[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]





 
                       CONTINUED OVERSIGHT OF THE


                      SEC'S OFFICES AND DIVISIONS

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

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 21, 2016

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 114-84
                           
                           
                           
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking 
    Vice Chairman                        Member
PETER T. KING, New York              CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
SCOTT GARRETT, New Jersey            GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas              MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico            RUBEN HINOJOSA, Texas
BILL POSEY, Florida                  WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK,              STEPHEN F. LYNCH, Massachusetts
    Pennsylvania                     DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia        AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri         EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan              GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin             KEITH ELLISON, Minnesota
ROBERT HURT, Virginia                ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana          TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina        BILL FOSTER, Illinois
RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida              PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina     JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri                 KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky                  JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania       DENNY HECK, Washington
LUKE MESSER, Indiana                 JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota

                     Shannon McGahn, Staff Director
                    James H. Clinger, Chief Counsel
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

ROBERT HURT, Virginia, Vice          CAROLYN B. MALONEY, New York, 
    Chairman                             Ranking Member
PETER T. KING, New York              BRAD SHERMAN, California
EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              STEPHEN F. LYNCH, Massachusetts
PATRICK T. McHENRY, North Carolina   ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan              DAVID SCOTT, Georgia
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
STEVE STIVERS, Ohio                  KEITH ELLISON, Minnesota
STEPHEN LEE FINCHER, Tennessee       BILL FOSTER, Illinois
RANDY HULTGREN, Illinois             GREGORY W. MEEKS, New York
DENNIS A. ROSS, Florida              JOHN C. CARNEY, Jr., Delaware
ANN WAGNER, Missouri                 TERRI A. SEWELL, Alabama
LUKE MESSER, Indiana                 PATRICK MURPHY, Florida
DAVID SCHWEIKERT, Arizona
BRUCE POLIQUIN, Maine
FRENCH HILL, Arkansas

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    April 21, 2016...............................................     1
Appendix:
    April 21, 2016...............................................    45

                               WITNESSES
                        Thursday, April 21, 2016

Butler, Thomas J., Director, Office of Credit Ratings, U.S. 
  Securities and Exchange Commission.............................     4
Flannery, Mark J., Director, Division of Economic and Risk 
  Analysis, U.S. Securities and Exchange Commission..............     6
McKessy, Sean, Chief, Office of the Whistleblower, U.S. 
  Securities and Exchange Commission.............................     8
Wyatt, Marc, Director, Office of Compliance, Inspections, and 
  Examinations, U.S. Securities and Exchange Commission..........     9

                                APPENDIX

Prepared statements:
    Joint statement of the SEC...................................    46

              Additional Material Submitted for the Record

Sherman, Hon. Brad:
    Letter to SEC Chair Mary Jo White, dated April 18, 2016......    59
Wagner, Hon. Ann:
    Majority Staff Report of the Committee on Homeland Security 
      and Governmental Affairs, United States Senate, entitled, 
      ``The Labor Department's Fiduciary Rule: How a Flawed 
      Process Could Hurt Retirement Savers,'' dated February 24, 
      2016.......................................................    62
Garrett, Hon. Scott:
    Written responses from the SEC to questions submitted for the 
      record.....................................................   102
Messer, Hon. Luke:
    Written responses from the SEC to questions submitted for the 
      record.....................................................   117
Neugebauer, Hon. Randy:
    Written responses from the SEC to questions submitted for the 
      record.....................................................   121


                       CONTINUED OVERSIGHT OF THE



                      SEC'S OFFICES AND DIVISIONS

                              ----------                              


                        Thursday, April 21, 2016

             U.S. House of Representatives,
                Subcommittee on Capital Markets and
                  Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 9:14 a.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Hurt, Royce, 
Neugebauer, Huizenga, Duffy, Hultgren, Ross, Wagner, Messer, 
Schweikert, Poliquin, Hill; Maloney, Sherman, Hinojosa, Lynch, 
Himes, Foster, Sewell, and Murphy.
    Also present: Representative Fitzpatrick.
    Chairman Garrett. The Subcommittee on Capital Markets and 
Government Sponsored Enterprises is hereby called to order. 
Today's hearing is entitled, ``Continued Oversight of the SEC's 
Offices and Divisions.''
    Without objection, the Chair is authorized to declare a 
recess of the subcommittee at any time.
    Also, without objection, members of the full Financial 
Services Committee who are not members of this subcommittee may 
sit on the dais and participate in today's hearing.
    At this point, I will now recognize myself for 3 minutes 
for an opening statement.
    Today, the subcommittee will continue its efforts to 
conduct vigorous oversight of the SEC, and in particular, the 
individual offices which make up the SEC.
    In the last 2 years, our subcommittee has heard testimony 
from the Directors of the Trading and Markets, Corporation 
Finance, Enforcement, and Investment Management Divisions at 
the SEC. These hearings have allowed us to take a more thorough 
look at the agencies' operations, their rulemaking agenda, and 
enforcement practices so that we can better understand whether 
the SEC is appropriately carrying out its three-fold mission 
to: protect investors; maintain fair and orderly, efficient 
markets; and last but certainly not least, facilitate capital 
formation.
    So I welcome our witnesses today. I look forward to hearing 
their testimony, and I hope between the four of you who are 
here on the panel that we are able to cover a lot of ground in 
the time we have.
    If you go back, in the year 2000 the SEC's operating budget 
was about $369 million. Today, the SEC's budget authority for 
Fiscal Year 2016 is a little over $1.6 billion. And the SEC has 
recently submitted a request for the Fiscal Year 2017 budget 
coming up of $1.8 billion.
    So during much of the time when Congress has been accused 
of starving the SEC of funds it needs to fulfill its mission, 
its budget has actually quadrupled and has done so in less 
than--a little over a dozen years.
    It would be one thing if this four-fold increase's funding 
coincided with an agency that has become 4 times more 
effective. Instead, we are likely to look back at this as a 
period of time when the SEC missed some of the greatest frauds 
in history, when it was ill-prepared for the financial crisis 
of 2008, and when it failed to properly incorporate economic 
analysis into its rulemaking and, more recently, has oftentimes 
been complicit in advancing the priorities of special 
interests.
    So, unfortunately, instead of addressing some of the 
fundamental structural issues at the SEC, the Dodd-Frank Act 
has created even more offices within the agencies, two of which 
are with us here today. Dodd-Frank also granted the agency vast 
new rulemaking authority that the SEC has oftentimes simply 
struggled to implement appropriately. For example, while the 
SEC has made strides towards improving the economic analysis 
that underlies its rulemakings, there is still much more work 
that can be done in this area.
    And so it is not acceptable for the SEC to simply say, 
``Well, Congress made me do it,'' and therefore assume that 
rulemaking is beneficial in all cases, as the SEC recently did 
with its pay ratio rule last year. It is also incumbent upon 
the SEC to clearly articulate a problem, or a market failure, 
if you will, that the rules are intended to address, which 
should be obvious, but it is still, unfortunately, lacking in 
many of the Dodd-Frank rules that have been implemented.
    So I am eager to hear about the steps the SEC is taking to 
further improve its economic analysis.
    Finally, I also continue to have concerns over recent 
rulemakings related to credit rating agencies. While there is 
broad agreement that certain provisions in Dodd-Frank, such as 
the removal of references to credit rating agencies' 
regulations, were much needed and directly address one of the 
causes of the financial crisis, I worry that many of the other 
micromanaging rules included in Dodd-Frank have had the effect 
of further stifling competition in the credit rating industry.
    So again, I want to thank all the witnesses for their 
testimony, and I will yield to the ranking member of the 
subcommittee, Mrs. Maloney, for 5 minutes.
    Mrs. Maloney. Good morning, and thank you so much, Mr. 
Chairman, for holding this important hearing. I also thank all 
of our participants today. This hearing will continue our 
subcommittee's series of oversight hearings on the SEC.
    Today, we are focusing on four divisions or offices in the 
SEC: the Office of Compliance, Inspections, and Examinations; 
the Office of Credit Ratings; the Office of the Whistleblower; 
and the Division of Economic Risk and Analysis, or DERA. All 
four of these offices play a critical role in policing our 
Nation's securities markets.
    The Office of Credit Ratings oversees the registered credit 
rating agencies such as Moody's, S&P, and Fitch. The financial 
crisis revealed the importance of credit rating agencies, but 
physically it revealed the catastrophic consequences that can 
result when the rating agencies all get their ratings wrong.
    In response, Dodd-Frank created the Office of Credit 
Ratings in order to increase the level of oversight of credit 
rating agencies. One of the principal missions of this office 
is to ensure that inappropriate conflicts of interest at the 
rating agencies do not influence the ratings that the firms 
assign to different securities.
    The Office of the Whistleblower was also created by Dodd-
Frank and is intended to encourage whistleblowers from the 
industry to come forward with specific and timely information 
about wrongdoing. In return for tips that lead to significant 
punishments of over $1 million, whistleblowers are entitled to 
a monetary reward, which incentivizes industry employees to 
blow the whistle before fraud gets too large and too 
devastating.
    Already, this office has received thousands of tips from 
potential whistleblowers, which is striking. In fact, in 2015 
the office received over 4,000 tips from whistleblowers.
    The Division of Economic Risk and Analysis, or DERA, is the 
data arm of the SEC. It supports all of the other divisions in 
the SEC by conducting cost-benefit analysis of potential 
rulemakings, developing models that help focus the Commission's 
resources on the riskiest practices, and even calculating the 
appropriate punishment for bad actors.
    Finally, the Office of Compliance, Inspections, and 
Examinations, or OCIE, is one of the largest and most 
underfunded offices in the SEC. It has over 1,000 employees who 
examine registered investment advisers, broker-dealers, 
exchanges, mutual funds, and mutual advisers. This sounds like 
a lot of examiners, but it pales in comparison to the number of 
market participants that the office has to examine.
    The office oversees more than 26,000 market participants, 
including over 12,000 investment advisers, 11,000 mutual funds, 
4,000 broker-dealers, 800 municipal advisers, and 18 securities 
exchanges. As a result, the Commission is only able to examine 
about 10 percent of all investment advisers each year, which is 
a terrifying thought. This means that roughly 40 percent of 
investment advisers have never been examined.
    What makes this even scarier is that in 2015, a whopping 77 
percent of the Commission's examinations identified 
deficiencies at investment advisers, and 11 percent resulted in 
referrals for enforcement action. If those numbers are 
constant, that means that of the 5,000 investment advisers that 
have never been examined, a little under 4,000 have 
deficiencies that have not been uncovered. This is a scary 
thought for investors who rely on those advisers to manage 
their savings.
    So I look forward to hearing from all of our witnesses 
today, and I look forward to your testimony. Thank you for your 
work.
    And I yield back the balance of my time. Thank you.
    Chairman Garrett. Thank you very much.
    The gentlelady yields back.
    The gentleman from Virginia, Mr. Hurt, the vice chairman of 
the subcommittee, is recognized for 2 minutes.
    Mr. Hurt. Thank you, Mr. Chairman.
    And welcome, to our panel.
    I represent a rural district in Virginia, Virginia's 5th 
District. It stretches from the northern Piedmont in Virginia 
to the North Carolina border. So as I travel across my 
district, I regularly hear from my constituents that they are 
concerned about jobs and the economy, and that they are 
concerned with the seemingly new normal administrative state 
here in Washington that makes it more difficult for our Main 
Street and small businesses to access capital and to be 
successful.
    While this committee has been laser-focused on producing 
legislation that would help our Nation's small businesses 
thrive, that would ease the access to capital, and that would 
build upon the bipartisan success of the JOBS Act, an equally 
important function is fulfilling Congress' duty to conduct 
vigorous oversight over Executive Branch agencies.
    Just as my constituents are concerned about our ever-
expanding administrative state, I, too, am concerned that the 
SEC often deviates from its three-part mission: to protect 
investors; to maintain fair, orderly, and efficient markets; 
and to facilitate capital formation.
    Hearings such as this allow Congress to exercise its 
responsibility of proper oversight over how the SEC allocates 
its resources in fulfilling its three-part mission. I look 
forward to the testimony of our witnesses.
    I thank the chairman for holding this hearing, and I yield 
back the balance of my time.
    Chairman Garrett. Great. The gentleman yields back.
    And now, I welcome the members of the panel before us. 
Without objection, your joint written statement will be made a 
part of the record.
    You will be recognized for 5 minutes. I know most of you 
have not been here before, but you know the drill, I assume.
    In front of you are the lights, which are green, yellow, 
and red. The yellow light should come on when you have 1 minute 
remaining, so we would ask you at that time to begin to wrap 
up, and the red light means your time has expired.
    And with that, Mr. Butler, you are recognized for 5 
minutes.

