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THE ROLES AND RESPONSIBILITIES OF INSPECTORS GENERAL WITHIN FINANCIAL REGULATORY AGENCIES

HEARING

BEFORE THE

SUBCOMMITTEE ON GOVERNMENT MANAGEMENT,

ORGANIZATION, AND PROCUREMENT

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED ELEVENTH CONGRESS

FIRST SESSION

MARCH 25, 2009

Serial No. 111–49

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.gpoaccess.gov/congress/index.html

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

EDOLPHUS TOWNS, New York, Chairman

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

ELEANOR HOLMES NORTON, District of

Columbia

PATRICK J. KENNEDY, Rhode Island

DANNY K. DAVIS, Illinois

CHRIS VAN HOLLEN, Maryland

HENRY CUELLAR, Texas

PAUL W. HODES, New Hampshire

CHRISTOPHER S. MURPHY, Connecticut

PETER WELCH, Vermont

BILL FOSTER, Illinois

JACKIE SPEIER, California

STEVE DRIEHAUS, Ohio

——— ———

——— ———

——— ———

DARRELL E. ISSA, California

DAN BURTON, Indiana

JOHN M. MCHUGH, New York

JOHN L. MICA, Florida

MARK E. SOUDER, Indiana

TODD RUSSELL PLATTS, Pennsylvania

JOHN J. DUNCAN, JR., Tennessee

MICHAEL R. TURNER, Ohio

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

BRIAN P. BILBRAY, California

JIM JORDAN, Ohio

JEFF FLAKE, Arizona

JEFF FORTENBERRY, Nebraska

JASON CHAFFETZ, Utah

AARON SCHOCK, Illinois

RON STROMAN, Staff Director

MICHAEL MCCARTHY, Deputy Staff Director

CARLA HULTBERG, Chief Clerk

LARRY BRADY, Minority Staff Director

SUBCOMMITTEE ON GOVERNMENT MANAGEMENT, ORGANIZATION, AND PROCUREMENT

DIANE E. WATSON, California, Chairman

PAUL E. KANJORSKI, Pennsylvania

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

HENRY CUELLAR, Texas

JACKIE SPEIER, California

PAUL W. HODES, New Hampshire

CHRISTOPHER S. MURPHY, Connecticut

BRIAN P. BILBRAY, California

AARON SCHOCK, Illinois

JOHN J. DUNCAN, JR., Tennessee

JEFF FLAKE, Arizona

——— ———

(III)

C O N T E N T S

Page

Hearing held on March 25, 2009 ............................................................................ 1

Statement of:

Kepplinger, Gary L., general counsel, Government Accountability Office .. 10

Kotz, H. David, inspector general, U.S. Securities and Exchange Commission; William Desarno, inspector general, National Credit Union Administration; A. Roy Lavik, inspector general, Commodities Futures

Trading Commission; Vanessa K. Burrows, legislative attorney, Congressional Research Service; Clark Kent Ervin, director, Homeland Security Program, Aspen Institute; and Danielle Brian, executive director,

Project on Government Oversight ............................................................... 31

Brian, Danielle .......................................................................................... 78

Burrows, Vanessa K. ................................................................................. 61

Desarno, William ....................................................................................... 48

Ervin, Clark Kent ...................................................................................... 74

Kotz, H. David ........................................................................................... 31

Lavik, A. Roy ............................................................................................. 55

Larson, Hon. John B., a Representative in Congress from the State of

Connecticut .................................................................................................... 4

Letters, statements, etc., submitted for the record by:

Brian, Danielle, executive director, Project on Government Oversight,

prepared statement of ................................................................................... 81

Burrows, Vanessa K., legislative attorney, Congressional Research Service, prepared statement of ............................................................................ 63

Desarno, William, inspector general, National Credit Union Administration, prepared statement of .......................................................................... 51

Ervin, Clark Kent, director, Homeland Security Program, Aspen Institute, prepared statement of .......................................................................... 76

Kepplinger, Gary L., general counsel, Government Accountability Office,

prepared statement of ................................................................................... 13

Kotz, H. David, inspector general, U.S. Securities and Exchange Commission, prepared statement of .......................................................................... 35

Larson, Hon. John B., a Representative in Congress from the State of

Connecticut, prepared statement of ............................................................ 7

Lavik, A. Roy, inspector general, Commodities Futures Trading Commission, prepared statement of .......................................................................... 57

(1)

THE ROLES AND RESPONSIBILITIES OF INSPECTORS GENERAL WITHIN FINANCIAL

REGULATORY AGENCIES

WEDNESDAY, MARCH 25, 2009

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON GOVERNMENT MANAGEMENT,

ORGANIZATION, AND PROCUREMENT,

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 2:35 p.m., in room

2247, Rayburn House Office Building, Hon. Diane Watson (chair of

the subcommittee) presiding.

Present: Representatives Watson, Cuellar, Speier, Bilbray,

Platts, Duncan, and Towns [ex officio].

Staff present: Bert Hammond, staff director; Valerie Van Buren,

clerk; Adam Bordes, professional staff; Carla Hultberg, chief clerk,

full committee; Jean Gosa, clerk, Domestic Policy Subcommittee

and Information Policy, Census, and National Archives Subcommittee; Charles Phillips, minority chief counsel for policy; Dan

Blankenburg, minority director of outreach and senior advisor;

Adam Fromm, minority chief clerk and Member liaison; Stephen

Castor, minority senior counsel; and Molly Boyl, minority professional staff member.

Ms. WATSON. I am sorry that the first thing I have to do is apologize for being so late.

But I want to say hello and good afternoon to all of you. This is

the Subcommittee on Government Management, Organization, and

Procurement of the Committee on Oversight and Government Reform. So I will now call you and myself to order.

Without objection, the Chair and the ranking minority member

will have 5 minutes to make opening statements followed by opening statements not to exceed 3 minutes by any other Member who

seeks recognition.

I would like to welcome you to our first subcommittee hearing

this session, ‘‘The Roles and Responsibilities of the Inspectors General in the Financial Regulatory Community.’’ As the chairwoman

of the Subcommittee on Government Management, Organization,

and Procurement, I look forward to working with Ranking Member

Bilbray and the subcommittee members to ensure that our Federal

bureaucracy is both effective and efficient in carrying out its responsibilities. I welcome our witnesses, especially my colleague

Congressman John Larson. I look forward to hearing your testimony.

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Today’s hearing could not come at a more critical time for our

panel, as our financial markets continue to struggle with mounting

losses and insufficient capital reserves to meet the credit needs of

our domestic economy. As we begin to implement newly established

market stabilization programs across the financial regulatory community, we must also look ahead to ensure that our financial regulators have an effective Inspector General component as part of

their agency operations. Personally, I believe no regulatory or market structure reforms will prove successful if our market regulators

lack an independent and objective IG to oversee their activities.

The role of Inspectors General is an essential one for ensuring

that our Federal agencies function both effectively and freely from

undue political pressure or conflicting interests. These pervasive

elements far too often creep into the culture of agencies, therefore

compromising the very programs and staff that are charged with

overseeing and enforcing the rule of law throughout the marketplace. In order to achieve this goal, we must ensure that our IGs

are fully independent in their activities while also ensuring that

they have adequate resources and legal authorities necessary for

carrying out their duties. These elements are critical if we are to

have faith in the regulatory mechanisms established to protect investors from reckless and fraudulent investment practices.

Last fall, Congressman Cooper worked to enact the Inspector

General Reform Act of 2008 which provided significant improvements in the authorities and responsibilities granted to the IGs for

carrying out their duties. These include new law enforcement authorities, increased budget autonomy, a unified Government-wide

IG council, and additional reporting responsibilities to improve

agency transparency. Today, however, many IGs are still appointed

by their agency heads or commission chairs, thus opening some IG

offices to potential conflicts of interest with the same agency leadership they are charged with overseeing. While this is a complicated issue with valid points on both sides, I believe it is one

that merits a serious discussion in order to ensure the independence and reliability of agencies’ IGs.

Today I hope that our panelists will be able to discuss their efforts to ensure that our market regulatory functions are being carried out efficiently by our agencies. Part of this must include how

agency IGs are coordinating with the newly established Special IG

for the Troubled Assets Relief Program [SIGTARP], in order to ensure that program funds are being spent appropriately and in accordance with the law. I am also hoping to hear about their ongoing activities to investigate where market regulators have failed in

overseeing the very institutions that now require nearly $1 trillion

in government assistance in order to remain viable.

Furthermore, I look forward to hearing from Congressman

Larson on his legislation, House of Representatives 885, the Improved Financial and Commodities Markets Oversight and Accountability Act. This bill would designate the IGs of several key

financial market regulators to the level of Presidential appointments, therefore removing agency heads from having any role in

the appointment or removal of an IG from office.

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So once again, I want to thank our panelists and I want to thank

the Members for coming today to join us. And we look forward to

their testimony.

And at this point our co-chair, the minority leader, will have

about 3 to 5 minutes for his statement.

Mr. BILBRAY. Madam Chair, I would just like to ask that my

opening statement be introduced into the record.

Ms. WATSON. Without objection, so ordered.

Mr. BILBRAY. Thank you. And so, to get to the testimony as

quickly as possible, let me just say that I appreciate you holding

this hearing.

And I would like to thank the Congressman for basically drafting

this bill because I think it is really critical that now is the time

that we take a look at this whole IG issue. I mean, the act was

originally initiated in 1978, back in the olden days when some of

us were young and just getting into politics. It is time that we look

at this very periodically to make sure the good intentions that we

have tried to wreck in the past are actually working, especially now

at a time with bailouts. You have rescues; you have big spending.

And Inspectors General are absolutely essential. I mean, if there

was any concern in the past of when and where and how public

funds were being used, right now the public has a hypersensitivity

to it. And for good reason because of just the sheer numbers and

the long-term impact that inefficiency can have.

I would just like to say that we always talk about how this is

not Democrat or is not Republican or whatever. That is all great

in abstracts. But this is one issue where we really don’t know

where the answer is. We need to probe. And it really is an example

of where politics is more of an art than a science. It is not as exact

as a lot of people like to think. And I hope that this hearing is the

beginning of that probing to find where is the fine tuning, where

is the nuance, where can we improve the system. I think the Congressman has one proposal that we need to look at seriously and

then compare it to other options along the road. And I really think

that a hearing like this is exactly how we can do it.

And I have to say, Madam Chair, I think a lot of people have

been concerned that in crisis we do things quick, not well. And a

lot of us, I know, are going back now and saying there were a lot

of things done in the recent past that we wish we could go back

and revisit. Here is a chance for us to get the facts, to work together, and to fine tune this before we ask the people of the United

States to live with our decisions. And so I appreciate the ability to

have this hearing. I appreciate the Congressman being here today.

And I look forward to hearing all of the witnesses today so we can

start that process of creating our work of art that hopefully will be

something we will be proud of long after we are gone, especially

one that makes sure that the voters are happy with the way we

are handling their resources. This IG issue is obviously one of those

issues that really is essential for us to do right if we are going to

fulfill our responsibility of being the vanguards and the protectors

of the taxpayers’ money. And I appreciate the hearing again and

yield back, Madam Chair.

Ms. WATSON. Thank you, Congressman Bilbray.

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Congressman Cuellar, would you like to have an opening statement?

[Inaudible due to sound system malfunction.]

Ms. WATSON. Thank you. I would like to call on Congressman

Platts at this time. Thank you for your leadership of this subcommittee. We appreciate the work that you do for the people.

Mr. PLATTS. Well, I thank you, Madam Chair. It certainly was

a honor for 4 years to chair this subcommittee with now the full

committee chair, then the ranking member, Mr. Towns from New

York. I am honored to stay part of this effort.

Thank you for your hosting this hearing. One of the things we

saw during those 4 years is the importance of IGs when it comes

to truly ensuring efficiency and responsible operations of the Federal Government. And I want to commend our colleague, Mr.

