Testimony 

Before the Subcommittee on Government 

Efficiency and Financial Management, 

Committee on Government Reform, 

House of Representatives 

United States General Accounting Office 

GAO

For Release on Delivery 

Expected at 10:30 a.m. EST 

Tuesday, April 20, 2004 SEC OPERATIONS 

Oversight of Mutual Fund 

Industry Presents 

Management Challenges 

Statement of Richard J. Hillman, Director, 

Financial Markets and Community Investment 

GAO-04-584T 
www.gao.gov/cgi-bin/getrpt?GAO-04-584T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Richard Hillman 

at (202) 512-8678 or hillmanr@gao.gov. 

Highlights of GAO-04-584T, a testimony to 

the Subcommittee on Government 

Efficiency and Financial Management, 

Committee on Government Reform, 

House of Representatives 

April 20, 2004

SEC OPERATIONS

Oversight of Mutual Fund Industry 

Presents Management Challenges 

In late 2003, state law enforcement authorities were the first to bring to light 

various abusive practices in the mutual fund industry. SEC did not identify 

these practices because detecting fraud in routine examinations is difficult 

and it has been challenged to keep pace with the rapid growth of the mutual 

fund industry using its existing resources. However, since the abuses were 

identified SEC has acted vigorously to address these inappropriate practices, 

including taking various enforcement actions to punish wrongdoers and 

issuing numerous rule proposals designed to better prevent or detect 

abusive practices in the future. 

After years during which its workload grew faster than its resources, SEC 

recently received budget increases that have allowed it to significantly 

increase its staffing. As shown in the table below, SEC also plans to 

significantly increase the numbers of staff that oversee mutual funds. 

However, SEC made these allocation decisions without the benefit of an 

updated and complete strategic plan, which it is preparing but has yet to 

finalize. As a result, GAO was unable to determine whether SEC has 

optimally allocated its limited resources to achieve the greatest benefits. 

Although it has received additional resources in recent years, SEC faces a 

number of agencywide challenges impacting its mission and ability to 

oversee the mutual fund industry. These include improving its ability to 

better anticipate and detect problems in the industry and identifying and 

obtaining all the staff it needs to achieve its mission. SEC has experienced 

difficulty in effectively implementing various agencywide information 

technology initiatives, such as an electronic document imaging system and 

projects needed by units responsible for mutual funds. SEC also has various 

gaps in its authority that impede its ability to gather information, cooperate 

with other law enforcement authorities, and collect monies owed by 

violators. 

Staff Positions for SEC Divisions and Offices with Responsibilities for Mutual Fund 

Regulation, Oversight, and Enforcement, at Fiscal Year End

SEC Unit 

Actual 

2002 

Actual 

2003 

Estimated 

2004 

Requested 

2005 

Percent change, 

2002-2005

Investment 

Management Division 173 167 190 200 16%

Office of Compliance 

Inspections and 

Examinationsa

397 439 545 579 46

Enforcement 

Divisionb

 980 1,016 1,248 1,278 30

Source: GAO analysis of SEC data. 

Notes: 

a These include only staff conducting or supporting mutual fund and investment adviser 

examinations. 

b These include staff that conduct enforcement of all securities activities. 

Having grown to over $7.5 trillion 

in assets, mutual funds have 

become vital components of the 

financial security of more than 95 

million American investors. 

However, in 2003, various 

allegations of misconduct and 

abusive practices involving mutual 

funds came to light. Therefore, 

ensuring that the Securities and 

Exchange Commission (SEC), 

which has primary oversight of the 

mutual fund industry, has the 

necessary resources and strategic 

focus to adequately oversee fund 

practices has never been more 

important. To assess how SEC is 

positioned to oversee mutual 

funds, GAO reviewed (1) how the 

abusive mutual fund practices were 

identified and SEC’s subsequent 

responses, (2) SEC’s plans for 

increasing its staffing in the 

divisions and offices responsible 

for overseeing mutual funds and its 

progress in developing a new 

strategic plan to guide staff 

deployment, and (3) the challenges 

SEC faces in overseeing the mutual 

fund industry. 

Although this testimony statement 

makes no recommendations, GAO 

discusses challenges that SEC will 

have to successfully overcome to 

improve its effectiveness and 

restore investor confidence in the 

securities markets. 
Page 1 GAO-04-584T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss the Securities and Exchange 

Commission’s (SEC) ongoing strategic planning efforts and the challenges 

that it is facing to proactively oversee our nation’s mutual fund industry. In 

the last 20 years, mutual funds have grown from under $400 billion to over 

$7.5 trillion in assets and have become vital components of the financial 

security of the more than 95 million American investors estimated to own 

them. These funds have also grown to represent a significant portion of 

the nation’s retirement wealth with 21 percent of the more than $10 trillion 

in pension plan assets now invested in mutual funds. However, various 

allegations of misconduct and abusive practices involving mutual funds 

have recently come to light. As a result, ensuring that SEC has the 

necessary resources and strategic focus to adequately oversee our nation’s 

mutual fund industry has never been more important. 

Today, I will discuss our work examining how well SEC is positioned to 

effectively oversee the mutual fund industry. Specifically, I will discuss (1) 

how the abusive practices involving mutual funds came to light and SEC’s 

subsequent responses, (2) SEC’s plans for increasing its staffing in the 

divisions and offices responsible for overseeing mutual funds and its 

progress in developing a new strategic plan to guide staff deployment, and 

(3) challenges that may be affecting SEC’s ability to effectively oversee the 

mutual fund industry. In preparing this testimony, we summarized 

perspectives gained from our recent series of reports and testimonies on 

practices in the mutual fund industry.1

 In addition, we also relied on 

information gathered from our previous and ongoing work involving SEC’s 

resources and strategic planning efforts.2

 We also met with SEC officials to 

 1

See U.S. General Accounting Office, Mutual Funds: Information on Trends in Fees and 

Their Related Disclosure, GAO-03-551T (Washington, D.C.: Mar. 12, 2003); Mutual Funds: 

Greater Transparency Needed in Disclosures to Investors, GAO-03-763 (Washington, D.C.: 

June 9, 2003); Mutual Funds: Additional Disclosures Could Increase Transparency of

Fees and Other Practices, GAO-03-909T (Washington, D.C.: June 18, 2003); Mutual Funds: 

Additional Disclosures Could Increase Transparency of Fees and Other Practices, 

GAO-04-317T (Washington, D.C.: Jan. 27, 2004); and Mutual Funds: Assessment of

Regulatory Reforms to Improve the Management and Sale of Mutual Funds, GAO-04-533T

(Washington, D.C.: Mar. 10, 2004). 

