[Senate Hearing 113-630]
[From the U.S. Government Publishing Office]
FINANCIAL SERVICES AND GENERAL GOV-
ERNMENT APPROPRIATIONS FOR FISCAL
YEAR 2015
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WEDNESDAY, MAY 14, 2014
U.S. Senate,
Subcommittee of the Committee on Appropriations,
Washington, DC.
The subcommittee met at 2 p.m., in room SD-138, Dirksen
Senate Office Building, Hon. Tom Udall (chairman) presiding.
Present: Senators Udall, Coons, Johanns, and Moran.
SECURITIES AND EXCHANGE COMMISSION
STATEMENT OF HON. MARY JO WHITE, CHAIR
OPENING STATEMENT OF SENATOR TOM UDALL
Senator Udall. Good afternoon. The subcommittee will come
to order.
I am pleased to convene this hearing of the Financial
Services and General Government Subcommittee to consider the
fiscal year 2015 funding requests of two key Federal regulatory
agencies, the Securities and Exchange Commission (SEC) and the
Commodity Futures Trading Commission (CFTC).
I welcome my distinguished ranking member, Senator Mike
Johanns, and some of our other colleagues I think will join us
here throughout the day.
Joining us today are also the Honorable Mary Jo White,
Chair of the Securities and Exchange Commission, and the
Honorable Mark Wetjen, Acting Chairman of the Commodity Futures
Trading Commission. They will discuss the critical work of
their agencies, their use of resources provided over the past
couple of years, and their budget needs for fiscal year 2015.
The workload for these agencies has grown dramatically in
recent years. The SEC and the CFTC all play critical roles in
stimulating and sustaining economic growth and prosperity in
our country, in protecting the marketplace from fraud and
manipulation, and in carrying out Dodd-Frank reforms. My
constituents have made clear they support these reforms to
prevent the reckless and abusive practices that led to the
financial crisis.
Fortunately, some sectors of our country are recovering.
But sadly, many families have not recovered, and they continue
to struggle. I believe it is my responsibility to the hard-
working and honest people of New Mexico and to all Americans
who suffered as a result of this crisis to ensure that we work
to fully implement Dodd-Frank.
We need a financial system that is safe and sound because
what happens on Wall Street touches every American family.
Whether they are saving to buy their first home, helping to put
their children through college, or planning for retirement,
they put their faith in the financial markets being sound. We
cannot let them down.
And they are not alone. Market users, financial investors,
and the U.S. economy all depend on vigilant oversight by these
two agencies, especially in today's rapid-paced, evolving, and
often volatile global marketplace.
In the past few years, both Chair White and Acting Chairman
Wetjen and their fellow commissioners and their respective
staffs I think have worked very hard to create a more reliable
regulatory structure to ensure the stability and integrity of
the futures and securities markets. But there is still, I think
everyone will admit, a lot of work to be done.
We depend on your leadership to implement the reforms
designed to strengthen our regulatory framework, to do so
promptly, prudently, and transparently, and help guard against
another financial meltdown.
As the investors' advocate, the SEC has an important role
in maintaining fair, orderly, and efficient stock in securities
markets. The SEC conducts day-to-day oversight of the major
market participants, monitors corporate disclosure of
information to the investing public, and investigates and
pursues enforcement action against securities laws violations.
Dodd-Frank dramatically expanded the SEC's
responsibilities. The SEC was thrust into the driver's seat for
issuing nearly 100 new rules, creating five new offices,
issuing more than 20 studies and reports, overseeing the over-
the-counter derivatives market and hedge fund advisers,
registering municipal advisers and security-based swap market
participants, and setting up a new whistleblower program.
The Jumpstart Our Business Startups Act of 2012 (JOBS Act)
added more to SEC's plate for further rules and studies on
capital formation, disclosure, and registration requirements.
Turning to the CFTC now, the CFTC carries out market
surveillance, compliance, and enforcement programs in the
futures and swaps arena. It detects, deters, and punishes
abusive trading activity and manipulation of commodity prices,
helping to prevent negative impacts both on consumers and on
the economy.
Four years ago, the CFTC's mission was substantially
expanded to include new oversight of the swaps marketplace, the
vast once-in-the-shadows world of over-the-counter derivatives.
It is a significantly transformed and highly diversified
marketplace, one that is globalized, electronic, and around the
clock.
The enactment of Wall Street reform in 2010 also added to
the job of the CFTC. CFTC now has oversight of the once
unregulated $400 trillion over-the-counter U.S. derivatives
market to protect and benefit end-users and the broader
American public. This complex swaps market has a notional value
of nearly eight times the size of that of the futures market.
Now, the forecast for 2015, looking ahead for fiscal year
2015 for the SEC, the President seeks funding of $1.7 billion,
an increase of $350 million, 26 percent above the fiscal year
2014 base enacted level of $1.35 billion. It is $236 million
above the SEC's $1.464 billion current operating level. The
$1.7 billion requested for fiscal year 2015 will support 5,143
permanent positions, an increase of 639 positions over the
current 4,504 permanent positions, for a 14 percent growth in
staff.
And for the CFTC, the President's budget requests $280
million, an increase of $65 million above the fiscal year 2014
enacted level of $215 million. This is a 30 percent increase in
funding above the current level. The proposed fiscal year 2015
level will support 920 staff or 253 more when compared to the
current staffing level of 667, a 37 percent increase.
Congress probably exercises its most effective oversight of
agencies and programs through the appropriations process,
permitting an annual checkup and review of operations, of
activities, and spending. Today's hearing provides a valuable
opportunity to ask some important questions.
Are the SEC and the CFTC keeping pace with the developments
in the markets, particularly with more complex financial
products which are emerging?
Do these agencies have the right mix of talent and
specialized expertise to be vigilant watchdogs?
Do they have the state-of-the-art information technology to
augment and support their human capital?
What are the top priorities for use of the resources
proposed for 2015?
And what are the likely consequences of continued budget
shortfalls and reduced resources?
I know Senator Johanns and I welcome the opportunity to
conduct critical oversight of these two agencies. And I now
turn to my distinguished ranking member, Senator Mike Johanns,
for his opening remarks.
STATEMENT OF SENATOR MIKE JOHANNS
Senator Johanns. Mr. Chairman, let me just start out and
say thank you to the witnesses for being here with us today. I
thank you, Mr. Chairman, for holding yet another important
hearing as we work our way through the various budget requests
under our subcommittee's jurisdiction.
I do look forward to hearing from the witnesses today
regarding the details of your requests as well as your plans to
carry out core missions and implement Dodd-Frank in a
responsible manner. There are three areas that I would like to
highlight, looking forward to your testimony and my questions.
First, the SEC's implementation of the JOBS Act. Where is
that on schedule? I am concerned that it is not on schedule,
and I want to learn more about that. I do encourage the SEC and
your team to move with all appropriate speed in finalizing
Regulation A and the crowdfunding rules.
Second, I would like to get both of your thoughts on
technological advancement in the marketplace, and what your
agencies are doing on the technology front to adapt.
And finally, I ask you to be persistent in trying to work
together and coordinate with your fellow regulators. Any
conflicts between SEC and CFTC on cross-border swaps and lack
of coordination between the SEC and Department of Labor over
fiduciary standards continues to cause uncertainty and
confusion.
Derivatives markets and effective oversight of those
markets matter a lot to farmers, to homeowners, and to small
businesses. We all benefit from a system that promotes fair and
orderly markets. So I am concerned when certain agency rules
seem to fragment the market and push businesses overseas.
In some instances, the CFTC has moved too quickly. Others,
the Commission has simply chosen to issue guidance in what
looks like an effort to avoid cost-benefit analysis. In many
cases, the Commission has opted to act alone instead of
properly coordinating with the SEC as well as other domestic
and international regulators.
In order to be an effective regulator, transparency is
critical. This need for transparency and coordination is
evident in the CFTC's approach to cross-border implementation
swaps regulation. CFTC's guidance, the delays, the lack of
coordination with other regulators have led to confusion and
concern for market participants, foreign government finance
ministers, and investors here and abroad.
No doubt that both the CFTC and SEC have an important job
of protecting investors who look to the markets to help secure
their retirements, pay for their homes, send kids to college.
Your agencies have an obligation to protect consumers,
hopefully, from the next Madoff, MF Global, or Stanford.
As we look at both of your budget requests, two things come
to mind. First, technological solutions are important to keep
up with next-generation trading platforms that operate at
lightning speeds. Two, staffing levels have to be carefully
considered. We also have to make sure that they are
sustainable.
All agencies have to make strategic decisions on how best
to allocate resources. As we all know, simple increasing
funding doesn't necessarily ensure that the agency will
successfully achieve its mission.
So, to the chairs, you both have difficult tasks before
you. We ask a lot. We ask that you improve transparency in our
securities markets, uncover fraud and deception, without over-
regulating our markets and hindering economic growth.
Chairman Udall, again, I look forward to working with you
as we consider the fiscal year 2015 budget requests of the CFTC
and the SEC, and I look forward to the testimony and the
opportunity to ask questions.
Thank you, Mr. Chairman.
Senator Udall. Thank you very much, Senator Johanns.
And at this time, I would invite Chair White to present
testimony on behalf of the SEC, followed by Acting Chairman
Wetjen on behalf of the CFTC. You each will have 5 minutes. I
know you have very thorough statements, which will be put in
the record, and you can use your 5 minutes as you choose.
Please proceed, Chair White.
SUMMARY STATEMENT OF HON. MARY JO WHITE
Ms. White. Thank you, Chairman Udall, Ranking Member
Johanns. Thank you for inviting me to testify in support of the
President's fiscal year 2015 budget for the Securities and
Exchange Commission.
Now more than ever, investors and our markets need a
strong, vigilant, and adequately resourced SEC. To put the
SEC's extensive responsibilities and its 2015 budget request
into context--from fiscal year 2001 to fiscal year 2014,
trading volume in the equity markets more than doubled to a
projected $71 trillion. The complexities of financial products
and the speed with which they are traded increased
exponentially.
Assets under management of mutual funds grew by 131 percent
to $14.8 trillion, and assets under management of investment
advisers jumped almost 200 percent to $55 trillion. There are
today over 25,000 SEC registrants, including broker-dealers,
clearing agents, transfer agents, credit rating agencies,
exchanges, and others.
During this time of unprecedented growth and change in our
markets, the SEC also has been given significant new
responsibilities for over-the-counter derivatives, private fund
advisers, municipal advisors, crowdfunding portals, and more.
The President's $1.7 billion budget request would enable
the SEC to address critical core priorities including enhancing
examination coverage for investment advisers and other key
entities who deal with retail and institutional investors;
protecting investors by expanding our enforcement program's
investigative capabilities, and strengthening our ability to
litigate against wrongdoers; deploying and leveraging cutting-
edge technology to better keep pace with those we regulate,
make our operations more efficient, and improve our ability to
identify a variety of market risks, including emerging frauds.
The SEC's funding, as you know, is deficit neutral, which
means that the amount Congress appropriates is offset by
transaction fees and thus does not impact the deficit, the
funding available for other agencies, or count against the caps
in the congressional budget framework.
Nonetheless, I fully recognize my duty to be an effective
and prudent steward of the funds we are appropriated. I believe
our accomplishments in the past year should give Congress and
the public confidence that we will fulfill this responsibility.
RECENT SEC ACCOMPLISHMENTS
While certainly much more remains to be done, since my
arrival in April 2013, the Commission has adopted or proposed
more than 20 significant rulemakings, including many mandated
by the Dodd-Frank and JOBS Acts, across the regulatory spectrum
of our jurisdiction. My written testimony details these.
We are also now more aggressively enforcing the securities
laws, requiring for the first time admissions to hold certain
wrongdoers more publicly accountable. And in fiscal year 2013,
we obtained orders for penalties and disgorgements of $3.4
billion, the highest in the agency's history.
We have intensified our data-driven disciplined approach to
analyzing and appropriately addressing complex market structure
issues, such as high-frequency trading and dark pools,
implementing a powerful new analytical tool called MIDAS. We
have begun a comprehensive review of the SEC's public company
disclosure rules to make disclosures more meaningful to
investors while at the same time making them more cost
effective for companies.
And I want to make clear that this significant progress I
am talking about was due to the incredible commitment, talent,
and expertise of the SEC staff. The fiscal year 2015 budget
request would permit the SEC to increase its examination
coverage of investment advisers who everyday investors are
increasingly turning to for investment assistance for
retirement and family needs.
SEC FUNDING NEEDS
While the SEC has made the most of its limited resources,
we nevertheless were only able to examine 9 percent of
registered investment advisers in fiscal year 2013. In 2004, 10
years ago, the SEC had 19 examiners per trillion dollars in
investment adviser assets under management. Today, in 2014, we
have only eight. More coverage is plainly needed, and the
industry itself has acknowledged that.
Very importantly, this budget request would also allow us
to better leverage technology across the agency to support a
number of key initiatives.
This budget request also allows us to continue augmenting
our Division of Economic and Risk Analysis by adding financial
economists and other experts to assist with economic analysis
in rulemaking, risk-based selection for investigations and
examinations, and structured data initiatives.
PREPARED STATEMENT
I firmly believe that the funding we seek is fully
justified by our important and growing responsibilities to
investors, companies, and the markets. Your continued support
will allow us to better fulfill our mission and to build on the
significant progress the agency has achieved, which I am
committed to continuing and enhancing.
I would be pleased to answer any of your questions.
[The statement follows:]
Prepared Statement of Hon. Mary Jo White
Chairman Udall, Ranking Member Johanns, and members of the
subcommittee:
Thank you for inviting me to testify today in support of the
President's fiscal year 2015 budget request for the Securities and
Exchange Commission.\1\ I appreciate the opportunity to describe why
and how the SEC needs the $1.7 billion requested for the coming fiscal
year in order to fulfill the obligations given to the agency by
Congress to protect investors, maintain fair, orderly, and efficient
markets, and facilitate capital formation.\2\
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\1\ A copy of the SEC's fiscal year 2015 Budget Congressional
Justification can be found on our website at http://www.sec.gov/about/
reports/secfy15congbudgjust.shtml.
\2\ The views expressed in this testimony are those of the Chair of
the Securities and Exchange Commission and do not necessarily represent
the views of the President, the full Commission, or any Commissioner.
In accordance with past practice, the budget justification of the
agency was submitted by the Chair and was not voted on by the full
Commission.
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I am pleased by the SEC's accomplishments this past year. We
adopted or proposed a substantial volume of mandated and other key
rules. We aggressively enforced the securities laws, changing a key
policy that can hold wrongdoers more publicly accountable and obtaining
orders for penalties and disgorgement of $3.4 billion in fiscal year
2013, the highest in the agency's history. We launched MIDAS and
intensified our review of market structure issues, including high-
frequency and off-exchange trading practices. And we have continued to
improve our efficiency by enhancing our technology, bringing in more
experts, and deploying more risk-based analytics to allow us to do more
with our limited resources, and to do so more quickly.
And with last week being Public Service Recognition Week, I want to
take this occasion to make clear that none of this would have been
possible without the incredible commitment, talent, and expertise of
the staff of the SEC.
As described in more detail below, the requested budget level would
allow the SEC to build upon its strong efforts and accomplish several
key and pressing priorities, including:
--Bolstering examination coverage for investment advisers and other
key areas within the agency's jurisdiction;
--Strengthening our enforcement program's efforts to detect,
investigate, and prosecute wrongdoing;
--Continuing the agency's investments in the technologies needed to
keep pace with today's high-tech, high-speed markets; and
--Enhancing the agency's oversight of the rapidly changing markets
and ability to carry out its increased regulatory
responsibilities.
significant gains, but work remains
The SEC's funding mechanism is deficit-neutral, which means that
the amount Congress appropriates to the agency will not have an impact
on the nation's budget deficit, nor will it impact the amount of
funding available for other agencies.\3\ Our appropriation also does
not count against the caps set in the bi-partisan Congressional budget
framework for 2014 and 2015.
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\3\ Section 991 of the Dodd-Frank Act requires the SEC to collect
transaction fees from self-regulatory organizations in an amount
designed to directly offset our appropriation. The current fee rate is
about $0.02 per every $1,000 transacted.
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Nonetheless, I deeply appreciate that I have a serious
responsibility to be an effective and prudent steward of the funds we
are appropriated. Since my arrival just over a year ago, we have made
every effort to effectively deploy our funds to accomplish our mission
and the goals that Congress has set for us. And, within the last year,
we have advanced a significant number of rules and other initiatives
across the wide range of our responsibilities with respect to the
regulatory objectives mandated for the SEC by the Dodd-Frank Wall
Street Reform and Consumer Protection Act (``Dodd-Frank Act'') and the
Jumpstart Our Business Startups Act (``JOBS Act''), proposing or
adopting rules concerning, among other things:
--The registration and regulation of nearly a thousand municipal
advisors;
--The cross-border application of our security-based swap rules in
the global swaps market;
--Lifting the ban on general solicitation in certain private
offerings and proposing rules to provide important data and
investor protections for this new market;
--Proprietary trading and investments in private funds by banks and
their affiliates, under what is commonly called the ``Volcker
Rule'';
--Increasing access to capital for smaller companies by permitting
securities-based crowdfunding;
--Programs required of broker-dealers, investment companies, and
other regulated entities to address risks of identity theft;
--Further safeguarding the custody of customer funds and securities
by broker-dealers;
--Updating and expanding the Regulation A exemption for raising
capital;
--The retention of a certain amount of credit risk by securitizers of
asset-backed securities;
--The removal of references to nationally recognized statistical
rating organization ratings in our broker-dealer and investment
company regulations; and
--Enhancing risk management and other standards for the clearing
agencies responsible for the safe and efficient transfer of
trillions of dollars of securities each year.
In addition, we put forward rule proposals to strengthen and reform
the structure of money market funds and require that certain key market
infrastructure participants have comprehensive policies and procedures
to better insulate market infrastructure technological systems from
vulnerabilities.
We also have taken steps to enhance the SEC's already strong
enforcement program, including by modifying the longstanding ``no
admit/no deny'' settlement protocol to require admissions in certain
cases. While no admit/no deny settlements still make a great deal of
sense in many situations, because admissions achieve a greater measure
of public accountability, they can bolster the public's confidence in
the strength and credibility of law enforcement and in the integrity of
our markets. Already the Commission has resolved a number of cases with
admissions, and my expectation is that there will be more such cases in
2014 as the new protocol continues to evolve and be applied. The
Commission also has brought a number of significant enforcement cases
across our regulatory spectrum, including actions against exchanges to
ensure they operate fairly and in compliance with applicable rules,
actions against auditors and others who serve as gatekeepers in our
financial system, landmark insider trading cases, and additional cases
against individuals and entities whose actions contributed to the
financial crisis.
In the past year, the Commission also has made great strides to
improve its technology, including through the development of tools that
permit us to better understand and protect the integrity of our markets
and inform our exam program. In October 2013, the agency brought on-
line a transformative tool called MIDAS that enables us to analyze
enormous amounts of trading data across markets almost instantaneously.
The SEC's Quantitative Analytics Unit in our National Exam Program has
developed groundbreaking new technology that allows our examiners to
access and systematically analyze massive amounts of trading data from
firms in a fraction of the time it has taken in years past. We are
laying the technological foundation for unified access to SEC
information, applications, and data across the agency, and are making a
variety of other technological investments to enable us to meet our
mission more efficiently and effectively.
Despite this significant progress, there is much that the SEC still
needs to accomplish. Completing the rulemakings and studies mandated by
Congress in the Dodd-Frank and JOBS Acts remains among my top
priorities. We must continue to seek to address structural concerns
about our complex, dispersed marketplace in a responsible and
empirically-based manner, and also continue our current review of the
SEC's public issuer disclosure rules. We also need to continue to
increase our capacity to examine and oversee the entities under the
SEC's jurisdiction, as well as hold accountable those that harm
investors through securities law violations. We are at a critical point
in the deployment of more sophisticated technology tools and platforms,
and it is vital that we have the resources necessary to continue
modernizing our IT systems and infrastructure.