Larson, for his proposal for further enhancing the status and the

independence of IGs of these five agencies, in particular given the

challenges we are facing in our financial market. So I look forward

to his testimony and to hopefully our successful movement of his

legislation. Thank you, Madam Chair.

Ms. WATSON. Thank you. I now would like to welcome the chairman of the full committee, Mr. Towns, who decided to come and sit

in with us on our first hearing. Would you like to make a statement?

Chairman TOWNS. Let me say first of all, I want to congratulate

you. And I want to say that I think this is the best subcommittee

of all, I want you to know that, because this is the one that, of

course, I was ranking member on and one that I had an opportunity to Chair as well. I had the opportunity to work with Congressman Platts on many, many issues.

So I just want to say, Madam Chair, that I look forward to working with you. I would just like to yield back and wait to hear from

Congressman Larson.

Ms. WATSON. Thank you so much. Let me call our committee to

order. And we are honored to have with us as our first witness the

Honorable John Larson. And thank you for your patience.

STATEMENT OF HON. JOHN B. LARSON, A REPRESENTATIVE

IN CONGRESS FROM THE STATE OF CONNECTICUT

Mr. LARSON. Thank you, Madam Chair.

[Inaudible due to sound system malfunction.]

Mr. LARSON. So let me thank you all again for this opportunity.

And most importantly, let me thank your committee, as I think the

chair adequately and eloquently stated the outset, for the work

that you have done, the fine legislation that you have produced

that Jim Cooper was a part of, and the pleasure of working with

Ed Towns and the committee in terms of shaping this current legislation, House of Representatives 885, that we have before you. I

would like to quickly, if the Chair would agree, submit a testimony

from the Public Citizen in support of this legislation.

Ms. WATSON. Without objection, so ordered.

Mr. LARSON. I also would like to revise and extend my remarks

and submit my testimony. I will summarize if I can so any questions that you might have, we can get to those as quickly as possible.

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The need for this arose as we dealt with the issue of speculation

more than a year ago in a nonpartisan basis, again recognizing the

increased need for oversight and review. It was pointed out at the

time that the CFTC did not have, it had an Inspector General, but

it did not have independent status. That individual was hired by

and reported directly to the CFTC. This committee waived jurisdiction but broadly supported it and this was taken to the floor and

passed overwhelmingly, nonpartisanly. It unfortunately was not

taken up in the Senate.

Upon discussion with Mr. Towns earlier this year and with his

staff, we said, you know, this goes beyond the CFTC. And if we

look at the kind of troubled waters, as Chairwoman Watson pointed out, that we find ourselves in today with all of these financial

institutions and the ramifications therein, it became apparent to

me and I think certainly to this committee and Mr. Towns that

there was a need for us to make sure that our Inspectors General,

a law that was first adopted in 1978 and upgraded last year by this

committee, that we further augment and bolster their responsibility and their credibility with the American public to make sure

that Inspectors General in critical agencies have independent status.

Now, under that legislation, there are two types of Igs. One is

under Section 3 that has independent status. By that they are appointed by the President and confirmed by the U.S. Senate. Under

Section 8, IGs also exist but in this case they are appointed by the

president of the agency, the governing entity of the agency, and

serve at the behest of that.

I think especially in these troubled times and with the problems

that we face only exponentially growing, it is the desire of the public to make sure, especially as it relates to governmental entities,

that they are doing their responsibility of oversight and review,

which of course this committee is specifically charged with.

So this legislation is very simple. It says that we need to focus

on the five agencies that have direct involvement in making sure

that they are involved with the oversight of our financial institutions, both in the commodities and financial markets: the CFTC,

the Board of Governors of the Federal Reserve, the National Credit

Union Administration, the Pension Guaranteed Benefit Fund, and

the Securities and Exchange Commission. All need to come under

this kind of independent scrutiny that I think everyone in the U.S.

Congress wants to see.

And all this bill does is augment the fine work that you have already done by giving them that kind of status that already exists

in the law under Section 3 of that code. That would make these Inspectors General independent in status. It would expand their

scope and their independence and give them additional resources.

This committee went a long way toward providing resources last

year and understood this early on. This gives added importance

and independence in this day and age.

Now, how do I know that we need that and what kind of information do we have to back that up? We all know and can feel in

our guts that intuitively this makes sense. But, in fact, we had the

Congressional Research Service do a study and what that study

showed was very clear. Amongst agencies that have an independVerDate 11-MAY-2000 14:09 Jun 07, 2010 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 U:\DOCS\56375.TXT KATIE PsN: KATIE
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ent Inspector General appointed by the President and approved by

the Senate, they are involved in more than 117 ongoing audits and

investigations.

Amongst their same counterparts who are not appointed by the

President but appointed by the agency and work at the direction

of the agency, they have currently done 12 and have 11 that are

under review. So in the case of independent Inspectors General appointed by the President and approved by the Senate, they do 10

times as many audits and reviews. At a time when every economist, every pundit, everyone who is looking at this situation says

what we need and what we have needed all along is to make sure

that we had greater oversight and review, I think this speaks volumes to the necessity for this legislation.

It is my hope along with Mr. Platts, and I was happy to hear him

say that, and in working with Mr. Towns that we can expedite this

legislative process. I believe this could probably be put on our consent calendar because of its nature and the gravity of this situation, as Chairwoman Watson has pointed out. I look forward to

working with Chairman Towns and I thank him for his help and

support and his committee’s aid.

It was at their suggestion, I might add, that we look into expanding this because they had already done such a thorough job with

the Cooper legislation last year. And with that, I will yield back the

balance of my time and submit to any questions you might have.

[The prepared statement of Hon. John B. Larson follows:]

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Ms. WATSON. Thank you so much, Congressman. This concludes

the Congressman’s testimony. If any of the Members would like to

raise a question, we will take about 5 minutes.

[Inaudible due to sound system malfunction.]

Ms. WATSON. So again, I must apologize. I will recess for a time

for us to go to the floor and vote. Then we will come back here and

we will go on with our panelists. So are there any questions from

committee members for Mr. Larson?

Chairman TOWNS. Not a question, but I would just like to assure

him that I look forward to working with him to make certain that

we move this legislation forward. I think it is very, very much

needed. And, of course, I agree with you. I think it is something

we should be able to get on the consent calendar.

Ms. WATSON. Mr. Bilbray.

Mr. BILBRAY. Yes, I appreciate the item. Let me just say right

off, one of the independent auditors who is handling the Agency for

International Development, I will just tell you, and I have talked

to the chairman about that, there is an agency that I think hasn’t

had enough auditing. I think in Afghanistan the big scandal is not

going to be what has happened with the war but what hasn’t happened with economic development. And with your encouragement

of going from a few agencies, would you just discuss the aspect of

rather than proving, expanding it in an evolutionary way, now it

has been kind of encouraged to be revolutionary and sort of be

much broader originally? Is there a degree of discomfort for the fact

that we may regret that we haven’t done one or the other? I mean

done one first and then phased in the next?

Mr. LARSON. Well, I think this would be what President Obama

has called the ‘‘fierce urgency of now.’’ And as Chairwoman Watson

pointed out, with the severity of the times we find ourselves in, indeed in uncharted waters, and the need for us to have more expertise, more oversight, and more independent hands on the wheel,

whether it was benign neglect or whether it was someone asleep

at the switch, I think the American public has demanded that we

have this kind of independent oversight and review. As my grandfather Nolan used to say, trust everyone but cut the cards.

Mr. BILBRAY. Well, let me just say that, you know, there was

that old saying that if you can keep your head cool and calm while

everybody else is losing it, you obviously don’t understand the magnitude of the problem. [Laughter.]

But a dirty little secret is everybody knows that I surf but they

don’t know I do a lot of sailing. And I remember somebody who was

sailing in Mexico with me one time said, you know when we are

in trouble and when we are in danger when Brian is quiet and

introverted. I think sometimes keeping cool and not panicking, not

just doing something is a very important part of a crisis.

I just want to make sure we make a diligent step here because

I do worry about how quickly we are jumping to things because of

crisis. And remember, the line that you have to do something is

what one lemming says to the other before jumping off a cliff. So

I want to make sure that we do have that. I think that you have

a good, sound proposal here. I just think that those of us by definition on oversight have to make sure that it is not a cliff but actuVerDate 11-MAY-2000 14:09 Jun 07, 2010 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 U:\DOCS\56375.TXT KATIE PsN: KATIE
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ally a step up in the direction we want to go. And I yield back,

Madam Chair.

Ms. WATSON. Thank you. We are now going to take a brief recess. We will reconvene, I imagine it will be around 3:30 p.m. So

thank you so very much Mr. Larson.

Mr. LARSON. I thank the Chair, I thank the ranking member,

and I thank our distinguished Chair and all the committee members for their time.

[Recess.]

Ms. WATSON. We are now going to start with the second panel.

It is a policy of the Committee on Oversight and Government Reform to swear in all witnesses before they testify. I would like to

ask Mr. Kepplinger, I think you are the first in this set, to rise and

raise your right hand.

[Witness sworn.]

Ms. WATSON. Let the record reflect that the witness answered in

the affirmative. I would now like to introduce Mr. Gary L.

Kepplinger, who serves as the General Counsel of the Government

Accountability Office. Prior to his appointment in 2006, he served

as Deputy General Counsel and Managing Associate General Counsel in charge of accounting, appropriations, information management, and special investigation matters. And I ask that the current

witness give a brief summary of your testimony. Keep the summary, if you can, under 5 minutes in duration. Your complete written statement will be included in the hearing record. Thank you

and you may begin.

STATEMENT OF GARY L. KEPPLINGER, GENERAL COUNSEL,

GOVERNMENT ACCOUNTABILITY OFFICE

Mr. KEPPLINGER. Thank you, Madam Chairwoman. It is always

a challenge for me to stay under 5 minutes but I am going to give

it my best shot.

Our Nation is currently in the midst of one of the worst financial

crises since the Great Depression. As we recently reported, the current U.S. financial regulatory system has relied on a fragmented

and complex arrangement of Federal and State regulators that has

not kept pace with major developments in financial markets and

products, let alone with their associated risks. It is now quite apparent that the U.S. financial regulatory system is ill suited to

meet the Nation’s needs in the 21st century and that significant reforms are critically needed. Both the Congress and the administration are considering a number of options aimed at strengthening

the financial regulatory system to reduce the likelihood that the

Nation will experience a similar financial crisis in the future. Effective oversight is an important part of any consideration in modernizing our current outdated system.

House of Representatives 885, the Improved Financial and Commodity Markets Oversight and Accountability Act, would provide

for the Inspectors General at selected financial regulatory agencies,

namely the Board of Governors of the Federal Reserve System; the

Commodity Futures Trading Commission; NCUA, the National

Credit Union Administration; Penny Benny, the Pension Benefit

Guarantee Corp.; and the Securities and Exchange Commission, to

be appointed by the President with Senate confirmation. These IGs

11

are currently appointed by their agency heads and can be removed

by their agency heads with advanced notification to the Congress.

In our opinion, House of Representatives 885 would enhance the

independence of these IGs either under the current financial regulatory system or a modernized system.

In the past, Congress has taken actions to convert IGs from appointment by their agency heads to appointment by the President

as a way to enhance independence. On the heels of the savings and

loan and banking crisis two decades ago, Congress converted the

IG at the Federal Deposit Insurance Corporation from agency appointment to appointment by the President due to the perceived

limitation of the IG’s independence resulting from the appointment

process. In another example, Congress converted the Tennessee

Valley Authority IG from appointment by the agency head to appointment by the President because of concerns about management

interference with the IG’s oversight. And there are others. In both

of the examples I talked about, Congress recognized that changes

in the appointment of the IGs would enhance their independence.

As we have noted in prior reports and testimony, independence

is one of the most important elements of an effective IG function.

Professional auditing standards, the Generally Accepted Government Auditing Standards [GAGAS] that are issued by the Comptroller General, recognize that audit organizations located in government entities, including IGs appointed by their agency heads,

can meet the requirement for organizational independence. Much of

the IG Act provides specific protections for IGs to ensure that the

audit and investigative functions located within the agency being

reviewed is insulated from inappropriate management pressure.