2

See U.S. General Accounting Office, Securities and Exchange Commission: Human 

Capital Challenges Require Management Attention, GAO-01-947 (Washington, D.C.,: Sept. 

17, 2001); SEC Operations: Increased Workload Creates Challenges, GAO-02-302

(Washington, D.C.: Mar. 5, 2002); and Securities and Exchange Commission: Preliminary 

Observations on SEC’s Spending and Strategic Planning, GAO-03-969T (Washington, 

D.C.: July 23, 2003). 
Page 2 GAO-04-584T 

discuss the status of their strategic planning efforts, including their plans 

to oversee the mutual fund industry. Finally, we reviewed SEC budgetrelated documents for fiscal years 2003 and 2004, and its 2005 budget 

request. We conducted our work from March to April 2004 in accordance 

with generally accepted government auditing standards. 

In summary, in late 2003 state authorities were the first to bring a case 

after being alerted to various abusive practices in the mutual fund 

industry. Although SEC is the organization primarily responsible for 

oversight of the mutual fund industry, it did not identify these abusive 

practices because of the difficulty of detecting fraud, the lack of focus on 

the trading of fund shares in its examinations, and the challenges it faces 

in overseeing a growing industry using its existing resources. However, 

since the abuses came to light, SEC has taken various enforcement actions 

and issued numerous rule proposals designed to punish wrongdoers and 

better prevent or detect abusive practices in the future. 

After years in which its workload grew faster than its resources, SEC 

recently received budget increases that have allowed it to significantly 

increase its staffing, including expanding the staff in the divisions and 

offices with mutual fund oversight responsibilities. However, SEC made 

these allocation decisions without the benefit of an updated and complete 

strategic plan. As a result, we are unable to determine whether SEC has 

optimally allocated its limited resources to achieve the greatest benefits. 

In addition, SEC continues to face a number of challenges in improving 

and maintaining an effective mutual fund oversight structure, including 

improving its ability to better anticipate and detect problems in the 

industry and hiring all the staff it intends to bring on board in the coming 

years. In trying to improve its oversight effectiveness, SEC is also 

challenged to obtain and make effective use of information technology and 

faces various gaps in its authority that impede its ability to gather 

information, cooperate with other law enforcement authorities, and 

collect the monies owed by violators. 
Page 3 GAO-04-584T 

State authorities uncovered various abusive practices in the mutual fund 

industry in 2003, but since then SEC has taken swift action designed to 

punish wrongdoers and better prevent or detect abusive practices in the 

future. In September 2003, the Attorney General of the State of New York 

filed a case alleging abusive practices involving mutual funds. After 

receiving a tip, the Attorney General’s staff investigated and filed fraud 

charges against a hedge fund manager for arranging with several mutual 

fund companies to improperly trade in fund shares and profit at the 

expense of other fund shareholders. 3

 The abuses in this case, and in 

others subsequently filed, included allegations of late trading and market 

timing. Late trading occurs when investors are able to illegally purchase or 

sell mutual fund shares after the 4:00 p.m. Eastern Time close of U.S. 

securities markets, when funds typically price their shares.4

 Market timing 

occurs when certain fund investors place orders to take advantage of 

temporary disparities between the share value of a fund and the values of 

the underlying assets in the fund’s portfolio. Although not illegal, most 

mutual funds discourage such trading because it increases their costs and 

lowers returns for their long-term investors. 5

 These inappropriate market 

timing cases generally involved either fund companies with stated policies 

against such trading that were facilitating market timing for selected 

 3

A hedge fund is generally an entity that holds a pool of securities and perhaps other assets 

whose securities are sold to a limited number of high income or high net worth individuals 

or institutional investors through private placements. As a result, hedge fund offerings are 

not required to be registered under the Securities Act of 1933 and hedge funds are not 

registered as investment companies under the Investment Company Act of 1940. 

4

Under current rules, mutual funds accept orders to sell and redeem fund shares at a price 

based on the current net asset value, which most funds calculate once a day at 4:00 p.m. 

Eastern Time. Orders received after this time are required to be executed at the next day’s 

asset value. Many investors, however, purchase mutual fund shares through other 

intermediaries such as broker-dealers, banks, and pension plan administrators. Because of 

the time required to combine and process these orders, SEC rules currently permit such 

intermediaries to forward the order information to funds after 4:00 p.m. An investor 

engaging in late trading is allowed to buy or sell shares at the current day’s price after 4:00 

p.m. With knowledge of developments in the financial markets that occurred after 4:00 

p.m., such investors have an unfair opportunity for profits that is not provided to other 

fund shareholders. 

5

Reduction of the returns of a fund’s long-term investors can occur, for example, when a 

U.S. mutual fund uses the last traded price for foreign securities (whose markets close 

hours before the U.S. markets) to value their portfolio. Opportunities for market timing can 

happen when events occur between the close of foreign securities markets and the close of 

U.S. securities markets that are likely to cause significant movements in the prices of those 

foreign securities when their home markets reopen. Investors with knowledge of such 

market-moving events and knowledge of a mutual fund’s portfolio holdings can make swift 

profits, or limit losses, at the expense of long-term fund investors. 

State Authorities 

Were First to Uncover 

Mutual Fund Trading 

Abuses but SEC Has 

Since Acted Swiftly to 

Address Problems 
Page 4 GAO-04-584T 

investors or broker-dealers or others that took deceptive actions to assist 

their customers to conduct market timing transactions. 

Since this case was filed, the New York State Attorney General’s Office has 

filed at least 10 additional cases involving mutual funds, broker-dealers, 

and other entities that were involved in late trading or market timing 

abuses. As of March 2004, state legal or regulatory authorities in at least 

three other states, including Massachusetts (3 cases), New Jersey (1 case), 

and Colorado (1 case) have taken actions against participants in the 

mutual fund industry for their involvement in late trading, market timing, 

or other abuses. Some of these cases also allegedly involved mutual fund 

executives or employees who were conducting market-timing activities in 

their own firms’ funds. 