   STATEMENT OF THOMAS J. BUTLER, DIRECTOR, OFFICE OF CREDIT 
        RATINGS, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Butler. Good morning, Chairman Garrett, Ranking Member 
Maloney, and members of the subcommittee. Thank you for 
inviting me to testify on behalf of the U.S. Securities and 
Exchange Commission regarding the activities and responsibility 
of the Office of Credit Ratings.
    The office supports the Commission's three-part mission: to 
protect investors; maintain fair, orderly, and efficient 
markets; and facilitate capital formation. It does this by 
overseeing credit rating agencies that are granted registration 
as nationally recognized statistical rating organizations, or 
NRSROs.
    In 2006, the Credit Rating Agency Reform Act established 
the regulatory framework and gave Congress the authority to 
implement a myriad of rules for the oversight of NRSROs. The 
Dodd-Frank Act expanded the Commission's authority and mandated 
the creation of an office, the Office of Credit Ratings, 
dedicated to the oversight of NRSROs.
    The office's activities generally fall within three areas: 
examinations; NRSRO monitoring and constituent monitoring; and 
policy and rulemaking.
    Examinations of NRSROs for compliance with Federal 
securities laws and Commission rules accounts for the majority 
of the office's activities. The Dodd-Frank Act requires the 
office to conduct an examination of each NRSRO at least 
annually, and the scope of the annual examinations covers eight 
required review areas.
    Further, the office employs a risk-based approach to exam 
planning, identifying different risks for different NRSROs. 
This improves the efficiency and the effectiveness of the 
examinations as resources are prioritized and focused on areas 
of higher risk. In addition to the annual examinations, the 
office conducts sweeps and targets examinations to address 
credit market issues and concerns and to follow up on tips, 
complaints, and self-reported incidents.
    The NRSROs have been responsive to the staff's findings and 
recommendations. Many have implemented fundamental changes such 
as increasing surveillance activities; strengthening policies 
and procedures for managing conflicts of interest; adding staff 
to compliance and oversight functions; investing in multiyear 
technology initiatives; and enhancing disclosure, transparency, 
and governance.
    The annual examinations that are currently under way 
include a comprehensive review of compliance with the 
significant new rules and rule amendments that were adopted by 
the Commission in August 2014, all of which became effective by 
June 2015. As required by the Dodd-Frank Act, the office 
prepares an annual examination report summarizing the essential 
findings of the examinations. In December 2015, the office 
published a fifth annual examination report.
    The NRSRO monitoring and constituent monitoring groups 
within the office gather, analyze, and assess data and identify 
trends across the industry. NRSRO monitoring conducts periodic 
meetings with NRSROs and also meets on an ad hoc, proactive 
basis as necessary to respond to industry developments. And 
importantly, NRSRO monitoring meets with certain boards of 
directors, including a separate discussion with the independent 
directors.
    Constituent monitoring holds meetings with investors, 
issuers, arrangers, and trade organizations. The group conducts 
ad hoc research as warranted by industry or credit market 
conditions. The information obtained by the monitoring group 
provides useful input for examinations and for guiding the 
direction of any future rulemakings.
    The policy and rulemaking group within the office is 
responsible for developing rule recommendations, conducting 
studies, drafting reports, and including those required by the 
Credit Rating Agency Reform Act and the Dodd-Frank Act.
    New rules adopted by the Commission in August 2014 address, 
among other things, reporting on internal controls; conflicts 
of interest, including an absolute prohibition requiring the 
separation of sales and marketing activities from analytics; 
procedures to protect the integrity and transparency of rating 
methodologies; a requirement for the board of directors to 
approve a methodology before it is used; and standards of 
training, experience, and competence for credit analysts. The 
rules also provide for an annual certification by the CEO as to 
the effectiveness of internal controls and additional 
certifications to accompany credit ratings affirming that no 
part of the credit rating was influenced by any other business 
activities.
    While the Commission has broad authority to examine all 
books and records of an NRSRO, and to impose sanctions for 
violating statutory provisions in the Commission's rules, the 
Commission is not permitted to regulate the substance of credit 
ratings or the procedures and methodologies used to determine 
credit ratings.
    Thank you again for having me here today, and I would be 
pleased to answer any questions.
    [The joint statement of Mr. Butler, Mr. Flannery, Mr. 
McKessy, and Mr. Wyatt can be found on page 46 of the 
appendix.]
    Chairman Garrett. Great. Thank you, Mr. Butler.
    Mr. Flannery, welcome to the panel, and you are recognized 
for 5 minutes.

 STATEMENT OF MARK J. FLANNERY, DIRECTOR, DIVISION OF ECONOMIC 
   AND RISK ANALYSIS, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Flannery. Thank you. Good morning, Chairman Garrett, 
Ranking Member Maloney, and members of the subcommittee. It is 
my pleasure to be here today to talk about the responsibilities 
and recent activities of the Division of Economic and Risk 
Analysis, which we call DERA.
    DERA supports the Commission's mission through data-driven, 
high-quality economic analyses. Over the past several years, we 
have grown from approximately 96 employees in 2013 to a 
projected workforce of 175 by the end of this fiscal year.
    By that time, we anticipate employing 88 Ph.D.s, mostly in 
economics or finance, but also some accountants, and we even 
have two Ph.D. physicists. These Ph.D.s will be supported by 22 
research associates by the end of the year. DERA staff also 
includes a diverse team of other technical experts and 
professional staff.
    The division's rapid growth and resultant depth of 
expertise has allowed DERA to expand its support across an 
ever-increasing range of Commission activities.
    Our most well-known function is to provide economic 
analyses in support of Commission rulemaking and other priority 
initiatives. DERA economists examine the need for regulatory 
action, analyze the potential economic effects of the proposed 
and final rules, and evaluate public comments on those rules.
    We provide theoretical and data-driven economic analyses of 
potential new policies and changes to existing policies. We 
work closely with staff from elsewhere in the Commission from 
the earliest stages of policy development through the 
finalization of a particular rule.
    In the course of assisting other divisions and offices, 
staff routinely prepares White Papers, or staff studies--White 
Papers and other documents that present novel economic analyses 
of specific policy issues or rulemakings. For example, last 
year DERA staff produced White Papers relating to the liquidity 
requirements for open-ended mutual funds' operation, the funds' 
derivative usage, voluntary clearing activity in the single-
name credit default swap market, and another paper on the 
market for unregistered security offerings.
    In addition to research performed in conjunction with 
particular rules, DERA staff regularly published their research 
in refereed journals, and staff papers are posted on the DERA 
webpage to provide the public with access to our current 
research on financial markets.
    DERA's analytical capabilities extend not just to 
rulemaking, but also to risk assessment. We provide financial 
and risk modeling expertise to other divisions and offices in 
support of their supervisory, surveillance, and investigative 
programs. Our data analysis helps SEC staff with examination 
prioritization and scoping, including providing guidance on 
which entities to examine and what to look for during the 
examinations.
    One example is our broker-dealer risk assessment tool, 
which was developed in close collaboration with OCIE staff. 
This tool analyzes how a firm's behavior compares to its peers 
to identify anomalous behavior that might indicate risks in a 
broker-dealer's operations, financing, workforce, or structure.
    We also have a new corporate issuer risk assessment tool, 
developed in conjunction with the Division of Enforcement, that 
allows enforcement attorneys to examine over 200 custom metrics 
that help them to assess corporate issuer risk by identifying 
financial reporting irregularities that may indicate fraud.
    We also work with the Division of Enforcement. During 
Fiscal Year 2015, DERA staff provided export assistance in over 
120 new enforcement matters. Those staff helped identify 
securities law violations, quantify the harm to investors, 
calculate ill-gotten gains, and evaluate economic-based claims 
of the defendant.
    For cases that go to trial, DERA helps to prepare the 
Commission's outside experts and to critique or challenge the 
work of opposing experts. In certain instances, DERA staff have 
recently testified on behalf of the Commission.
    None of this work can be performed without high-quality 
data. DERA, thus, acts as a central data hub for the intake, 
processing, and use of data throughout the Commission. DERA's 
data oversight falls into two distinct but related categories.
    First, we work closely with other SEC divisions and offices 
to design data structuring approaches for required disclosures. 
DERA supports the SEC's data collections and data usage by 
designing taxonomies, validation rules, data quality 
assessments, and data dissemination tools to facilitate high-
quality data analysis.
    Second, DERA is responsible for the day-to-day management 
of many Commission databases. We routinely generate summary 
information and statistics, which are provided to Commission 
staff within DERA and elsewhere within the Commission. We also 
develop and refine datasets that are purchased from outside.
    In sum, I believe DERA staff are delivering high-quality, 
data-driven analyses that are critical to the SEC's mission, 
and we look forward to continuing this work in the future.
    Thank you again for inviting us, and I am looking forward 
to answering your questions.
    [The joint statement of Mr. Butler, Mr. Flannery, Mr. 
McKessy, and Mr. Wyatt can be found on page 46 of the 
appendix.]
    Chairman Garrett. Thank you, Mr. Flannery.
    Mr. McKessy, good morning, and welcome to the panel.

STATEMENT OF SEAN MCKESSY, CHIEF, OFFICE OF THE WHISTLEBLOWER, 
            U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. McKessy. Good morning, Chairman Garrett, Ranking Member 
Maloney, and members of the subcommittee. Thank you for 
inviting me to testify on behalf of the United States 
Securities and Exchange Commission regarding the 
responsibilities and activities of the Office of the 
Whistleblower.
    The Office of the Whistleblower is a separate office within 
the Division of Enforcement currently comprised of 13 
attorneys, 5 legal assistants, and an administrative assistant, 
all of whom are tasked to administer the whistleblower program.
    The whistleblower program was designed to incentivize 
individuals to provide the Commission with specific, timely, 
and credible information about possible securities law 
violations, enhancing the Commission's ability to act swiftly 
to protect investors from harm and bring violators to justice. 
Under the program, individuals who voluntarily provide the 
Commission with original information that leads to a successful 
enforcement action resulting in monetary sanctions exceeding $1 
million may be eligible to receive an award equal to 10 to 30 
percent of the monies collected.
    One of our primary activities is to evaluate whistleblower 
award claims and make recommendations as to whether claimants 
satisfy the eligibility requirements for receiving an award. We 
continue to receive a significant number of award claims, 
including over 120 claims in Fiscal Year 2015 alone. As of the 
end of Fiscal Year 2015, preliminary determinations and/or 
final orders have been issued with respect to nearly 400 claims 
for whistleblower awards.
    Since the whistleblower program went into effect, the 
Commission has awarded more than $57 million to 27 
whistleblowers, including more than $37 million in Fiscal Year 
2015 alone. The efforts of these 27 whistleblowers have 
resulted in orders against individuals and companies totaling 
over $400 million in sanctions, including over $325 million in 
disgorgement ordered to be paid to compensate harmed investors. 
Because all our whistleblower award payments are made out of 
our investor protection fund, the amounts ordered to be 
returned to harmed investors have not been affected in any way 
by the awards paid to our whistleblowers.
    Thanks in part to the positive attention the program 
attracted in connection with our whistleblower awards, the 
number of whistleblower tips we receive has increased each 
year. In Fiscal Year 2015, the Commission received nearly 4,000 
whistleblower tips, a 30 percent increase over the number 
received in Fiscal Year 2012.
    Since the program's inception, we have received more than 
16,000 tips from whistleblowers in every State in the country 
as well as the District of Columbia, and from individuals in 95 
countries outside of the United States. Our office is also 
actively involved with enforcement staff in helping to ensure 
that employees feel secure in reporting wrongdoing either 
internally or to the Commission without fear of retaliation.
    In June 2014, the Commission brought its first enforcement 
action under the anti-retaliation provisions of the 
whistleblower program, sending a strong message to employers 
that retaliation against whistleblowers in any form is 
unacceptable. Through interpretive guidance and amicus briefs, 
the Commission has expressed its view that the anti-retaliation 
protections under the whistleblower program extend to those who 
report potential securities law violations internally, 
regardless of whether they separately reported the information 
to the Commission.
    Additionally, our office continues to assist enforcement 
staff to prevent companies from coercing their employees not to 
report possible wrongdoing to the Commission. In April 2015, 
the Commission brought its first enforcement action against a 
company that required its employees to sign broad 
confidentiality agreements in contravention of our Rule 21F-
17(a). This rule prevents any person from taking any action, 
including enforcing or threatening to enforce a confidentiality 
agreement, to impede an individual from reporting information 
about a possible securities law violation to the Commission.
    Protecting whistleblowers from retaliation and safeguarding 
whistleblowers' rights to report possible securities law 
violations to the Commission continues to be among our top 
priorities. In the less than 5 years since the implementation 
of the whistleblower program, we have demonstrated that we can 
and will protect the confidentiality of whistleblowers, take 
action against employers who retaliate against or interfere 
with their employees' ability to report wrongdoing, and award 
tens of millions of dollars to whistleblowers whose information 
leads to successful enforcement actions.
    Given this strong track record, we expect that the 
Commission will continue to receive high-quality tips that can 
be leveraged to detect and halt fraud earlier and more 
efficiently. We fully expect that the whistleblower program 
will continue to be a game-changer in the enforcement of the 
securities laws to protect investors and ensure the fairness 
and efficiency of the marketplace.
    Thank you again for the invitation, and I am happy to 
respond to your questions.
    [The joint statement of Mr. Butler, Mr. Flannery, Mr. 
McKessy, and Mr. Wyatt can be found on page 46 of the 
appendix.]
    Chairman Garrett. Thank you. Thank you, sir.
    Finally, last but not least, Mr. Wyatt, you are recognized 
for 5 minutes.

