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74–375 PDF 2012

THE SEC’S AVERSION TO COST-BENEFIT ANALYSIS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES 

AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS 

OF THE

COMMITTEE ON OVERSIGHT 

AND GOVERNMENT REFORM 

HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

APRIL 17, 2012 

Serial No. 112–139 

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

( 

Available via the World Wide Web: http://www.fdsys.gov 

http://www.house.gov/reform 

(II) 

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM 

DARRELL E. ISSA, California, Chairman 

DAN BURTON, Indiana 

JOHN L. MICA, Florida 

TODD RUSSELL PLATTS, Pennsylvania 

MICHAEL R. TURNER, Ohio 

PATRICK T. MCHENRY, North Carolina 

JIM JORDAN, Ohio 

JASON CHAFFETZ, Utah 

CONNIE MACK, Florida 

TIM WALBERG, Michigan 

JAMES LANKFORD, Oklahoma 

JUSTIN AMASH, Michigan 

ANN MARIE BUERKLE, New York 

PAUL A. GOSAR, Arizona 

RAU ́ L R. LABRADOR, Idaho 

PATRICK MEEHAN, Pennsylvania 

SCOTT DESJARLAIS, Tennessee 

JOE WALSH, Illinois 

TREY GOWDY, South Carolina 

DENNIS A. ROSS, Florida 

FRANK C. GUINTA, New Hampshire 

BLAKE FARENTHOLD, Texas 

MIKE KELLY, Pennsylvania 

ELIJAH E. CUMMINGS, Maryland, Ranking 

Minority Member 

EDOLPHUS TOWNS, New York 

CAROLYN B. MALONEY, New York 

ELEANOR HOLMES NORTON, District of 

Columbia 

DENNIS J. KUCINICH, Ohio 

JOHN F. TIERNEY, Massachusetts 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

JIM COOPER, Tennessee 

GERALD E. CONNOLLY, Virginia 

MIKE QUIGLEY, Illinois 

DANNY K. DAVIS, Illinois 

BRUCE L. BRALEY, Iowa 

PETER WELCH, Vermont 

JOHN A. YARMUTH, Kentucky 

CHRISTOPHER S. MURPHY, Connecticut 

JACKIE SPEIER, California 

LAWRENCE J. BRADY, Staff Director 

JOHN D. CUADERES, Deputy Staff Director 

ROBERT BORDEN, General Counsel 

LINDA A. GOOD, Chief Clerk 

DAVID RAPALLO, Minority Staff Director 

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND BAILOUTS OF PUBLIC AND

PRIVATE PROGRAMS

PATRICK T. McHENRY, North Carolina, Chairman 

FRANK C. GUINTA, New Hampshire 

ANN MARIE BUERKLE, New York 

JUSTIN AMASH, Michigan 

PATRICK MEEHAN, Pennsylvania 

JOE WALSH, Illinois 

TREY GOWDY, South Carolina 

DENNIS ROSS, Florida 

MIKE QUIGLEY, Illinois, Ranking Minority 

Member 

CAROLYN B. MALONEY, New York 

PETER WELCH, Vermont 

JOHN A. YARMUTH, Kentucky 

JACKIE SPEIER, California 

JIM COOPER, Tennessee 

(III) 

C O N T E N T S 

Page 

Hearing held on April 17, 2012 .............................................................................. 1 

WITNESSES 

The Honorable Mary Schapiro, Chairman, U.S. Securities and Exchange Commission 

Oral statement ........................................................................................... 5 

Written statement ..................................................................................... 7 

Mr. Henry Manne, Dean Emeritus, George Mason Univ. School of Law 

Oral statement ........................................................................................... 40 

Written statement ..................................................................................... 43 

Ms. Jacqueline McCabe, Executive Director for Research, Committee on Capital Markets Regulation 

Oral statement ........................................................................................... 54 

Written statement ..................................................................................... 56 

Mr. Mercer E. Bullard, Jesse D. Puckett, Jr., Lecturer and Assoc. Prof. 

of Law, Univ. of Mississippi School of Law 

Oral statement ........................................................................................... 70 

Written statement ..................................................................................... 73 

Mr. J.W. Verret, Asst. Prof. of Law, George Mason Univ. School of Law 

Oral statement ........................................................................................... 90 

Written statement ..................................................................................... 92 

Mr. H. David Kotz, Managing Director, Gryphon Strategies 

Oral statement ........................................................................................... 94 

Written statement ..................................................................................... 96 

APPENDIX 

The Honorable Patrick McHenry, Chairman, Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs: Written Statement ...................................................................................................................... 115 

Letter from Harvey L. Pitt, Kalorama Partners to Reps. McHenry and 

Quigley .................................................................................................................. 116 

The Honorable Mike Quigley, A Member of Congress from the State of Illinois: Written Statement ...................................................................................... 120 

(1) 

THE SEC’S AVERSION TO COST-BENEFIT 

ANALYSIS 

TUESDAY, APRIL 17, 2012, 

HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES, AND

BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS, 

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:03 a.m., in Room 

2154, Rayburn House Office Building, Hon. Patrick T. McHenry 

[chairman of the subcommittee] presiding. 

