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MANAGEMENT AND STRUCTURAL REFORMS AT 

THE SECURITIES AND EXCHANGE COMMISSION: 

A PROGRESS REPORT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

ON 

A PROGRESS REPORT ON THE MANAGEMENT AND STRUCTURAL 

REFORMS AT THE SEC 

NOVEMBER 16, 2011 

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

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

RIKER VERMILYE, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

JACK REED, Rhode Island, Chairman 

MIKE CRAPO, Idaho, Ranking Republican Member 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

TIM JOHNSON, South Dakota 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

KARA STEIN, Subcommittee Staff Director 

GREGG RICHARD, Republican Subcommittee Staff Director 

DEAN SHAHINIAN, Senior Counsel 

ROBERT PEAK, SEC Detailee 

HESTER PEIRCE, Republican Senior Counsel 

(II)

C O N T E N T S 

WEDNESDAY, NOVEMBER 16, 2011 

Page 

Opening statement of Chairman Reed ................................................................... 1 

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 3 

WITNESSES 

Robert Khuzami, Director, Division of Enforcement, Securities and Exchange 

Commission ........................................................................................................... 6 

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

Meredith Cross, Director, Division of Corporation Finance, Securities and 

Exchange Commission ......................................................................................... 8 

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

Robert Cook, Director, Division of Trading and Markets, Securities and Exchange Commission .............................................................................................. 9 

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

Eileen Rominger, Director, Division of Investment Management, Securities 

and Exchange Commission .................................................................................. 11 

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

Craig Lewis, Director, Division of Risk, Strategy, and Financial Innovation, 

Securities and Exchange Commission ................................................................ 12 

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

Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations, Securities and Exchange Commission ..................................................... 14 

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

(III)

(1) 

MANAGEMENT AND STRUCTURAL REFORMS 

AT THE SECURITIES AND EXCHANGE COMMISSION: A PROGRESS REPORT 

WEDNESDAY, NOVEMBER 16, 2011 

U.S. SENATE, 

Subcommittee on Securities, Insurance, and Investment, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met at 9:31 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Jack Reed, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN JACK REED 

Chairman REED. Let me call the hearing to order. I want to 

thank my Ranking Member, Senator Crapo, for joining us today, 

and I certainly want to thank the witnesses for taking time out of 

their very hectic and demanding and important schedules to be 

with us this morning. Our hearing is entitled, ‘‘Management and 

Structural Reforms at the SEC: A Progress Report.’’ This is a very 

critical hearing because we understand the important role that the 

SEC plays in the regulations of our securities markets. 

We have had vocal concerns about regulation, overregulation, but 

it appears indeed that revenues in the securities industries for each 

of the last 2 years have been greater than in any year in the previous 10 years. So the industry is, in fact, growing at a time when 

many other sectors of the American economy are in very serious 

distress. And I believe that those who want to starve the market 

watchdogs or repeal legislation seek a return to the days when 

toxic financial products were secretly negotiated and traded, profiting Wall Street bankers, and leaving taxpayers on the hook to 

clean up the mess later. 

Congress acted to stabilize the market with the Dodd-Frank Wall 

Street Reform and Consumer Protection Act to bring transparency 

and certainty into the marketplace. There is no question that slowing down the regulations and those who enforce the regulations 

will benefit those on Wall Street so that they can make more 

money but at a hefty price to the rest of us. I think that is the lesson of 2008 and 2009 and continuing. 

The Securities and Exchange Commission has a daunting job. It 

is charged with protecting investors and ensuring that our securities markets are operating in a fair and orderly manner. This is no 

small task given the growing volume and complexity of both markets and products. 

2 

For example, as of the end of October, the total market value of the United States equity market was estimated at $13.1 trillion. 

Approximately 45 percent of all U.S. households, or 92 million investors, make investments in the market, principally through mutual funds. So this is of interest to every American, not just those 

who are in the financial markets. 

There is little doubt that changes in both technology and trading 

practices are affecting exchanges. Trading venues are increasingly 

fragmented with no single exchange holding more than one-fifth of 

the market share. More trading is being done off exchanges in socalled dark pools or by broker-dealers executing trades internally. 

Over the past year and a half, this type of trading has increased 

by more than 30 percent, presenting new and challenging problems 

to regulators. 

Finally, high-frequency traders are using computers to execute 

trades in less than a blink of an eye. Although such trades may 

contribute to market volume in good times, they also may contribute to shrinking liquidity in times of market stress. 

While the securities markets have exploded with novel products 

and increasingly faster technologies, many argue that the SEC has 

been left behind. The financial crisis revealed troubling failures, 

weaknesses, and gaps in regulation. The SEC had responsibility for 

the oversight of investment banks. The financial revealed that the 

SEC failed to appreciate the growing risks, failed to ask the right 

questions, and failed to take the right steps. This is the same pattern we saw in the Madoff Ponzi scheme case. The agency failed 

to stop Bernard Madoff’s long-running investment fraud despite repeated warnings. It failed to ask the right questions and failed to 

take the right steps. 

In addition, the agency’s Inspector General has identified serious 

missteps in how the agency has handled information, how it conducts its operation, and how it executes its mission. Others have 

criticized the agency for inhibiting capital formation, decreasing 

U.S. competitiveness, and taking a light touch against law breakers. 

But my sense is that the SEC appears to be committed to reform. 

Chairman Mary Schapiro has installed new leadership across the 

SEC’s Divisions and Offices. Beginning in 2009, the SEC began restructuring its largest operating units: the Division of Enforcement 

and Office of Compliance Inspections and Examinations. The Commission has also created the Division of Risk, Strategy, and Financial Innovation to more closely examine new products, trading practices, and risk. 

Congress has tried to focus on improving the SEC as well. In the 

Dodd-Frank Wall Street Reform and Consumer Protection Act, it 

was mandated that the SEC engage an independent consultant to 

examine its internal operations structure and need for reform. This 

report identifies several opportunities for reform, including 

reprioritizing regulatory activities, reshaping the agency to maximize efficiency and effectiveness, investing to improve infrastructure, and improving engagement with self-regulatory organizations. 

The report also notes the considerable additional responsibilities 

placed on the SEC after the financial crisis and a gap in funding 

that cannot be overcome by improving efficiency. Congress must 

3 

fully fund the SEC, our market watchdog, if it is to effectively discharge the mandate to police the markets and protect investors. 

The SEC has been criticized for failures of its missions in the 

past. Today’s hearing will focus on how the SEC’s management has 

responded to this criticism and the need for reform. The securities 

markets need to work so that investors and companies can come 

together and allocate capital efficiently and productively, allowing 

new products, new technologies, and new jobs to be created. And 

they need to work for Americans who save for college, a new home, 

or retirement. 

What is being done and what needs to be done to right-size this 

agency, to improve its ability to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, and to 

reinvigorate its staff is at the forefront of our hearing today. 

Our witnesses this morning are the senior-most management of 

all the SEC Divisions and the largest SEC program office. It is critical that Congress understand what is being done to move this 

agency forward and ensure that the missteps of the past are not 

repeated. 

With that, I would now like to recognize my Ranking Member for 

his opening comments. Senator Crapo. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you very much, Senator Reed, and I agree 

with and appreciate a number of your comments and concerns in 

your opening statement, and I also appreciate you holding this 

hearing. I am one of those, as you know, who thinks that we are 

having a little bit of difficulty getting it right in terms of our regulatory approach right now, and I appreciate these opportunities for 

oversight hearings. 

As I have indicated to you, because of my activities in the either 

famous or infamous Gang of Six, I am going to have to leave in 

about half an hour for another meeting that I cannot avoid, and so 

I am going to miss probably a lot of the testimony. So I am going 

to try to identify a few areas of concern in my remarks and also 

ask that I could submit questions as well following the hearing for 

responses. I do believe that the issues we are dealing with today 

are critical. 

We must continue to think strategically about which areas of the 

market pose the greatest risk and which areas of potential improvement hold the greatest benefit for investors. The objective 

should be to apply the taxpayer resources in a way that provides 

the biggest investor protection bang for the buck. 

In addition to these important issues, I look forward to hearing 

from our different Division Directors of the SEC on Dodd-Frank 

implementation questions on ways to promote capital formation. 

With regard to capital formation, today the SEC is holding two 

panel discussions on the issue, and one focuses on current capital 

formation issues for private companies and another on initial public offerings and securities regulation involving smaller public companies. 

There are several, in my opinion, unnecessary restrictions on 

capital formation in both categories that should be removed. The 

House recently passed some targeted bipartisan capital formation 

4 

legislation that makes it easier for private companies to raise capital, and there have also been recently two reports that make recommendations on how to reverse the initial public offerings decline. 

To stimulate the IPO market and spur more job creation, the recent President’s Council on Jobs and Competitiveness Interim Report recommends that Congress amend Sarbanes-Oxley to allow 

shareholders of public companies with market valuations below $1 

billion to opt out of at least Section 404 compliance if not to all of 

the requirements of Sarbanes-Oxley; or, alternatively, exempt new 

companies from SOX compliance for 5 years after they go public. 

The IPO Task Force recommends providing an on ramp for 

emerging growth companies using existing principles of scaled regulation. The IPO Task Force expects scaled regulation and disclosure to reduce internal and external compliance for such companies 

by 30 percent to 50 percent. Both of these recommendations could 

result in a larger supply of emerging growth companies going public and increased job creation over the long term. 

With regard to Dodd-Frank Act, in addition to removing unnecessary restrictions on capital formation, we have to be careful that 

new rules being implemented under Dodd-Frank give sufficient 

consideration to how they are going to impact Main Street and the 

economy as a whole, how they interact with each other, and how 

they impact our global competitiveness. I am interested in what 

steps you are taking to ensure that the rules the agency adopts 

under Dodd-Frank Act are supported by rigorous economic analysis 

and how you will resolve inconsistencies in the approaches taken 

by different regulators. 

Yesterday, the House Subcommittee on Capital Markets approved four targeted bills to modify Dodd-Frank. One of the measures that passed by a voice vote would prohibit the SEC and CFTC 

from requiring that swap execution facilities have a minimum 

number of participants or mandating the display or delay of bids 

or offers for any period of time. This is in line with the SEC approach, which is more principles based and is in general far less 

prescriptive than that of the CFTC. 

In June, this Subcommittee held a hearing on swap execution facilities. One of the results of the hearing was that there was bipartisan agreement that the SEC and the CFTC need to provide greater coordination and harmonization to get the rules right. As many 

of you probably know, I am one of those who thinks we should 

merge the SEC and the CFTC, but until we can get into that discussion, I will encourage that they at least coordinate and harmonize their regulatory activities. 

The CFTC should know that Congress is going to closely monitor 

how they proceed, as well as the SEC, and that we expect this kind 

of harmonization and a change in course when the agencies begin 

to divert so that we can have the kind of seamless regulatory system that does protect investors and achieve the objectives that the 

Chairman pointed out, as he described the hope that all of us have 

as to how you and other regulatory agencies will operate. 

There will be other issues I would like to raise, Mr. Chairman, 

in my questions, but, again, at this point I will wait, and we can 

get to the witnesses. And when I have to step out, I apologize. I 

5 

will be paying very close attention not only to your opening statements but also to your responses to the questions that we provide. 

Thank you again for being here. 

Chairman REED. Thank you very much, Senator Crapo. 

Let me introduce the witnesses. We are extraordinarily fortunate 

today to have the key leaders of the Securities and Exchange Commission staff. 

First let me introduce Mr. Robert Khuzami. Mr. Khuzami is the 

Director of the Division of Enforcement of the U.S. Securities and 

Exchange Commission. As Director, Mr. Khuzami is responsible for 

the civil law enforcement efforts of SEC personnel located in 12 offices across the country. Prior to his tenure at the SEC, Mr. 

Khuzami served as General Counsel for the Americas at Deutsche 

Bank AG and before that as the bank’s global head of litigation and 

regulatory investigations. From 1990 through 2002, Mr. Khuzami 

was a Federal prosecutor with the United States Attorney’s Office 

for the Southern District of New York, where he prosecuted a wide 

range of crimes, including narcotics, money laundering, extortion, 

bank robbery, firearms, and tax, bank, and immigration fraud. 

During his service Mr. Khuzami also help the position of chief of 

the Securities and Commodities Fraud Task Force. Thank you, Mr. 

Khuzami. 

Eileen Rominger is the Director of the Division of Investment 

Management at the U.S. Securities and Exchange Commission. Ms. 

Rominger was sworn in by Chairman Mary Schapiro on February 

16, 2011, and is responsible for developing regulatory policy and 

administering the Federal securities laws applicable to investment 

advisers and funds. Prior to becoming the investment management 

Director, Ms. Rominger was with Goldman Sachs Asset Management as the chief investment officer responsible for managing that 

company’s core portfolio teams, including fixed income, equity, and 

quantitative strategies. She previously worked for 18 years at 

Oppenheimer Capital, where she was a portfolio manager, managing director, and a member of the executive committee. 

Ms. Meredith Cross is the Director of the Division of Corporation 

Finance at the U.S. Securities and Exchange Commission. Prior to 

joining the staff in June 2009, Ms. Cross was a partner at Wilmer 

Hale in Washington, DC, where she advised clients on corporate 

and security matters and was involved with a full range of issues 

faced by public and private companies in capital raising and financial reports. Ms. Cross also worked in the Division of Corporation 

Finance prior to joining Wilmer Hale, serving in various capacities, 

including as chief counsel and deputy director. 

Robert W. Cook is the Director of the Division of Trading and 

Markets at the U.S. Securities and Exchange Commission. Mr. 

Cook has served in this position since January 4, 2010. Prior to 

joining the Commission, Mr. Cook was partner at the law firm of 

Cleary, Gottlieb, Steen & Hamilton where he was an expert on 

broker-dealer and market regulation. 

Carlo di Florio became the Director of the Office of Compliance 

Inspections and Examinations on January 25, 2010. Prior to joining 

the Commission, Mr. di Florio was a partner in the financial service regulatory practice at PricewaterhouseCoopers. While in private 

practice, Mr. di Florio was one of Pricewaterhouse’s national leadVerDate Nov 24 2008 10:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\11-16 DISTILLER\111611.TXT JASON
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ers in corporate governance, enterprise risk management, and regulatory compliance and ethics. He has also led numerous fraud and 

corruption investigations nationally and internationally. 

And, finally, Dr. Craig Lewis is the Director and Chief Economist 

at the Division of Risk, Strategy, and Financial Innovation. Dr. 

Lewis has served in this position since June 2011. As the Madison 

S. Wigginton Professor of Finance at Vanderbilt University’s Owen 

Graduate School of Management, Dr. Lewis has taught corporate 

finance and economics since 1983 and has been on the faculty at 

Vanderbilt since 1986. In addition to teaching, Dr. Lewis has published research on volatility in stock and futures markets, margin 

adequacy, corporate earnings management, corporate financial policy, executive compensation, select disclosure, and herd behavior by 

equity analysts. Thank you. 

Your written testimony has already been submitted. It is part of 

the record. I would ask each of you to take 5 minutes and make 

an oral presentation, starting with Mr. Khuzami. 

STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF 

ENFORCEMENT, SECURITIES AND EXCHANGE COMMISSION 

Mr. KHUZAMI. Thank you, Chairman Reed, Ranking Member 

Crapo. My name is Robert Khuzami. I am Director of the Division 

of Enforcement. Thank you for the opportunity to testify today concerning the management and structural reforms at the SEC. 

When I arrived at the SEC in early 2009 to lead the enforcement 

Division, the United States was struggling to come to terms with 

the impact of the financial crisis. Our job, indeed our challenge at 

the Division of Enforcement was to investigate and hold accountable those who contributed to the financial crisis, and we took that 

challenge head on. We immediately set to work investigating conduct that may have contributed to the financial crisis, and at the 

same time launched an ambitious plan to reform the organizational 

structure of the Division so that we could work smarter and more 

efficiently than we had in the past. 

Through hard work and innovation, we have completed what was 

the most significant restructuring in the history of the Division of 

Enforcement. And although the conventional wisdom was that the 

dislocation caused by such significant organizational changes would 

undermine our productivity, that, in fact, did not happen. 

In fiscal year 2011, we filed a record 735 enforcement actions, 

more than ever filed in a single year in the history of the Securities 

and Exchange Commission. Those actions included 57 insider trading actions, a nearly 8-percent increase over last year’s total; 146 

enforcement actions related to investment advisers and investment 

companies, a single-year record and 30-percent increase over fiscal 

year 2010; and 112 enforcement actions related to broker-dealers, 

a 60-percent increase over last year. And our focus on financial crisis cases has continued. During the last 21⁄2 years, we filed 36 separate financial crisis-related actions against 81 defendants, nearly 

half of whom are CEOs, CFOs, or other senior corporate officials, 

and obtained nearly $2 billion in financial sanctions. This includes 

actions against Goldman Sachs, Citigroup, and senior executives at 

Countrywide, New Century, and American Home Mortgage. 

7 

And equally and perhaps more importantly, our record number 

of cases include many involving highly complex transactions, products, and market practices. In the past fiscal year, we filed actions 

against JPMorgan for misleading investors in CDOs as the housing 

market began to plummet; Wachovia for misconduct in the sale of 

two CDOs tied to the performance of residential mortgage-backed 

securities; two firms involved in the sale of unsuitable CDOs to five 

Wisconsin school districts; and charges against six executives at 

Brooke Corporation and three executives at IndyMac for misleading 

investors about their financial condition. 

In addition, to deprive the wrongdoers of unjust profits and to deter future misconduct, we obtained judgments totaling $2.8 billion in disgorgement and penalties this year, which was a 176-percent increase over previous years. And we have also distributed 

nearly $3.6 billion in disgorgement and penalties in the last 2 

years to harmed investors. 

And at the same time we were doing this, we instituted the large 

organizational changes in our division. We flattened our management structure. We revamped the way we handled tips and complaints. We facilitated the swift prosecution of wrongdoers through 

a formal program that encourages individuals and companies to cooperate in SEC investigations, and created five national specialized 

units focused on priority areas involving high risk. We have also 

hired many industry experts, non-lawyers with genuine market expertise and specialized experience, to assist in our investigation. So 

today, if someone is testifying in an SEC investigation about, for 

example, improper bond valuations, there is a good chance that sitting across the table from them on the SEC’s side of the table is 

someone who used to value bonds for a living. And one cannot overestimate the clarity and candor that that kind of expertise brings 

to witness testimony. 

We are also focused on thinking creatively and proactively to find 

emerging threats, stopping frauds earlier before they become more 

destructive. So using investment advisers as an example, we are 

now reviewing registration documents for high-risk advisers to determine who lies about things like their education or their business 

affiliations or their assets under management, under the theory 

that if they come face to face with an enforcement authority early 

on, for relatively small matters, they are going to know that we are 

watching, and they are going to be less likely to graduate to bigger 

frauds. 

We are reviewing mutual fund fee arrangements by analyzing 

data bases to find those funds that exhibit poor performance, high 

fee arrangement, and sub-advisory arrangements, all of which 

might suggest excessive fee arrangements and inadequate oversight. 

We have a cross-border working group using risk factors such as 

language fluency and the extent of use of overseas auditing affiliates and oversight capability of audit firms to identify those U.S. 

audit firms with foreign clients that may be engaged in financial 

reporting violations. 

As a result of our focus on initiatives and our proactive strategies 

and our hiring of experts, we are now better equipped to stop fraud 

sooner. But to continue to innovate, our resources need to keep 

8 

pace with our responsibilities. We have achieved these results in 

light of relatively flat budget amounts that have constrained our 

ability to backfill slots, to hire administrative staff, and to upgrade 

IT. And we need those resources to continue those efforts, but with 

that and our new ideas and our new structure, I think we will continue to be aggressively prosecuting fraud. 

Thank you. 

Chairman REED. Thank you very much. 

Ms. Cross. 

STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF 

CORPORATION FINANCE, SECURITIES AND EXCHANGE COMMISSION 

Ms. CROSS. Good morning, Chairman Reed and Ranking Member 

Crapo. My name is Meredith Cross, and I am the Director of the 

Division of Corporation Finance at the SEC. I am pleased to testify 

today along with my fellow Directors on behalf of the Commission 

to discuss the Division’s activities and responsibilities and the challenges that lie ahead. 

The Division of Corporation Finance’s core functions are reviewing company filings, making rulemaking recommendations to the 

Commission that relate to corporate finance matters, and providing 

interpretive advice to the public about the securities laws and corresponding regulations for corporate finance matters. With a staff 

of approximately 470, we are responsible for the review of nearly 

10,000 reporting companies, including tens of thousands of disclosure documents each year, plus initial public offerings and other 

public capital markets transactions of corporate issuers, public 

asset-backed securities offerings, and proxy statements, public 

mergers, acquisitions, and tender offers. 

Approximately 80 percent of the staff of the Division is assigned 

to the review function. The Sarbanes-Oxley Act requires the Commission to review disclosures, particularly the financial statements, 

of Exchange Act reporting companies at least once every 3 years 

and more frequently where circumstances warrant. This is no small 

task. 

Following enactment of the Sarbanes-Oxley Act in 2003, the Division revised its review program to meet the new review mandate 

and hired significant numbers of new staff accountants, which has 

enabled us to meet the review mandate each year. 

We also review the disclosures of many companies more often 

than once every 3 years. For example, the largest companies are 

reviewed more often and the largest financial institutions currently 

are reviewed continuously on a real-time basis. 

Corporation Finance has been working to enhance the disclosure 

review program, including by increasing the focus on large and financially significant registrants, and achieving additional efficiencies in our reviews of smaller companies. Our increased focus 

on larger and financially significant companies requires greater resources than traditional disclosure reviews, and our ability to implement these enhancements turns on whether we are able to allocate sufficient resources, balancing all other demands on the Division and our staff. 

9 

During the 2011 fiscal year, the Division established three new 

offices: the Office of Structured Finance, which focuses on disclosure reviews and policymaking for asset-backed securities; the Office of Capital Markets Trends, which evaluates trends in securities 

offerings and the capital markets to determine whether our rules, 

regulations, and review approach are adequately addressing them; 

and a new Review Group in Disclosure Operations that focuses on 

the largest financial institutions. 

The Division has staffed these offices almost entirely by transferring existing staff to them. If resources permit, we plan to hire to 

fully staff these offices to enable them to carry out their intended 

work. 

Corporation Finance also recommends new rules or changes to 

existing rules to the Commission to address areas in need of 

change. The Division’s recent rule-writing activities have focused 

on asset-backed securities, corporate governance disclosure-related 

matters, and Dodd-Frank Act implementation. 

Corporation Finance is responsible for preparing a wide variety 

of rules to implement a significant number of Dodd-Frank Act requirements. These include, for example, rules for corporate governance and executive compensation, including say-on-pay and golden 

parachutes; disclosure of pay versus performance, pay ratios, and 

employee and director hedging policies; and listing standards for 

compensation committees and compensation consultants, and for 

clawbacks of erroneously awarded compensation; also, specialized 

disclosure rules for conflict minerals, mine safety, and payments to 

governments by resource extraction issuers; regulation of assetbacked securities; and revisions to the definition of ‘‘accredited investor’’ and disqualification of offerings involving ‘‘bad actors’’ from 

relying on Rule 506 of Regulation D. 

Finally, at Chairman Schapiro’s request, the Division is undertaking a significant new initiative to look for ways to reduce regulatory burdens on small business capital formation in a manner 

consistent with investor protection. Topics included in this project 

include: the triggers for public reporting, generally known as the 

‘‘500 shareholder rule’’; restrictions on communications in private 

offerings, in particular the restrictions on general solicitation; restrictions on communication in public offerings; and new capitalraising strategies such as crowd funding and the scope of our existing rules that regulate capital raising. 

Thank you again for inviting me to appear before you today. I 

would be happy to answer any questions you may have. 

Chairman REED. Mr. Cook, please. 

STATEMENT OF ROBERT COOK, DIRECTOR, DIVISION OF 

TRADING AND MARKETS, SECURITIES AND EXCHANGE COMMISSION 

Mr. COOK. Good morning, Chairman Reed and Ranking Member 

Crapo. My name is Robert Cook, and I am the Director of the Division of Trading and Markets, and it is a pleasure to appear here 

today with my colleagues from the Commission staff. 

The Division of Trading and Markets is responsible for developing rules and standards for our markets and market intermediaries, including securities exchanges, alternative trading sysVerDate Nov 24 2008 10:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\11-16 DISTILLER\111611.TXT JASON
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tems, broker-dealers, clearing agencies, transfer agents, and selfregulatory organizations, such as FINRA and the MSRB. 

The exponential growth in the size and complexity of the U.S. securities markets in recent years has created special challenges for 

the Division’s mission. In the past year, the Division has focused 

on several key initiatives to improve the oversight and function of 

our equity markets. The Commission adopted a new rule to ban 

naked access arrangements under which broker-dealers would provide certain customers with unfettered access to the securities markets without any controls to protect market stability and integrity. 

Second, the Commission adopted large trader reporting requirements that will help identify and obtain trading information on the 

largest participants in the U.S. securities markets. 

Third, we are preparing a recommendation to the Commission for 

a rule to create, implement, and maintain a consolidated audit trail 

to address significant shortcomings in the agency’s present ability 

to collect and monitor trade data in an efficient and scalable manner. 

Fourth, the Division has worked on the implementation of several key regulatory initiatives to address significant market volatility such as occurred on May 6th of last year. These initiatives 

include a uniform single stock circuit breaker program designed to 

halt trading in a disorderly market. We have also coordinated proposed SRO efforts to implement a limit-up/limit-down functionality 

for equity markets that will help prevent trades outside specified 

parameters while allowing trading to continue within those parameters. In addition, the Division has assisted the SROs in the preparation of proposed updates to the existing marketwide circuit 

breakers. 

