[Senate Hearing 109-969]
[From the U.S. Government Publishing Office]
S. Hrg. 109-969
A REVIEW OF CURRENT SECURITIES ISSUES
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HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
ON
EXAMINATION OF CURRENT SECURITIES ISSUES, FOCUSING ON IMPROVING
FINANCIAL DISCLOSURE FOR INDIVIDUAL INVESTORS
__________
APRIL 25, 2006
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Mark Oesterle, Counsel
Justin Daly, Counsel
Dean V. Shahinian, Democratic Counsel
Alex Sternhell, Democratic Professional Staff
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
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TUESDAY, APRIL 25, 2006
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Sarbanes............................................. 2
Senator Hagel................................................ 3
Senator Dodd................................................. 3
Senator Bunning.............................................. 4
Prepared statement....................................... 38
Senator Sununu............................................... 4
Senator Allard............................................... 5
Senator Carper............................................... 21
Senator Bennett.............................................. 25
Senator Crapo................................................ 32
Senator Stabenow............................................. 38
WITNESS
Christopher Cox, Chairman, U.S. Securities and Exchange
Commission..................................................... 5
Prepared statement........................................... 39
Response to written questions of:
Senator Crapo............................................ 45
Senator Enzi............................................. 46
Senator Santorum......................................... 47
Senator Stabenow......................................... 48
(iii)
A REVIEW OF CURRENT SECURITIES ISSUES
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TUESDAY, APRIL 25, 2006
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:08 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing will come to order.
Today, the Banking Committee continues its review of the
regulatory landscape in the securities markets. I would like to
welcome back Chairman Christopher Cox, returning to the
Committee for the first time since being confirmed to lead the
Securities and Exchange Commission.
Chairman Cox's appearance this morning will provide the
Committee an opportunity to learn more about his ambitious
investor protector agenda at the SEC. I commend the Chairman
for making vigorous enforcement of securities laws his top
priority. Investor confidence in the fairness and the integrity
of U.S. markets simply would not exist without an aggressive
and relentless pursuit of wrongdoers. Chairman Cox's
initiatives to improve the quality and usefulness of
information and corporate disclosure will also benefit
investors and the markets.
For example, his efforts to enhance the transparency of
executive compensation will allow shareholders to compare in a
meaningful way the total pay packages awarded to corporate
management. Similarly, his technology-driven proposals
promoting electronic delivery of proxy materials and the use of
interactive data will empower shareholders to make better
informed investment decisions.
Last month, the Committee held hearings on two important
issues affecting investors and capital markets. The Committee's
hearing on credit rating agencies demonstrated that
Congressional reform of this self-regulated industry is long
overdue. I was pleased to learn that a virtual consensus exists
on the need to promote competition, address embedded and
pervasive conflicts of interest, and establish regulatory
oversight. I intend to continue working with Senator Sarbanes
and other Members of the Committee in the coming months on a
legislative solution to this longstanding problem.
The other recent Committee hearing examined the state of
self-regulation in the securities markets. The most important
development in SRO area is the conversion by each of the two
major U.S. markets to for-profit, shareholder-owned
corporations. The New York Stock Exchange's unprecedented
decision to make its regulatory apparatus a wholly owned
subsidiary of the for-profit parent company, has generated
substantial controversy. Almost all of the Committee's
witnesses, representing a diverse group of market participants,
questioned whether the fiduciary obligations to maximize
shareholders' profits and the statutory obligations to oversee
the exchange's customers and competitors could both be
satisfied.
Along with rating agencies and SRO's, the Committee intends
to review hedge funds, pension accounting, and other securities
issues this year. I anticipate a wide-ranging discussion this
morning on some of these matters.
Chairman Cox, again we thank you for your appearance today.
We thank you for your service to the country, and we look
forward to your testimony.
Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Chairman Shelby.
This is another instance of the Committee continuing to perform
its important role of overseeing the regulators and the
important issues under our jurisdiction.
I join the Chairman in welcoming Chairman Cox, the 28th
Chairman of the Commission, back before the Committee, I think
the first time since we did the confirmation. Already he has
worked to improve the disclosure of executive compensation, to
streamline accounting rules, and to enhance the usefulness of
data filed with the SEC through XBRL.
The Baltimore Sun, in an article, said, ``SEC Chief seeks
data to empower tiny investor,'' and went on to note that it
also should vastly improve the analysis of firms by
professionals in the field.
The Chairman has met with other regulators to address
issues raised by the CFTC reauthorization, and by Regulation B,
and given his skills in the Congress, working at developing
consensus, we think the Chairman can be a very constructive
person in the regulatory environment.
We appreciate the war on complexity. Things should be
written in simple English. It is a new departure in this area.
He has also enhanced the protection of vulnerable groups,
particularly elderly investors. I think that is extremely
important and I commend the Chairman for that initiative.
Another vulnerable population, I just want to note, is
young military personnel. We have held some hearings here on
that, and we have received testimony about abusive sales
practices used by some to sell unsuitable financial products to
young military personnel.
Furthermore, the Commission's effectiveness in these
efforts can be, and is, enhanced by cooperating with State
regulators. I am pleased that Chairman Cox has placed some
emphasis on this. He noted in a recent speech that it is
vitally important that we partner with them, and the
complementary nature of our regulatory regimes makes us far
stronger together.
There are a number of other items on the Commission's
agenda, which I am sure we will review in the course of the
question period here this morning.
I do want to commend the good work environment now
prevailing at the SEC. It was recognized in September 2005 as
one of five best places to work in the Federal Government, a
study by the Partnership for Public Service and U.S. News and
World Report. That effort began when Chairman Cox assumed his
responsibility, and a lot of it actually came from this
Committee, as we tried to get resources for the Commission, pay
parity for its employees, to stem the outflow of seasoned
personnel, but I know that Chairman Cox is very strongly
committed to enhancing and sustaining this position, and we
hear--I do not know whether to describe it as the grapevine--
but we heard through lots of sources that things have gotten
better at the Commission in terms of the work environment. We
think it is important to continue that. I notice the Chairman
is having considerable success in attracting some very able
people to fill important positions, although he has still got
some open positions yet to go.
Mr. Chairman, I look forward to the question period.
Chairman Shelby. Thank you.
Senator Hagel.
STATEMENT OF SENATOR CHUCK HAGEL
Senator Hagel. Mr. Chairman, thank you, and I look forward
to hearing from our witness, the respected Chairman of the
Securities and Exchange Commission, and also appreciate his
efforts in leadership over the last year.
Thank you.
Chairman Shelby. Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you, Mr. Chairman, for holding the
hearing. And we thank Chairman Cox for being here with us as
well. Now he had a little bout in January, and he tells me he
is back on his feet and got a clean bill of health, so we
welcome you to the Committee. It is good to see you. It has
been a while but we are grateful for your presence here today.
I have had a chance to look over your testimony, and
Senator Sarbanes and the Chairman have highlighted some of the
points that you make in the testimony, which are worthwhile.
Certainly, helping out those who may be most vulnerable in our
society, particularly seniors and others, to understand exactly
what they are getting into is worthwhile, so I commend you for
that.
This is a quiet time in some ways in terms of the
securities industry. We welcome that to some degree,
considering what we have been through, but it is also an
important time. It is during these quiet periods that not only
we do not end up passing a lot of legislation, but also what
the regulator does during the quiet time can really make a huge
difference. I have been impressed in watching the Commission as
it has grappled with some very significant issues.
I am very interested in hearing from you, Mr. Chairman, on
the advisory committee's report on Sarbanes-Oxley, which is a
big issue that has gotten some attention in the media recently.
I am interested in hearing about the mutual fund regulations as
well. I know that has also received a lot of attention. The
credit rating agencies, a very important issue to come before
the Committee. So there are a lot of major issues the
Commission is grappling with that will have significant
implications. So while we are not passing major bills up here
right now, it is a very important time, in my view, in terms of
setting the table for what the investor community can
anticipate.
I had a chance, privately, just a minute ago, talking to
the Chairman about the speech he gave in China as well, and I
am interested in hearing maybe some comments on your experience
there and what is going on internationally in terms of people,
foreign investors coming to the United States, and the kind of
environment we create here, and whether or not we are going to
sustain that environment, a very important issue as well.
So thank you for being here. I look forward to your
testimony. I notice that the Dow Jones had a 6-year high
yesterday, and I asked the Chairman whether or not he was going
to take credit for that this morning, and he wisely said, ``I
do not think I will because it is apt to go down in a couple of
days and I do not want you accusing me of being responsible for
that either.'' So we will leave the Dow record here as being
caused by other events.
But I wanted to underscore the point Senator Sarbanes made
as well, and that is, the environment at the SEC. You are
following a very good Chairman, and following him in many more
ways than just succeeding him, so I commend you for the
environment you are creating there and the quality of people
that you have working with you.
Thank you for being here.
Chairman Shelby. Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman.
Welcome, Chairman Cox. It is good to see you, and I am glad
to see that you have recovered from the surgery that you had.
I am happy to read in your testimony that you are focusing
your efforts on the individual investor, I do not think many
SEC chairmen have done that, and also using plain English. As
our Chairman has said, the language of the SEC is unusual to
say the least. To allow individual investors to step on a level
playing field is a great step in the right direction. I wish
more in Washington would follow your lead.
Anything that can be done to improve access to information
and people's understanding of it will help both the new and
experienced investor. Your program to use modern electronic
communications to reduce the burden on companies and the SEC
will lead to more efficient regulation and management. But most
importantly, it will give investors more and easier access to
financial data, and that will help them make better investment
decisions, and hopefully, encourage more Americans to get into
the markets.
Welcome, Chris. I am glad to see you here. Thank you.
Chairman Shelby. Senator Sununu.
STATEMENT OF SENATOR JOHN E. SUNUNU
Senator Sununu. Thank you, Mr. Chairman.
Welcome, Chairman Cox. Last year, I believe of the 25
largest initial public offerings of stock in the world, only 4
of the public offerings were issued on U.S. exchanges. I think
there are real questions as to whether, at least in part, that
dramatic change in the focal point of U.S. exchanges is being
that the best source of capital in the world was due to new
regulation, Sarbanes-Oxley or other regulations, or changes in
the regulatory environment on the U.S. exchanges. I think it
would be a huge mistake if American exchanges lost their
standing and their position in the world for attracting
listings, for attracting capital, for attracting investors, and
that really is a cornerstone of our American economy.
So, I am very interested in the work you are doing to
address the concerns that have been raised with Section 404 in
particular, and I certainly applaud the work that you have done
on improving transparency and disclosure, improving some of the
technology that is being used to share information with those
individual investors Senator Bunning spoke of, and I look
forward to your testimony.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I would also join
the other Members of the Committee in welcoming Chairman Cox
before our Committee. I am looking forward to your testimony.
As we all know, vibrant security markets are vital to more
than 50 percent of the families throughout the country. A lot
of people have a stake in the stock market. And in order for
our Nation to continue to prosper, I think we need to have a
lot of confidence, there has to be a sense of fairness,
integrity, and efficiencies in the stock market.
I would share some concerns also with what is happening now
with the exchanges and the self-regulatory principles that we
have put in place, and how they are applying today. I am
convinced that as the new Chairman, you will stay on top of the
new technologies and everything, because I know this is
something that has always been of interest to you. So, I just
want to take this opportunity to welcome you to the Committee.
I consider you a friend, having been a former colleague of
yours in the U.S. House. I have always viewed you as somebody
who is willing to step up to the plate and make changes when
necessary. I would like to hear some of your thoughts, so I am
looking forward to your testimony today.
Chairman Shelby. Chairman Cox, again, welcome to the
Committee. Your written testimony will be made part of the
hearing record in its entirety. You proceed as you wish.
STATEMENT OF CHRISTOPHER COX
CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION
Chairman Cox. Thank you very much, Mr. Chairman, Senator
Sarbanes, and Members of the Committee. I want to thank you for
giving me this opportunity to be here today to testify about
the initiatives and the priorities of the Securities and
Exchange Commission, in particular with reference to improving
financial disclosure for individual investors, which several of
you have referenced in your opening comments.
Several years ago, in the midst of financial scandals that
rocked the country, and a crisis of investor confidence, this
Committee held a series of very consequential hearings on the
topics of corporate responsibility and investor protection.
Those hearings laid the groundwork for landmark reforms that
have restored investor confidence and the health of our capital
markets. I want to commend you for your efforts, and I am happy
to report that the Securities and Exchange Commission is using
the tools that you gave us to ensure that those reforms are
implemented in exactly the way that Congress intended.
A lot has happened in the 9 months since I was last here
before you, and I appreciate this opportunity to give you a
report on the new initiatives the SEC has undertaken and to
hear further from you about your priorities.
The principal subject of my brief testimony is improving
disclosure for the benefit of individual investors. If I may, I
would like to take a step back and put these efforts into
context.
As a Member of Congress for 17 years, I was constantly
reminded by my constituents of the real-world impact of the
decisions that we make here in the Capitol every day. Like you,
I learned the importance of being a good listener, and of
remembering that the common sense of ordinary Americans is the
essence and the strength of our democracy.
Most of our constituents are not investment bankers,
accountants, or lawyers, but most of our constituents are
investors. It is a stunning fact of life in the 21st century
that a majority of Americans now own stocks, either directly or
in the form of mutual funds. It is chiefly to serve these
people that the SEC exists. Our mission, to protect investors,
promote capital formation, and maintain orderly markets, must
always put ordinary Americans first.
Since making the transition from the halls of Congress to
the SEC, I have set out to rededicate the Agency's ongoing
efforts in virtually every area to the service of the
individual investor.
In a well-ordered market, educated consumers can choose
from a number of competitive products, and find what they want
at a price that they are willing to pay. But, in order to
educate themselves, investors need comparative facts. So while
investors must bear the responsibility of learning what they
can about their investment choices, the correlative duty of
sellers of investment products is to provide the relevant
information.
To more closely match the theory of a well-ordered market
with today's reality, the SEC is currently pursuing four key
initiatives to improve the quality and usefulness of disclosure
for individual investors. These four initiatives are: Moving
from boilerplate legalese to plain English in every document
intended for retail consumption; moving from long and hard-to-
read disclosure documents to easy-to-navigate webpages that let
investors click through to find what they want; reducing the
complexity of accounting rules and regulations; and focusing
our antifraud efforts, in significant part, on scams that
target older Americans.
It is the SEC's job to see to it that financial data and
qualitative information about the issuers of securities are
fully and fairly disclosed. But we cannot say that we have
achieved that objective if the information is provided in a way
that is not clearly understandable for the men and women to
whom it is directed.
Empowering investors does not just mean better access to
information, it also means access to better information.
Empowering investors is our number one job. And simply put, the
question is: Once that SEC-mandated information is available,
is it understandable? The answer all too often is a resounding
and frustrated ``no.''
Exhibit A, when it comes to convoluted disclosure, is
today's regime for reporting executive compensation. Ordinary
American investors have a right to know what the company's
executives are being paid, because those investors own the
companies. The executives work for them.
How can an investor judge whether he or she is getting the
best executive talent at the best price? Too often the most
important parts of total compensation are hidden away in the
footnotes or not even disclosed at all until after the fact.
Three months ago, the Commission voted unanimously to
propose an overhaul of the executive compensation rules. The
proposal would require better disclosure on several fronts.
First, companies would report a total figure, one number,
for all annual compensation, including perquisites.
Companies would also outline retirement benefits and
payments that could be made if an executive is terminated, and
would fully disclose all compensation to board members for the
past year. That is something that does not happen under today's
rules.
In addition, a new Compensation Discussion and Analysis
section would replace the Compensation Committee Report and the
performance graph under today's regime, because in today's
system that disclosure is all too often pro forma, boilerplate,
and legalese.
Finally, since the purpose here is to improve
communications for the consumer, the proposed rules require
that all of this disclosure be in plain English, the new
official language of the SEC.