Present: Representatives McHenry, Walsh, Gowdy, Guinta, 

Maloney, and Quigley. 

Staff Present: Katelyn E. Christ, Majority Research Analyst; 

Peter Haller, Majority Senior Counsel; Ryan M. Hambleton, Majority Professional Staff Member; Christopher Hixon, Majority Deputy 

Chief Counsel, Oversight; Justin LoFranco, Majority Deputy Director of Digital Strategy; Rebecca Watkins, Majority Deputy Press 

Secretary; Jaron Bourke, Minority Director of Administration; Jennifer Hoffman, Minority Press Secretary; Adam Koshkin, Minority 

Staff Assistant; Jason Powell, Minority Senior Counsel; and Brian 

Quinn, Minority Counsel; Molly Boyl, Parliamentarian; David 

Brewer, Counsel; Gwen D’Luzansky, Assistant Clerk. 

Mr. MCHENRY. The Committee will come to order, the Subcommittee on TARP, Financial Services, and Bailouts of Public and 

Private Programs. Our hearing today is entitled The SEC’s Aversion to Cost-Benefit Analysis, and on our first panel we have 

Chairman Schapiro from the Commission. 

We will begin as is traditional for this Subcommittee and for this 

Committee, which is to begin the Oversight and Government Reform Committee’s mission statement. The Oversight Committee exists to secure two fundamental principles: first, Americans have a 

right to know that the money Washington takes from them is well 

spent and, second, Americans deserve an efficient, effective government that works for them. 

Our duty on the Oversight and Government Reform Committee 

is to protect these rights. Our solemn responsibility is to hold government accountable to taxpayers, because taxpayers have a right 

to know what they get from their government. We will work tirelessly in partnership with citizen watchdogs to deliver the facts to 

the American people and bring genuine reform to the Federal bureaucracy. This is the mission of the Oversight and Government 

Reform Committee. 

2 

I will now recognize myself for five minutes for the purposes of 

an opening statement. 

For nearly all Americans, the practice of cost-benefit analysis is 

a part of everyday life. Decisions about the method of transportation we take, to the type of television, make and model that we 

buy, right down to the food we cook for dinner are all based on a 

form of cost-benefit analysis. 

In the world of government regulators, specifically the Securities 

and Exchange Commission, the stakes are obviously much higher, 

influencing the behavior of millions of investors, allocation of trillions of dollars, and the competitiveness of our job and economic 

markets. The consequences of careless and unwarranted Federal 

regulations serve as a de facto tax on employers and consumers to 

the tune of over $1 trillion each year. Needless regulations lead to 

higher costs, reduced wages, and diminished hiring that harm our 

economy more than they benefit it. 

With those thoughts in mind, the SEC’s record on cost-benefit 

analysis is deeply troubling. The evidence of unjustifiable SEC regulations was so alarming that it spurred the bipartisan JOBS Act, 

which was signed into law this month by President Obama; passed 

by a Democrat controlled Senate and a Republican controlled 

House, and signed by a Democrat president, a rare moment of bipartisanship in Washington. 

Simply put, the SEC’s complacency emboldened Congress and 

the White House to make simple, yet meaningful, improvements to 

the securities laws to address the competitiveness of our capital 

markets and opportunities for U.S. startups and small businesses 

that had long been ignored by the Commission. 

Nonetheless, it is widely recognized that the SEC continues to 

fail at delivering adequate cost-benefit analysis of its rules and regulations. In January of this year, outgoing SEC Inspector General 

David Kotz issued a report identifying failures in the cost-benefit 

analysis procedures of the Commission. The report concludes that 

‘‘The SEC may not be fulfilling the essential purposes of such analyses, providing a full picture of whether the benefits of a regulatory 

action are likely to justify its costs and discovering which regulatory alternatives would be most cost-effective.’’ 