SEC did not identify these abusive practices involving mutual funds for 

various reasons. According to SEC staff, many of the cases involved fraud 

and collusion among personnel and such activity is very hard to detect in a 

routine examination. Also, according to testimony by the head of the SEC 

office that conducts mutual fund examinations, SEC examiners did not 

reveal these practices because their examinations focused primarily on the 

operations of the mutual fund and trading of the fund’s portfolio securities 

practices with an acknowledged potential for abuse. As a result, their 

examinations did not generally address the trading in the fund’s own 

shares. SEC has also faced resource challenges for years that have 

affected its ability to conduct oversight in the mutual fund industry and 

other areas. For example, we reported on SEC’s difficulties during the 

1990s to keep pace with the growth in the industry and its inability to 

examine funds and investment advisers frequently.6

 In recent testimony, 

the director of the SEC office that conducts examinations noted that, prior 

to 1998, SEC examinations of mutual fund firms had been as infrequent as 

once every 12-24 years.7

 Scarce resources may have also affected SEC’s 

 6

See U.S. General Accounting Office Investment Advisers: Current Level of Oversight Puts 

Investors at Risk, GGD-90-83 (Washington, D.C.: June 26, 1990); Bank Mutual Funds: Sales

Practices and Regulatory Issues, GGD-95-210 (Washington, D.C.: Sep. 27, 1995); and

Mutual Funds: SEC Adjusted Its Oversight in Response to Rapid Industry Growth, GGD97-67 (Washington, D.C.: May 28, 1997).

7

See U.S. Securities and Exchange Commission, Lori A. Richards, Director, Office of 

Compliance Inspections and Examinations, Testimony Before the U.S. Senate Committee 

on Banking, Housing and Urban Affairs Concerning Investor Protection Issues 

Regarding the Securities and Exchange Commission’s Examinations of Mutual Funds 

(Mar. 10, 2004). 
Page 5 GAO-04-584T 

decision to, unfortunately, not follow up on information it obtained 

regarding the recent wrongdoing in the mutual fund industry. In the 

summer of 2003, SEC staff had received a tip from a former fund employee 

who was aware of how his former employer was accommodating market 

timing by some investors, but SEC staff ultimately chose not to use further 

resources to pursue this case. The former fund employee then reported the 

matter to the Massachusetts Securities Division, which subsequently took 

action against the firm’s executives. As a result of another tip, however, 

the SEC staff promptly recommended and brought an enforcement action 

against the fund complex and two portfolio managers based on market 

timing and excessive short-term trading by investment professionals 

employed by the fund complex. 

However since these abuses have come to light, SEC and NASD, which 

oversees the broker-dealers that sell fund shares, have acted vigorously to 

address inappropriate practices in the mutual fund industry. For example, 

SEC has sent numerous requests for information to funds and brokerdealers about their trading practices. SEC’s preliminary analysis of these 

data show that 25 percent of responding broker-dealers had accepted 

orders after the 4:00 p.m. close and 30 percent allowed market timing. 

Since September 2003, SEC also has taken 15 enforcement actions that 

involved late trading and inappropriate market timing, in many cases 

against some of the same participants also pursued by state authorities. As 

of March 2004, NASD has also brought multiple enforcement cases against 

broker-dealers, including a February 2004 case against one of its brokerdealer members that failed to prevent market timing occurring in one of its 

affiliated firm’s mutual funds. 

SEC and NASD also have issued at least 11 rule proposals to address 

abusive and other practices in the mutual fund industry. For example, to 

address late trading and market timing, SEC issued proposed rule changes 

that would require orders for mutual fund shares to be processed by 

intermediaries and received by funds or their agents by 4:00 p.m.8

 SEC is 

also proposing a rule that would require that funds charge investors 

 8

See Securities and Exchange Commission, Proposed Rule: Amendments to Rules 

Governing Pricing of Mutual Fund Shares, Release No. IC-26288 (Dec. 11, 2003). Because 

many of the cases of late trading involved orders submitted through intermediaries, 

including banks and pension plans not regulated by SEC, this proposal requires that to 

obtain the current day’s price, orders to purchase or redeem mutual fund shares be 

received by a fund, its transfer agent, or a registered clearing agency before the time the 

fund calculates the net asset value price of its shares, which for most funds occurs at 4:00 

p.m. Eastern Time. 
Page 6 GAO-04-584T 

holding fund shares less than 5 days a 2-percent redemption fee, which 

would reduce the likely profitability of short-term trading strategies 

involving late trading or market timing.9

 SEC also proposed that funds 

disclose information about their policies regarding market timing and their 

use of a pricing technique called fair-value pricing, which is designed to 

better ensure that fund shares are priced accurately and thus are less 

susceptible to market timing.10 SEC’s Commissioners approved these rules 

on April 13, 2004. 

In addition to issuing proposals to address late trading and market timing, 

SEC has also taken some actions that address longstanding concerns over 

other mutual fund practices, including the lack of transparency of some 

fees and costs and the potential for conflicts of interest in fund 

distribution and sales practices. Some of the actions SEC and NASD are 

proposing would require greater disclosure of fees that funds charge or the 

payments that broker-dealers receive from fund firms for marketing 

certain funds. We discussed these and the late trading and market timing 

proposals and our views on them in testimony for the Senate Committee 

on Banking, Housing and Urban Affairs on March 10, 2004.11

Although SEC and the other regulators have acted swiftly to respond to 

the revelations of abusive mutual fund trading practices, other issues 

warrant SEC’s continued attention. For example, SEC is seeking 

information on how fund advisers use investors’ dollars to obtain research. 

This practice, called soft dollars, involves fund advisers receiving research 

or other services from broker-dealers in exchange for the commissions the 

advisers pay on trades conducted in fund portfolio securities. Although 

this practice can benefit the fund’s investors, whose assets are used to pay 

 9

See Securities and Exchange Commission, Proposed Rule: Mandatory Redemption Fees 

for Redeemable Fund Securities, Release No. IC-26375A (Mar. 5, 2004). 