The SEC needs significant additional resources to keep pace with
the growing size and complexity of the securities markets and the
agency's broad responsibilities. The agency currently oversees more
than 25,000 market participants, including over 11,000 investment
advisers, approximately 10,000 mutual funds and exchange-traded funds,
4,450 broker-dealers, 450 transfer agents, 18 securities exchanges, as
well as the Public Company Accounting Oversight Board (PCAOB),
Financial Industry Regulatory Authority (FINRA), Municipal Securities
Rulemaking Board (MSRB), Securities Investor Protection Corporation
(SIPC), and Financial Accounting Standards Board (FASB). The SEC also
has responsibility for reviewing the disclosures and financial
statements of approximately 9,000 reporting companies, and has new and
expanded responsibilities over the derivatives markets, an additional
2,500 reporting advisers to hedge fund and other private funds, close
to 1,000 municipal advisors, ten registered credit rating agencies, and
seven registered clearing agencies. And, as you know, between the Dodd-
Frank and the JOBS Acts, the SEC was given nearly 100 new rulemaking
responsibilities.
The SEC's responsibilities are extensive and complex and its
mission is critically important. The funding we are seeking is fully
justified by our growing responsibilities to investors, companies, and
the markets. With what I believe is a thoughtful and targeted approach
to our resource challenges, the fiscal year 2015 budget request of $1.7
billion would allow the SEC to hire an additional 639 staff in
critical, core areas and enhance our information technology.
Outlined below is a brief overview of some of the key components of
our request.
expanding oversight of investment advisers and strengthening compliance
There is an immediate and pressing need for significant additional
resources to permit the SEC to increase its examination coverage of
registered investment advisers so as to better protect investors and
our markets. During fiscal year 2013, due to significant resource
constraints, the SEC examined only about 9 percent of these advisers,
comprising approximately 25 percent of the assets under management.
The number of SEC-registered advisers has increased by more than 40
percent over the last decade, while the assets under management by
these advisers have increased more than two-fold, to almost $55
trillion. At the same time, the industry has been increasing its use of
new and complex products, including derivatives and certain structured
products, employing technologies that facilitate high-frequency and
algorithmic trading, and developing complex ``families'' of financial
services companies with integrated operations that include both broker-
dealer and investment adviser affiliates. While the SEC has efficiently
used its limited resources by improving its risk assessment IT
capabilities and focusing its examination staff and resources on those
areas posing the greatest risk to investors, in 2004, the SEC had 19
examiners per trillion dollars in investment adviser assets under
management. Today, we have only 8. More coverage is clearly needed as
the status quo does not begin to provide sufficient protection for
investors who increasingly turn to investment advisers for assistance
navigating the securities markets and investing for retirement and
family needs.
A top SEC priority under the fiscal year 2015 request is to add 316
additional staff to the examination program in its Office of Compliance
Inspections and Examinations (OCIE). This would allow the agency to
examine more registered firms, particularly in the investment
management industry; build out the examination program to implement
newly expanded responsibilities with respect to municipal advisors,
swap market participants, private fund advisers, crowdfunding portals
and other new registrants; and more effectively risk-target and monitor
other market participants. Additionally, OCIE would also be able to
continue ongoing efforts to enhance its risk assessment and
surveillance through the development of new technologies in areas such
as text analytics, visualization, search and predictive analytics.
bolstering enforcement
Strong and effective enforcement of our Federal securities laws is
central to the SEC's mission. In addition to modifying our settlement
policy to require public admissions in certain cases, the Commission in
the last year brought groundbreaking cases across the full range of the
securities laws, including, among many others, a $615 million
settlement of an insider trading case; a failure to supervise case
against a prominent hedge fund adviser; actions against exchanges and
municipal issuers; Foreign Corrupt Practices Act cases against large
multinational corporations; and additional matters against individuals
and entities whose actions contributed to the financial crisis.
Notwithstanding these results, the SEC's Division of Enforcement
faces a number of key challenges to preserve and enhance its ability to
vigorously pursue the entire spectrum of wrongdoing within our
jurisdiction. Our Enforcement work includes the detection,
investigation, and litigation of violations of the Federal securities
laws. In each of these areas, we face significant challenges:
--Detection. We receive over 15,000 tips, complaints, and referrals
annually, including the more than 3,000 tips that flow into the
Division's Whistleblower Office, which generate a fresh stream
of case leads in need of investigation. The review and analysis
of these tips require significant human and technological
resources. We also have focused intensively on potential
misconduct in the equity markets and in connection with new
rules, including those implemented under the Dodd-Frank and
JOBS Acts. But detecting misconduct in constantly evolving
securities markets, including as a result of the growth of
algorithmic, automated trading and ``dark pools,'' requires
substantial resources.
--Investigations. Technological advances across the industry allow
for more sophisticated schemes, which require improved
technology and significant resources to unravel. We also are
expanding our focus on financial reporting and auditing
misconduct cases, which are highly technical and labor
intensive.
--Litigation. We have seen an increase in litigation and trials as we
focus more extensively on individual wrongdoing. And, the
recent change to our long-standing settlement policy that now
requires admissions in certain cases may lead to more
litigation. Success at trial is critical to our ability to
carry out our mission, and litigation, often against well-
funded opposition.
In order to meet the challenges of our rapidly changing and
expanding markets, with increasingly complex products and more
sophisticated wrongdoers, Enforcement seeks to hire 126 new staff,
including additional legal, accounting, and industry specialized
experts, primarily for investigations and litigation. These critical
resources will enable us to improve our information processing and
analysis, expand our investigative capabilities, strengthen our
litigation capacity, and better use technology. In addition, the
Division will continue to: (1) invest in technology that enables the
staff to work more efficiently and effectively, and (2) collaborate
with external stakeholders who assist in the Division's identification,
investigation, and litigation of securities law violations, including
wrongdoing that crosses borders.
leveraging technology
The SEC is strongly committed to leveraging technology to
streamline operations and increase the effectiveness of its programs.
We are developing new analytic tools designed to process data more
efficiently and make timelier and better-informed decisions. For
example, we apply cutting-edge analytics, such as visual data analysis,
to increase the speed with which the exam and enforcement program
evaluate data and develop evidence. To support these tools, we are
investing in our information technology infrastructure to store and
process increased volumes of data. We generated over $18 million in
cost avoidance in fiscal year 2013 through a more efficient data center
structure, renegotiated contracts, server virtualization, and other
process improvements. Our recently initiated Quantitative Research and
Analytic Data Support program is structuring vast quantities of
financial market data and making it more accessible across the agency.
This program will enhance the quality and speed of data-driven analyses
and, importantly, link disparate sources of data to allow staff to
establish connections not previously possible.
While the agency has made significant progress over the past few
years in modernizing its technological systems, progress was set back
by our level of funding in fiscal year 2014. Increased funding for
these efforts and new technology investments are essential. The SEC's
fiscal year 2015 budget request, which includes full use of the SEC
Reserve Fund, would support a number of key information technology
initiatives, including:
--EDGAR modernization, a multi-year effort to simplify the financial
reporting process to promote automation and reduce filer
burden. EDGAR provides the most critical window into the
capital markets for investors and businesses. With a more
modern EDGAR, both the investing public and SEC staff will
benefit from having access to better data.
--Enterprise Data Warehouse, a centralized repository for the
Commission to organize different sources of data, which can
help the public gain easier access to more usable market data,
which will facilitate easier and more effective analysis.
--Data analytics tools, to assist in the integration and analysis of
large amounts of data, allowing for computations, algorithms
and quantitative models that can lead to earlier detection of
fraud or suspicious behavior. We have begun deploying these
tools on a limited basis within our enforcement and exam
programs, but due to current budget constraints have not yet
rolled them out more broadly. Under this request, more front-
line staff, including those performing examinations and
investigations, would be able to leverage these tools to
efficiently identify links, anomalies, or indicators of
possible securities violations.
--Examination improvements, to improve risk assessment and
surveillance tools and datasets that will help the staff
monitor for trends and emerging fraud risks, as well as
improving the workflow system supporting SEC examinations.
--Enforcement investigation and litigation tracking, to support
Enforcement teams with the receipt and loading of the high
volume of materials produced during investigations and
litigation, to build the capability to permit the electronic
transmittal of data, and to implement a document management
system for Enforcement's internal case files.
--SEC.gov modernization, to make one of the most widely used Federal
government websites more flexible, informative, easier to
navigate and secure for investors, registrants, public
companies, and the general public. SEC.gov receives more than
35 million hits per day, and there is high public demand for
quick and ready access to the tremendous amount of data
available there, including 21 million filings in the EDGAR
system and 170,000 documents on SEC.gov. When fully
implemented, the website will offer dramatically improved
search and filtering capabilities that will enhance the
transparency and availability of this data.
--Tips, Complaints, and Referral (TCR) system enhancements, to
bolster flexibility, configurability, and adaptability. The TCR
system is the SEC's central repository of tips, complaints, and
referrals that maximizes our ability to search, track, and
route workflow for the high volume that the agency receives
each year (e.g., over 15,000 in fiscal year 2013). System
enhancements will provide automated triage of the items the
agency receives, as well as improved intake, resolution
tracking, searching, and reporting functionalities.
--Information security, to upgrade security tools and processes, and
to develop and train staff to monitor, respond to, and
remediate ever-increasing risks and security threats and to
permit continuous risk monitoring.
--Business process automation and improvement, to improve the
efficiency and effectiveness of the agency's processes, thereby
enabling us to better serve the public.
strengthening oversight of the securities markets and infrastructure
To effectively assess constantly evolving market activity across a
wide range of complex trading venues, the SEC's Division of Trading and
Markets must:
--Enhance its effort to address market structure and technology
developments, including through MIDAS and other tools that
facilitate the analysis of trade and order data that reflects,
for example, high-frequency trading and trading on off-exchange
venues where pre-trade prices are not typically available to
the public;
--Continue its work with self-regulatory organizations (SROs) to
enhance critical market infrastructures that are essential for
the operation of the securities markets; and
--Expand its oversight of clearing agencies, large broker-dealers,
exchanges, and other major securities market participants.
Further, in fiscal year 2015 we expect a significant number of new
registrants under the Dodd-Frank and JOBS Acts as registration
requirements under those laws go into effect, including dealers and
other participants in the security-based swap market and crowdfunding
portals. Additional resources are needed to undertake these new market-
related responsibilities, including staff focused on market
supervision, analytics and research, and derivatives policy and trading
practices. Accordingly, for these core and new responsibilities, in the
fiscal year 2015 budget request the SEC proposes to add 25 positions in
its Division of Trading and Markets.
enhancing corporate disclosure reviews and supporting implementation of
the jobs act
For fiscal year 2015, the SEC requests 25 new positions for its
Division of Corporation Finance. These resources are needed for
Corporation Finance to continue its multi-year effort to enhance its
disclosure review program for large or financially significant
companies, meet the increased workload resulting from expected improved
market conditions and additional emerging growth companies
confidentially submitting registration statements for non-public
review, provide increased interpretive guidance, and evaluate trends in
the increasingly complex offerings of asset-backed securities and other
structured financial products. During fiscal year 2015, Corporation
Finance also will continue to implement the rulemakings required by the
Dodd-Frank and JOBS Acts and move forward on a comprehensive initiative
to update the disclosure requirements for reporting companies.
focusing on economic and risk analysis to support rulemaking and
structured data and risk-based initiatives
The SEC's Division of Economic and Risk Analysis (DERA) works to
integrate analysis of economic, financial, and legal disciplines with
data analytics and quantitative methodologies in support of the SEC's
mission. DERA is our most rapidly growing division, having more than
doubled since its creation in late 2009. In fiscal year 2014, we are
planning to hire 45 additional staff for DERA, primarily for additional
financial economists and other experts to perform and support economic
analyses and research and further enhance our risk assessment
activities. In fiscal year 2015, we seek to add 14 positions in DERA,
primarily financial economists and other experts who significantly
assist with:
--The rulemaking process by providing the Commission and staff with
economic analysis and technical advice;
--Data analysis for risk-based selection of firms and issues for
inquiries, investigations and examinations; and
--Improving structured data initiatives in order to enable the
Commission, investors, and other market participants to more
systematically and efficiently analyze and draw conclusions
from large quantities of financial information.
DERA also seeks to hire additional technologists with mathematical
and statistical programming experience to support the activities of the
Division, including by assisting with the development of risk
assessment models and risk metrics, data analytics, and economic
analysis in the agency's rulemakings.
enhancing monitoring of the investment management industry
In the past 10 years, the number of portfolios of mutual funds,
exchange-traded funds, and closed-end funds has increased by 17
percent, and assets under management held by those funds has increased
by 123 percent to $16 trillion. And significantly, during that period,
complexity in the investment management industry has increased
dramatically, reflecting growing sophistication in product design and
portfolio strategies.
For fiscal year 2015, the SEC requests 25 new positions for its
Division of Investment Management. With additional resources,
Investment Management plans to:
--Improve the reporting of information about fund operations and
portfolio holdings by mutual funds, closed-end funds, and
exchange traded funds;
--Continue to build capacity to manage and analyze data filed by
hedge funds and other private funds;
--Bolster the technical expertise of Investment Management's
disclosure review program to, among other things, identify
trends and monitor the risks related to the growth and
increased product sophistication in the asset management
industry; and
--Enhance the ability of Investment Management's Risk and
Examinations Office to manage, monitor, and analyze industry
data, and provide ongoing financial analysis of the asset
management industry.
enhancing training and development of sec staff
Nothing is more critical to the agency's success than the expertise
of the SEC's staff. And providing in-depth and up-to-date training is
essential for the staff to maintain and enhance its expertise over our
constantly changing markets. Historically, the SEC's training budget
has not matched that of its Federal financial regulatory agency peers.
The agency is requesting to increase its staff training budget in
fiscal year 2015 principally to support training and development for
employees directly involved in examinations, investigations, fraud
detection, litigation, and other core mission responsibilities of the
SEC. This will consist of specialized training about new trends in the
securities industry and changing market conditions, as well as
analytics and forensics. The investment in training also will allow the
SEC to provide continuing education courses that staff are required to
take to maintain necessary legal and financial credentials.
conclusion
Thank you for your support of the agency's vital mission and the
opportunity to present the President's fiscal year 2015 budget request.
I would be happy to answer your questions.
Senator Udall. Thank you very much.
And Acting Chairman Wetjen, please proceed.
COMMODITY FUTURES TRADING COMMISSION
STATEMENT OF HON. MARK P. WETJEN, ACTING CHAIRMAN
Mr. Wetjen. Good afternoon, Chairman Udall, Ranking Member
Johanns, and members of the subcommittee.
Thank you for inviting me today to the hearing on the
President's fiscal year 2015 funding request for the
Commission.
In my written remarks, I respond to the subcommittee's
request to detail on how the Commission has used its resources
in the previous 2 fiscal years. My goal this afternoon is to
provide this subcommittee with context to the important role
the Commission plays in the financial system and the economy as
a whole, as well as the important role this committee plays in
helping our agency achieve its mission.
As you know, the Commission was directed by Congress to
police the derivatives markets, which includes futures,
options, and swaps. The CFTC also has continued its effort to
implement the new regulatory framework for the swaps market
required under Dodd-Frank.
The operation and integrity of the derivatives markets are
critical to the efficient functioning of the global financial
system and the economies it supports. Without them, a farmer
cannot lock in a price for his crop; a small business cannot
lock in an interest rate that would otherwise fluctuate,
perhaps raising its costs; a global manufacturer cannot lock in
a currency value, making it harder to plan and grow its global
business; and a lender cannot manage its assets and balance
sheet to ensure it can continue lending. The derivatives
markets better enable these enterprises to do what they do
best--create jobs and grow the economy.
When not overseen properly, failures of firms or other
irregularities in the markets can severely and negatively
impact the economy and cause dramatic losses for individual
participants. This is why appropriately funding the Commission
is so important.
CFTC RESPONSIBILITIES
Measured in percentage terms, the Commission's funding
level today is substantially larger than it was through much of
the last decade. Previous funding increases were necessary and
appreciated. Nonetheless, the growth of the Commission's
responsibilities, including under Dodd-Frank, have
significantly outpaced the growth in the agency's budget.
Consequently, today the Commission is underfunded.
The markets the Commission oversees and the agency's
related responsibilities have grown by a variety of different
measures. For instance, the notional value of derivatives
centrally cleared by clearinghouses was estimated to be $124
trillion in 2010 and is now approximately $223 trillion. That
is nearly a 100 percent increase.
Now more than ever, a clearinghouse's failure to follow the
Commission's regulations--designed to ensure proper risk
management--could have significant consequences to the economy.
The amount of customer funds managed by clearinghouses and
futures commission merchants was $177 billion in 2010 and is
now over $218 billion, a nearly 40 percent increase.
The Commission's rules are designed to ensure customer
funds are safely kept by these firms, and a failure to provide
appropriate oversight increases the chance of risky practices,
placing customer funds at risk.
By one measure, the total number of registrants and
registered entities overseen directly by the Commission has
increased by at least 40 percent in the last 4 years. This
includes 102 swap dealers, two major swap participants, and
more than three dozen registered entities, which include
clearinghouses and trading venues.
The CFTC also oversees more than 4,000 advisers and
operators of managed funds, some of which have significant
outward exposures across financial markets. Additionally, the
Commission directly or indirectly supervises approximately
another 64,000 registrants, yet the agency's current onboard
staff is just 648 employees.
The registered entities the Commission oversees are, by and
large, well-run firms that perform important services for their
customers. Nevertheless, those relying upon them, as well as
the American public, deserve assurance that the risks the firms
pose are being mitigated by an agency capable of meaningful
oversight.
FISCAL YEAR 2015 REQUEST PRIORITIES
This year's budget request is a significant step towards a
longer-term funding level that is necessary to fully and
responsibly fulfill the agency's mission. It recognizes the
immediate need for an appropriation of $280 million and
approximately 920 full-time equivalents, which is heavily
weighted toward examinations, surveillance, and technology
functions. The request balances the need for more technological
tools to monitor the markets, detect fraud and abuse, and
identify risk and compliance issues with the need for expert
staff to analyze and make use of the data.
PREPARED STATEMENT
Without additional funding, the consequences are plain: the
Commission will be forced to perform fewer and less thorough
examinations of registered entities, including those deemed
systemically important or that steward customer funds; it will
be less able to develop analytical systems to effectively
perform surveillance of markets becoming increasingly
automated; it will be deterred in its mandate to collect and
analyze swaps data in an effort to enhance market transparency;
and it will be less able to timely investigate and prosecute
enforcement cases to address customer harm or threats to market
integrity.
Thank you for inviting me today, and I will be happy to
answer any questions.
[The statement follows:]
Prepared Statement of Hon. Mark P. Wetjen
Good afternoon, Chairman Udall, Ranking Member Johanns and members
of the subcommittee. Thank you for inviting me to today's hearing on
the President's fiscal year 2015 funding request and budget
justification for the Commodity Futures Trading Commission
(``Commission'' or ``CFTC'').
During the last 2 years, despite significant budgetary constraints,
the CFTC has made important progress in fulfilling its mission. As you
know, under the Commodity Exchange Act, the Commission has oversight
responsibilities for the derivatives markets, which include futures,
options, cash, and swaps. Each of these markets is significant.
Collectively, they have taken on particular importance to the U.S.
economy in recent decades and, as a consequence, have grown
substantially in size, measuring hundreds of trillions of dollars in
notional value. Their operation and integrity are critical to the
effective functioning of the U.S. and global economies.
At their core, the derivatives markets exist to help farmers,
producers, small businesses, manufacturers and lenders focus on what
they do best: providing goods and services and allocating capital to
reduce risk and meet Main Street demand. Well-regulated derivatives
markets facilitate job creation and the growth of the economy by
providing a means for managing and assuming prices risks and broadly
disseminating, and discovering, pricing information.