Just to be clear, the Commission does not propose getting
into the business of determining what is the proper method or
level of compensation. It is not the job of the SEC to
substitute our judgment for that of the board. Nor would I,
speaking as Chairman, subscribe to the notion that all
executive pay is excessive. Surely, many executives deserve
every penny they get and more. Being a CEO requires a rarified
collection of attributes and skills that are in all too short
supply, and compensation in the market for executive talent can
be fierce. At the same time, I need not cite here the several
notoriously public cases of extravagant waste of shareholder
assets by gluttonous CEO's and pliant compensation committees.
It is a testament to the importance of this issue that,
when the comment period on these proposed executive
compensation rules was closed, we had received 17,000 comments,
one of the highest totals in the 72-year history of the
Securities and Exchange Commission.
Making the SEC's mandated disclosures actually useful to
investors is the idea behind another of our initiatives:
Interactive data. Today, the SEC has over 800 forms. Yet it has
been estimated that the SEC might instead have need for no more
than a dozen.
The key to making this happen is looking at the data on the
forms independently from the forms themselves. That is what we
mean by interactive data. Computer codes can tag each separate
piece of information on a report and tell us what it is:
Operating income, interest expense, and so forth.
For individual investors, this means they will be able to
quickly search for any information they want, without slogging
through an 80-page disclosure document. Our initiative to let
investors get information fast, easily, and all in one place
envisions this added benefit: Instead of long and hard-to-read
annual reports and proxy statements, investors could have easy-
to-navigate webpages that let them click through to find what
they want.
With today's SEC reports, an investor or analyst who is
looking for comparative data on, say, annual capital
expenditures of two companies has to search through hundreds of
pages of the filings of each company, page-by-page. Not
surprisingly, this very time-consuming task has created a
cottage industry in rekeyboarding information in SEC reports so
that it can be downloaded into spreadsheets and other software.
Investors, or more precisely, the intermediaries, whose fees
they pay, can then buy this information from both domestic U.S.
firms and overseas providers to whom the drudge work has been
outsourced.
One hates even to think of the human error and data
corruption that inevitably occurs in this process.
Interactive data is a way to eliminate these problems, and
to connect investors directly to the information in a company's
filings. The SEC is strongly committed to interactive data and
has taken major steps to promote it. We have offered
significant incentives for companies to file their financial
reports using interactive data, and companies are now beginning
to do this.
These incentives include expedited review of registration
statements and annual reports. A number of well-known firms--
the list is now 17 and still growing--have already begun to
lead the way and are filing their reports using interactive
data. Starting in June of this year, the Commission will host a
series of roundtables focused on how we can move to interactive
data faster.
Revolutionizing the way the world exchanges financial
information is a worthy goal. We intend to achieve it.
When it comes to giving investors the protection they need,
information is the single most important tool that we have. It
is what separates investing from roulette. But, if the SEC is
truly to succeed in helping investors with more useful
information, we will need one more ingredient: An all-out war
on complexity.
At the SEC, we are looking at results from the vantage
point of the ordinary investor, and what we are finding is
that, in many cases, we are not getting the right results.
It is not just public companies that have a problem using
plain English. Our accounting rules and regulations also can be
complex and difficult to interpret; and, when the rules are
difficult to interpret, they may not be followed very well.
And, if the rules are not followed very well, then,
intentionally or not, individual investors inevitably will
suffer.
Weeding out the counterproductive complexity that has crept
into our financial reporting will require the concerted effort
of not only the Securities and Exchange Commission, but also
the FASB, the PCAOB, and every market participant. This cannot
be a one-time effort. We will have to commit for the long-term.
But it will be well worth it.
Finally, let me turn to our efforts to protect older
Americans against financial fraud. Consider these statistics.
An estimated 75 million Americans are due to turn 60 over the
next 20 years. That is an average of more than 10,000 people
retiring every day. Households led by people aged 40 or over
are already owners of over 91 percent of America's net worth.
Very soon the vast majority of our Nation's net worth will be
in the hands of the newly retired.
Following the Willie Sutton principle, the scam artists
will swarm like locusts over this increasingly vulnerable group
because that is where the money is.
On a daily basis our Agency receives letters and phone
calls from seniors and their caregivers who have been targeted
by fraudsters. Often the victims have already been taken in.
These fraudulent schemes may begin with a free lunch, but we
want to make sure that they end with a very high cost to the
perpetrators.
That is why we are attacking the problem from all angles,
from investor education, to targeted examinations, to
aggressive enforcement efforts. Because State securities
regulators share our concerns in this area, we are cooperating
in this initiative with State regulators across the country.
Each of the four initiatives I have outlined is part of an
overall strategy to make the individual investor, the average
American, the ultimate beneficiary of everything that we do at
the SEC. Our Agency has for many years proudly worn the badge
of the investor's advocate. In the months and years ahead, we
are pledged to rededicate ourselves to that mission.
I appreciate the opportunity to be with you here today, Mr.
Chairman and Members of the Committee. I want to thank you for
your continuing strong support of the work of the Commission,
and I am happy to be here to answer any questions that you
have.
Chairman Shelby. Thank you, Chairman Cox.
The Banking Committee has been actively reviewing the role
of credit rating agencies in the capital markets. The rating
industry is extremely powerful and is dominated by only two
firms that do not actually compete with each other, as
evidenced by the fact that Standard & Poor's and Moody's, each
rate more than 99 percent of the debt obligations and preferred
stock issues publicly traded in the United States.
In your view, Mr. Chairman, what is the impact of this
extreme concentration and absence of competition with respect
to ratings quality, pricing, innovation, and business
practices?
Chairman Cox. Mr. Chairman, as you know, this area has been
one of intense focus, both for the SEC and for this Committee.
It has also been a subject of legislative interest in the other
body.
First, let me say I appreciate the Congress's bicameral and
bipartisan attention to this issue, particularly your emphasis
on increasing and encouraging competition in the market for the
provision of credit ratings, given that the market, as you
point out, is dominated presently by a few firms.
The principles that I think that we support at the
Commission and that I know have been the focus of discussion
here in the Congress, when it comes to a regulatory approach to
the NRSRO's, would be, first, avoiding erecting any new
barriers to entry and promoting competition in the market for
the provision of credit ratings for regulatory compliance
purposes. Second, utilizing an entry process that is
transparent, timely, and that accommodates a variety of
business models. Third, I think the focus that we have seen and
the discussions in this Committee and throughout the Congress
on managing conflicts of interest is very important. Conflicts
of interest can arise between NRSRO's and issuers, and we have
to ensure that ratings issued for regulatory compliance
purposes, notwithstanding these potential and sometimes actual
conflicts of interest, are independent and objective.
Finally, I think we have to prevent the misuse of material,
nonpublic information by NRSRO's or their associated persons.
So all of these things have to feature into any reforms that
are adopted either legislatively or in a regulatory way. And as
you know, we are deeply into this at the Commission, and have
been for several years now.
Chairman Shelby. Thank you. Following up on that, it is my
understanding, Mr. Chairman, that the regulation of rating
agencies essentially begins and ends when a rating agency
receives a license from SEC staff designating it as nationally
recognized statistical rating organization. That is to say, it
is my understanding there is no ongoing oversight or
inspections by the SEC once the NRSRO license is awarded.
Given the overwhelming evidence--and we have had a hearing
here on this, as you know--relating to conflicts of interest,
aggressive and anticompetitive practices, and the well-known
failures to warn investors about impending bankruptcies--Enron,
WorldCom, and others, including a place you are familiar with,
Orange County, California--do you believe that self-regulation
is working in this area of the concept?
Chairman Cox. Chairman Donaldson testified to this
Committee on this subject, that without additional legislative
authority, the SEC will not be able to regulate in a
thoroughgoing way, the NRSRO's. What we can do under present
law is withdraw an NRSRO's no-action letter. We can bring an
enforcement action against an NRSRO for violation of the
antifraud provisions of the Federal securities laws, and at
least with respect to S&P, Moody's, and Fitch, which are
registered as investment advisers, we can regulate them under
the Investment Advisers Act.
Chairman Shelby. We want to work with you to give you
whatever means you need, and I believe we can do it in a
bipartisan way.
The New York Stock Exchange Regulation, the Committee
recently held a hearing, Mr. Chairman, on the state of self-
regulation in the securities industry with a particular focus
on the implications of the New York Stock Exchange's
unprecedented decision to keep its regulatory unit in-house
even after conversion to a for-profit, shareholder-owned
entity.
As your colleague, Commissioner Paul Atkins, at the SEC
recently noted, revenues derived by the NYSE regulation will
roll up on a consolidated basis to the New York Stock Exchange
Group, the public company. That means that penalties collected
by the New York Stock Exchange Regulation will roll up into the
aggregate revenue calculations of the New York Stock Exchange
Group. This further compounds the inherent conflict of a for-
profit entity possession regulatory authority over customers
and potential competitors.
Do you have some concerns there. Some of us do, but we
think the ground has changed a little out there.
Chairman Cox. The ground is changing. This is a new world
that we are entering upon. The evolution of our major exchanges
into for-profit entities, the demutualization of the markets,
and the prospect of global competition present challenges to
our historical regulatory approach.
The fundamental principle that we need to keep in mind
going forward is that, in order to be effective, regulation
needs to be independent and arms' length. The for-profit
structures that----
Chairman Shelby. Has to be considered open too, does it
not?
Chairman Cox. Pardon me?
Chairman Shelby. Fair. A regulation has to be considered to
be fair too.
Chairman Cox. Of course. The reality and the perception are
equally important; and, of course, ultimately the perception is
driven, one would expect, by the reality.
The Commission has already taken action designed to
strengthen regulatory independence, but I look at this as a
beginning, not an end. When we approved the NYSE merger, we
requested--and the NYSE Board accommodated us in those
requests--some additional changes to further strengthen the
independence of regulation there. But, in my conversations with
the management of the NYSE, I made it very clear--and I think
it is their understanding as well--that we are at the threshold
of understanding where this is all going to lead us, and we
have to be very nimble in our approach. We have to be willing
to constantly adjust and improve.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman.
I want to make a couple observations before I put a
question. First of all, Senator Dodd referred to the fact that
things were relatively quiet, and that the Dow Jones average
reached a 6-year high on Friday. It seems to me that creates
something of a tendency to forget, or to get a a sense of
amnesia. Just to make sure that does not happen, I want to just
note three enforcement actions that have happened in the last
month or so.
On March 16, the SEC settled on enforcement action against
Bear Stearns for securities fraud for facilitating unlawful
late trading deceptive market timing of mutual funds by its
customers, and customers of its introducing brokers. They will
pay $250 million--$160 million in disgorgement, $90 million in
penalty.
Tyco agreed to pay a $50 million settlement to the SEC
charges that is used improper accounting, overstating its
reported financial results, smoothing those reported earnings,
hiding vast amounts of senior executive compensation, and a
large number of related party transactions from investors.
April 20, just a few days ago, JPMorgan Chase and Company
announced that it agreed to pay $425 million to settle class
charges over its role in a scheme in which 55 underwriters
allegedly defrauded investors of billions of dollars through
hundreds of initial public offerings during the 1990's
technologies bubble.
So the responsibility of the SEC is to do all that it can
to prevent and preclude such practices, and sustain the
reputation of our capital markets for integrity, transparency,
and honesty.
Now, Ernst & Young has just done a report on Global IPO
Trends, 2006. And in that report they note that the U.S.
capital markets are perceived by issuers and investors as the
gold standard, particularly as it relates to corporate
governance. Companies realized evaluation premium in the form
of a higher-price earnings, or similar multiple, as compared to
what a similar company receives on another exchange. One
observer has said: Motivation for most companies listing in the
United States is evaluation premium averaging 30 percent that
accrues as a result of adhering to high standards of
governance.
Now, that report went on to note that exchanges outside the
United States have significantly different regulatory and
corporate governance requirements, and that some exchanges are
aggressively marketing the fact that their exchange has lower
regulatory requirements than in the United States.
They go on to say, ``These lower regulatory requirements
translate into increased risk for investors participating in
those exchanges, as they often do not have similar investor
rights and protections.''
I just simply want to say I think the United States should
consider on the path of high standards, of having the gold
standard. It has served us well in the past. I think it will
serve us well into the future.
Some say, well, you know, these IPO's are being issued on
other exchanges. But then you have to look a little into that,
and one of the things that is clear, when you do that, is that
the major driver of the global IPO markets is the privatization
of former state-owned enterprises. The top five IPO's in 2005
are all former state-owned enterprises. This trend is probably
going to continue, but, there is usually political direction to
list those IPO's on local exchanges. The Chinese Construction
Bank went to the Hong Kong Exchange. The two other Chinese
IPO's in the top five also listed in Hong Kong, and the two
French IPO's in the top group listed on Euronext. I just urge
the Commission to hold to its standards. I think we are going
to come out ahead if we do that.
The question I want to put to the Chairman involves hedge
funds, and the resources the SEC will need and be devoting to
make sure that the investigative and enforcement staffs at the
Commission are sufficiently knowledgeable and experienced in
the activities of these funds.
Last Friday, Floyd Norris wrote an article in The New York
Times headed: ``Are These Hedge Fund Results Real?'' He went on
to say, ``For those who favor open markets and open investment
management, it may look like the best of times, but it may
really be the worst, and we may not learn just how bad it is
until something horrible happens. More and more trading and
more and more money now falls outside almost all regulation.
Hedge funds trade with virtually no disclosure of what they are
doing.''
The New York Times ran a story in late March, ``An anxiety
about the growing power of hedge funds.'' ``These funds have
increased sharply in number, size, and effect on the market.
According to stock exchange officials they constitute from one
quarter to one half of all trading on that exchange every day.
Hedge funds operate with a fair amount of secrecy, which
naturally shrouds them in mystery, and often suspicion. Combine
that with a veiled practice of shorting and the devaluation of
stock research since the market collapse, and it becomes a
recipe for concern.'' And there are a whole series of comments
to that effect.
We recognize hedge funds perform an important function in
the markets, but given these concerns that are being expressed,
I want to ask the Chairman whether the SEC has the necessary
resources and authority to understand, investigate activities
in this area, and if necessary, to bring enforcement actions?
Chairman Cox. The straightforward answer to the last part
of your question is yes. We have been bringing enforcement
actions and regulating hedge funds to the extent that some of
them have been registered as investment advisers for the last
decade. We are now implementing authorities under a new rule
that went into effect within the last 90 days as you know.
I should bring to the attention of the Committee that as a
result of compliance with that new rule, we have essentially
doubled, nearly doubled the number of hedge fund advisers that
are registered with the Securities and Exchange Commission, and
our presumption is that virtually the entirety of those new
registrations are in consequence of our new rule. This is
giving us some reliable census data about how many advisers are
operating within the United States that are subject to our
jurisdiction, and that is one of the main things that we had
hoped would occur.
We are also training our inspectors specifically for the
purpose of understanding how to inspect hedge funds. This is a
new emphasis for the Commission. We are devoting significant
resources to it, and, importantly, we have drawn on the
expertise and resources of academics and hedge fund experts as
part of this training. So, I think that we are well-prepared to
embark on at least this next step. And, as we internalize this
new information that we are gaining from the hedge fund adviser
registration, and learn from it, I think we will then be
prepared with the recommendations of our professional staff on
what should be next steps.
Senator Sarbanes. I think it is an important process you
are going through. Some of us on this Committee lived through
the savings and loan debacle, and I think it is imperative that
the Commission and the Committee try to anticipate potential
problem areas, because once they hit, they can hit with
tremendous force, have wide-ranging repercussions, and so an
ounce of prevention is worth a pound of cure, and encourage the
Commission in its work.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Hagel.
Senator Hagel. Mr. Chairman, thank you.