10See Securities and Exchange Commission, Proposed Rules: Disclosure Regarding Market 

Timing and Selective Disclosure of Portfolio Holdings, Release No. IC-26287 (Dec. 11, 

2003). Specifically, this proposal would require mutual funds to disclose in their 

prospectuses the risks to shareholders of the frequent purchase and redemption of 

investment company shares, and fund policies and procedures pertaining to frequent 

purchases and redemptions. The proposal also would require funds to explain both the 

circumstances under which they would use fair-value pricing and the effects of using fairvalue pricing. Fair-value pricing involves the use of models or other analytical techniques 

funds use to adjust the prices of a fund’s portfolio securities in cases in which the last 

traded price for a security does not reflect its current market value. 

11See GAO-04-533T. 
Page 7 GAO-04-584T 

these commissions, it can also create conflicts of interest or potential for 

abuse. Given the increased spotlight Congress and regulators are placing 

on the mutual fund industry, in our view, the time is right to address the 

conflicts created by soft-dollar arrangements. In addition, we have 

identified other actions that SEC should take that would improve 

disclosure of mutual fund fees, thus improving investor awareness of the 

fees they pay on their mutual fund investments. These actions would 

increase the transparency of fund fees and likely enhance competition 

among funds on the basis of the fees charged investors. 

After experiencing an extended period in which increases in SEC’s 

workload grew faster than its staffing and other resources, SEC has 

received recent budget increases that have begun to allow it to increase its 

staffing, including positions in the divisions and offices with 

responsibilities for mutual fund regulation, oversight, and enforcement. 

However, SEC has taken these actions without the benefit of an updated 

strategic plan to guide staff deployment and the divisions and offices with 

responsibilities for mutual funds followed varying processes to determine 

their staffing needs. As a result, it is difficult to determine whether SEC 

has optimally allocated its limited resources to achieve the greatest 

benefits. 

After years of facing imbalances in its workload, SEC recently received 

additional resources that can help it more effectively oversee the 

securities markets, including the mutual fund industry. In March 2002, we 

reported that the growth rate of demands on SEC’s staff, including the 

number of corporate and regulatory filings they must review, the 

complaints and allegations of wrongdoing they must investigate, and the 

numbers of mutual funds, investment advisers and other entities they must 

examine, had increased by about 60 percent from 1996 to 2000.12 The rapid 

growth of the mutual fund industry during this time also posed challenges 

to SEC’s staff. For example, the number of mutual funds in existence grew 

from about 4,500 at the end of 1993 to over 8,100 by the end of 2000. In 

addition, the issues that SEC staff had to address had also become more 

complex. However, SEC’s staff resources during this period remained 

relatively flat. As a result, SEC’s ability to fulfill its mission had become 

 12GAO-02-302. 

SEC Has Increased 

Resource Allocations 

Without the Benefit of 

An Updated Strategic 

Plan 

Additional Resources SEC 

Receives to Address 

Workload Imbalances Will 

Also Benefit Mutual Fund 

Oversight 
Page 8 GAO-04-584T 

increasingly strained because of the imbalance between its workload and 

staffing resources. 

Following the issuance of our March 2002 report, several high-profile 

corporate failures and accounting scandals came to light in 2002. In 

response to the resulting demands that public companies be held more 

accountable for information they report to investors, Congress passed the 

Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).13 The act, which addressed a 

number of concerns involving corporate governance, auditor 

independence, and regulation and oversight of the accounting profession, 

also provided additional resources to SEC. Subsequently, Congress 

appropriated $716 million for SEC in 2003, an increase of 45 percent over 

its fiscal year 2002 budget. SEC was directed to use this increase both to 

add personnel and acquire new information technology to increase its 

effectiveness. The new personnel were expected to assist SEC in 

addressing its workload imbalance and to help it conduct the additional 

reviews of corporate filings mandated by the act. In recognition of the 

important role SEC plays in ensuring the integrity of U.S. securities 

markets, it has continued to receive additional budgetary resources since 

then with an appropriation for 2004 of $811.5 million and a requested 

budget of $913 million for 2005. 

In addition to addressing other needs with these additional resources, SEC 

has also been able to respond to the mutual fund scandals by increasing 

the staff allocated to the three primary divisions and offices within the 

agency responsible for mutual fund regulation, oversight, and 

enforcement. Within SEC, the Division of Investment Management is 

responsible for creating rules and reviewing filings for mutual funds and 

investment advisers.14 Staff in SEC’s Office of Compliance Inspections and 

Examinations (OCIE) conducts examinations and inspections of mutual 

funds companies and investment advisers.15 Finally, staff in SEC’s Division 

of Enforcement investigate possible violations of securities laws, including 

 13Pub. L. No. 107-204. 

14In addition to overseeing mutual funds and investment advisers, the Division of 

Investment Management also oversees entities required to register with SEC under the 

Public Utility Holding Company Act of 1935. 

15In addition to investment management-related examinations, OCIE also oversees the 

activities of self-regulatory organizations and conducts their own reviews of brokerdealers, exchanges, and other entities active in the securities industry. 
Page 9 GAO-04-584T 

the Investment Company Act of 1940 and the Investment Advisers Act of 

1940, and pursue legal actions against violators.16

To address the mutual fund scandals, SEC has plans to substantially 

increase the staffing in the units responsible for mutual fund oversight. As 

shown in table 1, between 2002 and 2005, SEC plans to increase the 

staffing for OCIE and the Division of Enforcement by 46 and 30 percent, 

respectively. SEC also plans to increase the staffing within the Division of 

Investment Management by 16 percent. SEC staff told us that many of the 

new personnel will be working on mutual fund issues. 

Table 1: Staff Positions for SEC Divisions and Offices with Responsibilities for 

Mutual Fund Regulation, Oversight, and Enforcement, at Fiscal Year End 

SEC Unit 

Actual 

2002 

Actual 

2003 

Estimated 

2004 

Requested 

2005 

Percent 

change 2002-

2005

Investment 

Management Divisiona

173 167 190 200 16%

OCIEb 397 439 545 579 46

Enforcement Divisionc 980 1,016 1,248 1,278 30

Source: GAO analysis of SEC data. 

