[Senate Hearing 112-412]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 112-412
 
   MANAGEMENT AND STRUCTURAL REFORMS AT THE SECURITIES AND EXCHANGE 
                     COMMISSION: A PROGRESS REPORT 

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

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

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

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

 A PROGRESS REPORT ON THE MANAGEMENT AND STRUCTURAL REFORMS AT THE SEC

                               __________

                           NOVEMBER 16, 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

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                   JACK REED, Rhode Island, Chairman

              MIKE CRAPO, Idaho, Ranking Republican Member

CHARLES E. SCHUMER, New York         PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey          MARK KIRK, Illinois
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
HERB KOHL, Wisconsin                 JIM DeMINT, South Carolina
MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
TIM JOHNSON, South Dakota

                Kara Stein, Subcommittee Staff Director

         Gregg Richard, Republican Subcommittee Staff Director

                     Dean Shahinian, Senior Counsel

                       Robert Peak, SEC Detailee

                Hester Peirce, Republican Senior Counsel

                                  (ii)



                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, NOVEMBER 16, 2011

                                                                   Page

Opening statement of Chairman Reed...............................     1

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     3

                               WITNESSES

Robert Khuzami, Director, Division of Enforcement, Securities and 
  Exchange Commission............................................     6
    Prepared statement...........................................    38
Meredith Cross, Director, Division of Corporation Finance, 
  Securities and Exchange Commission.............................     8
    Prepared statement...........................................    38
Robert Cook, Director, Division of Trading and Markets, 
  Securities and Exchange Commission.............................     9
    Prepared statement...........................................    38
Eileen Rominger, Director, Division of Investment Management, 
  Securities and Exchange Commission.............................    11
    Prepared statement...........................................    38
Craig Lewis, Director, Division of Risk, Strategy, and Financial 
  Innovation, Securities and Exchange Commission.................    12
    Prepared statement...........................................    38
Carlo V. di Florio, Director, Office of Compliance Inspections 
  and Examinations, Securities and Exchange Commission...........    14
    Prepared statement...........................................    38

                                 (iii)


   MANAGEMENT AND STRUCTURAL REFORMS AT THE SECURITIES AND EXCHANGE 
                     COMMISSION: A PROGRESS REPORT

                              ----------                              


                      WEDNESDAY, NOVEMBER 16, 2011

                                       U.S. Senate,
    Subcommittee on Securities, Insurance, and Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 9:31 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jack Reed, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN JACK REED

    Chairman Reed. Let me call the hearing to order. I want to 
thank my Ranking Member, Senator Crapo, for joining us today, 
and I certainly want to thank the witnesses for taking time out 
of their very hectic and demanding and important schedules to 
be with us this morning. Our hearing is entitled, ``Management 
and Structural Reforms at the SEC: A Progress Report.'' This is 
a very critical hearing because we understand the important 
role that the SEC plays in the regulations of our securities 
markets.
    We have had vocal concerns about regulation, 
overregulation, but it appears indeed that revenues in the 
securities industries for each of the last 2 years have been 
greater than in any year in the previous 10 years. So the 
industry is, in fact, growing at a time when many other sectors 
of the American economy are in very serious distress. And I 
believe that those who want to starve the market watchdogs or 
repeal legislation seek a return to the days when toxic 
financial products were secretly negotiated and traded, 
profiting Wall Street bankers, and leaving taxpayers on the 
hook to clean up the mess later.
    Congress acted to stabilize the market with the Dodd-Frank 
Wall Street Reform and Consumer Protection Act to bring 
transparency and certainty into the marketplace. There is no 
question that slowing down the regulations and those who 
enforce the regulations will benefit those on Wall Street so 
that they can make more money but at a hefty price to the rest 
of us. I think that is the lesson of 2008 and 2009 and 
continuing.
    The Securities and Exchange Commission has a daunting job. 
It is charged with protecting investors and ensuring that our 
securities markets are operating in a fair and orderly manner. 
This is no small task given the growing volume and complexity 
of both markets and products.
    For example, as of the end of October, the total market 
value of the United States equity market was estimated at $13.1 
trillion. Approximately 45 percent of all U.S. households, or 
92 million investors, make investments in the market, 
principally through mutual funds. So this is of interest to 
every American, not just those who are in the financial 
markets.
    There is little doubt that changes in both technology and 
trading practices are affecting exchanges. Trading venues are 
increasingly fragmented with no single exchange holding more 
than one-fifth of the market share. More trading is being done 
off exchanges in so-called dark pools or by broker-dealers 
executing trades internally. Over the past year and a half, 
this type of trading has increased by more than 30 percent, 
presenting new and challenging problems to regulators.
    Finally, high-frequency traders are using computers to 
execute trades in less than a blink of an eye. Although such 
trades may contribute to market volume in good times, they also 
may contribute to shrinking liquidity in times of market 
stress.
    While the securities markets have exploded with novel 
products and increasingly faster technologies, many argue that 
the SEC has been left behind. The financial crisis revealed 
troubling failures, weaknesses, and gaps in regulation. The SEC 
had responsibility for the oversight of investment banks. The 
financial revealed that the SEC failed to appreciate the 
growing risks, failed to ask the right questions, and failed to 
take the right steps. This is the same pattern we saw in the 
Madoff Ponzi scheme case. The agency failed to stop Bernard 
Madoff's long-running investment fraud despite repeated 
warnings. It failed to ask the right questions and failed to 
take the right steps.
    In addition, the agency's Inspector General has identified 
serious missteps in how the agency has handled information, how 
it conducts its operation, and how it executes its mission. 
Others have criticized the agency for inhibiting capital 
formation, decreasing U.S. competitiveness, and taking a light 
touch against law breakers.
    But my sense is that the SEC appears to be committed to 
reform. Chairman Mary Schapiro has installed new leadership 
across the SEC's Divisions and Offices. Beginning in 2009, the 
SEC began restructuring its largest operating units: the 
Division of Enforcement and Office of Compliance Inspections 
and Examinations. The Commission has also created the Division 
of Risk, Strategy, and Financial Innovation to more closely 
examine new products, trading practices, and risk.
    Congress has tried to focus on improving the SEC as well. 
In the Dodd-Frank Wall Street Reform and Consumer Protection 
Act, it was mandated that the SEC engage an independent 
consultant to examine its internal operations structure and 
need for reform. This report identifies several opportunities 
for reform, including reprioritizing regulatory activities, 
reshaping the agency to maximize efficiency and effectiveness, 
investing to improve infrastructure, and improving engagement 
with self-regulatory organizations.
    The report also notes the considerable additional 
responsibilities placed on the SEC after the financial crisis 
and a gap in funding that cannot be overcome by improving 
efficiency. Congress must fully fund the SEC, our market 
watchdog, if it is to effectively discharge the mandate to 
police the markets and protect investors.
    The SEC has been criticized for failures of its missions in 
the past. Today's hearing will focus on how the SEC's 
management has responded to this criticism and the need for 
reform. The securities markets need to work so that investors 
and companies can come together and allocate capital 
efficiently and productively, allowing new products, new 
technologies, and new jobs to be created. And they need to work 
for Americans who save for college, a new home, or retirement.
    What is being done and what needs to be done to right-size 
this agency, to improve its ability to protect investors, 
maintain fair, orderly, and efficient markets, and facilitate 
capital formation, and to reinvigorate its staff is at the 
forefront of our hearing today.
    Our witnesses this morning are the senior-most management 
of all the SEC Divisions and the largest SEC program office. It 
is critical that Congress understand what is being done to move 
this agency forward and ensure that the missteps of the past 
are not repeated.
    With that, I would now like to recognize my Ranking Member 
for his opening comments. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Senator Reed, and I 
agree with and appreciate a number of your comments and 
concerns in your opening statement, and I also appreciate you 
holding this hearing. I am one of those, as you know, who 
thinks that we are having a little bit of difficulty getting it 
right in terms of our regulatory approach right now, and I 
appreciate these opportunities for oversight hearings.
    As I have indicated to you, because of my activities in the 
either famous or infamous Gang of Six, I am going to have to 
leave in about half an hour for another meeting that I cannot 
avoid, and so I am going to miss probably a lot of the 
testimony. So I am going to try to identify a few areas of 
concern in my remarks and also ask that I could submit 
questions as well following the hearing for responses. I do 
believe that the issues we are dealing with today are critical.
    We must continue to think strategically about which areas 
of the market pose the greatest risk and which areas of 
potential improvement hold the greatest benefit for investors. 
The objective should be to apply the taxpayer resources in a 
way that provides the biggest investor protection bang for the 
buck.
    In addition to these important issues, I look forward to 
hearing from our different Division Directors of the SEC on 
Dodd-Frank implementation questions on ways to promote capital 
formation.
    With regard to capital formation, today the SEC is holding 
two panel discussions on the issue, and one focuses on current 
capital formation issues for private companies and another on 
initial public offerings and securities regulation involving 
smaller public companies.
    There are several, in my opinion, unnecessary restrictions 
on capital formation in both categories that should be removed. 
The House recently passed some targeted bipartisan capital 
formation legislation that makes it easier for private 
companies to raise capital, and there have also been recently 
two reports that make recommendations on how to reverse the 
initial public offerings decline.
    To stimulate the IPO market and spur more job creation, the 
recent President's Council on Jobs and Competitiveness Interim 
Report recommends that Congress amend Sarbanes-Oxley to allow 
shareholders of public companies with market valuations below 
$1 billion to opt out of at least Section 404 compliance if not 
to all of the requirements of Sarbanes-Oxley; or, 
alternatively, exempt new companies from SOX compliance for 5 
years after they go public.
    The IPO Task Force recommends providing an on ramp for 
emerging growth companies using existing principles of scaled 
regulation. The IPO Task Force expects scaled regulation and 
disclosure to reduce internal and external compliance for such 
companies by 30 percent to 50 percent. Both of these 
recommendations could result in a larger supply of emerging 
growth companies going public and increased job creation over 
the long term.
    With regard to Dodd-Frank Act, in addition to removing 
unnecessary restrictions on capital formation, we have to be 
careful that new rules being implemented under Dodd-Frank give 
sufficient consideration to how they are going to impact Main 
Street and the economy as a whole, how they interact with each 
other, and how they impact our global competitiveness. I am 
interested in what steps you are taking to ensure that the 
rules the agency adopts under Dodd-Frank Act are supported by 
rigorous economic analysis and how you will resolve 
inconsistencies in the approaches taken by different 
regulators.
    Yesterday, the House Subcommittee on Capital Markets 
approved four targeted bills to modify Dodd-Frank. One of the 
measures that passed by a voice vote would prohibit the SEC and 
CFTC from requiring that swap execution facilities have a 
minimum number of participants or mandating the display or 
delay of bids or offers for any period of time. This is in line 
with the SEC approach, which is more principles based and is in 
general far less prescriptive than that of the CFTC.
    In June, this Subcommittee held a hearing on swap execution 
facilities. One of the results of the hearing was that there 
was bipartisan agreement that the SEC and the CFTC need to 
provide greater coordination and harmonization to get the rules 
right. As many of you probably know, I am one of those who 
thinks we should merge the SEC and the CFTC, but until we can 
get into that discussion, I will encourage that they at least 
coordinate and harmonize their regulatory activities.
    The CFTC should know that Congress is going to closely 
monitor how they proceed, as well as the SEC, and that we 
expect this kind of harmonization and a change in course when 
the agencies begin to divert so that we can have the kind of 
seamless regulatory system that does protect investors and 
achieve the objectives that the Chairman pointed out, as he 
described the hope that all of us have as to how you and other 
regulatory agencies will operate.
    There will be other issues I would like to raise, Mr. 
Chairman, in my questions, but, again, at this point I will 
wait, and we can get to the witnesses. And when I have to step 
out, I apologize. I will be paying very close attention not 
only to your opening statements but also to your responses to 
the questions that we provide.
    Thank you again for being here.
    Chairman Reed. Thank you very much, Senator Crapo.
    Let me introduce the witnesses. We are extraordinarily 
fortunate today to have the key leaders of the Securities and 
Exchange Commission staff.
    First let me introduce Mr. Robert Khuzami. Mr. Khuzami is 
the Director of the Division of Enforcement of the U.S. 
Securities and Exchange Commission. As Director, Mr. Khuzami is 
responsible for the civil law enforcement efforts of SEC 
personnel located in 12 offices across the country. Prior to 
his tenure at the SEC, Mr. Khuzami served as General Counsel 
for the Americas at Deutsche Bank AG and before that as the 
bank's global head of litigation and regulatory investigations. 
From 1990 through 2002, Mr. Khuzami was a Federal prosecutor 
with the United States Attorney's Office for the Southern 
District of New York, where he prosecuted a wide range of 
crimes, including narcotics, money laundering, extortion, bank 
robbery, firearms, and tax, bank, and immigration fraud. During 
his service Mr. Khuzami also help the position of chief of the 
Securities and Commodities Fraud Task Force. Thank you, Mr. 
Khuzami.
    Eileen Rominger is the Director of the Division of 
Investment Management at the U.S. Securities and Exchange 
Commission. Ms. Rominger was sworn in by Chairman Mary Schapiro 
on February 16, 2011, and is responsible for developing 
regulatory policy and administering the Federal securities laws 
applicable to investment advisers and funds. Prior to becoming 
the investment management Director, Ms. Rominger was with 
Goldman Sachs Asset Management as the chief investment officer 
responsible for managing that company's core portfolio teams, 
including fixed income, equity, and quantitative strategies. 
She previously worked for 18 years at Oppenheimer Capital, 
where she was a portfolio manager, managing director, and a 
member of the executive committee.
    Ms. Meredith Cross is the Director of the Division of 
Corporation Finance at the U.S. Securities and Exchange 
Commission. Prior to joining the staff in June 2009, Ms. Cross 
was a partner at Wilmer Hale in Washington, DC, where she 
advised clients on corporate and security matters and was 
involved with a full range of issues faced by public and 
private companies in capital raising and financial reports. Ms. 
Cross also worked in the Division of Corporation Finance prior 
to joining Wilmer Hale, serving in various capacities, 
including as chief counsel and deputy director.
    Robert W. Cook is the Director of the Division of Trading 
and Markets at the U.S. Securities and Exchange Commission. Mr. 
Cook has served in this position since January 4, 2010. Prior 
to joining the Commission, Mr. Cook was partner at the law firm 
of Cleary, Gottlieb, Steen & Hamilton where he was an expert on 
broker-dealer and market regulation.
    Carlo di Florio became the Director of the Office of 
Compliance Inspections and Examinations on January 25, 2010. 
Prior to joining the Commission, Mr. di Florio was a partner in 
the financial service regulatory practice at 
PricewaterhouseCoopers. While in private practice, Mr. di 
Florio was one of Pricewaterhouse's national leaders in 
corporate governance, enterprise risk management, and 
regulatory compliance and ethics. He has also led numerous 
fraud and corruption investigations nationally and 
internationally.
    And, finally, Dr. Craig Lewis is the Director and Chief 
Economist at the Division of Risk, Strategy, and Financial 
Innovation. Dr. Lewis has served in this position since June 
2011. As the Madison S. Wigginton Professor of Finance at 
Vanderbilt University's Owen Graduate School of Management, Dr. 
Lewis has taught corporate finance and economics since 1983 and 
has been on the faculty at Vanderbilt since 1986. In addition 
to teaching, Dr. Lewis has published research on volatility in 
stock and futures markets, margin adequacy, corporate earnings 
management, corporate financial policy, executive compensation, 
select disclosure, and herd behavior by equity analysts. Thank 
you.
    Your written testimony has already been submitted. It is 
part of the record. I would ask each of you to take 5 minutes 
and make an oral presentation, starting with Mr. Khuzami.

