SEC Operations: Increased Workload Creates Challenges (05-MAR-02,
GAO-02-302).
The Securities and Exchange Commission (SEC) faces growing
regulatory and oversight challenges. Technological advances have
increased the complexity of securities markets and the range of
products offered to the public. More people than ever are
invested in securities, either directly or through mutual funds.
Technology has also fundamentally changed the way these markets
operate and how investors interact with them. SEC routinely
prioritizes and allocates resources, but the agency is under
increasing pressure because of the staffing imbalances caused by
its growing workload. Staffing shortages have delayed critical
regulatory activities, such as reviewing rule findings and
issuing guidance. Oversight and supervisory functions have also
been affected. SEC has tried to address its high turnover by
offering special pay rates and retention bonuses, but the lack of
funding for pay parity means little relief in the short-term. SEC
has generally managed the gap between staff and workload by
determining which basic duties mandated by statute could be
accomplished with existing resources. This approach has forced
SEC to be largely reactive rather than proactive.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-302
ACCNO: A02847
TITLE: SEC Operations: Increased Workload Creates Challenges
DATE: 03/05/2002
SUBJECT: Agency missions
General management reviews
Securities
Securities regulation
SEC Automation Review Policy Program
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GAO-02-302
United States General Accounting Office
GAO
Report to Congressional Requesters
March 2002
SEC OPERATIONS
Increased Workload Creates Challenges
GAO-02-302
United States General Accounting Office
G A O SEC OPERATIONS
Highlights
Highlights of GAO-02-302, a report to Paul S. Sarbanes, Chairman, Committee
on Banking, Housing, and Urban Affairs, U.S. Senate; Christopher J. Dodd,
Chairman, Subcommittee of Securities and Investment; and Jon S. Corzine,
Member, Committee on Banking, Housing and Urban Affairs, U.S. Senate.
Why GAO Did This Study
In the past decade, securities markets have undergone tremendous growth and
innovation. Responding to concern that the Securities and Exchange
Commission's (SEC) workload has outgrown its resources and impaired SEC's
ability to fulfill its mission, GAO undertook a study to (1) determine how
the securities markets have changed, (2) identify whether SEC's resource
levels have affected its ability to regulate and oversee the markets, and
(3) identify any other factors that may affect SEC's ability to fulfill its
mission.
What GAO Recommends
GAO recommends that SEC explore short-and long-term recommendations to
address its current challenges. In the short-term, SEC should ensure that it
explores ways to use all of its available resources to address its
recruiting and retention problems.
In the long-term, we recommend that SEC broaden its strategic planning
process to determine its regulatory priorities and the resources needed to
fulfill its mission, including identifying the skills needed.
SEC, generally, agreed with the report's findings, conclusions, and
recommendations.
What GAO Found
U. S. securities markets have grown tremendously and become more complex and
international. As a result, SEC's workload has increased in volume and
complexity over the past decade. As illustrated below, around 1996, SEC's
workload (e.g., filings, applications, and examinations) started to increase
at a much higher rate than SEC staff years devoted to this workload.
Although industry officials said that they respect SEC as a regulator, they
said that SEC's limited staff resources have resulted in substantial delays
in SEC regulatory and oversight processes, which hampers competition and
reduces market efficiencies. In addition, they said information technology
issues need additional funding, and SEC needs more expertise to keep pace
with rapidly changing financial markets. Finally, the officials said that
SEC's reliance on a small number of seasoned staff to do the majority of the
routine work does not allow those staff to adequately deal with emerging
issues.
Although most officials said that SEC's resource limitations create
challenges for SEC, they identified other contributing factors. First, SEC's
high staff turnover has resulted in it having a more inexperienced staff,
which contributes to the identified delays in SEC's regulatory processes.
Second, existing securities laws, which require SEC approval of most market
innovations and new products, can contribute to regulatory bottlenecks.
Finally, SEC's budget and strategic planning processes could be better
linked to help SEC identify the types and amounts of additional resources
needed to fulfill its mission.
Source: GAO analysis of SEC data.
This is a test for developing highlights for a GAO report. The full report,
including GAO's objectives, scope, methodology, and analysis is available at
www.gao.gov/cgi-bin/getrpt?GAO-02-302. For additional information about the
report, contact Richard J. Hillman (202-512-8678). To provide comments on
this test highlights, contact Keith Fultz (202-512-3200) or email
[email protected].
Contents
Letter
Background Securities Markets Have Become Larger and More Complex SEC's
Ability to Fulfill Its Mission Has Become Increasingly
Strained Other Factors Contribute to the Challenges Facing SEC Conclusions
Recommendations for Executive Action Agency Comments and Our Evaluation
Scope and Methodology
1
2 6
11 24 33 34 35 35
Appendix I Comments from the Securities and Exchange Commission
Figures
Figure 1: SEC Divisions and Selected Offices Figure 2: Number of Times Stock
Market Trading Volume and the Value of IPOs Have Increased between 1980 and
2000 Figure 3: Growth in Dollars Households Invested in Funds, 1980-2000
(trillions of dollars) Figure 4: Percent of U.S. Households Owning Mutual
Funds, 1980-2000 Figure 5: Percent Change in SEC Staff Years and Workload
from 1991 to 2000 Figure 6: Percent Change in Workload and Staff Years for
Selected SEC Activities Figure 7: SEC Fees Collected and Appropriated
Funding, 1991-2001 (billions of dollars)
4 7 8 9 12 14 30
Abbreviations
ARP Automation Review Policy
ATS alternative trading system
ECN electronic communication network
EDGAR Electronic Data Gathering Analysis and Retrieval
GLBA Gramm-Leach-Bliley Act of 1999
GPRA Government Performance and Results Act
IA investment adviser
IARD investment adviser registration depository
IC investment company
IG inspector general
IPO initial public offering
OCIE Office of Compliance Inspections and Examinations
OMB Office of Management and Budget
SEC Securities and Exchange Commission
SRO self-regulatory organization
United States General Accounting Office Washington, DC 20548
March 5, 2002
The Honorable Paul S. Sarbanes Chairman, Committee on Banking, Housing, and
Urban Affairs United States Senate
The Honorable Christopher J. Dodd
Chairman, Subcommittee on Securities and Investment
Committee on Banking, Housing, and Urban Affairs
United States Senate
The Honorable Jon S. Corzine
United States Senate
The securities markets have undergone tremendous change and
innovation over the last decade, and the Securities and Exchange
Commission (SEC) faces growing regulatory and oversight challenges to
stay abreast of these advances. More recently, the sudden highly
publicized collapse of Enron Corporation has increased the pressure on
SEC to ensure that investors receive accurate and meaningful financial
disclosure, an important part of SEC's mission to protect investors. In
addition, technological advances have increased the complexity of
securities markets and the range of products offered to the public.
Moreover, technology has changed the way investors can buy and sell
securities, for example through on-line brokerages, and how investors are
solicited, given the increased access to information on the Internet. These
changes and the internationalization of securities markets have presented
SEC with increasing responsibilities in a dynamic regulatory environment.
Also, legislative changes, such as the Gramm-Leach-Bliley Act of 1999
(GLBA), the Commodity Futures Modernization Act of 2000, and the USA
PATRIOT Act of 2001, place added demands on SEC. Because more
individuals and families are now invested in the markets, the role SEC
plays has become even more important to the investing public.
You asked that GAO review whether SEC had sufficient resources to stay
abreast of the changes in the markets. Our objectives were to (1) identify
how securities markets have changed, (2) determine whether SEC's
resource levels and workload have affected SEC's ability to regulate and
oversee the markets, and (3) identify any other factors that may affect
SEC's ability to fulfill its mission.
In addressing these objectives, we analyzed securities market and available
SEC workload trend data. However, in certain instances, quantifiable data
was not provided to us for workload measures, such as the length of review
and approval processes conducted within SEC divisions. We met with various
knowledgeable SEC and industry officials to obtain their views on whether
these processes were affected by SEC's existing workload demands and
resources levels. To obtain information on whether SEC's ability to regulate
and oversee the markets has been affected by resource constraints, we
interviewed current and past SEC officials, including division and office
directors, regional office directors, budget officials, former
commissioners, and academics. In addition, we interviewed numerous industry
officials, including those from various exchanges, associations, investment
companies, and broker-dealers. We also asked these parties about any other
factors that might affect SEC's ability to fulfill its mission. We also
reviewed relevant GAO and inspector general reports on SEC's oversight
activities. Finally, we reviewed and evaluated SEC's strategic plan and
Government Performance and Results Act (GPRA) reports.
