<DOC>
[106th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:58512.wais]
THE IMPACT OF MARKET VOLATILITY ON SECURITIES TRANSACTION FEES
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCE AND HAZARDOUS MATERIALS
of the
COMMITTEE ON COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
JULY 27, 1999
__________
Serial No. 106-41
__________
Printed for the use of the Committee on Commerce
U.S. GOVERNMENT PRINTING OFFICE
58-512 CC WASHINGTON : 1999
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
James E. Derderian, Chief of Staff
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Finance and Hazardous Materials
MICHAEL G. OXLEY, Ohio, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana EDOLPHUS TOWNS, New York
Vice Chairman PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania ELIOT L. ENGEL, New York
CHRISTOPHER COX, California DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California BILL LUTHER, Minnesota
GREG GANSKE, Iowa LOIS CAPPS, California
RICK LAZIO, New York EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois RALPH M. HALL, Texas
HEATHER WILSON, New Mexico FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Brodsky, William J., Chairman and CEO, Chicago Board Options
Exchange................................................... 5
Cader, Andrew, Senior Managing Director, Spear, Leeds &
Kellogg, on behalf of the Specialist Association of the New
York Stock Exchange........................................ 10
Kearney, Arthur J., Director of Equity Capital, John G.
Kinnard & Co., on behalf of Security Traders Association,
accompanied by Lee Korens, President and CEO, Security
Traders Association........................................ 19
Nelson, Stephen J., Vice President of Special Projects,
Herzog Heine Geduld, on behalf of Securities Industry
Association................................................ 14
Material submitted for the record by:
Securities and Exchange Commission, prepared statement of.... 40
(iii)
THE IMPACT OF MARKET VOLATILITY ON SECURITIES TRANSACTION FEES
----------
TUESDAY, JULY 27, 1999
House of Representatives,
Committee on Commerce,
Subcommittee on Finance and Hazardous Materials,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2322 Rayburn House Office Building, Hon. Michael G. Oxley
(chairman) presiding.
Members present: Representatives Oxley, Largent, Lazio,
Shimkus, Fossella, Blunt, Towns, Engel, DeGette, Barrett,
Luther, Pallone, and Rush.
Staff present: Brian McCullough, professional staff; Robert
Simison, legislative clerk; David Cavicke, majority counsel;
Linda Rich, majority counsel; and Consuela Washington, minority
counsel.
Mr. Oxley. The subcommittee will come to order. The Chair
will recognize himself for an opening statement.
The Dow average has been closing near or above 11,000
points in recent weeks. When I became chairman of this
subcommittee at the start of 1997, I remarked how unprecedented
the sustained growth in the markets had been. At that time we
thought it impressive that the Dow was approaching the 7,000
point barrier.
Remarkably, the trend has continued. Every week a new IPO,
a new Internet stock price going through the roof, and online
trading, bringing the markets directly into the homes of
individual investors. These are all positive benefits of one of
the strongest economic periods this country has ever enjoyed.
Our robust markets have translated into more jobs, better
services and better quality of life as they have kept our
economic engine going.
But with the good, we must also be prepared for the bad.
There is the possibility of inflation and therefore the
possibility of higher interest rates that could naturally
follow this economic boom.
Are there other potentially damaging effects of our recent
good fortune that we can prevent? We know the capital markets
have been good for investors, but could they be better, more
efficient than they are today?
Those are some of questions that will be discussed today.
One such question has to do with the effect of the record-
breaking performance of the securities markets on transaction
fees.
The impact that market volume has had on these fees has
gone largely unnoticed outside of those who directly pay the
bill. But it should not be overlooked. As more and more
Americans rely on investing in the markets for retirement
through work-sponsored retirement plans, IRAs and individual
stocks, these fees are paid indirectly by the investor. With
the growing importance of these savings mechanisms, it is
incumbent upon Congress to do everything possible to ensure
that our markets are operating at maximum efficiency.
In that regard, I am proud to say that this committee has
continued our commitment to improve our markets whenever
possible. This subcommittee has produced several legislative
efforts that will result in greater transparency in our
markets, that will benefit investors and market participants.
The most relevant legislative efforts to today's hearing is
a new fee structure enacted into law in 1996 under the
leadership of Chairman Bliley. The intention was to provide a
more stable funding structure for the SEC and reduce fees over
time to reflect the cost of running the agency. At the time,
total fee revenue collected was roughly $700 million, or more
than double the cost of funding the SEC. Last year, fee revenue
collected by the SEC was approximately $1.7 billion, more than
5 times the cost of funding the SEC, which again raises the
concern that these fees are an unnecessary tax on the investor.
This hearing will focus on the current status of the
application of securities transaction fees and their impact on
capital formation, the efficiency of the markets, investor
savings and any competitive disparity that may result from
these fees. Our witnesses will share their views on how these
fees impact their normal course of business and what the larger
implications for our economy might be. With this information,
we will be able to determine if this is an issue the Congress
should reexamine. Should the Commerce Committee decide to
reexamine the fee structure, there are several legislative
proposals which deal with this concern that we may wish to
discuss.
However, I would like to remind my colleagues and witnesses
that this is an oversight hearing only. We will not be
addressing any particular legislative proposal on this issue
today. I welcome our witnesses and look forward to their views
on this subject.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. John Shadegg, a Representative in Congress
from the State of Arizona
Thank you Mr. Chairman. I am pleased the subcommittee is addressing
today the collection of securities transaction fees and their impact on
the nation's equities markets. I share the concern held by Chairman
Oxley and other members of this subpanel regarding the skyrocketing fee
collections that have resulted from an unprecedented bull market over
the last several years. I commend the Chairman for his leadership on
this issue.
Currently, several securities fees are charged for various
activities associated with the equities markets. These fees are
intended to compensate for the operations of the federal securities
regulator, the Securities and Exchange Commission (SEC). The current
budget for the SEC is roughly $340 million, annually. However, the
projected revenue for securities fees in FY1999 is $1.6 billion.
Two of the more predominant securities fees are the Section 6(b)
registration fee and the Section 31 transaction fee. The Section 6(b)
registration fee is paid by corporations when they register new
securities for sale to investors. The rate of this fee is $200 per $1
million in securities sold, or \1/50\th of 1 percent. The Section 31
transaction fee, collected on the sale of corporate stock on exchanges
and the Nasdaq market, is currently at a rate of \1/300\th of 1
percent.
In 1996, Congress passed the National Securities Markets
Improvement Act which lowers the rate of these fees over 10 years. The
Section 6(b) fee will decline to \1/150\th of 1 percent or $67 per $1
million in 2007. The Section 31 fee will be reduced from \1/300\th to
\1/800\th of 1 percent in 2007. However, even with these reduced fee
rates, revenue from securities fees continues to increase, far
outweighing the SEC's annual budgetary needs to regulate the equities
markets.
These so-called ``user fees'' are, in fact, an unnecessary
burdensome tax on America's investors. I believe Congress must enact
legislation to further reduce the rate of securities fees and put an
end to this unfair tax on investors in the stock market. I look forward
to hearing from the witnesses assembled today to testify before this
subcommittee. In particular, I am interested to hear their thoughts on
the concerns some experts have regarding the reduction in fees and a
possible downturn in the market. Again, I thank the Chairman for
bringing this issue before the subcommittee today and I yield back the
balance of my time.
______
Prepared Statement of Hon. Vito J. Fossella, a Representative in
Congress from the State of New York
Thank you, Mr. Chairman. I want to start by thanking Chairman Oxley
for scheduling this important OVERSIGHT hearing. I know that the issue
of SEC transaction fees is one in which the Chairman has had a
longstanding interest, and I commend him for his leadership on this and
many other issues that are important to securities professionals and
investors in my district and across the United States. I share the
Chairman's commitment to addressing the issue of excessive Section 31
fees in a bipartisan, timely and meaningful fashion.
I also want to thank the witnesses for appearing today. These folks
and the industry they represent are an integral part of our economy--
they provide the oil which makes it possible for our economic engine to
continue running at peak efficiency. They help raise the capital
necessary for businesses to invest in new jobs and equipment, and they
are vital liquidity providers that help keep our secondary trading
markets vibrant.
As you will hear today, the government collected over $1.75 billion
in SEC fees last year, which is over five times the SEC's budget. The
SEC performs a crucial function, admirably I might add--of protecting
the integrity of the U.S. capital markets, and helping them remain the
deepest, most liquid and efficient in the world. Having said that,
there is simply no public policy rationale to justify such an absurd
amount of user fee collections. SEC fees have become a tax on capital
formation and on securities trading. This tax disproportionately
impacts areas such as my home, Staten Island, New York, which has one
of the largest concentrations of securities professionals in the
country.
I have introduced legislation, H.R. 1256, that would address this
issue, and I also want to thank Chairman Oxley for working with me and
other interested Members of this Committee to shed some light on this
growing problem. I also want to acknowledge the efforts of the lead
Democrat on the bill, Bob Menendez of New Jersey, who has worked
closely with me on this issue.
I am pleased that my bill now has 53 cosponsors from both sides of
the aisle, including conservatives, moderates and liberals--reflecting
what I believe is the essentially nonpartisan, nonideological nature of
this issue. I also want to thank my 20 colleagues on this Committee who
have joined as cosponsors of H.R. 1256. As Members may know, my
legislation would cap the amount of SEC fees at levels closer to what
was intended in 1996, when the various SEC fees were restructured. This
legislation is similar in approach to a bill that was scored as revenue
neutral by the CBO last year.
I am pleased to note that SEC Chairman Arthur Levitt recently told
this Subcommittee that he believes the most appropriate way to address
this problem is through a flexible cap--which is exactly the type of
approach embodied in my legislation. Nevertheless, I want to stress
that while I feel that my legislation represents the best approach, as
I have stated before, I would be fully supportive of any solution that
this Committee in its wisdom deems appropriate.
Once again, I want to commend Chairman Oxley for holding this
hearing, which I believe is an important step towards enactment of real
Section 31 fee relief. I understand that the Chairman is holding open
the option of holding a separate LEGISLATIVE hearing at a later date,
during which the Committee could explore the merits of specific
proposals to address the Section 31 fee issue. I will await such an
opportunity to discuss the details of my proposal, but it is my hope
that we will indeed be able to move forward towards a mark up of
legislation to provide American investors and securities professionals
with much-needed relief from Section 31 fees. Thank you, Mr. Chairman,
and I look forward to the testimony of this excellent panel.
______
Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
I would like to thank the Chairman of the Subcommittee for holding
this oversight hearing today. It is vital that this Committee maintain
a close eye on all aspects of our securities markets. As more Americans
invest their hard earned dollars in the markets for retirement, we must
ensure that the markets are as fair and efficient as possible. Concerns
have been raised that the revenue generated by securities transaction
fees has increased so quickly that it does not correspond with those
goals. Investors and businesses that rely on capital may actually be
disadvantaged by excessive transaction fees. That is money that could
be put to use elsewhere for more savings and investments.
This is not the first time that this Committee has dealt with the
fee structure. In 1996, Congress determined that the fee revenue
generated by the securities markets had grown to such a level that it
was a tax on investors. Fees needed to be reduced to more closely
reflect the SEC's budget. It was also determined that the SEC should
have a more sound funding structure. This accomplishes both goals.
After difficult negotiations with the Senate and the Administration, we
enacted changes to the fee structure as part of a larger securities
markets reform legislation. The intention was to save investors money
and eliminate the reliance on fee revenue to fund the SEC. Having spent
many hours working on that legislation, I have a special interest in
today's hearing.
In the 1996 Act, we applied transaction fees to NASDAQ traded
stocks for the first time to eliminate any competitive advantages they
had over exchange listed stocks. Removing competitive discrepancies is
good public policy. Unfortunately, it was impossible to anticipate the
explosive growth in the stock markets. Annual trading volume is
reported to be up nearly 50 percent over the last 2 years from the 1996
level. The impact of this dramatic increase has contributed largely to
the enormous level of total fee revenue being collected.
At the time we were considering the legislation in 1996, fee
revenue collected was double the cost of funding the SEC. There was a
consensus that this was a problem worthy of Congressional action.
Despite the intentions of that legislation, fee revenue being collected
has increased dramatically. With last year's total fee revenue of $1.7
billion collected--over 5 times the cost of funding the Commission--
this Committee may want to consider reexamining this issue.
The focus of the problem in 1996 was on the revenue being generated
by increases to the fee rate for securities registrations. We heard the
arguments, and agreed that it was a tax on capital formation. We
provided significant relief in the legislation for registration fees.
These changes will become more evident with each passing year as the
rate continues to decline.
Now, with transaction fees applied across the board to include
NASDAQ traded stocks, the issue is somewhat different. Combined with
the unprecedented level of market volume, the transaction fees are
generating far more revenue than was ever contemplated. This raises
serious public policy concerns when the laws we enact do not function
in the manner we intended.
Investors should not be paying more for a stock than its worth, nor
should they be paying excess fees that could be invested. I look
forward to learning how the transaction fees impact American investors,
the quality of our markets, and our economy. If these fees do pose
unnecessary burdens on our investors and capital markets, it may be an
issue that we need to reexamine.
______
Prepared Statement of Hon. Frank Pallone, a Representative in Congress
from the State of New Jersey
Thank you, Chairman Oxley. I want to commend you and Ranking Member
Towns for holding this important hearing on Section 31 fees. I know
that this Committee will carefully consider the facts regarding the
current SEC fee structure and hopefully move to change the law to bring
Section 31 fees in line with the needs of the Securities and Exchange
Commission. I believe this is an issue of importance to all savers and
investors. In the end, it is individual Americans who pay these fees.
The payment of excessive fees directly reduces their hard-earned
savings.
Excess Section 31 fee collections also have a negative impact on
financial firms located in New Jersey, many of whom are NASDAQ market
makers. For many, Section 31 fee payments have become quite onerous,
comprising a significant portion of their overhead. I note that today
we will hear from Steve Nelson from Herzog Heine Geduld, a New Jersey
firm and Mr. Kearney's group, the Securities Traders Association, which
also has many members in the State of New Jersey.
I have cosponsored H.R. 1256, the ``Savings and Investment Relief
Act of 1999,'' a fee cap bill introduced by Reps. Fossella (R-NY) and
Menendez (D-NJ) as well as H.R. 2441 ``The Fairness and Securities
Transaction Act'' cosponsored by Rep Lazio (R-NY) and Towns (D-NY)
which would lower the rate. Twenty-four members of this Committee have
collectively cosponsored both bills. Clearly something needs to be done
to correct this situation and I believe either approach, if properly
structured, could meet our policy concerns.
In closing, let me state that I strongly support full and ample
funding for the SEC. The Agency does an admirable, professional job and
should be given ample resources. However, the government should not
continue to collect fees that are five times in excess of what is
necessary to run the SEC.
Mr. Oxley. Let me now turn to our panel and introduce the
witnesses. Our first witness is Mr. William J. Brodsky,
Chairman and CEO of the Chicago Board Options Exchange, who has
been here in the past; Mr. Andrew Cader, Senior Managing
Director, Spear, Leeds & Kellogg of New York, on behalf of the
Specialist Association of the New York Stock Exchange; Mr.
Steve Nelson, Vice President of Special Projects for Herzog
Heine Geduld, on behalf of the Securities Industry Association;
and Mr. Art Kearney, Director of Equity Capital; and John G.
Kinnard & Company from Minneapolis, representing the Securities
Traders Association.
Welcome to all of you for appearing here today, and let us
begin with Mr. Brodsky.
STATEMENTS OF WILLIAM J. BRODSKY, CHAIRMAN AND CEO, CHICAGO
BOARD OPTIONS EXCHANGE; ANDREW CADER, SENIOR MANAGING DIRECTOR,
SPEAR, LEEDS & KELLOGG, ON BEHALF OF THE SPECIALIST ASSOCIATION
OF THE NEW YORK STOCK EXCHANGE; STEPHEN J. NELSON, VICE
PRESIDENT OF SPECIAL PROJECTS, HERZOG HEINE GEDULD, ON BEHALF
OF SECURITIES INDUSTRY ASSOCIATION; AND ARTHUR J. KEARNEY,
DIRECTOR OF EQUITY CAPITAL, JOHN G. KINNARD & CO., ON BEHALF OF
SECURITY TRADERS ASSOCIATION, ACCOMPANIED BY LEE KORENS,
PRESIDENT AND CEO, SECURITY TRADERS ASSOCIATION
Mr. Brodsky. Thank you, Mr. Chairman. I will ask to have my
testimony entered into the record.