Mr. Kotz is not alone in taking issue with the SEC’s decision on 

cost-benefit analysis. In July of last year, the United States Court 

of Appeals for the District of Columbia issued an opinion vacating 

the SEC’s proxy access rule, holding that the SEC acted arbitrarily 

and capriciously for having failed to adequately assess the economic effects of the rule. 

In particular, the court stated that ‘‘The Commission consistently 

and opportunistically framed the costs and benefits of the rule, 

failed adequately to quantify certain costs or to explain why those 

costs could not be quantified, and failed to respond to substantial 

problems raised by commentors.’’ In further explaining its objection, the court characterized the Commission’s reasoning as ‘‘unutterably mindless.’’ This is particularly harsh language from any 

court, but even more harsh considering this is a Federal bureaucracy that they were talking about, and an important one at that. 

3 

This was at least the third time in the last two years that an 

SEC rule has been struck down by the court for inadequate costbenefit analysis. 

Even the Obama Administration has recognized the need for 

more effective analysis. In a report to Congress, the Administration 

argued, ‘‘We emphasize that for the purposes of informing the public and obtaining a full accounting, it would be highly desirable to 

obtain better information on the benefits and costs of the rules 

issued by the independent regulatory agencies. The absence of such 

information is a continued obstacle to transparency and it might 

also have adverse effects on public policy.’’ 

In light of the SEC’s track record, Chairman Issa and I wrote a 

letter to Chairman Schapiro regarding the SEC’s decision not to 

perform cost-benefit analysis where Congress has mandated regulation. I am happy to learn that Chairman Schapiro, in response to 

that and other concerns, obviously, seems to have revised her earlier position on these issues. The Commission recently distributed 

a guidance memo to its staff that incorporates many of the policy 

suggestions we offered. 

While many questions remain about the implementation of these 

policies at an agency that has resisted this approach for many 

years, I am hopeful that the personal attention of Chairman 

Schapiro to the guidance’s implementation will lead to an improved 

decision-making process at the agency, and I appreciate her 

thoughtful attention to the concerns that we have raised. 

Make no mistake, however, this Subcommittee intends to vigorously monitor the implementation of this document at the Commission and we will hold Chairman Schapiro accountable for the commitments that she has made. And we certainly appreciate your 

service to our Government, Chairman Schapiro. You have a long 

and distinguished service, and we know that with some oversight 

from Congress, you know that we will have a fruitful discussion 

today, as we always do. 

The mission of the U.S. Securities and Exchange Commission is 

to protect investors, maintain fair, orderly, and efficient markets, 

and to facilitate capital formation. It is clear that performing rigorous cost-benefit analysis is necessary to help the Commission 

successfully live up to these goals. 

Thank you again, Chairman Schapiro, for being here, and for our 

other witnesses that will be on the second panel here this morning. 

With that, I recognize the distinguished Ranking Member of the 

Subcommittee, Mr. Quigley of Illinois, for five minutes. 

Mr. QUIGLEY. Thank you, Mr. Chairman, and thank you, Mr. 

Chairman, for holding today’s hearing on SEC’s rulemaking and 

cost-benefit analysis. 

Chairman Schapiro, thanks for being here. I understand this is 

your fourth appearance in the 112th Congress before this Committee. There is no truth to the rumor that with six appearances 

you get a set of steak knives, but we do appreciate your efforts. 

Mr. MCHENRY. We will be willing to test that later this year, if 

the Chairman is willing. 

[Laughter.] 

Mr. QUIGLEY. I would like to acknowledge the SEC’s responsiveness to the inquiries and oversight of this Committee, and I want 

4 

to commend you for your willingness to be so responsive to the 

Committee’s numerous and varied inquiries. 

Obviously, the SEC has been heavily scrutinized since it assumed numerous regulatory mandates under Dodd-Frank. Regulations are vital to protecting Americans, but we must ensure that 

they are carefully considered. 

After recent investigations by the SEC Inspector General and the 

U.S. Court of Appeals for D.C., the SEC created new staff guidance 

for cost-benefit analysis. I look forward to Chairman Schapiro’s testimony regarding this new guidance. 

As we examine this important issue, we have to remember that 

this is about good government pure and simple. As Chairman 

Schapiro previously noted in a January 26th letter to Chairman 

Issa, ‘‘The primary purpose for performing cost-benefit analysis 

should be assisting the Commission in making sound regulatory 

choices about the difficult discretionary decisions with which it is 

faced.’’ 