Background SEC's primary mission is to protect investors and the integrity
of the securities markets. SEC seeks to (1) promote full and fair
disclosure, (2) prevent and suppress fraud, (3) supervise and regulate the
securities markets, and (4) regulate and oversee investment companies,
investment advisers, and public utility holding companies. It works to
fulfill this mission through various divisions and offices. In 2001, GAO
issued a report that addressed many of the human capital challenges SEC
faces.1
SEC Focuses on Disclosure, Oversight, and Enforcement
SEC fulfills its mission to protect investors and the integrity of
securities markets through activities focused on disclosure, oversight, and
enforcement. The laws and rules governing the securities industry are based
on the concept that all investors, whether large institutions or private
individuals, should have access to basic information about an investment
prior to trading. To achieve this, the securities laws require public
companies to register with SEC and to periodically make public
1 U.S. General Accounting Office, Securities and Exchange Commission: Human
Capital Challenges Require Management Attention, GAO-01-947 (Washington,
D.C.: Sept. 17, 2001).
meaningful financial and other information for all investors to use to
determine whether a company's securities are an appropriate investment.
SEC also oversees the activities of a variety of key market participants. In
2001, SEC was responsible for 9 exchanges, the over-the-counter market,
approximately 70 alternative trading systems (ATSs), 2 12 registered
clearing agencies, about 8,000 registered broker-dealers employing over
700,000 registered representatives, almost 8,000 transfer agents,3 over
5,000 investment companies and 7,400 registered investment advisers. In
addition, over 14,000 companies that have issued securities filed annual
reports with SEC. SEC's oversight includes rulemaking, surveilling the
markets, interpreting laws and regulations, reviewing corporate filings,
processing applications, conducting inspections and examinations, and
determining compliance with federal securities laws. SEC is also responsible
for regulating public utility holding companies.
Each year SEC brings hundreds of civil enforcement actions against
individuals and companies that violate securities laws. Violations include
insider trading, financial and accounting fraud, providing false or
misleading information about securities and the companies that issue them,
selling of securities without proper registration, and violating
broker-dealer responsibility to treat customers fairly. An ongoing program
to educate investors and ensure that their concerns are known throughout SEC
supplements SEC's enforcement efforts.
SEC's Organizational Structure
As of September 30, 2001, SEC had 3,285 staff (or 2,936 full-time equivalent
staff years) working in 4 divisions and 18 offices in Washington, D.C. and
in 11 regional and district offices. Of these, approximately 39 percent were
attorneys, 18 percent were accountants or financial analysts, and 6 percent
were investigators or examiners. The remaining 37 percent were various other
professional, technical, administrative, and clerical staff. See figure 1
for a description of SEC's major divisions and offices.
2 An ATS is any entity that performs functions commonly performed by a stock
exchange.
3 Transfer agents are parties that maintain records of stock and bond
owners.
Figure 1: SEC Divisions and Selected Offices
Source: SEC.
2001 GAO Report Found SEC Faces Human Capital Challenges
In 2001, we issued a report, which discussed the human capital challenges
SEC faces.4 We surveyed current and former SEC attorneys, accountants, and
examiners to determine why they had left or would consider leaving SEC.
Overwhelmingly, compensation was cited as the primary reason for leaving.
Respondents also identified other nonpay factors that had or would affect
their decisions to leave, such as the lack of opportunities for advancement,
the amount of uncompensated overtime, and the quality of administrative
support.
To recruit, retain, and motivate employees, we found that SEC used various
compensation-based programs, such as recruitment bonuses, retention
allowances, and special pay rates, more actively than other government
agencies. For example, in March 2001, SEC received OPM approval to update
its special rates for attorneys, accountants, and examiners. These special
pay rates are generally equivalent to a several-step increase in the basic
government pay scale. Because staff cannot receive the special pay rate and
a locality pay adjustment, SEC would have to request special pay adjustments
annually to prevent the locality pay adjustments from eroding the benefit of
the special pay.
We also found that while SEC also offers a number of work life programs, it
has only recently increased its focus on providing greater flexibilities to
its staff such as opportunities to work compressed work schedules. We also
found that SEC management had made improvements to its recruitment program,
which included additional training for recruiters and expanded on-campus
recruiting and added a new human capital goal to its performance plan.
However, more remains to be done in order for SEC to strategically align its
core mission with its ability to recruit and retain qualified employees. We
recommended that the chairman, SEC, periodically survey employees to measure
job satisfaction, identify employee concerns, and analyze the effectiveness
of the agency's programs to retain employees. We also recommended that the
chairman, SEC, include a strategy for succession planning and a
comprehensive, coordinated workforce planning effort in the agency's annual
performance plan. Finally, we recommended that the chairman, SEC, identify
ways to involve human capital leaders in decision making and establish a
practice that requires management to continually ensure the effectiveness of
SEC's human capital approaches in addressing employees' needs, including
4 GAO-01-947.
Securities Markets Have Become Larger and More Complex
working with the National Treasury Employees Union to expeditiously address
the areas of dissatisfaction identified in our survey.5
Over the last decade, securities markets have experienced unprecedented
growth and change. Moreover, technology has fundamentally changed the way
markets operate and how investors access markets. These changes have made
the markets more complex. In addition to these market-driven changes, the
markets have become more international, and legislative changes have
resulted in a regulatory framework that requires increased coordination
among financial regulators and requires that SEC regulate a greater range of
products.
U.S. Capital Markets Have Grown Rapidly
Over recent decades, U.S. capital markets have experienced substantial
growth, especially in the 1990s. As shown in figure 2, the volume of shares
traded in U.S. stock markets in 2000 was over 30 times higher than the
volume in 1980. Although many factors contributed to this unprecedented
growth, it was in part spurred by technological advances and decreasing
transaction costs, which made it easier and more affordable for investors to
participate in the market. Figure 2 also shows that the value of initial
public offerings (IPOs) of securities issued in 2000 was over 50 times the
number of IPOs issued in 1980 as private companies took advantage of the
strong economy and favorable market conditions and issued stock to raise
capital.
5 In July 2000, SEC employees voted to join the National Treasury Employees
Union.
Figure 2: Number of Times Stock Market Trading Volume and the Value of IPOs
Have Increased between 1980 and 2000
Source: GAO analysis of SEC data.
Likewise, in the 1990s many more individuals became investors by buying
shares in mutual funds, further elevating the importance of SEC as a
regulator. Figure 3 shows that the dollars that households had invested in
mutual funds, excluding money market funds, grew from $46 billion in 1980 to
$3.3 trillion in 2000. Moreover, as of December 2001, the total dollars
invested6 in mutual funds was almost $7 trillion, about twice the amount on
deposit at commercial banks. This growth in amounts invested was due in part
to higher stock values.
6 Total dollars invested includes money market funds and funds owned by
households; fiduciaries; and financial, business, and other organizations.
Figure 3: Growth in Dollars Households Invested in Funds, 1980-2000
(trillions of dollars)
Source: GAO analysis of SEC data.
Between 1980 and 2000, more households and individuals became investors in
mutual funds and stocks. Figure 4 shows that the percent of U.S. households
owning mutual funds also had increased to almost 50 percent of households by
2000. According to SEC, the number of households owning mutual funds in 2001
continued to increase with 52 percent of households owning funds. According
to SEC, stock funds account for almost half of all mutual fund assets, and
75 percent of cash inflows to these funds come from retirement plans. Since
1990, the percent of U.S. retirement assets held in mutual funds has more
than tripled. Moreover, according to New York Stock Exchange data, the
number of individuals that owned shares of stocks increased 61 percent
between 1989 and 1998.
Figure 4: Percent of U.S. Households Owning Mutual Funds, 1980-2000
Driven by technological advances, the securities markets have become more
complex with an array of new products and market participants.
Exchange-traded funds,7 single-stock futures,8 and on-line portfolios add to
the products that SEC must oversee. Other technology-driven innovations such
as ATSs, on-line brokerages, and day trading firms have also stretched SEC's
regulatory capacity. For example, SEC regulates about 70 ATSs. Electronic
communication networks (ECNs) ,9 one type of ATS, account for about 30
percent of the daily share volume in Nasdaq
7 An exchange-traded fund is type of investment company whose shares can be
bought and sold on the secondary market, as well as from the investment
company in large blocks of shares.
8 A single-stock future is a contract to buy or sell a specific security at
a particular price in a stipulated future month.
9 An ECN is an electronic trading system that automatically matches buy and
sell orders at specified prices. ECNs register with the SEC as
broker-dealers.
Source: Investment Company Institute.
Securities Markets Have Become More Complex and International
securities. On-line brokerages, which were unknown a few years ago, are used
by almost 12 million investors in making about 1.1 million trades per day.
Likewise, investor protection concerns about day trading firms' activities
resulted in greater regulatory activity in this area over the past few
years.