Picking up on the conversation, the exchange that you have
just had with Senator Sarbanes regarding hedge funds, with the
support and concurrence of Chairman Shelby, Senator Dodd, and I
will be holding a hearing in our Subcommittee on Securities, on
hedge funds on May 16, and as you know, Mr. Chairman, you have
been, or a representative of the SEC, asked to testify. I think
so far all representatives of the President's Working Group
will be in attendance, recognizing that there is a lawsuit
challenging the SEC's ruling on hedge funds. But nonetheless, I
would hope--and I know we will have an opportunity to discuss
this in some detail privately this week--that the SEC will be
represented at the hearing.
A couple of follow-up questions to you, Mr. Chairman,
regarding Senator Sarbanes' questions. Could you give this
Committee a status report on where the SEC is on the current
regulation, even though it is being challenged in Federal
Court? Is it still the current regulation, the regulation that
in fact requires hedge fund managers to register? Has there
been any change in the status of the regulation as a result of
the lawsuit?
Chairman Cox. No. As I mentioned, I believe within 24 hours
of being sworn in as Chairman, we intended to, and we have, put
that rule into effect exactly as it was written. And it did in
fact require advisers to register by a deadline of February 1
of this year. That deadline has now, obviously, passed, and the
result is that over 2,400 investment advisers have registered.
That is, at least as of March 31, 2006, the most current data
that I brought with me to this hearing.
That covers more than 11,500 hedge funds with assets of
almost $2 trillion. The census information that we were hoping
to acquire, I think we are acquiring in a sturdy way. I should
reemphasize, as I mentioned in response to the question from
Senator Sarbanes, that roughly half of hedge fund advisers had
already been registered by their choice, and so, now that this
rule has gone into effect, I think we have our arms around what
is the true population.
Now, we understand inferentially that, because of the
lawsuit, there is a small group of people who may be holding
out and not registering, but I do not think that statistically
that is material.
Senator Hagel. We will have an opportunity to further
engage this issue with more specific questioning when we have
the hearing on May 16. Thank you.
Let me turn to a Wall Street Journal article, January 27,
2006. The headline is: ``New York Stock Exchange Grants Fannie
Request for Continued Listing.'' I will just set this question
up this way. The beginning of the article states, ``Embattled
mortgage finance company, Fannie Mae, announced Friday that the
New York Stock Exchange recently granted the company's request
to continue listing its stock despite the fact that Fannie has
not filed an earnings statement since the second quarter of
2004. The Securities and Exchange Commission approved last week
a controversial amendment that saves Fannie from certain
delisting procedures that were slated to begin as soon as March
under the New York Stock Exchange original rules for companies
that had fallen behind in their SEC filings.''
``Fannie, in an SEC disclosure, filed after the markets
filed Friday, said the New York Stock Exchange approved the
company's request last Thursday, which is also when the SEC
okayed the change.''
Can you explain to the Committee why you did that, and are
you concerned that this sends a very dangerous message to
others? And maybe take us down into some detail as to what was
the reasoning behind that approval?
Chairman Cox. We do not begin with the presumption or the
intention of forcing delisting. I have discussed these specific
cases with the New York Stock Exchange. We are watching very
carefully the promised compliance, and it appears that we are
now within reach of getting what we have expected. If that does
not come to pass, obviously, our approach will change
dramatically.
Senator Hagel. What do you mean getting what you expected?
Chairman Cox. We have right now a timetable by which we
expect that the work that was necessitated on account of
restatements will be completed and the filings with the
Securities and Exchange Commission will be made. We can review
those per normal.
Senator Hagel. I have to tell you, Mr. Chairman, you have
presented to the panel this morning, and you took a great deal
of time doing it and I think we all agree with it, a priority
of being concerned for investors. And I would have a concern
for investors when a public company has not presented
financials since the second quarter of 2004 and is still is
allowed to trade on a major stock exchange.
That would be a concern for me as an investor and one who,
like you, is concerned about investors. I would strongly
suggest that we need to take a further look at this. At least I
would like to have a further conversation with you about this.
There will be, I am sure, some additional hearings on this.
But I think this is a very serious problem aside from the
fact that it sends the wrong message to the markets. And I am
wondering also, which Senator Sununu got into a little bit with
you and I am sure he will follow up in his time for questions,
why is it that we are falling behind in IPO's here in the
United States?
Is this all connected? Are we having a confidence problem?
I will let Senator Sununu take that because my time is up, but
I again thank you for coming before the Committee, Mr.
Chairman.
Chairman Cox. Thank you. I want you to know that I take,
and the Commission takes, your message to heart. It is the
unusual circumstance of the transition to 1934 Act compliance,
and the coincidence of that with these massive restatements
that has landed us in this, what I expect to be temporary,
position. But, going forward, the kind of compliance that you
expect is the same kind of compliance that we would expect at
the SEC.
Senator Hagel. I think when you exempt companies, you are
headed for trouble, and we know that we have some trouble that
we are talking about, so we will follow this up in a private
conversation. Thank you.
Chairman Shelby. Senator Dodd.
Senator Dodd. Thank you, Mr. Chairman. Again, thank you,
Chairman Cox, for being here today. I know you have this
advisory committee on Sarbanes-Oxley, regarding smaller
companies, is about to--has it reported to you yet formally?
Chairman Cox. Yes, just this week, just yesterday.
Senator Dodd. I am interested in hearing your initial
reactions to the report. And in the context, I would like to
raise two issues that struck me as being--certainly all
hearings, as Members of Congress, we hear from corporations and
others in our respective States. I think probably all of us ask
when we meet with a corporate executive, how are you doing, how
is Sarbanes-Oxley affecting you? It is a common question. If we
do not raise it, certainly they will with us when the
opportunity presents itself.
I have been struck, by and large, by the positive reaction
to Sarbanes-Oxley. I have heard some very good comments about
the overall effect this has had on corporate governance, the
effectiveness of audit committees, the weeding out of board
members who were not necessarily doing a good job or serving on
too many boards. They describe it as having a very salutary
effect overall.
There have been some questions raised about the cost and so
forth to smaller companies, Section 404 questions and so forth
have come up. But I was struck in some reports that in fact the
cost of compliance under Sarbanes-Oxley is actually reduced by
45 percent over the last 2 years, and that if we were to follow
the recommendations of the advisory committee, as they have
been proposed, some 80 percent of all corporations presently
covered by Sarbanes-Oxley would be exempt. I want to know if
those two facts are true and what your initial reaction is to
this advisory board?
Chairman Cox. As you rightly observed, we have just
received this advisory committee report. I just yesterday had
an opportunity to congratulate the co-chairs of the advisory
committee and all of their members for a year of very hard
work. I think they performed admirably in representing the
concerns of small business, which are among the several
concerns that we will have to take into account as we go
forward.
As for the specific recommendations of the advisory
committee, I will simply represent what I have previously
stated, our emphasis is on making Section 404 work, and
implementing it in a way that provides all the needed investor
protections without unnecessary cost. This is all meant to be
for the protection and the benefit of investors, and therefore,
they are entitled to the maximum amount of investor protection
at the lowest possible cost. We do not want unnecessary cost.
We do not want make work. So we should be able to learn from
early experience and implementation.
Section 404 itself is a very modest part of the overall
legislation. It is just a few lines of text. The implementation
through AS 2 is hundreds of pages, and the practice that has
developed under that guidance is itself another gloss on the
statute. But what is very important, it seems to me, is to make
the statute work. So we are still in the early stages of
discussing these recommendations, having just received them,
and I cannot possibly represent the views of other
Commissioners, since I have not had a chance to really
thoroughly go through all of this with them and gain the
benefit of their reactions.
I can say that certainly my goal as Chairman is to find a
way to make Section 404 work, so that it should not be a
question of whether to apply it to companies of all sizes, but
rather how. The question you put to me also asked me to tell
you whether it is right or wrong that costs are coming down. I
think the answer is that some costs are coming down, and some
are not. There is a difference between internal and external
costs, the fees that auditors are charging as opposed to the
internal cost that companies bear.
I would further observe that going forward, one would
expect in a workable system that these costs will be coming
down simply because the work is routinized. If there is not any
routinization to this, and we keep inventing the wheel year
after year, then something has to be wrong. For foreign private
issuers, they are now just embarking on the front end first
year costs, and so I am sure that the concern about cost is
going to be with us throughout 2006 and maybe into 2007. We are
aggressively going to be working implementation with the PCAOB
so that we get all the benefits of 404 without needless cost.
Senator Dodd. The question I raised as well about the issue
of--as I understood it--and I am not suggesting this is the
position you have taken--but if the full recommendations of
this advisory committee were to be adopted, is it a fact that
about 80 percent of the corporations presently covered by
Sarbanes-Oxley would be exempt?
Chairman Cox. Yes, and it depends, of course, on whether
you are categorizing these companies by their, for example,
market capitalization or simply counting them up. There are
many small companies, and so in terms of a number of issuers
you get to a very high fraction of the total. On the other
hand, if you look at it from the standpoint of how big are
these companies, all the biggest firms would continue to be
covered even under their recommendations, and the lion's share
of market capitalization in the United States. So, I think both
statistics are correct and useful ways of looking at the
problem.
Nonetheless, I want to get back to what I consider to be
the main point, and that is that there should be a way--and the
advisory committee's recommendations contemplate this, I will
say-- to make this work. The advisory committee report focuses
on the fact that there seems to be lacking a framework
applicable specifically to smaller companies, but certainly we
can work that aspect of the problem as well. COSO is developing
such a framework at the request of the SEC, and that may well
be available as a place where we can hang our hat.
Senator Dodd. Mr. Chairman, I suggest that we might want
to--this is such an important issue that the Committee at some
point, in consultation with you and, obviously, Senator
Sarbanes and others, that we would be able to stay closely in
touch with the SEC as it works its way through this. I would be
very interested in making sure we had hearings and so forth on
the subject matter as it progresses.
Chairman Cox. I think we would welcome that. This is, after
all, an agency implementation of a still relatively recent
Congressional enactment, and so it is our main purpose to make
sure we are doing exactly what Congress intended.
Senator Sarbanes. You do have a roundtable already
scheduled for mid-May, do you not, to look specifically at the
question of further guidance that would come from the SEC and
the PCAOB?
Chairman Cox. That is exactly correct.
Senator Sarbanes. With respect to the very issue we have
been talking about?
Chairman Cox. Our 404 roundtable is the second annual such
event, and we are trying to take a look at lessons learned from
one more year under our belt.
Senator Dodd. Just one additional question, Mr. Chairman.
It may have been raised. I apologize, Senator Hagel may have
raised this, on the issue of international exchange mergers?
Have we touched on that, the merger issue, the exchange
mergers? Make it easier for U.S. citizens based in the United
States to trade in foreign listed securities, which has some
possibilities, but what entity? I am curious about what entity
would then have supervisory control over the holding company,
in effect, if the exchanges remain functionally regulated by
the home State, if you will, or the home country?
And then on a related matter, whether or not any thought
has been given to the possibility that a foreign interest could
purchase a U.S. exchange? And if so, what thoughts are then--we
have been through something fairly recently, not involving an
exchange but something else, and whether or not we have a
system set up to examine the implications of such a possible
acquisition?
Chairman Cox. The approach that I am taking is that this is
inevitable, that this globalization is proceeding apace and is
not to be ignored, whether or not, for example, the Nasdaq play
for the London Exchange actually materializes. These things,
these kinds of transactions in this category, will occur, and
presumably, with increasing rapidity. This is just a function
of the fact that these are now for-profit exchanges which have
their own stock as currency to make acquisitions. They are
interested in acquiring the capacity to deliver new products.
One of the key questions that needs to be answered in order
to know what form regulation takes is whether in these mergers
the trading platforms are going to be merged. It is entirely up
to the people who structure these future transactions whether
or not they subject themselves, at least under current law, to
regulation country by country, or to multinational regulation.
I am taking the view that it is best for the United States
and our overseas counterparts to work out some of these
conceptual issues in advance before a real deal is on the
table, and we know whose ox is being gored. And so the
leadership of the FSA and I will be getting together for some
quality time very soon. We have already met, of course, on
this, but we decided we need to set aside, in a retreat as it
were, more than a full day just to talk about these issues and
get our minds around the problems.
I think, through hearings and otherwise, this Committee
will want to do the same, because we have had a regulatory
structure in this country for 7 decades that really has not
contemplated any of this. Maybe it can be made to work. On the
other hand, maybe it is like stretching the new facts onto a
procrustean bed of regulation that just does not fit.
Senator Dodd. As I said, I would rather talk about it now
than have a specific case emerge and us scurrying around trying
to sort it out, or condemning it because it is occurring, and
then trying to write rules and regulations after the actual
event has occurred.
So, again, it is one of those issues, Mr. Chairman, with a
busy schedule and a lot of issues on the table, but one I would
be very interested in hearing what happens as a result of these
conversations you are having and any recommendations and
thoughts the SEC would have. I am sure Senator Hagel, as the
Chairman of our Subcommittee, would be interested as well.
This is, again, a fact of life. It is moving in that
direction. Clearly, as you point out, we should be thinking
about it, and something we never contemplated in the past, but
I think we had better start paying attention to it very
clearly.
Chairman Shelby. Senator Dodd, I think your recommendation
and observations are excellent, and the timing could not be
better.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
About 12 months ago, 14 Members of this Committee sent a
letter to then-Chairman Bill Donaldson, urging the Commission
to withdraw its proposed Regulation B, and resubmit it for
comment after talking to the banking regulators on the proper
scope of the regulation.
Shortly after taking office, you agreed to postpone
compliance, and indicated that you would revisit the
regulation. Now that you have been at the Commission for about
9 months, can you provide a report on the status of the
proposed Regulation B and any effort the Commission has made to
work with the banking regulators to propose a regulation that
merits the legislative intent of Gramm-Leach-Bliley?
Chairman Cox. I can certainly provide you with a status
report. Working backward from today at 2:00 o'clock, depending
on when this hearing adjourns, I am scheduled to get together
with the banking regulators for the next in our ongoing series
of meetings to try and hammer out a collaborative response on
Regulation B.
Going back to the other end of the spectrum, I remember
when I was a conferee on Gramm-Leach-Bliley, it was in a
different millennium. It was a long time ago.
Senator Bunning. Seems like.
Chairman Cox. Literally was. It was a 20th century issue.
We worked on it for several years during the 1990's. The law
concluded, the conference concluded in 1999. It is about time
that we had regulations implementing the law.
So my view is we should get this done. We can get it done,
and we intend to follow Congressional intent as closely as
humanly possible.
Senator Bunning. That would be a wonderful thing if you
could do that. On bonds, I understand the New York Stock
Exchange Group has filed a request with the SEC to allow them
to trade certain unlisted corporate bonds on its automated bond
system. That would greatly expand the number of bonds that
investors could trade on the exchange. When do you think the
SEC will act on this application, and do you have any thoughts
on the impact it will have on bond transparency for all
investors?
Chairman Cox. Well, to answer the first question first, I
think that we can reach a resolution to this issue in the near-
term. With respect to the more general question, we share the
concern of the Bond Market Association and others that the
industry not be burdened with duplicative trade reporting for
securities traded on the NYSE's automated bond system. The
Commission staff is currently discussing with both the NASD and
the NYSE the best way to address the duplicative reporting
issue, and that is the basis for my confidence that we can
resolve this very quickly.
Senator Bunning. Last, but not least--because there are
others waiting--proposed rules on online availability of proxy
materials. The Commission has proposed a rule that would allow
companies to provide shareholders with annual reports and proxy
statements only online unless the investors ask for printed
materials. Today, many investors, particularly the elderly and
low income, do not have access to the Internet, nor do they
feel comfortable doing their financial business online. We do
not want to discourage investor participation, and I know many
comments were filed expressing concerns about the options
proposed by the Commission. What is the correct balance between
increasing investors' participation and cutting the cost of
shareholders communication, and how can the Commission
accomplish both goals? Are there other options that are being
considered after the comment period for the rule ended?