Stated more simply, through the derivatives marketplace, a farmer
can lock in a price for his crop; a small business can lock in an
interest rate that would otherwise fluctuate, perhaps raising its
costs; a global manufacturer can lock in a currency value, allowing it
to better plan and grow its global business; and a lender can manage
its assets and balance sheet to ensure it can continue lending, fueling
the economy in the process.
Essentially, these complex markets facilitate the assumption and
distribution of risk throughout the financial system. Well-working
derivatives markets are key to supporting a strong, growing economy by
enabling the efficient transfer of risk, and therefore the efficient
production of goods and services. Accordingly, it is critical that
these markets are subject to appropriate governmental oversight.
Mr. Chairman, Ranking Member, and subommittee members, I do not
intend the testimony that follows to sound alarmist, or to overstate
the case for additional resources, but I do want to be sure that
Congress, and this subcommittee in particular, have a clear picture of
the potential risks posed by the continued state of funding for the
agency. When not overseen properly, the derivatives markets may
experience irregularities or failures of firms intermediating in them--
events that can severely and negatively impact the economy as a whole
and cause dramatic losses for individual participants. The stakes,
therefore, are high.
the cftc's responsibilities have grown substantially in recent years
The unfortunate reality is that, at current funding levels, the
Commission is unable to adequately fulfill the mission given to it by
Congress: to prevent disruptions to market integrity, protect customer
assets, monitor and reduce the build-up of systemic risk, and ensure to
the greatest extent possible that the derivatives markets are free of
fraud and manipulation.
Recent increases in the agency's funding have been essential and
appreciated. They have not, however, kept pace with the growth of the
Commission's responsibilities, including those given to it under Dodd-
Frank.
Various statistics have been used to measure this increase in
responsibilities. One often-cited measure is the increase in the gross
notional size of the marketplace now under the Commission's oversight.
Other measures, though, are equally and perhaps more illustrative.
trading volume has increased
For instance, the trading volume of CFTC-regulated futures and
options contracts was 3,060 million contracts in 2010 and rose to 3,477
million in 2013. Similarly, the volume of interest rate swap trading
activity by the 15 largest dealers averaged 249,564 swap events each in
2010, and by 2012, averaged 332,484 each (according to the
International Swaps and Derivatives Association (``ISDA'') data). Those
transactions, moreover, can be executed in significantly more trading
venues, and types of trading venues, both here and abroad. In addition,
the complexity of the markets--its products and sophistication of the
market tools, such as automated-trading techniques--has increased
greatly over the years.
clearing houses manage more risk
The notional value of derivatives centrally cleared by clearing
houses was $124 trillion in 2010 (according to ISDA data), and is now
approximately $223 trillion (according to CFTC data from swap data
repositories (``SDRs'')). That is nearly a 100 percent increase. The
expanded use of clearinghouses is significant in this context because,
among other things, it means that the Commission must ensure through
appropriate oversight that these entities continue to properly manage
the various types of risks that are incident to a market structure
dependent on central clearing. A clearinghouse's failure to adhere to
rigorous risk management practices established by the Commission's
regulations, now more than ever, could have significant economic
consequences. The Commission directly oversees 15 registered
clearinghouses and two of them, Chicago Mercantile Exchange, Inc., and
ICE Clear Credit LLC, have been designated as systemically important by
the Financial Stability Oversight Council.
clearing houses and intermediaries manage more customer funds
The amount of customer funds held by clearinghouses and futures
commission merchants (``FCMs'') was $177 billion in 2010 and is now
over $218 billion, another substantial increase. These are customer
funds in the form of cash and securities deposited at firms to be used
for margin payments made by the end-users of the markets, like farmers,
to support their trading activities. Again, Commission rules are
designed to ensure customer funds are safely kept by these market
intermediaries, and a failure to provide the proper level of oversight
increases the risk of certain practices by firms, including operational
risks or fraud. In fact, recent events in the FCM community led to the
temporary or permanent loss of more than a billion dollars of customer
funds.
substantially larger number of firms now registered with the cftc
The total number of registrants and registered entities overseen
directly or indirectly by the Commission, depending on the measure, has
increased by at least 40 percent in the last 4 years. This includes 102
swap dealers and two major swap participants (``MSPs'').
In addition, the CFTC oversees more than 4,000 advisers and
operators of managed funds, some of which have significant outward
exposures in and across multiple markets. It is conceivable that the
failure of some of these funds could have spill-over effects on the
financial system. In all cases, investors in these funds are entitled
to know their money is being appropriately held and invested.
Additionally, the Commission directly or indirectly supervises
another approximately 64,000 registrants, mostly associated persons
that solicit or accept customer orders or participate in certain
managed funds, or that invest customer funds through discretionary
accounts. Although it leverages the resources of the self-regulatory
organizations (``SROs''), the Commission itself must oversee these
registrants in certain areas and provide guidance and interpretations
to the SROs. The Commission does so with a total staff of only 648
employees currently onboard--about 1 percent of the number of
registrants under its purview. Separately, the Commission must oversee
more than three dozen registered entities, including clearinghouses and
trading venues, each of which is subject to a complex set of regulatory
requirements newly established or modified by the Dodd-Frank Act and
designed to mitigate systemic risk.
By almost any measure, in fact, the portfolio of entities that the
Commission is charged with overseeing has expanded dramatically in size
and risk over the last half decade. The intermediaries in the
derivatives markets are by and large well-run firms that perform
important services in the markets and for their customers.
Nevertheless, collectively, these firms can potentially pose risks--in
some cases significant risks--to the financial system and the broader
economy. Accordingly, those relying upon these firms and the public
deserve assurance that such firms are supervised by an agency capable
of meaningful oversight.
the cftc has made important progress but has been significantly
constrained
For much of fiscal year 2013, the CFTC operated under continuing
resolutions, which extended the fiscal year 2012 appropriation of $205
million. These appropriations, however, were subject to sequestration.
Effectively, our operating budget for fiscal year 2013 was $195
million. Thus, the fiscal year 2014 appropriation of $215 million was a
modest budgetary increase for the Commission, lifting the agency's
appropriations above the sequestration level of $195 million that has
posed significant challenges for the agency's orderly operation. As
directed by Congress, the agency has submitted a fiscal year 2014 Spend
Plan outlining its allocation of current resources, which reflects an
increased emphasis on examinations and technology-related staff.
Even with these significant budget constraints, the dedicated staff
of the Commission were able to complete the majority of new rulemakings
required by the Dodd-Frank Act--about 50 rulemakings in all. This was
in addition to the Commission's ongoing work overseeing the futures
exchange and options markets. These regulatory efforts resulted in
greater transparency, which is critical to reducing systemic risk and
lowering costs to end-users, while improving efficiency and supporting
competition.
With regard to technology, we made progress in a variety of areas.
We improved the quality of data reported to swap data repositories and
have laid groundwork to receive, analyze and promulgate new datasets
from SROs related to new authorities. We upgraded data analytics
platforms to keep up with market growth. Financial risk surveillance
tools were enhanced to support monitoring and stress testing related to
new authorities. The Commission has prototyped a high-performance
computing platform that dramatically reduces data analytics computation
times and an on-line portal for regulatory business transactions to
improve staff and industry productivity. The Commission has implemented
enhanced position limit monitoring and is ready to implement pre-trade
and heightened account ownership and control surveillance. Finally, the
Commission has ensured that foundational server, storage, networking,
and workstation technology are refreshed on a cost-effective cycle and
that technology investments have cybersecurity and business continuity
built-in.
In its role as a law enforcement agency, the Commission's
enforcement arm protects market participants and other members of the
public from fraud, manipulation and other abusive practices in the
futures, options, cash, and swaps markets, and prosecutes those who
engage in such conduct. As of May 1, 2014, the Commission filed 31
enforcement actions in fiscal year 2014 and also obtained orders
imposing more than $2.2 billion in sanctions. By way of comparison, in
fiscal year 2013, the Commission filed 82 enforcement actions, and
obtained orders imposing more than $1.7 billion in sanctions.
With the bulk of rulemaking behind us, the necessary focus must be
examinations, market supervision and enforcement. Simply stated, this
requires appropriate staffing and technological resources sufficiently
robust to oversee what are highly advanced, complex global markets, and
be able to take effective and timely enforcement action.
the fiscal year 2015 request prioritizes examinations, technology,
market integrity, and enforcement
The President's fiscal year 2015 budget request reflects these
priorities and highlights both the importance of the Commission's
mission and the potential effects of continuing to operate under
difficult budgetary constraints.
The request is a significant step towards the longer-term funding
level that is necessary to fully and responsibly fulfill the agency's
core mission: protecting the safety and integrity of the derivatives
markets. It recognizes the immediate need for an appropriation of $280
million and approximately 920 staff years full-time equivalents
(``FTEs'') for the agency, an increase of $65 million and 253 FTEs over
the fiscal year 2014 levels, heavily weighted towards examinations,
surveillance, and technology functions.
In this regard, the request balances the need for more
technological tools to monitor the markets, detect fraud and
manipulation, and identify risk and compliance issues, with the need
for staff with the requisite expertise to analyze the data collected
through technology and determine how to use the results of that
analysis to fulfill the Commission's mission as the regulator of the
derivatives markets. Both are essential to carrying out the agency's
mandate. Technology, after all, is an important means for the agency to
effectively carry out critical oversight work; it is not an end in
itself.
In light of technological developments in the markets today, the
agency has committed to an increased focus on technology. The fiscal
year 2015 budget request includes a $15 million increase in technology
funding above the fiscal year 2014 appropriation, or about a 42 percent
increase, solely for IT investments.
In my remaining testimony, I will review three of the primary
mission priorities for fiscal year 2015.
examinations
The President's request would provide $38 million and 158 FTEs for
examinations, which also covers the compliance activities of the
Commission. As compared to fiscal year 2014, this request is an
increase of $15 million and 63 FTEs.
I noted earlier that the Commission has seen substantial growth in,
among other things, trading volumes, customer funds held by
intermediaries in the derivatives markets, and margin and risk held by
clearinghouses. Examinations and regulatory compliance oversight are
perhaps the best deterrents to fraud and improper or insufficient risk
management and, as such, remain essential to compliance with the
Commission's customer protection and risk management rules.
The Commission has a direct examinations program for clearinghouses
and designated contract markets, and it will soon directly examine swap
execution facilities and SDRs. However, the agency does not at this
time have the resources to place full-time staff on site at these
registered entities, even systemically-important clearing
organizations, unlike a number of other financial regulators that have
on-the-ground staff at the significant firms they oversee. The
Divisions of Market Oversight and Clearing and Risk collectively have a
total of 47 examinations positions in fiscal year 2014 to monitor,
review, and report on some of the most complex financial market
operations in the world.
The Commission today performs only high-level, limited-scope
reviews of the nearly 100 FCMs holding over $218 billion in customer
funds and 102 swap dealers. In fact, the Commission currently has a
staff of only 38 to examine these firms, and to review and analyze,
among other things, over 1,200 financial filings and over 2,400
regulatory notices each year. This staff level is less than the number
the Commission had in 2010, yet the number of firms requiring its
attention has almost doubled, and there has been a noted increase in
the complexity and risk profile of the firms. Additionally, although it
has begun legal compliance oversight of swap dealers and MSPs, the
Commission has been able to allocate only 13 FTEs for this purpose.
This number is insufficient to perform the necessary level of oversight
of the newly registered swap dealer entities.
In fiscal year 2014, the Commission overall will have a mere 95
staff positions dedicated to examinations of the thousands of different
registrants that should be subject to thorough oversight and
examinations. The reality is that the agency has fallen far short of
performance goals for its examinations activities, and it will continue
to do so in the absence of additional funding from Congress. For
example, as detailed in the Annual Performance Review for fiscal year
2013, the Commission failed to meet performance targets for system
safeguard examinations and for conducting direct examinations of FCM
and non-FCM intermediaries. The President's budget request
appropriately calls on Congress to bolster the examinations function at
the agency, and it would protect the public, and money deposited by
customers, by enhancing the examinations program staff by more than 66
percent in fiscal year 2015.
Moreover, if Congress fully funds the President's request, the
Commission can move toward annual reviews of all significant
clearinghouses and trading platforms and perform more effective
monitoring of market participants and intermediaries. Partially funding
the request will mean accepting potentially avoidable risk in the
derivatives markets as the Commission is forced to forego more in-depth
financial, operational and risk reviews of the firms within its
jurisdiction. Thus, the Commission would be reactive, rather than
proactive in regard to firm or industry risk issues.
technology and market integrity
The fiscal year 2015 request also supports a substantial increase
in technology investments relative to fiscal year 2014, roughly a 42
percent increase. The $50 million investment in technology will provide
millions of dollars for new and sophisticated analytical systems that
will, in part, assist the Commission in its efforts to ensure market
integrity. As global markets have moved almost entirely to electronic
systems, the Commission must invest in technology required to collect
and analyze market data, and to handle the unprecedented volumes of
transaction-level data provided by financial markets.
The President's fiscal year 2015 budget request supports, in
addition, 103 data-analytics and surveillance-related positions in the
Division of Market Oversight alone, an increase of more than 98 percent
over the fiscal year 2014 staffing levels. Market surveillance is a
core Commission mission, and it is an area that depends heavily on
technology. As trading across the world has moved almost entirely to
electronic systems, the Commission must make the technology investments
required to collect and make sense of market data and handle the
unprecedented volumes of transaction-level data provided by financial
markets.
Effective market surveillance, though, equally depends on the
Commission's ability to hire and retain experienced market
professionals who can analyze extremely complex and voluminous data
from multiple trading markets and develop sophisticated analytics and
models to respond to and identify trading activity that warrants
investigation. The fiscal year 2015 investment in high-performance
hardware and software therefore must be paired with investments in
personnel that can employ technology investments effectively.
Accordingly, to make use of existing and new IT investments, the
fiscal year 2015 request would provide funding for 193 FTEs, an
increase of 74 FTEs over fiscal year 2014. These new staff positions
are necessary for the Commission to receive, analyze, and effectively
surveil the markets it oversees. These new positions, together with the
technology investments included in the fiscal year 2015 request, will
enable the Commission to make market surveillance a core component of
our mission.
The CFTC has invested appropriated funds in fiscal year 2013 and
fiscal year 2014 in technology to make important progress. We have the
groundwork in place to receive and effectively analyze swaps
transaction data submitted to repositories and SROs related to new
authorities. The fiscal year 2015 request would provide funding to
continue and increase the pace of progress in the areas noted above and
also support the additional examination, enforcement, and economic and
legal staff. Effective use of technology is essential to our mission to
ensure market integrity, promote transparency, and effectively surveil
market participants.
enforcement
The President's fiscal year 2015 request would provide $62 million
and 200 FTEs for enforcement, an increase of $16 million and 51 FTEs
over fiscal year 2014. The simple fact is that, without a robust,
effective enforcement program, the Commission cannot fulfill its
mandate to ensure a fair playing field. From fiscal year 2011 to date,
the Commission has filed 314 enforcement actions and also obtained
orders imposing more than $5.4 billion in sanctions.
The cases the agency pursues range from sophisticated manipulative
and disruptive trading schemes in markets the Commission regulates,
including financial instruments, oil, gas, precious metals and
agricultural products, to quick strike actions against Ponzi schemes
that victimize investors. The agency also is engaged in complex
litigations related to issues of financial market integrity and
customer protection. By way of example, in fiscal year 2013, the CFTC
filed and settled charges against three financial institutions for
engaging in manipulation, attempted manipulation and false reporting of
London Interbank Offered Rate (LIBOR) and other benchmark interest
rates.
Such investigations continue to be a significant and important part
of the Division of Enforcement's docket. Preventing manipulation is
critical to the Commission's mission to help protect taxpayers and the
markets, but manipulation investigations, in particular, strain
resources and time. And once a case is filed, the priority must shift
to the litigation. In addition to requiring significant time and
resources at the Commission, litigation requires additional resources,
such as the retention of costly expert witnesses.
In 2002, when the Commission was responsible for the futures and
options markets alone, the Division of Enforcement had approximately
154 people. Today, the agency's responsibilities have substantially
increased. The CFTC now also has anti-fraud and anti-manipulation
authority over the vast swaps market and the host of new market
participants the agency now oversees. In addition, the agency is now
responsible for pursuing cases under our enhanced Dodd-Frank authority
that prohibits the reckless use of manipulative or deceptive schemes.
Notwithstanding these additional responsibilities, however, total
enforcement staff has shrunk--there are currently only 147 members of
the enforcement staff. The President's budget request would bring this
number to 200. More cops on the beat means the public is better assured
that the rules of the road are being followed.
In addition to the need for additional enforcement staff and
resources, the CFTC also believes technology investments will make our
enforcement staff more efficient. For instance, the fiscal year 2015
request would support developing and enhancing forensic analysis and
case management capabilities to assist in the development of analytical
evidence for enforcement cases. In fiscal year 2013 and fiscal year
2014, appropriated funds invested in information technology have
enabled the Commission to continue enhancing enforcement and litigation
automation services, including a major upgrade to the document and
digital evidence review platform that will enable staff to keep pace
with the exploding volume of data required to successfully conduct
enforcement actions.
A full increase for enforcement means that the agency can pursue
more investigations and better protect the public and the markets. A
less than full increase means that the CFTC will continue to face
difficult choices about how to use its limited enforcement resources.
At this point, it is not clear that the agency could maintain the
current volume and types of cases, as well as ensure timely responses
to market events.
other fiscal year 2015 priorities: international policy coordination &
economic and legal analysis
The global nature of the derivatives markets makes it imperative
that the United States consult and coordinate with international
authorities. For example, the Commission recently announced significant
progress towards harmonizing a regulatory framework for CFTC-regulated
Swap Execution Facilitys (SEFs) and EU-regulated multilateral trading
facilities (``MTFs''). The Commission is working internationally to
promote robust and consistent standards, to avoid or minimize
potentially conflicting or duplicative requirements, and to engage in
cooperative supervision, wherever possible.
Over the past 2 years, the CFTC, SEC, European Commission, European
Securities and Markets Authority, and other market regulators from
around the globe have been meeting regularly to discuss and resolve
issues with the goal of harmonizing financial reform. The Commission
also participates in numerous international working groups regarding
derivatives. The Commission's international efforts directly support
global consistency in the oversight of the derivatives markets. In
addition, the Commission anticipates a significant need for ongoing
international policy coordination related to both market participants
and infrastructure in the swaps markets. The Commission also
anticipates a need for ongoing international work and coordination in
the development of data and reporting standards under Dodd-Frank rules.
Dodd-Frank further provided a framework for foreign trading platforms
to seek registration as foreign boards of trade, and 24 applications
have been submitted so far.
Full funding for international policy means the Commission will be
able to maintain our coordination efforts with financial regulators and
market participants from around the globe. If available funding is
decreased, we will be less able to engage in cooperative work with our
international counterparts, respond to requests, and provide staffing
for various standard-setting projects. The President's fiscal year 2015
request would enable the Commission to sustain its efforts, providing
$4.2 million and 15 FTEs that would be dedicated to international
policy.
In addition, for fiscal year 2015, the President's budget would
support $24 million and 92 FTEs to invest in robust economic analysis
teams and Commission-wide legal analysis. Compared to the fiscal year
2014 Spending Plan, this request is an increase of $4 million and 18
FTEs. Both of these teams support all of the Commission's divisions.
The CFTC's economists analyze innovations in trading technology,
developments in trading instruments and market structure, and
interactions among various market participants in the futures and swaps
markets. Economics staff with particular expertise and experience
provides leverage to dedicated staff in other divisions to anticipate
and address significant regulatory, surveillance, clearing, and
enforcement challenges. Economic analysis plays an integral role in the
development, implementation, and review of financial regulations to
ensure that the regulations are economically sound and subjected to a
careful consideration of potential costs and benefits. Economic
analysis also is critical to the public transparency initiatives of the
Commission, such as the Weekly Swaps Report. Moving into fiscal year
2015, the CFTC's economists will be working to integrate large
quantities of swaps market data with data from designated contract
markets and swap execution facilities, and large swaps and futures
position data to provide a more comprehensive view of the derivatives
markets.
