[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).
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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).
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    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\
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    \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.
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    \12\ Pub. L. No. 111-203 975, 124 Stat. 1922 (2010).
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    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].
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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.
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    \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).
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    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).
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    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'').
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    \17\  Pub. L. No. 111-203 975, 124 Stat. 1918 (2010).
    \18\ MSRB Notice 2010-59 (December 23, 2010).
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    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.
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    \19\ MSRB Notice 2011-12 (February 14, 2011).
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    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.
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    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.
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    \21\ MSRB Notice 2011-13 (February 14, 2011).
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    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).
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    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.
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    \23\ MSRB Notice 2011-04 (January 14, 2011).
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    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.
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    \24\ MSRB Notice 2011-16 (February 22, 2011).
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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\
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    \25\ MSRB Notice 2011-28 (May 25, 2011).
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    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).
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    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.
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    \27\ MSRB Press Release, MSRB Assumes Expanded Mission and 
Establishes Public Majority Board of Directors (October 1, 2010).
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    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.
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    \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.
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    \29\ This statistical information may be found by searching EMMA's 
Market Statistics tab at http://emma.msrb.org/MarketActivity/
ViewStatistics.aspx.
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    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.
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    \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\
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    \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.
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          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.
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    \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\
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    \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.
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    \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.
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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\
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    \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\
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    \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.
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    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.''
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    \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.
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    \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
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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\
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    \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.
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    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\
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    \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\
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    \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.
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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.
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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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