Since Dodd-Frank was signed into law, the SEC’s cost-benefit 

analysis procedures have been heavily criticized. According to a 

March 6, 2012 Bloomberg article, the SEC’s Dodd-Frank related 

rulemaking has slowed in the face of these criticisms. 

While we have to hold the SEC to the highest standards, the regulations that have been delayed are critical to addressing the 

causes of the 2008 financial crisis. There can be no amnesia about 

the fact that financial markets were not working for Americans before the financial crisis. A hands-off approach by Federal regulators 

contributed to the fraud that destroyed the retirement income of 

thousands of Americans. ‘‘If our economic system is going to work,’’ 

says Nobel laureate Joseph Stiglitz, ‘‘we have to make sure that 

what people gain when they cheat is offset by a system of penalties.’’ 

The financial regulatory form law passed last year was a step in 

the right direction, but it alone is insufficient. Trust in our financial system is at its lowest ebb, which means that laws have to be 

enforced and the SEC needs to be a strong enforcer. 

Unfortunately, the FY 2012 budget only appropriated $1.3 billion 

to fund the SEC. For comparison sake, Citibank spent $1.6 billion 

on marketing alone in 2010. How is the SEC expected to police 

Wall Street when its entire budget is less than the marketing 

budget of one bank? 

I strongly support cost-benefit analysis for SEC rulemaking, but 

challenges to the SEC’s cost-benefit analysis process should not be 

used by those opposed to financial reform to delay or derail the 

Commission’s implementation of Dodd-Frank. Our Country will be 

safer from another financial crisis if the SEC implements DoddFrank in accordance with the law in a timely fashion. 

I look forward to the testimony of all of our witnesses and, without objection, respectfully, Mr. Chairman, I ask that a letter addressed to the Chairman, yourself, and myself from former Chairman Harvey Pitt be included in the record. 

Mr. MCHENRY. Without objection. 

Mr. MCHENRY. With that, we will ask our witness to stand and 

be sworn in, as is the practice of this Committee. 

5 

Raise your right hand. Do you solemnly swear or affirm that the 

testimony you are about to give will be the truth, the whole truth, 

and nothing but the truth? 

[Witness responds in the affirmative.] 

Mr. MCHENRY. You may be seated. 

Let the record reflect that the witness answered in the affirmative. 

Chairman Schapiro, I know you have testified a time or two before Congress, so we don’t have to explain the lighting system, but 

for those watching we have a very simple thing everybody knows 

from their stop lights: green means go, red means stop, yellow 

means hurry up. 

So, with that, you can summarize your statement and please feel 

free to take as much time as you need to fully summarize that. 

With that, you are recognized. 

STATEMENT OF THE HONORABLE MARY SCHAPIRO, 

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION 

Ms. SCHAPIRO. Thank you, Mr. Chairman. I would note that I 

think this is my forty-second testimony since I became Chairman 

of the Securities and Exchange Commission. 

Chairman McHenry, Ranking Member Quigley, members of the 

Subcommittee, I do appreciate the opportunity today to address the 

apparent confusion regarding whether there is an aversion to providing economic analysis in Commission rulemakings. 

The SEC has for years considered economic analysis to be a critical element of its rule writing process. Indeed, I believe the SEC’s 

substantive rule releases include more extensive economic analysis 

than those of any other financial regulator. 

Economic analysis is a challenging task. Predicting how people 

and entities will respond to regulatory changes involves extremely 

difficult judgments. While supporting rulemaking with economic 

analysis is difficult under the best of circumstances, the unprecedented numbers, scope, significance, and complexity of rulemakings 

required by the Dodd-Frank Act have stretched the analytic and resource capabilities of the agency. 

With passage of the Dodd-Frank Act, the SEC, which might normally write, on average, about 20 rules in a given year, received 

a mandate from Congress to promulgate almost 100 under impossibly short time frames. As always, our goal in addressing these 

statutory rulemakings has been to get them right, but also to get 

them done as quickly as possible to provide certainty to our markets and to our regulated entities. 

Our rulemaking process has been open and transparent, seeking 

detailed input from interested parties through meetings and comments, in many cases even before proposing rules, and our formal 

rule proposals include economic analysis and seek comment and 

data from the public and industry to inform our thinking about the 

potential economic impacts of the proposal as the rulemaking progresses. Finally, when rules are adopted, after careful consideration of the comments and any additional data provided by 

commentors, we again include an economic analysis. The economic 

analyses we have done have informed and improved our rulemaking. 

6 

The Commission and its staff, including our economists, have 

spent considerable time grappling with difficult judgment calls in 

the scores of rules that the Act requires the Commission to issue. 