New technology also has affected how the markets operate and how
participants communicate. Stock exchanges and markets use complex electronic
trading systems that SEC must understand and monitor. The Internet has
allowed for rapid, widespread dissemination of information to investors,
which also presents ongoing regulatory challenges to which SEC has been
responding. For example, the Internet has provided simple, effective, and
essentially anonymous ways for unscrupulous persons to exploit investors. As
of May 2001, SEC had brought more than 240 Internet-related enforcements
actions, charging close to 800 persons and entities with federal securities
law violations.
The internationalization of securities markets also presents new challenges
for SEC. In 1991, U.S. investors purchased and sold $949 billion in foreign
securities. By 2000, that number had risen to $5.484 trillion-an increase of
478 percent. According to SEC documents, in 2001, approximately 130 foreign
companies from 29 countries entered U.S. securities markets for the first
time and filed over $312 billion in public offerings. In addition, over
1,300 foreign companies from over 59 countries filed periodic reports. SEC
also recognizes the importance of being able to work closely with its
international counterparts in enforcement and inspection activities, and to
participate in international initiatives that relate to the supervision of
global securities markets.
Legislative Changes Spur New Products and Regulatory Responsibilities
Legislative changes also created additional workload for SEC. For example,
GLBA made SEC the primary regulator for all securities firms, including
broker-dealers and investment advisers affiliated with financial holding
companies.10 While SEC has always coordinated with other financial
regulators to a certain extent, GBLA requires that SEC undertake additional
examinations and inspections of highly complex financial services firms,
both to fulfill its own oversight responsibilities and to provide the
Federal Reserve and other relevant agencies with the
10 Before GLBA, most banks' brokerage and investment adviser activities were
not subject to SEC regulation.
information and analyses to fulfill their missions. Likewise, the Commodity
Futures Modernization Act of 2000, which allowed single-stock futures to
trade in the United States, increases the number of potential regulated
entities over which SEC has responsibility. It requires futures markets and
certain futures commission merchants11 to register with SEC as national
securities exchanges and broker-dealers for the limited purpose of trading
these products. In addition, the USA PATRIOT Act of 2001 assigned to SEC an
expanded role in the fight against money laundering and terrorism. SEC is
working with the Department of Treasury on rulemakings related to shell
banks, customer identification, suspicious activity reporting, and
correspondent and private banking, as well as studies on managed funds and
the overall operation of the legislation. SEC has expanded examination
responsibilities for broker-dealer compliance under the Bank Secrecy Act and
new examination responsibilities for other financial institutions regulated
by SEC, including investment companies.
SEC's Ability to Fulfill Its Mission Has Become Increasingly Strained
SEC and industry officials said SEC's ability to fulfill its mission has
become increasingly strained due in part to imbalances between SEC's
workload (e.g., filings, complaints, inquiries, investigations,
examinations, and inspections) and staff resources.12 As figure 5
illustrates, since 1996 SEC's staff resources have not grown commensurate
with its workload.13 Although industry officials complimented SEC's
regulation of the industry given its staff size and budget, both SEC and
industry officials identified several challenges SEC faces. First, resource
constraints have contributed to substantial delays in the turnaround time
for many SEC regulatory and oversight activities, such as approvals for rule
filings and exemptive applications.14 Second, SEC's resource constraints
contributed to bottlenecks in the examination and inspection area as
workload grew. Third, limited resources have forced SEC to be selective in
its enforcement activities and have lengthened the time required to complete
certain
11 Futures commission merchants are firms that buy and sell futures
contracts as agents for customers.
12 Staff resources are measured in this report in terms of full-time
equivalent staff years.
13 Information presented throughout this report on SEC's staffing,
resources, budget, and other operations relates to fiscal years.
14 A company files an exemptive application when it seeks an SEC decision to
exempt a new activity from existing rules and laws.
enforcement investigations.15 Fourth, certain filings were subject to less
frequent and less complete reviews as workloads increased. Fifth, today's
technology-driven markets have created ongoing budgetary and staff
challenges. Finally, SEC and industry officials said that SEC has been
increasingly challenged in addressing emerging issues, such as the ongoing
internationalization of securities markets and technology-driven innovations
like ATSs and exchange-traded funds.
Figure 5: Percent Change in SEC Staff Years and Workload from 1991 to 2000
Source: GAO analysis of SEC data.
15 The SEC chairman has recently announced an initiative called real-time
enforcement, which is intended to protect investors by: (1) obtaining
emergency relief in federal court to stop illegal conduct expeditiously; (2)
filing enforcement actions more quickly, thereby compelling disclosure of
questionable conduct so that the public can make informed investment
decisions; and (3) deterring future misconduct through imposing swift and
stiff sanctions on those who commit egregious frauds, repeatedly abuse
investor trust, or attempt to impede SEC's investigatory processes.
According to SEC, insufficient resources may inhibit the effectiveness of
this initiative, which depends upon prompt action by enforcement staff.
SEC Resource Levels Have Not Grown Commensurate with Its Workload
Although there may not be a need for an identical offsetting increase in SEC
staff compared to the increases in its workload, larger, more active, and
more complex markets have produced more market participants, registrants,
filings, examinations and inspections, legal interpretations, complaints,
and opportunities for fraudulent activity. Over the last decade, staffing,
within different areas of SEC's regulatory oversight activities, has grown
between 9 and 166 percent, while workload measures in those areas have grown
from 60 to 264 percent. As figure 6 illustrates, the increases in SEC's
workload substantially outpaced the increases in SEC's staff. For example,
the number of corporate filings increased 60 percent, while related review
staff increased 29 percent. This figure also shows that the number of
complaints and inquiries received increased by 100 percent, while the
enforcement staff dedicated to investigate complaints and other matters
increased by 16 percent.16 In addition, the number of market and firm
supervision actions increased 137 percent, but the number of staff
responsible for these activities increased 51 percent. Market and firm
supervision actions include
* SRO17 and SEC rule proposals;
* interpretive guidance and exemptive applications;
* analyses of proposed enforcement actions, disclosure documents, and risk
assessment reports;
* automated trading system analyses and automation reviews of SRO systems;
* policy papers;
* Congressional, governmental, industry, and public correspondence; and *
other reports and analyses of SEC's Division of Market Regulation.
Investment company filings increased 108 percent while staff increased 9
percent. Likewise, total assets under management by investment companies
(IC) and investment advisers (IA) increased by about 264 percent over 10
years, while the number of IC and IA examination staff increased by 166
percent.
16 Although complaints are not a comprehensive measure to compare with the
level of investigative resources, many enforcement actions are initiated
based on complaints received by SEC. Investigations might also be started,
for example, from SEC inspections and examinations or matters referred to
SEC by SROs or state regulators.
17 SROs are organizations responsible for regulation of member
broker-dealers.
Figure 6: Percent Change in Workload and Staff Years for Selected SEC
Activities
The imbalance between workload and resources has resulted in SEC taking
longer to process various types of filings, issue guidance, and review
applications. Although SEC did not provide statistics on the time frames to
process its workload, various industry officials told us they have to wait
longer to receive SEC's response to their filings and applications. They
said that SRO rule filings take longer to get approved as SEC's workload has
increased. Likewise, the officials said that the amount of time SEC takes to
process interpretive guidance and no-action letters18 has increased, as has
the length of time taken to process exemptive applications. Finally, the
amount of time taken to review IPOs filings had also increased. The
officials said these delays could affect industry competition and
efficiency.
Source: GAO analysis of SEC data.
Substantial Delays Exist in the Completion of Many Regulatory and Oversight
Activities
18 A company would seek a no-action letter from SEC when it plans to act in
a new or unclear area.
Backlog of SRO Rule Filings Has Grown
Staff Constraints Result in Delays in Guidance
According to SEC officials, a growing backlog of SRO rule filings resulted
in delays in responding to filings. As of January 2002, SEC officials said
that there were 284 SRO rule proposals in the pipeline. The officials said
that because of the high staff turnover in recent years, SEC did not have
enough seasoned staff available to process the rule proposals more quickly.
SEC data shows that the number of rule filings open at year-end increased 40
percent from 174 in 1998 to 243 in 2001. Also, SEC expects the number of SRO
rule filings to continue to increase because of registration of new
exchanges and the implementation of additional oversight responsibilities
for exchanges trading single-stock futures. In 2001, SEC received 638
proposed rule changes compared to 444 in 1991-a 44 percent increase.
Industry officials believed resource constraints were one reason that SEC
now takes longer to complete these reviews than in the past. Such delays can
have important affects on those making the filings. For example, an SRO
official said that when SEC takes a year or more to approve a proposed
change, the SRO can lose the competitive advantage from making the change.