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

    Mr. Khuzami. Thank you, Chairman Reed, Ranking Member 
Crapo. My name is Robert Khuzami. I am Director of the Division 
of Enforcement. Thank you for the opportunity to testify today 
concerning the management and structural reforms at the SEC.
    When I arrived at the SEC in early 2009 to lead the 
enforcement Division, the United States was struggling to come 
to terms with the impact of the financial crisis. Our job, 
indeed our challenge at the Division of Enforcement was to 
investigate and hold accountable those who contributed to the 
financial crisis, and we took that challenge head on. We 
immediately set to work investigating conduct that may have 
contributed to the financial crisis, and at the same time 
launched an ambitious plan to reform the organizational 
structure of the Division so that we could work smarter and 
more efficiently than we had in the past.
    Through hard work and innovation, we have completed what 
was the most significant restructuring in the history of the 
Division of Enforcement. And although the conventional wisdom 
was that the dislocation caused by such significant 
organizational changes would undermine our productivity, that, 
in fact, did not happen.
    In fiscal year 2011, we filed a record 735 enforcement 
actions, more than ever filed in a single year in the history 
of the Securities and Exchange Commission. Those actions 
included 57 insider trading actions, a nearly 8-percent 
increase over last year's total; 146 enforcement actions 
related to investment advisers and investment companies, a 
single-year record and 30-percent increase over fiscal year 
2010; and 112 enforcement actions related to broker-dealers, a 
60-percent increase over last year. And our focus on financial 
crisis cases has continued. During the last 2\1/2\ years, we 
filed 36 separate financial crisis-related actions against 81 
defendants, nearly half of whom are CEOs, CFOs, or other senior 
corporate officials, and obtained nearly $2 billion in 
financial sanctions. This includes actions against Goldman 
Sachs, Citigroup, and senior executives at Countrywide, New 
Century, and American Home Mortgage.
    And equally and perhaps more importantly, our record number 
of cases include many involving highly complex transactions, 
products, and market practices. In the past fiscal year, we 
filed actions against JPMorgan for misleading investors in CDOs 
as the housing market began to plummet; Wachovia for misconduct 
in the sale of two CDOs tied to the performance of residential 
mortgage-backed securities; two firms involved in the sale of 
unsuitable CDOs to five Wisconsin school districts; and charges 
against six executives at Brooke Corporation and three 
executives at IndyMac for misleading investors about their 
financial condition.
    In addition, to deprive the wrongdoers of unjust profits 
and to deter future misconduct, we obtained judgments totaling 
$2.8 billion in disgorgement and penalties this year, which was 
a 176-percent increase over previous years. And we have also 
distributed nearly $3.6 billion in disgorgement and penalties 
in the last 2 years to harmed investors.
    And at the same time we were doing this, we instituted the 
large organizational changes in our division. We flattened our 
management structure. We revamped the way we handled tips and 
complaints. We facilitated the swift prosecution of wrongdoers 
through a formal program that encourages individuals and 
companies to cooperate in SEC investigations, and created five 
national specialized units focused on priority areas involving 
high risk. We have also hired many industry experts, non-
lawyers with genuine market expertise and specialized 
experience, to assist in our investigation. So today, if 
someone is testifying in an SEC investigation about, for 
example, improper bond valuations, there is a good chance that 
sitting across the table from them on the SEC's side of the 
table is someone who used to value bonds for a living. And one 
cannot overestimate the clarity and candor that that kind of 
expertise brings to witness testimony.
    We are also focused on thinking creatively and proactively 
to find emerging threats, stopping frauds earlier before they 
become more destructive. So using investment advisers as an 
example, we are now reviewing registration documents for high-
risk advisers to determine who lies about things like their 
education or their business affiliations or their assets under 
management, under the theory that if they come face to face 
with an enforcement authority early on, for relatively small 
matters, they are going to know that we are watching, and they 
are going to be less likely to graduate to bigger frauds.
    We are reviewing mutual fund fee arrangements by analyzing 
data bases to find those funds that exhibit poor performance, 
high fee arrangement, and sub-advisory arrangements, all of 
which might suggest excessive fee arrangements and inadequate 
oversight.
    We have a cross-border working group using risk factors 
such as language fluency and the extent of use of overseas 
auditing affiliates and oversight capability of audit firms to 
identify those U.S. audit firms with foreign clients that may 
be engaged in financial reporting violations.
    As a result of our focus on initiatives and our proactive 
strategies and our hiring of experts, we are now better 
equipped to stop fraud sooner. But to continue to innovate, our 
resources need to keep pace with our responsibilities. We have 
achieved these results in light of relatively flat budget 
amounts that have constrained our ability to backfill slots, to 
hire administrative staff, and to upgrade IT. And we need those 
resources to continue those efforts, but with that and our new 
ideas and our new structure, I think we will continue to be 
aggressively prosecuting fraud.
    Thank you.
    Chairman Reed. Thank you very much.
    Ms. Cross.

STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF CORPORATION 
          FINANCE, SECURITIES AND EXCHANGE COMMISSION

    Ms. Cross. Good morning, Chairman Reed and Ranking Member 
Crapo. My name is Meredith Cross, and I am the Director of the 
Division of Corporation Finance at the SEC. I am pleased to 
testify today along with my fellow Directors on behalf of the 
Commission to discuss the Division's activities and 
responsibilities and the challenges that lie ahead.
    The Division of Corporation Finance's core functions are 
reviewing company filings, making rulemaking recommendations to 
the Commission that relate to corporate finance matters, and 
providing interpretive advice to the public about the 
securities laws and corresponding regulations for corporate 
finance matters. With a staff of approximately 470, we are 
responsible for the review of nearly 10,000 reporting 
companies, including tens of thousands of disclosure documents 
each year, plus initial public offerings and other public 
capital markets transactions of corporate issuers, public 
asset-backed securities offerings, and proxy statements, public 
mergers, acquisitions, and tender offers.
    Approximately 80 percent of the staff of the Division is 
assigned to the review function. The Sarbanes-Oxley Act 
requires the Commission to review disclosures, particularly the 
financial statements, of Exchange Act reporting companies at 
least once every 3 years and more frequently where 
circumstances warrant. This is no small task.
    Following enactment of the Sarbanes-Oxley Act in 2003, the 
Division revised its review program to meet the new review 
mandate and hired significant numbers of new staff accountants, 
which has enabled us to meet the review mandate each year.
    We also review the disclosures of many companies more often 
than once every 3 years. For example, the largest companies are 
reviewed more often and the largest financial institutions 
currently are reviewed continuously on a real-time basis.
    Corporation Finance has been working to enhance the 
disclosure review program, including by increasing the focus on 
large and financially significant registrants, and achieving 
additional efficiencies in our reviews of smaller companies. 
Our increased focus on larger and financially significant 
companies requires greater resources than traditional 
disclosure reviews, and our ability to implement these 
enhancements turns on whether we are able to allocate 
sufficient resources, balancing all other demands on the 
Division and our staff.
    During the 2011 fiscal year, the Division established three 
new offices: the Office of Structured Finance, which focuses on 
disclosure reviews and policymaking for asset-backed 
securities; the Office of Capital Markets Trends, which 
evaluates trends in securities offerings and the capital 
markets to determine whether our rules, regulations, and review 
approach are adequately addressing them; and a new Review Group 
in Disclosure Operations that focuses on the largest financial 
institutions.
    The Division has staffed these offices almost entirely by 
transferring existing staff to them. If resources permit, we 
plan to hire to fully staff these offices to enable them to 
carry out their intended work.
    Corporation Finance also recommends new rules or changes to 
existing rules to the Commission to address areas in need of 
change. The Division's recent rule-writing activities have 
focused on asset-backed securities, corporate governance 
disclosure-related matters, and Dodd-Frank Act implementation.
    Corporation Finance is responsible for preparing a wide 
variety of rules to implement a significant number of Dodd-
Frank Act requirements. These include, for example, rules for 
corporate governance and executive compensation, including say-
on-pay and golden parachutes; disclosure of pay versus 
performance, pay ratios, and employee and director hedging 
policies; and listing standards for compensation committees and 
compensation consultants, and for clawbacks of erroneously 
awarded compensation; also, specialized disclosure rules for 
conflict minerals, mine safety, and payments to governments by 
resource extraction issuers; regulation of asset-backed 
securities; and revisions to the definition of ``accredited 
investor'' and disqualification of offerings involving ``bad 
actors'' from relying on Rule 506 of Regulation D.
    Finally, at Chairman Schapiro's request, the Division is 
undertaking a significant new initiative to look for ways to 
reduce regulatory burdens on small business capital formation 
in a manner consistent with investor protection. Topics 
included in this project include: the triggers for public 
reporting, generally known as the ``500 shareholder rule''; 
restrictions on communications in private offerings, in 
particular the restrictions on general solicitation; 
restrictions on communication in public offerings; and new 
capital-raising strategies such as crowd funding and the scope 
of our existing rules that regulate capital raising.
    Thank you again for inviting me to appear before you today. 
I would be happy to answer any questions you may have.
    Chairman Reed. Mr. Cook, please.