However, the difference in the appointment and removal processes

between Presidentially appointed IGs and those appointed by their

agency heads results in a clear difference in the level of IG organizational independence. In this regard, I think we would all agree

with the common sense proposition that the further removed the

appointment source is from the entity to be audited, the greater the

level of independence. And I think the flip of that is similar with

respect to the removal authority.

The recently enacted IG Reform Act of 2008 amends the IG Act

to further enhance the independence of the IGs. The agency appointed IGs will now be required to be selected without regard to

political affiliation and solely on the basis of integrity and defined

abilities, just like IGs appointed by the President.

In addition, the Reform Act enhances the independence of the

IGs by requiring notification to the Congress of the reasons for an

IG removal or transfer at least 30 days prior to any such action

rather than after the fact notification. The Reform Act also created

the Council of IGs on Integrity and Efficiency to replace the administratively created councils that governed the Presidentially appointed IGs and those of agency heads. The new IG Council is expected to aid the IG community and foster Government-wide efforts

to coordinate and improve IG oversight.

Currently, considerable debate is underway over whether and

how current financial regulatory systems should be changed, including calls for consolidating regulatory agencies, broadening certain regulators’ authorities, or subjecting certain products or entiVerDate 11-MAY-2000 14:09 Jun 07, 2010 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 U:\DOCS\56375.TXT KATIE PsN: KATIE
12

ties to more regulation. A strong, independent, and coordinated IG

oversight and accountability function should be an important element of this reform.

That is the end of my statement. I would be happy to take any

questions, Madam Chair.

[The prepared statement of Mr. Kepplinger follows:]

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Ms. WATSON. We are attempting, as you have heard, to really improve the efficacy of this particular position. Is there anything else

that you would suggest to make this a more independent agency

and a more reliable one? It is all going to come down with your

evaluations and your recommendations, so what are we missing

that you would like to see?

Mr. KEPPLINGER. We have approached the issue also from a

slightly different perspective. A number of the IGs, CFTC, SEC, I

think they are relatively small in size. Another approach would be

to consolidate those audit functions into existing, Presidentially appointed IGs. We had offered the concept before that you could make

CFTC and SEC part of the Treasury IG and NCUA part of the

FDIC IG’s Office and Penny Benny part of the Department of

Labor IG Office. Those are all Presidentially appointed IGs. We

had in the past recommended that the IG at the Federal Reserve

be Presidentially appointed because of the significance of the functions and the activities of that agency and its size.

Ms. WATSON. What bothers me is the politicizing of the IG reports and also the fact that the ideology from the administration

is part and parcel of the IGs’ function and office. So when you say

political appointment, how can we guard against politicizing that

particular position and the ideology that person might carry that

aligns itself with the President?

Mr. KEPPLINGER. I am a lawyer. I approach things as a lawyer.

I would note that with respect to the DFEs, as a result of your colleagues, Mr. Cooper and Senator McCaskill’s effort, that the DFE

IGs, those that are agency head appointed, they are now supposed

to be appointed without regard to political affiliation and solely on

the basis of integrity and the defined abilities that would be relevant to an IG. That has been the law with respect to Presidential

IGs since 1978. It was made explicit for DFEs in 2008.

Ms. WATSON. The turmoil that we are in at the current time and

the fact that we are at a crisis unseen before, maybe even worse

than it was at the end of the 1920’s and 1930’s, my concern is that

the IG report be absolutely impeccable and represent the facts as

they are found. Is there an evaluation component that we can add

in that might help? I know you do recommendations at the end of

your reports.

Mr. KEPPLINGER. I am the General Counsel in an audit organization and I agree with you 110 percent, Madam Chair, that the objectivity and the credibility of the audit organization is its most important asset. And we at GAO are very, very, very, very protective

of our objectivity and credibility. With respect to the IGs and the

audit communities, there is now the Council of IGs for Integrity

and Efficiency that has an integrity committee that looks at wrongdoing amongst the IGs. There are also peer reviews of their organizations and their activities. I believe it is on a 3-year cycle. And,

you know, that should go a long way to ensuring the quality of the

work of the auditors.

Ms. WATSON. Thank you for that. I would like to announce the

presence of Congresswoman Jackie Speier who hails out of California, one of my colleagues many, many years ago in one of my other

lives. Welcome to the committee and I welcome your presence here.

Would you like to address Mr. Kepplinger with questions?

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Ms. SPEIER. Thank you, Madam Chair. I am honored to serve on

this committee with you. Mr. Kepplinger, I couldn’t be more in

agreement with you, maybe more violently so, than you have already expressed. I believe strongly that the Inspector General function in this country has to be made stronger and more independent

than it is right now. And I would agree with you that we should

get rid of the agency appointed Inspectors General. I read in the

analysis, Madam Chair, that there actually have been examples

where recent investigations of IG Offices at the National Aeronautic and Space Administration and the Department of Commerce

have raised some concerns because there just is a closeness that exists when you are actually appointed by that entity.

It brings to mind a case in California, I believe after you left,

where there were horrendous problems in the Department of Corrections. The investigations unit at the Department of Corrections

was not operating properly. And I carried legislation to create an

Inspector General that was independent of the department and

that was appointed by the Governor for a specific timeframe so

that if the Governor didn’t like the kinds of inspections or the reports that the Inspector General came up with, that would not prevent the Inspector General from continuing to be in office. So I do

applaud that kind of an approach.

I think we really should get rid of the appointed Inspectors General from the departments. I am curious, Mr. Kepplinger, what

your feelings are about term limits or at least a fixed term, I

should say? And you can bleed a particular agency or starve a particular entity by just not giving it enough resources, so how do you

guarantee the independent funding of an Inspector General’s Office

that is adequate to do the job?

Mr. KEPPLINGER. Ms. Speier, there are I think about three questions in there and hopefully my memory will permit me to answer

all three. First, with respect to the issue of the appointment, you

know, it is a two sided coin, independence. To a certain extent,

once you are appointed and you have the position, your real concern is more often focused on who can remove you. And my point

has been the further removed you are from the entity you are auditing, the more independent you are going to be. So I think we are

in violent agreement, maybe not mob violent, but violent agreement.

With respect to the issue of term limits, the IGs are, I think, fairly characterized as executive branch employees. Term limits that

limit the President’s authority to oversee and to remove could pose

significant issues in terms of the Executive’s authority. There are,

certainly, the Comptroller General who has as a unique position

and other legislative Article 1 entities like the Court of Claims who

have term positions. There are only a few.

Well, the one executive branch position that has a term that I

can think of is the Director of FBI. And that is because of the desire, and I think it is a political accommodation, not necessarily a

legal one, but it is a political accommodation, between the two

Branches that the FBI’s need to be independent, credible, and objective in its investigations and enforcement actions, if you will,

argue in favor for a term limit. I think it is a 7-year term for the

Director of the FBI.

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Now, you had one other question and it is escaping my memory

at this point. I was happy to see people up here with the purple

banners in favor of Alzheimer’s because at times I feel I have early

stage dementia. But if you can remember your third question, I

had a response for it.

Ms. SPEIER. It was the funding issue and how you can starve an

Inspector General’s Office as a way of putting them out of business?

Mr. KEPPLINGER. Well, I would commend again Mr. Cooper and

Senator McCaskill because in the 2008 Reform Act a process was

put in place to make the IGs’ articulation of their funding needs

transparent through the budget process.

Ms. SPEIER. But let us say that an Inspector General is doing

very good work but is embarrassing an administration. The budget

for that Office could be reduced in a way that would then limit the

ability of that Inspector General to do his or her job.

Mr. KEPPLINGER. Under the Reform Act, the IGs’ comments

about their funding needs is part of the President’s budget when

submitted for the IG’s account so it has transparency. And presumably it would be a matter for the appropriations process to deal

with what is the right amount.

Ms. SPEIER. Thank you.

Ms. WATSON. Thank you very much. I would like now to go to

our Member from Tennessee, Mr. Duncan.

Mr. DUNCAN. I have just a couple of questions since I just got

here. Let me ask you, Mr. Kepplinger, are there any powers that

a Presidentially appointed IG has that other Inspectors General do

not have?

Mr. KEPPLINGER. No, generally I think they have the same scope

of authority.

Mr. DUNCAN. All right.

Mr. KEPPLINGER. There are a few exceptions but even those exceptions cut across Presidential appointees and agency head appointees.

Mr. DUNCAN. All right. And I have noticed that with the exception of the top Cabinet members, it sometimes takes an awfully

long time to get people appointed, like U.S. attorneys and so forth.

It seems that they put them though a needlessly lengthy investigation of 13 or 14 months sometimes. How long has it generally taken

to get a Presidentially appointed IG into office? Do you know?

Mr. KEPPLINGER. Off the top of my head, I do not know.

Mr. DUNCAN. All right. Thank you very much.

Ms. WATSON. Thank you so much. And thank you, Mr.

Kepplinger for coming. I have one more question and it is a short

one. Do we have enough protection in the long run for whistleblowers?

Mr. KEPPLINGER. My response is yes. And I haven’t, Madam

Chair, made a study of this except in one regard. Legislation

passed in the last Congress established a statutory IG in GAO.

This was a first for us. And in the process of doing that, we transferred the whistleblower protections that are currently in place for

the IGs into our own statute and made them applicable for our employees and our IG. At the time, my sense was that those were

really quite adequate. But leaving open the possibilities that there

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is always an opportunity for improvement, my general response

would be yes, I think they are adequate. But I don’t say that with

a heck of a lot of confidence or prior review of that issue. OK?

Ms. WATSON. The committee would like to thank you for your

time and the information you have shared with us. Thank you very

much.

Mr. KEPPLINGER. Thank you very much. It was my pleasure.

Thank you.

Ms. WATSON. Thank you. OK, it is now time to turn to the third

and the last panel. If they would come up to the table, I will swear

them in. Right now we are in recess for a couple of minutes while

the current witnesses come to the table.

[Recess.]

Ms. WATSON. It is the policy of the Committee on Oversight and

Government Reform to swear in all witnesses before they testify.

All of you are in place now. Would you raise your right hands?

[Witnesses sworn.]

Ms. WATSON. Thank you. You may be seated. Let the record reflect that the witnesses answered in the affirmative. I would now

like to take a moment to introduce our panel. Before we begin, I

will note for the record that Ms. Elizabeth A. Coleman, the Inspector General of the Board of Governors of the Federal Reserve System was invited to testify today but was unable to join us. She did,

however, submit a statement for the record. Without objection, we

will enter that into the record.

First I would like to introduce Mr. H. David Kotz. He is the Inspector General of the Securities and Exchange Commission. There

he conducts audits and investigations of both agency functions and

self-regulatory organization activities. Prior to his service at the

SEC, he served as the Inspector General of the Peace Corps and

as Assistant General Counsel.

The next is Mr. William DeSarno. He is the inspector general of

the National Credit Union Administration. There he developed his

Office’s first strategic plan and oversees all, including planning,

budget, and staffing, issues. Mr. DeSarno began his NCUA career

in 1997 as Assistant Inspector General for Audits and was named

Inspector General in 2005.

Then there is Mr. A. Roy Lavik. He is the Inspector General of

the Commodities Futures Trading Commission. He has over 25

years of Federal experience primarily in the area of anti-trust and

regulatory law. He has served in his current position since 1990.

Prior to his time at CFTC, he worked at both the Federal Reserve

Board and the Federal Trade Commission.

And next we have Ms. Vanessa K. Burrows, a Legislative Attorney in the American Law Division of the Congressional Research

Service. There she serves as an issue expert on matters relating to

Inspectors General throughout the Government.

And then Mr. Clark Kent Ervin—Clark Kent, I love that—Mr.