Although SEC officials said that they do not keep statistics on the length
of time it takes to review filings, other industry officials said that they
have waited months with no response from SEC.
In addition to approving SRO rule filings, SEC also develops its own rules.
For example, in 2001, SEC developed 74 rule proposals and interpretive
releases. One rule proposal SEC is considering would improve the SRO rule
proposal review process. To address many of the concerns mentioned
previously, the proposed Rule 19b-6 would, among other things, require SEC
to (1) issue a release relating to filed proposed rule changes within 10
business days of receipt of the filing, (2) eliminate the pre-filing
requirement and the 30-day delayed operational period before which
noncontroversial rule changes can be filed or become operative, (3) expand
the categories of proposed rule changes that qualify for immediate
effectiveness to include certain trading rules, and (4) permit SROs to file
proposed rule changes electronically. According to SEC staff, the initial
rule proposal that was released over a year ago, in January 2001, was
considered to be controversial. For example, some of the exchanges did not
think the proposal went far enough in streamlining the rule filing process,
while many broker-dealers were concerned about reduced SEC oversight. SEC is
still considering comments it received from the industry and has not decided
on the final contents of the rule.
In addition to reviewing and approving SRO rule filings, SEC provides
guidance to registrants, prospective registrants, and the public to help
them comply with securities laws. This usually takes the form of
SEC Also Takes Longer to Review Exemptive Applications
interpretive guidance and no-action letters, and each year SEC processes
hundreds of these requests. Industry officials said that they have to wait
longer to obtain SEC guidance in the form of no-action letters and
interpretive guidance than in past years. SEC officials said that there were
numerous no-action letters and interpretive guidance in process. In 2001,
SEC processed over 1,600 requests for guidance from securities firms,
investment companies, and investment advisors, which increased from about
1,360 in 1991. SEC staff also said that, as of January 2002, the chairman
was reviewing SEC's interpretive guidance process. Industry officials said
that delays in obtaining SEC guidance can create legal uncertainties and
stifle innovation. In the future, although staff levels are expected to
remain static, SEC expects its workload in this area to increase as more
firms request guidance on how SEC's financial responsibility and investor
protection rules apply to securities firms that become part of large
financial services organizations and enter into increasingly complex
financial transactions.
SEC's processing of exemptive applications has also experienced delays. SEC
is responsible for processing applications for exemptive relief from various
statutory provisions and rules. The Investment Company and the Investment
Adviser Acts authorize SEC to exempt any person, security, or transaction
from one or more provisions of the acts. Exemptive applications usually take
about 3 to 6 months to process but as the issues involved become
increasingly complex it can take much longer. A 1996 SEC inspector general
(IG) report19 noted that it was not unusual for the length of time required
for staff review to be a year or longer due to the complexity of the issues,
the lack of delegated authority, or workload pressures.20 Industry officials
said that the time that SEC takes to approve exemptive applications has
continued to increase and that inadequate staffing was part of the problem.
For example, in the more extreme cases, an official said that SEC took over
1 year to process "a relatively routine" exemptive application and over 5
years to render a decision on another application. The IG also found that to
avoid lengthy delays some firms abandoned plans that require exemptive
relief or altered them to adopt a less innovative approach that did not
require filing for an exemption.
19U.S. Securities and Exchange Commission, Inspector General, Applications
for Exemptive Relief, Audit Report No. 230 (Washington, D. C.: March 1996).
20 SEC is required to publish notice in the Federal Register of proposed
exemptions giving interested parties the opportunity to request a hearing
before a final exemptive order is issued. The notice period typically is 25
days.
SEC Reviews of IPO Filings Can Be Lengthy
Industry officials we spoke with also said that these delays stifled
innovation and hampered competition.
Industry officials also said that the time SEC takes to approve IPOs has
grown. Although the number of IPOs has decreased substantially in the past 2
years, industry officials continued to cite this as a challenge for SEC
albeit a less pressing one. In 2001, SEC completed 745 IPO issuer reviews,
down from 1,350 in 2000. SEC said that IPOs are a priority and that every
IPO gets a full review. Industry officials said that it generally takes SEC
4 to 7 weeks to complete the review process, but the officials added that
they see no reason that the process should take that long. These officials
also said that the industry perception is that SEC's existing staffing level
is insufficient given its workload. The length of time it takes to review an
IPO has economic implications for the issuing company because market
conditions can change (e.g., the estimated value of the stock can fall in
adverse market conditions), thereby increasing the cost of the IPO or making
the IPO not feasible. Moreover, the officials said that lengthy delays in
the completion of IPO filings can increase the likelihood that issuers may
opt for private placements or go offshore even if it is more costly. They
also said that lengthy delays may discourage foreign companies from entering
U.S. markets.
Workload Adversely Affects SEC Examination and Inspection Function
The increasing complexity and growth of the capital markets has also
affected SEC's ability to inspect and examine the operations of various
regulated entities. Each year, SEC usually conducts from 800 to 900
inspections and examinations of SROs, broker-dealers (including their branch
offices and registered representatives), transfer agents, and clearing
agents for compliance with the federal securities laws and regulations. To
better utilize its resources, in the mid-1990s the Office of Compliance
Inspections and Examinations (OCIE) began conducting fewer full scope
examinations, which review all aspects of operations, and more frequent
risk-based examinations, which focus on specific areas or issues.
Although staff levels are expected to remain unchanged in 2003, SEC expects
the number of larger, more complex brokerage firms and other financial
institutions to grow. SEC also expects to enhance its internal control
examination program. These internal control examinations usually
take longer to complete and require special training and skills.21 In 2001,
SEC said that they conducted about 22 to 25 broker-dealer internal control
examinations compared to 1 to 3 when they started the program in 1995.
However, with no increase in staffing SEC may find it difficult to continue
to increase the number of internal control examinations completed.
Although SEC officials said that they had been able to maintain their
examination schedules and workload with their existing staff levels, some
officials were concerned that the cycle for certain types of reviews could
stretch beyond the planned time frames. For example, some officials said
that the investment adviser reviews could stretch beyond the existing 5-year
cycle in the future, if that examination program does not have sufficient
resources. They added that a minimum review 1 in every 5 years was vital to
the level of oversight needed to protect investors. SEC officials also said
that new rules that have been implemented will add time and complexity to
the reviews. Overall, SEC officials said that OCIE had lost a lot of
experienced staff at the junior level and that new staff requires constant
training.
Several industry officials also said that the time between the completion of
SRO inspections and the issuance of final inspection reports is lengthy. SRO
officials said that after an inspection is done it usually takes a year or
two before the report is final. Some SRO officials said that the lag between
the completion of the inspection and the issuance of the report could result
in findings and recommendations becoming obsolete because the recommended
changes had already been made or programs revised. These officials said that
they would prefer to have the problem pointed out during the inspection
process so as not to delay any necessary corrective action. Such lags in the
inspection process can cause inefficiencies in SROs' operations.
According to SEC officials, other factors, in addition to resource
constraints, also contribute to the extended time required to complete SRO
inspections. SRO inspection reports require a more extensive level of review
due to the variety of complex issues relating to SROs. Moreover, any
recommendations must receive higher scrutiny because they could potentially
impact SRO members. However, SEC officials said they recognize this is an
issue and that steps are being taken to improve the
21 Internal control examinations are intense reviews of internal controls
relating to trading, liquidity, credit, new products, and other aspects of
broker-dealer operations.
inspection process. For example, SEC plans to provide more detailed
information about preliminary findings at exit interviews and inform SROs
sooner about the issues that will likely be addressed in the final
inspection reports. They also said that they plan to do more risk-based
inspections of SROs.
Workload Growth and Limited Staffing Raise Concerns about Enforcement
SEC and industry officials said that delays in closing cases and a backlog
of smaller investigations presented ongoing challenges for SEC. Between 1991
and 2000, Division of Enforcement staff devoted to investigations increased
16 percent, from 414 to 482 staff years, while the number of cases opened
increased 65 percent, from 338 to 558. Although increased staff has allowed
more work to be initiated, delays in completion of individual cases persist.
Moreover, the number of cases pending at the end of the year increased 77
percent, from 1,264 in 1991 to 2,240 in 2000. SEC officials said the
increase in cases pending was partly attributable to high staff turnover,
which has resulted in old cases not being closed or ongoing cases being
delayed until other staff can take over. The officials said that in 2000, 58
experienced staff left the division.
