==========================================START OF PAGE 1====== TESTIMONY OF ARTHUR LEVITT, CHAIRMAN U.S. SECURITIES AND EXCHANGE COMMISSION CONCERNING APPROPRIATIONS FOR FISCAL YEAR 1997 BEFORE THE SUBCOMMITTEE ON COMMERCE, JUSTICE, AND STATE, THE JUDICIARY, AND RELATED AGENCIES OF THE HOUSE COMMITTEE ON APPROPRIATIONS May 9, 1996 Chairman Rogers and Members of the Subcommittee: I appreciate this opportunity to testify in support of the Securities and Exchange Commission's (SEC or Commission) fiscal 1997 budget. The President's request for the SEC includes $308.2 million in fiscal year 1997. This request would put the Commission on a "no-growth" budget: it would allow for an increase of only $10.8 million above the funding appropriated to the Commission in fiscal year 1996. Most of that increase would go to fund mandatory increases in pay and related personnel benefits. The proposed appropriation would thus permit the SEC to maintain staffing at the 1996 level of 2,797 "full-time equivalents" (FTEs), but would also require the agency to stretch its resources to the maximum in order to adequately fulfill its responsibilities to investors in the rapidly expanding U.S. securities markets. Mindful that we are operating in an era of fiscal restraint, the Commission is willing to take on that challenge. (Indeed, the agency has already begun to reallocate existing resources to focus on certain critical tasks. For ==========================================START OF PAGE 2====== example, we are centralizing certain regional office disclosure functions in order to devote more personnel to the understaffed investment adviser examination program without increasing overall staff size.) Before discussing in greater detail the SEC's activities and projected budget needs, I would like to take this opportunity to thank Chairman Rogers, who, together with Chairmen Bliley, Archer, and Fields, worked hard to develop a workable, long-term funding structure for the SEC. Your approach, incorporated into H.R. 2972, the House-passed SEC authorization bill, would reduce SEC filing fees over five years while at the same time providing the agency with a stable funding mechanism. The Commission appreciates your efforts and believes that the approach embodied in H.R. 2972 would put SEC funding on a firm footing as we enter the 21st century. Role of the SEC The SEC performs an essential function: overseeing the fast-moving U.S. capital markets, worth trillions of dollars, that fuel the U.S. economy. Our country's securities markets are widely regarded as the deepest, most liquid, and fairest markets in the world. They serve the needs of almost 13,000 public corporations,1 raising capital to support new industries, finance operations, create jobs, fund research and development, and support growth for the future. In 1995 alone, some $900 billion worth of securities were sold in our markets. Capital ==========================================START OF PAGE 3====== was raised directly from both institutional investors (including mutual funds and pension funds) and private individuals. One in three American households participates in the U.S. securities markets, directly or through mutual funds; indeed, mutual fund assets now outstrip commercial bank deposits, and Americans have more household wealth invested in stocks than in real estate. Thus, the U.S. securities markets serve not only as a powerful engine for capital formation but also as an important vehicle for savings and investments by U.S. citizens. The Commission plays a vital role in preserving the strength and integrity of these markets. Since its creation in 1934, the Commission has been charged with protecting investors and maintaining fair and orderly markets. It is first and foremost a law enforcement agency. It fulfills its statutory mandate by policing fraud in the securities markets as a whole, requiring full disclosure by issuers of securities, overseeing the regulation of the nation's securities markets, and directly regulating the investment company and investment adviser industries. By protecting market integrity and fairness, the SEC's enforcement and regulatory programs foster the continued success of the U.S. capital markets. The SEC handles its broad mandate with a small staff of 2,797 FTEs. The agency is able to accomplish this objective by regulating, to a large extent, through a public-private partnership. The Commission takes responsibility for the "big picture" areas (e.g., fraud, financial responsibility of ==========================================START OF PAGE 4====== securities firms, and market structure) while much of the direct, day-to-day regulation of securities market participants is done by firms themselves and by industry self-regulatory organizations (SROs), under SEC oversight. This system of shared regulation between the SEC and industry is markedly different from the approach taken by other federal regulators, and allows an agency as small as the SEC to oversee markets that have grown to be worth more than $10 trillion. Market Growth To put the SEC's proposed appropriation in perspective, it has to be viewed