The legal analysis team provides interpretations of Commission
statutory and regulatory authority and, where appropriate, provides
exemptive, interpretive, and no-action letters to CFTC registrants and
market participants. In fiscal year 2013, the Commission experienced a
significant increase in the number and complexity of requests from
market participants for written interpretations and no-action letters,
and this trend is expected to increase into fiscal year 2015.
A full increase for the economics and legal analysis mission means
the Commission will be able to support each of the CFTC's divisions
with economic and legal analysis. Funding short of this full increase
or flat funding means an increasingly strained ability to integrate and
analyze vast amounts of data the Commission is receiving on the
derivatives markets, thus impacting our ability to study and detect
problems that could be detrimental to the economy. Flat funding also
means the Commission's legal analysis team will continue to be
constrained in supporting front-line examinations, adding to the delays
in responding to market participants and processing applications, and
hampering the team's ability to support enforcement efforts.
conclusion
Effective oversight of the futures and swaps markets requires
additional resources for the Commission. This means investing in both
personnel and information technology. We need staff to analyze the vast
amounts of data we are receiving on the swaps and futures markets. We
need staff to regularly examine firms, clearinghouses, trade
repositories, and trading platforms. We need staff to bring enforcement
actions against perpetrators of fraud and manipulation. The agency's
ability to appropriately oversee the marketplace hinges on securing
additional resources.
Thank you again for inviting me today, and I look forward to your
questions.
Senator Udall. Thank you both for your testimony.
And we will now proceed on 7-minute rounds of questions.
CFTC MISSION ACTIVITIES
Chairman Wetjen, the CFTC's budget justification submitted
to the committee suggests that the fiscal year 2015 request,
and I quote from that budget justification, ``A significant
step towards the longer-term funding level that is necessary to
fully and responsibly fulfill the agency's core mission.''
What do you consider to be the optimum funding level
necessary for the CFTC to fully and responsibly perform its
work? What functions would the CFTC not be able to adequately
address if the funding level enacted for 2015 is less than the
full $280 million requested?
Mr. Wetjen. Thank you, Chairman, for the question.
This request is especially focused on three key areas for
the agency and with regard to the agency's mission. The key
mission activities are enforcement, surveillance, and
examinations. And as I just said in my opening statement, we
are not going to be able to do as much as we should, I believe,
in each of those three key areas.
So we are not going to be able to do as many examinations
of some of these critical entities and intermediaries in our
marketplace. I mentioned clearinghouses. There is a tremendous
and enormous amount of risk that is now being housed at
clearinghouses. That has increased quite substantially in
recent years. We have 15 clearinghouses under our jurisdiction,
and we are able to annually examine 2 of them which have been
deemed systemically important.
We have, with current staffing, been able to get around to
some of the other clearinghouses as well, but we are not in a
position with the current staffing to examine all 15 of those
on a regular basis. So the staff has been forced to make
judgments about which clearinghouse might be a little more
risky than others and focus attention in that way. And I think
ideally--again, just focusing on the category of
clearinghouses--you would have examinations of all of them on
an annual basis.
Senator Udall. How about the optimum level? Do you have a
thought on that?
Mr. Wetjen. Well, the $280 million request I think gets us
very, very close to optimal, based on my judgment. The request
this year is slightly below what was asked for last year.
Primarily that was because we wanted to be respectful of
the direction the Congress gave us in passing the budget
resolution, which called for a very modest increase in overall
discretionary spending. So in light of that, it seemed
appropriate to adjust the request this year accordingly.
Senator Udall. Thank you.
Chair White, the SEC is seeking $1.7 billion for fiscal
year 2015. This would be a 26 percent increase in resources
compared to the level enacted for the current year.
KEY PRIORITIES FOR THE SEC
What are the top priorities to which these additional
resources will be devoted? What consequences can be expected if
the funding level approved for the SEC is less than the amount
requested by the President?
Ms. White. The priorities are to fund our exam program, our
enforcement program, our--really, our core areas, including our
Division of Economic and Risk Analysis.
IMPORTANCE OF SUFFICIENT SEC FUNDING
I don't think we can overstate the importance of sufficient
funding, what we request in this budget request, for
technology. We are at a critical juncture at the SEC with a
number of our systems enhancements, a number of our risk-based
tools that allow us to be smarter and more efficient in
detecting problems in the marketplace, including emerging
frauds.
Just as an illustration, I alluded to this in my oral
testimony as well--there are 11,000 registered investment
advisers now under the SEC's jurisdiction. And under current
levels, we were only able to cover 9 percent of those last
year. And that is using very smart, targeted, risk-based tools
to go to the areas where we think the highest risk is.
But there are 40 percent of those investment advisers who
have not been examined. So that is a very, very high priority
for us, as it was in the 2014 request, but we did not actually
receive funding for that.
Strong enforcement of our Federal securities laws is always
at the top of our highest priority list, along with others. And
this budget request does seek 126 additional enforcement staff,
including market experts, which I think is enormously important
to do our job better and more efficiently.
So if we were not to receive funding at that level, clearly
all of our functions really across the board would suffer. I
have tried to illustrate the areas of greatest need, and
certainly our request is intended to be quite targeted and
surgical to those core needs.
We obviously have the new responsibilities that you alluded
to in your opening remarks to implement the reforms in the
over-the-counter securities-based swap markets. We have new
advisers we are responsible for. All of that needs to be
implemented as well as, obviously, the rules put in place.
WALL STREET REFORMS
Senator Udall. Thank you.
In a couple of months, we will mark the fourth anniversary
of the enactment of comprehensive Wall Street reforms aimed at
strengthening the oversight in the wake of the financial crisis
of 2008. And recent analysis by outside monitoring entities
reflect that of the 398 total rulemakings required under Dodd-
Frank, 95--24 percent--are under the jurisdiction of the SEC,
and 60--15 percent--are under the jurisdiction of the CFTC.
A report by Davis Polk analysts issued last month indicates
that of the 95 rules under the SEC, 42--that is 44 percent--had
been finalized, and 10--11 percent--have not yet been proposed.
Of the 60 CFTC rules, 50--83 percent--have been finalized, and
3--5 percent--have not yet been proposed.
Both of you, I am interested in hearing how the independent
progress reports square with your agency's own internal
tracking of your implementation timetable. I think the best
thing for me to do is come back to that question, let Senator
Johanns question, because I have a couple of additional
questions on that. And if you can keep that in mind, I may end
up repeating some of that.
Senator Johanns, I am going to go to you for questioning at
this point.
BUDGET INCREASE REQUEST
Senator Johanns. Thank you, Mr. Chairman.
Chairman Wetjen, let me get started with you. If you look
at the Budget Control Act and then the Ryan-Murray agreement
that was reached last fall after, as you know, some very, very
difficult negotiations, total discretionary spending is due to
increase this year by about $1.4 billion--or in the next budget
year, I should say. That is less than 1 percent increase over
last year.
So I think the bipartisan message sent to everybody is that
this is going to be very tight, very challenging, very
difficult. However, in the budget request we get from CFTC, you
are asking for a 30 percent increase.
Now, I think by anybody's definition that is significant.
But it is especially high when you recognize what everybody
else is faced with across the Federal Government.
So I would ask you a couple questions. One is how do you
justify it, recognizing that colleagues across the Federal
Government with very important missions like yours are also
going to be held to this agreement?
And then, second, what if it doesn't happen? Do you have
contingency plans as to how you will deal with that and how you
will get your budget in line with what the Ryan-Murray
agreement calls for?
Mr. Wetjen. Thank you, Senator, for the question.
The request was based on a number of different factors. But
first and foremost, what are we responsible for doing under the
law? And again, I will go back to the three key areas of our
agency's mission--enforcement, surveillance, and examinations.
Those are the key mission activities. But meanwhile, the
number of entities we oversee has increased by a variety of
different measures that I just recently went through in
percentage terms that are even higher than the percentage
increase we sought with our budget request this year.
And so, I think our first responsibility--or my first
responsibility in my capacity at the moment is trying to make
my best judgment and best case for the kind of funding we need
to make sure we are complying with the law. And so, that formed
the basis of this.
And as I said before, we recognize the passage of the
budget agreement last year, and so we tried to be more modest
this year in the request. But we have to make sure that we are
executing on these key mission activities. Otherwise, I worry
that we are not fulfilling our responsibilities to the American
public.
There is quite a bit at stake. As I tried to lay out in my
testimony, there are enormous amounts of risk being managed by
the firms that we oversee. That is why we have fulsome rule
sets that they are required to comply with. It is primarily for
that purpose, to make sure they are managing risk in an
appropriate way.
And unfortunately, we have seen over the past number of
years the sorts of outcomes that can happen when they fail to
do that or when they fail to follow our rules. So that is the
basis for the request.
Your second--remind me again, Senator, the second part of
your question.
Senator Johanns. The second part of the question is what if
you don't get there? How are you going to----
Mr. Wetjen. Right.
Senator Johanns [continuing]. Describe for us how you are
going to deal with that if your argument isn't adopted and your
request isn't granted?
Mr. Wetjen. Well, I think we will have to continue doing--
we would be forced to continue doing what we have been doing.
And that is using our best judgment about which entities to
examine, which ones we are going to have to take a pass on in a
particular year, make judgments about which matters to pursue
by way of investigations once some incident comes to light,
whether by referral from another division within the agency or
through some other way outside of the agency. Judgments will be
have to made there--be made there.
And as far as those cases that are already under
development, enforcement cases under development, again,
judgments will have to be made about how to allocate resources.
Do we devote more to some cases based on, you know, certain
risks of success or risk of not succeeding, and so it might
involve an assessment of litigation risk in that way.
So these are the sort of judgments you prefer not to have
to make, given the responsibilities we have been given under
the law.
TECHNOLOGY SPENDING
Senator Johanns. In this general vein, let me ask a
question about the technology piece of your budget.
CFTC technology spending has grown less than 7 percent
since fiscal year 2011. The overall budget is up by 12 percent
during that same period of time. My concern is that the CFTC is
operating with Selectric typewriters while the industry is
operating with the latest technology, and I just worry that you
are getting behind.
It seems to me that what we are trying to achieve with your
agency is a faster, more technological advanced agency than we
have today that can keep up with what is going on in the
marketplace. Not necessarily a bigger agency. Bigger doesn't
necessarily solve the problems that you are dealing with out
there.
So tell us why the Commission has, it seems to me,
downplayed technology investment while spending in other areas
of the budget. It would seem to me technology would be critical
for you to keep up.
Mr. Wetjen. Sir, you are absolutely right. It is critical.
And by no means should this year's request be viewed as
downplaying the importance of technology. It is critically
important.
But what we have had to do, again, is given the fact that
there are finite resources and trying to be responsible in our
request and in light of other responsibilities of the agency,
we just had to make a judgment about how much is appropriate to
allocate to technology spending right now and how much is
appropriate to spend on these other important mission
activities.
And as important as technology is, we still need human
capital to use it and deploy it. And as important as technology
is, we need to be doing our level best on these key functions
such as examinations.
And I hate to beat this drum continually, but these
entities that we oversee are critically important, and the
amount of risk that they house is very, very significant. And
some of these intermediaries also manage billions and billions
of dollars of customer money, and we have seen instances of
FCMs, they are called, fail in the last number of years.
And in the case of MF Global, we had more than $1.5 billion
tied up in a bankruptcy proceeding. Now there is a variety of
different reasons why MF Global failed, but the point is
oversight is important, and the rules we have are designed to
prevent that sort of incident from taking place.
So $50 million is a slight increase, as you said, above
where we have been spending currently. I would like to spend
much more than that. But in the context of an overall budget
request that has limitations, that was my best judgment about
where we should be in the short term.
Senator Johanns. Mr. Chairman, I will yield back to you.
And I anticipate another round?
Senator Udall. Yes, yes. Of course. Thank you, Senator
Johanns.
STATUS OF MANDATORY RULEMAKING
I outlined a little bit on that Davis Polk analysis and the
numbers there. And going back to that question, how the
independent progress report squares with your agency's own
internal tracking of your implementation timetable. Yes? For
both of you.
Ms. White. Essentially, yes, whether the particulars match
up precisely, essentially, they do. I mean, the SEC, as you
mentioned in your opening remarks, was given nearly 100
rulemakings by Dodd-Frank, and then some additional ones under
mandated rulemakings and then additional ones under the JOBS
Act.
And I did from the beginning of my tenure and continue to
prioritize the completion of those rulemakings under both Dodd-
Frank and the JOBS Act. And I am pleased with the progress. We
have proposed or adopted about over 80 percent, but we clearly
have a ways to go.
Among those that we have adopted and proposed since I have
been at the agency for about a year now, I think there are 20-
quite significant ones. Among those adopted, the Volcker rule
is obviously one of them. The bad actor rule, which is very
important to investors, specifies that certain offerings should
not be exempt if they are associated with bad actors.
We have proposed all of the title VII rulemakings under our
jurisdiction and adopted some. It is a very high priority for
2014 for us to complete those. We have adopted the municipal
advisors rule. A number of others have been adopted. And again,
we have completed nearly all the mandated studies that were
assigned to us under Dodd-Frank.
It is very important that these rulemakings are done,
obviously, promptly--and that is certainly one of my
commitments and one of the commitments I made at my
confirmation--but also to be done well and to be done after
careful and appropriate economic analysis. And so, you know, we
are all very closely focused as one of our highest priorities
on completing those mandated rulemakings under the Dodd-Frank
Act and under the JOBS Act.
STAFFING EXPERTISE
Senator Udall. Do you feel you have the necessary expertise
on staff to adequately issue and enforce the rules required by
Dodd-Frank?
Ms. White. I think we have the necessary expertise on
staff. Obviously, some of our rulemakings are also done jointly
or in consultation with our fellow regulators, both
domestically and internationally.
But you make an excellent point, which is what we are
talking about is not just adopting those robust, strong rules,
but also then implementing them following their adoption. And
that is one of my significant resource concerns, that we
actually do have the resources to adequately and robustly
implement and enforce those rules once they are adopted.
Senator Udall. And do you have staffing plans adapted to
bring on more expertise in areas that contributed to the
financial crisis?
Ms. White. Again, a very high priority of mine since I
began was to bring on more experts, including economists. So
you will see that prioritized in our budget again this year as
it was last year with expertise certainly in areas that were
involved in the financial crisis and also in modern-day issues
with respect to our equity market structure.
And we have done that in the enforcement space as well. So
there is full understanding of the rules we are enforcing with
the requisite expertise. And that is one of the very important
things that we are seeking the funding for in this budget
request.
RULEMAKING
Senator Udall. Chair Wetjen, how are you coming on the
rules that you are promulgating, the ones that are in the
pipeline? Does it square pretty much with the independent
analysts, or do you take issue with their numbers?
Mr. Wetjen. No, I believe it does. The primary rulemakings
that come to mind when I think about those that we were
required to do under Dodd-Frank but have not yet finalized, it
is the rulemaking for margin requirements for uncleared swaps,
capital requirements for those firms entering into uncleared
swaps, and then the third one would be a final rule on position
limits, another rulemaking required under Dodd-Frank.
So I believe that Davis Polk study had the same count--they
might have mentioned one more, I believe you said. But those
are the three that I think of in terms of unfinished business.
On position limits, we proposed a rule there last fall. So
staff is working on the common file, creating a response to
that proposal.
On the other two, staff is working on a re-proposal. Those
were rulemakings that were actually proposed a couple of years
ago. But in light of significant international work done
through the auspices of a number of different key international
organizations, the decision was made to actually re-propose the
rule, those two rules. And so, we hope to have something in
circulation for the Commission very, very soon on those two.
Senator Udall. Now how would you characterize the efforts
to harmonize rules among multiple regulators? Why don't you
take a stab at that.
Mr. Wetjen. Thank you sir.
It is difficult. It is--everyone has their own
responsibilities and obligations to their own country and to
their own legislative bodies. But there has been considerable
effort through some of these same international organizations I
mentioned. The International Organization of Securities
Commissions (IOSCO) is a key one that comes to mind.
There is another group that was formed specifically related
to derivatives reforms, the OTC Derivatives Regulators Group
(ODRG) it is called. And so, those groups meet on a regular
basis all in an effort to try and get countries to adopt
reforms that are sufficiently comparable and comprehensive in
nature.
Senator Udall. Chair White.
COORDINATION IN RULEMAKING
Ms. White. Yes. I think, again, a high priority we have
both domestically and internationally is to try to--even on
rulemakings that are not required to be joint, ensure that
there is very close consultation and coordination to try to
make them as robust, but as consistent or at least compatible
as possible really around the globe.
When you talk about the title VII rulemakings and the over-
the-counter derivatives market, that is obviously a uniquely
global market. And so, we need to get that right. And I think
we are all working very hard to try to do that.
I think the fact that the agencies charged with
implementing the Volcker rule actually worked together and came
out with a joint rule, including the CFTC and the SEC, was
enormously important, both to the strength of the rule and the
consistency and certainty for the marketplace.
Senator Udall. Thank you.
Senator Moran, would you like to----
Senator Moran. Mr. Chairman, thank you very much.
Senator Johanns was--this may be based upon the
relationship I have had with other CFTC chairmen--telling me
that the presumption exists that if you are a Creighton grad,
you can do no wrong.
Chairman Wetjen, thank you very much for joining us today.
I appreciated the conversation that we had in my office
yesterday. You have indicated to me, and I have seen evidence
of it, the desire to work hard to develop good, solid
relationships with Congress, and I am very grateful for that. I
look forward to accomplishing that as well with you. Let me
just ask a question that in part we discussed yesterday.
Implications of rulemakings mandated by Dodd-Frank. What
are you able to do to mitigate what is always described as
unintended consequences? You and I have been in touch in regard
to a real-time reporting rule, which may unintentionally
identify swap participants in transactions, and you indicated
this is something you are looking into.
Would you bring me up to date? And maybe can put on the
record the conversation--the nature of the conversation we had
yesterday and where you are headed.
REPORTING TRADES
Mr. Wetjen. Thank you, sir.
We did pass a rulemaking that puts in place a real-time
reporting obligation of swaps activity. And depending on the
entity or the counterparty in the trade, there is a timeline by
which the party has to report their trade to the public.
And the matter you and I discussed, as you know, relates to
certain instruments that are not terribly liquid, meaning there
is not a lot of trading activity in some of these products. And
because of that fact, it becomes easier to identify the
identity of one of the counterparties.
And so this is a problem and a challenge for the agency
because the statute does say one of the considerations that has
to be made is that in this reporting obligation, the identity
of the party not be revealed. On the other hand, there is
tremendous public benefit in having information about a trade
available as quickly as possible. That is very useful in terms
of price discovery, which is one of the key functions of our
marketplace.
So that is where the tension is. And so, I have directed
the staff at the CFTC to examine this problem, to look into it,
and to see whether or not we can confirm that this is, in fact,
a problem.
The other analysis here is, again, I think we need to
review what the statute says and look carefully at that and
determine what was meant when we were cautioned not to have a
reporting obligation that could reveal someone's identity. It
is not like anyone said, ``Hey, it is so and so.'' But just
that, again, so few people are trading in a particular
instrument that the marketplace tends to figure out relatively
easily who those parties are.
So staff is looking at this. I actually had a conversation
after you and I spoke yesterday, a follow-up conversation with
the staff. They are doing a new type of analysis that I wasn't
aware of when you and I spoke. So they are looking at another
way to see if they can confirm some of what has been reported
by the parties in these particularly illiquid swaps. So we will
keep looking at it and keep you up to date.
FINANCIAL STABILITY OVERSIGHT COUNCIL DESIGNATIONS
Senator Moran. Thank you very much.
Let me turn to the SEC. Chair White, thank you very much
for your presence today. I am pleased to see you here, as I
sometimes do in the Banking Committee as well.
Two asset managers were recently graduated to Stage 2 of
the Financial Stability Oversight Council (FSOC's) review
process for systemically important financial institutions. And
I am concerned that asset managers who simply administer
customer accounts may be proceeding down a path of additional
regulation that, in my view, may be inappropriate for that
industry.