SEC and industry officials said that SEC's enforcement activities are
important for carrying out SEC's mandate to protect investors and deter
fraud and abuse. SEC officials said that they cannot prosecute every case
and, therefore, must prioritize the cases they will pursue. SEC officials
said they recognize that they have limited resources and operate
accordingly. According to SEC officials, SEC generally prioritizes the cases
in terms of (1) the message delivered to the industry and public about the
reach of SEC's enforcement efforts, (2) the amount of investor harm done,
(3) the deterrent value of the action, and (4) SEC's visibility in certain
areas such as insider trading and financial fraud. Except for the length of
time taken to complete an investigation, most officials said that SEC was
effective in this area. Although SEC data show that the average length of
time to complete an investigation decreased, we did not perform a detailed
review of the individual investigations to determine whether this was an
improvement or whether SEC on average pursued less time-consuming matters
for investigation.
SEC Information Technology Systems and Funding Gaps Contribute to
Inefficiencies
SEC and industry officials agree that SEC has improved its technological
capabilities and expertise and has been proactive in creating innovative
systems that assist the industry. However, SEC officials said that
additional money is needed to improve the usefulness of many of its systems
and to increase the technical knowledge of SEC staff. EDGAR22 and the
investment adviser registration depository (IARD) 23 systems were created to
provide electronic collection, storage, and retrieval of data for the
industry and investors. However, SEC staff and industry participants said
that these systems provide limited capability to retrieve information.
Currently, users can retrieve corporate and financial information from
EDGAR, but the system is unable to generate trend information. SEC officials
said that they must obtain this information from outside sources. An SEC
staff member noted that the IARD system could be upgraded to include a
variety of functions beyond storing investment adviser information including
a search capability that identifies advisers according to state and
specialty. However, the officials said that SEC was only allocated enough
funds to meet the requirement of providing investors with a readily
accessible database of information about investment advisers and persons
associated with investment advisers. It did not receive sufficient funding
to make the system fully useful for regulatory oversight or as an analytical
tool.
According to SEC officials, SEC's 2002 information technology budget of
$46.6 million was used primarily for hardware and software maintenance and
technology infrastructure needs. These officials said that they requested,
but did not receive, additional funding for capital improvements such as a
nationwide network to support the examination and inspection activities and
enhancements to the IARD. According to the officials, SEC has a list of
technological improvement projects that have not been funded due to
budgetary constraints. Several SEC officials said that requests have
included applications that allow for better manipulation and connectivity of
various SEC data systems and computerized reports. For example, one SEC
official said that he must wait days for market surveillance data to be
downloaded, even though technology exists that would allow SEC to obtain
this information in seconds. The officials said that SEC's technology needs
vary from having a simple toll-free number for investors
22 EDGAR is a database system through which public companies electronically
file registration statements, periodic reports, and other forms to SEC.
Anyone can access and download EDGAR information for free.
23 IARD is the system that investment advisers must use to register with
SEC.
to contact SEC staff to having the capability to reconstruct trading
activity in case of a major market failure, such as the 1987 market break.
SEC and the industry also cited the lack of additional technical staff as
another issue. Some SEC officials said that they would like to have more
information technology specialists to participate in certain examinations.
One official said that SEC needs more technical specialists to evaluate
industry participants' computer and information systems and to ensure
compliance with new privacy laws that protect investor information and
assets. As of January 2002, SEC had only two examination staff dedicated to
technology issues involving broker-dealers and other non-SRO examinations.
SEC requested an additional $13 million in its 2003 budget authorization
request to support the agency's information technology and automation
efforts. Such funding was necessary to enable SEC to
* respond to federal requirements to expand electronic interactions with
filers, registrants, the public, and other external customers;
* enhance SEC's examination and inspection program by providing automated
tools to analyze large information databases used by investment advisers;
* upgrade the database, which is used in its investigative process to search
and match lists of names received from other agencies;
* respond to federal requirements to ensure information security with better
intrusion-detection capabilities and incident responsiveness and provide
additional information security awareness training; and
* obtain the necessary hardware for creation of a "virtual private network"
that will allow secure access for offsite inspection and examination
activities.
SEC's oversight of SRO information systems is conducted through SEC's
Automation Review Policy (ARP) program,24 which in mid-2001 was administered
by 10 staff members in the Office of Technology and Enforcement within the
Division of Market Regulation. GAO reported in July 2001 that SEC's ability
to oversee information system issues was hampered by the limited resources
available to the ARP program, a factor
24 ARP is a program under which SROs agree to submit to SEC oversight of
their information systems.
that also constrained its staffs' ability to inspect the SRO's automated
systems on a timely basis.25
Industry officials were not impressed by SEC's technology oversight. One
industry official described SEC's technology reviews as fairly basic.
Another industry official said that SEC staff had limited technical
knowledge. This knowledge is vital for overseeing transaction systems
including settlement and trading systems. And yet another industry official
highlighted a "lack of confidence" in SEC's ability to effectively review
technology and related capacity issues. SEC officials said that SEC has made
improvement over the last several years and has tried to stay abreast of
technological advances, but like most regulators SEC remains behind market
developments.
Certain Financial Statement and Other Filings Are Subject to Less Frequent
Review by SEC Staff
The number of corporate filings SEC received increased 59 percent from
61,925 in 1991 to 98,745 in 2000. The increase was primarily due to the
tremendous increase in the number of IPOs and other market transactions
filed with SEC. During this same time period, the staff years devoted to the
review of these filings, primarily for accountants and attorneys, increased
29 percent from 125 in 1991 to161 in 2000. SEC officials said that this
limited staff growth combined with the high volume of IPOs limited SEC's
ability to review other filings, which also increased. The officials said
that staff perform full reviews26 of all registration statements for IPOs
and may review other transactional filings related to raising capital or
mergers and acquisitions. As a result, fewer resources are available to
review the annual and quarterly filings of previously registered securities
issuers. The percent of all corporate filings that received a full review, a
full financial review, or were just monitored for specific disclosure items
decreased from about 21 percent in 1991 when 13,198 were reviewed to about 8
percent in 2000 when 8,498 were reviewed.
25 U.S. General Accounting Office, Information Systems: Opportunities Exist
to Strengthen SEC's Oversight of Capacity and Security, GAO-01-863
(Washington, D.C.: July 25, 2001).
26 SEC's review of corporate filings may involve a full review, a full
financial review, or certain filings may be monitored for specific
disclosure items. A full review involves an in-depth examination of the
accounting, financial, and legal aspects of an issuer's filing. A full
financial review involves an in-depth accounting analysis of an issuer's
financial statements and management's discussion and analysis or business
plan disclosure.
According to SEC officials, until the early 1980s, SEC completed full
reviews of all transactional filings. The officials said that approach would
not be possible in today's market without a substantial increase in staff
resources. In addition, SEC's goal was to complete a full financial review
of each issuer's annual filings in at least 1 of every 3 years-a review goal
of about 30 to 35 percent of annual filings per year. According to SEC, this
proposed level of review was expected to "ensure that material issues are
disclosed clearly and completely and that possible fraudulent activities are
addressed promptly." However, in 2001, SEC completed full or full financial
reviews of about 16 percent, or 2,280 of 14,060 annual reports filed.
In November 2001, the Division of Corporation Finance announced that
staffing levels were expected to remain flat while filings were expected to
continue to increase and be more complex. In this post-Enron environment,
SEC plans to reconsider its approach to determining how it will select
filings for review and how it will review the filings selected. Rather than
conducting full reviews of fewer firms, the officials said SEC may limit its
review to a specific disclosure issue and review more filings for that
issue. For example, SEC may choose to focus on off-balance sheet activities
and work with the company to improve disclosure. However, the officials said
that full reviews will not be completely abandoned, but the revised approach
should help SEC better deploy limited staff resources and enable it to have
a greater review presence across all types of corporate filings in the
future. Further, in December 2001, in response to the disclosure and
accounting problems of Enron Corporation, SEC said that it began reviewing
the annual filings of the 500 largest U.S. companies.
SEC also reviews investment company filings, such as mutual fund
prospectuses for compliance with disclosure requirements. As previously
shown in figure 6, the number of investment company filings more than
doubled from 17,143 in 1991 to 35,686 in 2000, while staffing for that
activity increased by only 9 percent from 45 staff years in 1991 to 49 in
2000. However, the staff reviewed 33 percent of investment company filings
in 1991 and increased that rate to 49 percent in 2000. SEC officials said
the increase in the percentage of filings reviewed was due partly to changes
in the types of filings coming into the agency, and partly to the fact that
certain filings were counted as reviewed even though all aspects of the
filings were not always fully reviewed. For example, if a mutual fund
company introduces several new stock funds, only one of the new funds may be
given a full review, and only the unique aspects of the other funds may be
reviewed.
