Today, SEC Chairman Mary Schapiro testifies before the U.S. Senate Committee on Appropriations’ Subcommittee on Financial Services and General Government. A copy of her prepared testimony is available here. Key sections of her testimony are laid out below:
»»REINVIGORATING SEC ENFORCEMENT
Our Division of Enforcement has been working diligently. Since the end of January,
• We have filed at least 34 emergency temporary restraining orders. During roughly the same period last year, we filed 12.
• We have opened more than 358 investigations. During roughly the same period last year, we opened 292.
• The Commission has issued at least 188 formal orders. During roughly the same period last year, the Commission issued 74.
Since January, we have brought a number of important and complex cases. For example, in the Reserve Fund matter filed in May, we charged certain operators of the Reserve Primary Fund, a $62 billion money market fund whose net asset value fell below $1.00 or “broke the buck” last fall, with fraud for failing to provide key material facts to investors and trustees about the Fund’s vulnerability as Lehman Brothers Holding, Inc., sought bankruptcy protection. As part of this action, we are seeking to bring about an expedited, efficient, and equitable pro-rata distribution to shareholders of the Fund’s remaining assets, including $3.5 billion originally set aside in the Fund’s litigation reserve.[i] We believe this will help Reserve Fund investors recover a larger share of their assets.
In March, we initiated a case alleging fraud in connection with a kickback scheme involving New York’s largest pension fund. Namely, we charged New York’s former Deputy Comptroller and a top political advisor with extracting kickbacks from investment management firms seeking to manage the assets of the New York State Common Retirement Fund. Since March, we have amended the complaint to add additional defendants, including a former New York state political party leader, a former hedge fund manager, a Dallas-based investment management firm and one of its founding principals, and a Los Angeles-based “finder.”[ii]
As committed as we are to vigorous enforcement of the securities laws, we are also mindful that the complexity of 21st century markets, as well as the varied nature of frauds and scams, require that the sophistication and tools available to our Enforcement and Examination programs keep pace. Important questions have been raised concerning the agency’s handling of tips or whistleblower information related in particular to the activities of Bernard Madoff. Clearly this is something we must learn from, and I am committed to addressing it. Former Chairman Cox asked the SEC Inspector General to look into what happened, what failed to happen, and to report back to the Commission. We expect to receive the IG report this summer and will promptly take all appropriate actions and address any remaining shortcomings.
It is clear that, regardless of any findings of the Inspector General, the agency must improve its ability to process and pursue appropriately the hundreds of thousands of tips and referrals it receives annually. In February, we retained the Center for Enterprise Modernization which began work immediately on a comprehensive review of internal procedures to evaluate tips, complaints, and referrals. We are in the process of creating a system that will centralize this information so we can track it, analyze it and more effectively identify valuable leads for potential enforcement action and compliance exams.
The financial crisis has reminded us just how large, complex, and critical to our economy the securities markets have become in recent years. Whereas the dollar value of the average daily trading volume in stocks, exchange-traded options and security futures was $10 billion a day in February 1989, over the last 20 years it has grown to over 25 times that size, reaching approximately $251 billion a day in February 2009. And not only has the size of our markets exploded, the number and size of its participants have jumped as well. For example, since 2005, the number of registered investment advisers has increased by 32 percent, and their assets under management have jumped by over 70 percent to reach more than $40 trillion as of the beginning of this fiscal year. Broker-dealer operations have expanded significantly in size, complexity, and geographical diversity, as exemplified by the 67 percent rise in the number of broker-dealer branch offices. In all, the SEC’s 3,652 staff now oversee more than 35,000 registrants, including about 12,000 public companies, 8,000 mutual funds, 11,300 investment advisers, 5,500 broker dealers, and 600 transfer agents. By comparison, other financial regulators often have close to parity between the number of staff and the number of entities they regulate. For additional detail, attached to this testimony is an appendix, “SEC Staff Levels Have Not Kept Pace with Industry Growth.”
Yet at the same time that the securities markets have undergone such tremendous growth, the SEC’s resources have fallen further and further behind. Between FY 2005 and FY 2007, the agency experienced three years of flat or declining budgets, losing 10 percent of its employees and severely hampering key areas like our enforcement and examination programs. In the context of rapidly expanding markets, I believe these reductions in the SEC’s staff seriously limited the agency’s ability to effectively oversee the markets and pursue violations of the securities laws.
With support from this subcommittee, during the last two fiscal years, the SEC has been able to lift its hiring freeze and begin rebuilding its workforce. By increasing the SEC’s appropriation for this fiscal year, approving a reprogramming of additional resources, and just recently supporting emergency supplemental funds for the agency, this subcommittee has expressed its strong support for the SEC and its mission. I am very grateful for that support.