The Division’s core functions have expanded substantially in the 

past year under the Dodd-Frank Act. All told, the Division is primarily responsible for 27 separate rulemaking initiatives, of which 

the Commission has published 21 for public comment. The Division 

is also substantially involved in 12 studies, of which 7 have been 

completed. 

Most notably, we have been charged with the responsibility for 

developing the registration and regulatory regime for participants 

in the security-based OTC derivatives markets, including data repositories, dealers, major participants, execution facilities, and 

clearing agencies. 

Going forward, this will mean that Trading and Markets, in coordination with the other Divisions and Offices, will be registering 

these new entities, monitoring market developments, and promulgating new rules or modifications and guidance where needed. 

To date, the Commission has proposed 13 rules related to OTC 

derivatives. Once the proposal phase is complete, the Division is 

planning to recommend the Commission seek public comment on 

an implementation plan that will facilitate a rollout of the new requirements in a logical, progressive, timely, and efficient manner 

that minimizes unnecessary disruption and cost to the markets. 

The Division is responsible for many other aspects of the DoddFrank Act, ranging from rules related to proprietary trading activities of broker-dealers—the Volcker Rule; enhanced oversight of financial market utilities, such as clearing agencies; and new proceVerDate Nov 24 2008 10:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\11-16 DISTILLER\111611.TXT JASON
11 

dural requirements for processing proposed SRO rule changes. 

Pending the creation of new offices for credit rating agencies and 

municipal securities, the Division is also continuing to work with 

OCIE to carry out our existing functions in these areas, including 

the preparation of rules required by the Dodd-Frank Act. 

In conclusion, the Division’s workload is dominated by a diverse 

range of functions that are vital for protecting investors and markets, and the scope of these functions has expanded tremendously 

under the Dodd-Frank Act. Many of our current initiatives will extend well into 2012 and beyond. 

Thank you for inviting me to be here today, and I look forward 

to answering your questions. 

Chairman REED. Thank you very much. 

Ms. Rominger, please. 

STATEMENT OF EILEEN ROMINGER, DIRECTOR, DIVISION OF 

INVESTMENT MANAGEMENT, SECURITIES AND EXCHANGE 

COMMISSION 

Ms. ROMINGER. Chairman Reed, Ranking Member Crapo, Members of the Subcommittee, let me join my colleagues from the Commission in thanking you for the opportunity to testify today. My 

name is Eileen Rominger. It has been 9 months since I joined the 

SEC as Director of the Division of Investment Management. Before 

coming to the Commission, I had over 30 years of experience in the 

asset management industry as a portfolio manager and as a manager of portfolio teams. 

The Division assists the Commission in its oversight and regulation of America’s $43 trillion investment management industry. In 

doing this, we administer the Investment Company Act of 1940 and 

the Investment Advisers Act of 1940. We oversee and develop regulatory policy for investment advisers and funds. 

The Division has devoted the last year to implementing the provisions of the Dodd-Frank Act as they relate to investment advisers. The Dodd-Frank Act significantly changed the regulatory landscape for these entities. 

First, it increased the statutory threshold for SEC registration from $25 million to $100 million in assets under management. 

Second, it eliminated a registration exemption for advisers to 

hedge funds and other private funds. 

And, finally, it requires advisers that are not registered to submit reports to the Commission. 

As a result, advisers that do not meet the new asset threshold 

may have to withdraw their registration with the Commission and 

register instead in their home States. 

Advisers to hedge funds and other private funds will be required 

to register with the Commission or to qualify for one of the narrower exemptions added by the Dodd-Frank Act. 

In June, the Commission adopted rules to implement these 

changes. We anticipate adding approximately 750 new private fund 

advisers to the SEC registrant pool, but we estimate an overall decline of about 28 percent in adviser registrants overall. 

Under new rules, registered advisers will report more detailed 

information about their operations, including information about the 

private funds they manage. This will allow us for the first time to 

12 

obtain much needed information about private funds, such as 

hedge funds. Following the implementation of these rules, I anticipate that the Division will shift more work to its disclosure, interpretive advice, and exemptive relief programs. 

Another important area we are working on is to implement the 

requirements of the Dodd-Frank Act that concern systemic risk reporting. The Dodd-Frank Act mandated that the Commission require private fund advisers, including advisers to hedge funds and 

private equity funds, to report information about the private funds 

they manage for FSOC’s systemic risk assessment. Just recently, 

the Commission adopted a rule that requires registered investment 

advisers managing at least $150 million in private fund assets to 

report systemic risk information on a new form called ‘‘Form PF.’’ 

The initial stages of this reporting will begin next year for some 

of the very largest private fund advisers. 

The Division is also working on a number of important initiatives 

in other areas outside of its Dodd-Frank agenda, one of which I will 

highlight. Prior to my arrival at the SEC and in response to the 

run on money market funds during the financial crisis, the Commission adopted important reforms in the area of money market 

fund regulation. These reforms included a requirement for money 

market funds to report detailed portfolio holdings information on a 

monthly basis. Using this data, the Division is able to monitor and 

discuss trends and any associated risks in these funds with the 

Commission and with FSOC member staff. 

Given the structural fragilities that remain in money market 

funds, despite the Commission’s reforms, the Division continues to 

consult with FSOC member staff on additional regulatory reform 

steps. 

In addition to our role in Commission rulemaking, a large part 

of our administration of the Investment Company Act and the Investment Advisers Act consists of providing legal guidance in the 

form of interpretive and no-action letters, as well as exemptive relief from the provisions of both acts. We also review filings of investment companies in order to both monitor and enhance compliance with disclosure and accounting requirements. Pursuant to the 

requirements under the Sarbanes-Oxley Act of 2002, the Division 

reviews the annual reports of all investment companies no less frequently than once every 3 years. 

The Division also provides legal and policy guidance to the Division of Enforcement on enforcement matters concerning the investment management industry. 

Again, thank you for the opportunity to testify today. I am happy 

to answer any questions you may have. 

Chairman REED. Thank you very much. 

Mr. Lewis, please. 

STATEMENT OF CRAIG LEWIS, DIRECTOR, DIVISION OF RISK, 

STRATEGY, AND FINANCIAL INNOVATION, SECURITIES AND 

EXCHANGE COMMISSION 

Mr. LEWIS. Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, my name is Craig Lewis, and I am the 

Chief Economist and Director of the Division of Risk, Strategy, and 

Financial Innovation. Thank you for the opportunity to testify on 

13 

behalf of the Securities and Exchange Commission regarding the 

Division’s operations, activities, and challenges. 

I joined the Division as Director in June of this year. Before coming on board, I was a professor of finance at the Owen Graduate 

School of Management at Vanderbilt University where I focused on 

research and teaching, primarily in the area of corporate finance. 

I am also a Ph.D. economist. 

The Division was created as part of the agency’s modernization 

initiative to share expertise and bring together critical data from 

across the agency. It was established in September 2009 to provide 

the Commission and its staff with sophisticated analysis that integrates economic, financial, and legal expertise. RiskFin provides 

economic analyses as part of the Commission’s rulemaking process 

and supports its rule review, examination, and enforcement programs with data-driven, risk-based analytical models. It also oversees the Commission’s TCR and interactive data programs. The Division has been especially focused on the agency’s increased use of 

computerized risk analysis and data sharing. 

The Division participates in the rulemaking process by helping 

to develop the conceptual framing for and assisting in the subsequent writing of the economic consequences of the rules the Commission promulgates. Where appropriate, the SEC considers, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation when engaged 

in rulemaking. 

Economic analysis of agency rules considers the key economic effects of the various alternatives that should be considered in developing regulations. Analysis of the likely economic effects of proposed rules, while critical to the rulemaking process, can be challenging. Certain costs or benefits may be difficult to quantify or 

value with precision, particularly those that are indirect or intangible. The Division is committed to continuously improving economic analysis in Commission rulemakings and to the integration 

of RiskFin economists into the rulemaking process. While the Division is striving to fully comply with these increased demands, it 

faces challenges in its ability to do so given current resources. 

The second core function of the Division is to administer a number of data-driven responsibilities and initiatives. For example, the 

Division currently provides economic and statistical analysis to 

support all aspects of enforcement and litigation matters for the 

Commission. It also has developed innovative software tools and 

uses cutting-edge analytic methods to identify problem areas associated with investment managers. 

The interactive data program provides information contained in 

certain documents filed with the Commission in a structured format that makes the underlying data readily available for analysis. 

The Division has a number of responsibilities that include promoting the use of interactive data, developing infrastructure, and 

supporting rule writing to implement data-tagging requirements. 

To improve efficiency, the Division has been reorganized to reassign staff that have expertise in data analysis and risk assessment 

into the newly formed Office of Quantitative Research, which will 

be responsible for designing quantitative risk management models. 

14 

This office has begun to build a data infrastructure to facilitate the 

development and support of analytics. 

Going forward, the Division would like to expand its capabilities 

to developing risk assessment models and to build a scalable data 

infrastructure to support risk-based initiatives. Although the Division plans to pursue these objectives and has existing employees 

with the necessary expertise to work on these projects simultaneously, resource constraints inhibit progress and significantly slow 

the rate of innovation. For example, a project to develop a model 

to detect accounting fraud has been delayed due to resource constraints. 

While the Division has made significant progress since its inception in 2009, the scope of its responsibilities has been significantly 

expanded as it continues to find new ways to assist other Divisions 

and address the additional obligations that have been mandated by 

the Dodd-Frank Act. 

Thank you for inviting me to share with you the work of the Division of Risk, Strategy, and Financial Innovation. I look forward 

to answering your questions. 

Chairman REED. Thank you very much. 

Mr. di Florio, please. 

STATEMENT OF CARLO V. DI FLORIO, DIRECTOR, OFFICE OF 

COMPLIANCE INSPECTIONS AND EXAMINATION, SECURITIES AND EXCHANGE COMMISSION 

Mr. DI FLORIO. Good morning, Chairman Reed, Ranking Member 

Crapo, and Members of the Subcommittee. Let me join my colleagues in thanking you for the opportunity to testify today on behalf of the U.S. Securities and Exchange Commission. My name is 

Carlo di Florio, and I am the Director of the Office of Compliance 

Inspections and Examinations. As you noted, I joined the Commission on January 25, 2010, prior to which I was a partner in the 

financial services regulatory practice at PricewaterhouseCoopers in 

New York. 

Since joining the SEC, I have enjoyed working with colleagues 

who are so dedicated and committed to furthering the SEC’s important mission. The SEC’s National Exam Program helps protect investors and ensure market integrity by examining for fraud, monitoring risk, promoting compliance, and ensuring market integrity, 

and informing the SEC as the eyes and ears of the Commission in 

the field. 

Our exams assess whether registrants are treating investors fairly and complying with the securities laws and regulations that are 

designed to protect investors and prevent fraud. The 830 supervisors and examiners in the National Exam Program take a riskbased approach to examining 25,000-plus registrants, including investment advisers, investment companies, broker-dealers, derivatives registrants, hedge funds, mutual funds, credit rating agencies, 

SROs, national exchanges, clearing agencies, and transfer agents. 

Under the direction of the new leadership team, OCIE has undertaken a top-to-bottom review and launched over 20 improvement initiatives to strengthen our strategy, our structure, our people, our processes, and our technology. Accomplishments over the 

past year include the following: 

15 

We have recruited experts and launched new specialty groups 

that bring deep, needed expertise and specialization in program 

areas such as derivatives and structured products, hedge funds, 

credit rating agencies, high-frequency trading, and risk management. 

We have conducted over 1,600 exams that are better targeted to 

preventing fraud, identifying violations, and addressing higher-risk 

firms, products, and practices. 

We have implemented a new large-firm monitoring group to 

focus on systemic risk firms and a new Risk Analysis and Surveillance Unit to enhance our ability to monitor risk trends and target 

those firms and practices that present the greatest risk to investors, markets, and capital formation. 

We have created a national governance structure that breaks 

down silos and facilitates coordination, consistency, effectiveness, 

and accountability across the country. 

We have streamlined and automated our exam process with new 

technology. We have clearly defined expectations in a new exam 

manual, and we have implemented a new internal compliance and 

ethics program to monitor our performance and ensure our accountability. 

We are working to design and implement a new examiner training program that establishes technical training and certification 

standards across the country. 

No matter how much we improve our current program, however, 

the fact remains that our 830 examiners and supervisors can only 

cover a small portion of the 25,000-plus registrants we are responsible for overseeing. This results in a ratio of only one examiner for 

every 30 registrants. 

To give you a sense of benchmarking, bank regulators, for instance, typically have an examiner-to-registrant ratio of 1:1 or 1:2. 

FINRA’s ratio is 1:5. Needless to say, our 1:30 ratio presents an 

enormous gap with real consequences if not addressed. 

For instance, our staff was only able to examine 8 percent of registered investment advisers in fiscal year 2011, although we visited 

firms with more than 30 percent of the assets under management 

currently registered with the SEC. In addition, more than one-third 

of registered investment advisers have never been examined. 

We continue to pursue strategies such as risk-focusing our exams 

and automating our exam processes to be as efficient as possible 

and to maximize the usage of resources we are provided. Nevertheless, additional resources would enable us to more effectively fulfill 

our new responsibilities, protect investors, and ensure market integrity. 

Thank you, and I welcome the opportunity to answer your questions. 

Chairman REED. Thank you very much. I want to thank all the 

witnesses for superb testimony, and your collective testimony illustrates the range, the complexity, and the vital importance of what 

you do, and also I think underscores the need to be properly 

resourced to do a very complicated job, which gets complicated each 

and every day by innovations in the marketplace. So thank you 

very much again for what you are doing and what you continue to 

do. 

16 

I think, you know, one final point on this area, if you do not have 

these resources, you cannot effectively provide sort of direction and 

guidance in the marketplace. Perhaps Professor Lewis can comment. It is probably more inefficient than anything else that you 

are not giving them the guidance that they need to go forward and 

make appropriate decisions. 

Let me begin my questioning, and I am in an enviable position 

because I have lots of questions and I have experts before me. Mr. 

Khuzami, one of the most notorious incidents of the last few years 

was the Madoff scandal. Recently, the final act, perhaps, has been 

undertaken, which is the disposition of allegations against members of the SEC, their behavior. There were some people in the Enforcement Division involved. There have been sanctions, but no one 

has been dismissed, and that is a question which is at the forefront 

of many people’s minds, accountability. You are asking for accountability in the marketplace. I think the American public is also asking through us accountability at the SEC. Can you comment on the 

disposition and whether or not you feel that was appropriate? 

Mr. KHUZAMI. Yes, Senator. I think you are absolutely right that 

accountability is our obligation as well, and with respect to not only 

the Madoff matter in general, which has spawned and generated 

many of the forward-looking reforms and changes and organizational revisions that you have heard this morning with respect to 

individualized disciplinary decisions, the Inspector General’s report 

identified a total of 21 persons, approximately, who he believed 

warranted follow-up for possible disciplinary actions. About 10 of 

those left the Division since the report was issued, and the SEC 

has no ability to discipline ex-employees who have departed. So 

that left approximately 11, and we conducted an extremely thorough process to make these decisions, including bringing in an 

independent law firm to conduct its own independent investigation 

and then make recommendations to the proposing and deciding officials, because ultimately it is an agency decision. 

Of the 11 persons who remained, 9 were recommended for actions by the law firm, and action was, in fact, taken against all 9. 

In a couple of cases, it was—I think in two cases perhaps—less 

than what the law firm had recommended, and I will defer to Mr. 

di Florio, as I think the individual who the proposal was should be 

terminated was in the OCIE program. In fact, a different result 

was achieved. But, generally, all the persons recommended by the 

outside law firm suffered a range of discipline. 

Chairman REED. Mr. di Florio, can you comment? Then I have 

a follow-on question. 

Mr. DI FLORIO. Sure, Senator. As my colleague Mr. Khuzami 

noted—— 

Chairman REED. Is your microphone on? 

Mr. DI FLORIO. Yes. Are you able to hear me OK? As my colleague Mr. Khuzami indicated, a very serious review was undertaken, and all of the individuals ultimately that were identified 

were disciplined. In one instance, the independent third-party law 

firm recommended termination of an individual or, if termination 

would have a significant negative impact on the operations of the 

SEC, then to fashion an alternative remedy that would significantly change that individual’s roles and responsibilities, such as 

17 

a demotion and a reduction in pay. So the SEC staff followed that 

recommendation of the independent law firm and refashioned the 

roles and responsibilities of that individual. The individuals no 

longer have supervisory responsibilities. Their role was reduced. 

The individual received a reduction in pay, and there was a suspension of 30 days. 

I would also just assure the Congress and the American people 

that we have taken the lessons learned from Madoff very seriously 

and have implemented significant improvements to help us identify 

and prevent fraud so we can better protect investors, ensure market integrity, and facilitate capital formation. 

Chairman REED. Could you just follow up very quickly on some 

of the steps you have taking looking forward based upon the experience with Madoff? 

Mr. DI FLORIO. Sure. We have undertaken significant training for 

all examiners and investigators in the SEC of fraud techniques, 

fraud tools, and we have made sure that our forces truly understand the various fraud scenarios that are out there, how to identify them, and how to act quickly to shut them down. I think our 

results, as articulated by Mr. Khuzami and some of the results that 

I identified, demonstrate how we are beginning to have that impact. In addition, we have really brought technology to bear. We 

have a new system for tips, complaints, and referrals that centralizes any such tips, complaints, and referrals that come in and make 

sure that we have the right people triaging it and following up on 

it. We are bringing better technology, better resources, better people to the job. 

Chairman REED. Thank you very much. 

Mr. Khuzami, let me return to another topical issue. Judge 

Rakoff has raised some questions about the appropriateness of a 

settlement that you have proposed with Citicorp, but it raises a few 

questions. One is you have allegations against the company, but 

there are no individuals that have been, I think, pursued in this 

case and other cases. And to a lot of people on the street, they are 

wondering how a company can commit serious violations of securities laws, and yet no individuals seem to be involved and no individual responsibility is assessed. And that, I think, it at the heart 

of one of the concerns that Judge Rakoff has. Can you comment on 

that? 

Mr. KHUZAMI. Sure, Senator. We focus first and foremost on individuals for exactly the reason you identify: individuals commit 

wrongdoing, not institutions. But I think it is a misperception that 

we have not charged individuals. 

First of all, in the Citicorp case itself, we charged the individual 

who was responsible for the particular transaction, and we are in 

litigation now with him. We also charged a second individual who 

worked for the collateral manager on the deal, the firm that represented that it was independently selecting the portfolio when, in 

fact, that was not the case. So two individuals were charged in this 

case. And, overall, across our credit crisis cases, just to take an example, as I mentioned in my opening remarks, in approximately 26 

cases 89 individuals and entities, half of which are high-ranking 

corporate officers, have been charged. The entirety of the executive 

18 

suite at New Century and IndyMac and other companies and individuals who have sold these deals have been charged. 

I think part of the concern is that why hasn’t—and some of these 

cases have gone all the way up to the executive suite, and why 

haven’t the heads of banks been charged? But it is a difficult challenge in certain transactional cases because what is going on occurs, you know, two, three, and four levels below the executive 

suite. If you are selling a CDO, it is being put together by individuals working on the desks, and the disclosure is being written by 

individuals who are not at the executive level. So the evidence and 

the duties and obligations do not always rise all the way up to the 

top of the executive suite, unlike, say, in accounting fraud or financial statement fraud where CEOs and CFOs and others may have 

to sign off on the accuracy of financial statements. 

So to some degree, if that is the concern, it is a function of the 

nature of the cases, but we have aggressively charged, as I said, 

over half of the individuals in these cases, 40 to 50 high-ranking 

CEOs, CFOs, and senior corporate executives. 

Chairman REED. Let me follow up with one additional question 

before I recognize Senator Merkley and then Senator Menendez. 

You are, of course, talking about civil charges, which is your responsibility, but there have been many other commenters who have 

raised the issue of why aren’t there any criminal charges because 

there are at least suggestions or allegations of criminal violations 

as well as civil violations. And as I understand it, you would have 

to refer those cases to the Department of Justice. But the record 

is not—there are very few that I can think of criminal cases that 

have been taken in the wake of the worst financial crisis in the history of the country, and behavior which, at least to the outside observers, seems to be highly questionable. 

Have you been making referrals and has Justice been systematically turning you down? Or how can you comment on this relationship? 

Mr. KHUZAMI. Senator, we work extremely closely with the Justice Department and with the U.S. Attorney’s Office in New York 

and other offices, and I can assure you that they are keenly interested in cases arising out of the credit crisis and looking extremely 

closely at the evidence in these matters, conduct their own inquiries, and reach their own determinations. 

It is a hurdle for them. They have a higher standard of proof in 

a criminal case. They must prove a case beyond a reasonable doubt. 

And so some of the challenges that we face, they face even more 

forcefully because of that higher standard of proof. But I can assure 

you it is not for lack of dedication or professionalism or talent that 

criminal cases are not being filed. 

Chairman REED. I presume from that answer that you have 

made referrals, but they have not been followed through because 

of the judgments they have to make independently. 

Mr. KHUZAMI. Well, yes, it is referrals, but it is also—we work 

very closely with them. We do not just take a case and refer it over 

to them and wash our hands of it. We are in constant communications and discussions and reviewing evidence and working collaboratively. 

19 

Chairman REED. Thank you very much. There will be an additional round of questioning, but let me recognize Senator Merkley 

now for his statement or questions or a combination of both. 

Senator MERKLEY. Thank you, Mr. Chair. I do not have a statement, but I do have some questions, if that is appropriate. Thank 

you. 

I wanted to start to get anyone’s opinion on Congressman 

DeFazio’s proposal on high-frequency trading, which goes back to 

kind of thinking a little bit about the ‘‘flash crash.’’ I believe what 

he had in his most recent proposal is a 3-basis-point fee that discourages, if you will, the multitudinous high-speed trades while 

having very little impact on regular investors. 

Any thoughts about that? Mr. Cook. 

Mr. COOK. Thank you, Senator. I am not familiar with the details of that, but I think that proposal or versions of it have been 

raised several times, and I think there are a number of interesting 

issues that it raises. Obviously, there are concerns about the extent 

to which the traffic that is generated by high-frequency trades is 

of itself interfering with the effective functioning of the markets, 

and to some extent some type of fee, whether it is a message fee 

or an order cancellation fee—there are various versions this might 

take—that might be helpful in addressing that. 

I think the challenges are, first, picking the right metrics for 

when that would happen, when it would kick in, what the type of 

fee would be; and second, and probably more importantly, to not 

undermine the liquidity in the markets that may be very important, and certainly during normal market circumstances. Given the 

prevalence of high-frequency trading in our markets today, I think 

this is an area where we would have to move very carefully to ensure that whatever changes we introduce to a significant portion of 

the volume in the markets is carefully considered to avoid any unintended consequences. 

Senator MERKLEY. Does anyone else want to weigh in on that? 

[No response.] 

Senator MERKLEY. Very good. Thank you. 

The second issue I wanted to get some insights on is the crowd 

funding of companies. As we move to this Internet world, as people 

become familiar with peer-to-peer lending, certainly this is a very 

different avenue than traditional investing, very different for the 

investors and very different for the companies. And in some ways 

it is a very exciting possibility, but it also poses risks related to 

fraud. Any insights on how this gets pursued, supported, or guided 

so that it will be a win for investors and a win for companies? 

Ms. CROSS. I will start off. First off, I have to note that I am not 

participating in the crowd funding matter because of my prior work 

for a peer-to-peer lender, but in general, with regard to the new 

capital-raising strategy ideas that are being considered in Congress 

and also at the Commission, the key here is to make sure that 

whatever is built does not become fraught with fraud so that investor confidence is destroyed and then people will not invest in that 

market since that level of deregulation would not help anyone. 

So we are working with the market participants and Members of 

Congress and looking at the various pieces of legislation to help put 

in safeguards that would keep that from happening. I think one of 

20 

the ideas that has been discussed is the possibility of intermediaries as a means of protecting investors, and I can let Mr. 

Cook address that. 

Mr. COOK. So when we think of investors purchasing securities, 

one of the traditional tools we have to help provide protections for 

them is the registration and regulation of the party who is doing 

the selling as a broker-dealer. Some of the factors we think about 

when we think about whether that is appropriate include: Does the 

broker have a salesman’s stake in the transaction? Are there conflicts of interest that might arise? Is the intermediary handling 

customer funds and securities? 

And so I think, in our experience in this area, I have a couple 

of observations. One is that fact patterns matter, and there are 

very different forms in which these intermediaries may relate to investors. And I think in some cases we have given guidance that 

they are not subject to registration or would not because the regulatory policy concerns have not been triggered. 

I think another area that we need to think about, though, is 

whether we have a sufficiently flexible regime because the types of 

rules that might be appropriate for one type of entity may not be 

appropriate for a traditional brokerage house, for example. And I 

think if there were a regulatory regime in place here, I think that 

would be a key area in which we would want to have some flexibility to tailor the requirements to the specific facts and circumstances. 

Senator MERKLEY. Thank you. My time is up, so I am just going 

to say I appreciate your feedback on both of those. There are about 

ten other topics I would be happy to extend the conversation on, 

but I am going to defer to my colleagues. 

Chairman REED. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Ms. Cross, I authored Section 953(b) of the Dodd-Frank legislation which requires publicly listed companies to disclose the pay of 

their median worker compared to the pay of their CEO. And we 

weighed in with the SEC earlier this year about both our intention 

with this provision and where it is that you were at. We got an answer that was less than satisfactory because it was a nonanswer, 

as far as I am concerned. 

So can you tell me where it is that you are at in terms of being 

on track for finishing this rule on this provision by the end of this 

year? 