Can you give me a better sense of how this designation
process for asset managers is progressing at the FSOC, and
given the understanding that the assets in question are not
owned by the companies in question? And then I have a couple of
follow-ups, I think, based upon what you say.
Ms. White. I think although there have been media reports
to the effect of your question, I don't think there has been a
public announcement of the precise status, if any, with respect
to specific asset managers, which is the protocol of the FSOC
with respect to any company that might be considered.
Senator Moran. That is encouraging. Because what I would
ask you is--because I understand there is a roundtable
discussion to occur in the next couple of weeks. And so, part
of my concern is why are we making designations now when there
is more work yet to be done?
Ms. White. Well, again, I think that FSOC officials--the
Secretary of Treasury, obviously, the chair of the FSOC--are
engaged in a process of learning about and gathering data on
the asset manager industry. Again, I can't go beyond what I can
say publicly about the process otherwise.
I think it is a good development that there is the asset
manager conference on Monday, and it is a public forum, so that
the representatives of the FSOC, staff of the member agencies
will hear from the industry and other interested parties and
knowledgeable parties.
I do think it is important--and again, the FSOC is given
the responsibility to decide whether there are systemically
important institutions that aren't banks, are insurance
companies, et cetera. And if so, if they pose systemic risk to
the financial system, one of the powers Congress gave to FSOC
was to designate.
Now that doesn't say what that process should be, what the
data should be before one does that. I think those are very
important questions. And I think it is also very important--and
actually, the OFR study, which came out in September about the
asset management industry, not specific parties, pointed out
the very fact that you mentioned, which is the asset manager
business is an agency business.
And so, when you are considering what, if any, systemic
risk it may or may not pose, you are not talking about a
balance sheet of positions. You are talking about an agency
model. And I think it is very important that that be understood
by all who are considering this and that the right expertise be
brought to bear on that analysis.
SIGNIFICANCE OF AGENCY RELATIONSHIP IN FSOC DESIGNATIONS
Senator Moran. In your analysis, what is the significance
of that agency relationship? How do you personally, or how do
you at the SEC as chair, see this issue within your role at
FSOC?
Ms. White. Well, again, as the Chair, I am a member of
FSOC, as you know. I think it is an extremely important factor.
Essentially, if you are looking to what kinds of entities
and why they may create systemic risks, if these assets are not
yours and not on your balance sheet, that is a very different
situation before you to assess in terms of whether such an
entity, if it were to fail, fails in any sense similarly to a
bank, which does carry positions on the balance sheet,
obviously.
So I think it is a critical fact. Not the only fact to look
at, but a critical distinction between asset managers and some
of the other entities that have been considered.
Senator Moran. Thank you both. My time has expired.
Senator Udall. Senator Johanns.
CHANGES MADE AT THE SEC
Senator Johanns. Chair White, if I could turn to you. If
you look at the history of the SEC budget, even predating the
Obama administration going back to the year 2000, the budget
has grown from $377 million to $1.35 billion in 2014, very,
very significant growth by any definition.
But despite this tremendous growth in resources, the SEC--
and I acknowledge this was prior to your time. But it failed to
detect Ponzi schemes like Madoff, Stanford; didn't sound the
warning on the collapse of the U.S. financial system--or near
collapse. That describes for me a very serious problem within
the SEC. You may disagree with that. You may agree with that.
But I would like you to spend some time, since this is a
great opportunity for oversight, to talk to us on the committee
about your view of what needs to be done to avoid a future
Madoff, a future Ponzi scheme.
What are you doing at the SEC that changes the culture of
that dynamic of how people look at their role and
responsibility in terms of dealing with characters like that
and in terms of dealing with the financial system of the United
States?
SEC ENHANCEMENTS AND IMPROVEMENTS
Ms. White. I think several points there. One is--and the
agency has obviously acknowledged this--that there were
weaknesses and issues where before my arrival the agency had
made significant progress on addressing, and very important
that that did happen, I think.
For example, in terms of a Ponzi scheme, today one of the
items in our budget request that we are seeking to enhance even
further is the tips, complaints, and referral system whereby we
get about 15,000 complaints at the SEC every year. Three
thousand plus of those come into our whistleblower office, but
15,000 in toto, so to speak. And so, those are now all
centralized, automated, assessed electronically, quickly, and
sent out to where they need to be sent out.
One of the enhancements that we actually weren't able to do
last year because of the funding was to automate the triaging
of those complaints. But there is no question that that
feature, which did figure in those incidents you are
mentioning, is now quite, quite different at the SEC.
A number of other changes were made, both in the exam
program--enhancement, improvements--and in the enforcement
division as well. I mean, one of the things that I think is
enormously strengthening the enforcement program, for example,
is the specialty units, where you now have expertise residing
in different market strata that the SEC is responsible for. And
again, I think nothing is more important at the SEC than to
have a very strong compliance function, very strong enforcement
function.
On the examination side, also enhancements, improvements
have been made, really very significant ones. We have been
helped by our technology there. We have been helped by our
economists as part of that effort, which is basically that we
now have technological tools that allow us to analyze, assess,
and access massive amounts of data much more quickly.
For example, one of our newer tools in the examination
program is called NEAT, which is National Exam Analytics Tool.
Basically, it allows our examiners when they go in to an
investor adviser to examine, to look at all of their trading.
And so, we have one instance recently where I think 17
million transactions were accessed and analyzed in 36 hours.
The SEC of yesterday couldn't have come close to that.
And what do we do when we get that data analyzed? We look
for patterns of insider trading. We look for Ponzi schemes. We
look for front running. We look for other kinds of patterns
that may suggest wrongdoing.
So it is a much stronger SEC in those respects, I think. No
one could responsibly sit here and say that any law enforcement
agency will never miss a scheme going forward. But it is an
extraordinarily strong enforcement and exam function today.
PREVENTION OF ANOTHER MADOFF
Senator Johanns. Would you be confident in testifying to
the subcommittee today that under the current atmosphere, the
current approaches, that Madoff could not repeat what he did
some years ago?
Ms. White. From what I know of what occurred--and again, I
wasn't here, but I have studied what occurred. I think the
systems we were just talking about, among others, certainly at
the SEC, I believe that activity would have been detected and
proceeded upon.
Again, you can never guarantee that you will catch every
Ponzi scheme, every fraudster, every criminal in any agency.
But I do think it has been built to prevent that from happening
again.
SEC'S ABILITY TO USE FUNDS IN AN ABBREVIATED TIME PERIOD
Senator Johanns. The budget request you are making this
year admittedly is sizeable. I appreciate you are a little bit
different circumstance. But having said that, it is our job to
provide oversight wherever the dollar comes from.
Given recent past experience, history would probably tell
us that we might be facing a continuing resolution and that you
would not receive your full request for some period of time
into the budget year. We haven't done a lot of budgets around
here, unfortunately. Consequently, what would then happen is
your budget request may be met in January, February, March of
next year.
Under those circumstances, would you in that limited period
of time, between when you received that and the end of the
fiscal year--the end of September 2015, would you be able to
responsibly deal with that? Hire up the people you want to hire
up, do the things you want to do, within an abbreviated period
of time?
PRUDENT SPENDING
Ms. White. I think there is no question, and we have done
this in prior years as well. We take into account the
likelihood of a continuing resolution, and how long it may
last. And that clearly leads to prudent deferred spending. We
do have no year funds, however, so that we are able to more
flexibly deal with getting our money somewhat later in the
year.
But there is no question. One place where it is a
particular challenge is in our long-term mission-critical
information technology (IT) projects. I mean, for those of
necessity, you need to know you have the money. And then there
is a relatively lengthy procurement process. So they do present
challenges.
But I think our financial management folks, and I have
talked at length to them about these issues as well, are geared
up to be able to use if we would get the funding, as much of it
as is possible. And then they can carry over and be able to use
the funding in the following year, but having projected the
uses for it in this year.
Senator Johanns. I yield, Mr. Chairman.
Senator Udall. Thank you very much, Senator Johanns.
And thank you for those answers.
VOLCKER RULE
I wanted to shift over to the Volcker rule, which you all
know is a very, very important one. Chair White and Chairman
Wetjen, on September 10, 2013, five Federal financial
regulatory agencies issued uniform final regulations
implementing the Volcker rule.
The first question. How is the Volcker rule being enforced,
and what is the relevant role of each of your agencies in
overseeing compliance?
Ms. White. I think the rule itself actually became
effective April 1 of this year. But the compliance period is
still out into 2015 and beyond that. It is a scaled compliance
approach, both in terms of extent and also in terms of timing.
And again, I think I alluded to this a few minutes ago, it
is critical that the agencies did enact a joint rule. I think
it is a better rule, a stronger rule, and it plainly for the
marketplace was necessary to do that.
And one of the commitments, and I actually said this in my
opening statement when the SEC adopted the rule, is that we
need to be focused from this day forward on continuing that
coordination as we get into the compliance and enforcement
period.
And so, there is an interagency working group that all five
agencies have very active senior members on who are focused on
questions of interpretation, questions of compliance, questions
of enforcement. And we will try to stay as consistent and in
sync as we can. We are obviously independent agencies at the
end of the day.
With respect to entities who are covered by the rule--for
example, broker-dealers--the SEC is the primary regulator
there. And so, we will have the voice as to whether there is
compliance or not and proceed with enforcement, but we will
still coordinate with each other on questions of interpretation
that affect compliance and enforcement.
AGENCY COORDINATION
Senator Udall. Chair Wetjen, do you have thoughts on that?
Mr. Wetjen. I would like to echo what Chair White said. I
think there is a continued commitment to coordinating among the
agencies.
Another good example, in addition to what Chair White
shared, is we actually issued an interim final rule, I believe
that was late January, and it related to a special investment
vehicle issue that materialized and had come to the attention
of the agencies and to the Congress. And so, all five agencies
adopted this interim final rule very, very rapidly.
And again, I just think that is another example that there
is a continued commitment to solve these problems jointly,
again, in an effort to avoid any kind of uncertainty that not
doing so could create for the marketplace. So I expect that to
continue.
MONEY MARKET MUTUAL FUNDS
Senator Udall. Shifting now to money market mutual funds.
Chair White, as you know, Senator Johanns and I and several
other Senators wrote to you at the SEC in 2012, highlighting
the concerns raised by our local governments on changes to
money market mutual funds. And I keep hearing from folks back
home about this issue.
In fact, a little over 2 weeks ago, I had a conference call
with constituents representing local governments and businesses
in New Mexico, and they continue to express concern about
possible changes. As you know, local governments rely on these
money market mutual funds as a cash management tool and as an
important source of low-cost, short-term financing.
Can you give us an update on where the SEC is on the rule?
And how do you plan to address these concerns of local
governments and others?
Ms. White. Yes. The SEC commissioners and staff are
actively involved, quite actively involved in finalizing those
rules and those reforms of money market funds. They are a
priority for 2014. I expect in the relative near term to
proceed to finalizing those rules.
As you know, when we proposed the rules, we proposed two
alternatives. One is a floating net asset value (NAV) for prime
institutional funds and the other a fees and gates approach.
Government funds were actually exempted from the floating NAV,
but municipalities weren't. I think that is the issue that is
being raised.
We have gotten a lot of comments on precisely that point.
The staff has met with a number of representatives of
municipalities expressing that concern. Should we go in that
direction of a floating NAV, there is an exemption for retail
funds, which would cover some of the municipal funds, but I
think not all. We are very carefully focusing on all of the
comments, but quite focused on the concern that has been
expressed by the municipalities.
Senator Udall. Right. Thank you very much.
Senator Coons. Welcome. Good to have you here.
IT FUNDING
Thank you. I appreciate the opportunity to join you and
thank you both for your service and for the opportunity to
discuss with you your proposals.
If I might first ask CFTC Chair Wetjen, the core to your
funding request is about investments in technology and staff.
And your fiscal year 2015 request calls for a $15 million
increase in IT funding.
Could you just comment on the risks posed to your
organization, on the markets if your IT infrastructure isn't
upgraded or modernized, and what role it plays in your taking
on an expanded role?
Mr. Wetjen. Thank you, Senator Coons.
We have a plan developed by our Office of Data and
Technology on how to use the $50 million. It would include some
enhancements to current systems we have in place which are
necessary for surveillance purposes.
And the one system I would point out is one that tries--
well, tracks positions taken on by market participants. And so,
it is a critical tool that we have now, but it still needs to
be enhanced if it is going to be as effective as possible.
Going forward, I think what the agency should consider
doing is investing in new initiatives, technological
initiatives so that we can get a better understanding of not
only consummated trading activity, but order messaging, which
is something that happens a lot in automated markets.
You have firms or entities sending in orders that don't
always match with another counterparty. So it is important
because some firms inappropriately might use a number of
different order messages sent into a marketplace as a way to
engage in some kind of a manipulative scheme. And so, going
forward, you know, if we are able to get additional funding for
IT, I think that is the next key initiative we might want to
invest in.
CFTC ENFORCEMENT ACTIONS
Senator Coons. You had a budget of roughly $200 million
last year and collected north of $1.7 billion in fines. That is
about an eightfold return on taxpayer investment. So I just
wondered if you wanted to take a moment and explain, as an
entity that literally pays for itself, what enforcement actions
you pursued last year and how a more fully funded CFTC would
benefit taxpayers, as well as benefit the marketplace.
Mr. Wetjen. Yes, thank you, Senator, for that question.
I think we initiated and completed around 150, 160
enforcement actions last year, in fiscal year 2013, which, as
you mentioned, resulted in over $1.5 billion in fine
collections. So it was in that sense a good return on the
investment, when you consider the level of funding for the
agency.
Right now, we are on pace to probably have fewer
enforcement actions consummated and completed based on numbers
midway through the year--midway through the fiscal year. There
is a variety of reasons for that, but one of which is that we
have lost some staff in the Division of Enforcement. So that
does give you some indication about what the impact of reduced
staffing can have.
Again, there could be other reasons for that as well. It
could just be the nature of incidents that have been brought to
the attention of the agency this year are different than in
years past, but it is one thing you might want to take a look
at.
So I have some concerns about that. That is one of the
reasons why we have asked for additional attorneys for the
Division of Enforcement at the agency. Our request would bring
us roughly 50 additional FTEs. And again, I think we would
continue to demonstrate with that enhanced team an ability to
bring a good return for the taxpayer.
Senator Coons. Thank you.
Thank you for what you do, Chair White, at the SEC. I have
a sense that you are charged with overseeing more than 25,000
market participants roughly who engage in trillions of dollars
worth of economic activity, and I think what the SEC does is,
like the CFTC, critically important to a well-functioning
capital market that is secure and transparent.
SEC ENFORCEMENT EFFORTS
And as we continue to heal from the financial crisis, I
think it is critical we take steps to ensure that doesn't
happen again. Given the very broad range and significant
expansion in your responsibilities and given that, as is the
case I just referred to, you don't cost anything to the
taxpayers, net-net, I support funding the President's request
at $1.7 billion. But I would be interested in your comments on
the trends of security frauds that you are seeing in current
enforcement efforts and what sort of risks retail investors are
exposed to. I would also be interested in how you see progress
in rulemaking to implement the JOBS Act.
Ms. White. In terms of the enforcement efforts, I think
there is nothing more important than a strong, a very strong
enforcement presence by the SEC to protect investors--retail,
as well as institutional--to protect the integrity of our
markets, to protect the markets so that capital formation will
be facilitated.
The SEC had, and much of this before I arrived, but in
terms of the financial crisis cases, I think an extraordinarily
strong record. The agency charged over 165, I think it was 169,
entities and individuals. Seventy-plus of those were actually
senior executives--chief executive officers (CEOs) and chief
financial officers (CFOs). Enforcement actually got orders to
return over $3 billion in fines and disgorgement. So there is
obviously value--not only value added there, but it is actually
returning under our Fair Funds provision money to investors.
So we are just about through. We have some additional
financial crisis cases that obviously we are focused on
completing. One of the things that we have done--really, two of
the things that we have done since I have been there to
strengthen the enforcement function is to form two new task
forces. One is a financial reporting and auditing task force,
which I think is the core of investor protection. And that is
something that is already yielding results for the benefit of
investors and the markets.
We have also formed a microcap fraud task force, which
particularly targets that brand of securities fraud on retail
investors.
Another very disturbing pattern--and I have seen this when
I was a prosecutor, too. And it is some of the most egregious
frauds you see are what I call the affinity frauds, when
somebody commits a Ponzi scheme or other kind of investment
scam really against their own communities. And we are certainly
seeing really a growth in those, and so we are very focused on
dealing with those. We have brought a number of different
cases.
We have also intensified our enforcement efforts vis-aa-vis
the obligations of exchanges to make sure they are following
the various what I call the market structure rules of our
equity markets, which I think is important to everyone.
INVESTMENT ADVISOR EXAMINATIONS
And then one final point I would make is just talking
earlier about our need for resources to increase the number of
examinations we do of investment advisers. And of course, they
are the ones that are really day-to-day dealing with your
everyday investor, and we are only able to cover a very small
percentage of those under current funding.
And when we go to those places--and frankly, when we go to
the broker-dealers we examine as well--we find a lot of issues.
So it is these issues that make us at least understand the
critical importance of sufficient funding to be able to carry
out those responsibilities for investors.
And actually, by just showing up on an exam--I think since
fiscal year 2012, just showing up and pointing out, ``By the
way, those fees should not have been charged to those investors
or those funds. They should have been for your account.'' We
have returned, I think, $28.8 million just by showing up. So it
shows you across the span I think the benefits to investors.
SEC TRAINING FOR NON-U.S. REGULATORS
Senator Coons. One last question, if I might, Mr. Chairman.
One other area that I was surprised to see in your report
is that I didn't realize you were engaged in training non-U.S.
regulators.
Ms. White. Yes.
Senator Coons. It was roughly 1,700 in fiscal year 2013, I
think it is 1,400 this fiscal year and next. What are the
benefits of that program? How does it benefit us to provide
training to non-U.S. regulators whose markets may not be as
robust or scalable or secure?
Ms. White. I think there has been significant benefit and
has for decades, frankly, but even more so now. The securities
markets, and certainly the securities frauds markets, are quite
global. I mean, they don't respect borders.
And so, I think the training that we provide is invaluable
to the American investor who may well be defrauded from any
country you could name abroad. If they have a strong
enforcement function, we are protecting the American investors
there.
And we have seen an awful lot of progress. There is much
more to go, but I think it is an invaluable service to the
American investors. It is also I think an invaluable service
really to the global markets and the integrity of them.
Senator Coons. Thank you.
Thank you, Mr. Chairman.
Senator Udall. Senator Coons, thank you very much.
Senator Johanns, please proceed.
Senator Johanns. Mr. Chairman Wetjen, let me ask you a
question. But let me also, if I might, lay some groundwork for
this question so you know where I am coming from.
EFFECTS ON END-USERS
I think all of us agree that the CFTC must have smart,
forward-leaning regulation. The market changes so dramatically.
And yet, we still have to be sensitive to the potential to
over-regulate. We don't want to regulate everything that moves.
So trying to be--to strike that balance I think is key.
One example of regulatory overreach that I have been
working on since Dodd-Frank passed is margin requirements on
end-users when trading derivatives. I can state unequivocally
Congress never intended for nonfinancial end-users to be
subject to costly margin requirements, and yet here we are,
almost 5 years later, still battling with this.
So I have introduced legislation that exempts end-users
from margin requirement. This is not a Republican versus
Democrat issue. The measure has gained strong bipartisan
support. A companion bill has already passed the House with
over 400 votes.
This is one of those things that should be done. I don't
know of a Senator that opposes it. Maybe there is one out there
that I haven't come across yet. But again, I think Congress is
nearly unanimous on this.
I asked Gary Gensler about it one time, and I always felt
that he had a pretty aggressive view of regulating things. I
think that is what he saw his job as, and he was going to
regulate stuff. But he even agreed that nonfinancial end-users
don't pose a risk to the system and, therefore, should not be
burdened with what I would call a job-killing margin
requirement.