Chairman Cox. Well, as you would expect of us, we are
taking thoroughly into account the comments that we received,
and I can say, having been through many of them myself, that
there are some good suggestions in there that will help us
address some of the problems and the concerns that have been
raised.
When it comes to balancing the interests of investor
protection and trying to save money on sending them disclosure
documents, I have to say that I put by far the greatest weight
on the former and very little on the latter. It has been
pointed out there might be some cost savings if we move to
electronic delivery rather than paper delivery. But that is not
the reason that I would support it.
What I am interested in, as I mentioned in my opening
comments, is making the disclosure useful to customers. And if
what the customers are getting right now is a long document
written in legalese that they throw away, then we are not doing
the job. We have to find ways----
Senator Bunning. That is what we are getting.
Chairman Cox. Exactly. We have to find ways to turn this
into what it was supposed to be all along, and that is user-
friendly information from a customer standpoint. If the
customers are throwing away your product, you have to ask
yourself what is wrong with your model.
When it comes to seniors, and particularly because this is
such a focus of our efforts now at the SEC, we are looking at a
number of issues. First of all, for people of very advanced
age, many times the issue is not whether it is electronic or
paper, but who is managing that money, and is there a caregiver
involved, and can we find someone there that is authorized to
deal in their behalf, and have we got people selling things to
people who are non compos mentis? That is a big opportunity for
fraud, and we want to make sure that, as more and more of the
Nation's assets are held in that way, it does not come back to
bite us.
We will never get away from paper delivery. There will
always be paper delivery. Some people, sometimes me, but some
people always prefer paper to electronic delivery for a variety
of reasons. We want to make it as easy as it can possibly be
for people to get the information in whichever form they want.
And so, as we go forward with this final rule, we want to make
sure that we do not have so much of forced opt-in or -out as a
painless way to get your choice.
And to make sure that if it were possible--actually, one of
the things that we are thinking about is, is it possible--we do
not know quite yet if it is possible--but, if it were possible,
could you call one number once for everything you own, and say,
``I just want it in paper.'' That would be a lot simpler than
having to do it with every single security that you own. One of
the comments we received is, ``Find a way to do that,'' and we
are looking to see whether that is possible.
Senator Bunning. Thank you.
Chairman Shelby. Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thank you, Mr. Chairman.
Chairman Cox, it is great to see you. Welcome, and hope you
are doing well, and we appreciate your being with us today.
In reading your testimony, sometimes you read these
testimonies--you have read a lot of them in your time as well--
and say, what are they trying to say? And every now and then we
come across testimony that is as clear as a bell. It is
interesting too, because in your testimony you talked about
among the things you are trying to do is to move from
boilerplate legalese to plain English in every document
intended for retail consumption. And I just want to say it is
great to know that in your statement today, it is very clear,
it is well said, even understandable to a recovering Governor
from Delaware, so I thank you for that.
You mentioned in a section here in your testimony, talking
about making disclosure understandable for ordinary investors.
I am going to be down in Salisbury, Maryland later this
evening, Senator Sarbanes, and your hometown, and they are
having the Annual Delmarva Poultry Dinner. It is a big dinner,
as you know. I want to talk to the people that gather there, a
couple thousand people gather from all over the Eastern Shore,
Delaware, Maryland, and Virginia. I want to talk with them
about some things that we have been doing with respect to
getting a greater effort from the U.S. Department of
Agriculture to help us ensure that we are doing a better job of
testing chicken flocks for avian influenza.
My staff gave me a statement, a speech they thought I could
give, and it sounded like a speech that was written by somebody
right here in Washington, who had never been to a poultry farm,
maybe not even eaten chicken.
[Laughter.]
So, I gave it back to them and I said, ``I am going to be
speaking to hundreds of farmers, poultry farmers, and I want to
have something I can explain that they will understand.'' So
when I read this part of your testimony, it just really rang
clear with me.
You speak to, in the first part of your testimony, about
executive compensation. And you say very plainly that some
executives, CEO's, deserve every penny they are paid and
probably more, and frankly, some do not.
I came across a story recently about a big company in this
country where the CEO was paid a large amount of money, and the
article examined the firm that is retained by this big company,
who come in and recommend, among other things, compensation for
the CEO. And then it turns out that this firm who recommends
compensation for the CEO, also has a big consulting contract
with the whole company, and to the extent that it is worth a
whole lot more than the value of their making recommendations
for the CEO's compensation. It turned out the CEO serves on
other boards, where the other people from the other companies,
these boards he serves on, serve on his board, and he is on the
compensation subcommittees of these other boards. It just
struck me, I think an ordinary person looking at this would
just say this does not pass the smell test.
And I do not know if you are familiar with the situation I
am talking about. I am sure that it is not by itself. There are
probably a number of those. But just your reaction to that kind
of thing, and what you and your colleagues at the SEC are
trying to do about it?
Chairman Cox. The independence of compensation committees
is key to solving the problem that you described. I have to
say, even before I jump into this, earlier when you mentioned
that you were given a statement that looked like it had been
written by somebody in Washington who had never eaten chicken,
I was going to say that my experience in Congress is there are
very few people who have not had a chicken dinner.
[Laughter.]
There are also few enough people who write in clear, plain
English, so I appreciate your remarks with respect to what we
are trying to accomplish for customers at the SEC there.
When it comes to executive compensation being determined
fairly in the interest of shareholders, obviously, the SEC's
main tool is disclosure, and we want to make sure the market
works the way it is supposed to work, on the basis of clear
understandable information, the best information obtainable.
The compensation committees of the boards are the people that
the shareholders rely on to do this job well.
In a situation such as you describe, where we might
suspect, because of conflicts of interest, the board is not
doing its job, how can the shareholders know for sure? So
putting those tools directly in the hands of the shareholders
as well as the compensation committees is a way to provide a
check and balance.
If there is the greatest possible degree of transparency in
the marketplace, and if there is the very best information,
then not only the shareholders, but also the directors, can be
expected to do a better job.
Senator Carper. I commend you for your commitment to being
plainspoken, and to making sure that the people who work with
you are too. I commend you for your focus on executive
compensation, and to make sure that the old adage that we treat
other people the way we want to be treated and that we remind
boards and people who run these companies, that there is a
reasonable expectation that they should do that too.
And I commend you for your commitment to trying to get the
SEC, the five Commissioners, to be more collegial and to look
for common ground so that when you come forward with your
recommendations, that you find that you are more unanimous than
less.
Thank you.
Chairman Cox. I have to say when it comes to executive
compensation, I am also trying to lead by example. As Chairman
of the SEC, I have over 800 people at the Agency that make more
than I do.
Senator Carper. You are a great role model there.
Senator Bennett. [Presiding.] Senator Sununu.
Senator Sununu. Thank you.
Chairman Cox, Senator Hagel brought up the change in the
New York Stock Exchange rules. They were changes that exempted
a single company, Fannie Mae, from their mandatory delisting
proceedings. And it was done largely on the basis of the market
capitalization of the firm. I think your answer was
effectively--well, we hope that they can move forward and get
this restatement issue done in the near-term. And we all hope
that, but the fact is the Exchange had very clear procedures
regarding delisting and they chose to craft an exemption for
this one firm.
And basing it on the overall size of the market
capitalization begs the question, well, what happens when a
similar exemption is sought for Exxon or for General Electric
or for Google or for Philip Morris or for any one of the
companies that have a larger capitalization than Fannie Mae? Is
the SEC going to agree and concur that this is a good idea when
a similar exemption is sought for other firms that might be
larger than Fannie Mae?
Chairman Cox. No. This is, in my view, sui generis because
of the coincidence of the initial subjection of this Government
Sponsored Enterprise to the reporting requirements of the 1934
Act and their massive restatement. Getting them online, getting
them to be subjected to the Exchange Act, represents a
significant change that has been, as you know, the subject of
considerable legislative as well as Agency attention.
Senator Sununu. It is my understanding that the delay in
their filing of reports is not necessarily related to their
compliance with the 1934 Act. These are their financial
statements that have to be restated because of significant
discrepancies and irregularities in the way certain
transactions were accounted for. We have the findings of the
Rudman Report that certainly validate those concerns. They had
much more to do with irregularities in the accounting process
and attempts to manipulate earnings than any specific changes
that come as a result of their participation in compliance with
the 1934 Act.
Chairman Cox. Well, as you know, the timing of this was as
follows. Fannie registered under the Exchange Act and became a
reporting company for the first time on March 31, 2004. Their
last periodic report was their Form 10-Q for the quarter ended
June 30, 2004, that was filed August 9, 2004. And it was
September 2004 that OFEO issued their preliminary report about
Fannie Mae's accounting practices that led subsequently to
Fannie seeking guidance from the Commission and our accounting
staff regarding several of their accounting matters, including
deferred purchase price adjustments and derivatives and hedging
activities and so forth.
It is that confluence of events to which I refer that I
think makes this different than, for example, a Google or any
other recently public company.
Senator Sununu. I appreciate the point you are making, but
I think it is a stretch when these are irregularities that
occurred in 2001, 2002, and 2003 and they are irregularities
that would have delayed or forced a restatement of earnings
regardless of their decision to comply under the 1934 Act in
2004. Senator Hagel made the point that it perhaps sends a bad
message to investors, to other participants in the market. And
I am equally concerned that it establishes a very bad
precedent, because when you base the exemption, as was done--I
do not think the language mentions timing or changes or
applicability of the 1934 Act.
The Federal Register does not mention that: Standards apply
only in certain very rare circumstances where the Exchange
determines that delisting would be contrary to the national
interest and the interest of public investors--due to the
filer's position in the market, i.e., the nature of its
business and its very large publicly held market
capitalization.
That is the Federal Register from January 26, 2006.
So if this rationale had been presented by Fannie Mae or by
the Exchange, I might be a little bit more sympathetic. But I
do not think that is the argument that was made, and that is
why I have concerns about the precedent.
Chairman Cox. But I just want to say, I agree with you that
it cannot simply be the question of size and if you are of a
certain size then you get a pass.
Senator Sununu. I appreciate that clarification.
Final question on market data. The SEC has been looking at
this issue well before your time. They had a concept release in
1999, an advisory committee in 2000; they proposed some changes
to the way market data was dealt with in 2004 as part of
Regulation NMS, et cetera, et cetera. Where does this stand?
Can you commit to or talk about the Commission's determination
to finally come to some conclusion on the question of market
data, collection of revenues for market services, and the
allocation of those revenues?
Chairman Cox. I cannot tell you definitively how this is
going to turn out, but I can tell you that it is a subject of
intense focus, as you might expect. In the for-profit world,
this is a source of potential ongoing revenue. At the same
time, we want to make sure in the maintenance of orderly
markets--one of our chief missions at the SEC--that we have the
maximum amount of transparency. We also have correlative issues
in the ongoing implementation of Regulation NMS. And so I think
you can rest assured that this is on the front burner, but I
feel as if I cannot tell you definitively at this moment how it
is going to turn out.
Senator Sununu. I appreciate that, although, to be clear,
my question is not how will it turn out; my question is, is
there enough focus to ensure that there will be some
resolution, some decision, some determination, which, you know,
has not been achieved, has not been implemented in the past.
And I very much appreciate your point about----
Chairman Cox. And my answer to that question is absolutely
yes.
Senator Sununu. I appreciate that. And to your broader
concerns about transparency, I think this falls right into
those sets of issues because some of the existing structure of
the market data revenue collection distribution system can
perhaps encourage people to break up orders--you know, take a
1,000-share order, break it up into 10 different 100-share
orders--in order to effectively distort and maximize a firm's
benefit from the allocation and rebate schemes that are
inherent in the current system.
So from the transparency of both the regulator and an
investor, I think there are improvements that can be made that
would eliminate incentives to manipulate the trades and that
would improve the transparency of trades that are occurring.
Thank you very much.
Thank you, Mr. Chairman.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you.
Several items. Chairman Cox, thank you for being here and
welcome to your first experience. I hope we have a lot of
subsequent ones and that they are all pleasant.
I heard the conversation about Sarbanes-Oxley. My
experience during the break was not the same as Senator Dodd's.
I had some venture capitalists tell me flatly they no longer do
IPO's and Sarbanes-Oxley is the reason. And if it becomes
necessary for them to take a company public or--``necessary,''
if it is the logical thing--they look to do it at some foreign
exchange rather than in America. So as you do your analysis of
the reports you have, this is anecdotal, there is nothing
scientific about it, but it is a different kind of constituent
response than the one that Senator Dodd----
Chairman Cox. I appreciate that it is anecdotal. On the
other hand, I was speaking up at Harvard University recently,
Harvard Business School, to a group of venture capitalists who
expressed precisely the same views.
Senator Bennett. Okay.
Chairman Cox. But that was also anecdotal.
Senator Bennett. Right.
Chairman Cox. There are now two----
Senator Bennett. Okay, well, I heard Senator Dodd say he
found nothing but good comments about it, and I had heard some
of the other kind.
Let me move to a subject that I have been on for some time
and begin my remarks by saying that the SEC staff has been
responsive. I have been talking about this for maybe a year or
more, and they have, staff members have been in to see me, but
the problem still exists. We are talking about naked short
selling and the problems connected with that. One of the things
that I have been told that I want to lay down and say I think
this is an immaterial excuse, when they say but you get 99
percent settlement and the FTD's are only in 1 percent of the
dollar volume and therefore it is not really a big deal.
You made the comment earlier with respect to Sarbanes-Oxley
that you got 80 percent of the companies that might be made
exempt but, if you look at a market cap, it will be very large.
That same dichotomy exists with respect to the naked short
selling. I got into this because I had constituents that had
little companies, and for them it is a huge deal. And many of
them insist that they have been destroyed by it. That is, the
naked short sellers keep hammering their stock until finally
they cannot raise any money, the company goes under, and nobody
every has to cover. And I do not know that that is the case.
Again, this is an anecdotal accusation that is made. But if
indeed it is true, it is a demonstration of market manipulation
that is not only clearly illegal, but also devastating to
people who form companies and then try to turn to the markets
to raise money and cannot because the shorts keep hammering
them.
I want to make it clear also, I do not think short selling
is improper. I have sold short in my investment life. Usually I
have been burned by it, but I have done it. And the broker that
handled it gave me the old statement, ``He who sells what is
not his'n must buy it back or go to prison.'' And apparently,
some of these people are not buying it back. I always had to
when I sold short.
And it has gotten into the news again. I started doing this
because, as I say, I heard from very small companies who were
my constituents, and their stocks were traded on the pink
sheets. And it looked like nobody cared on the pink sheets and
they could hammer companies there all day long with naked short
selling and nobody would look at it. And that is the thing that
I raised with the SEC before.
Well, now it is getting a little more currency. There is a
piece in The Wall Street Journal on April 13. The headline
says, ``Despite SEC Rules, the Small Amount of Naked Shorting
Appears to Persist.'' And in that article, they talk about
companies that have stayed on the list for months and months,
on the list where the FTD's have not been cleaned up.
Overstock.com, Martha Stewart Living Omnimedia, Inc., and
Krispy Kreme Doughnuts have been on the threshold list for
months. Overstock.com happens to be located in Utah, so that
caught my eye.
Then, on April 12, Forbes had a piece about short selling
in hedge funds and how they felt that they were being taken
advantage of. The latest Bloomberg has a piece, not
specifically on short selling, but entitled ``Corporate Voting
Charade,'' and says that the people who buy shares to sell them
short then get involved in proxy fights and that people end up
voting shares they do not own. They have borrowed the shares
for short-selling purposes and then vote them when they really
have no interest in the long-term health of the company.