Ms. CROSS. I am happy to do so. Right now the Division is in the 

process of preparing the recommendation for the Commission so 

that they can act on a proposal. We are trying mightily to make 

it by the end of the year. That is the schedule that is up—that is 

the goal that is up on our public Web site, and I can assure you 

that we are doing everything we can to get there. 

We have a lot of things we are trying to do right now, and this 

is one of the very important ones. But I can assure you we are trying our hardest to make the year-end. 

Senator MENENDEZ. I would hope that what we see happening 

across the country and people’s concern about inequality would 

spur the SEC to have a mere transparency—we have had testimony here, particularly from those who have come from the private 

21 

sector, about how hard this will be, and they actually have said 

that they do not believe that it is that difficult to produce the information. So I hope we understand, particularly in light of actions 

that are being taken by citizens across this country about how important—I know you have a lot of work. We gave you a lot of work 

to do. I understand that. But this is something that clearly people 

are looking forward to have some transparency and to have it sooner rather than later. So we are looking forward to you achieving 

it by the end of the year, at least bringing it before the Commission. 

Ms. CROSS. We are doing our best, as I said. 

Senator MENENDEZ. OK. That means you will get it done before 

the end of the year. 

[Laughter.] 

Senator MENENDEZ. Let me ask you this as well: Earlier this 

year I introduced the Shareholder Protection Act with several of 

my colleagues to disclose corporate spending in elections in the 

wake of what I believe is a misguided decision on Citizens United. 

Since then, my staff has been told by SEC attorneys that the SEC 

already has the authority to implement rules that would require 

corporations to disclose their political spending to shareholders. Is 

that accurate? 

Ms. CROSS. Yes, it is accurate that the Commission has the authority to require that disclosure, if they decided to do so, through 

rulemaking. I would note that the Citizens United case has certainly piqued an interest in this topic. We have two rulemaking petitions pending at the Commission right now asking us to consider 

requiring disclosure about political spending. 

I also note that this is an area where the market is moving in 

that direction as well. A recent report showed that more than half 

of the S&P 100 is already providing this disclosure. Also, shareholder proposals are included under our rules in proxy statements 

so that shareholders can vote on whether they want this disclosure. 

So this is certainly an area of great interest. 

The staff is carefully considering all this as we think about the 

issue. 

Senator MENENDEZ. Well, I hope the SEC believes that this type 

of disclosure would be helpful for investors. An October 2010 Zogby 

poll of business leaders found that 77 percent of them believe that 

corporations should disclose all the direct and indirect political expenditures. Is that something the SEC disagrees with? 

Ms. CROSS. I cannot speak for the Commission on that point. We 

have not taken this up with—— 

Senator MENENDEZ. At the staff level, where are you headed on 

your recommendations? 

Ms. CROSS. We have not concluded what we should recommend. 

I think we are reviewing the petitions and considering the issue in 

light of recent developments. 

Senator MENENDEZ. Many large companies—Microsoft, Wells 

Fargo, Merck, Aetna—have already taken steps to disclose their political expenditures, and to me it illustrates the ease in which it 

can be done. And so I am hoping that the SEC looks for that to 

be for shareholders across the board a reality. So I am looking forward to what your recommendations are on that as well. 

22 

Mr. Cook, let me ask you one quick question. What is the SEC’s 

expected timing for issuing the remaining proposed rules on capital 

margins, segregation, and record-keeping requirements for security-based swaps under Title VII of Dodd-Frank? 

Mr. COOK. The rules you refer to, which are the final rules in the 

substantive proposal phase of our OTC derivatives regulation, are 

at the top of the list for our OTC derivatives work. The goal was 

to get them done by the end of the year. Whether we hit that or 

not, I am not sure, but that is probably the next item out of the 

Commission on the OTC derivatives front. 

Senator MENENDEZ. So let us say for argument’s sake that you 

reach it at the end of the year. What would be your overall implementation schedule or proposed implementation rules for its final 

rules? 

Mr. COOK. Well, what we propose to do after we propose all the 

substantive rules is to issue two releases that are also underway 

now so that we can get them out as quickly as possible. One is a 

release that discusses how our rules would apply internationally, 

so a cross-border release, looking across each of the different substantive rulemakings, whether it is execution facilities or dealer 

registration or clearing agencies, and talk about how those rules 

apply or would apply in a cross-border context and solicit comment 

on that, because it is a very important piece of the implementation. 

The second thing would be to issue an implementation plan— 

both of these would be for public comment—that would lay out the 

process by which we would propose to roll out the new framework 

in a timely, efficient manner with the goal of approaching this as 

a project management task where, if we can be as thoughtful in 

how we roll it out, we will get to the end more quickly and efficiently. 

Senator MENENDEZ. All right, Mr. Chairman. Thank you very 

much. I appreciate it. 

Chairman REED. Thank you, Senator Menendez. 

Let me begin the second round by asking Mr. Khuzami, again, 

in the context of this recent litigation under Judge Rakoff with respect to Citicorp—and this is not exclusive to one company, but 

typically you will reach a settlement in which the corporation neither admits nor denies, and it strikes a lot of people oddly why, if 

you do not have any culpability, you are paying several hundred 

million dollars. Have you reconsidered whether or not that is at all 

effective or what role it plays? That is one question. 

The second question would be: They typically also say that they 

will never do this again, and I am not using the precise language 

of the finding, and then you find that—and, again, not exclusive to 

one company but many companies—troubling patterns of behavior 

emerge in the future, maybe not exactly identical but certainly 

within the same sort of context of—and yet there does not seem to 

be action in your Division to take people up on their commitment 

never to do it again or anything like it again. 

Are you rethinking what you can do in terms of these settlements on both those points? 

Mr. KHUZAMI. Senator, let me explain our approach in these 

areas. First, the bottom line is we settle cases where we believe 

that the sanctions that we can obtain, including the monetary sancVerDate Nov 24 2008 10:16 Jan 10, 2013 Jkt 048080 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\11-16 DISTILLER\111611.TXT JASON
23 

tions and the business reforms, et cetera, are what we could likely 

obtain should the case go to trial, taking into account the risks, the 

strength of the evidence, the law, et cetera. 

In monetary sanctions, which is another matter that has been 

discussed, I would make it clear that we cannot obtain penalties in 

the amount of investor losses. We are limited by law to getting 

disgorgement, which is the ill gotten gains of the perpetrator, and 

then a penalty, in general, equal to the amount of that gain. So if 

you had somebody who earned $20 and defrauded investors of 

$100, we can get $20, representing the gain of the perpetrator, and 

another $20, and a penalty, but we cannot get the $100, in most 

circumstances. 

And so to some degree, there has been commentary about our 

settlements, that they do not seem to be significant enough in 

terms of the financial sanctions. That reflects, frankly, our view of 

the strength of the evidence of the case and the risks associated 

with it, but also some statutory restrictions on the amount of 

money that we can get. 

But in addition to that, with respect to ‘‘no admit, no deny,’’ our 

goal is to get money in the hands of investors as soon as possible. 

If we were to demand admissions in every case—and keep in mind, 

it is ‘‘no admit, no deny,’’ which means companies cannot deny liability. They are not required to admit it, but they cannot deny liability, as well. And so under that provision, if we were to insist 

on admissions, because of the collateral consequences of those admissions, both with respect to private civil litigation and even with 

respect to criminal exposure, companies are not going to open 

themselves up to that kind of exposure. 

Now, I do not have any particular sympathy for that. It is just 

a reality of the negotiation process that they will not settle cases 

and they will take more cases to trial. So we are left with a situation in which if we can settle a case now for the amount of money 

and the range of sanctions that we believe reasonably approximates what we can get if we were successful without the risks of 

a trial, and most importantly, get money in the hands of investors 

today rather than 2 years from now or 3 years from now or 4 years 

from now when that case goes to trial, and even more if it goes to 

appeal, and most importantly, we added more resources to attack 

the next fraud, because there are opportunity costs in everything 

that we do—if we are prosecuting Case A, we are not prosecuting 

Case B—and so it is cold comfort to victims of other frauds if we 

are putting all of our resources taking a case to trial and if one is 

not settling, when their case is not being prosecuted if we are getting a package of remedies that are strong and send a meaningful 

message. 

I would also say that in our cases, we issue a complaint with 

very detailed allegations. The company pays a large amount of 

money. They agree to business reforms. They cannot deny liability. 

My view is, while I certainly understand the desire for people 

wanting someone to stand up and admit to the wrongdoing, there 

is not a lot of mystery under those circumstances that the company 

is, in fact, engaged in wrongdoing. They would not be writing a 

check for $300 million or agreeing to reform their business in the 

24 

face of these very pointed and specific allegations of what happened. 

So on balance, trying to serve many values, we adopt a ‘‘no 

admit, no deny,’’ like the FTC, like the Department of Justice Civil 

Division, like the CFTC, and just the other day, the National Credit Union Administration settled the case against two banks for 

$300 million for mortgage related problems also on a ‘‘no admit, no 

deny’’ basis and the Supreme Court has endorsed it. 

So while I understand the desire for it, and there are cases 

where I might like to see it, as well, and we do review our policy, 

the fact of the matter is that we have to choose amongst some competing goals that we are trying to accomplish and that is where we 

come out. 

With respect to repeat offenders, this deals with the question of 

contempt, and I think there is a little bit of a misperception around 

our authority in this area. If a company engages in a securities law 

violation in 2005 and agrees not to do it again by way of an injunction, and then in 2008 sells a securities product that violates the 

law, we are not able—we can only get civil contempt, but civil contempt is only available if there is an ongoing fraud, so that we 

could go in court and say, Your Honor, this company is engaging 

in conduct now that violates their previous promise not to break 

the law again. You have to stop them from doing this conduct right 

now. But that only works if the conduct is ongoing. If the sale of 

the securities is over, there is no ongoing fraud. There is nothing 

to order compliance with. And that is the vast majority of cases. 

There has to be ongoing fraud in order to bring a contempt action. 

In addition, the most you would get from a judge is he would say, 

stop doing what you are doing now, but if it is already over, there 

is nothing to get. I think what most people want in this area is 

criminal contempt, which is punitive, which is sanctions for simply 

violating the previous order, and that, only the Department of Justice has authority to do. But we by no means ignore recidivism. We 

take it into account in deciding how much a company should pay 

in that second action, what kind of business reforms might need to 

be adopted, and other packages. So we thoroughly take into account prior misconduct, but contempt is a poor vehicle in most 

cases to accomplish that. 

Chairman REED. I have one quick follow-up question before I recognize Senator Merkley. I promise I will ask the other panelists, 

when I return, questions. 

Recently, you have used language in the Sarbanes-Oxley legislation to claw back gains that an individual received although he was 

not directly charged with any type of violation. Is that a practice 

that you are going to pursue with more frequency going forward? 

Mr. KHUZAMI. Yes, Senator. That is Section 304 of SarbanesOxley, which allows us to sue and require a CEO or CFO to claw 

back certain incentive-based bonuses and equity awards as well as 

certain stock sale profits when the company that they work for fails 

to comply with certain financial reporting requirements as a result 

of misconduct, and we have used that tool and we look in all of our 

cases to whether or not that tool is appropriate. It is a strong tool 

because, like you say, these are stand-alone actions. The CEO or 

the CFO does not have to be involved in the misconduct. If the 

25 

company they are working for does it, their compensation can be 

clawed back. And so we look at it closely. 

It is not without some issues. Obviously, CEOs and CFOs are differently positioned. Some are completely absentee and do not do 

their job at all and misconduct occurs. Others may be very active, 

may be even following best practices, and nonetheless misconduct 

occurs. So you need to exercise a range of discretion in these cases, 

but it is a tool we look at closely and we have brought a number 

of actions in this area. 

Chairman REED. Thank you. 

Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chair. 

I wanted to turn to MF Global, which, if I understand right, MF 

Global was both broker-dealers, if you will, regulated by the SEC 

and a futures dealer regulated by the CFTC. I believe it is on the 

futures side that the issue of client accounts and the segregation 

of client accounts is in question, that is, whether their accounts, 

the money was used in a proprietary trading or hedge fund style 

operation and in violation of the sanctity of those individual accounts. 

So it is very confusing to the public, certainly to us, as to where 

the oversight comes and what went wrong, but recognizing that the 

SEC is primarily on the broker-dealer side of the firm, did things 

go wrong on the broker-dealer side, or is the broker-dealer side 

deeply impacted, if you will, by the—which I am sure it is—by the 

futures side? How does the CFTC and SEC coordinate their regulation of this type of complex firm? 

Mr. COOK. Senator, as you have noted, the firm was dually registered as both a broker-dealer and an FCM, a Futures Commission 

Merchant. What that means is that both agencies and the self-regulatory organizations under them have oversight over the firm. 

In some respects, our oversight about certain activities would 

focus on securities and the CFTC’s and the DCOs under the CFTC 

would focus on the futures activities. We both have rules, as well, 

that would apply to the entity as a whole, for example, capital 

rules, and the entity would be subject to—have to comply with both 

sets of rules. So being jointly registered means that you have to 

comply with the rules applicable to a broker-dealer and the rules 

applicable to an FCM. 

As you noted, the shortfall that has received a great deal of attention in the press and is a significant concern is on the futures 

side, the segregation of customer assets related to the futures positions. Your question, does that affect the broker-dealer side, I 

think, of course, it is one entity that is now in bankruptcy and 

shortfalls are obviously a significant concern in any customer protection regime. We are continuing to work with the trustee, as is 

the CFTC and other regulatory agencies, to help identify exactly 

what is the position of the firm, both on the securities side and the 

futures side, because one of the challenges here is that the books 

and records of the firm appear to be challenging in terms of getting 

to the bottom of some of these questions. 

I think, just having been in close contact with the CFTC and 

other regulators through the weekend when the firm was exploring 

strategic options, absent this shortfall being identified, there would 

26 

have been a significant chance of a deal happening that would have 

transferred the customer accounts out in the way it is meant to 

happen. So if broker-dealers and FCMs fail sometimes, our goal is 

to make sure if that happens, there is a credible and reliable way 

to protect customers, and that only works if the customer assets 

are available to transfer to a new firm. So in that sense, the shortfall obviously impacts all customers. 

Senator MERKLEY. So is that happening on the broker-dealer 

side? 

Mr. COOK. You mean, is there 

Senator MERKLEY. On the customer—in terms of customers who 

own stocks or placed orders through the securities broker-dealer 

side, have their accounts been transferred out to some other firm? 

Mr. COOK. Not yet. There were many more futures customers, so 

I think the trustee has transferred 17,000 futures accounts that 

had positions in them. There are more that he is seeking to compensate that did not have positions but had collateral. 

Just by way of contrast, on the securities side, he has solicited 

interest in acquiring 450 securities accounts, so it is a much smaller number of affected customers. The trustee has solicited interest 

from potential transferees of those accounts so that they and their 

property could move forward. 

Senator MERKLEY. So is it likely that the account holders on the 

broker-dealer side are whole and undamaged? 

Mr. COOK. I would not want to provide any assurances at this 

time. I can tell you that what the firm self-reported was a shortfall 

on the futures side. The firm’s calculations on the securities side 

with respect to its customer segregation requirements indicated 

that it was in compliance with the securities customer segregation 

rules. But as you can imagine, we are not taking that at face value. 

We are currently working hard to try to verify exactly what is 

there and who owes what so we can provide assurances. 

Senator MERKLEY. The reason—and I am over my time now, so 

I will just summarize this—the reason I am pushing this point is 

trying to understand where there are insights here about the complexities of regulating a firm that is both a broker-dealer and a futures dealer, whether there needs to be stronger firewalls between 

the two halves of the business in order to ensure both the coherence of regulation and the security of one side of the firm, if you 

will, and the customers from fraud on the other side of the firm. 

Those were the types of pieces I am pushing, and I will look forward to kind of—maybe my team can continue the conversation 

with you about insights that can be derived from this. 

Mr. COOK. Absolutely. 

Senator MERKLEY. Thank you. 

Chairman REED. Thank you, Senator Merkley. 

Let me resume, and Ms. Cross, Senator Crapo indicated his interest in the formation of capital, particularly for small companies. 

I know you and your colleagues are working this. Could you let us 

know your latest efforts in terms of capital formation, particularly 

the small enterprises? 

Ms. CROSS. Absolutely. So at Chairman Schapiro’s request, last 

spring, we started an initiative to take a fresh look at our rules to 

see if there are steps we could take to reduce regulatory burdens 

27 

that would help facilitate capital formation by smaller companies, 

if it could be done consistent with investor protection. As I noted, 

if investors are not confident, then they are not going to invest and 

so you do not actually help anyone raise capital. So in everything 

we do, we try to balance the capital formation mission with the investor protection mission. 

The staff has several work streams going right now that are in 

the works. One is to do a study of whether the 500-shareholder 

threshold for reporting should be changed. In 1964 when Congress 

adopted the current 500-shareholder threshold, they had tasked the 

SEC with doing a robust study, so we are doing that again with 

help from Craig’s group. So that is one of the pieces. 

We are working on a concept release on the general solicitation 

issue in private offerings and we are looking at whether there are 

ways we can extend some of the benefits that we give to larger 

companies in capital raising, extend those to smaller companies. 

For example, access to shelf registration, things like that. 

We are being helped tremendously in this effort by our new Advisory Committee on Small and Emerging Companies. It had its 

first—its kick-off meeting 2 weeks ago and they are already working on recommendations, having considered these topics, which we 

brought forward to them at the first meeting. 

And then tomorrow is our—I think it is the 30th Annual Government Business Forum on Small Business Capital Formation that 

is being held at the Commission. I think every Commissioner is 

speaking at it and attending it, so there is obviously great interest 

in the topic. 

Chairman REED. Thank you very much. 

Mr. Lewis, you have an increasingly challenging role to play. The 

relevant legislation requires publication of a rule for the SEC to 

consider market effects, but given the recent court rulings, it is 

hard to tell what ‘‘consider’’ means. In fact, there seems to be suggestion now, and at least rhetoric now, that that is sort of a detailed cost-benefit analysis weighing every conceivable option, et 

cetera, which goes far beyond the literal term ‘‘consider.’’ 

But can you talk about your role in providing that kind of analysis? You alluded to it in your opening remarks. And also, if you 

have a practical difficulty of getting cooperation from market participants in giving you the data you need, which sort of sets up a 

catch-22. You cannot do the analysis to promulgate the regulation 

unless you get cooperation, and you do not get cooperation, so now 

you are vulnerable for a challenge. Can you comment? 

Mr. LEWIS. Yes, Chairman. I would like to comment. As you can 

imagine, the recent ruling on the proxy access case provides significant challenges to the Division including reassessing the way it 

conducts cost-benefit analysis. I think the D.C. Circuit Court clearly took issues with the way cost-benefit analysis has been conducted historically at the SEC, and there are lessons, I think. 

I think what they are really asking us is to take a look at the 

way you actually conduct cost-benefit analysis, and the big takeaway from a lot of the recent decisions, in my opinion, is we need 

to provide a more fulsome discussion of all the various alternatives 

that are on the table, a fulsome cost-benefit analysis around the 

proposed rule, but also around viable alternatives to the rule. And 

28 

part of that will be to provide a complete discussion not only of the 

costs and benefits that we are able to quantify, but of the qualitative costs and benefits, and that is really one of the rubs in trying to analyze cost-benefit analysis, is that so many of the benefits 

that are associated with a particular rule simply do not lend themselves to ready quantification and it is really not feasible in a lot 

of situations. 

I think the other take-away from the proxy access decision is 

that while there is a—currently, the typical practice is to involve 

the Ph.D. economists at the SEC at very early stages in the rulemaking process, I think we need to formalize that process and 

bring them in in a more formal, prescriptive way. 

Chairman REED. Any comment about access to information 

from—proprietary information that could be decisive in your analysis? 

Mr. LEWIS. Yes. That is one of the challenges we face, because 

to quantify benefits or costs associated with the rule, you have to 

avail yourself to data. And if data is not publicly available, many 

times the only way you can get it is to try to request the data 

through the comment period process from market participants. And 

so we, when we propose rules, we frequently will design questions 

that are designed to give us the data. But as you have mentioned, 

a real problem with that process, is that, frequently, there are not 

incentives to provide the data on the part of market participants. 

So if you do not get that data, it is very difficult to do the subsequent analysis. 

Chairman REED. Thank you very much. 

I want to begin with Ms. Rominger on this question, but I would 

like all the panel to weigh in, if appropriate, and that is that so 

much of what you do depends on sort of having a feel for the marketplace, real time information, data, intelligence, and particularly 

with your supervision of mutual funds, one of the issues today 

sweeping across the Atlantic is sovereign wealth funds and who is 

holding what, et cetera. Can you just comment in general terms 

about how you deal with making sure you have access to the most 

relevant information in real time to make these judgments to supervise, in your case, mutual funds, but in the case of others, investment advisors, broker-dealers, et cetera? And you can begin, 

Ms. Rominger. 

Ms. ROMINGER. I will start by giving an example of where having 

additional information has been very helpful to us, and that is in 

the area of money market fund regulation and oversight. Money 

market funds, as I mentioned in my opening comments, have a 

structural fragility in that they are susceptible to runs, as we saw 

in September 2008. In the first round of money market fund reform 

early in 2010, there was a requirement for money market funds to 

disclose holdings information to the SEC on a monthly basis. We 

started receiving that information exactly a year ago, at the end of 

November 2010, and we now have monthly holdings for money 

market funds. 

So this is, I think, an instance where having that data has provided us very important information with respect to the way these 

funds are structured and the implications of that with respect to 

systemic risk. It is a subject of much conversation amongst the 

29 

SEC and other regulators who are involved in systemic risk work. 

I think that is a very good example of where it has been put to 

good purpose. 

As I look at our responsibilities and think about where our greatest needs are, I think it is with respect to experts, technical experts, market experts, experts in analyzing complex financial strategies. I think that the Chairman has identified that as an area of 

increasing focus and increasing resource need for the SEC and that 

is certainly true in the Investment Management Division. 

Chairman REED. Mr. Cook, do you have comments from your perspective? 

Mr. COOK. Yes, sir. In terms of access to data, as I indicated in 

my opening remarks, one of the key challenges we face in monitoring the securities markets, the listed equity markets in particular, is just the enormous volume of data that is there and the 

relatively significant gap between our access and the ability to analyze that data in an efficient way. So we are working on a number 

of initiatives to try to narrow that gap. 

I would say part of it is a rulemaking process to make sure that 

there are the rules in place or a structure in place to get that data 

to the regulators. That would be, for example, the consolidated 

audit trail and the large trader reporting system, where we will 

have better access to data. 

But the second piece of it is having the resources internally to 

be able to make something of that data. We are working closely 

with our colleagues in other divisions, for example, when it comes 

to the consolidated audit trail to make sure that what we are designing is going to be useful for the examination program, for the 

enforcement program, as well as our own market oversight program. But it requires both people and technology to ultimately realize the promise of some of these data enhancement initiatives. 

Another key one that we are working on is in the swaps markets, 

and there, we have a proposed regime for the reporting of all swaps 

to data repositories. But that will present opportunities and challenges for us again in terms of having greater access to information, but now we need the people and the technology to be able to 

leverage that information and be more effective regulators. 

Chairman REED. Mr. di Florio. 

Mr. DI FLORIO. I would just add, Chairman Reed, that there has 

been a tremendous amount of improvement, I think, with the Division of Risk Strategy and Financial Innovation to really help the 

SEC think about taking in significant amounts of data and doing 

more sophisticated analytics around that data. That has been very 

helpful, for instance, with us on the examination program to make 

sure that we are agile and we are not planning our exams based 

on old data, but taking in new data, doing analytics, and as we 

learn about trends or risks, being agile and directing our efforts 

there. 

It has also been helpful to work with the Division of Investment 

Management and the Division of Trading and Markets to identify 

the data that we might be able to gather through the exam program, because we are in the field every day, and we have, I think, 

strengthened our ability and our coordination to be able to have 

dialogs with the firms around specific data that we think we need, 

30 

for instance, exposure to Europe, so that we can not only get data 

in a raw form, but then have the critical dialogs that we need to 

have with the firms to have it make sense and have us be able to 

have a significant response to that data. 

Chairman REED. Mr. Lewis or Ms. Cross. 

Ms. CROSS. I would note in the Division of Corporation Finance, 

what we have focused our resources on recently in the review program is looking at the largest companies on a real time basis. So 

historically, we would have picked them up once a year, looked at 

their filing, given them some comments, and perhaps moved on 

after they responded. What we have figured out is that if we have 

our accountants and lawyers looking at most of what they say and 

do over the course of the year, we are able to pick up trends and 

improve the disclosures across whole areas of the industry based 

on what we are seeing with the leading companies, and I think this 

has been a great innovation in the Division and we hope to do more 

of it because I think that is much more valuable than the episodic 

picking up of a company, looking at its filing, and giving some comments. 

Chairman REED. All right. Mr. Lewis, your comments, and then 

Mr. Khuzami. 

Mr. LEWIS. Yes, if I could just give an example—— 

Chairman REED. Yes, sir. 

Mr. LEWIS. ——of some of the cooperation and collaboration we 

have had with Carlo’s Office, and what we have done is we have 

taken the data initiative in my Division, and the idea is to build 

risk assessment tools that can be used to essentially score investment management companies as to certain classes of risk. And so 

we are taking a layered approach; we begin by discussing what the 

needs are in the Office, and determine the key risks. We start with 

fairly simple models that just perform basic screening of filers. And 

the idea is, as we learn more about the risks in the space, we develop increasingly sophisticated analytic models. So we move from 

screening techniques to, let us say, regression-based techniques, in 

that order. 

Chairman REED. Thank you. 

Mr. Khuzami, any comments? 