  STATEMENT OF ROBERT COOK, DIRECTOR, DIVISION OF TRADING AND 
          MARKETS, SECURITIES AND EXCHANGE COMMISSION

    Mr. Cook. Good morning, Chairman Reed and Ranking Member 
Crapo. My name is Robert Cook, and I am the Director of the 
Division of Trading and Markets, and it is a pleasure to appear 
here today with my colleagues from the Commission staff.
    The Division of Trading and Markets is responsible for 
developing rules and standards for our markets and market 
intermediaries, including securities exchanges, alternative 
trading systems, broker-dealers, clearing agencies, transfer 
agents, and self-regulatory organizations, such as FINRA and 
the MSRB.
    The exponential growth in the size and complexity of the 
U.S. securities markets in recent years has created special 
challenges for the Division's mission. In the past year, the 
Division has focused on several key initiatives to improve the 
oversight and function of our equity markets. The Commission 
adopted a new rule to ban naked access arrangements under which 
broker-dealers would provide certain customers with unfettered 
access to the securities markets without any controls to 
protect market stability and integrity.
    Second, the Commission adopted large trader reporting 
requirements that will help identify and obtain trading 
information on the largest participants in the U.S. securities 
markets.
    Third, we are preparing a recommendation to the Commission 
for a rule to create, implement, and maintain a consolidated 
audit trail to address significant shortcomings in the agency's 
present ability to collect and monitor trade data in an 
efficient and scalable manner.
    Fourth, the Division has worked on the implementation of 
several key regulatory initiatives to address significant 
market volatility such as occurred on May 6th of last year. 
These initiatives include a uniform single stock circuit 
breaker program designed to halt trading in a disorderly 
market. We have also coordinated proposed SRO efforts to 
implement a limit-up/limit-down functionality for equity 
markets that will help prevent trades outside specified 
parameters while allowing trading to continue within those 
parameters. In addition, the Division has assisted the SROs in 
the preparation of proposed updates to the existing marketwide 
circuit breakers.
    The Division's core functions have expanded substantially 
in the past year under the Dodd-Frank Act. All told, the 
Division is primarily responsible for 27 separate rulemaking 
initiatives, of which the Commission has published 21 for 
public comment. The Division is also substantially involved in 
12 studies, of which 7 have been completed.
    Most notably, we have been charged with the responsibility 
for developing the registration and regulatory regime for 
participants in the security-based OTC derivatives markets, 
including data repositories, dealers, major participants, 
execution facilities, and clearing agencies.
    Going forward, this will mean that Trading and Markets, in 
coordination with the other Divisions and Offices, will be 
registering these new entities, monitoring market developments, 
and promulgating new rules or modifications and guidance where 
needed.
    To date, the Commission has proposed 13 rules related to 
OTC derivatives. Once the proposal phase is complete, the 
Division is planning to recommend the Commission seek public 
comment on an implementation plan that will facilitate a 
rollout of the new requirements in a logical, progressive, 
timely, and efficient manner that minimizes unnecessary 
disruption and cost to the markets.
    The Division is responsible for many other aspects of the 
Dodd-Frank Act, ranging from rules related to proprietary 
trading activities of broker-dealers--the Volcker Rule; 
enhanced oversight of financial market utilities, such as 
clearing agencies; and new procedural requirements for 
processing proposed SRO rule changes. Pending the creation of 
new offices for credit rating agencies and municipal 
securities, the Division is also continuing to work with OCIE 
to carry out our existing functions in these areas, including 
the preparation of rules required by the Dodd-Frank Act.
    In conclusion, the Division's workload is dominated by a 
diverse range of functions that are vital for protecting 
investors and markets, and the scope of these functions has 
expanded tremendously under the Dodd-Frank Act. Many of our 
current initiatives will extend well into 2012 and beyond.
    Thank you for inviting me to be here today, and I look 
forward to answering your questions.
    Chairman Reed. Thank you very much.
    Ms. Rominger, please.

STATEMENT OF EILEEN ROMINGER, DIRECTOR, DIVISION OF INVESTMENT 
         MANAGEMENT, SECURITIES AND EXCHANGE COMMISSION

    Ms. Rominger. Chairman Reed, Ranking Member Crapo, Members 
of the Subcommittee, let me join my colleagues from the 
Commission in thanking you for the opportunity to testify 
today. My name is Eileen Rominger. It has been 9 months since I 
joined the SEC as Director of the Division of Investment 
Management. Before coming to the Commission, I had over 30 
years of experience in the asset management industry as a 
portfolio manager and as a manager of portfolio teams.
    The Division assists the Commission in its oversight and 
regulation of America's $43 trillion investment management 
industry. In doing this, we administer the Investment Company 
Act of 1940 and the Investment Advisers Act of 1940. We oversee 
and develop regulatory policy for investment advisers and 
funds.
    The Division has devoted the last year to implementing the 
provisions of the Dodd-Frank Act as they relate to investment 
advisers. The Dodd-Frank Act significantly changed the 
regulatory landscape for these entities.
    First, it increased the statutory threshold for SEC 
registration from $25 million to $100 million in assets under 
management.
    Second, it eliminated a registration exemption for advisers 
to hedge funds and other private funds.
    And, finally, it requires advisers that are not registered 
to submit reports to the Commission.
    As a result, advisers that do not meet the new asset 
threshold may have to withdraw their registration with the 
Commission and register instead in their home States.
    Advisers to hedge funds and other private funds will be 
required to register with the Commission or to qualify for one 
of the narrower exemptions added by the Dodd-Frank Act.
    In June, the Commission adopted rules to implement these 
changes. We anticipate adding approximately 750 new private 
fund advisers to the SEC registrant pool, but we estimate an 
overall decline of about 28 percent in adviser registrants 
overall.
    Under new rules, registered advisers will report more 
detailed information about their operations, including 
information about the private funds they manage. This will 
allow us for the first time to obtain much needed information 
about private funds, such as hedge funds. Following the 
implementation of these rules, I anticipate that the Division 
will shift more work to its disclosure, interpretive advice, 
and exemptive relief programs.
    Another important area we are working on is to implement 
the requirements of the Dodd-Frank Act that concern systemic 
risk reporting. The Dodd-Frank Act mandated that the Commission 
require private fund advisers, including advisers to hedge 
funds and private equity funds, to report information about the 
private funds they manage for FSOC's systemic risk assessment. 
Just recently, the Commission adopted a rule that requires 
registered investment advisers managing at least $150 million 
in private fund assets to report systemic risk information on a 
new form called ``Form PF.'' The initial stages of this 
reporting will begin next year for some of the very largest 
private fund advisers.
    The Division is also working on a number of important 
initiatives in other areas outside of its Dodd-Frank agenda, 
one of which I will highlight. Prior to my arrival at the SEC 
and in response to the run on money market funds during the 
financial crisis, the Commission adopted important reforms in 
the area of money market fund regulation. These reforms 
included a requirement for money market funds to report 
detailed portfolio holdings information on a monthly basis. 
Using this data, the Division is able to monitor and discuss 
trends and any associated risks in these funds with the 
Commission and with FSOC member staff.
    Given the structural fragilities that remain in money 
market funds, despite the Commission's reforms, the Division 
continues to consult with FSOC member staff on additional 
regulatory reform steps.
    In addition to our role in Commission rulemaking, a large 
part of our administration of the Investment Company Act and 
the Investment Advisers Act consists of providing legal 
guidance in the form of interpretive and no-action letters, as 
well as exemptive relief from the provisions of both acts. We 
also review filings of investment companies in order to both 
monitor and enhance compliance with disclosure and accounting 
requirements. Pursuant to the requirements under the Sarbanes-
Oxley Act of 2002, the Division reviews the annual reports of 
all investment companies no less frequently than once every 3 
years.
    The Division also provides legal and policy guidance to the 
Division of Enforcement on enforcement matters concerning the 
investment management industry.
    Again, thank you for the opportunity to testify today. I am 
happy to answer any questions you may have.
    Chairman Reed. Thank you very much.
    Mr. Lewis, please.

STATEMENT OF CRAIG LEWIS, DIRECTOR, DIVISION OF RISK, STRATEGY, 
  AND FINANCIAL INNOVATION, SECURITIES AND EXCHANGE COMMISSION

    Mr. Lewis. Chairman Reed, Ranking Member Crapo, and Members 
of the Subcommittee, my name is Craig Lewis, and I am the Chief 
Economist and Director of the Division of Risk, Strategy, and 
Financial Innovation. Thank you for the opportunity to testify 
on behalf of the Securities and Exchange Commission regarding 
the Division's operations, activities, and challenges.
    I joined the Division as Director in June of this year. 
Before coming on board, I was a professor of finance at the 
Owen Graduate School of Management at Vanderbilt University 
where I focused on research and teaching, primarily in the area 
of corporate finance. I am also a Ph.D. economist.
    The Division was created as part of the agency's 
modernization initiative to share expertise and bring together 
critical data from across the agency. It was established in 
September 2009 to provide the Commission and its staff with 
sophisticated analysis that integrates economic, financial, and 
legal expertise. RiskFin provides economic analyses as part of 
the Commission's rulemaking process and supports its rule 
review, examination, and enforcement programs with data-driven, 
risk-based analytical models. It also oversees the Commission's 
TCR and interactive data programs. The Division has been 
especially focused on the agency's increased use of 
computerized risk analysis and data sharing.
    The Division participates in the rulemaking process by 
helping to develop the conceptual framing for and assisting in 
the subsequent writing of the economic consequences of the 
rules the Commission promulgates. Where appropriate, the SEC 
considers, in addition to the protection of investors, whether 
the action will promote efficiency, competition, and capital 
formation when engaged in rulemaking.
    Economic analysis of agency rules considers the key 
economic effects of the various alternatives that should be 
considered in developing regulations. Analysis of the likely 
economic effects of proposed rules, while critical to the 
rulemaking process, can be challenging. Certain costs or 
benefits may be difficult to quantify or value with precision, 
particularly those that are indirect or intangible. The 
Division is committed to continuously improving economic 
analysis in Commission rulemakings and to the integration of 
RiskFin economists into the rulemaking process. While the 
Division is striving to fully comply with these increased 
demands, it faces challenges in its ability to do so given 
current resources.
    The second core function of the Division is to administer a 
number of data-driven responsibilities and initiatives. For 
example, the Division currently provides economic and 
statistical analysis to support all aspects of enforcement and 
litigation matters for the Commission. It also has developed 
innovative software tools and uses cutting-edge analytic 
methods to identify problem areas associated with investment 
managers.
    The interactive data program provides information contained 
in certain documents filed with the Commission in a structured 
format that makes the underlying data readily available for 
analysis. The Division has a number of responsibilities that 
include promoting the use of interactive data, developing 
infrastructure, and supporting rule writing to implement data-
tagging requirements.
    To improve efficiency, the Division has been reorganized to 
reassign staff that have expertise in data analysis and risk 
assessment into the newly formed Office of Quantitative 
Research, which will be responsible for designing quantitative 
risk management models. This office has begun to build a data 
infrastructure to facilitate the development and support of 
analytics.
    Going forward, the Division would like to expand its 
capabilities to developing risk assessment models and to build 
a scalable data infrastructure to support risk-based 
initiatives. Although the Division plans to pursue these 
objectives and has existing employees with the necessary 
expertise to work on these projects simultaneously, resource 
constraints inhibit progress and significantly slow the rate of 
innovation. For example, a project to develop a model to detect 
accounting fraud has been delayed due to resource constraints.
    While the Division has made significant progress since its 
inception in 2009, the scope of its responsibilities has been 
significantly expanded as it continues to find new ways to 
assist other Divisions and address the additional obligations 
that have been mandated by the Dodd-Frank Act.
    Thank you for inviting me to share with you the work of the 
Division of Risk, Strategy, and Financial Innovation. I look 
forward to answering your questions.
    Chairman Reed. Thank you very much.
    Mr. di Florio, please.