I would like you--I know this is an issue now in the Fed's
hands, but I would like your thoughts personally, as the acting
chair of the CFTC, on what I am trying to get done here.
Mr. Wetjen. Senator, I agree with you that Dodd-Frank tried
to, if I can use these words, hold harmless as much as possible
the end-user community as it related to title VII in
particular.
Senator Johanns. Right.
Mr. Wetjen. And we have a number of rules that provided
exemptions from clearing requirements for end-users, and we
have taken a number of different other actions as well to build
out that general principle. And one specific area has to do
with interaffiliate trades between companies that are not swap
dealers. And so, we have done a considerable amount of work
there.
So I agree with you in principle that that was a message
and intent behind Dodd-Frank. At least as it relates to title
VII, end-users are supposed to largely be left out of the grip,
so to speak, of the new rulemakings implementing title VII.
I am not familiar with the details of the Fed's proposal,
and I don't recall exactly where they are in the process. But I
agree in principle with what you are saying as it relates to
end-users in title VII.
Senator Johanns. Mm-hmm. See, Mr. Chairman, the Creighton
education kicks in, and good, practical, common sense stuff
come out.
Thank you. I will yield.
Senator Udall. Senator Coons, did you have additional
questions? Okay.
Chair White, one of the key components of Dodd-Frank was a
mandate that the SEC adopt a number of new rules relating to
credit rating agencies. And all of us remember what a key role
credit rating agencies played in the kind of meltdown that we
were in back in that time period.
And of these new rules, we included annual reports on
internal controls, conflict of interest with respect to sales
and marketing practices, various disclosure requirements, and
consistent application of rating symbols and definitions.
What is the status of the SEC's efforts to comply with the
mandates under Dodd-Frank relating to credit rating agencies,
and what further developments can we expect from the SEC on
this?
CREDIT RATING AGENCIES
Ms. White. A very important area, a very high priority for
the agency.
The agency did in January 2011 adopt, actually, a new rule
requiring Nationally Recognized Statistical Rating
Organizations (NRSROs) to disclose representations and
warranties and how investors might enforce breaches of those.
In May 2011, the agency proposed the rules you are alluding to.
I think they proposed that 11 be amended to accomplish the
objectives that you listed and 5 new ones. We are moving those
forward quite actively, and they are a priority to complete
this year.
Senator Udall. Do you believe there are additional
reporting requirements or controls necessary to prevent another
crisis?
Ms. White. There is no question in my mind that the credit
rating agency issues played a significant role in the financial
crisis. And I think the issues you have identified are ones
that do need further reforms, and that is the objective of
these rulemakings.
Senator Udall. Okay. And I know that some of the critics
have kind of come at this and said we should start over again.
I assume that isn't the position of the SEC at this point.
Ms. White. Well, we are certainly listening to all
comments. Obviously, the formal comment period is closed, but
we are listening very carefully to those who think that certain
aspects perhaps should be re-proposed or done differently and
perhaps not require a re-proposal.
So we are trying to come out with very robust rules, and we
are continuing to listen to all critics and all supporters and
really all ideas on it.
Senator Udall. Right. Thank you very much.
Senator Johanns, do you have--and it looks like Senator
Coons has completed his questioning here.
Let me thank both of you. We really appreciate having you
here today. We appreciate this frank discussion and exchange of
ideas.
We want to thank everyone who participated in preparing for
this hearing. You have excellent staff. We do also, and we very
much appreciate their help.
Today's discussion I think has provided helpful insights
into these--your operations and I think shows us what the
challenges are that are ahead of us. This information will be
instructive as we further consider the budget proposals and
develop our fiscal year 2015 bill during the coming weeks.
ADDITIONAL COMMITTEE QUESTIONS
The hearing record will remain open until next Wednesday,
May 21 at 12 noon for subcommittee members to submit statements
and/or questions to be submitted to the witnesses for the
record.
Questions Submitted to Hon. Mary Jo White
Questions Submitted by Senator Tom Udall
strengthening exams and oversight--frequency of reviews
Question. The SEC's Office of Compliance, Inspections and
Examinations (OCIE) is responsible for conducting examinations of the
Nation's registered entities. These include broker-dealers, transfer
agents, investment advisers, the securities exchanges, clearing
agencies, as well as self-regulatory organizations.
Chair White, your budget materials state that during fiscal 2013,
the SEC was able to examine only about 9 percent of registered
investment advisers. That means only 1 of every 12 of investment
advisers is inspected. What do you believe would be a more suitable
frequency?
Answer. As you point out, during fiscal year 2013, the SEC examined
about 9 percent of registered investment advisers, comprising
approximately 25 percent of the assets under management. As I stated in
my testimony, clearly more coverage is needed, as the status quo does
not provide sufficient protection for investors who increasingly turn
to investment advisers for assistance navigating the securities markets
and investing for retirement and family needs.
Examination staff uses a risk-based approach designed to focus its
limited resources on those firms and practices that pose the greatest
potential risk of securities law violations that can harm investors and
the markets. These high-risk firms frequently are large and complex
entities, and examinations of them often take significant time to
complete.
While we believe our risk-based approach has helped us to more
efficiently use our resources to better protect investors, an increase
of exam frequency to between 30 and 50 percent of investment adviser
firms annually would further enhance our effectiveness and bring us
closer to the current broker-dealer coverage level that, combined with
examinations conducted by the Financial Industry Regulatory Authority,
is approximately 50 percent.
Going forward, we will continue to use technology and risk-based
data analytics to be as efficient as possible with our limited
resources.
Question. What are the drawbacks of sporadic inspections?
Answer. OCIE staff's direct engagement with registrants allows the
staff to provide first-hand information to the Commission and other SEC
staff regarding the activities of our regulated entities, helping us
prevent fraud, identify compliance deficiencies, promote compliance,
inform policy, and monitor risk. Less frequent examinations therefore
limits the information available to the Commission in discharging its
mission to protect investors, including by reducing the instances in
which we may identify potential fraud and other wrongdoing and also
reducing incentives for registrants to put in place rigorous internal
controls and compliance programs.
Sporadic or less frequent examinations also factor into business
decisions that may not always be in the best interests of clients or
customers. For example, OCIE staff has identified an increase in firms
choosing to de-register as broker-dealers, or to conduct a greater
percentage of their business as investment advisers. The staff believes
that in some cases this shift could be due in part to the perception of
less rigorous oversight of investment advisers.
Question. Your request for fiscal 2015 seeks $373 million, a $72
million increase for the exams function above current spending. This
will support 316 additional staff positions above the 967 current
level. What impact will those enhanced funds have on accelerating the
frequency of exams?
Answer. The number and percentage of investment advisers examined
each year depends on a number of factors, including the type and scope
of the examinations conducted, the program priorities, the complexity
of the advisory business, and staffing levels. Of the 316 positions for
OCIE, we anticipate using 240 for investment adviser exams.
Our best estimate, as reflected in the budget request, is an
investment adviser coverage level of 9 percent in fiscal year 2014 and
12 percent in fiscal year 2015. The time it would take in fiscal year
2015 to hire and train new employees likely means we would not realize
the full effect from this staffing increase until future years. OCIE
estimates that with the requested fiscal year 2015 staffing increase,
the exam program would be able to cover at least 14-15 percent of the
population in fiscal year 2016. This outcome could vary depending on a
number of factors, including new program priorities or higher than
expected staff attrition/turnover rates. To achieve an annual
examination level of 30 percent to 50 percent would require incremental
increases in subsequent budgets to permit the agency to hire and
sufficiently train the necessary complement of examiners.
market transformation and high-frequency trading
Question. Chair White, as the leader of one of our key financial
regulators, you are acutely aware of the growing challenges facing your
agency in monitoring the markets. We now have significantly
transformed, globalized, round-the-clock, and highly diversified
marketplace. Stock exchanges can now execute trades in less than a half
a millionth of a second.
What is the current status of the SEC's oversight of high-frequency
trading and automated trading environments?
Does the SEC presently have the necessary talent and technology in
place to monitor and analyze high-frequency trading, to inform your
regulatory and enforcement work, and guard the integrity and safety of
the markets? What are the deficiencies?
Answer. Generally, the SEC's ability--in enforcement, examination,
and regulation--to monitor and analyze high-frequency trading (HFT)
activity in the U.S. markets has increased as more tools have become
available to SEC staff, including software that can handle larger data
sets and more advanced and powerful computers.
Data and Analysis of HFT Activity
The SEC has developed improved data sources and capabilities that
can be used to analyze HFT activity.
Most prominently, we have launched an equity market structure
website \1\ that builds on an analytical tool called MIDAS (Market
Information Data Analytics System), which enables us to quickly analyze
enormous amounts of trading data across markets.\2\ Though MIDAS does
not identify individual firms, MIDAS data is now used in conjunction
with existing investigations of specific firms. In particular, OCIE
examiners and Enforcement staff use MIDAS to compare the individual
trades and quotes of a particular firm (acquired from the firm itself)
in the context of all other contemporaneous market trades and quotes.
These types of analyses can help inform investigations on a variety of
issues, such as those relating to insider trading and market
manipulation.
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\1\ The web site is located at http://www.sec.gov/marketstructure/
and is broadly intended to promote a market-wide dialogue and fuller
empirical understanding of the equity markets. It serves as a central
location for SEC staff to publicly share evolving data, research, and
analysis about HFT and other market structure issues.
\2\ MIDAS is an SEC system that collects equity quote and trade
data from the consolidated public tapes as well as the individual data
feeds that are commercially available from each equity exchange. That
system supports a variety of powerful applications across the SEC's
enforcement, examination, and regulatory functions, including research
to better understand a market structure with a significant amount of
HFT trading. This research in turn helps better inform policy decisions
related to market structure issues, including HFT.
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SEC staff also is now analyzing information that recently has
become available to it though the Large Trader Reporting Rule \3\--
which provides SEC staff access to information about the trading
activity of the largest market participants, including many HFT firms,
upon request--into its policy-making, examination, and enforcement
efforts.
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\3\ See Exchange Act Release No. 64976 (July 27, 2011), 76 FR 46959
(August 3, 2011).
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Barriers to the development of comprehensive and reliable analyses
of HFT remain, however, and include: (1) the limitations of available
data; \4\ (2) the absence of a clear, commonly agreed definition of
HFT; and (3) inherent complexities in the econometric techniques
available for assessing the effect of HFT on market quality. To help
surmount these barriers, the SEC is in the midst of an initiative to
expand the data available to regulators. Specifically, in July 2012,
the SEC adopted Rule 613, which requires the self-regulatory
organizations to submit a national market system (NMS) plan to
establish a consolidated audit trail (CAT) for NMS securities, across
all U.S. markets, from the time of order inception through routing,
cancellation, modification, or execution.\5\ When the consolidated
audit trail is fully implemented, regulators will be able to readily
tie all order and trade activity in NMS securities throughout the U.S.
markets back to particular accounts and to properly sequence that
activity in time. Fully implementing CAT is a high priority for the
Commission.
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\4\ There currently is no comprehensive data source that enables
regulators to tie all order and trade activity in the U.S. equity
markets back to particular accounts. Accordingly, an exhaustive
analysis of HFT activity is not possible at this time.
\5\ See Exchange Act Release No. 67457 (July 18, 2012), 77 FR 45722
(August 1, 2012).
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A significant impediment to the SEC's ability to monitor and
analyze HFT trading is the absence of comprehensive data that links
orders and trades to individual market participants. Although current
data resources allow the SEC to monitor and analyze overall market
quality, questions regarding outcomes for end-users and intermediaries
are often difficult to answer without account-level data. Data from CAT
will facilitate many types of studies that are difficult to conduct
with current data.\6\ CAT will also significantly improve regulators'
ability to monitor the trading activity of individual firms, the
overall level of HFT activity in the market, and the outcomes realized
by end-users of the market.
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\6\ Examples of such studies include: how different types of market
participants provide liquidity, and how liquidity provision from
different market participants impact market quality at times of market
stress; whether aggressive HFT strategies increase investor trading
costs or serve to provide short-term liquidity at a premium; whether
certain HFT strategies crowd out passive liquidity suppliers, and if
so, how the costs of end-users are affected; and whether improvements
in price efficiency allow liquidity providers to provide more liquidity
to institutional orders.
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Oversight of Operational Risks in Automated Trading
To address the risk of instability and disruption that can arise in
an automated trading environment, the SEC and the securities industry
have undertaken a series of responsive initiatives. ``Limit up-limit
down,'' for example, is now fully implemented and moderating price
volatility in individual securities.\7\ Market-wide circuit breakers
are in place to address volatility across the equities, options, and
futures markets.\8\
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\7\ SEC Press Release No. 2012-107, ``SEC Approves Proposals to
Address Extraordinary Volatility in Individual Stocks and Broader Stock
Market'' (June 1, 2012).
\8\ Id.
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The SEC has taken additional steps to require market participants
to address their technology risks. We adopted--and are vigorously
enforcing--the Market Access Rule, which requires brokers to have risk
controls in place before providing their customers with access to the
market.\9\ Last March, the Commission proposed Regulation Systems
Compliance and Integrity (SCI) to put in place stricter requirements
relating to the technology used by exchanges, large alternative trading
systems, certain exempt clearing agencies, and securities information
processors--the SIPs.\10\ The staff is now completing a recommendation
for final rules.
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\9\ SEC Press Release No. 2010-210, ``SEC Adopts New Rule
Preventing Unfiltered Market Access'' (November 3, 2010). One market
access risk is the potential for erroneously submitting a single large
order or a flood of small orders that disrupt trading. See SEC Press
Release 2013-222, ``SEC Charges Knight Capital With Violations of
Market Access Rule'' (October 16, 2013).
\10\ SEC Press Release No. 2013-35, ``SEC Proposes Rules to Improve
Systems Compliance and Integrity'' (March 7, 2013).
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The SEC has closely focused on certain market infrastructure
systems that are ``single points of failure'' that can halt or severely
disrupt trading when a problem occurs. The exchanges have responded
with technology audits of the SIPs and a series of specific
enhancements to improve SIP robustness and resilience. In addition, the
exchanges have developed more robust SIP backup capabilities, and at
the end of June 2014 implemented a new ``hot-warm'' backup, with a 10-
minute recovery standard.
Further Enhancements to HFT Oversight
In addition, I recently publicly outlined a series of initiatives
that will, among other things, enhance the SEC's oversight of HFT firms
and automated trading tools.
--The SEC staff is now developing a recommendation to the Commission
for an anti-disruptive trading rule that would address the use
of aggressive, destabilizing trading strategies in vulnerable
market conditions. Such a rule will need to be carefully
tailored to apply to active proprietary traders in short time
periods when liquidity is most vulnerable and the risk of price
disruption caused by aggressive short-term trading strategies
is highest.
--The SEC staff is also preparing two recommendations for the
Commission that are focused on using our core regulatory tools
of registration and firm oversight: (1) a rule to clarify the
status of unregistered active proprietary traders to subject
them to our rules as dealers; and (2) a rule eliminating an
exception from Financial Industry Regulatory Authority (FINRA)
membership requirements for dealers that trade in off-exchange
venues. Dealer registration and FINRA membership should
significantly strengthen regulatory oversight over active
proprietary trading firms and the strategies they use.
--Finally, the SEC staff is preparing recommendations for the
Commission to improve firms' risk management of trading
algorithms and to enhance regulatory oversight over their use.
I also have asked the exchanges and FINRA to consider including a
time stamp in the consolidated data feeds that indicates when a trading
venue, for example, processed the display of an order or execution of a
trade. With this information, users of the consolidated feeds would be
able to better monitor the latency of those feeds and assess whether
such feeds meet their trading and other requirements.
enhancing corporate disclosure of material risk: climate change and
environmental impacts
Question. Generally, publicly traded companies disclose business
risks to investors through regular financial reports (called ``10-K
filings'') submitted to the SEC.
Recently, there have efforts to ensure that environmental costs and
risks are also reported to investors because they impact a company's
bottom line. In July 2010, the SEC issued guidance requiring companies
to address how climate change (and climate change regulation) could
potentially impact their businesses. Like all SEC disclosures, this is
aimed at informing market price and protecting investors. Yet, concerns
have been raised that despite existing disclosure guidance, reporting
by companies is not as robust as it should be. In response to this
subcommittee's fiscal 2014 report, the SEC submitted an updated staff
report focused on the quality, specificity, and thoroughness of
disclosure related to climate change.
I would be interested in hearing more about how the SEC is
reviewing climate disclosures and the extent to which public companies
are conforming to the guidance and making full disclosures.
Answer. The Commission's 2010 Guidance Regarding Disclosure Related
to Climate Change provides interpretive guidance about how companies
should evaluate climate change related issues when considering what
information to disclose to investors under existing disclosure
requirements, such as risk factors or management's discussion and
analysis. Companies that are subject to SEC disclosure rules must
provide climate change related disclosure if the information is
material. The U.S. Supreme Court has held that information is material
if there is a substantial likelihood that a reasonable investor would
consider it important in deciding how to vote or make an investment
decision. Companies must consider their own particular facts and
circumstances in evaluating whether information would be considered to
be material.
As you noted, the SEC submitted a report on public company
disclosures about climate change related matters to the Subcommittee
earlier this year. The staff of the Division of Corporation Finance
prepared the report based on its survey of climate change related
disclosures by a number of companies in selected industries. Of those
companies surveyed, most included risk factor disclosure about climate
change related matters. The companies surveyed also disclosed climate
change related matters in the business, management's discussion and
analysis, executive compensation discussion, and legal proceedings
sections of their filings.
The Division of Corporation Finance staff routinely reviews new
issuer filings and periodic reports of public companies for compliance
with applicable disclosure requirements and inclusion of material
information. The goal of the staff's reviews is to monitor and enhance
compliance with applicable disclosure requirements. In conducting its
filing reviews, the staff will continue to consider whether a company
has complied with applicable disclosure requirements, including with
respect to climate change, in their filings. Where the staff has
concerns about the adequacy of the disclosure in a filing, the staff
will issue a comment letter asking the company for further explanation
or additional disclosure.
ecological disclosure--pollution externalities
Question. There is also growing concern that while the SEC requires
public companies to disclose certain financial information, its
disclosures do not take into account the possible costs imposed on
public by corporate activities that have an adverse impact or pose
material risk to public health and the environmental such as pollution
damages.
What actions are underway at the SEC to evaluate public company
disclosure of environmental and ecological risks?
Answer. A number of Commission rules and regulations may trigger
disclosure of the possible costs and environmental and ecological risks
stemming from corporate activities, depending on a company's particular
facts and circumstances. The following provisions of Regulation S-K may
require disclosure of environmental and ecological risks and associated
costs, based on a company's particular facts and circumstances.
--Item 101 requires companies to disclose the material effects that
compliance with environmental laws may have upon the company,
as well as any material estimated capital expenditures for
environmental control facilities.
--Item 103 requires disclosure of certain proceedings arising under
environmental laws, including proceedings that involve a claim
for damages, potential monetary sanctions, capital
expenditures, deferred charges or charges to income if the
amount involved exceeds 10 percent of the company's
consolidated assets.
--Item 503(c) requires a discussion of significant risk factors,
which could include environmental and ecological risks.
--Item 303 requires companies to identify and disclose known trends,
events, demands, commitments and uncertainties that are
reasonably likely to have a material effect on financial
condition or operating performance.
The Division of Corporation Finance staff routinely reviews public
company disclosures to monitor and enhance compliance with applicable
disclosure requirements. Where the staff has concerns about the
adequacy of the disclosure in a filing, including with respect to
environmental and ecological risks and associated costs, the staff will
issue a comment letter asking the company for further explanation or
additional disclosure.
ustr special 301 report
Question. The United States Trade Representative (USTR) ``Special
301'' Report is an annual review of the state of intellectual property
rights (IPR) protection and enforcement among our trading partners
around world.
Does the SEC or the major U.S. exchanges take into account a
foreign company's inclusion in the USTR Special 301 Report when
considering whether to permit the company to be publicly listed?