And there is an interesting chart in the Bloomberg piece
about how some close corporate elections were decided by the
voters of the short sales, and says that Alaska Air Group, the
short sales were 4 percent of the voting and the winning votes
were 2.4. MONY Group, 6.2 percent of the votes were in short
proxies and the winning margin was 1.7. And El Paso, 76 percent
were short votes and the winning margin was 17.2. And there are
those who say this whole situation cries out for more SEC
oversight and attention.
So let me, with that, ask you the question, If you cannot
answer it here, would like a response for the record. There
have been a lot of companies that--well, ``a lot,'' several, we
will say ``several'' companies have been on the Regulation SHO
threshold list for a very long time. And one of them, as I say,
is one of my constituents. Presumably, at least some of what
has led these companies to be on the threshold list for so long
is illegal short selling. So, I would like to know, as you
examine the list, are you willing to use your authority to have
the SEC continue its pursuit of basic transparency by requiring
the disclosure of the amount of FTD's?
Chairman Cox. Well, you covered a lot of ground.
Senator Bennett. I apologize. Maybe I overwhelmed you here.
Chairman Cox. I am trying to keep track of all of it.
Senator Bennett. We will be happy to provide you with
pieces of paper on all of this.
Chairman Cox. Of course, I will take advantage of that as
well.
Senator Bennett. Sure.
Chairman Cox. To start at the beginning and end at the end,
the experiences that you described, some of them your own and
many more that you have been apprised of by your constituents
and others, are experiences that in some respects I have
shared. When I first came to the Congress in 1989, I served on
a subcommittee chaired by then-Chairman Doug Barnard, of
Georgia, of the Consumer, Commerce, and Monetary Affairs
Subcommittee. That subcommittee focused for several months on
bear raids and short sellers and what was going on in that
industry.
I share completely your approach to this problem, that
short selling is a component part of healthy markets, one that
is perfectly respectable; and, indeed, it is an important check
and balance in our system. From the standpoint of orderly
markets, it is vitally important that shares be delivered.
These are contracts, and they have to be fulfilled, and there
has to be a rule of law.
I also--moving to your next point--agree with you that it
is faint comfort for someone with a microcap company to hear
that statistically we are doing great, that we are reducing
these failures to deliver and that life is much better now than
it has ever been before because statistically we can prove it
so. In a thinly traded company, life is different. So enforcing
these rules in very different circumstances is also vitally
important.
Having said that, I do think it is important to recognize
the progress that has been made under Regulation SHO, which the
Commission, as you know, adopted in 2004, before I became
Chairman. That rule became fully effective in January of last
year. It has a modest ambition. It is designed not to eliminate
but to reduce failures to deliver on short-sale transactions
and to target potentially problematic short-selling--abusive
naked short selling.
What I can commit to now is that, when we have internalized
and understood the results of our examinations, which are now
ongoing, of compliance with Regulation SHO, and we have
completed the examinations of some 45 firms that include
comprehensive target exams of 19 clearing firms, I will
recommend changes to our rules if those exams demonstrate that
changes are necessary for the reasons that you describe.
Senator Bennett. Let me just conclude, Mr. Chairman. I
applaud what you are saying and I am sure you will go forward
with that. Picking up on what The Wall Street Journal had to
say with these three companies that are listed, that have been
on the list for months, that might be one of the places to
start. The company stays on the list for months, that is an
indication to me that there is something going on that is
unusual. I can understand an FTD, I can understand a flood of
FTD's for a variety of benign reasons. But when a company is on
the list 1 month, that says, well, okay, there are just some
problems. When the same company is on the list for 2 months,
well, maybe something is going on we need to pay--when it is on
for month after month after month and catches the attention of
publications like the Journal, I think that should be a rather
informal but strong flag that says we should pay attention at
least to these companies to see why they keep showing up on the
threshold list.
Thank you very much.
Chairman Cox. Thank you very much, and I hope to be able to
follow up with you on these things.
Chairman Shelby. [Presiding.] Thank you, Senator Bennett.
Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and thank you,
Chairman Cox, for being here. Glad to see you are on top of all
of these things.
I have a whole bunch of questions on cats and dogs here,
but one I know you have been asked about. I would just like to
underscore my concern here as a New Yorker, that so many of the
IPO's, none of the top 10, one out of the top 24, have not
listed in the United States. In 2000, 9 out of 10 listed in the
United States. And as I understand it, some people have asked
you a little about that, but obviously I hear from somebody
whose goal is to keep New York the financial capital of the
world. That troubles me.
What can we do about it? Does it worry you, I guess, is the
first question I have, and what can we do about it to try and
change it? Is it temporary?
Chairman Cox. All right, let me begin by saying that I
share your objective.
Senator Schumer. Thank you.
Chairman Cox. The U.S. capital markets are today, and
certainly have been for some time, the largest, deepest, most
liquid in the world. They are also--and, I believe, not
coincidentally--subject to the highest standards of quality in
the world.
Senator Schumer. Right.
Chairman Cox. It was remarked upon, I believe by Senator
Sarbanes earlier, that some studies show that there is a
quality premium that companies can demand when they list in the
United States.
That is the way strategically, I believe, the United States
should continue to approach our role in the world's capital
markets. Rather than participate in a race to the bottom that
surely, in terms of comparative advantage, we would lose, it
should be our objective to work together with other high-
standards countries to make sure that that is the way the world
goes as increasingly there are more global markets.
It is a fact of life that the domestic markets of other
countries are becoming rather rapidly more mature. And so I do
not think that by birthright the United States can lay claim to
every large issue by every foreign issuer. But we certainly are
entitled to our share. And certainly, if we are correct in our
view that our markets are in fact the most liquid, deepest,
largest in the world, we can expect that countries will want to
come and list here for precisely that reason and to gain that
premium the price premium that they should be getting.
Senator Schumer. Right. But they are not coming now. I
think we all agree with that. In an international world there
is a delicate balance, obviously. You want to strike the right
balance. It is just the change has been so dramatic over 5
years. Five years ago, we were also the most highly regulated.
Could it just be that others are catching up in sophistication?
And why are people not still willing to pay that little premium
so their investors worldwide know that they are being well-
regulated? It is a troubling phenomenon.
Chairman Cox. I agree with you that we need to keep our eye
on this ball. And to the extent that the perception exists, and
I believe that it does in Europe and elsewhere, that the costs
of regulation and of litigation in the United States are
comparatively unpleasant and they would like to sell
themselves, comparatively, as better in those respects, we need
to do everything that we can to make sure that we achieve our
objectives of high standards without unnecessary costs. And
that is something that is all in implementation. It is perhaps
some art as well as science. But it is what we aim to do at the
Commission, to make sure that investors get every ounce of
protection that we can give them at the lowest possible price.
Senator Schumer. Right.
You know, the cost issue troubles me some because for a
smaller company, you get the estimates, $15 million, $30
million the first year, but for a huge billion-dollar company,
I mean, $30 million is still nothing to sneeze at, but it seems
a small price to pay for the Good Housekeeping Seal of
Approval, if you will.
So, I cannot believe it is cost, at least for larger
companies, that keeps them away. It has to be something else.
Now, somebody suggested to me, and I do not know where I would
come down on this, that their directors do not like to be under
the kind of extra scrutiny that they are here now. Could that
be a possibility? Or ``extra responsibility'' is a better word
than ``scrutiny.''
Chairman Cox. Yes, I think expressed in that way and
understood through the prism of liability, it may well be that
human beings, particularly the human beings in control, have an
affective as well as quantitative response to----
Senator Schumer. Which might not be good for their
companies but might be better for them.
Chairman Cox. Yes. To some of these questions. You know, to
the extent that what we are trying to do here is for the
benefit of shareholders--eliminate conflicts of interest,
maximize transparency--I think that eventually it will be seen
for what it is, as an advantage to the people whose money we
are talking about. And so, I do not think we need to hesitate
at all in our drive to constantly reinforce our high standards
in this country. We do need to make sure that, as we implement
those high standards, we are doing it with the interests of
investors in mind.
And it is their money. So, if we are wasting their money on
needless complexity, some of what I talked about here earlier
today, if the rules are being implemented in a Rube Goldberg
way, if we have an instinct for the capillary instead of the
jugular, we can fix those things.
[Laughter.]
But we do not want to miss the main point. And so to the
extent we were talking about, elliptically here, Section 404 or
Sarbanes-Oxley, I want to get back to my main point of
emphasis, which is I was a conferee on that legislation, and I
worked with many of you to put it into force. I think we can
make it work in a way that causes people to want to list in the
United States and that causes investors to insist on those high
standards.
We are seeing some of that right now. We are seeing some of
Sarbanes-Oxley imitated in other countries, in other regulatory
regimes. So, I do not think we have to be supine here and not
fight back when it comes to standing up for ourselves.
Senator Sarbanes. Chuck, would you yield for a minute?
Senator Schumer. I would be happy to yield.
Senator Sarbanes. There is this--I mentioned earlier, Ernst
& Young has done this third annual report on global IPO trends,
which is pretty interesting. And the two trends they point to
that have an impact on all of this is, one, that a major driver
is the privatization of former state-owned enterprises and that
there is a lot of political direction or pressure when that
happens for it to be done on the local exchange. Like the
Chinese do it in Hong Kong, the French do it on Euronext, and
so forth.
The other point they make is the increasing pools of
capital that are available elsewhere around the world, and so,
the capital is not just in the New York market, it is to be
found in other places.
And third, some of the exchanges abroad are making a bald
pitch that they have less regulation. You know, come to us, we
are not as----
Senator Schumer. We have that here in America, too. Some of
them are doing that.
Just one quick other one. Soft dollars, where the SEC has
been making progress and you have been moving forward on it,
but the question I guess I have is very simple. And that is
when will the SEC issue a final interpretive release? Things
were moving along nicely and now--are there bumps in the road
now, or is there any reconsideration----
Chairman Cox. No.
Senator Schumer. What is slowing it down?
Chairman Cox. No, in fact we are on the threshold of
action.
Senator Schumer. You are?
Chairman Cox. Yes.
Senator Schumer. Good.
Thank you, Mr. Chairman.
Chairman Shelby. Mr. Chairman, what is the state of mutual
fund disclosure today, and are we obscuring truly important
information by requiring the disclosure of so much information
that is basically boilerplate in nature? Is that a concern
sometimes? You spoke about it earlier.
Chairman Cox. This is a central focus of our effort to make
things better for retail customers. Because, as you full well
know, for retail customers mutual funds are the investment of
choice.
Chairman Shelby. We have nearly 100 million Americans
investing one way or the other.
Chairman Cox. Precisely. And so, if there were any area
where we were going to focus our efforts--on plain English, on
information that consumers can understand--it would be here.
This also is an area where we are, early on, focusing our
efforts on interactive data. And I will say that the mutual
fund industry and the Investment Company Institute have been
willing partners in this. Very recently they have committed to
finishing writing the taxonomies necessary to present
information to consumers within interactive data.
I am tempted to go off on a riff about all the potential
benefits of interactive data, but that might be a topic for
another hearing. Suffice it to say, directly to your question,
that we can do a lot to make mutual fund disclosure more useful
to investors. And using the Web and letting investors find what
they want, letting intermediaries and analysts who prepare
information for retail customers more easily compare what is in
funds, which interactive data helps with, all is in the offing.
Chairman Shelby. Nothing like an informed customer, is
there?
Chairman Cox. That is what makes markets work.
Chairman Shelby. In the area of accounting, convergence of
accounting standards, which are very important, I applaud your
efforts to harmonize the international financial reporting
standards and U.S. GAAP. In my view, this endeavor will greatly
benefit the global capital markets, as we have been talking
about. Could you provide the Committee with an update on this
multiyear project now, or just for the record?
Chairman Cox. I would be happy to do a little of it now and
further for the record, if you would like.
In October of last year, IOSCO announced plans for creating
an arrangement for regulators to consult and share information
on their decisions regarding the application of International
Financial Reporting Standards. One end product of this project
will be a database for cataloging interpretations and decisions
that will help us improve cross-border enforcement of the
application of these standards, and work is continuing on the
development of that database. It is anticipated that IOSCO is
going to launch this in the second half of this year.
In February of this year, the FASB and the IASB announced
an MOU, which outlines their topical priorities and related
anticipated deliverables, in their efforts to further their
standards-setting work to converge the provisions of U.S. GAAP
and IFRS. And that MOU covers work that is planned to occur
between this year and in 2008.
Beginning in the second half of this year, the SEC staff
plans to begin reviewing the 2005 IFRS financial statements and
accompanying U.S. GAAP reconciliations filed with the SEC by
approximately 300 foreign registrants. That in turn is going to
help inform the SEC staff as to how IFRS is being applied and
practiced by those registrants. To keep us on the road map, we
want to make sure that there is a consistency in application
both within industries and across national boundaries.
Chairman Shelby. Mr. Chairman, Sarbanes-Oxley. In your
view, which provision or provisions in Sarbanes-Oxley have had
the most impact on corporate governance and financial
reporting?
Chairman Cox. I hesitate to pick my favorite because that
might sound like faint praise for all the rest.
Chairman Shelby. To my colleague sitting here.
Chairman Cox. Exactly. Let me come at the question from the
other end and take this advisory committee report that we just
received on Monday. It is instructive to read that report and
to find in it, coming from advocates for smaller public
companies, a fairly ringing endorsement of virtually every
provision of Sarbanes-Oxley. They have a great deal of focus
and concern on one section, on 404, but I think, for companies
of all sizes and for companies within and without the United
States, essentially all the rest of Sarbanes-Oxley is proving
to be of salutary effect.
Chairman Shelby. Senator Sarbanes. Oh, Senator Crapo has
not had a round yet, I am sorry.
Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Mr. Chairman.
I apologize. I have had to step out of the meeting, so I am
glad I got back before they cut you loose, Chairman Cox. I
first of all want to welcome you here. I remember when I first
sat together with you on the Commerce Committee in the House,
and I have enjoyed the opportunity to work with you on many
different issues and in many different contexts. I am very
pleased that you are now the Chairman at the SEC.
I did want to get back to address one issue. I found out as
I got back that Senator Bunning already raised it, and that is
Regulation B. I understand from what Senator Bunning brought up
with you that you are meeting with banking regulators later
today on Regulation B and you are going to be working on the
issue. So, I will not go into the whole thing because I know
you have already done it in the hearing today.
I just wanted to pursue one other aspect of this, and that
is I have been concerned enough about this issue that I have
concluded that we probably need to have some additional
legislative direction provided on the issue. And as I am sure
you are aware, I am working with Senator Shelby, Senator
Sarbanes, and others on the Committee on a regulatory relief
package for our financial institutions. It is my intent to see
if I can work with Senator Sarbanes and Senator Shelby to come
up with an acceptable approach to provide further legislative
guidance on how to address the issue.
And so the main purpose of my wanting to get back here to
talk with you about that is to ask if you would be willing to
work with us, especially after you have had this meeting with
the other regulators and people that you are working with on
it, to help us to craft the right approach in the regulatory
relief package that we are working on.
Chairman Cox. By all means. If the Congress chooses to
enact legislation in this area, rather obviously we would
follow it to a T. In the process of developing such
legislation, if you choose that course, we would be happy to
make our professional staff available for technical support.
And as Chairman, I would be happy to discuss the aims of any of
this with you.
In the meanwhile, we have a relatively new--although it is
hard to call a 1999 enactment new for much longer--legislative
enactment. But it is new in the sense that we have yet to adopt
rules under it. It is my view that it is high time we did so.
So, I intend to see if we cannot make this work in the short-
run.
Senator Crapo. I appreciate that and I certainly believe
that you should continue to pursue the avenue of the rulemaking
process in terms of improving it. As you know from the letters
that many of us sent to the SEC, to your predecessor, actually,
at the SEC, and then from the activities of many of us, I have
a high level of concern about the current proposed rule and the
negative impact that it will have. So that is one of the
reasons that I have concluded that, after waiting for so long
to see if we could not get something resolved, that we need to
provide further legislative guidance.