STATEMENT OF CARLO V. di FLORIO, DIRECTOR, OFFICE OF COMPLIANCE 
INSPECTIONS AND EXAMINATION, SECURITIES AND EXCHANGE COMMISSION

    Mr. di Florio. Good morning, Chairman Reed, Ranking Member 
Crapo, and Members of the Subcommittee. Let me join my 
colleagues in thanking you for the opportunity to testify today 
on behalf of the U.S. Securities and Exchange Commission. My 
name is Carlo di Florio, and I am the Director of the Office of 
Compliance Inspections and Examinations. As you noted, I joined 
the Commission on January 25, 2010, prior to which I was a 
partner in the financial services regulatory practice at 
PricewaterhouseCoopers in New York.
    Since joining the SEC, I have enjoyed working with 
colleagues who are so dedicated and committed to furthering the 
SEC's important mission. The SEC's National Exam Program helps 
protect investors and ensure market integrity by examining for 
fraud, monitoring risk, promoting compliance, and ensuring 
market integrity, and informing the SEC as the eyes and ears of 
the Commission in the field.
    Our exams assess whether registrants are treating investors 
fairly and complying with the securities laws and regulations 
that are designed to protect investors and prevent fraud. The 
830 supervisors and examiners in the National Exam Program take 
a risk-based approach to examining 25,000-plus registrants, 
including investment advisers, investment companies, broker-
dealers, derivatives registrants, hedge funds, mutual funds, 
credit rating agencies, SROs, national exchanges, clearing 
agencies, and transfer agents.
    Under the direction of the new leadership team, OCIE has 
undertaken a top-to-bottom review and launched over 20 
improvement initiatives to strengthen our strategy, our 
structure, our people, our processes, and our technology. 
Accomplishments over the past year include the following:
    We have recruited experts and launched new specialty groups 
that bring deep, needed expertise and specialization in program 
areas such as derivatives and structured products, hedge funds, 
credit rating agencies, high-frequency trading, and risk 
management.
    We have conducted over 1,600 exams that are better targeted 
to preventing fraud, identifying violations, and addressing 
higher-risk firms, products, and practices.
    We have implemented a new large-firm monitoring group to 
focus on systemic risk firms and a new Risk Analysis and 
Surveillance Unit to enhance our ability to monitor risk trends 
and target those firms and practices that present the greatest 
risk to investors, markets, and capital formation.
    We have created a national governance structure that breaks 
down silos and facilitates coordination, consistency, 
effectiveness, and accountability across the country.
    We have streamlined and automated our exam process with new 
technology. We have clearly defined expectations in a new exam 
manual, and we have implemented a new internal compliance and 
ethics program to monitor our performance and ensure our 
accountability.
    We are working to design and implement a new examiner 
training program that establishes technical training and 
certification standards across the country.
    No matter how much we improve our current program, however, 
the fact remains that our 830 examiners and supervisors can 
only cover a small portion of the 25,000-plus registrants we 
are responsible for overseeing. This results in a ratio of only 
one examiner for every 30 registrants.
    To give you a sense of benchmarking, bank regulators, for 
instance, typically have an examiner-to-registrant ratio of 1:1 
or 1:2. FINRA's ratio is 1:5. Needless to say, our 1:30 ratio 
presents an enormous gap with real consequences if not 
addressed.
    For instance, our staff was only able to examine 8 percent 
of registered investment advisers in fiscal year 2011, although 
we visited firms with more than 30 percent of the assets under 
management currently registered with the SEC. In addition, more 
than one-third of registered investment advisers have never 
been examined.
    We continue to pursue strategies such as risk-focusing our 
exams and automating our exam processes to be as efficient as 
possible and to maximize the usage of resources we are 
provided. Nevertheless, additional resources would enable us to 
more effectively fulfill our new responsibilities, protect 
investors, and ensure market integrity.
    Thank you, and I welcome the opportunity to answer your 
questions.
    Chairman Reed. Thank you very much. I want to thank all the 
witnesses for superb testimony, and your collective testimony 
illustrates the range, the complexity, and the vital importance 
of what you do, and also I think underscores the need to be 
properly resourced to do a very complicated job, which gets 
complicated each and every day by innovations in the 
marketplace. So thank you very much again for what you are 
doing and what you continue to do.
    I think, you know, one final point on this area, if you do 
not have these resources, you cannot effectively provide sort 
of direction and guidance in the marketplace. Perhaps Professor 
Lewis can comment. It is probably more inefficient than 
anything else that you are not giving them the guidance that 
they need to go forward and make appropriate decisions.
    Let me begin my questioning, and I am in an enviable 
position because I have lots of questions and I have experts 
before me. Mr. Khuzami, one of the most notorious incidents of 
the last few years was the Madoff scandal. Recently, the final 
act, perhaps, has been undertaken, which is the disposition of 
allegations against members of the SEC, their behavior. There 
were some people in the Enforcement Division involved. There 
have been sanctions, but no one has been dismissed, and that is 
a question which is at the forefront of many people's minds, 
accountability. You are asking for accountability in the 
marketplace. I think the American public is also asking through 
us accountability at the SEC. Can you comment on the 
disposition and whether or not you feel that was appropriate?
    Mr. Khuzami. Yes, Senator. I think you are absolutely right 
that accountability is our obligation as well, and with respect 
to not only the Madoff matter in general, which has spawned and 
generated many of the forward-looking reforms and changes and 
organizational revisions that you have heard this morning with 
respect to individualized disciplinary decisions, the Inspector 
General's report identified a total of 21 persons, 
approximately, who he believed warranted follow-up for possible 
disciplinary actions. About 10 of those left the Division since 
the report was issued, and the SEC has no ability to discipline 
ex-employees who have departed. So that left approximately 11, 
and we conducted an extremely thorough process to make these 
decisions, including bringing in an independent law firm to 
conduct its own independent investigation and then make 
recommendations to the proposing and deciding officials, 
because ultimately it is an agency decision.
    Of the 11 persons who remained, 9 were recommended for 
actions by the law firm, and action was, in fact, taken against 
all 9. In a couple of cases, it was--I think in two cases 
perhaps--less than what the law firm had recommended, and I 
will defer to Mr. di Florio, as I think the individual who the 
proposal was should be terminated was in the OCIE program. In 
fact, a different result was achieved. But, generally, all the 
persons recommended by the outside law firm suffered a range of 
discipline.
    Chairman Reed. Mr. di Florio, can you comment? Then I have 
a follow-on question.
    Mr. di Florio. Sure, Senator. As my colleague Mr. Khuzami 
noted----
    Chairman Reed. Is your microphone on?
    Mr. di Florio. Yes. Are you able to hear me OK? As my 
colleague Mr. Khuzami indicated, a very serious review was 
undertaken, and all of the individuals ultimately that were 
identified were disciplined. In one instance, the independent 
third-party law firm recommended termination of an individual 
or, if termination would have a significant negative impact on 
the operations of the SEC, then to fashion an alternative 
remedy that would significantly change that individual's roles 
and responsibilities, such as a demotion and a reduction in 
pay. So the SEC staff followed that recommendation of the 
independent law firm and refashioned the roles and 
responsibilities of that individual. The individuals no longer 
have supervisory responsibilities. Their role was reduced. The 
individual received a reduction in pay, and there was a 
suspension of 30 days.
    I would also just assure the Congress and the American 
people that we have taken the lessons learned from Madoff very 
seriously and have implemented significant improvements to help 
us identify and prevent fraud so we can better protect 
investors, ensure market integrity, and facilitate capital 
formation.
    Chairman Reed. Could you just follow up very quickly on 
some of the steps you have taking looking forward based upon 
the experience with Madoff?
    Mr. di Florio. Sure. We have undertaken significant 
training for all examiners and investigators in the SEC of 
fraud techniques, fraud tools, and we have made sure that our 
forces truly understand the various fraud scenarios that are 
out there, how to identify them, and how to act quickly to shut 
them down. I think our results, as articulated by Mr. Khuzami 
and some of the results that I identified, demonstrate how we 
are beginning to have that impact. In addition, we have really 
brought technology to bear. We have a new system for tips, 
complaints, and referrals that centralizes any such tips, 
complaints, and referrals that come in and make sure that we 
have the right people triaging it and following up on it. We 
are bringing better technology, better resources, better people 
to the job.
    Chairman Reed. Thank you very much.
    Mr. Khuzami, let me return to another topical issue. Judge 
Rakoff has raised some questions about the appropriateness of a 
settlement that you have proposed with Citicorp, but it raises 
a few questions. One is you have allegations against the 
company, but there are no individuals that have been, I think, 
pursued in this case and other cases. And to a lot of people on 
the street, they are wondering how a company can commit serious 
violations of securities laws, and yet no individuals seem to 
be involved and no individual responsibility is assessed. And 
that, I think, it at the heart of one of the concerns that 
Judge Rakoff has. Can you comment on that?
    Mr. Khuzami. Sure, Senator. We focus first and foremost on 
individuals for exactly the reason you identify: individuals 
commit wrongdoing, not institutions. But I think it is a 
misperception that we have not charged individuals.
    First of all, in the Citicorp case itself, we charged the 
individual who was responsible for the particular transaction, 
and we are in litigation now with him. We also charged a second 
individual who worked for the collateral manager on the deal, 
the firm that represented that it was independently selecting 
the portfolio when, in fact, that was not the case. So two 
individuals were charged in this case. And, overall, across our 
credit crisis cases, just to take an example, as I mentioned in 
my opening remarks, in approximately 26 cases 89 individuals 
and entities, half of which are high-ranking corporate 
officers, have been charged. The entirety of the executive 
suite at New Century and IndyMac and other companies and 
individuals who have sold these deals have been charged.
    I think part of the concern is that why hasn't--and some of 
these cases have gone all the way up to the executive suite, 
and why haven't the heads of banks been charged? But it is a 
difficult challenge in certain transactional cases because what 
is going on occurs, you know, two, three, and four levels below 
the executive suite. If you are selling a CDO, it is being put 
together by individuals working on the desks, and the 
disclosure is being written by individuals who are not at the 
executive level. So the evidence and the duties and obligations 
do not always rise all the way up to the top of the executive 
suite, unlike, say, in accounting fraud or financial statement 
fraud where CEOs and CFOs and others may have to sign off on 
the accuracy of financial statements.
    So to some degree, if that is the concern, it is a function 
of the nature of the cases, but we have aggressively charged, 
as I said, over half of the individuals in these cases, 40 to 
50 high-ranking CEOs, CFOs, and senior corporate executives.
    Chairman Reed. Let me follow up with one additional 
question before I recognize Senator Merkley and then Senator 
Menendez. You are, of course, talking about civil charges, 
which is your responsibility, but there have been many other 
commenters who have raised the issue of why aren't there any 
criminal charges because there are at least suggestions or 
allegations of criminal violations as well as civil violations. 
And as I understand it, you would have to refer those cases to 
the Department of Justice. But the record is not--there are 
very few that I can think of criminal cases that have been 
taken in the wake of the worst financial crisis in the history 
of the country, and behavior which, at least to the outside 
observers, seems to be highly questionable.
    Have you been making referrals and has Justice been 
systematically turning you down? Or how can you comment on this 
relationship?
    Mr. Khuzami. Senator, we work extremely closely with the 
Justice Department and with the U.S. Attorney's Office in New 
York and other offices, and I can assure you that they are 
keenly interested in cases arising out of the credit crisis and 
looking extremely closely at the evidence in these matters, 
conduct their own inquiries, and reach their own 
determinations.
    It is a hurdle for them. They have a higher standard of 
proof in a criminal case. They must prove a case beyond a 
reasonable doubt. And so some of the challenges that we face, 
they face even more forcefully because of that higher standard 
of proof. But I can assure you it is not for lack of dedication 
or professionalism or talent that criminal cases are not being 
filed.
    Chairman Reed. I presume from that answer that you have 
made referrals, but they have not been followed through because 
of the judgments they have to make independently.
    Mr. Khuzami. Well, yes, it is referrals, but it is also--we 
work very closely with them. We do not just take a case and 
refer it over to them and wash our hands of it. We are in 
constant communications and discussions and reviewing evidence 
and working collaboratively.
    Chairman Reed. Thank you very much. There will be an 
additional round of questioning, but let me recognize Senator 
Merkley now for his statement or questions or a combination of 
both.
    Senator Merkley. Thank you, Mr. Chair. I do not have a 