Clark Kent Ervin, the director of the Aspen Institute’s Homeland

Security Program. He joined the Institute in 2005. Before doing so,

he served as the first Inspector General of the U.S. Department of

Homeland Security from January 2003 to December 2004. Prior to

his service at DHS, he served as the Inspector General of the U.S.

Department of State and the Broadcasting Board of Governors.

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And finally, Ms. Danielle Brian serves as the executive director

of the Project on Government Oversight [POGO], a non-profit, nonpartisan watchdog organization that works with whistleblowers

and government insiders to expose corruption, fraud, and abuse of

power. She began her career with POGO in 1986 and has degrees

from Smith College and Johns Hopkins University.

I will ask that each of the witnesses now give a brief summary

of their testimony and to keep this summary, if you can, under 5

minutes in duration. Your complete written testimony will be included in the hearing record. And so we will start now with Mr.

Kotz. Please proceed.

STATEMENTS OF H. DAVID KOTZ, INSPECTOR GENERAL, U.S.

SECURITIES AND EXCHANGE COMMISSION; WILLIAM

DESARNO, INSPECTOR GENERAL, NATIONAL CREDIT UNION

ADMINISTRATION; A. ROY LAVIK, INSPECTOR GENERAL,

COMMODITIES FUTURES TRADING COMMISSION; VANESSA

K. BURROWS, LEGISLATIVE ATTORNEY, CONGRESSIONAL

RESEARCH SERVICE; CLARK KENT ERVIN, DIRECTOR,

HOMELAND SECURITY PROGRAM, ASPEN INSTITUTE; AND

DANIELLE BRIAN, EXECUTIVE DIRECTOR, PROJECT ON GOVERNMENT OVERSIGHT

STATEMENT OF H. DAVID KOTZ

Mr. KOTZ. Good afternoon. Thank you for the opportunity to testify today before this subcommittee as the Inspector General of the

Securities and Exchange Commission. In my testimony today, I am

representing the Office of Inspector General. The views I express

are those of my Office and do not necessarily reflect the views of

the Commission or any Commissioners.

The mission of the Office of Inspector General is to promote the

integrity, efficiency, and effectiveness of the critical programs and

operations of the SEC. This mission has become increasingly important in light of the current economic crisis facing our Nation.

My philosophy as an Inspector General is to focus on the significant issues and high risk areas, looking at big picture items relating to whether the programs and operations in the agency are

working effectively rather than simply identifying isolated minor

infractions or procedural violations. I believe that this approach is

particularly important in light of current market conditions and

the significant challenges facing the SEC and other governmental

agencies that regulate our financial markets.

I believe it is more important than ever that financial regulatory

agencies such as the SEC have an independent, effective, and fully

funded Office of Inspector General to assist the Commission in confronting these challenges. I am proud to report that over the past

14 months that I have served as the SEC’s Inspector General, our

Office has risen to these challenges and then some. Notwithstanding a small staff, we have issued numerous audit and investigative

reports discussing issues critical to SEC operations and the investing public and making significant recommendations for improvement. Many of these reports have been critical of SEC operations,

programs, and management. And I have not always been the most

popular individual at my agency. Nonetheless, I feel it is my duty

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to the Commission, the Congress, and the investing public, particularly in these challenging times to conduct independent audits and

investigations and to issue thoughtful, unbiased, and frank reports.

I will provide you just a few examples of recent activities undertaken by my Office, some at the request of congressional committees. In September 2008, our audit unit issued a comprehensive report analyzing the Commission’s oversight of the SEC’s Consolidated Supervised Entities [CSE], program which included Bear

Stearns, Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers. The audit identified significant deficiencies in the

CSE program and provided 26 recommendations to improve the

Commission’s oversight of the CSE firms.

In response to the report’s findings, former SEC Chairman Christopher Cox announced the end of the CSE program and promised

to review and move to aggressively implement the report’s recommendations. The Office of Inspector’s General audit unit also

issued a second report during that same time period analyzing the

Commission’s Broker-Dealer Risk Assessment Program and made

several recommendations to improve that program.

More recently, my Office has issued several other significant

audit reports. In February we issued an audit report that analyzed

the $178 million in disgorgement waivers that the Division of Enforcement had granted between October 2005 and May 2008. We

found that proper procedures were not always followed in recommending these waivers and provided several recommendations

designed to improve the process. Just last week we issued a comprehensive audit report on Enforcement’s practices and procedures

for responding to and processing naked short selling complaints.

Our report concluded that Enforcement’s existing complaint receipt

and processing procedures hinder its ability to respond effectively

to naked short selling complaints and that Enforcement’s procedures result in naked short selling complaints being treated differently than other types of complaints. We are also currently

working on several additional audit reports that we plan to issue

in the upcoming month that address issues currently of concern to

the Commission and the investing public, including a comprehensive analysis of the SEC’s oversight of the credit reporting agencies

which may have played a critical role in the current economic crisis.

We also have a vibrant and vigorous investigative unit that

under my direction is conducting or has completed over 50 comprehensive investigations of allegations of violations of statues,

rules, regulations, and other misconduct. These investigative reports have been issued without management influence or pressure

and have focused on all levels of employees including senior SEC

staff. In addition, we are currently conducting a comprehensive investigation and evaluation of matters related to Bernard Madoff

and affiliated entities.

In late December 2008, former SEC Chairman Chris Cox contacted me and asked my Office to undertake an investigation into

complaints received by the SEC regarding Mr. Madoff going back

10 years and the reasons why the agency found these complaints

lacked credibility. Since that time, we have been working at a rapid

pace to perform this important work and have made substantial

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progress to date. We have determined that the matters that must

be analyzed regarding the Madoff investigation go well beyond the

specific issues that former Chairman Cox asked us to investigate.

Therefore, our oversight efforts will include an evaluation of broader issues regarding the overall operations of the SEC. We intend

to provide overarching and comprehensive recommendations to ensure that the SEC is able to fulfil its mission.

In order to strengthen the oversight of Federal financial regulatory structure as a whole, my Office works in tandem with other

Federal financial regulatory IGs to provide coordinated oversight.

For example, I currently serve on the Troubled Assets Relief Program [TARP], Inspector General Council along with the Special IG

from the TARP and IGs from several financial regulatory agencies

as well as the GAO which meets to discuss coordination of TARP

related activities and oversight efforts. I also meet separately every

month with additional Federal financial regulatory IGs to discuss

coordinated oversight efforts among the financial regulatory IG

community.

I greatly appreciate the subcommittee’s interest in assisting the

IGs in performing their critical work. The recently enacted amendments to the Inspector General Act made great strides in enhancing Inspector General independence and ensuring that the Inspectors General receive sufficient appropriated funds to achieve their

mission. The improvements in this legislation include the requiring

of advance notice to Congress of the removal of an IG as well as

provisions establishing pay parity on the part of both Presidentially

appointed and Designated Federal Entity [DFE] IGs.

Since I began my tenure as Inspector General of the SEC in December 2007, my Office’s staffing levels have increased by nearly

80 percent and I have requested an increase of our overall budget

of nearly 30 percent for fiscal year 2009, which I understand will

be processed as soon as the funds become available. Notwithstanding these increases, additional resources would greatly assist my

Office in continuing its important work. I specifically suggest that

to the extent Congress provides additional appropriations to agencies such as the SEC for increased enforcement efforts, there be a

commensurate and proportionate funding to the corresponding Office of Inspector General to provide for oversight of the additional

funds allotted to the agency.

Additionally, the legislation recently passed by the Senate to provide the Special Inspector General for the TARP [SIGTARP], with

additional authorities and responsibilities is illustrative of measures that may be enacted to enhance Inspector General independence and effectiveness. For example, the SIGTARP legislation requires the Secretary of the Treasury to take action to address deficiencies identified by a report or investigation of the SIGTARP or

to certify to the appropriate committees of Congress that no action

is necessary or appropriate.

Finally, I respectfully offer my opinion that converting IGs from

DFE to Presidentially appointed is not necessary and in my view

would not improve the current level of DFE IG oversight. Having

been an Inspector General at two DFEs, at the Peace Corps and

now at the SEC, I can state without any hesitation that one can

be a completely independent and effective Inspector General within

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the DFE structure. Although I have issued numerous reports at

both agencies that have been critical of those agencies’ operations

and management, no one has ever attempted to impair or question

my independence. In my personal situation at the SEC, my Office’s

reports and approach to oversight have not diminished in any way

with the recent change in administration or appointment of a new

SEC chairman. I can report that politics play absolutely no role in

my Office’s decisions. For this reason, I do have some concerns that

converting the Inspector General of the SEC or the IGs of other financial regulatory agencies from DFE to Presidentially appointed

IGs could result in unnecessarily politicizing the Office of Inspector

General. There are additional potential drawbacks to the Presidentially appointed IG process including the often lengthy vetting

and confirmation process that may lead to the IG position being vacant for a significant period of time. During this time of financial

crisis, it is more important than ever that there is continuity of the

operations and oversight activities currently undertaken by IGs of

financial regulatory agencies.

In conclusion, I greatly appreciate this subcommittee’s interest in

the SEC and my Office. I believe that the subcommittee’s and

Congress’s involvement with the SEC is extremely important to

strengthen the accountability and the effectiveness of the Commission. Thank you.

[The prepared statement of Mr. Kotz follows:]

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Ms. WATSON. Before we proceed, I have a question. You said

something when you were referring to complaints that you were receiving from, I guess, whistleblowers, people on staff, and so on.

You said they lacked credibility. Now, did I hear you correctly?

Would you expand and explain what you said about the credibility?

Mr. KOTZ. Sure. In connection with the Madoff investigation,

what we are investigating in the Bernard Madoff investigation is

why is it that the SEC, not our Office but the SEC Enforcement

Division, received complaints. There was one whistleblower, Harry

Markopolos, who came forward with a complaint stating that he

believed that Bernard Madoff was engaged in illegal activity and

that complaint went to the SEC. It didn’t go to the IG’s Office, it

went to the SEC.

And obviously the SEC did not find that there was a Ponzi

scheme because that did not come out until Bernard Madoff confessed on December 11th. So our investigation is to look at why it

was that the SEC received these complaints and nevertheless was

unable to find the Ponzi scheme. And that was the concern about

credibility.

Ms. WATSON. That came from the SEC?

Mr. KOTZ. Yes, right.

Ms. WATSON. OK. I just wanted to place it where it should be.

Mr. KOTZ. Yes, yes.

Ms. WATSON. Thank you.

Mr. KOTZ. Thank you.

Ms. WATSON. We will now proceed to Mr. DeSarno.

STATEMENT OF WILLIAM DESARNO

Mr. DESARNO. Chairwoman Watson and members of the subcommittee, I appreciate this opportunity to come before you today

and testify on matters concerning the independence and authority

of Designated Federal Entity Inspectors General, including House

of Representatives 885. I thank you for calling this hearing and for

your support of the IG community.

My name is William DeSarno, inspector general of the National

Credit Union Administration, whose primary mission is to ensure

the safety and soundness of federally insured credit unions. I was

appointed to the IG position at NCUA in 2005 after having served

since 1997 as assistant IG for Audits and then deputy IG at NCUA.

Previously I was an audit manager at the Department of the Treasury, Office of Inspector General and before that an audit manager

at what is now the Government Accountability Office. Finally, I

began my Federal career 41 years ago in the U.S. Army where I

served in Vietnam.

The NCUA Board appointed its first IG in 1989 in the wake of

the 1988 amendments to the IG Act of 1978 which created statutory IGs at smaller Federal entities. The NCUA Board and the OIG

have worked hard over this 20 year period to establish a relationship built on mutual respect and trust. House of Representatives

885 would amend the IG Act to make the IG at the NCUA an establishment IG appointed by the President and confirmed by the

Senate. I do not believe that this change in the IG status at NCUA

would enhance either the independence or the effectiveness of the

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IG. Rather, I believe it would work to the detriment of the IG role

at NCUA.