Mr. Oxley. Without objection, all of the members' opening
statements as well as the witness' testimony will be made a
part of the record.
Mr. Brodsky. The Chicago Board Options Exchange is the
world's largest options exchange. We trade options on 1,300
stocks and over a dozen stock indexes, including the Standard &
Poor's 500 Index, the NASDAQ 100 and the Dow Jones Industrial
Average. Our volume has been averaging almost a million
contracts per day which accounts for 51 percent of all listed
options volume in the U.S. On behalf of the CBOE, I commend you
for holding this hearing on the transaction fees collected by
the SEC. As an organization whose products are subject to
transaction fees, and who represents market professionals who
pay such fees, we have a strong interest in bringing the fees
paid more into balance with the budget of the SEC.
Fees have been imposed on listed securities transactions
since the passage of the Securities Exchange Act of 1934 for
the purpose of funding the operations of the SEC, along with
fees such as those for registering securities. The legislative
history behind these fees does not show any intent by Congress
to use them as a general revenue source, but rather evidences
an intention to use the fees solely to defray the costs of
regulating the securities markets.
The amount of fees now collected, however, greatly exceeds
the SEC's budget. We believe that fees revenues in excess of
the SEC's budget represents a tax on capital which penalizes
investors and businesses and puts the U.S. Securities markets
at a competitive disadvantage. As you observed earlier, the
National Securities Improvement Act of 1996, or NSMIA,
restructured various fees with the intention of creating a
predictable funding source of the SEC and reducing, over time,
the fees collected by the SEC. This act was intended to bring
the SEC fee collections more into line with the level of funds
appropriated by Congress. This goal has been thwarted, however,
because of the market averages greatly increasing to levels
unforeseen in 1996, and trading volume has increased
substantially since that time. As a result, these collections
have increased significantly.
I will not go through the numbers that you have already
mentioned, only to say that waiting until fiscal year 2007 for
reductions will result in investors paying hundreds of millions
of dollars and maybe billions of dollars more in fees than
those needed to support the agency.
What I want to talk about next is why I am here and why the
options business is uniquely challenged in this area and where
we are seeking your help.
As the largest securities options exchange, we are
particularly disadvantaged by the imposition of these fees
which competitively injure us in a number of ways. First the
transaction fees applies to stock index options traded on the
CBOE that compete with stock index futures and options on stock
index futures traded on U.S. Futures exchanges, as well as off-
exchange derivatives markets such as swaps and over-the-counter
options. Stock index futures and options on stock index futures
and off-exchange derivatives are not subject to section 31 fees
at all.
This adds a competitive penalty for the use of exchange-
traded securities such as stock index options and places these
products at a substantial competitive disadvantage. Broad-based
stock index options compete directly with these products on the
futures exchanges. They are used by the same customers and are
employed for the same risk-shifting purposes.
As part of the decision whether to use an option or a
future for a particular strategy, a customer or trader will
evaluate the costs of both products to determine which will be
more effective. Because section 31 fees places the equivalent
of a transaction tax on exchange-traded securities such as
stock index options but not on stock index futures or options
on stock index futures, the fees can be a determining factor in
the decision of which product to select.
I implore Congress to remedy this disparity by eliminating
section 31 fees for broad-based stock index options so that
they can compete on a level playing field with economically
equivalent products. I think probably the best way to explain
this, Mr. Chairman, is because of the legislative accord that
goes back 17 years that is called Shad-Johnson, what you have
is a disparity where you have in the city of Chicago
economically equivalent products trading in 2 or 3 different
exchanges. One is being taxed by Federal law, and the other is
not.
And my favorite example would be--take an airplane ticket.
And if I said to my staff, you can fly American or United from
Chicago to Washington, and one has a Federal tax of $18 and the
other doesn't, which plane will they use when you hold them to
a standard of fiduciary responsibility of getting the best
price? And we have this anomaly that until now we really have
not had a forum to bring to your attention.
The second area is a complicated area that relates to the
option business, and that relates to what we call spread
strategies or other transactions that relate to multiple legs
of a transaction. And the way that this tax was structured,
when people used these strategies, they can be very expensive
based upon the way that the tax applies. And what we are asking
for in consideration by the committee is that the committee
look at the total transaction and not the individual legs of
the transaction.
I would be happy to go into this with you now or later or
with your committee staff, but it is in my testimony. It is
somewhat complex, but when this law was devised, options didn't
exist. Option strategies didn't exist, and the tax on option
strategies has created some very anticompetitive results which
I don't think that the committee intends. And I am happy to go
through it now but it is in my testimony.
In conclusion, I would say that aside from the relief that
I requested, the stock index options and the spread
transactions, we also favor an acceleration in the timetable
approved by Congress in 1996 for reducing section 31
transaction fees. A stepped-up timetable to reduce the fees as
soon as possible is justified by the unanticipated increase in
market activity which has resulted in significant overfunding.
The reduction would benefit all market participants, including
individual investors, pension funds, mutual funds, and market
professionals who provide customers with on-demand liquidity
and maintain orderly markets.
Consequently, we support the legislation such as H.R. 4269,
introduced last year, and recently introduced H.R. 2441, which
would reduce fees on securities transactions while maintaining
the full funding of the SEC.
I want to make very clear that we have no desire to do
anything that would limit or in any way threaten the
underpinning of the SEC's funding, but obviously the numbers
have become so compelling that there is an opportunity to
reduce the fees.
We are also aware that the introduction of H.R. 1256, which
would cap the transaction fee once a stated amount of revenue
has been collected in any given year--while we generally favor
anything that would reduce the burden of what we believe is an
unfair and unnecessary tax on investors, we believe that
reducing the percentage rate at which the fee is imposed on all
investors is a more equitable and easier-to-administer solution
to the problem than making the fee apply at its existing rate
to certain investors while making it not apply to others.
We also believe that a reduction in fees is more consistent
with the approach taken in NSMIA. NSMIA provided that the
transaction fee was reduced from \1/300\ of 1 percent to \1/
800\ of 1 percent in fiscal year 2007. While the act was
intended to bring SEC collections more in line with the level
of SEC funding appropriated by Congress, the gradual percentage
reduction has not been swift enough to prevent transaction fees
from greatly exceeding the levels envisioned during the
consideration of that act. Consequently, an accelerated
reduction in the percentage of fees is needed at this time.
Mr. Chairman, we commend you and the committee for your
recognition of this problem and look forward to working with
you to solve it. Thank you for giving me the opportunity to
present the views of the Chicago Board Options Exchange and
particularly how the impositions of section 31 fees hurts the
options markets. Thank you very much.
[The prepared statement of William J. Brodsky follows:]
Prepared Statement of William J. Brodsky, Chairman and Chief Executive
Officer, Chicago Board Options Exchange
I am William J. Brodsky, Chairman and Chief Executive Officer of
the Chicago Board Options Exchange (``CBOE''). I would like to present
CBOE's views on the transaction fees imposed by Section 31 of the
Securities Exchange Act of 1934.
The CBOE is the largest options exchange in the world. We trade
options on 1,300 stocks and over a dozen stock indexes such as the
Standard & Poor's 500 Index, the Nasdaq 100 Index, and the Dow Jones
Industrial Average. Our volume averages over 900,000 contracts per day,
which accounts for 51% of all the listed options volume traded on U.S.
securities exchanges. On behalf of the CBOE, I commend you for holding
a hearing on transaction fees collected by the Securities and Exchange
Commission. As an organization whose products are subject to
transaction fees, and who represents the market professionals who pay
such fees, we have a strong interest in bringing the fees paid more
into balance with the budget of the SEC.
Fees have been imposed on listed securities transactions since the
passage of the Securities Exchange Act of 1934 for the purpose of
funding the operations of the SEC, along with other fees such as those
for registering securities. The legislative history behind these fees
does not show any intent by Congress to use them as a general revenue
source, but rather evidences an intention to use the fees solely to
defray the costs of regulating the securities markets. The amount of
fees now collected, however, greatly exceeds the SEC's appropriated
budget. We believe that fee revenues in excess of the SEC's budget
represent a tax on capital which penalizes investors and businesses and
puts the U.S. securities markets at a competitive disadvantage.
The National Securities Markets Improvement Act of 1996 (NSMIA)
restructured various SEC fees with the intention of creating a
predictable funding source for the SEC and reducing, over time, the
fees collected by the SEC. NSMIA was intended to bring SEC fee
collections more in line with the level of funding appropriated by
Congress. This goal has been thwarted, however, because market averages
have greatly increased to levels unforeseen in 1996, and trading volume
has increased substantially since that time. As a result, actual
collections of transaction fees are significantly exceeding the levels
projected during consideration of NSMIA, and they are projected to do
so into the future. The revenue generated by Section 31 transaction
fees alone in fiscal year 1998 was $476 million, which exceeded the
SEC's entire appropriated budget of $315 million by $161 million. In
fiscal year 1999, total SEC fee collections are expected to exceed $1.6
billion, more than four times the Commission's appropriated funding of
$337 million. We strongly support adequate funding for the SEC, whose
regulatory program contributes to the strength and integrity of U.S.
securities markets, and would not want legislation to result in a
reduction of SEC appropriations. On the other hand, the transaction fee
has greatly exceeded revenue expectations since the passage of NSMIA
two years ago. The excess amount represents a hidden tax on all
investors. Waiting until fiscal year 2007 for a reduction in the
transaction fees will result in investors paying hundreds of millions
of dollars in fees over and above those needed to support the cost of
regulation.
As the largest securities options exchange in the world, we are
particularly disadvantaged by the imposition of transaction fees, which
competitively injure us in a number of ways. First, the transaction fee
applies to stock index options traded on the CBOE that compete with
stock index futures and options on stock index futures traded on U.S.
contract markets as well as with off-exchange derivatives such as swaps
and over-the-counter options. Stock-index futures, options on stock
index futures, and off-exchange derivatives are not subject to Section
31 fees. This adds a competitive penalty to the use of exchange-traded
securities such as stock index options and places stock index options
at a substantial competitive disadvantage. Broad-based stock index
options compete directly with stock index futures and options on stock
index futures. They are used by the same customers and are employed for
the same risk shifting purposes. As part of the decision whether to use
an option or a future for a particular strategy, a customer or trader
will evaluate the costs of both products to determine which will be
more cost-effective. Because Section 31 fees place the equivalent of a
transaction tax on exchange-traded securities such as stock index
options but not on stock index futures or options on stock index
futures, the fees can be a determining factor in the decision of which
product to select. I implore Congress to remedy this disparity by
eliminating Section 31 fees for broad-based stock index options so that
they can compete on a level playing field with economically equivalent
products.
Second, options traders often use multi-part strategies such as
spreads and straddles that involve multiple transactions as part of a
single trade. Each part of the trade is subject to Section 31 fees,
which, when combined, adds a significant cost to these strategies. For
example, a so-called box spread involves four simultaneous trades as
part of a single transaction. Each of the four trades is charged a
Section 31 fee. In the case of many box spreads, the impact of the
transaction fee is compounded by the fact that, although the spread as
a whole represents a market-neutral position used by market makers as a
financing technique, it is often the case that two parts of the spread
represent deep-in-the-money, high premium trades. This can cause the
transaction fee, which is based on the premium paid on the sell sides,
to be disproportionately high. This can act as a huge disincentive for
market makers to engage in these trades, thereby depriving the market
of added liquidity. I urge Congress to examine whether there are ways
to reduce the special burden that transaction fees place on box
spreads. For example, the fee could be calculated on the basis of the
average price of all the parts of the spread, which would reduce the
overall amount of the transaction fee for the strategy. We are ready to
work with you to find a way to ensure that multi-part trades such as
box spreads are not subject to a special, compounding cost from Section
31 fees.
In these and many other ways, Section 31 fees act as an expensive
surcharge on securities options. Our options markets are the best in
the world, offering both retail and institutional investors an
opportunity to reduce or transfer risk in an efficient manner. With
international competition from overseas derivatives markets and growing
competition domestically from new options markets and over-the-counter
derivatives, however, it is increasingly difficult to compete because
of the loadstone of transaction fees on our products.
Aside from the relief I have requested for stock index options and
box spreads, we also favor an acceleration of the timetable approved by
Congress in 1996 for reducing the Section 31 transaction fee. A
stepped-up timetable to reduce fees as soon as possible is justified by
the unanticipated increase in market activity which has resulted in
significant overfunding from fee collections. The reduction would
benefit all market participants, including individual investors,
pension funds, mutual fund investors, and the market professionals who
provide customers with on-demand liquidity and maintain orderly
markets. Consequently, we support legislation such as H.R. 4269,
introduced last year, and the recently introduced H.R.2441, which would
reduce fees on securities transactions while maintaining the full
funding of the SEC.
We also are aware of the introduction of H.R. 1256, which would cap
the transaction fee once a stated amount of revenue has been collected
in any given year. While we generally favor anything that would reduce
the burden of what we believe is an unfair and unnecessary tax on
investors, we believe that reducing the percentage rate at which the
fee is imposed on all investors is a more equitable and easier to
administer solution to the problem than making the fee apply at its
existing rate to certain investors, while making it not apply at all to
others.
We also believe that a reduction in fees is more consistent with
the approach taken in NSMIA. NSMIA provided that the transaction fee
would be reduced from \1/300\ of one percent to \1/800\ of one percent
in fiscal year 2007. While NSMIA was intended to bring SEC fee
collections more in line with the level of SEC funding appropriated by
Congress, the gradual percentage reduction has not been swift enough to
prevent transaction fees from greatly exceeding the levels envisioned
during consideration of NSMIA. Consequently, an accelerated reduction
in the percentage of the fees is needed.
We commend your recognition of this problem and look forward to
working with you to resolve the problem. Thank you for giving me the
opportunity to present the views of the CBOE and, particularly, how the
imposition of Section 31 fees hurts the U.S. options markets.
Mr. Oxley. Thank you, Mr. Brodsky.
Mr. Cader.
STATEMENT OF ANDREW CADER
Mr. Cader. Thank you, Chairman Oxley and members of this
subcommittee. I am Andrew Cader, I am Vice President and Member
of the Board of Directors of the Specialist Association of the
New York Stock Exchange. I am pleased to appear before you to
present the Association's views concerning the transaction fees
imposed by section 31. By way of further background, I am also
the Senior Managing Director of Spear, Leeds & Kellogg, the
largest specialist operation on the New York Stock Exchange and
the American Stock Exchange. Spear, Leeds also maintains a
significant presence as an over-the-counter market maker, and
clears trades for a number of smaller specialists and market
makers who are particularly adversely impacted by section 31
fees.
We are also ourselves members of and clear for many members
of the CBOE. I sit on the board of directors of the SIA, who
Steve Nelson is representing, and our over-the-counter group is
in fact in the same business as Herzog Heine Geduld and we are
members of the STA as well. So I think we have a broad
experience with all of the liquidity providers who are impacted
by this. As you may suspect, I have strong views on the topic.
The Specialist Association is comprised of 27 broker-dealer
firms which include all of the individual specialists of the
New York Stock Exchange. Our specialists are at the heart of
the auction market of the world's most active stock exchange.
The New York Stock Exchange's auction trading marketplace is
the mechanism through which the prices of stock listed on the
exchange are discovered and liquidity is provided to buyers and
sellers. We supply liquidity when necessary to the proper
operation of the market, acting as buyer or seller in the
absence of public demand to buy or sell in our respective
specialty stocks. We coordinate orderly trading in those
stocks.
Over 169 billion shares of stock were traded on the
exchange in 1998 in over 135 million transactions. Specialists
participated as principal, buying or selling for their own
accounts in 12.5 percent of those transactions, paying in
excess of $30 million in section 31 fees last year, an amount
we expect to increase to in excess of $40 million this year. A
total of $242 million was paid in section 31 fees in 1998 on
New York Stock Exchange transactions by all stock exchange
member firms and their customers.
