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37–462 PDF 2007

S. HRG. 109–969

A REVIEW OF CURRENT SECURITIES ISSUES

HEARING

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

ON

EXAMINATION OF CURRENT SECURITIES ISSUES, FOCUSING ON 

IMPROVING FINANCIAL DISCLOSURE FOR INDIVIDUAL INVESTORS

APRIL 25, 2006

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

RICK SANTORUM, Pennsylvania 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN E. SUNUNU, New Hampshire 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

PAUL S. SARBANES, Maryland 

CHRISTOPHER J. DODD, Connecticut 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey

KATHLEEN L. CASEY, Staff Director and Counsel 

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel 

MARK OESTERLE, Counsel 

JUSTIN DALY, Counsel 

DEAN V. SHAHINIAN, Democratic Counsel 

ALEX STERNHELL, Democratic Professional Staff 

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator 

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

TUESDAY, APRIL 25, 2006

Page

Opening statement of Chairman Shelby ................................................................ 1

Opening statements, comments, or prepared statements of: 

Senator Sarbanes .............................................................................................. 2

Senator Hagel ................................................................................................... 3

Senator Dodd .................................................................................................... 3

Senator Bunning ............................................................................................... 4

Prepared statement ................................................................................... 38

Senator Sununu ................................................................................................ 4

Senator Allard ................................................................................................... 5

Senator Carper ................................................................................................. 21

Senator Bennett ................................................................................................ 25

Senator Crapo ................................................................................................... 32

Senator Stabenow ............................................................................................. 38

WITNESS 

Christopher Cox, Chairman, U.S. Securities and Exchange Commission .......... 5

Prepared statement .......................................................................................... 39

Response to written questions of: 

Senator Crapo ............................................................................................ 45

Senator Enzi .............................................................................................. 46

Senator Santorum ..................................................................................... 47

Senator Stabenow ...................................................................................... 48

(III)

(1)

A REVIEW OF CURRENT SECURITIES ISSUES 

TUESDAY, APRIL 25, 2006

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC.

The Committee met at 10:08 a.m., in room SD–538, Dirksen Senate Office Building, Senator Richard C. Shelby (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY 

Chairman SHELBY. The hearing will come to order. 

Today, the Banking Committee continues its review of the regulatory landscape in the securities markets. I would like to welcome 

back Chairman Christopher Cox, returning to the Committee for 

the first time since being confirmed to lead the Securities and Exchange Commission. 

Chairman Cox’s appearance this morning will provide the Committee an opportunity to learn more about his ambitious investor 

protector agenda at the SEC. I commend the Chairman for making 

vigorous enforcement of securities laws his top priority. Investor 

confidence in the fairness and the integrity of U.S. markets simply 

would not exist without an aggressive and relentless pursuit of 

wrongdoers. Chairman Cox’s initiatives to improve the quality and 

usefulness of information and corporate disclosure will also benefit 

investors and the markets. 

For example, his efforts to enhance the transparency of executive 

compensation will allow shareholders to compare in a meaningful 

way the total pay packages awarded to corporate management. 

Similarly, his technology-driven proposals promoting electronic delivery of proxy materials and the use of interactive data will empower shareholders to make better informed investment decisions. 

Last month, the Committee held hearings on two important 

issues affecting investors and capital markets. The Committee’s 

hearing on credit rating agencies demonstrated that Congressional 

reform of this self-regulated industry is long overdue. I was pleased 

to learn that a virtual consensus exists on the need to promote 

competition, address embedded and pervasive conflicts of interest, 

and establish regulatory oversight. I intend to continue working 

with Senator Sarbanes and other Members of the Committee in the 

coming months on a legislative solution to this longstanding problem. 

The other recent Committee hearing examined the state of selfregulation in the securities markets. The most important development in SRO area is the conversion by each of the two major U.S. 

2

markets to for-profit, shareholder-owned corporations. The New 

York Stock Exchange’s unprecedented decision to make its regulatory apparatus a wholly owned subsidiary of the for-profit parent 

company, has generated substantial controversy. Almost all of the 

Committee’s witnesses, representing a diverse group of market participants, questioned whether the fiduciary obligations to maximize 

shareholders’ profits and the statutory obligations to oversee the 

exchange’s customers and competitors could both be satisfied. 

Along with rating agencies and SRO’s, the Committee intends to 

review hedge funds, pension accounting, and other securities issues 

this year. I anticipate a wide-ranging discussion this morning on 

some of these matters. 

Chairman Cox, again we thank you for your appearance today. 

We thank you for your service to the country, and we look forward 

to your testimony. 

Senator Sarbanes. 

STATEMENT OF SENATOR PAUL S. SARBANES 

Senator SARBANES. Thank you very much, Chairman Shelby. 

This is another instance of the Committee continuing to perform its 

important role of overseeing the regulators and the important 

issues under our jurisdiction. 

I join the Chairman in welcoming Chairman Cox, the 28th Chairman of the Commission, back before the Committee, I think the 

first time since we did the confirmation. Already he has worked to 

improve the disclosure of executive compensation, to streamline accounting rules, and to enhance the usefulness of data filed with the 

SEC through XBRL. 

The Baltimore Sun, in an article, said, ‘‘SEC Chief seeks data to 

empower tiny investor,’’ and went on to note that it also should 

vastly improve the analysis of firms by professionals in the field. 

The Chairman has met with other regulators to address issues 

raised by the CFTC reauthorization, and by Regulation B, and 

given his skills in the Congress, working at developing consensus, 

we think the Chairman can be a very constructive person in the 

regulatory environment. 

We appreciate the war on complexity. Things should be written 

in simple English. It is a new departure in this area. He has also 

enhanced the protection of vulnerable groups, particularly elderly 

investors. I think that is extremely important and I commend the 

Chairman for that initiative. 

Another vulnerable population, I just want to note, is young military personnel. We have held some hearings here on that, and we 

have received testimony about abusive sales practices used by some 

to sell unsuitable financial products to young military personnel. 

Furthermore, the Commission’s effectiveness in these efforts can 

be, and is, enhanced by cooperating with State regulators. I am 

pleased that Chairman Cox has placed some emphasis on this. He 

noted in a recent speech that it is vitally important that we partner 

with them, and the complementary nature of our regulatory regimes makes us far stronger together. 

There are a number of other items on the Commission’s agenda, 

which I am sure we will review in the course of the question period 

here this morning. 

3

I do want to commend the good work environment now prevailing at the SEC. It was recognized in September 2005 as one of 

five best places to work in the Federal Government, a study by the 

Partnership for Public Service and U.S. News and World Report.

That effort began when Chairman Cox assumed his responsibility, 

and a lot of it actually came from this Committee, as we tried to 

get resources for the Commission, pay parity for its employees, to 

stem the outflow of seasoned personnel, but I know that Chairman 

Cox is very strongly committed to enhancing and sustaining this 

position, and we hear—I do not know whether to describe it as the 

grapevine—but we heard through lots of sources that things have 

gotten better at the Commission in terms of the work environment. 

We think it is important to continue that. I notice the Chairman 

is having considerable success in attracting some very able people 

to fill important positions, although he has still got some open positions yet to go. 

Mr. Chairman, I look forward to the question period. 

Chairman SHELBY. Thank you. 

Senator Hagel. 

STATEMENT OF SENATOR CHUCK HAGEL 

Senator HAGEL. Mr. Chairman, thank you, and I look forward to 

hearing from our witness, the respected Chairman of the Securities 

and Exchange Commission, and also appreciate his efforts in leadership over the last year. 

Thank you. 

Chairman SHELBY. Senator Dodd. 

STATEMENT OF SENATOR CHRISTOPHER J. DODD 

Senator DODD. Thank you, Mr. Chairman, for holding the hearing. And we thank Chairman Cox for being here with us as well. 

Now he had a little bout in January, and he tells me he is back 

on his feet and got a clean bill of health, so we welcome you to the 

Committee. It is good to see you. It has been a while but we are 

grateful for your presence here today. 

I have had a chance to look over your testimony, and Senator 

Sarbanes and the Chairman have highlighted some of the points 

that you make in the testimony, which are worthwhile. Certainly, 

helping out those who may be most vulnerable in our society, particularly seniors and others, to understand exactly what they are 

getting into is worthwhile, so I commend you for that. 

This is a quiet time in some ways in terms of the securities industry. We welcome that to some degree, considering what we have 

been through, but it is also an important time. It is during these 

quiet periods that not only we do not end up passing a lot of legislation, but also what the regulator does during the quiet time can 

really make a huge difference. I have been impressed in watching 

the Commission as it has grappled with some very significant 

issues. 

I am very interested in hearing from you, Mr. Chairman, on the 

advisory committee’s report on Sarbanes-Oxley, which is a big issue 

that has gotten some attention in the media recently. I am interested in hearing about the mutual fund regulations as well. I know 

that has also received a lot of attention. The credit rating agencies, 

4

a very important issue to come before the Committee. So there are 

a lot of major issues the Commission is grappling with that will 

have significant implications. So while we are not passing major 

bills up here right now, it is a very important time, in my view, 

in terms of setting the table for what the investor community can 

anticipate. 

I had a chance, privately, just a minute ago, talking to the Chairman about the speech he gave in China as well, and I am interested in hearing maybe some comments on your experience there 

and what is going on internationally in terms of people, foreign investors coming to the United States, and the kind of environment 

we create here, and whether or not we are going to sustain that 

environment, a very important issue as well. 

So thank you for being here. I look forward to your testimony. 

I notice that the Dow Jones had a 6-year high yesterday, and I 

asked the Chairman whether or not he was going to take credit for 

that this morning, and he wisely said, ‘‘I do not think I will because it is apt to go down in a couple of days and I do not want 

you accusing me of being responsible for that either.’’ So we will 

leave the Dow record here as being caused by other events. 

But I wanted to underscore the point Senator Sarbanes made as 

well, and that is, the environment at the SEC. You are following 

a very good Chairman, and following him in many more ways than 

just succeeding him, so I commend you for the environment you are 

creating there and the quality of people that you have working 

with you. 

Thank you for being here. 

Chairman SHELBY. Senator Bunning. 

STATEMENT OF SENATOR JIM BUNNING 

Senator BUNNING. Thank you, Mr. Chairman. 

Welcome, Chairman Cox. It is good to see you, and I am glad to 

see that you have recovered from the surgery that you had. 

I am happy to read in your testimony that you are focusing your 

efforts on the individual investor, I do not think many SEC chairmen have done that, and also using plain English. As our Chairman has said, the language of the SEC is unusual to say the least. 

To allow individual investors to step on a level playing field is a 

great step in the right direction. I wish more in Washington would 

follow your lead. 

Anything that can be done to improve access to information and 

people’s understanding of it will help both the new and experienced 

investor. Your program to use modern electronic communications to 

reduce the burden on companies and the SEC will lead to more efficient regulation and management. But most importantly, it will 

give investors more and easier access to financial data, and that 

will help them make better investment decisions, and hopefully, 

encourage more Americans to get into the markets. 

Welcome, Chris. I am glad to see you here. Thank you. 

Chairman SHELBY. Senator Sununu. 

STATEMENT OF SENATOR JOHN E. SUNUNU 

Senator SUNUNU. Thank you, Mr. Chairman. 

5

Welcome, Chairman Cox. Last year, I believe of the 25 largest 

initial public offerings of stock in the world, only 4 of the public offerings were issued on U.S. exchanges. I think there are real questions as to whether, at least in part, that dramatic change in the 

focal point of U.S. exchanges is being that the best source of capital 

in the world was due to new regulation, Sarbanes-Oxley or other 

regulations, or changes in the regulatory environment on the U.S. 

exchanges. I think it would be a huge mistake if American exchanges lost their standing and their position in the world for attracting listings, for attracting capital, for attracting investors, and 

that really is a cornerstone of our American economy. 

So, I am very interested in the work you are doing to address the 

concerns that have been raised with Section 404 in particular, and 

I certainly applaud the work that you have done on improving 

transparency and disclosure, improving some of the technology that 

is being used to share information with those individual investors 

Senator Bunning spoke of, and I look forward to your testimony. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Senator Allard. 

STATEMENT OF SENATOR WAYNE ALLARD 

Senator ALLARD. Thank you, Mr. Chairman. I would also join the 

other Members of the Committee in welcoming Chairman Cox before our Committee. I am looking forward to your testimony. 

As we all know, vibrant security markets are vital to more than 

50 percent of the families throughout the country. A lot of people 

have a stake in the stock market. And in order for our Nation to 

continue to prosper, I think we need to have a lot of confidence, 

there has to be a sense of fairness, integrity, and efficiencies in the 

stock market. 

I would share some concerns also with what is happening now 

with the exchanges and the self-regulatory principles that we have 

put in place, and how they are applying today. I am convinced that 

as the new Chairman, you will stay on top of the new technologies 

and everything, because I know this is something that has always 

been of interest to you. So, I just want to take this opportunity to 

welcome you to the Committee. I consider you a friend, having 

been a former colleague of yours in the U.S. House. I have always 

viewed you as somebody who is willing to step up to the plate and 

make changes when necessary. I would like to hear some of your 

thoughts, so I am looking forward to your testimony today. 

Chairman SHELBY. Chairman Cox, again, welcome to the Committee. Your written testimony will be made part of the hearing 

record in its entirety. You proceed as you wish. 

STATEMENT OF CHRISTOPHER COX

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION 

Chairman COX. Thank you very much, Mr. Chairman, Senator 

Sarbanes, and Members of the Committee. I want to thank you for 

giving me this opportunity to be here today to testify about the initiatives and the priorities of the Securities and Exchange Commission, in particular with reference to improving financial disclosure 

for individual investors, which several of you have referenced in 

your opening comments. 

6

Several years ago, in the midst of financial scandals that rocked 

the country, and a crisis of investor confidence, this Committee 

held a series of very consequential hearings on the topics of corporate responsibility and investor protection. Those hearings laid 

the groundwork for landmark reforms that have restored investor 

confidence and the health of our capital markets. I want to commend you for your efforts, and I am happy to report that the Securities and Exchange Commission is using the tools that you gave 

us to ensure that those reforms are implemented in exactly the 

way that Congress intended. 

A lot has happened in the 9 months since I was last here before 

you, and I appreciate this opportunity to give you a report on the 

new initiatives the SEC has undertaken and to hear further from 

you about your priorities. 

The principal subject of my brief testimony is improving disclosure for the benefit of individual investors. If I may, I would like 

to take a step back and put these efforts into context. 

As a Member of Congress for 17 years, I was constantly reminded by my constituents of the real-world impact of the decisions 

that we make here in the Capitol every day. Like you, I learned 

the importance of being a good listener, and of remembering that 

the common sense of ordinary Americans is the essence and the 

strength of our democracy. 

Most of our constituents are not investment bankers, accountants, or lawyers, but most of our constituents are investors. It is 

a stunning fact of life in the 21st century that a majority of Americans now own stocks, either directly or in the form of mutual 

funds. It is chiefly to serve these people that the SEC exists. Our 

mission, to protect investors, promote capital formation, and maintain orderly markets, must always put ordinary Americans first. 

Since making the transition from the halls of Congress to the 

SEC, I have set out to rededicate the Agency’s ongoing efforts in 

virtually every area to the service of the individual investor. 

In a well-ordered market, educated consumers can choose from 

a number of competitive products, and find what they want at a 

price that they are willing to pay. But, in order to educate themselves, investors need comparative facts. So while investors must 

bear the responsibility of learning what they can about their investment choices, the correlative duty of sellers of investment products is to provide the relevant information. 

To more closely match the theory of a well-ordered market with 

today’s reality, the SEC is currently pursuing four key initiatives 

to improve the quality and usefulness of disclosure for individual 

investors. These four initiatives are: Moving from boilerplate 

legalese to plain English in every document intended for retail consumption; moving from long and hard-to-read disclosure documents 

to easy-to-navigate webpages that let investors click through to 

find what they want; reducing the complexity of accounting rules 

and regulations; and focusing our antifraud efforts, in significant 

part, on scams that target older Americans. 

It is the SEC’s job to see to it that financial data and qualitative 

information about the issuers of securities are fully and fairly disclosed. But we cannot say that we have achieved that objective if 

7

the information is provided in a way that is not clearly understandable for the men and women to whom it is directed. 

Empowering investors does not just mean better access to information, it also means access to better information. Empowering investors is our number one job. And simply put, the question is: 

Once that SEC-mandated information is available, is it understandable? The answer all too often is a resounding and frustrated 

‘‘no.’’