SEC Is Not Addressing Many Current and Evolving Issues
Other Factors Contribute to the Challenges Facing SEC
Both SEC and industry officials agree that the current level of human
capital and budgetary resources has strained SEC's capacity to address
current and evolving market issues. Industry officials generally hold SEC
staff in high regard and said that SEC does a good job overall. However,
industry officials also said that they would like to see SEC devote more
effort to evolving and ongoing areas such as global market issues,
technology, ATSs, financial statement reporting, and the net capital rule.27
For example, one industry official said that SEC should be more proactive in
coordinating with other regulators and industry in dealing with these
issues. The official noted that SEC's reliance on a small number of seasoned
staff to do the majority of the routine work does not allow those staff to
adequately deal with new and emerging issues. For example, this official and
others said that SEC needs to overhaul its approach to net capital to make
use of modern risk management techniques. They said that SEC could benefit
from hiring more financial economists to assist in this effort. They said
that the current net capital rule imposes unnecessary costs on
broker-dealers that deal in multiple products.
According to SEC officials, SEC lacks resources to deal with an increasing
workload, review new products, and implement needed changes to rulemaking
and policy interpretations. For example, one SEC official said that
additional resources would be needed for SEC to review new products, like
exchange-traded funds, and still be able to address its traditional
workload. Likewise, recent high-profile accounting scandals, such as that
involving Enron Corporation, have raised questions about SEC's ability to
monitor disclosure requirements, which is vital to its goal of protecting
investors.
In addition to the staff and workload imbalances, other factors also
contribute to the challenges SEC currently faces. SEC officials said that,
although additional resources could help SEC do more, additional resources
alone would not help SEC to address its high staff turnover, which continues
to be a problem. Furthermore, in recent years the staff turnover and large
differentials in pay between SEC and other financial regulators and industry
employers resulted in many staff positions remaining vacant as staff left at
a faster rate than officials could hire new staff. Although SEC now has the
authority to provide pay parity,
27 The net capital rule, SEC Rule 15c3-1, is a liquidity standard that
requires broker-dealers to (1) maintain a minimum level of liquid capital
sufficient to promptly satisfy all of its obligations to customers and other
market participants and (2) provide a cushion of liquid assets to cover
potential market, credit, and other risks.
implementing it will depend upon SEC receiving sufficient budgetary
resources. Industry officials also said that existing securities laws, which
require SEC to approve market innovations and changes before they can be
introduced into the market, can create a regulatory bottleneck. Industry
officials said that there are steps SEC could take to avoid these
bottlenecks and work more efficiently and effectively, such as by reforming
its regulatory approval processes. Finally, we found that SEC's budget and
strategic planning processes could be improved to better enable SEC to
determine the resources needed to fulfill its mission. For example, unlike
"high performing organizations," SEC has not systematically utilized its
strategic planning process to ensure (1) that resources are best used to
accomplish its basic statutorily mandated duties and (2) that human capital
planning addresses the resource needs that are necessary to fulfill the full
scope of its mission, including activities to address emerging issues.28
SEC and Industry Officials Cite Turnover as a Primary Challenge
As we noted in our 2001 report on SEC's human capital practices, about
one-third of SEC's staff left the agency from 1998 to 2000.29 SEC's turnover
rate for attorneys, accountants, and examiners averaged 15 percent in 2000,
more than twice the rate for comparable positions governmentwide. Although
the rate had decreased to 9 percent in 2001, turnover at SEC was still
almost twice as high as the rate governmentwide. Further, as a result of
this turnover and inability to hire qualified staff quickly enough, about
250 positions remained unfilled in September 2001. SEC officials said that
they could do more if they had more staff, but all cited SEC's high turnover
rate as a major challenge in managing its workload. Likewise, industry
officials agreed that many of the challenges SEC faces today are exacerbated
by its high turnover rate, which results in more inexperienced staff and
slower, often less efficient, regulatory processes.
From the industry's perspective, SEC's high turnover and resulting staff
inexperience has contributed to many of the delays and problems discussed in
the previous section. Industry officials said that, in the examination area,
staff inexperience sometimes resulted in examinations taking longer to
complete or focusing on procedural violations rather than
28 High performing organizations are organizations that have been recognized
in the current literature or by GAO as being innovative or effective in
strategically managing their human capital.
29 GAO-01-947.
substantive ones. At the beginning of 2000, 76 percent of examiners had
worked at SEC fewer than 3 years. Likewise, from 1992 to 1999, the average
tenure of an examiner declined from 2.9 to 1.9 years. SEC officials also
told us that high staff turnover contributed to the delays in rulemaking and
regulatory guidance discussed earlier. For example, SEC officials said that
SEC has had problems retaining senior market supervision staff and that
junior staff, on average, stay only for two years. In 1992, the average
tenure for attorneys leaving SEC was 3.4 years, by 1999 the average had
declined to 2.5 years. The officials said that this has contributed to the
backlog in the SEC's rulemaking, interpretive guidance, and other
activities. The officials also said that they have to constantly focus on
current priorities, while other work gets put aside.
Although SEC and industry officials said that SEC would always have a
certain amount of turnover because staff can significantly increase their
salaries in the private sector, many said pay parity with other financial
regulators could enable SEC to attract and retain staff for a few additional
years. SEC estimated that a new employee generally takes about 2 years to
become fully productive, and that pay parity could help them keep staff a
year or two beyond the initial 2 years. Although industry officials said
they were generally impressed by the caliber of staff that SEC hires and the
amount of work they do, they said that staff inexperience often requires
senior officials to become more involved in basic activities. Industry
officials also said that certain divisions, such as the Division of Market
Regulation, could benefit from more staff with a fundamental understanding
of both how markets work and market experience. They said that such
experience could help speed rulemaking and review processes. According to
SEC, the Division of Market Regulation over the past two years hired six
attorney "fellows"30 with considerable industry experience. However, one
attorney fellow recently informed the division that he will be leaving the
program because of the failure to implement pay parity. SEC officials said
that they have a difficult time attracting staff with market experience,
given the government's pay structure.
Some officials said that SEC's turnover rate should decrease after pay
parity is implemented. Presently, SEC professional staff are paid according
to government pay rates. On January 16, 2002, the president of the United
30 Like SEC's Office of the Chief Accountant, Market Regulation has a
fellows program to attract seasoned attorneys. According to SEC officials,
twenty percent of the division's GS-15 attorneys are attorney fellows.
States signed legislation that exempted SEC from federal pay restrictions
and provided it with the authority necessary to bring salaries in line with
those of other federal financial regulators. Although SEC now has the
authority to implement pay parity, as of March 1, 2002, SEC has not received
an additional appropriation to fund its implementation. In February 2002,
SEC's chairman wrote to the chairman, Committee on Banking, Housing, and
Urban Affairs, U.S. Senate, that SEC urgently needed pay parity and, that
since the legislation had passed and become law, any decision not to support
funding for pay parity would exacerbate the staffing problems it was
intended to cure. The chairman also advised that SEC could "face even
greater employee losses and suffer greater irreparable harm to morale" if
pay parity was not funded. Therefore, it is too soon to determine the
effect, if any, of pay parity on SEC's ability to attract and retain staff.
Industry Cites Challenges Posed by the Securities Laws
In addition to turnover, industry officials said that provisions in
securities laws, which require upfront approvals, determine the pace at
which SEC can approve market innovations the participants want to implement.
For example, the Securities Act of 1933 and the Securities Exchange Act of
1934 generally require SEC to approve certain new products or market
innovations prior to their implementation. Unlike banking regulators, who
generally allow banks to engage in various banking-related financial
activities unless they are specifically prohibited by statute, SEC must
approve many new products before they can be introduced into the market. The
securities laws also require SEC approval of new activities before market
participants can adopt them. For example, SEC must approve exemptive
applications that are filed by investment companies to engage in activities
that may be prohibited by statute. However, as the number of these
applications filed increases and the activities become more complex, SEC may
be able to close fewer applications each year, and the time taken to close
the applications may increase. As a result, registrants are unable to engage
in certain activities until SEC approves them, which may put them at a
competitive disadvantage. Although an in-depth analysis of this issue was
beyond the scope of this report, some industry officials questioned whether
the cost of delaying potentially useful products from entering the market
outweighed the benefit of blocking a few harmful products.
Like any regulatory structure, provisions of these laws present advantages
and disadvantages. First, the provisions enable SEC to prohibit new products
or actions by industry participants that SEC believes to be harmful. Yet,
SEC faces the difficult task of trying to evaluate the risks of
products that are untested in the market. Conversely, the provisions can
also stifle innovations and advances in the market if the review process is
cumbersome. Some officials said that it would be a more efficient use of SEC
resources if SEC were able to focus on oversight instead of advanced
approvals when the exemptive applications, or proposed rule filings, would
have no adverse competitive effects on other market participants. However,
SEC officials said that if new products and innovations were no longer
subject to review and approval before their introduction, SEC would need
significantly more examiners to monitor the new products and innovations
after they were introduced.