Beginning the 1930's, the Federal Government through the
SEC has collected fees in respect to sales securities
registered under the Securities Act of 1933, the section 6(b)
fees, and, in respect to the sales effected in the trading
markets subject to regulation under the exchange act, section
31 fees. Although these fees were conceived as user fees to
defray the costs of Federal securities regulation, the amounts
collected have exceeded the cost of running the SEC ever since
1983. As will be discussed momentarily, those collected amounts
now surpass the SEC's budget by a factor of greater than 5.
In short, the section 6(b) and section 31 fees have become
a general tax on capital raising. Moreover, as I will discuss
in a moment, section 31 fees represent a tax imposed at a
particularly inopportune time in the life cycle of a
specialist's or market maker's capital and its deployment in
the marketplace.
Before going further, please let there be no
misunderstanding. We support continued full funding for the
SEC, an agency that has overseen our constantly growing,
remarkably fair and efficient markets, that raise new capital
and serve the public investor, contributing to our worldwide
reputation for fairness and integrity. What we object to is
misuse of the financing mechanism designed to compensate the
government for providing that funding--the section 31 fees,
through overcollection of the fee and application of the
proceeds to completely unrelated objectives.
When congressional appropriators began to increase the
section 6(b) fees annually in 1990, various Members of Congress
recognized that the fee increases amounted, in reality, to a
new tax because the amounts collected so significantly exceeded
the SEC's annual budget. In 1993, the House responded by
unanimously passing a bill that, after fiscal 1998, would have
required the SEC to set and collect fees for the exclusive
purpose of recovering for the government the cost of funding
the SEC's regulatory activities. No further action was taken on
that bill.
A similar effort was made by both Chambers of Congress in
1996, in the National Securities Markets Improvements Act, to
compel a slowdown and finally a reduction in the amounts of
section 6(b) and 31 fees collected. The basic idea of limiting
the section 31 fee to the cost of funding the SEC, however, has
proven to be very elusive.
In fiscal 1997, the SEC's collections from 6(b) and 31 fees
and all other sources grew to $990 million, significantly more
than 3 times the agency's budget of $305 million. To bring
transaction fees back into line with the cost of running the
SEC, a bipartisan bill was introduced in the House in 1998 to
cap section 31 fees. Another bill was introduced in the House
in that year that would have cut the section 31 fee in half
rather than capping it. These initiatives were cosponsored by
over 60 House members, and one or the other was endorsed by,
among many others, the STA, the Chicago and Pacific Stock
Exchanges, the Securities Industry Association, the NASD, the
Profit Sharing/401(K) Council, Americans for Tax Reform, the
National Taxpayers Union, Citizens for a Sound Economy, the
U.S. Chamber of Commerce, as well as the New York Stock
Exchange and our Association. Neither bill was voted upon.
More recently, two new bipartisan bills have been
introduced in the House to remedy the section 31 fee: H.R. 2441
and 1256 introduced by Representatives Lazio and Towns and
Representatives Fossella and Menendez respectively. Each have
garnered more than 30 cosponsors. In fiscal 1998, the SEC's fee
collections mushroomed to an astounding $1.78 billion. That is,
the SEC's fee collections amounted to 5\1/2\ times its $322
million budget.
Our colleagues of the Security Traders Association have
laid out in detail in their written testimony to the
subcommittee the history of how the section 31 fee has been
transformed from an SEC funding mechanism into a general tax
and the efforts of Members of the House and the Senate over the
last decade to return the section 31 fees to its original
purpose. We wish to associate ourselves with the STA's
recitation of that history and see no need to repeat or
elaborate upon it.
As things stand, the section 31 fee cannot be viewed as
anything but a tax on the sale of securities, a purpose for
which it was never intended. That tax, although levied in
relatively small increments, is creating a near billion dollar
drag on the capital markets. That drag on our markets
represents a cost paid by all investors, including the huge
number of individually small participants in mutual funds,
pension plans, and other forms of retirement accounts.
Moreover the section 31 tax is imposed at a particularly
inopportune time in terms of its ultimate effect on market
liquidity. Unencumbered by section 31 fees, revenue generated
by specialists and market makers and other liquidity providers
in securities transactions would in many cases be put to its
normal use and leveraged in a manner allowing those market
professionals to provide liquidity to the market in a multiple
exceeding many times the absolute amount of the revenue itself.
Thus, investors and the market in general lose more than simply
the amount of the section 21 fees themselves in terms of
sacrificed market liquidity.
We would also be wise to remember that we have had the
benefit of a thriving and competitive bull market for an
unprecedented number of years, as the chairman mentioned in his
opening remarks. During such times, the impact of measures
placing inappropriate burdens on capital formation and market
activity can be softened or blunted. As is often the case with
respect to ill-advised policy, it is only when market
conditions eventually decline and liquidity becomes more scarce
that the full brunt of a cloaked tax, such as the current
section 31 fees, will be felt by us all. This will be
particularly true to the extent that market prices might
stagnate or decline, but today's record volume levels remain
the norm.
In conclusion, general tax revenue is the objective of
other laws, not the exchange act. Congressional action to
restore the unintended tax now represented by the section 31
fee to its original purpose--to fund the operations of the SEC
and not for any other type of Federal expenditure, is long
overdue.
We applaud your inquiry into this matter and hope for a
solution in the near term. We would support any realistic
method of achieving the objective of bringing the revenue
collected from the section 31 fee back into line with the SEC's
annual budget.
The Association is thankful for the opportunity to express
our views on the section 31 fee. Thank you, Mr. Chairman. I
would be pleased to respond to any questions you or your staff
have now or later.
[The prepared statement of Andrew Cader follows:]
Prepared Statement of Andrew Cader, Vice President, The Specialist
Association of the New York Stock Exchange
Chairman Oxley, Members of the Subcommittee, good morning. I am
Andrew Cader, Vice President and member of the Board of Directors of
The Specialist Association of the New York Stock Exchange. I am pleased
to appear before you to present the Association's views concerning the
transaction fees imposed by Section 31 of the Securities Exchange Act
of 1934. By way of further background, I also am a Senior Managing
Director of Spear, Leeds & Kellogg, the largest specialist operation on
the New York Stock Exchange and American Stock Exchange. Spear Leeds
also maintains a significant presence in the over-the-counter market,
and clears trades for a number of smaller specialists and market makers
who are particularly adversely impacted by Section 31 fees. Therefore,
as you might suspect, I have strong views on today's topic.
The Specialist Association is comprised of 27 broker-dealer firms
which include all of the individual specialists of the New York Stock
Exchange. Our specialists are at the heart of the auction market of the
world's most active stock exchange. The Exchange's auction trading
marketplace is the mechanism through which the prices of stocks listed
on the Exchange are ``discovered'' and liquidity is provided to buyers
and sellers. We supply liquidity when necessary to the proper operation
of the market, acting as buyer or seller in the absence of public
demand to buy or sell in our respective specialty stocks. We coordinate
orderly trading in those stocks. Over 169 billion shares of stock were
traded on the Exchange in 1998 in over 135 million transactions.
Specialists participated as principal, selling for their own accounts,
in 12.6% of those transactions, paying in excess of $30 million in
Section 31 fees last year (an amount we expect to increase to in excess
of $40 million this year). A total of $242.6 million was paid in
Section 31 fees in 1998 on NYSE transactions by all NYSE member firms
and their customers.
Beginning in the 1930s, the federal government, through the
Securities and Exchange Commission, has collected fees in respect to
the sales of securities registered under the Securities Act of 1933
(``Section 6(b) fees'') and in respect to the sales effected in the
trading markets subject to regulation under the Exchange Act (``Section
31 fees''). Although these fees were conceived as user fees to defray
the costs of federal securities regulation, the amounts collected have
exceeded the cost of running the SEC ever since 1983. As discussed
below, those collected amounts now surpass the SEC's budget by a factor
of five. In short, the Section 6(b) and Section 31 fees have become a
general tax on capital raising. Moreover, as I will discuss in a
moment, Section 31 fees represent a tax imposed at a particularly
inopportune time in the life cycle of a specialist's or market maker's
capital.
Before going further, please let there be no misunderstanding. We
support continued full funding for the Securities and Exchange
Commission, an agency that has overseen our constantly growing,
remarkably fair and efficient markets that raise new capital and serve
the public investor, contributing to our worldwide reputation for
fairness and integrity. What we object to is misuse of the financing
mechanism designed to compensate the government for providing that
funding--the Section 31 fee--through over-collection of the fee and
application of the proceeds to completely unrelated objectives.
When Congressional appropriators began to increase the Section 6(b)
registration fees annually in 1990, various members of Congress
recognized that the fee increases amounted, in reality, to a new tax
because the amounts collected so significantly exceeded the SEC's
annual budget. In 1993, the House responded by unanimously passing a
bill that, after fiscal 1998, would have required the SEC to set and
collect fees for the exclusive purpose of recovering for the government
the cost of funding the SEC's regulatory activities. No further action
was taken on that bill. A similar effort was made by both chambers of
Congress in 1996 in the National Securities Markets Improvements Act,
to compel a slow-down and, finally, a reduction in the amounts of
Section 6(b) and 31 fees collected. The basic idea of limiting the
Section 31 fee to the cost of funding the SEC, however, has proven to
be very elusive.
In fiscal 1997, the SEC's collections from Section 6(b) and 31 fees
(and all other sources) grew to $990 million, significantly more than
three times the agency's budget of $305 million. To bring transaction
fees back into line with the cost of running the SEC, a bipartisan bill
was introduced in the House in 1998 to cap Section 31 fees. Another
bill was introduced in the House in that year that would have cut the
Section 31 fee in half rather than capping it. These initiatives were
cosponsored by over 60 House members and one or the other was endorsed
by, among many others, the Security Traders Association, the Chicago
and Pacific Stock Exchanges, the Securities Industry Association, the
NASD, the Profit Sharing/401(k) Council, Americans for Tax Reform, the
National Taxpayers' Union, Citizens for a Sound Economy, the U.S.
Chamber of Commerce, as well as the New York Stock Exchange and our
Association. Neither bill was voted upon. More recently, two new
bipartisan bills have been introduced in the House to remedy the
Section 31 fee problem. H.R. 2441 and 1256, introduced by
Representatives Lazio (R-NY) and Towns (D-NY), and Representatives
Fossella (R-NY) and Menendez (D-NJ), respectively, each have garnered
more than 30 cosponsors.
In fiscal 1998, the SEC's fee collections mushroomed to an
astounding $1.78 billion. That is, the SEC's fee collections amounted
to five and one-half times its $322 million budget.
Our colleagues of the Security Traders Association have laid out in
detail in their written testimony to the Subcommittee the history of
how the Section 31 fee has been transformed from an SEC funding
mechanism into a general tax and the efforts of members of the House
and Senate over the last decade to return the Section 31 fee to its
original purpose. We wish to associate ourselves with the STA's
recitation of that history and see no need to repeat or elaborate upon
it.
As things stand, the Section 31 fee cannot be viewed as anything
but a tax on the sale of securities, a purpose for which it was never
intended. That tax, although levied in relatively small increments, is
creating a near billion-dollar drag on the capital markets. That drag
on our markets represents a cost paid by all investors, including the
huge number of individually small participants in mutual funds, pension
plans, and other forms of retirement accounts.
Moreover, the Section 31 ``tax'' is imposed at a particularly
inopportune time in terms of its ultimate effect on market liquidity.
Unencumbered by Section 31 fees, revenue generated by specialists and
market makers in securities transactions would, in many cases, be put
to its normal use and leveraged in a manner allowing these market
professionals to provide liquidity to the market in a multiple
exceeding the absolute amount of the revenue itself. Thus, investors
and the market in general lose more than the simply the amount of the
Section 31 fees themselves in terms of sacrificed market liquidity.
We would also be wise to remember that we have had the benefit of a
thriving and competitive bull market for an unprecedented number of
years. During such times, the impact of measures placing inappropriate
burdens on capital formation and market activity can be softened or
blunted. As is often the case with respect to ill-advised policy, it is
only when market conditions eventually decline and liquidity becomes
more scarce that the full brunt of a cloaked tax such as the current
Section 31 fees will felt by us all. This will be particularly true to
the extent that market prices stagnate or decline, but today's record
volume levels remain the norm.
In conclusion, general tax revenue is the objective of other laws,
not the Exchange Act. Congressional action to restore the unintended
tax now represented by the Section 31 fee to its original purpose--to
fund the operations of the SEC, and not for any other type of federal
expenditure--is long overdue. We applaud your inquiry into this matter
and hope for a solution in the near term. We would support any
realistic method of achieving the objective of bringing the revenue
collected from the Section 31 fee back into line with the SEC's annual
budget.
The Association is thankful for this opportunity to express its
views on the Section 31 fee. Thank you, Mr. Chairman.
I would be pleased to respond to any questions you, other
Representatives, or your staff may have.
Mr. Oxley. Thank you, Mr. Cader.
Mr. Nelson.
STATEMENT OF STEPHEN J. NELSON
Mr. Nelson. Chairman Oxley, Congressman Towns, members of
the subcommittee, I am Steve Nelson, vice president of Herzog
Heine Geduld, a leading NASDAQ market maker. I am here today
representing the Securities Industry Association. Thank you for
inviting me to testify at this hearing on the subject of
securities transaction fees. This is a subject on which the
chairman of the full committee, Congressman Bliley, has been a
leader for a number of years and we are grateful to him for the
leadership he has provided.
Chairman Oxley, we commend and appreciate your interest in
the subject of today's hearing, and, more broadly, your
interest in fair, efficient, and internationally competitive
securities markets. We look forward to working with you on this
issue.
Congressman Towns, we are also grateful for the work you
have done to reduce regulatory burdens and reduce costs to
investors. We appreciate your continued interest and
involvement in issues affecting the securities markets.
We also wish to express our special gratitude to
Congressman Lazio, Congressman Fossella, and Congressman
Menendez for the leadership they have demonstrated on the
subject of SEC transaction fees.
We know that our markets have been made better and fairer
by the presence of a strong and effective Securities and
Exchange Commission. And because it is in our interest and,
more importantly, in the public interest to have an effective
SEC, the SIA has been a strong supporter of full funding for
the agency so it can carry out its important mission of
investor protection. Our support for legislation today to
reduce the excess fees charged to the industry, investors, and
issuers will still provide more in revenues than the budget of
the SEC.
NSMIA was adopted in 1996 with the goal of bringing fees
collected by the SEC more in line with the cost of running the
agency. But in 1996, no one anticipated the explosion of market
activity that has taken place over the past several years. In
particular, no one could have predicted the phenomenal
influence that online investors would have on equity markets.
The investing public has found a new way to participate in the
markets, and we believe at Herzog Heine Geduld that this is
only the beginning. Fees now paid by investors, issuers, and
the industry amount to 5 times the cost of running the SEC. We
do not believe it is in the interest of investors or in the
interest of our capital markets for these fees to so grossly
dwarf the regulatory costs involved.
The fees have a particularly profound impact on NASDAQ
market makers and on specialists in traditional exchanges who
perform similar functions. The market makers' business is
similar in many ways to that of the grocer who buys milk for 10
cents and hopes to sell it for 11. The section 31 fee is
particularly burdensome to a market maker because where the fee
exceeds the cost of regulation, it amounts to a tax on the
market makers' gross revenues. The fee must be paid, whether we
sell the milk profitably for 11 cents or at a loss for 9.
In the last several years, technological advances have
lowered transaction costs. These reduced costs have encouraged
more trading activity. We have larger share volume and even
larger trading volume but margins have also declined. We are
selling more milk but we are making less on each sale. As
transaction volume and market evaluations have increased, the
amount of fees collected under section 31 has ballooned. In
contrast, our profit margins have declined.
As a result, section 31 fees comprise an increasing share
of our gross trading revenues, even though the rate of the fee
has remained constant. Herzog Heine Geduld's payments of
section 31 fees currently amount to more than 3 percent of our
gross trading revenues. Market makers must continue to make
significant investments in technology to handle ever-increasing
volumes. The increase in volumes is accompanied by lower
margins and increasing SEC fees. We are on a collision course
that, if left uncorrected, will have a significant effect on
the ability of market makers to conduct their business
profitably.