My independence as IG at NCUA has not been hampered because I was appointed by the NCUA Board. To the contrary, the

Board has never attempted to interfere with an IG audit or investigation. Indeed, the NCUA Board has consistently expressed high

expectations for oversight, stated its intolerance of fraud and

abuse, and paid close attention to IG findings.

The NCUA OIG, while small, has historically been adequately

staffed and with adequate resources to carry out its statutory obligations. My Office formulates its own budget and has a separate

line item in the agency’s budget. The NCUA Board has consistently

supported my staffing needs.

The NCUA IG has had its own counsel since 1990 who reports

exclusively to the Inspector General. The NCUA Board has also

consistently approved funding for contract help when I have requested it. And let me also add that our audit and investigation reports are in no way filtered through either the Board or the chairman’s office prior to issuance.

Prior to the enactment of the IG Reform Act, the only area where

the NCUA IG did not enjoy similar stature with other senior managers at NCUA was in the area of pay where the IG was paid significantly less than other NCUA senior staff. This situation was

further exacerbated because the IG did not accept bonuses or cash

awards as other NCUA senior managers regularly did. With the

agency’s implementation of the IG Reform Act’s pay provisions, the

IG salary was elevated to the average of the other senior managers

and the pay disparity was resolved. Were House of Representatives

885 to pass, the Presidentially appointed IG’s pay would be significantly less than the average total compensation of NCUA’s senior

level managers. Moreover, a Presidentially appointed NCUA IG

could end up with an annual salary less than some of his or her

subordinates in the OIG. This is precisely the outcome the IG Reform Act of 2008 sought to and did correct.

Due to the current challenges facing the entire financial services

industry, the NCUA OIG has a critical role in its oversight and accountability functions. For example, my Office has seen a growing

material loss review workload in the past year. This work is mandated by the Federal Credit Union Act and the OIG currently has

an unprecedented number of reviews either underway or in the

planning process. We have redirected most of our audit resources

to this review work. Were a Presidential appointee to replace an

IG who is familiar with the unique nature of the credit union industry as well as the day to day functioning of an IG Office, the

potential disruption to OIG operations in completing this critical

work would, I believe, be significant.

A final concern I have should House of Representatives 885

change the appointment status of DFE IGs is that the selection

process risks politicization which would significantly threaten IG

independence. Congress required that IGs be nonpartisan and that

the President appoint them without regard to political affiliation.

In the 20 years that the IG concept has existed at NCUA, the

NCUA Board has never appointed an IG on the basis of political

affiliation.

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In conclusion, while I do not speak for the NCUA Board or the

other DFE IGs, I do not believe that House of Representatives 885

would enhance the independence already afforded the NCUA IG.

With the greater protections and enhanced independence afforded

IGs by the IG Reform Act of 2008, the NCUA IG is well suited to

carry out the responsibilities mandated by the act. Thank you

again for the opportunity to appear before this subcommittee and

I would be pleased to answer any questions you might have.

[The prepared statement of Mr. DeSarno follows:]

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Ms. WATSON. Thank you so much. Mr. Lavik.

STATEMENT OF A. ROY LAVIK

Mr. LAVIK. I appreciate as the others do the opportunity to come

before you all and give our view of the legislation and what we

think is probably happening. And again, I will stand ready for

questions. I don’t think, given the time and so on that I will regurgitate my statement here. But let me just concentrate on a couple

of things.

One is the independence issue. And I can only speak for my own

agency, not for the others. But for example, some time ago we investigated the chairman of our agency because there was a question of whether she had replaced someone at the behest of the

White House or whether it was because of her own feelings about

the situation. It was someone who we found was not, she just

didn’t like the head of the enforcement. But that shows you that

we certainly were independent. I will give her much credit. She is

now Mr. Kotz’s boss in a sense. She is now chairman of the SEC,

a very good person.

We also more recently looked in at the behest of four Senators

on the question of the huge price increase for barrels of oil this last

July. It was called an interim report and was issued by CFTC staff

and staff from other economic regulatory agencies. And what we

found there is that in fact there had been a change in classification

of one of the large oil companies into what is called speculative.

That is a bad word these days. I am not so sure it should always

be bad, but it is and at least it should be explained readily what

was going on.

We found that the agency had reclassified appropriately. The

problem was that unless you were an expert in the field, someone

who is constantly in it, you would not have understood the push

and the shove of that. And we noted that in our report to the four

Senators that there had been an inadequate explanation. I cite this

again as an indication of independence. This was lobbying the

chairman, not just the CFTC but other entities.

The other thing I would say about House of Representatives 885

is, there is an old cliche, you get what you pay for. And that is not

always true. We had a chairman just prior to that who was willing

to take the pay salary because he made a hell of a lot of money

in the investment banking business. You can find that. But there

are those of us who haven’t and have kids in college and so on. Pay

is a big consideration.

I can tell you at my agency, and I think it is true of others but

I will let them speak themselves, and I can be objective about this

because I am at such an age I probably won’t be around for more

than another year or two, but my pay would be decreased on the

order of about $40,000 a year. And that is relative to the other people at the CFTC. Now, if that is Congress’s will, that is fine. I

mean, that is your responsibility.

But it seems to me, as you might guess given my advice, perverse. If you want to have good people, generally you have to pay

for it. And I think cutting someone’s salary $40,000, and again, I

can be semi-objective because I don’t plan to be around much

longer, but I think this is something you ought to really think

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about and make your decision. That is all I really have to say. If

you have any questions, whenever it will be fine.

[The prepared statement of Mr. Lavik follows:]

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Ms. WATSON. Thank you so much. And now Ms. Burrows.

STATEMENT OF VANESSA K. BURROWS

Ms. BURROWS. Thank you, Madam Chairwoman. Chairwoman

Watson and members of the subcommittee, thank you for inviting

me here today to comment on proposed changes effecting Offices of

Inspectors General in House of Representatives 885. In particular,

my testimony will focus on differences between the IGs located in

Federal establishments and IGs located in the Designated Federal

Entities. DFE IGs are typically found in the smaller agencies. Establishment and designated Federal entity differ in terms of their

removal, appointment, transfer, budgets, applicable hiring laws,

avenues for seeking legal counsel, and pay.

The most notable difference between establishment IGs and Designated Federal Entity IGs is the individual who appoints and who

may remove or transfer the IG. Establishment IGs are appointed

by the President, as you know, with the advice and consent of the

Senate. They may be removed or transferred only by the President

except in case of impeachment. Designated Federal Entity IGs are

appointed and may be removed or transferred by the agency head

except in the case of impeachment. My written statement discusses

the potential advantages and disadvantages of converting these

five IGs into Presidentially appointed, Senate confirmed positions.

Another difference between the establishment IGs and the Designated Federal Entity IGs is that by statue, establishment IGs receive a separate appropriations account or a line item in the establishment’s appropriations. The Inspector General Reform Act of

2008 has increased and created additional safeguards in terms of

the budgets of both establishment and Designated Federal Entity

IGs. The IG Reform Act requires the IG to report an initial budget

estimate to the head of the agency. The agency head must then include this information as well as comments of the Inspector General when transmitting the request to the President. The President

in turn must then include in his budget submission the IG’s initial

budget estimate, the President’s requested amounts, and the comments of the affected IG if the IG determines that the President’s

budget would substantially inhibit the IG from performing his or

her duties.

The two types of IGs also differ in terms of how they may select

their own employees. DFE IGs, the Designated Federal Entity IGs,

are exempt from the sections of the IG Act, and have always been

since their creation in 1988, from the sections that mandate the selection, appointment, and employment of officers and employees in

the establishment IG Offices according to civil service employment

laws. And that is because, as Congress indicated in a House Report

back in 1988, some of these entities do not have to follow those

laws and are subject to different laws and regulations.

Establishment and DFE IGs also differ in their ability to hire

counsel or seek legal advice. These changes were created in the IG

Reform Act of 2008, which addressed the use of legal counsel by

the IG and specified that an establishment IG must seek legal advice from an attorney who they hire under civil service laws and

who reports directly to that IG or to another IG.

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The Reform Act also provided three ways for a Designated Federal Entity IG to obtain counsel. First, the Designated Federal Entity IG could obtain counsel from an attorney appointed by that IG

in accordance with the specific laws and regulations governing appointments in the agency within the Designated Federal Entity.

This counsel would report directly to the appointing IG.

Second, the Designated Federal Entity IGs, on a reimbursable

basis, could obtain services from a counsel who was appointed by

and who reports to another Inspector General. Third, the Designated Federal Entity IG may obtain the legal services of an appropriate person on the newly created Council of Inspectors General on Integrity and Efficiency.

The IG Reform Act of 2008 also continued preexisting differences

between establishment and Designated Federal Entity IGs. For example, the Reform Act increased the pay of the establishment IGs

to the rate of Level III of the Executive Schedule plus 3 percent.

And currently Level III of the Executive Schedule is $126,900.

However, it included a provision which would allow the IGs who

currently received higher pay to continue at that level. The IG Reform Act also increased the pay of Designated Federal Entity IGs

but did not link them to the Executive Schedule. Some Designated

Federal Entity IGs may make more than their establishment IG

counterparts. The IG Reform Act also provided that Designated

Federal Entity IGs should be classified for pay purposes at a level

at or above the majority of the senior level executives of the Designated Federal Entity IG such as a General Counsel or Chief Financial Officer but that their pay could not be less than the average total compensation including bonuses of those senior level executives. The Reform Act also provided that the Designated Federal

Entity IGs pay could not increase by more than 25 percent of the

Designated Federal Entity IG’s total pay for the previous three fiscal years.

Madam Chairwoman, that concludes my prepared statement. I

would be happy to answer question that you might have.

[The prepared statement of Ms. Burrows follows:]

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Ms. WATSON. Thank you, Ms. Burrows. And now Mr. Ervin.

STATEMENT OF CLARK KENT ERVIN

Mr. ERVIN. Thank you, Madam Chair. Thank you very much for

calling this very important hearing. I commend you for your leadership on this issue.

We are learning the hard way because of the economic crisis that

we are in. the midst of the greatest economic crisis since the Great

Depression, yet again the importance of vigorous oversight and aggressive regulation. And it is absolutely critical to oversight that

we have independent Inspectors General. As you see from my prepared remarks, I have made four recommendations that in my

judgment would make Inspectors General more independent and

therefore give them greater incentive to be aggressive in exercising

the oversight responsibilities that they have been given.

The first one goes, of course, to the very heart of the legislation

that we are considering and that is that I strongly believe as you

do that all of the Inspectors General in the Federal system, and especially the Inspectors General of these critical financial regulatory

agencies—the Federal Reserve Board, the Securities and Exchange

Commission, the CFTC—be Presidentially appointed. It simply

stands to reason, as Mr. Kepplinger said. It is a matter of logic that

an IG is more likely to stand up to an agency head if there is a

disagreement between the agency head and the Inspector General

as to a particular audit or investigation if ultimately the Inspector

General cannot be removed by that agency head.

I do not know Mr. Kotz, Mr. DeSarno, and Mr. Lavik. They are

all, I am sure, fine gentleman. I take them at their word when they

say that they themselves have been independent in the discharge

of their responsibilities. I take them at their word when they say

that their respective agency heads, boards, as the case may be,

have never interfered with their work. But that is beside the point.

The point is, I am concerned about their successors and whether

their successors will likewise have the impeccable character and

reputation and ability to stand up to pressure that they have. We

shouldn’t make it harder for Inspectors General to stand up to

agency heads. We should make it easier. And it simply is a matter

of logic as I said. I think it is noteworthy for example, that in Mr.

Kotz’s statement, he began essentially by saying, the testimony I

am about to give is my own testimony, that of the Office of Inspector General and not the SEC. There would be no reason to say that

if he were an appointee of the President. No one would think that

any remarks that he would make in a forum like this would be

those of the SEC.