But also, I encourage you as you work on the rulemaking
side of it to please pay attention to the issues that we have
raised and see if we cannot move forward in a way that does not
create the kinds of burdens and unintended consequences that we
have suggested are lurking in the current proposal.
Chairman Cox. You mentioned that you and I sat next to each
other on the Commerce Committee. When we did so back in the
1990's, we were working on this issue. So, I think it really is
high time for us to implement the rules.
Senator Crapo. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Sarbanes.
Senator Sarbanes. I just have a couple of questions, Mr.
Chairman. I do want to follow up on Senator Crapo's question
just to say that we know Chairman Cox well and we have seen his
skill in the Congress of being able to develop a consensus and
move complicated and difficult issues through the Congress. And
as I understand, he is undertaking that role on this Regulation
B issue in terms of interacting with the other regulators. So,
I think it is a welcome and important initiative on the part of
the Chairman.
I wanted to ask about the money laundering issue, which is
something this Committee has spent a lot of time on. It has
been very much the focus of attention by the Chairman. We feel
particularly keenly because the September 11 Commission
recently evaluated all of the different areas on which they
have made recommendations as to how our Government was doing in
those areas. And the only issue on which they gave up an A-
minus was on money laundering and terrorist financing. We think
there is even more to be done, but at least we keep pressing
that issue.
A year and a half ago the Federal banking agencies and the
Financial Crimes Enforcement Network, FinCEN, executed a
memorandum of understanding to ensure better coordination and
information sharing on the critical issue of Bank Secrecy Act
compliance. I think it is fair to say the Committee pushed very
hard to get that memorandum of understanding. And FinCEN has
since advised us they are executing similar agreements with
State banking agencies.
The first question, it says FinCEN approached the SEC about
executing an information sharing agreement about the results of
Bank Secrecy Act examinations involving brokers and dealers in
securities, and if so, is the SEC planning to execute such an
agreement?
Chairman Cox. Well, the answer to both questions is yes.
Our staff are quite close, in fact, to reaching an agreement in
principle with FinCEN which will then come to the full
Commission for its approval. And, in the meantime, the staff
have been having regular meetings and sharing information with
FinCEN, including the results of examinations we propose.
Senator Sarbanes. Second, on the Chairman's question on
convergence with the international financial reporting
standards. I agree with the Chairman in that it is desirable to
achieve convergence, but I think it is important to do so
moving the standards upward and not downwards. I know in the
EU--well, let me put it the other way. The International
Accounting Standards Board, I think, Sir David Tweedie and
others take the same approach, so I am hopeful that out of that
would come that the convergence would be achieved at a higher
not a lower level. And I think that is a very important
objective to keep in mind.
I do want to--we focused on financial literacy here. I know
you have emphasized that issue down at the Commission. And I
want to underscore its importance. Every survey just gives the
most distressing results about the degree of financial
illiteracy, particularly amongst our young people. Although, as
you point out, seniors end up getting exploited in a very
different way, and I welcome that initiative you have taken in
that area. But what is your view on the financial----
You know, we set up the Financial Literacy and Education
Commission to bring all the Federal agencies together to
develop a program and carry it forward and then develop
cooperative arrangements with the States and nonprofits, many
of which work in this area--some of which have quite good
programs, others not so good. What is your take on this effort,
or this initiative?
Chairman Cox. This is a priority not only for the SEC, but
also for virtually every financial agency in the Federal
Government and for the President's Working Group. And under
those auspices the FLEC report was recently approved. The SEC
for its part is doing a fair amount through our Office of
Investor Education and Assistance to spread the word not only
through our website and through the provision of educational
materials, but also through seminars and cooperative efforts
that we put on with community organizations around the country.
And as you pointed out earlier, Senator, a good deal of this
focus has also been on our men and women in the armed services.
Senator Sarbanes. Yes. Finally, Mr. Chairman, since we have
been talking about 404, I cannot resist a final comment. All
the statute does, it has two short paragraphs, as Chairman Cox
noted earlier. One says if you are a publicly listed company
you have to have a system of internal controls. Presumably, if
you talked to someone who wanted to list or was trying to get
you to invest in their company, you said to them, well, how is
your system of internal controls; and the person says, well, I
do not believe in a system of internal controls, I do not have
one. You would say, hey, now, wait a minute. What kind of
operation is this?
The other paragraph says that the system of internal
controls has to be certified as being adequate, appropriate--I
forget the exact language. And of course that is designed to
make sure you do not have a phony system of internal controls.
In that arena, there is considerable discretion in the
PCAOB and the SEC in terms of developing the protocols that are
appropriate. And it seems to me that that is where the focus
should be in terms of addressing these issues that are being
raised. The proposal for a total exemption would take out of
the system a very significant number of companies, 80 percent.
Many of the studies show that some of the worst abuses
occur in smaller companies, not large companies, the number of
restatements. We get these letters that come in over the
transom from people who say I have been reading these proposals
to exempt the smaller public companies, I used to work for a
smaller public company, whatever you do, do not exempt them,
they need to have some routine that improves their operations.
And of course the Commission last year held a roundtable and
gave some guidance, and you are going right back at it this
year, in the middle of May, with a further roundtable.
It is being looked at. I think the fees still remain too
high, but they are coming down. You had a situation where a lot
of people were not up to standards. They in effect had to make
an investment, almost like a capital cost, in order to set the
system up. Presumably, once set up, in subsequent years it will
not be as expensive. And I think we have to work through that
system. I know you are hearing a lot about it, but I want to
leave you with that observation.
Mr. Chairman, thank you. And I thank Chairman Cox.
Chairman Shelby. Chairman Cox, it is my understanding that
you will be coming back next month to the hearing dealing with
financial literacy. You will be appearing with Secretary Snow
and Chairman Bernanke. I hope then that we can get into more
depth on the issue of financial literacy. We think it is very
important.
Oh, Senator Schumer again. Second round.
Senator Schumer. Thank you. Another two quick ones on
issues of some importance here.
Chairman Shelby. Okay.
Senator Schumer. One, this is about credit rating agencies,
also located in the great City of New York. First, I saw that
the Commission recognized the First Amendment issues when they
had the interaction between the SEC and journalists. I thought
you handled that well, Mr. Chairman.
We have similar issues with some of these rating agencies,
where people will threaten to sue them, you know, to threaten
them, bamboozle them, push them around and stuff like that.
They need to be strictly regulated. They need to make sure
there is no conflicts of interest. But on the other hand, they
cannot be cowered for making an independent judgment that
somebody might not like.
So the first question I have on this is, what steps should
the Commission take to show the same kind of sensitivity you
showed with reporters about these agencies in terms of First
Amendment ability to say what they really come up with?
Chairman Cox. Well, it goes without saying, I would hope,
that neither the Securities and Exchange Commission nor any arm
of Government, Federal or State, should be intruding upon the
independent judgment of these credit rating agencies. That is
what we expect them to be exercising.
Senator Schumer. Right. I am more worried about private
people pushing them around a little bit.
Chairman Cox. At the same time, you know, to the extent
that we can do so, we need to be completely supportive of the
agencies vis-a-vis all comers in the exercise of that
independent judgment.
Senator Schumer. Right. Okay.
Let me ask you this, because they are opposite sides of the
same coin, obviously, if they are--if everyone thinks they are
fair, impartial, on the level, they have more protection built
in. So the rating agencies have issued in the last few years,
when certain abuses were put out, codes of conduct about
quality, integrity, transparency, they were based on the model
code of conduct developed by the IOSCO under the leadership of
the SEC--particularly Commissioner Campos was very involved in
this. And rating agencies are beginning to issue reports on how
they have implemented their codes of conduct. Moody's and S&P
have already done so. They are making good-faith efforts to
improve the transparency of their ratings.
And I also understand that the SEC and the current NRSRO's
have been working on a voluntary framework for SEC oversight of
them. What role do you envision for the Commission in
finalizing the framework, and what is the timeline here?
Chairman Cox. Well, as you point out, the SEC has been
supportive of the development of the IOSCO guidance. I think
the recognition of the global aspect of this is very important.
Albeit, it is essentially the U.S. firms that are dominant;
this is a global business.
Also, with respect to the voluntary framework that is being
developed by the NRSRO's themselves, that effort has been under
way since somewhere in the middle of 2004, I think. We are
working at the Commission on the assumption that we really do
not know the answer to the question whether you are going to
legislate or not on this topic, and therefore we need to be
prepared alternatively with our own action or with cooperative
technical guidance----
Senator Schumer. But do you intend to wait to see if we
legislate before you do what you were doing?
Chairman Cox. I will say, I am trying to be sensitive to
the ongoing process. I mean, there have been hearings on both
sides of the Capitol on this subject, and we want to be as
supportive as we can on the technical side in the development
of any legislation that might happen.
But no, we are not--since I do not know whether there will
be any legislation, we are not going to abey until we know the
answer to that question. We are proceeding apace.
Senator Schumer. You are?
Chairman Cox. Yes.
Senator Schumer. Because you might come up with something
that makes everybody happy and we will not have to legislate.
Chairman Cox. That would be pleasant all around.
Senator Schumer. Yes, it would.
Okay, thank you, Chairman Cox.
Thank you, Mr. Chairman.
Chairman Shelby. Mr. Chairman, thank you very much for your
appearance. It has taken us awhile this morning. We look
forward to working with you. And Senator Sarbanes asked you
earlier, alluded to the fact you have the resources you need.
We will talk about that, because I chair a different committee
and would like to sit down with you and see how you are doing
with your money, what you need, and where you want to go. Fair
enough?
Chairman Cox. I welcome the opportunity, Mr. Chairman.
Chairman Shelby. We will do that. Thank you.
The hearing is adjourned.
[Whereupon, at 12:25 p.m., the hearing was adjourned.]
[Prepared statements and response to written questions
supplied for the record follow:]
PREPARED STATEMENT OF SENATOR JIM BUNNING
Welcome Chairman Cox. It is good to see you, and I am glad to see
you have recovered from your surgery.
Chairman Cox, I am happy to read in your testimony that you are
focusing your efforts on the individual investor. Making plain English
the official language of the SEC is an important step to level the
playing field for all investors. I wish that more of Washington would
follow your lead.
Anything that can be done to improve access to information, and
people's understanding of it, will help both new and experienced
investors.
Your program to use modern electronic communications to reduce the
burden on companies and the SEC will lead to more efficient regulation
and management. But most importantly it will give investors more and
easier access to financial data, and that will help them make better
investment decisions and hopefully encourage more Americans to get into
the markets. I am glad you are taking your time with the new data
program to make sure it is done right. I think it is also important to
make sure investors continue to have access to the information in ways
they can use.
I hope the Commission does not rush to adopt proposals that could
have the effect of making information, such as printed annual reports
or proxy statements, harder for shareholders to get. The last
Commission Chairman left you with some controversial and misguided
proposals.
In fact, just weeks ago, the DC Circuit sent the regulation
requiring independent chairman and directors for mutual funds back to
the SEC for the second time. A court decision is coming soon on hedge
fund regulation too.
Also, as many Members of this Committee stated in a letter to
Chairman Donaldson, the proposed Regulation B goes against the clear
intent of Congress in the Gramm-Leach-Bliley Act.
I encourage you to take a fresh look at those regulations and
whether they are needed before proceeding with them.
I encourage you to keep looking out for all investors, and to do so
in a way that encourages business innovation. Giving people access to
better and more useful information is an important step, but financial
education is also very much needed.
I look forward to hearing other ideas you have to help the public
better understand the securities markets.
----------
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Thank you, Chairman Shelby and welcome, Chairman Cox.
I have been following your efforts over the last 8 months and I
want to commend you on a successful beginning. You have worked to gain
consensus with your colleagues and establish some key reforms that have
been beneficial to investors and consumers alike. I support your
efforts in enhancing disclosures and simplifying the law.
As you know, the SEC's role is absolutely vital to maintaining a
robust and vibrant economy, and providing working men and women the
piece of mind they need to become investors in the American Dream.
As you testify today, I am very interested in hearing your
suggestions to improve education for the common investor. As more and
more individuals retire, I am concerned that the average investor will
not have the resources to appropriately scrutinize the options
available to them upon retirement.
In Michigan, this is a critical concern for families--workers who
have worked hard and paid into a retirement account need to understand
what their options are after retirement.
Second, I am interested in your perception of the global economy. I
understand that the largest IPO's this year have been from foreign
companies. In fact, the top three IPO's were from Chinese and French
companies, and the largest IPO, China Construction Bank, was the
biggest deal in 5 years.
In your opinion, what impact does this have on our domestic
markets? And, how do you see this trend moving in the future?
Last, I have been hearing from businesses in Michigan that some of
the current regulations out there are burdensome and costly. I hope to
hear your opinions and improvement ideas to increase security yet
maintain a manageable process for businesses.
Again, I want to commend you on a great beginning and I look
forward to this ongoing dialogue on maintaining investor confidence and
finding improvement opportunities whenever possible.
Thank you again for sharing your time with us today.
PREPARED STATEMENT OF CHRISTOPHER COX
Chairman, U.S. Securities and Exchange Commission
April 25, 2006
Chairman Shelby, Ranking Member Sarbanes, and Members of the
Committee, thank you for giving me the opportunity to be here today to
testify about the initiatives and priorities underway at the Securities
and Exchange Commission to improve financial disclosure for individual
investors.
Several years ago, in the midst of rampant financial scandals and a
crisis of investor confidence, this Committee held a series of
exceptionally important hearings on corporate responsibility and
investor protection. Those hearings, and the work of the Members of
this Committee that followed, laid the foundation for landmark reforms
that have restored investor confidence and the health of our capital
markets. I commend each of you for your efforts, and am happy to report
that the SEC is using the new tools that you have given us to ensure
that those reforms are implemented exactly as intended by the Congress.
A lot has happened in the 9 months since I last sat at this table.
I very much appreciate this opportunity to give you a report on the new
initiatives the SEC has undertaken, as well as to hear from you about
your priorities.
Introduction
The principal subject of this brief testimony is improving
disclosure for the benefit of individual investors. If I may, I would
like to take a step back and put these efforts into context.
As a Member of Congress for 17 years, I was constantly reminded by
my constituents of the real world impact of the decisions we make here
in the Capitol. Like every one of you, I learned the importance of
being a good listener, and of remembering that the common sense of
ordinary Americans is the essence and the strength of our democracy.
Most of your constituents are not investment bankers, or lawyers,
or accountants. But most of them are investors. It is a stunning fact
of life in the 21st century that a majority of Americans now own
stocks, either directly or through mutual funds. It is chiefly to serve
these people that the SEC exists. Our mission--to protect investors,
promote capital formation, and maintain orderly markets--must always
put ordinary Americans first.
Since making the transition from the halls of Congress to the SEC,
I have set out to rededicate the agency's ongoing efforts in virtually
every area to the service of the individual investor.
In a well-ordered market, educated consumers can choose from a
number of competitive products, and find what they want at a price they
are willing to pay. But in order to educate themselves, investors need
comparative facts. So while investors must bear the responsibility of
learning what they can about their investment choices, the correlative
duty of sellers of investment products is to provide the relevant
information. What's more, in order for investors to make sound
decisions, the seller's information has to be understandable,
accessible, and accurate.
These are the basic ingredients of healthy competition in every
corner of the financial marketplace.
To more closely match the theory of a well-ordered market with
today's reality, the SEC is currently pursuing four key initiatives to
improve the quality and usefulness of disclosure for individual
investors. These initiatives, taken together, are designed to ensure
that investors have access to more accurate and understandable
information about the securities they own or are considering buying.
These four initiatives are:
Moving from boilerplate legalese to plain English in every
document intended for retail consumption;
Moving from long, hard-to-read disclosure documents to easy-
to-navigate webpages that let investors click through to find what
they want;
Reducing the complexity of accounting rules and regulations;
and
Focusing our antifraud efforts on scams that target older
Americans.