We believe that our equity markets, much admired and envied
throughout the world, would operate much less efficiently if
there were no market makers. This result was certainly not
intended by Congress. The language of section 31 states that
transaction fees to be collected by the SEC are designed to
recover the cost to the government of the supervision and
regulation of the securities markets and securities
professionals and costs related to such supervision and
regulation.
We have demonstrated that we are more than willing to pay
the costs associated with regulation. But it is simply not
right to charge investors, issuers. And market makers 5 times
the cost of regulation. At a minimum, a burden of this size
with its potential to adversely effect the structure of the
capital markets should not be allowed to happen inadvertently
because of changing circumstances.
Mr. Chairman, we urge you to craft a solution that will
better align fees with the cost of regulation. We have
confidence that Congress, once it reviews the facts, will make
a decision that is in the interest of millions of investors. We
are committed to work with this subcommittee to find an
appropriate solution. Thank you for the opportunity to testify.
I am ready to answer any questions.
[The prepared statement of Stephen J. Nelson follows:]
Prepared Statement of Stephen J. Nelson, Vice President, Herzog Heine
Geduld
Chairman Bliley, Chairman Oxley, Congressman Towns and Members of
the Subcommittee, I am Steve Nelson, Vice President of Herzog Heine
Geduld, a leading NASDAQ market maker. I am here today representing the
Securities Industry Association.<SUP>1</SUP> Thank you for inviting me
to testify at this hearing on the subject of securities transaction
fees. This is a subject on which the Chairman of the full Committee,
Congressman Bliley, has been a leader for a number of years, and we are
grateful to him for the leadership he has provided.
---------------------------------------------------------------------------
\1\ The Securities Industry Association brings together the shared
interests of more than 740 securities firms to accomplish common goals.
SIA member-firms (including investment banks, broker-dealers, and
mutual fund companies) are active in all U.S. and foreign markets and
in all phases of corporate and public finance. The U.S. securities
industry manages the accounts of more than 50 million investors
directly and tens of millions of investors indirectly through
corporate, thrift and pension plans. The industry generates
approximately $300 billion of revenues yearly in the U.S. economy and
employs more than 600,000 individuals. (More information about the SIA
is available on its home page: http://www.sia.com.)
---------------------------------------------------------------------------
Chairman Oxley, we commend and appreciate your interest in the
subject of today's hearing and, more broadly, your interest in fair,
efficient and internationally competitive securities markets. We look
forward to working with you on this issue.
Congressman Towns, we are also grateful for the work you have done
to reduce regulatory burdens and reduce costs to investors. We
appreciate your continued interest and involvement in issues affecting
the securities markets.
We also wish to express our special gratitude to Congressman Lazio,
Congressman Fossella and Congressman Menendez for the leadership they
have demonstrated on the subject of SEC transaction fees.
We believe it is critical that Congress examines the issue of SEC
fees, because the facts and assumptions on which enactment of the
current statutory fee structure was based have changed. Fees that were
developed several years ago to fund the cost of regulating the
securities markets now exceed the government's cost of regulation to
such a degree that they constitute a tax on capital formation, and a
special tax on every American investor.
Our securities markets serve as a strong engine of growth and job
creation for our economy, furnishing the seed capital for start-up
companies, providing the liquidity essential to bring investors into
the market, harnessing investment for growth and expansion for our
economy, and creating savings and investment vehicles for millions of
Americans. Today, forty-eight percent of U.S. households own stock,
directly or indirectly. By the year 2000, the number of individuals who
own stock is likely to exceed 80 million. The more than 600,000 men and
women who go to work in the securities industry every day work hard to
ensure that we have the fairest, deepest and most liquid securities
markets in the world.
We know that our markets have been made better, and fairer, by the
presence of a strong and effective Securities and Exchange Commission.
And, because it is in our interest--and, more importantly, in the
public interest--to have an effective SEC, the SIA has been a strong
supporter of full funding for the agency, so that it can carry out its
important mission of investor protection. In the past, the SIA has
supported full funding for the SEC, even at times when budget freezes
and budget cuts were being pressed on all federal agencies. Our support
for legislation today to reduce the excess fees charged to the
industry, investors and issuers will still provide substantially more
in revenues than the budget of the SEC.
Three years ago, the industry was asked to step up to the plate and
pay additional fees in order to help Congress move to a more reliable
funding mechanism for the SEC. We agreed to do so, because we believed
it was in the long term interests of our markets. The fee structure
adopted as part of the National Securities Markets Improvement Act of
1996 for the first time assessed transaction fees on the NASDAQ
markets. This provision was intended to establish parity between the
fees assessed on exchange and NASDAQ markets.<SUP>2</SUP> While it was
expected that, as a result of these changes, the fees paid by investors
and the industry would increase in the near term, the ultimate goal of
NSMIA's fee provisions was to bring fees collected by the SEC more in
line with the cost of running the agency.
---------------------------------------------------------------------------
\2\ NSMIA provided for a gradual reduction over 10 years in filing
fees for securities registration statements under Section 6(b) of the
Securities Act of 1933. The securities registration fee was set at $295
per $1 million in 1998, to be lowered over time to $67 per $1 million
in 2007. NSMIA also expanded the reach of securities transaction fees,
which previously had been assessed on transactions in exchange-
registered securities, to include transactions in NASDAQ markets. The
transaction fee, under Section 31 of the Exchange Act, was set at 1/300
of one percent during the years 1997 through 2006, and was scheduled to
be reduced to 1/800 of one percent in 2007.
---------------------------------------------------------------------------
At the time these provisions were enacted, no one anticipated the
explosion of market activity that has taken place over the past several
years, and that appears to be continuing and increasing. In particular,
no one could have predicted the phenomenal influence that online
investors would have on the equity markets.
In 1996 average daily trading volume on the exchange, NASDAQ and
regional markets was 1.0 billion shares a day, by 1998 it had risen to
1.5 billion shares. Total annual share volume in these markets was 261
billion shares in 1996; by 1998 volume had risen to 400 billion shares
traded annually--a 50% jump in just two years.
Transaction volume has increased even more dramatically than share
volume with the rise in popularity of online investing. In 1996, when
Herzog Heine Geduld moved into its new trading room in Jersey City, our
facilities were handling on average approximately 25,000 trades each
day. Since the beginning of this year, less than four years later, we
have averaged more than 100,000 trades each day, and we are
experiencing a 10% growth in trade volume each quarter. The investing
public has found a new way to participate in the markets, and we
believe that this is only the beginning.
During this period, SEC appropriations have risen in an effort to
give the SEC sufficient resources to oversee the markets and enforce
the federal securities laws. However, the increase in transaction and
other fees paid by investors, issuers and the industry has far exceeded
the increase in the cost of running the SEC. The following chart sets
forth the fees collected by the SEC during fiscal years 1996-1998 and
estimated to be collected during the current and next fiscal year
(including Section 6(b) fees, Section 31 fees, and other fees),
compared with the amounts appropriated or requested to be appropriated
to the SEC during these years (dollar amounts in millions):
<SUP>3</SUP>
---------------------------------------------------------------------------
\3\ Where estimates of fee collections are indicated, they are OMB
estimates; CBO estimates may differ. SEC appropriations for certain
years are stated as the amounts requested; actual funding amounts may
differ slightly.
----------------------------------------------------------------------------------------------------------------
Sec. 6(b) Sec. 31 Other Total SEC Budget
----------------------------------------------------------------------------------------------------------------
FY 1996................................... $575 $134 $65 $774 $297.4
FY 1997................................... 653 274 63 990 305.4
FY 1998................................... 1,034 632 114 1,780 315.0
FY 1999 (est.)............................ 1,040 432 50 1,522 337.4
FY 2000 (est.)............................ 1,079 491 50 1,620 360.8 (Req.)
----------------------------------------------------------------------------------------------------------------
Fees now paid by investors, issuers and the industry amount to five
times the cost of running the SEC. In 1998 alone, while the SEC's
budget was just over $315 million, securities registration, transaction
and other fees collected by the SEC totaled more than $1.7 billion.
From FY 1998 through FY 2000, if the present trend continues, the
amounts paid by investors, issuers and the industry will have exceeded
the SEC's budget by more than $3.8 billion. We do not believe it is in
the interest of investors--or in the interests of our capital markets
more broadly--for these fees to so grossly dwarf the regulatory costs
incurred. These fees drain capital from the private markets--removing
it at the very beginning of the capital raising process--and diverting
it into the U.S. Treasury.
The fees have a particularly profound impact on NASDAQ market
makers and on specialists at traditional exchanges, who perform similar
functions. The market maker's business is similar in many ways to that
of the grocer, who buys milk for ten cents and hopes to sell it for
eleven. The Section 31 fee is especially burdensome to a market maker
because, where the fee exceeds the cost of regulation, it amounts to a
tax on the market maker's gross revenues, unlike an income tax, for
example, which taxes profits. In other words, we must pay the fee
whether we sell the milk profitably for eleven cents or are forced by
market conditions to sell at loss for nine cents. Moreover, the Section
31 fee must be paid before the electric bill, the rent, salaries to the
staff or even federal and state income taxes, and whether or not our
business is profitable.
In the last several years, technological advances have lowered
transaction costs. These reduced costs have encouraged more trading
activity--larger share volume and even larger trading volume. Margins
have also declined, but to some extent, increases in volume have
compensated for lower margins. We are selling more milk, but making
less on each sale. These declining margins have greatly magnified the
effect on our industry of the Section 31 tax--the portion collected in
excess of the cost of regulating the NASDAQ and Exchange equity
markets.
Section 31 fees are based on the value of transactions. As
transaction volume and market valuations have increased, the amount of
fees collected under Section 31 has ballooned. In contrast, the market
maker's revenue on these transactions, our profit margins, have
declined. As a result, Section 31 fees comprise an increasing share of
our gross trading revenues, even though the rate of the fee has
remained constant. Herzog Heine Geduld's payments of Section 31 fees
currently amount to more than 3% of our gross trading revenues. To
illustrate the significance of this tax, the current amount of the
Section 31 fee is about twice as much as the rent paid on the property
that houses our Nasdaq trading operations.
Market makers must continue to make significant investments in
technology to handle ever-increasing volumes. The increase in volumes
is accompanied by lower margins and increasing SEC fees. We are on a
collision course that, if left uncorrected, will have a significant
effect on the ability of market makers to conduct their business
profitably. We believe that our equity markets--much admired and envied
throughout the world--would operate much less efficiently if there were
no market makers.
This result certainly was not intended by Congress. When Congress
adopted NSMIA's fee provisions, its intent was clear. The language of
Section 6(b) states that the registration fees to be collected by the
SEC under that section ``are designed to recover the costs to the
government of the securities registration process, and costs related to
such process . . .'' The language of Section 31 states that the
transaction fees to be collected by the SEC ``are designed to recover
the costs to the Government of the supervision and regulation of
securities markets and securities professionals and costs related to
such supervision and regulation . . .''
Unfortunately, the fees have far exceeded the cost of regulation.
They divert resources which could be used more productively elsewhere
in our economy; and they discourage capital investments in technology
that could be used to make our equity markets more efficient and
attractive to investors. This is real capital that could be used to
fund new businesses, to build plants, to create jobs, and to add to the
national wealth.
There may be some who believe that, since the U.S. stock market is
near an all time high, market makers, specialists and other market
participants somehow can, or should, pay these fees. So what if they
pay a little more here or there?
In the first place, specialists' and market makers' profits are not
related to the value of stocks. Our willingness to devote capital to
making markets necessarily depends on our ability to make a fair and
reasonable profit on transactions. We have demonstrated that we are
more than willing to pay the cost associated with regulation. But, it
simply is not right to charge investors, issuers and market makers five
times the cost of regulation. At a minimum, a burden of this size, with
its potential to adversely affect the structure of the capital markets,
should not be allowed to happen inadvertently because of changed
circumstances.
Mr. Chairman, we urge you to craft a solution that will better
align fees with the cost of regulation. We have confidence that
Congress, once it reviews the facts, will make a decision that is in
the interest of millions of investors. We are committed to work with
this subcommittee to find such a solution.
The securities industry is faced with a number of challenges in the
immediate future: how to make a successful conversion to the Year 2000,
so that it is seamless for investors and issuers; how to make systems
``Euro'' compatible; how to make the conversion and expand quote
capacity to accommodate decimalization; how to ensure that investors
and issuers benefit from the explosion in technology and electronic
commerce; and, how to meet the competitive challenges of globalization.
All of these challenges have required, and will continue to require,
significant financial investment on our part, as well as the time and
efforts of our most talented industry professionals. We intend to meet
these challenges, to maintain and enhance the international preeminence
of our capital markets, to help fund the continued growth of the U.S.
economy, and to ensure that investors and issuers have even more
opportunities in the next century.
Thank you again for the opportunity to testify. I am ready to
answer any questions.
Mr. Oxley. Thank you, Mr. Nelson.
Mr. Kearney.
STATEMENT OF ARTHUR J. KEARNEY
Mr. Kearney. Chairman Oxley, members of the subcommittee,
thank you for the invitation to testify before you today on the
subject of SEC transaction fees, an issue in which you have had
an interest for quite some time. I do very much appreciate this
opportunity to present the views of the Security Traders
Association, and I applaud your leadership in scheduling a
hearing on this important issue.
I also want to specifically commend Congressman Fossella,
Congressman Lazio, and Congressman Towns for the outstanding
leadership that they have shown on this issue this year as well
as Congressman Bob Menendez. Mr. Chairman, with your permission
I would like to summarize my written testimony and I would ask
that my full written testimony be made part of the record.
I am Arthur Kearney, Chairman of the Security Traders
Association, the STA, and Director of Equity Capital Markets
and a member of the board of directors of John G. Kinnard &
Company, a broker-dealer located in Minneapolis, Minnesota. I
am accompanied by Lee Korens, President and CEO of STA, who is
available to answer any questions.
STA is composed of 34 regional affiliates and over 7,000
individual members throughout North America and Europe, and it
is the largest group of its kind in the world. Our membership
represents all facets of the securities industry. While many
members are traders for securities firms and institutions,
others are partners, specialists, floor traders, proprietors,
or registered representatives, all of whom are charged with the
responsibility of executing orders at the fairest prevailing
prices.
Mr. Chairman, in my written testimony I have provided a
fairly detailed description of the history and structure of SEC
fees, so I will give a brief overview and turn to our position.
Before I start, however, I do want to thank this committee
for its longstanding interest in this issue and its hard work
in attempting to reduce these fees paid by the investing public
and securities professionals. As you know, the government
collects various Securities and Exchange Commission SEC user
fees imposed by the securities laws in order to recover the
Federal Government's cost of running the SEC, including
transaction fees on sale of stocks assessed pursuant to section
31 of the 1934 act.
Over time, these fees have grown to significantly exceed
the SEC's budget. By 1996, collected fees exceeded the SEC's
budget by a factor of more than 2 to 1. Under this committee's
leadership, Title 4 of the NSMIA of 1996 significantly
restructured the various SEC fees with the intent of reducing
total SEC fee collection over time and providing the SEC with a
more stable funding source.
We commend Chairman Bliley and others on this committee for
working tirelessly to produce legislation designed to reduce
these fees. Indeed, the committee prevailed in designing a fee
structure which explicitly contemplated that section 31 fees
would recoup the cost of the SEC's supervision and regulation
of the securities markets and securities professionals.
Unfortunately, actual fees collections have significantly
outpaced the CBO's and OMB's conservative estimates of market
growth relied on by this committee and Congress.
In fiscal year 1997, actual collections from all sources
grew to $990 million, over 3 times the SEC's budget of $3.5
million. In fiscal year 1998, the excess worsened considerably
when actual fees collection ballooned to a staggering $1.78
billion, 5\1/2\ times the SEC's $322 million budget. Clearly,
this is not the scenario the committee intended when it
redesigned the SEC funding structure in 1996 to reduce the
amount of fee surplus.
I want to emphasize that the issue here is not SEC funding.
The issue is that the government is taking in over 5 times as
much fee revenue as is reasonably needed to fund the SEC's
activities. What was explicitly designed to be a user fee has
become a large unintended back-door tax on the securities
markets.