   STATEMENT OF MARC WYATT, DIRECTOR, OFFICE OF COMPLIANCE, 
  INSPECTIONS, AND EXAMINATIONS, U.S. SECURITIES AND EXCHANGE 
                           COMMISSION

    Mr. Wyatt. Chairman Garrett, Ranking Member Maloney, and 
members of the subcommittee, thank you for the opportunity to 
discuss the SEC's Office of Compliance, Inspections, and 
Examinations, which we call OCIE, with you today.
    OCIE, through our national examination program, advances 
the SEC's mission through examinations that improve compliance, 
prevent fraud, monitor risk, and inform policy.
    With a staff of just over 1,000 employees, OCIE has 
examination responsibility for registered entities consisting 
of more than 12,000 investment advisers, 11,000 mutual funds 
and ETFs, over 4,000 broker-dealers, more than 400 transfer 
agents, and over 650 registered municipal advisers. We also 
have oversight responsibility for 18 national securities 
exchanges, 6 active registered clearing agencies, FINRA, the 
MSRB, SIPC, and the PCAOB.
    Recent legislative changes, such as the Dodd-Frank Act and 
the JOBS Act, have expanded OCIE's responsibility to include 
examinations of security-based swap market participants, 
including dealers, repositories, and execution facilities, as 
well as crowdfunding portals. Compounding the challenges in the 
sheer number of registrants we oversee is the continued growth 
in the financial markets and the complexity of market 
participants. In order to maximize the use of our limited 
staff, OCIE is in the formative stages of reallocating 
examiners to increase coverage of investment advisers.
    To meet the challenges posed by a registrant population 
that far exceeds our resources, we have adopted a risk-based 
framework for examinations, we have increased our utilization 
of advanced data analytics, and we promote compliance through 
transparency. We have adopted our risk-based framework to 
identify business practices or activities which may harm 
investors.
    We aggregate and analyze internal and external data sources 
to find operational red flags in our registrant population. 
This analysis enables examiners to identify higher-risk firms 
when selecting candidates for examination and in determining 
the areas that will be reviewed in the course of an 
examination.
    Over the past 5 years, OCIE has recruited industry experts, 
enhanced our technological capabilities, and increased our use 
of data analytics to further refine our risk-based program. For 
example, in the last fiscal year OCIE developed a new version 
of the national exam analytics tool, or NEAT. NEAT enables 
examiners to access and systematically analyze a year's worth 
of trading data much faster than we ever could before.
    Our quants have also developed techniques and technologies 
that help examiners detect suspicious activity in areas such as 
money laundering and high-frequency trading. These ongoing 
efforts will further enhance and expand our capabilities to 
prevent fraud and monitor risk.
    OCIE strives to improve compliance with Federal securities 
law through greater transparency. We engage in extensive 
communication and outreach initiatives with the industry and 
other regulators.
    Through this process, we provide registrants the 
opportunity to self-assess and remediate noncompliant behavior 
on their own. For example, each year OCIE publishes our annual 
statement of examination priorities to inform registrants about 
areas that staff believes represent heighted risk and may 
warrant examination.
    As outlined in our recent priorities, we are pursuing 
several key initiatives that are critical to the protection of 
investors. For example, in 2015 OCIE launched the ReTIRE 
Initiative, a multiyear examination effort focused on 
investment advisers and broker-dealers and the services they 
offer to investors with retirement accounts. We remain focused 
on retirement-based savings because retail investors are faced 
with a complex and evolving set of factors when making critical 
investment decisions.
    Another priority we have announced is cybersecurity. Over 
the last 2 years, we have conducted examinations to identify 
cybersecurity risks and assess cybersecurity preparedness among 
broker-dealers and investment advisers.
    As another example of our transparency, prior to initiating 
these exams we published our intended areas of focus, and after 
conducting the exams, OCIE published a summary of our 
observations. In 2016, we are continuing to conduct 
cybersecurity examinations, including testing and assessment of 
firms' access and control rights, data loss prevention, vendor 
management, and incident response.
    The final priority I will mention is liquidity. In light of 
changes in the fixed-income markets over the past several 
years, OCIE is examining advisers to mutual funds, ETFs, and 
private funds that have exposure to potentially illiquid fixed-
income securities. These examinations include a review of 
various controls including liquidity management, trading 
activity, and valuation policies.
    Thank you for inviting me to testify today, and I would be 
happy to answer any questions.
    [The joint statement of Mr. Butler, Mr. Flannery, Mr. 
McKessy, and Mr. Wyatt can be found on page 46 of the 
appendix.]
    Chairman Garrett. Thank you for your testimony.
    And I thank all the members of the panel.
    At this point I will recognize myself for 5 minutes to 
begin questioning.
    I will begin over here, Mr. Butler, with regard to credit 
rating agencies. So one of the areas that there was actually 
bipartisan support on in Dodd-Frank was with regard to the 
removal of references to credit rating agencies, 939A. And that 
was an area, actually, that I worked on with Chairman Frank at 
the time to get included in the Dodd-Frank Act and remove 
references at NRSROs.
    And the purpose of putting that in Dodd-Frank was to say 
that investment decisions should not be, as they had been prior 
to that, relying entirely upon credit rating agencies. But we 
have seen since then, despite the removal at NRSROs in 
specific--in the regulations that pension funds--some pension 
funds are still including them; some pension funds are still 
specifically including the names of two of the large agencies 
in their investment guidelines.
    So in 30 seconds, can you say, has 939A been effective, as 
far as what the intention was here?
    Mr. Butler. 939A spoke with regard to the removal of 
references with regard to Federal statutes, and the SEC has 
actually worked, although it wasn't the Office of Credit 
Ratings responsible for the removal--
    Chairman Garrett. Right.
    Mr. Butler. --the offices and divisions that were 
responsible completed the work there, and so all references 
have been removed from Federal statute--
    Chairman Garrett. Right.
    Mr. Butler. --in the work that was done.
    Chairman Garrett. But has that been effective? I understand 
that there are certain pension funds which are actually suing 
two of the larger credit rating agencies, saying that their 
opinions in the past were widely inaccurate on the one hand, 
but on the other hand they actually are still using them as far 
as their investment guidelines, which seems counterintuitive or 
perhaps opposed to their fiduciary duty. Would you agree?
    Mr. Butler. I am aware of the fact that there are pension 
funds, as well as State and local laws, that require specific 
references to credit ratings by name oftentimes, or actually by 
reference to ``the big three.''
    Chairman Garrett. And is that a problem?
    Mr. Butler. I wouldn't necessarily characterize it as a 
problem. I would say that the 939A statute didn't allow for us 
to do more, other than remove references within Federal 
statute.
    Chairman Garrett. That is a good segue. Is there something 
more that should be done--either that Congress should be doing 
in this regard, or that the SEC can be, or should be, directed 
to?
    Mr. Butler. 939A, as I mentioned, was not within the ambit 
of what the Office of Credit Ratings oversees. That was the 
Division of Corporation Finance, Trading, and Markets, and 
Investment Management. I would be happy to take the question 
back--
    Chairman Garrett. So is there anything else that we should 
be doing in this regard, in light of my opening position on 
this?
    Mr. Butler. With regard to the Office of Credit Ratings, we 
are comfortable with the authority we have with regard to 
examinations.
    Chairman Garrett. Okay. Is there anything else that you 
would recommend, though, that we should be doing in light of 
the fact that funds are still relying upon them?
    Mr. Butler. With regard to the Office of Credit Ratings, we 
are comfortable with the authority we have. Beyond that, I 
really wouldn't want to comment.
    Chairman Garrett. Okay.
    Mr. Flannery, when it comes to certain issue regulations, 
economic benefit analysis in one form or another is conducted 
by the agency, correct?
    Mr. Flannery. Yes.
    Chairman Garrett. Right. When you came to the issue of the 
pay ratio rule, that was done?
    Mr. Flannery. Yes.
    Chairman Garrett. And in that analysis, did they find 
that--is it true that they found that they cannot quantify a 
benefit?
    Mr. Flannery. Yes, I think that is right. Ultimately, the 
justification, the benefit for the pay ratio rule was tied to 
informing investors about the possible advisability of their 
say on pay votes.
    Chairman Garrett. Right. But at the end of the day, the SEC 
could not find--quantify a benefit, correct?
    Mr. Flannery. Yes, sir. I think there is a difference 
between ``quantify'' and ``find''--
    Chairman Garrett. Okay.
    Mr. Flannery. --but certainly. So a lot of what we do is 
very difficult to quantify even though it is very important.
    Chairman Garrett. So in the decision-making process of 
which regulations you will go forward to, why was this one done 
rather than other areas when you can quantify a benefit?
    Mr. Flannery. DERA responds to the rules as they come up, 
as they are treated by the Commission. We try to explain and 
clarify to them what the economic facets of the decision are, 
and then they are free to weigh those benefits and costs 
against the other considerations.
    Chairman Garrett. Is it fair to say that this was done 
because it was a mandate of Congress, as opposed to the SEC 
recommending that it be done?
    Mr. Flannery. I believe it was a mandate of Congress. I 
believe it was in Dodd-Frank, yes, sir.
    Chairman Garrett. And it is a ``shall'' situation as 
opposed to a ``may'' situation. But of course, there was no 
time limit on this, so within a whole gamut of things that the 
SEC could be working on, there were other areas where you could 
quantify a benefit, correct?
    Mr. Flannery. We can probably do more quantification then 
in that case, yes.
    Chairman Garrett. Right. So is there a reason that we see 
in areas where you can quantify, the SEC goes ahead and does 
so, and where you can't quantify, vice-versa?
    Mr. Flannery. We are in many ways a reactive division in 
the sense that we are asked to weigh in on a rule that is to be 
considered; we don't actually control when the rules are 
considered.
    Chairman Garrett. But do you make recommendations at the 
end of your report?
    Mr. Flannery. About the order of consideration?
    Chairman Garrett. Yes.
    Mr. Flannery. No, sir, we don't.
    Chairman Garrett. Okay.
    Of course, my time is already up.
    The gentlelady from New York is recognized for 5 minutes.
    Mrs. Maloney. Thank you, Mr. Chairman.
    Dr. Flannery, it is very good to see you again. And as you 
know, I am a big fan of structured data, especially the use of 
XBRL. It certainly makes it easier for investors to locate good 
investments, diamonds in the rough, and makes it easier for 
startups and new businesses, if they have a good story, to get 
it out and let investors know where they can make a good 
investment.
    In your testimony, you described DERA as the hub of 
information within the Commission, so can you talk a little bit 
about why structured data like XBRL is useful to the investor, 
and useful to the SEC, and exactly where does the 
implementation of it stand now with the SEC?
    Mr. Flannery. Yes. We have an Office of Structured 
Disclosure inside of DERA, and the purpose of that office is to 
advise where and what and how data should be structured. So 
when there is a new rule, when there is a revised form, these 
folks evaluate what can be captured and what is the best 
technical way for it to be captured, of which XBRL is one good 
possibility.
    A good example of what that does for us, the XBRL, is we 
now publish on our website quarterly financial reports for all 
registrants. So we have about 8,000 registrants, and the small 
ones don't get a lot of attention from the commercial data 
services, the commercial data providers.
    So we have a complete set of information, and that is 
useful to investors for the purposes you said. It is useful for 
us when we do a rule or when we do a risk analysis because we 
have a more complete and a much better grasp of the information 
that is most relevant to the firms that have the hardest time 
raising capital. So it is a very valuable resource for us and 
we provided the data to the public.
    One of the things about XBRL is that the data are to be 
filed by the end of the quarter, and usually within the next 
week we have those data sets up and available for people to 
use.
    Mrs. Maloney. Some people say they don't use it because 
there is no enforcement on the accuracy of the XBRL. And aren't 
you dependent on what the industry hands you?
    The company hands you their data. You don't check to make 
sure that data is correct. Is that correct?
    Mr. Flannery. There are various internal consistency checks 
that can be done pretty easily with an XBRL taxonomy. This 
whole--
    Mrs. Maloney. But you do rely on the industry giving you 
the information, correct?
    Mr. Flannery. Yes, we do. And there has been a learning 
process since 2009 when we first required the largest 
registrants to report using XBRL.
    Mrs. Maloney. How could you enforce the accuracy more? That 
is the one complaint that I hear from investors, that they 
would like it to be accurate and there is no guarantee that it 
is accurate so they say they don't use it because there is no 
really check on the accuracy. How could we improve the accuracy 
and the enforcement of accuracy on the data you receive?
    Mr. Flannery. That is a primary objective of our Office of 
Structured Disclosure, and as I mentioned, within XBRL there 
are various mechanisms for at least assuring the internal 
consistency of the data. Now, if somebody files an incorrect 
number, whether that is in XBRL or it is on paper, there is 
nothing we can do about that as long as it is not inconsistent 
with other parts of the report.
    But our OSD people, Office of Structured Disclosure, are 
investigating at all times--when I said, ``how the data get 
reported,'' they are investigating how we can most 
parsimoniously and efficiently assure increased compliance.
    Mrs. Maloney. They say that one of the best ways to get 
accurate data is, when the sale takes place on the exchange, 
just being able to capture that, as opposed to depending on 
private industry. What is your response to that?
    Mr. Flannery. That would be a stock sale.
    Mrs. Maloney. Yes.
    Mr. Flannery. Yes. And the data I have been thinking about, 
I thought you were talking about, was the financials provided 
by registrants in XBRL, so that wouldn't be in the same venue.
    Mrs. Maloney. Yes. But the stock sales.
    Mr. Flannery. Yes. The stock sales, we have direct feeds, 
and of course there are direct feeds that go to various private 
participants, but we have direct feeds. And the CAT, 
consolidated audit trail, which is to be considered by the 
Commission next Wednesday, I believe, will eventually make 
those audit trails extremely accurate and extremely detailed.
    Mrs. Maloney. Now, how does your work differ from the 
Office of Financial Research, which is also capturing this 
information? Do you share your information with them or--
    Mr. Flannery. Yes, we absolutely do. The Office of 
Financial Research is, of course, responsible to the FSOC, and 
we have collaborated with them on a couple of important data 
sets. One is Form PF, which is hedge fund data--very 
confidential data but very valuable data. The other is money 
market mutual fund data. They have been involved in helping us 
design taxonomies, and we look forward to continuing a fruitful 
relationship with them.
    Chairman Garrett. I thank you. The gentlelady's time has 
expired.
    And we are going to be coming up on votes. I am going to 
try to keep things within time, so Mr. Hurt is now recognized.
    Mr. Hurt. Thank you, Mr. Chairman.
    Mr. Flannery, I have some questions for you. As you know, 
the President signed Executive Order 13579, that required all 
agencies to perform an analysis of rules that may be outmoded, 
ineffective, insufficient, or excessively burdensome, and to 