As you know, the SEC’s cost-benefit analysis in rulemaking has 

been subject to reviews by the GAO and the SEC’s Inspector General. While these reviews found that the Commission engages in a 

systematic approach to cost-benefit analysis in rulemaking, it also 

provided useful direction for improvement in our processes. 

A recent court decision and communications from members of 

Congress also have raised issued about certain aspects of the Commission’s economic analysis in rulemaking. We have learned valuable lessons from our experiences in implementing the Act to date. 

As a result, our rulemaking processes have continued to improve 

and evolve. 

As part of this continuing effort, I directed the Division of Risk, 

Strategy, and Financial Innovation, and the Office of the General 

Counsel to develop specific guidance for staff engaged in rule writing to further improve the economic analysis the SEC employs. Recently, they provided the SEC’s divisions and offices with detailed 

guidance on conducting economic analysis in rulemaking. The 

newly operative guidance also has been provided to my fellow commissioners to solicit their views and to incorporate their suggestions for any additional process improvements. 

Among the specific steps that we have been taking and that are 

included in the current staff guidance are: involving our economists 

in the rulemaking process before preferred approaches are decided; 

assuring that rule releases clearly identify the justification for the 

proposed rule, such as a market failure or statutory mandate; 

where a statute directs rulemaking, considering the overall economic impacts of the rule, including those attributable to congressional mandates and those resulting from the Commission’s exercise of discretion; quantifying the costs and benefits where feasible 

and, where not feasible, transparently explaining why not; more 

fully integrating analysis of economic issues in the Commission’s 

rule releases; explicitly encouraging commentors to provide quantitative, verifiable estimates of costs and benefits; and adding 

greater discussion of reasonable alternatives not chosen. 

In conclusion, economic analysis is a critical element of SEC rulemaking. As we have worked through the unprecedented workload 

required by the Dodd-Frank Act, we have learned a great deal and 

our rulemaking processes have continued to evolve and improve. 

Our new guidance reflects many of the current best practices in 

economic analysis which the agency will continue to refine in the 

future as necessary, and I am, of course, happy to answer any 

questions. 

[Prepared statement of Chairman Schapiro follows:] 

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Mr. MCHENRY. Thank you, Chairman Schapiro, and thank you 

for your service to our Government. You have a long and distinguished career in government service and broadly in the financial 

marketplace, and I want to start, before anything we say today, 

and thank you for your service. 

We also know it is difficult to testify before Congress, but you 

have been willing to submit yourself to this process. We certainly 

appreciate it. And as I said in my opening, as well as with the mission statement of the Subcommittee and this Committee, it is important that the American people know what is happening in their 

government so they have some confidence in it. 

So, with that, I recognize myself for five minutes for purposes of 

questions. 

I want to begin by the culture within the SEC. Now, the SEC has 

a very fine staff. You have over 3,000 staffers, but Meredith Cross, 

who is the Director of Corporate Finance, she has testified before 

this Subcommittee and before Congress, she is a very fine individual, but culturally the SEC, if we look at an email from September 13, 2010, from Meredith Cross, the Director of Corporate 

Finance, to the Director of Risk Fin, which is this process where 

you are going to have economic analysis attached to it, cost-benefit 

analysis, ‘‘I think there will be some rulemaking that it doesn’t 

bother anyone to say the rule benefits are along the lines of what 

Congress was trying to achieve, but there will be some where we 

really can’t go there and maintain any level of internal harmony.’’ 

Next quote: ‘‘My main request is that Risk Fin not add qualitative cost-benefit discussions that could be controversial without 

having senior discussions.’’ 

Seems to me that there is a deeply held cultural problem with 

cost-benefit analysis if you have to have senior level discussions before an economist attaches any real costs that could raise problems. 

So the reason why we have a Commission is not to put power in 

one person, but to hash out those controversies and try to get better rulemaking more agreeable to everyone. 

I want to go on to something else. In your prepared testimony 

today you said, ‘‘No statute explicitly requires the Commission to 

conduct a formal cost-benefit analysis as part of its rulemaking activities.’’ 

Well, let’s go back to the House Commerce Committee report 

that accompanied H.R. 3005, the National Securities Market Improvements Act. ‘‘In considering efficiency, competition, and capital 

formation, the Commission shall analyze the potential costs and 

benefits of any rulemaking initiative. The Committee expects that 

the Commission will engage in rigorous analysis pursuant to this 

section. Such analysis will be necessary to the Congress in connection with Congress’s view of major rules.’’ 