Excessive SEC fees have a tremendous negative impact on
securities professionals. The effect is particularly severe for
NASDAQ market makers and exchange specialists who often must
trade from their own accounts in order to fulfill their legal
responsibility to maintain orderly markets and to provide
customers with on-demand liquidity. Section 31 transaction fees
operate as a tax on the gross trading revenue of these
professionals. One STA member firm which makes markets in
NASDAQ 100 stocks, estimates that its section 31 fee payments
amounted to a whopping 6 percent of OTC trading income over a
recent 16-month period.
Another firm found that its section 31 fee payments were
twice the amount of its rental payments for the building
housing its trading activities.
Let me also give you my perspective as an employer in the
regional brokerage and underwriting business. Our firm trades
NASDAQ stocks and underwrites IPOs and secondaries. Some of the
recent ventures we have been involved in include Excelsior-
Henderson, a motorcycle manufacturer, and Zomax, an optical
media softwear company. These are the types of companies that
create 75 percent of all new jobs in America. We also make
markets in approximately 175 NASDAQ stocks, and Kinnard employs
over 350 people.
Section 31 fees operate as a gross receipt tax. This means
that the fees are paid before Federal and State taxes, before
salary and before allocations of overhead. The result is to
magnify the impact on our firm's profitability. Changes in the
NASDAQ market, which include increasing cost pressures
associated with the newer handling rules, the regulatory-driven
computer upgrades and monitors, have greatly reduced the
profitability of NASDAQ market making activities across the
board. Excessive section 31 fees only exacerbate the situation.
Mr. Chairman, excessive section 31 fees negatively impact
our trading revenue, and reduced revenues translate directly to
fewer jobs. As a manager, when I am looking at a reduced
revenue from section 31 fees, it means I can hire one less
analyst, one less trader, one less support staff. Reduced
revenues go right to our bottom line and right to our core
business decisions. It is really that simple. Excessive fees
also contribute to reduced liquidity in the markets. The major
impact falls on thinly traded stocks of those small and startup
companies in which we specialize. STA urges Congress to take
swift corrective action to eliminate the SEC transaction fee
excess and reduce the burdensome and unintended tax on
America's savers, investors, and securities professionals.
While this result could be achieved through a number of
approaches, STA is committed to support any initiative that
produces meaningful relief for all investors.
STA is encouraged by the continuing commitment of this
committee to reduce SEC fees, as reflected in Chairman Oxley's
scheduling this hearing, and the fact that 24 Commerce
Committee members have cosponsored two separate bills this year
to address the issue. We are also heartened that SEC Chairman
Arthur Levitt testified in March that the fee problem needs to
be addressed and pledged to work with Congress to fashion a
solution.
In closing, Mr. Chairman, STA applauds you for scheduling
this prompt hearing on an issue of great importance to our
members across the United States. Thank you, and I will be
happy to answer any questions.
[The prepared statement of Arthur J. Kearney follows:]
Prepared Statement of Arthur J. Kearney, Chairman, Security Traders
Association
i. introduction
Chairman Oxley, Chairman Bliley, Members of the Subcommittee, thank
you for the invitation to testify before you today on the subject of
SEC transaction fees, an issue in which you have had an interest for
quite some time. I do very much appreciate this opportunity to present
the views of the Security Traders Association, and I applaud your
leadership in scheduling a hearing on this important issue. I also want
to specifically commend Congressman Fossella, Congressman Lazio, and
Congressman Towns for the outstanding leadership they have shown on
this issue this year, as well as Congressman Bob Menendez.
I am Arthur Kearney, Chairman of the Security Traders Association--
the STA--and Director of Capital Markets and a Member of the Board of
Directors at John G. Kinnard & Co., a broker/dealer located in
Minneapolis, Minnesota.
STA is composed of 34 regional affiliates and over 7,000 individual
members throughout North America and Europe, and it is the largest
group of its kind in the world. Our membership represents all facets of
the securities industry. While many members are traders for securities
firms and institutions, others are partners, specialists, floor
traders, proprietors or registered representatives--all of whom are
charged with the responsibility of executing orders at the fairest
prevailing prices. The fact is that no one speaks for individual
professionals in the securities industry better than STA. It is the
only organization that represents, at all levels, the interests of over
7,000 individuals.
Before I start, however, I do want to take a moment to thank this
Committee for its longstanding interest in this issue and its hard work
in attempting to reduce these fees paid by the investing public and
securities professionals.
ii. history of the sec funding structure
Public Law 104-290, the National Securities Market Improvement Act
of 1996, was signed into law by President Clinton on October 11, 1996.
The Act combined securities and mutual fund market reforms with a
reauthorization of the Securities and Exchange Commission (SEC). The
Act extended the imposition of the Securities Exchange Act of 1934's
Section 31 transaction fees to NASDAQ stock transactions. The SEC
reauthorization was the result of a complex deal worked out between
House and Senate authorizers and appropriators, the Office of
Management and Budget (OMB), and the SEC, following years of
Congressional wrangling over a new SEC funding mechanism.
Background
Since the 1930s, the federal government has levied SEC fees on the
regulated community, including registration fees authorized by Section
6(b) of the Securities Act of 1933, and transaction fees authorized by
Section 31 of the Securities Exchange Act of 1934. These fees were
deposited in the Treasury's General Fund as general revenues. The SEC
received no credit for collected fees and could not directly use the
funds, but rather was funded through an annual appropriation from the
Appropriations Committee. Since 1983, the SEC has been a net
contributor to the Treasury, collecting far more fees than necessary to
cover its budget.
In 1990, the budget rules were significantly changed. Specifically,
the 1990 Budget Enforcement Act set limitations on specific spending
categories and created ``pay-as-you-go'' procedures to require offsets
for decreases in revenue or increases in entitlement spending. These
rules put severe restraints on discretionary spending, forcing
appropriators to choose among competing programs. The SEC was thus
forced to compete for discretionary funding with the Departments of
Commerce, Justice and State. The income collected by the SEC fees did
not create any additional funding for the appropriators.
Beginning in 1990, appropriators decided to respond to the problem
of insufficient resources to fund competing programs by imposing one-
year rate increases in the Section 6(b) registration fee in the annual
Commerce, Justice, State Appropriations Bill through which the SEC is
funded. The amounts attributable to such increases were credited
against the agency's appropriation account as an offsetting collection.
Offsetting collections are deposited in special appropriations
accounts, as opposed to the General Fund, and are available to
appropriators to finance agency activities. This funding mechanism
increased the overall funds available to the appropriators.
This practice eventually led to objections by various Members of
Congress on both jurisdictional and public policy grounds. Since the
agency was collecting far more in fees than its budget required,
opponents argued that increasing SEC fees constituted a tax. Members
began to call for a new SEC funding structure that allowed the
government to cover the costs of the SEC's regulatory activities
without artificially inflating the cost of raising capital in the
markets. In 1993, this Committee, under the leadership of then-Chairman
Dingell and current Chairman Bliley, crafted a bill which would have
established a mechanism by which the SEC would set and collect fees
solely to recover the costs of its regulatory activities.<SUP>1</SUP>
The House subsequently passed the bill unanimously.
---------------------------------------------------------------------------
\1\ H.R. 2239, passed on July 20, 1993, would have authorized the
SEC to continue to collect general revenues for fiscal years 1994
through 1998, in order to avoid raising the deficit and maintain pay-
as-you-go budget scorecard neutrality. After fiscal year 1998, SEC fees
would have been set and collected so as not to exceed the costs of
running the agency.
---------------------------------------------------------------------------
During that same year, the House and Senate again passed an SEC
appropriations measure which raised registration fees and credited the
amount as an offsetting collection. After several complaints were
lodged with the Appropriations Committee by both House Ways and Means
and House Energy and Commerce Committee members, language was included
in the conference report on the Commerce, Justice, State Appropriations
bill conference report indicating that the practice would be ended.
Funding Crisis
The funding situation came to a head the following year. When the
Commerce, Justice, State Appropriations Bill for fiscal year 1995 came
to the floor of the House on June 28, 1994, the bill again contained a
provision that would have imposed additional registration fees as
offsetting collections. House Members frustrated with the Senate's
failure to act on the SEC funding issue succeeded in striking the
provision from the House bill on procedural grounds, and subsequently
prevailed in an effort to keep the provision out of the conference
agreement. This move left the SEC with an appropriation of $59.6
million, significantly below the $297 million originally provided by
appropriators. The agency indicated that it would have to severely
restrict its operations beginning in October 1994 absent Congressional
action.
This funding crisis prompted Congress, with the help of this
Committee's leadership, to pass a stop-gap measure (P.L. 103-352),
authorizing the registration fee increase <SUP>2</SUP> and offsetting
revenue practice for another year, in order to fund the agency through
1995. House Report 103-739 indicated that this was done as a one-time
fix to avert an SEC shutdown, and contemplated passage in the next
Congress of an SEC reauthorization that would ``eliminate the need for
one-year-at-a-time increases in registration fees.'' The bill
originated in the House Ways and Means Committee with the support of
the this Committee. The stage was thus set for an SEC reauthorization
that would establish a predictable and adequate fee structure to
recover funds solely to offset the cost of the agency's regulatory
activities.
---------------------------------------------------------------------------
\2\ The fee was continued at \1/29\ of 1% of the maximum offering
price of the securities, the rate supplied in the FY 1994 Commerce,
Justice, State Appropriations Act. Without the stop-gap extension, the
rate would have fallen to its statutorily authorized rate of \1/50\ of
1%.
---------------------------------------------------------------------------
Action in the 104th Congress
During 1995, the first session of the 104th Congress, control
shifted to the Republican party and the legislative agenda was crowded,
leaving unaddressed the SEC fee issue. However, in light of the prior
year's funding crisis, the Administration's FY 1996 budget proposal
submitted at the beginning of 1995 stressed the need for a sound,
stable and long-term funding structure for the SEC. H.R. 2076, the
Commerce, Justice, State Appropriations Bill which passed that year,
was vetoed by the President due to unrelated policy disputes, and the
SEC's FY 1996 budget was funded by a series of continuing resolutions.
Finally, an omnibus spending bill (H.R. 3019) was passed, providing SEC
funds for the remainder of the year.
In 1996, House Commerce Committee Chairman Bliley (R-VA) introduced
H.R. 2972, the SEC Reauthorization Act of 1996. The bill was designed
ultimately to end the appropriators' practice of funding SEC activities
through the yearly ritual of raising registration fees as offsetting
collections. The proposal would have reduced 6(b) registration fees
over a 6-year period, incrementally extended the Section 31 transaction
fees to NASDAQ trades, and reduced the rate for all transaction fees
beginning in 2002. In total, the package was projected to reduce fee
collections by $751 million by 2002. Initially, a portion of the fees
was to be deposited as offsetting collections. Beginning in 2002, all
fees would be deposited as general revenue and no fees would be
allotted as offsetting collections. Thus, by 2002, the SEC would rely
on the allocation made to the appropriators for Commerce, Justice,
State and related programs. The House unanimously passed H.R. 2972 on
March 12, 1996.
A similar transaction fee provision was included in a bill also
introduced in 1996 by then Senate Banking Securities Subcommittee
Chairman Gramm (R-TX), S. 1855. However, Gramm and then Senate Banking
Committee Chairman D'Amato (R-NY) agreed to postpone consideration of
the SEC reauthorization in response to concerns by Senate Democrats and
the Administration. They were concerned that ending the offsetting
collections funding practice would require appropriators to fund the
SEC's full budget out of the General Fund, subject to the discretionary
spending caps, forcing reductions in other programs.
The House passed H.R. 3005, the Securities Amendments of 1996, on
June 19, 1996, but not before adding the SEC reauthorization provisions
originally embodied in H.R. 2972. The Senate amended and passed H.R.
3005 without the fee provisions on June 27, 1996, setting up a
conference in which the SEC fee issue would have to be resolved. The
fee issue was highly controversial in conference. Negotiations among
House and Senate authorizers and appropriators, the OMB, and the SEC
held up the bill for weeks and threatened to entirely derail the
legislation. An agreement was finally reached on the fee issue and the
bill was passed in the closing days of the 104th Congress. The
conference report was agreed to by the House on September 28, 1996, and
by the Senate on October 1, 1996. H.R. 3005 became P.L. 104-290 when
the President signed the bill on October 11, 1996.
Under the complex deal worked out in conference, registration fees
are gradually reduced until FY 2007, when they drop dramatically. A
portion of the registration fee is deposited as General Fund revenue,
and a portion is made available to appropriators as offsetting
collections. Transaction fees remain at 1/300 of 1% until FY 2007, when
they drop dramatically. Beginning in 1997, NASDAQ trades became subject
to the full transaction fee rate. While the exchange transaction fees
are collected as General Fund revenue, the NASDAQ transaction fees are
deposited as offsetting collections and must be triggered on each year
by Appropriations Act. By pushing general revenue losses into the out-
years, the new fee structure avoided budget scoring problems.
iii. current situation and impact
Unfortunately, actual fee collections have significantly outpaced
the CBO's and OMB's conservative estimates of market growth relied on
by this Committee and Congress. In fiscal year 1997, actual collections
from all sources grew to $990 million dollars--over three times the
SEC's budget of $305 million. In fiscal year 1998, the excess worsened
considerably, when actual fee collections ballooned to a staggering
$1.78 billion--five and one-half times the SEC's $322 million budget.
Clearly, this is not the scenario this Committee intended when it
fought to redesign the SEC funding structure in 1996 to reduce the
amount of the fee surplus.
I want to emphasize that the issue here is not SEC funding. The
issue, very simply, is that the government is taking in over five times
as much fee revenue as is reasonably needed to fund the SEC's
activities. What was explicitly designed to be a user fee has become a
large, unintended backdoor tax on the securities markets.
Excessive SEC fees have a tremendously negative impact on
securities professionals. The effect is particularly severe for NASDAQ
market markers and exchange specialists, who often must trade from
their own accounts in order to fulfil their legal responsibility to
maintain orderly markets and to provide customers with on-demand
liquidity. Section 31 transaction fees operate as a tax on the gross
trading revenue of these professionals. One STA member firm which makes
markets in about 100 NASDAQ stocks estimated that its Section 31 fee
payments amounted to a whopping 60 percent of OTC trading income over a
recent sixteen month period. Another firm found that its Section 31 fee
payments were twice the amount of its rental payments for the building
housing its trading activities.
Let me also give you my perspective as an employer in the regional
brokerage and underwriting business. Our firm trades NASDAQ stocks and
underwrites initial public offerings and secondaries. Some of the
recent ventures we have been involved in include Excelsior-Henderson, a
motorcycle manufacturer, and Zomax, an optical media software company.
These are the types of companies that create 75 percent of all new jobs
in America. We also make markets in approximately 175 NASDAQ stocks.
Kinnard employs over 350 people.
Section 31 fees operate as a gross receipts tax. This means that
fees are paid before federal and state taxes, before salary, and before
allocations for overhead. The result is to magnify the impact on our
firm's profitability. Changes in the NASDAQ market--which include
increasing costs pressures associated with the new order handling rules
and regulatory driven computer upgrades, among others--have greatly
reduced the profitability of NASDAQ market making activities. Excessive
section 31 fees only exacerbate this situation.
Mr. Chairman, excessive section 31 fees negatively impact our
trading revenue, and reduced revenues translate directly into fewer
jobs. As a manager, when I am looking at reduced revenue from section
31 fees, it means that I can hire one less analyst, one less trader,
one less support staff. Reduced revenues go right to our bottom line,
and right to our core business decisions. It's really that simple.
Excessive fees also contribute to reduced liquidity in the market. The
major impact falls on the thinly traded stocks of those small and
start-up companies in which we specialize.
I should also note that it appears the primary factor contributing
to the transaction fee collection overage is that the projections for
the dollar volume growth in the markets have been based on extremely
conservative assumptions. Actual transaction fee collections have
consistently outpaced the government's projections by a significant
amount. The transaction fee overage is not a result of a temporary
spike in volume, but is a recurring and compounding problem. Without a
statutory correction that somehow limits the amount of fees collected,
the amount of the fee collection overage will continue to grow
exponentially into the foreseeable future.
iv. conclusion
STA urges Congress to take swift, corrective action to eliminate
the SEC transaction fee excess and reduce this burdensome and
unintended tax on American savers, investors and securities
professionals. While this result could be achieved though a number of
approaches, STA has committed to support any initiative that produces
meaningful relief for all investors.