modify, streamline, expand, or repeal them in accordance with 
that which has been learned.
    It seems to me your division is uniquely qualified to 
perform research for the SEC, and that is the purpose of your 
division, correct?
    Mr. Flannery. It is certainly one of the purposes, yes.
    Mr. Hurt. Has your division participated in any of these 
retrospective reviews, so to speak?
    Mr. Flannery. We are committed under the Regulatory 
Flexibility Act to examine existing rules, as you know. They 
usually get examined after about 10 years after their instance, 
and we do that in conjunction with the General Counsel's 
Office.
    I think rather than taking credit for finding potential 
things that can be improved in these rules, I should share it 
with some of the other divisions, because a lot of information 
comes into the other divisions from the industry, either in the 
form of inquiries or complaints. And there are frequently 
things that can be--where the burden can be reduced by staff 
guidelines, by no-action letters, and a lot of the kinks, if 
you will, that might be in an initial rule can be worked out 
that way, by staff interaction with the registrants.
    Mr. Hurt. But since the President signed this order, can 
you think of any example in which a rule has been repealed, 
such as it is, because it was excessively burdensome, 
ineffective, or outmoded?
    Mr. Flannery. I can give you an example of a proposed rule 
in the mutual fund space that is based on a need for better 
information and a reduction in the frequency of reporting, and 
that would have to do with what we call N-PORT, which is the 
mutual fund asset composition reports that are going to be 
filed if the rule is approved. So we were trying to take 
advantage of better information, tagging the data, and we were 
trying to reduce the burdensomeness of the--
    Mr. Hurt. And that was done through staff--
    Mr. Flannery. Yes.
    Mr. Hurt. --guidelines?
    Mr. Flannery. Yes, with--
    Mr. Hurt. But again, just to be clear, there--you know, 
modify, streamline, expand, or repeal. There is not an instance 
that you can think of where a rule has been repealed based on 
this analysis that is taking place in the agency?
    Mr. Flannery. I cannot remember one, no, sir.
    Mr. Hurt. All right.
    Another question that I have deals with the issue of 
regulations that are developed, some pursuant to Dodd-Frank, 
with joint participation from individual agencies. And 
obviously, there is a requirement of review by your office, in 
terms of cost-benefit analysis, the economic impact, economic 
effects of these rules.
    But there are some who suggest that when it is a joint 
rulemaking, that cost-benefit analysis is not required. What is 
your take on that, and have you all had pushback from the other 
agencies that you have had to develop rules with on that 
specific issue? How do you deal with that?
    Mr. Flannery. Yes, of course, you are right. We have a 
securities law requirement that we consider, among other 
things, efficiency, competition, and capital formation, which 
is unique to the SEC. So there are instances where we will do a 
joint rule, most often with the banking regulators, and ours 
will be the only economic analysis.
    There is one that we are involved in now where we--
    Mr. Hurt. So is the analysis that you do used in the 
promulgation of the rule in the process?
    Mr. Flannery. Yes. We do an analysis as it affects our 
registrants because, of course, the rule that we promulgate 
affects only--
    Mr. Hurt. The banking regulators don't do that.
    Mr. Flannery. I believe that is correct. They are not 
required. I don't know what they do inside, but they are not 
required to put an economic analysis out with the rule text for 
public comment.
    Mr. Hurt. Do you see a problem there, where you have 
extensive work done by your agency evaluating the costs and 
benefits on your side as it relates to your registrants, but 
not as it relates to those who are regulated by the other 
agency? Is that a problem?
    Mr. Flannery. I don't know whether there is a problem in 
that regard. What I know is that we have different statutory 
and regulatory constraints that we operate under. We have 
developed our guidance on economic analysis to take advantage 
of our specific expertise and to take--and to fit with the 
specific institutions and parts of the capital markets we work 
with.
    Mr. Hurt. Okay.
    Mr. Flannery. Whether that should transplant elsewhere is 
beyond my expertise.
    Mr. Hurt. Okay.
    Thank you. My time has expired.
    Chairman Garrett. Thank you.
    Mr. Hinojosa is now recognized for 5 minutes.
    Mr. Hinojosa. Thank you, Mr. Chairman.
    My first statement is to thank you and to thank our 
distinguished panel of witnesses for their appearance and 
testimony today.
    My first question is to Mark Flannery.
    Mr. Flannery, as you are aware, the Department of Labor 
issued a rule earlier this month regarding the fiduciary 
standard of care that is owed to investors when providing them 
personalized investment advice about their retirement accounts. 
This standard of care ensures that financial advisers providing 
advice act in their client's best interest.
    Chair White has publicly stated that she would like the SEC 
to implement its own fiduciary duty rule. My question to you 
is, has the SEC studied whether conflicts of interest in the 
provision of investment advice hurts investors?
    Mr. Flannery. As you say, this is a major objective of the 
Chair, and she has people in Trading and Markets who oversee 
brokers and dealers; she has people in I.M., Investment 
Management, who oversee registered investment advisers; and 
staff from DERA, collaborating on developing a rule. For 
reasons that surprised me very much because I was new to the 
SEC, that turned out to be a very difficult problem. It is 
taking a long time to get it right, and we want to make sure 
that we get it right when we get something out.
    Mr. Hinojosa. This committee has considered bills that 
would impose a cost-benefit analysis on the SEC, and I believe 
these bills would favor industry over investors and open the 
SEC up to increased litigation risks. Can you please describe 
all of the economic analysis obligations that the SEC 
undertakes when it looks to propose a new rule or an amendment 
to an existing rule?
    Mr. Flannery. Yes. As I said, we have a 15- or 20-page 
document that we refer to as the ``guidance,'' which is about 4 
years old and lays out the content of what should go into an 
economic analysis at the SEC.
    The first thing we do is we establish what is called a 
baseline. We try to document what is the state of the market, 
what is the state of the affected players if we don't introduce 
the rule.
    So we start with a baseline. We spend a lot of time trying 
to document that with statistics. And that gives everybody 
involved in the discussion an opportunity or perhaps an 
obligation to work off of the same baseline.
    Then, we are interested in identifying who will be affected 
by the rule, who is likely to be affected by the rule, and what 
would be the benefits and costs to the various people who are 
affected, the various firms and individuals.
    One of the things that we find is that there are many cases 
where we cannot quantify a benefit, so I would love for someone 
to explain to me how, for example, I could quantify the benefit 
of a more informed investor. I know it is positive, but I don't 
know how big it is compared to a dollar.
    Mr. Hinojosa. I can't answer your question, but I am very 
much in favor of that rule that the Secretary of Labor has 
recommended and has had hearings on for a long time, and that I 
think would certainly help investors.
    My next question is to Mark Wyatt.
    Mr. Wyatt, the Office of Compliance, Inspection, and 
Examinations completed approximately 2,000 examinations by 11 
regional offices. Is the current agency budget sufficient to 
keep pace with the increasing number of examinations that need 
to be conducted?
    Mr. Wyatt. We certainly are trying to use our limited 
resources as effectively as possible. We are trying to endeavor 
to increase our examinations. Last year, Fiscal Year 2015, was 
a 4-year high for the examinations.
    That said, we are striving to conduct additional 
examinations and increase our coverage in the investment 
adviser space, which currently is around 10 percent. On the 
broker-dealer side, together with FINRA, we get to roughly 50 
percent of those registrants.
    So we certainly welcome additional resources and 
information that can help us develop our exam program and our 
risk-based program to conduct further exams.
    Mr. Hinojosa. How do the SEC's resources to examine 
registrants compare to the resources of some of the large 
broker-dealers, banks, or other public companies that the SEC 
is supposed to hold accountable?
    Chairman Garrett. Very quickly, please.
    Mr. Wyatt. OCIE has 1,011 examiners. There are some large 
global registrants who have over 3,000 alone in their 
compliance program--for a global compliance program, I will 
highlight.
    Mr. Hinojosa. Thank you.
    I yield back.
    Chairman Garrett. The gentleman yields back.
    Mr. Royce is now recognized.
    Mr. Royce. Thank you, Mr. Chairman.
    And thank you, to the witnesses, for joining us today.
    Experts have deemed the United Kingdom's retail 
distribution review as being effectively identical to the Labor 
Department's rule. In the eyes of not just industry but the 
British government itself, implementation of that RDR review 
created what they called an advice gap that locked out middle- 
and lower-income savers from investment advice.
    And I have studied the Johnson report about the Department 
of Labor's communications with the SEC during the lead-up to 
the rules release. I share the Senator's frustration with the 
Department's lack of cooperation in releasing all of its 
communication with the Commission regarding its rule.
    So I am just going to ask Mr. Flannery, did the DOL and the 
SEC communicate about the impact of Great Britain's RDR on 
British consumers? And if so, to what extent? And if not, why 
did the SEC not think it relevant to reference the fact that a 
developed economy has already implemented a rule similar to the 
DOL's rule and this was no longer a hypothetical situation?
    Mr. Flannery. The retail distribution review, which I think 
took effect at the beginning of 2013, we viewed--in the SEC, we 
viewed that as an extraordinarily interesting policy step. We 
could call it an experiment because it didn't involve us.
    I undertook a couple of conference calls with people over 
in the regulatory agencies there. With me on those conference 
calls was one of my staff who was involved in dealing with the 
Department of Labor economists, so we certainly conveyed that 
information to them.
    I don't know in what form. I am not familiar with the 
details. But certainly, the information was conveyed through 
that individual.
    Mr. Royce. But information coming back the other way about 
the advice gap that they were experiencing in Britain with 
middle-income and lower-income savers from investment advice--
that information was being collected or--
    Mr. Flannery. It was certainly conveyed to the Department 
of Labor. When we are asked to provide technical advice to any 
organization, we provide technical advice based on our 
expertise with our institutions and our space.
    So if we send over comments or suggestions, those people 
are operating in a different regulatory environment under 
different legislation, and it is therefore their decision which 
of our comments is most appropriate to their situation.
    Mr. Royce. I was going to ask Mr. McKessy a question, and 
this goes to the issue of the office's creation under an 
amendment that I offered in this committee. It came as a 
result, actually, of Harry Markopolos' struggle, which he 
explained to us, his decade-long travail to bring Bernie 
Madoff's Ponzi scheme to the attention of the SEC, and in 
particular, his frustration year after year after year about 
the failure of the SEC to take any action against Bernie 
Madoff.
    So the idea in a nutshell was that by establishing a 
separate office within the Commission, the SEC would be better 
situated to protect whistleblowers and ensure that their 
concerns are, in fact, acted on and not handled as that 
previous situation was.
    Do you think the new structure is working? And what could 
be done to improve it?
    And I am also concerned that not unlike the gaps in 
coordination we had between regional offices and divisions in 
the SEC before your office was created, there may be gaps in 
coordination with other parts of the government. How does your 
office coordinate with other Federal agencies that allege 
conduct that is beyond the SEC's jurisdiction? That is the 
thrust of what I am concerned about.
    Mr. McKessy. I think the creation of the Office of the 
Whistleblower--by the way, I am very grateful for it because it 
created my job--has been effective in encouraging 
whistleblowers to come forward. I certainly have had a number 
of meetings now with Mr. Markopolos and gathered his thoughts 
on how we can be as effective in advocating for whistleblowers.
    I think beyond the Office of the Whistleblower, there are 
other structure changes in the agency that have been effective 
in dealing with issues like information gaps. The creation of 
the Office of Market Intelligence, which is the centralized 
office that centralizes all the intelligence that comes into 
the agency to make sure that when we get a tip from a 
whistleblower, if it is related to something that somebody is 
already looking at, that it finds the right home and that we 
don't have competing offices working on the same matter.
    And at the end of the day, I think the fact that the 
Whistleblower Office provides three benefits to 
whistleblowers--confidentiality, anti-retaliation protections, 
and the ability to be paid--has created real incentives to 
allow people to come forward if they otherwise were unwilling 
to or reluctant to. I think we are seeing the results of that 
in the fact that we have solicited over 16,000 tips since the 
program went into effect.
    Mr. Royce. Good.
    Thanks again, Chairman Garrett. Thank you.
    Chairman Garrett. The gentleman's time has expired.
    The gentleman from Massachusetts is recognized for 5 
minutes.
    Mr. Lynch. Good morning, and thank you, Mr. Chairman.
    I want to thank the witnesses for their help on this issue.
    Mr. Butler, I was a member of this committee during the 
financial crisis going back to 2008, and I think it is beyond 
any reasonable doubt that the rating agencies played an 
important role as a facilitator of that crisis, and they not 
only amplified the intensity of the crisis, but also, I think, 
facilitated the wider scope of that crisis, as well.
    And independent researchers and investigators as well as 
the Justice Department have basically said that the sort of 
pay-to-play role or system that has been in place, where 
customers pay for ratings and that the conflict of interests on 
the part of the rating agencies contributed greatly to the 
problems we had back then, and that model has to change.
    Now, since the crisis, your agency hasn't instituted any 
fundamental changes in the credit agency business model that 
created those conflicts of interest, and credit rating agencies 
have returned to record profits. Your own most recent 
examinations, however, found severe failures by major credit 
agencies to comply with their own stated policies and 
procedures.
    Yet, you have not levied any fines or penalties on rating 
agencies. You have not used your statutory authority under 
Section 15E of the Security Exchange Act to suspend agencies or 
individuals from ratings.
    And the Office of Credit Ratings' public examinations do 
not even identify the specific rating agencies that violate 
procedural rules. You don't even call them out. No name and 
shame.
    It seems to me that the system is designed really to shield 
the rating agencies from any accountability. We don't even 
identify the people. We use terms like, ``one of the larger 
rating agencies,'' which I assume is one of the big three.
    Your testimony states that the OCR attempts to serve the 
public interest and protect users of credit ratings, but I have 
to ask you, do you really believe that we can get to that place 
without eliminating the conflict of interest that currently 
exists where companies pay the rating agencies for favorable 
credit ratings, and that the companies are in competition with 
each other?
    There is a great segment in, ``The Big Short,'' that movie, 
where they are talking to one of the folks from Standard & 
Poor's and the analyst asks, ``Why aren't you tougher or more 
demanding on these guidelines?''
    And the woman from Standard & Poor's says, ``Well, if we 
do, they will just go to Moody's.'' That sort of encapsulates 
the problem here.