Exhibit A, when it comes to convoluted disclosure, is today’s regime for reporting executive compensation. Ordinary American investors have a right to know what the company’s executives are 

being paid, because those investors own the companies. The executives work for them. 

How can an investor judge whether he or she is getting the best 

executive talent at the best price? Too often the most important 

parts of total compensation are hidden away in the footnotes or not 

even disclosed at all until after the fact. 

Three months ago, the Commission voted unanimously to propose an overhaul of the executive compensation rules. The proposal 

would require better disclosure on several fronts. 

First, companies would report a total figure, one number, for all 

annual compensation, including perquisites. 

Companies would also outline retirement benefits and payments 

that could be made if an executive is terminated, and would fully 

disclose all compensation to board members for the past year. That 

is something that does not happen under today’s rules. 

In addition, a new Compensation Discussion and Analysis section 

would replace the Compensation Committee Report and the performance graph under today’s regime, because in today’s system 

that disclosure is all too often pro forma, boilerplate, and legalese. 

Finally, since the purpose here is to improve communications for 

the consumer, the proposed rules require that all of this disclosure 

be in plain English, the new official language of the SEC. 

Just to be clear, the Commission does not propose getting into 

the business of determining what is the proper method or level of 

compensation. It is not the job of the SEC to substitute our judgment for that of the board. Nor would I, speaking as Chairman, 

subscribe to the notion that all executive pay is excessive. Surely, 

many executives deserve every penny they get and more. Being a 

CEO requires a rarified collection of attributes and skills that are 

in all too short supply, and compensation in the market for executive talent can be fierce. At the same time, I need not cite here the 

several notoriously public cases of extravagant waste of shareholder assets by gluttonous CEO’s and pliant compensation committees. 

It is a testament to the importance of this issue that, when the 

comment period on these proposed executive compensation rules 

was closed, we had received 17,000 comments, one of the highest 

totals in the 72-year history of the Securities and Exchange Commission. 

Making the SEC’s mandated disclosures actually useful to investors is the idea behind another of our initiatives: Interactive data. 

Today, the SEC has over 800 forms. Yet it has been estimated that 

the SEC might instead have need for no more than a dozen. 

8

The key to making this happen is looking at the data on the 

forms independently from the forms themselves. That is what we 

mean by interactive data. Computer codes can tag each separate 

piece of information on a report and tell us what it is: Operating 

income, interest expense, and so forth. 

For individual investors, this means they will be able to quickly 

search for any information they want, without slogging through an 

80-page disclosure document. Our initiative to let investors get information fast, easily, and all in one place envisions this added 

benefit: Instead of long and hard-to-read annual reports and proxy 

statements, investors could have easy-to-navigate webpages that 

let them click through to find what they want. 

With today’s SEC reports, an investor or analyst who is looking 

for comparative data on, say, annual capital expenditures of two 

companies has to search through hundreds of pages of the filings 

of each company, page-by-page. Not surprisingly, this very timeconsuming task has created a cottage industry in rekeyboarding information in SEC reports so that it can be downloaded into spreadsheets and other software. Investors, or more precisely, the intermediaries, whose fees they pay, can then buy this information from 

both domestic U.S. firms and overseas providers to whom the 

drudge work has been outsourced. 

One hates even to think of the human error and data corruption 

that inevitably occurs in this process. 

Interactive data is a way to eliminate these problems, and to connect investors directly to the information in a company’s filings. 

The SEC is strongly committed to interactive data and has taken 

major steps to promote it. We have offered significant incentives for 

companies to file their financial reports using interactive data, and 

companies are now beginning to do this. 

These incentives include expedited review of registration statements and annual reports. A number of well-known firms—the list 

is now 17 and still growing—have already begun to lead the way 

and are filing their reports using interactive data. Starting in June 

of this year, the Commission will host a series of roundtables focused on how we can move to interactive data faster. 

Revolutionizing the way the world exchanges financial information is a worthy goal. We intend to achieve it. 

When it comes to giving investors the protection they need, information is the single most important tool that we have. It is what 

separates investing from roulette. But, if the SEC is truly to succeed in helping investors with more useful information, we will 

need one more ingredient: An all-out war on complexity. 

At the SEC, we are looking at results from the vantage point of 

the ordinary investor, and what we are finding is that, in many 

cases, we are not getting the right results. 

It is not just public companies that have a problem using plain 

English. Our accounting rules and regulations also can be complex 

and difficult to interpret; and, when the rules are difficult to interpret, they may not be followed very well. And, if the rules are not 

followed very well, then, intentionally or not, individual investors 

inevitably will suffer. 

Weeding out the counterproductive complexity that has crept into 

our financial reporting will require the concerted effort of not only 

9

the Securities and Exchange Commission, but also the FASB, the 

PCAOB, and every market participant. This cannot be a one-time 

effort. We will have to commit for the long-term. But it will be well 

worth it. 

Finally, let me turn to our efforts to protect older Americans 

against financial fraud. Consider these statistics. An estimated 75 

million Americans are due to turn 60 over the next 20 years. That 

is an average of more than 10,000 people retiring every day. 

Households led by people aged 40 or over are already owners of 

over 91 percent of America’s net worth. Very soon the vast majority 

of our Nation’s net worth will be in the hands of the newly retired. 

Following the Willie Sutton principle, the scam artists will 

swarm like locusts over this increasingly vulnerable group because 

that is where the money is. 

On a daily basis our Agency receives letters and phone calls from 

seniors and their caregivers who have been targeted by fraudsters. 

Often the victims have already been taken in. These fraudulent 

schemes may begin with a free lunch, but we want to make sure 

that they end with a very high cost to the perpetrators. 

That is why we are attacking the problem from all angles, from 

investor education, to targeted examinations, to aggressive enforcement efforts. Because State securities regulators share our concerns in this area, we are cooperating in this initiative with State 

regulators across the country. 

Each of the four initiatives I have outlined is part of an overall 

strategy to make the individual investor, the average American, 

the ultimate beneficiary of everything that we do at the SEC. Our 

Agency has for many years proudly worn the badge of the investor’s advocate. In the months and years ahead, we are pledged to 

rededicate ourselves to that mission. 

I appreciate the opportunity to be with you here today, Mr. 

Chairman and Members of the Committee. I want to thank you for 

your continuing strong support of the work of the Commission, and 

I am happy to be here to answer any questions that you have. 

Chairman SHELBY. Thank you, Chairman Cox. 

The Banking Committee has been actively reviewing the role of 

credit rating agencies in the capital markets. The rating industry 

is extremely powerful and is dominated by only two firms that do 

not actually compete with each other, as evidenced by the fact that 

Standard & Poor’s and Moody’s, each rate more than 99 percent of 

the debt obligations and preferred stock issues publicly traded in 

the United States. 

In your view, Mr. Chairman, what is the impact of this extreme 

concentration and absence of competition with respect to ratings 

quality, pricing, innovation, and business practices? 

Chairman COX. Mr. Chairman, as you know, this area has been 

one of intense focus, both for the SEC and for this Committee. It 

has also been a subject of legislative interest in the other body. 

First, let me say I appreciate the Congress’s bicameral and bipartisan attention to this issue, particularly your emphasis on increasing and encouraging competition in the market for the provision of 

credit ratings, given that the market, as you point out, is dominated presently by a few firms. 

10

The principles that I think that we support at the Commission 

and that I know have been the focus of discussion here in the Congress, when it comes to a regulatory approach to the NRSRO’s, 

would be, first, avoiding erecting any new barriers to entry and 

promoting competition in the market for the provision of credit ratings for regulatory compliance purposes. Second, utilizing an entry 

process that is transparent, timely, and that accommodates a variety of business models. Third, I think the focus that we have seen 

and the discussions in this Committee and throughout the Congress on managing conflicts of interest is very important. Conflicts 

of interest can arise between NRSRO’s and issuers, and we have 

to ensure that ratings issued for regulatory compliance purposes, 

notwithstanding these potential and sometimes actual conflicts of 

interest, are independent and objective. 

Finally, I think we have to prevent the misuse of material, nonpublic information by NRSRO’s or their associated persons. So all 

of these things have to feature into any reforms that are adopted 

either legislatively or in a regulatory way. And as you know, we 

are deeply into this at the Commission, and have been for several 

years now. 

Chairman SHELBY. Thank you. Following up on that, it is my understanding, Mr. Chairman, that the regulation of rating agencies 

essentially begins and ends when a rating agency receives a license 

from SEC staff designating it as nationally recognized statistical 

rating organization. That is to say, it is my understanding there is 

no ongoing oversight or inspections by the SEC once the NRSRO 

license is awarded. 

Given the overwhelming evidence—and we have had a hearing 

here on this, as you know—relating to conflicts of interest, aggressive and anticompetitive practices, and the well-known failures to 

warn investors about impending bankruptcies—Enron, WorldCom, 

and others, including a place you are familiar with, Orange County, California—do you believe that self-regulation is working in this 

area of the concept? 

Chairman COX. Chairman Donaldson testified to this Committee 

on this subject, that without additional legislative authority, the 

SEC will not be able to regulate in a thoroughgoing way, the 

NRSRO’s. What we can do under present law is withdraw an 

NRSRO’s no-action letter. We can bring an enforcement action 

against an NRSRO for violation of the antifraud provisions of the 

Federal securities laws, and at least with respect to S&P, Moody’s, 

and Fitch, which are registered as investment advisers, we can regulate them under the Investment Advisers Act. 

Chairman SHELBY. We want to work with you to give you whatever means you need, and I believe we can do it in a bipartisan 

way. 

The New York Stock Exchange Regulation, the Committee recently held a hearing, Mr. Chairman, on the state of self-regulation 

in the securities industry with a particular focus on the implications of the New York Stock Exchange’s unprecedented decision to 

keep its regulatory unit in-house even after conversion to a forprofit, shareholder-owned entity. 

As your colleague, Commissioner Paul Atkins, at the SEC recently noted, revenues derived by the NYSE regulation will roll up 

11

on a consolidated basis to the New York Stock Exchange Group, 

the public company. That means that penalties collected by the 

New York Stock Exchange Regulation will roll up into the aggregate revenue calculations of the New York Stock Exchange Group. 

This further compounds the inherent conflict of a for-profit entity 

possession regulatory authority over customers and potential competitors. 

Do you have some concerns there. Some of us do, but we think 

the ground has changed a little out there. 

Chairman COX. The ground is changing. This is a new world that 

we are entering upon. The evolution of our major exchanges into 

for-profit entities, the demutualization of the markets, and the 

prospect of global competition present challenges to our historical 

regulatory approach. 

The fundamental principle that we need to keep in mind going 

forward is that, in order to be effective, regulation needs to be independent and arms’ length. The for-profit structures that——

Chairman SHELBY. Has to be considered open too, does it not? 

Chairman COX. Pardon me? 

Chairman SHELBY. Fair. A regulation has to be considered to be 

fair too. 

Chairman COX. Of course. The reality and the perception are 

equally important; and, of course, ultimately the perception is driven, one would expect, by the reality. 

The Commission has already taken action designed to strengthen 

regulatory independence, but I look at this as a beginning, not an 

end. When we approved the NYSE merger, we requested—and the 

NYSE Board accommodated us in those requests—some additional 

changes to further strengthen the independence of regulation there. 

But, in my conversations with the management of the NYSE, I 

made it very clear—and I think it is their understanding as well—

that we are at the threshold of understanding where this is all 

going to lead us, and we have to be very nimble in our approach. 

We have to be willing to constantly adjust and improve. 

Chairman SHELBY. Senator Sarbanes. 

Senator SARBANES. Thank you very much, Mr. Chairman. 

I want to make a couple observations before I put a question. 

First of all, Senator Dodd referred to the fact that things were relatively quiet, and that the Dow Jones average reached a 6-year 

high on Friday. It seems to me that creates something of a tendency to forget, or to get a a sense of amnesia. Just to make sure 

that does not happen, I want to just note three enforcement actions 

that have happened in the last month or so. 

On March 16, the SEC settled on enforcement action against 

Bear Stearns for securities fraud for facilitating unlawful late trading deceptive market timing of mutual funds by its customers, and 

customers of its introducing brokers. They will pay $250 million—

$160 million in disgorgement, $90 million in penalty. 

Tyco agreed to pay a $50 million settlement to the SEC charges 

that is used improper accounting, overstating its reported financial 

results, smoothing those reported earnings, hiding vast amounts of 

senior executive compensation, and a large number of related party 

transactions from investors. 

12

April 20, just a few days ago, JPMorgan Chase and Company an- nounced that it agreed to pay $425 million to settle class charges 

over its role in a scheme in which 55 underwriters allegedly defrauded investors of billions of dollars through hundreds of initial 

public offerings during the 1990’s technologies bubble. 

So the responsibility of the SEC is to do all that it can to prevent 

and preclude such practices, and sustain the reputation of our capital markets for integrity, transparency, and honesty. 

Now, Ernst & Young has just done a report on Global IPO 

Trends, 2006. And in that report they note that the U.S. capital 

markets are perceived by issuers and investors as the gold standard, particularly as it relates to corporate governance. Companies 

realized evaluation premium in the form of a higher-price earnings, 

or similar multiple, as compared to what a similar company receives on another exchange. One observer has said: Motivation for 

most companies listing in the United States is evaluation premium 

averaging 30 percent that accrues as a result of adhering to high 

standards of governance. 

Now, that report went on to note that exchanges outside the 

United States have significantly different regulatory and corporate 

governance requirements, and that some exchanges are aggressively marketing the fact that their exchange has lower regulatory 

requirements than in the United States. 

They go on to say, ‘‘These lower regulatory requirements translate into increased risk for investors participating in those exchanges, as they often do not have similar investor rights and protections.’’

I just simply want to say I think the United States should consider on the path of high standards, of having the gold standard. 

It has served us well in the past. I think it will serve us well into 

the future. 

Some say, well, you know, these IPO’s are being issued on other 

exchanges. But then you have to look a little into that, and one of 

the things that is clear, when you do that, is that the major driver 

of the global IPO markets is the privatization of former stateowned enterprises. The top five IPO’s in 2005 are all former stateowned enterprises. This trend is probably going to continue, but, 

there is usually political direction to list those IPO’s on local exchanges. The Chinese Construction Bank went to the Hong Kong 

Exchange. The two other Chinese IPO’s in the top five also listed 

in Hong Kong, and the two French IPO’s in the top group listed 

on Euronext. I just urge the Commission to hold to its standards. 

I think we are going to come out ahead if we do that. 

The question I want to put to the Chairman involves hedge 

funds, and the resources the SEC will need and be devoting to 

make sure that the investigative and enforcement staffs at the 

Commission are sufficiently knowledgeable and experienced in the 

activities of these funds. 

Last Friday, Floyd Norris wrote an article in The New York 

Times headed: ‘‘Are These Hedge Fund Results Real?’’ He went on 

to say, ‘‘For those who favor open markets and open investment 

management, it may look like the best of times, but it may really 

be the worst, and we may not learn just how bad it is until something horrible happens. More and more trading and more and more 

13

money now falls outside almost all regulation. Hedge funds trade 

with virtually no disclosure of what they are doing.’’

The New York Times ran a story in late March, ‘‘An anxiety 

about the growing power of hedge funds.’’ ‘‘These funds have increased sharply in number, size, and effect on the market. According to stock exchange officials they constitute from one quarter to 

one half of all trading on that exchange every day. Hedge funds operate with a fair amount of secrecy, which naturally shrouds them 

in mystery, and often suspicion. Combine that with a veiled practice of shorting and the devaluation of stock research since the 

market collapse, and it becomes a recipe for concern.’’ And there 

are a whole series of comments to that effect. 

We recognize hedge funds perform an important function in the 

markets, but given these concerns that are being expressed, I want 

to ask the Chairman whether the SEC has the necessary resources 

and authority to understand, investigate activities in this area, and 

if necessary, to bring enforcement actions? 

Chairman COX. The straightforward answer to the last part of 

your question is yes. We have been bringing enforcement actions 

and regulating hedge funds to the extent that some of them have 

been registered as investment advisers for the last decade. We are 

now implementing authorities under a new rule that went into effect within the last 90 days as you know. 

I should bring to the attention of the Committee that as a result 

of compliance with that new rule, we have essentially doubled, 

nearly doubled the number of hedge fund advisers that are registered with the Securities and Exchange Commission, and our presumption is that virtually the entirety of those new registrations 

are in consequence of our new rule. This is giving us some reliable 

census data about how many advisers are operating within the 

United States that are subject to our jurisdiction, and that is one 

of the main things that we had hoped would occur. 