STA is encouraged by the continuing commitment of this Committee to
reduce SEC fees, as reflected in Chairman Oxley's scheduling this
hearing and the fact that 24 Commerce Committee members have
cosponsored two separate bills this year to address this issue. We are
also heartened that SEC Chairman Arthur Levitt testified in March that
the fee problem needs to be addressed, and pledged to work with
Congress to fashion a solution.
In closing, Mr. Chairman, STA applauds you for scheduling this
prompt hearing on an issue of great importance to our members across
the United States. Thank you, and I will be happy to answer any
questions.
Mr. Oxley. Thank you, Mr. Kearney. That completes the
testimony of our witnesses. There are 4 minutes left in the
vote. We will stand in recess for 15 minutes.
[Brief recess.]
Mr. Oxley. The subcommittee will reconvene. Let me begin
with some just general questions from the Chair.
Part of the problem of the excessive fee revenue stems from
record-breaking volumes on transactions. I would like to ask,
do you believe that the markets will continue to experience
similar volume levels in the future? Is this a temporary
phenomenon or is this something that is not going to abate any
time soon?
Mr. Kearney. If you look at all of the market design and
everything that is in front of the NASD and the SEC for
approval and all of the regulatory changes, et cetera, they are
going to make access to liquidity easier and easier. They are
going to make access so you as an individual investor will be
able to buy or sell a security at a lower rate and faster.
Everything leads me to believe that these volumes are going to
continue to explode and increase at rates that we don't even--
we have no comprehension of. The fragmentation of the market
today is actually slowing down the volumes. If they address
those fragmentation issues, it is going to go higher.
Mr. Nelson. We think that the markets have changed. Up
until, I would say the fall of last year, as a general
proposition, the big institutions and institutional investors
set prices in the markets. They would give us huge orders. They
really were the stopgap in the market.
Last year for the first time, the online investor really
came of age. Thousands of 200, 300, 500 shareholders would
simply overwhelm these institutional orders and sweep them away
in a tide up and tide down. I think--we think that this is just
the start of this. The public has just now figured out what
online trading is all about. All of the big bull tracking firms
are standing in line and putting in systems that have always
traditionally gone through a broker, which, in a fairly steady
fashion, are now going to be hitting these machines. I think we
have just seen the beginning of an overwhelming increase in
volume.
Mr. Oxley. Mr. Cader.
Mr. Cader. I would agree with all of that. I would point
out additionally as we see the demographic and economic
underpinnings of the markets and volumes seem likely not to
change in the near future--and you can have a discussion
whether that argues for higher or lower stock prices--but stock
ownership and stock trading that has accrued to individuals has
exploded in a way that history suggests does not go away
quickly, no matter which way prices move in.
Several dynamics of market structure which are likely to
change and which are familiar to all of you from looking at the
industry and from reading the papers, such as decimalization,
such as 24-hour trading or extended-hour trading, which will
also be upon us soon, are almost certain to increase volume
even aside from whatever other secular or cyclical trends might
drive volume up or down.
So for demographic and economic reasons, volumes will trend
up, you will have an additional likelihood of volume going up
even more if in fact decimalization and extended hours are, as
I suspect they are, helpful to and friendly to investor access
to the marketplace.
So I think there are a lot of reasons to believe that
whether prices go up or down--which, of course we don't know--
that volumes will continue at particularly high levels.
Mr. Oxley. Mr. Brodsky, the same thing in Chicago?
Mr. Brodsky. I would say the same thing, not only in
Chicago but all over the world. You have seem the
democratization of equity markets, and it is to a large extent
attributable to the work that this committee has done over the
years, the SEC has done. And we are seeing more and more
business not only from abroad but from a younger group of
investors. I think that it does flow through all of the things
that the people spoke before me have said.
I will give you a general statistic. The fastest growth in
our business is through people who use the Internet, through
brokerage firms. Our Web site, 2\1/2\ years ago, in a month had
50,000 hits, and recently it was 50 million. These people are
using electronics as a way of accessing markets.
I agree with what was said. The combination of after-hours
trading and the greater competition, we expect even though we
are the first option exchange in the world, in the next year or
2, there will be at least electronic competitors. This will add
to volume.
Mr. Oxley. I will begin with you, Mr. Brodsky. First of
all, are you subject to 6(b) registration fees on stock
options?
Mr. Brodsky. No, we are just subject to section 31.
Mr. Oxley. Let me skip then to Mr. Cader. What is the
difference in the impact on investors between the two different
fees, 6(b) and section 31?
Mr. Cader. I will speak to what I call the multiplier
effect of the section 31 fees. The 6(b) fees are leveled now at
the point in the capital-raising process where transactions
take place with the help of market makers, specialists and
liquidity providers, all different names for folks doing what
we are talking about.
The underwriting fees occur once in the cycle of a security
being distributed from an issuer to an owner. The section 31
tax which falls upon the liquidity providers falls at a point
in the capital-raising and, in fact, the capital-transferring
process, which is what happens when shares trade on an
exchange. The tax falls not only on the investors who trade
those securities one to the other, but disproportionately on
those members of the community who are the liquidity providers.
Liquidity providers, who go by names like specialist and market
maker, are simply those who turn the capital over many, many
more times than typically a service provider such as a grocery
store selling milk will do so.
X dollars in the hands of a market maker or a specialist
actually gets deployed many, many, many times over in the
course even of a few hours, certainly a few days, taking the
other side of customer trades. What happens on the exchanges is
that customers--buyers and sellers--look for each other to find
the best price available at the time when they wish to
transact. In a perfect world, which of course we don't live in,
one customer finds another and they both wish to transact the
same amount at the same time. No need for intermediaries.
The intermediaries, who are the buyers and sellers in the
absence of customers who meet each other, fill in the gaps
between supply and demand, time and time again during the day.
So the section 31 tax takes money out of the hands of those
who at the point of sale, the place where the transactions take
place, would actually use that money many, many, many times
over to satisfy many, many customer needs, one after the other,
during relatively short spans of trading.
A specialist or market maker in the security will buy from
one customer and sell to another, filling in those imbalances,
literally, in trades that are seconds apart.
So the tax falls, aside from the question of whether
overfunding is appropriate or not, the tax falls at the worst
possible place given the acknowledged role of the intermediary
liquidity provider in the system, which serves investors by
assuring that there will always be buyers and sellers there to
meet them in the marketplace, with reasonable capital, able to
trade at reasonable prices at all times.
Mr. Oxley. Mr. Nelson and Mr. Kearney?
Mr. Nelson. We don't have a corporate finance business so I
cannot speak about 6(b) fees.
Mr. Kearney. I would just say that 6(b) fees are usually
put into the cost of the whole deal, so they are spread to the
corporate issuer, to the lawyers, to the bankers so it is more
of a--it doesn't affect the trading firms so much. It is backed
into the cost of doing the deal.
Mr. Oxley. Thank you. The Chair now recognizes the ranking
member, the gentleman from New York, Mr. Towns.
Mr. Towns. Thank you, Mr. Chairman. There have been some
folks who have recommended that we cap the fees. Let me get
your views on that in terms of capping.
Mr. Kearney. I would just like to say that from the
perspective of STA, we would take any relief whatsoever.
However, I think most of my colleagues and constituents in the
STA believe that a cap is probably the way to go, and the logic
behind it is if you have a rate increase, you basically have a
moving target.
In 1996 we built a formula based on what we thought the
volumes would be in 1998, 1999 and 2000 and we missed the mark
tremendously. If we were to do a rate decrease again, we are
trying to predict what the volumes will be going forward. Are
volumes going up? If they go down, the SEC might be
underfunded. Therefore, a cap seems to be the most logical
solution to the problem.
Mr. Towns. I am trying in my own mind, trying to figure how
a cap would work. Say, for instance, if there is a lot of
activity in the first 3 months, and therefore you cap it, and
then I recognize the fact that this is going to happen and so I
will do business until after the cap, it seems to me a degree
of unfairness.
Mr. Kearney. The degree of unfairness--there are certain
firms that are in favor of the rate cut and that is because it
will be fair economically, it will benefit them the most. I
think they are probably the smaller percentage of the types of
firms in the industry. And probably if you look at the total
industry, the fairest to the broad industry would be the cap.
How would you compute it? I am not sure if I can answer
that question today. But I think given the amount of dollars at
stake, I think the securities firms could probably reach some
kind of a consensus.
Mr. Towns. Thank you.
Mr. Brodsky. My problem is that this tax falls not only on
the professionals that make the markets but also on customers,
and you can't predict when a customer is going to buy or sell
securities. This is a tax that falls on sales of securities. If
the cap were reached on July 1, people who trade at the first
half of the year would pay it, but those who traded the second
half wouldn't pay it. My feeling is unless you can figure out
an administrative way to deal with it, that a reduction is the
fairest, because then it applies to everybody in a
proportionate way.
The committee decision has to be grounded on what is
fiscally prudent to fund the SEC, making certain assumptions,
and also that is realistic in terms of administration. We have
a situation now where the amount of overfunding is so great it
may be that you can have it--a fee can be scaled down over a
period of years, but we would accelerate when it would start.
Under the law that is in effect now, the scale-down
wouldn't begin until 2007. Obviously we are way ahead of
ourselves in terms of where the volume was. I think we have a
threshold, based upon the chairman's questions, where we really
believe that the volume is not going to go down appreciably,
and you are at 5 times funding. Reasonable people ought to be
able to sit down and figure out what is a reasonable amount of
coverage for the current funding needs of the agency and have
the fee reduced accordingly and start that reduction soon.
Mr. Nelson. I represent the Securities Industry Association
and I can tell you that the industry wants relief. Much of the
discussion that we have had among ourselves about what approach
to get to that relief has really involved a question of what
would be most likely to sell up here on the Hill.
I can tell you that we would very much appreciate any
advice that the committee can give us as to what is likely to
work. That has been a big topic of conversation among us.
Mr. Cader. From the specialist perspective, we are in
alignment with Steve's viewpoint. The issue is what is the most
feasible way to get some relief. I think technically it appears
to us that both a cap could work and a reduction could work and
I would agree with what Steve said.
Mr. Kearney. That is exactly our position at STA.
Mr. Towns. Do you have any idea how a cap might work?
Mr. Cader. I think there are a variety of ways that a cap
could work. I think they are too technical to elaborate in more
than a few seconds or minutes here. I think we would all be
glad to come help out with that. I think there are ways that
either approach could work. I think the industry and you all
have dealt with more complicated mathematical propositions than
this one. I don't think that it would be hard.
Mr. Towns. Section 31 fees are leveled across all
securities products. Why should options be singled out for
special treatment?
Mr. Brodsky. I am asking for relief not on all option
trades but only on option trades where there is an economically
equivalent product trading on futures exchanges in the United
States, because we have a jurisdictional disparity in this
country which, as I said earlier, this committee is fully aware
of in terms of the Shad-Johnson Accord, where you have an S&P
option trading on the Chicago Mercantile Exchange, where there
is no tax because it is a futures product; and yet we have an
S&P 500 option trading on the CBOE and there is a full tax
because it is a securities product.
And I don't think that this committee would feel very happy
about the fact that people would choose to use a futures
product because there is no tax and not a securities product
because there is one. And I don't think that this was ever
envisioned, and as we have studied the issue and talked to
customers, they are, as all customers are in the world we live
in today, very price sensitive. They say, Why should we pay a
tax?
I was President of the Chicago Mercantile Exchange almost
13 years, and the futures exchanges have been strong and
successful in not having any transaction tax on any of their
trades. The securities industry is saying that we want the SEC
funded, and funded fully, and we want to work with the
committee. You have another industry that is trading, in this
case, similar products and they say, We don't want any funding
for our agency, let it come out of the General Treasury. We
need to plead for this committee to understand that only a
small amount of our products are subject to tax which are
competitive with another industry in our same city. And we need
help from this committee.
Now, I will tell you as a percentage of our total business,
it is a relatively small percent of our total business, less
than 25 percent of our business. But yet it is brought home to
us every single day that there are these competitive
disparities that, by the way, in the past and maybe even now--
because the Agriculture Committee is looking at the Share
Johnson Accord that can create jurisdictional battles between
this committee and the Agriculture Committee. If we can't seek
help from this committee, there is no place we can come.
Mr. Oxley. The Chair recognizes the gentleman from Staten
Island, an aforementioned sponsor of one of the bills dealing
with section 31 fees.
Mr. Fossella. Thank you, Mr. Chairman. I want to really
compliment you for advancing this issue once again. You made a
commitment to all of us that you would hold this hearing as
soon as possible after H.R. 10 was passed, and I want to thank
you because I think we need to maintain what this hearing is
all about and what our focus should be. Clearly, what I think
we need to do is understand that we want to return section 31
fees to what they were originally intended to do.
The witnesses all testified that they fully recognize the
importance of the SEC in maintaining the integrity of our
financial markets. Clearly I share, and I think every member of
this committee shares, that view.
We also need to understand what this fee, euphemistically,
really is; and that is, a tax or drain on capital. If you own a
mutual fund or stock or are involved in a pension plan, you are
affected by this tax. And the question now becomes what do we
do?
Some of the witnesses went into elaborate detail as to the
history of the SEC fee and how we got to this point. But my
view is very simple. To do what is logical, to do what is
right, to adequately fund the SEC, and then what is left over
send back to investors, send back to the people who are paying
that fee right now.
I have a question for Mr. Brodsky. You are obviously a
strong supporter of a rate cut, and I can understand where you
are coming from. The reality, I guess, up here is whether this
has been scored and whether it is revenue neutral and whether
you know that to be true or not.
Mr. Brodsky. Well, if we look at the numbers that Chairman
Oxley spoke about in his opening remarks, clearly the amount of
money that is raised by this fee far exceeds the agency's
needs, and if you go back to the legislative history of this
law that goes back to 1934, it was never intended to do
anything other than the operating expenses of the SEC on an
annual basis. I don't know if you call it revenue neutrality.
I think there is coverage for the SEC's operating expenses
from this fee, and it is really a question of how this
committee will address itself to finding a way to scale back
the amount raised and yet be sure that the SEC's operating
expenses are covered.
Mr. Fossella. I guess the general thing we need to find out
is whether this complies with the budget rules in the pay-go
provisions. Let me be clear, I share the view of everybody. I
have a bill, a cap on the fee, and there is another bill
introduced by my good colleague, Rick Lazio, and Congressman
Towns. At the end of the day, we need to cut bait and do what
is right, whether it is the rate cut or the cap. I think we
have talked about that a number of times.
I have a question, I guess, that Chairman Levitt of the
SEC, who is going to be integral to this process, has testified
before the Senate and before this committee that he would
prefer a cap on the fee. I am curious, Mr. Kearney, what is
your view on Mr. Levitt's testimony?
Mr. Kearney. I wasn't allowed in the meetings when he was
making his decision, but there is a proposal that the SEC has
signed in March 1999 that gives some relief. However, it
doesn't look like it is going to get implemented this year
because of some regulatory problems, which is the riskless
principle which will give the industry an $8 to $10 million
relief. Maybe that is some of the logic that Mr. Levitt was
using.
I think his fears are that the volumes in this market are
very unpredictable. If volumes should decrease, and we have
seen that--I have seen it get really bad, and volumes do go
away--if that should happen, would the SEC be underfunded? And
I think one of the things he used in his testimony was the
1994--when the SEC had to go to Congress and ask for additional
funding, if I recall. I think he is just being prudent in
saying there is a possibility that revenues--that transaction
revenues could decrease and the Commission could be
underfunded, and the Commission might have to increase their
budgets due to the Internet phenomenon, et cetera.
So we have to make sure that we do collect enough to run
the Commission. And I think that is his logic, and that would
be mine if I was in his chair. Maybe it is a compromise: a rate
reduction, and once you hit that number, it is capped. There
probably is going to have to have to be a compromise somewhere.
Mr. Fossella. Anybody else have any thoughts? Mr. Nelson.
