank should be redirected to harmed investors.
        Finally, the Dodd-Frank's mandated internal changes at the
    SEC I believe are symbolic of the Act's empty promise of
    investor protection. Dodd-Frank requires the SEC to set up an
    Office of Investor Advocate and an Ombudsman for that office.
        Think about it. The SEC is supposed to be the investor's
    advocate already and has an Office of Investor Education and
    Advocacy. Adding another two layers of bureaucracy I believe is
    not the kind of help that investors need.
        It is now 1 year since the passage of Dodd-Frank, and we
    can see more clearly the consequences of a special interest
    agenda. The Act, I believe, again, has not helped investors but
    has saddled Main Street and providers of capital--the engines
    of economic growth, in other words--with a long list of new
    regulatory requirements and more to come. At a time when the
    unemployment rate is at 9.2 percent, this hardly seems like a
    wise course to me.
        Thank you, Mr. Chairman.
        Chairman Johnson. Are there any other Members who wish to
    speak? If not, we are fortunate to have a distinguished panel
    of regulators and experts before the Committee today.
        Mr. David Massey is the President of the North American
    Securities Administrators Association. Mr. Massey is also the
    Deputy Securities Administrator of North Carolina Securities
    Division and serves as a member of the Financial Stability
    Oversight Council.
        Ms. Lynnette Hotchkiss is the Executive Director of the
    Malpractice Securities Rulemaking Board, a self-regulatory
    organization whose mission is to promote a fair and efficient
    municipal securities market.
        Mr. Harvey Pitt is currently the Chief Executive Officer of
    the consulting firm Kalorama Partners. Previously he served as
    the Chairman of the SEC from 2001 to 2003.
        Ms. Barbara Roper is the Director of Investor Protection at
    the Consumer Federation of America and has in the past served
    as a member of the Investor Advisory Committee at the SEC.
        Ms. Anne Simpson is Senior Portfolio Manager at the
    California Public Employees' Retirement System, where she heads
    the corporate governance program.
        Mr. Paul Atkins is a Visiting Fellow at the American
    Enterprise Institute. From 2002 to 2008 he served as a
    Commissioner at the SEC.
        Our final witness is Mr. Lynn Turner. In addition to his
    decades of experience in the accounting field, from 1998 to
    2001 he served as the Chief Accountant at the SEC.
        I would like to welcome our witnesses and thank them for
    their willingness to testify at this important hearing.
        Mr. Massey, please proceed with your testimony.

     STATEMENT OF DAVID MASSEY, NASAA PRESIDENT AND NORTH CAROLINA
                    DEPUTY SECURITIES ADMINISTRATOR

        Mr. Massey. Good morning, Chairman Johnson, Ranking Member
    Shelby, and Members of the Committee. I am David Massey, the
    Deputy Securities Administrator for the State of North Carolina
    and the current President of the North American Securities
    Administrators Association, known as NASAA. Thank you for the
    opportunity to offer NASAA's view of the gains made in investor
    protection since the passage of the Dodd-Frank Act 1 year ago.
        The Wall Street reforms and investor protections in Dodd-
    Frank Act were born out of necessity. The financial crisis made
    it clear that the existing securities regulatory landscape
    needed an overhaul.
        This comprehensive law was developed to promote stronger
    investor protection and more effective oversight to help
    prevent another economic crisis from threatening the financial
    security of Main Street investors. State securities regulators
    were pleased that the Dodd-Frank Act addresses a number of
    critical issues for investors by incorporating disqualification
    provisions to prevent people who violate securities law from
    selling unregistered securities offerings under Rule 506 of
    Regulation D, by strengthening the ``accredited investor''
    definition, and by increasing State oversight of investment
    advisors. Dodd-Frank also includes a provision to safeguard
    senior investors from unqualified advisors and creates an
    investor advisory committee to provide input to the SEC on its
    regulatory priorities.
        Dodd-Frank took a necessary first step toward reducing
    risks for investors in unregistered private offerings by
    requiring the SEC to write rules to prevent known offenders
    from using the Regulation D, Rule 506 exemption from
    registration. In 1996, the National Securities Markets
    Improvement Act curtailed the authority of State securities
    regulators to oversee these unregistered private offerings
    before and while they are being sold to the public.
        In the years since, these private offerings have become a
    favorite vehicle for unscrupulous promoters and brokers with
    criminal and disciplinary records to prey on investors. The SEC
    recently proposed rules mandated by Dodd-Frank to close this
    avenue to known violators of our securities laws.
        Unregistered private offerings were originally intended
    only for institutional investors and sophisticated individuals.
    These accredited investors were presumed capable of assessing
    risks and making investment decisions without the protection of
    regulatory review and registration. However, the net worth
    standard the SEC uses to determine the eligibility of an
    investor to participate in private offerings has remained
    unchanged since 1982. Dodd-Frank improved the way eligibility
    is determined by excluding the value of individual investors'
    homes in the calculation of their net worth.
        NASAA will continue to push for additional improvements to
    the accredited investor standard, and we urge Congress to go
    further by reinstating State regulatory authority and oversight
    of all Rule 506 offerings.
        Dodd-Frank recognized the strong investor protection record
    of the States with its provision to expand State authority to
    include mid-sized investor advisors with $25 million to $100
    million in assets under their management. Investors will
    benefit from this change because it will enable the SEC to
    focus on the largest investment advisors while mid-sized and
    smaller advisors will be subject to the strong State system of
    oversight and regulation.
        State securities regulators are preparing for this
    increased responsibility. We now employ a more automated and
    uniform exam process as well as risk assessment analyses to
    better prioritize our exams. This enables States to do more
    intelligent and effective exams.
        Finally, NASAA members have launched an aggressive outreach
    effort to prepare the investment advisor industry for State
    oversight and to enable new registrants to set up their
    business operations the correct way and avoid inadvertent
    noncompliance.
        Last month, the SEC extended its timeline for the
    completion of this investment advisor switch into the middle of
    2012. Dodd-Frank outlined many ambitious reforms to be
    implemented by Federal regulatory agencies. Some delay is to be
    expected. However, State securities regulators are concerned
    about any effort that might derail or delay important investor
    protections. A lack of adequate funding already has forced the
    SEC to defer a number of valuable investor protections promised
    by Dodd-Frank, such as the creation of the Investor Advisory
    Committee.
        Also, controversies over the Consumer Financial Protection
    Bureau have indefinitely delayed the creation of a senior
    investor protection grant program that would support State
    initiatives to protect vulnerable senior investors from
    individuals using misleading professional designations.
        What NASAA asks of the Congress is simple and clear: Please
    continue your commitment to protecting investors and do not
    weaken the critical investor protections of Dodd-Frank, either
    directly through legislative repeals or indirectly through a
    lack of adequate funding.
        We look forward to working with the Committee, as well as
    all Members of Congress and fellow regulators, to ensure that
    the Dodd-Frank Act's investor protections are implemented
    fully.
        Thank you.
        Chairman Johnson. Thank you, Mr. Massey.
        Ms. Lynnette Hotchkiss, please proceed.

    STATEMENT OF LYNNETTE HOTCHKISS, EXECUTIVE DIRECTOR, MUNICIPAL
                      SECURITIES RULEMAKING BOARD

        Ms. Hotchkiss. Good morning, Chairman Johnson, Ranking
    Member Shelby, and Members of the Committee. I appreciate the
    opportunity to testify here this morning on behalf of the
    Municipal Securities Rulemaking Board.
        Congress created the MSRB in 1975 to protect investors in
    the municipal market, and last year, in Dodd-Frank, you
    expanded our jurisdiction to include the protection of State
    and local government bond issuers as well as public pension
    plans. To the best of our knowledge, this is the first time
    ever that a securities regulator has been charged with
    protecting an issuer of securities. You also gave us
    jurisdiction to regulate municipal advisors in addition to our
    existing jurisdiction over dealers in this market. We
    appreciate the opportunity to report to you today on how we
    have responded to these increased responsibilities.
        As you can see from the chart, the municipal securities
    market makes up just over $3.7 trillion of the total U.S. debt
    market. Additionally, about $150 billion is invested in 529
    college savings plans, another kind of municipal securities
    which fall under our jurisdiction.
        The second chart shows how the $382 billion of municipal
    securities issued since the enactment of Dodd-Frank last July
    are being used. It is hard to imagine a street, airport,
    school, park, or town hall in this country not financed through
    the issuance of municipal securities, and I do not need to tell
    those of you who have served in State or local office just how
    important the municipal bond market is to the continued health
    and vitality of our States, cities, towns, schools, and
    universities.
        Like every market, transparency and disclosure are critical
    to investing protectors. Our free online resource called EMMA
    does exactly that. As you can see, EMMA provides investors with
    free access to disclosures and pricing data, information they
    need to make informed investment decisions. An example of
    information on EMMA from a recent issuance in your respective
    States is included with my written testimony.
        In fact, a journalist from Reuters reported just last week
    that, and I quote, ``Since the Municipal Securities Rulemaking
    Board made their EMMA system operational, transparency in muni
    land is an order of magnitude better than any other bond
    market.''
        Because retail accounts for two-thirds of all investors and
    over 80 percent of all customer transactions in municipal
    securities, we designed our EMMA system to be easily usable by
    the general public.
        The MSRB has undertaken other substantial initiatives to
    protect investors. We are in the process of implementing a
    Federal fiduciary duty standard, additional restrictions on
    ``pay to play'' activities, and mandated disclosures of all
    conflicts of interest. These are described in detail in my
    written testimony.
        In Dodd-Frank, Congress gave the MSRB the authority to
    regulate municipal advisors and swap advisors. Mr. Chairman, as
    you and Ranking Member Shelby are well aware, the events of
    Jefferson County, Alabama, made it very clear that vast
    improvement in the municipal derivatives market was needed, and
    the MSRB has already taken significant steps in this area:
    first, by ensuring that State and local governments are given
    impartial professional advice by qualified advisors; and,
    second, by ensuring that underwriters that recommend swaps
    explain in clear language all of the risks attendant to that
    transaction.
        In a similar way, our expanded authority allows us to
    further protect investors in competitive bidding situations.
    Just last week, the SEC and the Department of Justice announced
    settlements with JPMorgan Securities in connection with bid
    rigging. Earlier this year, UBS and Bank of America Securities
    entered into similar agreements.
        Until now, the SEC could only address this egregious
    behavior through its anti-fraud jurisdiction. But now, under
    recent initiatives of the MSRB, such conduct would be a clear
    violation of our fair dealing and fiduciary duty rules,
    providing additional fire power to the SEC to go after these
    wrongdoers.
        The MSRB is dedicated to ensuring that the municipal market
    regulations we promulgate and the transparency afforded by our
    EMMA system promote an open, fair, and efficient market, one
    that protects issuers and investors alike, and one that
    continues to fund the critical public infrastructure needs of
    our country.
        Thank you again for the invitation to testify, and I look
    forward to any questions that you might have.
        Chairman Johnson. Thank you, Ms. Hotchkiss.
        Mr. Pitt, please proceed.

     STATEMENT OF HARVEY L. PITT, FORMER CHAIRMAN, SECURITIES AND
                          EXCHANGE COMMISSION

        Mr. Pitt. Good morning, Chairman Johnson, Ranking Member
    Shelby, Members of the Committee. I am pleased to be back
    before you today to respond to the Committee's invitation to
    testify about the critical issue of ``Enhanced Investor
    Protection After the Financial Crisis.''
        The Committee has specifically requested that today's
    testimony focus on Titles IV and IX of the Dodd-Frank Act and
    the extent to which those provisions enhance investor
    protection or could be improved.
        I would like to highlight five overarching observations
    about Dodd-Frank in Titles IV and IX from my written statement
    for your consideration.
        First, the financial crisis that began in 2007-08 was the
    product of the failure of our outmoded and cumbersome financial
    regulatory system and the lack of adequate tools that would
    have enabled regulators to respond effectively, efficiently,
    and with alacrity both to the warning signs that a crisis was
    imminent and to what eventually became a full-blown crisis. I
    believe that Dodd-Frank unfortunately represents a missed
    opportunity to fix that which was clearly broken and to provide
    a better arsenal of regulatory rules to detect and cope with
    the next financial crisis, which sadly is not all that far
    away.
        Instead of producing a more nimble regulatory regime, we
    have saddled regulators with a more cumbersome regulatory
    system that almost ensures that we will not be any better
    equipped to respond to future financial and capital markets
    developments than we were for this last crisis. And, worse, we
    have created the possibility that the independence of three
    critical financial regulators--the Federal Reserve Board, the
    SEC, and the CFTC--will be impaired by subjecting these
    agencies to the dictates of the new Financial Stability
    Oversight Council that is led by the Treasury Secretary and,
    therefore, must be responsive to policies pushed by whatever
    Administration is in power at that particular time.
        Second, I am deeply concerned that Dodd-Frank sets
    financial regulators, and particularly the SEC, up for failure.
    The SEC has been saddled with extensive new regulatory
    obligations, but has been denied the necessary resources with
    which to fulfill those obligations. In particular, the Act
    imposes or expands SEC jurisdiction and oversight over more
    than 10,000 new and potential regulatees. Despite the agency's
    good-faith and diligent efforts, the public will be lulled into
    believing that we have solved the problems that caused our most
    recent economic collapse. But in my view, Dodd-Frank represents
    only the triumph of optimism over decades of hard-learned,
    real-world experience.
        Third, Dodd-Frank tackles significant and difficult issues
    of corporate governance in awkward and potentially pernicious
    ways. Among such provisions, Dodd-Frank's whistleblower bounty
    program threatens to undermine corporate governance and
    compliance programs by encouraging potential whistleblowers to
    evade internal corporate policies and ethical precepts in order
    to maximize the potential lucre these whistleblowers may demand
    from the SEC. Similarly, the Act's say-on-pay provisions have
    usurped the proper province of State corporation laws and
    potentially subject shareholders to a steady stream of
    frivolous litigation, which has already begun, designed to
    force those companies whose shareholders object to specific
    compensation programs into treating what was intended as an
    advisory expression of shareholder sentiment into a binding
    declaration that potentially any corporate officer's or
    director's compensation package is too high.
        Equally troublesome is the approach toward proxy access
    that Dodd-Frank has encouraged the SEC to adopt. The solution
    to proxy access issues, in my view, is to permit proxies to be
    solicited electronically rather than by snail-mailed hard copy.
    That simple change would reduce rather dramatically the current
    fervor with which corporate shareholder activists seek to
    append their agendas and proposals onto management's proxy-
    soliciting materials.
        But even in the absence of such a change, the easiest
    solution to the so-called proxy access issue is to permit
    shareholders to amend their companies' by-laws to the extent
    such power is granted under the law of the State of
    incorporation by whatever majority vote State law requires. All
    the SEC would need do in such an environment is prescribe the
    disclosures that must be made as well as the length of time and
    the number of shares any shareholder must hold the company's
    securities to entitle any shareholder to propose a by-law
    amendment.
        Fourth, Dodd-Frank imposes upon the SEC a new Office of the
    Investor Advocate, a position clearly designed to permit a non-
    Presidential appointee to second-guess, challenge, and attack
    virtually any action or any inaction of the Commission with
    which the Investor Advocate disagrees. Investor advocacy is one
    of the two critical objectives of the SEC, the other being to
    facilitate the development of effective capital markets that
    can compete with markets anywhere in the world. Creating a
    special position whose principal function apparently will be to
    harangue the Commission without any censorship of any kind,
    including rational and intelligent common sense, is something
    that can create the seeds of further SEC dysfunctionality.
        Fifth, there are ways to ameliorate Dodd-Frank's unintended
    consequences, but they require this Committee to approach this
    legislation in a nonpartisan and evenhanded manner. Among other
    things that should be considered are: mandating the development
    of an independent compliance audit process, akin to the
    financial audit process that currently exists; ensuring that
    the SEC has appropriate resources to fulfill its new compliance
    examination and broad regulatory oversight responsibilities;
    extending the existing deadlines for SEC rulemaking beyond
    their current artificial and often impossible dates; and
    providing a better means for the Government to assess the true
    costs and benefits of each of the hundreds of new regulations
    that Dodd-Frank requires.
        Dodd-Frank was intended to address laudable goals.
    Unfortunately, it creates perverse incentives that will likely
    undermine the intended benefits to investors. With care and a
    bipartisan effort, the Act can be tailored so that it more
    likely accommodates its original objectives.
        Thank you again for the invitation to appear here, and I
    will be happy to respond to any questions the Committee Members
    may have.
        Chairman Johnson. Thank you, Mr. Pitt.
        Ms. Roper, please proceed.

     STATEMENT OF BARBARA ROPER, DIRECTOR OF INVESTOR PROTECTION,
                     CONSUMER FEDERATION OF AMERICA

        Ms. Roper. Good morning, Chairman Johnson, Ranking Member
    Shelby, and Members of the Committee. I appreciate the
    invitation to appear before you today.
        Improving protections for average investors has been a
    priority for CFA for roughly a quarter-century. The issue has
    taken on new urgency, however, in the wake of a devastating
    financial crisis that has left average investors, American
    investors, as fearful for their financial security as the
    events of September 11 left them fearful for their physical
    safety.
        Among the lesser known achievements of the Dodd-Frank Act
    is its creation of a multi-faceted investor protection
    framework that, if properly and effectively implemented, could
    significantly improve regulation of the securities markets and
    with it protection of investors. My written testimony discusses
    a broad range of the Act's investor protection provisions. In
    my oral testimony, however, I focus on just a couple of the
    bill's provisions, starting with its provisions to strengthen
    credit rating agency regulation.
        Before the crisis, the entire system of regulating asset-
    backed securities was built on the assumption that credit
    rating agencies could reliably assess the risks associated with
    these complex and opaque investments, an assumption that proved
    to be disastrously misguided. Title IX of the Dodd-Frank Act
    seeks to address this fundamental weakness in the regulatory
    system with a package of measures designed to make credit
    ratings more reliable.
        Among the most important are provisions to improve the
    SEC's oversight of ratings agencies, to strengthen the agency
    ratings agencies' internal controls over the rating process, to
    make the assumptions behind the ratings more transparent to
    users of those ratings, to hold rating agencies legally
    accountable for following sound procedures, and to reduce
    regulatory reliance on ratings. Implementation of these
    provisions is still a work in progress and we would simply note
    that, with the major ratings agencies still subject to massive
    conflicts of interest, a lot hinges on the SEC's ability to
    provide tough and effective oversight.
        The Act also includes provisions addressing more generic
    weaknesses in securities regulation, and among these are
    provisions designed to provide investors with greater input
    into the SEC's policymaking process by creating a potentially
    powerful new Office of Investor Advocate within the SEC and
    establishing a permanent Investor Advisory Committee. I think
    it will come as no surprise that I view these provisions very
    differently than former Chairman Pitt.
        Some question the need for these provisions because the SEC
    is supposedly the investor advocate, but it is not. Its job is
    to protect investors, which is different from advocating for
    investors. And the simple fact is that investors lack the
    organization, manpower, and resources to monitor agency actions
    and effectively interact with SEC leaders and staff. As a
    result, the agency's agenda is often developed and specific
    proposals to implement that agenda are developed with minimal
    impact for investors, at least until the public comment
    process, while industry is involved at every step of the
    process. Once the Office of Investor Advocate and the Advisory
    Committee are up and running, investors should benefit from an
    agency that is more attuned and responsive to their concerns.
        Another set of little noticed provisions in the bill have
    the potential to transform the disclosures retail investors
    rely on in making investment decisions. The Act requires the
    SEC to identify ways to improve the timing, content, and format
    of disclosures. It authorizes the agency to engage in investor
    testing of new and existing disclosures to ensure their
    effectiveness. And it authorizes the agency to require pre-sale
    disclosures with regard to investment products and services.
    Together, these provisions give the agency the tools and
    authority it needs to develop disclosure documents that are
    more timely, relevant, and comprehensible to retail investors.
        All of the many investor protection provisions in the Act
    will depend for their effectiveness on the SEC's receiving the
    funding necessary to carry them out. Unfortunately, after three
    decades in which our securities markets experienced explosive
    growth in size, complexity, technological sophistication, and
    international reach, the SEC today is critically underfunded
    and understaffed to carry out its existing responsibilities,
    let alone take on the vast new responsibilities entrusted to it
    in Dodd-Frank.
        Congress attempted to address this problem in Dodd-Frank by
    authorizing funding increases that would roughly double the
    agency budget by 2015. Unfortunately, the debates over the
    fiscal year 2011 and 2012 budgets have already made clear that
    turning those authorizations into appropriations is going to be
    a tough fight, and we appreciate the leadership that you,
    Chairman Johnson, and Members of this Committee have played in
    fighting for that full SEC funding. While we are sympathetic to
    those who argue that money alone cannot solve all the agency's
    problems, we also believe that without additional funding, the
    agency cannot reasonably be expected to effectively fulfill its
    investor protection mission.
        In conclusion, the investor protection framework provided
    in Dodd-Frank is a sound one, but it only takes us so far. For
    it to succeed, regulators will have to demonstrate a
    willingness to use their authority aggressively and
    effectively, and Congress will have to provide them with both
    the resources and the backing to enable them to do so.
        Chairman Johnson. Thank you, Ms. Roper.
        Ms. Simpson.

      STATEMENT OF ANNE SIMPSON, SENIOR PORTFOLIO MANAGER, GLOBAL
        EQUITIES, CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM

        Ms. Simpson. Thank you. Good morning. Chairman Johnson,
    Ranking Member Shelby, and Members of the Committee, thank you
    very much for the opportunity to come and speak to you this
    morning. My name is Anne Simpson. I am Senior Portfolio Manager
    in the Global Equity's Division of CalPERS. So my purpose this
    morning is really to share with you some practical insight into
    how Dodd-Frank is working, emphasize to you how important the
    corporate governance provisions are, and if anything, to remind
    the Committee that there is still further work to be done.
        But let me start at the most important point, which is
    explaining something about CalPERS and the size and
    significance of our fund in the market. As you will be aware,
    CalPERS is the largest public pension fund in the United
    States. We have approximately $235 billion in global assets and
    our equity holdings extend to something like 9,000 companies
    worldwide.
        Now, this money is invested for an extremely serious
    purpose. We provide retirement benefits to more than 1.6
    million public workers, retirees, and their families. And if
    you want to think about that in terms of its economic impact,
    this year, we will have paid out something in the order of $11
    billion in benefits. Seventy cents on every dollar that we pay
    out typically comes from investment return. So think of the
    number of people reliant on the market through the activities
    of our investment fund. This is not a theoretical exercise.
        The people that we are investing for, generally, they are
    on modest incomes. On average, a CalPERS beneficiary will be
    living on benefits from the fund on the order of $2,000 a
    month. Today, we have released a report actually looking at the
    economic impact through those payments, if you would be
    interested in a copy.
        So for this reason, we have a very serious fiduciary duty
    to pay attention to the safety and soundness of the market, and
    this is why corporate governance is, to us, absolutely
    fundamental to the security of those returns, which we have to
    think about on a risk-adjusted basis over a very long
    investment time horizon.
        Our size and our very long-term liabilities mean that we
    cannot ignore problems in the market. There is no safe place
    for CalPERS to go when things go wrong. We are simply too big.
    There is not a corner of the stock market where everything is
    working wonderfully well and you can talk over $200 billion and
    hope these difficulties will somehow go away. So we have been
    paying very close attention to Dodd-Frank's reform proposals
    and we are also very glad to be working within the new rigor,
    the new transparency and accountability that this Act is
    providing.
        I also would like to draw to your attention that in
    addition to the corporate governance reforms, CalPERS has been
    actively supportive of other elements of Dodd-Frank, the
    proposals around systemic risk oversight, proper funding and
    independence for regulators, which has just been touched on,
    proper derivatives reform, credit rating agency overhauls, and
    consumer protection. We see these as a package of measures that
    need to be carefully coordinated. Corporate governance will not
    do the job on its own.
        So let me then just turn to a number of corporate
    governance provisions in Dodd-Frank which we see as
    particularly important, and I would be glad in the questions to
    explain further why that is so.
        I think it is fair to say it is almost commonplace now that
    we acknowledge that the financial crisis was fueled by a toxic
    combination of lax oversight and misaligned incentives. This is
    why governance reform is vital. It is through improved
    transparency and accountability that we will be able to address
    these sorts of systemic weakness. Too many chief executives
    pursued risky strategies or investments that bankrupted their
    companies or weakened them financially for years to come, and
    we know the knock-on effect in the economy has been devastating
    for millions. Boards were often complacent. They were blinded
    by group-think, which is also why we regard board divestiture
    so important, and unwilling to challenge or rein in reckless
    executives who threw caution to the wind. We know that
    accountability is critical to motivating people to do a better
    job. This is why sound pay is so important.
        We also think it is vital that proxy access is finally
    introduced in order that we can hold boards to account. Our
    significant and most important role is to be able to vote on
    the hiring, the firing, and the removal of board directors, and
    without proxy access and its companion piece, majority voting,
    we are not in a position to do that. We are simply those with
    bark but no bite.
        Finally, we would like to encourage the further improvement
    of disclosure, which Dodd-Frank has begun, notably around
    important subjects like board leadership, for example, the
    separation of the chairman and the chief executive. And we
    welcome the efforts that are being made to give investors the
    information they need that is critically important, but also it
    is very important that that information can be matched by
    appropriate action, which is where proxy access will give us an
    extremely useful tool for improving the situation, not just for
    the benefit of our beneficiaries, but we think it will have a
    systemically useful impact.
        Thank you.
        Chairman Johnson. Thank you, Ms. Simpson.
        Mr. Atkins is a visiting scholar instead of a fellow, as
    was said at the beginning of the hearing. I regret that.

        STATEMENT OF PAUL S. ATKINS, VISITING SCHOLAR, AMERICAN
            ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

        Mr. Atkins. That is OK. Thank you very much, Mr. Chairman
    and Ranking Member Shelby and Members of the Committee for
    inviting me to appear today at this hearing.
        I come before you today not only as a former Commissioner
    of the Securities and Exchange Commission, but also a member of
    the former Congressional Oversight Panel for the TARP program
    and, of course, as a Visiting Scholar at AEI. It is a privilege
    for me to be able to participate in the public discussion about
    the issues of the day in the context of my years of work in the
    public and private sectors.
        The news of this past week has highlighted the
    disappointing state of affairs in our economy. The unemployment
    rate increased to 9.2 percent while the labor force itself
    shrank by more than a quarter of a million people. More than 14
    million Americans are out of work, and almost half of those
    have been out of work for more than 6 months.
        Uncertainty in the legal and regulatory landscape of the
    financial services industry is a major cause of why the economy
    is doing so poorly, because it discourages investment and
    extensions of credit to entrepreneurs. A primary reason for
    this uncertainty is Government policy, particularly Dodd-Frank,
    which was ostensibly enacted for the sake of market stability
    and investor confidence. Because most of the provisions were
    not directly related to the underpinnings of the financial
    crisis, investors ultimately will pay for the increased costs
    associated with the mandates without receiving commensurate
    benefits. Further exacerbating uncertainty, legal challenges to
    Dodd-Frank and the rules that the various agencies will issue
    are inevitable, not just as to the technicalities of the rules
    and whether they have been properly promulgated, but also as to
    basic questions of jurisdiction and, yes, constitutionality.
        As the past year has shown, Dodd-Frank also mandates very
    tight deadlines for Federal agencies to draft and implement
    these rules. Members of this Committee have been justifiably
    concerned that Federal agencies are sacrificing quality for
    speed as they neglect to properly weigh the costs and benefits
    to the economy of their proposed rules. These are complicated
    concepts with huge ramifications and the regulators have got to
    get it right.
        Today, you have asked specifically that we address Titles
    IV and VII of Dodd-Frank. Title IV and the rules that the SEC
    adopted effectively force all investment advisors managing more
    than $150 million in assets to register with the SEC. Even
    advisors to venture capital funds, which Congress specifically
    exempted from registration, effectively are caught up in the
    SEC's new registration and examination scheme. These rules will
    have a multi-pronged effect. They will burden advisors and thus
    investors with costs, increasing barriers to entry. They will
    strain SEC resources and divert its attentions from protecting
    retail investors, which is what its primary focus should be.
    And the effect of these two situations will foster a mistaken
    sense of security among investors so that they may think that
    SEC registration means that they can let their guard down.
    Bernie Madoff indicates otherwise.
        Now, moving on to Title IX, which encompasses a wide range
    of issues, including credit rating agencies, whistleblowing,
    fiduciary duties, SEC management, and then a grab-bag of issues
    that have been pushed for years by special interest groups of
    politicized investors and trial lawyers, I just want to make a
    few points in the time remaining.
        This Committee took action with respect to the Credit
    Rating Agency Reform Act of 2006 to address the troubling
    oligopoly of credit rating agencies and the SEC's opaque method
    of designating these agencies as nationally recognized
    statistical rating organizations. Ultimately, unfortunately,
    Dodd-Frank has taken an inconsistent approach with respect to
    credit rating agencies. The threats currently being levied by
    Government officials in Europe demonstrate that rating agencies
    are susceptible to political pressure as to the supposed
    correctness of their ratings. Congress should consistently push
    transparency, accountability, and competition instead of
    Government control and second-guessing of ratings so that
    investors can get high quality and objective advice from credit
    rating agencies.
        Now, with respect to whistleblowers, I agree with the
    remarks of Chairman Pitt. Under Section 913, the SEC has
    recommended that Congress harmonize a standard of care for
    investment advisors and broker-dealers. I think it is important
    to remember that not all investors are the same. The standard
    of care as has developed over the past 75 years for brokers is
    robust and has features that vindicate grievances that are more
    streamlined than what investors face in State court with a
    fiduciary duty standard. In those cases, the contract rules--
    the fine print under the contract, especially.
        Some investors perhaps want and need a fiduciary who
    possesses intimate knowledge of their financial condition and
    can advise them accordingly. On the other hand, some investors
    would prefer to have a true broker who is engaged on a
    transaction basis and is compensated accordingly. These two
    kinds of activities should have different standards of care
    attached to them.
        Title IX contains many other provisions, most of which have
    nothing to do with the causes of the financial crisis, and in
    my short window of time today, I cannot discuss all of these
    sections, but I do want to make one special plea. I encourage
    this Committee to exercise its oversight over SEC management.
    Just last week, the SEC Chairman testified about the recent
    leasing decision and suggested that the SEC should no longer
    have leasing authority. In contrast, last year, some were
    suggesting that the SEC should have a self-funding mechanism
    outside of the normal Congressional appropriations process.
        In the meantime, the SEC has pursued an extremely divisive
    agenda marked by more than a dozen three-to-two votes in the
    past 2 years alone. I have never witnessed such a division.
    This record is in marked contrast to my experience of 10 years
    total at the SEC, first as a staffer in two Chairmen's offices
    and then as a Commissioner under three Chairmen. The dissenters
    today are reasonable people and their dissents are not always
    fundamentally opposed to the rulemaking itself. But the sad
    fact is that it appears that the leadership of the SEC does not
    engage effectively on the finer points of the policy issues.
    Thus, I encourage this Committee to continue to exercise
    oversight of SEC management.
        Thank you.
        Chairman Johnson. Thank you, Mr. Atkins.
        Mr. Turner.

         STATEMENT OF LYNN E. TURNER, FORMER CHIEF ACCOUNTANT,
                   SECURITIES AND EXCHANGE COMMISSION

        Mr. Turner. Thank you, Chairman Johnson and Ranking Member
    Shelby. It is always a pleasure and, quite frankly, an honor to
    be back here in front of this Committee, and it is especially a
    pleasure with our distinguished Senator from Colorado.
        I have listened to the comments today and I guess we can
    all agree that we do not all agree. But it is fascinating to
    me, in light of the fact that here we are, 4 years after the
    subprime crisis imploded on us, the worst since the Great
    Depression. Investors around the globe lost $28 trillion in the
    capital markets in value. That was half of the entire world's
    GDP at the time. Ten to 11 trillion was lost here in the United
    States, and that does not include the loss in value of their
    homes.
        People have said Dodd-Frank was the cause of this. Dodd-
    Frank was not even passed at the time that this occurred. What
    Dodd-Frank tried to deal with was the outcome of that. It was
    the crisis that started and caused the lost jobs we have heard
    about, tens of millions of lost jobs, lost wages, and lost
    homes.
        If Congress had not have acted as it did, I believe we
    would have been in a Hooveresque-type depression at this point
    in time, and it certainly was not brought on by a regulatory
    structure that was out of whack, although certainly I think
    Dodd-Frank fixed some of the problems that are there, and on
    that point, I think I would agree with Harvey that there were
    some changes that did need to be made. But it was regulatory
    inaction leading up to and throughout the crisis that caused us
    problems.
        As Dr. Greenspan has noted himself, there were things they
    could have done, they had the power to do. Congress had given
    them the power. This Banking Committee had given the Fed the
    right to regulate those bad loans that were made, and the Fed
    chose not to regulate. That is what has caused the unemployment
    and jobs, and I congratulate Congress for acting on that.
        In my 35 years of experience, though, as a banker, an
    auditor, a regulator, investor, and teacher, I have always
    found that if you are going to have markets work, they have got
    to have five basic fundamental pillars to work. There has got
    to be transparency. You have got to have the information you
    need to make the investments. You have got to have
    accountability, the people who take that money, including the
    management teams, the boards, have got to be accountable for
    their actions, as do the regulators. It is up to this Committee
    to oversee those regulators, and I agree with Paul that good
    oversight at the SEC is important. There has to be
    independence. The conflicts that we saw at the credit rating
    agencies were outrageous and certainly contributed to the
    problems. You have got to have effective regulators. And,
    finally, you have got to have enforcement of the laws.
        Yet, as we look back at the mayhem of this last decade, we
    see that there was absolutely a dearth of transparency,
    accountability, law enforcement by the regulators and
    investors, and regulators alike. No one could decipher the
    financial statements from an AIG, a Lehman, a Merrill Lynch.
    Assets and capital were inflated, liabilities understated, and
    profits upon which huge compensation packages were granted were
    a mirage.
        So in light of that, in this hearing on Title IX, let me
    get back to some of my comments. First of all, the
    whistleblower issue. A lot of people have different views on
    whistleblowers. Business in general does not like them.
    Investors like them. Some people think they go too far. Some do
    not. Senator Shelby, you mentioned that they could pay out tens
    of millions, and you are absolutely right. But if they are
    paying out tens of millions, that means the SEC will have been
    imposing fines of $30 to $300 million. That means that you have
    got huge financial restatements out there of the like we saw at
    WorldCom, where it was restated $11 billion. Those financial
    statements were fictional. They were like watching a movie
    called ``Fantasia.''
        If it is that big, I do want to see that whistleblower come
    in and alert the SEC at the earliest possible date. The
    Association of Certified Fraud Examiners has shown that it
    takes on average 27 months to find a fraud. Why would we not,
    in a situation like that, want that tipster to come in at a
    much earlier date so people do not have those great big losses
    from a WorldCom or an Enron or some of these things we have
    seen in the bank.
        I have served as an audit committee chair on public
    companies overseeing whistleblower and compliance programs. I
    think the SEC was very reasonable in their final rulemaking
    back in May, and if anything, it is going to result in better
    internal compliance and hotlines. They encourage people to go
    to the business first, which is good. But 89 percent of the
    frauds that the SEC investigated from 1998 to 2007 involved the
    CEO and/or CFO at the company. There is a reason whistleblowers
    are hesitant, quite frankly, to go to the top. So giving them
    the chance to come into the SEC, I think, is great.
        Quickly, on proxy access, it was mentioned that just 3
    percent. That is actually not correct, because it takes a
    majority. All I am asking for investors is give investors the
    same right, the owners of the business the same right that the
    management team that they have hired has to the proxy to vote
    the directors. And it is not 3 percent. The labor unions never
    will be able to control this. That is a figment of someone's
    imagination, because it takes a majority of the shareholders to
    put it through. That is excellent.
        As far as the SEC funding, I would just say I totally agree
    with Ms. Roper. From 2005 to 2007, the staff of the SEC was cut
    by 10 percent. Its spending was cut by $75 million. As a
    business executive, I know you cannot shrink to greatness, and
    that is what people were trying to do at the SEC leading up to
    the subprime crisis.
        There was some--I was asked to comment just briefly on
    PCAOB and some of the provisions on broker-dealer audits which
    the PCAOB is acting on today, very appropriately. We saw from
    Madoff that audits of these companies were very poor, the audit
    of the assets was very poor, and this provision of the law
    helps the PCAOB prevent those type of things, which I think
    will be very good as well as work much better with
    international regulators.
        So I think with that, I will end my comments. But overall,
    I think this Title IX of Dodd was well done. Investors did not
    get everything they wanted, but, you know, I found that it
    would be nice if people in D.C., rather than thinking about
    being Democrats or Republicans, started thinking like being
    Americans, and I think in Title IX that is exactly what you did
    as a Congress and I think that is great. Thank you.
        Chairman Johnson. Thank you, Mr. Turner.
        I will ask the Clerk to put 5 minutes on the clock.
        For any and all witnesses, reflecting on the financial
    crisis, what do each of you feel was the most serious harm it
    caused to retail and to institutional investors? In reflecting
    on the new law, what do you feel are the reforms that will be
    most helpful to investors? Mr. Massey.
        Mr. Massey. Senator, in my opinion, the most injury from
    the perspective that we as State securities regulators see is
    with respect to what we call retail investors, also known as
    mom-and-pop investors, and these are the people that not only
    have taken big hits to their life savings, they have also
    suffered impacts on their financial planning that they were
    hoping to send their kids to college with. They have lost jobs.
    They have lost ownership of their small firms. The landscape is
    littered with victims of the financial crisis, and these are
    regular people who depended to a great extent for their future
    on the integrity of the financial system. Now, when it fell
    apart, they took the hit.
        Chairman Johnson. Does anyone else care to respond?
        Ms. Roper. I would just like to add to that. I think, you
    know, there is no question, the financial losses that investors
    took were devastating. I think equally devastating is their
    loss of confidence in the integrity of the financial system,
    their loss of confidence that they can rely on this as a place
    to save for retirement, to save for their long-term goals.
        And I think one thing that contributes to that is that sort
    of a peculiar characteristic of this crisis is that the harm
    that flowed to retail investors was not primarily as a result
    of anything that was done to them directly. They were not
    defrauded by a broker. They are the collateral damage of a
    regulatory system of a largely institutional market that simply
    did not function. And so they cannot even point to anything
    that they did. They followed the rules. They bought and held
    and diversified and suffered devastating consequences. So I
    think it is that sense in which it undermines their confidence
    that they know how to participate safely in these markets and
    that their regulators will protect them in the future.
        Chairman Johnson. Ms. Simpson.
        Ms. Simpson. I would like to answer that. This is Anne
    Simpson. In addition to regulators letting people down, let us
    shine a spotlight on the shareholder community. That is where
    we sit, as CalPERS. The question is, where were the owners? Why
    were we not able to see what the problems were as they were
    growing? Why were we not able or willing to intervene, to do
    something? And it is a simple corporate governance failure in
    the market which has left us powerless to behave as responsible
    owners.
        Think about two parts of the story. The first is majority
    voting. This is something which we wanted to come out of Dodd-
    Frank and in the end did not survive passage from the early
    discussions. This is a situation where, without majority
    voting, we cannot remove directors. And second, without proxy
    access, we cannot put forward people who we think are better
    able to do the job that needs to be done. And if we are not
    able to hold boards of directors accountable and regulators are
    not in a position to intervene, then, really, this is how you
    can have rampant risk running through the system, executive pay
    that is out of control, and the situation which really took us
    to the brink of the abyss.
        Our portfolio was hit to the tune of $70 billion and we are
    slowly but surely coming back. But it is extremely important
    that in capitalism, and that is the system we are all relying
    on, the owners have to be in a position to behave like owners,
    and that means being able to hold boards accountable. And if we
    are toothless, then I do not see who else can intervene to do
    the job.
        Chairman Johnson. Mr. Pitt and anybody else on the panel, I
    want you to reflect on say-on-pay. In an interview, you were
    asked whether say-on-pay is going to be an effective tool to
    prevent excesses, to which you replied, ``I think it will be. I
    think that this will have a very definite impact on how
    corporations and shareholders view these critical issues.''
        In your testimony today, you note that say-on-pay would
    lead to increased shareholder litigation. Is some litigation,
    which you note is finally likely to fail, a necessary
    consequence of getting the benefits of say-on-pay? Mr. Pitt and
    other panelists, would you comment on this.
        Mr. Pitt. Yes. I believe that shareholders have the right
    to be fully informed about compensation, and they have the
    right to express their views. The difficulty that I see is that
    there has evolved a clear trend already on the part of some
    lawyers to sue anytime a corporation's shareholders express
    disagreement with the compensation levels. So what could have
    been an advisory kind of view, which is what the clear intent
    of Dodd-Frank was, has now been converted into a litigation
    tool, and that costs investors enormous expense. It also
    imposes on investors enormous burdens that I think are very
    difficult.
        I am very much in favor of transparency and having
    shareholders have the ability to express whatever views they
    have. But I am not in favor of seeing this turned into a
    referendum and then a litigation exercise, which appears to be
    the direction in which this is headed.
        Chairman Johnson. Does anyone else care to comment?
        Ms. Simpson. Yes, thank you. CalPERS has voted on 4,000
    say-on-pay votes in our U.S. portfolio this year, but we have
    been voting on this same issue in Australia, the United
    Kingdom, the Netherlands, and Norway for some time. We are a
    global player, and I would say that say-on-pay is simply
    bringing the United States in line with international best
    practice.
        We have also found it extremely useful, and the reason is
    this: It has meant that companies want to pick up the phone or
    answer the phone and talk. They do not want to lose the vote,
    they do not want a high level of opposition, and they actually
    are being much more attentive to what the owners think, and
    this is only proper. Whatever pay is being paid, guess what?
    That money is being provided by the shareholders, and it is
    only good manners, surely, to be discussing the amounts and the
    performance targets.
        So we have seen two good things come out of this:

        One, the performance periods are getting longer. That is
    extremely important because we need to relieve the short-term
    pressure on companies, and that in part comes through having
    short-term targets for pay.
        Second, we have seen a better alignment of pay and
    performance, and we have been delighted to see companies filing
    amendments to their plans all the way in the run-up to the AGM
    deadline. The result of that for CalPERS is that we voted
    against 7 percent of the plans that came forward. So we really
    see this as a good platform for dialogue, and thank you very
    much for the efforts in Dodd-Frank for doing that.
        I also forgot to mention earlier the importance of the
    claw-back rule in Dodd-Frank. It is extremely important that we
    have now clearly got this ability to retrieve ill-gotten gains.
    If you know that you cannot get away with it and people will
    come after you to turn the money back that you have perhaps bet
    your company on a short-term bet and done well yourself
    personally, if you know people can come after you and ask for
    that money back, I think it concentrates the mind wonderfully.
    So thank you for that.
        Mr. Atkins. If I could interject one thing.
        Chairman Johnson. Yes.
        Mr. Atkins. The United States is a lot different than other
    countries around the world. Our litigation system and the
    shareholder rights system is a lot different. And so I think
    the things that Chairman Pitt is pointing out ought to lead to
    some caution.
        And the other thing that troubles me very much when we talk
    about ``investor rights'' is that some owners are treated
    differently than others, and the sense that some people can
    pick up the phone and talk to and cut back-room deals or
    influence things because of their special interest or size I
    think is very troubling. And so what we need is more
    transparency, and to the extent that these special rules give
    certain shareholders more clout than others have I think is a
    very troubling development.
        Chairman Johnson. Senator Shelby.
        Senator Shelby. Thank you, Mr. Chairman.
        Mr. Atkins, in the self-funding situation, some
    commentators, as you well know as a former Commissioner, have
    advocated self-funding for the Securities and Exchange
    Commission. Self-funding I believe would make the SEC less
    accountable to Congress, and as a former Commissioner, what is
    your view about how self-funding for the SEC would change the
    incentive perhaps for Commissioners to properly execute their
    duties? Would it make them less responsible obviously to
    Congress, you know, if they did not have to come before
    Congress for an appropriation?
        Mr. Atkins. Yes, sir, I think that is a very important
    point. I am not in favor of the idea of self-funding. If I were
    to put myself in the shoes of you all on the other side of the
    table and considering the responsibility to taxpayers, I think
    it is incumbent to try to exercise oversight and understand
    what is going on: To have various departments and agencies of
    the Government go through the normal appropriations process, to
    justify their budgets and then make decisions as to who is more
    deserving of the capital that is going to be allocated. So, I
    think that transparency is very important, and I think it has
    done the SEC well over the last decade. Accountability is
    crucial.
        Senator Shelby. Thank you.
        I would like to address this question to the former
    Chairman, Mr. Pitt, and also to you, Mr. Atkins, as you both
    are former Commissioners of the SEC. Dodd-Frank enacted, as we
    all know, a number of changes. We have been talking about
    corporate governance. These changes give shareholders with 3-
    percent holdings I believe substantially more power than the
    average investors. Could these provisions cause companies to
    defer to the political or financial agendas of certain special
    interest shareholders at the expense of building the company's
    value for the benefit of all shareholders? And how do these
    changes benefit individual investors if they do? Mr. Pitt,
    former Chairman.
        Mr. Pitt. Thank you, Senator Shelby. I have a basic concern
    with any provision that holds a corporation's shareholders
    hostage to the views of special interests with respect to a
    company. The ultimate goal of accountability, which is what was
    behind these provisions, is a good one, but the solution was
    much simpler than the one that the SEC has come up with. The
    solution was simply to allow solicitations electronically so
    that there would not be the same fervor to make use of
    management's proxy materials; and, second, to rely on State
    law. The State law determines whether shareholders have the
    right to amend their by-laws, and if State law gives
    shareholders that right, then they ought to be able to exercise
    it subject to restraints on inundating the corporation with too
    many proposals and the like.
        So I think there is a way to achieve the goal, but it is
    not necessarily the one that Dodd-Frank contemplated.
        Senator Shelby. Mr. Atkins.
        Mr. Atkins. Yes, sir. About 5 years ago, at an SEC
    roundtable, in response to a question that I asked, a couple of
    witnesses basically admitted that these sorts of provisions add
    more arrows to their quiver for them to be able to advance in
    smoke-filled rooms--out of sight of the public and without any
    transparency--to advance their ulterior motives and their
    special agendas. And in the past, State pension funds have also
    been basically in cahoots from time to time with some of these
    special interests.
        So I think that lack of transparency is very troubling, and
    for an agency like the SEC, which stands for transparency in
    the marketplace, I think that is a troubling development.
        Senator Shelby. Mr. Massey, Dodd-Frank shifts the
    regulation of certain registered investment advisors from the
    SEC to State regulators. Will the State regulators have the
    resources and expertise necessary to properly oversee the
    investment advisors that would be moved to the States under
    their jurisdiction? And how would investors be helped by the
    change, if they will?
        Mr. Massey. Senator, right now the estimate from the SEC is
    that approximately 3,200 investment advisor firms that are
    currently federally registered would be shifted over to State
    registration and regulation in the so-called investor advisor
    switch. NASAA has been preparing for this switch for more than
    a year now and has created a number of tools to make the
    State's role in regulating these investment advisors much more
    intelligent and much more efficient and much more responsive
    rather than a rubber stamp type of treatment of the examination
    requirement.
        We have risk analysis software that is distributed to the
    States to let them adjudge the relative risk of the various
    firms so they can set their priorities of examination. We have
    uniform examination procedures so that every examination is
    going to ask the same question of every investment advisor out
    there. And, most importantly, the shift has motivated the
    States to have an outreach program by which road presentations
    are conducted in major cities for not only existing State
    registered investor advisors but also Federal advisors that are
    coming over, to let the Federal advisors know who the regulator
    is, to establish a positive working relationship with the State
    regulator, and to set up a good working relationship with what
    I refer to as the legitimate side of the industry so that the
    local cops on the beat can take their enforcement resources and
    put them against the Ponzi scheme operators.
        Senator Shelby. Ms. Roper, recently the National
    Association of Manufacturers estimated that the new Dodd-Frank
    disclosure requirement with respect to conflict minerals, such
    as the Congo and so forth, would cost between $9 billion and
    $16 billion--in other words, to the industry--rather than the
    $46 million that the SEC estimated. Are you concerned at all
    that this provision could end up costing investors more than
    the benefit that they will receive from disclosure? You know,
    we are all interested in doing the right thing, but we are also
    interested in some balance of cost here for our manufacturers.
        Ms. Roper. We did no work on that provision. I do not know
    anything about the provision. I have no basis for analyzing
    either of those cost estimates, so I just do not have a basis
    for commenting.
        Senator Shelby. OK. Ms. Simpson, do you have any knowledge
    base on this?
        Ms. Simpson. Thank you. Yes, we actually are great fans of
    getting all relevant and material information properly provided
    to shareholders. But the root is going to be to ensure that,
    you know, the costs do not outweigh the benefits. That is a
    very sensible point of view.
        I have not seen the underlying estimates that you are
    referring to, so I cannot comment on that, but it would seem to
    me quite extraordinary in this day and age of the Internet that
    a company could not find the relevant information in a cheap
    and affordable way.
        Senator Shelby. OK. Mr. Turner, one last question. In your
    testimony here today, among other things, you noted that in the
    lead-up to the financial crisis, and I quote, ``most of the
    regulators were captured by industry.'' Your words. In your
    view, which regulators were captured by industry or are
    captured by industry? And if a regulator is captured by
    industry, isn't the solution to make the regulator more
    accountable to the American people by subjecting the regulators
    to more congressional oversight? That is one way, maybe not the
    only way. In other words, who was captured by industry?
        Mr. Turner. I certainly think the banking regulators were
    captured by industry. The Federal Reserve--I have dealt with
    the Fed for much of my career, and I think even Dr. Greenspan
    has acknowledged, I think, probably the best way to deal with
    it is through much greater transparency on the part of the Fed.
    I think the SEC in the mid-part of the last decade was
    extremely captured by industry, and contrary to what Paul said,
    the divisiveness at that point in time o the Commission was
    tremendous as well. In fact, I think the current Chairman,
    Chairman Schapiro, should be applauded for trying to dial the
    tone back a little bit.
        But on your point about accountability, I do think both the
    Fed and the securities regulator, as well as the CFTC, all of
    them need to be subjected to much more rigorous oversight. I
    will tell you leading----
        Senator Shelby. Like right here.
        Mr. Turner. Like right here, Senator. You are absolutely
    right. And, in fact, I will tell you that myself and others--
    and I think Barb Roper was included in the group at the time.
    Just as we were getting into the subprime crisis, probably in
    about January of 2007, there was a group of us who came and met
    with the Banking Committee staff here as well as the House
    Financial Committee staff and members, and we urged at that
    point in time much greater, robust, in-depth oversight of the
    Commission. And, unfortunately, it did not happen in either
    institution.
        I will say on the funding issue, I believe you have been
    one of the proponents--I have testified before you when you
    pleaded with the SEC Chairman to take more funding, and I
    greatly applaud you, Senator, for that. We probably disagree on
    the issue of self-funding. I am a strong proponent of self-
    funding. I think you can self-fund and still do the oversight
    hearing. I understand appropriators, people on the
    Appropriations Committee, like that oversight, so I understand
    where you are coming from.
        Senator Shelby. Like the two of us.
        [Laughter.]
        Mr. Turner. Yes, and I think there is actually----
        Senator Shelby. He wants to give up his power. We do not.
        Mr. Turner. But I think you could have done it. But, you
    know, whether you self-fund or not, the most important thing is
    that the money that you scheduled out in Title IX get delivered
    to the SEC. And my problem and my concern is if you look at the
    first year, 2011, which is $1.3 billion, you are not even
    hitting that target. And if you are not even hitting that
    target, I have no expectation that you will get the SEC the
    funds that it needs. And I think the fact that you saw their
    staff cut by 10 percent from 2005 to 2007, $75 million cut in
    spending, the management was absolutely atrocious at the agency
    at the time, and I would have encouraged you to bring them up,
    as we did in January of 2007, and ask them what they were
    doing, because they did get the job done. And they did a great
    disservice to investors.
        Senator Shelby. You are not saying to us today here in the
    Banking Committee that the SEC's whole problem or the Federal
    Reserve's whole problem--of course, they have no funding
    problem.
        Mr. Turner. Certainly it was not the Fed because they got
    self-funded.
        Senator Shelby. It was a lack of money? Or was it a lack of
    will and a lack of action and a lack of diligence?
        Mr. Turner. I think first and foremost it was a lack of
    will and a lack of diligence.
        Senator Shelby. Thank you.
        Mr. Turner. I think in some cases funding contributed to
    that.
        Senator Shelby. Thank you, Mr. Chairman.
        Chairman Johnson. Senator Reed.
        Senator Reed. Thank you, Mr. Chairman, and thank you for
    your testimony.
        This issue of funding I think is central because Mr. Pitt
    expressed a concern I have, that we will give responsibilities
    to the SEC and not the resources to get them done, and that
    goes for the CFTC also. And so I was a strong proponent of
    self-funding even though I am also an appropriator.
        I presume, Mr. Pitt, that ultimately you would be
    supportive of some type of self-funding mechanism?
        Mr. Pitt. Yes. I believe that there are a number of
    financial regulators who have the ability to self-fund, and the
    SEC should not be a stepchild. I think the concerns that have
    been expressed about accountability make it imperative that if
    self-funding is granted--and I believe it should be--that there
    be complete accountability before the appropriate committees,
    this Committee and others, so that you can assess where the SEC
    proposes to spend its money. But you would wind up saving
    taxpayers a billion plus dollars if the money did not come out
    of the Treasury, as it presently does.
        Senator Reed. Thank you, Mr. Pitt.
        The back and forth has revealed the issue of accountability
    as well as funding, and there are ways for accountability. One
    is this Committee--in fact, probably a more effective way, if
    used correctly, than the Appropriations Committee. But also
    there is the issue of regulatory capture, and as you point out,
    every other regulatory agency, except the CFTC, financial
    agency, is self-funded. But there is still the issue of
    regulatory capture. But I think that has to be resolved
    probably in other forums. I do not see anyone here--if someone
    would like to put their hand up and say if the Fed should be
    subject to the appropriation process, do I have any takers?
    Barbara? Not even Consumer Federation of America.
        [No response.]
        Senator Reed. So I think this issue of----
        [Laughter.]
        Senator Reed. I think this issue of sort of, well, if they
    do not have appropriate oversight by the appropriators, they
    just will not be accountable to the American people defies the
    financial system we have in place today.
        Ms. Simpson, you talked about majority voting, and I just
    want to clarify because the proposal that we had in the
    legislation I think is essential. It fell out, unfortunately.
    That would have required a director to receive the majority of
    the votes cast. Today, a director could be elected to a board
    with 10 percent of the votes or one vote if no one decides to
    cast votes. That happens sometimes and leads to anomalies. So
    effectively without this majority--without the ability to
    nominate directors and then without the ability to insist they
    at least get a majority vote, the leverage of shareholders is
    diminished.
        Now, we have made some improvements, but you would suggest
    we should go further in terms of a majority vote. Is that
    correct?
        Ms. Simpson. Yes, thank you. And the situation you describe
    is not that uncommon. We sort of had a look back last year.
    Just in the Russell 3000, there are over 100 directors who did
    not win a majority of the vote and who are still just quietly
    sitting on the board. So far this year, another 36. So this is
    an environment which is really very troubling. You know, this
    may be a democracy, but it is of a very peculiar sort if you do
    not have to win the election in order to keep yourself in
    place. And, of course, the comment that was made about special
    interests, I have to say with great respect to be rather like a
    politician saying we should not trust the electorate with
    something as important as the vote.
        Senator Reed. But let me follow up on that line of
    criticism that, well, this creates this lack of transparency
    because you might have big voting blocs doing things.
    Essentially whatever benefit you gain is equally shared by
    every other shareholder. Is that----
        Ms. Simpson. Yes, that is absolutely right, and two points
    on that. First, CalPERS, being a great champion of
    transparency, thinks that has to apply to us as well. We put
    all of our votes on our Web site. Our policies are there for
    you to see. And I think that is very important, and I would
    encourage all investors to follow the same approach.
        The other issue about the financial benefit is really
    important. So even though CalPERS is so big, typically we will
    hold about half a percent of a company, and if we want to do
    anything, first of all, we have to collaborate with others;
    and, second, you are quite right, the benefit is shared.
        We had a report done for our board just before the end of
    last year looking at 10 years of our investor engagement to see
    what had happened at those companies, and sure enough, you went
    from a situation where that group of companies went from
    underperforming to producing excess returns. And, of course,
    that is not just going to help CalPERS; it is going to help
    every other shareholder. So there is a net-net gain in the
    market.
        Senator Reed. I think one of the dilemmas or sort of
    contradictions is that the presumption, of course, is that
    corporations are run for the benefit of shareholders, but I
    think particularly when you look at the companies that failed--
    Lehman Brothers, Bear Stearns--they were not being run for the
    benefit of shareholders at all. They were being run for the
    benefit of the management, with huge rewards to management. In
    fact, as I sort of look back, it was a public ownership model
    and a private compensation model, and it worked very well
    until, you know, the tide turned.
        In many respects, shareholders are the least powerful
    people in corporations, and they are, according to corporate
    law--and I will defer to Mr. Pitt and others. They are the
    ultimate owners. They are the ones which every director has a
    fiduciary duty to and manager has a fiduciary duty to. But it
    appears from what has happened in the lead-up to this collapse
    that shareholders were sort of the last people being
    considered. Is that your view?
        Ms. Simpson. Yes, I do agree with you. You know, we are the
    one-armed paper hanger. We need to have the tools to hold
    boards accountable, and I think what you will find, my
    conclusion is that if shareholders have votes that do not
    really matter and they do not have the ability to intervene in
    an effective way, they think, OK, the system is designed.
    Either you can sell or you can sue. Now, that is not going to
    work for CalPERS because we are too big and we are too long
    term. But we really do need the tools to be able to behave like
    owners, and that is why--and I know it has been said, well, we
    could go--Mr. Pitt has said we should go door to door with
    companies in different States filing resolutions to have
    amendments. But to be honest, we see this as a market
    fundamental. If capitalism cannot turn to the owners to hold
    companies accountable, then we should not be surprised when we
    have the problems that we do.
        Senator Reed. Thank you very much.
        Chairman Johnson. Senator Menendez.
        Senator Menendez. Well, thank you, Mr. Chairman. Thank you
    for holding the hearing.
        I look at this issue, and I think about what is the market.
    The market is a series of investors seeking to invest in
    companies that hopefully will provide them a yield, a return on
    their investment so that they can personally prosper. And the
    flip side of that is a series of companies looking for
    investors so that they can grow their companies and prosper as
    well. And so there are two essential ingredients here, and one
    of them, but for their investments, would really not make the
    market what it is. Without them there is no market. And so
    investor protection seems to me to be incredibly important.
        And I know that some say that the CalPERS of the world and
    the unions of the world are special interests. They happen to
    be the biggest singular investors along the way in this
    marketplace. So I do not look at them as a special interest. I
    look at them as a significant part of the marketplace,
    representing a broad universe of individuals at the end of the
    day who are taking their savings and making investments for
    them. And so ultimately it seems to me that investor protection
    in their respect as well is a very broad one because they
    represent a very large universe of people, and at the end of
    the day, more than ideological issues, I think they want to see
    their investments grow on behalf of the people who they invest
    in. So I have a little different view.
        I have two sets of questions that I want to pursue. One is,
    Ms. Roper, with you. Soon after Dodd-Frank was signed into law,
    the SEC put out a study recommending a consistent best interest
    of the customer or fiduciary duty standard for broker-dealers
    and investor advisors, a priority that both Senator Akaka and I
    successfully fought for in the Wall Street reform with our
    honest broker amendment. And I know that the Certified
    Financial Planner Board of Standards recently sent a petition
    to the SEC with more than 5,000 signatures of financial
    planning professionals who favor fiduciary duties for all
    financial professionals giving investment advice.
        Do you agree with having a high and consistent standard of
    the best interests of the customer for all stockbrokers and
    financial professionals? And if so, why?
        Ms. Roper. Absolutely, I agree, and any of you who are the
    recipients of my nearly daily letters on this subject during
    the legislative battle maybe remember that. This is in many
    ways the most important issue for retail investors. The last
    investment decision most people will make is who to rely on for
    recommendations. And the situation in the marketplace is this.
    Mr. Atkins says, you know, broker-dealers and investment
    advisors are doing two different things, so they should be
    subject to two standards. But let us review that. They call
    themselves by titles that are indistinguishable to the average
    investor. They both offer extensive personalized investment
    advice. And they both market their services primarily based on
    that advice. If they are doing two separately distinctly
    different things, why has the SEC allowed them to present
    themselves in a way that makes it impossible for the average
    investor to distinguish between them?
        So if the investor cannot distinguish between them--and we
    know from survey research and focus group research that they
    cannot. In fact, the RAND study found that investors could not
    tell whether their personal advisor was a broker or an
    investment advisor, even after the differences had been
    explained to them. So they cannot go into the marketplace and
    make an informed decision based on an understanding of what
    services are being offered or what the standard of conduct is
    for those services.
        So the reform that is needed is to ensure that when they
    are doing the same thing, when they are providing personalized
    investment advice to retail investors, they should be subject
    to the same standards.
        Now, the brilliance of the proposal that the SEC has put
    out there is that it recognizes both the need to raise the
    standard and the need to preserve investor access to a
    transaction-based source of advice. Not every investor wants
    ongoing account management. Not every investor wants, you know,
    comprehensive financial planning. So investors benefit if there
    is a source of advice available that is compensated through
    commissions, that offers advice on a transaction basis. And the
    SEC uses the authority that Dodd-Frank gave it to put out a
    proposal that recognizes this. Brokers can still charge
    commissions. Brokers can still sell proprietary products. They
    can sell from a limited menu of products. And the SEC has said
    they will deal with the principal trading issue. They are
    making every effort to ensure that this advance in terms of the
    standard of conduct nonetheless retains investor choice.
        Senator Menendez. At the end of the day, they can make all
    of their commissions, but they have one standard. That would be
    the best interest of the investor.
        Ms. Roper. Absolutely.
        Senator Menendez. Otherwise, you could very well lead them
    to investments that would not necessarily be in their best
    interests, but for the standard----
        Ms. Roper. Absolutely. Absolutely. There is--you know,
    there is a difference between what you can do to satisfy a
    suitability standard and what you would have to do to satisfy a
    fiduciary duty. Now, they start from the same basis. You have
    to know the customer. You have to do that analysis to determine
    what is appropriate for that investor. The fiduciary duty
    requires the broker to take an additional step and have a
    reasonable basis for believing that what they are recommending
    is not just appropriate for the investor, but in the best
    interest of the investor within the limited menu of options
    that they have available to sell.
        And where they have conflicts of interest, they are still
    able to operate, but they have to fully disclose those
    conflicts of interest to the investors. So they can no longer
    make recommendations based on their own financial interest
    because they get higher commission without disclosing that
    conflict to the investor and without then ensuring that that
    recommendation is also in the best interest of the investor,
    and not just their own bottom line.
        Senator Menendez. Thank you very much.
        I have one other question. I want to turn to Mr. Turner.
    Mr. Turner, one of the provisions that I successfully included
    in Dodd-Frank would require publicly listed companies to
    disclose in their SEC filings the amount of CEO pay, the
    typical worker's pay at that company, and the ratio of the two.
    Now, over the last few decades, CEO pay has skyrocketed while
    the median family income has actually gone down.
        There are those in the House that have opposed this because
    they say it is too burdensome for companies to disclose that,
    and second, that the information is not useful to investors. I
    find it hard to believe that companies that do all kinds of
    complicated calculations for everything else involving their
    revenues and expenses would find it difficult to take their
    2,000 employees, figure out how much employee number 1,000 is
    paid, and report that one number to the SEC. It seems to me
    that it is much more about hiding the fact that, many times,
    CEOs have 400 times the pay of their typical employee.
        Do you think it would be burdensome for companies to figure
    out how much their median worker is paid and report that
    number?
        Mr. Turner. Senator, as you know, I was an executive in a
    semiconductor company that was international. We were one of
    the larger importer-exporters at the time, in fact, in the
    country, and I do not think--in fact, I would be surprised if
    for most companies that was a difficult thing. First of all, it
    is something you ought to be managing, so you only manage what
    you measure in the first place. And if the compensation
    committee of a board, and I have sat on some of these boards,
    was not even looking at that ratio, I would probably be
    concerned. It would tell me there is a lack of management here,
    a degree of management that should exist.
        But in terms of just getting the raw data, no, I think
    there are ways you can go about it. The SEC can implement some
    rules. I think they have been encouraged to implement some
    rules that are reasonable that would not have a great deal of
    cost. And again, let us keep in mind, when we talk about cost,
    this cost global markets $28 trillion. It cost U.S. investors
    $10 to $11 trillion. Much of that was due to very, very poor
    incentive packages. And in light of the fact that executive
    compensation this year--last year was up 23 percent while Main
    Street wages went up zero--zero--I think it is fair to turn
    around and start managing and taking a look at that issue, and
    I think compensation committees should. I think they can. I
    think CFOs in the same role I was in can get that number. And,
    no, I do not expect that to be a high-cost number. If it is a
    high-cost number, that company probably has some other
    management problems, as well.
        Senator Menendez. Thank you. Thank you, Mr. Chairman.
        Chairman Johnson. Senator Akaka.
        Senator Akaka. Thank you very much, Mr. Chairman, and I
    welcome our witnesses here as we hear what is the latest that
    has been happening to the Dodd-Frank bill and how it has
    impacted our national community.
        Ms. Roper, you have mentioned that the Dodd-Frank bill is a
    multi-protection framework and it provides tools that investors
    need to deal with, and I want to speak toward the Investor
    Advocate. In the Office of the Investor Advocate, which was
    created to empower retail investors and represent their
    interests with the SEC and SROs, there will now be an
    independent external check that investors did not have during
    the Madoff or Stanford Ponzi schemes or the financial crisis.
    My question to you is, how will the structure of the Investor
    Advocate affect its ability to achieve its purpose?
        Ms. Roper. I think we know from looking at how Inspector
    Generals function within agencies that if we want them to have
    any sort of ability to hold the agency accountable, they have
    to be independent and they have to have the ability to report
    out when they find problems. And the strength, I think, of the
    investor protection, the Office of Investor Advocate provision
    in this Act are precisely those, frankly, that former Chairman
    Pitt has criticized. They are the provisions that ensure that
    this office does not become just another weak and meaningless
    addition to the SEC bureaucracy.
        You know, agencies do not like their IGs. They are
    uncomfortable with that function within the agencies. But I
    think we can all agree that they do perform a valuable function
    in terms of holding the agency accountable. The Office of
    Investor Advocate has exactly that same potential, to hold the
    agency accountable for being responsive to investor concerns.
        Now, I find it interesting that people who say that the
    SEC's job to be the investor advocate are so threatened by the
    notion that it would be held accountable for listening to
    investor concerns. The Office of Investor Advocate cannot
    compel them to do anything. But they cannot be ignored, because
    they have to--the Commission has to respond. They cannot be
    denied access to the paperwork that they need to analyze
    proposals. They have to be built into the process of developing
    the Commission's rule proposals and agenda.
        You know, I think that it is instructive that these same
    provisions that are designed to make the agency accountable to
    investors are viewed as so threatening by some. When I hear
    these words, the SEC, we do not need this because the SEC is
    the investor advocate, well, I have been an investor advocate
    for 25 years and, you know, I do not think you would find a
    single investor advocate who would agree with that statement.
    It is not the SEC's job to advocate on behalf of investors, and
    in the best of times, investors find it very difficult to have
    their voices heard.
        So I think this is an important addition to the Act. I look
    forward to having the office established and up and running,
    and I think we can trust--the Chairman said, we will appoint
    this person. We will not put cowboys into that office who will
    behave recklessly. It is not in their interest.
        And just one final note. This question of the--the threat
    is that the Investor Advocate can criticize the agency action.
    What we are talking about here is that they report to their
    oversight committee. Now, Members of this Committee just
    expressed a lot of concern about the ability of Congress to
    provide effective Congressional oversight. The fact that the
    Office of Investor Advocate will be reporting to the oversight
    committee should ensure that the committees can do a better job
    of providing oversight to ensure that the Commission is
    effectively protecting the interests of investors.
        Senator Akaka. Thank you.
        Mr. Massey, you have mentioned that this bill should be
    implemented fully, and Mr. Turner also said that the law should
    be enforced. Mr. Massey, NASAA's statement on an SEC study on
    the obligations of broker-dealers and investment advisors said
    that a uniform fiduciary standard would have a, and I quote,
    ``significant positive impact on investors.'' Do you have
    anything to add to Ms. Roper's comments about how investors
    would be positively impacted by a uniform fiduciary standard?
        Mr. Massey. Senator, I agree substantially with what Ms.
    Roper said. I would add that I believe that it is appropriate
    to introduce a fiduciary standard on those brokers who are
    presenting themselves as purveyors of investment advice.
        The brokerage industry has gone to a marketing mode in
    which it holds itself out to retail investors as being trusted
    advisors. Surveys have shown that regular retail investors do
    not know the difference between a stockbroker and an investment
    advisor, and they also believe that when they are sitting in
    front of a financial professional, that that financial
    professional is acting in their best interest, but that is not
    the situation.
        The fiduciary duty that has been discussed would be imposed
    only on the brokers who are providing investment advice just
    like investment advisors provide investment advice. So if you
    are going to present yourself as a trusted advisor, you ought
    to be held to the standards of a trusted advisor and be
    responsible. The benefits to the investors would be a mandatory
    disclosure of any conflicts of interest that might show any
    kind of bias in that advice that is being communicated. The
    benefits would be to obtain full information about the--
    enabling the investor to choose the best performing product at
    the lowest expense to the investor. It makes sense to me and we
    fully support it.
        Senator Akaka. Thank you very much. Thank you, Mr.
    Chairman.
        Chairman Johnson. Senator Hagan.
        Senator Hagan. Thank you, Mr. Chairman, and thank you for
    holding this hearing on investor protection after the financial
    crisis.
        I did want to welcome David Massey, who is from my State in
    North Carolina, and he has been a strong advocate for
    investors, especially those who lack the expertise or resources
    to protect themselves, so thank you for being here, too, and
    all of thee other panel members for being here.
        I did want to ask Mr. Pitt, Mr. Atkins, and Mr. Turner a
    question concerning the Department of Labor. Right now--
    recently, the DOL has unilaterally proposed regulations under
    ERISA that would redefine the term ``fiduciary,'' and many of
    my colleagues, I know, have expressed concerns about the
    coordination that is taking place, or the lack of coordination,
    too, between the SEC and the Department of Labor. In light of
    the SEC's recommendation that the Commission use its authority
    under Dodd-Frank to promulgate a uniform standard, and given
    you all's expertise at the SEC, I wanted to get your thoughts
    on this matter. Are you concerned that DOL's changes have not
    been made in coordination with the SEC, and what could some of
    the consequences of this coordination, if it does not take
    place, if we do not have the coordination?
        Mr. Pitt. I believe in requiring coordination between
    agencies of Government. It is one Government, and when Paul
    Atkins and I were there, when we would take enforcement actions
    that affected national banks or affected entities overseas, we
    would coordinate with the Federal Reserve Board or the State
    Department. I think there is no place for unilateral action
    when other agencies have a vested interest. And indeed, in the
    context of pension investments, the SEC has a lot of expertise
    to offer in that area.
        Senator Hagan. Mr. Atkins?
        Mr. Atkins. Yes, Senator. I agree with Chairman Pitt. Both
    SEC and the Department of Labor have overlapping jurisdiction
    with respect to these pension funds, 401(k) offerings, which
    touch just about everybody in the country. So, it is really
    vital that they coordinate, and as you are saying, the current
    situation has been characterized apparently by a lack of
    coordination. What is really important here are the
    consequences of unilateral action. It will raise costs and
    restrict choices that people have with respect to their 401(k)
    programs. The huge liability that will come down to peripheral
    actors will really discourage those people from being involved.
        Senator Hagan. I have heard that quite a bit.
        Mr. Turner?
        Mr. Turner. Senator Hagan, the proposals that you refer to
    relate to a fiduciary standard that, as I recall, was adopted
    back at the time of ERISA, back in 1974. So things have
    dramatically changed since then. I think the Secretary over
    there is absolutely correct that they need to be updated. It
    has been, what, 35, 36, 37 years since those things were done,
    and investment funds like 401(k)s, IRAs, et cetera, have
    dramatically changed since then. I have served on the board of
    a mutual fund as a trustee. I currently am an independent
    member of the board of a $40 billion pension fund, as well, so
    have to deal with those fiduciary laws. And I do think that
    they need to be changed and updated.
        The things she is changing to, in fact, are already in many
    instances incorporated into our contracts, so she is catching
    up the law to already what exists in many of our business
    contracts. So I do not think it is as dramatic a change as what
    some criticize her for. So I think they are good rules. I think
    she should move forward with them. But to the same point that
    Paul and Harvey say, though, in this city, it is always good to
    have people coordinate with one another and be talking with one
    another. I do not care whether it is the banking regulators,
    the SEC, CFTC. The more you can get in the room and hash over
    things, I think that is good.
        But ultimately, the independence of any agency or any
    cabinet position, I think, is important. Ultimately, it is the
    Department of Labor Secretary that is responsible for those
    rules. So if she goes through consultation, including with the
    SEC, and then decides after that to go ahead and move, I do not
    have a problem with that because I think she is moving wisely
    in the right direction. But I would certainly encourage her to
    do that after consultation with the Commission.
        Senator Hagan. Well, it seems to me that it would be a
    problem if we have two different definitions of ``fiduciary,''
    one at the DOL and then one at the SEC.
        Mr. Turner. I would say this, that the things she is
    dealing with--there are two different things here. The
    fiduciary standard she is dealing with is dealing with what
    ultimately runs to the trustees on those funds. It will be
    applied broader, and I think to that extent, your concern has
    got some basis. But I do not think it is necessarily going to
    be the same fiduciary situation that the SEC necessarily has,
    so I do not know that, ultimately, at the end of the day, if
    they all talk to one another, I think you can have them talk to
    one another until they get blue in the face, and they may
    actually find that they do not have the same fiduciary standard
    at the end of the day.
        Ms. Roper. Yes. I think there is an issue here. I actually
    think if you look at it, you will find that the changes to the
    fiduciary definition under DOL actually bring it closer into
    alignment with the definition of fiduciary under securities
    laws. The problem is not so much with the definition, but then
    what flows from that definition under ERISA.
        And when I first started looking at this issue, I assumed,
    oh, it is fiduciary duty. I am all for it. As we have looked at
    the issues more closely, there are issues with the ERISA
    proposal, I mean, with the DOL proposal on fiduciary duty and
    they are varied. One of them is that there is a conflict with
    the business conduct rules for swaps dealers. And I was
    involved working with the drafters in writing that section of
    the legislation and the clear intent was to avoid bringing the
    ERISA fiduciary duty into this interaction between swaps
    dealers and special entities because it then brings--you know,
    you cannot have an adverse interest. You basically cannot be a
    counterparty.
        Now, members worked very hard to draft the legislation in a
    way that did not bring ERISA into play. Under the DOL fiduciary
    definition, there are things that swaps dealers that would have
    to do to satisfy the business conduct rules that would make
    them fiduciaries under the DOL definition and then would
    preclude them from acting as counterparties, precisely what
    Congress was trying to avoid.
        There are other problems. I think a legitimate concern
    about what happens in, say, the individual retirement account
    context----
        Senator Hagan. I am hearing a lot of concerns on that.
        Ms. Roper. Right. If you bring into play the DOL, the ERISA
    restrictions on any third-party compensation, say, 12(b)(1)
    fees, they are not--these are not irresolvable problems. I
    mean, you can--but the real issue here is so DOL rolled out
    what I think is a very well intended definition and one that
    does, in fact, come closer to the SEC definition, but it rolled
    them out without putting out the prohibited transaction
    exemption explanations at the same time. So people do not know
    how it is going to work in the real world. And all of ERISA
    seems I am not an ERISA expert, but all of it seems to be
    devoted to figuring out what the prohibited transaction
    exemptions are.
        And so you cannot sort of reasonably comment on the DOL
    proposal of the fiduciary definition unless you know how it is
    going to interact with those exemptions. So while we would very
    much like to see the agency move forward with a proposal that
    is designed to benefit investors, there are issues with that
    definition that need to be resolved before it is finalized.
        Senator Hagan. I see that my time has expired, but I do
    have other questions that I will submit to the record. Thank
    you, Mr. Chairman.
        Chairman Johnson. Thank you.
        Senator Shelby has one last question.
        Senator Shelby. Just a few observations. Thank you, Mr.
    Chairman, for calling this hearing. I think it is important.
        One of my observations, and I have asked everybody that has
    come before this Committee for the last 25 years that were
    nominated for the Securities and Exchange Commission, a
    Commissioner and the Chairman, who owns a corporation? Who
    does? And what does a corporation exist for, for whom? The
    shareholder. Who owns it? The shareholder. Not management. Not
    special interests and so forth. In other words, shareholders,
    the investors, certainly not the directors or management.
        I believe that we need to have--create conditions, that is,
    our regulators and so forth, where a corporation cannot be
    hijacked for financial reasons by management or by special
    interests also hoping to advance a political agenda, because
    why do you buy stock? To make money, for it to grow and so
    forth.
        So our challenge, I believe, is how do we balance all of
    this without destroying something. We certainly do not want to
    give management a free pass. On the other hand, I do not think
    we ought to give special interests a free pass to hijack a
    company to advance something other than making money for me or
    my pension fund or my mutual fund or whatever. That is my
    observation. That is a challenge for us, as I know, and I do
    appreciate all of you coming here today. I think we had a
    lively discussion and a very important one.
        Thank you, Mr. Chairman.
        Chairman Johnson. I thank each witness for testifying and
    we appreciate your concern for the protection of investors in
    the United States securities markets.
        I ask all the Members of the Committee to submit any
    questions for the record by close of business next Tuesday, and
    I ask the witnesses to submit your answers to us in a timely
    manner.
        This hearing is adjourned.
        [Whereupon, at 11:58 a.m., the hearing was adjourned.]
        [Prepared statements, responses to written questions, and
    additional material supplied for the record follow:]

                       PREPARED STATEMENT OF DAVID MASSEY
       NASAA President and North Carolina Deputy Securities Administrator
                                 July 12, 2011

        Chairman Johnson, Ranking Member Shelby, and Members of the
    Committee, I'm David Massey, Deputy Securities Administrator for North
    Carolina and President of the North American Securities Administrators
    Association, Inc. (``NASAA''). I am honored to be here today to discuss
    how the Dodd-Frank Wall Street Reform and Consumer Protection Act (the
    ``Dodd-Frank Act'') is providing enhanced protection to investors,
    particularly Main Street Americans who are looking to lawmakers and
    State and Federal regulators to help them rebuild and safeguard their
    financial security.
        The Wall Street reforms and investor protection provisions in the
    Dodd-Frank Act were born out of necessity. The financial crisis made it
    clear that the existing securities regulatory landscape required an
    overhaul. NASAA sincerely appreciates the work of Chairman Johnson and
    Members of this Committee to ensure that investor protection remained
    the foremost goal of the legislative effort to usher in the next
    generation of financial services regulation.
        This comprehensive law was crafted to promote stronger investor
    protection and more effective oversight to help prevent another
    economic crisis and restore the confidence of Main Street investors.
    The Dodd-Frank Act addresses a number of critical issues for investors
    by incorporating disqualification provisions to prevent securities law
    violators from conducting securities offerings under SEC Regulation D,
    Rule 506; strengthening the accredited investor standard; and
    increasing State regulatory oversight of investment advisers. Dodd-
    Frank also includes a provision to safeguard senior investors from
    unqualified advisers and creates an investor advisory committee to
    advise the SEC on its regulatory priorities. In two other priority
    areas for investors, fiduciary duty and arbitration, the law authorizes
    the SEC to take action to provide enhanced protections and remedies for
    investors.