statement, but I do have some questions, if that is 
appropriate. Thank you.
    I wanted to start to get anyone's opinion on Congressman 
DeFazio's proposal on high-frequency trading, which goes back 
to kind of thinking a little bit about the ``flash crash.'' I 
believe what he had in his most recent proposal is a 3-basis-
point fee that discourages, if you will, the multitudinous 
high-speed trades while having very little impact on regular 
investors.
    Any thoughts about that? Mr. Cook.
    Mr. Cook. Thank you, Senator. I am not familiar with the 
details of that, but I think that proposal or versions of it 
have been raised several times, and I think there are a number 
of interesting issues that it raises. Obviously, there are 
concerns about the extent to which the traffic that is 
generated by high-frequency trades is of itself interfering 
with the effective functioning of the markets, and to some 
extent some type of fee, whether it is a message fee or an 
order cancellation fee--there are various versions this might 
take--that might be helpful in addressing that.
    I think the challenges are, first, picking the right 
metrics for when that would happen, when it would kick in, what 
the type of fee would be; and second, and probably more 
importantly, to not undermine the liquidity in the markets that 
may be very important, and certainly during normal market 
circumstances. Given the prevalence of high-frequency trading 
in our markets today, I think this is an area where we would 
have to move very carefully to ensure that whatever changes we 
introduce to a significant portion of the volume in the markets 
is carefully considered to avoid any unintended consequences.
    Senator Merkley. Does anyone else want to weigh in on that?
    [No response.]
    Senator Merkley. Very good. Thank you.
    The second issue I wanted to get some insights on is the 
crowd funding of companies. As we move to this Internet world, 
as people become familiar with peer-to-peer lending, certainly 
this is a very different avenue than traditional investing, 
very different for the investors and very different for the 
companies. And in some ways it is a very exciting possibility, 
but it also poses risks related to fraud. Any insights on how 
this gets pursued, supported, or guided so that it will be a 
win for investors and a win for companies?
    Ms. Cross. I will start off. First off, I have to note that 
I am not participating in the crowd funding matter because of 
my prior work for a peer-to-peer lender, but in general, with 
regard to the new capital-raising strategy ideas that are being 
considered in Congress and also at the Commission, the key here 
is to make sure that whatever is built does not become fraught 
with fraud so that investor confidence is destroyed and then 
people will not invest in that market since that level of 
deregulation would not help anyone.
    So we are working with the market participants and Members 
of Congress and looking at the various pieces of legislation to 
help put in safeguards that would keep that from happening. I 
think one of the ideas that has been discussed is the 
possibility of intermediaries as a means of protecting 
investors, and I can let Mr. Cook address that.
    Mr. Cook. So when we think of investors purchasing 
securities, one of the traditional tools we have to help 
provide protections for them is the registration and regulation 
of the party who is doing the selling as a broker-dealer. Some 
of the factors we think about when we think about whether that 
is appropriate include: Does the broker have a salesman's stake 
in the transaction? Are there conflicts of interest that might 
arise? Is the intermediary handling customer funds and 
securities?
    And so I think, in our experience in this area, I have a 
couple of observations. One is that fact patterns matter, and 
there are very different forms in which these intermediaries 
may relate to investors. And I think in some cases we have 
given guidance that they are not subject to registration or 
would not because the regulatory policy concerns have not been 
triggered.
    I think another area that we need to think about, though, 
is whether we have a sufficiently flexible regime because the 
types of rules that might be appropriate for one type of entity 
may not be appropriate for a traditional brokerage house, for 
example. And I think if there were a regulatory regime in place 
here, I think that would be a key area in which we would want 
to have some flexibility to tailor the requirements to the 
specific facts and circumstances.
    Senator Merkley. Thank you. My time is up, so I am just 
going to say I appreciate your feedback on both of those. There 
are about ten other topics I would be happy to extend the 
conversation on, but I am going to defer to my colleagues.
    Chairman Reed. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Ms. Cross, I authored Section 953(b) of the Dodd-Frank 
legislation which requires publicly listed companies to 
disclose the pay of their median worker compared to the pay of 
their CEO. And we weighed in with the SEC earlier this year 
about both our intention with this provision and where it is 
that you were at. We got an answer that was less than 
satisfactory because it was a nonanswer, as far as I am 
concerned.
    So can you tell me where it is that you are at in terms of 
being on track for finishing this rule on this provision by the 
end of this year?
    Ms. Cross. I am happy to do so. Right now the Division is 
in the process of preparing the recommendation for the 
Commission so that they can act on a proposal. We are trying 
mightily to make it by the end of the year. That is the 
schedule that is up--that is the goal that is up on our public 
Web site, and I can assure you that we are doing everything we 
can to get there.
    We have a lot of things we are trying to do right now, and 
this is one of the very important ones. But I can assure you we 
are trying our hardest to make the year-end.
    Senator Menendez. I would hope that what we see happening 
across the country and people's concern about inequality would 
spur the SEC to have a mere transparency--we have had testimony 
here, particularly from those who have come from the private 
sector, about how hard this will be, and they actually have 
said that they do not believe that it is that difficult to 
produce the information. So I hope we understand, particularly 
in light of actions that are being taken by citizens across 
this country about how important--I know you have a lot of 
work. We gave you a lot of work to do. I understand that. But 
this is something that clearly people are looking forward to 
have some transparency and to have it sooner rather than later. 
So we are looking forward to you achieving it by the end of the 
year, at least bringing it before the Commission.
    Ms. Cross. We are doing our best, as I said.
    Senator Menendez. OK. That means you will get it done 
before the end of the year.
    [Laughter.]
    Senator Menendez. Let me ask you this as well: Earlier this 
year I introduced the Shareholder Protection Act with several 
of my colleagues to disclose corporate spending in elections in 
the wake of what I believe is a misguided decision on Citizens 
United. Since then, my staff has been told by SEC attorneys 
that the SEC already has the authority to implement rules that 
would require corporations to disclose their political spending 
to shareholders. Is that accurate?
    Ms. Cross. Yes, it is accurate that the Commission has the 
authority to require that disclosure, if they decided to do so, 
through rulemaking. I would note that the Citizens United case 
has certainly piqued an interest in this topic. We have two 
rulemaking petitions pending at the Commission right now asking 
us to consider requiring disclosure about political spending.
    I also note that this is an area where the market is moving 
in that direction as well. A recent report showed that more 
than half of the S&P 100 is already providing this disclosure. 
Also, shareholder proposals are included under our rules in 
proxy statements so that shareholders can vote on whether they 
want this disclosure. So this is certainly an area of great 
interest.
    The staff is carefully considering all this as we think 
about the issue.
    Senator Menendez. Well, I hope the SEC believes that this 
type of disclosure would be helpful for investors. An October 
2010 Zogby poll of business leaders found that 77 percent of 
them believe that corporations should disclose all the direct 
and indirect political expenditures. Is that something the SEC 
disagrees with?
    Ms. Cross. I cannot speak for the Commission on that point. 
We have not taken this up with----
    Senator Menendez. At the staff level, where are you headed 
on your recommendations?
    Ms. Cross. We have not concluded what we should recommend. 
I think we are reviewing the petitions and considering the 
issue in light of recent developments.
    Senator Menendez. Many large companies--Microsoft, Wells 
Fargo, Merck, Aetna--have already taken steps to disclose their 
political expenditures, and to me it illustrates the ease in 
which it can be done. And so I am hoping that the SEC looks for 
that to be for shareholders across the board a reality. So I am 
looking forward to what your recommendations are on that as 
well.
    Mr. Cook, let me ask you one quick question. What is the 
SEC's expected timing for issuing the remaining proposed rules 
on capital margins, segregation, and record-keeping 
requirements for security-based swaps under Title VII of Dodd-
Frank?
    Mr. Cook. The rules you refer to, which are the final rules 
in the substantive proposal phase of our OTC derivatives 
regulation, are at the top of the list for our OTC derivatives 
work. The goal was to get them done by the end of the year. 
Whether we hit that or not, I am not sure, but that is probably 
the next item out of the Commission on the OTC derivatives 
front.
    Senator Menendez. So let us say for argument's sake that 
you reach it at the end of the year. What would be your overall 
implementation schedule or proposed implementation rules for 
its final rules?
    Mr. Cook. Well, what we propose to do after we propose all 
the substantive rules is to issue two releases that are also 
underway now so that we can get them out as quickly as 
possible. One is a release that discusses how our rules would 
apply internationally, so a cross-border release, looking 
across each of the different substantive rulemakings, whether 
it is execution facilities or dealer registration or clearing 
agencies, and talk about how those rules apply or would apply 
in a cross-border context and solicit comment on that, because 
it is a very important piece of the implementation.
    The second thing would be to issue an implementation plan--
both of these would be for public comment--that would lay out 
the process by which we would propose to roll out the new 
framework in a timely, efficient manner with the goal of 
approaching this as a project management task where, if we can 
be as thoughtful in how we roll it out, we will get to the end 
more quickly and efficiently.
    Senator Menendez. All right, Mr. Chairman. Thank you very 
much. I appreciate it.
    Chairman Reed. Thank you, Senator Menendez.
    Let me begin the second round by asking Mr. Khuzami, again, 
in the context of this recent litigation under Judge Rakoff 
with respect to Citicorp--and this is not exclusive to one 
company, but typically you will reach a settlement in which the 
corporation neither admits nor denies, and it strikes a lot of 
people oddly why, if you do not have any culpability, you are 
paying several hundred million dollars. Have you reconsidered 
whether or not that is at all effective or what role it plays? 
That is one question.
    The second question would be: They typically also say that 
they will never do this again, and I am not using the precise 
language of the finding, and then you find that--and, again, 
not exclusive to one company but many companies--troubling 
patterns of behavior emerge in the future, maybe not exactly 
identical but certainly within the same sort of context of--and 
yet there does not seem to be action in your Division to take 
people up on their commitment never to do it again or anything 
like it again.
    Are you rethinking what you can do in terms of these 
settlements on both those points?
    Mr. Khuzami. Senator, let me explain our approach in these 
areas. First, the bottom line is we settle cases where we 
believe that the sanctions that we can obtain, including the 
monetary sanctions and the business reforms, et cetera, are 
what we could likely obtain should the case go to trial, taking 
into account the risks, the strength of the evidence, the law, 
et cetera.
    In monetary sanctions, which is another matter that has 
been discussed, I would make it clear that we cannot obtain 
penalties in the amount of investor losses. We are limited by 
law to getting disgorgement, which is the ill gotten gains of 
the perpetrator, and then a penalty, in general, equal to the 
amount of that gain. So if you had somebody who earned $20 and 
defrauded investors of $100, we can get $20, representing the 
gain of the perpetrator, and another $20, and a penalty, but we 
cannot get the $100, in most circumstances.
    And so to some degree, there has been commentary about our 
settlements, that they do not seem to be significant enough in 
terms of the financial sanctions. That reflects, frankly, our 
view of the strength of the evidence of the case and the risks 
associated with it, but also some statutory restrictions on the 
amount of money that we can get.
    But in addition to that, with respect to ``no admit, no 
deny,'' our goal is to get money in the hands of investors as 
soon as possible. If we were to demand admissions in every 
case--and keep in mind, it is ``no admit, no deny,'' which 
means companies cannot deny liability. They are not required to 
admit it, but they cannot deny liability, as well. And so under 
that provision, if we were to insist on admissions, because of 
the collateral consequences of those admissions, both with 
respect to private civil litigation and even with respect to 
criminal exposure, companies are not going to open themselves 
up to that kind of exposure.
    Now, I do not have any particular sympathy for that. It is 
just a reality of the negotiation process that they will not 
settle cases and they will take more cases to trial. So we are 
left with a situation in which if we can settle a case now for 
the amount of money and the range of sanctions that we believe 
reasonably approximates what we can get if we were successful 
without the risks of a trial, and most importantly, get money 
in the hands of investors today rather than 2 years from now or 
3 years from now or 4 years from now when that case goes to 