Making Disclosure Understandable for Ordinary Investors
It is the SEC's job to see to it that financial data and
qualitative information about the issuers of securities are fully and
fairly disclosed. But surely we cannot say we have achieved that
objective if the information is provided in a way that is not clearly
understandable to the men and women for whom it is intended. Empowering
investors does not just mean better access to information--it also
means access to better information. Simply put, the question is: Once
that SEC-mandated information is available, is it understandable? The
answer all too often is a resounding and frustrated ``no.''
Even though they are nominally written in English, the disclosure
in some documents that are provided to investors is often so full of
legal jargon and boilerplate disclosure that it can actually obscure
important information.
Convoluted language and disclosure in footnotes may serve lawyers
and insurance companies, but it does not improve an investor's ability
to understand the most important facts about a particular investment.
Exhibit A when it comes to convoluted disclosure is today's regime
for reporting executive compensation. Ordinary American investors have
a right to know what company executives are paid, because those
investors own the companies. The executives work for them.
It is a direct corollary of the fact that more than half of
Americans own stock today, that executive compensation will be judged
just like every other labor and material cost that a firm incurs. Gone
are the days when investors were mostly privileged, high-income elites.
Today's investors come from middle class households that sit around the
kitchen table and make tough choices about their monthly budgets. They
expect the companies they invest in to do the same.
But how can an investor judge whether he is getting the best
executive talent at the best price? Too often, the most important parts
of total compensation are hidden away in footnotes, scattered in
different parts of the proxy statement, or--depending on the form the
compensation takes--not even disclosed at all until after the fact.
Three months ago, the Commission voted unanimously to propose an
overhaul of the executive compensation rules. This marks the first time
in 14 years that the SEC has undertaken significant revisions of the
disclosure rules in this area.
The proposal would require better disclosure on several fronts.
First, companies would report a ``total'' figure--one number--for
all annual compensation, including perquisites.
Second, retirement benefits would be clearly outlined in new tables
showing the defined-benefit and defined-contribution plans of top
officers.
Third, there would also be clear descriptions of payments that
could be made if an executive is terminated. No such disclosure is
required under our current rules.
Fourth, for the first time, all compensation for the last year to
board members would be fully disclosed.
Fifth, a new Compensation Discussion and Analysis section would
replace the Compensation Committee Report and the performance graph,
which is now often mere boilerplate and legalese. This new narrative
section will allow the board members to have a frank discussion with
their bosses, the shareholders, about how they have gone about
determining the compensation for the company's top executives.
Just to be clear, the Commission does not propose getting into the
business of determining what is the proper method or level of
compensation. It is not the job of the SEC to substitute our judgment
for that of the board. Nor would I, speaking as Chairman, subscribe to
the notion that all executive pay is excessive. Surely many executives
deserve every penny they are paid, and more. It should go without
saying that being a CEO requires a rarefied collection of attributes
and skills that are in all too short supply. And it is a fact that
competition in the market for executive talent can be fierce. At the
same time, I need not cite here the several notoriously public cases of
extravagant wastes of shareholder assets by gluttonous CEO's and pliant
compensation committees.
By improving the total mix of information available to investors,
the directors who work for them, and the marketplace, we can help
shareholders and compensation committees to better inform themselves
and reach their own conclusions.
Sixth, and finally: Since the purpose here is to improve
communications, the proposed rules require that all of this disclosure
be in plain English--the new official language of the SEC. That will be
true whether the information is in a proxy statement, an information
statement, or an annual report.
Plain English uses plain words--and, among other basic ingredients,
the active voice. We want to promote the use of the active voice not
just because it makes for punchier sentences, but because it requires a
definite subject to go with the predicate. That is the only way that
investors will be able to figure out who did what to whom.
It is a testament to the importance of this issue that, when the
comment period on these proposed executive compensation rules closed on
April 10, we had received nearly 17,000 comments. That is one of the
highest totals in the SEC's 72-year history. We are now reviewing these
comments and look forward to incorporating them into any final rules
that the Commission may adopt for improved, plain English compensation
disclosure.
And we will not stop there. Some years ago, under Chairman Arthur
Levitt, the SEC began a crusade for plain English in investor
documents. It was a noble first step that has been carried on by both
Harvey Pitt and Bill Donaldson. During my time at the Commission, I
hope to advance this cause still further, so that ultimately every
communication aimed at retail investors is so free of jargon and
legalese that it could pass muster with the editors of the Money
section of USA Today.
Improving Disclosure via Interactive Data
Making the SEC's mandated disclosures more useful to investors is
the idea behind another of our initiatives: Interactive data.
The beauty of interactive data is that it will not only make
today's 10K's, proxies, and mutual fund prospectuses more useful to
investors, but it will also reduce much of the time and expense that
companies currently devote to filing SEC reports.
Today, the SEC has over 800 different forms. Each form is required
to have its own cover page. The genesis of this requirement dates back
to when reports were hand-filed in steel cabinets. Back then, the cover
pages helped Commission staff do the filing--but today, they provide no
useful information to the public, or to the SEC. Despite the fact that
every individual company is required to file many different forms,
these cover pages ask over and over again for the very same information
in a slightly different format. In other words, more junk disclosure
that no one needs, or wants.
If one goes beyond the cover pages to the entire form, to focus
only on the truly unique information in each one, it has been estimated
that instead of the 800 forms now required, the SEC might have need of
no more than a dozen.
The key to making this happen is looking at the data on the forms
independently from the forms themselves. That is what we mean by
interactive data. Computer codes can tag each separate piece of
information on a report, and tell us what it is: Operating income,
interest expense, and so forth. That way, every number in a report or
financial statement is individually identified, both qualitatively and
quantitatively.
For individual investors, this means they will be able to quickly
search for any information they want without slogging through an 80-
page document. And it means they could search through our database not
by the names of individual reports, but instead just by looking up the
companies that file them. We would no longer need what we have for
domestic issuers today: 9 Securities Act registration statement forms,
3 Exchange Act registration statement forms, 2 annual report forms, 2
quarterly report forms, 1 current report form . . . and a partridge in
a pear tree.
And I have not even gotten to all the forms for proxy materials,
annual reports, securities ownership, tender offers, and mergers and
acquisitions. Investors, and the analysts who interpret financial
information for them, should not have to hunt around for each separate
form--all the information should be in one place, organized by company.
Today, every one of these forms has to be filed and processed
separately, which adds to the SEC's workload; and then the investors
have to separately hunt down every different form for a single company,
making more work for all of them. Rube Goldberg would be proud.
Our initiative to let investors get information fast, easily, and
all in one place, envisions this added benefit: Instead of long and
hard-to-read annual reports and proxy statements, investors could have
easy-to-navigate webpages that let them click through to find what they
want.
I am extremely pleased that our interactive data initiative has the
support of the Chairman and other Members of this Committee. In
hearings and briefings before this and other Committees, you have heard
the technology variously described as data tagging, or XBRL, or my
personal favorite, interactive data. But whatever one calls it, the
point is the same: To allow investors to more easily access, search,
analyze, and compare data provided by public companies.
The move to interactive data represents a sorely needed upgrade in
the SEC's electronic disclosure regime.
From the 1930's to the 1980's, the Commission required that
disclosure documents be filed exclusively on paper. Thousands of
companies mailed us hundreds of thousands of documents. Each document
was date-stamped, copied, sent to various divisions for review, and
made available to the public for physical inspection in a Washington,
DC library that is still maintained by the agency at significant
expense.
In the 1980's, the Commission pioneered the use of electronic
filing on our EDGAR system. (EDGAR stands for Electronic Data
Gathering, Analysis, and Retrieval.) This was a significant leap
forward, and it became even more so with the dawn of the Internet. Now,
investors and analysts are able to download documents with the click of
a mouse instead of making a trip to the SEC's library in Washington,
DC.
But while EDGAR was a great improvement for the 1980's, 20 years is
a lifetime in the computer age. EDGAR may be electronic, but it is not
interactive. It does not begin to tap the potential of the Web. Because
today's EDGAR filings are really just snapshots of paper reports that
are stored in electronic form, the information they contain is not
searchable. Nor can it be used in any of the myriad ways that
electronic data now speed around offices, home computers, and the
Internet.
With today's SEC reports, an investor or analyst who is looking to
compare, say, data on annual capital expenditures of two companies, has
to search through perhaps hundreds of pages of the filings of each
company page-by-page. Not surprisingly, the burden of this time-
consuming, tiresome task has led to the creation of a cottage industry
in rekeyboarding the information in SEC reports, so that it can be
downloaded into spreadsheets and other software. Investors, or more
precisely the intermediaries whose fees they pay, can then buy this
information from both domestic U.S. firms and overseas providers to
whom the drudge work has been outsourced. Once the information is
manually input, it is often first sold to third or fourth parties for
further reduction and analysis before it eventually is made available
to an individual investor.
One hates even to think of the human error and data corruption that
inevitably occurs in this process. We know from experience that the
error rate is unacceptably high.
Interactive data is a way to eliminate these problems, and to
connect investors directly to the information in a company's filings--
accurately, cheaply, and quickly. It will allow anyone to easily
search, extract, compile, compare, and analyze financial and
qualitative data according to each individual's preferences.
What about the benefits beyond retail investors? For preparers of
financial reports, interactive data could streamline and accelerate the
collection and reporting of financial information to the SEC and the
public. Further down the road, the potential exists for companies to
use interactive data as a means of getting real-time management control
information.
The SEC is strongly committed to interactive data. This is why we
have taken major steps to promote it. We have offered significant
incentives for companies to file their financial reports using
interactive data. These include expedited review of registration
statements and annual reports. A number of well-known firms--the list
is 17 and growing--have already begun to lead the way and are filing
their reports using interactive data.
And because mutual funds and exchange-traded funds have become the
investment of choice for millions of Americans, I am very encouraged
that the Investment Company Institute and its member funds recently
decided to throw their weight behind interactive data.
Throughout 2006, the Commission will host a series of roundtables
focused on the move to interactive data. The first roundtable is in
June. The discussions will focus on several topics:
What investors and analysts really need from interactive data;
How to encourage the development of software for companies,
institutions, and retail investors that takes full advantage of the
potential of interactive data; and
How to redesign the SEC's disclosure requirements to maximize
the advantage of using interactive data.
Our aim is to move from long, hard-to-read disclosure documents to
easy-to-navigate webpages that let investors click through to find what
they want. We want to emancipate the data from the page, and let it
find its way across the Internet and around the world in the form of
RSS feeds, AJAX applications, and whatever comes next. Revolutionizing
the way the world exchanges financial information is a worthy goal. We
intend to achieve it.
Accounting Complexity
When it comes to giving investors the protection they need,
information is the single most powerful tool we have. It is what
separates investing from roulette. But if the SEC is truly to succeed
in helping investors with more useful information, we will need one
more ingredient: An all-out war on complexity.
It is, of course, true that a complex world often requires complex
solutions. And certainly, there are desirable states of complexity--the
ones that arise from a thing's intrinsic nature: DNA. A snowflake.
Encryption algorithms. There, the complexity is essential to the
function. But it is the contrived, artificial complexities that cause
the problems--intricacy without function. Winston Churchill said it
best: ``However beautiful the strategy, you should occasionally look at
the results.''
That, Mr. Chairman, is what we are now doing at the SEC. We are
looking at results from the vantage point of the ordinary investor. And
what we are finding is that, in many cases, we are not getting the
right results. The complexity of the disclosure mandated by our rules
too often adds nothing to function.
It is not just public companies that sometimes have difficulty
using plain English. Our accounting rules and regulations also can
sometimes be complex and difficult to interpret. And when the rules are
difficult to interpret, they may not be followed very well. And if the
rules are not followed very well, then intentionally or not, individual
investors inevitably will suffer.
When complexity needlessly adds to the costs and efforts involved
in financial reporting, it is the investors who foot the bill. And when
a company takes advantage of detailed standards and complex reporting
to hide information from investors, rather than to disclose it,
investors are doubly damaged.
Not surprisingly, users of financial statements--investors and
regulators alike--are looking for more balance in making financial
reporting comparable and understandable. Preparers and auditors are
also looking for standards that are easier to understand and implement.
The SEC has been helping to lead a major national effort to reduce
complexity in financial reporting. The laboring oar is being manned by
the Financial Accounting Standards Board, which is already intently
focused on improving the understandability, consistency, and overall
usability of the existing accounting literature. The SEC staff are
working closely with the FASB in a supportive role.
The first step is to systematically readdress specific accounting
standards that do not provide the most relevant and comparable
financial information. Examples of standards in need of reworking for
this reason include consolidations policy, certain off-balance sheet
transactions, performance reporting, and revenue recognition.
The second task is to codify generally accepted accounting
principles. The codification will be a comprehensive and integrated
collection of all existing accounting literature, and it will be
organized by subject matter. The aim is to provide a single, easily
accessible source for all of GAAP. A dividend of this project is that
it will provide a useful roadmap to those areas most in need of
simplification.
A third priority is to stem the proliferation of new accounting
pronouncements from multiple sources. We are encouraging the FASB to
consolidate U.S. accounting standard setting under its auspices, and to
develop new standards more consistent with a principles-based,
objectives-oriented system.
The final element of this strategy is to strengthen the existing
conceptual framework for U.S. GAAP in order to provide a more solid and
consistent foundation for the development of objectives-oriented
standards in the future.
Making financial reporting more user-friendly goes far beyond the
work of the FASB. Weeding out the counter-productive complexity that
has crept into our financial reporting will require the concerted
effort of the SEC, the FASB, the PCAOB, and every market participant.
This cannot be a one-time effort; we will have to commit for the long-
term. But it will be well worth it.
Financial Education for Retirees and Elderly Investors
Finally, let me turn to our efforts to better protect older
Americans against financial fraud.
Consider these statistics: An estimated 75 million Americans are
due to turn 60 over the next 20 years. That's an average of more than
10,000 people retiring every day. Households led by people aged 40 or
over already own 91 percent of America's net worth. The impending
retirement of the baby boomers will mean that, very soon, the vast
majority of our Nation's net worth will be in the hands of the newly
retired.
Following the Willie Sutton principle, scam artists will swarm like
locusts over this increasingly vulnerable group--because that is where
the money is.
On a daily basis, our agency receives letters and phone calls from
seniors and their caregivers who have been targeted by fraudsters.
Sometimes there is still time to help. But often, the victims have
already been taken. These fraudulent schemes may begin with a free
lunch, but we want to make sure that they end with a very high cost to
the perpetrators.
That is why we are attacking the problem from all angles--from
investor education, to targeted examinations, to aggressive enforcement
efforts. And because State securities regulators share our concern
about fraud aimed at seniors, we are cooperating in this initiative
with State regulators across the country--the local cops on the beat.
A top priority is education. SEC programs are aimed not only at
older Americans and their caregivers, but also at preretirement
workers, designed to help them reach their personal savings and
investing goals as they age. While we cannot tell investors which
products to purchase, we can arm them with the information they need to
assess various products and investment strategies.
We are expanding our efforts to reach out to community
organizations, and to enlist their help in educating older Americans
about investment fraud and abuse.
A portion of the SEC website is devoted specifically to senior
citizens (http://www.sec.gov/investor/seniors.shtml). We provide links
to critical information on investments that are commonly marketed to
seniors--including variable annuities, equity-indexed annuities,
promissory notes, and certificates of deposit.
On the SEC website, investors can also find detailed warnings
against the dangers of listening to the sales pitches of cold-callers.
We are alerting seniors to the very real threat of affinity fraud--
scams that prey upon members of groups to which they may belong,
including their religion, their nationality or ethnic heritage, or
their profession.