against the backdrop of the dramatic growth and rapid change our markets have experienced over the past 15 years. Between 1980 and 1995, for example, the value of public offerings (including debt and equity, but not investment company securities) increased more than ten-fold, from $58 billion to $768 billion. Between 1990 and 1995, the dollar volume of equity securities traded on U.S. securities exchanges and NASDAQ grew 182%, with over $5.94 trillion traded in 1995. Volume continues to explode. December 15, 1995, was the heaviest trading day in the history of the New York Stock Exchange, with over 636 million shares trading hands. On NASDAQ, record daily volume was set on April 24, 1996, with volume exceeding 728 million shares. Over the last few months, there have been several instances in which daily share volume on all U.S. markets combined has exceeded one billion shares. ==========================================START OF PAGE 5====== Dramatic growth also has occurred with respect to assets under management by investment advisers. Between 1980 and 1995, assets managed by investment advisers (excluding investment advisers to registered investment companies) rose from $205 billion to $7.6 trillion (an increase of 3,607%). Over the same period, assets of investment companies increased 1,203% from $235 billion to $3.062 trillion. The numbers of securities firms and professionals registered with the Commission or with the SROs have also surged. Between 1980 and 1995, the number of registered advisers increased from 3,500 to 22,000 (an increase of 529%). The number of broker- dealers grew, over the same period, from around 5,200 to approximately 8,500 (an increase of 63%), and the number of registered representatives grew from 196,000 to over 505,000 (an increase of 158%). Technological change and internationalization also have had a significant effect on the U.S. securities markets. New and more complex financial products are rapidly evolving as a result of the continuing globalization of commerce and financial markets, and major advances in information processing and telecommunications. Investors are increasingly using electronic communications media to trade securities and obtain market information and advice. U.S. securities markets and firms have played a leading role in many of these changes. The Commission's responsibilities have expanded with the securities markets. The overall growth of the Commission's ==========================================START OF PAGE 6====== staff, however, has fallen far short of the rate of market growth. For example, while the Commission's staff grew at an annual rate of 1.9% from 1980 to 1995, the assets under investment company management grew at an annual rate of 18.7% over the same period, and the assets managed by investment advisers increased at an annual rate of 23.6%. Recent Commission Achievements and Ongoing Initiatives: Selected Highlights Today, the rapid growth of the U.S. securities markets (combined with increasing pressures on government resources) demands that the Commission function as efficiently as possible. It is not possible to describe all of the Commission's programs here; but the balance of this testimony will try to highlight some of the SEC's recent and ongoing achievements and its efforts to anticipate and respond to new market and regulatory challenges. Making Agency Structure and Processes More Efficient Over the past two years, the SEC has tried to streamline its own operations through such initiatives as: ú conducting a comprehensive review of the 60-year old statute (administered by the SEC) that governs public utility holding companies, and recommending legislative repeal of that Act; ú facilitating access to market information by providing increased public access to corporate filings on the Commission's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system, and by reevaluating and updating EDGAR to take advantage of new technology; ==========================================START OF PAGE 7====== ú revising the SEC's rules governing adjudications and administrative proceedings, to streamline the adjudicative process and allow speedier, more efficient completion of administrative proceedings; ú eliminating the need for prior review of certain self- regulatory organization rule filings; ú realigning the regional/district office structure to improve program accountability and resource utilization; ú reallocating existing resources to establish a new Office of Compliance Inspections and Examinations to conduct and coordinate examinations of brokers, dealers, SROs, investment companies and advisers, and transfer agents; and ú reallocating existing resources to create a new Office of Municipal Securities to provide technical expertise, coordination, and assistance in rulemaking and enforcement efforts affecting the municipal securities market. More recently, the Commission developed plans to centralize its small business disclosure function in SEC headquarters, phasing out its regional office disclosure function. This will allow the Commission to make better use of its scarce resources, permitting the