trial, and even more if it goes to appeal, and most 
importantly, we added more resources to attack the next fraud, 
because there are opportunity costs in everything that we do--
if we are prosecuting Case A, we are not prosecuting Case B--
and so it is cold comfort to victims of other frauds if we are 
putting all of our resources taking a case to trial and if one 
is not settling, when their case is not being prosecuted if we 
are getting a package of remedies that are strong and send a 
meaningful message.
    I would also say that in our cases, we issue a complaint 
with very detailed allegations. The company pays a large amount 
of money. They agree to business reforms. They cannot deny 
liability. My view is, while I certainly understand the desire 
for people wanting someone to stand up and admit to the 
wrongdoing, there is not a lot of mystery under those 
circumstances that the company is, in fact, engaged in 
wrongdoing. They would not be writing a check for $300 million 
or agreeing to reform their business in the face of these very 
pointed and specific allegations of what happened.
    So on balance, trying to serve many values, we adopt a ``no 
admit, no deny,'' like the FTC, like the Department of Justice 
Civil Division, like the CFTC, and just the other day, the 
National Credit Union Administration settled the case against 
two banks for $300 million for mortgage related problems also 
on a ``no admit, no deny'' basis and the Supreme Court has 
endorsed it.
    So while I understand the desire for it, and there are 
cases where I might like to see it, as well, and we do review 
our policy, the fact of the matter is that we have to choose 
amongst some competing goals that we are trying to accomplish 
and that is where we come out.
    With respect to repeat offenders, this deals with the 
question of contempt, and I think there is a little bit of a 
misperception around our authority in this area. If a company 
engages in a securities law violation in 2005 and agrees not to 
do it again by way of an injunction, and then in 2008 sells a 
securities product that violates the law, we are not able--we 
can only get civil contempt, but civil contempt is only 
available if there is an ongoing fraud, so that we could go in 
court and say, Your Honor, this company is engaging in conduct 
now that violates their previous promise not to break the law 
again. You have to stop them from doing this conduct right now. 
But that only works if the conduct is ongoing. If the sale of 
the securities is over, there is no ongoing fraud. There is 
nothing to order compliance with. And that is the vast majority 
of cases. There has to be ongoing fraud in order to bring a 
contempt action.
    In addition, the most you would get from a judge is he 
would say, stop doing what you are doing now, but if it is 
already over, there is nothing to get. I think what most people 
want in this area is criminal contempt, which is punitive, 
which is sanctions for simply violating the previous order, and 
that, only the Department of Justice has authority to do. But 
we by no means ignore recidivism. We take it into account in 
deciding how much a company should pay in that second action, 
what kind of business reforms might need to be adopted, and 
other packages. So we thoroughly take into account prior 
misconduct, but contempt is a poor vehicle in most cases to 
accomplish that.
    Chairman Reed. I have one quick follow-up question before I 
recognize Senator Merkley. I promise I will ask the other 
panelists, when I return, questions.
    Recently, you have used language in the Sarbanes-Oxley 
legislation to claw back gains that an individual received 
although he was not directly charged with any type of 
violation. Is that a practice that you are going to pursue with 
more frequency going forward?
    Mr. Khuzami. Yes, Senator. That is Section 304 of Sarbanes-
Oxley, which allows us to sue and require a CEO or CFO to claw 
back certain incentive-based bonuses and equity awards as well 
as certain stock sale profits when the company that they work 
for fails to comply with certain financial reporting 
requirements as a result of misconduct, and we have used that 
tool and we look in all of our cases to whether or not that 
tool is appropriate. It is a strong tool because, like you say, 
these are stand-alone actions. The CEO or the CFO does not have 
to be involved in the misconduct. If the company they are 
working for does it, their compensation can be clawed back. And 
so we look at it closely.
    It is not without some issues. Obviously, CEOs and CFOs are 
differently positioned. Some are completely absentee and do not 
do their job at all and misconduct occurs. Others may be very 
active, may be even following best practices, and nonetheless 
misconduct occurs. So you need to exercise a range of 
discretion in these cases, but it is a tool we look at closely 
and we have brought a number of actions in this area.
    Chairman Reed. Thank you.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair.
    I wanted to turn to MF Global, which, if I understand 
right, MF Global was both broker-dealers, if you will, 
regulated by the SEC and a futures dealer regulated by the 
CFTC. I believe it is on the futures side that the issue of 
client accounts and the segregation of client accounts is in 
question, that is, whether their accounts, the money was used 
in a proprietary trading or hedge fund style operation and in 
violation of the sanctity of those individual accounts.
    So it is very confusing to the public, certainly to us, as 
to where the oversight comes and what went wrong, but 
recognizing that the SEC is primarily on the broker-dealer side 
of the firm, did things go wrong on the broker-dealer side, or 
is the broker-dealer side deeply impacted, if you will, by 
the--which I am sure it is--by the futures side? How does the 
CFTC and SEC coordinate their regulation of this type of 
complex firm?
    Mr. Cook. Senator, as you have noted, the firm was dually 
registered as both a broker-dealer and an FCM, a Futures 
Commission Merchant. What that means is that both agencies and 
the self-regulatory organizations under them have oversight 
over the firm.
    In some respects, our oversight about certain activities 
would focus on securities and the CFTC's and the DCOs under the 
CFTC would focus on the futures activities. We both have rules, 
as well, that would apply to the entity as a whole, for 
example, capital rules, and the entity would be subject to--
have to comply with both sets of rules. So being jointly 
registered means that you have to comply with the rules 
applicable to a broker-dealer and the rules applicable to an 
FCM.
    As you noted, the shortfall that has received a great deal 
of attention in the press and is a significant concern is on 
the futures side, the segregation of customer assets related to 
the futures positions. Your question, does that affect the 
broker-dealer side, I think, of course, it is one entity that 
is now in bankruptcy and shortfalls are obviously a significant 
concern in any customer protection regime. We are continuing to 
work with the trustee, as is the CFTC and other regulatory 
agencies, to help identify exactly what is the position of the 
firm, both on the securities side and the futures side, because 
one of the challenges here is that the books and records of the 
firm appear to be challenging in terms of getting to the bottom 
of some of these questions.
    I think, just having been in close contact with the CFTC 
and other regulators through the weekend when the firm was 
exploring strategic options, absent this shortfall being 
identified, there would have been a significant chance of a 
deal happening that would have transferred the customer 
accounts out in the way it is meant to happen. So if broker-
dealers and FCMs fail sometimes, our goal is to make sure if 
that happens, there is a credible and reliable way to protect 
customers, and that only works if the customer assets are 
available to transfer to a new firm. So in that sense, the 
shortfall obviously impacts all customers.
    Senator Merkley. So is that happening on the broker-dealer 
side?
    Mr. Cook. You mean, is there
    Senator Merkley. On the customer--in terms of customers who 
own stocks or placed orders through the securities broker-
dealer side, have their accounts been transferred out to some 
other firm?
    Mr. Cook. Not yet. There were many more futures customers, 
so I think the trustee has transferred 17,000 futures accounts 
that had positions in them. There are more that he is seeking 
to compensate that did not have positions but had collateral.
    Just by way of contrast, on the securities side, he has 
solicited interest in acquiring 450 securities accounts, so it 
is a much smaller number of affected customers. The trustee has 
solicited interest from potential transferees of those accounts 
so that they and their property could move forward.
    Senator Merkley. So is it likely that the account holders 
on the broker-dealer side are whole and undamaged?
    Mr. Cook. I would not want to provide any assurances at 
this time. I can tell you that what the firm self-reported was 
a shortfall on the futures side. The firm's calculations on the 
securities side with respect to its customer segregation 
requirements indicated that it was in compliance with the 
securities customer segregation rules. But as you can imagine, 
we are not taking that at face value. We are currently working 
hard to try to verify exactly what is there and who owes what 
so we can provide assurances.
    Senator Merkley. The reason--and I am over my time now, so 
I will just summarize this--the reason I am pushing this point 
is trying to understand where there are insights here about the 
complexities of regulating a firm that is both a broker-dealer 
and a futures dealer, whether there needs to be stronger 
firewalls between the two halves of the business in order to 
ensure both the coherence of regulation and the security of one 
side of the firm, if you will, and the customers from fraud on 
the other side of the firm. Those were the types of pieces I am 
pushing, and I will look forward to kind of--maybe my team can 
continue the conversation with you about insights that can be 
derived from this.
    Mr. Cook. Absolutely.
    Senator Merkley. Thank you.
    Chairman Reed. Thank you, Senator Merkley.
    Let me resume, and Ms. Cross, Senator Crapo indicated his 
interest in the formation of capital, particularly for small 
companies. I know you and your colleagues are working this. 
Could you let us know your latest efforts in terms of capital 
formation, particularly the small enterprises?
    Ms. Cross. Absolutely. So at Chairman Schapiro's request, 
last spring, we started an initiative to take a fresh look at 
our rules to see if there are steps we could take to reduce 
regulatory burdens that would help facilitate capital formation 
by smaller companies, if it could be done consistent with 
investor protection. As I noted, if investors are not 
confident, then they are not going to invest and so you do not 
actually help anyone raise capital. So in everything we do, we 
try to balance the capital formation mission with the investor 
protection mission.
    The staff has several work streams going right now that are 
in the works. One is to do a study of whether the 500-
shareholder threshold for reporting should be changed. In 1964 
when Congress adopted the current 500-shareholder threshold, 
they had tasked the SEC with doing a robust study, so we are 
doing that again with help from Craig's group. So that is one 
of the pieces.
    We are working on a concept release on the general 
solicitation issue in private offerings and we are looking at 
whether there are ways we can extend some of the benefits that 
we give to larger companies in capital raising, extend those to 
smaller companies. For example, access to shelf registration, 
things like that.
    We are being helped tremendously in this effort by our new 
Advisory Committee on Small and Emerging Companies. It had its 
first--its kick-off meeting 2 weeks ago and they are already 
working on recommendations, having considered these topics, 
which we brought forward to them at the first meeting.
    And then tomorrow is our--I think it is the 30th Annual 
Government Business Forum on Small Business Capital Formation 
that is being held at the Commission. I think every 
Commissioner is speaking at it and attending it, so there is 
obviously great interest in the topic.
    Chairman Reed. Thank you very much.
    Mr. Lewis, you have an increasingly challenging role to 
play. The relevant legislation requires publication of a rule 
for the SEC to consider market effects, but given the recent 
court rulings, it is hard to tell what ``consider'' means. In 
fact, there seems to be suggestion now, and at least rhetoric 
now, that that is sort of a detailed cost-benefit analysis 
weighing every conceivable option, et cetera, which goes far 
beyond the literal term ``consider.''
    But can you talk about your role in providing that kind of 
analysis? You alluded to it in your opening remarks. And also, 
if you have a practical difficulty of getting cooperation from 
market participants in giving you the data you need, which sort 
of sets up a catch-22. You cannot do the analysis to promulgate 
the regulation unless you get cooperation, and you do not get 
cooperation, so now you are vulnerable for a challenge. Can you 
comment?
    Mr. Lewis. Yes, Chairman. I would like to comment. As you 
can imagine, the recent ruling on the proxy access case 
provides significant challenges to the Division including 
reassessing the way it conducts cost-benefit analysis. I think 
the D.C. Circuit Court clearly took issues with the way cost-
benefit analysis has been conducted historically at the SEC, 
and there are lessons, I think.
    I think what they are really asking us is to take a look at 
the way you actually conduct cost-benefit analysis, and the big 
take-away from a lot of the recent decisions, in my opinion, is 
we need to provide a more fulsome discussion of all the various 
alternatives that are on the table, a fulsome cost-benefit 
analysis around the proposed rule, but also around viable 
alternatives to the rule. And part of that will be to provide a 
complete discussion not only of the costs and benefits that we 
are able to quantify, but of the qualitative costs and 
benefits, and that is really one of the rubs in trying to 
analyze cost-benefit analysis, is that so many of the benefits 
that are associated with a particular rule simply do not lend 
themselves to ready quantification and it is really not 
feasible in a lot of situations.
    I think the other take-away from the proxy access decision 
is that while there is a--currently, the typical practice is to 
involve the Ph.D. economists at the SEC at very early stages in 
the rulemaking process, I think we need to formalize that 