Mr. KHUZAMI. From the enforcement perspective, it is slightly 

different, but the same theme. We do everything that we can to get 

access to data and to analyze it, but we are seriously behind the 

curve in our ability to do that. I mean, if you want to conduct a 

thorough and proper insider trading investigation and make sure 

you get all the parties who may be involved in an illicit scheme, 

you would love to have ready access to all equity trading data and 

derivatives data and debt data and overlay a chronology of marketmoving events and you would be able to see patterns and trends. 

We are trying to do some of that, but it is difficult. We need better 

tools, not only in analytics, but to be able to upload information 

and manipulate data to investigate it. It can take weeks and even 

months to upload the massive amount of electronic information we 

get in our investigation and we do not have the proper tools in 

order to be able to analyze it the way we would like to. 

31 

Chairman REED. I have two final questions, but Senator 

Merkley, do you have additional questions? Let me recognize you 

now and take your time and then I will conclude, I hope quickly. 

Senator MERKLEY [presiding]. OK. Thank you, Mr. Chair. 

I wanted to continue this conversation about information, but 

really focus on derivatives. Certainly, we did not have a very good 

understanding of the writing of derivatives here in the United 

States, and I am not sure that we have a very good understanding 

of it currently abroad. Conversations with some of the experts from 

our own rating companies have generated kind of a response of, no, 

we do not really understand who is writing, who is holding, how 

the dominos are set up regarding Europe. And, of course, a lot of 

credit default swaps are being written on a host of European firms 

and sovereign debt. 

So I wanted to start—I realize that this is a world where the 

credit default—the swap world is so divided with interest and foreign exchange swaps on the CFTC side, equity swaps on the SEC 

side, so you all have a piece of this picture, but what do we know 

about European credit default swaps? And if we do not know 

enough, what needs to change? 

Mr. COOK. Senator, maybe I could start with that and then invite 

Mr. Lewis to comment. The primary entities that we regulate that 

would be likely to take on direct exposures to this, are the brokerdealers, and anecdotally and through FINRA, our impression is it 

is not significant exposure to credit defaults. Also capital rules 

make it expensive to book a credit default swap in a broker-dealer. 

However, obviously those transactions can be booked at other entities that are also of general regulatory interest with the banks or 

holding companies or financial institutions, and other regulators 

may have access to some of that information as well. 

But I think overall, there is a gap in our knowledge of this, and 

I think the solution that we are working on, and the CFTC is as 

well, is the development of a mandatory trade reporting regime 

pursuant to Title VII of the Dodd-Frank Act, which would require 

all swap transactions to be reported to a data repository. That 

would be available to regulators. 

There is a separate piece about reporting out to the marketplace, 

which is sort of a transparency piece. But in terms of our prudential systemic oversight of the markets and the risks—— 

Senator MERKLEY. Let me hold you on for just a second there. 

On that repository, when do we expect to have it up and operating? 

Mr. COOK. Well, we have our proposed rules out for the data repository and we would, as I mentioned earlier, need to finish our 

proposal phase for Title VII and then begin adopting. So I think 

we would likely see adoption of this rule sometime in 2012, but I 

am not exactly sure. The order in which we adopt these rules is 

one of the things on which we want to get public comment. 

I will say, though, that most parties we have spoken to have suggested that this ought to be one of the first things that we do because it will enhance our information that we have as regulators 

about what is out there, and may help inform our rulemaking in 

other areas of Title VII. 

Senator MERKLEY. And I will say, in the context of what is going 

on in Europe, it seems like a critical element and it seems like one 

32 

of the simpler elements that ought to be able to be put into place. 

Is there any parallel effort on the European or Asian side? 

Mr. COOK. There are efforts to develop data repositories in other 

jurisdictions, yes. And to some extent, some of this information is 

available today through the trade warehouse that is operated in 

the U.S. Mr. Lewis’s group has done some work in analyzing some 

of that data. It is not complete, and I think that what we are trying 

to get to is a complete picture. 

Mr. LEWIS. So let me briefly tell you, Senator, about some of the 

work that my division has done on the credit default swap data 

that has been provided by the data warehouse. One of the projects 

that we have worked on is to characterize the positions and exposures of the participants in the swap market. And one of the, I 

think, take-aways that we have going up through the data through 

June of 2011 is that financial institutions have been unwinding 

their exposures to the PIIGS’ debt, to basically sovereign European 

debt. 

One of the issues, I think, that is critical if we want to consider 

and evaluate systemic risk is that we need to have a complete picture of all the parties that transact in this space. And to give you 

an example of why I think this is important, one of the experiments we conducted in our group to see how important this issue 

might be is we looked at positions by only considering U.S. financial institutions and U.S. counterparties, but excluded U.S. 

branches in foreign domiciles. 

So take an investment bank, New York Investment Bank, consider their U.K. branches, ignore those U.K. branches transactions, 

and you get a picture of what the counterparty exposures are, what 

the positions look like across counterparties, gross exposures and 

net. 

And then run the experiment again including all the exposures 

by also including the trades that occur in the international or the 

foreign branches, and what we discovered was that positions or exposures could reverse. So if you look like you were a purchaser of 

protection in a credit default swap market, when you incorporated 

all the branches, all the transactions we had access to, you could 

actually see the positions reversing. 

If we are going to manage systemic risk, I would advocate we 

need to get all the trades, not just the trades that take place by 

U.S. banks and their branches, but if you want to measure systemic risk, you want to look at everybody who is in this market so 

you can get a complete picture of what the credit risk is like. 

Senator MERKLEY. How does the Office of Financial Research fit 

into this issue of understanding the collective picture? 

Mr. LEWIS. I have actually had discussions with the Office of Financial Research and alerted them to this issue, and I believe that 

they are actually working on it. Probably should not attribute 

workload to the Office of Financial Research, but it is certainly a 

suggestion that I have made to them, that they should investigate. 

Senator MERKLEY. Thank you. 

Chairman REED. Thank you, Senator Merkley, and let me just 

say that they would even be more responsive if they had a confirmed head of the Office of Financial Research. That is a message 

to the broader public. 

33 

Final question and I think it is an important one to ask and it 

is just really two parts. One is that there has been criticism lodged 

against the SEC about being too close to the institutions and the 

businesses that you regulate. Related to that is the issue of a revolving door process. And I wanted to get, Mr. di Florio, a comment 

on how you sort of deal with that in terms of making sure that 

does not affect your ability to effectively perform your duties on behalf of the public. 

And then a related question. I ask this with trepidation because 

one of my former experiences was commanding a paratrooper company. If anybody asked my company how the morale was, I shuddered a little bit in terms of what they might say. But you might 

also indicate just what you sense the morale is in your division. 

Those are those two little related issues. 

Mr. DI FLORIO. Sure. First, Senator Reed, we are very cognizant 

of the revolving door issues and have put in place a number of significant controls that really focus on that issue. We have an Ethics 

office that reports directly to the Chairman and has a new head 

and is very focused on ensuring that there are effective policies and 

procedures, and there are limitations on how people can interact 

with the SEC once they leave the SEC. They maintain that dialog 

with the Office of Ethics. So there are a lot of rules, both civil and 

criminal, that govern our conduct with regard to the revolving door. 

In the Exam Program, in addition to that, we have our own Code 

of Conduct that adds additional requirements because we want to 

make sure that examiners do not present conflict of interest, and 

there are additional controls that require supervisors to be 

dialoguing with individuals on their team involved in various 

exams and make sure that there are not any conflicts or relationships. 

I would make an observation on the flip side, which is that we 

have been able to bring in some terrific talent to the SEC that 

makes us relevant and current with regard to complex structured 

products, derivatives, hedge funds, because we are able to recruit 

people who have their finger on the pulse of industry practices. 

And my observation in my own view has been that individuals 

that we have brought in with industry expertise and experience 

have been some of our most effective and aggressive examiners because they understand the games that registrants can play. They 

are very focused on targeting our efforts exactly to those high-risk 

points of interaction or product and making sure that we are identifying those issues. 

So I think when it works well, the complement of our talented 

and dedicated existing team at the SEC, coupled with incoming individuals from industry to bring new expertise and experience, 

really strikes a terrific balance and makes us more effective in protecting investors, ensuring market integrity, staying in front of 

issues, and being able to protect the markets and investors. 

With regard to the second issue on morale, I think that is a terrific question and something that we are very focused on at the 

SEC. Chairman Schapiro has fostered a very open culture of teamwork and collaboration, and I think that is stronger than it has 

probably ever been at the SEC. 

34 

At the same time, we have an incredible workload with DoddFrank and have made requests for more resources to help us meet 

that workload. And I think that tension can create some morale 

challenges that we need to be very cognizant of. There is a relationship between resources and morale and an ability to do the job 

well. 

At the same time, we have initiated, throughout the agency, 

human capital surveys to make sure that we are keeping our finger 

on the pulse of morale, what are the root causes of morale concerns 

or issues, and putting in place action plans every year that are 

monitored to follow up on the morale issues. 

And I think that that is something that we all need to make a 

priority and we do, as directors of the various divisions and offices. 

I know in the National Exam Program, people, culture, and morale 

is one of our top priorities this year. 

Chairman REED. Thank you. Mr. Lewis, please, any comments? 

Mr. LEWIS. With respect to the issue of morale? 

Chairman REED. Or people coming in and out, too close. You are 

somewhat removed because of your analytical responsibilities, but 

those two topics, comments that you might have. 

Mr. LEWIS. Well, if I had to comment on the revolving door, I 

would say it is probably a good thing for economists because they 

basically go back to their academic institutions when they revolve 

back out. And actually, if we can engage financial economists in becoming interested in regulation, it creates a lot more opportunity 

to see research being conducted, independent research being conducted around the rulemaking space. So you could argue it is a 

positive for my division. 

With respect to morale, I have only been in the office since June, 

but I would like to think that things are going pretty well. 

Chairman REED. Good. Ms. Rominger. 

Ms. ROMINGER. In the Division of Investment Management, there 

are very few people in the division, with the exception of myself, 

who have come from the asset management industry. Frankly, I 

think we need additional people from the industry. It has grown 

much more complex over time. 

Some of the challenges we are facing today are quite different 

than the challenges that the division faced 5 or 10 years ago, and 

with the increase in complexity, we need people on board who understand how these instruments and how these strategies actually 

work in the real world. 

And so, we absolutely must have the correct protections in place 

to make sure that we have the appropriate distance as regulators, 

but we do need that expertise. So with respect to morale, in my 9 

months at the SEC, I have found that most of the people I work 

with are motivated to engage in public service because of their 

strong desire that they can make things better and that is what 

drives them and motivates them. 

And I think morale is quite good because I think they get a sense 

that there is a great deal of positive change occurring in the agency 

right now. 

Chairman REED. Thank you. Mr. Cook, please. 

Mr. COOK. Thank you. I think keeping in touch with the markets 

and keeping up to speed with the latest developments is critical to 

35 

the effective implementation of our responsibilities and we do that 

through a variety of ways including the comment process, and 

meetings with market participants. 

But the ability to bring in folks who have been on the other side 

and know where the issues lurk, I think, is pretty crucial. I echo 

the comments of my colleagues about how it is obviously crucial to 

manage the ethical obligations associated with that, but I think 

that that can be done and done effectively, and I think it has really 

enhanced and enriched our ability to try to get the rules right. 

In terms of morale, I would just add that I am, having come from 

outside of Government into Government, I am truly amazed by the 

dedication of the staff and the long hours they put in on the tasks 

that we give them. The productivity in our division is many multiples of what it has been in some prior years in terms of just the 

output. Same number of people, much more being asked of them 

and it is truly remarkable how far they are willing to go. 

I think to some extent, this is why they are there. This is a great 

time to be working at the agency and working on these key issues. 

But I would echo the concerns that have been mentioned already 

about how ultimately people do need to feel they have the resources to do their jobs effectively, and it is hard to take the hill 

if you do not have the right equipment and manpower. 

Chairman REED. Absolutely. Ms. Cross. 

Ms. CROSS. I agree with everything that has been said about the 

revolving door—the fresh insights that come in from people who 

have recently been in industry help us do our job better. And we 

are extremely careful about the ethical concerns. You have heard 

me mention recusals today. There is no shame in saying, I cannot 

work on something because I had a contact with it in my prior job, 

and I think that regularly occurs and I think that is an important—— 

Chairman REED. If I may, one of the concerns is not so much 

people coming in, it is the people going out, and—— 

Ms. CROSS. And I think on the going out front, I would say, since 

I have done that—— 

Chairman REED. Right. 

Ms. CROSS. ——I think that overall, the investing public benefits 

because people who have worked at the Commission have an appreciation of what it is that we are trying to do, and I think SEC 

alumni are especially careful practitioners. I think they go out and 

populate the securities bar with people who want to do the right 

thing. So I think actually it is a very positive development and I 

would hope it will continue. 

On the morale point, I would like to echo what Robert said about 

the incredibly hard work the staff is currently going through. I 

worry sometimes that we do not say enough about how much we 

appreciate them. You have to stop and take a deep breath and remember to do that a lot because they have all been sacrificing their 

personal lives to work through the Dodd-Frank rulemaking, and 

before that we were very busy in my division with rulemaking. So 

it has been flat-out for 21⁄2 years since I have been there. 

And then on the review program, I am amazed every day at how 

enthusiastic and fresh they remain when they pick up a company 

and they look at the filing and they search the Internet to see what 

36 

else the company is saying and come up with good comments that 

improve the disclosures. 

And I think that—I hope—morale is good. It is hard to know 

with as many people as we have, but I would say that I know I 

appreciate how hard they are working. 

Chairman REED. Thank you. Mr. Khuzami. 

Mr. KHUZAMI. Yes, thank you, Mr. Chairman. I agree with the 

sentiments expressed here. With respect to the expertise, it is critically important. You know, it was not very long ago at all that everyone was criticizing the SEC for lacking the expertise in order to 

deal with complex products and transactions and markets, and we 

have done that. 

We have as good, if not better, set of ethical restrictions on the 

way out with respect to permanent bans on involvement in matters 

that you participated in once you leave, 2-year ban on being involved in matters that you supervised, and just down the line a 

great deal of restrictions. 

Second of all, in my experience, both in the Department of Justice and here, particularly the SEC, the ability of one person, even 

if they were so inclined, not to do anything other than follow a case 

on its merits and make a recommendation and decision and take 

investigative steps that were in the best interest of the case, is virtually impossible to do. 

We work in teams with great levels of review by multiple people, 

with thorough oversight. It would be very difficult for one person 

to do that, even if they were so inclined, and I have not met such 

a person. 

In addition, that is not the way you would gain any respect within the Enforcement Division and within the Commission. You are 

respected if you are hard-driving and thorough and professional 

and disciplined and intelligent. And to do anything else hurts your 

reputation, hurts your ability in the outside world, when and if you 

were to leave. 

And last, the people who leave the SEC are really Ambassadors 

for compliance and good practices. They go to firms and they advise 

clients and they know the consequences of what can happen if they 

cross the line, and we have to leverage those people so that some 

CEO who may be inclined to take a shortcut will listen to their 

general counsel or their compliance officer who says, Here is what 

can happen to you, here is what the SEC might do if you do not 

act appropriately. So I think it is a win-win all the way around. 

GAO looked at our revolving door issues as part of Dodd-Frank 

and came away with the single recommendation that we should 

better document our ethics advice. And so, I think all in all, the 

arrangement is the right one for investors. 

With respect to morale, people work incredibly hard and are incredibly committed. The undifferentiated criticism that sometimes 

occurs takes its toll, quite honestly. People are not afraid of being 

told that they can do things better. We restructured the entire Enforcement Division. People responded in a way that is in the best 

traditions of anybody in the public or private sector. You know, do 

not shoot the messenger. Look at what is the right thing to do. 

Make changes that are necessary. That has occurred up and down 

throughout the division. 

37 

What will happen is eventually if the market turns and people 

do not have the resources they need, they will be more attracted 

to jobs on the outside and that would be a terrible, I think, result 

for investor protection and our efforts because our employees are 

highly valued and experienced. 

They want to be at the SEC. They want to be public servants. 

It can be difficult if you are at the Xerox machine at 11 o’clock at 

night photocopying your own trial exhibits. That is what happens. 

Chairman REED. Well, thank you all very, very much today, not 

only for your thoughtful responses and testimony, but for your 

dedicated public service and particularly your patience. Thank you 

all. 

If Members, my colleagues, have their own written statements or 

additional questions for witnesses, they should be submitted no 

later than next Wednesday, November 23rd, and I would ask the 

panel to respond as quickly as possible to any written questions 

you may receive. 

All the written testimony that you have submitted will become 

part of the record. Again, I thank you for your service and for your 

testimony this morning. With that, the hearing is adjourned. 

[Whereupon, at 11:31 a.m., the hearing was adjourned.] 

[Prepared statements supplied for the record follow:] 

38 

PREPARED JOINT STATEMENT OF HEARING WITNESSES FROM THE 

SECURITIES AND EXCHANGE COMMISSION 

NOVEMBER 16, 2011 


11161101.eps
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11161102.eps

longstanding core responsibilities. These responsibilities - pursuing securities fraud, reviewing 

public company disclosures and financial statements, inspecting the activities of investment 

advisers, investment companies, broker-dealers and other registered entities, and maintaining fair 

and efficient markets - remain essential ingredients to restoring investor confidence and trust in 

financial institutions and markets following the recent financial crisis. 

Over the past decade, the SEC has faced significant challenges in maintaining a staffing level 

and budget sufficient to carry out its core mission. The SEC experienced three years of frozen or 

reduced budgets from FY 2005 to 2007 that forced a reduction of 10 percent of the agency's 

staff. Similarly, after significant increases in technology spending from FY 2002 to FY 2005 the 

agency's investments in new or enhanced IT systems declined about 50 percent from FY 2005 to 

2009. 

As a result of increased funding levels in FY 2009 and FY 2010, current SEC staffing levels are 

just returning to the level ofFY 2005, despite the enormous growth in the size and complexity of 

the securities markets since then. During the past decade, for example, trading volume has more 

than doubled, the number of investment advisers has grown by 50 percent, and the assets they 

manage have increased to $43 trillion. A number of financial firms spend many times more each 

year on their technology budgets alone than the SEC spends on all of its operations. Six years 

ago, the level of SEC funding was sufficient to provide 19 examiners for each trillion dollars in 

assets under management by investment advisers. Today, that figure stands at 12 examiners per 

trillion dollars. 

Today, the SEC has responsibility for approximately 35,000 entities, including oversight of 

11 ,700 investment advisers, 9,500 mutual funds and ETFs and close to 5,000 broker-dealers with 

more than 160,000 branch offices. We also review the disclosures and financial statements of 

nearly 10,000 reporting companies. The SEC also oversees approximately 500 transfer agents, 

15 national securities exchanges, 8 active clearing agencies, and several nationally recognized 

statistical ratings organizations (NRSROs), as well as the Public Company Accounting Oversight 

Board (PCAOB), Financial Industry Regulatory Authority (FINRA), Municipal Securities 

Rulemaking Board (MSRB), and the Securities Investor Protection Corporation (SIPC) In 

addition, the Enforcement Division has jurisdiction over any person or entity that violates the 

securities laws, regardless of whether they are associated with one of these 35,000 entities. 

In addition to our traditional market oversight and investor protection responsibilities, the 

enactment of the Dodd-Frank Act has added significant new responsibilities to the SEC's 

workload. These new responsibilities include a parallel set of responsibilities to oversee the 

over-the-counter derivatives market, including direct regulation of participants such as securi tybased swaps dealers, venues such as security-based swap execution facilities, warehouses such as 

security-based swap data repositories, and clearing agencies set up as long-term central 

counterparties. In a similar fashion, whereas the agency has long overseen traditional asset 

managers, under the Dodd-Frank Act, the SEC has been charged with similar responsibilities for 

private fund advisers, including those that trade with highly complex instruments and strategies. 

Additionally, the Commission has new responsibility for the registration of municipal advisors, 

enhanced supervision ofNRSROs, heightened regulation of asset-backed securities, and creation 

of a new whistleblower program. 

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In acknowledgement of this significant new workload, the Dodd-Frank Act authorized a 

significant increase in the agency's budget authority over the next several years. So far, the SEC 

has proceeded with the first stages of implementation of the Dodd-Frank Act without additional 

funding as appropriations have not matched the increased budget authority This implementation 

activity largely has involved performing studies, analyses, and writing rules. These initial tasks 

have taken staff time away from other critical responsibilities, as we have carried them out 

almost entirely with existing staff. It is the next step of making the new oversight regimes 

operational that will require significant additional resources. 

This resource gap was highlighted in a report prepared by the Boston Consulting Group (BCG) 

pursuant to Section 967 of the Dodd-Frank Act that directed the agency to engage the services of 

an independent consultant to study a number of specific areas of SEC operations. In addition to 

highlighting this resource gap, the BCG study is providing an opportunity to re-examine and 

improve the SEC's operations. The Commission staff is conducting a thorough anal ysis of each 

recommendation and designing appropriate approaches for those recommendations selected for 

implementation. 

Notwithstanding these challenges, the Commission remains committed to serving the public in 

satisfying our three-part mission. To this end, it is incumbent upon us to use our existing 

resources as efficiently as we can. Simply put, as we protect investors, we have an obligation to 

be good stewards of the resources that are or may be allotted to us. 

DIVISION OF ENFORCEMENT 

Director, Robert Khuzami I 

A vigorous enforcement program is at the heart of the agency's efforts to protect investors and 

promote the integrity of the marketplace. As the SEC's largest division, the Enforcement 

Division investigates and brings civil charges in federal district court or in administrative 

proceedings based on violations of the federal securities laws. Successful enforcement actions 

result in sanctions that deter wrongdoing, protect investors, both now and in the future, and 

result in penalties and the disgorgement of ill-gotten gains that are returned to harmed investors, 

as well as barring wrongdoers from working in the industry. 

Structural Reforms 

Over the past two years, the Enforcement Division carried out the most significant structural 

reforms of the enforcement program since 1972 - reforms designed to maximize resources and 

enable us to more effectively combat securities fraud. Highlights of this programmatic 

transformation include: 

Specialization. The introduction of five new national specialized investigative units 

dedicated to high-priority areas of enforcement which consist of: Asset Management (hedge 

1 Mr. Khuzami joined the SEC as Director of Enforcement in March 2009. 

http://www.sec.gov/newsJpressI200912009-31.htm 

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11161104.eps

funds and investment advisers), Market Abuse (high-volume and computer-driven trading 

strategies, large-scale insider trading, and market manipulation schemes), Structured and New 

Products (various derivative products), Foreign Corrupt Practices Act violations, and Municipal 

Securities and Public Pensions. The specialized units, as well as various specialization initiatives 

in our regional offices, are utilizing enhanced training, specialized industry experience and skills, 

and targeted investigative approaches to better detect links and patterns suggesting wrongdoing 

- and ultimately to conduct more efficient and effective investigations. In addition to 

investigative work, the specialized units are engaged in a number of initiatives with our 

colleagues in the Office of Compliance Inspections and Examinations (OcrE) and other 

divisions to develop risk analytics that proactively identify high-risk areas for further 

examination and investigation. 

Management Restructuring. The Division has adopted a flatter, more streamlined 

organizational structure under which it has reallocated a number of managerial staff to the 

mission-critical work of conducting front-line investigations While a layer of management has 

been eliminated, the Division is maintaining staff-to-manager ratios that allow for close 

substantive consultation and collaboration, resulting in a management structure that facilitates 

timeliness, quality, and staff development. 

Office of the Managing RtecutiJle. A strong operations function is also critical to the 

success of the Division. To that end, we created the Office of the Managing Executive to apply 

critical expertise to the operations arena. This office now oversees functions such as IT forensics 

and litigation support, case management systems, and collections and distributions activities; and 

broader operational areas like the budget, process improvement and project management, 

internal controls, and human resources. This office is also leading the division's efforts to create 

and collect data, including a set of quantitative and qualitative metrics, and to incorporate this 

data into our regular case review process. The result of creating this "COO-type" function 

within the Division is that the critical operational tasks just mentioned will be performed by 

persons with the appropriate expertise, thus leaving more time for the staff to focus on the 

mission-critical work of conducting investigations and core enforcement activities. 

Office of Market Intelligence. Enforcement established an Office of Market Intelligence 

to serve as a central office to handle tips, complaints and referrals ("TCRs") that come to the 

attention of the division; coordinate Enforcement's risk assessment activities; and support 

Enforcement's strategic planning activities. This office will allow the division to have a unified, 

coherent, coordinated response to the huge volume ofTCRs we receive every year, thereby 

enhancing our ability to conduct the right investigations, bring solid cases, and effectively 

protect investors. In addition, we will use this information to identify emerging threats to 

investors and markets, which will in turn inform how we employ our limited enforcement 

resources in order to optimize investor protection and deterrence. 

Moreover, over the past two years, we have completely revamped the way the entire agency 

handles TCRs, including new policies, procedures and systems, as well as creating a centralized 

database so that staff across the agency has this information available to them. The TCR system 

improves our ability to obtain information from the public while providing the staff with 

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workflow tools to better correlate, prioritize, assign and track progress of TCRs through to 

resolution. 

Streamlining Process. We improved our law enforcement capabilities and sent a clear 

signal internally and externally that we value toughness and speed. For example, the 

Commission delegated to senior staff the authority to initiate formal investigations and issue 

subpoenas without the prior approval of the Commission. We also have eliminated approvals for 

certain routine settlement discussions, Wells notices and the opening of initial matters under 

investigation. Proper levels of supervision and oversight remain across all of these areas. 