Should the SEC or major U.S. exchanges take into account a foreign
company's inclusion in USTR's Special 301 Report or its Special 301
Out-of-Cycle Review of Notorious Markets before allowing the company to
be publicly listed?
What role do the SEC and major U.S. exchanges have in ensuring that
US capital markets do not enrich companies that profit from
intellectual property rights (IPR) infringement?
Answer. The U.S. Federal securities regulatory system as applied to
listed companies is based on the principle of full and fair disclosure
of information to investors, and the Commission does not consider the
merits of the transaction or company during the registration process. A
company is, however, required to provide disclosure of material risks
and litigation to which the company is subject, including any material
risks associated with a company's intellectual property or the
enforcement of rights related to intellectual property.
As to the U.S. exchanges, section 6(b)(5) of the Exchange Act
requires that, among other things, the rules of a registered securities
exchange be designed to ``prevent fraudulent and manipulative acts and
practices,'' ``promote just and equitable principles of trade,''
``remove impediments to and perfect the mechanism of a free and open
market and a national market system,'' and ``protect investors and the
public interest.'' The exchanges have adopted rules relating to the
qualification, listing and delisting of foreign issuers on their
markets, which have been determined by the Commission to be consistent
with the Exchange Act. These rules, among other things, set forth
financial, corporate governance, and disclosure requirements that
issuers must comply with in order to be eligible for listing.
Furthermore, the exchanges generally retain broad discretion in their
rules to deny the listing of a company (or suspend dealings in, or
delist, a company's securities once listed) even if the company meets
the listing or continued listing standards, if the exchange determines
there are circumstances that make the initial or continued listing of
the company inadvisable or unwarranted. Thus, pursuant to this broad
authority, an exchange could take into account a company's country's
inclusion in the USTR Special 301 Report or the Special 301 Out-of-
Cycle Review of Notorious Markets when considering whether to permit
the company to be publicly listed.
We understand that the exchanges are considering adopting
procedures to ensure companies on the Special 301 Out-of-Cycle Review
of Notorious Markets list are identified in the listing application
process and would generally not warrant listing. The USTR Special 301
Report does not actually list foreign companies, but rather lists
countries that have a particular problem with respect to intellectual
property rights protection, enforcement, or market access for persons
relying on such rights. To the extent a company from one of these
foreign countries has applied to list on an exchange and has disclosed
that there is a material risk or litigation about an issue related to
intellectual property rights, the listing exchange would inquire about
the issue and take it into consideration when considering the listing
application of the company.
executive compensation
Question. The Dodd-Frank Wall Street Reform and Consumer Protect
Act required a number of regulations on executive compensations to
allow for greater transparency and to discourage the excessive risk
taking that contributed to the economic crisis, including those
outlined in section 956. There was also significant outcry after it was
reported that banks who relieved taxpayer bailouts awarded their top
executives nearly $1.6 billion in salaries, bonuses and other benefits
the following year.
On March 2, 2011, the SEC issued a proposed rule made jointly with
other regulators that would require certain financial institutions to
disclose the structure of their incentive-based compensation and
prohibit compensation that encourages inappropriate risks.
What is the expected timeline for the rule to be finalized?
How does the SEC plan to address the criticisms of the proposed
rule?
Does the SEC believe that the proposed rule would have discouraged
the troubling practices that contributed to the economic crisis? Will
it help prevent future excessive risk-taking?
Is the SEC considering additional measures or actions on this
issue?
Answer. In the spring of 2011, the SEC, acting jointly with the
Federal Reserve Board, the Office of the Comptroller of the Currency,
the Federal Deposit Insurance Corporation, the Federal Housing Finance
Agency, the National Credit Union Administration, and the Office of
Thrift Supervision proposed a rule pursuant to section 956. As required
by the statute, the proposed rule would apply to bank holding
companies, banks, the Federal National Mortgage Association, the
Federal Home Loan Mortgage Corporation, broker-dealers, credit unions,
and investment advisers.
In general, the jointly proposed rules drew upon the Guidance on
Sound Incentive Compensation Policies finalized by the Federal banking
agencies in the summer of 2010. The banking agency guidance is designed
to address compensation structures that could cause imprudent risk
taking.
The proposed joint rule is comprised of three parts:
--Disclosures: A covered firm would be required to file an annual
report describing the firm's incentive-based compensation
arrangements.
--Prohibition on Encouraging Inappropriate Risk: All covered firms
would be prohibited from establishing or maintaining an
incentive-based compensation arrangement that encourages
inappropriate risks. This portion of the rule draws upon the
banking agency guidance.
--Deferral for Large Firms: For covered firms with $50 billion or
more in total consolidated assets, executive officers would
have at least 50 percent of their incentive-based compensation
deferred for at least 3 years. The deferred compensation could
not be paid faster than on a pro-rata basis, and would have to
be adjusted to reflect actual losses. The firm's board also
would approve incentive compensation for individuals determined
to have the ability to expose the firm to substantial losses.
The comment period for the proposed rule closed on May 31, 2011.
The SEC and its fellow regulators received approximately 10,000 comment
letters. Common themes in the comment letters included:
--Concern in applying a single mandatory deferral requirement to a
broad array of firms with dramatically different businesses;
--How the proposed rule would apply to affiliates regulated by
multiple agencies;
--How the proposed rule would apply to certain types of investment
advisers; and
--Tax and accounting consequences.
The SEC staff is working closely with the staff of the banking
regulators to consider these comments and how the jointly proposed
rules could be revised to address commenters' concerns with those
rules.
The SEC is also moving forward with enhanced disclosures related to
executive compensation required by the Dodd-Frank Act. In the fall of
2013, the Commission proposed a new rule that would require public
companies to disclose the ratio of the compensation of its chief
executive officer to the median compensation of its employees.
Advancing the other executive compensation rules required under the
Dodd-Frank Act is also a near-term priority.
______
Questions Submitted by Senator Richard C. Shelby
Question. In recent years, the SEC has responded to events like the
2010 flash crash or the concerns raised by Michael Lewis with narrowly
focused studies of the problem at hand. While examining the latest
problems and reassuring market participants is important, ad hoc
reviews and immediate responses to crises often crowd out the
opportunity to engage in deeper assessments of complex reform issues
such as market infrastructure, off-exchange trading, and Regulation
National Market System (NMS).
Given the growing complexity and fragmentation of our equity
markets, are you supportive of calls for the SEC to undertake a
comprehensive review of market structure?
Answer. Yes. As reflected in a recent public speech, I set forth
three core principles that are grounding the SEC's review of equity
market structure and guiding further actions: (1) all issues must be
evaluated through the prism of the best interest of investors and the
facilitation of capital formation for public companies; (2) we must
account for the varying nature of companies and products, with a
particular sensitivity to the needs of smaller companies; and (3) our
review of market structure must be comprehensive, including testing
assumptions about long-standing rules and market practices.\11\
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\11\ Enhancing Our Equity Market Structure, Speech by SEC Chair
Mary Jo White, at Sandler O'Neill & Partners, L.P. Global Exchange and
Brokerage Conference New York, N.Y. (June 5, 2014), available at http:/
/www.sec.gov/News/Speech/Detail/Speech/1370542004312.
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Addressing the issues of our current market structure demands a
continuous and comprehensive review that integrates targeted
enhancements with an expansive consideration of broader changes.\12\
Accordingly, as we evaluate the merits of broader changes, we will also
continue to assess and address specific elements of today's market
structure that work against the interests of investors and public
companies. In these remarks, I outlined the initiatives we are
advancing across five broad sets of issues: market instability, high
frequency trading, fragmentation, broker conflicts, and the quality of
markets for smaller companies.\13\ These initiatives are designed to
address discrete issues that will, among other things, enhance
transparency and the Commission's ability to oversee HFT firms.
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\12\ Id.
\13\ Id.
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While our review in each of these five areas has already resulted
in discrete actions targeting specific issues, the more fundamental
policy questions demand--and are receiving--close attention at the SEC.
To facilitate engagement with market participants and the public, SEC
staff will populate our market structure website with summaries of key
issues that provide a framework for further analysis, identifying areas
that the staff is focused on and where public perspectives are
essential. To help in our review of equity market structure, I have
also recommended to the Commission the creation of a new Market
Structure Advisory Committee comprised of experts with a diversity of
backgrounds and viewpoints. The new committee will serve as an
additional forum and resource for reviewing specific, clearly
articulated initiatives or rule proposals.
Question. In early July, the Commission's rules providing for the
regulation and registration of municipal advisors will become
effective. The Commission routinely publishes updated and final
``Frequently Asked Questions'' (FAQs) which provide practical
information to firms seeking to comply with the rule. The Office of
Municipal Securities provided general interpretive guidance on certain
aspects of the final rules on May 19, 2014. However, FAQ's detailing
the manner in which the rule treats wholly owned bank subsidiaries
making tax exempt loans have not been finalized and published. It is my
hope that these would be published well before the effective date so
that covered entities have the time and opportunity to understand and
comply with the rule.
When will you publish Commission FAQs relating to wholly owned bank
subsidiaries?
Answer. The Commission's final rules for municipal advisor
registration became effective on July 1, 2014. To address specific
questions arising from market participants and to facilitate a smooth
implementation of these major new rules, the staff in the Office of
Municipal Securities provided interpretive guidance, in the form of
frequently asked questions (FAQs), in January and May of this year.
In the May FAQs, the staff specifically addressed several questions
raised by banks regarding implementation of the final rules, including:
(1) the treatment of so-called ``dual employees'' of banks (i.e.,
individuals who are employed by a bank and also are associated with the
bank's broker-dealer affiliate); (2) the applicability of the bank
exemption to banks that provide advice to a municipal entity regarding
the structure, timing, and terms under which the bank would purchase
municipal securities for its own account; (3) the treatment of proceeds
of pension obligation bonds; and (4) transitional guidance for
identifying existing proceeds of municipal securities held in existing
accounts or existing investments.
Although the staff did not provide specific guidance regarding the
treatment of transactions in which wholly-owned bank operating
subsidiaries make tax-exempt loans under the final rules, the staff
issued an FAQ regarding the purchase of municipal securities by an
institutional buyer in a principal capacity that may be relevant for
these transactions. Specifically, in this FAQ, the staff stated that an
institutional buyer would not be engaged in municipal advisory activity
under the final rules if the institutional buyer only provides
information regarding the terms under which the institutional buyer
would purchase municipal securities for its own account and does not
provide advice to the municipal entity regarding an issuance of
municipal securities that would be offered to other investors. The
staff believes that this guidance could be relevant to and useful for
advice on transactions involving those wholly-owned bank operating
subsidiaries that meet the general parameters specified in the FAQ.
______
Question Submitted by Senator Richard J. Durbin
Question. Chair White, you have received several letters, one
signed by the Illinois Secretary of State (and 7 others) and the other
by the Illinois Securities Commissioner (and 17 other Commissioners),
expressing concerns about the SEC's proposal to preempt the States from
reviewing Regulation A offerings. Under the JOBS Act, issuers are
exempt from State review for shares traded on a national exchange or
sold to a ``qualified purchaser.'' The SEC's proposed rules define a
qualified purchaser as ``all offerees of securities in a Regulation A
offering and all purchasers in a Tier 2 offering,'' applying to anyone
and eliminating State review.
Many have suggested that with smaller offerings and newer issuers
also comes greater risk and likelihood of fraudulent activity. Although
your points on investor protection and costs associated with complying
with State law are well-taken, states currently offer review on these
smaller offerings that can further protect investors. States also have
taken steps to harmonize review processes, streamlining requirements
among states in response to concerns about the time and costs
associated with complying with State review.
How will the SEC work with State regulators' to address concerns
that preempting State authority beyond what Congress intended under the
JOBS Act would limit the additional investor protections states can
offer, especially in light of commitments to streamline State review
processes to address issuer concerns?
Answer. As part of our ongoing dialogue with State securities
regulators, Commission staff and I periodically meet with
representatives of the states and the North American Securities
Administrators Association (NASAA) to discuss developments in the
securities markets and, where applicable, to address areas of specific
concern.
With respect to the Commission's proposed rules for implementing
Title IV of the JOBS Act, the Commission has received more than 100
comment letters on its rule proposal, many of which addressed the
proposed approach to State securities law compliance. The staff is
carefully reviewing the comments as it works to develop recommendations
for final rules for the Commission's consideration. In addition, the
staff is closely monitoring the development and implementation of
NASAA's multi-State coordinated review program for Regulation A
offerings. It should also be noted that the proposed rules would not
limit in any way the states' authorities to pursue fraudulent offerings
and would permit that all offers under proposed Regulation A be filed
with a State with such a requirement.
I look forward to continuing our ongoing dialogue with State
securities regulators and NASAA, including with respect to the
Commission's proposal to adopt rules to implement title IV of the JOBS
Act. Our objective for this rulemaking is to ensure that the framework
and requirements for Regulation A offering are both workable and
protective of investors.
______
Questions Submitted by Senator Christopher A. Coons
Question. Since becoming Chairman, have you found the SEC to have
the right resources necessary to go after those that commit fraud,
regardless of where the security is bought?
Answer. Since my arrival, we have made every effort to
effectively--and efficiently--deploy our funds in order to identify,
investigate and prosecute those within our jurisdiction that commit
fraud. These efforts have resulted in a number of significant
enforcement cases across our regulatory spectrum, including actions
against exchanges to ensure they operate fairly and in compliance with
applicable rules, actions against investment advisers and broker-
dealers for taking undisclosed fees and for disrupting the markets
through failures in their automated trading systems, important
financial reporting cases against issuers, actions against auditors and
others who serve as gatekeepers to our financial system, Foreign
Corrupt Practices Act (FCPA) cases against large multinational
corporations, actions against municipal issuers, landmark insider
trading cases, and additional cases against individuals and entities
whose actions contributed to the financial crisis.
That said, the SEC needs significant additional resources to keep
pace with the growing size and complexity of the securities markets and
the agency's broad responsibilities. Specific to our Enforcement
program, we face a number of key challenges to preserve and enhance our
ability to vigorously pursue the entire spectrum of wrongdoing within
our jurisdiction. Our Enforcement work includes the detection,
investigation, and litigation of violations of the Federal securities
laws. In each of these areas, we face significant challenges:
--Detection. We receive over 15,000 tips, complaints, and referrals
annually, including the more than 3,000 tips that flow into the
Division's Whistleblower Office, which generate a fresh stream
of case leads in need of investigation. The review and analysis
of these tips require significant human and technological
resources. We also have focused intensively on potential
misconduct in the equity markets and in connection with new
rules, including those implemented under the Dodd-Frank and
JOBS Acts. But detecting misconduct in constantly evolving
securities markets, including as a result of the growth of
algorithmic, automated trading and ``dark pools,'' requires
substantial resources.
--Investigations. Technological advances across the industry allow
for more sophisticated schemes, which require improved
technology and significant resources to unravel. We also are
expanding our focus on financial reporting and auditing
misconduct cases, which are highly technical and labor
intensive.
--Litigation. We have seen an increase in litigation and trials as we
focus more extensively on individual wrongdoing. And, the
recent change to our long-standing settlement policy that now
requires admissions in certain cases may lead to more
litigation. Success at trial is critical to our ability to
carry out our mission, and litigation, often against well-
funded opposition.
In order to meet the challenges of our rapidly changing and
expanding markets, with increasingly complex products and more
sophisticated wrongdoers, Enforcement seeks to hire 126 new staff,
including additional legal, accounting, and industry specialized
experts, primarily for investigations and litigation. These critical
resources will enable us to improve our information processing and
analysis, expand our investigative capabilities, strengthen our
litigation capacity, and better use technology. In addition, the
Enforcement Division will continue to: (1) invest in technology that
enables the staff to work more efficiently and effectively, and (2)
collaborate with external stakeholders who assist in the Division's
identification, investigation, and litigation of securities law
violations, including wrongdoing that crosses borders.
Question. I believe private enforcement and investors' right to
recover losses is very important, and serves as a deterrent to
securities fraud. Would you agree and can you discuss how the SEC can
work with victims of securities fraud to recover losses?
Answer. The SEC is fully committed to its mission of protecting
investors and continuously strives to maximize the return of funds to
victims of securities fraud whenever possible. This may consist of ill-
gotten gains required to be disgorged and/or penalties imposed by a
court in the Commission's enforcement actions. The Sarbanes-Oxley Act
of 2002 enhanced the Commission's ability to more fully compensate
harmed investors by giving us authority, in appropriate cases, to
create Fair Funds through which we can distribute civil penalties
(along with disgorgement) to victims. Prior to the Act, the Commission
was required to transmit all penalties obtained to the U.S. Treasury.
This Fair Fund authority is an important part of our effort to help
harmed investors recover losses. Additionally, meritorious private
actions can help supplement regulatory enforcement of the securities
laws.
The SEC's Office of Distributions (OD) within the Division of
Enforcement is responsible for overseeing the Commission's
distributions program. The OD handles all distributions to victims in
enforcement actions where a disgorgement fund exists or where the
Commission or a court has created a Fair Fund that includes monetary
penalties. The office was reorganized in 2011 to centralize the
handling of distributions, develop expertise, and improve speed and
efficiency in the distribution process. Its mission is to return money
to harmed investors whenever practicable in a fair, reasonable, cost-
effective, and efficient manner. It also seeks to promote awareness
among injured investors about the distributions process through
proactive outreach and targeted mailings.
The OD handles an average of 200 distribution funds at any given
time. Since the passage of the Sarbanes Oxley Act, the SEC has returned
more than $9.9 billion to harmed investors through its distributions.
In fiscal year 2013, the SEC returned over $250 million to harmed
investors through 22 different distribution funds. We are committed to
continuing to work to maximize the return of funds to harmed investors
whenever possible.
Question. There are reports that the SEC is considering allowing
U.S. companies to utilize accounting standards from the International
Standards Board to report their financial results in the United States.
Could you comment on the validity of these reports, as well as the
strengths and weaknesses of such an approach?
Answer. The Commission has long promoted the objective of a single
set of high-quality globally accepted accounting standards. The
Financial Accounting Standards Board (FASB) and the International
Accounting Standards Board (IASB) have been working together to more
closely converge U.S. Generally Accepted Accounting Principles (U.S.
GAAP) and International Financial Reporting Standards (IFRS) since
2002. The FASB's ongoing work with the IASB on convergence projects has
resulted in the elimination of many significant differences between
U.S. GAAP and IFRS. The Commission continues to monitor the progress of
the remaining convergence projects.
Under the Commission's rules, foreign private issuers are permitted
to file financial statements in accordance with IFRS as issued by the
IASB without reconciliation to U.S. GAAP. Today, over 500 companies,
representing trillions of dollars of market capitalization, avail
themselves of this method of reporting by submitting reports to the
Commission as foreign private issuers using IFRS. Therefore, high-
quality IFRS standards are critically important to the U.S. markets.
The Commission has not yet made any determinations as to whether
there would be any further incorporation of IFRS into the U.S.
financial reporting system. I believe it is important for the
Commission to continue to consider the potential benefits and
challenges of further incorporating IFRS into the U.S. financial
reporting system. As we do, it is imperative to fully consider the
interests of U.S. investors, the FASB's role as the standard setter of
accounting standards for U.S. companies, and the role the United States
plays in the development of global accounting standards.
______
Questions Submitted by Senator Jerry Moran
sec registration threshold under section 12(g)
Question. In implementing Section 401 of the JOBS ACT, the SEC
proposed Regulation A+, which is intended relieve the reporting burden
for small businesses by exempting securities offerings of less than $50
million annually from the registration requirements of the Securities
Act. Additionally, the JOBS Act increased one of the registration
thresholds under section 12(g) of the Exchange Act, by allowing up to
2000 accredited investors for companies with over $10 million in
assets. Recently, Kansas businesses have expressed concerns about
increasing asset threshold under 12(g) in order to match the exemption
provided for public offerings in Regulation A+.
Has the SEC examined the effects of increasing the 12(g) asset
threshold?
What is the policy rationale for such an increase? Do you believe
that rationale is consistent with Congressional intent?