The second recommendation that I would have is that Inspectors

General like the FBI Director, as Mr. Kepplinger noted, and I

would note another example he could not think of one during his

testimony, but another example of course is the Federal Reserve

chairman, and the Federal Reserve chairman, which of course is

exactly relevant here, likewise have a fixed term, not term limits,

but a fixed term. And the reason for that, of course, is that these

two officials are intended to be independent from Presidential administrations. Though they are appointed by a President, this fixed

term is intended to insulate them to the maximum extent possible.

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It matters less to me exactly what the term is. It is more important

that there be a term. It would be most helpful if the term were to

be long enough to span Presidential terms. In the case of the FBI

Director, it is 7 years. I would note also, of course, the Comptroller

General has a 15 year term and that is intended to insulate the

Comptroller General from pressure from the administration and

also from the Congress.

Third, of course, Inspectors General are human beings and therefore they are fallible like everybody else. So on occasion an Inspector General should be removed from office. But Inspectors General

should be removed only for abusing their office, not simply for

doing their jobs. An aggressive IG will occasionally, as I say, rub

his or her agency head and the incumbent administration the

wrong way. But that is not cause for removal. At present, a President need only notify Congress in writing 30 days before he removes an IG that he is doing so and why, with any reason given

being reason enough. I think that Presidents should have the ability to remove an IG only for a cause that is spelled out in a statute.

That is another recommendation I would make.

And then fourth, no one to date has mentioned this, but there

are provisions in certain Inspectors General statutes, Inspectors

General who are appointed by the President that even there limits

the ability of the Inspector General to carry out certain audits and

investigations. In particular, there is a provision in the statute for

the Treasury IG that allows the Treasury Secretary to prevent an

Inspector General from accessing sensitive information concerning

deliberations and decisions on policy matters, the disclosure of

which could reasonably be expected to have significant influence on

the economy or market behavior. As I say in my statement, it is

easy to imagine a situation in which a Treasury Secretary could

prevent an IG from looking at policies with regard to things like,

years ago, subprime mortgage lending and the variety of exotic financial instruments that lie at the heart of the present crisis.

So I think that we should look at all of the statutes that pertain

specifically to a given Inspector General and remove those provisions that allow the agency head, even in those circumstances

where at present an Inspector General is appointed by the President, that allows the agency head to prevent an Inspector General

from looking at a particular matter either on the grounds of affecting market conditions or on national security grounds. There are

like provisions in certain statutes of national security Inspectors

General.

Finally, the greater the amount of money, the greater the complexity of programs an Inspector General has to oversee, the greater should be the resources given to the Office of Inspector General.

So I hope very much that efforts will be made to significantly increase the budgets of all of the financial regulatory Inspectors General during this critical time. Thank you, Madam Chair.

[The prepared statement of Mr. Ervin follows:]

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Ms. WATSON. And thank you. We can now proceed to Ms. Brian.

STATEMENT OF DANIELLE BRIAN

Ms. BRIAN. Thank you very much, Madam Chairwoman, for inviting me to discuss one of my favorite topics, the Federal Inspector

General system.

Over the past year and a half, POGO has been investigating both

the independence and accountability of that system. Last week, we

released our second report on IGs. Our first report, which was released last year, focused specifically on weaknesses that we believe

hampered some of the IGs’ independence and recommended some

necessary changes to the law. The IG Reform Act of 2008, with the

terrific leadership from Congressman Cooper and Senator

McCaskill, included most of the improvements we believe were

needed to enhance IG independence.

Since that time, POGO has been examining the other side of that

essential equation for Inspectors General which is accountability.

And we have provided copies of our report to you today. Holding

IGs accountable is a job that needs also to be embraced more

thoughtfully by the Congress and accomplished more effectively by

their peers through the IG Council’s Integrity Committee. But the

IG system is not broken. However, POGO urges the IG community

to review its priorities.

The most troubling finding we found in our most recent report

is that IGs all to often treat those complainants or whistleblowers

who come to them with problems in their agencies as mere afterthoughts. I need to point out this is not a specific concern regarding

the IGs who I share the table with. But to answer your wonderful

question, Madam Chairwoman, of the earlier panel, I would strongly suggest that at this point Federal employees do not have adequate whistleblower protections. And that is no fault of the House.

The House has been regularly stalwart in insisting that Federal

employees have better whistleblower protections. Our problem has

been that the Senate has not accepted the strong recommendations

from the House on that matter so they remain very underprotected,

we believe.

But as our country reels from the economic crisis, we are relying

more on the IGs not only to detect and deter the misuse of public

funds, but to help restore confidence in our Government’s operations. I believe House of Representatives 885 has been offered in

that spirit in order to provide IGs of the financial regulatory agencies the independence that they require. But I would respectfully

suggest that the tools given IGs in last year’s legislation largely accomplish that goal.

And I did want to react to some of the earlier testimony and offer

a couple of cautionary notes. One thing is that IGs whose behavior

has caused concerns about their independence have far more often

actually been Presidential appointees. Two that were specifically

noted before were that of NASA and Commerce. Those were Presidentially appointed IGs. I was also very concerned about the discussion of the use of numbers of audits or investigations as a measure of effectiveness of DFE IGs as opposed to Presidentially appointed IGs. That is a big part of the point of the report that we

have offered to you. We don’t believe it is a good way to measure

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the quality of work of an IG to measure the number of investigations or audits they complete. I have learned that you can double

the number of audits by cutting in half the subject matter of the

audits, and then suddenly you have double the number of audits.

That is not a useful measure for measuring the quality of an IG.

It also didn’t recognize that over half the DFE IG Offices only have

a total of six people. So it is important to keep in perspective how

many of those DFE Offices are just absolutely tiny.

I must admit that when I began focusing on the IG system over

a year ago, I shared the perception that underlies House of Representatives 885, that DFE IGs are somehow less independent because they are appointed by their agency heads rather than the

President. I have come to appreciate that in some cases there is

some logic to the DFE structure especially for those agencies that

are headed by a multi-person commission or board generally filled

with bipartisan appointments rather than having a single agency

head.

So it may in fact be the case that some DFE IGs, many of those

are those that are being discussed in this legislation, are actually

more independent because, as one IG put it to me, I would have

to PO five people to be removed as a DFE but as a Presidential

appointee only one person would have to want me gone.

My second reason for believing that House of Representatives

885, while very well intentioned, may be counterproductive is that

which was discussed before with regards to the comparability pay

structure because of these uniquely unusual pay structures for the

financial regulatory agencies. And that would actually reverse the

fix that had been accomplished through last year’s legislation.

Finally, while the legislation provides for the current IGs to remain in place until a Presidential appointee is confirmed, this

change would then undercut the current IGs’ authority by making

them acting at a time we would want these IGs to be confident

they can be bold and protected even when they are the messengers

of bad news.

Congress should be applauded for turning to the Inspectors General and worrying about whether they are able to be the aggressive

watchdogs we need. But if the goal of this legislation is to strengthen the important work of these IGs, I would suggest respectfully

that we may be focusing on the wrong issue and that making them

Presidential appointments may merely be a distraction. I would

suggest there are a few other changes that you might consider to

enhance their roles. For example, most of these IGs are currently

restricted from accessing information directly from the regulated

entities. These IGs should have the capacity to subpoena both documents and testimony from the entities regulated by their agencies. A second valuable step forward, as mentioned earlier, would

be to apply the provision in the SIGTARP legislation which requires the head of an agency to certify to Congress whether they

are implementing IG recommendations and to explain why if they

are not. A third improvement would be to give IGs control over

their approved budgets which means not just that their budgets

are more transparent, which was a very important improvement of

last year, but DFEs still have trouble making hiring and promotion

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decisions within those budgets. And that is a change that I think

would be very important to accomplish.

And finally, the OIGs we are talking about today have not benefited from the extra funds provided to their agencies that have received stimulus funds. Increasing the resources available to these

IGs commensurate with the new expectations of their Offices would

be another real way of helping them do their work.

So I applaud the Congress and I applaud you Madam Chairwoman and the subcommittee for turning your attention to this

very important issue. And I look forward to working with the subcommittee as it endeavors to make sure the IGs are all they can

be.

[The prepared statement of Ms. Brian follows:]

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Ms. WATSON. I want to thank all of the panelists. I really appreciate your patience and coming up with something we can dig into.

Ms. Brian, I was quite interested in your final remarks. You are

an independent, private agency, right?

Ms. BRIAN. Non-profit, yes, Madam.

Ms. WATSON. Non-profit?

Ms. BRIAN. Yes, Madam.

Ms. WATSON. And I think you stated that information could not

be shared with your, I guess, investigators and so on. Would you

clarify that for me?

Ms. BRIAN. Well, I wasn’t talking about my own. I was talking,

speaking to the IGs’ access. Currently their capacity is to gather

information, and it actually changes slightly agency by agency so

you might ask my colleagues about their particular agencies, but

a number of those in question have the capacity to look at what

their agency has collected but can’t reach out to the bank or the

financial institution and subpoena documents. And they can’t subpoena any testimony from anybody, currently. That is the kind of

capacity we think could be really very valuable.

Ms. WATSON. Let me go back to Mr. Kotz. Do you find it very

difficult to go into those lending agencies and get information?

What are the hurdles and challenges that you face?

Mr. KOTZ. Yes. I mean, I do agree with those remarks that if we

had the ability to subpoena individual testimony of lending agencies, of investment banks, of institutions that are regulated by the

SEC, that would be very helpful in our operations. Right now, we

can subpoena documents but not testimony. We can subpoena testimony of SEC individuals but not testimony of other folks. So we

wanted to take the testimony of the General Counsel of a large

bank and we were able to do it, but he would not submit to being

under oath because we don’t have the power to subpoena the testimony in that manner. So I would suggest that is a very good suggestion to improve our ability to do our job.

Ms. WATSON. Well, you know, I am stunned by the response that

you cannot get all the information you need to do a credible job.

And so with subpoenaing power, you think that would be possible?

Mr. KOTZ. Yes, I think that would be very helpful.

Ms. WATSON. Mr. DeSarno, would you like to speak to that concern?

Mr. DESARNO. Well, I would echo the comments from David

Kotz. At NCUA we have never had a problem in getting information because if we need information, either records or documents

from the credit unions that NCUA supervises, we would go through

the NCUA examination staff to get those documents. And of course,

the agency had the authority to get those documents for us from

the regulated credit unions. And we have been successful in every

instance we have ever had so we have never had to use any subpoena authority. But David is correct. While we could, if we had

to, subpoena records and documents from the credit unions, I don’t

believe we have the authority to actually force testimony from the

employees of those credit unions.

Ms. WATSON. Is there anyone else on the panel that would like

to address that concern?

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Mr. LAVIK. I would just say that I have always found it very

strange, the bifurcated manner that you can subpoena documents

but not witness testimony. I think it goes back to someone I met

in a conference, a Congressman from Texas. He explained to me

that he just didn’t trust us enough. He is no longer there. He is

a very good fellow, by the way, let me hasten to add.

Ms. WATSON. Is it like taking the fifth?

Mr. LAVIK. Yes, sort of.

Ms. WATSON. I do not understand how an individual who has

other people’s money in their hands, Madoff, was able to get away

with it this long. What happened? Where did the system break

down? I understand he did his own accounting and all of his own

paperwork. You know, we talk about it here as cooking the books.

How in the world, I know there is a Ponzi scheme, but with the

SEC, how in the world could he get away with it that long? I have

people in my district that lost hundreds of millions of dollars

through him. How in the world could he get away with that? Does

anybody dare to give their idea of how he was able to carry on in

this way?

Mr. KOTZ. I can only say that we will have that answer. We are

working on a report of how the SEC let it happen and we will have

an answer to all of those questions. And it will be a report that,

as appropriate, will be very critical of SEC, you know, as an independent IG can do. So we will get to the bottom of it from the SEC

perspective. That I can assure you.

Ms. WATSON. Well, thank you so much. When do you expect you

will be able to get to the bottom?

Mr. KOTZ. We think we will have a report by the end of the summer. It will be a comprehensive report of all the different complaints that came into the SEC going back many years, all the different examinations and investigations that the SEC conducted

and how it went wrong.