So what is important about this, and this is back from 1996, 

when that became the law of the land, and there is a speech that 

we can go on to about Chairman Bliley when this passed. The point 

is, and my question is, is cost-benefit analysis the rule of the land, 

the law of the land for the Securities and Exchange Commission? 

Ms. SCHAPIRO. Mr. Chairman, it obviously is and has been for 

many years. While the testimony says there is no specific statutory 

requirement to conduct cost-benefit analysis, there is, and we cerVerDate Aug 31 2005 12:13 Jun 25, 2012 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\74375.TXT APRIL
25 

tainly acknowledge in our testimony and in our actions, that there 

are requirements for the Commission to conduct a Regulatory 

Flexibility Act analysis, a Paperwork Reduction Act analysis, and 

whenever we are engaged in rulemaking, to consider, in addition 

to the protection of investors, whether the action will promote efficiency, competition, and capital formation; and when we are doing 

rulemaking under the 34 Act, to consider burdens on competition 

that our rules might impose. 

So we do broadly economic impact analysis, which often includes 

a cost-benefit analysis, and, of course, under the new guidance it 

is quite explicit the extent to which the staff needs to try to quantify costs and benefits and, where they can’t, explain why. 

But if I could just add one other thing. I think Meredith Cross 

is one of the finest public servants I have ever worked with. She 

has only been at the SEC a couple of years and came from the private sector. She believes deeply in cost-benefit analysis, economic 

analysis, and our engaging in rulemaking in a way that is fully 

transparent and responsive to congressional mandates. 

Mr. MCHENRY. Well, I think it is important to understand the 

cultural problem here that I see with the communications within 

your staff and the discussions going forward. 

So the question is about this guidance that you are working 

through that mandates cost-benefit analysis, and the question I 

have is does it mandate that before these rules can go forward 

there has to be basic clearance through the economists on the costs 

and benefits of rulemaking? 

Ms. SCHAPIRO. Yes. The new guidance does require that even before there is a preferred approach from the rule-writing divisions 

about what a regulatory response might be, that the economists 

need to be involved. They are to be integrated into the process as 

key policy choices are made through the pre-proposal stage, the 

proposing stage, the comment period, and the adopting stage; and 

they are as integral a part of the rulemaking team as anybody else. 

Mr. MCHENRY. But is there a veto power? 

Ms. SCHAPIRO. I believe there is sign-off—I have to pull the guidance out to look at it specifically—by the economists on the economic analysis. 

Mr. MCHENRY. Please, go ahead, because I would like to know. 

I think it is important for folks to understand. Is it required as a 

precondition? 

Ms. SCHAPIRO. Concurrence is required by the economists, yes. 

Mr. MCHENRY. Concurrence is required. 

Ms. SCHAPIRO. Yes. And, Mr. Chairman—— 

Mr. MCHENRY. So that can act as a veto power. 

Ms. SCHAPIRO. It certainly would be something that would be 

brought to the attention of the commissioners if there was no concurrence. And it is important to note that the commissioners are 

deeply involved in any rule proposal and any rule adoption, including analyzing whether the staff’s cost-benefit analysis is up to the 

task, meets the requirements that they think are important, 

whether we have explored the appropriate issues. 

Mr. MCHENRY. So roughly how many economists do you have at 

the Securities and Exchange Commission? 

26 

Ms. SCHAPIRO. Working on rulemaking, we have 24 economists 

in Risk Fin. We have a number of additional economists who are 

doing risk analytics, modeling—— 

Mr. MCHENRY. And what is a comparable number of attorneys 

you have? 

Ms. SCHAPIRO. We have obviously many more attorneys. I would 

be happy to get you the exact number, but—— 

Mr. MCHENRY. Is it hundreds? 

Ms. SCHAPIRO. Oh, yes, it is—— 

Mr. MCHENRY. Hundreds of attorneys. Okay. 

Ms. SCHAPIRO.—hundreds of attorneys. We also are in the process of hiring 20 additional economists this year and we have asked, 

in the FY 2013 budget, for 20 more economists. So it is—— 

Mr. MCHENRY. And is that part of Risk Fin? 

Ms. SCHAPIRO. Those are all part of Risk Fin. There actually are 

economists in other parts of the agency, but in terms of those who 

support from an independent perch the rulemaking process, those 

are in Risk Fin. 

Mr. MCHENRY. Thank you. 

With that, I recognize the Ranking Member for his five minutes, 

but I ask unanimous consent he have two additional as well. Without objection. 

Mr. QUIGLEY. Thank you, Mr. Chairman. 