Notes: 

a

Includes staff in the office that administers the Public Utility Holding Company Act of 1935. 

b

The amounts for OCIE present only those staff in SEC’s headquarters and regional offices who 

support or conduct examinations of mutual funds and investment advisers. 

c

The amounts for the Division of Enforcement include all staff in SEC’s headquarters and regional that 

support or conduct enforcement activities over mutual funds, investment advisers, broker-dealers, 

and all other entities that SEC regulates. 

The units responsible for mutual fund oversight benefited from the 

additional staff they received. For example, OCIE staff said that with the 

added resources they received in 2003, they were able to begin conducting 

additional examinations that they hoped would allow them to increase the 

frequency of the reviews they conduct of the largest fund companies as 

well as those that pose the greatest compliance risks to as often as every 2 

years. OCIE staff said that additional positions requested for 2005 would 

be used to expand its examination program in the SEC regional offices. 

 16SEC’s Division of Enforcement also pursues cases against broker-dealers for abuses 

involving the sale of mutual fund shares under rules and regulations of the Securities 

Exchange Act of 1934. 
Page 10 GAO-04-584T 

SEC’s Chairman also recently testified that he has asked the staff to 

prepare a rule proposal that would require managers to hedge funds to 

register with SEC and submit to examinations.17 OCIE staff said that some 

of the additional staff SEC requested for 2005 could likely be used to assist 

with those efforts. 

SEC’s Enforcement Division has also been able to devote more resources 

to mutual fund cases. After filing less than 10 cases involving mutual funds 

in 2003, Enforcement Division staff told us that they had already filed 18 

cases involving funds as of March 2004 and currently had about 20 percent 

of their staff pursuing mutual fund-related matters. 

Division of Investment Management officials told us that the 2003 budget 

increase allowed them to hire additional accountants to review investment 

company financial statements, as mandated by Sarbanes-Oxley. The 

officials said that additional resources obtained in 2004 and requested for 

2005 will enable the division to increase its reviews of funds’ financial 

statements from 1,134 in 2003, which represents about 10 percent of funds, 

to 4,800 in 2004, or about 40 percent of all funds. 

Although SEC has directed increased resources to oversee mutual funds, 

these allocation decisions were made without the benefit of an updated 

strategic plan; thus, it is difficult to determine the extent to which these 

increases reflect the optimal use of SEC’s limited resources. According to 

GAO guidance on effectively developing and implementing strategic plans, 

leading organizations recognize that their activities, core processes, and 

resources must be aligned to support their missions and help them achieve 

their goals.18 To achieve this, leading organizations articulate a welldefined mission in their overall strategic plan that forms the foundation for 

the key business systems and processes they use to ensure the successful 

outcome of their operations. By aligning activities to support missionrelated goals, the organizations are also better able to link the levels of 

funding for their activities and anticipated results. As a complement to the 

 17See U.S. Securities and Exchange Commission, Chairman William H. Donaldson, 

Testimony Before the U.S. Senate Committee on Banking, Housing and Urban Affairs 

Concerning Investor Protection Issues Regarding the Regulation of the Mutual Fund 

Industry (Apr. 8, 2004). 

18U.S. General Accounting Office, Executive Guide: Effectively Implementing the 

Government Performance and Results Act, GAO/GGD-96-118 (Washington, D.C.: June 1, 

1996). 

SEC Allocated Resources 

Absent a Current Strategic 

Plan 
Page 11 GAO-04-584T 

strategic plan, organizations should also determine the specific staff 

competencies needed to fulfill their mission and develop a human capital 

plan that addresses how they will acquire, develop, and retain the 

employees they need.19

SEC is in the process of updating its strategic plan but as of April 13, 2004, 

had not completed this process. Under the Government Performance and 

Results Act, federal agencies are required to prepare strategic plans that 

address how they will fulfill their mission over the next 5 years. These 

strategic plans are required to be updated to reflect current circumstances 

every 3 years. Since SEC’s last plan was prepared in 2000, significant 

changes in the securities markets and its budgetary resources have 

occurred. SEC was slated to complete its latest update by September 30, 

2003. According to SEC staff, a draft summary of the agency’s plan was 

present to the SEC Chairman in October 2003 but he directed staff to start 

fresh and not rely on the previous strategic plan. As of April 2004, SEC 

staff told us that the latest draft of the plan was awaiting approval by the 

Office of the Chairman and would need to be approved by the other SEC 

Commissioners. 

In recent years, SEC has taken various steps to determine its resource 

allocations but has done so without an updated strategic plan to guide 

these decisions. As we reported in 2002, SEC traditionally had not 

reviewed its staffing and resources in terms of its overall strategic plan.20

Instead, it generally developed its annual budget request, including 

requests for additional staff positions, by basing the request on its previous 

year’s appropriation, rather than on the level of resources it actually may 

need to fulfill its mission. 

Although lacking an updated strategic plan, SEC did use an internal study 

of its operations to guide resource decisions for 2003. The large budget 

increase resulting from Sarbanes-Oxley provided SEC with an additional 

842 positions for fiscal year 2003. To allocate these positions across its 

various units, SEC drew upon an internal study that analyzed its 

operations, including workload, resource allocations, methods for 

assigning and managing work, and measures of performance, productivity, 

 19See U.S. General Accounting Office, Human Capital: Key Principles for Effective 

Strategic Workforce Planning, GAO-04-39 (Washington, D.C.: Dec. 11, 2003) and A Model of 

Strategic Human Capital Management, GAO-02-373SP (Washington, D.C.: Mar. 15, 2002). 

20GAO-02-302. 
Page 12 GAO-04-584T 

and quality of effort. Each SEC division and office also had to provide the 

SEC Chairman with details of what would be accomplished if additional 

resources were provided. 

To allocate the positions included in the 2004 budget, the various units 

with responsibility for mutual fund oversight took varying steps to 

determine their staffing needs. Staff in the Enforcement and Investment 

Management divisions told us their managers were required to consider 

priorities and goals for the coming year and then estimate the number of 

staff needed to complete the activities associated with those goals. Staff in 

these divisions told us that determining those numbers was difficult 

because the amount of time required to complete the activities they 

perform, such as developing rules or investigating cases, can vary widely. 

In the case of the Enforcement Division, their resulting staffing allocation 

reflected an estimate of what they believed they could obtain rather than 

the amount of staff required to investigate all matters they might receive. 