Commission -- without an overall increase in staffing -- to add 38 new examiners to its investment adviser examination program. At the same time, the agency recognizes that the special needs of small businesses must be met. Accordingly, the Commission has developed plans to provide small business liaisons in each regional office, create a special small business review unit at headquarters, and add a small business area to the SEC's home page on the Internet. ==========================================START OF PAGE 8====== Promoting Capital Formation Today, companies need to raise more capital, and to do so more quickly, more easily, and more cost-efficiently than ever before. The SEC, accordingly, is taking concerted steps to streamline and promote the capital formation process without compromising investor protection. For example, the Commission has: ú introduced a new integrated disclosure system for small businesses, that standardizes and simplifies disclosure and reduces financial statement requirements for qualifying businesses; ú eliminated a number of financial schedules for domestic companies, thereby reducing their reporting costs; ú extended the availability of short form and shelf registration to smaller and newer issuers; ú increased the thresholds that govern when a company must register and report under the Exchange Act, thereby affording more small entities the opportunity to grow before becoming subject to those requirements; and ú provided a new exemption from federal registration requirements for issuers that comply with an exemption from qualification under the laws of California. The Commission's efforts in this area continue. Just two months ago, an internal SEC Task Force on Disclosure Simplification released a report proposing revisions to modernize and streamline the regulatory framework that governs corporate finance and accounting. The report is far-reaching: it recommends the elimination or modification of fully one quarter of the SEC rules, and one half of the forms and schedules, related to corporate finance. The Commission has already proposed one set of rule changes based on the Task Force report, ==========================================START OF PAGE 9====== and expects in coming months to propose eliminating or modifying dozens more rules and forms. Separately, the Commission's Advisory Committee on the Capital Formation and Regulatory Processes is also expected shortly to recommend further reforms of the registration and disclosure process -- perhaps including a shift from a securities registration system to a company registration system. Improving Disclosure In order to reduce the costs, while retaining the benefits, of the disclosure-oriented federal securities regulatory scheme, the SEC in recent years has sought to improve the usefulness of the information received by investors (by encouraging, among other things, "plain English" disclosure) while at the same time minimizing the regulatory costs and burdens imposed on issuers. For example, in the investment company area, the SEC has worked with the investment company industry and state securities regulators to develop the concept of a "fund profile." The initial pilot "profiles" took the form of standardized, short- form summaries accompanying the full-length prospectuses; they were designed to enable mutual fund investors to better understand what they are buying. Pilot profiles of this sort have been available from eight fund groups since August 1, 1995, and have received very positive investor reaction. The Commission also continues to take steps to bring the filing and dissemination of disclosure documents into the ==========================================START OF PAGE 10====== electronic era. Almost all issuer filings with the SEC are now submitted electronically through the Commission's EDGAR system. In September 1995, the Commission launched its own Internet Web site, following up on a National Science Foundation initiative funded by Congress. The SEC's "home page" contains SEC releases and announcements, investor information, and EDGAR filings, updated on a daily, 24-hour delayed basis. In addition, the Commission has approved the issuance of two interpretive releases designed to encourage the use of electronic media in providing prospectuses and other disclosure documents to investors. In this rapidly developing area, the Commission and its staff will continue to support the development of various means of electronic delivery of information to investors and the market. Promoting the International Competitiveness of U.S. Markets The integrity as well as the depth of the U.S. securities markets have attracted increasing numbers of foreign issuers and investors and have made our markets preeminent in the world. This continuing internationalization is beneficial for U.S. markets and investors alike: it promotes the leading position of the U.S. markets and gives U.S. investors a broader array of investment choices within the strong disclosure and investor protection framework of the U.S. markets. The Commission has sought to promote the international competitiveness of the U.S. markets (while safeguarding their transparency and fairness), through initiatives to streamline ==========================================START OF PAGE 11====== registration, reporting, and reconciliation requirements for foreign companies; permit, in cross-border offerings, the use of certain international accounting standards; and streamline financial statement disclosure requirements for both foreign and domestic issuers with respect to acquired foreign businesses. Due in part to these and related efforts, foreign issuers are increasingly turning to the U.S. markets to raise capital. As of March 29, 1996, 768 foreign reporting companies representing 46 countries were registered with the Commission. The Commission is also devoting considerable time and effort to working with the International Accounting Standards Committee to develop high quality international accounting standards that could be used in cross-border offerings and listings. Law enforcement The Commission continues to pursue its traditionally vigorous enforcement program in a time of increased caseloads and scarce resources. In the past two years, the Commission has brought almost 1,000 enforcement actions against approximately 2,200 defendants and respondents.2 Recent notable cases have involved domestic and international insider trading, Ponzi schemes, government securities trading fraud, misleading disclosure, kickbacks or conflicts of interest relating to municipal securities offerings, broker-dealer sales practices abuses, prime bank notes, and unregistered securities offerings over the Internet. For example: ==========================================START OF PAGE 12====== ú In the Matter of PaineWebber Incorporated. In this case involving the sale of partnership interests, PaineWebber consented to a cease and desist order requiring it to comply with its representation that it had paid or would pay $292.5 million to defrauded investors, and requiring payment of a $5 million civil penalty. ú Orange County Actions. In the wake of the financial collapse of Orange County, California, the Commission brought enforcement proceedings against Orange County, its former treasurer, and others. In addition, the Commission issued a Report of Investigation concerning the conduct of individual members of the County Board of Supervisors.3 The proceedings concern the fraudulent offer and sale of over $2.1 billion in municipal securities issued in 1993 and 1994. ú SEC v. Qualified Pensions, Inc. This enforcement action involves the misappropriation of approximately $11.4 million that was to have been maintained in Individual Retirement Accounts and other retirement plans. More than 14,500 individuals allegedly were induced to transfer at least $270 million of their retirement savings to be administered by QPI; much of that amount was put into unsuitable investments. ú SEC v. Nicholas Rudi. The Commission alleges that more than $300,000 in kickbacks were paid to a financial adviser in connection with the offering of debt securities by New Jersey's Camden County Municipal Utilities Authority. Three individuals have consented to injunctions, and agreed to pay a total of $347,000 in disgorgement and prejudgment interest. The case has been stayed as to another individual, pending the outcome of criminal proceedings, and is still pending as to an advisory firm under that person's control. Examinations Investment adviser inspections present a continuing challenge for the Commission. Today, investment advisers (excluding investment advisers to mutual funds) are responsible for managing almost $7.6 trillion of investor assets, sixteen times the figure of ten years ago. Unfortunately, while investors have entrusted more and more of their savings to the ==========================================START OF PAGE 13====== care of investment advisers, the SEC's inspection resources have not increased commensurately. As a result, at present, the SEC inspects the 8,000 higher-risk investment advisers with custody of or discretionary management authority over client assets only once every 8-10 years, on average. The remaining 13,000 advisers are currently inspected only on a "for cause" basis or in geographic sweep examinations conducted with the state securities regulators; as a result, such advisers are inspected, on average, only once every 44 years. In the current budgetary environment, the Commission has sought to develop alternative approaches to shortening the inspection cycles for investment advisers. One such approach -- currently embodied in S. 148, a bill introduced last year by Senator Gramm -- would be to change the existing regulatory scheme through legislative action. If Congress delegated responsibility for the regulation of smaller advisers to state regulators, the SEC could focus its efforts on larger investment advisers, i.e., those who have the most assets under management. These advisers tend to have business activities that cross many state lines and affect national markets. The states, in turn, could regulate and examine smaller advisers, who tend to have community-based business and, therefore, are best regulated at