Whistleblower Office. The Dodd-Frank Act substantially expands the agency's authority 

to compensate individuals who provide the SEC with useful information about violations of the 

federal securities laws. Last November, the Commission proposed rules mapping out the 

procedure for would-be whistleblowers to provide critical information to the agency. The 

Commission adopted final rules in May, which became effective on August 12, 2011. The final 

rules set forth how eligible whistleblowers must submit their tips to be eligible for an award, the 

process to apply for an award, and sets forth eligibility criteria and applicable definitions. The 

Office of the Whistleblower is currently staffed with six attorneys and a senior paralegal and is 

actively recruiting a Deputy Chief. Staff in the Office of the Whistleblower are communicating 

with whistleblowers and their counsel, conducting internal and external training sessions and 

working with enforcement staff on documenting whistleblowers' ongoing contributions to 

current investigations. The Commission also has fully funded from monetary sanctions collected 

in enforcement actions, the SEC Investor Protection Fund, which will be used to pay awards to 

qualifying whistleblowers. 

Cooperation Progr(lf1L We have added a series of measures to encourage corporate 

insiders and others to come forward with evidence of wrongdoing. These new cooperation 

initiatives establish incentives for individuals and companies to fully and truthfully cooperate 

and assist with SEC investigations and enforcement actions. This program encourages "insiders" 

with knowledge of wrongdoing to come forward early, thus allowing us to build stronger cases 

and shut down fraudulent schemes earlier than would otherwise be possible. 

Effective Results 

Record Number of Enforcement Actions Filed. Although statistics alone cannot capture 

the breadth of the Division's work, since undertaking these reforms, the SEC's enforcement 

activity has increased significantly, resulting in substantial benefits for markets and investors. In 

recently-ended fiscal year 2011 , the first complete fiscal year since the Division's reorganization, 

the SEC filed 735 enforcement actions - more enforcement actions than ever filed in a single 

year in SEC history. Those enforcement actions resulted in more than $2.8 billion in penalties 

and disgorgement ordered in fiscal year 2011. In fact, in each of the past three fiscal years, we 

have filed more enforcement actions than in the previous fiscal year. 

Financial Crisis Cases. During the last two-and-a-halfyears, the agency has filed 36 

separate actions in its financial crisis-related cases against 81 defendants - nearly half of whom 

were CEOs, CFOs and senior corporate executives, resulting in approximately $1 .97 billion in 

disgorgement, penalties, and other monetary relief obtained. This includes enforcement actions 

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against Goldman Sachs and Citigroup, as well as senior executives from Countrywide Financial, 

New Century and American Home Mortgage. In FY 2011 , the SEC filed 15 separate financialcrisis-related actions naming 17 individuals, including 16 CEOs, CFOs and other senior 

corporate officers, involving wrongdoing related to the financial crisis. These cases include 

enforcement actions involving collateralized debt obligations (CDOs) charging J.P. Morgan 

with misleading investors in a CDO as the housing market began to plummet, Wachovia Capital 

Markets with misconduct in the sale of two CDOs tied to the performance of residential 

mortgage-backed securities, and two firms (Stifel, Nicolaus & Co. and RBC Capital Markets) 

with misconduct in the sale of unsuitable CDO investments to five Wisconsin school districts. 

The SEC also charged six executives at Brooke Corporation and three executives at mortgage 

lender IndyMac Bancorp for misleading investors about the deteriorating financial condition at 

their respective companies. Separately, Morgan Keegan & Company this year paid $200 million 

to settle charges brought in fiscal year 201 0 that it falsely valued subprime mortgage securities in 

five funds managed by an affiliate, with the controller and portfolio manager also charged. 

Insider Trading Cases. The Division's focus on insider trading cases has resulted in 

enhanced enforcement, with 57 actions filed in fiscal year 2011 by the SEC - a nearly 8 percent 

increase over last year's total. Among those charged in SEC insider trading cases in the past 

fiscal year were various hedge funds managers and traders involved in a $30 million expert 

networking trading scheme, a former NASDAQ Managing Director, a former Major League 

Baseball player and an FDA chemist The SEC also brought insider trading charges against a 

Goldman Sachs employee and his father who traded on confidential information learned at work 

on the firm's ETF desk, and a corporate board member of a major energy company and his son 

for trading on confidential information about the impending takeover of the company. In fiscal 

year 2011 , the SEC obtained judgments in 18 actions arising out of its investigation of hedge 

fund manager Raj Rajaratnam, the founder of Galleon Management, who was recently convicted 

of multiple counts of insider trading. Just last week, the SEC obtained a record financial penalty 

of $92.8 million in its civil action against Rajaratnam In addition, the SEC provided significant 

assistance to the U.S. Attorney's Office for the Southern District of New York in its successful 

criminal prosecution of Rajaratnam. 

Financial Fraud and Issuer Disclosure Cases. The SEC brought 89 actions in fiscal 

year 2011 charging financial fraud and issuer disclosure violations. Those cases included actions 

charging Sat yam Computer Services Limited with fraudulently overstating its financial results by 

more than $1 billion over five years, the India-based affiliates of Price waterhouse Coopers for 

their audit failures related to Sat yam, and DHB Industries, Inc. , a major supplier of body armor 

to the U.S. military and law enforcement agencies, for engaging in a massive accounting fraud. 

The SEC also filed separate fraud charges against DHB's former outside directors and audit 

committee members charging them with facilitating the company's fraud. 

Im'estment A(b>iser and Broker-Dealer Cases. The agency filed a total of 146 

enforcement actions related to investment advisers and investment companies, a single-year 

record and 30 percent increase over fiscal year 2010. The SEC also brought 112 enforcement 

actions related to broker-dealers in fiscal year 2011 , a 60 percent increase over last fiscal year. 

Among those charged in SEC investment adviser and broker dealer actions in the past fiscal year 

were Charles Schwab entities and executives for making misleading statements to investors 

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regarding a mutual fund heavily invested in mortgage-backed and other risky securities, AXA 

Rosenberg Group LLC and its founder for concealing a significant error in the computer code of 

the quantitative investment model that they used to manage client assets, and Merrill Lynch, 

Pierce, Fenner & Smith for misusing customer order information to place proprietary trades for 

the firm and for charging customers undisclosed trading fees. The Schwab entities paid more 

than $118 million to settle the SEC's charges, while AXA Rosenberg paid $217 million to cover 

investor losses and a $25 million penalty. 

Cases Arising from Cross Border Working Group. The work of the SEC's Cross Border 

Working Group, a proactive risk-based initiative focusing on U.S. companies with substantial 

foreign operations, led to numerous important enforcement actions in fiscal year 2011. This 

included the first-ever stop orders for post-effective registration statements due to the resignation 

ofa company's independent auditor and multiple trading suspensions of China-based U.S. 

securities because of concerns over the accuracy and completeness of their publicly filed 

information. 

Cases Targeting Vulnerable Investors. The SEC also brought actions against 

individuals and firms charging them with targeting vulnerable investors in fiscal year 2011, such 

as cases charging the three senior executives at Fair Finance Company with orchestrating a $230 

million fraudulent scheme involving thousands of investors, many of them elderly, and the 

internet-based investment company Imperia Invest IBC with operating a scheme targeting many 

members of the deaf community. 

Finally, the following sample of cases filed by the Enforcement Division in one seven-day period 

in October 2011 reveals both the complexity and the diversity of the markets, practices, and 

products that we police, as well as the depth of expertise needed to do our job effectivel y: 

• Failure to disclose to investors that a firm structuring and marketing a $1 billion 

collateralized debt obligation also exercised significant influence over the selection of 

$500 million of the assets included in the CDO and took a proprietary short position 

concerning those $500 million of assets during a time when the U.S. housing market was 

showing signs of distress. (SEC v. Citigroup Global Markets and Brian H. Stoker, filed 

October 19, 2011); 

• Misleading representations to customers of a "dark pool" trading platform that 

customers' interests in trading large amounts of stock would be anonymously matched 

while failing to disclose that the overwhelming majority of the shares traded on its dark 

pool platform were in fact bought or sold by a wholly owned subsidiary of Pipeline. 

(SEC v. Pipeline Trading System LLC, Fred Federspeil and Alfred R. Berkeley III, filed 

October 24, 2011); 

• Insider trading by a then-director of both Goldman Sachs and Procter & Gamble who 

provided confidential Board information about both companies' quarterly earnings and 

about an impending $5 billion Berkshire Hathway investment in Goldman Sachs to Raj 

Rajaratnam, the now-convicted founder of the Galleon hedge fund, who traded on that 

information. (SEC v. Rajat K. Gupta and Raj Rajaratnam, filed October 26, 2011); and 

• Misleading statements to prospective investors by an investment advisory firm and its 

principal concerning the principal's education, work experience, and the fund 's auditor, 

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prime broker/custodian, and corporate status when soliciting individuals to invest in their 

purported quantitative hedge fund while at the same time diverting investor money to the 

principal's personal bank account. (SEC v. Loclist Offshore Management and Andrey C. 

Hicks, temporary restraining order and asset freeze filed October 26, 2011). 

Upcoming Challenges 

Two overarching principles drive the Division's enforcement program. First, we need to stop 

fraud and misconduct as early as possible, before investor losses have mounted, evidence 

becomes stale, perpetrators have vanished, and the opportunities to partner with our criminal law 

enforcement colleagues to employ undercover and other proactive investigative techniques have 

been lost. Second, we must be an effective enforcement and deterrent force in complex markets 

and with regard to opaque and complicated products and transactions. This can be accomplished 

through increased expertise, recruitment and retention of high-quality legal talent, and expanded 

use of market data and other quantitative analytics. As shown above, the Division's record fiscal 

year 2011 achievements in both the quality and quantity of cases reflect that we are achieving 

both of these visions - an accomplishment all the more noteworthy given that it occurred sideby-side with implementation of the biggest restructuring in the history of the Division. 

The Enforcement program continues to face challenges in securing the necessary expertise, 

human capital and technology resources to fulfill our mission of investor protection. For 

example, in the market abuse area, we need increased expertise and human capital to analyze 

new trading technologies, such as high-frequency and algorithmic trading, data feed latency 

issues, and large volume trading, as well as systemic insider trading and manipulation schemes. 

In the asset management area, we must keep pace with the ever-evolving issues of valuation of 

illiquid portfolios, false performance claims, preferential redemptions, and high-risk emerging 

products. In the municipal securities markets, we need better understanding of pension liability 

disclosures, valuation issues, and tax-arbitrage activities. These examples are just part of a 

broader array of challenges stemming from the fast-paced change and increasing complexity 

apparent in the financial products, markets, transactions, and practices that the Division 

confronts. 

Integral to our understanding of these and other areas is an improved ability to analyze large 

volumes of information, including both structured and unstructured data. As a result of 

subpoenas and other information-gathering efforts, the Division receives each month 

approximately three to four terabytes of electronic data. As a comparison, 20 terabytes is often 

noted as the equivalent to the printed book collecti on of the US. Library of Congress. We need 

enhanced tools to consolidate and mine this data, link it together, and combine it with data 

sources from within and beyond the Commission. This level of analysis would enable staff to 

more effectively identify risks to investors, trends in the markets, and patterns of activity that 

may merit further investigation. 

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11161109.eps

CORPORATION FINANCE 

Director, Meredith Cross2 

The Division of Corporation Finance (CF) is responsible for overseeing the agency's review of 

company disclosure to the investing public. The Division has two primary missions: to see that 

investors have access to material information and to deter fraud and misrepresentation in the 

offering, trading, voting, and tendering of securities. The Division's primary authority is derived 

from three statutes the Securities Act of 1933 ("1933 Act"), the Securities Exchange Act of 

1934 ("1934 Act"), and the Sarbanes-Oxley Act of2002. 

Generally, CF reviews company filings, makes rulemaking recommendations to the 

Commission, and provides interpretive advice to market participants and the public about the 

securities laws and corresponding regulations. During FY 2011 , the Division established three 

new offices - the Office of Structured Finance, which focuses on disclosure reviews and policymaking for asset-backed securities and other structured products; the Office of Capital Markets 

Trends, which evaluates trends in securities offerings and in our capital markets to determine 

whether our rules, regulations, and review approach are adequately addressing them; and a new 

review group in disclosure operations, which focuses on the largest financial institutions. In light 

of budget constraints, the Division staffed these offices almost entirely by transferring existing 

staff to them. If resources permit, the Division plans to add resources to these offices to fully 

staff them to enable them to carry out their intended work. 

Review of Filings 

CF selectively reviews filings of new issuers and public companies reporting under the 1934 Act 

to both monitor and enhance compliance with disclosure and accounting requirements. The 

particular filings reviewed are selected based on the Division's non-public selective review 

criteria. The staff members engaged in filing reviews have accounting and disclosure expertise 

aligned with the industries in their respective review groups. Approximately 80 percent of the 

staff of the Division is assigned to the disclosure review program. 

The Sarbanes-Oxley Act requires the Commission to review disclosures made by companies 

reporting under the 1934 Act at least once every three years and more frequently where 

circumstances warrant. Under Sarbanes-Oxley, this review is required to include the company's 

financial statements. In fulfilling its missions, the staff reviews the disclosure of many 

companies more often than once every three years. For example, the largest companies that 

represent the most risk to investors are reviewed more often and the largest financial institutions 

currently are reviewed continuously on a real-time basis. CF also selectively reviews registration 

statements and other filings made under the 1933 Act and the 1934 Act relating to capital raising 

transactions or business combinations. For example, the staff in CF has also allocated its 

resources to the review of 1934 Act filings made in connection with reverse mergers. 

In the course of a review, the staff will issue comments to a company to elicit better compliance 

with applicable disclosure requirements. In response to those comments, a company may need to 

amend its financial statements or other disclosures to provide additional or enhanced 

2 Ms. Cross joined the SEC as Director of Corporation Finance in June 2009. 

http://www.sec.gov/news/pressI200912009-78.htm 

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information, or may undertake to improve its disclosures in future filings. Where appropriate, 

CF refers matters to the Division of Enforcement. 

CF is in the process of enhancing its disclosure review program, including by increasing its focus 

on large and financially significant registrants The increased focus on these companies requires 

greater resources than traditional disclosure reviews, and the ability to implement these 

enhancements turns on whether we are able to allocate sufficient resources, balancing all other 

demands on the Division and its limited staff. 

Smaller reporting companies - generally, those with a public float less than $75 million -

comprise over half of the public companies filing with the SEC, yet their aggregate market 

capitalization is less than one percent of the total market capitalization of all reporting companies 

that the Division reviews. While these companies, and investors making decisions about them, 

may particularly benefit from detailed SEC staff review, in light of resource constraints and the 

small market capitalization of these issuers, the Division is in the process ofrecalibrating its 

reviews of smaller companies to gain efficiencies, while still satisfying the Sarbanes-Oxley Act 

mandate to review the financial statements of all public companies at least once every three 

years. 

Interpretive Advice 

CF provides advice to market participants and the public through interpretive releases, staff legal 

and accounting bulletins, updates to the Division's financial reporting manual, no-action and 

interpretive letters, issuance of compliance and disclosure interpretations and staff disclosure 

guidance topics on the Commission's website, and responses to telephone and e-mail inquiries. 

As the Commission implements the remaining rules required under the Dodd Frank Act, CF 

expects there to be an increase in workload in requests for interpretive advice. 

Rulewriting 

CF also recommends new rules or changes to existing rules to the Commission as needed to 

improve investor protection through enhanced disclosure requirements and to facilitate capital 

formation. CF's recent rulewriting activities have focused on asset-backed securities, proxy 

disclosure and voting, and Dodd-Frank Act implementation. Most recently, CF has commenced 

a significant project designed to facilitate capital formation by reviewing and if consistent with 

investor protection, recommending changes to current offering rules. These efforts, which have 

been largely staffed using existing resources, are described briefly below. 

Capital Formation Matters. The Division is currently reviewing some of the current 

offering rules to develop ideas for the Commission to consider that may reduce the regulatory 

burdens for capital formation, including for small business, in a manner consistent with investor 

protection. These include: 

• The number of shareholders and other triggers for public reporting. The staff is 

reviewing the triggers for public reporting and the characteristics of companies that 

should be subject to public reporting obligations. To facilitate the Commission's 

review of the issues related to the thresholds for public reporting (and those for 

leaving the reporting system), the staff is undertaking a robust study much like the 

one conducted when Section 12(g) was enacted. The study is seeking to determine 

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whether the current thresholds and standards effectively implement the 1934 Act 

registration and reporting requirements and what it means to be a "public" company 

such that an issuer should be required to register its securities and file with the 

Commission. The staff has begun a detailed analysis of public company information 

- including numbers of record and beneficial owners, total assets, and public float -

to assess the characteristics of public companies. The study also will seek to obtain 

and consider private company information to assess current reporting thresholds. 

• The restriction on general solicitation in private offerings. CF staff is also 

reviewing the restrictions the Commission's rules impose on communications in 

private offerings, in particular the restrictions on general solicitation. In anal yzing 

whether to recommend changes to the restriction, the staff is considering next steps, 

and is preparing a concept release for the Commission's consideration, through which 

it could seek the public's input on the advisability and the costs and benefits of 

retaining or relaxing the restrictions on general solicitation. 

• Restrictions on communications in public offerings. The Division's staff is also 

assessing the Commission's rules, and the regulatory burdens they impose, with 

respect to communications in public offerings. The staff is reviewing the rules to 

consider whether any of the liberalizations adopted in 2005 3 for the largest issuers 

should be adapted for smaller public companies, including whether more companies 

should be able to use free writing prospectuses before a substantially complete 

prospectus is filed. As a result of this review, Division staff may recommend 

proposed changes to the offering rules, or recommend that the Commission seek 

additional input through the issuance of a concept release. 

Additional areas CF staff is reviewing with respect to capital formation concern the regulatory 

questions posed by new capital raising strategies, such as crowdfunding, and the scope of the 

Commission's existing rules that provide for capital raising, such as Regulation A. 

In connection with these projects, the Division will consider recommendations of the recentlyformed SEC Advisory Committee on Small and Emerging Companies and the Government 

Business Forum on Small Business Capital Formation, as well as ideas from other sources in 

developing recommendations for the Commission's consideration to facilitate small business 

capital formation, consistent with investor protection. 

Improvements to proxy voting and shareholder communications processes. The 

Commission received significant public comment on its concept release regarding proxy voting 

and shareholder communications4 CF staff is working closely with other SEC divisions and 

offices with regard to possible recommendations to the Commission for proposed rule 

amendments or other Commission action to address areas that may be in need of improvement. 

3 See Release No. 33-859 1, Securities Offering Reform (July 19, 2005), http://www.sec.gov/ruleS/final/33 -8591.pdf. 

4 See Release No. 34-62495, Concept Release on the US Proxy System (July 14, 20 10), 

http://www. sec. gov/rules/concept/20 10/34-62495. pdf 

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Asset-backed securities. The Division is preparing recommendations for the 

Commission to consider adopting several ABS rules, following rule proposals in April 2010 and 

a reproposal in July 2011. In April 2010, the Commission proposed significant revisions to the 

disclosure, reporting and offering process for asset-backed securities5 In July 2011 , the 

Commission re-proposed some of the proposals from April 2010, including the proposals 

relating to the shelf eligibility requirements for ABS, and requested comment on other aspects of 

the April 2010 proposal 6 The comment period for the July 2011 release ended on October 4, 

2011. 

Dodd-Frank Rules. In addition to the rulemaking initiatives discussed above, CF staff is 

responsible for preparing recommendations for the Commission to adopt rules to implement a 

significant number of Dodd-Frank Act requirements. CF reassigned a number of attorneys from 

throughout the Division, including disclosure operations, to work on these rulemaking projects. 

CF completed several projects mandated by the Dodd-Frank Act during FY 2011 , and expects to 

present the Commission with recommendations to complete the remaining rulemaking projects 

during FY 2012. 

Dodd-Frank rules for which CF is responsible include, among others, the following: 

Asset-Backed Securities. Asset-backed securities (ABS) rules in a number of areas, 

including, among others: 

• Representations and Warranties. On January 20, 2011 , the Commission adopted final 

rules to implement Section 943 of the Dodd-Frank Act, which requires the Commission 

to adopt rules regarding representations and warranties in ABS7 

• Issuer Review of Underlying Assets. On January 20, 2011 , the Commission adopted 

final rules to implement Section 945 of the Dodd-Frank Act. 8 Section 945 requires the 

Commission to issue rules requiring an asset-backed issuer in a 1933 Act registered 

transaction to perform a review of the assets underlying the ABS, and disclose the nature 

of such review. 

• Risk Retention. On March 30, 2011 , the Commission joined fellow financial regulators 

in issuing for public comment proposed risk retention rules to implement Section 941 of 

5 See Release No. 33-911 7, Asset-Backed Securities (April 7, 20 I 0), http://www.sec.gov/rules/proposed/20 10/33-

9117.pdf. 

6 See Release No. 33-9244, Re-proposa/ of Shelf Eligibility Conditions for Asset-Backed Securities and Other 

Additional Requests for Comment (July 26, 20 11 ), http://www.sec.gov/rules/prooosedI20 11 /33 -9244.pdf. 

7 See Release No. 33-9175, Disclosurefor Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act (January 20, 20 11 ), http://www.sec.gov/ruleS/finaI120 11 /33 -9175.pdf. 

8 See Release No. 33-9176, issuer Review of Assets in Offerings of Asset-Backed Securities (January 20, 20 II), 

http://www.sec.gov/rules/finaI/20 11/33-9176.pdf 

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the Dodd-Frank Act9 The proposed rules address the appropriate amount, form, and 

duration of required risk retention for ABS securitizers, and the definition of qualified 

residential mortgages. Although the original comment period was scheduled to close on 

June 10, 2011, in light of requests from various sources for an extension to allow 

sufficient time for data gathering and impact analyses related to the provisions of the 

proposed rule, the Commission extended the comment period to August I, 2011. The 

Commission staff, together with stafffrom the other regulators, is carefully considering 

the issues and concerns raised in the comments received as it prepares recommendations 

for the Commission for final rules. 

• In August 2011, the Commission adopted rules in connection with Section 942(a) of the 

Dodd-Frank Act, which eliminated the automatic suspension of the duty to file reports 

under Section 15(d) of the 1934 Act for ABS issuers and granted the Commission 

authority to issue rules providing for the suspension or termination of this duty to file 

reports. The new rules permit suspension of the reporting obligations for ABS issuers 

when there are no longer asset-backed securities of the class sold in a registered 

transaction held by non-affiliates of the depositor. 10 

Corporate GOI'ernance and Executive Compensation. Corporate governance and executive 

compensation provisions of the Dodd-Frank Act including, among others: 

• "Say-on-Pay" and "Golden Parachute." In January 2011, the Commission adopted 

rules to implement the provisions of the Dodd-Frank Act that require public companies 

subject to the federal proxy rules to provide their shareholders with 

o an advisory vote on executive compensation, generall y known as "say-on-pay" 

votes, as well as with an advisory vote on the desired frequency of say-on-pay 

votes. 

o an advisory vote on compensation arrangements and understandings in connection 

with merger transactions, known as "golden parachute" arrangements. 

• Compensation Committees and Compensation Consultants. The Commission is 

required by Section 952 of the Dodd-Frank Act to mandate new listing standards relating 

to the independence of compensation committees and to establish new disclosure 

requirements and contlict of interest standards that boards must observe when retaining 

compensation consultants. In March 2011 , the Commission issued a proposal to 

implement Section 952. 11 The comment period for the proposal ended on May 19, 2011 , 

and the staff is currently developing recommendations for final rules. 

9 See Release No. 34-64148, Credit Risk Retention (March 30, 20 II), http://www.sec.gov/rules/proposedI2011/34-

64148.pdf 

10 See Release No. 34-65 148, Suspension of the Duty to File Reports for Classes of Asset-Backed Securities under 

Section 15(d) of the Securities Exchange Act of 1934 (August 17, 2011), http://www.sec.gov/rules/finaI12011/34-

65 148.pdf 

11 See Release No. 33-9199, Listing Standards for Compensation Committees (March 30, 20 II), 

http://www.sec.gov/rules/proposed/2011 /33-9199.pdf. 

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In addition, CF staff is working on developing recommendations for the Commission 

conceming the implementation of the following provisions of the Dodd-Frank Act: 

• Recovery of Erroneously Awarded Compensation. Section 954 of the Dodd-Frank 

Act requires the Commission to adopt rules mandating new listing standards relating to 

specified executive compensation "clawback" policies. 

• Pay versus Performance and Pay Ratios. Under Section 953 of the Dodd-Frank Act, 

the Commission must adopt rules requiring new disclosures about the relationship 

between executive compensation and company performance, and the ratio between the 

median of the annual total compensation of an issuer's employees and the annual total 

compensation of the issuer's chief executive officer. 

• Employee and Director Hedging. Section 955 of the Dodd-Frank Act requires the 

Commission to adopt rules requiring disclosure by issuers of their policies relating to 

certain employee and director hedging activities. 

Specialized Disclosures. Title XV of the Dodd-Frank Act contains specialized disclosure 

provisions related to conflict minerals, coal or other mine safety, and payments by resource 

extraction issuers to foreign or U.S. government entities. The Commission published the rule 

proposals relating to these three provisions in December 2010 12 and the comment period ended 

on March 2, 2011. The Commission recently held a public roundtable regarding the conflict 

minerals rulemaking, and reopened the comment period from October 6, 2011 until November 1, 

2011 in connection with the roundtable. The staff is preparing final rule recommendations for 

the Commission on these three rulemakings. 

E..tempt Offerings. 

• Accredited Investor. Section 413(a) of the Dodd-Frank Act requires the definition of 

"accredited investor" in the Commission's 1933 Act rules to exclude the value ofa 

person's primary residence for purposes of determining accredited investor status on the 

basis of having net worth in excess of$l million. The Commission proposed rule 

amendments on January 25, 2011 that would implement this provision, and would clarify 

the treatment of any indebtedness secured by the residence in the net worth calculation. J3 

The comment period on this proposal ended on March 11 , 2011 and the staff is preparing 

final rule recommendations for the Commission. 