process and bring them in in a more formal, prescriptive way.
    Chairman Reed. Any comment about access to information 
from--proprietary information that could be decisive in your 
analysis?
    Mr. Lewis. Yes. That is one of the challenges we face, 
because to quantify benefits or costs associated with the rule, 
you have to avail yourself to data. And if data is not publicly 
available, many times the only way you can get it is to try to 
request the data through the comment period process from market 
participants. And so we, when we propose rules, we frequently 
will design questions that are designed to give us the data. 
But as you have mentioned, a real problem with that process, is 
that, frequently, there are not incentives to provide the data 
on the part of market participants. So if you do not get that 
data, it is very difficult to do the subsequent analysis.
    Chairman Reed. Thank you very much.
    I want to begin with Ms. Rominger on this question, but I 
would like all the panel to weigh in, if appropriate, and that 
is that so much of what you do depends on sort of having a feel 
for the marketplace, real time information, data, intelligence, 
and particularly with your supervision of mutual funds, one of 
the issues today sweeping across the Atlantic is sovereign 
wealth funds and who is holding what, et cetera. Can you just 
comment in general terms about how you deal with making sure 
you have access to the most relevant information in real time 
to make these judgments to supervise, in your case, mutual 
funds, but in the case of others, investment advisors, broker-
dealers, et cetera? And you can begin, Ms. Rominger.
    Ms. Rominger. I will start by giving an example of where 
having additional information has been very helpful to us, and 
that is in the area of money market fund regulation and 
oversight. Money market funds, as I mentioned in my opening 
comments, have a structural fragility in that they are 
susceptible to runs, as we saw in September 2008. In the first 
round of money market fund reform early in 2010, there was a 
requirement for money market funds to disclose holdings 
information to the SEC on a monthly basis. We started receiving 
that information exactly a year ago, at the end of November 
2010, and we now have monthly holdings for money market funds.
    So this is, I think, an instance where having that data has 
provided us very important information with respect to the way 
these funds are structured and the implications of that with 
respect to systemic risk. It is a subject of much conversation 
amongst the SEC and other regulators who are involved in 
systemic risk work. I think that is a very good example of 
where it has been put to good purpose.
    As I look at our responsibilities and think about where our 
greatest needs are, I think it is with respect to experts, 
technical experts, market experts, experts in analyzing complex 
financial strategies. I think that the Chairman has identified 
that as an area of increasing focus and increasing resource 
need for the SEC and that is certainly true in the Investment 
Management Division.
    Chairman Reed. Mr. Cook, do you have comments from your 
perspective?
    Mr. Cook. Yes, sir. In terms of access to data, as I 
indicated in my opening remarks, one of the key challenges we 
face in monitoring the securities markets, the listed equity 
markets in particular, is just the enormous volume of data that 
is there and the relatively significant gap between our access 
and the ability to analyze that data in an efficient way. So we 
are working on a number of initiatives to try to narrow that 
gap.
    I would say part of it is a rulemaking process to make sure 
that there are the rules in place or a structure in place to 
get that data to the regulators. That would be, for example, 
the consolidated audit trail and the large trader reporting 
system, where we will have better access to data.
    But the second piece of it is having the resources 
internally to be able to make something of that data. We are 
working closely with our colleagues in other divisions, for 
example, when it comes to the consolidated audit trail to make 
sure that what we are designing is going to be useful for the 
examination program, for the enforcement program, as well as 
our own market oversight program. But it requires both people 
and technology to ultimately realize the promise of some of 
these data enhancement initiatives.
    Another key one that we are working on is in the swaps 
markets, and there, we have a proposed regime for the reporting 
of all swaps to data repositories. But that will present 
opportunities and challenges for us again in terms of having 
greater access to information, but now we need the people and 
the technology to be able to leverage that information and be 
more effective regulators.
    Chairman Reed. Mr. di Florio.
    Mr. di Florio. I would just add, Chairman Reed, that there 
has been a tremendous amount of improvement, I think, with the 
Division of Risk Strategy and Financial Innovation to really 
help the SEC think about taking in significant amounts of data 
and doing more sophisticated analytics around that data. That 
has been very helpful, for instance, with us on the examination 
program to make sure that we are agile and we are not planning 
our exams based on old data, but taking in new data, doing 
analytics, and as we learn about trends or risks, being agile 
and directing our efforts there.
    It has also been helpful to work with the Division of 
Investment Management and the Division of Trading and Markets 
to identify the data that we might be able to gather through 
the exam program, because we are in the field every day, and we 
have, I think, strengthened our ability and our coordination to 
be able to have dialogs with the firms around specific data 
that we think we need, for instance, exposure to Europe, so 
that we can not only get data in a raw form, but then have the 
critical dialogs that we need to have with the firms to have it 
make sense and have us be able to have a significant response 
to that data.
    Chairman Reed. Mr. Lewis or Ms. Cross.
    Ms. Cross. I would note in the Division of Corporation 
Finance, what we have focused our resources on recently in the 
review program is looking at the largest companies on a real 
time basis. So historically, we would have picked them up once 
a year, looked at their filing, given them some comments, and 
perhaps moved on after they responded. What we have figured out 
is that if we have our accountants and lawyers looking at most 
of what they say and do over the course of the year, we are 
able to pick up trends and improve the disclosures across whole 
areas of the industry based on what we are seeing with the 
leading companies, and I think this has been a great innovation 
in the Division and we hope to do more of it because I think 
that is much more valuable than the episodic picking up of a 
company, looking at its filing, and giving some comments.
    Chairman Reed. All right. Mr. Lewis, your comments, and 
then Mr. Khuzami.
    Mr. Lewis. Yes, if I could just give an example----
    Chairman Reed. Yes, sir.
    Mr. Lewis. ----of some of the cooperation and collaboration 
we have had with Carlo's Office, and what we have done is we 
have taken the data initiative in my Division, and the idea is 
to build risk assessment tools that can be used to essentially 
score investment management companies as to certain classes of 
risk. And so we are taking a layered approach; we begin by 
discussing what the needs are in the Office, and determine the 
key risks. We start with fairly simple models that just perform 
basic screening of filers. And the idea is, as we learn more 
about the risks in the space, we develop increasingly 
sophisticated analytic models. So we move from screening 
techniques to, let us say, regression-based techniques, in that 
order.
    Chairman Reed. Thank you.
    Mr. Khuzami, any comments?
    Mr. Khuzami. From the enforcement perspective, it is 
slightly different, but the same theme. We do everything that 
we can to get access to data and to analyze it, but we are 
seriously behind the curve in our ability to do that. I mean, 
if you want to conduct a thorough and proper insider trading 
investigation and make sure you get all the parties who may be 
involved in an illicit scheme, you would love to have ready 
access to all equity trading data and derivatives data and debt 
data and overlay a chronology of market-moving events and you 
would be able to see patterns and trends. We are trying to do 
some of that, but it is difficult. We need better tools, not 
only in analytics, but to be able to upload information and 
manipulate data to investigate it. It can take weeks and even 
months to upload the massive amount of electronic information 
we get in our investigation and we do not have the proper tools 
in order to be able to analyze it the way we would like to.
    Chairman Reed. I have two final questions, but Senator 
Merkley, do you have additional questions? Let me recognize you 
now and take your time and then I will conclude, I hope 
quickly.
    Senator Merkley [presiding]. OK. Thank you, Mr. Chair.
    I wanted to continue this conversation about information, 
but really focus on derivatives. Certainly, we did not have a 
very good understanding of the writing of derivatives here in 
the United States, and I am not sure that we have a very good 
understanding of it currently abroad. Conversations with some 
of the experts from our own rating companies have generated 
kind of a response of, no, we do not really understand who is 
writing, who is holding, how the dominos are set up regarding 
Europe. And, of course, a lot of credit default swaps are being 
written on a host of European firms and sovereign debt.
    So I wanted to start--I realize that this is a world where 
the credit default--the swap world is so divided with interest 
and foreign exchange swaps on the CFTC side, equity swaps on 
the SEC side, so you all have a piece of this picture, but what 
do we know about European credit default swaps? And if we do 
not know enough, what needs to change?
    Mr. Cook. Senator, maybe I could start with that and then 
invite Mr. Lewis to comment. The primary entities that we 
regulate that would be likely to take on direct exposures to 
this, are the broker-dealers, and anecdotally and through 
FINRA, our impression is it is not significant exposure to 
credit defaults. Also capital rules make it expensive to book a 
credit default swap in a broker-dealer.
    However, obviously those transactions can be booked at 
other entities that are also of general regulatory interest 
with the banks or holding companies or financial institutions, 
and other regulators may have access to some of that 
information as well.
    But I think overall, there is a gap in our knowledge of 
this, and I think the solution that we are working on, and the 
CFTC is as well, is the development of a mandatory trade 
reporting regime pursuant to Title VII of the Dodd-Frank Act, 
which would require all swap transactions to be reported to a 
data repository. That would be available to regulators.
    There is a separate piece about reporting out to the 
marketplace, which is sort of a transparency piece. But in 
terms of our prudential systemic oversight of the markets and 
the risks----
    Senator Merkley. Let me hold you on for just a second 
there. On that repository, when do we expect to have it up and 
operating?
    Mr. Cook. Well, we have our proposed rules out for the data 
repository and we would, as I mentioned earlier, need to finish 
our proposal phase for Title VII and then begin adopting. So I 
think we would likely see adoption of this rule sometime in 
2012, but I am not exactly sure. The order in which we adopt 
these rules is one of the things on which we want to get public 
comment.
    I will say, though, that most parties we have spoken to 
have suggested that this ought to be one of the first things 
that we do because it will enhance our information that we have 
as regulators about what is out there, and may help inform our 
rulemaking in other areas of Title VII.
    Senator Merkley. And I will say, in the context of what is 
going on in Europe, it seems like a critical element and it 
seems like one of the simpler elements that ought to be able to 
be put into place. Is there any parallel effort on the European 
or Asian side?
    Mr. Cook. There are efforts to develop data repositories in 
other jurisdictions, yes. And to some extent, some of this 
information is available today through the trade warehouse that 
is operated in the U.S. Mr. Lewis's group has done some work in 
analyzing some of that data. It is not complete, and I think 
that what we are trying to get to is a complete picture.
    Mr. Lewis. So let me briefly tell you, Senator, about some 
of the work that my division has done on the credit default 
swap data that has been provided by the data warehouse. One of 
the projects that we have worked on is to characterize the 
positions and exposures of the participants in the swap market. 
And one of the, I think, take-aways that we have going up 
through the data through June of 2011 is that financial 
institutions have been unwinding their exposures to the PIIGS' 
debt, to basically sovereign European debt.
    One of the issues, I think, that is critical if we want to 
consider and evaluate systemic risk is that we need to have a 
complete picture of all the parties that transact in this 
space. And to give you an example of why I think this is 
important, one of the experiments we conducted in our group to 
see how important this issue might be is we looked at positions 
by only considering U.S. financial institutions and U.S. 
counterparties, but excluded U.S. branches in foreign 
domiciles.
    So take an investment bank, New York Investment Bank, 
consider their U.K. branches, ignore those U.K. branches 
transactions, and you get a picture of what the counterparty 
exposures are, what the positions look like across 
counterparties, gross exposures and net.
    And then run the experiment again including all the 
exposures by also including the trades that occur in the 
international or the foreign branches, and what we discovered 
was that positions or exposures could reverse. So if you look 
like you were a purchaser of protection in a credit default 
swap market, when you incorporated all the branches, all the 
transactions we had access to, you could actually see the 
positions reversing.
    If we are going to manage systemic risk, I would advocate 
we need to get all the trades, not just the trades that take 
place by U.S. banks and their branches, but if you want to 
measure systemic risk, you want to look at everybody who is in 
this market so you can get a complete picture of what the 
credit risk is like.
    Senator Merkley. How does the Office of Financial Research 
fit into this issue of understanding the collective picture?