SEC's Could Improve Its Budget Planning Process
SEC's Budget Process Begins with the Past Year as a Base
Although SEC annually participates in the federal budget process, SEC has
not reviewed its staffing and resource needs independent of the budget
process. That is, SEC generally develops its annual budget request based on
the previous year's appropriation, not on what it actually would need to
fulfill its mission. Although SEC officials said that they can shift staff
from one area to another to address new priorities, SEC's reactive approach
can result in regulatory gaps. Comprehensive strategic planning that relates
SEC's resource needs to its ability to fulfill its mission could help SEC
better identify and manage resource needs.
SEC officials said that the annual budget cycle begins with the preparation
of an agency-wide estimate based on the previous budget year's
appropriation. Next, SEC develops a conforming budget estimate based on the
budget guidance, including a specified budget amount that the Office of
Management and Budget (OMB) provides to SEC. SEC budget staff then asks
officials from each of SEC's divisions and offices to review and update
program information and provide estimates of their resource needs. However,
the division and office officials said that they are often told how much of
an increase they can request in order to be consistent with the budget
guidance. The budget staff coordinates the requests and discusses staffing
needs with the division and office officials. SEC's proposed budget estimate
is then sent to OMB, and a budget hearing is subsequently held. During the
hearing, any policy changes or shifts in the SEC chairman's priorities are
discussed. SEC's budget estimate is incorporated into the president's
budget, which is presented to Congress. However, before the budget is final,
SEC has the opportunity to appeal to OMB to modify its approved funding
level. SEC's funding level is also
subject to congressional review and appropriation before it becomes final.31
In addition to its budgeted funding level, SEC also has a "no-year account,"
which consists of certain fees collected and funds that have been
appropriated over the years but not expended by year-end. SEC, like several
other agencies, is allowed to keep appropriated funds that are not expended
at the end of the year.32 Money in this fund is generally used for one-time
expenditures that are not included in the annual budget. SEC officials said
SEC can use funds from the no-year account after OMB and Congress approve
these expenditures. SEC officials said that money from the no-year account
was used to pay expenses incurred to reopen SEC's Northeast Regional Office,
which was located at 7 World Trade Center, following September 11th.33 SEC
also used money from the no-year account to modernize its EDGAR system.
Although SEC had over $75 million in its no-year account in fiscal year
2001, SEC officials said that Congress rescinded $50 million from the
no-year account as part of SEC's 2002 appropriation. As of the beginning of
fiscal year 2002, SEC had about $25 million in its no-year account.
Similar to banking regulators collecting assessments and fees from banks,
SEC collects fees on registrations, certain securities transactions, and
other filings and reports. However, unlike the banking regulators, which are
self-funded, SEC deposits its collections in an SEC-designated account at
the U.S. Treasury that is used by SEC's congressional appropriators for,
among other things, providing appropriations to SEC.34 Public Law 107-123,
which authorized pay parity for SEC, also amended the Securities Act of
1933, the Securities Exchange Act of 1934, and the Trust Indenture Act of
1939 to reduce the fees collected by SEC while providing a stable long-
31 Separate from this process, SEC also prepares a budget authorization
request that gives it a greater opportunity to independently determine its
needs and make a corresponding request, which is submitted to SEC's
congressional oversight committees.
32 The Departments of Commerce, Justice, State, and the Judiciary, for
example, are also able to keep unspent funds.
33 SEC was subsequently reimbursed for the expenses it incurred as a result
of the attacks.
34 Federal banking regulators, like the Federal Reserve System, the Federal
Deposit Insurance Corporation, and the Office of the Comptroller of the
Currency are self-funded and are not subject to the federal budget process.
These agencies are funded from fees and assessments collected and earnings
on investments.
term funding source for SEC.35 According to SEC, even after the fee
reduction, SEC fee collections are projected to bring in a sizable amount of
revenues, of which those in excess of SEC's appropriation would be available
to fund other programs. For example, in 2003, SEC appropriators will have
approximately $1.3 billion in projected SEC fee collections from which to
fund the agency versus the president's request of about $467 million.36 In
2001, SEC collected almost $2.1 billion compared to its appropriated funding
of $423 million. SEC fee collections and appropriated funding levels are
shown in figure 7.
Figure 7: SEC Fees Collected and Appropriated Funding, 1991-2001 (billions
of dollars)
Source: SEC.
35 The law also mandated a GAO study of SEC self-funding, which is currently
under way.
36The amendments include complex formulas designed to adjust SEC fee rates
to result in predetermined amounts of fee collections over the next 9 years.
Projected fee collections in excess of SEC's appropriation are available to
fund other programs. Prior to the amendments' enactment, SEC was required to
deposit a significant portion of its collections in the Treasury for general
use. The amendments eliminated such deposits.
Strategic Planning Could Help SEC to Better Identify and Manage Its Resource
Needs
To respond to expanding markets and new challenges, SEC has requested
additional resources and funding. For example, in 2001, SEC received funding
for an additional 50 positions. However, in its 2002 budget, it lost 57
positions in order to absorb mandatory inflation-related increases that were
not covered by its budget.37 However, SEC received $3.9 million for special
pay rates for its most experienced attorneys, accountants, and examiners in
2002. In its May 2001 authorization request submitted to Congress, SEC
requested an additional $70 million in 2002, with adjustments for inflation
for years thereafter, to fund staff pay parity. In addition for 2003, SEC
requested authorization for an additional $36.4 million and 261 positions.
According to SEC, these additional staff resources would allow it to (1)
respond to new regulatory, oversight, and examination requirements of GLBA;
(2) undertake joint regulation of the market for single stock futures and
narrow-based index futures under the Commodity Futures Modernization Act of
2000; (3) enforce and support its new auditor independence rules; (4)
monitor and review exchange automation efforts; and (5) continue combating
Internet fraud and insider trading. As previously noted, SEC also requested
an additional $13 million to support its information technology initiatives.
The president's budget for 2003 did provide SEC an additional $7.6 million
for certain technology and security initiatives but did not provide funding
for any additional staff or for pay parity. As a result, SEC will continue
to be restrained from fully addressing the new regulatory challenges and
growing workload that it faces.
Previous GAO reports noted that high-performing organizations identify their
current and future human capital needs-including the appropriate number of
employees, the key competencies needed for mission accomplishment, and the
appropriate deployment of staff across the organization-and then create
strategies for identifying and filling any gaps.38 SEC generally has
identified its available resources and determined what could be accomplished
with existing staff. However, its inability to meet its goals due to
resource constraints has resulted in SEC reconsidering the goals, for
example, in its approach to selecting
37 SEC was unaffected by this reduction in 2002 because it was absorbed from
the agency's many vacant positions, about 250 at the time.
38 See U.S. General Accounting Office, Managing for Results: Next Steps to
Improve the Federal Government's Management and Performance, GAO-02-439T,
(Washington, D.C.: Feb. 15, 2002) and Determining Performance and
Accountability Challenges and High Risks, GAO-01-159SP, (Washington, D.C.:
Nov. 2000).
corporate filings for review and the type of review selected. According to
SEC officials, SEC's ability to redeploy its staff is limited by existing
statutory requirements, which define the responsibilities that SEC must
carry out and determine its use of the staff. Nevertheless, in determining
how to address evolving issues, ideally, SEC would periodically evaluate the
related resources needed to fulfill the full scope of its mission and
develop strategies to achieve its goals.
We performed a limited review of SEC's strategic plan in light of its
ongoing resource limitations and increased workload. We found that SEC has
not engaged in a comprehensive strategic planning process. SEC's GPRA
strategic plan includes four goals: "protect investors; maintain fair,
honest, and efficient markets; facilitate capital formation; and sustain and
improve organizational excellence." However, the performance measures for
achieving these goals focus on outputs not outcomes. For example, SEC's
objectives for protecting investors include deterring fraud and requiring
compliance with the federal securities laws, promoting informed investment
decisions, and promoting the prevention of fraud through investor education.
However, the output-oriented performance measures include the number of
enforcement actions taken, filings reviewed, examinations completed, and
deficiencies identified. These measures generally would not help SEC gauge
whether the actions taken actually result in greater protection for
investors or establish the levels of these actions and activities needed to
achieve its goals. In its annual GPRA performance plan and report, SEC has
recognized that its performance measures are not outcome-oriented.