Moreover, staff told us that it was not possible to determine how much 

fraud existed within the securities markets and therefore it was difficult to 

determine what level of resources realistically were needed to ensure 

enforcement of the federal securities laws. OCIE staff, in contrast, told us 

that they were better able to estimate workload measures, including the 

number and types of examinations to be completed and the amount of 

time required to complete them, in order to determine the number of staff 

they needed. 

In the absence of a complete and updated strategic plan that identifies its 

key mission-related goals, we were unable to determine whether SEC’s 

recent allocation decisions made the best possible use of its resources. In 

making these decisions, SEC has obviously increased staffing in key areas, 

including providing additional resources to develop rules, examine 

participants, and pursue enforcement actions against abusive practices in 

the mutual fund industry. However, without a complete and current 

strategic plan that outlines the agency’s priorities, the agency lacks a key 

guide for ensuring that it is deploying its resources across these areas in 

the most efficient way to achieve the most effective outcomes. 

Although SEC has yet to complete updated strategic and human capital 

plans, it has made some progress in addressing strategic human capital 

management and measuring its performance. For example, it has taken 

steps to improve its recruiting and hiring processes and has implemented 

an agencywide training program to increase its overall staff competency. 

Recognizing that retention of staff is important to achieving its mission, 

Some Progress Made in 

Human Capital 

Management and 

Performance Measurement 
Page 13 GAO-04-584T 

SEC has negotiated an agreement with its new employee union that 

includes various “worklife” programs such as flextime, flexiplace, and 

tuition reimbursement as a means for increasing morale and job 

satisfaction. 

SEC also has made progress in developing performance measures that are 

part of an overall strategic planning framework. To track the performance 

of its various units, SEC staff recently developed various measures of the 

activities undertaken within their units that they are calling the 

“performance dashboard.” Although still undergoing revision, these appear 

to contain key measures of performance for each program area within 

SEC. SEC staff acknowledged that many of the measures are still outputoriented, but they will likely be useful for improving SEC’s effectiveness. 

For example, Division of Investment Management staff told us that after 

seeing the “dashboard” reports, they made changes to their procedures 

that helped them reduce the number of applications for exemptions that 

were pending for 12 months or more by almost 30 percent. While the 

development of the dashboard report is promising, we are concerned that 

creating performance measures before the latest version of the agency’s 

strategic plan is complete may mean that SEC will have to replace some 

measures with others to be consistent with its newly defined strategic 

vision. 

Although it has received additional resources in recent years, SEC still 

faces a number of agencywide challenges impacting its mission and its 

ability to oversee the mutual fund industry. These challenges include 

improving its ability to head off major problems before they occur by 

better anticipating and detecting abuses in the securities industry. SEC 

also faces challenges in hiring and retaining all the staff it needs to achieve 

its mission as demands on staff continue to grow. Moreover, SEC has 

experienced difficulties in obtaining the information technology it needs to 

effectively oversee the mutual funds industry. Finally, SEC faces 

challenges in overcoming impediments to its ability to gather information, 

cooperate with other law enforcement authorities, and collect monies 

owed. Overall, SEC must effectively address these challenges to 

successfully restore and, in the long-run, maintain investor confidence in 

our securities markets. 

SEC Faces 

Agencywide 

Challenges That Also 

Affect Mutual Fund 

Oversight 
Page 14 GAO-04-584T 

One of the challenges SEC faces is being able to anticipate potential 

problems and identify the extent to which they exist. Historically, limited 

resources have forced the SEC to be largely reactive, focusing on the most 

critical events of the day. In this mode, the agency lacked the institutional 

structure and capability to systematically anticipate risks and align 

agencywide resources against those risks. In an environment such as this, 

it is perhaps not surprising that SEC was not able to identify the 

widespread misconduct and trading abuses in the mutual fund industry. 

Increasing SEC’s effectiveness would require it to become more proactive 

by thinking strategically, identifying and prioritizing emerging issues, and 

marshalling resources from across the organization to answer its most 

pressing needs. 

To improve its ability to better anticipate, identify, and manage emerging 

risks and market trends that stand to threaten SEC’s ability to fulfill its 

mission, SEC is implementing a centralized risk assessment function 

within the agency. According to SEC’s Chairman, this function will be 

housed in SEC’s newly created Office of Risk Assessment and Strategic 

Planning, whose duties include: 

• gathering and maintaining data on new trends and risks from external 

experts, domestic and foreign agencies, surveys, focus groups, and other 

market data; 

• analyzing data to identify and assess new areas of concern across 

professions, companies, industries, and markets; and 

• preparing assessments and forecasts on the agency’s risk environment. 

According to statements by SEC’s Chairman, the yet-unstaffed office will 

work in coordination with staff assigned to conduct risk assessment 

activities from each division and a Risk Management Committee 

responsible for reviewing implications of identified risks and 

recommending an appropriate course of action. The new office is also 

intended to foster better communication and coordination between 

divisions and offices within the Commission. 

SEC staff in the units with responsibility for mutual funds told us they 

have begun activities to identify emerging risks within their areas. For 

example, OCIE officials said that examiners have begun efforts to identify 

what they believe to be the key risks in their ongoing examinations. With 

this information, OCIE officials hope to develop a formalized process in 

which this information would flow up through the office and into the risk 

Timely Anticipation and 

Identification of Problems 

Is a Challenge 
Page 15 GAO-04-584T 

assessment office. Similarly, according to Division of Enforcement 

officials, the division has reorganized staff in its Office of Chief Counsel by 

functional lines rather than by geographical location. The functional lines 

include investment adviser and mutual funds, broker-dealers and markets, 

and corporate accounting. The intent of this reorganization is to increase 

the staff’s subject matter expertise and better detect emerging issues. 

Enforcement officials said they have already hired experts in the first two 

lines to further increase the division’s expertise and assist in the 

agencywide risk analysis project, and have plans to hire a corporate 

accounting expert soon. 