We are also training our inspectors specifically for the purpose 

of understanding how to inspect hedge funds. This is a new emphasis for the Commission. We are devoting significant resources to it, 

and, importantly, we have drawn on the expertise and resources of 

academics and hedge fund experts as part of this training. So, I 

think that we are well-prepared to embark on at least this next 

step. And, as we internalize this new information that we are gaining from the hedge fund adviser registration, and learn from it, I 

think we will then be prepared with the recommendations of our 

professional staff on what should be next steps. 

Senator SARBANES. I think it is an important process you are 

going through. Some of us on this Committee lived through the 

savings and loan debacle, and I think it is imperative that the 

Commission and the Committee try to anticipate potential problem 

areas, because once they hit, they can hit with tremendous force, 

have wide-ranging repercussions, and so an ounce of prevention is 

worth a pound of cure, and encourage the Commission in its work. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Senator Hagel. 

Senator HAGEL. Mr. Chairman, thank you. 

Picking up on the conversation, the exchange that you have just 

had with Senator Sarbanes regarding hedge funds, with the supVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
14

port and concurrence of Chairman Shelby, Senator Dodd, and I will 

be holding a hearing in our Subcommittee on Securities, on hedge 

funds on May 16, and as you know, Mr. Chairman, you have been, 

or a representative of the SEC, asked to testify. I think so far all 

representatives of the President’s Working Group will be in attendance, recognizing that there is a lawsuit challenging the SEC’s ruling on hedge funds. But nonetheless, I would hope—and I know we 

will have an opportunity to discuss this in some detail privately 

this week—that the SEC will be represented at the hearing. 

A couple of follow-up questions to you, Mr. Chairman, regarding 

Senator Sarbanes’ questions. Could you give this Committee a status report on where the SEC is on the current regulation, even 

though it is being challenged in Federal Court? Is it still the current regulation, the regulation that in fact requires hedge fund 

managers to register? Has there been any change in the status of 

the regulation as a result of the lawsuit? 

Chairman COX. No. As I mentioned, I believe within 24 hours of 

being sworn in as Chairman, we intended to, and we have, put that 

rule into effect exactly as it was written. And it did in fact require 

advisers to register by a deadline of February 1 of this year. That 

deadline has now, obviously, passed, and the result is that over 

2,400 investment advisers have registered. That is, at least as of 

March 31, 2006, the most current data that I brought with me to 

this hearing. 

That covers more than 11,500 hedge funds with assets of almost 

$2 trillion. The census information that we were hoping to acquire, 

I think we are acquiring in a sturdy way. I should reemphasize, as 

I mentioned in response to the question from Senator Sarbanes, 

that roughly half of hedge fund advisers had already been registered by their choice, and so, now that this rule has gone into effect, I think we have our arms around what is the true population. 

Now, we understand inferentially that, because of the lawsuit, 

there is a small group of people who may be holding out and not 

registering, but I do not think that statistically that is material. 

Senator HAGEL. We will have an opportunity to further engage 

this issue with more specific questioning when we have the hearing 

on May 16. Thank you. 

Let me turn to a Wall Street Journal article, January 27, 2006. 

The headline is: ‘‘New York Stock Exchange Grants Fannie Request for Continued Listing.’’ I will just set this question up this 

way. The beginning of the article states, ‘‘Embattled mortgage finance company, Fannie Mae, announced Friday that the New York 

Stock Exchange recently granted the company’s request to continue 

listing its stock despite the fact that Fannie has not filed an earnings statement since the second quarter of 2004. The Securities and 

Exchange Commission approved last week a controversial amendment that saves Fannie from certain delisting procedures that were 

slated to begin as soon as March under the New York Stock Exchange original rules for companies that had fallen behind in their 

SEC filings.’’

‘‘Fannie, in an SEC disclosure, filed after the markets filed Friday, said the New York Stock Exchange approved the company’s 

request last Thursday, which is also when the SEC okayed the 

change.’’

15

Can you explain to the Committee why you did that, and are you 

concerned that this sends a very dangerous message to others? And 

maybe take us down into some detail as to what was the reasoning 

behind that approval? 

Chairman COX. We do not begin with the presumption or the intention of forcing delisting. I have discussed these specific cases 

with the New York Stock Exchange. We are watching very carefully the promised compliance, and it appears that we are now 

within reach of getting what we have expected. If that does not 

come to pass, obviously, our approach will change dramatically. 

Senator HAGEL. What do you mean getting what you expected? 

Chairman COX. We have right now a timetable by which we expect that the work that was necessitated on account of restatements will be completed and the filings with the Securities and Exchange Commission will be made. We can review those per normal. 

Senator HAGEL. I have to tell you, Mr. Chairman, you have presented to the panel this morning, and you took a great deal of time 

doing it and I think we all agree with it, a priority of being concerned for investors. And I would have a concern for investors 

when a public company has not presented financials since the second quarter of 2004 and is still is allowed to trade on a major stock 

exchange. 

That would be a concern for me as an investor and one who, like 

you, is concerned about investors. I would strongly suggest that we 

need to take a further look at this. At least I would like to have 

a further conversation with you about this. There will be, I am 

sure, some additional hearings on this. 

But I think this is a very serious problem aside from the fact 

that it sends the wrong message to the markets. And I am wondering also, which Senator Sununu got into a little bit with you 

and I am sure he will follow up in his time for questions, why is 

it that we are falling behind in IPO’s here in the United States? 

Is this all connected? Are we having a confidence problem? I will 

let Senator Sununu take that because my time is up, but I again 

thank you for coming before the Committee, Mr. Chairman. 

Chairman COX. Thank you. I want you to know that I take, and 

the Commission takes, your message to heart. It is the unusual circumstance of the transition to 1934 Act compliance, and the coincidence of that with these massive restatements that has landed us 

in this, what I expect to be temporary, position. But, going forward, 

the kind of compliance that you expect is the same kind of compliance that we would expect at the SEC. 

Senator HAGEL. I think when you exempt companies, you are 

headed for trouble, and we know that we have some trouble that 

we are talking about, so we will follow this up in a private conversation. Thank you. 

Chairman SHELBY. Senator Dodd. 

Senator DODD. Thank you, Mr. Chairman. Again, thank you, 

Chairman Cox, for being here today. I know you have this advisory 

committee on Sarbanes-Oxley, regarding smaller companies, is 

about to—has it reported to you yet formally? 

Chairman COX. Yes, just this week, just yesterday. 

Senator DODD. I am interested in hearing your initial reactions 

to the report. And in the context, I would like to raise two issues 

16

that struck me as being—certainly all hearings, as Members of 

Congress, we hear from corporations and others in our respective 

States. I think probably all of us ask when we meet with a corporate executive, how are you doing, how is Sarbanes-Oxley affecting you? It is a common question. If we do not raise it, certainly 

they will with us when the opportunity presents itself. 

I have been struck, by and large, by the positive reaction to Sarbanes-Oxley. I have heard some very good comments about the 

overall effect this has had on corporate governance, the effectiveness of audit committees, the weeding out of board members who 

were not necessarily doing a good job or serving on too many 

boards. They describe it as having a very salutary effect overall. 

There have been some questions raised about the cost and so 

forth to smaller companies, Section 404 questions and so forth have 

come up. But I was struck in some reports that in fact the cost of 

compliance under Sarbanes-Oxley is actually reduced by 45 percent 

over the last 2 years, and that if we were to follow the recommendations of the advisory committee, as they have been proposed, some 80 percent of all corporations presently covered by Sarbanes-Oxley would be exempt. I want to know if those two facts are 

true and what your initial reaction is to this advisory board? 

Chairman COX. As you rightly observed, we have just received 

this advisory committee report. I just yesterday had an opportunity 

to congratulate the co-chairs of the advisory committee and all of 

their members for a year of very hard work. I think they performed 

admirably in representing the concerns of small business, which 

are among the several concerns that we will have to take into account as we go forward. 

As for the specific recommendations of the advisory committee, 

I will simply represent what I have previously stated, our emphasis 

is on making Section 404 work, and implementing it in a way that 

provides all the needed investor protections without unnecessary 

cost. This is all meant to be for the protection and the benefit of 

investors, and therefore, they are entitled to the maximum amount 

of investor protection at the lowest possible cost. We do not want 

unnecessary cost. We do not want make work. So we should be able 

to learn from early experience and implementation. 

Section 404 itself is a very modest part of the overall legislation. 

It is just a few lines of text. The implementation through AS 2 is 

hundreds of pages, and the practice that has developed under that 

guidance is itself another gloss on the statute. But what is very important, it seems to me, is to make the statute work. So we are still 

in the early stages of discussing these recommendations, having 

just received them, and I cannot possibly represent the views of 

other Commissioners, since I have not had a chance to really thoroughly go through all of this with them and gain the benefit of 

their reactions. 

I can say that certainly my goal as Chairman is to find a way 

to make Section 404 work, so that it should not be a question of 

whether to apply it to companies of all sizes, but rather how. The 

question you put to me also asked me to tell you whether it is right 

or wrong that costs are coming down. I think the answer is that 

some costs are coming down, and some are not. There is a difVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
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ference between internal and external costs, the fees that auditors 

are charging as opposed to the internal cost that companies bear. 

I would further observe that going forward, one would expect in 

a workable system that these costs will be coming down simply because the work is routinized. If there is not any routinization to 

this, and we keep inventing the wheel year after year, then something has to be wrong. For foreign private issuers, they are now 

just embarking on the front end first year costs, and so I am sure 

that the concern about cost is going to be with us throughout 2006 

and maybe into 2007. We are aggressively going to be working implementation with the PCAOB so that we get all the benefits of 404 

without needless cost. 

Senator DODD. The question I raised as well about the issue of—

as I understood it—and I am not suggesting this is the position you 

have taken—but if the full recommendations of this advisory committee were to be adopted, is it a fact that about 80 percent of the 

corporations presently covered by Sarbanes-Oxley would be exempt? 

Chairman COX. Yes, and it depends, of course, on whether you 

are categorizing these companies by their, for example, market capitalization or simply counting them up. There are many small companies, and so in terms of a number of issuers you get to a very 

high fraction of the total. On the other hand, if you look at it from 

the standpoint of how big are these companies, all the biggest firms 

would continue to be covered even under their recommendations, 

and the lion’s share of market capitalization in the United States. 

So, I think both statistics are correct and useful ways of looking at 

the problem. 

Nonetheless, I want to get back to what I consider to be the main 

point, and that is that there should be a way—and the advisory 

committee’s recommendations contemplate this, I will say— to 

make this work. The advisory committee report focuses on the fact 

that there seems to be lacking a framework applicable specifically 

to smaller companies, but certainly we can work that aspect of the 

problem as well. COSO is developing such a framework at the request of the SEC, and that may well be available as a place where 

we can hang our hat. 

Senator DODD. Mr. Chairman, I suggest that we might want to—

this is such an important issue that the Committee at some point, 

in consultation with you and, obviously, Senator Sarbanes and others, that we would be able to stay closely in touch with the SEC 

as it works its way through this. I would be very interested in 

making sure we had hearings and so forth on the subject matter 

as it progresses. 

Chairman COX. I think we would welcome that. This is, after all, 

an agency implementation of a still relatively recent Congressional 

enactment, and so it is our main purpose to make sure we are 

doing exactly what Congress intended. 

Senator SARBANES. You do have a roundtable already scheduled 

for mid-May, do you not, to look specifically at the question of further guidance that would come from the SEC and the PCAOB? 

Chairman COX. That is exactly correct. 

Senator SARBANES. With respect to the very issue we have been 

talking about? 

18

Chairman COX. Our 404 roundtable is the second annual such 

event, and we are trying to take a look at lessons learned from one 

more year under our belt. 

Senator DODD. Just one additional question, Mr. Chairman. It 

may have been raised. I apologize, Senator Hagel may have raised 

this, on the issue of international exchange mergers? Have we 

touched on that, the merger issue, the exchange mergers? Make it 

easier for U.S. citizens based in the United States to trade in foreign listed securities, which has some possibilities, but what entity? 

I am curious about what entity would then have supervisory control over the holding company, in effect, if the exchanges remain 

functionally regulated by the home State, if you will, or the home 

country? 

And then on a related matter, whether or not any thought has 

been given to the possibility that a foreign interest could purchase 

a U.S. exchange? And if so, what thoughts are then—we have been 

through something fairly recently, not involving an exchange but 

something else, and whether or not we have a system set up to examine the implications of such a possible acquisition? 

Chairman COX. The approach that I am taking is that this is inevitable, that this globalization is proceeding apace and is not to 

be ignored, whether or not, for example, the Nasdaq play for the 

London Exchange actually materializes. These things, these kinds 

of transactions in this category, will occur, and presumably, with 

increasing rapidity. This is just a function of the fact that these are 

now for-profit exchanges which have their own stock as currency 

to make acquisitions. They are interested in acquiring the capacity 

to deliver new products. 

One of the key questions that needs to be answered in order to 

know what form regulation takes is whether in these mergers the 

trading platforms are going to be merged. It is entirely up to the 

people who structure these future transactions whether or not they 

subject themselves, at least under current law, to regulation country by country, or to multinational regulation. 

I am taking the view that it is best for the United States and 

our overseas counterparts to work out some of these conceptual 

issues in advance before a real deal is on the table, and we know 

whose ox is being gored. And so the leadership of the FSA and I 

will be getting together for some quality time very soon. We have 

already met, of course, on this, but we decided we need to set aside, 

in a retreat as it were, more than a full day just to talk about these 

issues and get our minds around the problems. 

I think, through hearings and otherwise, this Committee will 

want to do the same, because we have had a regulatory structure 

in this country for 7 decades that really has not contemplated any 

of this. Maybe it can be made to work. On the other hand, maybe 

it is like stretching the new facts onto a procrustean bed of regulation that just does not fit. 

Senator DODD. As I said, I would rather talk about it now than 

have a specific case emerge and us scurrying around trying to sort 

it out, or condemning it because it is occurring, and then trying to 

write rules and regulations after the actual event has occurred. 

So, again, it is one of those issues, Mr. Chairman, with a busy 

schedule and a lot of issues on the table, but one I would be very 

19

interested in hearing what happens as a result of these conversations you are having and any recommendations and thoughts the 

SEC would have. I am sure Senator Hagel, as the Chairman of our 

Subcommittee, would be interested as well. 

This is, again, a fact of life. It is moving in that direction. Clearly, as you point out, we should be thinking about it, and something 

we never contemplated in the past, but I think we had better start 

paying attention to it very clearly. 

Chairman SHELBY. Senator Dodd, I think your recommendation 

and observations are excellent, and the timing could not be better. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

About 12 months ago, 14 Members of this Committee sent a letter to then-Chairman Bill Donaldson, urging the Commission to 

withdraw its proposed Regulation B, and resubmit it for comment 

after talking to the banking regulators on the proper scope of the 

regulation. 

Shortly after taking office, you agreed to postpone compliance, 

and indicated that you would revisit the regulation. Now that you 

have been at the Commission for about 9 months, can you provide 

a report on the status of the proposed Regulation B and any effort 

the Commission has made to work with the banking regulators to 

propose a regulation that merits the legislative intent of GrammLeach-Bliley? 

Chairman COX. I can certainly provide you with a status report. 

Working backward from today at 2:00 o’clock, depending on when 

this hearing adjourns, I am scheduled to get together with the 

banking regulators for the next in our ongoing series of meetings 

to try and hammer out a collaborative response on Regulation B. 

Going back to the other end of the spectrum, I remember when 

I was a conferee on Gramm-Leach-Bliley, it was in a different millennium. It was a long time ago. 

Senator BUNNING. Seems like. 

Chairman COX. Literally was. It was a 20th century issue. We 

worked on it for several years during the 1990’s. The law concluded, the conference concluded in 1999. It is about time that we 

had regulations implementing the law. 

So my view is we should get this done. We can get it done, and 

we intend to follow Congressional intent as closely as humanly possible. 

Senator BUNNING. That would be a wonderful thing if you could 

do that. On bonds, I understand the New York Stock Exchange 

Group has filed a request with the SEC to allow them to trade certain unlisted corporate bonds on its automated bond system. That 

would greatly expand the number of bonds that investors could 

trade on the exchange. When do you think the SEC will act on this 

application, and do you have any thoughts on the impact it will 

have on bond transparency for all investors? 

Chairman COX. Well, to answer the first question first, I think 

that we can reach a resolution to this issue in the near-term. With 

respect to the more general question, we share the concern of the 

Bond Market Association and others that the industry not be burdened with duplicative trade reporting for securities traded on the 

NYSE’s automated bond system. The Commission staff is currently 

20

discussing with both the NASD and the NYSE the best way to address the duplicative reporting issue, and that is the basis for my 

confidence that we can resolve this very quickly. 