Mr. Nelson. No.
Mr. Fossella. Thank you, Mr. Chairman, for bringing
attention to this matter. Like so many fees out there which
have overextended their original purpose, now it has become an
avalanche of money into the General Treasury. We have to
maintain the trust of the American people and indicate that a
user fee is just that, and not become just an unnecessary--or a
tax to spend as folks see fit. Thank you.
I want to compliment my colleague from New Jersey, Bob
Menendez, who has helped me advance this issue as well.
Mr. Oxley. I thank you for your attention to this issue.
The Chair now recognizes the gentleman from Minnesota, Mr.
Luther.
Mr. Luther. Thank you, Mr. Chairman. I certainly want to
thank all of the panelists, and particularly I want to make
note of the fact that Mr. Kearney is from Minneapolis,
Minnesota and with an outstanding firm there, a very well-
respected firm, and I certainly appreciate him being here.
Mr. Kearney. Thank you.
Mr. Luther. I think you have done a fine job of covering
the subject on the rate cap and this principal trade issue that
you dealt with. And you have touched on this area and ,Mr.
Brodsky, I think you have done a good job of mentioning the
notion that there are sometimes equivalent products, one is
covered and one isn't.
I think as we look at this issue, anything any of you can
do to help us understand where there is a current unfairness in
the current system, that is where there is substantially
equivalent products, one is covered and one isn't, or maybe
where there are some proposals which structure the transactions
in such a way that they are covered by some places, not covered
by other places, anywhere where there is unfairness in the
current system, I think that would be very, very helpful to us
as we look at this issue.
If you want to comment on that or if you want to supplement
anything that is in your experience with any other instances
along those lines, I think that would be very helpful to us.
Obviously there might be some public policy reasons for
treating them differently. I think most of us would agree if we
are going to have good, fair, free and open markets, that we
would not want to have arbitrary differences applying to the
same equivalent products or transactions.
So anything that you want to comment on or anything you can
supplement on that issue of fairness among transactions or
products, I think would be very helpful.
Mr. Brodsky. I appreciate your comment. I think I would ask
if we could work with the staff and give them all of the
examples and information that would be appropriate for the
committee to have so you can see it in black and white.
Mr. Kearney. The only comment that I would make is as it
relates to the professional who is creating the liquidity that
is needed to maintain the markets, and that is the specialist
and the NASDAQ trader. That is the probably the person who is
impacted the greatest with this rule because of the way that we
commit our capital. And then to reliquefy as a trader, you
don't want to hang on to positions. That is where the big
effect is being felt, at the trading desks, both at the
specialist level and at the NASDAQ level.
Mr. Nelson. I think it is useful to just think about it a
little bit. The problem is that this is a moving target. One of
the things that you are seeing going on right now in my
industry, in the market-making industry, is that there are
efforts, rules being proposed, committees forming to talk about
different ways, that when you sum it all up will be a way of
avoiding this tax. A lot of those moves have to do with
transforming the NASDAQ market into something, an agency market
rather than a principal market. If it is an agency market, then
the professionals who do the transactions are not involved in
the tax.
The problem with all of that is that I don't think that
when Congress put this fee in place, they intended to transform
the market into something other than what it was. They thought
that the market was going to stay the way that it was. I think
if we are just talking about the amount necessary to fund the
SEC, that is what would happen. People would pay this little
bit and that would be that.
When it gets to be an enormous amount where it begins to
affect your profitability, people begin to look for ways to
change their business and accommodate this problem. That is the
kind of change that I don't think it is in anybody's best
interest to make willy nilly. That is something that people
should think about. This is a market that has done a lot for
the economy, and a lot of the problems we are currently seeing
in terms of volatility, that was just unheard of a little while
ago, are related to this problem of trying to shift away from
principal trades and agency trades and avoid this tax and other
issues that have come up in a similar way.
That is what is going on. And so I think we can talk about
what is happening now today and what people perceive as unfair,
but you have to understand that is going to change, and in 6
months or a year there will be a new landscape out there and it
might not be the kind of landscape that you might like.
Mr. Cader. I think from our perspective that really the
greatest economic impact and the greatest fairness on public
policy implications simply has to do with the outsized amount
of money that is collected. I think there are, from time to
time, fairness issues between markets, NASDAQ and New York
Stock Exchange, Chicago Board Options Exchange, and those are
worth paying attention to. But I think from our perspective
they are somewhat dwarfed by the $1.8 billion next to the $320
million. So I think as the markets continue to evolve in ways
that we sometimes influence and sometimes don't and often can't
predict, have a way of accommodating themselves through
whatever fee structure is imposed, the less onerous that
structure is, the less the markets will be faced with doing
what Steve has just talked about and responding to tax and fee
policy rather than competitive issues.
Mr. Oxley. The Chair now recognizes the gentleman from Long
Island, Mr. Lazio.
Mr. Lazio. I want to thank the panel for their testimony
and their efforts to try to find consensus, which I don't need
to understate to this group, I think. It is in the end a
question of fairness, I think. If you distill it down to its
most basic level, where you have the SEC operating at a cost to
the public at about $324 million and you have collections
through the section 31 fees 5 times that amount, and growing as
volume increases, you obviously have a huge discrepancy.
My first question is, Why should an average investor care?
It is broadly true that Americans no longer save their money in
mattresses. They are less likely to keep their savings in
banks. And they are increasingly planning for their retirement
through 401(k)s and other pension vehicles. Almost half of all
Americans have some equity stake through mutual funds by virtue
of a direct equity bond investment.
Let me ask Mr. Cader first, it doesn't amount to so much
per small investor, does it? Why should it matter to an average
American?
Mr. Cader. I wouldn't stand here and argue that the extra
$1-$2 billion, a portion of which comes out of investors'
pockets, is going to have a significant impact on their
economic behavior. Given the capitalizations of the equity
markets and the size of trading, I wouldn't put forth the
proposition that the difference of a billion dollars or so
means people will buy stocks or not buy stocks.
However, it is important, No. 1, for a fairness reason;
because as someone said, a billion dollars here and a billion
dollars there, before you know it, it is economically
significant.
Going back to the points that I raised during my testimony,
that portion of the section 31 fee which falls specifically on
the market makers, the specialists and liquidity providers,
offers the possibility for an unpredictable and insidious and
significant impact, although an indirect one on investors, the
users of the markets, in the event that conditions are not as
friendly as they are today. And by the way, the environment,
the business environment for liquidity providers continues to
get more competitive and margins go down for good reasons.
Those reasons are competition, technology, and the ongoing
benefits that are provided to consumers because of that.
Mr. Lazio. Let me get to this point which is this liquidity
issue. Mr. Brodsky had raised it in his testimony and you raise
it now. Can you explain how the fees impact on the ability of
specialists, market makers, to provide more liquidity and why
that is important to the individual investor that there be this
type of liquidity so that the market operates efficiently?
Mr. Cader. It is important because what markets consist of
simply are investors who wish to buy and sell, looking for an
investor with exactly the opposite opinion at the same time. A
buyer for every seller. And markets exist and the need for
liquidity providers exists because investors don't show up at
the same time, at the same price, with the same quantity of
shares. So the liquidity providers, which is the fancy word for
the buyers--the ever-present assigned obligated risk-taking
buyers and sellers in all of the marketplaces, use their money,
their capital, to take the other side of investors' trades,
hundreds of thousands, millions of times a day. So capital that
is taken from the hands of the liquidity providers is then not
available to use to satisfy investor needs in the marketplace
every day.
And to the extent that market conditions are more or less
friendly, and friendly meaning a market in which--that is not
going up or down too much--which indicates that supply and
demand to a certain extent balance out, as opposed to markets
that are moving sharply which indicates an imbalance--the more
sharply the markets are moving around, the more the investors
with their actions are stating that there is not sufficient
liquidity and requiring the assigned obligated risk-takers, the
market makers, to step in and buy and sell with their money to
take the other side of investors' trades.
Mr. Lazio. Let me distill this. The more thinly the market
is traded, the less liquidity there is, the more volatility
there is potentially in price; which, am I correct in assuming
that the smaller investors are probably more likely to be
adversely affected in a situation like that as opposed to the
more sophisticated players that are more attuned to what is
going on?
Mr. Cader. Smaller investors generally have fewer choices
how to mitigate or deal with volatility.
Mr. Lazio. This is not only a tax on capital, it is passed
on to individual and institutional investors, and it increases
the transactional costs when technology is lowering
transactional costs and Americans are more and more likely to
be investing in markets. But it also potentially adversely
affects small investors because of this volatility.
Mr. Cader. That is correct. And it happens in an indirect
way, which is why it is a little hard to explain. The money is
not being taken out of the smaller investors' pocket, but it is
being taken out of a system which is designed to benefit the
small investor at the very place where it can be most needed to
serve the small investor under stressful market conditions.
Mr. Lazio. One last question, and I want to pay honor to my
colleague, Mr. Fossella, for his work on this issue as well.
But for some arcane budgetary rules, is there any market reason
why a rate reduction is not a more efficient, more predictable,
and fairer way to go than a cap?
Mr. Cader. As I think I mentioned before, what is--I think
what is most important to us is that we find a way to some
relief, and since I am unfamiliar with the budgetary process
and the process here----
Mr. Lazio. Forget about the budgetary. That may end up
dictating results, but just in terms from the market
standpoint.
Mr. Cader. I don't think see where it matters. I can draw
on a piece of paper a solution either way, or a hybrid solution
that would involve a reduction and then a cap. I honestly
couldn't see why one is more or less workable than the other.
Mr. Brodsky. All of us are looking for relief and it really
becomes a question of how it can be administered and if there
is a way where a cap can work, that is fine. I think that from
my perspective, about half our business is done through the
liquidity providers.
Again, I echo Mr. Cader's comments that we have many small
investors, and if you make it more expensive for the liquidity
providers, it impedes their liquidity for the small investor. I
just wonder whether a cap can be--for the benefit of the public
investor--can be applied in a fair and even way as opposed to
liquidity providers. Because a cap liquidity provider, they are
in the market all of the time. But if I am an investor that
trades at the beginning of the year, and not at the end, I
probably don't benefit in terms of the specific fees.
But I think all of us are saying we really appreciate what
you are doing. How it gets done is not as important, as we all
believe 5 times the agency's funding makes no sense and it is
fundamentally unfair. So if the committee in its wisdom says we
would rather do it one way than the other, we are as willing to
figure that out administratively. But there are administrative
dynamics that come into play.
Mr. Lazio. Thank you.
Mr. Oxley. I thank the gentleman for his leadership. The
Chair now recognizes the gentleman from Illinois, Mr. Rush.
Mr. Rush. Thank you, Mr. Chairman. Mr. Chairman, I want to
commend you for chairing this very important hearing. I want to
also welcome Bill Brodsky from the Chicago Board Options
Exchange to this hearing and it is good to have him here. The
Chicago Board Options Exchange is an integral part of not only
the Nation but the city of Chicago and we want to do all that
we can to ensure that it is a healthy exchange and we want to
make sure that the section 31 fee issue is resolved amicably
among all of the different parties.
I have a question for Mr. Brodsky. It has been suggested
that the excess fees are back-door taxes which place U.S.
Securities markets at a competitive disadvantage. Do you have
projections of the impacts on the securities market if we as
Members of Congress do not act to resolve the section 31 fee
issue?
Mr. Brodsky. Well, thank you for your warm welcome and it
is good to see you, Congressman.
The markets that we are all living in right now are
changing more rapidly in the current era than they have in many
years, and I too have been in the business over 30 years. There
are exchanges outside the U.S. That are banging on the doors to
try to bring terminals into the U.S. And trade products. How
that impacts on our competitiveness is very much a concern of
ours.
What we want to do is maintain the strong regulation that
we have in this country and make sure that it is paid for, but
be mindful of the fact that if we charge more for that than
necessary, it can limit our competitiveness. I think that is
something that this committee, in its oversight of the
securities markets, should be concerned about, whether it is
section 31 fees or anything else.
Right now, the largest derivative exchange in the world is
no longer in the U.S., it is in Germany and Switzerland, and it
is all screen based, and the biggest products that they trade
are equity derivative products. If they try to offer products
similar to ours without these kinds of fees, that is a great
concern to us. To the extent that they offer them as securities
exchanges in the U.S., they would be subject to our fees, but
right now they are not registered as securities exchanges in
the U.S.
Mr. Rush. Mr. Nelson, would you respond to my question
also?
Mr. Nelson. We have an office in London. We trade 500
European stocks. Those stocks are not subject to these fees.
They are traded on EASDAQ, they are traded on the Deutsche
Borse, and the London Stock Exchange. Some of those stocks are
also traded as NASDAQ stocks here in the United States and some
of them as listed stocks.
I can tell you that customers who have the opportunity to
buy those stocks over in Europe usually do. They are cheaper
typically to do that. I don't know whether that trend will
continue. I think to give a complete picture, their securities
markets are not nearly as well developed or technologically
advanced. It is much more difficult to do business in Europe, I
can tell you that firsthand. A lot of things will have to
change before we would really believe that those markets would
outdo what we do here in the United States. But certainly there
is that opportunity and they are very aware of it over there.
They really want to develop their markets in a way that will be
competitive. This will be a problem, I think, as time goes on.
Mr. Rush. Currently there are two legislative proposals,
two bills before this committee and before the Congress.
Is there any way that any of you would suggest that we
improve upon those bills or are those bills--if the Congress in
its wisdom passes one over the other, would that be
satisfactory? Or can we improve either of those bills?
Mr. Kearney. My own insight, I think that from the
perspective of a cap, I think that speaking to the regulators
and to other people, Chairman Levitt, et cetera, I think that
is probably going to be the easiest, something in the form of a
cap is going to be the easiest bill to pass. If you don't put
that in, I think the regulators might put a major objection to
anything that we are trying to change. That is probably what is
leading the STA to lean toward some form of capping it, because
the chairman of the Commission has basically said more than
once that he is in favor of some type of relief, but it has to
have some form of a cap in it. So for simplistic reasons, we
would be in favor of something along those lines. We will take
anything, but I think that is the logical process. You tend to
go where you are being directed.
Mr. Rush. Mr. Cader?
Mr. Cader. As I said before, I really believe,
mechanically, either approach is workable. The greater the size
of reduction, the greater the amount of money released back
into capital markets to serve investors, the happier we will be
and the better off the public will be. I think it is up to you
all, with as much help as we can give you, to craft the most
workable option.
Mr. Rush. Mr. Brodsky, would you describe the role of
options in the overall picture of securities markets and how
these section 31 fees impact on capitalization, market
capitalization?
Mr. Brodsky. First of all, I think the question is an
appropriate one, except that there is a time constraint. But I
would say to you that the listed option business as it exists
today was created in Chicago in 1973 and there are now 55
exchanges which have copied the CBOE model. The option market
is integral to the securities business. It has provided risk-
shifting abilities, both for individual investors and market
makers so they can provide more liquidity to the markets. It
gives investors, both small investors and very large investors,
both individuals and institutions, a way to manage their risk
that never before existed, and I think it has thrived because
the regulation in the U.S. Has been so effective and there has
been fairness to public investors. So it adds a lot of
liquidity to the markets.
My friend Dick Grasso at the New York Stock Exchange will
always tell me that the Chicago Board Options Exchange send the
NYSE more business a day than any other entity because our
market makers are liquidity providers. When they deal in
options for small public customers, we will hedge on the New
York Stock Exchange or in the NASDAQ market in enormous
quantities. So we have added liquidity to the system and
everyone benefits.
I think particularly at a time like this where we have 5
years of unprecedented growth in equity markets, option markets
provide customers of all types, individuals, institutions,
large and small, with the ability to basically buy insurance on
their stocks. So when you have a stock that has gone up 5
times, you don't want to sell it, you want to keep it, an
option contract can give you the way of buying insurance on
your stock the same way you buy insurance on your house or car,
and I think in that respect options have added a tremendous
amount to the vibrancy and integrity of the U.S. Markets.
Mr. Oxley. The gentleman's time has expired. The Chair now
recognizes another gentleman from Illinois, Mr. Shimkus.