SEC continues to face agencywide challenges in hiring and retaining 

sufficient numbers of quality staff to achieve its mission. With the 

additional staff positions authorized in 2003 and vacancies and attrition in 

existing positions, SEC staff indicated that they were faced with hiring 

over 1,280 people in the last 1 1⁄2 years. Although it has made considerable 

progress in filling these positions, SEC’s Chairman stated in his recent 

testimony to a House Appropriations subcommittee that SEC still expects 

to have as many as 425 vacancies by May 2004, which is equal to an 

11 percent agencywide vacancy rate.21 According to the Chairman’s 

statement, about 150 of these vacancies are attorney positions, 120 are 

accountant positions, and 60 are examiner positions. In addition, by the 

end of 2005, SEC hopes to receive funding to hire an additional 106 staff, 

which SEC intends to use to, among other things, further enhance its 

oversight of mutual funds and to address its market structure reform 

initiatives. 

As we reported to you in July 2003, the competitive service hiring 

requirements with which SEC was required to comply to hire staff 

involved the completion of various lengthy processes, such as ranking 

candidates by position, before filling a vacancy. According to SEC staff, 

the considerable time required to complete these processes hampered the 

agency’s ability to meet its hiring goals. As a result, the agency asked for 

and received relief from these requirements under the Accountant, 

Compliance and Enforcement Staffing Act of 2003, enacted in July 2003 

 21See U.S. Securities and Exchange Commission Chairman William H. Donaldson, 

Testimony Before the Subcommittee on Commerce, Justice, State, and the Judiciary, 

Committee on Appropriations, United States House of Representatives Concerning 

Fiscal 2005 Appropriations Request for the U. S. Securities and Exchange Commission 

(Mar. 31, 2004). 

Filling New Positions and 

Existing Vacancies May 

Not Address All Needs 
Page 16 GAO-04-584T 

and intended to enable SEC to expedite the hiring of accountants, 

economists, and examiners. SEC staff told us that bypassing competitive 

processes has helped them hire individuals for such positions more 

quickly. In recent testimony, SEC’s Chairman noted that the number of 

vacant positions would have been much higher without this legislation. 

In addition, acting under recently granted compensation authority, SEC 

also implemented a new compensation system, which established a pay 

structure more comparable to other federal financial regulators. SEC 

officials stated that the new hiring and compensation authority, along with 

current economic conditions, has improved the hiring and retention of 

staff. For example, according to SEC staff, since 2001 the agency’s 

turnover rate dropped from approximately 8 percent in fiscal year 2001 to 

1.2 percent in fiscal year 2002 and 1.5 percent in fiscal year 2003. 

Previously turnover had been as high as almost 14 percent. 

The units responsible for mutual fund oversight generally have been 

making progress in meeting their goals for hiring additional staff, but 

demands on their staff continue to grow. SEC’s Investment Management 

Division is attempting to reach a staffing level of 190 positions by the end 

of fiscal year 2004. According to division staff, at midyear they had about 

175 staff on board. Of the remaining 15 vacancies, 5 are staff that are 

designated for public utility holding company oversight. Staff from the 

Enforcement program, which is attempting to reach 1,248 positions by the 

end of fiscal year 2004, had about 1,070 on board as of April 2004. 

However, staff from both these divisions told us that they have had 

difficulty in recruiting accountants due to competition from the private 

sector as well as the Public Company Accounting Oversight Board, which 

they said is able to pay much higher salaries. 

Although OCIE has had some success in hiring additional examiners, the 

revelations of the widespread abuses in the industry has also resulted in 

an expansion of its workload. OCIE staff told us that in trying to reach 

their mutual fund-related staffing goals for the end of fiscal year 2004, only 

about 3 percent of their positions were vacant as of March 2004, primarily 

as a result of attrition. However, OCIE staff also told us that as a result of 

the mutual fund abuses, examiners will be conducting more 

comprehensive examinations and more targeted mini-sweeps, which are 

focused examinations that deal with just a single issue across a number of 

firms. For example, to aid in detecting any misconduct that might not 

otherwise be reflected in the books and records kept by a firm and shown 

to examiners, OCIE staff said that their routine examinations would now 

include a review of a sample of fund executives’ internal e-mail 
Page 17 GAO-04-584T 

communications. Other new examination steps OCIE said they were 

implementing include reviewing personal trading records that show fund 

executives trading in their funds’ shares and reviews of procedures to 

ensure that fund share orders are processed to receive the appropriate 

day’s net asset value, including firms’ procedures governing order receipt 

time and order time stamping. 

Given these additional activities, OCIE staff said that the time required to 

complete an examination has increased dramatically and threatens their 

ability to meet the newly established goals for increased examination 

frequency. With the additional resources added to the examination 

program in 2003, SEC was able to increase examination frequency of the 

largest fund firms and of those posing the greatest compliance risk from 

once every 5 years to once every 2 years. As noted previously, SEC’s 

examinations of some mutual fund companies had been as infrequent as 

once every 12-24 years during the 1990s. OCIE staff said that they are 

currently considering ways in which they could save time as well as 

maximize coverage of the industry, but they are not yet in a position to 

provide assurances that they have sufficient resources to both increase the 

frequency of examinations and conduct more in-depth reviews and minisweeps at their currently projected resource levels. 

Staff in both OCIE and the Investment Management Division also told us 

that they will face additional demands on their time in the event that SEC 

requires hedge fund advisers to register with the agency, which SEC’s 

Chairman has publicly stated he intends to propose. Potentially SEC staff 

might have to conduct additional regulatory filing reviews and 

examinations. The amount of additional effort required to oversee hedge 

fund advisers is not currently known, but Investment Management staff 

told us that they estimate that between 600 and 1,100 additional advisers 

would be required to register with SEC. 

Having traditionally lacked sufficient funding for information technology, 

SEC is in the process of implementing various agencywide initiatives, and 

the units responsible for mutual funds also have identified projects that 

could further improve their efficiency. Like the rest of the government, 

SEC’s needs in the area of information technology continue to increase, 

but SEC recently received authorizations for additional funding to address 

its needs. As we reported in July 2003, SEC’s fiscal year 2003 information 

technology budget increased more than 100 percent, from around $44 

million to $100 million, which allowed SEC to begin funding a number of 

Obtaining and Effectively 

Using Information 

Technology Also a 

Challenge 
Page 18 GAO-04-584T 

agencywide, long-term technology projects. Many of these major initiatives 

are still in process. These projects include 

• Implementing a document management and imaging initiative, intended to 

eventually eliminate paper documents and allow SEC staff to review and 

electronically file the large volumes of information that are part of 

litigation, examination, and enforcement activities. Staff told us that the 

planned system will provide an agencywide electronic capture, search, and 

retrieval mechanism for all investigative and examination materials. 