    Role of State Securities Regulators
        State securities regulators have protected Main Street investors
    from fraud for the past 100 years, longer than any other securities
    regulator. From the enactment of the first blue sky securities law in
    Kansas in 1911, State securities regulators continue, more so than any
    other kind of regulator, to focus on protecting retail investors. Our
    primary goal has been and remains to advocate and act for the
    protection of investors, especially those who lack the expertise,
    experience, and resources to protect their own interests.
        The securities administrators in your States are responsible for
    enforcing State securities laws, the licensing of firms and investment
    professionals, registering certain securities offerings, examining
    broker-dealers and investment advisers, pursuing cases of suspected
    investment fraud, and providing investor education programs and
    materials to your constituents. Like me, 10 of my colleagues are
    appointed by State Secretaries of State, five come under the
    jurisdiction of their States' Attorneys General, some are appointed by
    their Governors and Cabinet officials, and others work for independent
    commissions or boards. Many call us ``local cops on the securities
    beat.'' I think of my State colleagues at NASAA as a national network
    of local crime fighters working to protect investors.
        Securities regulation is a complementary regime of both State and
    Federal securities laws, and we work closely with our Federal
    counterparts to uncover and prosecute violators of those laws.
        States have been the undisputed leaders in criminal prosecutions of
    securities violators because we believe in serious jail time for
    securities-related crimes. Over the past few years, ranging from 2004
    through 2009, State securities regulators have conducted nearly 14,000
    enforcement actions, which led to $8.4 billion ordered returned to
    investors. And, we have worked to secure convictions for securities
    laws violators resulting in more than 6,000 years in prison.
        Traditionally, State securities regulators have pursued the
    perpetrators at the local level who are trying to defraud the ``mom and
    pop'' investors in your States. That allows the SEC to focus on the
    larger, more complex fraudulent activities involving the securities
    market at a national level.
        Even so, States have successfully exposed and addressed the
    conflicts of interest among Wall Street stock analysts by requiring
    changed behavior. We led all regulators on late trading and market
    timing in mutual funds. And State securities regulators continue to
    lead the nationwide effort to address problems related to the offer and
    sale of auction rate securities, an effort that has resulted in the
    largest return of funds to investors in history. As regulators, we are
    convinced that every investor deserves protection and an even break.

    Enhanced Investor Protections in Dodd-Frank
        As we enter our second century of investor protection, State
    securities regulators are at the forefront of investor protection. By
    passing and signing the Dodd-Frank legislation into law, President
    Obama and Congress signaled the beginning of a new era of investor
    protection and financial market oversight. Reforms now taking shape at
    the national level are giving new authority to State securities
    regulators to address the challenges facing 21st century investors.
        Trust in the markets must be restored if our system of capital
    formation is to thrive. The Dodd-Frank Act helps restore investor trust
    by enacting a number of much-needed investor protections that empower
    State securities regulators to protect citizens from fraud and abuse in
    the financial markets.

    Reducing Investor Risk in Rule 506 Offerings
        Section 926 of the Dodd-Frank Act took a necessary first step
    toward reducing risks for investors in private offerings by requiring
    the SEC to issue rulemaking excluding securities law violators from
    utilizing the Regulation D, Rule 506 exemption (``Rule 506'') from
    securities regulation. In 1996, the National Securities Markets
    Improvement Act dramatically curtailed the authority of State
    securities regulators to oversee these unregistered private offerings.
    Rule 506 offerings are also exempted from Federal oversight and the SEC
    generally does not review them, so they receive virtually no regulatory
    pre-screening.
        These unregistered private offerings naturally have become a
    favorite vehicle for unscrupulous promoters, who use the Rule 506
    exemption to fly under the radar. In 2009, more than 26,000 of these
    offerings were filed with the SEC with an estimated offering total of
    $609 billion. Section 926 took the important step of ensuring that
    promoters and brokers who have a criminal or disciplinary history will
    no longer be able to prey on investors by using this exemption from
    registration.
        We appreciate the inclusion in the Dodd-Frank Act of the so-called
    ``bad actor'' disqualifier language to prevent recidivist securities
    law violators from conducting securities offerings under Rule 506.
    However, we continue to believe the best way to deter fraud is to fully
    reinstate State authority over these unregistered offerings through the
    repeal of Subsection 18(b)(4)(D) of the Securities Act of 1933.
    Allowing State securities regulators to review these offerings provides
    regulators with a powerful weapon to detect and prevent fraud.
        As required under Section 926, the SEC recently proposed rules
    mandated by the Dodd-Frank Act to disqualify known securities law
    violators from using the exemption contained in Regulation D, Rule 506.
    The proposed rules protect investors without hampering legitimate
    capital-raising by disqualifying felons and other ``bad actors'' from
    evading registration and review. Under the proposal, an offering would
    not qualify for the exemption from registration if the company issuing
    the securities or any other person covered by the rule had a specified
    ``disqualifying event.''
        NASAA is a long-time supporter of the adoption of disqualification
    provisions for securities offerings under Rule 506. We commend the SEC
    for proposing disqualification provisions that are in line with many of
    our concerns and will continue to work with the SEC to strengthen the
    proposal.

    Strengthening the ``Accredited Investor'' Standard
        Private offerings were originally intended only for institutional
    investors and sophisticated individuals who were presumed capable of
    assessing risks and making investment decisions without the benefit of
    regulatory review and registration. The ``accredited investor''
    standard, which sets out certain financial thresholds that must be met
    before an investor can purchase private offerings, was adopted as a
    means of assessing which investors could presumably fend for
    themselves. The standard as adopted by the SEC in 1982 has remained
    unchanged. Inflation has severely diminished the standard and eroded
    the investor protection goals it was meant to serve. To make matters
    worse, investors, and particularly retirees, with much of their net
    worth tied to their homes have been able to meet these diminished
    standards and purchase risky private placements that they may not fully
    understand.
        NASAA has long advocated for adjusting the definition of
    ``accredited investor'' in light of inflation and has expressed concern
    at the length of time the thresholds contained in the definition have
    remained static.
        Section 412 of the Dodd-Frank Act addressed this problem by
    adjusting the financial thresholds in the definition of an ``accredited
    investor'', and by removing the value of the investor's primary
    residence from the net worth calculation. Dodd-Frank also directs the
    SEC, 4 years after enactment, and once every 4 years thereafter, to
    review the definition of ``accredited investor'' to determine whether
    the requirements of the definition should be adjusted or modified for
    the protection of investors, in the public interest, and in light of
    the economy. Upon completion of the review, the SEC may adjust the
    other economic elements of ``accredited investor''.
        Raising the standard for individual investors will provide greater
    protection for investors and will aid State regulators in enforcement
    activities by furthering more accurate suitability determinations for
    those individuals who choose to take greater risks by investing in
    unregistered securities.

    Expanding State Oversight of Investment Advisers with the IA ``Switch''
        The oversight of investment advisers has always been a partnership
    between State and Federal regulators, both of which are directly
    accountable to the investing public. Congress recognized the strong
    record of the States in this area when it enacted Section 410 of Dodd-
    Frank to expand State authority to include mid-sized investment
    advisers with $25 million to $100 million in assets under management.
        By the time this provision takes effect in mid-2012, State
    securities regulators will oversee the majority of all registered
    investment adviser firms. Having the States assume responsibility for
    mid-sized advisers will allow the SEC to focus on larger advisers.
    Investors will benefit from this change because it will enable the SEC
    to focus on the largest investment advisers, while mid-sized and
    smaller advisers will be subject to the strong State system of
    oversight and regulation.
        States continue to prepare to receive oversight of approximately
    3,200 mid-sized investment advisers from the SEC. Over the past year,
    NASAA members have been hosting a series of workshops for investment
    advisers in their jurisdictions. This outreach program is helping to
    educate federally regulated advisers about State registration and
    examination requirements. In addition, NASAA developed a memorandum of
    understanding calling for State securities agencies, when necessary, to
    assist one another with examinations of investment advisers. This MOU
    embodies the long-standing practice among NASAA members to work
    together to protect investors. NASAA members are actively engaged in
    sharing resources, including staff expertise, in an effort to bolster
    examination programs.
        Last month, the SEC extended its timeline for this ``investment
    adviser switch'' from later this year into the middle of 2012 to
    accommodate the reprogramming of the Investment Adviser Registration
    Depository (IARD) system and to give investment advisers sufficient
    time to transition from SEC to State registration. NASAA remains
    committed to coordinating the actions of the States in response to the
    SEC's timetable and we will continue to work with the SEC, as well as
    industry, to see that the switch by investment advisers from SEC
    regulation to State regulation goes as efficiently and seamlessly as
    possible.

    Extending the Fiduciary Duty
        State securities regulators routinely see the financial devastation
    caused when the interests of investors do not come first. That is why
    NASAA has consistently urged policymakers to protect investors by
    requiring all who provide investment advice about securities to be held
    to the fiduciary duty currently applicable to investment advisers under
    the Investment Advisers Act of 1940.
        Section 913 of the Dodd-Frank Act called for the SEC to examine the
    obligations of brokers, dealers, and investment advisers. We support
    the recommendations of the SEC staff report to apply a fiduciary duty
    to broker-dealers who provide personalized investment advice about
    securities to retail customers and believe it will have a significant
    positive impact on investors. NASAA looks forward to assisting the
    Commission as it develops rules to apply a fiduciary standard of care
    and loyalty to all who provide investment advice to ensure that this
    standard is as strong as the existing fiduciary duty of the Advisers
    Act.

    Delays to Important Investor Protections
        As with the fiduciary duty provision, Dodd-Frank shifts the
    ultimate responsibility to decide whether, and in what form, several
    important investor safeguards will be delivered. For example, the SEC
    and the Commodity Futures Trading Commission were given broad and
    sorely needed regulatory authority over certain segments of our
    marketplace, such as over-the-counter derivatives and private funds.
        Yet in spite of their increased responsibility, the agencies are
    operating at inadequate funding levels. NASAA has consistently urged
    Congress to support funding the SEC at the level requested by the
    Administration so that the agency can fully implement its
    responsibilities mandated by Dodd-Frank. We support funding the SEC at
    the $1.3 billion level authorized by Dodd-Frank to carry out the
    functions, powers and duties of the Commission for FY 2011.

    Giving Investors a Voice at the SEC
        The SEC has already deferred action on a number of new activities,
    such as the creation of the Office of Investor Advocate and the
    Investor Advisory Committee. In 2009, the SEC established an Investor
    Advisory Committee to provide the Commission with a variety of
    viewpoints regarding its regulatory agenda. The committee included a
    State securities regulator, along with other investor advocates, to
    make certain that all SEC regulatory actions serve the best interests
    of investors.
        This committee wound down in anticipation that legislation,
    ultimately the Dodd-Frank Act, would resurrect it under a statutory
    mandate. Indeed, Section 911 of the Dodd-Frank Act did require the SEC
    to establish and maintain a committee of investors to advise the SEC on
    its regulatory priorities and practices and also designated that a
    State securities regulator continue to serve as a member. SEC
    Commissioner Luis Aguilar recently said that this committee is of
    ``critical importance to ensuring that the SEC is focused on the needs
    and the practical realities facing investors.'' Unfortunately, budget
    uncertainty has forced the SEC to defer the creation of the Investor
    Advisory Committee.

    Providing Choice of Forum for Investors and Promoting Transparency
        Every year thousands of investors file complaints against their
    stockbrokers. Almost every broker-dealer presently includes in their
    customer agreements a mandatory pre-dispute arbitration provision that
    forces those investors to submit all disputes that they may have with
    the brokerage firm or its associated persons to mandatory arbitration.
    If cases are not settled, the only alternative is arbitration. For all
    practical purposes, the only arbitration forum available to investors
    is one administered by the Financial Industry Regulatory Authority
    (FINRA).
        Arbitration has been presented to the investing public as an
    inexpensive, informal, totally private process that results in a speedy
    resolution of cases. However, the mandatory arbitration provisions in
    contracts take away the ability of a harmed customer to ``have their
    day in court'' by forcing investors into a forum that limits discovery,
    reduces the pleading standards and allows decisions in which there is
    severely limited appeal. Arbitration as it exists does not treat the
    investing public fairly. If the system were a level playing field,
    arbitration probably would not be a universal requirement of the
    brokerage industry, and the investing public likely would embrace it
    voluntarily. Not surprisingly, studies have confirmed the belief that
    the securities arbitration forum is not perceived as fair to investors,
    and recovery rates in fact favor the securities industry.
        In February, the SEC approved a FINRA rule proposal that would
    allow all investors filing arbitration claims the option of having an
    all-public panel, thus expanding a pilot program to all investor
    claims. Historically, the panels had been comprised of two public
    arbitrators and an arbitrator who had worked in the securities
    industry. The FINRA rule change was an important step toward leveling
    the playing field for investors and improving the integrity of the
    arbitration system. However, with the economy as it is today, investor
    confidence remains very low. Another major step in restoring investor
    confidence and industry integrity would be to restore investor choice
    in their agreements with their brokerage firm.
        Section 921 of Dodd-Frank provides the SEC with rulemaking
    authority to prohibit, or impose conditions or limitations on the use
    of mandatory predispute arbitration agreements if it finds that such
    prohibition, imposition of conditions, or limitations are in the public
    interest and for the protection of investors. Pursuant to this
    provision, Congress should urge the SEC to use the authority provided
    the agency in Section 921 and impose rules prohibiting the mandatory
    nature of pre-dispute securities arbitration. This would allow
    investors the choice they ought to have between arbitration and
    litigation in an independent judicial forum.

    Funding the Grant Program to Safeguard Senior Investors from
            Unqualified Advisers
        One of the highest priorities of NASAA's membership is to protect
    vulnerable senior investors from investment fraud. We have long been
    concerned with the use of misleading professional designations that
    convey an expertise in advising seniors on financial matters. Many of
    these designations in reality reflect no such expertise. Our concern
    led us to promulgate a model rule designed to curb abuses in this area,
    and 27 States have adopted rules or laws governing the use of these
    designations.
        Section 989A of Dodd-Frank recognizes the harm to seniors posed by
    the use of such misleading activity and establishes a mechanism for
    providing grants to States as an incentive to adopting provisions
    meeting the minimum requirements of NASAA's model rule on the use of
    designations in the offer or sale of securities or investment advice.
    The law provides parallel incentives for States that have adopted
    provisions meeting the minimum requirements of the National Association
    of Insurance Commissioners' model rule on the use of senior
    designations in the sale of life insurance and annuities.
        The grants are designed to give States the flexibility to use funds
    for a wide variety of senior investor protection efforts, such as
    hiring additional staff to investigate and prosecute cases; funding new
    technology, equipment, and training for regulators, prosecutors, and
    law enforcement; and providing educational materials to increase
    awareness and understanding of designations.
        Unfortunately, disputes over the funding and leadership of the
    Consumer Financial Protection Bureau (``CFPB'') not related to investor
    protection have indefinitely delayed the creation of the senior
    investor protection grant program under Section 989A. The CFPB Office
    of Financial Literacy must be fully funded and operational to begin
    issuing grants of up to $500,000 to States that have adopted the NASAA
    and NAIC model rules on misleading senior designations. These important
    senior investor protections should not be delayed because Congress has
    not provided sufficient funding for the Federal financial regulatory
    agencies.

    Conclusion
        As discussed above, the Dodd-Frank Act provides meaningful,
    tangible benefits to investors. It requires the SEC to raise standards
    that are long overdue and blocks fraudulent actors from taking
    advantage of exemptions that should be reserved for reputable issuers.
    The Dodd-Frank Act empowers the SEC to raise the standards under which
    broker-dealers provide investment advice to ensure that the interests
    of investors come first. The law also recognizes the investor
    protection contributions of State regulators by increasing our
    authority over the regulation of investment advisers and by ensuring we
    have a voice on both the SEC's investor advisory committee and the
    Financial Stability Oversight Council. I am honored to serve on the
    FSOC along with my State banking and insurance colleagues. State
    regulators bring to the FSOC the insights of ``first responders'' who
    see trends developing at the State level that have the potential to
    impact the larger financial system.
        I want to thank Chairman Johnson for his consistent support for the
    important investor protections included in the Dodd-Frank Act. I
    appreciate your comments, Senator Johnson, that it ``would be dangerous
    and irresponsible,'' to rollback these hard-won reforms.
        Our message to Congress is simple and clear: Please continue your
    commitment to protecting investors and do not undermine the Dodd-Frank
    Act's regulatory authority either directly through legislative repeals
    or indirectly through a lack of appropriate funding or delayed
    execution.
        We look forward to working cooperatively with the Senate Banking
    Committee, as well as all Members of Congress and fellow regulators to
    ensure full implementation of the investor protections included in the
    Dodd-Frank Act.
                                     ______

                 PREPARED STATEMENT OF LYNNETTE KELLY HOTCHKISS
           Executive Director, Municipal Securities Rulemaking Board
                                 July 12, 2011

        Good morning Chairman Johnson, Ranking Member Shelby and Members of
    the Committee. I appreciate the invitation to testify today on behalf
    of the Municipal Securities Rulemaking Board.
        Since the MSRB was created by Congress in 1975 as the principal
    regulator for the municipal securities market, the MSRB has placed
    investors front-and-center in all of our market initiatives. Through
    our rulemaking over municipal market intermediaries as well as our
    ground-breaking market information systems, we have put in place
    protections for the significant U.S. retail market for municipal
    securities.\1\
    ---------------------------------------------------------------------------
        \1\ The size of the municipal market is approximately $3.7
    trillion. See Bloomberg L.P., Municipal Market: Bloomberg Brief (June
    21, 2011). It is estimated that approximately two-thirds of the
    municipal market is comprised, directly or indirectly, of retail
    investors. See SIFMA Statistics, U.S. Municipal Securities Holders,
    Quarterly Data to Q1 2011.
    ---------------------------------------------------------------------------
        While the MSRB's original jurisdictional authority was limited to
    the regulation of broker-dealers and banks that buy, sell, trade and
    underwrite municipal bonds (referred to herein as ``dealers'') with the
    principal purpose of protecting investors, Title IX of the Dodd-Frank
    Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) greatly
    expanded our ability to protect investors and increased our
    responsibilities to the marketplace by vesting us with the duties of
    regulating municipal advisors and protecting State and local government
    issuers, public pension plans and obligated persons. Over the past
    year, the MSRB has undertaken substantial rulemaking and transparency
    efforts to promote high standards of professional conduct and market
    disclosure aimed at creating conditions for fair, well-informed
    financial decisions by all market participants.
        The MSRB cannot act as a guarantor against poor decisions by either
    investors or issuers, or guard against the occurrence of adverse events
    in the market. However, we believe that a principles-based approach to
    regulating market intermediaries leads to the best possible outcome in
    terms of market fairness and efficiency. Key elements to ensuring such
    a fair and efficient market are such principles as suitability,
    disclosure, pricing and liquidity for investors. These elements also
    can have a substantial impact on the taxpayer's wallet and the public's
    confidence in the municipal market.
         Since Dodd-Frank was signed into law, the MSRB has been operating
    under the leadership of its first majority-public Board of Directors,
    which represents the interests of the public and municipal market
    investors and issuers, in addition to regulated entities. This public
    Board has moved decisively but carefully to put in place safeguards
    that more fully protect the municipal market that is so fundamental to
    the public interest.
        Since last October, MSRB rulemaking initiatives have addressed
    fiduciary duty, fair dealing, municipal advisor registration, pay-to-
    play, gift-giving and supervision. We are also developing municipal
    advisor professional qualifications requirements, including appropriate
    licensing examinations, and have enhanced our Electronic Municipal
    Market Access (EMMA) Web site to allow investors unprecedented access
    to market data and disclosures. These are the initiatives I would like
    to discuss with you today.

    The Dodd-Frank Act and the Municipal Market
        First, I would like to address the impact of the Dodd-Frank Act on
    the municipal market. This piece of legislation represents the most
    significant change affecting the municipal market since 1986--including
    key changes in the regulatory landscape for municipal advisors,\2\
    asset-backed securities,\3\ credit rating agencies \4\ and
    derivatives.\5\ Furthermore, to our knowledge, this is the first time
    Congress has enacted a law to protect issuers of securities.\6\
    ---------------------------------------------------------------------------
        \2\ Pub. L. No. 111-203 975, 124 Stat. 1917 (2010).
        \3\ Pub. L. No. 111-203 942-943, 124 Stat. 1897 (2010).
        \4\ Pub. L. No. 111-203 932, 124 Stat. 1872-1888 (2010).
        \5\ Pub. L. No. 111-203 764, 124 Stat. 1785 (2010).
        \6\ Pub. L. No. 111-203 975, 124 Stat. 1918 (2010).
    ---------------------------------------------------------------------------
        The MSRB's expanded authority falls under Title IX of the Dodd-
    Frank Act, which covers investor protections and improvements to the
    regulation of securities intermediaries. The Dodd-Frank Act granted the
    MSRB regulatory jurisdiction over municipal advisors.\7\ It also
    provides that MSRB rules for municipal advisors are to, among other
    things: (1) promote fair dealing, the prevention of fraudulent and
    manipulative acts and practices, and the protection of investors,
    municipal entities, and obligated persons; (2) prescribe means
    reasonably designed to prevent acts, practices, and courses of business
    that are not consistent with a municipal advisor's fiduciary duty to
    its municipal entity clients; (3) prescribe professional standards; (4)
    provide continuing education requirements; (5) provide for periodic
    examinations; (6) provide for recordkeeping and record retention; and
    (7) provide for reasonable fees and charges necessary or appropriate to
    defray the costs and expenses of operating and administering the
    Board.\8\
    ---------------------------------------------------------------------------
        \7\ Pub. L. No. 111-203 975, 124 Stat. 1917 (2010).
        \8\ Pub. L. No. 111-203 975, 124 Stat. 1919 (2010).
    ---------------------------------------------------------------------------
        The establishment of a comprehensive set of rules for the
    activities of municipal advisors will provide significant protections
    to State and local governments and other municipal entities and will
    greatly enhance the existing protections afforded to investors beyond
    the protections already provided by the MSRB's longstanding investor
    protection rules covering broker-dealers and banks. By way of
    illustration, the MSRB has previously established a series of investor
    protection rules covering the activities of brokers marketing 529
    college savings plans, which are investments sold exclusively to
    parents, grandparents and other retail investors, many of whom may have
    little or no prior experience as investors. With the enactment of Dodd-
    Frank, the MSRB now has authority to adopt a more comprehensive set of
    rules that go beyond the brokers marketing 529 plans to professionals
    that advise the States on the structure and related fundamental matters
    relating to the operation of such 529 plans that have a direct impact
    on investors and beneficiaries of the plans.
        The MSRB has undertaken its Dodd-Frank responsibilities in a
    deliberate and thorough manner, recognizing that many of these
    financial professionals and products are falling under regulation for
    the first time. With respect to the Dodd-Frank provisions that affect
    the municipal market, but that come under the purview of other Federal
    regulators, the MSRB has provided input and coordinated with other
    municipal market authorities to create consistent and well thought-out
    regulatory decisions.\9\ We would especially like to recognize the
    Securities and Exchange Commission (SEC), the Financial Industry
    Regulatory Authority and the Commodity Futures Trading Commission in
    these coordination efforts.
    ---------------------------------------------------------------------------
        \9\ See, e.g., MSRB Comment Letter Re: SEC Proposed Rules on
    Registration of Municipal Advisors, File No. S7-45-10 (February 22,
    2011).
    ---------------------------------------------------------------------------
    Fiduciary Duty
        I would now like to turn our attention to MSRB rulemaking efforts
    since the Dodd-Frank Act became effective. The Dodd-Frank Act has
    fundamentally altered the relationship of municipal advisors and
    municipal entities. As of October 1, 2010, municipal advisors owe a
    Federal fiduciary duty to their municipal entity clients under the
    Dodd-Frank Act. The MSRB has proposed a rule and interpretive guidance
    to provide the underpinning for this fiduciary duty.\10\ The MSRB's
    interpretive guidance would provide that a municipal advisor has a duty
    of loyalty to its municipal entity client, which requires the municipal
    advisor to deal honestly and in good faith with the municipal entity
    and to act in the municipal entity's best interests. This duty of
    loyalty would also require municipal advisors to make clear, written
    disclosure of all material conflicts of interest and to receive
    written, informed consent from appropriate officials of the municipal
    entity.
    ---------------------------------------------------------------------------
        \10\ MSRB Notice 2011-14 (February 14, 2011).
    ---------------------------------------------------------------------------
        The MSRB's interpretive guidance would also require municipal
    advisors to exercise due care in performing their responsibilities to
    municipal entity clients. That means that a municipal advisor should
    not undertake a municipal advisory engagement for which the advisor
    does not possess the degree of knowledge and expertise needed to
    provide the municipal entity with informed advice. For example, a
    municipal advisor should not undertake a swap advisory engagement or
    security-based swap engagement for a municipal entity unless it has
    sufficient knowledge to evaluate the transaction and its risks, as well
    as the pricing and appropriateness of the transaction.\11\
    ---------------------------------------------------------------------------
        \11\ Section 4s(h)(5) of the Commodity Exchange Act, as amended by
    the Dodd-Frank Act, requires that a swap dealer with a special entity
    client (including States, local governments and public pension funds)
    must have a reasonable basis to believe that the special entity has an
    independent representative that satisfies these criteria, among others.
    Section 15F(h)(5) of the Exchange Act, as amended by the Dodd-Frank
    Act, imposes the same requirements with respect to security-based
    swaps.
    ---------------------------------------------------------------------------
        We believe investors will benefit from ensuring that municipal
    advisors act in their clients' best interest. Municipal securities
    offerings borne from self-interested advice or in the context of
    conflicting interests or undisclosed payments to third-parties are much
    more likely to be the issues that later experience financial or legal
    stress or otherwise perform poorly as investments, resulting in
    significant harm to investors and increased costs to taxpayers.
        Importantly, under the Dodd-Frank Act, ``municipal advisor'' was
    defined to include guaranteed investment contract (GIC) brokers.\12\
    That means that GIC brokers now have a Federal fiduciary duty to their
    municipal entity clients and a duty of fair dealing to other clients,
    as described below. The proposed MSRB interpretive guidance on
    fiduciary duty would provide that they could not receive payments from
    other parties in return for giving them favorable treatment in what is
    supposed to be a competitive bidding process, even if they disclosed
    such payments. This is a major increase in the arsenal of enforcement
    agencies that, until now, have had to address this conduct through
    their anti-fraud jurisdiction.
    ---------------------------------------------------------------------------
        \12\ Pub. L. No. 111-203 975, 124 Stat. 1922 (2010).
    ---------------------------------------------------------------------------
        We believe that the new Federal fiduciary duty, and the MSRB's
    proposed guidance with respect to that duty arising from our new grant
    of authority under Dodd-Frank, would have squarely addressed much of
    the wrongdoing uncovered by the SEC, Internal Revenue Service and
    Department of Justice in their major GIC bid rigging investigation \13\
    had this Dodd-Frank provision been in place when the wrongdoing
    occurred. In light of these allegations concerning the conduct of GIC
    brokers, the MSRB Board of Directors will discuss whether additional
    guidance specifically directed at such conduct is warranted.
    ---------------------------------------------------------------------------
        \13\ SEC Complaint para. 1, SEC v. J.P. Morgan
    Securities LLP, Case No. 2:11-cv-03877 (D.N.J. July 7, 2011) (alleging
    fraudulent bidding practices by J.P. Morgan Securities in at least 93
    municipal bond reinvestment transactions); SEC Litigation Release No.
    21956, Securities and Exchange Commission v. UBS Financial Services
    Inc. (May 4, 2011) (alleging fraudulent bidding practices by UBS
    Financial Services in at least 100 municipal bond reinvestment
    transactions); In the Matter of Banc of America Securities LLP,
    Exchange Act Release No. 63451 (December 7, 2010) (alleging fraudulent
    bidding practices by Banc of America Securities in at least three
    municipal bond reinvestment transactions) [hereinafter Bid Rigging
    Enforcement Actions].
    ---------------------------------------------------------------------------
    Fair Dealing
        MSRB Rule G-17 provides that, in the conduct of its municipal
    securities and municipal advisory activities, each dealer and municipal
    advisor must deal fairly with all persons and may not engage in any
    deceptive, dishonest or unfair practice. This ``fair dealing'' rule is
    key to defining the relationships of dealers and municipal advisors
    with investors and issuers, and has served as the basis for numerous
    enforcement actions.\14\ The MSRB's rule goes further than SEC Rule
    10b-5 \15\ in that it imposes an affirmative duty to supply investors
    and issuers with disclosure about their transactions. This duty exists
    under the MSRB's rule even in the absence of fraud.
    ---------------------------------------------------------------------------
        \14\ See, e.g., In the Matter of J.P. Morgan Securities Inc., SEC
    File No. 3-13673 (October 7, 2010) (providing a plan of final
    distribution for the disgorgement and civil penalty paid by J.P. Morgan
    Securities for violating MSRB Rule G-17 and other Federal securities
    laws).
        \15\ 17 C.F.R.  240.10b-5, 15 U.S.C. 78j (2010).
    ---------------------------------------------------------------------------
        Last fall, the MSRB reminded dealers of their fair dealing
    obligations,\16\ including their duty to disclose to customers all
    material facts known by the dealer and those reasonably accessible to
    the market prior to or at the time of sale of a municipal security. The
    MSRB also stated that firms must analyze and disclose credit risks and
    other material information about a bond, such as redemption options or
    features that would affects its tax status, in order to meet their fair
    dealing obligations. For example, if the credit rating of a municipal
    issuer was recently downgraded, the dealer must provide an investor
    with this information. The MSRB made clear to the dealer community the
    critical importance of sharing with investors such key information so
    they are able to make the best possible decision based on their
    individual circumstances and risk tolerance.
    ---------------------------------------------------------------------------
        \16\ MSRB Notice 2010-37 (September 20, 2010).
    ---------------------------------------------------------------------------
        As I mentioned earlier, Congress expressly directed the MSRB in the
    Dodd-Frank Act to protect municipal entities.\17\ As one of the MSRB's
    initial municipal advisor rules, the MSRB extended its fair dealing
    rule, MSRB Rule G-17, to cover the actions of municipal advisors.\18\
    The MSRB has proposed two pieces of interpretive guidance under Rule G-
    17, which apply this basic principle of fair dealing to municipal
    advisors and to underwriters of municipal securities in their
    interactions with municipal entities, as well as with organizations
    such as hospitals and colleges that borrow through municipal entities
    (referred to in the statute as ``obligated persons'').
    ---------------------------------------------------------------------------
        \17\  Pub. L. No. 111-203 975, 124 Stat. 1918 (2010).
        \18\ MSRB Notice 2010-59 (December 23, 2010).
    ---------------------------------------------------------------------------
        The MSRB's proposed interpretive guidance on fair dealing
    obligations for underwriters \19\ states that representations made by
    underwriters to issuers of municipal securities in connection with
    municipal securities underwritings must be truthful and accurate. It
    also requires an underwriter of a negotiated issue that recommends a
    complex municipal securities financing (e.g., a financing involving a
    swap) to disclose all material risks and characteristics of the
    financing, as well as any incentives for the underwriter to recommend
    the financing and any other conflicts of interest. The guidance also
    contains pricing and compensation standards.
    ---------------------------------------------------------------------------
        \19\ MSRB Notice 2011-12 (February 14, 2011).
    ---------------------------------------------------------------------------
        We note that, if true, the fraudulent and deceptive conduct of some
    major underwriters alleged to have occurred in actions brought by the
    SEC and Department of Justice as a result of their GIC bid rigging
    investigation \20\ would be considered a clear violation of Rule G-17
    under this proposed interpretive guidance.
    ---------------------------------------------------------------------------
        \20\ Bid Rigging Enforcement Actions, supra note 12.
    ---------------------------------------------------------------------------
        The MSRB's proposed interpretive guidance on fair dealing
    obligations for municipal advisors \21\ covers a municipal advisor's
    duties to obligated persons in a municipal securities or financial
    product transaction, as well as duties to municipal entities (such as
    public pension funds) when the advisor is soliciting business from a
    municipal entity on behalf of a third party. This guidance contains
    disclosure and competency requirements, as well as prohibitions on
    engaging in municipal advisory business in certain conflict of interest
    situations, such as those involving kickbacks. This interpretive
    guidance would offer protections to market participants when a stronger
    fiduciary duty does not exist.
    ---------------------------------------------------------------------------
        \21\ MSRB Notice 2011-13 (February 14, 2011).
    ---------------------------------------------------------------------------
        A dealer's or municipal advisor's compliance with its fair dealing
    obligations to municipal entities creates uniform practices and fair
    pricing methods that improve market efficiency and have cascading
    benefits to investors in terms of receiving a fair return on their
    investment. We believe our revised fair dealing rule to be a pillar in
    investor protection.