Senator BUNNING. Last, but not least—because there are others 

waiting—proposed rules on online availability of proxy materials. 

The Commission has proposed a rule that would allow companies 

to provide shareholders with annual reports and proxy statements 

only online unless the investors ask for printed materials. Today, 

many investors, particularly the elderly and low income, do not 

have access to the Internet, nor do they feel comfortable doing their 

financial business online. We do not want to discourage investor 

participation, and I know many comments were filed expressing 

concerns about the options proposed by the Commission. What is 

the correct balance between increasing investors’ participation and 

cutting the cost of shareholders communication, and how can the 

Commission accomplish both goals? Are there other options that 

are being considered after the comment period for the rule ended? 

Chairman COX. Well, as you would expect of us, we are taking 

thoroughly into account the comments that we received, and I can 

say, having been through many of them myself, that there are 

some good suggestions in there that will help us address some of 

the problems and the concerns that have been raised. 

When it comes to balancing the interests of investor protection 

and trying to save money on sending them disclosure documents, 

I have to say that I put by far the greatest weight on the former 

and very little on the latter. It has been pointed out there might 

be some cost savings if we move to electronic delivery rather than 

paper delivery. But that is not the reason that I would support it. 

What I am interested in, as I mentioned in my opening comments, is making the disclosure useful to customers. And if what 

the customers are getting right now is a long document written in 

legalese that they throw away, then we are not doing the job. We 

have to find ways——

Senator BUNNING. That is what we are getting. 

Chairman COX. Exactly. We have to find ways to turn this into 

what it was supposed to be all along, and that is user-friendly information from a customer standpoint. If the customers are throwing away your product, you have to ask yourself what is wrong 

with your model. 

When it comes to seniors, and particularly because this is such 

a focus of our efforts now at the SEC, we are looking at a number 

of issues. First of all, for people of very advanced age, many times 

the issue is not whether it is electronic or paper, but who is managing that money, and is there a caregiver involved, and can we 

find someone there that is authorized to deal in their behalf, and 

have we got people selling things to people who are non compos 

mentis? That is a big opportunity for fraud, and we want to make 

sure that, as more and more of the Nation’s assets are held in that 

way, it does not come back to bite us. 

We will never get away from paper delivery. There will always 

be paper delivery. Some people, sometimes me, but some people always prefer paper to electronic delivery for a variety of reasons. We 

want to make it as easy as it can possibly be for people to get the 

information in whichever form they want. And so, as we go forward 

21

with this final rule, we want to make sure that we do not have so 

much of forced opt-in or -out as a painless way to get your choice. 

And to make sure that if it were possible—actually, one of the 

things that we are thinking about is, is it possible—we do not know 

quite yet if it is possible—but, if it were possible, could you call one 

number once for everything you own, and say, ‘‘I just want it in 

paper.’’ That would be a lot simpler than having to do it with every 

single security that you own. One of the comments we received is, 

‘‘Find a way to do that,’’ and we are looking to see whether that 

is possible. 

Senator BUNNING. Thank you. 

Chairman SHELBY. Senator Carper. 

STATEMENT OF SENATOR THOMAS R. CARPER 

Senator CARPER. Thank you, Mr. Chairman. 

Chairman Cox, it is great to see you. Welcome, and hope you are 

doing well, and we appreciate your being with us today. 

In reading your testimony, sometimes you read these testimonies—you have read a lot of them in your time as well—and say, 

what are they trying to say? And every now and then we come 

across testimony that is as clear as a bell. It is interesting too, because in your testimony you talked about among the things you are 

trying to do is to move from boilerplate legalese to plain English 

in every document intended for retail consumption. And I just want 

to say it is great to know that in your statement today, it is very 

clear, it is well said, even understandable to a recovering Governor 

from Delaware, so I thank you for that. 

You mentioned in a section here in your testimony, talking about 

making disclosure understandable for ordinary investors. I am 

going to be down in Salisbury, Maryland later this evening, Senator Sarbanes, and your hometown, and they are having the Annual Delmarva Poultry Dinner. It is a big dinner, as you know. I 

want to talk to the people that gather there, a couple thousand 

people gather from all over the Eastern Shore, Delaware, Maryland, and Virginia. I want to talk with them about some things 

that we have been doing with respect to getting a greater effort 

from the U.S. Department of Agriculture to help us ensure that we 

are doing a better job of testing chicken flocks for avian influenza. 

My staff gave me a statement, a speech they thought I could 

give, and it sounded like a speech that was written by somebody 

right here in Washington, who had never been to a poultry farm, 

maybe not even eaten chicken. 

[Laughter.] 

So, I gave it back to them and I said, ‘‘I am going to be speaking 

to hundreds of farmers, poultry farmers, and I want to have something I can explain that they will understand.’’ So when I read this 

part of your testimony, it just really rang clear with me. 

You speak to, in the first part of your testimony, about executive 

compensation. And you say very plainly that some executives, 

CEO’s, deserve every penny they are paid and probably more, and 

frankly, some do not. 

I came across a story recently about a big company in this country where the CEO was paid a large amount of money, and the article examined the firm that is retained by this big company, who 

22

come in and recommend, among other things, compensation for the 

CEO. And then it turns out that this firm who recommends compensation for the CEO, also has a big consulting contract with the 

whole company, and to the extent that it is worth a whole lot more 

than the value of their making recommendations for the CEO’s 

compensation. It turned out the CEO serves on other boards, where 

the other people from the other companies, these boards he serves 

on, serve on his board, and he is on the compensation subcommittees of these other boards. It just struck me, I think an ordinary 

person looking at this would just say this does not pass the smell 

test. 

And I do not know if you are familiar with the situation I am 

talking about. I am sure that it is not by itself. There are probably 

a number of those. But just your reaction to that kind of thing, and 

what you and your colleagues at the SEC are trying to do about 

it? 

Chairman COX. The independence of compensation committees is 

key to solving the problem that you described. I have to say, even 

before I jump into this, earlier when you mentioned that you were 

given a statement that looked like it had been written by somebody 

in Washington who had never eaten chicken, I was going to say 

that my experience in Congress is there are very few people who 

have not had a chicken dinner. 

[Laughter.] 

There are also few enough people who write in clear, plain 

English, so I appreciate your remarks with respect to what we are 

trying to accomplish for customers at the SEC there. 

When it comes to executive compensation being determined fairly 

in the interest of shareholders, obviously, the SEC’s main tool is 

disclosure, and we want to make sure the market works the way 

it is supposed to work, on the basis of clear understandable information, the best information obtainable. The compensation committees of the boards are the people that the shareholders rely on to 

do this job well. 

In a situation such as you describe, where we might suspect, because of conflicts of interest, the board is not doing its job, how can 

the shareholders know for sure? So putting those tools directly in 

the hands of the shareholders as well as the compensation committees is a way to provide a check and balance. 

If there is the greatest possible degree of transparency in the 

marketplace, and if there is the very best information, then not 

only the shareholders, but also the directors, can be expected to do 

a better job. 

Senator CARPER. I commend you for your commitment to being 

plainspoken, and to making sure that the people who work with 

you are too. I commend you for your focus on executive compensation, and to make sure that the old adage that we treat other people the way we want to be treated and that we remind boards and 

people who run these companies, that there is a reasonable expectation that they should do that too. 

And I commend you for your commitment to trying to get the 

SEC, the five Commissioners, to be more collegial and to look for 

common ground so that when you come forward with your recVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
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ommendations, that you find that you are more unanimous than 

less. 

Thank you. 

Chairman COX. I have to say when it comes to executive compensation, I am also trying to lead by example. As Chairman of the 

SEC, I have over 800 people at the Agency that make more than 

I do. 

Senator CARPER. You are a great role model there. 

Senator BENNETT. [Presiding.] Senator Sununu. 

Senator SUNUNU. Thank you. 

Chairman Cox, Senator Hagel brought up the change in the New 

York Stock Exchange rules. They were changes that exempted a 

single company, Fannie Mae, from their mandatory delisting proceedings. And it was done largely on the basis of the market capitalization of the firm. I think your answer was effectively—well, 

we hope that they can move forward and get this restatement issue 

done in the near-term. And we all hope that, but the fact is the 

Exchange had very clear procedures regarding delisting and they 

chose to craft an exemption for this one firm. 

And basing it on the overall size of the market capitalization 

begs the question, well, what happens when a similar exemption is 

sought for Exxon or for General Electric or for Google or for Philip 

Morris or for any one of the companies that have a larger capitalization than Fannie Mae? Is the SEC going to agree and concur 

that this is a good idea when a similar exemption is sought for 

other firms that might be larger than Fannie Mae? 

Chairman COX. No. This is, in my view, sui generis because of 

the coincidence of the initial subjection of this Government Sponsored Enterprise to the reporting requirements of the 1934 Act and 

their massive restatement. Getting them online, getting them to be 

subjected to the Exchange Act, represents a significant change that 

has been, as you know, the subject of considerable legislative as 

well as Agency attention. 

Senator SUNUNU. It is my understanding that the delay in their 

filing of reports is not necessarily related to their compliance with 

the 1934 Act. These are their financial statements that have to be 

restated because of significant discrepancies and irregularities in 

the way certain transactions were accounted for. We have the findings of the Rudman Report that certainly validate those concerns. 

They had much more to do with irregularities in the accounting 

process and attempts to manipulate earnings than any specific 

changes that come as a result of their participation in compliance 

with the 1934 Act. 

Chairman COX. Well, as you know, the timing of this was as follows. Fannie registered under the Exchange Act and became a reporting company for the first time on March 31, 2004. Their last 

periodic report was their Form 10–Q for the quarter ended June 

30, 2004, that was filed August 9, 2004. And it was September 

2004 that OFEO issued their preliminary report about Fannie 

Mae’s accounting practices that led subsequently to Fannie seeking 

guidance from the Commission and our accounting staff regarding 

several of their accounting matters, including deferred purchase 

price adjustments and derivatives and hedging activities and so 

forth. 

24

It is that confluence of events to which I refer that I think makes 

this different than, for example, a Google or any other recently 

public company. 

Senator SUNUNU. I appreciate the point you are making, but I 

think it is a stretch when these are irregularities that occurred in 

2001, 2002, and 2003 and they are irregularities that would have 

delayed or forced a restatement of earnings regardless of their decision to comply under the 1934 Act in 2004. Senator Hagel made 

the point that it perhaps sends a bad message to investors, to other 

participants in the market. And I am equally concerned that it establishes a very bad precedent, because when you base the exemption, as was done—I do not think the language mentions timing or 

changes or applicability of the 1934 Act. 

The Federal Register does not mention that: Standards apply 

only in certain very rare circumstances where the Exchange determines that delisting would be contrary to the national interest and 

the interest of public investors—due to the filer’s position in the 

market, i.e., the nature of its business and its very large publicly 

held market capitalization. 

That is the Federal Register from January 26, 2006. 

So if this rationale had been presented by Fannie Mae or by the 

Exchange, I might be a little bit more sympathetic. But I do not 

think that is the argument that was made, and that is why I have 

concerns about the precedent. 

Chairman COX. But I just want to say, I agree with you that it 

cannot simply be the question of size and if you are of a certain 

size then you get a pass. 

Senator SUNUNU. I appreciate that clarification. 

Final question on market data. The SEC has been looking at this 

issue well before your time. They had a concept release in 1999, an 

advisory committee in 2000; they proposed some changes to the 

way market data was dealt with in 2004 as part of Regulation 

NMS, et cetera, et cetera. Where does this stand? Can you commit 

to or talk about the Commission’s determination to finally come to 

some conclusion on the question of market data, collection of revenues for market services, and the allocation of those revenues? 

Chairman COX. I cannot tell you definitively how this is going to 

turn out, but I can tell you that it is a subject of intense focus, as 

you might expect. In the for-profit world, this is a source of potential ongoing revenue. At the same time, we want to make sure in 

the maintenance of orderly markets—one of our chief missions at 

the SEC—that we have the maximum amount of transparency. We 

also have correlative issues in the ongoing implementation of Regulation NMS. And so I think you can rest assured that this is on 

the front burner, but I feel as if I cannot tell you definitively at this 

moment how it is going to turn out. 

Senator SUNUNU. I appreciate that, although, to be clear, my 

question is not how will it turn out; my question is, is there enough 

focus to ensure that there will be some resolution, some decision, 

some determination, which, you know, has not been achieved, has 

not been implemented in the past. And I very much appreciate 

your point about——

Chairman COX. And my answer to that question is absolutely 

yes. 

25

Senator SUNUNU. I appreciate that. And to your broader concerns 

about transparency, I think this falls right into those sets of issues 

because some of the existing structure of the market data revenue 

collection distribution system can perhaps encourage people to 

break up orders—you know, take a 1,000-share order, break it up 

into 10 different 100-share orders—in order to effectively distort 

and maximize a firm’s benefit from the allocation and rebate 

schemes that are inherent in the current system. 

So from the transparency of both the regulator and an investor, 

I think there are improvements that can be made that would eliminate incentives to manipulate the trades and that would improve 

the transparency of trades that are occurring. 

Thank you very much. 

Thank you, Mr. Chairman. 

STATEMENT OF SENATOR ROBERT F. BENNETT 

Senator BENNETT. Thank you. 

Several items. Chairman Cox, thank you for being here and welcome to your first experience. I hope we have a lot of subsequent 

ones and that they are all pleasant. 

I heard the conversation about Sarbanes-Oxley. My experience 

during the break was not the same as Senator Dodd’s. I had some 

venture capitalists tell me flatly they no longer do IPO’s and Sarbanes-Oxley is the reason. And if it becomes necessary for them to 

take a company public or—‘‘necessary,’’ if it is the logical thing—

they look to do it at some foreign exchange rather than in America. 

So as you do your analysis of the reports you have, this is anecdotal, there is nothing scientific about it, but it is a different kind 

of constituent response than the one that Senator Dodd——

Chairman COX. I appreciate that it is anecdotal. On the other 

hand, I was speaking up at Harvard University recently, Harvard 

Business School, to a group of venture capitalists who expressed 

precisely the same views. 

Senator BENNETT. Okay. 

Chairman COX. But that was also anecdotal. 

Senator BENNETT. Right. 

Chairman COX. There are now two——

Senator BENNETT. Okay, well, I heard Senator Dodd say he 

found nothing but good comments about it, and I had heard some 

of the other kind. 

Let me move to a subject that I have been on for some time and 

begin my remarks by saying that the SEC staff has been responsive. I have been talking about this for maybe a year or more, and 

they have, staff members have been in to see me, but the problem 

still exists. We are talking about naked short selling and the problems connected with that. One of the things that I have been told 

that I want to lay down and say I think this is an immaterial excuse, when they say but you get 99 percent settlement and the 

FTD’s are only in 1 percent of the dollar volume and therefore it 

is not really a big deal. 

You made the comment earlier with respect to Sarbanes-Oxley 

that you got 80 percent of the companies that might be made exempt but, if you look at a market cap, it will be very large. That 

same dichotomy exists with respect to the naked short selling. I got 

26

into this because I had constituents that had little companies, and 

for them it is a huge deal. And many of them insist that they have 

been destroyed by it. That is, the naked short sellers keep hammering their stock until finally they cannot raise any money, the 

company goes under, and nobody every has to cover. And I do not 

know that that is the case. Again, this is an anecdotal accusation 

that is made. But if indeed it is true, it is a demonstration of market manipulation that is not only clearly illegal, but also devastating to people who form companies and then try to turn to the 

markets to raise money and cannot because the shorts keep hammering them. 

I want to make it clear also, I do not think short selling is improper. I have sold short in my investment life. Usually I have 

been burned by it, but I have done it. And the broker that handled 

it gave me the old statement, ‘‘He who sells what is not his’n must 

buy it back or go to prison.’’ And apparently, some of these people 

are not buying it back. I always had to when I sold short. 

And it has gotten into the news again. I started doing this because, as I say, I heard from very small companies who were my 

constituents, and their stocks were traded on the pink sheets. And 

it looked like nobody cared on the pink sheets and they could hammer companies there all day long with naked short selling and nobody would look at it. And that is the thing that I raised with the 

SEC before. 

Well, now it is getting a little more currency. There is a piece in 

The Wall Street Journal on April 13. The headline says, ‘‘Despite 

SEC Rules, the Small Amount of Naked Shorting Appears to Persist.’’ And in that article, they talk about companies that have 

stayed on the list for months and months, on the list where the 

FTD’s have not been cleaned up. Overstock.com, Martha Stewart 

Living Omnimedia, Inc., and Krispy Kreme Doughnuts have been 

on the threshold list for months. Overstock.com happens to be located in Utah, so that caught my eye. 