12 See Release No. 34-63547, Conj/ict Minerals (December 15,2010), http://www.sec.gov/ruleslproposed/2010/34-

63547.pdf; Release No. 33-9164, Mine Safety Disclosure (December 15, 2010), 

http://www.sec.gov/rules/proposed/201 0/33-9164.pdf, Release No. 34-63549, Disclosure of Payments by Resource 

Ettractionlssuers (December 15, 2010), http://www.sec.gov/rules/proposedI20 10/34-63549.pdf. 

13 See Release No. 33-9177, Net Worth Standardfor Accredited Investors (January 25, 20 II), 

http://www.sec.gov/rules/proposed/201I/33-9177.pdf. 

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• "Felons and Other 'Bad Actors"'. Under Section 926 of the Act, the Commission is 

required to adopt rules that disqualify securities offerings involving certain "felons and 

other 'bad actors'" from relying on the safe harbor from 1933 Act registration provided 

by Rule 506 of Regulation D. The Commission proposed rules to implement the 

requirements of Section 926 on May 25, 2011 ,14 and the comment period for this rule 

proposal ended on July 14, 2011. The staff is preparing final rule recommendations for 

the Commission. 

Credit Rating Agencies. The Dodd-Frank Act resulted in several rulemakings related to 

nationally recognized statistical rating organizations. In July 2011, the Commission adopted rule 

amendments removing credit ratings as conditions for companies seeking to use short-form 

registration when registering non-convertible securities for public sale. Under the new rules, the 

test for eligibility to use Form S-3 or Form F-3 short-form registration is tied to the amount of 

debt and other non-convertible securities (other than equity) a particular company has sold in 

registered primary offerings within the previous three years, or that the company has outstanding 

that were issued in registered primary offerings. 15 In addition, in September 2010, as required by 

Section 939B of the Dodd-Frank Act, the Commission adopted a rule amendment to remove 

communications with credit rating agencies from the list of excepted communications in 

Regulation FD. 16 

Security-Based Swaps. CF has responsibility for certain rulemakings related to Title vn of 

the Dodd-Frank Act, which imposed a new regime for the regulation of OTC derivatives. This 

includes proposed exemptions under the 1933 Act, the 1934 Act, and the Trust Indenture Act of 

1939 for security-based swaps transactions involving certain clearing agencies satisfying certain 

conditions, in order to facilitate clearing of security-based swaps, 17 interim exemptions from 

certain provisions of the federal securities laws that would otherwise have applied to securitybased swaps on July 16, 2011 ,18 and extension of certain existing temporary rules and relief to 

continue to facilitate the clearing of certain credit default swaps by clearing agencies functioning 

as central counterparties. 19 The Commission also readopted certain beneficial ownership rules to 

preserve their application to persons who purchase or sell security-based swaps20 

14 See Release No. 33-9211, Disqualification of Felons and Olher "Bad Aclors "from Rule 506 Offerings (May 25, 

20 II), http://www.sec.gov/rules/proposedI201I/33-92II .pdf 

15 See Release No. 33-9245, Security Ratings (July 27, 2011), http://w\Vw.sec.gov/ruleS/finaI/201 I133-9245.pdf 

16 See Release No. 33-9146, Removal from Regulation FD of the Exemption for Credit Rating Agencies (September 

29, 2010), http://www.sec.gov/rules/finaI/201 0/33-9146.pdf 

17 See Release No. 33-9222, Exemptions for Security-Based Swaps Issued by Certain Clearing Agencies (June 9, 

20 11 ), http://www.sec.gov/rules/proposed/20 11 /33 -9222.pdf 

18 See Release No. 33-9231 , Exemptions for Security-Based Swaps, (July 1,2011 ), 

http://www.sec.gov/ruleslinteriml2011 /33 -923 1.pdf 

19 See Release No. 33-9232, Extension ofTemporQ/Y Exemptions for Eligible Credit Default Swaps to Facilitate 

Operation of Central Counlerparlies to Clear and Settle Credil Defaull Swaps (July 1,20 II), 

http://www.sec.gov/ruleslinteriml2011 /33 -9232.pdf 

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Enforcement Liaison 

The Division regular! y provides technical assistance to the Division of Enforcement on 

enforcement matters. In the 2011 fiscal year, CF responded to close to 2,000 inquiries from that 

Division, and referred more than 400 matters to Enforcement. In the first month of the 2012 

fiscal year, CF referred more than 50 matters to Enforcement. 

International Coordination 

The globalization of securities markets requires CF to work with its foreign counterparts on an 

ongoing basis. The active participation ofCF staff with technical expertise in international 

working groups - of, among others, the International Organization of Securities Commissions, 

the Financial Stability Board, and the Organization for Economic Co-operation and Development 

- is essential to the fulfillment of the Commission's international responsibilities The staff 

works to represent the interests of US investors and markets on relevant international issues. In 

addition to working with international groups, there are also a number ofbi-lateral relationships, 

such as with European regulators, which are increasingly important in today's global 

environment. The international work of CF also includes collaborating with other Federal 

agencies, such as the Federal Reserve Board and the Department of the Treasury, by providing 

them with technical assistance on matters related to international coordination of financial 

regulation. 

Upcoming Challenges 

While CF has developed review practices and procedures to satisfy the Sarbanes-Oxley Act 

review mandate,limited resources constrain the Division's ability to devote sufficient resources 

to the review of companies that represent the largest portion of US. market capitalization. The 

Division's limited staff is responsible for reviewing the disclosures ofnear!y 10,000 reporting 

companies under this review mandate, and also for selectively reviewing registration statements 

and other transactional filings made under the 1933 Act and 1934 Act, such as filings related to 

capital raising and business combinations. The challenges of staffing the review program are 

even greater in light of the Division's new responsibilities under the Dodd-Frank Act. As noted, 

CF is currently implementing changes to its review program with the goal of increasing its focus 

on large and financially significant registrants and recalibrating its reviews of smaller reporting 

companies in order to gain additional efficiencies, in a manner consistent with its obligations 

under the Sarbanes-Oxley Act. CF has also made targeted changes to its operations, including 

the formation of three new offices in order to better fulfill our mission of investor protection. 

The ability to realize these benefits will be compromised, however, if we are unable to fully staff 

them and/or are unable to hire additional staff to enhance our expertise in these areas. 

20 See Release No. 34-64628, Beneficial Ownership Reporting Requirements and Security-Based Swaps (June 8, 

20 II), http://www.sec.gov/ruleS/finaI12011 /34-64628.pdf 

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11161117.eps

TRADING AND MARKETS 

Director, Robert COOk21 

The Division ofTrading and Markets (TM) is responsible for establishing and maintaining 

standards for fair, orderly, and efficient markets. TM's workload is dominated by a diverse 

range of core functions that are vital for protecting investors and markets, and the scope of many 

of these functions expanded significantly under the Dodd-Frank Act. In addition, TM has taken 

on substantial new responsibilities as a result of the Dodd-Frank Act, in particular the 

implementation of a new regulatory regime governing certain over-the-counter (OTC) 

derivatives. 

TM's Core Functions 

Regulation for Securities Markets 

TM devotes substantial resources to developing and maintaining appropriate regulations for the 

securities markets, including 15 securities exchanges (equities and options), 3 electronic 

communication networks (ECNs), over 60 active alternative trading systems, and over 200 

internalizing broker-dealers. TM's ongoing responsibilities include: 

• Reviewing new exchange registrations, an extensive process that requires analysis of, 

among other complex issues, the impact of a new exchange on the protection of investors, 

the public interest, and the national market system. 

• Processing proposed SRO rule changes, which address issues ranging from new fee 

structures to changes in trading rules to revamped governance structures. As of last 

month, TM had received over 1,800 rule filings this calendar year, and we anticipate 

receiving over 350 more before the end of the year22 These filings are reviewed for 

consistency with the Exchange Act, including requirements for fair and orderly markets 

and for limiting burdens on competition. The Dodd-Frank Act imposed new procedural 

requirements with respect to the Commission's processing of these filings, which 

substantially increased TM's workload. 

• Reviewing new financial products, ranging from now-common index exchange traded 

funds (ETFs) to physical commodity trusts to more esoteric products. 

• Initiating changes to market rules to keep apace with market developments. 

Over the past few years, TM has focused on several key initiatives to improve the oversight and 

function of our markets: 

21 

22 

Mr. Cook joined the SEC as the Director ofTrading and Markets in January 20 I o. http://www.sec.gov/news/pressI200912009-242.htm 

This number includes fi lings by the exchanges and other SROs, such as clearing agencies, FINRA, and the 

MSRB. 

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11161118.eps

23 

24 

25 

• Sponsored Access. In November 2010, the Commission took an important step to 

promote market stability by adopting a new market access rule.

23 Broker-dealers that 

access the markets themselves or offer market access to customers will be required to put 

in place appropriate pre-trade risk management controls and supervisory procedures. The 

rule effectively prohibits broker-dealers from providing customers with "unfiltered" 

access to an exchange or alternative trading system. By helping ensure that brokerdealers appropriately control the risks of market access, the rule should help prevent 

broker-dealers or their customers from engaging in practices that could increase risks to 

the financial condition of other market participants and clearing organizations, as well as 

the integrity of trading on the securities markets. 

• Large Trader Reporting In July 2011 , the Commission adopted new rules to help 

identify, and obtain trading information on, market particpants that conduct a substantial 

amount of trading activity in the U.S. securities markets2 These new large trader 

reporting requirements are designed to provide the Commission with a valuable source of 

useful data to support: (1) its investigative and enforcement efforts; (2) reconstruction of 

trading activity following significant market events; and (3) analysis of the impact of 

large traders on the securities markets. 

• Consolidated Audit Trail. TM is preparing recommendations for the Commission's 

consideration for a final rule to create, implement, and maintain a consolidated audit trail, 

another of the Commission's proposals to address significant shortcomings in the 

agency's present ability to collect and monitor trade data in an efficient and scalable 

manner2 ) If implemented, the consolidated audit trail would, for the first time, allow 

SROs and the Commission to track trade data across multiple markets, products and 

participants simultaneously. It would also boost regulators ability to rapidly reconstruct 

trading activity and to more quickly analyze both suspicious trading and unusual market 

events. The Commission received many informative comments on the proposed rule, 

which TM is taking into account in preparing its recommendations - including discussion 

of the benefits of a consolidated audit trail, feedback addressing the estimated cost of 

implementing a consolidated audit trail and proposals for possible alternatives for 

achieving the Commission's goals. 

• Additional Steps to Address the Events of May 6,2010. TM leads the Commission's 

efforts to monitor and respond to significant market events, such as the severe market 

disruption of May 6, 2010. In addition to spearheading the Commission's inquiry into 

that day's events, coordinating an independent joint SEC-CFTC advisory committee 

focusing on those events, and publishing two joint reports with the staff of the CFTC, TM 

recommended implementation of key regulatory responses, including: (1) a uniform 

circuit breaker pilot program designed to halt trading in a disorderly market; (2) pilot 

See Release No. 34-63241 , Risk Managelllent Controls for Brokers or Dealers with Market Access 

(November 3, 2010), http!/II'II'II'.sec.gov/ruleslfinaIl2010/34-63 241 .pdf 

See Release No. 34-64976, Large Trader Reporting (July 27, 2011), 

http!/lI'ww.sec.gov/ruleslfinaI12011/34-64976.pdf 

See Release No. 34-62174, Consolidated Audit Trail (May 26, 2010), 

http!/wlI'w.sec.gov/rules/proposedI2010/34-62174.pdf. 

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11161119.eps

exchange rules designed to improve the process of breaking "clearly erroneous" trades; 

and (3) exchange rules to enhance quotation standards for market makers. In addition, 

TM has coordinated proposed SRO efforts to implement a "limit-up/limit-down" 

mechanism that would directly prevent trades outside specified parameters, while 

allowing trading to continue within those parameters. This procedure should prevent 

many anomalous trades from ever occurring, as well as limiting the disruptive effect of 

those that do occur. Similarl y, TM has assisted the preparation of proposed updates to 

the market-wide circuit breakers. 

• Supporting Critical Market Infrastructure and Operations. TM performs cyclical 

reviews of exchanges, ECNs, and clearing agencies to ensure they are acting in 

accordance with the Commission's Automation Review Policies (ARP) and have 

adequate systems in place to deal with technology disruptions. TM plans to enhance its 

ARP reviews, with a particular focus on whether registered entities have appropriate 

cybersecurity measures, and is preparing recommendations for the Commission to further 

strengthen the ARP standards. 

• Advancing a Comprehensive Review of Equity Market Stl'llcture. In January 2010, the 

SEC published a concept release on equity market structure in order to solicit public input 

on several of the key issues highlighted by the explosive growth in trading volume: (1) 

the quality of performance of the current market structure; (2) high frequency trading; 

and (3) undisplayed liquidity in all its forms 26 In addition to considering the more than 

200 comment letters that the Commission received, TM organized a Commission-hosted 

public roundtable on market structure in June 2010. TM plans to continue to advance this 

discussion and consider whether any rulemaking responses are warranted. 

Regulation for Clearing Agencies 

TM currently participates in the regulation of8 active clearing agencies that are examined by the 

Commission, and anticipates that a number of additional clearing agencies may become subject 

to Commission oversight in the next few years. TM has significant ongoing responsibilities with 

respect to clearing agencies, including the review of new clearing agency registration 

applications and rule changes; engaging in rulemaking, including adopting new prudential 

standards and monitoring risk-related issues utilizing the recently created Clearing Agency 

Monitoring group. 

These responsibilities were expanded by Title VIII of the Dodd-Frank Act, which provides for 

enhanced oversight of financial market utilities (FMUs), including clearing agencies registered 

with the Commission, and payment, clearing or settlement activities that are designated as 

systemically important. TM worked closely with the staffs of the CFTC and the Federal Reserve 

Board (the Board) to propose requirements that would require clearing agencies, among other 

things, to maintain certain standards with respect to risk management and operations, have 

procedures that identify and address conflicts of interest, and require minimum governance 

standards for boards of directors. Many of the proposed requirements would apply to all clearing 

26 See Release No. 34-61358, Concept Release on Equity Market Structure (January 14, 2010), 

http://www.sec.gov/rulesfconceptI2010/34-61358.pdf 

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11161120.eps

agencies, while others would focus more specifically on clearing agencies that clear securi tybased swaps27 

Additionally, as directed by Title VIII, TM worked jointly with the staffs of OClE, the CFTC 

and the Board over the past year to develop a report to Congress reflecting recommendations 

regarding risk management supervision of clearing entities designated as systemically important 

by the FSOC. The report should establish a strong framework for ongoing consultation and 

cooperation in clearing agency oversight among the Commission, the CFTC, and the Board. 

Regulation for Broker-Dealers 

The Division is responsible for regulations governing close to 5,000 registered broker-dealers, 

including by: 

• Establishing or approving rules governing broker-dealer activities, including rules 

pertaining to capital adequacy, the protection of customer assets, anti-money laundering, 

sales practices and record-keeping. 

• Reviewing, on an ongoing basis and together with OClE, the financial activities of 

certain "risk-supervised broker-dealers," and reviewing filings of other broker-dealers 

with respect to their material affiliates. 

TM is continuing to recommend improvements to the rules in this area. Most recently, in June 

2011 , the Commission proposed amendments to the broker-dealer financial reporting rules, 

which are intended to strengthen requirements regarding broker-dealers' custody of customer 

funds and securities28 These amendments would, among other things, facilitate the ability of the 

PCAOB to implement oversight of independent public accountants of broker-dealers, as required 

by the Dodd-Frank Act, and eliminate potentially redundant requirements for certain brokerdealers affiliated with, or dually-registered as, investment advisers. The amendments also would 

enhance the ability of the Commission and SRO examiners to oversee broker-dealers' custody 

practices by requiring broker-dealers to provide additional information to the Commission. 

Regulation for Credit Rating Agencies 

TM currently makes rule recommendations for the Commission's consideration applicable to the 

several credit rating agencies registered with the Commission as NRSROs, reviews applications 

from potential new registrants and, in conjunction with OClE, monitors their activities. 

Under the Dodd-Frank Act, these responsibilities were expanded significantly, with the 

Commission required to undertake approximately a dozen rulemakings related to NRSROs. The 

Commission adopted the first of these required rulemakings in January, and in May, the 

27 

28 

See Release No. 34-64017, Clearing Agency Standards for Operation and Governance (March 3, 20 II), 

http://www.sec.gov/rules/proposed/2011/34-64017.pdf 

See Release No. 34-64676, Broker-Dealer Reports (June 15, 20 II), 

http://www.sec.gov/rules/proposed/2011/34-64676.pdf 

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11161121.eps

Commission published for public comment a series of proposed rules that would largely 

implement the Dodd-Frank Act requirements by requiring NRSROs to, among otherthings)9 

• Report on their internal controls; 

• Better protect against any conflicts of interest; 

• Establish professional standards for their credit analysts; 

• Publicly provide - along with the publication of any credit rating - disclosure about the 

credit rating and the methodology used to determine it; and 

• Provide enhanced public disclosures about the performance of their credit ratings. 

The proposals also would require disclosure concerning third-party due diligence reports for 

asset-backed securities. 

The Dodd-Frank Act also requires the SEC to conduct three studies relating to credit rating 

agencies. In December, the Commission requested public comment on the feasibility and 

desirability of standardizing credit rating terminology 30 The Dodd-Frank Act also requires (I) 

a 2012 study on alternative compensation models for rating structured finance products; and (2) a 

2013 study on NRSRO independence. 

With respect to alternative compensation models, the Dodd-Frank Act directs the Commission to 

study the credit rating process for structured finance products and the conflicts associated with 

the "issuer-pay" and the "subscriber-pay" models. It further requires the Commission to study 

the feasibility of establishing a system in which a public or private utility or a self-regulatory 

organization would assign NRSROs to determine the credit ratings for structured finance 

products. Accordingly, in May the Commission published a request for public comment on the 

feasibility of such a system, asking interested parties to provide comments, proposals, data, and 

analysis by September3 ! 

TM is also working with OClE to assist in the annual examination of each NRSRO, as mandated 

by the Dodd-Frank Act. 

29 

JO 

31 

See Release No. 34-64514, Proposed Rules jor Nationally Recognized Statistical Rating Organizations 

(May 18, 20 II ), http://www.sec.gov/rules/proposed12011/34-64514.pdf The Dodd-Frank Act also requires 

regulatory agencies to remove references to credit ratings from their regulations and to substitute such 

standards of creditworthiness as the agencies determine to be appropriate. As part of a Commission-wide 

effort to meet this requirement, in April 20 II , the Commission proposed to remove references to credit 

ratings in rules concerning broker-dealer financial responsibility, distributions of securities, and 

confirmations of transactions. See Release No. 34-64352, Removal ojCertain Rejerences to Credit Ratings 

Under the Securities Exchange Act oj 1934 (April 27, 2011), http://www.sec.gov/rules/proposed/2011/34-

64352.pdf. 

See Release No. 34-63573, Credit Rating Standardization Study (December 17, 2010), 

http://sec. gOY /ruleslother120 I 0/34-63573 .pdf 

See Release No. 34-64456, Solicitation ojComment to Assist in Study on Assigned Credit Ratings (May 10, 

20 II), http://www.sec.gov/rules/other1201l/34-64456.pdf 

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11161122.eps

Regulation for the Municipal Securities Market 

TM currently administers the rules of the Commission with respect to the practices of municipal 

securities brokers and dealers and municipal advisors. It also reviews rule filings by the 

Municipal Securities Rulemaking Board (MSRB), coordinates with the MSRB in rulemaking and 

enforcement actions, and advises the Commission on policy matters relating to the municipal 

bond market32 

Under the Dodd-Frank Act, TM is responsible for adopting rules to implement a new registration 

regime for municipal advisors. Specifically, as of October 1, 2010, the Act made it unlawful for 

any municipal advisor to provide advice to a municipality unless registered with the 

Commission. In September 2010, the Commission adopted an interim final rule establishing a 

temporary means for municipal advisors to satisfy the registration requirement.)) In December, 

the Commission proposed a permanent rule creating a new process by which municipal advisors 

must register with the SEC.) The Commission received over 1,000 comment letters on the 

proposal, including many expressing concerns regarding the treatment of appointed officials and 

traditional banking products and services. TM is carefully considering all of these comments in 

preparing its recommendation for the Commission. In addition, working with other Divisions 

and offices, TM is supporting the Commission's broad-based review of the municipal securities 

market, including the three public field hearings held to date and the preparation of a staff report 

concerning the state of the market. 

Enforcement Liaison 

The Division regularl y provides technical assistance to the Division of Enforcement on 

enforcement matters. In 2011 , TM responded to over 950 inquiries from that Division, and we 

are on track to address over 1,000 inquiries this year. 

Investor / Market Participant Guidance 

TM also responds to calls, emails, correspondence and other communications from industry, 

counsel, the public, congressional staff, foreign sources and others. Last year, the Division 

handled roughly 15,000 such communications and processed roughly 1,000 tips, complaints, 

referrals, and regulated entity notices. TM also issues written interpretive guidance to market 

participants. 

International Coordination 

The globalization of securities markets requires TM to coordinate its regulatory activities with its 

foreign counterparts on an ongoing bilateral and multilateral basis. The active participation of 

32 

33 

34 

The Dodd-Frank Act envisions that the credit rating agency and municipal securities functions currently 

being carried out by TM will eventually be folded into separate offices. The Dodd-Frank Act requires the 

Commission to create several offices within the Commission, including the Office of Credit Ratings, and 

the Office of Municipal Securities. Each of these offices is statutorily required to report directly to the 

Chairman, the creation of these offices is subject to approval by the Commission's appropriations 

subcommittees to reprogram funds for this purpose. Until reprogramming approval is received, the initial 

functions of the offices are being performed on a limited basis by other divisions and offices. 

See Release No. 34-62824, Te lllpormy Regis/ra/ion of Municipal Advisors (September 1, 20 I 0), 

http://www . sec. gov lrules/interiml20 I 0/34-62824. pdf. 

See Release No. 34-63 576, Registration of Municipal Advisors (December 20, 20 I 0), 

http://sec. gov lrules/proposedl20 I 0/34-63576.pdf 

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11161123.eps

TM staff with technical expertise in international working groups - with, among others, the 

Financial Stability Board (FSB), the International Organization of Securities Commissions 

(lOSCO), the Financial Action Task Force, and the Joint Forum - is essential to the fulfillment 

of the Commission's responsibilities. TM staff serves in a leadership capacity in a number of 

these groups, including, the FSB Working Group on OTC Derivatives, the Committee on 

Payment and Settlement Systems (CPSS)-IOSCO group on Principals for Financial Market 

Infrastructures, the IOSCO Standing Committee on Credit Rating Agencies, and the IOSCO 

Task Force on OTC Derivatives Regulation. Through such participation, the staff works to 

represent the interests of U.S . investors and markets on relevant international issues. 

Additional Responsibilities under the Dodd-Frank Act 

In addition to substantially expanding many ofTM's core functions, the Dodd-Frank Act also 

calls for the development of: (1) a registration and regulatory regime for entities that participate 

in the security-based OTC derivatives market; (2) new restrictions upon proprietary trading 

activities of certain entities under the "Volcker Rule", as well as prohibitions involving conflicts 

of interest related to certain securitizations; and (3) new coordination mechanisms with other 

regulatory agencies, most notably through the Financial Stability Oversight Council (FSOC). 

Regulation of OTC Derivatives 

Title VII of the Dodd-Frank Act establishes a new regulatory regime for the OTC derivatives 

market and requires the Commission to write rules that address, among other things: business 

conduct, capital, and margin requirements for market intermediaries; mandatory clearing 

requirements; the operation of security-based swap data repositories and trade execution 

facilities; and public transparency for security-based swap price and other transaction 

infonnation. To date, the Commission has proposed rules in thirteen areas required by Title VII: 

35 

36 

37 

• Rules prohibiting fraud and manipulation in connection with security-based swaps;3; 

• Rules regarding trade reporting, data elements, and real-time public dissemination of 

trade information for security-based swaps that would lay out who must report securitybased swafs, what infonnation must be reported, and where and when it must be 

reported;3 

• Rules regarding the obligations of security-based swap data repositories that would 

require them to register with the SEC and specify the extensive confidentiality and other 

requirements with which they must comply;37 

See Release No. 34-63236, Prohibition Against Frauc( Manipulation, and Deception in Connection with 

Security-Based Swaps (November 3, 20 I 0), http://www.sec.gov/rules/proposedI2010/34-63236.pdf. 

See Release No. 34-63346, Regulation SBSR- Reporting and Disselllination of Security-Based Swap 

inforlllation (November 19, 20 I 0), http://www.sec.gov/rulesJproposedl2010134-63346.pdf. 

See Release No. 34-63347, Security-Based Swap Data Repository Registration, Duties, and Core 

Principles (November 19, 2010), http://www.sec.gov/rulesJproposedI2010/34-63347.pdf. 