What is the SEC doing to make certain the reporting requirements
for companies with assets of $10 million and 2000+ accredited investors
are not more burdensome than requirements for companies with potential
assets of up to $50 million?
Answer. As described in the Commission's rule proposal to implement
new section 3(b)(2), often referred to as Regulation A+ exemption, a
company raising capital under that exemption would have to comply with
the requirements of Exchange Act Section 12(g) just as any other
company would. That is, no matter how much a company raised in a
Regulation A+ offering, if, at the end of the year it had more than $10
million of assets and 2,000 holders of record, it would be required to
register under the Exchange Act.
Under the rule proposal, certain Regulation A+ issuers would be
required to file annual and semiannual ongoing reports and current
event updates that are similar to the requirements for public company
reporting, but scaled for these issuers. In the proposing release, the
Commission noted that such disclosures would benefit investors by
providing a regular flow of information and would further the
development of a market for the securities. The reporting obligations
would be required even if the issuer has fewer than 2,000 holders of
record and therefore does not meet the thresholds under section 12(g).
The staff is carefully reviewing the public comment received on this
rule proposal as it works to develop recommendations for final rules
for the Commission's consideration.
With regard to Exchange Act Section 12(g), Congress established a
$1 million total assets threshold in 1964. The Commission subsequently
used its authority under Exchange Act Section 12(h) to raise the asset
threshold several times, and raised it to $10 million in 1996. The
changes made by the JOBS Act, which were effective immediately upon
enactment, codified the $10 million threshold in the Exchange Act, but
did not raise it.
The Commission staff is preparing rule recommendations to revise
its rules to implement the changes made by the JOBS Act to section
12(g). When undertaking these rulemakings, as is the case with all
rulemakings, the Commission and its staff are mindful of the economic
effects associated with the requirements proposed or adopted, including
the costs and benefits of regulation and potential effects on
efficiency, competition and capital formation.
accredited investors
Question. Section 413 of the Wall Street Reforms and Consumer
Protection Act of 2010 requires the SEC to examine its definition of an
accredited investor to determine whether it should be modified ``for
the protection of investors, in the public interest, and in light of
the economy.'' To qualify as an accredited investor, SEC requires an
investor to earn an annual income over $200,000 or a net worth over $1
million, excluding a primary residence. There is concern among the
angel investing community and new businesses across the country that a
dramatic increase in the threshold for qualification as an accredited
investor could limit the number of individuals who are able to provide
capital to early stage businesses at their most critical juncture. GAO
analysis of Federal data on household net worth showed that adjusting
the $1 million minimum threshold to approximately $2.3 million, to
account for inflation, would decrease the number of households
qualifying as accredited from approximately 8.5 million to 3.7 million,
or approximately a 56 percent drop in eligible accredited investors.
What criteria will the SEC use to determine whether or not to
increase the threshold for qualification as an accredited investor?
Is there strong evidence that the current thresholds pose any risk
for investors? What data suggests current accredited investors do not
understand risk when making investments?
Answer. The Commission staff, including staff from the Division of
Corporation Finance and the Division of Economic and Risk Analysis,
currently is engaged in a comprehensive review of the accredited
investor definition. The review and the feedback received through that
process will inform the Commission's consideration of whether to change
the definition of accredited investor, including whether net worth and
annual income should be used as tests for determining whether a natural
person is an accredited investor. As part of this review, Commission
staff is also independently evaluating alternative criteria for the
accredited investor definition suggested by the public and other
interested parties. Careful consideration is being given to both the
need to facilitate capital formation and the need to protect investors.
Any possible changes to the definition would subsequently occur through
the rulemaking process, which includes opportunities for public comment
on any such changes and a thorough economic analysis of their potential
effects.
accounting rules under jobs act
Question. The section 4(a)(6) exemption of the JOBS Act was
intended to provide investors with protection in the form of disclosure
while allowing companies an easy pay to accessing investment capital.
Balancing these goals is why Congress included mandatory financial
disclosures for companies seeking investment. However, Congress did not
stipulate the basis of accounting required and deferred to the SEC to
make that determination. In response, the Commission has proposed U.S.
generally accepted accounting principles (U.S. GAAP), a standard basis
of accounting designed for use by larger and public corporations. Many
companies and crowdfunding platforms believe this requirement is
unnecessary, unduly burdensome, and inconsistent with Congress's intent
to create an exemption that was compatible with the reality of small
business. As the National Federation of Independent Business (NFIB) has
shown, most small businesses do not use U.S. GAAP accounting. In fact,
only a small minority uses any sort of pure accrual-based accounting
(of which U.S. GAAP is a subset) with the vast majority using either
cash-based accounting or a hybrid method. Small businesses choose the
method of accounting that makes the most sense for their needs, both in
terms of how it reflects the reality of their business and the costs of
preparation and compliance.
Why did the SEC decide to require U.S. GAAP as the preferred
accounting practice?
Answer. As you know, the Commission has proposed rules to implement
the crowdfunding provisions of the JOBS Act.\14\ Under the proposal,
companies would be required to provide financial statements prepared in
accordance with U.S. generally accepted accounting principles (``U.S.
GAAP''). The Commission considered a variety of factors when issuing
the proposal, including that (i) financial statements prepared in
accordance with U.S. GAAP are currently required for offerings under
Regulation A, which is another exemption available to smaller issuers
to raise capital; (ii) financial statements prepared in accordance with
U.S. GAAP are generally self-scaling to the size of the issuer, which
should reduce the burden of preparing financial statements for many
early stage issuers; and (iii) some commenters suggested that the
Commission require financial statements prepared in accordance with
U.S. GAAP.
The Commission requested comment on the proposal and alternatives,
such as whether financial statements should be prepared differently
than under U.S. GAAP and, if so, which changes from U.S. GAAP would be
appropriate The Commission also requested comment on whether the
Commission should allow issuers to prepare financial statements using a
comprehensive basis of accounting other than U.S. GAAP.
The Commission has received approximately 320 comment letters,
including 30 form letters, on the crowdfunding proposal. Comments
received on this aspect of the proposal were mixed, and contained a
variety of suggested approaches. The Commission staff is reviewing
these letters and will consider them carefully as they develop
recommendations for final rules for the Commission's consideration.
audit threshold
Question. In the JOBS act Congress established a tiered system of
required financial disclosures that companies would have to meet in
order to participate in an offering under Regulation Crowdfunding.
Under the law, issuers offering more than $500,000 within a 12-month
period, or such other amount as the Commission may establish, by rule,
are required to provide audited financial statements. The Commission
has proposed keeping the threshold for requiring an audit at $500,000.
The $500,000 audit threshold as proposed has received criticism in both
the media and comments to the Commission because of the prohibitive
cost of audits for small companies, especially since the audit will
need to be undertaken prior to the company being certain that it will
secure funding. The Commission proposes to keep the threshold at
$500,000 because ``Congress specifically selected'' it. However this is
not true; Congress specifically gave the SEC authority to select a
different threshold amount to avoid the very scenario that appears to
be developing--that the audit requirement is too onerous for companies
to comply with, excluding them from being able to take advantage of
crowdfunding.
Is the SEC aware of concerns raised by small businesses interested
in using crowdfunding?
Will the SEC monitor and potential modify these thresholds over
time?
Answer. Title III of the JOBS Act, which establishes a new
crowdfunding exemption, contains a number of requirements mandated by
Congress, including those to ensure investor protection. As you note,
the Commission proposed rules designed to implement the crowdfunding
exemption and received approximately 320 comment letters, including 30
form letters, on the proposal. While some commenters were supportive of
the Commission's proposal, other commenters expressed concerns about
costs that may arise under the proposal, including costs associated
with preparing audited financial statements. Commission staff is
reviewing these comment letters and has been meeting with individuals
and groups interested in sharing their views about the rule proposal.
The staff is considering all of the feedback provided as it works to
develop recommendations for final rules for the Commission's
consideration. The Commission and staff appreciate the need to develop
rules to implement the crowdfunding exemption in a way that both
promotes capital formation while at the same time providing key
protections for investors.
In issuing the proposal, the Commission noted its understanding
that the proposed rules, if adopted, could significantly affect the
viability of crowdfunding as a capital-raising method for startups and
small businesses. Rules that are unduly burdensome could discourage
participation in crowdfunding. Rules that are too permissive, however,
may increase the risks for individual investors, thereby undermining
the facilitation of capital raising for startups and small businesses.
The Commission also directed the staff to develop a comprehensive
work plan to review and monitor the use of the crowdfunding exemption
under section 4(a)(6) and the rules the Commission adopts to implement
crowdfunding. Upon adoption of the final rules, the Commission staff
will monitor the market for crowdfunding offerings, focusing in
particular on the types of issuers using the exemption, the level of
compliance by issuers and intermediaries, and whether the exemption is
achieving its objectives. This monitoring program will assist the
Commission's efforts in evaluating the development of market practices
in offerings made in reliance on the crowdfunding exemption and related
rules. These efforts also will facilitate future Commission
consideration of any potential amendments to the rules implementing
crowdfunding.
ongoing audit requirement
Question. The Commission has proposed a requirement that companies
subject to an initial audit must undergo audits on a yearly basis until
the securities are retired, the company becomes a reporting company, or
the company liquidates or dissolves. This proposal is in no way
mandated by the JOBS Act. The Commission justifies this requirement on
the grounds of providing investors and potential secondary purchasers
with up-to-date information. While this is an important objective, and
was the reason for Congress requiring certain limited ongoing
disclosures in the JOBS act, requiring ongoing audits is excessively
expensive, burdensome, and ultimately contrary to the needs of small
businesses and potential investors. The ongoing audit requirement will
also render the cost-of-capital of crowdfunding higher than other
sources of funding, possibly creating an adverse selection problem
where the best companies avoid crowdfunding in favor of other types of
offerings with less onerous requirements such as offerings made in
reliance on Rule 506(c), leaving only companies for whom crowdfunding
is the last resort in the marketplace.
Is the Commission aware of the concern about this requirement?
Why would the Commission treat crowdfunding investments differently
than securities sold under Regulation A, which do not require a yearly
audit?
Answer. While some commenters were supportive of the Commission's
proposal, other commenters expressed concerns about costs that may
arise under the proposal, including costs associated with preparing
ongoing annual reports with audited financial statements. As indicated
above in response to Question 3, Commission staff is reviewing these
comment letters and has been meeting with individuals and groups
interested in sharing their views about the rule proposal.
The crowdfunding provisions of the JOBS Act require ongoing
disclosure, which differs from current Regulation A. Under the proposal
to implement the crowdfunding provisions, a company's ongoing
disclosure about its financial condition would have to meet the
financial statement requirements that were applicable to its initial
offering of securities. As a result, only companies whose offering
statement included audited financial statements would be required to
provide audited financial statements on a yearly basis until one of
three terminating events occurs. The Commission requested comment on
the proposed ongoing annual reporting requirement and will consider
carefully the comments submitted on this requirement when adopting
final rules.
______
Questions Submitted to Hon. Mark P. Wetjen
Questions Submitted by Senator Tom Udall
importance of conducting annual exams
Question. Chairman Wetjen, the Commodity Futures Trading Commission
(CFTC) regulates the activities of over 68,000 registrants who handle
customer funds, solicit or accept orders, or give trained advice. These
include commodity pool operators, futures commission merchants, floor
brokers, floor traders, and salespersons. I understand that due to
resource constraints, the CFTC is unable to conduct reviews more
frequently than once every 3 years. Because of the triennial cycle, the
ability to check compliance is diluted. Your fiscal 2015 budget request
seeks $38.1 million dollars which will support 158 staff. That is 63
more staff than the 95 supported by the current spending level of $23.6
million dollars.
Would the requested funding permit more frequent reviews?
Answer. Yes. Currently, the Commission's review cycles of
registered entities varies depending on many factors, including the
Commission's available resources and whether an entity is considered
systemically important. By fully funding the President's budget
request, the Commission can move toward annual reviews of all
significant clearinghouses and trading platforms and perform more
proactive monitoring of higher risk market participants and
intermediaries. Partially funding the request will mean accepting
potentially avoidable risk in the derivatives markets as the Commission
is forced to reduce the frequency of reviews and forego more in-depth
financial, operational and risk reviews of the firms within its
jurisdiction.
Question. What are some of the benefits CFTC could realize from the
proposed increase in resources for the Exams functions?
Answer. The CFTC would be in a better position to monitor risk in
the markets and entities we oversee, verify that registered entities
are complying with our rules, and proactively monitor the activities of
our registrants. This would also help the CFTC to ensure that the
financial, risk, compliance and operational reports that we receive are
materially correct. Likewise, the CFTC would be better able identify
industry trends and assess new and emerging risks in the industry.
Lastly, the CFTC would be in an improved position to proactively
monitor and detect problems at firms sooner. The benefit to customers
would be just as important as closer monitoring would help ensure the
firms are following our customer protection rules.
Question. Would more frequent reviews require adding staff with
enhanced expertise?
Answer. While our staff has, on average, 23.6 years of experience,
the industry is constantly changing and becoming more complex. In
enhancing its examinations program, the CFTC would expect to hire
individuals with more specialized skills, and possibly train current
employees to provide those specialized skills. The skills necessary for
an effective examinations program include risk management, technology
(including data security and data management), swaps expertise,
liquidity analysis, market risk analysis, and operational risk
analysis.
Question. Is the CFTC encountering any problems in acquiring the
skills and experience needed to support the growth you project to need?
Answer. The key challenges the CFTC faces in this regard are having
adequate resources to train existing staff and hire qualified new
staff. An additional challenge the Commission faces when hiring new
staff is that it competes for qualified staff directly with private
sector employers who have significant financial resources at their
disposal and are often able to provide greater compensation than public
sector employers. Regarding our existing staff, the Commission faces
challenges in retaining some of its most experienced and knowledgeable
staff. In recent years, the Commission has had to reduce investments in
training opportunities for existing staff. Such training is vital to
retaining employees and updating their skills and knowledge about the
markets we regulate and our agency's increased regulatory
responsibilities under the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank).
market transformation and high-frequency trading
Question. Chairman Wetjen, as the leader of one of our key
financial regulators, you are acutely aware of the growing challenges
facing your agency in monitoring the markets. We now have significantly
transformed, globalized, round-the-clock, and highly diversified
marketplace. Rapid, electronic, algorithmic trading platforms are
replacing the traditional open-outcry trading floors.
What is the current status of the CFTC's oversight of high-
frequency trading and automated trading environments?
Answer. The Commodity Exchange Act (Act) and Commission regulations
are designed to protect market participants and the public from fraud,
manipulation, abusive practices, and systemic risk related to futures
and swaps. The Commission oversees designated contract markets (DCMs),
swap execution facilities (SEFs), clearinghouses, futures commission
merchants (FCMs), swap dealers (SDs) and other entities and
intermediaries to monitor their compliance, and in the case of DCMs and
SEFs, reviews their self-regulatory programs. DCMs are subject to 23
core principles under the Act and SEFs are subject to 15. As the front-
line self-regulatory organizations, DCMs and SEFs have primary
responsibility for identifying misconduct by all market participants,
including those engaged in automated trading and high-frequency trading
(HFT). The CFTC's Division of Market Oversight conducts rule
enforcement reviews of DCMs' self-regulatory programs and evaluates
their compliance with the Act and Commission regulations.
The Act and Commission regulations do not distinguish between HFT
and non-HFT. ``High-frequency trader'' is not a distinct category of
market participant within the Commission's regulations, nor is it a
defined term or separate registration status. Applicable regulations
and resources developed by the Commission to detect trading abuses are
equally relevant regardless of the trading strategy used to effectuate
the abuse. Many Commission rulemakings implementing Dodd-Frank apply to
automated trading and HFT because the rules address trading on DCMs and
SEFs, or apply to registrants who may engage in automated trading of
HFT activity.
In April 2012, the Commission adopted Regulations 1.73 and 23.609
requiring FCMs, SDs and major swap participants (``MSPs'') that are
clearing members to establish risk-based limits based on ``position
size, order size, margin requirements, or similar factors'' for all
proprietary accounts and customer accounts. The rules also require
FCMs, SDs and MSPs to ``use automated means to screen orders for
compliance with the [risk] limits'' when such orders are subject to
automated execution. The Commission also adopted rules in April 2012
requiring SDs and MSPs to ensure that their ``use of trading programs
is subject to policies and procedures governing the use, supervision,
maintenance, testing, and inspection of the program.''
In June 2012, the Commission adopted rules to implement the 23 core
principles for DCMs. Regulation 38.255 requires DCMs to ``establish and
maintain risk control mechanisms to prevent and reduce the potential
risk of price distortions and market disruptions, including, but not
limited to, market restrictions that pause or halt trading in market
conditions prescribed by the designated contract market.'' Regulation
37.405 imposes similar requirements on SEFs.
The DCM rules also set forth risk control requirements for
exchanges that provide direct market access (``DMA'') to clients.
Regulation 38.607 requires DCMs that permit DMA to have effective
systems and controls reasonably designed to facilitate an FCM's
management of financial risk. These systems and controls include
automated pre-trade controls through which member FCMs can implement
financial risk limits. Regulation 38.607 also requires DCMs to
implement and enforce rules requiring member FCMs to use these systems
and controls. The DCM rules also implement new requirements in the Act
related to exchanges' cyber security and system safeguard programs. The
Act and Commission regulations also address cyber security and system
safeguards within SEFs.
Finally, the Division also conducts direct surveillance of its
regulated markets, and continues to improve the regulatory data
available for this purpose. For example, in November 2013 the
Commission published final rules to improve its identification of
participants in futures and swaps markets (OCR Final Rules). While
enhancing the Commission's already robust position-based reporting
regime, the OCR Final Rules also create new volume-based reporting
requirements that significantly expand the Commission's view into its
regulated markets, including with respect to HFT.
In addition to its current rules, on September 12, 2013, the
Commission published a Concept Release on Risk Controls and System
Safeguards for Automated Trading Environments. The Concept Release
proposes consideration of a series of 23 additional pre-trade risk
controls; post-trade reports; design, testing, and supervision
standards for automated trading systems (ATS) that generate orders for
entry into automated markets; market structure initiatives; and other
measures designed to reduce risk or improve the functioning of
automated markets. The Concept Release is intended to foster a public
dialogue and inform the Commission as it considers what additional
measures, if any, might be necessary to address automated and high-
frequency trading.
The initial 90-day comment period closed on December 11, 2013, but
was reopened from January 21 through February 14, 2014, in conjunction
with a meeting of the CFTC's Technology Advisory Committee (TAC). The
Commission received over 40 public comments on the Concept Release,
including comments from DCMs; an array of trading firms; trade
associations; public interest groups; members of academia; a U.S.
Federal reserve bank; and consulting, technology and information
service providers in the financial industry. CFTC Staff is currently
studying all publicly submitted comments received and upon completing
the review will make initial recommendations if necessary.
Question. Does the CFTC presently have the necessary talent and
technology in place to monitor and analyze high-frequency trading, to
inform your regulatory and enforcement work, and guard the integrity
and safety of the markets? What are the deficiencies?
Answer. As noted above, the Commission's rules do not distinguish
between HFT and non-HFT trading. The Commission does face challenges in
making sure its technology and personnel are adequate to oversee
trading in the markets, including HFT trading. The most significant
impediment to enhanced Commission surveillance of HFT is insufficient
staff and resources. In particular, the Commission does not have the
resources in place to receive and analyze complete messaging (e.g.,
order book) data from DCMs or SEFs. Access to messaging data is
critical to overseeing electronic trading because it permits analysts
to reconstruct what actually happened during a particular trading
period. With appropriate staff and technology, staff can use this data
to detect disruptive trading practices such spoofing. Achieving
comprehensive surveillance of electronic trading will require
additional financial, staff and other resources not currently available
to the Commission.
SUBCOMMITTEE RECESS
Senator Udall. The subcommittee hearing is hereby
adjourned.
[Whereupon, at 3:25 p.m., Wednesday, May 14, the
subcommittee was recessed, to reconvene subject to the call of
the Chair.]