Then, on April 12, Forbes had a piece about short selling in 

hedge funds and how they felt that they were being taken advantage of. The latest Bloomberg has a piece, not specifically on short 

selling, but entitled ‘‘Corporate Voting Charade,’’ and says that the 

people who buy shares to sell them short then get involved in proxy 

fights and that people end up voting shares they do not own. They 

have borrowed the shares for short-selling purposes and then vote 

them when they really have no interest in the long-term health of 

the company. 

And there is an interesting chart in the Bloomberg piece about 

how some close corporate elections were decided by the voters of 

the short sales, and says that Alaska Air Group, the short sales 

were 4 percent of the voting and the winning votes were 2.4. 

MONY Group, 6.2 percent of the votes were in short proxies and 

the winning margin was 1.7. And El Paso, 76 percent were short 

votes and the winning margin was 17.2. And there are those who 

say this whole situation cries out for more SEC oversight and attention. 

So let me, with that, ask you the question, If you cannot answer 

it here, would like a response for the record. There have been a lot 

of companies that—well, ‘‘a lot,’’ several, we will say ‘‘several’’ comVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
27

panies have been on the Regulation SHO threshold list for a very 

long time. And one of them, as I say, is one of my constituents. Presumably, at least some of what has led these companies to be on 

the threshold list for so long is illegal short selling. So, I would like 

to know, as you examine the list, are you willing to use your authority to have the SEC continue its pursuit of basic transparency 

by requiring the disclosure of the amount of FTD’s? 

Chairman COX. Well, you covered a lot of ground. 

Senator BENNETT. I apologize. Maybe I overwhelmed you here. 

Chairman COX. I am trying to keep track of all of it. 

Senator BENNETT. We will be happy to provide you with pieces 

of paper on all of this. 

Chairman COX. Of course, I will take advantage of that as well. 

Senator BENNETT. Sure. 

Chairman COX. To start at the beginning and end at the end, the 

experiences that you described, some of them your own and many 

more that you have been apprised of by your constituents and others, are experiences that in some respects I have shared. When I 

first came to the Congress in 1989, I served on a subcommittee 

chaired by then-Chairman Doug Barnard, of Georgia, of the Consumer, Commerce, and Monetary Affairs Subcommittee. That subcommittee focused for several months on bear raids and short sellers and what was going on in that industry. 

I share completely your approach to this problem, that short selling is a component part of healthy markets, one that is perfectly 

respectable; and, indeed, it is an important check and balance in 

our system. From the standpoint of orderly markets, it is vitally 

important that shares be delivered. These are contracts, and they 

have to be fulfilled, and there has to be a rule of law. 

I also—moving to your next point—agree with you that it is faint 

comfort for someone with a microcap company to hear that statistically we are doing great, that we are reducing these failures to 

deliver and that life is much better now than it has ever been before because statistically we can prove it so. In a thinly traded company, life is different. So enforcing these rules in very different circumstances is also vitally important. 

Having said that, I do think it is important to recognize the 

progress that has been made under Regulation SHO, which the 

Commission, as you know, adopted in 2004, before I became Chairman. That rule became fully effective in January of last year. It 

has a modest ambition. It is designed not to eliminate but to reduce failures to deliver on short-sale transactions and to target potentially problematic short-selling—abusive naked short selling. 

What I can commit to now is that, when we have internalized 

and understood the results of our examinations, which are now ongoing, of compliance with Regulation SHO, and we have completed 

the examinations of some 45 firms that include comprehensive target exams of 19 clearing firms, I will recommend changes to our 

rules if those exams demonstrate that changes are necessary for 

the reasons that you describe. 

Senator BENNETT. Let me just conclude, Mr. Chairman. I applaud what you are saying and I am sure you will go forward with 

that. Picking up on what The Wall Street Journal had to say with 

these three companies that are listed, that have been on the list 

28

for months, that might be one of the places to start. The company 

stays on the list for months, that is an indication to me that there 

is something going on that is unusual. I can understand an FTD, 

I can understand a flood of FTD’s for a variety of benign reasons. 

But when a company is on the list 1 month, that says, well, okay, 

there are just some problems. When the same company is on the 

list for 2 months, well, maybe something is going on we need to 

pay—when it is on for month after month after month and catches 

the attention of publications like the Journal, I think that should 

be a rather informal but strong flag that says we should pay attention at least to these companies to see why they keep showing up 

on the threshold list. 

Thank you very much. 

Chairman COX. Thank you very much, and I hope to be able to 

follow up with you on these things. 

Chairman SHELBY. [Presiding.] Thank you, Senator Bennett. 

Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman, and thank you, 

Chairman Cox, for being here. Glad to see you are on top of all of 

these things. 

I have a whole bunch of questions on cats and dogs here, but one 

I know you have been asked about. I would just like to underscore 

my concern here as a New Yorker, that so many of the IPO’s, none 

of the top 10, one out of the top 24, have not listed in the United 

States. In 2000, 9 out of 10 listed in the United States. And as I 

understand it, some people have asked you a little about that, but 

obviously I hear from somebody whose goal is to keep New York 

the financial capital of the world. That troubles me. 

What can we do about it? Does it worry you, I guess, is the first 

question I have, and what can we do about it to try and change 

it? Is it temporary? 

Chairman COX. All right, let me begin by saying that I share 

your objective. 

Senator SCHUMER. Thank you. 

Chairman COX. The U.S. capital markets are today, and certainly have been for some time, the largest, deepest, most liquid in 

the world. They are also—and, I believe, not coincidentally—subject 

to the highest standards of quality in the world. 

Senator SCHUMER. Right. 

Chairman COX. It was remarked upon, I believe by Senator Sarbanes earlier, that some studies show that there is a quality premium that companies can demand when they list in the United 

States. 

That is the way strategically, I believe, the United States should 

continue to approach our role in the world’s capital markets. Rather than participate in a race to the bottom that surely, in terms 

of comparative advantage, we would lose, it should be our objective 

to work together with other high-standards countries to make sure 

that that is the way the world goes as increasingly there are more 

global markets. 

It is a fact of life that the domestic markets of other countries 

are becoming rather rapidly more mature. And so I do not think 

that by birthright the United States can lay claim to every large 

issue by every foreign issuer. But we certainly are entitled to our 

29

share. And certainly, if we are correct in our view that our markets 

are in fact the most liquid, deepest, largest in the world, we can 

expect that countries will want to come and list here for precisely 

that reason and to gain that premium the price premium that they 

should be getting. 

Senator SCHUMER. Right. But they are not coming now. I think 

we all agree with that. In an international world there is a delicate 

balance, obviously. You want to strike the right balance. It is just 

the change has been so dramatic over 5 years. Five years ago, we 

were also the most highly regulated. Could it just be that others 

are catching up in sophistication? And why are people not still willing to pay that little premium so their investors worldwide know 

that they are being well-regulated? It is a troubling phenomenon. 

Chairman COX. I agree with you that we need to keep our eye 

on this ball. And to the extent that the perception exists, and I believe that it does in Europe and elsewhere, that the costs of regulation and of litigation in the United States are comparatively unpleasant and they would like to sell themselves, comparatively, as 

better in those respects, we need to do everything that we can to 

make sure that we achieve our objectives of high standards without 

unnecessary costs. And that is something that is all in implementation. It is perhaps some art as well as science. But it is what we 

aim to do at the Commission, to make sure that investors get every 

ounce of protection that we can give them at the lowest possible 

price. 

Senator SCHUMER. Right. 

You know, the cost issue troubles me some because for a smaller 

company, you get the estimates, $15 million, $30 million the first 

year, but for a huge billion-dollar company, I mean, $30 million is 

still nothing to sneeze at, but it seems a small price to pay for the 

Good Housekeeping Seal of Approval, if you will. 

So, I cannot believe it is cost, at least for larger companies, that 

keeps them away. It has to be something else. Now, somebody suggested to me, and I do not know where I would come down on this, 

that their directors do not like to be under the kind of extra scrutiny that they are here now. Could that be a possibility? Or ‘‘extra 

responsibility’’ is a better word than ‘‘scrutiny.’’

Chairman COX. Yes, I think expressed in that way and understood through the prism of liability, it may well be that human 

beings, particularly the human beings in control, have an affective 

as well as quantitative response to——

Senator SCHUMER. Which might not be good for their companies 

but might be better for them. 

Chairman COX. Yes. To some of these questions. You know, to 

the extent that what we are trying to do here is for the benefit of 

shareholders—eliminate conflicts of interest, maximize transparency—I think that eventually it will be seen for what it is, as 

an advantage to the people whose money we are talking about. And 

so, I do not think we need to hesitate at all in our drive to constantly reinforce our high standards in this country. We do need 

to make sure that, as we implement those high standards, we are 

doing it with the interests of investors in mind. 

And it is their money. So, if we are wasting their money on needless complexity, some of what I talked about here earlier today, if 

30

the rules are being implemented in a Rube Goldberg way, if we 

have an instinct for the capillary instead of the jugular, we can fix 

those things. 

[Laughter.] 

But we do not want to miss the main point. And so to the extent 

we were talking about, elliptically here, Section 404 or SarbanesOxley, I want to get back to my main point of emphasis, which is 

I was a conferee on that legislation, and I worked with many of you 

to put it into force. I think we can make it work in a way that 

causes people to want to list in the United States and that causes 

investors to insist on those high standards. 

We are seeing some of that right now. We are seeing some of 

Sarbanes-Oxley imitated in other countries, in other regulatory regimes. So, I do not think we have to be supine here and not fight 

back when it comes to standing up for ourselves. 

Senator SARBANES. Chuck, would you yield for a minute? 

Senator SCHUMER. I would be happy to yield. 

Senator SARBANES. There is this—I mentioned earlier, Ernst & 

Young has done this third annual report on global IPO trends, 

which is pretty interesting. And the two trends they point to that 

have an impact on all of this is, one, that a major driver is the privatization of former state-owned enterprises and that there is a lot 

of political direction or pressure when that happens for it to be 

done on the local exchange. Like the Chinese do it in Hong Kong, 

the French do it on Euronext, and so forth. 

The other point they make is the increasing pools of capital that 

are available elsewhere around the world, and so, the capital is not 

just in the New York market, it is to be found in other places. 

And third, some of the exchanges abroad are making a bald pitch 

that they have less regulation. You know, come to us, we are not 

as——

Senator SCHUMER. We have that here in America, too. Some of 

them are doing that. 

Just one quick other one. Soft dollars, where the SEC has been 

making progress and you have been moving forward on it, but the 

question I guess I have is very simple. And that is when will the 

SEC issue a final interpretive release? Things were moving along 

nicely and now—are there bumps in the road now, or is there any 

reconsideration——

Chairman COX. No. 

Senator SCHUMER. What is slowing it down? 

Chairman COX. No, in fact we are on the threshold of action. 

Senator SCHUMER. You are? 

Chairman COX. Yes. 

Senator SCHUMER. Good. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Mr. Chairman, what is the state of mutual 

fund disclosure today, and are we obscuring truly important information by requiring the disclosure of so much information that is 

basically boilerplate in nature? Is that a concern sometimes? You 

spoke about it earlier. 

Chairman COX. This is a central focus of our effort to make 

things better for retail customers. Because, as you full well know, 

for retail customers mutual funds are the investment of choice. 

31

Chairman SHELBY. We have nearly 100 million Americans investing one way or the other. 

Chairman COX. Precisely. And so, if there were any area where 

we were going to focus our efforts—on plain English, on information that consumers can understand—it would be here. This also 

is an area where we are, early on, focusing our efforts on interactive data. And I will say that the mutual fund industry and the 

Investment Company Institute have been willing partners in this. 

Very recently they have committed to finishing writing the 

taxonomies necessary to present information to consumers within 

interactive data. 

I am tempted to go off on a riff about all the potential benefits 

of interactive data, but that might be a topic for another hearing. 

Suffice it to say, directly to your question, that we can do a lot to 

make mutual fund disclosure more useful to investors. And using 

the Web and letting investors find what they want, letting intermediaries and analysts who prepare information for retail customers more easily compare what is in funds, which interactive 

data helps with, all is in the offing. 

Chairman SHELBY. Nothing like an informed customer, is there? 

Chairman COX. That is what makes markets work. 

Chairman SHELBY. In the area of accounting, convergence of accounting standards, which are very important, I applaud your efforts to harmonize the international financial reporting standards 

and U.S. GAAP. In my view, this endeavor will greatly benefit the 

global capital markets, as we have been talking about. Could you 

provide the Committee with an update on this multiyear project 

now, or just for the record? 

Chairman COX. I would be happy to do a little of it now and further for the record, if you would like. 

In October of last year, IOSCO announced plans for creating an 

arrangement for regulators to consult and share information on 

their decisions regarding the application of International Financial 

Reporting Standards. One end product of this project will be a 

database for cataloging interpretations and decisions that will help 

us improve cross-border enforcement of the application of these 

standards, and work is continuing on the development of that database. It is anticipated that IOSCO is going to launch this in the 

second half of this year. 

In February of this year, the FASB and the IASB announced an 

MOU, which outlines their topical priorities and related anticipated 

deliverables, in their efforts to further their standards-setting work 

to converge the provisions of U.S. GAAP and IFRS. And that MOU 

covers work that is planned to occur between this year and in 2008. 

Beginning in the second half of this year, the SEC staff plans to 

begin reviewing the 2005 IFRS financial statements and accompanying U.S. GAAP reconciliations filed with the SEC by approximately 300 foreign registrants. That in turn is going to help inform 

the SEC staff as to how IFRS is being applied and practiced by 

those registrants. To keep us on the road map, we want to make 

sure that there is a consistency in application both within industries and across national boundaries. 

32

Chairman SHELBY. Mr. Chairman, Sarbanes-Oxley. In your view, 

which provision or provisions in Sarbanes-Oxley have had the most 

impact on corporate governance and financial reporting? 

Chairman COX. I hesitate to pick my favorite because that might 

sound like faint praise for all the rest. 

Chairman SHELBY. To my colleague sitting here. 

Chairman COX. Exactly. Let me come at the question from the 

other end and take this advisory committee report that we just received on Monday. It is instructive to read that report and to find 

in it, coming from advocates for smaller public companies, a fairly 

ringing endorsement of virtually every provision of Sarbanes-Oxley. 

They have a great deal of focus and concern on one section, on 404, 

but I think, for companies of all sizes and for companies within and 

without the United States, essentially all the rest of SarbanesOxley is proving to be of salutary effect. 

Chairman SHELBY. Senator Sarbanes. Oh, Senator Crapo has not 

had a round yet, I am sorry. 

Senator Crapo. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you very much, Mr. Chairman. 

I apologize. I have had to step out of the meeting, so I am glad 

I got back before they cut you loose, Chairman Cox. I first of all 

want to welcome you here. I remember when I first sat together 

with you on the Commerce Committee in the House, and I have enjoyed the opportunity to work with you on many different issues 

and in many different contexts. I am very pleased that you are now 

the Chairman at the SEC. 

I did want to get back to address one issue. I found out as I got 

back that Senator Bunning already raised it, and that is Regulation B. I understand from what Senator Bunning brought up with 

you that you are meeting with banking regulators later today on 

Regulation B and you are going to be working on the issue. So, I 

will not go into the whole thing because I know you have already 

done it in the hearing today. 

I just wanted to pursue one other aspect of this, and that is I 

have been concerned enough about this issue that I have concluded 

that we probably need to have some additional legislative direction 

provided on the issue. And as I am sure you are aware, I am working with Senator Shelby, Senator Sarbanes, and others on the 

Committee on a regulatory relief package for our financial institutions. It is my intent to see if I can work with Senator Sarbanes 

and Senator Shelby to come up with an acceptable approach to provide further legislative guidance on how to address the issue. 

And so the main purpose of my wanting to get back here to talk 

with you about that is to ask if you would be willing to work with 

us, especially after you have had this meeting with the other regulators and people that you are working with on it, to help us to 

craft the right approach in the regulatory relief package that we 

are working on. 

Chairman COX. By all means. If the Congress chooses to enact 

legislation in this area, rather obviously we would follow it to a T. 

In the process of developing such legislation, if you choose that 

course, we would be happy to make our professional staff available 

33

for technical support. And as Chairman, I would be happy to discuss the aims of any of this with you. 

In the meanwhile, we have a relatively new—although it is hard 

to call a 1999 enactment new for much longer—legislative enactment. But it is new in the sense that we have yet to adopt rules 

under it. It is my view that it is high time we did so. So, I intend 

to see if we cannot make this work in the short-run. 