Madam Chairman, my harshness isn’t directed towards you, but 

when we start thinking about benefits, you have to think about 

what the costs are of the risk. So in a broad picture, those were 

some pretty big oops since the 2000s. We missed Enron, we missed 

Worldcom, Madoff’s Ponzi scheme. Extraordinary cost and risk. So 

how do you determine, when you try to do this cost-benefit analysis, how can you possibly take into consideration the thousands of 

lives that were ruined and the millions of dollars that were lost 

with the lack of accurate and adequate regulation? 

Ms. SCHAPIRO. Congressman, even the GAO has recognized that 

the task of quantifying cost is difficult, but the task of quantifying 

benefits is very much more difficult because they are often very, 

very hard to put a dollar number on, to monetize. So our challenge 

is to do the best that we can; where we can’t actually quantify the 

benefits with hard numbers, to explain what we believe the benefits are from a qualitative perspective and lay that out for 

commentors and the public to react to. 

Mr. QUIGLEY. But what do you use now to try to ascertain that 

the potential risk involved—they have to be included in your analysis, correct? 

Ms. SCHAPIRO. Right. And we do talk about, depending upon the 

rulemaking, what, for example, with respect to over-the-counter derivatives that were largely unregulated or wholly unregulated during the financial crisis and leading up to that time period, we talk 

about the impact of the financial crisis on the economy and on citizens, and talk about the benefits that we think creating a regulatory regime around derivatives will be. But, again, they are very, 

very hard to quantify. 

Mr. QUIGLEY. Let’s just elaborate to an extent. Just dealing with 

cost, do you talk with industry experts about what their best guess 

on what costs would be when they talk about regulating a product? 

27 

Ms. SCHAPIRO. We do. We talk to them about direct costs that 

they might incur as a result of a new rule. Do they have to put 

in a new compliance system as their new recordkeeping obligations? 

Mr. QUIGLEY. Staff? 

Ms. SCHAPIRO. Staffing. We talk about competitive effects on 

them and might they withdraw from a business and what would 

be the impact not just on them, but on the economy or their customers more broadly. So we talk extensively with them. 

We also, after we have made an estimate of what we think the 

costs are and detailed what types of costs we believe there to be, 

we affirmatively ask for data that can help support the cost-benefit 

analysis that we have done or that tells us we got it completely 

wrong and we need to go back to the drawing board. So we affirmatively seek that data from commentors. 

Oftentimes only industry has access to the data that might be 

useful for us to understand what the true costs are of a regulatory 

action. 

Mr. QUIGLEY. Costs and benefits, I guess you have come to the 

conclusion you are not going to be able to capture it all, correct? 

Ms. SCHAPIRO. It is very difficult. If I could give you another example. When we do a disclosure rule there are lots of benefits to 

that, including that investors will have better information upon 

which to make their capital allocation decisions, maybe that will 

lower risk premiums, it will lead to lower prices and better competition. Those are all things that we try to measure as benefits. 

Might it lead to some fewer number of securities class actions with 

multi hundreds of millions of dollars of awards. Those kinds of 

things are benefits that we try to measure, for example, when we 

do a disclosure rule. The costs are going to be the cost of providing 

that information to investors, the costs of assembling disclosure 

documents for the intermediaries that are required to provide 

them. 

Mr. QUIGLEY. And on the benefits side you talked about getting 

industry help on the cost side. Besides the things you just mentioned, who, if anyone, helps detail what the risks are in helping 

you ascertain how risky a product might be and what the benefits 

of reducing that risk are? 

Ms. SCHAPIRO. Well, in that regard the staff of the SEC has a 

lot of the expertise to understand the risk profile, for example, of 

a product, or to study it and learn it. Industry is much better situated to provide data and to influence the rulemaking process in a 

very specific and operational kind of way. We do have investor 

groups that often comment very constructively and helpfully, and 

we rely on their input and data as well. They are sometimes in a 

position even to commission studies and analysis better than provide it to us in part of the comment file. 

Mr. QUIGLEY. And if you have answered this, I apologize, but, in 

short, do you always use cost-benefit analysis as you are developing 

new rules for consideration? 

Ms. SCHAPIRO. We always do regulatory flexibility analysis, Paperwork Reduction Act analysis, and analysis of the impact of our 

rules on competition, capital formation, and efficiency. We don’t alVerDate Aug 31 2005 12:13 Jun 25, 2012 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 C:\DOCS\74375.TXT APRIL
28 

ways find ourselves in a position to be able to monetize those costs 

and benefits, but we always have at least a qualitative discussion. 