Seniors are often subjected to high pressure sales pitches that are
simply not true, such as telling seniors that equity-indexed annuities
``just can't lose money.'' There are also ``free lunch'' seminars that
encourage seniors to buy complex products that do not fit the risk
profile of a retiree with a relatively short life expectancy. There are
also outright scams, such as Ponzi schemes.
To detect abusive sales tactics that target seniors, examiners in
our SEC field offices will share regulatory intelligence with their
counterparts at the State level, and with other regulators. Once we
identify firms that may be preying on seniors, we will examine those
firms to make sure their sales practices are lawful.
This effort has already started in Florida, where we've recently
initiated on-site compliance examinations, along with the State of
Florida and the NASD, of firms that sponsor ``free lunch'' investment
seminars. Our goal is to see that the sales people at these seminars
are properly supervised by their firms, and that the seminars are not
used as a vehicle to sell unsuitable investment products to seniors.
Each of our offices across the country will work closely with State
and local law enforcement, and both Federal and State regulatory
agencies, to target scams aimed at seniors. And they will work together
to bring both civil and criminal actions aimed at shutting them down.
This effort is already well under way in California.
Finally, when we do find fraud, you can be sure that we will do
something about it. Over the past 2 years, the SEC's Division of
Enforcement has brought at least 26 enforcement actions aimed
specifically at protecting elderly investors. Many of these actions
were coordinated with State authorities.
In one notable case, SEC v. D.W. Heath and Associates, the
Commission coordinated with the Riverside County District Attorney's
Office to crack down on a $144.8 million Ponzi scheme that lured
elderly victims in southern California to workshops with the promise of
free food. The Commission's complaint alleged that the defendants then
bilked them out of their retirement money by purporting to sell them
safe, guaranteed notes.
Just last month, in SEC v. Reinhard et al., the Commission halted
another possible Ponzi scheme, this time in Allentown, Pennsylvania.
The Commission's complaint alleges that the defendants raised more than
$3.9 million from at least 50 investors in several States by claiming
to sell certificates of deposit that did not exist.
The complaint further alleges that the primary salesman lured
investors, many of whom are elderly, with promises of above-market
rates on FDIC-insured CD's purportedly issued by a nonexistent entity
called the ``Liberty Certificate of Deposit Trust Fund.'' The complaint
also alleges that the defendants distributed fictitious investment
documents and account statements to attract investors and to ensure
they continued to invest in the scheme.
As reflected in these recent cases, any would-be fraudsters should
consider themselves on notice that the SEC's enforcement staff will
aggressively investigate and file actions against anyone who preys upon
seniors.
Conclusion
Mr. Chairman, Members of the Committee--thank you for your interest
in these vital issues. Each of the four initiatives I have outlined is
part of an overall strategy to make the individual investor--the
average American--the ultimate beneficiary of all that we do at the
SEC. Our agency has for many years proudly worn the badge of the
``Investor's Advocate.'' In the months and years ahead, we are pledged
to rededicate ourselves to that mission.
I appreciate the opportunity to be with you here today. Thank you
for your continuing strong support for the work of the Commission. I am
happy to answer any questions you may have.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM CHRISTOPHER COX
Q.1. Last November, the Commission committed to approving by
June 30, 2006 self-regulatory organization rules to permit
portfolio margining for securities futures and security
options. I understand that NYSE and CBOE rule changes are
pending that would do that by expanding the current pilot
program that permits certain customers to use portfolio
margining for certain limited classes of products. Do you
anticipate that the Commission will be able to meet its
commitment to Congress to act on these proposals by June 30?
A.1. I am pleased to report that on July 11, 2006 we approved
rule changes at two major exchanges--the New York Stock
Exchange and the Chicago Board Options Exchange to permit
portfolio margining on equity options and security futures. In
addition, we have also noticed for comment NYSE and CBOE
proposals to permit single stocks and OTC derivatives to be
included in a portfolio margin account. The public comment
period for these two proposals closed in May. After reviewing
comments received by the Commission, NYSE and CBOE recently
submitted technical amendments to their proposals and I expect
that the Commission will take action on the proposals in early
September. In addition to these rules changes, I am also
engaged in direct discussions with Ruben Jeffery, the Chairman
of the Commodity Futures Trading Commission, to identify
further areas of agreement on portfolio margining.
Q.2. The proposed NYSE and CBOE rules would allow broad-based
futures to be included in a portfolio margining securities
account I understand that there are some obstacles to actually
including such futures in a securities account, because all of
the financial instruments in a securities account must be
provided with coverage by the Securities Investor Protection
Act (SIPA), and SIPA specifically excludes futures from its
coverage. In testimony before the Banking Committee last
September, Bob Colby testified that the Commission supports
targeted amendments to SIPA to address this issue. This sounds
like an idea where a legislative fix is the cleanest way to
make sure that the market can take full advantage of portfolio
margining. Do you agree? If so, could the Commission provide us
with some technical assistance in drafting a targeted amendment
to SIPA?
A.2. The Commission agrees that targeted legislative changes to
SIPA are the ``cleanest'' way to make sure customers can take
full advantage of the new NYSE and CBOE portfolio margining
rules. Under the NYSE's and CBOE's rules, securities and
futures positions must be carried in a securities account to
provide a customer with the protections of applicable
securities laws and regulations. Including futures positions in
a portfolio margin securities account, however, raises an issue
as to how futures positions would be treated in a liquidation
of a broker-dealer under SIPA.
SIPA protections apply to cash and securities held at a
broker-dealer, but not to futures positions. This result is a
function of the SIPA definition of ``security,'' which
specifically excludes futures. Moreover, there is no
corresponding statutory protection for futures customers under
which they would receive advances if futures assets are
missing. To assure SIPA protection to all products in a
portfolio margin securities account, amendments to SIPA would
enable customers to take full advantage of the portfolio
margining rules. This legislative amendment could be very
narrowly tailored to, in effect, provide that futures
(including options on futures) held in a portfolio margin
account under a Commission-approved portfolio margin program
would receive SIPA protection, thereby extending SIPC
protection to those futures products permitted to be deposited
into a portfolio margin securities account. The Commission
staff would be pleased to provide you with technical assistance
in drafting such a targeted amendment to SIPA to address this
issue.
At the same time, however, the Commission is actively
engaged in a dialogue with the Commodity Futures Trading
Commission and the futures and securities industry regarding
the optimal means to structure cross margining between
securities and futures positions--whether through a single
account or separate securities and futures accounts (the so-
called ``one-pot'' or ``two-pot'' models).
RESPONSE TO A WRITTEN QUESTION OF SENATOR ENZI
FROM CHRISTOPHER COX
Q.1. Mr. Chairman, the position of the Chairman of the Public
Company Accounting Oversight Board has been open since November
30, 2005. Since that time, Mr. Bill Gradison has served as
Acting Chair, and has done an excellent job. Does the SEC have
plans to nominate a new Chairman in the near future?
A.1. On June 19, 2006, the Securities and Exchange Commission
was pleased to announce the appointment of Federal Reserve
Board Governor Mark W. Olson to the position of Chairman of the
five-member Public Company Accounting Oversight Board (PCAOB)
until 2010. Mark Olson's experience as a central banker, his
background in securities law, his expertise gained as partner
in a major accounting firm, his management and business
experience as a bank president, and his national leadership as
President of the American Bankers' Association--together with
his demonstrated commitment to public service and protecting
the interests of investors--will be an exceptional addition to
the PCAOB.
Mr. Olsen's appointment was conducted in accordance with
the comprehensive selection procedures for the selection of
Chairpersons and Board members of the PCAOB that the Commission
approved last December. These new procedures are intended to
make the selection process transparent, encourage the thorough
consideration of all qualified candidates, ensure a thorough
vetting of candidates, and establish timetables for the
expeditious appointment of individuals of the highest caliber
for this critical body.
These selection procedures build upon the previous practice
of the Commission, and include a timetable for the
recommendation of candidates, background checks, Commission
interviews, and final selection. The new procedures will apply
whenever vacancies occur.
Under these procedures, the SEC Chairman will lead a search
to identify qualified candidates and will solicit nominations
and input from each of the SEC's current Commissioners, who may
each submit up to three nominations.
The SEC Chairman will also consult with the Secretary of
the Treasury and the Chairman of the Federal Reserve, as
required by the Sarbanes-Oxley Act, and solicit recommendations
from other executive branch, Congressional, investor, academic,
and business community sources, and such others as the SEC
Chairman deems appropriate.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SANTORUM
FROM CHRISTOPHER COX
Q.1. You may know that I have sponsored, along with Senator
Allen and Senator Dole, S. 1396, a bill that would update the
definition of eligible portfolio company (EPC) under the
Investment Company Act of 1940. The House unanimously passed an
identical version twice (H.R. 3170 in the 108th Congress and
H.R. 436 in the 109th Congress).
Does the SEC agree the use of the Federal Reserve Board
definition of ``marginable security'' as a statutory standard
for what Business Development Companies (BDC's) can invest in
is outdated? If so, while the SEC has been given authority to
establish additional categories of companies that qualify for
treatment as an EPC, is not the only way to eliminate this
outdated standard through legislation striking the provision,
as is accomplished in the pending legislation? Does the SEC
oppose the pending legislation? If the SEC believes an
alternative approach should be considered, what is that
alternative approach?
A.1. We agree that the use of the Federal Reserve Board's
definition of ``marginable security'' as a means to define an
eligible portfolio company is outdated. As you know, that
definition was amended by the Federal Reserve Board so as to
make most securities marginable. Consequently, many companies
that previously met the definition of eligible portfolio
company may have lost their status as such.
As you know, the Commission has rulemaking authority to
establish alternative criteria to define eligible portfolio
company. Pursuant to that authority, the Commission proposed a
new rule to define eligible portfolio company under the
Investment Company Act. In developing the proposed rule, the
Commission was mindful of Congress's intent when it established
BDC's in 1980 that they should invest a significant percentage
of their assets in small, developing, and financially troubled
companies, largely defined as eligible portfolio companies.
Accordingly, the proposed rule was intended to realign the
definition of eligible portfolio company with that intent. The
Commission received 36 comment letters addressing the proposed
definition. Most commenters were concerned that the rule would
not include many of the small public companies that
historically would have met the definition of eligible
portfolio company before the margin rule amendments. Commenters
also suggested various alternative approaches. It is
anticipated that the Commission will take final action on this
rule in the near future.
The Commission has not taken a position on the legislation.
At the request of staff of the House Financial Services
Committee and the Senate Banking Committee, Commission staff
has provided technical assistance on the legislation.
Commission staff expressed its view that the legislation was
drafted very broadly. Among other things, it noted that the
legislation, if adopted, could actually result in BDC's
investing more of their assets in larger, well-established
companies. Consequently, there could be less BDC capital
available for small companies. The staff also noted its concern
that the legislation, by permitting BDC's to invest more of
their assets in larger, well-established companies, would make
BDC's more closely resemble registered closed-end investment
companies. The staff also noted that the legislation would not,
however, provide BDC shareholders with critical investor
protections available to shareholders of those other investment
companies.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR STABENOW
FROM CHRISTOPHER COX
Q.1. As I mentioned in my opening statement--the largest IPO's
this year have been from foreign companies. Although U.S. IPO's
continue to lead in total capital raised and number of deals,
foreign markets are emerging. Not only are foreign companies
offering larger equity deals around the world, but also foreign
companies are also holding our debt in greater amounts.
In your opinion, will this trend continue into the future?
And, how will the emergence of foreign-owned debt impact
domestic markets?
A.1. The opportunity for companies to access worldwide capital
is a positive trend that reflects the health of the U.S. and
the global equity market, and one that we expect to continue.
IPO's in the U.S. capital markets are the largest segment of
global IPO's, with $33 billion raised in 2005, and represent 20
percent of the global capital market activity.
While the number and size of IPO's in the United States has
dipped slightly in recent years, many smaller companies
continue to list on the NYSE and Nasdaq. In 2005, over 70
countries hosted IPO's of over $1 billion and the largest
offerings were conducted overseas. That so many foreign
companies chose to list their securities in foreign markets is
a welcome indication that the quality and liquidity of those
markets has increased and that accounting and corporate
governance standards are improving worldwide. However, as
globalization provides companies with a wider choice of markets
in which to raise capital, we have seen a decrease in multiple
listings as companies seek to reduce their costs.
The SEC has responded to foreign company concerns about
compliance with Sarbanes-Oxley requirements and their inability
to deregister with a number of initiatives intended to reduce
their compliance burdens while maintaining our high standards
of investor protection. Among these initiatives is a proposal
to facilitate the ability of foreign issuers to terminate their
SEC reporting obligations when there is relatively little
interest in their securities among U.S. investors. Foreign
issuers also benefit from extended Section 404 internal control
deadlines and the SEC continued evaluation of these
requirements. Finally, the SEC supports efforts to converge
accounting standards, and I have stressed the SEC's commitment
to creating a ``roadmap'' for eliminating a requirement to
reconcile financial statements prepared using International
Financial Reporting Standards to U.S. GAAP.
With regard to how foreign-owned debt may impact domestic
markets, our capital markets are based on transparency of
information as it relates to many areas of disclosure. While
our rules require public companies, and significant investors
in those companies, to provide full disclosure of material
information related to the sale, purchase, and ownership of a
company's securities, our rules do not dictate who those
significant investors may or may not be. Any person or entity
that owns more than 5 percent of a public company's voting
securities must publicly disclose certain information,
including information regarding that person's intent in
purchasing the securities. Our rules also require a public
company to disclose information about that level of ownership
of its securities.
Other Federal and State agencies as well as U.S. exchanges
may regulate significant investments in public companies and
may have some policy role in whether the emergence of foreign
companies and foreign-owned debt impacts our markets.
Q.2. Recently, I came across a report that was conducted in
2004 by the Center for Medicare and Medicaid Services. The
report revealed that the government was paying 9.3 percent in
hospital overage charges. In Michigan, that percentage was even
higher, 13.6 percent. It was my understanding that Section 404
was intended to establish internal controls for healthcare
benefits--however, it seems that the current accounting
standards for employee benefits may have contributed to these
overage charges. I am concerned that the standards are not
being enforced or applied as intended.
Do you have any suggestions for improvements or do you
intend to rectify this issue in some other way?
A.2. The accounting standards related to employee benefits are
based on the premise that post retirement health care benefits
are part of an employee's compensation for services rendered.
Since payment is deferred until retirement, the benefits are a
type of deferred compensation. Under fundamental accrual
accounting, during the years that the employee renders the
necessary service the company accrues and reports the cost of
providing those benefits to the employee and to the employee's
beneficiaries and covered dependents. To estimate this cost,
the company must make several assumptions, including an assumed
discount rate to determine the present value of the future cash
outflows currently expected to be required to satisfy the post-
retirement benefit obligations. The primary accounting
standards body in the United States, the Financial Accounting
Standards Board (FASB), currently has a two-phase project
underway to improve the reporting of these and other related
post-retirement benefits. The first phase involves recognition
of the overfunded or underfunded status of defined post-
retirement plans as an asset or liability on a company's
balance sheet. The second phase will be a more comprehensive
reassessment of pension and post-retirement accounting. These
accounting rules may vary, however, for government-owned
hospitals, which are not subject to the Commission's reporting
requirements.
Section 404 of the Sarbanes-Oxley Act of 2002 requires
certain public companies to report to shareholders on the
effectiveness of their internal controls over financial
reporting. This reporting requirement should provide reasonable
assurance to investors that a company's financial records
appropriately reflect the costs of health care benefits as
calculated under the existing accounting standards. The
Commission currently is reviewing alternatives to make this
reporting more efficient and effective. This reporting
requirement, however, does not apply to privately held or
government-owned hospitals and medical facilities.
As noted above, the Commission and FASB are reviewing how
to improve both the accounting for health care benefits and
reports on companies' internal controls over financial
reporting. Although we are not aware of any direct link between
these requirements and hospital overage charges, we will be
alert to such issues as we proceed.