Senator CRAPO. I appreciate that and I certainly believe that you 

should continue to pursue the avenue of the rulemaking process in 

terms of improving it. As you know from the letters that many of 

us sent to the SEC, to your predecessor, actually, at the SEC, and 

then from the activities of many of us, I have a high level of concern about the current proposed rule and the negative impact that 

it will have. So that is one of the reasons that I have concluded 

that, after waiting for so long to see if we could not get something 

resolved, that we need to provide further legislative guidance. 

But also, I encourage you as you work on the rulemaking side 

of it to please pay attention to the issues that we have raised and 

see if we cannot move forward in a way that does not create the 

kinds of burdens and unintended consequences that we have suggested are lurking in the current proposal. 

Chairman COX. You mentioned that you and I sat next to each 

other on the Commerce Committee. When we did so back in the 

1990’s, we were working on this issue. So, I think it really is high 

time for us to implement the rules. 

Senator CRAPO. Thank you. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Senator Sarbanes. 

Senator SARBANES. I just have a couple of questions, Mr. Chairman. I do want to follow up on Senator Crapo’s question just to say 

that we know Chairman Cox well and we have seen his skill in the 

Congress of being able to develop a consensus and move complicated and difficult issues through the Congress. And as I understand, he is undertaking that role on this Regulation B issue in 

terms of interacting with the other regulators. So, I think it is a 

welcome and important initiative on the part of the Chairman. 

I wanted to ask about the money laundering issue, which is 

something this Committee has spent a lot of time on. It has been 

very much the focus of attention by the Chairman. We feel particularly keenly because the September 11 Commission recently evaluated all of the different areas on which they have made recommendations as to how our Government was doing in those areas. 

And the only issue on which they gave up an A-minus was on 

money laundering and terrorist financing. We think there is even 

more to be done, but at least we keep pressing that issue. 

A year and a half ago the Federal banking agencies and the Financial Crimes Enforcement Network, FinCEN, executed a memorandum of understanding to ensure better coordination and information sharing on the critical issue of Bank Secrecy Act compliance. I think it is fair to say the Committee pushed very hard to 

get that memorandum of understanding. And FinCEN has since 

advised us they are executing similar agreements with State banking agencies. 

34

The first question, it says FinCEN approached the SEC about 

executing an information sharing agreement about the results of 

Bank Secrecy Act examinations involving brokers and dealers in 

securities, and if so, is the SEC planning to execute such an agreement? 

Chairman COX. Well, the answer to both questions is yes. Our 

staff are quite close, in fact, to reaching an agreement in principle 

with FinCEN which will then come to the full Commission for its 

approval. And, in the meantime, the staff have been having regular 

meetings and sharing information with FinCEN, including the results of examinations we propose. 

Senator SARBANES. Second, on the Chairman’s question on convergence with the international financial reporting standards. I 

agree with the Chairman in that it is desirable to achieve convergence, but I think it is important to do so moving the standards 

upward and not downwards. I know in the EU—well, let me put 

it the other way. The International Accounting Standards Board, I 

think, Sir David Tweedie and others take the same approach, so 

I am hopeful that out of that would come that the convergence 

would be achieved at a higher not a lower level. And I think that 

is a very important objective to keep in mind. 

I do want to—we focused on financial literacy here. I know you 

have emphasized that issue down at the Commission. And I want 

to underscore its importance. Every survey just gives the most distressing results about the degree of financial illiteracy, particularly 

amongst our young people. Although, as you point out, seniors end 

up getting exploited in a very different way, and I welcome that 

initiative you have taken in that area. But what is your view on 

the financial——

You know, we set up the Financial Literacy and Education Commission to bring all the Federal agencies together to develop a program and carry it forward and then develop cooperative arrangements with the States and nonprofits, many of which work in this 

area—some of which have quite good programs, others not so good. 

What is your take on this effort, or this initiative? 

Chairman COX. This is a priority not only for the SEC, but also 

for virtually every financial agency in the Federal Government and 

for the President’s Working Group. And under those auspices the 

FLEC report was recently approved. The SEC for its part is doing 

a fair amount through our Office of Investor Education and Assistance to spread the word not only through our website and through 

the provision of educational materials, but also through seminars 

and cooperative efforts that we put on with community organizations around the country. And as you pointed out earlier, Senator, 

a good deal of this focus has also been on our men and women in 

the armed services. 

Senator SARBANES. Yes. Finally, Mr. Chairman, since we have 

been talking about 404, I cannot resist a final comment. All the 

statute does, it has two short paragraphs, as Chairman Cox noted 

earlier. One says if you are a publicly listed company you have to 

have a system of internal controls. Presumably, if you talked to 

someone who wanted to list or was trying to get you to invest in 

their company, you said to them, well, how is your system of internal controls; and the person says, well, I do not believe in a system 

35

of internal controls, I do not have one. You would say, hey, now, 

wait a minute. What kind of operation is this? 

The other paragraph says that the system of internal controls 

has to be certified as being adequate, appropriate—I forget the 

exact language. And of course that is designed to make sure you 

do not have a phony system of internal controls. 

In that arena, there is considerable discretion in the PCAOB and 

the SEC in terms of developing the protocols that are appropriate. 

And it seems to me that that is where the focus should be in terms 

of addressing these issues that are being raised. The proposal for 

a total exemption would take out of the system a very significant 

number of companies, 80 percent. 

Many of the studies show that some of the worst abuses occur 

in smaller companies, not large companies, the number of restatements. We get these letters that come in over the transom from 

people who say I have been reading these proposals to exempt the 

smaller public companies, I used to work for a smaller public company, whatever you do, do not exempt them, they need to have 

some routine that improves their operations. And of course the 

Commission last year held a roundtable and gave some guidance, 

and you are going right back at it this year, in the middle of May, 

with a further roundtable. 

It is being looked at. I think the fees still remain too high, but 

they are coming down. You had a situation where a lot of people 

were not up to standards. They in effect had to make an investment, almost like a capital cost, in order to set the system up. Presumably, once set up, in subsequent years it will not be as expensive. And I think we have to work through that system. I know you 

are hearing a lot about it, but I want to leave you with that observation. 

Mr. Chairman, thank you. And I thank Chairman Cox. 

Chairman SHELBY. Chairman Cox, it is my understanding that 

you will be coming back next month to the hearing dealing with 

financial literacy. You will be appearing with Secretary Snow and 

Chairman Bernanke. I hope then that we can get into more depth 

on the issue of financial literacy. We think it is very important. 

Oh, Senator Schumer again. Second round. 

Senator SCHUMER. Thank you. Another two quick ones on issues 

of some importance here. 

Chairman SHELBY. Okay. 

Senator SCHUMER. One, this is about credit rating agencies, also 

located in the great City of New York. First, I saw that the Commission recognized the First Amendment issues when they had the 

interaction between the SEC and journalists. I thought you handled that well, Mr. Chairman. 

We have similar issues with some of these rating agencies, where 

people will threaten to sue them, you know, to threaten them, bamboozle them, push them around and stuff like that. They need to 

be strictly regulated. They need to make sure there is no conflicts 

of interest. But on the other hand, they cannot be cowered for making an independent judgment that somebody might not like. 

So the first question I have on this is, what steps should the 

Commission take to show the same kind of sensitivity you showed 

36

with reporters about these agencies in terms of First Amendment 

ability to say what they really come up with? 

Chairman COX. Well, it goes without saying, I would hope, that 

neither the Securities and Exchange Commission nor any arm of 

Government, Federal or State, should be intruding upon the independent judgment of these credit rating agencies. That is what we 

expect them to be exercising. 

Senator SCHUMER. Right. I am more worried about private people 

pushing them around a little bit. 

Chairman COX. At the same time, you know, to the extent that 

we can do so, we need to be completely supportive of the agencies 

vis-a ́-vis all comers in the exercise of that independent judgment. 

Senator SCHUMER. Right. Okay. 

Let me ask you this, because they are opposite sides of the same 

coin, obviously, if they are—if everyone thinks they are fair, impartial, on the level, they have more protection built in. So the rating 

agencies have issued in the last few years, when certain abuses 

were put out, codes of conduct about quality, integrity, transparency, they were based on the model code of conduct developed 

by the IOSCO under the leadership of the SEC—particularly Commissioner Campos was very involved in this. And rating agencies 

are beginning to issue reports on how they have implemented their 

codes of conduct. Moody’s and S&P have already done so. They are 

making good-faith efforts to improve the transparency of their ratings. 

And I also understand that the SEC and the current NRSRO’s 

have been working on a voluntary framework for SEC oversight of 

them. What role do you envision for the Commission in finalizing 

the framework, and what is the timeline here? 

Chairman COX. Well, as you point out, the SEC has been supportive of the development of the IOSCO guidance. I think the recognition of the global aspect of this is very important. Albeit, it is 

essentially the U.S. firms that are dominant; this is a global business. 

Also, with respect to the voluntary framework that is being developed by the NRSRO’s themselves, that effort has been under 

way since somewhere in the middle of 2004, I think. We are working at the Commission on the assumption that we really do not 

know the answer to the question whether you are going to legislate 

or not on this topic, and therefore we need to be prepared alternatively with our own action or with cooperative technical guidance——

Senator SCHUMER. But do you intend to wait to see if we legislate before you do what you were doing? 

Chairman COX. I will say, I am trying to be sensitive to the ongoing process. I mean, there have been hearings on both sides of the 

Capitol on this subject, and we want to be as supportive as we can 

on the technical side in the development of any legislation that 

might happen. 

But no, we are not—since I do not know whether there will be 

any legislation, we are not going to abey until we know the answer 

to that question. We are proceeding apace. 

Senator SCHUMER. You are? 

Chairman COX. Yes. 

37

Senator SCHUMER. Because you might come up with something 

that makes everybody happy and we will not have to legislate. 

Chairman COX. That would be pleasant all around. 

Senator SCHUMER. Yes, it would. 

Okay, thank you, Chairman Cox. 

Thank you, Mr. Chairman. 

Chairman SHELBY. Mr. Chairman, thank you very much for your 

appearance. It has taken us awhile this morning. We look forward 

to working with you. And Senator Sarbanes asked you earlier, alluded to the fact you have the resources you need. We will talk 

about that, because I chair a different committee and would like to 

sit down with you and see how you are doing with your money, 

what you need, and where you want to go. Fair enough? 

Chairman COX. I welcome the opportunity, Mr. Chairman. 

Chairman SHELBY. We will do that. Thank you. 

The hearing is adjourned. 

[Whereupon, at 12:25 p.m., the hearing was adjourned.] 

[Prepared statements and response to written questions supplied 

for the record follow:] 

38

PREPARED STATEMENT OF SENATOR JIM BUNNING 

Welcome Chairman Cox. It is good to see you, and I am glad to see you have recovered from your surgery. 

Chairman Cox, I am happy to read in your testimony that you are focusing your 

efforts on the individual investor. Making plain English the official language of the 

SEC is an important step to level the playing field for all investors. I wish that more 

of Washington would follow your lead. 

Anything that can be done to improve access to information, and people’s understanding of it, will help both new and experienced investors. 

Your program to use modern electronic communications to reduce the burden on 

companies and the SEC will lead to more efficient regulation and management. But 

most importantly it will give investors more and easier access to financial data, and 

that will help them make better investment decisions and hopefully encourage more 

Americans to get into the markets. I am glad you are taking your time with the 

new data program to make sure it is done right. I think it is also important to make 

sure investors continue to have access to the information in ways they can use. 

I hope the Commission does not rush to adopt proposals that could have the effect 

of making information, such as printed annual reports or proxy statements, harder 

for shareholders to get. The last Commission Chairman left you with some controversial and misguided proposals. 

In fact, just weeks ago, the DC Circuit sent the regulation requiring independent 

chairman and directors for mutual funds back to the SEC for the second time. A 

court decision is coming soon on hedge fund regulation too. 

Also, as many Members of this Committee stated in a letter to Chairman Donaldson, the proposed Regulation B goes against the clear intent of Congress in the 

Gramm-Leach-Bliley Act. 

I encourage you to take a fresh look at those regulations and whether they are 

needed before proceeding with them. 

I encourage you to keep looking out for all investors, and to do so in a way that 

encourages business innovation. Giving people access to better and more useful information is an important step, but financial education is also very much needed. 

I look forward to hearing other ideas you have to help the public better understand the securities markets. 

—————

PREPARED STATEMENT OF SENATOR DEBBIE STABENOW 

Thank you, Chairman Shelby and welcome, Chairman Cox. 

I have been following your efforts over the last 8 months and I want to commend 

you on a successful beginning. You have worked to gain consensus with your colleagues and establish some key reforms that have been beneficial to investors and 

consumers alike. I support your efforts in enhancing disclosures and simplifying the 

law. 

As you know, the SEC’s role is absolutely vital to maintaining a robust and vibrant economy, and providing working men and women the piece of mind they need 

to become investors in the American Dream. 

As you testify today, I am very interested in hearing your suggestions to improve 

education for the common investor. As more and more individuals retire, I am concerned that the average investor will not have the resources to appropriately scrutinize the options available to them upon retirement. 

In Michigan, this is a critical concern for families—workers who have worked 

hard and paid into a retirement account need to understand what their options are 

after retirement. 

Second, I am interested in your perception of the global economy. I understand 

that the largest IPO’s this year have been from foreign companies. In fact, the top 

three IPO’s were from Chinese and French companies, and the largest IPO, China 

Construction Bank, was the biggest deal in 5 years. 

In your opinion, what impact does this have on our domestic markets? And, how 

do you see this trend moving in the future? 

Last, I have been hearing from businesses in Michigan that some of the current 

regulations out there are burdensome and costly. I hope to hear your opinions and 

improvement ideas to increase security yet maintain a manageable process for businesses. 

Again, I want to commend you on a great beginning and I look forward to this 

ongoing dialogue on maintaining investor confidence and finding improvement opportunities whenever possible. 

Thank you again for sharing your time with us today. 

39

PREPARED STATEMENT OF CHRISTOPHER COX

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION

APRIL 25, 2006

Chairman Shelby, Ranking Member Sarbanes, and Members of the Committee, 

thank you for giving me the opportunity to be here today to testify about the initiatives and priorities underway at the Securities and Exchange Commission to improve financial disclosure for individual investors. 

Several years ago, in the midst of rampant financial scandals and a crisis of investor confidence, this Committee held a series of exceptionally important hearings on 

corporate responsibility and investor protection. Those hearings, and the work of the 

Members of this Committee that followed, laid the foundation for landmark reforms 

that have restored investor confidence and the health of our capital markets. I commend each of you for your efforts, and am happy to report that the SEC is using 

the new tools that you have given us to ensure that those reforms are implemented 

exactly as intended by the Congress. 

A lot has happened in the 9 months since I last sat at this table. I very much 

appreciate this opportunity to give you a report on the new initiatives the SEC has 

undertaken, as well as to hear from you about your priorities. 

Introduction 

The principal subject of this brief testimony is improving disclosure for the benefit 

of individual investors. If I may, I would like to take a step back and put these efforts into context. 

As a Member of Congress for 17 years, I was constantly reminded by my constituents of the real world impact of the decisions we make here in the Capitol. Like 

every one of you, I learned the importance of being a good listener, and of remembering that the common sense of ordinary Americans is the essence and the 

strength of our democracy. 

Most of your constituents are not investment bankers, or lawyers, or accountants. 

But most of them are investors. It is a stunning fact of life in the 21st century that 

a majority of Americans now own stocks, either directly or through mutual funds. 

It is chiefly to serve these people that the SEC exists. Our mission—to protect investors, promote capital formation, and maintain orderly markets—must always put ordinary Americans first. 

Since making the transition from the halls of Congress to the SEC, I have set out 

to rededicate the agency’s ongoing efforts in virtually every area to the service of 

the individual investor. 

In a well-ordered market, educated consumers can choose from a number of competitive products, and find what they want at a price they are willing to pay. But 

in order to educate themselves, investors need comparative facts. So while investors 

must bear the responsibility of learning what they can about their investment 

choices, the correlative duty of sellers of investment products is to provide the relevant information. What’s more, in order for investors to make sound decisions, the 

seller’s information has to be understandable, accessible, and accurate. 

These are the basic ingredients of healthy competition in every corner of the financial marketplace. 

To more closely match the theory of a well-ordered market with today’s reality, 

the SEC is currently pursuing four key initiatives to improve the quality and usefulness of disclosure for individual investors. These initiatives, taken together, are designed to ensure that investors have access to more accurate and understandable 

information about the securities they own or are considering buying. 