• Converting SEC’s Electronic Data Gathering Analysis and Retrieval 

(EDGAR) system into a searchable database that would help SEC conduct 

various types of industry and trend analyses. EDGAR is the database 

system that public companies use to file registration statements, periodic 

reports, and other forms electronically. Currently, EDGAR receives and 

archives data, but staff cannot immediately and easily analyze it. The goal 

is to create filings that will allow anyone to extract relevant data. 

• Implementing a disaster recovery program that is being designed to store 

and move large amounts of data among regional or district offices without 

first going through Washington, D.C. The current project, when completed, 

will allow the agency to back up critical information and data on a daily 

basis at multiple locations. 

In addition to these agencywide initiatives, staff in the units responsible 

for mutual fund oversight have identified a number of other technology 

projects that could help to improve the efficiency of their operations. For 

example, OCIE officials told us that they would like to provide audit 

guidance in an electronic format for examination staff, and create Web site 

links for staff to use in accessing information useful in an examination. 

They said that having these capabilities would likely reduce the time 

required to complete examinations. 

OCIE officials also stated that they are considering a longer-term project 

involving the development of a mutual fund surveillance program. On 

March 5, 2004, the SEC Chairman announced the formation of an internal 

task force to draft the outlines of this new surveillance program. This 

group will examine the mutual fund reporting regime and consider 

changes to both the frequency of reporting to the Commission and the 

categories of information to be reported, as well as how new technologies 

can be used to enhance SEC’s oversight responsibilities. OCIE’s director 

stated that the goal of such a surveillance program would be to identify 

indications of problems, and then target the particular fund or adviser for 
Page 19 GAO-04-584T 

a follow-up inquiry. With such information, SEC staff would also likely be 

able to examine relevant data on an industrywide basis to determine if a 

systemic problem was emerging. Implementation of such an initiative will 

require a continued commitment to enhancing SEC’s information 

technology capabilities. 

Additionally, Investment Management officials said that they have started 

a project designed to allow investment companies to submit more of their 

required filings electronically. Their staff are evaluating available 

technology that will allow them to identify and analyze the data they 

receive more readily. Currently, most of the filings come in as pure text 

files and thus are not very well suited for quick quantitative analysis. 

Officials in the Division of Enforcement said that recent upgrades to their 

computers have been helpful. We also spoke with an official in SEC’s 

Office of Investor Education and Assistance, which is responsible for 

analyzing investor complaints, responding to inquiries, and providing 

educational materials on numerous investing topics, including mutual 

funds. This official also told us about a number of technology projects that 

could improve staff operational efficiency. For example, according to the 

official, the office could benefit from data imaging and retrieval 

technology for inquiries and complaints that come in a paper format, as 

the technology would allow staff to access this information by topic or 

complainant. The official did note that one project, a database that 

catalogs complaints from the Internet, is currently being implemented. 

In addition to the agency’s ongoing document management and imaging 

initiative, SEC staff told us that additional efficiencies could be gained 

from an improved case tracking system and having greater ability to 

analyze data to look for trends taking place in the securities industry, 

particularly in the mutual fund area. Moreover, all of the SEC officials with 

whom we spoke agreed that the high costs associated with new 

technologies coupled with a limited information technology budget 

created a challenge for SEC in meeting its information technology needs. 
Page 20 GAO-04-584T 

SEC also faces challenges that affect its ability to investigate violations 

and to collect monetary fines and disgorgements that violators are ordered 

to pay, a process integral to effective oversight.22 Investigations of 

securities law violations can be labor intensive, complex, and sometimes 

require SEC staff to coordinate with staff from other law enforcement or 

regulatory authorities as has occurred in many of the mutual fund cases 

that SEC has brought recently. In addition, according to SEC staff, 

collecting the amounts that violators are ordered to pay can be time 

consuming and difficult. 

SEC’s staff has identified various issues that they believe hamper their 

efficiency in conducting enforcement and collections activities, including 

investigations involving mutual funds. At a February 2003 congressional 

hearing, the director of SEC’s Enforcement Division testified that under 

existing criminal procedure law, SEC staff generally are not allowed 

access to grand jury information. In such cases SEC staff must conduct a 

separate, duplicative investigation to obtain the same information already 

in the hands of federal criminal authorities. In some cases, involving 

mutual funds, state law enforcement authorities convened grand juries. 

SEC’s ability to protect privileged information also remains in question, 

hampering its ability to collect such material. In a report mandated by the 

Sarbanes-Oxley Act, SEC staff noted that their investigative efforts are less 

efficient and effective at times because the parties under investigation 

have a disincentive to provide privileged or protected information to SEC. 

By disclosing such information to SEC, the parties risk that others, such as 

an adversary in private litigation, could argue that the disclosure waives 

the protection of that information. SEC staff would like to be able to 

ensure that these parties can maintain protection over such information 

after a disclosure to SEC. 

The need for SEC staff to make lengthy and complicated efforts to collect 

fines or disgorgements also prevent them from investigating other matters. 

As a result, SEC staff indicated their efficiency would be improved if they 

had authority to contract with private attorneys to undertake litigation to 

enforce collection orders. The House is considering a bill introduced in 

 22Fines are amounts violators are ordered to pay as punishment for violating the securities 

laws. Disgorgement is the process by which a violator is ordered to return money obtained 

as a result of a violation of these laws. 

Investigation and 

Collection Difficulties Also 

Hamper SEC’s Regulatory 

Efficiency 
Page 21 GAO-04-584T 

2003 that would give SEC authority to obtain these contracts, as well as 

other enhancements to the authority of SEC Enforcement staff.23

This concludes my prepared statement. I would be happy to respond to 

questions. 

For further information regarding this testimony, please contact Cody J. 

Goebel at (202) 512-8678. Individuals making key contributions to this 

testimony include Toayoa Aldridge, James Lawrence, and David Tarosky. 

 23These additional authorities are included as part of the Securities Fraud Deterrence and 

Investor Restitution Act of 2003, H.R. 2179. 

Contacts and 

Acknowledgements 

(250192) 
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