    So what is the answer here? As long as we have that 
conflict of interest, are we ever going to get to a place where 
we are actually, as your mission states, going to be able to 
protect the users of credit ratings?
    Mr. Butler. In my estimation, compliance is not a 
destination but it is a journey, and we are well along on that 
journey with regard to the rating agencies and infusing in them 
the importance of compliance, enhanced governance, 
transparency, training, and other methods to build rigor within 
the rating process and to establish integrity.
    To address specifically your question with regard to the 
issuer pays conflict, in August 2014 the Commission adopted a 
new set of rules, and the rules were effective fully in June 
2015. Importantly, within that set of rules there is a 
requirement for a complete separation of the sales and 
marketing function from the analytical function, and that is 
accomplished by prohibiting rating analysts or developers of 
methodology from participating in sales or marketing activities 
or from being influenced by other business considerations.
    And apart from the prohibition--
    Mr. Lynch. Let me just stop you there because I only have 
30 seconds left. Your report says that they are departing from 
their own policies and that they are not following their own 
programs, and those companies are not being held accountable 
under your system, the one you have right now. And that is 
after this last iteration of changes has gone forward.
    They are still paying for ratings. The rating agencies know 
where their deals flow comes from, and they are acting 
accordingly. I don't see any changes here compared to what we 
were doing before.
    Chairman Garrett. I thank the gentleman for his questions, 
and I would ask everybody not to end with a question since we 
are trying to get in before the vote is called.
    Mr. Hill is recognized for 5 minutes.
    Mr. Hill. Thanks, Mr. Chairman.
    And I thank the panel. Thanks for your service at the 
Commission.
    Dr. Flannery, I took a question you answered a few minutes 
ago about the DOL rule and your work and the Chair's commitment 
to a fiduciary rule at the Commission. The SEC has 80 years of 
experience in overseeing broker-dealers and investment managers 
and doing economic analysis on that, and you made the statement 
that it is really, really hard to get it right.
    And obviously, this was something that the Commission was 
asked to study back in 2010 as a part of Dodd-Frank. And yet, 
the Department of Labor has rushed into this rule--not rushed; 
that is not fair to the DOL, because they have worked on it for 
2 or 3 years.
    But my biggest complaint about the fiduciary rule is that 
it wasn't done in conjunction with the Commission and the 
Commission didn't take the lead on it to get it right on behalf 
of all market participants.
    Since it is hard, what do you think are the hardest things 
about it when you look at it from an economic, analytic point 
of view of trying to ``get it right?'' Obviously, FINRA and the 
SEC have led the way in designing suitability standards and 
best interest standards, and if we manage money on a 
discretionary basis, it is subject to a fiduciary standard in 
the industry. So what do you rank as the most difficult 
challenges there? You can answer that question because you are 
not commenting on the Department of Labor, I think.
    Mr. Flannery. No, in the context of the SEC--
    Mr. Hill. Yes.
    Mr. Flannery. --and in the context of combining the 
standards to which--the fiduciary standards to which broker-
dealers and investment advisers have been held historically, 
they are different standards. In the old days, broker-dealers 
sold things to people and got compensated via commissions; 
investment advisers gave advice, didn't get compensated via 
commissions, but got compensated via fees.
    Now, the broker-dealers have moved into the advice-giving 
space. And they bring with them a compensation arrangement that 
was designed and that survived in a somewhat different 
environment.
    So one of the first questions that comes up here is, what 
does it mean to give financial advice? If I am a broker, I have 
to make sure that the security is suitable for my customer, but 
after the customer has bought the security, I don't have any 
further responsibility to monitor the customer's portfolio.
    Mr. Hill. That is not true, is it? They have an obligation 
to make sure that the financial disclosure and their situation 
is reviewed at least annually in most firms' policy manuals for 
net worth, earnings, suitability, changing circumstances, 
marriage, having children, having an estate plan. They do have 
a continuing obligation to their client, don't they, under all 
policies of FINRA and the SEC?
    Mr. Flannery. I believe that the broker-dealer has an 
obligation that is transactions-oriented, as opposed to life 
change. So if there is a life change and the customer comes 
back, there could be a different definition of suitability. But 
if there is a life change and the customer doesn't come back, 
there is no responsibility, as I understand it, for a broker to 
call up and say, ``Hey, now that you are remarried you ought to 
do something different.''
    Mr. Hill. We don't have to debate that here. I would very 
much disagree with that based on looking at firms' policies and 
procedures manuals for a couple of decades.
    But what else do you think is challenging about getting it 
right, from the Commission's point of view?
    Mr. Flannery. One of the things that is surprising to me is 
how difficult it is to disclose information effectively. The 
broker-dealer and the investment adviser rules and standards 
are based on disclosure, and there is sometimes a difference 
between disclosure and the transmission of information.
    So we have, in DERA, just started a small behavioral 
finance unit to try to understand how people process 
information that is maybe second nature to those in the finance 
industry but new and confusing to those outside.
    Mr. Hill. Couldn't the Department of Labor's approach, 
though, of creating one set of approaches for a retirement 
account versus another set of approaches executed by the SEC 
and FINRA on behalf of all other account categories lead to 
investor confusion?
    Mr. Flannery. I suppose it could. Certainly, there is some 
inevitable confusion, I suppose, because the Department of 
Labor rules are promulgated under a different set of statutes, 
a different set of considerations than the securities laws 
under which we operate.
    Mr. Hill. And hence, that is why I really think that in an 
ideal circumstance the OMB, the Administration would have 
insisted that the Commission take the leadership role in 
harmonizing this approach.
    Thank you, Mr. Chairman. I yield back.
    Chairman Garrett. Thank you. The gentleman yields back.
    The gentleman from Connecticut is recognized for 5 minutes.
    Mr. Himes. Thank you, Mr. Chairman.
    And thank you, gentlemen, for being with us today, and for 
your good work.
    I have two questions, which I recognize are a little 
tangential to your offices and divisions, but both pertain to 
topics which I have been concerned about, what I perceive as 
silence on the part of the SEC, so I am hoping I can get at 
least some provisional feedback on these two topics.
    The first pertains to insider trading. As you all know, the 
2nd Circuit on the Newman decision, apart from overturning two 
very high-profile insider trading convictions, put a great deal 
of uncertainty into future prosecutions of insider trading.
    I think we could all agree on two things. First, we now 
don't have a good definition of insider trading, and I, for 
one, am a believer that if we are going to send people to jail, 
we should have pretty good statutory definitions for why we are 
sending them to jail. Second, without getting into the guts of 
Newman, as you know, the decision really was around whether a 
tippee can be held liable, unless the tippee knows of the 
personal benefit received by the tipper in exchange for the 
disclosure.
    So if I am a corporate insider and I tell you, ``Hey, I 
shouldn't be telling you this, it is probably illegal, but you 
could make a lot of money,'' and you trade on it, so long as 
you don't know that I have received some tangible personal 
benefit, you are not prosecutable. You are not liable under the 
Newman decision.
    So I am looking for, I guess, a little bit more clarity 
from the SEC about whether there should, in fact, be a 
statutory definition of insider trading.
    I would point out that my colleague, Mr. Lynch, and I have 
also put forward some legislation; two Senators, Senators 
Menendez and Reed, have put forward legislation. But I am 
looking, I guess, for a little bit more guidance from the SEC 
about whether the uncertainty introduced by Newman is, in fact, 
a problem that we should address.
    Mr. McKessy. I believe as the only member of the 
Enforcement Division, I am probably the best-qualified to talk 
about this. But that beingsaid, I think the Newman decision 
raises issues that are extraordinarily nuanced, and I think--I 
want to be as helpful as I can, but I think to get a real 
appreciation for the considerations that go into how Newman 
affects our Enforcement Division and our ability to bring 
insider trading cases is best addressed by someone who has more 
background in that.
    And, of course, I would be happy to take any questions back 
and have the right person get back to you. Obviously, we are 
well aware of the Newman decision and the nuances of it, but I 
think you probably would be better served by hearing from 
people who more appreciate the nuances of how it impacts our 
enforcement efforts.
    Mr. Himes. I appreciate that. I recognize this isn't 
exactly the panel that is right on point for that.
    I am sensing a certain amount--and I understand this. We 
have a vast body of case law associated with insider trading; 
we have a lot of ambiguity that stems from no direct statutory 
definition of insider trading.
    I would really appreciate it if the Commission would, in 
fact, focus on nuance and getting us a more clear message and 
maybe try to get away a little bit from what is bureaucratic--
or what is case law tradition and maybe a little bit of 
bureaucratic inertia. Because again, under the example that I 
gave on the question of tipper to tippee liability, at some 
level, yes, it is nuanced, but at some level, it is also kind 
of common-sensical.
    Second question: We have been doing a lot of work on the 
JOBS Act, which I supported, and now we are sort of looking at 
a bunch of additional changes, expansions to the JOBS Act. And 
the whole idea of the JOBS Act, of course, is that young 
companies shouldn't bear the full burden of Sarbanes-Oxley 
compliance.
    I have had estimates anywhere between $1 million and $2 
million a year for the cost of Sarbanes-Oxley compliance, and 
we are spending a ton of time on that issue. I think that is 
good.
    But I can't seem to get enough attention drawn to the odd 
fact that one of the biggest sources of cost for our young 
companies going public is a remarkably consistent gross spread 
of 7 percent. Let's just say that the average IPO is in the 
neighborhood of $200 million; 7 percent, that means $14 million 
in the IPO out the door.
    We are spending a ton of time on that $1 million or $2 
million a year associated with Sarbanes-Oxley compliance, but I 
am having trouble sort of really understanding why we are not 
focused more on the odd fact that 95 percent of all IPOs that 
have occurred, at least in the 10-year period after 1998 to 
2007 in the United States, 95 percent had a 7 percent gross 
spread. Exactly.
    In Europe, there is no such clustering. And in fact, in 
Europe, IPOs' gross spread average about 4 percent, and you 
almost never see a gross spread as high as 1 percent.
    Does that clustering at 7 percent over such a persistent 
period of time strike you as odd and perhaps worthy of 
investigation?
    Mr. Flannery. Let me try that.
    Another industry, which is not nearly so germane to the 
issues you express, but another industry that has the same 
phenomenon is real estate brokers, where I believe there the 
number is more likely to be 6 percent. That has always puzzled 
me.
    There are some economic analyses for both of these cases 
about why this might actually be a good contract. But you can 
also find arguments that are equivalent to what is implicit in 
your comment, that maybe there is something nefarious going on.
    So you can find economic arguments on both sides.
    Chairman Garrett. Thank you. Thank you for the question.
    Mr. Himes. Thank you. I yield back. Thank you, Mr. 
Chairman.
    Chairman Garrett. Mr. Hultgren is now recognized.
    Mr. Hultgren. Thank you, Mr. Chairman.
    Thank you all so much for being here. I appreciate your 
work and your testimony today.
    Mr. Wyatt, Harry Markopolos, who initially warned the SEC 
about Bernie Madoff's Ponzi scheme, recently revealed that he 
is working to uncover three multibillion-dollar schemes, 
including one that will be bigger than Madoff's. As you know, 
many of the failures that allowed Bernie Madoff to continue his 
Ponzi scheme for as long as he did can be traced to the 
failures of OCIE examinations to connect the very apparent 
dots. Multiple SEC offices, including OCIE, were unaware of 
parallel investigations into Madoff's entities.
    Do you believe the institutional changes implemented by 
OCIE since 2009 are sufficient to stop future fraud? And if 
not, what else needs to be done?
    Mr. Wyatt. I do believe that the changes we made after 
Madoff have significantly enhanced our ability to detect those 
types of activities: the streamlining of our TCR program to 
ensure that there are no silos in the regions, as well as the 
connectivity that we have amongst the regions to ensure if we 
see a theme or a risk throughout we can act on it accordingly 
and bring the resources to bear.
    So we are continuing to run a risk-based program. Part of 
evaluating our risks is continuing to look for any emerging 
risks and connecting the dots, as you say, with the TCR program 
and other areas, including information gathered from other 
divisions, such as DERA.
    Mr. Hultgren. Okay.
    Mr. Wyatt, the SEC did not and still does not have a 
standardized identification code that consistently identifies 
all the entities it regulates and makes connections between 
them. I believe the Madoff failure was in part a data standards 
failure.
    Last year Congressman Issa, myself, and a number of other 
members of this committee introduced legislation called the 
Financial Transparency Act to direct all financial regulators, 
including the SEC, to adopt data standards for information they 
collect with the hope of transforming the current landscape of 
disconnected documents into open, searchable data. In fact, the 
original name of the bill was the Madoff Transparency Act.
    This means, for instance, that the SEC would adopt the 
legal entity identifier to consistently identify all the 
entities it regulates and affiliations between them so in the 
future parallel investigations into related entities like 
Madoff's will be electronically visible. For all information 
required by other laws to be made public, the bill directs each 
agency to public such information as open data, machine-
readable, and freely downloadable.
    Won't an open data initiative like this help prevent future 
failures, like we saw with the Bernie Madoff scheme?
    Mr. Wyatt. We certainly have adopted strategies to enhance 
our use of data analytics and to capture all the data that is 
available to us, as I mentioned, from internal and external 
sources. We have also centralized all the information we have 
regarding examinations, so anyone throughout OCIE can go in, 
look at a given registrant, see what activities have been 
involved in an examination or even a non-exam review for that 
registrant.
    So we are certainly applying the data analytics and would 
welcome anything that could give us additional insight into the 
activities of the registrants that we are examining.
    Mr. Hultgren. Thanks.
    I believe we have to do better. We can do better. With 
incredible technologies and connectivity, we ought to be able 
to recognize this a lot sooner.
    Let me switch to Mr. Flannery, if I could. The Department 
of Labor's proposed fiduciary rule, which was recently 
finalized, mentions annuities 172 times, but the regulatory 
impact analysis does not examine the impact of the rule on 
annuities, advisers, insurers, or the retirement savers using 
them.
    Last October, David Grim, from the SEC's Division of 
Investment Management, testified that, ``A lot of what we have 
been talking about with them''--the Department of Labor--``has 
been on impacts, the impacts of choices that they are making on 
investors.'' What impact is Mr. Grim describing, and did your 
office conduct any cost-benefit analysis?
    Mr. Flannery. We did not directly do a cost-benefit 