These four initiatives are:

• Moving from boilerplate legalese to plain English in every document intended for 

retail consumption; 

• Moving from long, hard-to-read disclosure documents to easy-to-navigate 

webpages that let investors click through to find what they want; 

• Reducing the complexity of accounting rules and regulations; and 

• Focusing our antifraud efforts on scams that target older Americans. 

Making Disclosure Understandable for Ordinary Investors 

It is the SEC’s job to see to it that financial data and qualitative information 

about the issuers of securities are fully and fairly disclosed. But surely we cannot 

say we have achieved that objective if the information is provided in a way that is 

not clearly understandable to the men and women for whom it is intended. Empowering investors does not just mean better access to information—it also means access to better information. Simply put, the question is: Once that SEC-mandated inVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00043 Fmt 6621 Sfmt 6621 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
40

formation is available, is it understandable? The answer all too often is a resounding and frustrated ‘‘no.’’

Even though they are nominally written in English, the disclosure in some documents that are provided to investors is often so full of legal jargon and boilerplate 

disclosure that it can actually obscure important information. 

Convoluted language and disclosure in footnotes may serve lawyers and insurance 

companies, but it does not improve an investor’s ability to understand the most important facts about a particular investment. 

Exhibit A when it comes to convoluted disclosure is today’s regime for reporting 

executive compensation. Ordinary American investors have a right to know what 

company executives are paid, because those investors own the companies. The executives work for them. 

It is a direct corollary of the fact that more than half of Americans own stock 

today, that executive compensation will be judged just like every other labor and 

material cost that a firm incurs. Gone are the days when investors were mostly 

privileged, high-income elites. Today’s investors come from middle class households 

that sit around the kitchen table and make tough choices about their monthly budgets. They expect the companies they invest in to do the same. 

But how can an investor judge whether he is getting the best executive talent at 

the best price? Too often, the most important parts of total compensation are hidden 

away in footnotes, scattered in different parts of the proxy statement, or—depending 

on the form the compensation takes—not even disclosed at all until after the fact. 

Three months ago, the Commission voted unanimously to propose an overhaul of 

the executive compensation rules. This marks the first time in 14 years that the 

SEC has undertaken significant revisions of the disclosure rules in this area. 

The proposal would require better disclosure on several fronts. 

First, companies would report a ‘‘total’’ figure—one number—for all annual compensation, including perquisites. 

Second, retirement benefits would be clearly outlined in new tables showing the 

defined-benefit and defined-contribution plans of top officers. 

Third, there would also be clear descriptions of payments that could be made if 

an executive is terminated. No such disclosure is required under our current rules. 

Fourth, for the first time, all compensation for the last year to board members 

would be fully disclosed. 

Fifth, a new Compensation Discussion and Analysis section would replace the 

Compensation Committee Report and the performance graph, which is now often 

mere boilerplate and legalese. This new narrative section will allow the board members to have a frank discussion with their bosses, the shareholders, about how they 

have gone about determining the compensation for the company’s top executives. 

Just to be clear, the Commission does not propose getting into the business of determining what is the proper method or level of compensation. It is not the job of 

the SEC to substitute our judgment for that of the board. Nor would I, speaking 

as Chairman, subscribe to the notion that all executive pay is excessive. Surely 

many executives deserve every penny they are paid, and more. It should go without 

saying that being a CEO requires a rarefied collection of attributes and skills that 

are in all too short supply. And it is a fact that competition in the market for executive talent can be fierce. At the same time, I need not cite here the several notoriously public cases of extravagant wastes of shareholder assets by gluttonous CEO’s 

and pliant compensation committees. 

By improving the total mix of information available to investors, the directors who 

work for them, and the marketplace, we can help shareholders and compensation 

committees to better inform themselves and reach their own conclusions. 

Sixth, and finally: Since the purpose here is to improve communications, the proposed rules require that all of this disclosure be in plain English—the new official 

language of the SEC. That will be true whether the information is in a proxy statement, an information statement, or an annual report. 

Plain English uses plain words—and, among other basic ingredients, the active 

voice. We want to promote the use of the active voice not just because it makes for 

punchier sentences, but because it requires a definite subject to go with the predicate. That is the only way that investors will be able to figure out who did what 

to whom. 

It is a testament to the importance of this issue that, when the comment period 

on these proposed executive compensation rules closed on April 10, we had received 

nearly 17,000 comments. That is one of the highest totals in the SEC’s 72-year history. We are now reviewing these comments and look forward to incorporating them 

into any final rules that the Commission may adopt for improved, plain English 

compensation disclosure. 

41

And we will not stop there. Some years ago, under Chairman Arthur Levitt, the 

SEC began a crusade for plain English in investor documents. It was a noble first 

step that has been carried on by both Harvey Pitt and Bill Donaldson. During my 

time at the Commission, I hope to advance this cause still further, so that ultimately every communication aimed at retail investors is so free of jargon and 

legalese that it could pass muster with the editors of the Money section of USA 

Today.

Improving Disclosure via Interactive Data 

Making the SEC’s mandated disclosures more useful to investors is the idea behind another of our initiatives: Interactive data. 

The beauty of interactive data is that it will not only make today’s 10K’s, proxies, 

and mutual fund prospectuses more useful to investors, but it will also reduce much 

of the time and expense that companies currently devote to filing SEC reports. 

Today, the SEC has over 800 different forms. Each form is required to have its 

own cover page. The genesis of this requirement dates back to when reports were 

hand-filed in steel cabinets. Back then, the cover pages helped Commission staff do 

the filing—but today, they provide no useful information to the public, or to the 

SEC. Despite the fact that every individual company is required to file many different forms, these cover pages ask over and over again for the very same information in a slightly different format. In other words, more junk disclosure that no one 

needs, or wants. 

If one goes beyond the cover pages to the entire form, to focus only on the truly 

unique information in each one, it has been estimated that instead of the 800 forms 

now required, the SEC might have need of no more than a dozen. 

The key to making this happen is looking at the data on the forms independently 

from the forms themselves. That is what we mean by interactive data. Computer 

codes can tag each separate piece of information on a report, and tell us what it 

is: Operating income, interest expense, and so forth. That way, every number in a 

report or financial statement is individually identified, both qualitatively and quantitatively. 

For individual investors, this means they will be able to quickly search for any 

information they want without slogging through an 80-page document. And it 

means they could search through our database not by the names of individual reports, but instead just by looking up the companies that file them. We would no 

longer need what we have for domestic issuers today: 9 Securities Act registration 

statement forms, 3 Exchange Act registration statement forms, 2 annual report 

forms, 2 quarterly report forms, 1 current report form . . . and a partridge in a pear 

tree. 

And I have not even gotten to all the forms for proxy materials, annual reports, 

securities ownership, tender offers, and mergers and acquisitions. Investors, and the 

analysts who interpret financial information for them, should not have to hunt 

around for each separate form—all the information should be in one place, organized by company. Today, every one of these forms has to be filed and processed 

separately, which adds to the SEC’s workload; and then the investors have to separately hunt down every different form for a single company, making more work for 

all of them. Rube Goldberg would be proud. 

Our initiative to let investors get information fast, easily, and all in one place, 

envisions this added benefit: Instead of long and hard-to-read annual reports and 

proxy statements, investors could have easy-to-navigate webpages that let them 

click through to find what they want. 

I am extremely pleased that our interactive data initiative has the support of the 

Chairman and other Members of this Committee. In hearings and briefings before 

this and other Committees, you have heard the technology variously described as 

data tagging, or XBRL, or my personal favorite, interactive data. But whatever one 

calls it, the point is the same: To allow investors to more easily access, search, analyze, and compare data provided by public companies. 

The move to interactive data represents a sorely needed upgrade in the SEC’s 

electronic disclosure regime. 

From the 1930’s to the 1980’s, the Commission required that disclosure documents 

be filed exclusively on paper. Thousands of companies mailed us hundreds of thousands of documents. Each document was date-stamped, copied, sent to various divisions for review, and made available to the public for physical inspection in a Washington, DC library that is still maintained by the agency at significant expense. 

In the 1980’s, the Commission pioneered the use of electronic filing on our 

EDGAR system. (EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval.) This was a significant leap forward, and it became even more so with the 

dawn of the Internet. Now, investors and analysts are able to download documents 

42

with the click of a mouse instead of making a trip to the SEC’s library in Washington, DC. 

But while EDGAR was a great improvement for the 1980’s, 20 years is a lifetime 

in the computer age. EDGAR may be electronic, but it is not interactive. It does not 

begin to tap the potential of the Web. Because today’s EDGAR filings are really just 

snapshots of paper reports that are stored in electronic form, the information they 

contain is not searchable. Nor can it be used in any of the myriad ways that electronic data now speed around offices, home computers, and the Internet. 

With today’s SEC reports, an investor or analyst who is looking to compare, say, 

data on annual capital expenditures of two companies, has to search through perhaps hundreds of pages of the filings of each company page-by-page. Not surprisingly, the burden of this time-consuming, tiresome task has led to the creation of 

a cottage industry in rekeyboarding the information in SEC reports, so that it can 

be downloaded into spreadsheets and other software. Investors, or more precisely 

the intermediaries whose fees they pay, can then buy this information from both 

domestic U.S. firms and overseas providers to whom the drudge work has been 

outsourced. Once the information is manually input, it is often first sold to third 

or fourth parties for further reduction and analysis before it eventually is made 

available to an individual investor. 

One hates even to think of the human error and data corruption that inevitably 

occurs in this process. We know from experience that the error rate is unacceptably 

high. 

Interactive data is a way to eliminate these problems, and to connect investors 

directly to the information in a company’s filings—accurately, cheaply, and quickly. 

It will allow anyone to easily search, extract, compile, compare, and analyze financial and qualitative data according to each individual’s preferences. 

What about the benefits beyond retail investors? For preparers of financial reports, interactive data could streamline and accelerate the collection and reporting 

of financial information to the SEC and the public. Further down the road, the potential exists for companies to use interactive data as a means of getting real-time 

management control information. 

The SEC is strongly committed to interactive data. This is why we have taken 

major steps to promote it. We have offered significant incentives for companies to 

file their financial reports using interactive data. These include expedited review of 

registration statements and annual reports. A number of well-known firms—the list 

is 17 and growing—have already begun to lead the way and are filing their reports 

using interactive data. 

And because mutual funds and exchange-traded funds have become the investment of choice for millions of Americans, I am very encouraged that the Investment 

Company Institute and its member funds recently decided to throw their weight behind interactive data. 

Throughout 2006, the Commission will host a series of roundtables focused on the 

move to interactive data. The first roundtable is in June. The discussions will focus 

on several topics:

• What investors and analysts really need from interactive data; 

• How to encourage the development of software for companies, institutions, and retail investors that takes full advantage of the potential of interactive data; and 

• How to redesign the SEC’s disclosure requirements to maximize the advantage of 

using interactive data.

Our aim is to move from long, hard-to-read disclosure documents to easy-to-navigate webpages that let investors click through to find what they want. We want to 

emancipate the data from the page, and let it find its way across the Internet and 

around the world in the form of RSS feeds, AJAX applications, and whatever comes 

next. Revolutionizing the way the world exchanges financial information is a worthy 

goal. We intend to achieve it. 

Accounting Complexity 

When it comes to giving investors the protection they need, information is the single most powerful tool we have. It is what separates investing from roulette. But 

if the SEC is truly to succeed in helping investors with more useful information, 

we will need one more ingredient: An all-out war on complexity. 

It is, of course, true that a complex world often requires complex solutions. And 

certainly, there are desirable states of complexity—the ones that arise from a thing’s 

intrinsic nature: DNA. A snowflake. Encryption algorithms. There, the complexity 

is essential to the function. But it is the contrived, artificial complexities that cause 

the problems—intricacy without function. Winston Churchill said it best: ‘‘However 

beautiful the strategy, you should occasionally look at the results.’’

43

That, Mr. Chairman, is what we are now doing at the SEC. We are looking at 

results from the vantage point of the ordinary investor. And what we are finding 

is that, in many cases, we are not getting the right results. The complexity of the 

disclosure mandated by our rules too often adds nothing to function. 

It is not just public companies that sometimes have difficulty using plain English. 

Our accounting rules and regulations also can sometimes be complex and difficult 

to interpret. And when the rules are difficult to interpret, they may not be followed 

very well. And if the rules are not followed very well, then intentionally or not, individual investors inevitably will suffer. 

When complexity needlessly adds to the costs and efforts involved in financial reporting, it is the investors who foot the bill. And when a company takes advantage 

of detailed standards and complex reporting to hide information from investors, 

rather than to disclose it, investors are doubly damaged. 

Not surprisingly, users of financial statements—investors and regulators alike—

are looking for more balance in making financial reporting comparable and understandable. Preparers and auditors are also looking for standards that are easier to 

understand and implement. 

The SEC has been helping to lead a major national effort to reduce complexity 

in financial reporting. The laboring oar is being manned by the Financial Accounting Standards Board, which is already intently focused on improving the understandability, consistency, and overall usability of the existing accounting literature. 

The SEC staff are working closely with the FASB in a supportive role. 

The first step is to systematically readdress specific accounting standards that do 

not provide the most relevant and comparable financial information. Examples of 

standards in need of reworking for this reason include consolidations policy, certain 

off-balance sheet transactions, performance reporting, and revenue recognition. 

The second task is to codify generally accepted accounting principles. The codification will be a comprehensive and integrated collection of all existing accounting literature, and it will be organized by subject matter. The aim is to provide a single, 

easily accessible source for all of GAAP. A dividend of this project is that it will provide a useful roadmap to those areas most in need of simplification. 

A third priority is to stem the proliferation of new accounting pronouncements 

from multiple sources. We are encouraging the FASB to consolidate U.S. accounting 

standard setting under its auspices, and to develop new standards more consistent 

with a principles-based, objectives-oriented system. 

The final element of this strategy is to strengthen the existing conceptual framework for U.S. GAAP in order to provide a more solid and consistent foundation for 

the development of objectives-oriented standards in the future. 

Making financial reporting more user-friendly goes far beyond the work of the 

FASB. Weeding out the counter-productive complexity that has crept into our financial reporting will require the concerted effort of the SEC, the FASB, the PCAOB, 

and every market participant. This cannot be a one-time effort; we will have to commit for the long-term. But it will be well worth it. 

Financial Education for Retirees and Elderly Investors 

Finally, let me turn to our efforts to better protect older Americans against financial fraud. 

Consider these statistics: An estimated 75 million Americans are due to turn 60 

over the next 20 years. That’s an average of more than 10,000 people retiring every 

day. Households led by people aged 40 or over already own 91 percent of America’s 

net worth. The impending retirement of the baby boomers will mean that, very soon, 

the vast majority of our Nation’s net worth will be in the hands of the newly retired. 

Following the Willie Sutton principle, scam artists will swarm like locusts over 

this increasingly vulnerable group—because that is where the money is. 

On a daily basis, our agency receives letters and phone calls from seniors and 

their caregivers who have been targeted by fraudsters. Sometimes there is still time 

to help. But often, the victims have already been taken. These fraudulent schemes 

may begin with a free lunch, but we want to make sure that they end with a very 

high cost to the perpetrators. 

That is why we are attacking the problem from all angles—from investor education, to targeted examinations, to aggressive enforcement efforts. And because 

State securities regulators share our concern about fraud aimed at seniors, we are 

cooperating in this initiative with State regulators across the country—the local 

cops on the beat. 

A top priority is education. SEC programs are aimed not only at older Americans 

and their caregivers, but also at preretirement workers, designed to help them reach 

their personal savings and investing goals as they age. While we cannot tell invesVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00047 Fmt 6621 Sfmt 6621 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
44

tors which products to purchase, we can arm them with the information they need 

to assess various products and investment strategies. 

We are expanding our efforts to reach out to community organizations, and to enlist their help in educating older Americans about investment fraud and abuse. 

A portion of the SEC website is devoted specifically to senior citizens (http://

www.sec.gov/investor/seniors.shtml). We provide links to critical information on investments that are commonly marketed to seniors—including variable annuities, equity-indexed annuities, promissory notes, and certificates of deposit. 

On the SEC website, investors can also find detailed warnings against the dangers of listening to the sales pitches of cold-callers. We are alerting seniors to the 

very real threat of affinity fraud—scams that prey upon members of groups to which 

they may belong, including their religion, their nationality or ethnic heritage, or 

their profession. 