    Pay to Play
        As the first regulator to adopt a ``pay to play'' rule,\22\ the
    MSRB recognized the potential for market abuse that can arise as a
    result of market professionals using political contributions to
    influence the award of business by public officials. The MSRB has
    curbed potential abuses by underwriters of municipal securities that
    made political contributions to win business and is seeking to do the
    same for municipal advisors.
    ---------------------------------------------------------------------------
        \22\ MSRB Rule G-37 was adopted by the MSRB in 1994 due to concerns
    about the opportunity for abuses and the problems associated with
    political contributions by dealers in connection with the award of
    municipal securities business, known as ``pay to play.'' See MSRB
    Reports, Volume 14, Number 3 (June 1994).
    ---------------------------------------------------------------------------
        Municipal advisors that seek to influence the award of business by
    Government officials by making or soliciting political contributions to
    those officials distort and undermine the fairness of the process by
    which Government business is awarded. These practices can harm
    municipal entities and their citizens by resulting in inferior services
    and higher fees, as well as contributing to the violation of the public
    trust of elected officials. The MSRB has proposed a rule that would,
    for the first time, regulate pay to play activities of firms and
    individuals that advise municipal entities, such as State and local
    governments and public pension plans, on municipal securities and
    municipal financial products, including derivatives.\23\ The rule would
    also cover firms and individuals that solicit investment advisory
    business from municipal entities, such as public pension plans, on
    behalf of others.
    ---------------------------------------------------------------------------
        \23\ MSRB Notice 2011-04 (January 14, 2011).
    ---------------------------------------------------------------------------
        Draft MSRB Rule G-42 would require quarterly disclosure of certain
    campaign contributions and would prohibit a municipal advisor from:

        Engaging in ``municipal advisory business'' with a
            municipal entity for compensation for a period of time
            beginning on the date of a non-de minimis political
            contribution to an ``official of the municipal entity'' and
            ending 2 years after all municipal advisory business with the
            municipal entity has been terminated; and

        Soliciting third-party business from a municipal entity for
            compensation, or receiving compensation for the solicitation of
            third-party business from a municipal entity, for 2 years after
            a non-de minimis political contribution to an ``official of the
            municipal entity.''

    Furthermore, draft MSRB Rule G-42 would prohibit municipal advisors and
    municipal advisor professionals from:

        Soliciting contributions, or coordinating contributions, to
            officials of municipal entities with which the municipal
            advisor is engaging or seeking to engage in municipal advisory
            business or from which the municipal advisor is soliciting
            third-party business;

        Soliciting payments, or coordinating payments, to political
            parties of States or localities with which the municipal
            advisor is engaging in, or seeking to engage in, municipal
            advisory business or from which the municipal advisor is
            soliciting third-party business; and

        Committing indirect violations of Rule G-42.

        MSRB pay to play restrictions have served as a model for Federal
    and State regulators imposing restrictions on pay to play activities in
    other areas and play a vital role in preserving market integrity. The
    MSRB has served as a key resource to such other regulators as they have
    developed and administered their rules.

    Gifts
        Gifts to employees controlling the award of municipal securities
    business by market professionals can similarly harm investors. The MSRB
    limits these gifts by dealers and recently proposed to extend the
    restrictions of MSRB Rule G-20 to municipal advisors.\24\ Just as the
    existing rule helps to ensure that dealers' municipal securities
    activities are undertaken in arm's length, merit-based transactions in
    which conflicts of interest are minimized, amendments to Rule G-20
    would help to ensure that engagements of municipal advisors, as well as
    engagements of dealers, municipal advisors, and investment advisers for
    which municipal advisors serve as solicitors, are awarded on the basis
    of merit and not as a result of gifts made to employees controlling the
    award of such business.
    ---------------------------------------------------------------------------
        \24\ MSRB Notice 2011-16 (February 22, 2011).
    ---------------------------------------------------------------------------
    Supervision
        The establishment of a basic supervisory structure for municipal
    advisors is particularly important as the MSRB adopts new rules for
    municipal advisors that municipal advisors must understand and comply
    with in order to avoid possible enforcement actions and to effectively
    put in place practices that serve to protect investors. The MSRB
    recently requested comment on a supervisory rule, draft MSRB Rule G-44,
    to require that each municipal advisor firm establish a supervisory
    structure to oversee compliance with applicable MSRB and SEC rules.\25\
    ---------------------------------------------------------------------------
        \25\ MSRB Notice 2011-28 (May 25, 2011).
    ---------------------------------------------------------------------------
        Draft Rule G-44 would require a municipal advisor to establish and
    maintain a system to supervise the municipal advisory activities of
    each associated person designed to achieve compliance with applicable
    rules. Draft Rule G-44 would also require municipal advisors to adopt,
    maintain and enforce written supervisory procedures designed to ensure
    that the conduct of the municipal advisory activities of the municipal
    advisor and its associated persons are in compliance with applicable
    rules.

    Board of Directors
        The new composition of the MSRB's Board of Directors has assisted
    us in carrying out our regulatory actions over the past year. The Dodd-
    Frank Act requires the MSRB's governing Board to be majority-public and
    to include municipal advisors.\26\
    ---------------------------------------------------------------------------
        \26\ Pub. L. No. 111-203 975, 124 Stat. 1917 (2010).
    ---------------------------------------------------------------------------
        On October 1, 2011, the MSRB seated a 21-member Board with a
    majority of public members, including three municipal advisors.\27\ The
    Board also includes representatives of issuers and investors, as well
    as members representing securities firms and banks. We have a newly
    structured majority-public Nominating Committee chaired by a public
    member.
    ---------------------------------------------------------------------------
        \27\ MSRB Press Release, MSRB Assumes Expanded Mission and
    Establishes Public Majority Board of Directors (October 1, 2010).
    ---------------------------------------------------------------------------
        We believe this Board of Directors reflects the benefits of a self-
    regulatory organization and, at the same time, the wisdom of
    increasingly diverse and public membership. Our rulemaking--and the
    public's interest--has benefited from the many perspectives offered by
    our Board members. The Board vigorously debates issues, carefully
    considers the experience and insight of each of its members and then
    proceeds with the best possible course of action. We believe the
    progress we have made over the last 9 months in further protecting the
    market has been unprecedented.
        The rules I have mentioned are just a small part of the regulatory
    backbone that helps support a fair and efficient municipal market.

    Professional Qualifications
        It is vital to our mission that municipal market professionals can
    competently provide their services to investors and municipal entities.
    The MSRB Professional Qualification Program fosters competency of
    municipal professionals and compliance with MSRB rules through required
    examinations and continuing education. The Dodd-Frank Act requires the
    MSRB to set standards of professional qualification for municipal
    advisors.\28\ The MSRB has been conducting outreach events and focus
    groups to gather input from municipal advisors and others about the
    development of a professional qualification examination to assess the
    competency of entry-level municipal advisors.
    ---------------------------------------------------------------------------
        \28\ Pub. L. No. 111-203 975, 124 Stat. 1919 (2010).
    ---------------------------------------------------------------------------
        The MSRB recently organized a municipal advisor examination working
    group to consider all comments received by the MSRB, assess
    commonalities in municipal advisory activities and provide additional
    input. The working group expects to survey registered municipal
    advisors about the proposed examination content in late 2011 and use
    the results of the survey to prepare a draft examination content
    outline. We will continue to keep interested parties apprised of our
    progress in this area as we proceed.

    EMMA and Market Transparency
        I would now like to discuss another top priority of the MSRB--
    market transparency. Beginning as a pilot program in 2008, our EMMA
    system, at www.emma.msrb.org, has transformed the transparency of the
    municipal market. Any investor can now access from anywhere hundreds of
    thousands of disclosure documents and real-time trading information on
    1.5 million outstanding municipal bonds. We provide all of this
    information to the public for free.

        EMMA was created for the purpose of providing retail investors with
    easy access to key market information that was previously unavailable
    or difficult to find. Retail investors are heavily involved in the
    municipal market, with retail trades (generally viewed as trades of
    $100,000 or less) accounting for over 80 percent of the approximately
    7.3 million customer transactions in municipal securities over the past
    year.\29\ The MSRB's EMMA Web site supports well-informed
    decisionmaking by these investors.
    ---------------------------------------------------------------------------
        \29\ This statistical information may be found by searching EMMA's
    Market Statistics tab at http://emma.msrb.org/MarketActivity/
    ViewStatistics.aspx.
    ---------------------------------------------------------------------------
        Over the past year, the MSRB has greatly expanded the amount and
    type of information available to investors on EMMA. The MSRB began
    providing interest rate information on EMMA about auction rate
    securities (ARS) and variable rate demand obligations (VRDO) in 2009,
    after instability in these markets raised significant disclosure and
    market transparency concerns. Today EMMA remains the only source of
    current, market-wide interest rates for variable rate securities
    available to the general public. In May 2011, the MSRB enhanced EMMA to
    provide public access to key ARS auction and VRDO liquidity
    information, including actual copies of liquidity documents such as a
    letter of credit. Providing investors with easy access to these
    documents and data increases their ability to make informed decisions
    about investing. The MSRB testified before you in 2009 regarding our
    plans to increase the information and documents available about ARS and
    VRDOs \30\ and I am happy to report that this increased transparency
    has been accomplished.
    ---------------------------------------------------------------------------
        \30\ Transparency and Regulation in the Municipal Securities Market
    Hearing Before the U.S. Senate Committee on Banking, Housing, and Urban
    Affairs (2009) (statement of Ronald A. Stack, Chair, Municipal
    Securities Rulemaking Board).
    ---------------------------------------------------------------------------
        EMMA also is a tool for issuers to communicate important
    information about their bonds and their finances to investors. The MSRB
    received requests from State and local government issuers to provide
    the ability for issuers to voluntarily post preliminary official
    statements to EMMA. We are happy to announce that, as of May 2011, we
    have made this possible. Preliminary official statements can provide
    potential investors with the details of a new issue before it comes to
    market. Issuers in several States have already taken advantage of this
    new EMMA feature--including South Carolina, Utah, Kentucky, Florida and
    Wisconsin--and we expect its use to increase over time.
        As part of its investor protection rules, the MSRB requires timely
    disclosure by our regulated entities and promotes good continuing
    disclosure practices by issuers. Issuers provide some types of
    continuing disclosure information under SEC Rule 15c2-12. The MSRB has
    added the ability for issuers to submit numerous voluntary disclosures
    that go beyond this SEC baseline. Most recently, the MSRB enhanced EMMA
    to allow issuers to submit information about the timing and accounting
    standard used to prepare annual financials. This helps investors
    acquire a more complete picture of the issuers and issues in which they
    are investing. As EMMA provides a centralized location for disclosures,
    investors and others interested in the disclosure practices of issuers
    and trading activity of bonds can easily use EMMA to access and compare
    the available information.
        The MSRB will continue to improve EMMA. This fall, EMMA will
    display credit ratings from one or more of the Nationally Recognized
    Statistical Rating Organizations. These ratings will be available on
    the EMMA Web site, for free, and updated in real-time.

    Conclusion
        The municipal market funds much of this nation's health, education
    and transportation infrastructure. It is the MSRB's role to balance and
    protect the competing interests in this public-purpose market. Where we
    have the jurisdiction and ability to act, the MSRB has raised the bar
    on professional conduct by financial professionals and advanced market
    transparency in many significant ways. The benefits of these efforts
    ultimately flow to the investor and taxpayer.
        The MSRB is dedicated to a thoughtful, thorough rulemaking process
    that involves significant input from municipal market participants. We
    depend on input from investors, issuers, industry members and others to
    ensure MSRB rules are timely and appropriate. We believe that this
    widespread participation in rulemaking makes both the process and the
    product at the MSRB as balanced as possible and in the best interests
    of investors and municipal entities.
        We believe we not only have a responsibility to write regulations
    and provide transparency, but also a corresponding responsibility to
    educate market participants on the progress of these efforts. Since the
    Dodd-Frank Act, the MSRB has conducted outreach events across the
    country to provide a forum for education and input regarding our new
    mission and jurisdiction. We appreciate the opportunities provided by
    the Dodd-Frank Act to improve the municipal market and look forward to
    continuing to work with Congress, industry members, issuers and
    investors with this goal in mind.
        I thank you again for the invitation to speak today and will take
    any questions you may have.

                                     ______

                    PREPARED STATEMENT OF HARVEY L. PITT\1\
    ---------------------------------------------------------------------------
        \1\ Mr. Pitt is the Chief Executive Officer of Kalorama Partners,
    LLC, and its law-firm affiliate, Kalorama Legal Services, PLLC. Prior
    to founding the Kalorama firms in 2003, Mr. Pitt served as Chairman of
    the U.S. Securities and Exchange Commission (2001-2003), was a senior
    corporate law firm partner (1978-2001), and served for over 10 years as
    a member of the Staff of the SEC (1968-1978), the last 3 years of which
    he served as the Agency's General Counsel.
    ---------------------------------------------------------------------------
              Former Chairman, Securities and Exchange Commission
                                 July 12, 2011

    Introduction
        Chairman Johnson, Ranking Member Shelby, Members of the Committee:
        I am pleased to appear before you today to respond to this
    Committee's invitation to testify about the critical issue of
    ``Enhanced Investor Protection After the Financial Crisis.'' The
    financial crisis that began in 2007-2008 was, as we know only too well,
    one of the worst economic collapses this Country has experienced. The
    failures that led to that collapse are manifold, but principal among
    them, in my view, was the failure of our regulatory system (and
    financial regulators) to respond effectively, efficiently and with
    alacrity to both the warning signs that a crisis was imminent, and to
    cabin what eventually became a full-blown crisis.
        Thus, I strongly believe this Country needed (and still needs) to
    reform its financial regulatory apparatus, and that was clearly the
    impetus behind the adoption and enactment of the Dodd-Frank Wall Street
    Reform and Consumer Protection Act (``D-F''). The Committee has
    specifically requested that testimony today focus on Titles IV and IX
    of D-F, which were intended, among other things, to enhance ``investor
    protection.'' While Congress' intent in passing D-F was laudable, and
    while there was a compelling need to reform our financial regulatory
    system, D-F unfortunately did not provide the regulatory reform that
    our financial and capital markets, and those who invest, so urgently
    needed, and still require.
        Notwithstanding my belief that D-F falls short of what we need, I
    believe the principal effort at this point should be to figure out what
    it will take to make the substance of D-F workable. Thus, my testimony
    is directed at the changes needed to enable D-F to fulfill its goals,
    without incurring many of the unintended consequences that I believe
    plague so much of this legislation. The views I set forth are solely my
    own, formed on the basis of an aggregate of over 43 years experience in
    the financial and capital markets, both as a regulator, as a counselor
    to those in the financial services industry and, for the past 8 years,
    as the Chief Executive Officer of Kalorama Partners, LLC and its law-
    firm affiliate, Kalorama Legal Services, PLLC.\2\ My views do not
    reflect the views of any past or current clients of the Kalorama firms,
    and do not reflect the views of the SEC.
    ---------------------------------------------------------------------------
        \2\ As a matter of policy, the Kalorama firms do not engage in
    adversarial efforts vis-a-vis the SEC; rather, they assist companies,
    firms, governmental entities and individuals that are committed to
    enhancing their fidelity to important fiduciary and governance
    principles, internal controls and compliance programs.
    ---------------------------------------------------------------------------
    Summary
        There is no question that, in the wake of the financial crisis that
    began in 2007-2008, financial regulatory reform was needed. We needed a
    more nimble regulatory regime. However, the legislation passed nearly 1
    year ago did not provide the reform the Country needed. While this is
    not the forum in which to revisit all the problems with D-F, in brief,
    I believe the Country required that financial regulatory reform provide
    three critical elements:

        A steady flow of significant, current information on the
            activities of anyone playing a meaningful role in our financial
            and capital markets;

        The imposition on Government of a duty to analyze the
            information it receives to discern trends and developments,
            along with the obligation to publish, generically, the trends
            and developments Government discerns; and

        The grant to the Government of the ability to create so-
            called tripwires, so that as trends start to become apparent,
            Government can halt those trends until it determines (subject
            to appropriate Congressional oversight) whether these trends
            are potentially harmful and, if so, what steps should be taken
            to cabin their further development.

        D-F did not achieve these goals. Worse, the Act is unduly complex,
    adds more layers of regulatory bureaucracy to an already over-bloated
    bureaucracy, makes financial regulation more cumbersome and less nimble
    than it already was, and contains the seeds for destroying the
    independence of three regulators whose independence was always a
    strength of our existing regulatory system-the Federal Reserve Board,
    the SEC, and the CFTC.\3\
    ---------------------------------------------------------------------------
        \3\ Through the creation of the Financial Stability Oversight
    Council, which is led by the Treasury Secretary, the independent views
    of the Fed, the SEC and the CFTC, as well as their functions, can
    effectively be overridden.
    ---------------------------------------------------------------------------
        Notwithstanding these impediments, the SEC and other financial
    regulators have been working assiduously to adopt hundreds of new
    rules, and produce a plethora of written studies, often without being
    afforded the necessary time to achieve the demands imposed by D-F,
    including rules to implement provisions under Titles IV and IX of D-F--
    the Committee's current focus--as well as Title VII and other
    provisions of the Act, and many more rules are in process. While the
    SEC has valiantly attempted to address, through its rulemaking, many of
    the concerns that I and others have raised regarding the potential for
    mischief contained within the 2,300+ pages of D-F, there is only so
    much the Agency can, or should, do once Congress has expressed its
    judgment on important policy issues.
        Without attempting to be exhaustive regarding the myriad problems I
    perceive in Titles IV and IX of D-F, there are four provisions that
    particularly deserve this Committee's attention if D-F is to serve its
    intended investor protection purposes:

        The expansion of the SEC's examination and regulatory
            responsibilities over hedge funds, private equity firms, and
            some venture capital firms (as well as enhanced obligations
            regarding credit ratings agencies) that the SEC cannot possibly
            fulfill given the current wording of D-F and the lack of
            appropriate resources;

        The establishment of a whistleblower ``bounty'' program
            that:

          creates negative incentives that threaten to undermine
            corporate compliance programs;

          threatens to make every ``tip'' of which both the SEC and
            private sector firms become aware a ``Federal case''; and

          sets the SEC up for failure by likely causing it to be
            inundated with a slew of ``tips,'' without giving it the
            resources necessary to ``separate the wheat from the chaff'';

        Corporate governance provisions that:

          intrude on the traditional province of State corporate
            law;

          favor certain special interests at the expense of rank
            and file shareholders; and

          impose significant unanticipated costs on corporations,
            and thus shareholders; and

        Provisions that establish a new Office of Investor Advocate
            that:

          Undermine the authority not only of the Staff but of the
            Commission itself with respect to both enforcement and
            rulemaking decisions; and

          Create a potentially divisive source of internal second-
            guessing that may actually slow down, rather than facilitate,
            regulatory reforms that protect retail investors.

    Discussion

    1. Increasing the SEC's Examination Responsibilities
        As a result of Title IV of D-F, and especially D-F 402 & 403, the
    SEC's jurisdiction over hedge funds, private equity funds and certain
    venture capital firms has increased exponentially. While there is a
    paucity of precise data, it appears that, as of the end of 2009, there
    were over 9,000 hedge funds in existence.\4\ The Commission already
    oversees approximately 11,000 registered investment advisers and 6,000
    registered securities broker-dealers, beyond which D-F imposes on the
    SEC new oversight responsibilities for credit ratings agencies,
    municipal securities dealers and a host of swaps professionals and
    participants.
    ---------------------------------------------------------------------------
        \4\ See IFSL Research, ``Hedge Funds 2010'' (Apr. 2010), available
    at http://www.scribd.com/doc/36124567/Hedge-Funds-2010.
    ---------------------------------------------------------------------------
        Putting to one side the substance of D-F's creation of a new
    regulatory regime for hedge funds and other private fund investment
    advisers,\5\ the grant of this authority begs the question: How will
    the SEC exercise its oversight and compliance examination
    responsibilities once it has registered these new entities? It seems
    rather clear that the SEC's own compliance and examination efforts
    cannot match the number of entities requiring examination, or the
    sophistication and diversity of investment strategies with which the
    SEC's Staff will be confronted. Despite promises of new funding that
    were made when D-F was first enacted, the current budget crisis makes
    it impossible that the Commission will have sufficient resources to
    enable it to:
    ---------------------------------------------------------------------------
        \5\ Because hedge funds were, initially, marketed only to highly
    sophisticated investors, in denominations that placed these funds
    beyond the reach of ordinary investors, it was not deemed sufficient to
    require detailed regulation of those who managed these funds. As hedge
    fund advisers have become publicly traded entities, and pension funds
    have turned more and more frequently to hedge funds to increase their
    returns, this justification for the absence of regulation disappeared.
    But, no nexus has ever been suggested between the economic crisis that
    began in 2007-2008 and the market/investment activities of hedge funds.

        Develop the necessary expertise to permit it to examine an
    ---------------------------------------------------------------------------
            additional 9-10,000 new entities subject to its jurisdiction;

        Deploy such expertise as it has to perform regular
            compliance examinations; or

        Provide investors with appropriate confidence that the
            funds in which they invest are subject to extensive compliance
            oversight by the Federal Government.

        In February 2003, under my direction, the SEC proposed to require
    all investment advisers to undergo an exemption every year, or in the
    case of smaller advisers, every 2 years, by an independent, expert,
    private-sector entity that would perform a detailed compliance
    ``audit'' akin to the annual financial audits performed by independent
    outside public accounting firms.\6\ The Commission would define
    requisite independence and expertise, and would dictate the substance
    of the annual (or biennial) compliance audit, and these audits would
    result in the preparation of a detailed report of findings that would
    be submitted both to the SEC and to the governing board of the funds
    whose advisers are examined.
    ---------------------------------------------------------------------------
        \6\ See Compliance Programs of Investment Companies and Investment
    Advisers, Investment Company Act Rel. No. 25925, Investment Advisers
    Act Rel. No. 2107, 79 SEC Docket 1696 (Feb. 5, 2003).
    ---------------------------------------------------------------------------
        Although this is a proposal that could address the serious problems
    that inhere in the SEC's existing compliance examination process, this
    proposal--or anything comparable--has not yet been adopted by the
    Commission. It is, in my view, long overdue, and should be mandated by
    Congress, to reduce the likelihood of future ``Madoff-like''
    situations.\7\
    ---------------------------------------------------------------------------
        \7\ ``Enlisting'' third-party expert examiners is not a guarantee
    against future Madoffs, but it will equalize the sophistication gap
    that exists between the young men and women who perform examinations
    for the SEC, on the one hand, and the experienced money managers whose
    operations the SEC Staff must examine.
    ---------------------------------------------------------------------------
    2. Whistleblower Provisions
        D-F 922 creates a new SEC whistleblower program that was intended
    to increase both the number and quality of ``tips'' received by the SEC
    from anyone who becomes aware of ``possible'' misconduct that could
    adversely affect our capital markets. It cannot be gainsaid that a
    well-designed whistleblower program that achieves the goal of providing
    the Commission with better access to quality indications of potential
    wrongdoing is a proposal that could benefit investors enormously. But,
    as D-F was enacted, this provision threatens to undermine corporate
    governance, internal compliance and the confidence of public investors
    in our heavily regulated capital markets.

    a. Impact on Corporate Governance and Internal Compliance Programs
        Over the last half-Century, great strides have been taken to
    provide investors with the most valuable first-line of defense against
    securities fraud and other forms of misconduct--internal corporate
    governance has been improved to ensure that corporate employees
    inculcate and adhere to proper values, while internal compliance
    processes at the firms of securities professionals have been
    strengthened and expanded to nip nascent potential frauds in the bud.
    While it is undoubtedly beneficial to encourage those who become aware
    of possible misconduct to report to their firms and corporations any
    perceived instances of misconduct, and to encourage those firms and
    corporations to inquire into perceived instances of misconduct, D-F and
    the rules it compelled the SEC to adopt threaten to have exactly the
    opposite effect.
        D-F, and the SEC rules adopted under it on May 25, 2011, may
    incentivize tipsters to submit unsupported--and possibly speculative or
    even frivolous--``tips'' directly to the SEC, rather than to the
    companies or firms to which their ``tips'' relate. More significantly,
    the system created threatens to divert the SEC Staff's attention away
    from more productive investigations. This is a logical outcome of the
    fact that the D-F whistleblower provisions give formal legal rights to
    those who claim their ``tips'' were significant factors in the SEC's
    ability to recover monetary payments in excess of $1 million, as a
    result of alleged securities-related misconduct. I believe that the
    potentially huge amounts at stake--a bounty ranging from between 10 and
    30 percent of the monetary sanctions recovered in any successful
    enforcement action that resulted from the tip--and D-F's unfortunate
    premium for being ``first in line,'' will at best undermine, and at
    worst eviscerate, companies' existing internal compliance programs.
        Sound risk management practices as well as legal requirements, such
    as the Sarbanes-Oxley Act (``S-Ox''), place great emphasis on
    companies' implementation of robust compliance programs to help ensure
    that wrongdoing is prevented or detected, and if detected, stopped and
    remedied as quickly as possible. Companies with strong compliance
    programs may be able to detect and remedy misconduct more quickly and
    more effectively than the SEC can, given the Commission's many other
    responsibilities and its need to comply with the legal formalities
    required of Government actors. Public investigative and enforcement
    processes simply take more time than internal action.
        However, D-F 922 and the SEC's implementing rules do not require
    an employee first to report internally the suspected wrongdoing.
    Instead, they create overwhelming financial incentives to bypass
    internal reporting mechanisms and requirements, and go directly to the
    SEC with their tips. As a result, they may effectively deny companies
    the opportunity to detect and take prompt remedial action in response
    to internally reported tips from employees. They also reduce the likely
    quality of any tips received by placing more importance on speed than
    factual support. By diverting tips and complaints from internal
    compliance and legal channels to the SEC, the whistleblower provisions
    paradoxically may result in violations continuing and becoming more
    serious. This is the very opposite of the result intended by Congress
    in enacting both S-Ox and D-F.
        In response to comments prior to the promulgation of the final
    rules, the Commission acknowledged the potential of 922 to undermine
    internal compliance programs, and adopted certain measures that are
    intended to ``encourage'' employees to report wrongdoing to their
    compliance or legal departments, before or at the same time they report
    to the SEC. These are:

        A provision granting an employee whistleblower status as of
            the date the employee reports the information internally, if
            the employee provides the same information to the SEC within
            120 days, thereby affording employees the ability to report the
            alleged wrongdoing internally first, without losing their
            ``spot in line'' for a possible award from the SEC.

        A provision that credits employees who report their
            suspicions internally first with information obtained from a
            company's internal investigation, that resulted (in whole or in
            part) from information that was reported internally by the
            whistleblower, even if the internal report, by itself, would
            not have been ``sufficiently specific, credible, and timely''
            to ``commence or reopen an [SEC] investigation . . . ''

        A provision permitting the SEC to consider initial internal
            reporting as a factor weighing in favor of larger whistleblower
            awards. This provision, however, is permissive, not mandatory.
            Indeed, the failure to report suspicions internally will not
            necessarily result in a lower bounty, and whistleblowers who
            fail to report internally are still eligible to receive the
            highest possible bounty--30 percent.

        I do not believe these measures, taken together, create sufficient
    affirmative incentives to ensure that employees will actually report
    their suspicions internally first. Tipsters who bypass internal
    compliance procedures and report to the SEC in the initial instance--
    even after they become aware of an internal investigation about the
    alleged wrongdoing--are still eligible for a 30 percent award, and
    tipsters who do report internally first are not assured of receiving
    the highest level award. Further, with the lure of million-dollar
    bounties, it is unlikely that potential whistleblowers will consider
    (assuming they understand) the prospect that they will be credited with
    the additional information generated by an internal investigation
    initiated as a result of an internal report. I believe that,
    notwithstanding the SEC's efforts to incentivize initial internal
    reporting, the overwhelming majority of tipsters will report directly
    to the SEC, bypassing their companies' internal reporting mechanisms
    and compliance departments.
        Other provisions of the rules exacerbate the potential for damage
    to corporations' existing internal compliance programs. Specifically,
    the exclusion from eligible whistleblower status of internal compliance
    and internal audit personnel--including lawyers who receive tips in the
    context of a privileged attorney-client communication--is not
    meaningful. This is because the ``exclusion'' carves out, and thus
    makes eligible for whistleblower status, internal compliance, internal
    audit and legal personnel who claim ``a reasonable basis to believe
    that disclosure of the privileged information is necessary to prevent
    substantial injury to the financial interest or property of
    investors.''
        As both Commissioners Casey and Paredes have observed, these
    exceptions effectively swallow the rule. Consequently, as a practical
    matter, such personnel are eligible to receive a bounty without taking
    any further internal action; like all other persons eligible for
    whistleblower status, these persons are not subject to a prior internal
    reporting requirement, despite being the very individuals directly
    charged with responsibility for the company's internal compliance,
    internal audit and legal functions.
        By effectively negating the exemption of internal compliance and
    audit personnel from eligibility for whistleblower status, the rules:
    (1) create additional disincentives for both business heads and other
    employees to bring problems to the attention of internal compliance
    personnel, for fear that they will turn around and go directly to the
    SEC; (2) engender mistrust of internal compliance and audit personnel;
    and (3) otherwise create internal divisiveness between business lines
    and internal control support functions.

    b. Transforming Every ``Tip'' into a Federal Case
        Whether or not a tip is first reported to the tipster's employer, a
    likely consequence of this provision of D-F will be to convert every
    tip into a significant ordeal for those companies that learn of them.
    This is so for several reasons.

        Depending on the volume of tips received, but even if the
            Agency is not inundated with tips, it is in the SEC Staff's
            interest to refer every tip to the company or firm to which the
            tip relates, for initial review. In that way, the SEC Staff
            will not run the risk that they may mistake a valuable tip they
            receive for something of no real consequence.

        Once a tip is referred to a company--either by the tipster
            or by the SEC Staff--companies will have little choice but to
            elevate every tip to a higher level of attention than would
            otherwise be appropriate. After all, if a company investigating
            a tip wants to avoid having to go through at least two
            investigations--one by the company itself, and one by the SEC
            Staff--it will want to be able to document precisely how a
            spurious tip misses the mark in reality. This will add
            extensively to the cost of handling these kinds of tips,
            whether or not the tip has any merit at all.

        Because the tipster will have legal rights to recover money
            if it turns out the tip has merit and leads to a recovery in
            excess of $1 million, the company may feel the necessity of
            expending undue resources on even frivolous tips, since a
            company determination the tip is frivolous that persuades the
            SEC Staff may result in litigation brought to contest the
            company's bona fides in reaching it conclusion that the tip had
            no merit.

        This is a hidden ``cost'' of this provision of D-F that will
    elevate the price extracted for those who seek, in good faith, to
    comply with the statute.

    c. Impact on SEC Resources and Efficiency
        In addition to the concerns I have about the whistleblower
    provisions' potentially devastating consequences for internal
    compliance programs, I am also concerned about the potentially impact
    of these provisions on the SEC itself. The prospect of huge bounties
    merely for reporting a ``possible'' violation will spur an excessive
    flow of whistleblowing claims to the SEC, with people reporting claims
    based on weak or speculative information or reporting wholly spurious
    claims ``just in case.'' And, while responsible counsel for
    whistleblowers could serve as effective gatekeepers, there is no
    assurance they will do so. D-F 922 specifically provides that any
    whistleblower, who makes a claim, may be represented by counsel, and
    must be represented by counsel if he or she wishes to submit the claim
    anonymously.
        It is therefore not surprising that the Commission, in its adopting
    release, estimated that it will receive approximately 30,000 tips,
    complaints and referral submissions each year. Further, despite the
    extraordinary number of tips expected, neither the statute nor the
    rules ensure that the quality of tips is commensurately high. To the
    contrary, as the adopting release acknowledges, the standards for
    qualifying for a bounty under the False Claims Act are much higher than
    those under D-F. Yet, the SEC has been given relatively few additional
    resources with which to ``separate the wheat from the chaff,'' and has
    set aside $450 million to fund a pool from which rewards can be paid.
    D-F requires the SEC to establish a new, separate office within the
    agency to administer and enforce the whistleblower provisions. This new
    office will report annually to House and Senate committees on its
    activities, whistleblower complaints, and the SEC's response to such
    complaints. However, due to funding constraints, that office is being
    staffed out of existing SEC personnel--diverting them from other
    responsibilities.
        In short, the SEC is being set up for failure. That serves no one's
    interests, let alone that of investors. Somewhere, somebody should step
    back and say, ``We are piling all these responsibilities on, creating
    all these new provisions, but how do we expect the agency to cope?''
    The SEC has been given more rulemaking, more studies and more demanding
    responsibilities under D-F than any other financial regulator, but was
    denied what many other financial regulators have--the ability to self-
    fund its operations (with accountability to Congress for the policy
    decisions it makes). The SEC should be given this authority, provided
    there is full and complete accountability to Congress on the uses to
    which the SEC proposes to put the funds available to it through this
    mechanism.

    d. Proposed Amendment
        On May 11, 2011, Rep. Michael Grimm of New York circulated draft
    legislation that would amend D-F to require a whistleblower to first
    report fraud through an internal compliance program before being
    eligible to receive an award under the program. I strongly support such
    an amendment. Indeed, I would go further and advocate that the ``carve-
    out'' from the exemption for whistleblower eligibility for internal
    compliance, audit and legal personnel be tightened, if not completely
    eliminated.

    2. Corporate Governance

    a. Proxy Access.
        D-F's proxy access provisions are intended to promote shareholder
    democracy by requiring companies to include board candidates in
    management's proxy materials if nominated by shareholders holding at
    least 3 percent of the voting equity for at least 3 years. As a
    practical matter, however, the proxy access provisions, which have been
    stayed by the SEC pending the outcome of litigation over the validity
    of the Commission's rule, give disproportionate influence to certain
    shareholder constituencies--such as unions and pension funds--that have
    special interests that may be different from, or even adverse to, rank
    and file investors. Given that these special shareholder constituencies
    already usually possess significant leverage to affect corporate policy
    through the power of collective bargaining, it is not clear why
    providing them with an additional means of advancing their interests
    promotes shareholder democracy.
        And, it follows that, if the benefits of the new rule were
    overstated, the likely costs of the rule were not properly considered.
    Contested elections are expensive, and shareholders ultimately bear
    their cost. While the SEC said in its adopting release that it expects
    about 51 proxy contests a year as a result of the new rule, that would
    mean a drop from the 57 contested corporate elections in 2009. It is
    not clear how a rule designed to facilitate shareholder nominees can
    lead to fewer contested elections?
        While recognizing that some companies likely would oppose a
    particular shareholder nominee, and incur the consequent expenses, the
    Commission assumed that these costs would be limited because the
    directors' fiduciary duties would prevent them from using corporate
    funds to resist shareholder director nominations in the absence of any
    good-faith corporate purpose. Even if this assumption were true in an
    abstract sense, there is no way to quantify it sufficiently to support
    the Commission's estimates of the number of proxy contests likely to
    result from the new rule.
        Quite apart from the flaws in the Commission's cost-benefit
    analysis, the new rules reflect an unnecessary and ill-advised change
    in shareholders' rights, by pre-empting State law--the traditional
    source of such rights--in favor of imposing a new, one-size-fits-all
    regime on corporations from which they cannot opt out, even if their
    shareholders would prefer to do so. In 1934, when this Committee's
    predecessors passed the Securities Exchange Act, power over proxy
    contests was divided between the Federal Government and the States.
    State law determines what substantive rights a corporate shareholder
    may claim, while Federal regulation was intended to govern the
    disclosure applicable to, and the mechanics of, shareholder votes.
        In stark contrast, this provision of D-F turns the traditional
    situs of legal authority over shareholder voting power on its head.
    And, it ignores the most efficient ways to have resolved the thorny
    issue of proxy access:

        Given the current ubiquitous state of computer facilities,
            proxy materials should no longer be required to printed and
            mailed to corporate shareholders. Instead, the Commission
            should permit proxy solicitations to occur utilizing electronic
            communications. This change alone would diminish much of the
            effort on the part of corporate insurgents to utilize
            management's proxy materials to further their own policy
            choices.

        Even in the absence of a shift to electronic proxy
            solicitations, all the SEC need do is provide that shareholders
            have the right to amend their corporation's by-laws in whatever
            way State law permits, including an amendment to permit
            whatever form of proxy access the requisite number of
            shareholders approves. By dictating the mechanics of how this
            issue would be presented to shareholders (in particular,
            limiting the number of such proposals as well as the size and
            length of shareholdings entitling a shareholder to make such a
            proposal in management's proxy materials), the SEC has a
            relatively non-controversial way to resolve the thorny issue of
            proxy access without turning the supremacy of State law over
            shareholder voting rights on its head.

        This approach would take advantage of changes to State laws
            regarding proxy access. In 2007, the Commission considered
            amending Rule 14a-8(i)(8) to permit shareholders to propose
            binding shareholder resolutions to amend a company's by-laws to
            require the company to grant proxy access. Since 2007, the
            Delaware General Corporation Law and the ABA's Model Business
            Code have been amended to include provisions that explicitly
            permit proxy access bylaws and proxy reimbursement bylaws.