Ms. WATSON. Well, I am going to request of my staff that when

that report is made public or given to Congress that we hold another hearing and let you go through it and have people to comment on it.

Mr. KOTZ. Thank you, absolutely.

Ms. WATSON. Now, I would like to continue to address areas of

concern. I would like to talk about the legal authorities of the IG

and whether the IGs at our financial regulatory agencies have adequate laws. Of course, we have already talked about the subpoenaing power. But is there anything else that you think would be necessary legally to get to the bottom line, get to the truth? Would

anybody like to tackle that one?

Well, let me give you an example. The Federal Reserve IG is required to examine all failed FDIC insured institutions that have resulted in a material loss to the Deposit Insurance Fund. Now, I

would like to know whether any of the IGs here today have had

similar statutory requirements that would permit them to examine

financial institutions that have failed or that require Government

assistance to remain solvent? Wouldn’t such requirements for the

IG from the SEC or the CFTC make sense if we should witness another Lehman Brothers or collapse of a hedge fund that is signifiVerDate 11-MAY-2000 14:09 Jun 07, 2010 Jkt 000000 PO 00000 Frm 00089 Fmt 6633 Sfmt 6633 U:\DOCS\56375.TXT KATIE PsN: KATIE
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cantly leveraged in commodities or futures? What is it that you

would need? Anyone can respond.

Mr. DESARNO. Well, let me respond for the National Credit

Union Admnistration. Like the FDIC and the Treasury, we have

legislation in the Federal Credit Union Act that requires us to do

a material loss review of any failed institution, in this case a credit

union, that causes a loss of greater than $10 million to the Shared

Insurance Fund. We have already completed two of those reviews.

Right now we are doing two more and we have about three or four

more in the queue waiting to do those.

So we have the authority we need to do those material loss reviews. We are doing the work. It is stretching our resources as far

as we can possibly go. And the only thing I would request is I

would wish that the Congress and the agency and the agencies that

have the authority would provide the Inspectors General with

whatever resources they need in order to get that work done.

In my case, I did request additional staff. We are hiring an additional staff person. In fact, she will be coming on board on Monday

and that will help alleviate some of our problems. We also requested additional funding, contract dollars. We did get the contract dollars in our budget so we can use the additional staff and

contract dollars to augment some of our material loss review work.

But we do have the authority that we need right now to look into

those failed institutions.

Ms. WATSON. Well, you just answered my next question, if you

had reasonable resources.

Mr. DESARNO. Yes.

Ms. WATSON. And I understand you don’t. Let me pose something

else. Under current law, the heads of six Federal agencies including Treasury and the Federal Reserve are permitted to terminate

or prevent an IG from carrying out an audit, investigation, examination, or other activities for specified reasons that include national security or criminal investigative matters.

While I would never want an inquiry of any kind to jepordize a

criminal or a national security matter, I am concerned that this

type of exemption in power for an agency head is excessive over

what is supposed to be an independent office. I would like to hear

from any of you or each of you whether the law ought to be altered

in some way to ensure that these exemptions are not misused.

Now, let me give you an example. I suppose the Treasury Secretary or the Federal Reserve chairman could make a case that

market instability or systemic risk may be a threat to national

securit—how many times have you heard that?—so perhaps an examination of firms on the verge cf collapse is inappropriate. Now,

would you consider this an inappropriate use of the law?

But we as Congress, we are cutoff from the information, shall I

say, linkages out of the White House. We stood in the dark on

many things. When the whole economic crisis came out publically

in September and we had to move really quickly, I was stunned.

How did the market collapse so quickly and nobody forecasted it?

That blows my mind. You know, I know people in futures; isn’t that

what futurists are all about? What happened? Mr. Ervin.

Mr. ERVIN. Thank you, Madam Chair. I can’t comment on the futures aspect of this, but you began by asking about our position on

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these various provisions for certain IGs that allow the agency head

to prevent the Inspector General from pursuing an investigation or

audit on national security grounds. I touched on that in my prepared remarks. There is such a provision for the CIA Inspector

General, for the Justice Department Inspector General, for the Department of Homeland Security Inspector General. So I was under

that provision when I was the Inspector General there, and the

Treasury Inspector General.

But as I mentioned in my statement, a Treasury Secretary would

not have to make the argument that a particular investigation

might impinge upon national security. There is a specific provision

in the Treasury IG statute that allows the Treasury Secretary to

stymie an investigation if, in the judgment of the Treasury Secretary, there would be adverse market effects from such an investigation without having to show any national security nexus.

And my position is that all such provisions should be excised

from the applicable statutes because an agency head could use such

provisions, as you were suggesting, merely to shield an administration from political embarrassment or because an investigation

might in its conclusion be contrary to the ideology of a given administration. So I am very much opposed to those provisions.

I had in my very first, and I will conclude, I had in my very first

meeting with then Secretary-Designate Ridge a discussion about

this very provision in the Department of Homeland Security statute. I told him that if I were to be confirmed that I would work

very hard, in the spirit of full disclosure, with Congress to try to

get that provision excised. He assured me that he would never use

the provision, and to his credit he never did. But the fact that it

was in the statute was always a potential sort of Damocles over the

head of the Inspector General. And I think this present economic

crisis that we are experiencing underscores how important it is to

excise such provisions.

Ms. WATSON. Ms. Brian.

Ms. BRIAN. I would just want to echo my friend Mr. Ervin’s comments. I think it is a very problematic provision and I think it is

something the Congress should be reviewing.

Ms. BURROWS. Madam Chairwoman, if I could also comment, I

can’t comment as CRS on whether it would be good or bad to remove this provision. But the way the provision works now is that,

for the Federal Reserve for example, the chairman makes a statement to the IG that he is going to be exercising this power. Then

the IG provides the explanatory statement to Congress within 30

days. One way or one approach might be that the statement can

go directly to Congress from the chairman of the Federal Reserve

or from the Secretary of the Treasury so that Congress receives direct notification. And you could place a time limit so it would occur

within 3 days or 5 days or whatever so you would know immediately if such power was being exercised.

Ms. WATSON. Thank you. I would like to direct this to Mr. Kotz.

In 2008, at a request of Senator Grassley’s, your office completed

two inquiries on the effectiveness of the SEC’s Consolidated Supervised Entities and Broker-Dealer Risk Assessment Programs.

These were done in response to the fall of Bear Stearns and Lehman Brothers. Your CSE report made 26 recommendations to the

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SEC for areas needing improvement and several recommendations

regarding the Risk Assessment Program. First, can you tell us how

many of these recommendations are in the implementation stage

by the SEC? Then let me just add the other couple of questions on

the same issue.

Mr. KOTZ. OK, there is a process in our office. The agency comes

to us and says, we would like to close these recommendations.

Then we make a decision of whether we think that it is appropriate

to close the recommendation and provide advice on that. So we recently received from the SEC numerous requests to close recommendations. Many, almost all were of the recommendations in

the CSE report and many of the recommendations in the BrokerDealer Risk Assessment report.

However, I will tell you that we are looking at them very carefully to see if we believe that sufficient work has been done to close

them. So there is certainly an effort on the part of the agency to

try to demonstrate that they have implemented those recommendations but we have not completed our process as to whether we believe that they actually have been. And we are very careful. We

scrutinize very carefully what the agency has done before we actually agree that something should be closed.

Ms. WATSON. Now, did you take initiative on your own to inquire

how did Bear Stearns and Lehman Brothers got to where they are?

Mr. KOTZ. Yes. Well, I mean, we conducted that audit report. We

conducted the audit looking at Bear Stearns to try to figure out

how it is that this process went forward while the SEC was engaged in regulation and yet, as you said, it seemed to be a surprise

to everybody. It is one thing for it to be a surprise to, you know,

investors out there. It is another thing for it to be a surprise for

the regulators who are meeting with the folks from the entities,

you know, on a common basis. And going back to your previous

point, it was raised somewhat in our audit that if we issue this report it would have some effect on the markets because it was very

critical of the SEC. And there was no provision in place like with

those other agencies. Those are all the Presidentially appointed IG

agencies. In those cases, there was a provision that allowed the

agency head to stop it. In our case, it was suggested that perhaps

this would have an adverse impact and we simply said well, thank

you very much, but we are going to go ahead and issue the report

anyway. So this was a case where we did feel it was important to

get out the information about what happened with the SEC’s regulation of Bear Stearns, and so we provided a comprehensive report.

And now we are following up to make sure they actually did what

they said they were going to do.

Ms. WATSON. You know, it is like trying to unscramble eggs. I

don’t know if it can ever be done. But anyway, did you find that

there was enough there before it was revealed to really get started

investigating? I think I heard you say you were taking a look at

it. You know, all of a sudden, this thing blew up to the public and

I am wondering what were the indicators along the way?

Mr. KOTZ. We found that, you know, the SEC was aware of

vulnerabilities on the part of Bear Stearns and did not place

enough pressure on Bear Stearns to reduce its leverage or risk. You

know, I mean, it is a little bit difficult because hindsight is 20/20.

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So at that point in time, after it happened, you look at the indicators and you say, oh, that was an indicator.

Nevertheless we did find that there were situations where the

agency was aware of potential risk factors and yet did not pressure

Bear Stearns enough with respect to those risk factors. We also

found, for example, that there were certain standards that the SEC

could have been tougher with requiring Bear Stearns to comply

with. We found that the SEC authorized those firms to have internal audit staff perform critical audit work.

So they allowed internal audit staff to perform the audit work involving risk management rather than having an outside entity. Obviously if you have an outside entity, you are going to have better

audit work. So there were specific areas that we found that we felt

after looking at it, even with hindsight being 20/20, that said these

are indicators—you missed these indicators—how come you didn’t

see this at the time? And then we made recommendations so the

SEC now knows how to deal with things going forward.

Ms. WATSON. You deserve a drink of water.

Mr. KOTZ. Thank you.

Ms. WATSON. I am going to go to Mr. DeSarno now. What are,

Mr. DeSarno, the greatest challenges that now face the NCUA in

its oversight of the credit union industry? And are credit unions

also experiencing higher default rates from market issues? Has the

recession exposed an increasing number of NCUA insured institutions?

Mr. DESARNO. Well, let me say first of all that I have been at

NCUA for about 11 years and this is the first time we have had

to do any material loss reviews. So what that means is that we

have never had losses to the Shared Insurance Fund of $10 million

or more. And we are having them now. But with that said, I think

I can comfortably say that the credit union industry is much better

off than the banking industry. It may sound self-serving but it is

because they really didn’t get involved in a lot of the riskier investments.

For the most part, credit unions did make mortgages and they

did make mortgage loans, and they are having some higher default

rates, but that is not causing them the problems of going out of

business. The material loss reviews that we have done so far in two

specific credit unions, the reason that those credit unions went

down is because they got involved in very speculative real estate

deals outside of their area of influence. These were credit unions

in the middle of the country that decided they were going to get

involved in the real estate market in Florida. And when the housing market went down, then they lost an awful lot of money.

NCUA now is taking steps to prevent that from happening in the

future.

Looking forward, what are the most critical challenges right

now? I think the most critical challenge right now for NCUA is

dealing with the corporate credit union structure. They are taking

action right now. That, because the corporate credit unions were

the ones that were involved in investing in mortgage backed securities and of course they got bit by the mortgage backed security

problem that everyone else has run into. And so NCUA right now

is in the process of trying to restructure the corporate credit

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unions. And I think that will have a positive impact on the credit

union industry as we go forward.

Ms. WATSON. OK, thank you. And Mr. Lavik.

Mr. LAVIK. The futures industry has had some instances of bankruptcy, failure, but certainly not to the same extent as commercial

banks or, from what Bill says, credit unions. Partly I think it is because of the provision of margin. You have to put up margin to buy

a futures contract and that is adjusted daily. So, for example, if

your price of your futures goes down, you have to put up more margin.