Seniors are often subjected to high pressure sales pitches that are simply not true, 

such as telling seniors that equity-indexed annuities ‘‘just can’t lose money.’’ There 

are also ‘‘free lunch’’ seminars that encourage seniors to buy complex products that 

do not fit the risk profile of a retiree with a relatively short life expectancy. There 

are also outright scams, such as Ponzi schemes. 

To detect abusive sales tactics that target seniors, examiners in our SEC field offices will share regulatory intelligence with their counterparts at the State level, 

and with other regulators. Once we identify firms that may be preying on seniors, 

we will examine those firms to make sure their sales practices are lawful. 

This effort has already started in Florida, where we’ve recently initiated on-site 

compliance examinations, along with the State of Florida and the NASD, of firms 

that sponsor ‘‘free lunch’’ investment seminars. Our goal is to see that the sales people at these seminars are properly supervised by their firms, and that the seminars 

are not used as a vehicle to sell unsuitable investment products to seniors. 

Each of our offices across the country will work closely with State and local law 

enforcement, and both Federal and State regulatory agencies, to target scams aimed 

at seniors. And they will work together to bring both civil and criminal actions 

aimed at shutting them down. This effort is already well under way in California. 

Finally, when we do find fraud, you can be sure that we will do something about 

it. Over the past 2 years, the SEC’s Division of Enforcement has brought at least 

26 enforcement actions aimed specifically at protecting elderly investors. Many of 

these actions were coordinated with State authorities. 

In one notable case, SEC v. D.W. Heath and Associates, the Commission coordinated with the Riverside County District Attorney’s Office to crack down on a 

$144.8 million Ponzi scheme that lured elderly victims in southern California to 

workshops with the promise of free food. The Commission’s complaint alleged that 

the defendants then bilked them out of their retirement money by purporting to sell 

them safe, guaranteed notes. 

Just last month, in SEC v. Reinhard et al., the Commission halted another possible Ponzi scheme, this time in Allentown, Pennsylvania. The Commission’s complaint alleges that the defendants raised more than $3.9 million from at least 50 

investors in several States by claiming to sell certificates of deposit that did not 

exist. 

The complaint further alleges that the primary salesman lured investors, many 

of whom are elderly, with promises of above-market rates on FDIC-insured CD’s 

purportedly issued by a nonexistent entity called the ‘‘Liberty Certificate of Deposit 

Trust Fund.’’ The complaint also alleges that the defendants distributed fictitious 

investment documents and account statements to attract investors and to ensure 

they continued to invest in the scheme. 

As reflected in these recent cases, any would-be fraudsters should consider themselves on notice that the SEC’s enforcement staff will aggressively investigate and 

file actions against anyone who preys upon seniors. 

Conclusion 

Mr. Chairman, Members of the Committee—thank you for your interest in these 

vital issues. Each of the four initiatives I have outlined is part of an overall strategy 

to make the individual investor—the average American—the ultimate beneficiary of 

all that we do at the SEC. Our agency has for many years proudly worn the badge 

of the ‘‘Investor’s Advocate.’’ In the months and years ahead, we are pledged to rededicate ourselves to that mission. 

I appreciate the opportunity to be with you here today. Thank you for your continuing strong support for the work of the Commission. I am happy to answer any 

questions you may have. 

45

RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO

FROM CHRISTOPHER COX 

Q.1. Last November, the Commission committed to approving by 

June 30, 2006 self-regulatory organization rules to permit portfolio 

margining for securities futures and security options. I understand 

that NYSE and CBOE rule changes are pending that would do that 

by expanding the current pilot program that permits certain customers to use portfolio margining for certain limited classes of 

products. Do you anticipate that the Commission will be able to 

meet its commitment to Congress to act on these proposals by June 

30?

A.1. I am pleased to report that on July 11, 2006 we approved rule 

changes at two major exchanges—the New York Stock Exchange 

and the Chicago Board Options Exchange to permit portfolio margining on equity options and security futures. In addition, we have 

also noticed for comment NYSE and CBOE proposals to permit single stocks and OTC derivatives to be included in a portfolio margin 

account. The public comment period for these two proposals closed 

in May. After reviewing comments received by the Commission, 

NYSE and CBOE recently submitted technical amendments to 

their proposals and I expect that the Commission will take action 

on the proposals in early September. In addition to these rules 

changes, I am also engaged in direct discussions with Ruben Jeffery, the Chairman of the Commodity Futures Trading Commission, 

to identify further areas of agreement on portfolio margining.

Q.2. The proposed NYSE and CBOE rules would allow broad-based 

futures to be included in a portfolio margining securities account 

I understand that there are some obstacles to actually including 

such futures in a securities account, because all of the financial instruments in a securities account must be provided with coverage 

by the Securities Investor Protection Act (SIPA), and SIPA specifically excludes futures from its coverage. In testimony before the 

Banking Committee last September, Bob Colby testified that the 

Commission supports targeted amendments to SIPA to address this 

issue. This sounds like an idea where a legislative fix is the cleanest way to make sure that the market can take full advantage of 

portfolio margining. Do you agree? If so, could the Commission provide us with some technical assistance in drafting a targeted 

amendment to SIPA?

A.2. The Commission agrees that targeted legislative changes to 

SIPA are the ‘‘cleanest’’ way to make sure customers can take full 

advantage of the new NYSE and CBOE portfolio margining rules. 

Under the NYSE’s and CBOE’s rules, securities and futures positions must be carried in a securities account to provide a customer 

with the protections of applicable securities laws and regulations. 

Including futures positions in a portfolio margin securities account, 

however, raises an issue as to how futures positions would be treated in a liquidation of a broker-dealer under SIPA. 

SIPA protections apply to cash and securities held at a brokerdealer, but not to futures positions. This result is a function of the 

SIPA definition of ‘‘security,’’ which specifically excludes futures. 

Moreover, there is no corresponding statutory protection for futures 

customers under which they would receive advances if futures asVerDate 0ct 09 2002 17:25 Sep 17, 2007 Jkt 000000 PO 00000 Frm 00049 Fmt 6602 Sfmt 6602 S:\DOCS\37462.TXT SBANK4 PsN: KEVIN
46

sets are missing. To assure SIPA protection to all products in a 

portfolio margin securities account, amendments to SIPA would enable customers to take full advantage of the portfolio margining 

rules. This legislative amendment could be very narrowly tailored 

to, in effect, provide that futures (including options on futures) held 

in a portfolio margin account under a Commission-approved portfolio margin program would receive SIPA protection, thereby extending SIPC protection to those futures products permitted to be 

deposited into a portfolio margin securities account. The Commission staff would be pleased to provide you with technical assistance 

in drafting such a targeted amendment to SIPA to address this 

issue. 

At the same time, however, the Commission is actively engaged 

in a dialogue with the Commodity Futures Trading Commission 

and the futures and securities industry regarding the optimal 

means to structure cross margining between securities and futures 

positions—whether through a single account or separate securities 

and futures accounts (the so-called ‘‘one-pot’’ or ‘‘two-pot’’ models). 

RESPONSE TO A WRITTEN QUESTION OF SENATOR ENZI

FROM CHRISTOPHER COX 

Q.1. Mr. Chairman, the position of the Chairman of the Public 

Company Accounting Oversight Board has been open since November 30, 2005. Since that time, Mr. Bill Gradison has served as Acting Chair, and has done an excellent job. Does the SEC have plans 

to nominate a new Chairman in the near future?

A.1. On June 19, 2006, the Securities and Exchange Commission 

was pleased to announce the appointment of Federal Reserve 

Board Governor Mark W. Olson to the position of Chairman of the 

five-member Public Company Accounting Oversight Board 

(PCAOB) until 2010. Mark Olson’s experience as a central banker, 

his background in securities law, his expertise gained as partner in 

a major accounting firm, his management and business experience 

as a bank president, and his national leadership as President of 

the American Bankers’ Association—together with his demonstrated commitment to public service and protecting the interests 

of investors—will be an exceptional addition to the PCAOB. 

Mr. Olsen’s appointment was conducted in accordance with the 

comprehensive selection procedures for the selection of Chairpersons and Board members of the PCAOB that the Commission 

approved last December. These new procedures are intended to 

make the selection process transparent, encourage the thorough 

consideration of all qualified candidates, ensure a thorough vetting 

of candidates, and establish timetables for the expeditious appointment of individuals of the highest caliber for this critical body. 

These selection procedures build upon the previous practice of 

the Commission, and include a timetable for the recommendation 

of candidates, background checks, Commission interviews, and 

final selection. The new procedures will apply whenever vacancies 

occur. 

Under these procedures, the SEC Chairman will lead a search to 

identify qualified candidates and will solicit nominations and input 

from each of the SEC’s current Commissioners, who may each submit up to three nominations. 

47

The SEC Chairman will also consult with the Secretary of the 

Treasury and the Chairman of the Federal Reserve, as required by 

the Sarbanes-Oxley Act, and solicit recommendations from other 

executive branch, Congressional, investor, academic, and business 

community sources, and such others as the SEC Chairman deems 

appropriate. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SANTORUM

FROM CHRISTOPHER COX 

Q.1. You may know that I have sponsored, along with Senator 

Allen and Senator Dole, S. 1396, a bill that would update the definition of eligible portfolio company (EPC) under the Investment 

Company Act of 1940. The House unanimously passed an identical 

version twice (H.R. 3170 in the 108th Congress and H.R. 436 in the 

109th Congress). 

Does the SEC agree the use of the Federal Reserve Board definition of ‘‘marginable security’’ as a statutory standard for what 

Business Development Companies (BDC’s) can invest in is outdated? If so, while the SEC has been given authority to establish 

additional categories of companies that qualify for treatment as an 

EPC, is not the only way to eliminate this outdated standard 

through legislation striking the provision, as is accomplished in the 

pending legislation? Does the SEC oppose the pending legislation? 

If the SEC believes an alternative approach should be considered, 

what is that alternative approach?

A.1. We agree that the use of the Federal Reserve Board’s definition of ‘‘marginable security’’ as a means to define an eligible portfolio company is outdated. As you know, that definition was amended by the Federal Reserve Board so as to make most securities 

marginable. Consequently, many companies that previously met 

the definition of eligible portfolio company may have lost their status as such. 

As you know, the Commission has rulemaking authority to establish alternative criteria to define eligible portfolio company. Pursuant to that authority, the Commission proposed a new rule to define eligible portfolio company under the Investment Company Act. 

In developing the proposed rule, the Commission was mindful of 

Congress’s intent when it established BDC’s in 1980 that they 

should invest a significant percentage of their assets in small, developing, and financially troubled companies, largely defined as eligible portfolio companies. Accordingly, the proposed rule was intended to realign the definition of eligible portfolio company with 

that intent. The Commission received 36 comment letters addressing the proposed definition. Most commenters were concerned that 

the rule would not include many of the small public companies that 

historically would have met the definition of eligible portfolio company before the margin rule amendments. Commenters also suggested various alternative approaches. It is anticipated that the 

Commission will take final action on this rule in the near future. 

The Commission has not taken a position on the legislation. At 

the request of staff of the House Financial Services Committee and 

the Senate Banking Committee, Commission staff has provided 

technical assistance on the legislation. Commission staff expressed 

its view that the legislation was drafted very broadly. Among other 

48

things, it noted that the legislation, if adopted, could actually result 

in BDC’s investing more of their assets in larger, well-established 

companies. Consequently, there could be less BDC capital available 

for small companies. The staff also noted its concern that the legislation, by permitting BDC’s to invest more of their assets in larger, 

well-established companies, would make BDC’s more closely resemble registered closed-end investment companies. The staff also 

noted that the legislation would not, however, provide BDC shareholders with critical investor protections available to shareholders 

of those other investment companies. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR STABENOW

FROM CHRISTOPHER COX 

Q.1. As I mentioned in my opening statement—the largest IPO’s 

this year have been from foreign companies. Although U.S. IPO’s 

continue to lead in total capital raised and number of deals, foreign 

markets are emerging. Not only are foreign companies offering 

larger equity deals around the world, but also foreign companies 

are also holding our debt in greater amounts. 

In your opinion, will this trend continue into the future? And, 

how will the emergence of foreign-owned debt impact domestic 

markets?

A.1. The opportunity for companies to access worldwide capital is 

a positive trend that reflects the health of the U.S. and the global 

equity market, and one that we expect to continue. IPO’s in the 

U.S. capital markets are the largest segment of global IPO’s, with 

$33 billion raised in 2005, and represent 20 percent of the global 

capital market activity. 

While the number and size of IPO’s in the United States has 

dipped slightly in recent years, many smaller companies continue 

to list on the NYSE and Nasdaq. In 2005, over 70 countries hosted 

IPO’s of over $1 billion and the largest offerings were conducted 

overseas. That so many foreign companies chose to list their securities in foreign markets is a welcome indication that the quality and 

liquidity of those markets has increased and that accounting and 

corporate governance standards are improving worldwide. However, as globalization provides companies with a wider choice of 

markets in which to raise capital, we have seen a decrease in multiple listings as companies seek to reduce their costs. 

The SEC has responded to foreign company concerns about compliance with Sarbanes-Oxley requirements and their inability to 

deregister with a number of initiatives intended to reduce their 

compliance burdens while maintaining our high standards of investor protection. Among these initiatives is a proposal to facilitate the 

ability of foreign issuers to terminate their SEC reporting obligations when there is relatively little interest in their securities 

among U.S. investors. Foreign issuers also benefit from extended 

Section 404 internal control deadlines and the SEC continued evaluation of these requirements. Finally, the SEC supports efforts to 

converge accounting standards, and I have stressed the SEC’s commitment to creating a ‘‘roadmap’’ for eliminating a requirement to 

reconcile financial statements prepared using International Financial Reporting Standards to U.S. GAAP. 

49

With regard to how foreign-owned debt may impact domestic 

markets, our capital markets are based on transparency of information as it relates to many areas of disclosure. While our rules 

require public companies, and significant investors in those companies, to provide full disclosure of material information related to 

the sale, purchase, and ownership of a company’s securities, our 

rules do not dictate who those significant investors may or may not 

be. Any person or entity that owns more than 5 percent of a public 

company’s voting securities must publicly disclose certain information, including information regarding that person’s intent in purchasing the securities. Our rules also require a public company to 

disclose information about that level of ownership of its securities. 

Other Federal and State agencies as well as U.S. exchanges may 

regulate significant investments in public companies and may have 

some policy role in whether the emergence of foreign companies 

and foreign-owned debt impacts our markets.

Q.2. Recently, I came across a report that was conducted in 2004 

by the Center for Medicare and Medicaid Services. The report revealed that the government was paying 9.3 percent in hospital 

overage charges. In Michigan, that percentage was even higher, 

13.6 percent. It was my understanding that Section 404 was intended to establish internal controls for healthcare benefits—however, it seems that the current accounting standards for employee 

benefits may have contributed to these overage charges. I am concerned that the standards are not being enforced or applied as intended. 

Do you have any suggestions for improvements or do you intend 

to rectify this issue in some other way?

A.2. The accounting standards related to employee benefits are 

based on the premise that post retirement health care benefits are 

part of an employee’s compensation for services rendered. Since 

payment is deferred until retirement, the benefits are a type of deferred compensation. Under fundamental accrual accounting, during the years that the employee renders the necessary service the 

company accrues and reports the cost of providing those benefits to 

the employee and to the employee’s beneficiaries and covered dependents. To estimate this cost, the company must make several 

assumptions, including an assumed discount rate to determine the 

present value of the future cash outflows currently expected to be 

required to satisfy the post-retirement benefit obligations. The primary accounting standards body in the United States, the Financial Accounting Standards Board (FASB), currently has a twophase project underway to improve the reporting of these and other 

related post-retirement benefits. The first phase involves recognition of the overfunded or underfunded status of defined post-retirement plans as an asset or liability on a company’s balance sheet. 

The second phase will be a more comprehensive reassessment of 

pension and post-retirement accounting. These accounting rules 

may vary, however, for government-owned hospitals, which are not 

subject to the Commission’s reporting requirements. 

Section 404 of the Sarbanes-Oxley Act of 2002 requires certain 

public companies to report to shareholders on the effectiveness of 

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quirement should provide reasonable assurance to investors that a 

company’s financial records appropriately reflect the costs of health 

care benefits as calculated under the existing accounting standards. The Commission currently is reviewing alternatives to make 

this reporting more efficient and effective. This reporting requirement, however, does not apply to privately held or governmentowned hospitals and medical facilities. 

As noted above, the Commission and FASB are reviewing how to 

improve both the accounting for health care benefits and reports on 

companies’ internal controls over financial reporting. Although we 

are not aware of any direct link between these requirements and 

hospital overage charges, we will be alert to such issues as we proceed.