        This would have been (and still would be) an appropriate
            approach to proxy access. An enabling proxy access rule would
            avoid discriminatory distinctions among shareholders--
            potentially pitting self-interested groups, like unions and
            pension funds, against the average rank and file investor--in
            favor of true shareholder suffrage. Such an approach would
            facilitate companies' and shareholders' State-given rights to
            determine the processes that govern the nomination and election
            of directors, based on their unique circumstances. This
            approach would also, of course, facilitate shareholders'
            ability to avail themselves of the rights afforded by those
            processes.
    b. Say-on-Pay
        D-F 951 requires public companies to solicit non-binding
    shareholders' votes at least once every 3 years on the compensation of
    their highest paid executive officers. This new requirement has been
    referred to as say-on-pay. The first proxy season with say-on-pay votes
    has passed, and the overwhelming majority--88 percent--of these votes
    were positive, with more than 80 percent of these resolutions garnering
    at least 80 percent positive votes.
        However, shareholders in at least 39 companies voted ``no'' on
    executive compensation. At least six of these ``no'' votes have been
    followed by derivative claims against those companies and their boards,
    claiming the pay packages awarded effectively breach the fiduciary
    duties owed to shareholders who have rejected the specific executive
    compensation involved, as well as corporate waste, in awarding the
    rejected pay packages. Other ``investigations'' have been announced
    into the approval of pay packages that presumably will lead to
    litigation.
        The first wave of post-say-on-pay lawsuits lends credence to the
    warnings of those who predicted that the provision would lead to
    increased shareholder litigation, despite the express provision in D-F
    951(c) that the results of a say-on-pay vote do not create or imply
    any additional fiduciary duties on the part of the company's board, nor
    change the scope of any existing fiduciary duties. While most legal
    commentators expect these suits to fail, given not only the language of
    951(c) but also the high burden of proof set by the corporate law of
    most States with respect to breaches of fiduciary duty and corporate
    waste in the area of executive compensation, that only makes the
    litigation costs that say-on-pay is likely to impose on corporations--
    and thus their shareholders--even harder to justify.

    3. Office of the Investor Advocate
        Another example of D-F's unintended consequences is found in 915,
    its directive that the SEC establish an Office of the Investor
    Advocate. Putting to one side the fact that it is the SEC as a whole
    that is the ``Investor's Advocate,'' this provision contains the seeds
    of unnecessary conflict and adversarial posturing that will, ultimately
    redound to the disadvantage of investors. The statute empowers the
    Investor Advocate publicly to criticize and challenge agency actions or
    inactions, without any obligation to seek the input of--or even give
    notice to--the agency officials whose judgments may be publicly
    challenged.
        Moreover, at a time that the SEC's resources are strained to the
    limit (and beyond) by the imposition of D-F's other mandates, coupled
    with the denial to the SEC of the ability to self-fund (but with
    accountability to Congress), the Investor Advocate is expressly
    entitled to retain or employ independent counsel--that is, counsel not
    already a part of the SEC's staff--as well as its own research and
    service staff, as the Investor Advocate deems necessary to carry out
    the duties of the office. It is true that D-F 915 requires the
    Investor Advocate to ``consult'' with the SEC's Chairman before making
    any such expenditures, but there is no requirement that the SEC
    Chairman's views be given any deference whatsoever.
        In short, the statute creates an independent bureaucracy within the
    SEC that is inherently adversarial to both the Commission and its other
    Staff, rather than collaborative. Indicative of the adversarial nature
    of this position is the requirement imposed on the Commission to
    establish procedures requiring a formal response to all recommendations
    submitted to the Commission by the Investor Advocate. Such responses
    must be received within 3 months, and then trigger the Investor
    Advocate's ability to criticize the Commission's or Staff's failure to
    implement the Investor Advocate's agenda of recommended action. This is
    the same obligation that is imposed upon the Commission in the face of
    any Inspector General ruling or criticism of the Agency or its Staff.
    The creation of this Office threatens to disrupt, rather than
    facilitate, the SEC's investigative, enforcement and rulemaking
    functions.
        The ostensible purpose of creating the Office of Investor Advocate
    is to ensure that the interests of retail investors are built into
    rulemaking proposals from the outset and that agency priorities reflect
    the issues confronting investors. But, in order to achieve that
    objective, it was not necessary to create an entire new bureaucracy in
    order to achieve that end, nor was it necessary to give the Investor
    Advocate the effective ability to second-guess every judgment made by
    the Commission and its Staff as to how best to set priorities, balance
    competing interests and allocate scarce resources. The Office of
    Investor Advocate, far from being a resource to the Commission and its
    Staff in fulfilling the Agency's mission to protect investors, will be
    unnecessarily divisive.

    Conclusion
        The purposes behind D-F were surely laudable. But, in the critical
    area of investor protection, the provisions of the Act leave a great
    deal to be desired, and ultimately threaten to have adverse
    consequences on investor protection. It is possible to cure these
    problems, but that will require a determination by Congress, and
    resolve by the Agency, to implement that regulation which will indeed
    be likely to promote the needs of all investors.
        I will be happy to respond to any questions the Members of the
    Committee may have.
                                     ______

                      PREPARED STATEMENT OF BARBARA ROPER
     Director of Investor Protection for the Consumer Federation of America
                                 July 12, 2011

        Chairman Johnson, Ranking Member Shelby and Members of the
    Committee:
        My name is Barbara Roper, and I am Director of Investor Protection
    for the Consumer Federation of America (CFA), where I have been
    employed since 1986. CFA is a non-profit association of approximately
    300 national, State and local pro-consumer organizations founded in
    1968 to advance the consumer interest through research, advocacy, and
    education. I appreciate the invitation to appear before you today to
    discuss enhanced investor protection after the financial crisis.

    Introduction
        Improving protections for average investors has been a CFA priority
    for roughly a quarter century. During that time, experience has taught
    us that it often takes a crisis, or at least a scandal of major
    proportions, to highlight the need and provide the momentum for
    investor protection reforms. The recent financial crisis was traumatic
    event for U.S. investors that revealed serious shortcomings in the
    regulation of certain securities markets and market players. In
    particular, regulatory failures with regard to the market for asset-
    backed securities (ABS) and the credit ratings on which their sales
    depend were contributing causes of the crisis. Those regulatory
    shortcomings resulted in serious harm even to investors with no direct
    investments in ABS and no direct reliance on credit ratings. Indeed,
    many individuals with no investments at all nonetheless suffered
    devastating consequences in the form of lost jobs and lost homes.
        The crisis and events that occurred in conjunction with the
    crisis--such as the exposure of the Madoff Ponzi scheme--also revealed
    more general short-comings in the quality of regulatory oversight
    provided by the Securities and Exchange Commission (SEC). In some
    cases, those regulatory shortcomings can be attributed to lack of
    needed enforcement tools or authority. In others, inadequate resources
    appear to be the cause. But recent events have also revealed regulatory
    stumbles at the SEC that cannot be blamed on either of these causes but
    must instead be acknowledged as operational failures of the agency
    staff or a failure of will to regulate on the part of its leaders.
        Since Congress began consideration of financial regulatory reform
    legislation, a great deal of attention has been given to reforms
    designed to improve our ability to identify and address systemic
    threats, bring long-overdue regulatory oversight to the over-the-
    counter derivatives markets, and even to improve consumer financial
    protections by creating a new independent agency devoted to this task.
    Among the lesser known achievements of the Dodd-Frank Act is its
    creation of a framework that, if properly and effectively implemented,
    could significantly improve investor protections. Dodd-Frank takes a
    multi-faceted approach to bringing about this improvement in investor
    protections. Responding to abuses directly related to the crisis, it
    includes sweeping proposals to address flaws in both the asset-backed
    securitization process and in credit ratings, flaws that created
    incentives to write risky mortgages and helped mask those risks from
    investors. In addition:

        Dodd-Frank includes a suite of provisions designed to
            improve the quality of regulatory oversight provided by the
            SEC.

        These include enhanced regulatory and enforcement tools and the
    potential for increased resources to enable the SEC to carry out its
    investor protection mission more effectively. Responding to recent
    problems in the operations of the SEC, the Dodd-Frank Act also includes
    provisions to improve outside oversight of the agency. And recognizing
    that investor voices are too often drowned out by industry in debates
    over agency policy, it includes mechanisms to increase investor input
    in the policymaking process.

        Dodd-Frank includes another set of provisions designed to
            strengthen specific protections for average retail investors.

        Among these, the provision to raise the standard of conduct that
    applies to brokers when they give investment advice has received the
    most attention, both during the legislative debate and since. However,
    Title IX of Dodd-Frank also includes a number of other important
    investor protections, including provisions to strengthen the ability of
    defrauded investors to recover their losses, authority to address
    severe conflicts of interest in industry compensation practices, and
    provisions with the potential to dramatically improve the quality of
    disclosures investor receive regarding both investment products and
    services and the investment professionals who provide those services.
        While Dodd-Frank creates a broad framework to improve investor
    protections, investors will only reap the benefits if the SEC uses its
    new tools and new authority effectively and if Congress provides it
    with the resources necessary to enable it to do so. It is too soon to
    tell whether that is likely to occur. To date, the SEC has
    appropriately focused its implementation efforts on those aspects of
    Dodd-Frank where it is required to act, leaving for another day areas
    where it has been given new authority but no such mandate. Many of the
    provisions in the Investor Protection Title fit in the latter category.
    Moreover, the agency's funding status is far from clear. While the
    Senate secured a welcome funding increase for the agency in 2011, the
    House has been reluctant to provide 2012 funding for the agency that is
    commensurate with its broadly expanded authority. Not only does this
    put at risk the high profile Dodd-Frank provisions related to
    derivatives, hedge funds, securitization, and credit ratings, but, if
    the agency is forced to rob Peter to pay Paul, the lower profile
    investor protection issues would also suffer. If that happens, average
    retail investors will not only fail to reap the strengthened investor
    protections promised by Dodd-Frank, they will see those basic
    protections diminished and will inevitably suffer the consequences.
        The investor protection provisions of Dodd-Frank are too numerous
    to discuss each in detail here. Instead, my testimony will provide a
    broad overview of significant reforms and highlight a few areas of
    particular importance. My primary focus will be on topics of particular
    relevance to retail investors. Some issues with implications for retail
    investors, including municipal securities and whistleblower reforms,
    are not included in this testimony, not because they are not important,
    but because we lack the relevant expertise to provide informed
    commentary regarding the legislative provisions on these topics.
    Similarly, this testimony does not cover Dodd-Frank provisions to
    improve corporate governance. Although CFA strongly supported those
    reforms, others on the panel are better equipped to discuss their
    particulars. On the other hand, two other issues that aren't primarily
    retail investor issues--securitization reforms and credit rating agency
    reforms--are discussed briefly here because they so clearly illustrate
    the harm that can come to retail investors when institutional markets
    are not regulated effectively.

    I. Improving the Quality of Regulatory Oversight
        Dodd-Frank includes a suite of provisions intended to improve the
    overall quality of regulatory oversight provided by the SEC. These
    include general provisions to enhance the tools available to the agency
    to enforce the securities laws, provide better independent oversight of
    the agency, increase investor input into the agency's policymaking
    process, and authorize an increase in its funding. They also include a
    provision designed specifically to strengthen regulatory oversight of
    investment advisers, an area that has long been lacking. These
    provisions should help to improve the quality of regulatory oversight
    across the broad range of the SEC's responsibilities. The following
    section describes some of those provisions in greater detail.

    A. Enhancing the SEC's Enforcement Tools (various sections from 925
            through 929Z)
        Title IX of the Dodd-Frank Act provides the SEC with a whole host
    of fairly technical but important enhancements to its enforcement
    tools. These include provisions that: give the SEC broader authority to
    bar bad actors from the industry (Section 925, collateral bars); ensure
    that the SEC has the ability to exercise its anti-fraud authority with
    regard to conduct that occurs overseas but significantly affects U.S.
    investors or conduct that occurs in the United States but involves
    transactions executed elsewhere (Section 929P, extraterritorial
    jurisdiction); enable the PCAOB to share information with foreign
    jurisdictions (Section 292J); clarify that the SEC's authority to act
    against those who aid and abet securities violations is satisfied by a
    showing of recklessness (Sections 929M-O); and allow for the ability to
    hire specialist personnel outside the usual hiring system (Section
    929G). These are sensible reforms that should strengthen the SEC's
    ability to provide effective enforcement of the securities laws.
    Several of them deserve extra mention.
        Expert Staff: The SEC's failure to uncover the Madoff fraud has
    been blamed in part on its lack of staff with the sophisticated
    financial knowledge needed to understand the mechanism of the fraud.
    The need to enhance the technical expertise of the staff, already
    great, takes on added urgency as the agency assumes responsibility for
    oversight of securities-based swaps, credit rating agencies, and hedge
    funds and private equity funds--all highly complex and technical areas
    that will demand staff with specialized expertise to enforce them
    effectively. Giving the agency the ability to hire specialist personnel
    outside the usual hiring system should assist the agency in building
    the technical expertise necessary to fulfill these functions and
    provide more effective regulatory oversight of an increasingly complex
    market.
        Extraterritoriality: The Supreme Court decision in Morrison v.
    National Australia Bank left a gaping hole in SEC enforcement authority
    with its ruling that Section 10(b) of the Securities Exchange Act
    applies only to ``transactions in securities listed on domestic
    exchanges, and domestic transactions in other securities.'' Had this
    decision gone unaddressed, the SEC's ability to protect investors in an
    increasingly international marketplace would have been severely
    compromised. Moreover, the ability to evade U.S. fraud claims simply by
    moving transactions off-shore would have created a strong incentive for
    companies to avoid a U.S. listing and to execute transactions on
    foreign exchanges.
        Unfortunately, Dodd-Frank did not provide the same fix for private
    actions under Section 10(b) and Rule 10b-5, deferring a decision until
    after an SEC study of the issue. That study is currently underway. We
    are hopeful that the SEC will recommend that Congress amend the
    Exchange Act to ensure that Section 10(b), and the rules thereunder,
    are applicable to all purchases and sales of securities by U.S.
    financial institutions and individual investors residing in the United
    States. This is an important addition to the authority already provided
    to the SEC in the Act, first because private actions serve as an
    important supplement to SEC actions, particularly in light of limited
    agency resources, and second because there will still be an incentive
    for companies to avoid a U.S. listing and execute transactions overseas
    until the protections of U.S. law are fully restored for U.S.
    investors.
        PCAOB Sharing of Information with Foreign Authorities: Limits on
    the PCAOB's ability to share information with foreign regulators have
    been cited by some foreign jurisdictions as a reason not to permit
    PCAOB to inspect auditors within their jurisdiction. But the Sarbanes-
    Oxley Act requires PCAOB to inspect all auditors, including foreign
    auditors that play a significant role in the audits of U.S. listed
    companies. The PCAOB has sought to satisfy this requirement by
    developing a program of joint audits with foreign jurisdictions, with
    mixed results. While it is not likely to immediately remove all
    impediments, the provision in Dodd-Frank permitting this sharing of
    information should help open the way to greater cooperation in
    inspections of foreign auditors. Given the important role that foreign
    audit firms play in the audits of large multi-national companies as
    well as foreign companies listed in the United States, ensuring that
    these auditors comply with U.S. audit standards is an important
    investor protection priority. We are encouraged that the new leadership
    at the PCAOB has made this a priority and appears to be working
    effectively to make progress in this area.

    B. Strengthening Oversight of the SEC (Subtitle F)
        Dodd-Frank also includes a package of reforms designed to improve
    outside oversight of the SEC. It achieves this primarily through a
    series of Government Accountability Office (GAO) reviews and reports to
    Congress. These include an annual financial controls audit of the
    agency, a triennial report by GAO on the quality of the agency's
    personnel management, triennial GAO reports on the SEC's oversight of
    SROs, and a GAO study of the revolving door between the SEC and the
    securities industry it regulates. Perhaps most significantly, Section
    961 of Dodd-Frank requires the SEC to report to Congress each year on
    its examinations of regulated entities and, in doing so, to certify the
    adequacy of its supervisory controls to carry out these exam functions.
    Effective exams are central to the agency's ability to detect and deter
    wrong-doing. This annual reporting requirement, subject to GAO and
    congressional review, should help to quickly identify any weaknesses in
    the exam program and focus agency attention on improving the quality of
    these examinations. That has the potential to significantly enhance
    investor protection.
        An organizational study of the agency required by Dodd-Frank has
    already been completed.\1\ The purpose of the study was to examine the
    internal operations, structure, and the need for reform at the SEC. In
    addition to praising recent initiatives undertaken by the agency to
    improve its efficiency and effectiveness,\2\ the report suggests
    additional steps for the agency to take to improve efficiency. Among
    its more substantive recommendations are for the agency to play a more
    active role in overseeing the self-regulatory organizations (SROs)
    under its jurisdiction, to upgrade its information technology, and to
    hire staff with risk management and other high-priority skills.
    Ultimately, however, the report concludes that agency is unlikely to be
    able to fulfill even its high priority functions without additional
    resources. We share that conclusion, as we discuss in greater detail
    below.
    ---------------------------------------------------------------------------
        \1\ ``U.S. Securities and Exchange Commission Organizational Study
    and Reform,'' Boston Consulting Group, March 10, 2011.
        \2\ These include reorganization of the Division of Enforcement and
    the Office of Compliance Inspections and Examinations, the rollout of
    the new Tips, Complaints and Referrals program, and hiring of a Chief
    Operating Office and a new Chief Information Officer.
    ---------------------------------------------------------------------------
    C. Providing Investors with Greater Input into Agency Policy Decisions
            (Sections 911 and 915)
        The SEC decides issues of enormous import to investors every day,
    often with little or no input from the investors affected by those
    decisions. This does not reflect any intent to shut investors out of
    the process. Rather, it reflects the simple fact that investors often
    lack the organization, manpower and resources to monitor agency actions
    and interact effectively with SEC leaders and staff as they set the
    agency's agenda and develop specific proposals to achieve that agenda.
    In contrast, industry is well funded and organized to perform this
    function, giving market participants an advantage in communicating with
    the agency that is further magnified by the revolving door that exists
    between the SEC and the securities industry. The inevitable result is
    that industry concerns tend to dominate the policy debate, while
    investor concerns can too easily be drowned out.
        The Dodd-Frank Act includes two provisions specifically designed to
    increase investor input into the agency's policymaking process and
    ensure that investor concerns are heard. Section 915 creates a new
    Office of Investor Advocate within the agency, while Section 911
    establishes a permanent Investor Advisory Committee. Properly
    implemented, these provisions have the potential to make the agency
    more aware of and thus more responsive to investor concerns and
    priorities. The result should be an agency that more effectively
    fulfills its mission to protect investors and promote the integrity of
    the capital markets.
        The Office of Investor Advocate: The legislation seeks to ensure
    that this office will truly and effectively serve the interests of
    investors by requiring that the Investor Advocate be an individual with
    a background representing the interests of investors, by providing the
    office of the Investor Advocate with appropriate staffing and with
    unimpeded access to agency and SRO documents, by ensuring that the
    Investor Advocate reports directly to the Chairman, and by requiring
    that the Commission respond promptly to recommendations of the Investor
    Advocate.
        Moreover, several important functions are entrusted to this office,
    including:

        Identifying areas in which investors would benefit from
            changes in the regulations of the Commission or industry self-
            regulatory organizations (SROs);

        Identifying problems investors have with financial service
            providers and investment products;

        Analyzing the potential impact on investors of proposed
            Commission and SRO rules and regulations; and

        Assisting retail investors in resolving problems with the
            SEC and SROs.

        If the Commission follows through by appointing an energetic,
    effective and knowledgeable individual to this position and staffing
    the office appropriately, investors should benefit from an agency that
    is more attuned and responsive to their concerns.
        This provision also has the potential to improve the quality of
    congressional oversight of the SEC. That is because Dodd-Frank requires
    the Investor Advocate to report directly to Congress without prior
    review or approval by the Commission or its staff. This should enhance
    Congress's ability to assess the effectiveness of the agency in serving
    the needs of investors, particularly in administrations that are less
    attuned to those concerns.
        So far, however, this provision of the legislation has not been
    implemented. Implementation was delayed first by the hold-up in
    finalizing a 2011 budget. Now that the SEC's 2011 budget has been set,
    we understand that the Commission is awaiting approval by the House and
    Senate appropriations committees of its plan to reprogram funds for
    this purpose. We hope that any questions about this reprogramming plan
    can be resolved without difficulty so that this potentially powerful
    ally for investors can be put into place. The need for this investor
    input is particularly pressing given the importance of the issues
    currently being decided by the agency and the intensity of industry
    lobbying to weaken or water down many of those proposals.
        The Investor Advisory Committee: When SEC Chairman Mary Schapiro
    took office, she made it an early priority to establish an Investor
    Advisory Committee to provide input on investor priorities to the
    Commission and its staff. Recognizing the potential benefits of this
    committee, the Dodd-Frank Act formalizes its existence as a permanent
    advisory committee to the Commission. As with the Office of Investor
    Advocate, however, implementation of this provision is awaiting
    approval of the Commission's funding reprogramming plan by
    congressional appropriators. Meanwhile, the existing committee has been
    disbanded in order to allow for changes in its make-up required by
    Dodd-Frank. Because this committee has the potential to enhance the
    agency's understanding of and responsiveness to investor protection
    concerns, we urge a speedy resolution to any remaining impediments to
    its implementation.

    D. Increasing SEC Funding (Subtitle J)
        Over the course of the past three decades, U.S. securities markets
    have exploded in size, complexity, international reach, and
    technological sophistication, all the while becoming the primary means
    by which Americans fund their retirement. Meanwhile, with the exception
    of a one-time major funding boost after the Enron and WorldCom
    accounting scandals, the staffing level of the SEC has grown slowly if
    at all. To be specific, staffing at the agency has grown roughly 85
    percent from 2,050 FTEs in 1980 to 3,800 FTEs today, but the workload
    of the agency has grown many times faster. For example, based on my
    rough calculations, since 1980:

        the number of investment adviser firms overseen by the
            agency has grown by more than 150 percent, and the assets
            managed by these professionals has grown by roughly 7,400
            percent;

        the number of mutual funds overseen by the agency has grown
            more than 430 percent; and

        while the number of broker-dealer firms has decreased by 20
            percent, the number of registered representatives they employ
            and the number of branch offices from which they operate has
            skyrocketed, by roughly 225 percent and 2,100 percent
            respectively.\3\
    ---------------------------------------------------------------------------
        \3\ These calculations are based in large part on numbers from a
    ``Self-Funding Study,'' prepared by the Office of the Executive
    Director of the U.S. Securities and Exchange Commission and submitted
    in partial response to the request of the Securities Subcommittee of
    the Senate Committee on Banking, Housing and Urban Affairs S. Rpt. 100-
    105), December 20, 1988 as well as on more recent speeches by and
    testimony of SEC Chairman Mary Schapiro.

        The result is that the SEC today is critically under-staffed to
    carry out its existing responsibilities, let alone take on the vast new
    responsibilities entrusted to the agency in Dodd-Frank. And that
    doesn't take into account the woeful state of the agency's technology.
        In Dodd-Frank, Congress recognized the need for increased SEC
    resources by authorizing funding increases that would roughly double
    the agency budget by 2015. Specifically, the bill authorizes funding of
    $1.3 billion in 2011, $1.5 billion in 2012, $1.75 billion in 2013, $2
    billion in 2014, and $2.25 billion in 2015. We strongly support fully
    funding the agency at these levels as an essential component of any
    effort to increase investor protections, and we greatly appreciate the
    leadership that Chairman Johnson and Members of this Committee have
    shown in fighting for increased funding. Unfortunately, the debates
    over the FY 2011 and 2012 budget have already made clear that turning
    those authorizations into appropriations is going to be a tough fight.
    Some in Congress continue to resist these funding hikes, even though
    the agency's budget is fully offset by user fees and, since fees have
    to be adjusted to match the appropriation, there is no deficit
    reduction benefit from reduced funding. Indeed, even if the agency were
    fully funded at the authorized level for 2012, user fees would be
    reduced, since they currently bring in well over the authorized amount.
        While we are sympathetic to those who argue that money alone cannot
    solve all of the agency's problems, we also believe that, without
    additional funding, the agency cannot reasonably be expected to
    effectively fulfill its investor protection mission. We urge Members of
    this Committee to continue to fight for full funding, and we offer our
    full support for those efforts.

    E. Improving the Quality of Investment Adviser Oversight (Section 914)
        One area where the funding shortfall is particularly critical is in
    the regulatory oversight of investment advisers. This issue received
    heightened attention as a result of the unraveling of the Madoff Ponzi
    scheme. This is ironic, since Madoff was a broker-dealer regulated
    exclusively as a broker-dealer up until just 2 years before his fraud
    was uncovered. If the Madoff scandal was an indictment of anything,
    therefore, it was an indictment of the effectiveness of broker-dealer
    oversight.\4\ That said, the problem of inadequate investment adviser
    oversight is quite real. And it is first and foremost a resource
    problem, a problem that began to emerge in the late 1980s at a time
    when both mutual funds and investment advisers were growing at an
    extremely rapid pace and agency staffing to oversee these areas was
    growing slowly if at all. By the early 1990s, the problem had reached
    crisis proportions, with inspections so infrequent that a small adviser
    might reasonably expect to set up shop and reach retirement without
    ever seeing an SEC inspector.\5\
    ---------------------------------------------------------------------------
        \4\A group of independent FINRA board members, led by Charles
    Bowsher, has since conducted a very credible examination of FINRA's
    failure to uncover both the Madoff and the Stanford frauds, and FINRA
    has reportedly begun to implement the recommendations of that study to
    improve the quality of its broker-dealer oversight.
        \5\ At the time, SEC staff members estimated that it small advisers
    were on a once every 40 years inspection cycle.
    ---------------------------------------------------------------------------
        Over the years, CFA has supported a variety of approaches to solve
    this resource problem, including increased appropriations to the SEC,
    self-funding for the agency to free it from the appropriations process,
    and user fees on investment advisers to pay for increased oversight.
    None has been adopted. While the resource problem ultimately rests with
    Congress to resolve, Section 914 of the Dodd-Frank Act required the SEC
    to conduct a study assessing the need for additional resources for
    investment adviser examinations and options available to Congress to
    address this issue, including by delegating this responsibility to a
    self-regulatory organization (SRO).
        Earlier this year, the SEC issued its Section 914 study.\6\ In it,
    the staff documented a decline in the number and frequency of
    inspections of registered investment advisers over the past 6 years and
    described new challenges the Commission will face as it takes on
    responsibility for registration and oversight of private fund advisers.
    We share the study's conclusion that, ``The Commission's examination
    program requires a source of funding that is adequate to permit the
    Commission to meet the new challenges it faces and sufficiently stable
    to prevent adviser examination resources from periodically being
    outstripped by growth in the number of registered investment
    advisers.''
    ---------------------------------------------------------------------------
        \6\ ``Study on Enhancing Investment Adviser Examinations,'' by the
    staff of the Division of Investment Management of the Securities and
    Exchange Commission, January 2011. The study is available here:
    www.sec.gov/news/studies/2011/914studyfinal.pdf.
    ---------------------------------------------------------------------------
        The study outlines three options for Congress to consider adopting
    to address this ``capacity constraint:''

        imposing user fees on SEC-registered investment advisers to
            fund their examinations by SEC inspection staff;

        authorizing one or more SROs to examine, subject to SEC
            oversight, all SEC-registered investment advisers; or

        authorizing FINRA to examine dual registrants for
            compliance with the Advisers Act.

        In the past, CFA has categorically opposed delegating investment
    adviser oversight to an SRO, particularly one dominated by broker-
    dealer interests and particularly if that SRO were given rulemaking
    authority. We continue to believe the user-fee approach outlined in the
    SEC report offers the best option for funding enhanced inspections in a
    way that promotes investor protection while minimizing added costs to
    industry.
        However, having spent the better part of two decades arguing for
    various approaches to increase SEC resources for investment adviser
    oversight with nothing to show for our efforts, we have been forced to
    reassess our opposition to the SRO approach. Specifically, we have
    concluded that a properly structured SRO proposal would be a
    significant improvement over the status quo. Too often, however, the
    SRO approach is presented as an easy solution by individuals who have
    not adequately confronted the many thorny issues it presents. The SEC
    study does an excellent job, in our view, of laying out the issues that
    would need to be addressed if Congress were to pursue this approach.
    Only by answering the following questions can Congress develop an SRO
    proposal that adequately protects investor interests while avoiding
    imposing undue costs on small advisers.

        How should such an approach be structured in light of the
            diversity in the investment adviser community?

        How can the risks of industry capture be avoided?

        What are the implications of strong industry opposition to
            such an approach?

        What would the costs of effective SRO oversight be, and how
            would they be borne by the many small investment adviser firms?

        What resources would the SEC need in order to provide
            effective oversight of any such SRO or SROs to which this
            responsibility might be delegated?

        Should an SRO be an inspection-only SRO, or should it also
            have broader rulemaking authority?

        What entity (or entities) is best suited to this task?

        Ultimately, whatever approach Congress chooses to take, we share
    the view expressed by SEC Commissioner Elisse Walter in her statement
    on the study, ``that the current resource problem is severe, that the
    problem will only be worse in the future, and that a solution is needed
    now.'' We urge you to act to resolve this problem sooner rather than
    later.

    F. Improving Regulation of Financial Planners (Section 919C)
        Section 919C of Dodd-Frank required a GAO study of the adequacy of
    financial planning regulation. Deferring to a study was a reasonable
    approach for Congress to take, since the crowded legislative calendar
    in the midst of the crisis did not allow for an adequate review of the
    issues or of various proposals that have been put forward to improve
    financial planning regulation. Unfortunately, the GAO study on
    financial planning regulation,\7\ which was released in January,
    represents a real missed opportunity. While it correctly highlights
    problems with the weak conduct standards that apply to insurance
    agents, it fails to address the basic question of how best to regulate
    activity that cuts across a variety of regulatory domains.\8\ This is
    an important question that deserves more thoughtful analysis than it
    received in the GAO study. Indeed, we would encourage this Committee to
    look into the issue once the press of overseeing implementation of
    Dodd-Frank has passed.
    ---------------------------------------------------------------------------
        \7\ ``Consumer Finance: Regulatory Coverage Generally Exists for
    Financial Planners, but Consumer Protection Issues Remain,'' Government
    Accountability Office, January 2011. The report is available here:
    http://www.gao.gov/new.items/d11235.pdf.
        \8\ The problems with the GAO study are summed up well in a
    Morningstar article by University of Mississippi Law Professor Mercer
    Bullard, ``The Future of Financial Planning Regulation.'' The article
    is available here: http://news.morningstar.com/articlenet/
    article.aspx?id=386262
    ---------------------------------------------------------------------------
    II. Strengthening Protections for Retail Investors
        As the financial reform legislation worked its way through
    Congress, it became a vehicle for several specific measures to improve
    investor protections. These are not for the most part directly related
    to the causes of the crisis (though some are directly related to the
    Madoff scandal). Instead, they address long-standing weaknesses in
    protections for retail investors. The issues covered by these
    provisions range from the protections that apply to investors'
    interactions with those they rely on for investment advice, the quality
    of disclosures investors receive regarding investment products and
    services, and the ability of defrauded investors to recover their
    losses. For the most part, these Title IX provisions authorize rather
    than require the SEC to act. With the agency so far occupied primarily
    with Dodd-Frank mandates, and appropriately so, progress to date has
    been minimal. Once the agency has an opportunity to turn its attention
    to these issues, however, these provisions have the potential to
    dramatically improve protections for retail investors in areas long
    identified as high priorities by investor advocates.

    A. Raising the Standard for Brokers' Investment Advice (Section 913)
        Improving the protections that apply to investors' interactions
    with the financial intermediaries they rely on for investment advice
    and recommendations has long been a priority for CFA and other investor
    advocates. There are several reasons for this. Research suggests that
    investors are ill-equipped to make an informed choice among investment
    professionals, since they typically cannot distinguish between brokers
    and investment advisers, do not realize that their recommendations are
    subject to different legal standards, and do not understand the
    difference between those standards. Moreover, additional research has
    found that investors rely heavily, if not exclusively, on the
    recommendations they receive from investment professionals, typically
    doing little if any additional research on the investments recommended.
    This makes them extremely vulnerable to investment professionals who
    take advantage of that trust. That is why ensuring that these
    investment professionals act in their customers' best interests--both
    by raising the standard of conduct that applies to broker dealers when
    they give investment advice and by improving the quality of regulatory
    oversight for investment advisers--is such a high investor protection
    priority.
        Section 913 of Dodd-Frank advances this goal by authorizing the
    Securities and Exchange Commission to impose a fiduciary duty on
    brokers when they give personalized investment advice to retail
    investors. In January, the Commission released the study required by
    the Act as a predicate to any regulatory action in this area.\9\ In it,
    the Commission proposes to impose a uniform fiduciary duty on brokers
    and advisers through dual rules under the Securities Exchange Act and
    the Investment Advisers Act. This approach, which preserves the broker-
    dealer business model while raising the standard that applies to broker
    recommendations, has won enthusiastic praise not only from traditional
    proponents of a fiduciary duty, such as CFA, but also from the leading
    broker-dealer trade associations.\10\
    ---------------------------------------------------------------------------
        \9\ ``Study on Investment Advisers and Broker-Dealers,'' by the
    staff of the U.S. Securities and Exchange Commission, January 2011. The
    report is available here: http://www.sec.gov/news/studies/2011/
    913studyfinal.pdf.
        \10\ Unfortunately, a relatively small but vocal segment of the
    broker-dealer community, in particular those whose business model is
    dependent on the sale of high-cost variable annuities, has continued to
    oppose any Commission action to raise the standard of conduct for
    brokers. In voicing their opposition, they rely on arguments that are
    at best misinformed, at worst are outright deceptive, that requiring
    brokers to act in their customers' best interests would somehow harm
    middle income and rural investors. Contrary to the claims of these
    critics, the proposal put forward by the SEC offers middle income
    investors the best of both worlds, preserving their access to
    commission- and transaction-based services while simultaneously helping
    to ensure that those services are delivered with the investor's best
    interests in mind.
    ---------------------------------------------------------------------------
        The fact that the SEC has identified an approach to this issue that
    has won such broad support offers an opportunity for long-overdue
    progress on this key investor protection priority. SEC Chairman Mary
    Schapiro has indicated that the Commission is likely to move forward on
    rulemaking later this year. CFA strongly supports the Commission on
    this and urges Members of this Committee to do so as well.

    B. Improving Disclosures (Sections 912, 917, 919, 919B)
        In a number of areas and to a large extent, our system of investor
    protection is predicated on the notion that investors who are armed
    with complete and accurate information will be able to look out for
    their own interests. This concept, which predates the democratization
    of securities markets that has occurred over the past several decades,
    may be overly optimistic in its assumptions about the financial
    sophistication of average retail investors. At the very least, it puts
    a premium on our ability to deliver the information investors need, in
    a form they can access and understand, at a time when it is useful to
    them in making their investment decisions. I suspect that, if the SEC
    were to make extensive use of the disclosure testing authority provided
    to the agency in Dodd-Frank, it would find that few if any of the
    disclosures currently provided to investors satisfy this three-part
    test for effectiveness. In short, much can and should be done to
    improve the content, format and timing of disclosures, and the Dodd-
    Frank Act provides the SEC with a sound framework for making those
    improvements.
        Section 917, for example, requires the SEC, as part of its study of
    financial literacy, to look at a variety of issues that are central to
    developing effective disclosures. These include identification of the
    key information investors need to make sound investment decisions as
    well as ways to improve the timing, content and format of disclosures.
    By requiring this analysis in the context of a study of financial
    literacy, this provision highlights the need to design disclosures with
    a realistic understanding of the financial sophistication of investors
    in mind. Section 912 builds on this study by authorizing the agency to
    engage in investor testing of disclosures. This authority can be used
    both to learn what methods and formats of disclosure generally are most
    effective in conveying information to investors and to test specific
    disclosure documents for clarity and effectiveness. It can and should
    be used both to help in the development of new disclosures and to
    improve existing disclosures. It is our understanding that the agency
    has begun to make at least limited use of this new authority, and we
    hope that is a trend that will continue and grow. For that to happen,
    however, the SEC must receive adequate funding for this purpose.
        Timing of disclosures can determine whether or not they play a
    significant role in conveying important information to investors.
    Information received after the sale is of little if any use, but that
    is the current norm in all too many situations. Even information
    delivered at the point of sale may be of little value, if the
    investment decision has already been reached. To really benefit,
    investors must receive the key information when they are still
    evaluating their investment options. That argues for delivery at the
    point of recommendation, a goal that may be more easily achieved as we
    move toward greater use of the Internet to satisfy disclosure
    requirements. Section 919 of Dodd-Frank provides the SEC with tools to
    achieve this goal of timelier disclosures, by authorizing the agency to
    require pre-sale disclosures with regard to both investment products
    and services. We especially appreciate the decision to expand this
    provision beyond just mutual funds to include all investment products
    and services. This will give the agency the ability to take what it
    learns from its study on financial literacy and from any disclosure
    testing it conducts and use it to develop disclosure documents that are
    much more useful to retail investors.