the state level. Because this approach would require legislative action to implement, the SEC has also sought other ways to improve the efficiency of its examinations: shifting resources within the ==========================================START OF PAGE 14====== agency (as discussed above, p. 6), and increasing the coordination of regulatory examinations with other federal, state, and foreign regulators. Through these efforts, the SEC expects to further reduce the inspection cycle for higher-risk advisers to once every five years. Investor outreach In 1995, approximately 17% of all agency enforcement investigations were initiated, at least in part, on the basis of investors' complaints to the SEC. Over 42,000 complaints and inquiries were handled by the SEC's investor education and assistance staff. One of the best ways to prevent fraud, and minimize the need for enforcement actions, is to educate investors so they are better able to protect themselves. The Commission and its Office of Investor Education and Assistance have made concerted efforts to reach out to investors through "town meetings," seminars, its home page on the World-Wide Web, focus groups, and other innovative means. The SEC has launched an important initiative to promote the use of "plain English" throughout the agency and the securities industry. Working with the industry and many of its trade associations, the SEC has also prepared and distributed brochures that provide self-protection tips for investors about choosing investment professionals, information on mutual funds, and the settlement of securities trades. In other outreach efforts, the Commission has established an automated telephone ==========================================START OF PAGE 15====== information line that provides investors with basic information and the ability to order educational materials, and has sought to involve investors in SEC rulemaking by publicizing new rule proposals through the electronic media and other nontraditional channels. Other Current Projects The Commission continues to pursue a large number of additional projects related to its oversight of the capital markets, its full disclosure program, and its enforcement of the federal securities laws generally. For example, as part of its effort to enhance market transparency and fairness, the Commission recently proposed order handling rules that are intended to improve the execution of customer orders across all equity markets. The Commission also recently proposed amending its rules in order to streamline and simplify SEC anti- manipulation regulation of securities offerings, without compromising or diminishing important investor protections. In another closely watched area, the Commission's staff in 1994 and 1995 reviewed derivatives-related disclosures by over 500 registrants and considered findings published by various public and private sector organizations to evaluate the effectiveness of existing disclosure requirements and practices with respect to derivatives activities and related market risks. Following up on that review, the Commission at the end of 1995 released for comment proposed amendments to its financial ==========================================START OF PAGE 16====== disclosure rules, designed to help investors better assess the market risks faced by public companies and how those risks are managed. The Commission also continues to receive reports from the members of the private-sector "Derivatives Policy Group" (a group which, with encouragement from the Commission, undertook to develop a framework for voluntary oversight of the over-the- counter derivatives activities of unregulated affiliates of securities firms). The Commission's staff is reviewing this information as part of the agency's financial responsibility and risk assessment program. ==========================================START OF PAGE 17====== Funding Structure The SEC is pleased with the support for the agency's mission evidenced in the President's 1997 budget request. However, the Commission is concerned that the request proposes to continue relying on increased fee collections. As you know, the SEC has been a net contributor to the U.S. Treasury, collecting more in fees than was necessary to cover its budget in every year since 1983. In recent years, the bulk of the SEC's funding has been generated through "offsetting collections," which have been produced by increasing the rate of the fee the SEC collects when securities are registered (the so- called Section 6(b) fee). These offsetting fee increases have been imposed through the appropriations process, and therefore have been in effect for only one year at a time. Over the past several years, both the SEC and members of Congress have expressed concern over the increasing rate of securities filing fees. Because the total fees collected by the SEC under the increased Section 6(b) filing rate so far outstrip the amounts appropriated to the agency, those fees could constitute a "tax" on capital formation. And because the fee increases are effective for only one year at a time, the SEC has lacked a stable and predictable, long-term