However, even with these important steps, the number of staff with which the SEC can detect fraud, prosecute wrongdoing, ensure proper disclosure, conduct strong oversight of the markets, and take other actions to protect investors, is still significantly below the levels of only a few years ago. Under the SEC’s current funding level, the agency’s workforce still will fall about 200 staff, or about 5 percent, short of the FY 2005 level.
I believe additional resources are essential if we hope to restore the SEC as a vigorous and effective regulator of our financial markets. The President is requesting a total of $1.026 billion for the agency in FY 2010, a 7 percent increase over the FY 2009 funding level. This proposal would permit the SEC to fully fund an additional 50 staff positions over 2008 levels, enhance our ability to uncover and prosecute fraud, and begin to build desperately needed technology.
Specifically, these positions would help the SEC’s Enforcement program enhance its pursuit of tips, complaints and other leads, thus increasing the resources the SEC can dedicate to frauds that citizens bring to our attention. They would also allow us to hire more trial lawyers and staff with specialized skills that will help our Enforcement program’s efficiency, expertise and success. The Examination program would hire market experts to strengthen risk-based oversight of the investment management industry and expand its inspections of credit rating agencies. Our Division of Trading and Markets would strengthen its oversight of entities that play critical roles in our markets, such as broker-dealers, exchanges, clearing corporations, and other self-regulatory organizations. And the President’s Budget would allow us to expand our Office of Risk Assessment by fully funding our program to bring in seasoned industry professionals to help uncover hidden risks to investors.
Although expanding our workforce is a critically important step, I believe we also must give our staff better tools to conduct oversight of vast financial markets. That is why the President’s request for FY 2010 also contains funds for additional investments in our information systems. Investments in new systems have dropped by more than half over the last four years, and as a result the SEC has a growing list of technology needs that have gone unfunded. With the additional IT funds provided under the President’s Budget for FY 2010, I would plan to focus on several key projects:
First and foremost, we would use additional funds to enhance our systems for handling tips, complaints and referrals. Although the SEC has a number of different processes to track this kind of information, there is no central repository or system through which this information comes together to ensure it is handled consistently or appropriately. Nor is there any present capability to mine the data to find connections, patterns or trends that would enable us to more intelligently focus our enforcement efforts.
The SEC also plans to improve our ability to identify emerging risks to investors. We have many internal data repositories from filings, examinations, investigations, economic research and other ongoing activities. But the SEC needs better tools to mine this data, link it together, and combine it with data sources from outside the Commission to determine which firms or practices raise red flags and deserve a closer look.
Finally, we would invest in our multi-year efforts to improve the case and exam management tools available to our enforcement and examination programs. These systems would give our senior managers better information on the mix of cases, investigations, and examinations, so they can apply resources swiftly to the continually evolving set of issues and problems in the markets. In addition, these tools will provide better support for line staff in these programs, so they can be more productive and better able to match the sophisticated systems used by the financial industry.
I came to the SEC to shape public policy in the interest of investors and to strengthen our enforcement program. The things I have described in this testimony are important to those efforts. But what I have also discovered in the past four months is that much attention needs to be focused on the internal operations of the agency, the processes that guide our work, the agency’s infrastructure and how we are organized. I have been disappointed to find that in some areas of our internal operations, we fall short of what the taxpayer has a right to expect of us, and what our employees have a right to expect of a world class organization. I am committed to a complete review of areas large and small, including FOIA operations, call centers operations, records management, and others, to ensure that we meet the highest standards and that we are fully supporting the important work of our employees in these operations. Doing this will take time and energy and focus. To ensure that we do it well and thoroughly, I intend to bring in a Chief Operating Officer to manage the process. Federal agencies do not manage themselves; we must be actively engaged in that process everyday.
In one area, we have already made progress: we are moving to build an internal compliance program that is second to none. The public appropriately holds the SEC to a very high standard for integrity and professionalism, and we hold ourselves to that very high standard as well. That is why I have initiated several steps to guard against inappropriate securities trading by SEC staff, as well as to avoid any appearance of inappropriate trading. Among other steps, the agency has drafted new internal rules that would prohibit staff from trading in the securities of companies under SEC investigation, regardless of whether an employee has personal knowledge of the investigation, and require preclearance of all trades. The SEC also is contracting with an outside firm to develop a computer compliance system to track, audit and oversee employee trades and financial disclosures in real time. Finally, I consolidated responsibility for this area within our Ethics Office and authorized the hiring of a new chief compliance officer. To further enhance the SEC’s financial controls, the agency also will continue its multi-year efforts to build an automated, integrated financial management system.