In addition to its 5-year strategic plan, SEC develops annual programmatic
budget estimates and GPRA performance plans and reports addressing its
strategic goals and performance results. However, neither of these documents
provide the detailed analysis and information needed to make informed
workforce decisions, including information on (1) the relationship between
budget requests for full-time equivalent staff years and the ability to meet
individual strategic goals and (2) any excesses or gaps in needed
competencies within the agency's various divisions and offices. Such an
analysis would call upon each division and office to accurately identify the
human capital resources needed to achieve their respective strategic goals.
This information could help SEC better determine the right size, skill
needs, and deployment of its workforce to fulfill its goals and mission.
Conclusions
Securities markets have undergone tremendous growth and change over the past
decade. More individuals than ever are invested in securities markets,
either directly or through mutual funds. Likewise, these markets have become
more complex and global as technology has fundamentally changed the way
markets operate and how investors around the world interact with the
markets. Moreover, the recent, sudden collapse of Enron Corporation and
other corporate failures have stimulated an intense debate on the need for
broad-based reform in such areas as financial reporting and accounting
standards, oversight of the accounting profession, and corporate governance.
All of these areas of possible reform hold significant repercussions and
pose challenges for SEC's oversight role. At the same time, SEC has been
faced with an ever increasing workload and ongoing human capital challenges,
most notably high staff turnover and numerous vacancies.
SEC routinely prioritizes and allocates resources to meet agency demands,
but SEC faces increasing pressure in managing its mounting workload and
staffing imbalances that resulted from its workload growing much faster than
its staff. Critical regulatory activities such as reviewing rule filings and
exemptive applications and issuing guidance have suffered from delays due to
limited staffing. According to industry officials, these delays have
resulted in foregone revenue and have hampered market innovation. Oversight
and supervisory functions have also been affected. For example, staffing
limitations and increased workload have resulted in SEC reviewing a smaller
percentage of corporate filings, an important investor protection function.
In 2001, SEC reviewed about 16 percent of the annual corporate filings or
about half of its annual goal of 30 to 35 percent. Although SEC is revamping
its review process, recent disclosure and accounting scandals illustrate how
important it is that SEC rise to the challenge of providing effective market
oversight to help maintain investor confidence in securities markets.
Although industry officials said that the challenges faced by SEC were in
part attributable to resource constraints, they cited other issues such as
SEC's high turnover rate, which in 2001 was almost twice the governmentwide
rate. They said that SEC's high turnover created a staffing drain that often
resulted in slower, less efficient regulatory processes. We explored the
reasons for SEC's turnover rate and actions taken to address this problem in
our 2001 human capital report.
Although SEC has taken numerous actions to address its high turnover
including use of special pay rates and retention bonuses, the lack of
funding for pay parity will provide little needed relief in the short-term.
In the 2001 report, we also identified several issues beyond pay that
warranted ongoing attention by management and recommended actions
on these issues that could help SEC mitigate its turnover problem. These
actions included conducting periodic employee surveys to identify staff
concerns, expanding SEC's human capital plan to include a strategy for
succession planning, finding ways to involve human capital leaders in
decision making, and working with the union to address the areas of
dissatisfaction identified in our 2001 survey (i.e., lack of opportunities
for advancement, the amount of uncompensated overtime, and quality of
administrative support services).
Although SEC's workload and staffing imbalances have challenged SEC's
ability to protect investors and maintain the integrity of securities
markets, SEC has generally managed the gap between workload and staff by
determining what basic, statutorily-mandated duties it could accomplish with
existing resource levels. This approach, while practical, has forced SEC's
activities to be largely reactive rather than proactive. For instance, SEC
has not put mechanisms in place to identify what it must do to address
emerging and evolving issues. Although SEC has a strategic plan and has
periodically adjusted staffing or program priorities to fulfill basic
obligations, SEC has not engaged in a much needed, systematic reevaluation
of its programs and activities in light of current and emerging challenges.
Given the regulatory pressures facing SEC and its ongoing human capital
challenges, it is clear that SEC could benefit from some additional funding.
However, a comprehensive, agencywide planning effort could help SEC better
determine the optimum human capital and funding needed to fulfill its
mission.
We recommend that the chairman, SEC, develop short-term and long-term
strategies to address the challenges SEC faces. In the short-term, we
recommend that SEC take definitive steps to continue to address its turnover
problem and fill its vacant positions. These actions should include
exploring use of its no-year fund to expand recruiting and retention efforts
to ensure that all available resources are maximized to attract and retain
staff. Likewise, we recommend that SEC explore innovative ways to attract
senior level staff and bring in additional information technology expertise
to better position itself to oversee evolving securities markets.
In the long-term, we recommend that the chairman, SEC, address several
issues relating to strategic planning by broadening SEC's strategic planning
process to systematically determine regulatory priorities and resource
levels needed to fulfill its mission. Furthermore, we recommend that once
SEC has completed the strategic planning process, each division
Recommendations for Executive Action
Agency Comments and Our Evaluation
Scope and Methodology
and office accurately identify the skills needed to perform the regulatory
priorities identified. Once this is completed, we recommend that SEC link
the strategic plan to staffing allocation and workforce determinations and
expand its existing recruiting effort to include any additional disciplines
identified as necessary to effectively regulate evolving securities markets.
SEC provided written comments on a draft of this report that are reprinted
in appendix I. In general, SEC agreed with most of the report's findings,
conclusions, and recommendations. In particular, SEC strongly supported our
recommendation that strategic planning could help SEC better identify and
manage its resource needs. SEC said that it had earlier planned to perform
an in-depth review of its operations, effectiveness, and resource needs.
However, the events of September 11th, the loss of SEC's Northeast Regional
Office, and the recent bankruptcy of Enron Corporation have prohibited that
review. Nevertheless, SEC stated that it was committed to completing an
in-depth review of SEC's resource needs.
In response to our recommendation that SEC take definitive steps to address
its staffing problem, SEC agreed that the lack of funding for pay parity
would provide it with little needed relief in the short term. However, SEC
stated that, despite the lack of funding, it was planning to implement and
manage pay parity within the agency. SEC will soon submit a Pay Parity
Implementation Report to Congress and the Office of Personnel Management.
The report is to consider the challenges SEC faces in implementing pay
parity in light of all of the various interests in the issue. Although we
have not reviewed SEC's specific implementation plan, developing a plan to
implement pay parity is a vital step in improving SEC's staff recruiting and
retention efforts.
To determine how the markets and SEC's workload have changed, we analyzed
various securities markets and SEC workload trend data. The various workload
data used include numbers of corporation and investment company filings,
complaints and inquiries, rule proposals, various industry interpretive and
exemptive requests, investigations opened, and investment company and
investment adviser assets under management, and examinations and inspections
conducted. These workload data are published as part of SEC's annual budget
request. We did not attempt to verify any of these data.
To determine whether SEC's resources and workload have affected SEC's
ability to regulate and oversee the markets, we interviewed current and
past SEC officials, including division and office directors, regional office
directors, budget officials, former commissioners, and academics. Likewise,
to obtain views from industry officials regarding how well SEC is
functioning; we met with officials from various exchanges, associations,
investment companies, and broker-dealers. Although SEC and industry
officials agreed that the length of time taken to complete various reviews
and issue guidance had increased, we were unable to quantify these effects,
because SEC was unable to provide consistent detailed statistics on the time
it takes to complete certain regulatory processes for the program areas
discussed in the report such as reviewing filings, issuing guidance, and
reviewing applications. We also obtained these parties' views about any
other factors that may affect SEC's ability to fulfill its mission.
We also met with OMB officials regarding SEC's budget and the federal budget
process. We met with banking industry regulators to obtain information on
their funding and budget processes. We reviewed SEC GPRA performance plans
and reports and recent GAO reports that address strategic planning at high
performing organizations. We also reviewed relevant GAO reports on SEC's
oversight and its operations.
We did our work in Los Angeles and San Francisco, California; Washington,
D.C.; and New York, New York, between April 2001 and February 2002 in
accordance with generally accepted government auditing standards.
We are sending copies of this report to the ranking minority members of the
Senate Committee on Banking, Housing, and Urban Affairs and its Subcommittee
on Securities and Investment; the chairman and ranking minority member,
Senate Committee on Governmental Affairs; the chairman and ranking minority
member, House Committee on Financial Services; and other interested
congressional committees. We will also send copies to the chairman of SEC
and will make copies available to others upon request.
If you or your staff have any questions regarding this report, please
contact me or Orice M. Williams at (202) 512-8678. Key contributors to this
report were Toayoa Aldridge, Edwin Lane, Barbara Roesmann, and David
Tarosky.
Richard J. Hillman, Director Financial Markets and Community Investment
Appendix I: Comments from the Securities and Exchange Commission
Appendix I: Comments from the Securities and Exchange Commission
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