analysis. We are involved in advising and providing comments--
technical comments. And I'm sorry, I am not familiar with what 
Mr. Grim was--
    Mr. Hurt [presiding]. The gentleman's time has expired--
    Mr. Hultgren. My time has expired. I yield back.
    Mr. Hurt. --and we are getting ready to vote.
    The Chair now recognizes Mr. Foster for 5 minutes.
    Mr. Foster. Thank you, Mr. Chairman.
    And my questions, I guess, will be directed to Mr. 
Flannery.
    I would like to first and foremost congratulate you on your 
hiring of two physics Ph.D.s. As the only physicist in 
Congress--in fact, the only Ph.D. scientist of any kind--I 
recognize the complexities of things like structured financial 
products, the technology that is involved in high-frequency 
trading. All these are the sort of things where you need that 
kind of expertise, and I am very glad to see that you are 
recognizing that, too.
    Mr. Flannery. Thank you.
    Mr. Foster. I am also the author of the contingent capital 
requirements in the Dodd-Frank bill, and as someone who is 
widely credited with having invented the concept back, I guess 
in 2002, and then now we have seen it adopted really worldwide, 
I think, with what I see as a lot of success.
    You have seen, for example, the Swiss banking regulators, 
which are faced with a problem that their economy is not big 
enough to backstop the size banks that they have. They have 
used contingent capital to make those viewed as very solid 
counterparties, even in contemplated times of financial stress.
    We have seen the whole Deutsche Bank ongoing saga where 
Deutsche Bank is aggressively restructuring, deleveraging, 
cutting bonuses, and so on, driven in large part by the worries 
that the contingent convertible coupons will not be paid more 
than a year away. So it is, to my mind, working very 
successfully at providing the early warning signal that is one 
of their main merits.
    And then finally, I guess most recently, Canada--the new 
government in Canada announcing that they are going to use 
contingent capital instruments to make sure the Canadian 
taxpayer is not on the hook if their big banks get in trouble.
    So I view this as a very successful thing, and I have 
continued to try to get them adopted, which they have full 
regulatory authority but we are not seeing very aggressive 
adoption. So I was wondering if you could just give your take 
on what you see as the lessons learned in the worldwide thing 
and the way forward for potentially getting those lessons used 
in the United States.
    Mr. Flannery. First of all, it is a pleasure to meet you. 
Contingent capital is something that I personally, and in my 
academic career, spent a fair amount of time talking about.
    I think you put your finger on what I view to be the 
biggest advantage of contingent capital instruments, which is 
that rather than wait until the last minute when a firm is 
close to insolvency, contingent capital instruments address 
that possibility, keep us away from that possibility, and give 
the managers and the shareholders of the firm an incentive to 
stay away from certain trigger points.
    When I first started talking about this, the crisis was 
fresh in our minds, and people who had this vision that capital 
would be almost zero, then there would be a conversion. But by 
the time capital is almost zero, all sorts of bad things have 
started to happen to these firms.
    I am sure you are correct when you say that they could be 
permitted as part of the capital stack in the United States. 
They haven't been, and I think there are people who feel that 
higher capital--formal equity requirements are safer, more 
protective than contingent capital requirements are. And then 
how one comes out on that is based on how one--what one 
believes is the effect of higher capital requirements on the 
operation of the firm and the pricing of its products.
    Mr. Foster. Do you think at this point there are good 
examples of trigger mechanisms that have proven workable in 
times of stress, or is that still an ongoing experiment?
    Mr. Flannery. I believe that is a problem. The securities 
in Europe and Asia that have been so successful have book value 
trigger mechanisms, and one of the characteristics of firms 
that get into trouble is that their market value deteriorates 
much more quickly than their book value does. In other words, 
the market loses confidence in the firm despite the fact that 
it may be showing strong book-capital relations.
    And so the triggering of these CoCos, contingent capital 
instruments, off of book capital ratios, I view as sort of 
problematic and likely to interfere with their value.
    Mr. Foster. And are there issues just related to the SEC, 
how they would be registered under the 1933 act, or are those--
if you go to the European websites with the thought of 
investing in contingent capital, there is this big warning, as 
if you are a U.S. citizen, forget it. And I was just wondering 
if there is a clear regulatory path or whether you would see 
SEC issues involved in making these widely used?
    Mr. Flannery. I am not aware of any considerations actively 
going on inside the SEC, but it would focus on disclosure of 
the risk so that investors could understand what was likely to 
happen and accept the risks for the compensation they are being 
given.
    Chairman Garrett. I thank you. The gentleman's time has 
expired.
    Mr. Duffy is now recognized.
    Mr. Duffy. Thank you, Mr. Chairman.
    Welcome, panel. It is great to have you here.
    I am just a warm-up act for Mrs. Wagner, who is going to go 
in a second on the DOL fiduciary. Obviously many of us, as you 
are well aware, have concerns about the rule. And it is my 
understanding that the SEC also shared some concerns about the 
proposed rule and now the actual rule.
    Mr. Flannery, is it fair to say that the Department of 
Labor, for the most part, disregarded much of the advice that 
the SEC gave to them in regard to this rule?
    Mr. Flannery. The advice that was given, I think of it more 
as technical comments. Some of it was incorporated into the 
final rule and some was not. I don't know about the 
preponderance.
    Mr. Duffy. Okay.
    One of our concerns, for example, would be that one of your 
economists suggested that the Department of Labor should 
measure improper activity of advisers through measuring 
conflict of interest, the proposed--or the purpose of the 
rulemaking process, not projected investment returns. And it 
seems like the DOL didn't take that advice. Is that fair to 
say?
    Mr. Flannery. I am not familiar with the final DOL rule. It 
is 395 pages and I look forward to reading it, but I haven't 
yet, so I can't be sure.
    Mr. Duffy. Have you undertaken any analysis of the impact 
of this rule on investors?
    Mr. Flannery. We have not yet gotten to that point because 
our internal deliberations--again, in a different securities 
space--have not gotten to the point of generating a rule. So we 
have not yet done that sort of economic analysis.
    Mr. Duffy. Tell me if you share my concern, because I come 
from central, western, and northern Wisconsin--not a really 
wealthy part of the world. We don't have a lot of people who 
have $500,000 or $750,000 in their retirement accounts. We have 
people who have $30,000 and $50,000 and $80,000 in their 
retirement accounts.
    There is some concern that we are going to migrate those 
folks from getting advice from someone that they have worked 
with and that they know and trust to a different computer 
model: the robo-adviser. Do you foresee that happening, as 
well?
    Mr. Flannery. I think you can look at the robo-adviser in 
the way you have. You can also look at it as an opportunity for 
people who are just getting into retirement savings, people who 
are generally more comfortable taking advice from computers 
than I might be or you might be.
    Mr. Duffy. So let's actually play that out a little bit, 
because it might not be just the person who just started to 
invest. Now, the first-time investor in Washington, D.C., might 
start after a couple of years and have $80,000 in their 
retirement account; but in my community, it is after 25 years, 
they have $80,000 in their account.
    And maybe this is open to the panel--do you think that 
maybe someone who is not an expert in investing, their life 
focus has been elsewhere but they have been responsible, they 
have put a little bit of money away--do you think that, say, 
look back to last August, that that person, when the markets 
start to move, is going to be more compelled to look at their 
computer screen and make the right choice as opposed to calling 
their investment advisers and trying to sell their investments 
and their adviser is going to say, ``Whoa, hold on a second. 
Whoa, whoa, whoa, whoa, whoa. That is not the right call right 
now. We should actually ride out this storm. That is not part 
of our plan. We know there are peaks and we know there are 
valleys. We ride it out. Don't sell.''
    Are they going to get the same advice from the computer? 
And I guess my question is, aren't they going to make really 
bad choices for their future if you have a robo-adviser as 
opposed to a financial adviser?
    Mr. Flannery. I suspect that there were a lot of people in 
the world in Wisconsin who didn't even know what was happening 
that day, didn't look at their financial statements. In 
general, I agree with you entirely that good financial advice 
is valuable. I think that good financial advice also sometimes 
comes with conflicts, and--
    Mr. Duffy. I don't dispute that, but does good financial 
advice come from a computer?
    Mr. Flannery. I don't know enough about those computers so 
I can't tell you that.
    Mr. Duffy. If I am able to get 8 or 10 questions about some 
of my goals, some of my income, how many kids I have, what I 
want at retirement, I put it in and it hits an algorithm and it 
spits out some advice, do you think that just because I am a 
low-income individual, I am a low-dollar saver, that I 
shouldn't be entitled to the advice that comes from someone who 
makes $800,000 a year?
    Mr. Flannery. I guess we don't know--certainly the point 
you make is widely discussed--for a fact what is going to 
happen.
    Mr. Duffy. So do you have a study in the works so that we 
can know?
    Mr. Flannery. We will know when we take up a rule at the 
SEC--
    Mr. Duffy. And isn't it too late? Isn't it too late? 
Because my people are already going to be kicked out of 
personal advice and they are going to be relegated to their 
computer.
    Do you share that concern? They are already out once you do 
your study and the rule is implemented.
    Mr. Flannery. Again, the rules under which the DOL operate 
are different from those--and the legislative authorities are 
different from those under which we operate--
    Mr. Duffy. I can't wait to see how we navigate both an SEC 
and a DOL rule and how that is going to play out on the expense 
side and how--
    Chairman Garrett. The gentleman's time--
    Mr. Duffy. I know. Sorry, Mr. Chairman. I yield back.
    Chairman Garrett. The gentleman from California is 
recognized.
    Mr. Sherman. Thank you.
    I would point out that I think it was Congress' intention 
that the SEC and the Department of Labor have very similar 
identical roles. It is absurd to think that IRA accounts would 
have one set of protections and non-IRA, non-pension accounts 
would have another. And it is even more absurd to say that the 
IRA accounts typically controlled by those in their 50s and 60s 
should have more protection than widows and widowers and 
elderly people who typically, in middle-class families, control 
the larger accounts. So I share some of the last gentleman's 
concerns.
    Mr. Chairman, the one part of the SEC we don't have before 
us are those concerned with accounting standards. I would like 
to enter into the record my letter of earlier this month 
demonstrating the incredible harm that is being done to our 
economy by the--well, the departure from accepted accounting 
theory that requires companies to write off their research and 
experimentation costs.
    Chairman Garrett. Without objection, it is so ordered.
    Mr. Sherman. Thank you.
    Mr. Butler, we have just--we are still suffering from this 
2008 downturn. I think it was mostly caused by the credit 
rating agencies.
    We still have a system where the umpire is paid by one of 
the teams and selected by that team. And the SEC has decided, 
instead of being an agency that favors transparency for 
investors, to conceal this by such relatively meaningless so-
called protections. It says, ``Well, the sales force can't talk 
to those who do the ratings.''
    The people who do the ratings are compensated by the 
company; their promotions depend upon the company; they want 
the company to be successful. Is there any rule that those 
engaged in rating debt obligations cannot receive stock 
options, bonuses, or any benefit from the success of a company 
they work for?
    Mr. Butler?
    Mr. Butler. Each of the companies have different 
compensation arrangements--
    Mr. Sherman. I asked, is there any SEC prohibition?
    Mr. Butler. With regard specifically to rating analysts and 
compensation?
    Mr. Sherman. Yes.
    Mr. Butler. I would have to take that back--
    Mr. Sherman. Okay. So if you give great inflation, the 
company makes money, your stock options do better, and the SEC 
has no rule of which you are aware--and if you are not aware of 
the rule, it would be very hard to think the rule is being 
enforced, since you are the one who would be enforcing the 
rule.
    The debt markets are obviously far more important to the 
economy, or at least involve far more capital, than the stock 
markets. Those who invest are basically entirely dependent upon 
the ratings. Even if you know better--you are managing, say, 
the T. Rowe Price bond fund--if you decide to forgo buying a 
AA-rated bond that pays 20 basis points more, then I am going 
to invest in Vanguard because all I am going to be able to do 
as an investor is decide which has the highest rating and the 
highest yield.
    I want to talk to you about one particular problem. That is 
the Peruvian agrarian reform bonds.
    Obviously, the way to make money is to try to get Peru as a 
client. It is a significant country. And one way to do that is 
to avoid even offering to rate these agrarian bonds that seem 
to be a part of a selective default.
    Is there any rule that says that a credit rating agency 
can't refuse to rate bonds because they can make more money 
by--they are paid off one way or another not to rate them?
    Mr. Butler. I am generally familiar with the media coverage 
on the Peruvian bonds, and I can't obviously discuss the 
specifics of a--
    Mr. Sherman. Is there any rule that says you can--that you 
enforce that would prohibit Peru from saying, ``Please don't 
comment on our agrarian bonds and we will make sure to give you 
a contract worth millions of dollars in some other part of our 
financial dealings?'' Is there any rule that you can point to 
which prohibits that?
    Mr. Butler. The rules provide specifically for an absolute 
prohibition of rating analysts to be involved in sales and 
marketing activities.
    Mr. Sherman. This is whether you take the engagement. It 
doesn't involve the rating analysts; it involves the sales 
force.
    Mr. Butler. The rule prohibits rating--the analysts--the 
analytical function from being involved in the sales and 
marketing function. That is achieved by prohibiting analysts 
from being involved in sales and marketing or from being 
influenced--
    Mr. Sherman. That is not what I am asking.
    Mr. Butler. --consideration.
    Mr. Sherman. The sales force decides whether to take the 
engagement. So if Peru pays them a few million dollars to say, 
``Just don't even get your credit rating analysts involved; 
don't let them look at it; don't take the engagement--''
    Chairman Garrett. He has the question. Do you have the 
answer?
    Mr. Butler. In addition to the rule, there is a required 
certificate to accompany each rating action that says there was 
no influence of the analyst--
    Mr. Sherman. This is a non-rating action, sir. You are 
avoiding my question and the answer is obvious.
    Chairman Garrett. Okay. Thank you. The gentleman's time is 
up.
    Mr. Sherman. I yield back.
    Chairman Garrett. Mrs. Wagner is recognized for 5 minutes.
    Mrs. Wagner. Thank you, Mr. Chairman.
    Director Flannery, as part of last year's transportation 
bill, one of my bills was included that would allow small 
reporting companies to incorporate by reference any post-
effective amendments on the Form S-1. The SEC, when 
implementing this provision in January, estimated that over 
70,000 work hours and $85 million would be saved annually by 
small business. Clearly, this is a huge benefit for small 
companies.
    However, in February I wrote a letter to the SEC asking for 
a similar analysis on the effects of expanding the availability 
of Form S-3 for small reporting companies regardless of public 