23 
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11161124.eps

38 

39 

40 

41 

42 

43 

44 

• Joint rules with the CFTC regarding the definitions of swap and security-based swap 

dealers, and major swap and security-based swap participants;38 

• Rules relating to mandatory clearing of security-based swaps that would establish a 

process for clearing agencies to provide information to the SEC about security-based 

swaps that the clearing agencies plan to accept for clearing; 39 

• Rules regarding the exception to the mandatory clearing requirement for hedging by end 

users that would specify the steps that end users must follow, as required under the Act, 

to notify the SEC of how they generally meet their financial obligations when engagin~ 

in security-based swap transactions exempt from the mandatory clearing requirement; 

• Rules defining and regulating security-based swap execution facilities, which specify 

their registration requirements, and establish the duties and implement the core principles 

for security-based swap execution facilities specified in the Act; 41 

• Rules regarding the confirmation of security-based swap transactions that would govern 

the way in which certain of these transactions are acknowledged and verified by the 

parties who enter into them; 42 

• Rules regarding certain standards that clearing agencies would be required to maintain 

with respect to, among other things, their risk management and operations;43 

• Joint rules with the CFTC regarding further definitions of the terms "swap", "securitybased swap," and "security-based swap agreement"; the regulation of mixed swaps; and 

security-based swap agreement recordkeeping;44 

• Rules regarding business conduct that would establish certain minimum standards of 

conduct for security-based swap dealers and major security-based swap participants, 

See Release No. 34·63452. Further Definition of "Swap Dealer, " "Security·Based Swap Dealer, " "Major 

Swap Participant, ""Major Security· Based Swap participant" and "Eligible Contract Participant" 

(December 7, 20 I 0), http://www.sec.gov/rules/proposedI2010/34·63452.pdf 

See Release No. 63557, Process for Submissions for Review of Security· Based Swaps for Mandatory 

Clearing and No tice Filing Requirements for Clearing Agencies; Technical Amendments to Rule 19b·4 and 

FOI'I1/ 19b-4 Applicable to All Self-RegulatolY Organizations (December 15, 2010), 

http://www . sec. gOY /rules/proposedI20 I 0/34·63557. pdf. 

See Release No. 34·63556, End· User Exception of Mandatory Clearing afSecurity-Based Swaps 

(December 15, 20 I 0), http://www.sec.gov/rules/proposed/2010/34·63556.pdf 

See Release No. 34·63825, Registration and Regulation afSecurity·Based Swap Execution Facilities 

(F ebruary 2, 20 II), http://www.sec.gov/rules/proposedJ2011/34·63825.pdf. 

See Release No. 34·63727, Trade Acknowledgment and Verification on Security-Based Swap Transactions 

(January 14, 2011), http://www.sec.gov/ruIes/proposedJ2011/34·63727.pdf. 

See Release No. 34·64017, Clearing Agency Standards for Operation and Governance (March 2, 20 II), 

http://www.sec.gov/rules/proposedJ2011134-64017.pdf. 

See Release No. 33·9204, Further Definition of "Swap, " "Security·Based Swap, " and "Security-Based 

Swap Agreement"; Mixed Swaps; Security-Based Swap Agreement Recordkeeping (April 29, 2011), 

http://www.sec.gov/rules/proposedI2011/33·9204.pdf 

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11161125.eps

including in connection with their dealings with "special entities", which include 

municipalities, pension plans, endowments and similar entities;4; 

• Rules regarding the registration process for security-based swap dealers and major 

security-based swap participants;46 and 

• Rules intended to address conflicts of interest at security-based swap clearing agencies, 

security-based swap execution facilities, and exchanges that trade security-based swaps. 47 

The Commission also adopted an interim final rule regarding the reporting of outstandin~ 

security-based swaps entered into prior to the date of enactment of the Dodd-Frank Act. 8 TM is 

continuing to develop other proposed rules required by Title VII for the Commission's 

consideration, including proposals to address capital, margin, and segregation requirements. 

Additionally, the Division is working to develop proposed rules concerning the treatment of 

cross-border security-based swap transactions, as well as an implementation plan that will aim to 

permit the roll-out of the new security-based swap requirements in a logical, progressive, and 

efficient manner. 

Going forward, TM's regulatory responsibilities will be significantly expanded by the addition of 

the new categories ofregistered entities, the required regulatory reporting and public 

dissemination of security-based swap data, and the mandatory clearing of security-based swaps. 

In coordination with OCIE and the other Divisions, TM will be responsible for the registration 

and other rules for four entirely new categories of entities: security-based swap execution 

facilities (SEFs) (an estimated 20 new registrants within a year of the adoption of final rules); 

security-based swap data repositories (SDRs) (an estimated three new registrants within a year of 

the adoption offinal rules); security-based swap dealers (an estimated 50 new registrants within 

a year of adoption of final rules); and major security-based swap participants. TM also will need 

to: (1) monitor market developments and develop new rules for Commission consideration and 

provide guidance where needed; (2) respond to numerous interpretive requests in connection 

with the requirements applicable to the new registrants; and (3) as applicable, review new rule 

and product submissions by security-based swap execution facilities. 

Volcker Rule & Conflicts of Interest in Certain Securitizations 

Va/eker Rule. In January 2011 , FSOC approved and released to the public a study formalizing 

its findings and recommendations for implementing Section 619 of the Dodd-Frank Act, 

45 

46 

47 

48 

See Release No. 34-64766, Business Conduct Standards for Security-Based Swaps Dealer and Major 

Security-Based Swap Participants (June 29, 20 II), http://www.sec.gov/ruleslproposed/2011/34-64766.pdf 

See Release No. 34-65543, Registration of Security-Based Swap Dealers and Major Security-Based Swap 

Participants (Oct 12, 20 II), http://sec.gov/rules/proposedI2011/34-65543.pdf . 

See Release No. 34-63 107, Ownership Limitations and Governance Requirements for Security-Based Swap 

Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges with 

Respect to Security-Based Swaps under Regulation MC (October 14, 20 I 0), 

http://www . sec. gOY /rules/proposed/20 I 0/34-631 07. pdf. 

See Release No. 34-63094, Reporting of Security-Based Swap Transaction Data (October 13, 20 I 0), 

http://www.sec.gov/ruleslinteriml2011 /34-63094. pdf. 

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11161126.eps

commonly referred to as the Volcker Rule4 9 Section 619, among other things, generally 

prohibits: (i) federally insured depository institutions and their affiliates (banking entities) from 

engaging in short-term proprietary trading of any security, derivative, and certain other financial 

instruments for a banking entity's own account and (ii) owning, sponsoring, or having certain 

relationships with a hedge fund or private equity fund. The Commission staff worked closely 

with staffs from the federal banking agencies and the CFTC in drafting proposed rules to 

implement Section 619, and on October 12, 2011 , the Commission issued the proposal jointly 

with the Federal Deposit Insurance Corporation, the Board, and the Office of the Comptroller of 

the Currency50 The Commission's proposed rule would apply to banking entities that are SECregistered broker-dealers, investment advisers, and security-based swap dealers, among others. 

Under the jointly-proposed rule, transactions in certain instruments would be exempt from the 

prohibition on proprietary trading, including obligations of U.S. government or a U.S. 

government agency, government-sponsored enterprises, and state and local governments. 

Additionally, the proposal, like the statute, would exempt activities such as market making, 

underwriting, and risk-mitigating hedging. 

Banking entities would be required to establish an internal compliance program subject to 

supervisory oversight and designed to ensure and monitor compliance with the prohibitions and 

restrictions of Section 619. The proposal also would require firms with significant trading 

operations to report to the appropriate federal supervisory agency certain quantitative 

measurements designed to assist the supervisory agency and banking entities in identifying 

prohibited proprietary trading from permitted market making-related activities, among other 

purposes. 

Section 621. In September 2011, the Commission proposed for comment a new rule under the 

Securities Act of 1933 to implement the prohibition under Section 621 of the Dodd-Frank Act 

concerning material conflicts of interest in connection with securitizations. Section 621 prohibits 

entities that create and distribute asset-backed securities from engaging in transactions that 

involve or result in material conflicts of interest with respect to the investors in such assetbacked securities. 

Interagency Coordination 

In addition to the supervision ofFMUs described above, TM is significantly engaged in 

additional new interagency projects mandated by the Dodd-Frank Act, including the designation 

of systemically important non-bank financial entities and the design of mechanisms for the 

orderly liquidation of broker-dealers under new liquidation authority afforded FSOC and the 

FDIC. This coordination, which involves complex, interagency regulatory issues, is expected to 

continue into 2012 and beyond. 

49 

50 

The FSOC Volcker Rule study and recommendations can be found at 

http://www.treasurv .govlinitiatives/DocumentsiVolcker%20sec%20%20619%20studv%20final%20 I %20 I 

8%2011 %2Org.pdf See also http://sec.gov/spotlight/dodd·frankivolckerrule.htm. 

See Release No. 34·65545, Prohibitions and Restrictions on ProprietOlY Trading and Certain Interests In, 

and Relationships with, Hedge Funds and Private Equity Funds (October 12, 2011), 

http://www. sec. gov/rules/proposed/20 11/34-65545. pdf 

26 
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11161127.eps

OFFICE OF COMPLIANCE INSPECTIONS AND EXAMINA TIONS 

Director, Carlo di Florio , I 

The Office of Compliance Inspections and Examinations (OCIE) supports the SEC's mission to 

protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation by 

conducting risk-based examinations across the country through the Commission's National 

Examination Program ("NEP"). These examinations cover investment advisers, investment 

companies, broker-dealers, municipal advisors, municipal securities dealers, transfer agents, 

credit rating agencies, clearing agencies, exchanges, and other SROs such as FINRA, and the 

MSRB. The results of OCIE's examinations are utilized by the Commission to inform rulemaking initiatives, to identify and monitor risks, to improve industry practices and to pursue 

misconduct. 

Recent Internal Reforms 

Over the past two years, OCIE has undertaken a broad self-assessment of its strategy, structure, 

people, processes and technology. This has resulted in a comprehensive improvement plan to 

break down silos and promote a high-performance culture. OCIE continues to implement key 

program improvement initiatives in the following areas: 

Strategy - Strengthening Gur Governance and Risk-Focusing ollr National Exam Program. 

OCIE is implementing many reforms to an integrated National Exam Program designed to 

achieve consistency, effectiveness and efficiency. The cornerstone is a national governance 

model and enhanced risk-focused exam strategy to better allocate and leverage limited resources 

to their highest and best use. Both of these were implemented in 2011. 

Structure - Strengthening Expertise in Critical Risk Areas. OCIE is implementing 

significant structural enhancements to support the National Exam Program and a risk-focused 

exam strategy. This restructuring will strengthen expertise and facilitate teamwork, while 

driving greater consistency, effectiveness and accountability. In 2011 , the steps to implement 

this initiative included 

• Creating a centralized Risk Assessment and Surveillance Unit to enhance the ability of 

the National Exam Program to perform more sophisticated data analytics to identify the 

firms and practices that present the greatest risks to investors, markets and capital 

formation; and 

• Enhancing the large firm monitoring program through engagement of senior management 

and boards on critical risk and regulatory issues, and public reports on issues that the 

NEP has identified as key risk concerns. 

People - Recruiting Specialists, Improving Training and Strengthening Culture. OCIE has 

been recruiting people with new skill sets that are critical to supervising our modern capital 

markets. We also are building a leading practice training program. To that end,we 

introduced mentoring, project-based staffing, and other steps to build a culture of high51 Mr. di Florio joined the SEC as the Director of OCIE in January 2010. 

http://www.sec.gov/news/presS/201012010-I.htm 

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11161128.eps

performance, teamwork and accountability. In 2011 , the steps to implement this initiative 

included: 

• Recruiting experts to deepen program knowledge and experience in areas such as 

derivatives, complex structured products, hedge funds and credit rating agencies; and 

• Strengthening examiner skill sets through the development of an examiner training 

program. 

Process - Streamlining Processes to Drive Consistency, Effectiveness and Efficiency. We are reengineering our exam process end-to-end. This enables us to target more risk-focused 

examinations, enhance pre-exam preparation, improve multidisciplinary staffing, and increase 

field supervision. In FY 2011 , we conducted approximately 1600 examinations. 

Technology - Automating and Improving the Exam Process to Keep Pace with New 

Developments. We are focusing our technology strategy on moving from a manual to an 

automated exam process where possible. This includes enhancing information gathering to help 

automate risk assessment and surveillance and improving exam preparation and providing tools 

and techniques to enhance key activities associated with exam execution, such as work paper 

management, trade analysis and other data analytics and reporting. In 2011 , we developed and 

brought on board a number of new tools and technologies to enhance program efficiency and 

effectiveness. 

Governance, Entelprise Risk Management and Internal Controls. The financial crisis revealed 

just how dramatically risk management failures can harm investors, jeopardize market integrity 

and hinder capital formation. It also revealed the need for better oversight of risk at the board 

and senior management levels, and the need for stronger independence, standing and authority 

among a firm's internal risk management, control and compliance functions. As a result, where 

appropriate we focus our exams on the overall governance and risk management framework of a 

firm so we can assess the firm's system of checks and balances. 

National Examination Program Strategic Objectives 

The National Exam Program seeks to advance the SEC's mission through risk-focused strategies 

that (1) improve compliance; (2) prevent fraud; (3) inform policy, and (4) monitor firm-wide and 

systemic risk In the coming fiscal year we will pursue our four strategic objectives by further 

implementing our risk-based examination strategy, addressing the implementation of DoddFrank Act requirements, and enhancing intra-agency and inter-agency coordination. 

Further Implement Risk-Focused Exam Strategy. The NEP considers the national exam 

priorities and information from multiple sources to identify focus areas to review as well as 

which registrants to examine. We will tailor the scope of our examinations based on identified 

risks through our understanding of, for example, the registrant's business model (e.g., revenue 

streams, profit centers, products, business plans), affiliations and conflicts of interest, and control 

environment. OCIE now reviews and evaluates tips, complaints and referrals in accordance with 

the new national TCR system and related policies. Particular attention is given to TCRs that 

provide allegations or indications offraud and surprise custody audits that identify qualified 

28 
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11161129.eps

opinions and material discrepancies. This process helps inform the selection of registrants for 

examination and the scope of such exams. 

As we identify risk trends or emerging risks in the course of the examination program, we will 

communicate this information to our examination staff. We will also publish reports and risk 

alerts describing notable risks, as well as observations about effective methods for addressing 

these risks that the NEP staff has observed. Through these public reports we will seek to 

encourage and strengthen the effectiveness of registrants' risk management and compliance 

programs in recognizing and appropriately addressing key risks. 

Implement Dodd-Frank Act Requirements. The Dodd-Frank Act imposes significant additional 

responsibilities on the NEP, including the registration and examination of new entities, such as 

certain private fund advisers, private equity firms, municipal advisors and five new categories of 

swap/derivatives registrants. In addition, the Dodd-Frank Act significantly increases oversight 

expectations with regard to existing registrants, such as credit rating agenci es, clearing agencies 

and FINRA. In FY 2012, the NEP will continue to adapt its infrastructure (e.g., examination 

tools and techniques, as well as other resources) to effectively accomplish the Dodd-Frank 

mandates, as well as contribute more broadly to the agency's work on rulemaking, related 

studies, and implementation of the Dodd-Frank Act 

Enhance Intra-Agency and Inter-Agency Coordination. We will continue to collaborate with 

stafffrom the other Divisions and Offices as well as our regulatory counterparts, to share 

information, identify areas of interest or potential regulatory risk, and coordinate examinations. 

Within the Commission, we have been working closely with colleagues in other divisions and 

offices at all levels. For example, in addition to giving input in myriad rulemakings, we have 

conducted numerous joint training exercises, been in almost constant contact with other divisions 

on changes to forms such as ADV, FOCUS and BD, as well as on examination priorities, 

planning and review, and made joint inquiries to the industry in response to emergency issues, 

such as the May 6, 2010 Flash Crash or MF Global Our collaboration with the Division of 

Enforcement has been particularly close. We have formed joint referral committees to make sure 

that there is close communication on referrals from the moment they are made through the 

course of any ensuing investigation. 

Outside the SEC, we have collaborated with SROs, firms, regulatory counterparts at federal 

banking agencies, the CFTC, and state regulators on a wide range of examination priorities and 

regulatory initiatives. For example, pursuant to Section 813 of the Dodd-Frank Act, on July 21 , 

2011 the Commission reported jointly to Congress with the CFTC and the Federal Reserve 

Board how we will collaborate to identify emerging risks, advance supervisor oversight, and 

promote enhanced risk management practices for designated clearing entities. 

Programmatic Priorities for FY 2012. Pursuant to our risk-based approach to prioritizing 

examinations, we have identified certain likely areas of emphasis in each of our program areas 

for the coming year. These program areas are the broker-dealer exam program, the investment 

management exam program, the market oversight exam program, the clearance and settlement 

exam program, and the credit rating agency exam program. 

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Broker-Dealer Exam Program. This program will provide a risk-based focus to the program and 

also assist in selecting particular broker-dealers for examination. Since broker-dealer 

examinations may involve activities by enterprises with related entities registered in multiple 

capacities and acting in concert (e.g., broker-dealer, investment adviser, transfer agent, etc.), 

examination activities will be coordinated as appropriate. Some of the areas of focus include, 

new issue diligence, supervision of broker-dealer employees, fraud, unregistered activities, 

trading risks, new regulatory risks (e.g., compliance policies and procedures related to DoddFrank Act requirements or the new Market Access Rule), risks posed by large and complex 

firms, and enhanced collaboration with other regulatory authorities. 

Investment Management Exam Program. The Investment Management Exam Program is 

responsible for examinations of numerous types of registrants. In FY2012, focus areas for the 

Investment Management Program include complex entities, fund governance, risk management, 

fraudulent activities and safety of assets, and performance and advertising. 

Market Oversight Exam Program. The Market Oversight Program is responsible for examining 

certain SROs and other entities compliance with applicable federal securities laws and rules and 

the SRO's own rules. As of September 2011 , the population subject to examination by Market 

Oversight included 15 national securities exchanges, FINRA, MSRB, PCAOB, and SIPc. The 

priorities in FY2012 in this area include risk assessment examinations based on SRO 

assessments, enhanced oversight ofFINRA and other entities, Section 31 fee examinations, and 

examinations of potential new registrants. 

Clearance and Settlement Program. The Clearance and Settlement Program currently oversees 

transfer agents and clearing agencies. In addition, if the Commission adopts final rules for 

Security-based Swap Data Repositories (SB SDRs) requiring registration with the Commission, 

the Clearance and Settlement Program will take on the responsibility within OCIE for 

conducting examinations of SB SDRs. The priorities for the Clearance and Settlement Program 

currently include: the Transfer Agent Program, the Clearing Agency Program and the Securitybased Swap Data Repository Program 

Credit Rating Agency Program. The Dodd-Frank Act requires the Commission to establish an 

independent "Office of Credit Ratings" to administer the Commission's rules with respect to 

credit rating agencies registered as NRSROs. The specific duties of this new office include 

annual examinations of each NRSRO and an annual report summarizing the examinations. 

OCIE and TM have worked closely together to achieve the office's goals. In particular, OCIE 

has created an office within the NEP for NRSRO examinations. This office, with help from 

examiners from other OCIE examination areas and from members ofTM's NRSRO monitoring 

unit, successfully completed the first set of annual examinations of each NRSRO, and the 

Commission approved publishing the staffs summary report of those examinations. 

Upcoming Challenges 

Our new risk-based approach is driven in part by the simple fact that our current examination 

resources can only cover an ever smaller portion of the registrants that we are responsible for 

examlmng. Only eight percent of registered advisers were examined in FY 2011 and 

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approximately 38 per cent of advisers registered with the SEC have never been examined. 

Additionally, out of more than 160,000 broker-dealer branch offices, less than one percent of 

these offices are examined by either the SEC or FINRA annually. 

Moreover, increases in the regulatory population and new complex products and lines of 

business complicate examination oversight. Examinations have grown more complex with the 

increased use of new complex products, including derivatives and ETFs; the growth of 

technology to facilitate such activities as high-frequency trading; and with the growth of 

"families" of financial service firms with integrated operations that include both broker-dealer 

and investment adviser affiliates. 

Keeping up with these changes requires not only greater training and expertise, but also better 

technology. For example, high frequency trading has grown over the past six years from 

approximately 20 percent of trading volume in U.S. equities to well over 60 percent, and is 

likely to increase further. In order for the examination program to monitor developments in 

that market in a timely manner will require greater resources for data collection and processing 

as well as expertise to analyze these data feeds. Hedge funds and other complex financial 

entities and products pose similar technological challenges. 

The Dodd-Frank Act shifted the responsibility for examining many smaller advisers to the states. 

However, the Dodd-Frank Act expanded the SEC's responsibilities by adding to its jurisdiction 

municipal advisors, as well as a large number of complex entities, such as five new categories of 

securities-based swap participants as well as hedge fund and other private fund advisers. The 

staff recently concluded, as a result, that the Commission likely will not have sufficient capacity 

in the near or long term to conduct effective examinations of registered investment advisers with 

adequate frequency. 

The result of these changes in the registrant population will play out during FY2012. Overall, 

the approximately 25,000 registrants in the SEC regulated community in FY 2012 will dwarf the 

size of the current examination program (currently slightly less than 900 total staff nationwide). 

At current funding levels, we will not be able to expand our supervision of the population of 

current and future supervised entities. 

INVESTMENT MANAGEMENT 

Director, Eileen Rominger'Z 

The Division of Investment Management ("1M") assists the Commission in executing its 

responsibility for investor protection and for promoting capital formation through oversight and 

regulation of America's $43 trillion investment management industry. 1M's core mission is to 

administer the Investment Company Act of 1940 ("Investment Company Act") and the 

Investment Advisers Act of 1940 ("Advisers Act") and oversee and develop regulatory policy for 

investment advisers, mutual funds and other investment companies. 1M carries out its mission 

through the following main programs: 

52 Ms. Rominger joined the SEC as the Director of Investment Management in February 20 II. 

http://www.sec.gov/newsJpressI201112011-14.htm. 

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• Interpretive Advice and Exemptil'e Relief 1M provides formal and informal legal 

guidance in the form of interpretive and no-action letters, exemptive relief, interpretive 

releases, memoranda, and other letters and materials. In FY 2010, the staff closed 1,325 

matters involving formal and informal legal guidance. 

• Rel'iew of Filings. 1M reviews filings of investments companies that register under the 

Investment Company Act and register their securities under the Securities Act of 1933 to 

both monitor and enhance compliance with disclosure and accounting requirements. The 

filings reviewed include initial registration statements, post-effective amendments 

thereto, proxy statements, and annual and period reports. In FY 2010, the staff reviewed 

18,976 filings. Under Commission rules, some filings containing non-material changes 

or disclosure that is substantially similar to a prior filing may not be subject to staff 

review or may be subject to a limited review. Pursuant to requirements under the 

Sarbanes-Oxley Act of 2002, 1M reviews the annual reports of all investment companies 

no less frequently than once every three years. In FY 2010, such reviews amounted to 

4,741. 

• Enforcement Liaison. 1M regularly provides formal and informal legal and policy 

guidance to the Division of Enforcement on enforcement matters. In FY 2011 , 1M 

reviewed over 474 enforcement-related matters from the Division of Enforcement, and 

expects to review approximately the same number of enforcement-related matters in FY 

2012. In addition, 1M conducts reviews of disciplinary disclosures in new or amended 

Form ADVs filed by registered investment advisers to assess whether there are grounds 

to bring actions against the adviser or any of their associated persons. 1M also works 

with the Division of Enforcement on 1M-related tips, complaints and referrals. 

• Rlllemaking. In the last year, 1M has been focusing its rulemaking program on 

implementing the provisions of the Dodd-Frank Act as they relate to investment 

companies and advisers, and, as rules are adopted, much of the work will shift to the 

Division's disclosure, interpretive advice and exemptive relief programs. Provided below 

is a list and brief description of the recent Dodd-Frank implementation rules 1M was 

responsible for implementing. 

Adopted Rules 

Investment Adviser Regulation. The Dodd-Frank Act changed the population of investment 

advisers that must register with the Commission in two significant ways. First, the Dodd-Frank 

Act increased from $25 million to $100 million in assets under management the statutory 

threshold for Commission registration. Second, the Dodd-Frank Act eliminated the "private 

adviser" exemption, which exempted from registration many advisers to hedge funds and other 

private funds. Advisers that do not meet the new asset threshold may have to withdraw their 

registrations with the Commission and register instead in their home states. Furthermore, 

advisers to hedge funds and other private funds will be required to register with the Commission 

or qualify for one of the narrower exemptions added by the Dodd-Frank Act 

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In June 2011, the Commission adopted new rules and rule amendments that: (1) reallocate 

primary responsibility for oversight of certain advisers to the states; (2) provide for an orderly 

transition to state registration for advisers that will no longer be eligible to register with the 

Commission; and (3) provide a transition period until March 30, 2012 for advisers that 

previously relied on the "private adviser" exemption to register with the Commission and come 

into compliance with the Advisers Act. 53 The staff estimates that, as a result, approximately 750 

private fund advisers will have to register with the Commission and approximatel y 3,200 small 

advisers will withdraw their registrations. While the staff expects the number of registered 

advisers to decrease overall by 28 percent, the total assets managed by advisers registered with 

the Commission are expected to rise. 

Concurrently, the Commission adopted rules to implement new adviser registration exemptions 

created by the Dodd-Frank Act. 54 The new rules implement new exemptions for advisers solely 

to venture capital funds (by defining the term "venture capital fund") and advisers solely to 

private funds with less than $150 million in assets under management in the United States. The 

new rules also clarify the meaning of certain terms included in the new exemption for foreign 

private advisers. 

The Commission also adopted rules that require advisers registered with the Commission to 

provide information about the private funds that they advise, as well as information regarding 

their relationships with other affiliated financial institutions. Advisers that do not register, either 

because they are advising only venture capital funds or have less than $150 million in private 

fund assets under management in the United States, are subject to a more limited reporting 

obligation. 

Family Offices. In June 2011 , the Commission adopted a new rule defining "family offices" 

that will be excluded from the definition of an investment adviser under the Advisers Act and 

thus will not be subject to regulation under the Advisers Act. 55 Family offices are entities 

established by wealthy families to manage their money and provide tax and estate planning and 

similar services. Historically, family offices have not been required to register with the 

Commission because of an exemption for private advisers. The Dodd-Frank Act eliminated that 

exemption to enable the Commission to regulate advisers to hedge funds and other private funds 

(as discussed above), but included a new provision requiring the Commission to define family 

offices in order to exempt them from regulation under the Advisers Act. The Commission 

defined a family office as any firm that: (1) provides investment advice only to family members, 

as defined by the rule; certain key employees; and certain family entities; (2) is wholly owned by 

family clients, as defined by the rule, and controlled by family members or certain family 

entities; and (3) does not hold itself out to the public as an investment adviser. 