source of funding. Controversy over these issues came to a head in the Fall of 1994 during the fiscal 1995 appropriations process. Indeed, the SEC came close to shutting down due to controversy over the appropriate funding mechanism for the agency. In the end, the ==========================================START OF PAGE 18====== Commission was funded in 1995 through yet another short-term funding solution. The President's budget for fiscal 1997 would provide a somewhat more stable funding mechanism than currently exists: it would create a permanent special fund that would cover much of the SEC's current budget needs. On the other hand, this approach would also provide for a permanent reliance on securities filing fees (and would impose a new fee on corporate bond transactions), as a means of funding the SEC and assuring a continuing flow of fees into the General Fund of the Treasury. Under this approach, projected fee collections for fiscal 1997 would exceed $776 million; of this total, only $308 million (or 40%) would go to fund SEC operations, and the other $468 million would be paid into the General Fund. Last summer, Chairman Rogers and his staff, together with Chairmen Bliley, Archer, and Fields, developed a new and different approach to the problem of SEC funding. This approach, embodied in H.R. 2972 as passed by the House, would reduce Section 6(b) fees over a five-year period and equalize the application of existing securities transaction fees. The SEC would also act to eliminate "user fees" that it now collects, pursuant to the Independent Offices Appropriations Act of 1952 (IOAA), in connection with the filing of certain types of applications, and reports such as 10-Ks. (IOAA fees currently account for only two percent of SEC revenue, but involve a disproportionately large effort and cost to administer.) Under ==========================================START OF PAGE 19====== H.R. 2972, the SEC would gradually move from reliance on increased offsetting fees towards full appropriation status. Earlier this year the Commission endorsed this approach; the agency continues to believe that it could provide a long-term solution to the SEC's funding problems. Conclusion The Commission recognizes that this is an era of fiscal restraint and low budgetary growth. The SEC has put a high priority on working within that context to achieve greater efficiencies: the agency has taken significant steps to streamline its own operations, to reallocate existing resources to the most essential functions, and to take advantage of new technologies. In short, the Commission has tried hard to meet the challenge of operating as effectively and as frugally as possible, and will continue those efforts under the budget proposed for fiscal 1997. But the Commission also urges Congress to recognize that the U.S. securities markets have been growing at an extraordinary pace -- and so, too, have the SEC's responsibilities. More individuals than ever before rely on the markets to generate the income they need for education and retirement; more firms are turning to the markets to finance their operations, create jobs, and support their future growth. The volatility of the markets, continuing technological change, the development of complex new financial products, and the globalization of the markets also ==========================================START OF PAGE 20====== place new demands on the SEC. And further out on the horizon loom vast future challenges -- for example, the proposed privatization of the Social Security system, which would bring huge new inflows of money and investors to the already dynamic U.S. markets. In order to continue the Commission's excellent record of effective law enforcement, market oversight, and investor protection in 1997, the SEC will need funding at least at the level requested today -- as well as a long-term funding mechanism. The Commission looks forward to working with the Subcommittee in its continuing efforts to provide stable and sufficient funding for the SEC. ==========================================START OF PAGE 21====== ENDNOTES 1. This figure does not include the roughly 5,000 registered investment companies (representing over 23,000 separate portfolios) that also raise capital in the U.S. markets. 2. It is not clear what impact the recently-enacted Private Securities Litigation Reform Act of 1995 (Pub. L. No. 104- 67) will ultimately have on the Commission's law enforcement responsibilities. President Clinton has asked the Commission to report by year-end on how the Act affects the agency's programs. We are currently monitoring developments in this area, in addition to carrying out the Act's mandate to study protections for senior citizens and qualified retirement plans. Without knowing more about the Act's impact, and recognizing the need for fiscal restraint throughout government, we are not requesting additional resources in connection with the Litigation Reform Act at this time. 3. In the Matter of County of Orange, California, As It Relates to the Conduct of the Members of the Board of Supervisors, Exchange Act Release No. 36761 (Jan. 24, 1996).