    C. Strengthening Protections for Defrauded Investors (Sections 921,
            929B, 929H, 929Y, 929Z)
        Title IX of Dodd-Frank also includes several provisions that could
    be used to improve, or at least protect, the ability of defrauded
    investors to recover their losses. These include provisions in Section
    929B to expand the Fair Fund to include civil penalties, the Section
    929Y study of extraterritoriality and private rights of action, and the
    Section 929Z study of private rights of action against those who aid
    and abet securities fraud. For investors to benefit from the latter two
    provisions, however, Congress will need to follow up on these studies
    and amend the Securities Exchange Act to provide U.S. investors with
    the ability to pursue private actions under Section 10(b) for foreign
    transactions and against those who aid and abet securities fraud. A
    series of recent court decisions have significantly limited defrauded
    investors' right to recovery. We urge Congress to redress that
    imbalance by restoring basic private rights of action in these areas.
        Perhaps more significantly, Section 921 of Dodd-Frank authorizes
    the SEC to limit or restrict the use of forced arbitration clauses in
    brokerage contracts. CFA is a strong support of alternative dispute
    mechanisms. We believe it is absolutely essential the investors retain
    access to an arbitration system that is fair, efficient and affordable.
    It is precisely for this reason that we oppose pre-dispute binding
    arbitration clauses. Certain cases simply are not suited for resolution
    through arbitration, particularly complex fraud cases that require
    extensive discovery proceedings and a sophisticated reading of the
    applicable law. When forced into arbitration by pre-dispute binding
    arbitration clauses, these cases can both clog the arbitration system
    and increase its costs. Those operating the arbitration forum, in this
    case FINRA, come under pressure to adopt more formal, court-like
    proceedings to ensure that such cases can be dealt with fairly. And the
    goals of a fast, efficient, affordable system to resolve disputes end
    up being undermined. CFA therefore supports a careful approach to
    limiting the use of binding arbitration clauses that preserves investor
    access to arbitration but doesn't force cases into arbitration that
    don't belong there. So far, however, the SEC does not appear to have
    taken up this issue.

    D. Strengthening Protections Regarding Custody of Client Assets
            (Section 411)
        Responding at least in part to concerns raised by the Madoff
    scandal, Section 411 of the Dodd-Frank Act requires investment advisers
    to have appropriate protections in place to safeguard client assets
    held in custody, including by requiring an independent auditor to
    verify the assets. While we believe this is a useful requirement, it is
    worth noting that Madoff was a broker, not an investment adviser, for
    the bulk of the period covered by the scandal. Any Madoff-related
    reforms to address weaknesses in custody requirements would more
    appropriately focus on strengthening protections with regard to brokers
    who self-custody.

    E. Adjusting the Definition of Accredited Investor (Section 413)
        Several definitions in our securities laws seek to draw a line
    between sophisticated investors capable of looking out for their own
    interests and others who require the protection of the securities laws.
    One such is the accredited investor definition. While we question the
    validity of any definition based primarily on net worth or income, the
    validity of the definition is particularly questionable when it is not
    regularly adjusted to keep pace with inflation. Such has been the case
    with the accredited investor definition. Section 413 of Dodd-Frank
    significantly improves the definition by adjusting the net worth
    trigger upward, excluding the value of the primary residence from that
    calculation, and providing for periodic reviews and adjustments of the
    standard.

    III. Addressing Securities Regulation Failures Related to the Crisis
        While they fall somewhat outside the range of topics typically
    thought of as retail investor protection issues, two investor
    protection issues directly related to the financial crisis deserve at
    least a mention here--securitization reform and strengthened regulation
    of credit rating agencies. These issues perfectly illustrate how a
    failure to regulate effectively in largely institutional markets can
    have devastating consequences for retail investors.

    A. Reforming the Asset-Backed Securitization Process
        As the crisis unfolded, much attention was given to the way
    securitization had fundamentally changed incentives in the mortgage
    markets, making lenders far less concerned about ensuring the
    borrower's ability to repay. One reason this occurred was that the
    mortgage-backed securities (MBS) and collateralized debt obligations
    (CDOs) based on those securities were both incredibly complex and
    almost completely opaque, leaving investors in the securities with
    little or no information about the quality of underlying loans. As Penn
    State Visiting Law Professor Richard E. Mendales put it, ``The many
    layers between debt instruments providing the underlying cash-flow for
    such instruments and the final instruments sold on world markets
    destroyed the transparency that the securities laws are designed to
    create . . . ''\11\
    ---------------------------------------------------------------------------
        \11\ Mendales, Richard E., ``Collateralized Explosive Devices: Why
    Securities Regulation Failed to Prevent the CDO Meltdown, and How to
    Fix It,'' University of Illinois Law Review.
    ---------------------------------------------------------------------------
        The diligent investor who attempted to conduct due diligence on
    these securities got no assistance from securities regulations, which
    allowed the sale of MBS with minimal disclosures through the SEC's
    shelf-registration process. As a result, even those MBS that were
    registered with the SEC could be sold based ``not upon a detailed
    prospectus but rather on a basic term sheet with limited
    information.''\12\ Regulation A/B also eliminated underwriters'
    obligation to perform due diligence to confirm adequate loan
    documentation. Bad as disclosures were for more traditional MBS, they
    were often even worse for CDOs, which were typically sold in private,
    144A sales to Qualified Institutional Buyers (QIBs) with even less
    information on underlying assets.
    ---------------------------------------------------------------------------
        \12\ Investors Working Group, U.S. Financial Regulatory Reform: The
    Investors' Perspective, July 2009. (The Investors Working Group is an
    Independent Taskforce Sponsored by CFA Institute Centre for Financial
    Market Integrity and Council of Institutional Investors.) [Hereinafter,
    The Investors' Perspective]
    ---------------------------------------------------------------------------
        Subtitle D of Title IX includes a broad set of provisions to reform
    the asset-backed securitization process. The legislation attempts to
    address the securitization's deleterious effect on incentives to ensure
    borrowers' ability to repay by requiring securitizers to have some
    ``skin in the game'' with regard to the asset-backed securities they
    issue. Just as important, Section 942 of Dodd-Frank requires more
    extensive disclosures of information necessary to permit investors to
    conduct a reasonable due diligence review of the securities. Section
    945 requires issuers of asset-backed securities to perform a review of
    the assets underlying the security and to disclose the nature of that
    review to investors. Importantly, in issuing its rules implementing
    Section 945, the SEC appropriately specified that the due-diligence
    reviews must be adequate to provide reasonable assurance that the
    disclosures provided to investors are accurate. Meanwhile, the broader
    ABS disclosure rules required by the Act have been proposed but not yet
    adopted. When they are fully implemented, these provisions should go a
    long way toward making it possible for the institutional investors who
    participate in this market to make better informed investment
    decisions, and that should benefit retail investors by reducing risks
    in the financial system.

    B. Strengthening Regulation of Credit Rating Agencies
        One justification given for allowing sale of MBS and CDOs without
    adequate disclosures was that they were highly rated by the credit
    rating agencies. In fact, the entire system of regulation for the
    securitization process was built on the assumption that ratings could
    reliably assess the risks associated with these investments. Special
    Purpose Vehicles set up to issue the securities were exempt from
    regulation under the Investment Company Act by virtue of their
    investment grade ratings. Eligibility for sale through the shelf
    registration system was also based on ratings, as was favorable
    treatment under financial institution capital standards. Mendales
    summed up our regulatory reliance on ratings this way: ``Unregulated
    ratings for asset-backed securities became proxies for the full
    disclosure required by securities law. Thus, when they were repackaged
    into more complex CDOs or used indirectly to create derivative
    obligations such as default swaps, participants in transactions and
    institutions holding the securities as part of their required
    capitalization relied on the high ratings given to component asset-
    backed securities rather than looking at the assets underlying
    them.''\13\ As events later demonstrated, the reliance on ratings by
    investors and regulators alike proved to be disastrously misguided.
    ---------------------------------------------------------------------------
        \13\ Collateralized Explosive Devices. [footnotes omitted]
    ---------------------------------------------------------------------------
        Subtitle C of the Dodd-Frank Act seeks to address this fundamental
    weakness in the system through a multi-faceted approach to credit
    rating agency reform. This includes: improving regulatory oversight of
    credit ratings agencies, strengthening internal controls over the
    rating process, making the assumptions behind the ratings more
    transparent to users of those ratings, making the ratings agencies more
    accountable for following sound procedures, and reducing regulatory
    reliance on ratings.
        Implementation of the reforms is still very much a work in
    progress. Still awaiting approval by House and Senate appropriators of
    its funding reprogramming plan, the SEC has not yet been able to create
    the new Office of Credit Ratings required by Dodd-Frank. However, it
    has reportedly begun the stepped up inspections of rating agencies
    required under the Act. In addition, the SEC recently issued the rule
    proposals implementing the operational reforms required by the Act.
    Meanwhile, the agency has put on hold provisions designed to increase
    legal accountability of ratings agencies by subjecting them to the same
    expert liability that auditors and underwriters face when their ratings
    are used in prospectuses. Faced with a threatened boycott by ratings
    agencies and fearing a shut-down of the still struggling MBS market,
    the SEC has issued a no action letter permitting asset-backed
    securities to be issued without inclusion of a rating in the
    prospectus. While we believe ratings agencies ought to be held legally
    accountable for following reasonable ratings procedures, we understand
    the rationale behind the SEC action.
        The SEC has also begun the difficult task of reducing regulatory
    reliance on credit ratings. CFA strongly supports the concept behind
    this proposal, but we preferred the more flexible approach contained in
    the original Senate bill. Had that approach prevailed, Federal
    financial regulators might not be in the situation in which they now
    find themselves--forced to remove regulatory references to credit
    ratings without having identified any acceptable alternative measures
    of creditworthiness to put in their place. We are deeply concerned that
    this well-intended provision of the legislation may end up increasing
    risks in the financial system. We strongly encourage this Committee to
    take a closer look at how this provision is being implemented and what
    the implications are for the safety and stability of the financial
    system.

    Conclusion
        With the exception of the September 11 terrorist attacks, I can
    think of no events in recent history that have been as frightening for,
    or as devastating to, investors as the recent financial crisis. For
    several months, the markets appeared to be in free-fall. As the Dow
    plunged ever lower, hard won retirement savings accumulated over many
    years were vaporized overnight. No one knew when, of where, the market
    would finally reach bottom. Some who had planned to retire had to put
    those plans on hold. The least fortunate lost their jobs and their
    homes as the credit markets froze and the economy tanked. With
    unemployment still topping 9 percent, many Americans are still feeling
    those ill effects today. In short, the financial crisis has left
    Americans feeling as fearful of financial disaster as the events of 9/
    11 left us fearful of another terrorist attack.
        A peculiar characteristic of the crisis for retail investors is
    that they suffered these devastating effects despite the fact that they
    had never invested in the toxic but nonetheless AAA-rated mortgage-
    backed securities that were a root cause of the crisis and had probably
    never even heard of the credit default swaps that helped spread that
    risk throughout the global economy. Instead, retail investors suffered
    the collateral damage of regulatory failures in markets to which they
    had no direct exposure. The bulk of Dodd-Frank is dedicated to
    rectifying those broader market failures, and appropriately so.
    Although most investors are unlikely to understand the cause and
    effect, reforms designed to improve the overall effectiveness of
    regulation in the financial markets should benefit these investors
    indirectly both by promoting the financial stability that is crucial to
    their financial security, but also by making the regulators (in this
    case the SEC) more effective in carrying out their basic investor
    protection functions. In addition, Dodd-Frank includes a number of
    provisions designed to address long-standing weaknesses in our system
    of protections for unsophisticated retail investors. If these
    provisions are implemented effectively, the SEC and our system of
    investor protection generally could emerge stronger than before.
        The investor protection framework provided in Dodd-Frank is a sound
    one. But it only takes us so far. For it to succeed, regulators will
    have to demonstrate a willingness to use their authority aggressively
    and effectively, and Congress will have to provide them with both the
    resources and the backing to enable them to do so.
                                     ______

                       PREPARED STATEMENT OF ANNE SIMPSON
                   Senior Portfolio Manager, Global Equities
                 California Public Employees' Retirement System
                                 July 12, 2011

        Chairman Johnson, Ranking Member Shelby, and Members of the
    Committee:
        Good morning. I am Anne Simpson, Senior Portfolio Manager, Global
    Equities at the California Public Employees' Retirement System
    (CalPERS). I am pleased to appear before you today on behalf of CalPERS
    and share our views on a number of important investor protections
    included in Dodd-Frank Wall Street Reform and Consumer Protection Act
    (Dodd-Frank).
        My testimony includes a brief overview of CalPERS, including how we
    participate in corporate governance and make investment decisions. My
    testimony also includes a discussion of our views on those key
    provisions of the Dodd-Frank we believe significantly enhance corporate
    governance and thereby contribute to the quality of risk adjusted
    returns in our portfolio.

    Some Background on CalPERS
        CalPERS is the largest public pension fund in the United States
    with approximately $232 billion in global assets and equity holdings in
    over 9,000 companies worldwide. CalPERS provides retirement benefits to
    more than 1.6 million public workers, retirees, their families and
    beneficiaries. We payout some $15 billion in benefits a year, and 70
    cents on the dollar comes from investments, a significant portion of
    which in internally managed.\1\
    ---------------------------------------------------------------------------
        \1\ Approximately three-quarters of CalPERS global equities
    portfolio is managed by internal investment professionals.
    ---------------------------------------------------------------------------
        Those we support are on modest incomes: typically, $2,000 in
    benefits a month. For that reason, as a significant institutional
    investor with a long-term investment time horizon, CalPERS has a vested
    interest in maintaining the integrity and efficiency of the capital
    markets. Moreover, size and long term liabilities mean we have to look
    for market solutions. We cannot simply sell our shares when things go
    wrong. As a result, corporate governance issues are of great concern to
    us and those on whose behalf we are investing: the public servants such
    as the police officers, firefighters, school employees and others who
    rely on us for their retirement security.

    Participation in Corporate Governance Decisions
        CalPERS has been a long-time proponent of good corporate
    governance, which serves to protect, preserve and grow the assets of
    the fund, and we strongly support the corporate governance reforms
    found in Dodd-Frank. We have also strongly supported other measures
    which are vital to a coordinated and comprehensive reform effort. These
    are not the focus of today's discussion, but they are critical to the
    project: systemic risk oversight, proper funding and independence for
    regulators, derivatives reform, credit rating agency overhauls among
    them.
        As a shareowner of each of the stocks held in its portfolios,
    CalPERS has developed, and periodically updates, a comprehensive set of
    corporate governance principles and detailed guidelines that govern the
    voting of the related proxies. These principles and guidelines focus on
    a broad range of issues including how we will vote on director nominees
    in uncontested elections and in proxy contests.
        CalPERS votes its proxies in accordance with our guidelines. Both
    the CalPERS proxy policy and the actual proxy votes cast are published
    on our Web site, so that all constituents and interested parties can
    know our positions on these important issues. Moreover, as part of our
    proxy voting diligence process, we have detailed discussions with many
    companies in our portfolio. We engage underperforming companies in
    extensive dialogue through our Focus List program, which was found to
    produce superior returns over a 10-year period.\2\
    ---------------------------------------------------------------------------
        \2\ See The CalPERS Effect on Targeted Company Share Prices,
    Wilshire Associates, (November 2010). http://www.calpers.ca.gov/eip-
    docs/about/board-cal-agenda/agendas/invest/201008/item05a-2-02-01.pdf.
    ---------------------------------------------------------------------------
        Shareowner proxy voting rights are considered to be valuable assets
    of the fund. Attention to corporate governance promotes responsible
    business practices that serve as an integral component to a company's
    long-term value creation. In instances where guidelines are not
    dispositive on shareowner or management proposals, the Office of
    Corporate Governance, which I oversee, reviews and makes proxy voting
    recommendations that are consistent with the best interests of the fund
    and our fiduciary duties.

    Investment Decision Making Process
        As indicated above, CalPERS takes a long-term strategic approach to
    its investment decisionmaking process. Annually, a comprehensive
    ``Strategic Investment Plan'' is developed jointly by CalPERS'
    investment staff and its external consultants, with input from and
    subject to final approval of the 13-member board. The plan is based on
    careful analysis of the long-term outlook for the capital markets and
    major qualitative and quantitative factors including the unique needs,
    preferences, objectives and constraints of CalPERS. This detailed
    investment plan manifests itself in the development of an asset
    allocation framework designed to achieve the ongoing commitment to
    diversification and provide guidance in the investment decisionmaking
    process including advancing investment strategies, the hiring and
    monitoring of external investment advisors, portfolio rebalancing and
    meeting cash needs.

    How Inadequate Corporate Governance Contributed to the 2008 Financial
            Meltdown
        It is widely acknowledged that the 2008 financial crisis was
    fuelled by a toxic combination of lax oversight and misaligned
    incentives.\3\ Too many CEOs pursued excessively risky strategies or
    investments that bankrupted their companies or weakened them
    financially for years to come.\4\ Boards of directors were often
    complacent, failing to challenge or rein in reckless senior executives
    who threw caution to the wind.\5\ And too many boards approved
    executive compensation plans that rewarded excessive risk taking.\6\
    Others simply did not have robust risk management systems in place, or
    had these subservient to short term revenue chasing. The Dodd-Frank
    focus upon improving transparency around incentives and giving
    shareowners the tools to improve oversight of boards is therefore
    absolutely on target. We look forward to further improvements in
    disclosure also under discussion by financial regulators, for example
    to ensure that compensation below board level is disclosed for those
    who can have an impact upon the company's over risk profile, and also
    to improve understanding of pay equity across companies.
    ---------------------------------------------------------------------------
        \3\ See Financial Crisis Inquiry Commission, The Financial Crisis
    Inquiry Report xviii (Jan. 2011), http://www.gpoaccess.gov/fcic/
    fcic.pdf (``We conclude dramatic failures of corporate governance and
    risk management at many systemically important financial institutions
    were a key cause of this crisis'' ) [hereinafter FCIC Report];
    Investors' Working Group, U.S. Financial Regulatory Reform, The
    Investors' Perspective 22 (July 2009), http://www.cii.org/UserFiles/
    file/resource%20center/investment%20issues/
    Investors'%20Working%20Group%20Report%20(July%
    202009).pdf (``The global financial crisis represents a massive failure
    of oversight'') [hereinafter IWG Report].
        \4\ IWG Report, supra note 1, at 22.
        \5\ See Staff of S. Permanent Subcomm. on Investigations, Wall
    Street and the Financial Crisis: Anatomy of a Financial Collapse 185-86
    (Apr. 13, 2011), http://hsgac.senate.gov/public/_files/
    Financial_Crisis/FinancialCrisisReport.pdf (providing evidence that
    board oversight of Washington Mutual, Inc., including oversight of
    enterprise risk management, was ``less than satisfactory''); IWG
    Report, supra note 1, at 22.
        \6\ FCIC Report, supra note 1, at xix (``Compensation systems-
    designed in an environment of cheap money, intense competition, and
    light regulation-too often rewarded the quick deal, the short-term
    gain-without proper consideration of long-term consequences); see also
    Deputy Secretary of the Treasury Neal Wolin, Remarks to the Council of
    Institutional Investors 4 (Apr. 12, 2010), http://www.ustreas.gov/
    press/releases/tg636.htm (noting that ``irresponsible pay practices . .
    . led so many firms to act against the interests of their
    shareholders''); IWG Report supra note 1, at 22.
    ---------------------------------------------------------------------------
        More specifically, a common element in the failure of Lehman
    Brothers, American International Group, Fannie Mae, Washington Mutual,
    and many other companies implicated in the 2008 financial meltdown, was
    that their boards of directors did not control excessive risk-taking,
    did not prevent compensation systems from encouraging a `bet the ranch'
    mentality, and did not hold management sufficiently accountable.\7\ As
    famed investor Warren Buffett observed in his 2009 letter to the
    shareowners of Berkshire Hathaway Inc.:
    ---------------------------------------------------------------------------
        \7\ See, e.g. Press Release, CalPERS, Investors Speak Out on Dodd's
    Financial Reform Bill--Offer Do's, Don'ts as Bill Reaches Critical
    Stage 2 (Mar. 19, 2010), http://www.calpers.ca.gov/index.jsp?bc=/about/
    press/pr-2010/mar/investors-financial-reform-bill.xml.

            In my view a board of directors of a huge financial institution
            is derelict if it does not insist that its CEO bear full
            responsibility for risk control. If he's incapable of handling
            that job, he should look for other employment. And if he fails
            at it--with the Government thereupon required to step in with
            funds or guarantees--the financial consequences for him and his
    ---------------------------------------------------------------------------
            board should be severe.

            It has not been shareholders who have botched the operations of
            some of our country's largest financial institutions. Yet they
            have borne the burden, with 90 percent or more of the value of
            their holdings wiped out in most cases of failure.
            Collectively, they have lost more than $500 billion in just the
            four largest financial fiascos of the last 2 years. To say
            these owners have been ``bailed-out'' is to make a mockery of
            the term.

            The CEOs and directors of the failed companies, however, have
            largely gone unscathed. Their fortunes may have been diminished
            by the disasters they oversaw, but they still live in grand
            style. It is the behavior of these CEOs and directors that
            needs to be changed: If their institutions and the country are
            harmed by their recklessness, they should pay a heavy price--
            one not reimbursable by the companies they've damaged nor by
            insurance. CEOs and, in many cases, directors have long
            benefited from oversized financial carrots; some meaningful
            sticks now need to be part of their employment picture as
            well.\8\
    ---------------------------------------------------------------------------
        \8\ Letter from Warren E. Buffett, Chairman of the Board, to the
    Shareholders of Berkshire Hathaway, Inc. 16 (Feb. 26, 2010), http://
    www.berkshirehathaway.com/letters/2009ltr.pdf.

        Accountability is critical to motivating people to do a better job
    in any organization or activity.\9\ An effective board of directors can
    help every business understand and control its risks, thereby
    encouraging safety and stability in our financial system and reducing
    the pressure on regulators, who, even if adequately funded, will be
    unlikely to find and correct every problem.\10\ Unfortunately, long-
    standing inadequacies in corporate governance requirements and
    practices have limited shareowners' ability to hold boards
    accountable.\11\
    ---------------------------------------------------------------------------
        \9\ Press Release, supra note 5, at 2.
        \10\ Id.
        \11\ IWG Report, supra note 1, at 22 (``shareowners currently have
    few ways to hold directors' feet to the fire'').
    ---------------------------------------------------------------------------
        Fortunately, Dodd-Frank contains a number of corporate governance
    reforms that when fully implemented and effectively enforced will
    reduce those inadequacies by providing long-term investors like with
    better tools, including better information, to hold directors more
    accountable going forward.\12\
    ---------------------------------------------------------------------------
        \12\ S. Comm. On Banking, Housing, & Urban Affairs, Rep. On The
    Restoring American Financial Stability Act 30 (Mar. 22, 2010), http://
    banking.senate.gov/public/_files/RAFSAPostedCommitteeReport.pdf.
    (Noting that the Senate version of Dodd-Frank contained provisions
    designed to give investors ``more protection'' and shareholders ``a
    greater voice in corporate governance'') [hereinafter S. Rep.].
    ---------------------------------------------------------------------------
        The remainder of my testimony highlights some of the key corporate
    governance provisions of Dodd-Frank and why CalPERS believes those
    provisions are beneficial to investors in terms of improving the
    accountability of boards and enhancing investor protection.

    Dodd-Frank Corporate Governance Provisions
    SEC. 971 Proxy Access
        The most fundamental of investor rights is the right to nominate,
    elect and remove directors.\13\ Anything less provides a fundamental
    flaw in capitalism. The providers of capital need to be able to hold
    boards accountable, and boards in turn need to have effective oversight
    of management. The United States is virtually alone in world markets by
    not providing capital providers the ability to hold their stewards to
    account. Several roadblocks, however, have prevented this fundamental
    right from being an effective remedy for shareowners dissatisfied with
    the performance of their public companies.\14\
    ---------------------------------------------------------------------------
        \13\ See IWG Report, supra note 1, at 22.
        \14\ Id.
    ---------------------------------------------------------------------------
        One of the most significant roadblocks is that Federal proxy rules
    have historically prohibited shareowners from placing the names of
    their own director candidates on public company proxy cards.\15\ Thus,
    long-term shareowners who may have wanted the ability to run their own
    candidate for a board seat as a means of making the current directors
    more accountable have only had the option of pursuing a full-blown
    election contest--a prohibitively expensive action for most public
    pension funds like CalPERS.\16\
    ---------------------------------------------------------------------------
        \15\ Id.
        \16\ Id.
    ---------------------------------------------------------------------------
        Fortunately, due to the extraordinary leadership of this Committee
    and the U.S. Securities and Exchange Commission (``Commission or
    SEC''), this roadblock--the inability for shareowners to place director
    nominees on the company's proxy card--we hope will soon be lifted.\17\
    As background, in June 2009, the Commission issued a thoughtful
    proposal providing for a uniform measured right for significant long-
    term investors to place a limited number of nominees for director on
    the company's proxy card.\18\ Some opponents of the proposal
    subsequently raised questions about whether the Commission had the
    authority to issue a proxy access rule.\19\ In response, Senator
    Schumer introduced, what would later become Section 971 of Dodd-Frank,
    removing any doubt that the Commission had the authority to issue a
    proxy access rule.\20\
    ---------------------------------------------------------------------------
        \17\ We note that a second roadblock to the fundamental right of
    investors to nominate, elect, and remove directors--``plurality
    voting''--was not addressed by Dodd-Frank and remains a significant
    impediment to improving board accountability. More specifically, most
    companies elect directors in uncontested elections using a plurality
    standard, by which shareowners may vote for, but cannot vote against, a
    nominee. If shareowners oppose a particular nominee, they may only
    withhold their vote. As a consequence, a nominee only needs one ``for''
    vote to be elected and, therefore, potentially unseating a director and
    imposing some accountability becomes virtually impossible. We would
    respectfully request that the Committee consider stand alone
    legislation to remove this roadblock. Id.
        \18\ Facilitating Shareholder Director Nominations, 74 Fed. Reg.
    29,024 (proposed rule June 18, 2009), http://www.sec.gov/rules/
    proposed/2009/33-9046.pdf.
        \19\ Facilitating Shareholder Director Nominations, 75 Fed. Reg.
    56,668, 56,674 (final rule Sept. 16, 2010), http://www.gpo.gov/fdsys/
    pkg/FR-2010-09-16/pdf/2010-22218.pdf (``Several commentators challenged
    our authority to adopt Rule 14a-11'').
        \20\ See id.
    ---------------------------------------------------------------------------
        After careful consideration of the input received in response to
    two separate comment periods on the proposal, the SEC issued a final
    rule on September 16, 2010.\21\ The final rule provides the ability for
    CalPERS, as part of a larger group of long-term investors, to place a
    limited number of nominees for director on the company's proxy card
    and, thereby, effectively exercise its traditional right to nominate
    and elect directors to company boards.\22\
    ---------------------------------------------------------------------------
        \21\ Id. at 56,668.
        \22\ Id.
    ---------------------------------------------------------------------------
        Unfortunately, despite Section 971 of Dodd-Frank, opponents of the
    Commission's final rule have chosen to sue the SEC to delay its
    implementation.\23\ The legal challenge, based largely on
    Administrative Procedure Act grounds, is currently before the D.C.
    Circuit Court of Appeals (``Court'') on an expedited review.\24\ A
    decision is expected this summer.\25\ Whatever the Court's decision, we
    fully expect that the Commission will, after curing any administrative
    deficiencies, promptly implement the final rule and remove this long-
    standing roadblock to the exercise of shareowners' fundamental right to
    nominate, elect, and remove directors.
    ---------------------------------------------------------------------------
        \23\ Ted Allen, U.S. Appeal Court to Hear Proxy Access Lawsuit, ISS
    (Apr. 6, 2011), http://blog.riskmetrics.com/gov/2011/04/us-appeals-
    court-to-hear-proxy-access-lawsuit.html.
        \24\ Id.
        \25\ Id.
    ---------------------------------------------------------------------------
    SEC. 951 Shareholder Vote on Executive Compensation Disclosures
        As described by the Financial Crisis Inquiry Commission, the
    financial crisis revealed compensation systems:

            [D]esigned in an environment of cheap money, intense
            competition, and light regulation--too often rewarded the quick
            deal, the short-term gain--without proper consideration of
            long-term consequences. Often those systems encouraged the big
            bet--where the payoff on the upside could be huge and the
            downside limited. This was the case up and down the line--from
            the corporate boardroom to the mortgage broker on the
            street.\26\
    ---------------------------------------------------------------------------
        \26\ FCIC Report, supra note 1, at xix.

        During the development of Dodd-Frank, this Committee concluded that
    ``shareholders, as the owners of the corporation had a right to express
    their opinion collectively on the appropriateness of executive
    pay.''\27\ The result was Section 951 of Dodd-Frank that provides that
    any proxy for an annual meeting of shareowners will include a separate
    resolution subject to shareowner advisory vote to approve the
    compensation of executives.\28\
    ---------------------------------------------------------------------------
        \27\ S. Rep., supra note 10, at 109.
        \28\ Id.
    ---------------------------------------------------------------------------
        We agree with the Council of Institutional Investors that Section
    951 provides with:

            a tool . . . [to] effectively, efficiently and regularly
            provide boards with useful feedback about whether investors
            view the company's compensation practices to be in shareowners'
            best interests. Nonbinding shareowner votes on pay offer a more
            targeted way to signal shareowner discontent than withholding
            votes from compensation committee members, and can serve as a
            helpful catalyst and starting point for dialogue on excessive
            or poorly structured executive pay. Also, the possibility of a
            majority ``against'' vote might serve as an additional
            deterrent against devising incentive plans that promote
            excessive risk-taking and/or enrichment.\29\
    ---------------------------------------------------------------------------
        \29\ Letter from Justin Levis, Senior Research Associate, Council
    of Institutional Investors to Mr. Mike Duignan, Head of Market
    Supervision, Irish Stock Exchange 1-2 (Aug. 11, 2010), http://
    www.cii.org/UserFiles/file/resource%20center/correspondence/2010/8-11-
    10CIILetter
    IrishCorpGovCode%20.pdf.

        Section 951 became effective for the first time this proxy season.
    As recently discussed by SEC Commissioner Luis Aguilar, it appears that
    ---------------------------------------------------------------------------
    the new requirement is benefiting investors in at least three ways:

            First, say-on-pay seems to have resulted in increased
            communication between shareholders and corporate management.
            Reports seem to indicate that both shareholders and corporate
            management are pro-actively initiating discussions regarding
            executive compensation, which is far from the predictions that
            say-on-pay would lead to disrepair or at best be ineffective--
            this sounds like a positive development to me.

            Second, the reports indicate that shareholders are making their
            voices heard. For example, as of this month, 31 public
            companies have failed to obtain majority support for their
            executive compensation packages.

            Lastly, some pay practices appear to be changing in deference
            to shareholders' views. Some companies have actually altered
            the pay and benefits of top executives. Many companies are
            putting in more performance-based compensation plans and they
            are addressing items that shareholders often criticized, such
            as: excessive severance; perks; Federal income tax payments;
            and pensions. For example, approximately 40 of the Fortune 100
            companies have eliminated policies that had the company pay
            certain tax liabilities of executives. As another example,
            General Electric modified the pay of its CEO 2 weeks prior in
            anticipation of the shareholder vote, deferring the vesting of
            certain options and conditioning the vesting on whether the
            company meets certain performance targets. According to news
            reports, this was apparently done to avoid losing a say-on-pay
            vote.\30\
    ---------------------------------------------------------------------------
        \30\ Commissioner Luis A. Aguilar, U.S. Securities and Exchange
    Commission, Speech at the Social Investment Forum 2011 Conference 3-4
    (June 10, 2011), http://www.sec.gov/news/speech/2011/spch061011laa.htm.
    ---------------------------------------------------------------------------
    Section 954 Recovery of Erroneously Awarded Compensation
        Another means identified by this Committee, the Investors Working
    Group, the Council of Institutional Investors, and many other parties
    to combat poorly structured executive pay plans that rewarded short
    term but unsustainable performance was to enhance current clawback
    provisions on unearned executive pay.\31\ In response, Section 954 of
    Dodd-Frank strengthens the existing clawback provisions in three
    important ways: First, it expands the application of the existing
    clawback requirements to any current or former executive officer (not
    just the CEO or CFO).\32\ Second, it clarifies that a clawback is
    triggered by an accounting restatement due to material noncompliance
    without regard to the existence of misconduct.\33\ Finally, it
    strengthens the existing clawback requirements by extending the
    clawback to 3 years from the existing 12-month period.\34\
    ---------------------------------------------------------------------------
        \31\ See, e.g., Letter from Laurel Leitner, Senior Analyst, Council
    of Institutional Investors to Robert E. Feldman, Executive Secretary,
    Federal Deposit Insurance Corporation 1-2 (May 19, 2011), http://
    www.fdic.gov/regulations/laws/Federal/2011/11c07Ad73.PDF.
        \32\ John E. McGrady, III, & Kristen R. Miller, Executive
    Compensation Clawbacks--Effective Deterrent or Effective Remedy?, BNA
    Insights, Daily Rep. Executives, at B-4 (July 7, 2011).
        \33\ Id.
        \34\ Id.
    ---------------------------------------------------------------------------
        CalPERS' support for Section 954 is based on our belief, shared by
    the Council of Institutional Investors, and many other corporate
    governance and compensation experts, that a tough clawback policy is an
    essential element of a meaningful pay for performance philosophy.\35\
    If executives are rewarded for hitting their performance metrics--and
    it later turns out that they failed to do so--they should return to
    shareowners the pay that they did not rightly earn.\36\ We look forward
    to the Commission's proposed and final rules to implement Section 954
    scheduled for later this year.
    ---------------------------------------------------------------------------
        \35\ Letter from Laurel Leitner, supra note 29, at 1.
        \36\ Id.
    ---------------------------------------------------------------------------
    Section 973. Disclosures Regarding Chairman and CEO Structures
        Finally, as indicated, the financial crisis represented an enormous
    failure of board oversight of management. We share the view of the
    Council of Institutional Investors, the Investor's Working Group and
    many others that board oversight may be weakened by forceful CEO's who
    also serve as a chair of the board.\37\ In our view, Independent board
    chairs are a key component of robust boards that can effectively
    monitor and, when necessary, rein in management.\38\ To have the CEO
    effectively running the board means the oversight process is
    fundamentally comprised. No one can grade their own performance
    objectively. Independent board oversight of the CEO is vital.
    ---------------------------------------------------------------------------
        \37\ Letter from Justin Levis, Senior Research Associate, Council
    of Institutional Investors, to Jose Manuel Barroso, President, European
    Commission 1-2 (Aug. 31, 2010), http://www.cii.org/UserFiles/file/
    resource%20center/correspondence/2010/CII%20Letter%20on%20EC
    %20Green%20Paper%20on%20Bank%20Governance%208-31-10%20final.pdf.
        \38\ Id.
    ---------------------------------------------------------------------------
        While not requiring the separation of the role of the chair and
    CEO, Section 973 of Dodd-Frank provides an important step forward by
    directing the SEC to issue rules, which are already in place, requiring
    those companies who have a Chairman/CEO structure to disclose an
    explanation of the reasons that it has chosen that structure.\39\ This
    is an important advancement in corporate governance disclosure that we
    continue to support.
    ---------------------------------------------------------------------------
        \39\ S. Rep., supra note 10, at 119.
    ---------------------------------------------------------------------------
        That concludes my testimony. Thank you, Mr. Chairman for inviting
    me to participate at this hearing. I look forward to the opportunity to
    respond to any questions.