Mr. Shimkus. Thank you, Mr. Chairman. I also want to extend
my welcome to Mr. Brodsky, and I don't think that Illinois
takes a second seat in financial services to any New York
facility. All of these New Yorkers are on this bill but we have
great boards of trades and options and the Mercantile and so we
are proud to have you here. I think you hear commonality on the
need to get the fees in line with the exact expenses. Look, all
the New Yorkers are leaving now.
And I am a proponent of budget simplification. I do think
that it is a tax imposed upon the consumers if there is
additional money over the identified costs of the services in
which the fee was in place to begin with. So I think there is
pretty much unanimity. I think the question debated here is
caps versus deceleration of fees and how that would have
happened, and I do feel that it will adversely affect the
international competition if these fees remain in place. If
they are fees in excess of the fees needed to fund the
Commission, then I think it will adversely effect us.
Mr. Brodsky, in your statement you talk about--for the sake
of argument, what kind of acceleration of the reduction fees
would you recommend? What is the disadvantage of having the cap
in place?
Mr. Brodsky. First of all, in terms of acceleration, I
think the whole panel is in agreement that we seek relief as
soon as possible. We know how difficult it is to get consensus
on these things. But the sheer numbers indicate that there is
money that could be used elsewhere to add to the capital
markets, and I think that again I will share the views of those
on the panel. We are looking for relief and looking for relief
promptly, but we don't want to jeopardize the funding of the
agency, and we would rather find some way to sit down--whatever
the committee thinks it can get done, we would like it to get
done.
Mr. Shimkus. You are being very gallant and political in
terms of not wanting to stir up the chairman based upon his
proposal, and I understand that.
The question that we have to address--and if you want to do
that with staff as we deal with this--I think members are going
to want to know why you prefer one or the other and what would
be the benefits and disadvantages of each. But I guess I will
just defer to the chairman as we move forward, if that is
something that we want to do, to try to get a delineation
between staff. But either you have a lot of agreement that
there is an excess of charges being collected, that it ought to
be in line with what the actual costs are, so what is the
proper way to go about it for the industry; and you all as
panelists should say, We don't like the cap, this is why. Or,
We want immediate changing of the fee structure now; and then
who, what, when, where, why and how?
I am going to have to go to the floor to preside as Chair,
and I yield back the balance of my time, or if anyone wants to
answer. If we want to get into which one is better, I will
leave that up to the chairman's discretion.
Mr. Oxley. I think we have had a pretty good discussion on
that. That is something that we need to work with the
appropriate parties and staff on that, which will clearly be
part of the work product of our worthy staff during the August
recess while the members are back at the county fairs.
Mr. Brodsky. Mr. Chairman, while Mr. Shimkus is still here,
I appreciate your comments about Illinois, but I must say
something. I was born in Brooklyn and I grew up on Long Island,
and with Mr. Towns and Mr. Lazio, I had to say that.
Mr. Oxley. The gentleman's time has more than expired.
Mr. Lazio. Easy, easy.
Mr. Rush. We don't hold that against him, Mr. Chairman.
Mr. Oxley. The gentlewoman from Colorado, Ms. DeGette.
Ms. DeGette. I guess I would like to have Mr. Brodsky
answer Mr. Shimkus's question. We can all pussyfoot around here
and talk to staff during the recess. We have no county fairs in
my district in August. Tell us why you don't favor the caps and
what you would prefer to see.
Mr. Brodsky. In my prepared remarks, I favored the general
reduction over the cap because I am not aware of how we could
administer the cap as it relates to smaller investors. The cap,
I think, would work well with the professionals who are trading
all of the time, so when you reach X amount, you know that you
don't pay any more. But investors don't trade on some sort of
particular schedule. They do things because it either moves
them or because it is in their economic benefit to do so. I am
not ruling it out as being a bad thing, I am just not aware of
how people would administer a cap for millions of investors who
pay the fee as well.
I can't tell you in dollar terms how much of it is paid by
the liquidity providers versus the investor, and I know
liquidity providers pay a very large amount because they do
provide the grease that oils the wheels. But clearly I as an
individual investor will sell stock or sell options at odd
times during the year; and how does the cap work? You are not
going to administer it from millions of individual accounts.
Ms. DeGette. I wonder if some of the rest of you would
comment on that issue, how you would administer this for small
investors.
Mr. Kearney. It is probably not dissimilar to the Social
Security tax or whatever. We have a lot of caps in this economy
that, yeah, you participate early and you don't participate
later, and I think that one of the things STA is looking at is
what is doable. And I think that the Commission is looking at
some form of relief. However, they are in fear of having to go
back to Congress at a further date if the securities business
should slow down.
I think that some type of compromise, a rate decrease with
a cap, is probably the most logical thing. It is not going to
be fair to everybody. A rate increase will benefit certain
people. A cap will benefit certain people more or less. I don't
think that you can reach a compromise that is going to be fair
to every investor and the liquidity providers and everybody
involved in this.
The reason that we teed this up was because of the amount
of dollars that are being collected by the government. So maybe
the consensus is you do a rate decrease. You have a cap just in
case the thing starts to decrease to where the SEC is
uncomfortable, and that is probably something that the chairman
would go along with--Chairman Levitt. He is going to be an
obstacle if we don't--we have to listen to him. He has a lot of
responsibility.
Ms. DeGette. And I think one thing we have unanimous
agreement on in this room is that we need to do something to
establish a stable fee structure that adequately reflects an
offset of the SEC's regulatory activities. And the only
question we have got is how do we do that.
Mr. Brodsky, let me ask you one more question and maybe the
others can comment. Just to play devil's advocate, if we reduce
the section 31 transaction fees, how can we be sure that this
will not jeopardize SEC revenue fees over the long term, where
there is significantly reduced market activities and the
possibility of severe market downturns? A lot of you think that
this will not be a problem, but I would like to hear your
comments on it.
Mr. Brodsky. I think if you look at the overall trend of
volume in business over the last 20-30 years, the overall trend
is clearly up. You would not necessarily have to have a cap
that would go from here to here, but it could be scaled down
over a period of years, and the committee meets more than once
a year and they can keep an eye on it.
I think there are lots of ways to do it. Again, I think it
doesn't have to be all done in 1 year, but we have to recognize
that the trend has been clearly dramatically up over every 3-
to 5-year period of time that has existed.
Ms. DeGette. Do the rest of you have comment on that issue?
No? I have stumped the panel.
Mr. Nelson. The reality is that there are significant
design issues with either approach. We recognize that. We did
not come prepared today to talk about this issue. I didn't. And
this is something that we would love to get into in more
detail, but it is a complex issue. There are--each side--you
have certainty on one side, which is what you are referring to
right now: the certainty that the SEC will be funded, the
certainty that they will not be overfunded against a
potentially greater relief through a rate reduction.
It is a very difficult design issue and it is something
that really needs to be explored in a lot of depth. We would
love to get into that. We came here today to talk about the
issue of funding. That was our mandate and that is what we came
prepared to talk about.
Ms. DeGette. Whatever we end up coming up with, Mr.
Chairman, if we can try to design it as well as we can to be
accurate and to minimize future congressional involvement. I
know this would be a goal shared by all members of this panel.
I yield back the balance of my time.
Mr. Oxley. That is exactly what we would try to achieve.
This is going to take some heavy lifting, but once that is
completed, we would hope that we could put it on automatic
pilot and go on to other project.
We thank all of you for what was a most impressive
testimony and response to questions. I think we have teed up
the issues very, very effectively. And now we will start the
hard work of putting together some ideas as to how we best move
forward. We look forward to working with all of you toward the
same goal. The subcommittee stands adjourned.
[Whereupon, at 12 noon, the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
Prepared Statement of the Securities and Exchange Commission
Thank you for giving the Securities and Exchange Commission (SEC or
Commission) the opportunity to present this statement concerning
securities transaction fees. The SEC shares the Subcommittee's concern
that fee collections are currently well in excess of initial
projections. The existing fee structure, last revised in 1996, was the
product of many years of negotiations, involving many players with
competing interests. However, tremendous market growth in recent years
has pushed fee collections far beyond the levels anticipated during
those negotiations. The SEC welcomes an inclusive, reasoned dialogue on
fee collections.
History of Fees
Federal securities laws direct the Commission to collect three
different types of fees: registration fees, transaction fees, and fees
on mergers and tender offers. Securities registration fees (Section
6(b) fees) are paid by corporations and investment companies when they
register securities for sale. These were first enacted at a rate of \1/
50\th of 1 percent under Section 6(b) of the Securities Act of 1933.
Starting in 1990, the Section 6(b) fee rate was increased yearly
through the appropriations process. The first \1/50\th of 1 percent
goes directly to the U.S. Treasury and is unavailable for funding the
SEC. The amount over the \1/50\th of 1 percent (called offsetting
collections) can be used to fund the agency through appropriations.
Transaction fees (Section 31 fees) are paid when securities are
sold. These were enacted at a rate of \1/300\th of 1 percent on
exchange-listed securities under Section 31 of the Securities Exchange
Act of 1934. Proceeds from this fee are deposited directly in the U.S.
Treasury and are not available to fund the agency.
Fees on mergers and tender offers are paid by corporations directly
to the U.S. Treasury and also are not available to fund the agency.
The SEC's fee collections have been a subject of concern since
1983, when the Commission first began contributing more to the U.S.
Treasury than was required to fund the agency. In 1988, the Securities
Subcommittee of the Senate Committee on Banking, Housing, and Urban
Affairs requested that the SEC examine its fee collections and funding
structure. The report prepared by the SEC in response to this request
was the first step in the process that eventually led to the compromise
reached in Title IV of the National Securities Markets Improvement Act
of 1996 (NSMIA).<SUP>1</SUP>
---------------------------------------------------------------------------
\1\ Report submitted in response to the request of the Securities
Subcommittee of the Senate Committee on Banking, Housing and Urban
Affairs (S. Rpt. 100-105), December 20, 1988.
---------------------------------------------------------------------------
Fee Agreement in NSMIA
Title IV of NSMIA mandates a fee structure that was the result of
extensive negotiations between six different Congressional Committees,
the Administration, and the SEC.
In general, the NSMIA fee structure was designed to:
<bullet> gradually reduce total fee collections;
<bullet> ``level the playing field'' by extending Section 31
transaction fees, which had previously only applied to
transactions involving exchange-listed securities, to
securities subject to ``last sale reporting'' in the over-the-
counter market;
<bullet> gradually reduce the SEC's reliance on fee collections,
thereby increasing the amount of new budget authority required
to fund the agency through the appropriations process; and
<bullet> provide the SEC with a stable, long-term funding structure.
NSMIA set in motion a gradual reduction in Section 6(b)
registration fee rates over a ten-year period intended to more closely
align fee collections with the funding needs of the SEC. Specifically,
NSMIA authorized the Commission to collect securities registration fees
at the rate of \1/50\th of 1 percent of the aggregate offering price in
fiscal year 2006, declining annually from \1/34\th of 1 percent in
1998. In fiscal year 2007, the rate will be further reduced to \1/
150\th of 1 percent. In addition, NSMIA classified the portion of the
Section 6(b) fees in excess of \1/50\th of 1 percent (i.e., the portion
declining from 1998 to 2006) as offsetting collections that can be used
directly to fund Commission operations, subject to prior approval by
the Commission's appropriations committees.
NSMIA also provided equity in the application of Section 31 fees by
authorizing the SEC to collect these fees on transactions in the over-
the-counter (OTC) market involving securities subject to ``last sale
reporting.'' Unlike the Section 31 fees imposed on sales of exchange-
listed securities, these new OTC fees are classified as offsetting
collections and, therefore, can be used to fund Commission operations,
subject to approval by the Commission's appropriations committees.
Under NSMIA, all Section 31 fees will fall to \1/800\th of 1 percent in
fiscal year 2007.
Because the fees collected by the SEC are tied--directly and
indirectly--to market activity, they are nearly impossible to predict
accurately. The fee rates established in NSMIA were based on 1996
projections of market activity. However, the tremendous growth in the
markets over the past few years has far exceeded the 1996 estimates on
which NSMIA was based, resulting in fee collections well in excess of
original estimates. Unfortunately, the potential for either excess
collections or shortfalls is inherent in activity-based fees.
While the NSMIA fee structure has eliminated the funding
uncertainties and crisis situations that surrounded the agency's
funding from the late 1980s to the mid-1990s, it has not reduced total
collections due to unexpectedly strong market activity.
Budget Enforcement Act
The rules enacted as part of the Budget Enforcement Act (BEA) have
restricted efforts to undertake a comprehensive fee reduction. The BEA
splits our fee collections into two different categories: mandatory and
discretionary. Under the BEA, any fees in existence prior to 1990 are
deemed mandatory and are deposited directly into the General Fund of
the U.S. Treasury; they are unavailable for SEC use. The SEC's fees
that fall into this category are:
<bullet> the first \1/50\th of 1 percent of Section 6(b) registration
fees;
<bullet> Section 31 fees on transactions involving exchange-listed
securities; and
<bullet> fees on mergers and tender offers.
These fees, which account for nearly 70 percent of total SEC
collections, are estimated by the Congressional Budget Office (CBO) to
exceed $1.1 billion in fiscal year 2000. Because these collections
currently are protected by the BEA rules, they cannot be reduced
without a corresponding increase in revenues or decrease in federal
spending elsewhere. According to CBO's estimates, to fully repeal these
fees, other collections flowing to the Treasury's General Fund would
have to increase by $9.6 billion over the next seven years, or spending
from the General Fund would have to be reduced by the same amount.
The remaining 30 percent of SEC collections are unaffected by the
requirements of the BEA. These ``discretionary'' fees, available for
use by our appropriators under NSMIA, are the fees previously
identified as our offsetting collections. Specifically, they are:
<bullet> Section 6(b) registration fees collected above \1/50\th of 1
percent; and
<bullet> Section 31 fees on transactions in securities subject to
``last sale reporting'' in the over-the-counter market.
The following chart shows the current CBO estimates of total fee
collections broken down between mandatory and discretionary under the
BEA.
($ in millions)
------------------------------------------------------------------------
Total
Fiscal Year Mandatory Discretionary Collections
------------------------------------------------------------------------
2000............................. $1,155 $501 $1,656
2001............................. $1,206 $498 $1,704
2002............................. $1,260 $503 $1,763
2003............................. $1,314 $516 $1,830
2004............................. $1,422 $508 $1,930
2005............................. $1,544 $552 $2,096
2006............................. $1,675 $601 $2,276
2007............................. $783 $285 $1,068
------------------------------------------------------------------------
As the chart illustrates, total fee collections are projected to
increase through fiscal year 2006, and then fall sharply in 2007 when
the final NSMIA fee reductions go into effect.
Fee Reductions
The Commission recognizes the magnitude of this issue, and has
tried to reduce fees, where possible, when it is within its authority
to do so. The Commission has taken two specific actions to reduce fees
and administrative burdens. In 1996, fees for filing certain disclosure
documents were eliminated, saving public companies an estimated $8 to
$12 million per year. While this is a small amount relative to the size
of the industry, it is significant in reducing the administrative
burden on registrants, as well as the SEC. In addition, the Commission
responded to industry concerns that there was a double counting of
transactions in the over-the-counter market imposing an unfair burden
on certain market participants. The Commission encouraged and actively
supported changes in industry practices to eliminate this problem and
approved NASD rule proposals to implement this change in March 1999.
Conclusion
Today, we are faced with fee collections well above the levels
anticipated in NSMIA. As stated earlier, CBO's estimates for fiscal
year 2000 fee collections are $1.66 billion. Not only is that amount
far greater than our funding requirements for fiscal year 2000, but 70
percent of that figure is unavailable to fund the agency because of the
restrictions imposed by the BEA rules.
However, we are still faced with many of the same issues that
required years of Congressional negotiation and that resulted in the
compromise embodied in NSMIA. Any alternative funding mechanism must:
<bullet> provide full funding for the SEC;
<bullet> spread the costs of regulation among those who benefit;
<bullet> consider the effect of market conditions on collections; and
<bullet> address the competing interests of all parties.
The SEC welcomes the opportunity to discuss this issue and
appreciates the help and support of all the interested parties in
ensuring that the SEC remains adequately funded regardless of the
funding approach taken.