float or exchange-traded status. This is a provision of a piece 
of legislation that I sponsored and which has been passed out 
of this committee. Unfortunately, the response that I received 
to my letter was wholly inadequate and didn't indicate whether 
such a review or study would actually be done.
    Dr. Flannery, would you commit today to performing that 
kind of analysis of the benefits of this provision for small 
companies and providing a more detailed response?
    Mr. Flannery. I'm sorry, but I never saw your letter. I 
don't know what went into the response.
    One of the things that concerns me about reducing reporting 
from small companies is certainly there is room for there to be 
waste, but there is also evidence that companies that go to the 
markets with less information are less likely to be traded, and 
a secondary market trading for stock is ultimately what 
companies would like to have if they are going to have access 
to capital.
    To get back to your immediate point, I have a number of 
current policy things that we need to deal with. I would be 
more than happy to consider doing that--
    Mrs. Wagner. I would really like you to take a--
    Mr. Flannery. --among those things.
    Mrs. Wagner. --a look at this. Facilitating capital 
formation obviously is part of the SEC's mission, and this is a 
provision that has appeared in that SEC's form on small 
business capital formation annual report several times. I think 
we can really find common ground here, and I would ask, Dr. 
Flannery, that you all commit to performing this kind of 
analysis. I will make sure that you get a copy of my original 
letter; I will make sure I send it directly to you.
    Moving on, I would like to obviously discuss the extent to 
which the SEC and the Department of Labor coordinated in 
crafting their recently finalized fiduciary rule. According to 
e-mail records outlined in a recent Senate report--and Mr. 
Chairman, I would like to have these entered into the record--
it seems that the Department of Labor disregarded advice from 
the SEC, specifically regarding concerns raised by the Division 
of Economic and Risk Analysis.
    Chairman Garrett. Without objection, it is so ordered.
    Mrs. Wagner. In fact, a specific quote--and these are 
fascinating reads--from an economist at the Department of Labor 
states, ``We have now gone far beyond the point where your 
input is helpful to me.'' These exchanges between the SEC and 
the DOL should make for very interesting reading.
    From your perspective, over the past year, sir, from the 
proposed rule to the recently issued final rule, how well has 
the Department of Labor coordinated with the SEC?
    Mr. Flannery. We certainly had opportunities to provide 
technical assistance. I am familiar with the e-mail you 
described because it involved one of my staff.
    Mrs. Wagner. Yes.
    Mr. Flannery. The staffer from DOL had also been a friend 
and a professional acquaintance of this fellow for a while, so 
I think what you are seeing is the culmination of a long stream 
of e-mails.
    Economists can be pretty direct. If somebody says, ``I 
understand what you are saying but it is not applicable to my 
case; I don't want to hear any more about it,'' that is kind of 
the way I interpret that e-mail.
    Mrs. Wagner. There are others here, too. And I don't see 
the Department of Labor being open to any of your advice from, 
I think, a very fine office that you run.
    And certainly, I have great concerns. I want the DERA to do 
an analysis and an impact of this DOL rule as it stands right 
now. Is that forthcoming?
    Mr. Flannery. When and if--and I hope it is when--the 
Commission considers a rule for fiduciary standards in our 
space, we will look carefully at the DOL rule because that will 
be part of the baseline. We always start with the baseline; 
what is in existence--
    Mrs. Wagner. It is your jurisdiction, sir. Honestly, it is, 
as is laid out very perfectly in Dodd-Frank Section 913. And we 
want you to do your own uniform fiduciary rulemaking here.
    This is your purview, your space. You are the regulators, 
including FINRA. And I really encourage and would like to get a 
commitment that you are willing to do a cost-benefit analysis 
when doing this.
    Mr. Flannery. Yes. Absolutely. That is always part of one 
of our economic analyses for a rule.
    Mrs. Wagner. Thank you very, very much. I look forward to 
working with you as we move forward.
    Mr. Flannery. I look forward to getting that. Thank you.
    Chairman Garrett. The gentlelady yields back.
    The gentleman from Texas, Mr. Neugebauer, is now 
recognized.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Mr. Butler, could you please describe the statutory 
requirements for the annual examinations for NRSROs?
    Mr. Butler. Yes, sir.
    The annual examination is required to cover eight specific 
review areas, and it also requires that we conduct an exam of 
each of the NRSROs registered with the SEC. The eight required 
review areas are informed by the risk assessment process that 
we use internally.
    The risk assessment process takes a variety of inputs: 
information from the prior exams; inputs from the media; inputs 
from the other offices and divisions of the SEC; as well as 
tips, complaints, and referrals that we receive on the SEC's 
TCR line. The risk assessment process is then used to 
effectively differentiate risks by registrant, which are then 
informing the exam scoping, which allows for our exam teams to 
then be most effective as they go their examination process.
    We also have examination teams arrayed in such a way that 
we have, if you will, larger examination teams examining the 
larger registrants and smaller examination teams with smaller 
registrants, so that we have an effective allocation of 
resources.
    As a result of the examinations, there is a report given to 
each of the registrants specifically identifying the 
deficiencies that we have noted, and there is also a summary 
report that is required to be put together by the office, which 
is assembled and reports publicly a summary of all the 
essential findings that we found in the examinations.
    Mr. Neugebauer. Do you think there is room for improvement 
on the present requirements?
    Mr. Butler. I think we are doing a very good job and a very 
effective job with what we have. I also believe that we can 
always do better, which is one of the reasons why from the 
budget request we have added an additional request for two head 
count in Fiscal Year 2017 who would be used as specialized 
examiners, because I think having specialized examiners would 
allow for us to be able to go narrow and deep, specifically on 
particular issues that arise perhaps during the course of an 
examination, perhaps at other times during the course of the 
year.
    Mr. Neugebauer. Do you think it is necessary for those 
exams to be annual and for your folks to be present?
    Mr. Butler. I think it is important at the stage that we 
are right now with regard to oversight of the credit rating 
agencies. We have seen real change as a result of the 
examinations conducted and real change implemented at the firms 
as a result of the recommendations that accompany our findings. 
And but for the fact that we are in there with the regularity 
that we are, I would not be able to sit here today and say with 
such conviction that there was real change.
    I think the annual requirement, though, is one that allows 
for us to bring a different approach each year to focus on 
different areas within the firm so that we are not going in on 
a predictable basis, but rather on a more tailored basis for a 
particular firm with regards to risks that have been identified 
to us or that we have seen.
    Mr. Neugebauer. If you could scale or tailor the current 
requirements, what would you do?
    Mr. Butler. I'm sorry. Could you repeat the question?
    Mr. Neugebauer. If you could scale or tailor the current 
structure, what would you do?
    Mr. Butler. I am comfortable with the structure as it is 
currently crafted.
    Mr. Neugebauer. And, Mr. McKessy, the written statement 
notes that your office authorized to award whistleblower is in 
the range of 10 to 30 percent. Why is the threshold not zero?
    Mr. McKessy. I think if the intention is to incentivize 
individuals to come forward if they are aware of wrongdoing, I 
think if--the calculus that individuals go through to decide 
whether they are going to report something to a regulator is 
very complicated and has a lot of factors, and amongst them, I 
think, is, ``How much is in it for me?'' or could be, ``How 
much is in it for me?''
    And if it is true that when a person is making the calculus 
of whether they should approach a regulator, one of the 
outcomes could be that they get zero, that could change and 
affect negatively their incentive and their enthusiasm about 
coming forward. And so, I think it is appropriate to not have 
zero as the baseline so that individuals who may otherwise be 
reluctant to come forward know that there is at least a 
possibility of some monetary award.
    Mr. Neugebauer. What is the current value of the 
whistleblower fund?
    Mr. McKessy. Just over $400 million.
    Mr. Neugebauer. $400 million?
    Mr. McKessy. Correct.
    Mr. Neugebauer. What kind of internal controls do you have 
in place with respect to that fund? That is a pretty sizeable 
amount of money.
    Mr. McKessy. We can only make payments when the Commission 
approves it, and there is a process by which we pay only 
against what we can confirm has been collected. And so we have 
internal controls to make sure that the cases that have been 
deemed to be worthy of an award, we have the documentation 
requirements; that we receive documentation either from the 
court or from the appropriate person inside the SEC to verify 
that we have actually collected the money, and then we multiply 
that against what the percentage that the Commission has 
approved.
    Mr. Neugebauer. Does the SEC Inspector General or the 
Government Accountability Office (GAO) audit those funds?
    Mr. McKessy. Yes. On an annual basis, the GAO audits the 
investor protection fund.
    Mr. Neugebauer. Thank you.
    Mr. Chairman, I yield back.
    Chairman Garrett. The gentleman's time has expired.
    We have been called for votes. We have 5 minutes left on 
the vote, so Members should run over. This is on passage of the 
bill.
    I think there are only two votes, if I am not mistaken, and 
I believe there is one or perhaps two other Members who were 
here and will be returning after votes for final questioning. 
The subcommittee is adjourned, to be reconvened immediately 
after votes.
    [recess]
    Chairman Garrett. Good afternoon. I hope you appreciated 
your little break.
    The subcommittee is called back into session, and at this 
time I recognize the gentleman from Pennsylvania for 5 minutes.
    Mr. Fitzpatrick. Thank you, Chairman Garrett, for 
permitting me to participate in this hearing.
    This is a really important hearing, SEC oversight of the 
credit rating agencies and the United States Congress oversight 
over the SEC, especially as it relates to consumer protection. 
Because each of the witnesses in their opening statements 
pretty much indicated one of the foundational principles of, 
whether it is the whistleblower section, Office of Credit 
Rating Agencies, and investor protection is sort of central to 
what you do.
    I have been following a couple of issues that are the 
subject of the hearing today.
    The first actually slightly separate issue has to do with 
foreign companies that somehow get listed on the stock 
exchanges of our Nation. They end up being fraudulent 
companies, many of them Chinese companies. We then find out 
that they are nothing but shell entities. A lot of U.S. 
investors have been hurt significantly.
    I am not going to ask the members of the panel to address 
this, but with the chairman's permission I would like to write 
to the members. I will do it through the chairman's office. I 
am concerned that either the SEC and/or the United States 
Congress or us working together are not doing enough to protect 
investors, and so I want to follow up on that issue.
    But today, I want to follow up on the issues that were 
raised by Mr. Lynch and Mr. Sherman. Mr. Lynch is concerned, as 
am I, that we are not doing enough to stamp out conflicts of 
interest within the credit rating agency sector of our economy 
or the financial services industry. We have a lot of work to do 
there.
    Mr. Butler, in response to Mr. Lynch's questions, you 
indicated that in terms of full compliance with new regulations 
that are being issued by the SEC, that you see this more as--I 
think you said a journey rather than a destination. I would 
hope the destination is full compliance with all the new 
regulations, including stamping out all conflicts of interest.
    Maybe you can explain what you mean by a journey rather 
than a destination? I hope the journey is pretty quick and that 
we are not adrift in that journey. What did you mean by that, 
that it is more of a journey than a destination?
    Mr. Butler. What I meant by that, Congressman, is 
compliance isn't an end state that companies achieve and then 
compliance is over. I view compliance as something that is 
needed every single day.
    The firms have large compliance staffs. They have been 
adding significantly to the numbers of their compliance staffs. 
They have been conducting reorganizations internally to effect 
enhanced compliance.
    And what I meant by saying it is a journey not a 
destination is that this is a continually evolving necessity. 
As the industry changes, as the types of products change, the 
types of compliance that is necessary within the firms may 
itself need to change.
    Mr. Fitzpatrick. Certainly, you are concerned about 
conflicts within especially the big three of the credit rating 
agencies, since those big three account for, what, 80 percent 
of the market?
    Mr. Butler. We have been very concerned about conflicts of 
interest across all the 10 registrants that are registered with 
the SEC--
    Mr. Fitzpatrick. I want to follow up on Mr. Sherman's 
questions about this Peruvian issue. Certainly, you have seen 
the newspaper stories and the advertisements about the agrarian 
land bonds. Are you familiar with that?
    Mr. Butler. I am familiar with some of the media coverage 
about the bonds, yes, sir.
    Mr. Fitzpatrick. Can you explain to the committee what your 
understanding is of the conflict at this point?
    Mr. Butler. With regard to the Peruvian bonds, I really 
don't have any particular details other than what the media 
reported, and it had to do with two of the rating agencies, one 
of which is registered with the SEC for sovereigns and one of 
which is not.
    Mr. Fitzpatrick. I am looking at a Standard & Poor's rating 
services. This appears to be an analysis of the Republic of 
Peru done about 6 months ago, September 2015. It seems to have 
rated as investment grade with a stable outlook--the sovereign 
debt or the bonds of the Republic of Peru.
    But you are aware that there are other bonds issued by the 
government a couple of decades ago that are in default? You 
have heard that, correct?
    Mr. Butler. I have seen the media articles on it. It has 
been a while since I read the media articles on it.
    Mr. Fitzpatrick. And you are aware that these same rating 
agencies are not willing to rate that debt for some reason? Are 
you aware of that?
    Mr. Butler. Again, it has been a while since I read the 
media coverage on it--
    Mr. Fitzpatrick. With respect to this particular issue, 
what are the circumstances that a rating agency should be 
permitted to rate new sovereign debt, get paid to do that--and 
that is part of their business model; I understand that--but 
ignore the requests of the investor community to rate other 
debt issued by the government that is in default?
    How is it the rating agencies get to pick and choose what 
debt they are going to rate and what debt they are not going to 
rate, especially when it affects small investors in the United 
States of America?
    Mr. Butler. The rating agencies are required to establish, 
maintain, and enforce policies and procedures to address their 
conflicts of interest. And within that, there are conflicts of 
interest identified which would be disclosure-based, and others 
that are absolutely prohibited. And prohibited conflicts would 
include the separation--
    Mr. Fitzpatrick. But what kind of discretion does a credit 
rating agency have to just decide on their own what they are 
going to rate and what they are not going to rate?
    Mr. Butler. With regard to our oversight, Congressman, we 
look at the work and the work product that has been done. We 
don't have authority with regard to the substance of ratings or 
the procedure or methodology--
    Mr. Fitzpatrick. I'll tell you what my concern is. My 
concern is that there are pension funds in half of the States 
in this country that have invested the retirements savings of 