So there have been some failures but, interestingly enough, the

two that I am aware of were not recently. They go back, the one

case about 5 years. The fellow who was in charge of it was a rather

big, what they call a futures commission merchant. He is now

spending some time in jail. And there was one about 2 or 3 years

ago. But anyway, the point is I can’t think of one right now of a

large size that has been in the recent economic turmoil. We have

been lucky.

Ms. WATSON. Yes, I always saw credit unions differently because

it is the field of people who invest in their credit union and usually

they are in——

Mr. DESARNO. It is a cooperative move.

Ms. WATSON. It is a cooperative move. And they don’t take the

same kind of risks. And I have always been stunned by the fact

that we don’t know what is inside those portfolios. And when you

make the wrong decision, we suffer. And so, not being able to get

to that kind of information leaves it strung out.

I want to know also, how has the newly combined Council on Inspectors General for Integrity and Efficiency improved the coordination and the efficacy of IGs? Anybody want to talk about improvement? Do you see it yet?

Mr. LAVIK. The one thing I would say is that when we met

seperately there were usually 25 to 30 people in the room depending upon the particular time. Now there are almost 60. My impression generally is that, and I think there are some studies on this,

the more people you have in a room can inhibit decisionmaking or

consensus. Now, that has some pluses, but frankly, and I will defer

to my Deputy back here, Ms. Judith Ringle, because she has actually gone to the meetings. They are crowded, she says. I have to

say, as you can probably tell from my comments, I am not sure if

it was a positive move to combine the two.

Ms. WATSON. Do they feel intimidated, do you think, that large

group sitting among the experts?

Mr. LAVIK. You know, I don’t know. I have always been an ECIE

and I used to go to some of their meetings because I was an adjunct. I didn’t feel intimidated. It is like—but that was smaller,

that was 30 people—it is like anything. You find some really sharp

PCIEs and you find some sharp maybe ECIEs and you find some

who aren’t that much.

Mr. DESARNO. Let me, I just want to, you know, add a comment

to that as well. We have only had, I think we have had maybe

three joint meetings now so far as the CIGIE. And I think it is

helpful. Even though it is a bigger room and it is a much bigger

setting, I think it is good that everybody meets at the same time

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and we are all getting the same message at the same time. Because

in the past, even though we, you know, we met individually as

ECIE, it was a smaller group and a lot of times we weren’t getting

the same message as the PCIE, Presidentially appointed IGs. So I

think now we are all getting the same message. We all have the

same opportunities. So I think it will work out for the best.

Ms. WATSON. Thank you. Ms. Burrows, how are the DFE IGs

currently evaluated when their agency heads have the appointment

authority? Are there independent evaluations that are conducted or

is it done by agency personnel? And is the process different from

the Presidential appointment IGs?

Ms. BURROWS. Well, currently both the Presidentially appointed

IGs and the Designated Federal Entity IGs have to be appointed

without regard to political affiliation and solely based on their

skills in auditing, management, and other types of skills. But I

couldn’t necessarilly speak to how each agency decides how to appoint its IG. It might vary between the agencies. I don’t think there

is necessarily any criteria that they are looking for. But that might

be a question that I could, you know, research and get back to you.

Ms. WATSON. Could you do that?

Ms. BURROWS. Sure, of course. I would be happy to.

Ms. WATSON. Put it in writing. We appreciate that.

Mr. LAVIK. Excuse me, Madam. One of the things that our agency, when I was initially appointed, the person did rate me. But I

would say it is well over 10 years ago now that we came to an

agreement that we are not rated and we don’t take bonuses. This

was even before the legislation that now forbids it. And that is certainly very helpful because there are subtle pressures one can

make in ratings and so on as we are all aware. But at least, as I

say, in my agency, I can’t speak for that though I think there are

many others that are not evaluated, rated by their chairmen, but

certainly the CFTC, we haven’t been. And that goes back, I would

say, to 1998, several years.

Mr. DESARNO. Yes, the situation is very similar at NCUA. You

know, we are on a merit pay system so I receive kind of like a pass/

fail evaluation almost. But my average increase is just the average

of what the other senior staff receive for that year. So it is not a

written performance evaluation so I am not going to be downgraded or penalized if I issue a hard hitting report. I mean, that

won’t happen. And so my increase would just be the average of

what the other senior staff members get.

Ms. BURROWS. If I could also add that in 2005 there was a controversy with the Legal Services Corp. that they had tried, the

board of the Legal Services Corp. had tried to impose performance

evaluations on their IG after their IG had issued some reports that

were highly critical of how the agency was spending its resources.

It is an agency that generally serves, provides legal services to the

poor. And CRS had done an analysis to whether it was legally tenable to require performance evaluations of IGs. There is no specific

part in the IG Act that would prohibit a performance evaluation

but the general tenets of the IG Act in terms of independence and

only general supervision by the agency head would seem to indicate

that would not be a favorable avenue to pursue in terms of the

agency head conducting a performance evaluation of its IG. But

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that could be something that Congress could clarify, that this

would be a prohibited act to conduct a performance evaluation of

an IG.

Ms. BRIAN. Madam Chairwoman, in our review of the Inspectors

General, our sense was the only time that was at all operative was

prior to the legislation when some DFEs were actually receiving bonuses, many of which wouldn’t accept them even though they were

eligible.

Ms. WATSON. Please don’t mention the B word, bonuses.

Ms. BRIAN. Right, well, I mean and as you can imagine, there is

an essential problem with that. And so the law then prohibited

such bonuses and sort of removed that concept from the IG system

as far as I understand.

Mr. ERVIN. And if I can add to that, in my experience as a Presidentially appointed IG, I would say a couple of things. There is, for

Presidentially appointed IGs, there really isn’t an evaluation process per se. Certainly there is no evaluation by the agency head. Of

course if there are complaints against an IG, those could be lodged

with the PCIE, under the old system and that system continues to

this day. A complaint can be lodged and then it is investigated. In

terms of salary, compensation as Ms. Brian said, the issue arose

since a Presidentially appointed IG controlled his or her budget, in

theory an IG could give himself or herself a bonus. But that was

never done. Obviously it was frowned upon. If I just might take

this occasion, also to say a quick word since we are talking about

bonuses and salaries?

Ms. WATSON. Please do because you were the next I was going

to call on and I think you are addressing most of my question. So

go ahead.

Mr. ERVIN. On this salary issue, because it is tangentially related, a number of people have raised the point that one of the effects

of this legislation that we are here to talk about would be in effect

to lower the compensation of the Inspectors General who are not

Presidentially appointed if they were to be. And certainly that is

a legitimate concern. I think that should be addressed separately.

Of course, I would not support an effect where as a consequence

of this, their salaries would be diminished. But to me that is not

an argument for not appointing, not making these Inspectors General Presidentially appointed. As I say, doing so clearly and only

logically, it seems to me, would enhance their independence.

Ms. WATSON. Thank you so much. You covered some of the questions I was going to ask so we are going to go to our last witness

now, Ms. Brian. Your recommendation in your most recent report

on IGs states that Congress should consider adding more meaningful and reflective reporting requirements to statutorily required

semi-annual reports. Please describe for us what some of these

might be.

Ms. BRIAN. Well, what I found is when we looked at the numbers, and this goes back to my earlier questioning of using numbers

to measure the effectiveness of an IG’s work, is that is one of the

measures that an IG is required to report in their SAR. And we

found, sadly, there is a lot of work that goes into these semi-annual

reports or SARs. I am sad to report how few people read those reVerDate 11-MAY-2000 14:09 Jun 07, 2010 Jkt 000000 PO 00000 Frm 00096 Fmt 6633 Sfmt 6633 U:\DOCS\56375.TXT KATIE PsN: KATIE
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ports because they are really boring. They are full of a lot of numbers.

Ms. WATSON. A lot of words, many pages.

Ms. BRIAN. And you know, I am just calling it as it is. So one

example of that is that they are to report the numbers of cases referred for prosecution. And that is a measurement that has been

used, I was with a former Deputy Director of OMB where he was

testifying that was a real measure of the quality of the work of an

IG. But when we got behind those numbers, we found that it really

doesn’t tell you very much. So, for example, if the numbers of referrals for prosecution from an IG shop is declining, it is assumed that

means they are working less hard. It could be, however, that they

are taking on much more important, putting their resources into

much more important audits that aren’t beefing the numbers up

but are taking a lot more resources. Another thing to keep in mind

is we found over the last 10 years, we talked to a lot of prosecutors,

and it turns out that the IG shops are referring fewer bad cases.

What we found was a pretty high declination rate. They refer a lot

of cases for prosecution. The U.S. attorneys would look at them and

say this is a dog; I am not going to do it. So there is a pretty high

declination rate. Now what we are finding is that the declination

rate is much lower because the IGs are referring fewer but stronger

cases and they are actually consulting with U.S. attorneys, you

know, early on in a more consultative way. So those are sort of the

examples of why the numbers aren’t very effective.

We thought the better way of approaching reports to Congress

was to look at what the IG thought was the most important work.

What were the things they really wanted the Congress to be aware

of that was happening in their agencies? If that kind of reporting

is done to really focus the SARs in those ways, then maybe you

would be able to find out, you know, as an early warning in some

of these crises that are approaching us and we are saying how did

we find out about them after the fact.

Ms. WATSON. I appreciate that. We have seen a couple of cases

in recent years where the IGs were found to have acted inappropriately or to have conflicts with the very agencies they are charged

with overseeing. Are there adequate measures in place such as a

peer review, which has been mentioned already, or external monitoring programs to keep check on these IG Offices?

Ms. BRIAN. Thank you for that question. We looked at the mechanism that is used to evaluate an IG’s poor conduct, the Integrity

Committee, and that continues to be the case through the laws now

statutorily created. And we think that is a pretty good model where

it is other IGs reviewing allegations of misconduct. However, there

are some flaws in its execution. One is that we have found what

has been happening is the Integrity Committee will have a finding

or will go through an entire lengthy investigation but then won’t

have an actual finding at the end of the day. In one fairly famous

case, the conclusion was that the IG should be disciplined up to

and including removal from office. It was in the last administration. And the OMB received this information and then came back

to the Integrity Committee and said, so are you saying he should

be removed? And because they hadn’t really made that conclusion,

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they said, well, we didn’t say that. And so nothing actually happened. So we think that is a change that needs to occur.

The other flaw we believe is that the Integrity Committee is currently now statutorily headed up by a member of the FBI. And the

problem with that is that the FBI is, of course, looking for criminality. Rarely, I would hope, is it going to be the case that an IG is

accused of criminality. It is going to be more a case of poor judgment or inappropriate behavior for an IG. We had another case

where an IG actually acknowledged that he had provided to the

President—this was a Presidentially appointed IG—provided to the

President a very controversial report prior to its release for his

counsel’s opportunity to redact information. The Integrity Committee concluded essentially that he didn’t violate the law, which is

true.

However, I would believe most IGs would agree with me and I

certainly believe that was really inappropriate behavior for an IG.

So if that committee were headed up by an IG rather than a member of the FBI, I think the standards for conduct would be more

appropriate.

Ms. WATSON. Well, I want to thank Mr. Kotz, Mr. DeSarno, Mr.

Lavik, Ms. Burrows, Mr. Ervin, and Ms. Brian for your expert testimony. And believe me, we have taken a lot of this down. Our

work is just beginning. And if there is one place that I think Congress has failed, and that is in its oversight duties. As the Secretary of Labor said in her acceptance speech, there is a new sheriff in town. So I want to thank my colleagues who were here and

had to leave.

I want to thank each and every one of you for the time you have

given us this afternoon and the wealth of information to start our

wheels rolling. I think you are going to see a difference now with

a new administration and more openness and all our concerns

about how did we get ourselves into this mess. We have to answer

to the people who sent us here to Washington. We expect to be able

to do that. And we expect to be able to mitigate some of these problems, provide solutions, so that they who pay their taxes will have

a better quality of life.

So without objection, this committee is adjourned with a sincere

thanks to all of you.

[Whereupon, at 5:15 p.m., the subcommittee was adjourned.]

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