53 See Release No. IA·3221 , Rules IlIIplelllenting Alllendlllents to the Investlllent Advisers Act oj 1940 (June 

22,20 II), http://www.sec.gov/rules/finaIl2011Iia·3221.pdf. 

54 See Release No.IA·3222, Exelllptionsjor Advisers to Venture Capital Funds, Private FundAdvisers With 

Less Than $150Million in Assets Under Managelllent, and Foreign Private Advisers (June 22, 2011)), 

http://www.sec.gov/rules/finaIl2011Iia·3222.pdf. 

55 See Release No. JA·3220, Falllily Offices (June 22, 2011), http://www.sec.gov/rulesifinaIl2011/ia·3220.pdf. 

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Form PF. The Dodd-Frank Act mandated that the Commission require private fund advisers 

(including hedge and private equity fund advisers) to confidentially report information about the 

private funds they manage for the purpose of the assessment of systemic risk by the Financial 

Stability Oversight Council ("FSOC"). On October 31 , 2011 , in a joint release with the CFTC, 

based on a staff consultation with staff representing members ofFSOC, the Commission adopted 

a new rule that requires hedge fund advisers and other private fund advisers to report systemic 

risk information on a new form ("Form PF"). 56 Under the new rule, registered investment 

advisers managing at least $150 million in private fund assets will periodically file Form PF. 

The data collection would dovetail with the enhanced private fund reporting discussed above for 

investment advisers registered with the Commission. 

The Form PF reporting requirements are scaled to the adviser. Advisers with less than a certain 

amount of hedge fund, liquidity fund or private equity fund assets under management will report 

only very basic information on an annual basis. Advisers over specified thresholds will report 

more information, and large hedge fund and liquidity fund advisers also will report on a quarterly 

basis. This approach ensures that FSOC will have a broad picture of the industry while relieving 

smaller advisers from much of the reporting requirements. In addition, the reporting 

requirements are tailored to the types of funds that an adviser manages and the potential risks 

those funds may present, meaning that an adviser will respond only to questions that are relevant 

to its business model. The Commission does not intend to make public Form PF information 

identifiable to any particular adviser or private fund, although the Commission may use the data 

in an enforcement action. The Dodd-Frank Act provides special confidentiality protections for 

this data. The initial stages of this reporting will begin next year. 

Pay to Play. In July 2010, the Commission adopted an Advisers Act rule to address so-called 

"pay to play" practices in which investment advisers make campaign contributions to elected 

officials in order to influence the award of contracts to manage public pension plan assets and 

other government investment accounts 57 In June 2011 , the Commission amended the pay-toplay rule in response to Dodd-Frank Act amendments to the Advisers Act that would have 

narrowed the application of the rule with respect to certain advisers to private funds 58 The 

Commission also amended the rule to permit an adviser to pay a registered municipal advisor, a 

new Dodd-Frank Act category of SEC-registrants, to solicit government entities on the adviser's 

behalf Such municipal advisors, however, must be subject to a pay-to-play rule adopted by the 

MSRB that the Commission has determined is substantially equivalent to or more stringent than 

the Commission's pay-to-play rule for investment advisers. 

56 See Release No. IA-3308, Reporting by Ilniestment Advisers to Private Funds and Certain Commodify Pool 

Operators and Commodify Trading Advisors on Form PF (October 31 , 2011), 

http llwww.sec.gov/rules/finaIl2011Iia-3308.pdf 

57 See Release No. IA-3043, Political Contributions by Certain Investment Advisers (July 1, 2010), 

http://www.sec.gov/rules/finaIl2010Iia-3043.pdf 

58 See Release No. IA-3221 , Rules Implementing Amendments to the Investment Advisers Act of 1940 (June 

22,20 II), http://www.sec.gov/rules/finaIl2011Iia-3221.pdf. 

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Proposed Rules 

Volcker Rule. IM assisted the Commission with certain parts of the proposed rule 

implementing the Volcker Rule. Specifically IM focused on the provisions that relate to 

investments in and sponsorship of hedge funds and private equity funds by banking entities. 59 

Qualified Clients. In May 2011 , the Commission proposed changes to the rule that permits 

investment advisers to charge clients performance fees 60 The rule's conditions already include 

minimum standards, such as net worth, that clients must satisfy for the adviser to charge these 

fees. The proposed amendments would incorporate the revised dollar amount levels that the 

Commission adjusted by order this past July to account for the effects of inflation, as required by 

the Dodd-Frank Act. The amendments also would remove the value of a client's primary 

residence from the calculation of net worth. 

Incentive-Based Compensation Arrangements. The Dodd-Frank Act mandated that financial 

regulators jointly develop rules or guidelines governing incentive-based compensation practices 

at certain financial institutions with balance sheet assets of $1 billion or more. On March 29, 

2011 , the Commission proposed a rule - substantially similar to the rules proposed by the other 

financial regulators around the same time - that would apply to brokers, dealers and investment 

advisers with balance sheet assets of at least $1 billion6 The proposed rule contains: (1) 

disclosure requirements about incentive-based compensation arrangements; (2) prohibitions on 

encouraging inappropriate risk; and (3) provisions concerning policies and procedures for 

incentive-based compensation arrangements. The comment period on the proposed rule has 

ended. The staff is considering the various issues raised by the large number of commenters. 

Other Significant Initiatives 

While IM has been focused on bringing to closure its Dodd-Frank Act related rulemakings, the 

Division has also been engaged in rulemakings and other initiatives outside of its Dodd-Frank 

agenda. The most significant of these initiatives include the following: 

Use of Derivatives by Investment Companies. In August 2011 , the Commission issued a 

concept release to seek public comment on a wide range of issues raised by the use of derivatives 

by mutual funds and other investment companies regulated under the Investment Company 

Act6 2 The concept release is a continuation of the SEC's ongoing review of mutual funds' use 

of derivatives announced last year. The comment period ended on November 7, 2011 . After 

consideration of public comments, the Division will evaluate recommendations for further action 

by the Commission. 

S9 See Release No. 34-65545, Prohibitions and Restrictions on Proprietmy Trading and Certain Interests In, 

and Relationships with, Hedge Funds and Private Equity Funds (October 12, 20 II), 

httpllwww.sec.gov/rules/proposed/20 11/34-65545. pdf 

if) See Release No. IA-31 98,Inveslment Adviser Performance Compensation (May 10, 20 II), 

httpllwww.sec.gov/rules/proposedI2011/ia-3198.pdf. 

61 See Release No. 34-64 I 40,Incentive-based Compensation Arrangements (March 29, 20 II), 

httpllwww.sec.gov/rules/proposed/20 11 /34-64 140. pdf 

62 See Release No. IC-29776, Use of Derivatives by Investment Companies under the Investment Company 

Act of 1940 (August 31, 2011 ), httpllwww.sec.gov/rulesIconceptl201 Ilic-29776. pdf. 

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Asset-Backed Issuers under the Investment Company Act. In August 2011 , the Commission 

also issued an advance notice of proposed rulemaking to seek public input on possible 

amendments to Rule 3a-7 under the Investment Company Act that the Commission might 

consider proposing. 63 Rule 3a-7 excludes certain issuers of asset-backed securities from having 

to comply with the requirements of the Investment Company Act Among the issues that the 

Commission set forth for public comment is the role, if any, that credit ratings should continue to 

play in the context of the rule. The comment period also ended on November 7, 2011 and the 

Division staff is currently analyzing the comments. 

Mortgage-Related Pools under the Investment Company Act. In a companion concept 

release to the advance notice of proposed rulemaking on Rule 3a-7 for asset-backed issuers, the 

Commission solicited public comment on interpretive issues relating to some real estate 

investment trusts and other mortgage-related pools that rely on the exclusion from regulation 

underthe Investment Company Act set forth in Section 3(c)(5)(C) of that Act64 The concept 

release noted concerns that mortgage-related pools potentially are making judgments about their 

status under the Investment Company Act without sufficient Commission guidance, and that 

certain mortgage-related pools today appear to resemble investment companies such as closedend funds and may not be the kinds of companies that were intended to be excluded under the 

statutory provision. The comment period ended on November 7, 2011 and the Division staff is 

currently analyzing the comments. 

12b-l. In July 2010, the Commission proposed to reform the regulation of distribution fees that 

are paid by mutual funds and their investors65 These fees are a significant method of paying for 

the distribution of fund shares. Mutual funds paid over $10 billion in distribution fees in 2010. 

The Commission's proposal would establish limits on these fees, improve disclosures to 

investors, and promote more competition among broker-dealers in setting market-based fees. 

The Commission received about 2,400 comment letters in response to its proposal Most 

investors and investor advocates supported the proposal, while many industry commenters 

argued that the proposed changes would be too costly for too little benefit The Division is 

evaluating recommendations for further action by the Commission. 

Target Date Funds. In June 2010, the Commission proposed changes to rules regarding fund 

names and marketing materials with respect to target date funds 66 A target date fund is typically 

intended for investors whose retirement date is at or around the fund's stated target date. 

American workers increasingly rely on target date funds for their retirement needs. After 

consideration of public comments, the Division will evaluate whether to recommend that the 

Commission adopt rule changes to address target date funds. 

63 See Release No. IC- 29779, Treatment of Asset-Bocked Issuers under the IJnlestment Company Act (August 

31, 20 II), http://www.sec.gov/rules/conceptl20 11 /ic-29779.pdf 

&4 See Release No. IC-29778, Companies Engaged in the Business of Acquiring Mortgages and MortgageRelated Instruments (August 31, 20 II), http://www.sec.govlrules!conceptI20 11 !ic-29778.pdf. 

65 See Release Nos. 33-9128, Mutual Fund Distribution Fees; Confinnations (July 21 , 201 0), 

http://www . sec. gov!rules!proposedI20 I 0!33 -9128. pdf. 

66 See Release Nos. 33-9126, Investment Company Advertising; Target Date Retirement Fund Names and 

Marketing (June 16, 201 0), http://www.sec. gov!rulesJproposed!2010!33-9126.pdf 

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Money Market Fund Rulemaking, Oversight, and Surveillance. The Commission continues 

its more extensive oversight and surveillance of money market funds based on detailed monthly 

portfolio holdings data it began collecting in November 2010. Using this data, IM is able to 

monitor trends in money market funds' portfolio exposures, liquidity levels and average 

maturities and is able to discuss these trends and any associated risks with the Commission and 

with staff representing members ofFSOC. 

In November 2010, the Commission requested comment on the options discussed in the 

President's Working Group Report on Money Market Fund Reform Options67 Commenters 

both discussed the options in the President's Working Group Report and raised other options for 

reform. In May 2011 , the Commission sponsored a roundtable to discuss money market funds, 

systemic risk, and options for further regulatory reform to reduce their systemic risk and 

susceptibility to runs. IM continues to consult with their counterparts in the other agencies that 

comprise FSOC on options for further regulatory reform. 

Other Functions and Special Projects. 

IM also participates in international working groups and engages in other special projects, some 

of which are highlighted below. 

International Coordination. Funds and the advisers that operate them, including private funds 

and private fund advisers, frequently operate on a global basis. The active participation of IM 

staff with technical expertise in international working groups, such as IOSCO, is essential to the 

fulfillment of the Commission's international responsibilities. Such participation helps promote 

an internationally coordinated approach and standards that are consistent with Commission 

policy. 

Investor Testing. IM is proceeding on several fronts to engage investors about how best to 

provide them with useful disclosure. We are currently working with the Commission's Office of 

Investor Education and Advocacy to examine the effectiveness of mutual fund shareholder 

reports in communicating useful information to individual investors. The Commission staff is 

also using investor testing as part of a study mandated by Section 917 of the Dodd-Frank Act 

regarding financial literacy and methods to improve the timing, content, and format of 

disclosures to investors with respect to financial intermediaries, investment products, and 

investment services. Finally, the SEC staff is currently conducting investor testing as part of its 

rulemaking efforts on target date retirement funds. 

Cross-Divisional Studies. We have undertaken a number of cross-divisional studies required by 

the Dodd-Frank Act, including: 

• Im'estment Adl';serIBroker Dealer Fiduciary Study. In January 2011 , SEC staff 

completed a study required by Section 913 of the Dodd-Frank Act that, among other 

things, evaluated the effectiveness of existing legal or regulatory standards of care for 

broker dealers and investment advisers when providing personalized investment advice 

61 See Release No. IC-29497, President's Working Group Report on Money Market Fund Reform (November 

3, 2010), http://www.sec.gov/rules/otherI2010/ic-29497.pdf. 

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about securities to retail customers 68 SEC staff recommended that the Commission 

adopt rules, consistent with Congress' grant of authority in the Dodd-Frank Act, which 

would apply a uniform fiduciary standard of conduct to both broker-dealers and 

investment advisers when providing personalized investment advice about securities to 

retail investors. SEC staff also recommended that the Commission consider whether 

certain regulations applicable to broker-dealers and investment advisers should be 

harmonized to add meaningful investor protection. 

In light of the Commission's concerns over the potential economic impact of any 

rulemaking under Section 913 of the Dodd-Frank Act, Chairman Schapiro has asked a 

core team of economists from the Commission's Division of Risk, Strategy and Financial 

Innovation to study, among other things, data pertaining to the standards of conduct in 

place under the existing broker-dealer and investment adviser regulatory regimes to 

further inform the Commission. Since the Commission issued the study, this team of 

economists has been studying these issues, and staff has been reviewing public 

comments, meeting with interested parties to discuss their concerns, and requesting 

additional data to inform the staffs economic analysis. IM staff is participating in this 

process as appropriate. 

• Study on Enhancing Im'estmentAdviser Examinations. In January 2011 , IM staff, with 

assistance from other divisions and offices, completed a study required by Section 914 of 

the Dodd-Frank Act that reviewed the need for enhanced examination resources for 

investment advisers that are registered with the Commission6 9 The staff report 

concluded that the Commission's examination program requires a stable and scalable 

source of funding, and it highlighted three options (1) imposing user fees on SECregistered investment advisers to fund their examinations; (2) authorizing one or more 

SROs to examine, subject to SEC oversight, all SEC-registered investment advisers; or 

(3) authorizing FINRA to examine dually registered investment advisers and brokerdealers for compliance with the Advisers Act. 

Upcoming Challenges 

IM staffing levels have remained flat over the past several years and currently are at the same 

level as they were FY 2005, despite the fact that the size and complexity of the investment 

management industry has grown tremendously since then. As a result, IM has staffing needs for 

both its core programs and new responsibilities stemming from a variety of Dodd-Frank Act 

provisions. In particular, IM would like to bolster its technical expertise in complex areas 

including derivatives, hedge funds, ETFs, asset-backed arrangements, credit analysis, portfolio 

management, securities analysis, mutual fund trading strategies, and investment company 

operations. IM also would like to enhance its oversight of money market funds and specialized 

68 Fonner Commissioner Casey and Commissioner Paredes did not support release of the study as published 

and issued a separate statement in conjunction with publication of this study. The study is available at 

http://www.sec.gov/newslstudiesl20l1l9l3studvfinal.pdf. The statement by Commissioners Casey and Paredes is 

available at http://www.sec.gov/news/speechl2011/spchOI221Iklctap.htm. 

IE The study is available at http://www.sec.gov/newslstudieslZOI1l9l4studyfinal.pdf. A separate statement by 

Commissioner Walter is available at http://www.sec.gov/news/speechI2011 /spchOI1 911ebw.pdf. 

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products such as ETFs. The core program needs alone have put strain on existing resources and 

the Division continues to face challenges with allocating sufficient staff resources to additional 

responsibilities arising from the Dodd-Frank Act. 

RISK, STRATEGY, AND FINANCIAL INNOVA nON 

Chief Economist and Director, Craig Lewis /0 

The Division of Risk , Strategy, and Financial Innovation (RSFI) was created as part of the 

agency's modernization initiative to share expertise and bring together critical data from across 

the agency. The Division was established in September 2009 to provide the Commission and its 

staff with sophisticated analysis that integrates economic, financial, and legal expertise. As part 

of this mandate, RSFI provides economic analyses as part of the Commission's rulemaking 

process, and supports its rule review, examination and enforcement programs with data-driven, 

risk-based analytical methods. It also oversees the Commission's TCR and interactive data 

programs. The Division has been the leader behind the agency's increased use of computerized 

risk analysis and inter- and intra-agency data sharing. 

Economic Analysis 

The Office of Economic Analysis (OEA) has the primary responsibility within the Division for 

providing economic analysis that supports rule making. OEA has 18 PhD economists that are 

dedicated to this activity. OEA is comprised of three offices that focus on particular areas of 

financial economics, which are similar to the areas covered by the three primary rule writing 

divisions the Office of Corporation Finance, the Office of Markets, and the Office of 

Investments and Intermediaries. 

The SEC has included cost-benefit analysis ("CBA") section in its rule releases since the early 

1980s. RSFI participates in the rulemaking process by helping to develop the conceptual 

framing for and assisting in the subsequent writing of the its effects on the economic analysis 

sections. Where appropriate, the SEC "considers, in addition to the protection of investors, 

whether the action will promote efficiency, competition, and capital formation" ("ECCF") when 

engaged in rulemaking. 

Economic analysis of agency rules considers the key economic effects of the various alternatives 

that should be considered in developing regulations. Analysis of the likely economic effects of 

proposed rules, while critical to the rulemaking process, can be challenging. Certain costs or 

benefits may be difficult to quantity or value with precision, particularly those that are indirect or 

intangible. In light of recent court decisions, RSFI and the other divisions are examining 

improvements in the economic analysis the SEC employs in rulemaking. Although the existing 

procedures and policies are designed to provide a rigorous and transparent economic analysis, we 

are taking steps to improve this process so that future rules are consistent with best practices in 

economic analysis. 

70 Dr. Lewisjoined the SEC as the Chief Economist and Director of Risk, Strategy and Financial Innovation 

in May 2011. http://www.sec.gov/news/pressI201112011-114.htm . 

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Rulemaking Initiatives 

In addition to assisting in the preparation of economic analyses related to rulemakings, RSFI 

conducts special research projects to inform the Commission about key aspects of rules, and 

performs independent research to investigate issues of relevance to the Commission. RSFI is 

assisting with several projects relating to market structure reform. RSFI also is conducting 

several concurrent analyses of smaller reporting and private companies to better understand the 

effects of the 12(g) registration requirement of 500 shareholders and $10 million in assets. This 

includes an investigation of non-reporting companies that publicly trade in the OTC markets. 

These analyses are being conducted in concert with the Division of Corporation Finance 

RSFI contributed to rulemakings under the Dodd-Frank Act, including rulemakings for OTC 

derivatives and asset backed securities. In addition to rulemaking, the Dodd-Frank Act 

mandated a number of studies. RSFI has been engaged in a number of these studies, including: 

• Valeker Rule Study - RSFI assisted SEC staff and staff from other Federal financial 

agencies on a Dodd-Frank-mandated, inter-agency study on effective implementation of 

the Volcker Rule. 

• Short Selling - RSFI is completing the Dodd-Frank-mandated study of real time short 

sale position reporting and a voluntary pilot program in which new short-related marks 

would be reported to the Consolidated Tape. Concurrently, RSFI is conducting a second 

Dodd-Frank study of the state of short selling, with an emphasis on recent rule changes 

and fails to deliver. RSFI will also be assessing the impact of Rule 201 on the option 

markets, as required by that rule. 

• Extraterritariality- Dodd-Frank Act Section 929Y requires a study of the extent to 

which private rights of action under the antifraud provisions of the securities laws should 

be extended to conduct and transactions occurring outside the United States, including a 

study of the economic costs and benefits of extending a private right of action for 

transnational securities frauds. 

Rulemaking Challenges 

As noted, RSFI has had a significant role in many of the rules mandated by the Dodd-Frank Act. 

At the same time, the Division is committed to continuously improving economic analysis in 

Commission rulemakings and to better integrate RSI economists into the rulemaking process. 

While the Division is striving to fully comply with these increased demands, it faces challenges 

in its ability to do so given current resources. 

Data-Driven Analysis and Risk Assessment 

In addition to rulemaking, there are a number of data-driven responsibilities and initiatives that 

are specific to RSFL The Division provides economic and statistical analysis to support all 

aspects of enforcement and litigation matters for Commission. RSFI has developed innovative 

software tools and cutting edge analytical methods that are designed to identify potential 

problem areas associated with investment managers that support the efforts of the Office of 

Compliance, Inspections, and Examinations. 

The Division also oversees the TCR system and interactive data programs. RSFI is responsible 

for the operation, management, and governance of the system. RSFI is responsible for, among 

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other things, generating data and statistics on how the system is operating, checking whether the 

system is being used properly, and helping with system development. 

The interactive data program provides information contained in certain documents filed with the 

Commission in a structured format that makes the underlying data readily available for analysis. 

The Office of Interactive Data has a number of objectives that include, among others, promoting 

the use of interactive data, developing infrastructure and supporting rule writing to implement 

data tagging requirements RSFI is responsible for producing web pages that support company 

filings on the EDGAR web site. 

To improve efficiency, the Division has been reorganized to reassign staff that have expertise in 

data analysis and risk assessment into the newly formed Office of Quantitative Research (OQR), 

which will be responsible for building quantitative risk assessment models. This office has 

begun to build a data infrastructure to facilitate the development and support of analytics 

utilizing data that is collected by the Commission. OQR houses subject matter experts that 

include three PhDs with degrees in Economics and Mathematics and nine financial analysts that 

have significant industry experience 

The Office of Litigation Support (OLS) provides economic and statistical analysis to support all 

aspects of enforcement and litigation matters for the Commission. OLS is comprised of subjectmatter experts that include five PhD economists, three senior analysts that have significant 

industry experience, and two junior analysts. 

Litigation Support, Data Analysis, and Risk Assessment Initiatives 

The data analysis and risk assessment functions ofRSFI contribute to initiatives and activities of 

divisions and offices across the SEC: 

• Enforcement cases: RSFI staff designs and implements analytical tools to assist the 

Division of Enforcement to identify and quantify potential violations, including insider 

trading and front-running. RSFI staff is frequently consulted as expert witnesses in 

Commission actions. 

• Insider Trading Prosecutions - Recently, RSFI staff provided support to Federal 

prosecutors in the successful prosecution of Raj Rajaratnam for insider trading. RSFI 

staff assisted these prosecutors with analyzing expert testimony and other documents 

proffered by the Rajaratnam defense. Additionally, federal prosecutors asked an RSFI 

staff member to serve as a testifying expert in the insider trading case against Winifred 

Jiau. 

• Supreme COllrt Briefs - RSFI provided statistical expertise and arguments for the amicus 

brief filed by the United States in Matrixx v. Siracllsano, in which the U.S. Supreme 

Court defined the role of statistical significance in securities litigation. In addition, RSFI 

staff provided expertise for the amicus brief filed in Erica P. John Fund v. Halliburton, 

on whether fraud plaintiffs need to prove loss causation to obtain class certification. 

• Regulated Entity Risk Models - RSFI has developed and is continuously refining risk 

models to help OCIE efficiently direct exam resources among investment advisers, 

broker-dealers, and fund complexes in light of current trends and suspected abuses. 

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These models are designed to identify candidates for examination and focus resources 

mid-exam. 

• Analytical Tools and Expertise for Examination and Investigations - RSFI has 

participated in exams and investigations, and developed tools, algorithms, and analytics 

that enhance the effectiveness offield teams at registrants. In particular, RSFI also 

provides guidance to OCIE staff during examinations of investment advisers that rely on 

quantitative or model driven strategies to help the examiners understand these strategies. 

• Dodd-Frank Data Collections -RSFI will handle the new data collection responsibilities 

mandated by the Dodd-Frank Act, which include, among other items, credit default swap 

data and information about private fund advisers submitted using Form PF. For example, 

RSFI has been preparing for this responsibility by analyzing data provided by Depository 

Trust and Clearing Corporation (DTCC) on a voluntary basis for more than a year. 

• New Products - RSFI has formed a working group to evaluate risks posed by new 

financial products. These products come to the working group's attention through a 

steady work flow of SRO rule changes and exemption requests, registrations for new 

issuances, its own research and through referral by SEC staff. 

Challenges with Expanding Data Analytic and Risk Assessment Capabilities. RSFI would like 

to expand its capabilities to develop risk assessment models and to build a scalable data 

infrastructure to support risk-based initiatives across the SEC. Although the Division plans to 

pursue these objectives simultaneously and has existing employees with the necessary expertise 

to work on these projects, resource constraints inhibit progress and significantly slow the rate of 

innovation. For example, projects to develop risk assessment models to detect accounting fraud 

have been delayed due to resource constraints. 

Research 

RSFI economists conduct research on financial and economic subjects relevant to the SEC's 

mission for publication in peer-reviewed academic journals. This work includes researching and 

writing papers, and presenting these papers at conferences and similar academic forums for 

critique. Active participation in the research community helps inform its input into Commission 

policy and operations and ultimately helps make the SEC a more effective regulator. 

Conclusion 

While the SEC has made substantial progress in reforming its operations and increasing its 

efficiency, our efforts are ongoing. We will continue to further improve our internal operations, 

and will seek the resources needed to accomplish our core mission, implement the 

responsibilities given to us under the Dodd-Frank Act, and undertake seriously needed new 

technology initiatives. Investors and our markets deserve nothing less. We look forward to 

continuing to work closely with Congress, and we are happy to answer any questions you may 

have. 

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