police officers, of firefighters, of building construction 
trades workers, average everyday Americans who are losing money 
in certain investments where Standard & Poor's, in this 
particular case, has said, ``Yes, the Republic of Peru is 
investment-grade,'' but they are in default on other bonds.
    And I am concerned that they are deciding what bonds they 
are going to rate and what bonds they are not going to rate, 
because if they rated these land bonds that were issued a 
couple of decades ago and found out that they are all in 
default, that would affect all of the other ratings that they 
have issued. And that may have an effect on the ratings not 
just of the Republic of Peru, but other corporate bonds that 
they have rated also within that governmental area.
    So I would ask you to take a look at that and question the 
rating agencies--four or five or however many there are, not 
very many; not enough, I would say--and question them as to how 
they are using the discretion what to rate, what not to rate, 
whether there is a conflict inherent in that decision, and how 
many small investors, how many working-class Americans are 
being affected, negatively impacted, losing retirement savings 
as a result. Would you do that for me?
    Mr. Butler. Thank you, sir.
    Mr. Fitzpatrick. Would you do that?
    Mr. Butler. I am not at liberty to discuss the substance of 
an examination, but I am happy to take your comment under 
advisement.
    Mr. Fitzpatrick. I will follow it up with you. Thank you.
    Thank you, Mr. Chairman.
    Chairman Garrett. Thanks.
    And before I call on the gentleman from Maine, I just want 
clarity as to one of the answers on that.
    When you say that there are already rules in place as far 
as the conflict of interests for what--the decision by the 
rating agency, I think I understand what you are saying. But 
the conflict that they have is on the--that conflict that they 
have to make sure that there isn't a conflict of interest is on 
the--going forward, the decision--on the entity that they are 
going to be rating tomorrow. So if they are rating the XYZ 
country or entity over here, they have to make sure there is no 
conflict in that decision, right, is what you are saying?
    Mr. Butler. The new rules that were adopted in August 2014, 
effective June 2015, require--there is a certificate with 
regard to any rating action. The rating action could be either 
a new issuance or a surveillance of an old rating.
    Chairman Garrett. Right. But it doesn't really go to the 
point that the gentleman from Pennsylvania was making as far as 
their decision not to rate someone. There is no question, you 
don't look to see whether there was a conflict of interest when 
they decided, ``We are not going to rate X, Y, and Z.'' Is that 
correct?
    Mr. Butler. As it is currently crafted today, we are 
looking for surveillance activities and new issuance 
activities.
    Chairman Garrett. Okay. Thank you.
    With that, last, but certainly not least, the gentleman 
from Maine is recognized for 5 minutes.
    Mr. Poliquin. Thank you, Mr. Chairman. I appreciate it very 
much.
    Mr. Wyatt, you represent or you are the Director of the 
Office of Compliance, Inspections, and Examinations for the 
SEC, correct, sir?
    Mr. Wyatt. That is correct.
    Mr. Poliquin. Okay. And the SEC has about 4,000 employees 
and a budget of about $1.6 billion the last time I looked?
    Mr. Wyatt. SEC-wide, that is correct.
    Mr. Poliquin. Yes, exactly. And of those 4,000 employees, 
1,000 work for you.
    Mr. Wyatt. 1,011, yes, sir.
    Mr. Poliquin. Okay.
    I represent Maine's 2nd District. This is western, central, 
northern, and down east Maine. It is the most wonderful part of 
the world. If you haven't vacationed there, Mr. Wyatt, I know 
you are going to want to take your other associates with you to 
go vacation there this summer, which is upon us. We have a 
little bit of snow in Aroostook County, but it is melting.
    Now, we are a district of small business owners. We are a 
district of small savers--hardworking people; honest people; 
people putting aside $50, maybe $100 a month to save for their 
kid's college education or maybe for their retirement.
    Now, your job at the SEC--and all your jobs--is to make 
sure that there is integrity with respect to our publicly 
traded and other securities to make sure our investors have a 
fair shake at knowing what they are investing in.
    Now, help me out, if you don't mind, Mr. Wyatt. Your budget 
goes up for the entire--not just yours, but your part of it--
for the SEC you always come back to us every year for more 
money. And I think you asked for another 10 or 15 percent from 
last year to this year.
    So my question is, with 1,000 folks on your staff, how many 
examinations per inspector do you folks conduct for our 
registered investment advisers, the folks who manage our 
pension funds and our 401K funds and IRAs? How many 
examinations per inspector per year?
    Mr. Wyatt. The average is six to nine per examiner. So I 
would highlight that we do not conduct examinations on an 
individual basis; our examiners go out and examine investment 
advisers in teams.
    Mr. Poliquin. Right. Okay.
    Six to nine, okay. But you ask for an increase in your 
budget every year. What was the number--how many examinations 
did your teams conduct the year before?
    Mr. Wyatt. Last year, we conducted 1,992--
    Mr. Poliquin. No, how many per inspector, Mr. Wyatt?
    Mr. Wyatt. Per inspector it was--we have had a 23 percent 
increase in the number of exams per examiner in the past 3 
years.
    Mr. Poliquin. Okay. Thank you. I appreciate that very much.
    Let's continue to drill down a little bit on these 
examinations, sir. I know that the Administration's financial 
regulations ask you to make sure that you conduct robust 
examinations of the investment advisery space. And if I am not 
mistaken, there are about 14,000 registered investment advisers 
in America. Did I get that right?
    Mr. Wyatt. Roughly 12,000, yes, sir.
    Mr. Poliquin. Roughly. Okay.
    Do you think that you folks have spent a disproportionate 
amount of time recently on the private equity space--in other 
words, the type of investment adviser that deals with more 
accredited investors, larger investors, more sophisticated 
investors, as compared to folks who don't make a living 
investing but might be nurses or teachers or folks who work in 
the forest products industry in our districts?
    Do you spend a disproportionate amount of your time, sir, 
on the private equity examinations for large investors, as 
compared to the investment adviser space for smaller investors?
    Mr. Wyatt. I would suggest that those large investors that 
you are referring to are the endowments institutional investors 
and pension funds. Those pension funds are investing on behalf 
of the firefighters, the police officers, and the teachers.
    Mr. Poliquin. Yes.
    Mr. Wyatt. I would say with regards to our examinations of 
private funds, we have been very efficient in the resources we 
have dedicated to them. When they came into registration with 
the SEC as a result of Dodd-Frank, we conducted the presence 
exam initiative, when we had focused, limited-scope 
examinations of private funds. Those funds uncovered some 
activities regarding fees and expenses and allocation of trades 
that resulted in funds being returned to those institutional 
investors who, again, are investing on behalf of the 
firefighters--
    Mr. Poliquin. Sure.
    Mr. Wyatt. --policemen, and teachers.
    Mr. Poliquin. But I think you would--and I appreciate that 
you want to make sure that your scope of examination expands 
all investment types, and I understand that.
    Mr. Wyatt, wouldn't you agree that it is incumbent upon us 
to make sure we look out for the small saver, the small 
investor, whereas those who make a living in that business are 
usually better able to get the information they need to make 
their investments?
    Mr. Wyatt. We certainly want to protect investors. We 
certainly are doing our utmost to increase our exam coverage.
    I would highlight to you, as a result of our examinations 
of the private fund, many of those institutional investors have 
come to OCIE and asked for our assistance in how they can 
improve their due diligence because we got access to 
information that they otherwise wouldn't get in the course of 
their due diligence.
    So we are sharing that information so those institutional 
investors can be more informed when they make investments, and 
we are also doing our utmost to expand our coverage ratio 
within the investment adviser space to get to roughly 10 
percent a year, roughly 30 percent of the assets under 
management.
    We hit a 4-year high with regards to the number of 
examinations we have done, but in a 2-year period we have had a 
net increase of advisers of roughly 1,000. So we are continuing 
to increase our numbers.
    We certainly want to dedicate resources to improve our 
efficiencies. We certainly want to make sure we are doing our 
utmost to protect investors.
    Mr. Poliquin. Thank you, Mr. Wyatt.
    Mr. Chairman, if I may just continue one line of questions, 
please, sir? I am the last one here.
    Chairman Garrett. You have more questions?
    Mr. Poliquin. Yes, sir. I do.
    Chairman Garrett. Go ahead.
    Mr. Poliquin. Thank you very much. Thank you, Mr. Chairman.
    And thank you, Mr. Wyatt. Mr. Wyatt, what would be a great 
help to me and my office in representing our 2nd District of 
Maine, and also, I am sure, to our committee and the rest of 
the country, is when you are dealing with such an important 
part of our capital markets, you must have in your department a 
written set of procedures such that we, who are responsible for 
oversight for your entity, can make sure that we know exactly 
how you are conducting your business, exactly how you make your 
decision on what inspectors go where and what the expectation 
is for the number of examinations, just to make sure when you 
folks come back to us and ask for more money, we know that the 
taxpayers are getting the right bang for the buck. Would you be 
able to provide those procedural guidelines to us?
    Mr. Wyatt. We are doing our utmost to be as transparent as 
possible about--
    Mr. Poliquin. Do you have a set of written guidelines, sir, 
that we--
    Mr. Wyatt. We have a guideline--we have an exam manual that 
we use that is private.
    Mr. Poliquin. Yes, but that is for the examinations. I am 
talking about for Congress, that represents the people. Do you 
have a set of procedures that articulate exactly how you 
conduct your examinations?
    Mr. Wyatt. That is our exam manual that guides how we 
conduct our examinations, yes--
    Mr. Poliquin. Okay. And can you add an addendum to that 
such that we know what kind of activity--the amount of activity 
for the money that we are spending on behalf of your 
organization such that taxpayers know that they are getting 
their money's worth?
    Mr. Wyatt. We can certainly liaise with your office to try 
to provide you with the information that you are seeking.
    Mr. Poliquin. That would be great. And we will be in touch 
with you--what is today? Today is Thursday? We will be in touch 
with you tomorrow.
    Mr. Wyatt. I look forward to it. Thank you.
    Mr. Poliquin. Thank you, Mr. Wyatt. I appreciate it.
    And thank you very much, Mr. Chairman.
    Chairman Garrett. Thank you.
    Since no one else is here, I could just go on for hours 
here, but I won't. I will just ask two quick questions, just to 
drill back down a little bit on something else.
    I think Vice Chairman Hurt raised this question, Mr. 
Flannery, as far as taking a look back at--doing a look back at 
past rules and how that is all supposed to work and what have 
you, can you just spend 30 seconds? What is your game plan, 
what is your goal, to look backwards towards the last half a 
dozen years of rules that have been promulgated over the last 
half a dozen years and just see whether they are all working?
    Mr. Flannery. Of course, one of the biggest sources of 
rules over the past half dozen years has come out of the Dodd-
Frank Act.
    Chairman Garrett. Right.
    Mr. Flannery. And I know that the Congress is concerned 
about the cumulative effect of the Dodd-Frank rules and 
regulations on liquidity in financial markets. So DERA has been 
charged with doing a study on that very thing.
    I think it is a terrific study to be doing. We have 
started. We haven't gotten deeply into it.
    But the question of how liquid are our financial markets, 
particularly maybe the debt markets, I think has very important 
policy implications both here and around the world, and so we 
are looking forward to doing that.
    And the impact of these cumulative regulations on that 
liquidity is going to be an important conclusion. An assessment 
of that is going to be an important conclusion of our study.
    Chairman Garrett. Okay. And, of course, that always begs 
the question as to when?
    Mr. Flannery. You have told us, which is that we will get 
back to you within a year of the omnibus act last year being 
passed. I think that is our first draft, and 18 months is the 
final draft.
    Chairman Garrett. And that will look into also, besides 
those two points, will look into the--I will say the cost, 
economic impact on the industry and the marketplace?
    Mr. Flannery. On the liquidity, as I understand it, is what 
you are primarily interested in.
    Chairman Garrett. Well, yes. That I get. It will look at 
the liquidity.
    But will it also look at the overall cost? What is the 
economic cost measured in dollars and cents to the industry, 
per se? It is costing us--this firm X millions of dollars to do 
it and this firm X millions of dollars, what the total cost--
that may or may not impact always upon liquidity I presume, 
right? It costs another $10 million to do so, but liquidity 
stays the same.
    Mr. Flannery. Right.
    Chairman Garrett. So you are doing liquidity over here. 
That is good. Are you also looking out to the overall nominal 
cost, I guess is the word?
    Mr. Flannery. Yes. I think the nominal cost would be the 
word. And that would certainly be a part of that study. A part 
of any economic analysis is to set a baseline, and the baseline 
would include considerations of the costs of operating today, 
absolutely.
    Chairman Garrett. Yes. And I will end here where you began, 
with one of my very first questions.
    I have heard some good things as far as what you are 
talking about here from industry and otherwise, as far as in 
your--one of your opening comments, and it was talking about 
how this--some of this information is now being put out, as far 
as your studies and what you have presented.
    I will put it this way: Is that as far as you can go, or 
can you improve that? Can you reveal--I don't know what the 
right word is here--more information as far as the methodology, 
the data points, and everything else that goes into it? And I 
ask that question because some folks look here and say, 
``Good,'' but look at other agencies and how they do their 
analysis that you do in their area and they put out a fuller, 
more complete, more in-depth background, if you will, onto 
that.
    Do you see a comparison--maybe I should put it that way--do 
you see a comparison to other ones at how--what you do, and do 
you see that you could do a little bit more or more in these 
areas?
    Mr. Flannery. Yes. I have been--
    Chairman Garrett. That is my last question to you.
    Mr. Flannery. One of the things I have been working on in 
the past year-and-a-half since I got there--
    Chairman Garrett. Yes.
    Mr. Flannery. --is the idea that we bring in all this 
registrant information, it is treated as confidential and 
private because the registrants don't wish to be identified for 
obvious reasons, but that shouldn't interfere with our ability 
to provide information about various aggregated forms of that 
information.
    Chairman Garrett. Okay.
    Mr. Flannery. If we are going to be useful, we have to tell 
people how we made the decision about the aggregation, so I 
agree with you entirely about that.
    Chairman Garrett. Okay. And so you are going to be working 
on--
    Mr. Flannery. Yes.
    Chairman Garrett. Okay.
    Mr. Flannery. Yes.
    Chairman Garrett. That is good.
    So with that all being said, I thank the members of the 
panel and all the witnesses here today.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    And I would be remiss if I did not add this, that if you 
can't make the trip all the way up to Maine, the snow is 
already gone in New Jersey and things are blooming already in 
New Jersey. It will be another 6 months before the snow and the 
ice melts in Maine.
    So with that, this hearing is adjourned.
    [Whereupon, at 11:44 a.m., the hearing was adjourned.]

                            A P P E N D I X



                             April 21, 2016
                             
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