                                     ______

                     PREPARED STATEMENT OF PAUL S. ATKINS *
       Visiting Scholar, American Enterprise Institute for Public Policy
                                    Research
                                 July 12, 2011

        Thank you very much, Mr. Chairman, Ranking Member Shelby, and
    Members of the Committee, for inviting me to appear today at your
    hearing. It is an honor and privilege for me to provide information for
    your deliberations on Dodd-Frank and the SEC.
    ---------------------------------------------------------------------------
        * The views expressed in this testimony are those of the author
    alone and do not necessarily represent those of the American Enterprise
    Institute.
    ---------------------------------------------------------------------------
    Dodd-Frank Overview
        I come before you today not only as a former Commissioner of the
    Securities and Exchange Commission and member of the former
    Congressional Oversight Panel for the TARP, but also as a visiting
    scholar at the American Enterprise Institute for Public Policy
    Research. AEI has a long history of focus on the economic and
    psychological fundamentals of entrepreneurism, economic development,
    and the political economy. It is a privilege for me to be able to
    participate in the public discussion about the issues of the day in the
    context of my years of work in the public and private sector.
        The news of this past week has highlighted the disappointing state
    of affairs in our economy. The data released by the Bureau of Labor
    Statistics show the unemployment rate increasing to 9.2 percent, while
    the labor force itself shrank by more than a quarter of a million
    people. Basically, unemployment has risen as the supply of available
    workers has shrunk. More than 14 million Americans are out of work--and
    almost half of those have been out of work for more than 6 months.
        In a productive economy, jobs are normally created by people with
    entrepreneurial spirit--whether small businesses or large corporations.
    Starting with an idea for a product or service and the risk appetite to
    make it a reality, the entrepreneur will need to engage the help of
    others to make it a reality. To hire people and develop their product,
    entrepreneurs of course need money. The money has to come from
    somewhere, and with efficient financial markets, an entrepreneur should
    be able to borrow the money or find others willing to invest in the
    idea--risk their own capital for an interest in the potential profits.
        We have a great debate in this country as to whether there is a
    shortage of credit supply or demand. Last year, as a member of the
    Congressional Oversight Panel, I had the privilege of testifying before
    the House Financial Services Committee regarding small business lending
    initiatives. The debate was then, as it is now, whether the issuance of
    credit is constrained because of a lack of demand or a shortage of
    supply. Regardless of the cause, in the current regulatory climate it
    is difficult for lenders to increase their small business lending.
    Small businesses produce most of the new jobs in the country. From my
    work on the Congressional Oversight Panel, we heard many anecdotal
    reports from our field hearings and elsewhere that bank examiners have
    become more conservative and have required increasing levels of capital
    since the advent of the financial crisis. The balance between
    sufficient regulation and over-regulation is often a fine one. We have
    to remember that it is the investors who pay for regulation--effective
    or otherwise--through higher prices, diminished returns, or restricted
    choices.
        Why do I go through this description of how jobs are created?
    Because confidence and certainty are crucial to fostering a business
    climate that creates jobs. It is my belief that a major cause of the
    uncertainty handcuffing our economy today is in fact Government policy,
    particularly the sweeping new financial law enacted last year
    ostensibly for the sake of market stability and investor confidence.
    Because many of the provisions were not directly related to the
    underpinnings of the financial crisis, investors ultimately will pay
    for the increased costs associated with the mandates without receiving
    commensurate benefits.
        That is the single tragedy of Dodd-Frank. It is a calamity--2,319
    pages are aggravating uncertainty and undermining the climate necessary
    for economic growth. Yet considering its length and scope, the Dodd-
    Frank Act was passed with relatively few hearings and no real debate
    about provisions that now threaten economic growth. In contrast,
    following the market crash of 1929, Congress attempted comprehensive
    reform over a period of a decade, involving extensive hearings and
    public debate. Dodd-Frank calls for the creation of anywhere between
    243 and 533 new rules, depending on how you count them, and 84 rules by
    3 new agencies alone--the Consumer Financial Protection Bureau (CFPB),
    the Office of Financial Reporting (OFR), and the Financial Stability
    Oversight Council (FSOC). Each of these new agencies has far-reaching
    powers, and we will not know for years how they will develop. Legal
    challenges are inevitable, not just as to the technicalities of the
    rules and whether they have been properly promulgated, but also as to
    basic questions of jurisdiction and constitutionality.
        As the past year has shown, Dodd-Frank also mandates very tight
    deadlines for Federal agencies to draft and implement these rules. In
    this quarter alone, Dodd-Frank mandates more than 100 rules to be
    finalized.\1\ As some experts have noted previously,\2\ this rate of
    rulemaking required by Dodd-Frank far outpaces the agencies' respective
    historical workloads. From 2005-2006 the SEC annually averaged 9.5 new
    substantive rules, while the CFTC averaged 5.5. Post-Dodd-Frank those
    numbers have soared to an average of 59 new rules for the SEC and 37
    for the CFTC.\3\ Members of this committee have previously expressed
    concern that Federal agencies are sacrificing quality for speed as they
    neglect to properly weigh the costs and benefits to the economy of
    their proposed rules. In these circumstances, something has to give,
    and so far we have seen very little in the way of cost benefit analysis
    (some agencies' inspectors general are investigating whether this lack
    of analysis may have violated the Administrative Procedure Act and
    other mandates), contracted timelines for the public to comment on
    proposed rulemakings (most comment periods are about 20 days shorter
    than usual), missed deadlines (right before the statutory effective
    date, registration requirements under Title IV had to be delayed by 8
    months because the rules were finalized so late), and proposed
    rulemaking that is vague or overly broad. Taken together, the ability
    of stakeholders to provide input on matters directly impacting their
    business is severely impaired.
    ---------------------------------------------------------------------------
        \1\ See Promoting Economic Recovery and Job Creation: Hearing
    before the H. Comm. on Financial Services, 112th Cong., 1st Sess. (Jan.
    25, 2011) (statement of Hal H. Scott, Professor, Harvard Law School).
        \2\ Id.
        \3\ Id.
    ---------------------------------------------------------------------------
        An example on the latter point can be found with the Financial
    Stability Oversight Council (FSOC), a new agency created by Title I to
    identify threats to the financial stability of the United States. While
    this seemed like an attractive idea to officials who wish never to
    relive the anxiety of the ``Too Big to Fail'' era, the realities and
    impracticalities of such a Council have already started to reveal
    themselves.
        The principal new authority assigned to FSOC is to identify
    systemically important financial institutions. FSOC's proposed
    rulemaking in January 2011 regarding this process was roundly
    criticized by the public and bipartisan Members of Congress for merely
    parroting the broad statutory language. This lack of transparency--
    magnified by leaks to the media about the staff's methodology under
    consideration--has only compounded market uncertainty. FSOC recently
    announced plans to provide further guidance of this most important
    authority of the new systemic risk regulatory regime--although the form
    and extent of that guidance remains to be seen.
        The activities of the Financial Stability Oversight Council
    (including OFR) and the Bureau of Consumer Financial Protection have
    received much scrutiny over the past year, and for good reason. They
    comprise just 2 of the Act's 16 Titles, however, and so I welcome
    today's hearing on the subject of the investor protection provisions.
    As I intend to make clear today, many of these provisions impose
    sweeping changes, yet received relatively little attention during
    consideration of last year's Dodd-Frank Act, which naturally raises the
    likelihood of unintended consequences.

    Title IV: The Private Fund Investment Advisers Registration Act of 2010
        Under Title IV of Dodd-Frank, investment advisers to hedge funds
    and private equity firms are required to comply with a set of
    registration rules, which hinders the success of both investors in the
    funds by adding administrative costs and potentially keeping
    competitors out of the market, and the SEC by spreading its resources
    too thinly and diverting its attention from protecting retail
    investors. This situation, together with the likely mistaken sense of
    security that investors might infer from SEC registration, endangers
    all investors.
        By repealing the ``15-client'' exemption, Title IV effectively
    forces all investment advisers managing more than $150 million in
    assets to register with the SEC. The Commission estimates that this
    will bring 3,200 advisers under its supervision. The rules recently
    finalized by the SEC specify the exemptions provided by Dodd-Frank for
    advisers solely to venture capital funds, foreign private advisers, and
    family offices. The rulemaking was not completed until close to the
    deadline before which advisers were originally required to register.
    Prior to the adoption of the rule, the SEC allowed the affected
    entities to wonder for several months through rumor and staff
    statements if, when, and in what form the requirement might come into
    effect.
        Why do we have this new registration process? One narrative has
    been that supposed ``deregulation'' during the past 6, 10, or 15
    years--you pick the time period--led to the crisis. But, one can hardly
    say that the past 6-15 years have been deregulatory. In the United
    States we had Sarbanes-Oxley, new SEC rules, new stock exchange and
    NASD/FINRA rules, and new accounting rules. We saw the financial crisis
    hit regulated entities around the world, even in countries like Germany
    and France that one could hardly characterize as deregulatory.
        Regulators and lawmakers abroad, especially in Europe, have tried
    to blame hedge funds and short selling. Hedge funds were supposedly
    over-leveraged and drove the demand for esoteric securities. This
    narrative claims they shorted all kinds of assets during the 2008
    crisis, driving the market down and creating panic.
        It will be surprising for subscribers to the popular narrative to
    learn that hedge funds overall had the least leverage, at 2:1.\4\
    Compare that to other financial institutions at the time, which had
    significantly higher leverage ratios. Taking short positions, in turn,
    is an important investment activity as it helps to provide liquidity
    and points out excessive valuations. I have yet to see a compelling
    argument for why the price declines and flagging investor confidence
    experienced in 2008 might be attributed to hedge funds' shorting
    activities rather than the obvious decline in economic and business
    fundamentals.
    ---------------------------------------------------------------------------
        \4\ See Andrew Ang, et al., Hedge Fund Leverage 19 (Jan. 25, 2011)
    available at http://www2.gsb.columbia.edu/faculty/aang/papers/
    HFleverage.pdf.
    ---------------------------------------------------------------------------
        The costs borne by registering advisers, and in turn by their
    pension, institutional and private individual investors, are real and
    significant. Sending off the registration form is the deceptively easy
    part. Registered advisers will have to bear numerous administrative,
    legal, and personnel costs.
        In the recently adopted rules, advisers exempted from registration
    requirements would still be required under Sections 407 and 408 to
    comply with some of the same reporting requirements as registered
    advisers. For example, venture capital advisers would be subject to
    examination and recordkeeping requirements. For venture capital firms
    especially, it is not clear what the investor protection rationale is.
    This construct seems to be contrary to the intent of Section 407; if
    so, this committee has an oversight interest in the new rules for
    exempt reporting advisers.
        Obviously this shakeup will be particularly hard on smaller hedge
    funds and private equity firms, which have fewer resources all around.
    As some have already argued, this new regulatory structure has the
    potential to raise barriers to entry and drive segments of the industry
    overseas. In the end, all of this may add many more costs to an economy
    that can scarcely afford it.
        Under proposed rulemaking passed earlier this year, a new reporting
    requirement will be imposed on all registered advisers known as Form
    PF. As proposed, Form PF is unprecedented in scope and detail: it is 44
    pages long in its entirety. All registered private fund advisers would
    be required to file Form PF at least annually, and large advisers would
    be required to file quarterly. Advisers will be required to complete
    different sections based on their fund type and size, and the reporting
    burden increases exponentially for large firms. For example, advisers
    to private equity funds of at least $1 billion would have to file Form
    PF within 15 days of quarter's end, including possibly detailed
    information on their portfolio company holdings.
        Requiring registered advisers to compile and report all this
    detailed information represents an enormous regulatory burden that
    provides no appreciable benefit to investors. Demonstrably, much like
    many other Federal agencies, in the SEC's rush to draft and implement
    rules in accordance with Dodd-Frank's statutory deadlines, it has not
    properly weighed the costs and benefits. The industry has raised
    numerous concerns with the draft rule, and I hope the SEC will consider
    the implications of Form PF carefully.
        As the following chart \5\ illustrates, since 2008 the number of
    examinations has actually been decreasing because of management
    priorities and allocation of resources. The flood of new registrants
    will only dilute the SEC's resources, and further reduce the frequency
    or scope of examinations. The allocation of resources in this area is
    critical--it should not be forgotten that in the case of the largest
    Ponzi scheme ever perpetrated, Bernard L. Madoff Investment Securities
    was both a registered broker-dealer and a registered adviser subject to
    regular SEC examinations.
    ---------------------------------------------------------------------------
        \5\ See United States Securities and Exchange Commission, Study on
    Enhancing Investment Adviser Examinations 15 (Jan. 2011) available at
    http://www.sec.gov/news/studies/2011/914studyfinal.pdf.

    Title IX: The Investor Protection and Securities Reform Act of 2010
        Moving on to Title IX. Title IX encompasses a wide range of issues
    including credit rating agencies, whistleblowing, fiduciary duties, and
    SEC management.

    Credit Rating Agencies
        This Committee took action with the Credit Rating Agency Reform Act
    of 2006 to address the troubling oligopoly of credit rating agencies
    and the SEC's opaque method of designating nationally recognized
    statistical rating organizations (NRSROs). Unfortunately, the SEC had
    never addressed these issues in the 30 years after instituting the
    NRSRO designation. The framework adopted in 2006 (unfortunately too
    late to forestall the crisis) aimed to encourage transparency and
    competition among rating agencies. That approach, unfortunately, has
    been undermined by some provisions of Dodd-Frank that set up an
    expectation for ultimately unachievable regulatory control.
        After the financial crisis, credit rating agencies were under fire
    for their faulty methodologies and conflicts of interest. To combat
    this, the SEC has requested comment for a study on the feasibility of
    standardizing credit ratings and has proposed hundreds of pages of new
    rules. Addressing problems of faulty methodologies and transparency,
    the SEC has proposed rules requiring internal controls for determining
    ratings, establishing professional standards for credit analysts, and
    providing for greater public disclosure about credit ratings.
        Dodd-Frank also gives the SEC the power to penalize credit rating
    agencies for consistently inaccurate ratings. Further, Dodd-Frank also
    raises the dubious possibility that the SEC would assess the accuracy
    of ratings. It is unclear how that could ever be accomplished.
        In an attempt to break up the oligopoly imposed by the three
    largest credit rating agencies, the SEC has proposed rules to remove
    references to credit ratings from regulations, pursuant to authority
    under Section 939. In addition, the SEC has alleviated the problem of
    conflicts of interest by precluding ratings from being influenced by
    sales and marketing and by enhancing a ``look-back'' review to
    determine whether any conflicts of interest influenced a rating.
        Unfortunately, Dodd-Frank has taken an inconsistent approach with
    respect to credit rating agencies. With respect to sovereign debt, the
    threats currently being levied by government officials in Europe
    demonstrate that rating agencies are susceptible to political pressure
    as to the ``correctness'' of their ratings. Congress should
    consistently push transparency and competition so that investors get
    high-quality and objective advice from credit rating agencies.

    Whistleblower Programs
        Dodd-Frank provides that the SEC and the CFTC may award
    whistleblowers from 10 percent to 30 percent of monetary sanctions
    collected in enforcement actions.\6\ Two special funds of $300 million
    and $100 million are set up for the SEC and CFTC, respectively, to
    ensure payment of whistleblowers. Dodd-Frank provides that
    whistleblowing employees can hire attorneys and that they must hire an
    attorney if they wish to remain anonymous. One can imagine what
    percentage of the 10 percent-30 percent take the lawyers will demand
    from the whistleblower.
    ---------------------------------------------------------------------------
        \6\ Section 922 provides for the SEC's whistleblower program.
    Section 748 provides for the CFTC's whistleblower program.
    ---------------------------------------------------------------------------
        Dodd-Frank clearly aims to encourage whistleblowers and ease their
    fears of retaliation, ostracism, and reputational damage for future
    employment-all authentic concerns for legitimate protesters. But it
    creates perverse incentives as well, and sets up a system that has many
    inherent problems. For example, if an employee approaches an attorney
    with a potential claim of less than $1 million, what will the attorney
    advise if the problem is ongoing and is likely to result in a
    settlement of more than $1 million at some time in the future? Will the
    attorney advise the employee to report it immediately, or to remain
    quiet until the problem crosses the compensation threshold? Moreover,
    the unintended consequences of unfounded charges from disgruntled
    employees with ulterior motives will be devastating for shareholders.
    Of course, this only considers the employee side of the system. From
    the SEC's side, how will it cope with effectively investigate the
    potentially overwhelming number of tips? The Bernie Madoff case is
    again an apt reminder.
        Already, a company must hire attorneys and accountants to
    investigate almost any purported complaint, with strict policies and
    procedures to ensure due process. The injection of plaintiffs'
    attorneys into the mix increases the potential for specious claims to
    get traction and win a settlement, especially if the complainant is
    anonymous. Congress has skewed the delicate balance between good policy
    and over-indulgence of accusations.
        Despite comments to the contrary, the SEC chose not to make
    mandatory internal reporting to a company's own compliance program.
    Because the bounties available to whistleblowers (and their attorneys)
    are so large, and because the SEC chose not to make internal reporting
    mandatory, whistleblowers are incentivized to ``report out'' directly
    to the SEC rather than to ``report up'' through their companies'
    compliance programs. Thus, the rule undermines internal compliance
    programs. Moreover, companies have no protection from disclosure of
    confidential information, and there is no real way to sanction a false
    whistleblower, absent ``bad faith''--which is a tough standard to meet.

    Fiduciary Duty
        Under Section 913, the SEC was required to conduct a study on
    harmonizing the standard of care for investment advisers and broker-
    dealers. Under the Investment Advisers Act of 1940 and Supreme Court
    precedent, advisers have been deemed to owe a ``fiduciary duty'' to
    their clients whereas broker-dealers are subject to standards imposed
    by the Securities Exchange Act of 1934 and their self-regulatory
    organizations. The SEC has recommended to Congress that it harmonize
    these concepts into a uniform standard.
        Under the 1934 Act and SRO rules, broker-dealers ultimately are
    held to a very high standard of care that has benefited investors for
    many years. With respect to an advisory relationship, any dispute
    ultimately will likely be judged through a lawsuit in State court under
    terms of the advisory contracts, which tend to be long and include many
    disclaimers of conflicts of interest. On the other hand, broker-dealers
    are subject to broad standards of practice that the SEC and FINRA have
    adopted and interpreted over the years, as well as a low-cost
    arbitration system.
        It is important to remember that not all investors are the same.
    Some investors perhaps want and need a fiduciary who possesses intimate
    knowledge of their financial condition and can advise accordingly. On
    the other hand, some investors would prefer to have a true broker who
    is engaged on a transaction basis and is compensated accordingly. These
    two kinds of activities should have different standards of care
    attached to them. When the SEC turns to rulemaking later this year, as
    it has indicated it plans to do, it should respect the different needs
    of different investors.
        At the same time, the Department of Labor is pursuing a separate
    rulemaking that aims to increase the ambit of fiduciary duty within the
    context of ERISA plans. Unfortunately, this Labor Department initiative
    does not seem to be coordinated with the SEC and carries potentially
    profound effects for the retirement plan market and the availability of
    product offerings.

    SEC Management
        Title IX contains many other provisions, most of which have nothing
    to do with the causes of the financial crisis. In my short window of
    time before you, I cannot discuss all of these sections. Suffice it to
    say that many sections respond to long-standing requests of special
    interest groups. The SEC's compliance with these provisions has been
    spotty: The ink was not even dry on Dodd-Frank when the SEC gave a new
    Federal right for some shareholders to be able to nominate corporate
    board members directly instead of going through the normal process by
    which directors are nominated. This rulemaking is being challenged in
    Federal court. Yet, the SEC has neglected Section 965, the intent of
    which was to direct the SEC to disband the Office of Compliance
    Inspections and Examinations and return the examiners to the Divisions
    of Investment Management and Trading and Markets.
        Just last week the SEC chairman testified about the recent leasing
    decision and suggested that the SEC should no longer have leasing
    authority. In contrast, last year, some were suggesting the SEC should
    have a self-funding mechanism outside of the normal congressional
    appropriations process. In the meantime, the SEC has pursued an
    extremely divisive agenda, marked by more than a dozen 3-2 votes in the
    past 2 years alone. I have never witnessed such division--this record
    is in marked contrast to my experience of 10 years as staffer in two
    chairman's offices and as a commissioner under three chairmen. The
    dissenters are reasonable people and their dissents are not always
    fundamentally opposed to the rulemaking itself. The sad fact is that it
    appears that the leadership of the SEC does not engage effectively on
    the finer points of the policy issues. Thus, I encourage this Committee
    to continue to exercise oversight of SEC management.
        Dodd-Frank attempted to focus on organizational and managerial
    issues at the SEC, but it wound up, in effect, micro-managing and
    making things more complicated. Section 911 codifies in statute the
    Investor Advisory Committee that the current chairman established,
    which itself was similar to the Consumer Affairs Advisory Committee
    that I helped Chairman Levitt establish when I worked in his office in
    the mid-1990s. This statutory provision etches in stone one way of
    doing things to the exclusion of others. We shall see how the Investor
    Advocate, an independent office established under Section 915,
    ultimately develops. The statute thus adds yet another direct report to
    the chairman, who already has more direct reports than is practicable.
        Management philosophies like Total Quality Management and Six Sigma
    teach that in any organization, measurement drives human behavior
    because the incentive is to try to meet the measurement criteria (``You
    get what you measure'').
        For example, Enron was not reviewed for years because review
    personnel were judged by how many filings they reviewed, not
    necessarily by the quality of their review. The incentive was to
    postpone review of the complicated Enron filing because one could
    review many others in the time it would take to review Enron. By the
    late 1990s, this focus on numbers more than quality had decreased staff
    morale so much that employees began to organize to form a union.
    Despite management's campaign to thwart it, in July 2000, SEC employees
    voted overwhelmingly to unionize the workforce.
        The emphasis on numbers over quality also affects behavior in the
    enforcement division and examination office. Every enforcement attorney
    knows that statistics (or ``stats'') help to determine perception and
    promotion potential. The statistics sought are cases either brought and
    settled or litigated to a successful conclusion, and amount of fines
    collected. These statistics do not necessarily measure quality (such as
    an investigation performed well and efficiently, but the evidence
    ultimately adduced did not indicate a securities violation). Thus, the
    stats system does not encourage sensitivity to due process.
        In addition, the stats system tends to discourage the pursuit of
    penny stock manipulations and Ponzi schemes, which ravage mostly retail
    investors. These frauds generally take a long time and much effort to
    prove--the perpetrators tend to be true criminals who use every effort
    to fight, rather than the typical white-collar corporate violator of a
    relatively minor corporate reporting requirement who has an incentive
    to negotiate a settlement to put the matter behind him and preserve his
    reputation and career. Thus, over the years several staff attorneys
    have told me that their superiors ``actively discourage'' them from
    pursuing Ponzi schemes and stock manipulations, because of the
    difficulty in bringing the case to a successful conclusion and the lack
    of publicity in the press when these cases are brought (with the
    exception of Madoff, these sorts of cases tend to be small). Some
    senior enforcement officers openly refer to these sorts of cases as
    ``slip-and-fall'' cases, which disparages the real effect that these
    cases have on individuals, who can lose their life savings in them.
    Because of the interstate and international aspect of many of these
    cases, if the SEC does not go after them, no one can or will.
        Sadly, this attitude is reflected even outside the SEC. Just last
    week, I saw a quotation in an article regarding the steps that the SEC
    needs to take to collect on the settlements that it has entered into.
    The sentiment expressed by the commenter was that many of the cases are
    very small, but that the agency is under political pressure to go after
    the smaller schemes. Not to discount the importance of combating any
    fraud, we need to remember that one individual losing his entire life's
    savings is extremely serious, even if it is ``only'' 5-digits in size.
        During my tenure as commissioner, I emphasized the need to focus
    from an enforcement perspective on microcap fraud, including Ponzi
    schemes, pump-and-dump schemes, and other stock manipulations. I was a
    strong advocate for the formation of the Microcap Fraud Group in the
    Enforcement Division, which was finally formed in 2008. I had also
    strongly supported the good efforts of the Office of Internet
    Enforcement, established under Chairman Levitt in the late 1990s, which
    worked closely with other law enforcement agencies to tackle Internet
    and other electronic fraud. Unfortunately, it appears that while the
    administrative overhead functions within enforcement are gaining
    resources, insufficient attention is being paid to ``boots-on-the-
    ground'' investigative resources to combat the pernicious frauds that
    prey on individual investors.
        There are many intelligent, competent, dedicated, hard-working
    people at the SEC. It is the management system and how it determined
    priorities over the past decade that has let them down. Three years
    ago, in an article published in the Fordham Journal of Corporate and
    Financial Law, \7\ I called for the SEC to follow the example from 1972
    of Chairman William Casey, who formed a committee to review the
    enforcement division--its strategy, priorities, organization,
    management, and due-process protections. Thirty-seven years later, and
    especially after the Madoff incident, this sort of review is long
    overdue.
    ---------------------------------------------------------------------------
        \7\ See Paul S. Atkins and Bradley J. Bondi, ``Evaluating the
    Mission: A Critical Review of the History and Evolution of the SEC
    Enforcement Program,'' 8 Fordham Journal of Corp. & Fin. Law 367
    (2008).
    ---------------------------------------------------------------------------
    Conclusion
        Dodd-Frank overall is a poorly drafted statute that drastically
    expands the power of the Federal Government, creates new bureaucracies
    staffed with thousands, and does little to help the struggling American
    citizen. Ambiguous language will result in frivolous and unnecessary
    litigation. Huge amounts of power and discretion have been ceded to
    regulators, who were given the impossible task of about a year or two
    to put things in place. All of these costs and distractions will
    further stifle economic growth. Consumers, investors, and workers will
    pay the price. That is certainly not the best way to get the economy up
    and running!
        The Dodd-Frank Bill started out as a bill to ``get'' Wall Street
    and morphed into a bill that sticks it to everyone--Wall Street, Main
    Street, consumers, entrepreneurs, shareholders and taxpayers alike. The
    financial markets are critically important to America. They raise
    capital for businesses producing good and services. They create jobs,
    fund ideas and increase wealth for all Americans. When Americans save
    and invest, they are putting their capital to work, building their nest
    egg and that of others, too. We need a more thoughtful, balanced plan
    to make sure that the nest egg is as safe as it can be, but also to
    ensure the we are not killing the proverbial, golden egg-laying goose.
    The arguments over Dodd-Frank will continue. Regulators will continue
    to grind away at implementing its provisions. There will continue to be
    calls for repeal of all or parts of it. This will be a vital topic to
    follow for the foreseeable future.
        Thank you again for the invitation to come here and testify before
    you today.
                                     ______

                      PREPARED STATEMENT OF LYNN E. TURNER
          Former Chief Accountant, Securities and Exchange Commission
                                 July 12, 2011

        Thank you Chairman Johnson and Ranking Member Shelby for holding
    this hearing and it is an honor to be invited to testify before you.
    Our capital markets in the United States have been the crown jewel of
    our economy for over two centuries. But in the last decade, they have
    been the source of great scandal, resulting in investors questioning
    whether they are on a level playing field or sitting across the table
    at a casino where the odds are greatly stacked against them. This along
    with a declining U.S. economy has led investors to invest increasing
    amounts of capital overseas, with less available here for jobs,
    investment in plant, and research and development. If that trend is to
    be reversed, investors must know they will be afforded reasonable
    protections and have regulators who serve as their advocates.

    Background
        Before I start, it might be worthwhile to provide some background
    on my experience. I have held various positions in the accounting
    profession for some 35 years. I started my career with one of the
    world's largest international accounting and auditing firms where I
    rose to become an audit and SEC consulting partner. I served as a CFO
    and vice president of an international semiconductor company as well as
    a business executive in a venture backed newly formed startup company.
    I have had the good fortune to be the Chief Accountant of the
    Securities and Exchange Commission (``SEC''). In addition, I have been:
    a member of and chaired audit committees of corporate boards of both
    large and small public companies; a trustee of a mutual fund and a
    public pension fund; and a professor of accounting. In 2007, Treasury
    Secretary Paulson appointed me to the U.S. Treasury Advisory Committee
    on the Auditing Profession (``ACAP''). I have also served on the
    Standing Advisory Group (``SAG'') and Investor Advisory Group (``IAG'')
    of the Public Company Accounting Oversight Board (``PCAOB'').

    The Financial Crisis
        It has now been over 4 years since the worst post Great Depression
    financial crisis imploded in this country and around the globe,
    resulting in the Great Recession. The financial damage to civilization
    was tremendous as Exhibit A illustrates; investors in the global
    markets lost over $28 trillion in the value of their holdings. In the
    United States, investors saw approximately $10-11 trillion in value
    disappear, not including the value of their homes which continue to
    depreciate. And consider the numbers: in 1930, 1.2 percent of the
    population owned stock; in 2008, the number invested in the markets
    through stock, mutual funds or retirement accounts approximated 110
    million.
        To put the damage to investors and the capital markets in greater
    perspective, the Dow Jones Industrial Average closed on October 9, 2007
    at 14,164.53 but then proceeded to plunge as fear grasped investors to
    close at 6547.05 on March 9, 2009. That represents a fall during the
    financial crisis of 7839.88 points or 54.9 percent. The S&P 500 closed
    on October 9, 2007 at 1565.15. On March 9, 2009, it would close at
    676.53, representing a fall of 898.36 points or 57.4 percent. By this
    point in time, investors and the American public had lost confidence in
    the capital markets, no longer trusted business executives, and
    believed Wall Street had become a casino where the house odds were
    overwhelming in favor of Wall Street, not Main Street. Congress had to
    act.

    Sound Financial Markets and Capitalism
        My 35 years of experience as a businessman, regulator, and investor
    have taught me that sound financial markets and efficient capitalism,
    can only exist if built upon five fundamental bedrock pillars. These
    pillars are:

      1.  Transparency--Investors must receive unambiguous financial
            information that allows them to make fully informed decisions
            as to which companies they should invest in.

      2.  Accountability--Those entrusted with the money millions of
            Americans invest must be held accountable for how they use that
            money. Business executives should be rewarded for sound
            business decisions and long term performance. Their
            compensation should be cut or they should be replaced when
            underperforming. And investors must have redress when they have
            been recklessly or worse yet, fraudulently wronged, such as
            when credit rating agencies or public companies issue
            misleading reports.

      3.  Independence--A lack of conflicts and where conflicts do exist,
            clear and timely disclosure of those conflicts prior to
            solicitation of investor's money.

      4.  Effective Regulators--Independent, strategic and balanced
            regulators who understand their mission is necessary to protect
            investors, create confidence in the markets and attract
            capital. Effective regulation also requires that regulators be
            held accountable by Congress in a timely manner.

      5.  Enforcement of the Laws--In the past, the United States has
            prided itself as being a nation of laws. Those who break the
            laws, should be held accountable so that the markets and all
            market participants operate in a fair market place, and the
            playing field is not tilted to any one party's advantage.

    Yet when we look back of the mayhem of the past decade, we see that:

        There was a dearth of transparency as investors and
            regulators alike could not decipher the financial statements
            and financial condition of institutions such as AIG, Lehman
            Brothers and many of the largest banks in the country. Assets
            and capital were inflated, liabilities understated and profits
            upon which huge compensation packages granted, a mirage.

        Regulation was most ineffective under the onslaught of
            those who mistakenly thought the markets and market
            participants could police themselves. These disciples of
            laissez faire failed to understand the culture of markets and
            power of greed and megalomania. At the same time, most of the
            regulators were captured by industry, lacked adequate funding
            and resources in the case of the SEC and CFTC, and lacked
            authority to regulate such markets as derivatives which had
            become increasingly toxic as they grew close to 10 times the
            GDP of the entire world.

        As the Senate's own investigations have illustrated,
            conflicts abounded as institutions collected fees for
            originating loans aptly named ``Liars'', ``No Doc'', or
            ``NINJA'', packaged them up for another fee, and then collected
            even greater fees when they sold them off to an unsuspecting,
            and poorly informed investing public. Conflicts were rampant
            among credit rating agencies, the lawyers who drafted and
            reviewed all these agreements, and auditors.

        Things falsely done in the name of capitalism or
            entrepreneurship, had nothing to do with them. As Charlie
            Munger, Vice Chairman of Berkshire Hathaway recently said:
            ``None of us should fall for the idea that this was
            constructive capitalism. In the 1920s they called it bucket
            shops--just the name tells you it's bad--and they eventually
            made it illegal, and rightly so. They should do the same this
            time.''

        And the public now questions whether the law enforcement
            agencies have created a two tier justice system; one for Wall
            Street and business executives and one for Main Street.

    Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
            (``The Act'')
        With that as a backdrop, Congress chose to act passing the Dodd-
    Frank Wall Street Reform and Consumer Protection Act. I believe doing
    nothing was not an option even though some have suggested that, or
    something akin to fringe changes, more intent on maintaining the status
    quo then protecting investors and consumers. And while I would have
    preferred a Pecora style investigation as Senator Shelby had urged, it
    is abundantly clear that was not going to happen in this city.
    Accordingly, I applaud Congress for acting.
        Within the Act, are Title IV, Private Fund Advisors and Title XI,
    Investor Protection and Securities Regulation. I shall confine my
    remarks to Title XI and certain of the strong investor protections
    afforded within that section.

    Whistle Blower Protection--Sections 922, 923, and 924
        It is important the SEC become aware of securities law violations
    at the earliest possible date, so that it can act to stop the violation
    before further harm to investors and the markets occur, and it can hold
    people accountable. Obtaining credible information is vital to early
    action and successful prosecution by law enforcement agencies.
        In its 2010 Global Fraud Study, The Association of Certified Fraud
    Examiners stated that on average, it took 27 months for companies to
    detect financial statement fraud. That's over 2 years investors would
    be unknowingly investing based on false and misleading financial
    information. The report also notes that the number one way in which
    frauds are detected is not a management review, internal audit or
    external auditors. Rather it is through tips.
        Consistent with these findings, Dodd-Frank allows the SEC to reward
    those who provide it with a wide range of information of securities
    laws violations resulting in successful prosecutions. The SEC had very
    limited authority to do so before passage of the Act. In fact, since
    1989 and prior to Dodd-Frank, the SEC had only made seven payouts to
    five whistleblowers for a total of $159,537.
        The SEC adopted rules implementing the whistle blower sections of
    Dodd-Frank in May of this year, after soliciting and receiving public
    comments on the issue. While some from the business community feel the
    rules as proposed will encourage people to report to the SEC without
    going through the normal hot lines and compliance program a company
    sets up, others felt they would cause some to avoid providing useful
    tips to the SEC and result in tips showing up on the Internet at sites
    such as Wiki Leaks.
        Having served on audit committees of public companies, I believe
    the SEC took a reasonable and balanced approach to the final rules it
    adopted. Hot lines will not work unless employees have confidence their
    identity will remain anonymous and protected, and the complaint will be
    addressed in an unbiased thorough manner. This is especially important
    as the business groups forming the Committee of Sponsoring
    Organizations of the Treadway Commission (COSO), noted in a May 2010
    report that in the 347 cases of fraudulent reporting brought by the SEC
    from 1998 through 2007, the CEO and/or CFO were named in 89 percent of
    the cases, up from 83 percent in the prior decade. I believe Dodd-Frank
    and the new SEC rules will result in companies reexamining their hot
    lines and compliance programs, ensuring employees can put their faith
    in them.
        The SEC provided reasonable protections for public companies. The
    SEC encouraged those who provide tips, to go through the normal company
    compliance channels. It did so stating that reporting internally will
    be considered when the size of an award is determined by the SEC. The
    Commission also provided individuals the opportunity to first report to
    the company, and then if they chose, reporting to the SEC. This is very
    beneficial from my perspective as it allows the company to act on the
    information and where appropriate, self report to the SEC. In addition,
    the SEC excluded payments to certain employees such as in house
    counsel, compliance personnel, internal auditors, certain executives
    and external auditors.

    Enhanced Law Enforcement--Sections 925, 926, 929E, and 929KLMNOP
        Dodd-Frank includes a number of beneficial provisions that will
    enhance law enforcement giving investors greater protections and
    ensuring fair markets. For example, under prior law, a securities
    professional who had been barred by the SEC as a result of serious
    misconduct as an investment advisor, could simply participate as a
    broker dealer, offering similar services. Dodd-Frank appropriately
    addressed this issue by giving the SEC the authority it sought to
    impose collateral bars against regulated persons. Likewise, Dodd-Frank
    prohibits someone already convicted of a felony in connection with a
    securities offering, from offering securities under Rule 506 of
    Regulation D. While the Act allows critical financing for startups, it
    keeps felons from gaining a foothold in the process, reducing the
    likelihood of fraud being perpetrated by repeat offenders.
        Previously the SEC did not have the authority to bring claims and
    seek penalties against those who recklessly and knowingly aided or
    abetted others in a violation of the Securities Act of Investment
    Company Act. In essence, certain individuals could ``drive the getaway
    car'' when it came to a securities law violation and know they were
    beyond the reach of the regulator and law. Dodd-Frank addressed that
    problem. It also called for a study by the SEC on whether investors
    should be given redress against these individuals. Today, professionals
    including gatekeepers and investment bankers critical to a fair and
    orderly market, can assist an individual in the commission of a
    securities law violation. Such actions have contributed to great damage
    being inflicted on shareholders, but the person aiding or abetting the
    crime here in the United States knows the shareholder has no right to
    sue them, unless the person aiding and abetting the crime tells the
    public they are doing so. Such a ridiculous standard, which fails any
    test of common sense, needs to be corrected. And as is discussed later
    on, regulators often have not had the resources or the will to pursue
    such cases.
        The Act further enhances investor protections by giving the SEC
    enforcement authority in key areas, and giving the SEC greater ability
    to hold market participants accountable for violations of the law.
    Under the Act, civil money penalties may now be imposed by the SEC in
    cease and desist proceedings. This should serve as a further deterrence
    to fraud. The SEC enforcement director has stated this will also
    enhance the effectiveness and efficiency of the Division's enforcement
    efforts, a view I agree with.
        With the growing number of global markets, the legislation amends
    the 1933 Securities Act and 1934 Exchange Act to give U.S. district
    courts' jurisdiction over violations of the antifraud provisions when
    there is conduct in the United States that furthers the fraud, even if
    the securities transaction occurs outside the United States. Being able
    to have redress in these situations is critical to investor confidence
    and ability to invest safely. It is also important to ensure
    accountability on the part of those who engage in such unlawful
    behavior.
        Dodd-Frank also requires the SEC to study the extraterritorial
    application of the securities laws to actions that would be brought by
    investors. This is in response to the U.S. Supreme Court ill advised
    opinion in the case of Morrison v. National Australia Bank, Ltd. In
    November, 2010, a number of public pensions, including one for which I
    serve as a trustee, wrote this Committee urging them to reverse this
    opinion. Investors must have an opportunity to obtain redress in the
    U.S. courts for fraud committed in the United States by foreign
    entities which seek capital from U.S. investors, and U.S. Federal
    securities laws should deter fraudulent statements by foreign entities
    to investors.