    Mr. Lewis. I have actually had discussions with the Office 
of Financial Research and alerted them to this issue, and I 
believe that they are actually working on it. Probably should 
not attribute workload to the Office of Financial Research, but 
it is certainly a suggestion that I have made to them, that 
they should investigate.
    Senator Merkley. Thank you.
    Chairman Reed. Thank you, Senator Merkley, and let me just 
say that they would even be more responsive if they had a 
confirmed head of the Office of Financial Research. That is a 
message to the broader public.
    Final question and I think it is an important one to ask 
and it is just really two parts. One is that there has been 
criticism lodged against the SEC about being too close to the 
institutions and the businesses that you regulate. Related to 
that is the issue of a revolving door process. And I wanted to 
get, Mr. di Florio, a comment on how you sort of deal with that 
in terms of making sure that does not affect your ability to 
effectively perform your duties on behalf of the public.
    And then a related question. I ask this with trepidation 
because one of my former experiences was commanding a 
paratrooper company. If anybody asked my company how the morale 
was, I shuddered a little bit in terms of what they might say. 
But you might also indicate just what you sense the morale is 
in your division. Those are those two little related issues.
    Mr. di Florio. Sure. First, Senator Reed, we are very 
cognizant of the revolving door issues and have put in place a 
number of significant controls that really focus on that issue. 
We have an Ethics office that reports directly to the Chairman 
and has a new head and is very focused on ensuring that there 
are effective policies and procedures, and there are 
limitations on how people can interact with the SEC once they 
leave the SEC. They maintain that dialog with the Office of 
Ethics. So there are a lot of rules, both civil and criminal, 
that govern our conduct with regard to the revolving door.
    In the Exam Program, in addition to that, we have our own 
Code of Conduct that adds additional requirements because we 
want to make sure that examiners do not present conflict of 
interest, and there are additional controls that require 
supervisors to be dialoguing with individuals on their team 
involved in various exams and make sure that there are not any 
conflicts or relationships.
    I would make an observation on the flip side, which is that 
we have been able to bring in some terrific talent to the SEC 
that makes us relevant and current with regard to complex 
structured products, derivatives, hedge funds, because we are 
able to recruit people who have their finger on the pulse of 
industry practices.
    And my observation in my own view has been that individuals 
that we have brought in with industry expertise and experience 
have been some of our most effective and aggressive examiners 
because they understand the games that registrants can play. 
They are very focused on targeting our efforts exactly to those 
high-risk points of interaction or product and making sure that 
we are identifying those issues.
    So I think when it works well, the complement of our 
talented and dedicated existing team at the SEC, coupled with 
incoming individuals from industry to bring new expertise and 
experience, really strikes a terrific balance and makes us more 
effective in protecting investors, ensuring market integrity, 
staying in front of issues, and being able to protect the 
markets and investors.
    With regard to the second issue on morale, I think that is 
a terrific question and something that we are very focused on 
at the SEC. Chairman Schapiro has fostered a very open culture 
of teamwork and collaboration, and I think that is stronger 
than it has probably ever been at the SEC.
    At the same time, we have an incredible workload with Dodd-
Frank and have made requests for more resources to help us meet 
that workload. And I think that tension can create some morale 
challenges that we need to be very cognizant of. There is a 
relationship between resources and morale and an ability to do 
the job well.
    At the same time, we have initiated, throughout the agency, 
human capital surveys to make sure that we are keeping our 
finger on the pulse of morale, what are the root causes of 
morale concerns or issues, and putting in place action plans 
every year that are monitored to follow up on the morale 
issues.
    And I think that that is something that we all need to make 
a priority and we do, as directors of the various divisions and 
offices. I know in the National Exam Program, people, culture, 
and morale is one of our top priorities this year.
    Chairman Reed. Thank you. Mr. Lewis, please, any comments?
    Mr. Lewis. With respect to the issue of morale?
    Chairman Reed. Or people coming in and out, too close. You 
are somewhat removed because of your analytical 
responsibilities, but those two topics, comments that you might 
have.
    Mr. Lewis. Well, if I had to comment on the revolving door, 
I would say it is probably a good thing for economists because 
they basically go back to their academic institutions when they 
revolve back out. And actually, if we can engage financial 
economists in becoming interested in regulation, it creates a 
lot more opportunity to see research being conducted, 
independent research being conducted around the rulemaking 
space. So you could argue it is a positive for my division.
    With respect to morale, I have only been in the office 
since June, but I would like to think that things are going 
pretty well.
    Chairman Reed. Good. Ms. Rominger.
    Ms. Rominger. In the Division of Investment Management, 
there are very few people in the division, with the exception 
of myself, who have come from the asset management industry. 
Frankly, I think we need additional people from the industry. 
It has grown much more complex over time.
    Some of the challenges we are facing today are quite 
different than the challenges that the division faced 5 or 10 
years ago, and with the increase in complexity, we need people 
on board who understand how these instruments and how these 
strategies actually work in the real world.
    And so, we absolutely must have the correct protections in 
place to make sure that we have the appropriate distance as 
regulators, but we do need that expertise. So with respect to 
morale, in my 9 months at the SEC, I have found that most of 
the people I work with are motivated to engage in public 
service because of their strong desire that they can make 
things better and that is what drives them and motivates them.
    And I think morale is quite good because I think they get a 
sense that there is a great deal of positive change occurring 
in the agency right now.
    Chairman Reed. Thank you. Mr. Cook, please.
    Mr. Cook. Thank you. I think keeping in touch with the 
markets and keeping up to speed with the latest developments is 
critical to the effective implementation of our 
responsibilities and we do that through a variety of ways 
including the comment process, and meetings with market 
participants.
    But the ability to bring in folks who have been on the 
other side and know where the issues lurk, I think, is pretty 
crucial. I echo the comments of my colleagues about how it is 
obviously crucial to manage the ethical obligations associated 
with that, but I think that that can be done and done 
effectively, and I think it has really enhanced and enriched 
our ability to try to get the rules right.
    In terms of morale, I would just add that I am, having come 
from outside of Government into Government, I am truly amazed 
by the dedication of the staff and the long hours they put in 
on the tasks that we give them. The productivity in our 
division is many multiples of what it has been in some prior 
years in terms of just the output. Same number of people, much 
more being asked of them and it is truly remarkable how far 
they are willing to go.
    I think to some extent, this is why they are there. This is 
a great time to be working at the agency and working on these 
key issues. But I would echo the concerns that have been 
mentioned already about how ultimately people do need to feel 
they have the resources to do their jobs effectively, and it is 
hard to take the hill if you do not have the right equipment 
and manpower.
    Chairman Reed. Absolutely. Ms. Cross.
    Ms. Cross. I agree with everything that has been said about 
the revolving door--the fresh insights that come in from people 
who have recently been in industry help us do our job better. 
And we are extremely careful about the ethical concerns. You 
have heard me mention recusals today. There is no shame in 
saying, I cannot work on something because I had a contact with 
it in my prior job, and I think that regularly occurs and I 
think that is an important----
    Chairman Reed. If I may, one of the concerns is not so much 
people coming in, it is the people going out, and----
    Ms. Cross. And I think on the going out front, I would say, 
since I have done that----
    Chairman Reed. Right.
    Ms. Cross. ----I think that overall, the investing public 
benefits because people who have worked at the Commission have 
an appreciation of what it is that we are trying to do, and I 
think SEC alumni are especially careful practitioners. I think 
they go out and populate the securities bar with people who 
want to do the right thing. So I think actually it is a very 
positive development and I would hope it will continue.
    On the morale point, I would like to echo what Robert said 
about the incredibly hard work the staff is currently going 
through. I worry sometimes that we do not say enough about how 
much we appreciate them. You have to stop and take a deep 
breath and remember to do that a lot because they have all been 
sacrificing their personal lives to work through the Dodd-Frank 
rulemaking, and before that we were very busy in my division 
with rulemaking. So it has been flat-out for 2\1/2\ years since 
I have been there.
    And then on the review program, I am amazed every day at 
how enthusiastic and fresh they remain when they pick up a 
company and they look at the filing and they search the 
Internet to see what else the company is saying and come up 
with good comments that improve the disclosures.
    And I think that--I hope--morale is good. It is hard to 
know with as many people as we have, but I would say that I 
know I appreciate how hard they are working.
    Chairman Reed. Thank you. Mr. Khuzami.
    Mr. Khuzami. Yes, thank you, Mr. Chairman. I agree with the 
sentiments expressed here. With respect to the expertise, it is 
critically important. You know, it was not very long ago at all 
that everyone was criticizing the SEC for lacking the expertise 
in order to deal with complex products and transactions and 
markets, and we have done that.
    We have as good, if not better, set of ethical restrictions 
on the way out with respect to permanent bans on involvement in 
matters that you participated in once you leave, 2-year ban on 
being involved in matters that you supervised, and just down 
the line a great deal of restrictions.
    Second of all, in my experience, both in the Department of 
Justice and here, particularly the SEC, the ability of one 
person, even if they were so inclined, not to do anything other 
than follow a case on its merits and make a recommendation and 
decision and take investigative steps that were in the best 
interest of the case, is virtually impossible to do.
    We work in teams with great levels of review by multiple 
people, with thorough oversight. It would be very difficult for 
one person to do that, even if they were so inclined, and I 
have not met such a person.
    In addition, that is not the way you would gain any respect 
within the Enforcement Division and within the Commission. You 
are respected if you are hard-driving and thorough and 
professional and disciplined and intelligent. And to do 
anything else hurts your reputation, hurts your ability in the 
outside world, when and if you were to leave.
    And last, the people who leave the SEC are really 
Ambassadors for compliance and good practices. They go to firms 
and they advise clients and they know the consequences of what 
can happen if they cross the line, and we have to leverage 
those people so that some CEO who may be inclined to take a 
shortcut will listen to their general counsel or their 
compliance officer who says, Here is what can happen to you, 
here is what the SEC might do if you do not act appropriately. 
So I think it is a win-win all the way around.
    GAO looked at our revolving door issues as part of Dodd-
Frank and came away with the single recommendation that we 
should better document our ethics advice. And so, I think all 
in all, the arrangement is the right one for investors.
    With respect to morale, people work incredibly hard and are 
incredibly committed. The undifferentiated criticism that 
sometimes occurs takes its toll, quite honestly. People are not 
afraid of being told that they can do things better. We 
restructured the entire Enforcement Division. People responded 
in a way that is in the best traditions of anybody in the 
public or private sector. You know, do not shoot the messenger. 
Look at what is the right thing to do. Make changes that are 
necessary. That has occurred up and down throughout the 
division.
    What will happen is eventually if the market turns and 
people do not have the resources they need, they will be more 
attracted to jobs on the outside and that would be a terrible, 
I think, result for investor protection and our efforts because 
our employees are highly valued and experienced.
    They want to be at the SEC. They want to be public 
servants. It can be difficult if you are at the Xerox machine 
at 11 o'clock at night photocopying your own trial exhibits. 
That is what happens.
    Chairman Reed. Well, thank you all very, very much today, 
not only for your thoughtful responses and testimony, but for 
your dedicated public service and particularly your patience. 
Thank you all.
    If Members, my colleagues, have their own written 
statements or additional questions for witnesses, they should 
be submitted no later than next Wednesday, November 23rd, and I 
would ask the panel to respond as quickly as possible to any 
written questions you may receive.
    All the written testimony that you have submitted will 
become part of the record. Again, I thank you for your service 
and for your testimony this morning. With that, the hearing is 
adjourned.
    [Whereupon, at 11:31 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
 PREPARED JOINT STATEMENT OF HEARING WITNESSES FROM THE SECURITIES AND 
                          EXCHANGE COMMISSION
                           November 16, 2011 

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