[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
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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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