    Improvements to the Management of the Securities and Exchange
            Commission--Sections 961, 962 963, 964, 966, 967, and 968
        Leading up to and during the subprime financial crisis, the SEC has
    been the subject of much public criticism of its management. Most
    notably have been complaints for its failure to investigate
    whistleblower complaints on Madoff and the Stanford Group, a failure to
    adequately supervise market participants such as Bear Stearns, Lehman
    and Merrill Lynch, questionable investigations such as in the Aguirre
    matter, the leasing matter that has now been referred to the Department
    of Justice by the Inspector General, poor internal controls and lax
    enforcement actions such as the one against Bank of America which the
    judge was extremely critical of. I can't help but believe some of these
    criticisms are the result of very poor leadership and management of the
    agency during the later half of the past decade. Leadership that, in my
    opinion, failed to foster the right tone at the top, culture and
    investor advocate mission that had long been the mantra of a proud
    agency and its staff.
        In the past, the SEC has had a reputation as the gold standard
    among regulators. But that image has been tarnished by the criticisms
    noted. Yet a well managed and run, independent SEC is vitally important
    to the capital markets. Investors over the years have had confidence in
    the markets, firmly believing the SEC ensured confidence could be
    placed in financial disclosures, that the markets were fair and the
    playing field level. I can tell you from personal experience, many an
    employee of the SEC has taken great pride in providing outstanding
    public service and their efforts to ensure the agency was indeed the
    public watchdog, the one true investors advocate.
        There are a number of provisions in Dodd-Frank that I believe, as a
    former business executive, will contribute in a positive manner to the
    SEC restoring public confidence in the agency. I have found one manages
    what one measures, and does not manage what one does not measure. While
    the SEC has required public companies to increase their transparency,
    controls, monitoring and accountability, it has fallen short of
    adopting some of its own recommendations in a timely manner that could
    have been beneficial, such as reporting on internal controls.
    Accordingly, enhancements to the SEC's management and structure that
    will in the long run benefit it, include:

        An assessment of its overall structure and personnel;

        Enhanced monitoring, assessment and transparency of
            supervisory controls;

        Greater accountability for supervision through
            certification of the effectiveness of controls;

        Increased evaluation, monitoring and transparency of
            personnel management including actions taken with respect to
            those who have failed to perform their duties;

        A suggestion program and hotline for the employees of the
            agency; and

        Taking a long hard look at its ``revolving door.''
            Unfortunately, the study mandated by Dodd-Frank only requires a
            study of employees leaving the SEC for financial institutions
            and not the largest and fastest spinning revolving door--
            employees who leave the SEC bound for legal firms that
            represent individuals and public companies before the SEC.

    Securities and Exchange Commission Funding--Section 991
        The SEC has sought now for over two decades, the same types of
    self-funding mechanisms that banking regulators have. Unfortunately,
    Senate conferees rejected such a provision, which in June, 2010, the
    Federal Bar Associations securities law committee stated was
    ``critical'' to the ``chronic underfunding'' of the SEC.
        Current and former SEC Chairmen such as Arthur Levitt and Richard
    Breeden have urged Congress to increase the SEC's funding so that it
    can do the job Congress and investors expect of it. Those who represent
    investors such as the Council of Institutional Investors have also
    called for increased funding of the SEC. Investors have always voiced
    support for adequate funding of the SEC and ultimately, the money comes
    out of their pockets.
        As the GAO has noted in prior reports, the SEC was essentially
    starved by Congress of necessary resources during much of the 1990s.
    During this time period the markets experienced fast growth as millions
    of Americans invested through their retirement accounts. After this
    underfunding contributed to and played a role in the corporate scandals
    of a decade ago, Congress increased the funding of the agency. But
    during the period from 2005 to 2007, as the subprime market bubble was
    growing toward an implosion, the SEC staff was again reduced by over 10
    percent and its spending reduced by some $75 million as a result of
    actions by Congress and management of the agency.
        Despite the fact no taxpayer dollars are used to fund the SEC, but
    rather it is funded through user-based fees, it seems as if Congress
    has been bent and determined to somehow shrink the SEC to greatness.
    The fact of the matter is that congressional approach at times over the
    past two decades has been an absolute miserable failure.
        Congress through Dodd-Frank, as well as the public has upped the
    bar for performance by the SEC and rightly so. The SEC is being asked
    to increase its inspections, its enforcement, the number of entities
    and the types of transactions it regulates. Dodd-Frank also requires
    the SEC to establish several new offices such as the office of the
    Investor Advocate and Ombudsman, the Office of Credit Ratings and the
    Whistle Blower office. I believe investors in general are strong
    proponents of these new functions at the SEC. At the same time, the SEC
    is being asked to do a much better job of market surveillance and take
    proactive steps to identify and address in a timely manner future
    market problems, before they become a crisis. To accomplish all of
    these tasks takes top notch people with the requisite experience, and
    very significant investment in technology, training and support
    services. And that takes money.
        Dodd-Frank specified acceptable levels of funding, which have been
    applauded by many investors. Those levels are as follows:

        2011--$1.3 billion

        2012--$1.5 billion

        2013--$1.75 billion

        2014--$2 billion

        2015--$2.25 billion

        Unfortunately, Congress is already breaking its promise to
    investors and the SEC for the year 2011 as its funding is below the
    $1.3 billion level. If such funding is not forthcoming, and there are
    further crisis in the capital markets, such as has been seen with the
    flash crash, a good deal of the blame will rest squarely on the
    shoulders of Members of Congress.

    Expansion of Audit Information to Be Produced and Sharing Privileged
            Information with Other Agencies--Section 929, and 929 K
        The Act expands the power of the Public Company Accounting
    Oversight Board (``PCAOB'') by:

      1.  Broadening the PCAOB's authority to include independent audits of
            broker dealers;

      2.  Enhancing the PCAOB's access to work papers of foreign auditors;
            and

      3.  Share information with foreign regulators.

        The Madoff ponzi scheme brought to light a gaping hole in the
    regulation of independent audits investors rely upon. The PCAOB did not
    have the authority to inspect the audit of the Madoff fund, and the
    auditor was not subject to inspection by the accounting professions
    peer review program. To this day, the Madoff auditor would not be
    subject to inspection by the State regulator as he was a sole
    practitioner. Dodd-Frank rightly remedies this shortcoming by giving
    the PCAOB the right to inspect such audits and ensure the firms
    providing such audits have effective systems of quality controls.
        More recently, scandals resulting from flawed audits of Chinese
    companies have also come to light, resulting in large losses for
    investors. Much of the audit work has been performed by Chinese
    auditors, although a U.S. audit firm may issue the audit report read
    and relied upon by investors. At the same time, with U.S. companies
    increasing their global operations, a growing portion of their audits
    are performed by foreign audit firms, many of which are affiliated with
    U.S. audit firms. If the PCAOB is to carry out its mandate of providing
    investor protections, it must be able to inspect the auditor work, and
    documentation of that work, regardless of where it is performed.
        For example, frauds at such companies such as Satyam, Enron, Xerox,
    and the now infamous Lehman Repo 103 transactions involved transactions
    and related audit work executed in foreign countries. Without the
    access to audit work papers for this audit work, the PCAOB cannot
    ensure that the work supports the overall opinion the auditors are
    providing on the consolidated financial statements of the company. Nor
    can they inspect audit quality for a significant portion of the audit,
    leaving investors exposed to a portion of an audit where quality may be
    substandard at best.
        Ensuring international audit quality, especially with respect to
    large international conglomerates that can attract hundreds of billions
    in capital from investors, is critical to confidence in financial
    disclosures that are the life blood of any capital market. It is
    important the PCAOB be able to share information, work and cooperate
    with its counterparts in carrying out this mandate. But I have talked
    to foreign regulators who expressed criticisms of the PCAOB, and a
    reluctance to work with it. That was because while they could share
    information with the PCAOB, it was a one way street because the prior
    law prevented the PCAOB from sharing information with them. The prior
    law had been adopted when the PCAOB was new and its counterparts in
    foreign jurisdictions did not exist. But that has changed and once
    again, to its credit, Dodd-Frank has updated the law and corrected this
    deficiency. It did so by giving the PCAOB the ability to share
    information with foreign regulators on a confidential basis. This was a
    badly needed reform to ensure regulatory cooperation on an
    international basis.
        At the same time, the PCAOB has also called upon Congress to allow
    it to enhance the transparency of its enforcement program. It would do
    so by making its enforcement actions public, at an appropriate time,
    consistent with the way the SEC handles its 102(e) enforcement actions.
    Having been involved with the development of the current SEC 102(e)
    rule, I applaud the PCOAB for working to enhance its transparency.
    Without such a rule change, as evidence is now starting to show, audit
    firms will take every action available to them to seriously delay
    enforcement actions, during which time they continue to issue audit
    reports while their quality controls and audit work may suffer from
    serious deficiencies. This exposes investors and the capital markets to
    great risks which lack any transparency whatsoever.

    Other Sections
        There are many other important sections of Title IX of the Act
    which I also strongly support. The governance provisions granting
    investors the same access to the proxy for nominating directors as
    management has, is a great tool for establishing accountability over
    entrenched and underperforming boards. Creating independent
    compensation committees, enhancing the transparency of compensation and
    incentives, and giving shareholders an advisory vote on pay should all
    prove to be beneficial to ensure destructive risks taking is not
    rewarded, and executives compensation is based on performance. Already
    investors have shown they can use such rights in a wise and reasoned
    manner. And while investors did not get all that they wanted in this
    section of the bill, it was a very positive step forward.
        The enhanced regulations of credit rating agencies should also
    improve the quality of credit ratings. Especially important is the
    private right of action granted investors, a useful mechanism to hold
    credit rating agencies accountable.

    Closing
        I believe the sections of Dodd-Frank I have discussed all help
    build and contribute to a stronger foundation upon which the capital
    markets can function more effectively. They increase transparency and
    accountability, they enhance independence including that of the
    regulator, they will improve the effectiveness of the SEC and PCAOB,
    and they certainly give these agencies greater authority necessary to
    enforce the laws and protect investors. That in turn should give a
    boost to investors confidence in the markets which is necessary if the
    capital markets are to continue to be the crown jewel of our economy.
        Thank you and I would be happy to take any questions.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR MORAN FROM DAVID
                                 MASSEY

    Q.1. Mr. Massey, as you know Section 410 of the Dodd-Frank Act
    will shift between 3,000 and 4,000 registered investment
    advisors from SEC regulation to State regulation. However, this
    shift is coming at a time when States are struggling with major
    budget deficits and dwindling resources. How can we be certain
    that State regulators will have the resources necessary to
    properly regulate investment advisors and protect investors?
    How will States meet this challenge and increase their
    examination and regulatory resources?

    A.1. Senator, the States have been presented with a unique
    regulatory challenge--an increase of approximately 25 percent
    in the number of investment advisers subject to State
    regulation that will result from the increase in the assets-
    under-management threshold from $25 million to $100 million,
    mandated under Section 410 of the Dodd-Frank Act (``Act'').
    Fortunately, the States and the North American Securities
    Administrators Association (``NASAA'') have been preparing to
    meet the challenge of regulating an additional 3,200 investment
    advisers for over a year, and I am confident that these
    preparations will permit State regulators to implement
    intelligent, efficient and responsive regulation.
        As I testified during the Senate Banking Committee hearing
    of July 12, the States have a proven track record in the area
    of investment adviser regulation. Further, NASAA is confident
    that State securities regulators will continue to marshal the
    examination and enforcement resources necessary to effectively
    regulate the investment adviser population subject to their
    oversight. While State investment adviser examination programs
    and resources are documented in significant detail in the
    comprehensive report that NASAA provided the Securities and
    Exchange Commission in support of the Act's Section 913
    study,\1\ some significant findings from that report include:
    ---------------------------------------------------------------------------
        \1\ Available at http://www.sec.gov/comments/4-606/4606-2789.pdf.

       LStates employ more than 400 experienced employees
            dedicated to the licensing and examination function,
            including field examiners, auditors, accountants, and
            attorneys. More than half of the States that reported
            qualitative staffing data indicate an average staff
            experience exceeding 10 years, with a heavy
    ---------------------------------------------------------------------------
            concentration of personnel in the 5- to 14-year range.

       LState investment adviser examination totals have
            progressively increased each year for the past 5 years,
            resulting in a 20 percent increase in the total number
            performed through the first three quarters of 2010 as
            compared to 2006. As of August 2010, States had
            completed 2,463 onsite examinations of investment
            adviser registrants.

       LThe majority of State routine (non-cause)
            investment adviser examinations are performed on a
            formal cyclical basis. All States that adhere to a
            formal cycle audit their entire investment adviser
            registrant populations in 6 years or less. Half of the
            States complete the examinations on 3-year-or-less
            cycles.

    Memorandum of Understanding (MOU) for the Sharing of Resources
        Even a highly skilled workforce cannot succeed absent
    adequate resources, and the need for additional resources is a
    natural consequence of additional responsibility. To that end,
    the 50 States have agreed through a formal MOU to work together
    and share resources as needed to regulate the expanded State
    investment adviser population. Pursuant to this MOU, all States
    will work to ensure that examination resources are augmented,
    and that schedules are coordinated, to allow for maximum
    coverage and consistent audits. The MOU also provides for the
    possibility of joint exams funded by NASAA. The MOU will bridge
    the gap while and until State regulators acquire any necessary
    additional resources.

    Frequency of Examinations
        In recent years, the States have undertaken to increase the
    frequency of investment adviser examinations. In 2006, States
    reported 2,054 examinations of investment advisers, while in
    2007 and 2008 that number increased to 2,136 and 2,389
    examinations respectively. In 2009, State regulators performed
    2,378 onsite examinations of investment advisers, not including
    the countless number of regular-desk, registration, and other
    abbreviated examinations that States perform every day. As of
    August, 2010, the States had performed 2,463 investment adviser
    audits, putting them on pace to again increase the total number
    of investment adviser examinations relative to the previous
    year. This trend constitutes a material and progressive
    increase, year over year, for five consecutive years.
        The States stand ready and able to take on these new
    examination duties, and State securities administrators have
    been proactive in their preparation, as outlined below.

    Development of Uniform Exam Procedures
        Another important step that the States have recently
    undertaken to prepare for the switch-over has been to develop
    uniform examination procedures. These new procedures will
    promote and guarantee a consistent and high standard of
    examination at the State level, effectively ensuring that all
    State examinations--whether conducted in North Carolina, North
    Dakota, or Kansas--ask the same questions of investment
    advisers.

    Utilization of New Risk Analysis Tools
        NASAA has invested in new tools that will permit States to
    continue to do an even better job of leveraging their resources
    in the examination of investment advisers. Specifically, NASAA
    has acquired advanced risk-analysis software and has made this
    software available to all State regulators. The software will
    provide States a mechanism to rapidly review their investment
    adviser registrants, and rank the individual risk factors
    associated with each registrant. This tool will evolve as time
    goes on, but the bottom line is that the new software will
    permit States to better evaluate the risks associated with
    various firms and allocate their examination resources
    accordingly.

    Industry Outreach Campaign
        NASAA members have in the past year initiated an aggressive
    industry outreach campaign to prepare the industry for State
    oversight and to enable new registrants to set up their
    operations properly in order to avoid inadvertent
    noncompliance. The goal of this outreach campaign is to bring
    the legitimate investment advisers, the State regulators, and
    NASAA together, prior to the switch-over, so that all parties
    can establish a positive and constructive working relationship.
    By facilitating a partnership among the States and the many
    investment advisers who conduct their businesses in a
    legitimate and professional manner, this initiative will
    maximize the time and resources that State regulators can
    devote to protecting investors.
        Senator, I would be pleased to answer any additional
    questions you may have.
                                    ------

      RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM LYNNETTE
                               HOTCHKISS

    Q.1. Ms. Hotchkiss, the Board through the EMMA Web site makes a
    large amount of municipal bond market information freely and
    instantly available to investors. Do you feel that the
    availability and use of EMMA impacted the stability of the
    municipal market during the recent financial crisis and, if so,
    how? Does the Wall Street Reform Act impact the ability to
    operate and expand EMMA?

    A.1. Of course it's impossible to know the precise effect that
    EMMA may have had in helping the municipal market weather the
    financial crisis, but I do know that it has had a considerable
    impact in raising the level of confidence in the municipal
    marketplace and giving all market participants equal access to
    the critical information needed to make informed investment
    decisions. EMMA came just when it was most needed, as the full
    impact was being felt of the municipal bond insurance
    downgrades resulting from the spreading financial devastation
    of the mortgage-backed securities collapse. We launched EMMA as
    a pilot disclosure utility in March 2008, for the first time
    making the full library of basic bond offering documents for
    most outstanding municipal securities issued since 1990, along
    with real-time trading information, available for all market
    participants at no cost. We have received highly complementary
    feedback from many retail investors attesting to the value of
    the information they find on EMMA and on their increased
    confidence in investing in the municipal securities market as a
    result of such availability.
        As to the effect of the Dodd-Frank Act, we believe it was
    important to have our information dissemination function
    clearly delineated in our authorizing statute, and we look
    forward to working with other regulatory organizations in
    creating cross-market information systems as contemplated under
    Dodd-Frank. The ability to fully fund future enhancements to
    EMMA and to ensure secure and reliable operations of the system
    are the biggest barriers we see to realizing EMMA's full
    potential. Given that the information available through EMMA is
    a significant benefit to all market participants, we believe it
    is crucial that funding for the system be as broad-based as
    possible. We believe that Dodd-Frank struck the delicate--and
    right--balance of preserving free public access to EMMA's core
    collection while providing the MSRB with the ability to provide
    for the financial viability of our information systems through
    commercially reasonable fees for subscription or similar
    services as well as for customized data and document products
    and services. So long as we maintain the free core collection
    through EMMA, we think it is crucial for the health of the
    system and the benefit of marketplace that our ability to
    charge such commercially reasonable fees not be read too
    restrictively.

    Q.2. Section 975(c)(8) of the new law created Section
    15B(c)(9)(A) of the Exchange Act, which states that ``Fines
    collected by the Commission for violations of the rules of the
    Board shall be equally divided between the Commission and the
    Board'' and

            Fines collected by a registered securities association under
            section 15A(7) with respect to violations of the rules of the
            Board shall be accounted for such registered securities
            association separately from other fines collected under section
            15A(7) and shall be allocated between such registered
            securities association and the Board, and such allocation shall
            require the registered securities association to pay the Board
            \1/3\ of all fines collected by the registered securities
            association reasonably allocable to violations of the rules of
            the Board, or such other portion of such fines as may be
            directed by the Commission upon agreement between the
            registered securities association and the Board.

        Have fines subject to this provision been collected thus
    far? If so, how have these fines been allocated? Please
    describe how this process will work going forward.

    A.2. With respect to fine collections by a registered
    securities association--which means the Financial Industry
    Regulatory Authority, or FINRA--our two organizations have
    worked through an initial process for allocating fines and the
    MSRB began receiving monthly remittances earlier this year. The
    current allocation is based on the \1/3\ apportionment formula
    set out in the statute and our two organizations continue to
    review how that apportionment is applied in situations where a
    broker-dealer may have violated both MSRB and FINRA rules, and
    we will make any adjustments that may be necessary if we find
    that some situations call for a different manner of application
    on overlapping violations. We are in the final stages of
    memorializing the allocation in a memorandum of understanding
    between our two organizations.
        As of now, the Commission has not yet collected any fines
    since October 1, 2010, that it has attributed to a violation of
    MSRB rules, but we expect that the Commission will be stepping
    up its enforcement activities with respect to MSRB rules,
    particularly in light of the additional areas of MSRB
    rulemaking and the broader scope of the protections of those
    rules called for under the Dodd-Frank Act. One complicating
    factor that has delayed our establishment of a precise
    allocation process is that most fines levied by the Commission
    are paid directly to the U.S. Treasury, which could result in
    significant complications in having the MSRB allocable portion
    paid to us. It is our understanding that the Commission is
    considering providing for a separate levy of the MSRB allocable
    portion on any broker, dealer, municipal securities dealer or
    municipal advisor found to be in violation of MSRB rules, with
    payment of the MSRB allocable portion mandated under the Dodd-
    Frank Act to be made directly from such entity to the MSRB. We
    hope that the Commission is able to come to resolution on this
    process in the very near future so that we can proceed to
    document this allocation process.

    Q.3. Earlier this month, the U.S. Securities and Exchange
    Commission (SEC) charged a division of JPMorgan Chase with
    fraud in connection with rigging of 93 municipal bond
    transactions in 31 States. What proactive steps has the MSRB
    taken to address conduct similar to that uncovered by the SEC?

    A.3. The MSRB has been extremely active in undertaking
    rulemaking that covers the behavior of bond underwriters and
    municipal advisors to issuers in connection with questionable
    or illegal activities such as bid rigging. We proposed in
    February and are nearing the completion of the rulemaking
    process on guidance under both our general fair practice rule,
    Rule G-17, and a new Rule G-36, implementing the new Federal
    fiduciary duty of municipal advisors under the Dodd-Frank Act,
    that would squarely prohibit the key wrongful actions
    undertaken in this case. For example, under the Dodd-Frank Act,
    ``municipal advisor'' was defined to include guaranteed
    investment contract brokers, or GIC brokers, who now have a
    Federal fiduciary duty to the issuer. The MSRB guidance on
    fiduciary duty would prohibit receipt of payments from other
    parties in return for giving favorable treatment in what is
    supposed to be a competitive bidding process, even if they
    disclosed such payments. In addition, the proposed MSRB fair
    practice guidance for underwriters would establish significant
    new disclosure obligations to issuers, including specifically
    disclosures on conflicts of interest. That guidance would
    require that underwriters not charge excessive compensation. In
    determining whether compensation is excessive, underwriters
    would have to include payments from third parties, such as
    payments from swap providers or GIC brokers paid to the
    underwriters for recommending those parties to the municipal
    issuer.
                                    ------

      RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM BARBARA
                                 ROPER

    Q.1. In your written testimony, you state that credit rating
    agencies should be held to the same accountability standards
    faced by auditors and underwriters. Could you go into a little
    more detail about what you mean by this? What are the strengths
    and weaknesses of this approach? How should the SEC address the
    current state of relief (no-action letters) to issuers that do
    not disclose ratings in their prospectuses?

    A.1. Much like auditors, credit rating agencies operate as
    private gatekeepers in our financial system. In fact, much as
    our system of financial disclosure rests on the assumption that
    auditors can provide reasonable assurance of the accuracy of
    those disclosures, the entire system of regulation for the
    securitization process was built on the assumption that ratings
    could reliably assess the risks associated with these
    investments.

       LThe special purpose vehicles that purchase the
            assets and issue the asset-backed securities (ABS) were
            exempted from the Investment Company Act based on
            credit ratings.

       LABS, including mortgage-backed securities (MBS),
            qualified for sale through shelf registration based on
            credit ratings.

       LUnder the Secondary Mortgage Market Enhancement
            Act, MBS that received ratings in one of the two
            highest categories were deemed acceptable investments
            for Federal savings and loan associations and credit
            unions and for State-regulated entities, such as
            insurance companies, unless the State opted out.

       LOther Federal and State regulators of financial
            institutions counted asset-backed securities that
            received top ratings from an NRSRO at face value toward
            minimum capital requirements.

        Just as auditors' failure to serve as effective gatekeepers
    was a key contributing cause of massive accounting scandals a
    decade ago, the rating agencies' failure to serve that
    gatekeeper function effectively was a key contributing cause of
    the 2008 financial crisis.
        One way Dodd-Frank deals with that failure is by
    eliminating regulatory references to ratings. While this is an
    appropriate step, in our view, the regulators have struggled to
    find a way to implement it without inadvertently introducing
    new risks into the financial system. Even the harshest rating
    agency critics have failed to identify alternative measures of
    creditworthiness to serve as effective substitutes for credit
    ratings. As a result, for better or worse, credit rating
    agencies are likely to continue to play an important role in
    the financial system as arbiters of credit risk. Their
    gatekeeper function, while diminished, is therefore expected to
    continue. The clear implication is that it is not enough simply
    to reduce regulatory reliance on ratings, it is also essential
    to take steps to increase rating agency reliability.
        In seeking an explanation for the rating agencies' failure
    to perform as effective gatekeepers, it quickly becomes
    apparent that they lack two of the most important
    characteristics we look for in a gatekeeper: independence and
    accountability. Their lack of independence is well documented
    in the recent bipartisan report on the causes of the financial
    crisis by the Senate Permanent Subcommittee on Investigations.
    With voluminous evidence taken from internal emails and witness
    testimony, the report shows rating agencies well aware of
    growing risks in the housing market but reluctant to reflect
    those risks in their ratings out of concern that it would cost
    them market share. In short, the major rating agencies
    prioritized profits over rating accuracy, and nearly brought
    down the financial system in the process.
        The fundamental conflict at the heart of the credit rating
    agencies' issuer-pays business model creates a strong incentive
    for rating agencies to under-invest in analysis, to assign
    ratings even where the credit risks are unknown, and to inflate
    ratings in order to protect their market share and maximize
    profits. In the past, they have faced no comparable
    countervailing pressure to promote rating accuracy. Given the
    scale of the conflict, we share the view expressed by Columbia
    University law professor John Coffee in March 10, 2009
    testimony before this Committee, that, ``The only force that
    can feasibly induce'' credit rating agencies to perform the
    kind of independent verification and analysis demanded of
    gatekeepers ``is the threat of securities law liability.''
    While enhanced regulatory oversight can help, past experience
    suggests that the SEC is likely to be too timid in exerting its
    authority to serve as an effective deterrent, particularly if
    Congress fails to come through with the increased funding the
    agency needs to implement the law effectively.
        In order to strike the right balance, credit ratings should
    be liable not simply for getting it wrong but rather when they
    show a reckless disregard for the accuracy of their ratings. As
    noted above, the Permanent Subcommittee on Investigations
    Report is full of examples of these sorts of abuses, as is the
    early study by the staff of the Securities and Exchange
    Commission. That is the balance struck in Dodd-Frank, which
    establishes recklessness as the standard of proof in private
    actions. It remains to be seen, however, whether courts will
    accept that approach, or will continue to view ratings as
    protected by the First Amendment, even where the ``opinion'' in
    question does not reflect the actual views of the rating
    analyst of credit risk. If courts do begin to hold rating
    agencies liable, it should make the rating agencies less likely
    to assign ratings to securities (such as CDOs-squared) whose
    risks they do not understand and cannot calculate. Likewise, it
    should make them less willing to override their rating criteria
    to assign inflated ratings or to delay updating their rating
    criteria to reflect emerging risks out of a concern that it
    could cost them business.
        The SEC no action position with regard to issuers who do
    not disclose ratings in their prospectuses raises a somewhat
    different set of issues. In keeping with its goal of reducing
    reliance on ratings, Dodd-Frank eliminated the special
    exemption from expert liability that was granted to rating
    agencies specifically to encourage the use of their ratings in
    prospectuses. When the provision took effect, however, the
    major rating agencies threatened to shut down the still fragile
    securitization market by refusing to allow their ratings to be
    published in prospectuses. Under pressure to revive
    securitization, the SEC issued a no action letter, later
    indefinitely extended, permitting issuers to forego disclosing
    ratings in the prospectus. Because of the separate Dodd-Frank
    provisions requiring financial regulators to eliminate all
    regulatory references to credit ratings, the requirement to
    disclose ratings was presumably on its way out anyway.
        Under the circumstances, we did not come out in strong
    opposition to the SEC action, despite our support for making
    ratings agencies legally accountable for their actions. Once
    the regulatory requirement to disclose ratings in the
    prospectus is eliminated, however, the Commission should
    rescind its no action letter so that only the ratings of
    ratings agencies willing to stand behind their work would be
    disclosed in prospectuses. Under no circumstances should the
    special exemption from liability be reinstated. To do so would
    encourage reliance on ratings by encouraging their inclusion in
    prospectuses and would do so without subjecting them to
    appropriate legal accountability when they show reckless
    disregard for the accuracy of their ratings.
                                    ------

    RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM BARBARA
                                 ROPER

    Q.1. A provision that I successfully included in Dodd-Frank
    would require publicly listed companies to disclose in their
    SEC filings the amount of CEO pay, the typical workers' pay at
    that company and the ratio of the two. The past few decades,
    CEO pay has skyrocketed while the median family income has
    actually gone down. The House Financial Services Committee
    voted to repeal the provision last week under the guise of two
    arguments, first that it was ``too burdensome'' for companies
    to disclose that and second, that the information wasn't useful
    to investors.
        I believe the real reason some companies don't want to
    reveal it is because they would find it embarrassing to reveal
    that they pay their CEO say 400 times what they pay their
    typical employee. And I find it very hard to believe that
    companies that do all kinds of complicated calculations for
    everything else involving their revenues and expenses would
    find it difficult to take their 2,000 employees, figure out how
    much employee number 1,000 is paid, and report that one number
    to the SEC. It seems to me that a company that can't manage to
    do that needs a new H.R. Department.
        Do you believe such information would be useful to
    investors? These same investors are now often voting on an
    annual basis in say-on-pay votes. Would it be useful for them
    for example to know that in the past few years, a company has
    increased its CEO's pay by 50 percent while decreasing its
    typical worker's pay by 10 percent? Would it help investors to
    determine what a company's philosophy is, such as whether it is
    following Peter Drucker's theory that there should not be huge
    pay disparities between the executives and the typical worker
    for morale, inherent fairness, or other reasons?

    A.1. Investors have an interest in CEO pay disclosures for a
    variety of reasons. First, excessive CEO compensation comes at
    the expense of shareholders of publicly traded companies.
    Second, excessive compensation may encourage executives to take
    undue risks. Ironically, existing compensation disclosures have
    been criticized for inadvertently promoting excessive
    compensation by encouraging competition among executives for
    more generous pay packages. In addition, while they provide a
    certain amount of data, existing disclosures fail to put that
    data in context. One of the best measures of executive
    compensation that is out of line can be found by comparing it
    to the pay of average workers, as your provision would require.
    Where CEO compensation is many times higher than that of the
    average worker, investors may reasonably conclude that the
    company is being run for the benefit of executives rather than
    for the benefit of shareholders. That may affect how they vote,
    not only on say-on-pay votes, but also how they vote in
    director elections. That may help to encourage compensation
    committees to be more responsible when doling out CEO pay. The
    required disclosures also provide information about typical
    employee compensation packages, information investors are
    likely to find relevant in light of the fact that compensation
    is the biggest single expense at many public companies. For all
    these reasons, we oppose efforts to repeal the enhanced CEO
    compensation disclosures provided by Dodd-Frank.
                                    ------

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ANNE
                                SIMPSON

    Q.1. Section 953 of Dodd-Frank requires companies to disclose
    the ratio between the compensation of the chief executive
    officer and that of the median employee. Are you aware of any
    evidence that links relative pay ratios to corporate
    performance? Is this ratio material for making investment
    decisions?

    A.1. We are unaware of any research on this specific topic.
    However, this should not come as a surprise since issuers do
    not presently disclose these ratios. As far as whether an
    investor would find this information material, it probably
    depends on the investor. Similar to disclosures by an issuer's
    highest paid executives, the ratio between a company's CEO and
    a typical employee would be yet another metric for measuring
    assessing the reasonableness of executive compensation in the
    context of the company's performance.

    Q.2. In your testimony, you observed that a ``a common element
    in the failure of . . . many . . . companies implicated in the
    2008 financial meltdown, was that their boards of directors did
    not control excessive risk taking, did not prevent compensation
    systems from encouraging a `bet the ranch' mentality, and did
    not hold management sufficiently accountable.'' A recent
    European Corporate Governance Institute paper reported that
    financial firms with more independent boards and higher
    institutional ownership suffered larger losses during the
    crisis period and that these losses were related to executive
    compensation contracts that focused too much on short-term
    results. Why do institutional investors such as CALPERS endorse
    executive compensation contracts that focus on short-term
    results and encourage aggressive risk-taking?

    A.2. Institutional investors such as CALPERS do NOT endorse
    executive compensation contracts that focus on short-term
    results and encourage aggressive risk-taking and we reject the
    conclusion in the referenced working paper. The fatal flaw of
    the paper is that it includes exactly one corporate governance
    factor--board independence. Although the independence of the
    board of directors is a key governance consideration, it is
    certainly not the only consideration. See CalPERS Principles of
    Accountable Corporate Governance (http://www.calpers-
    governance.org/docs-sof/principles/2010-5-2-global-principles-
    of-accountable-corp-gov.pdf. I also would refer you to an
    October 2010 report by Wilshire Associates (http://www.calpers-
    governance.org/docs-sof/principles/2010-5-2-global-principles-
    of-accountable-corp-gov.pdf) which concluded that engagement by
    institutional investors with corporate boards/management has
    resulted in long-term performance superior to market
    benchmarks.
                                    ------

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGAN FROM ANNE
                                SIMPSON

    Q.1. Many witnesses addressed the fact that the Department of
    Labor (``DOL'') recently proposed regulations under ERISA that
    would redefine the term ``fiduciary''. Many Members of the
    Committee have expressed concerns about the coordination that
    is taking place between the DOL and SEC.
        As an investor at a large pension system, do you have
    concerns about the DOL's changes or concerns about the
    interaction that is taking place between the DOL and other
    agencies on this issue?

    A.1. As a Government-sponsored plan, CalPERS is not governed by
    ERISA. Instead, CalPERS is regulated by State law. As such,
    CalPERS has no opinion as to DOL's definition of fiduciary
    duty.

    Q.2. In your testimony you stated that ``a tough clawback
    policy is an essential element of a meaningful pay for
    performance philosophy.'' It is my understanding that, in
    addition to internally managed equity investments, many State
    retirement systems such as CaIPERs, may allocate to external
    alternative investment managers.
        Does your support for ``tough clawbacks'' extend to
    compensation arrangements with external managers?

    A.2. Compensation arrangements between a corporation and its
    executives are quite different than those between an
    Institutional investor and its external money managers.
    However, in the spirit of protecting long-term shareowner
    value, CalPERS supports the notion of accountability by both
    corporate executives and its external money managers.
    Accountability for money managers comes in the form of
    agreements whereby contractual rights and obligations are
    imparted upon each party. Fortunately, CalPERS has not needed
    to seek judicial redress with any external manager.

    Q.3. Is it common for pension funds to negotiate compensation
    arrangements with external managers that contain performance
    clawbacks as way deter managers from prioritizing short-term
    gains over long-term alignment? If not, what have been the
    hurdles?

    A.3. CalPERS is unfamiliar with how other plans negotiation
    money management agreements, so we are unable to opine on
    whether a particular practice is common for public pension
    funds. However, when we negotiate such agreements, we insist
    that they include legal protections for the plan. We would
    expect other prudent fiduciaries would demand similar
    protections.
                                    ------

     RESPONSE TO WRITTEN QUESTION OF CHAIRMAN JOHNSON FROM PAUL S.
                                 ATKINS

    Q.1. Mr. Atkins, in your testimony you stated that, ``Congress
    should consistently push transparency and competition so that
    investors get high-quality and objective advice from credit
    rating agencies.''
        Section 932 of the Dodd-Frank Act contains many provisions
    that promote transparency for the benefit of investors,
    including requirements that:

       LNRSROs publish a form accompanying their ratings
            that will include the assumptions underlying the credit
            rating procedures and methodologies, the data that were
            relied on to determine the credit rating, and any
            problems or limitations with those data;

       LNRSROs publish the initial credit ratings
            determined for each type of obligor, security and money
            market instrument, and any subsequent changes to such
            credit ratings, for the purpose of allowing users of
            credit ratings to evaluate the accuracy of ratings and
            compare the performance of ratings by different NRSROs;
            and

       LNRSROs publicly disclose the reasons when they make
            material changes to credit rating procedures and
            methodologies, and notify users of credit ratings of
            the version of a procedure or methodology used with
            respect to a particularly credit rating, when a
            material change is made to a procedure or methodology,
            and when a significant error is identified in a
            procedure or methodology that may result in credit
            rating actions.

        Subtitle D of Title IX of the Act contains new disclosure
    requirements including Section 943, the requirement that each
    NRSRO include in any report accompanying a credit rating a
    description of the representations, warranties and enforcement
    mechanism available to investors.
        Do you feel that such transparency requirements could be
    useful to investors?

    A.1. Yes, Mr. Chairman, I agree that transparency requirements
    for credit ratings can be useful to investors, especially if
    they can help investors discern for themselves which ratings
    deserve more credence. Ratings, after all, are professional
    opinions, and the key to evaluating such an opinion is
    understanding the qualifications of the person propounding the
    opinion, the reasoning underlying the opinion, and any
    influences that might affect the opinion one way or another.
    But, we must recognize that any regulation can have unintended
    consequences and should be subjected to a cost-benefit
    analysis, since investors invariably pay for regulations one
    way or another, through higher prices or reduced choices.
    Because the credit-rating business has suffered from
    concentration and lack of competition, largely due to a non-
    transparent ``no-action'' process that the Commission permitted
    to exist for three decades, which this Committee in 2006 wisely
    prompted Congress to take strong steps to reform, the SEC must
    be very careful to ensure that regulations in this area do not
    further restrict competition or the ability of new entrants to
    compete against the more established firms.
        For example, the burden and costs of required disclosure
    must be carefully weighed, as should the usefulness of the
    required disclosure to investors. Ironically, the more
    disclosure around ratings that make them seem more
    authoritative, the more investors (especially retail investors)
    may rely on them, discounting the fact that the ratings are
    opinions at the end of the day.
        In addition, the SEC should be careful to avoid influencing
    the ratings themselves or consciously or inadvertently being a
    judge as to supposed ``quality'' of ratings. Those sorts of
    decisions are best left to the marketplace and investors
    themselves. Finally, the SEC also must be careful, through
    requirements that are one-size-fits-all, not to lead ratings
    into the same general mold, reducing diversity of opinion. The
    market thrives on diverse opinions--those who can warn of
    anomalies that they perceive versus the ``group think'' of
    consensus or conventional wisdom. Thus, in credit ratings,
    standardization may not be necessarily helpful to investors,
    although diversity of viewpoint is critical.

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