Mr. QUIGLEY. I began the conversation talking about the disparity in budgets. Do you feel like you have a sufficient budget to 

police Wall Street? 

Ms. SCHAPIRO. I have become fond of saying we are about the 

size of the District of Columbia Police Department, yet our responsibility is to police the entire U.S. capital markets, mutual funds, 

public company disclosure, brokerage firms and investment advisors, and now hedge funds and over-the-counter derivatives, as well 

as our many stock markets and trading venues. So while Congress 

has given the SEC some budget increases in the last two years, for 

which we are very grateful, my view is that the agency is still 

under-resourced to the task that we face. 

Mr. QUIGLEY. Thank you. I yield back. 

Mr. MCHENRY. But hopefully you have fewer cars stolen than in 

the District of Columbia. 

With that, I recognize the Vice Chairman, Mr. Guinta, for five 

minutes. 

Mr. GUINTA. Thank you, Mr. Chairman. 

Thank you very much for appearing this morning. Can you just 

briefly talk about—I listened to your opening statement. I just 

briefly read through it again. It seems like, and I don’t want to put 

words in your mouth, but the Dodd-Frank Act has dramatically expanded the SEC role and the requirements placed on the SEC. Is 

that a fair statement? 

Ms. SCHAPIRO. In the rule writing context, yes. 

Mr. GUINTA. And I think you referred to some of those requirements in Dodd-Frank as either overburdensome, challenging. 

Ms. SCHAPIRO. I don’t believe I said overburdensome. I think 

some of them are challenging, some are very, very different 

rulemakings for the Securities and Exchange Commission, for example, the requirement to have disclosure rules around the use of 

conflict minerals mined in the Democratic Republic of the Congo. 

Those are very different kinds of rules that we have been called 

upon to do. The over-the-counter derivatives market, wholly unregulated market until Dodd-Frank, we have developed a lot of expertise. We continue to develop it, but, again, challenging because 

of both its breadth and its complexity and its novelty from our perspective. 

Mr. GUINTA. So is Dodd-Frank putting—I guess I will ask it. Is 

it putting an undue burden on the SEC? 

Ms. SCHAPIRO. I am enormously proud of the work the SEC staff 

has done to date. We have about 100 rulemakings to do and 20 

studies. I believe 13 or 14 of the studies are completed. Seventyfive percent of the rulemakings have been either proposed or adopted. But this is with staff pretty much working around the clock for 

the last year and a half. But we continue to work. It is, as I said 

to the Chairman earlier in a private conversation, this is the law 

of the land and we will implement it to the best of our ability, and 

the staff continues to work towards doing that. 

Mr. GUINTA. Well, how would you feel if we repealed it. 

Ms. SCHAPIRO. I think my personal view is it would be a mistake 

to repeal Dodd-Frank. I think we are working through, in the ruleVerDate Aug 31 2005 12:13 Jun 25, 2012 Jkt 000000 PO 00000 Frm 00032 Fmt 6633 Sfmt 6633 C:\DOCS\74375.TXT APRIL
29 

making process, those areas where the legislation has created challenges to implementation, but I think there are significantly important portions of the law that deal with systemic risk and regulation 

of entirely unregulated areas that are important. We think that, to 

the extent there are imperfections, that we can deal with them 

largely through the rulemaking process. 

Mr. GUINTA. And going back to the rulemaking process, is 20 additional economists enough, in your opinion, to implement? 

Ms. SCHAPIRO. First of all, I should say that we are getting people of enormous quality and depth of expertise, and even the Inspector General’s report and the GAO report, but particularly the 

Inspector General report, acknowledged deep knowledge and expertise on the part of our SEC economists, and our chief economist is 

here with me today. We can certainly use more economists, but I 

think this is a very, very rapid expansion of our economics group 

over just a very short period of time. 

Mr. GUINTA. But I’m not sure. In your opinion, though, would the 

20 additional be sufficient? You said it is a rapid expansion, but it 

is 20, correct? 

Ms. SCHAPIRO. It is 20. We have 24 currently working just on 

rulemaking. We have other economists doing other kinds of work 

like litigation support and risk and analysis and quantitative modeling. Twenty we expect to hire this year, of which 17 are PhDs, 

and as soon as the academic year is over they will be joining us. 

And then we have asked for 20 additional in our fiscal year 2013 

budget. 

I think it is our view that that will help us significantly. But I 

would also add that, as a result of Dodd-Frank, extraordinary 

amounts of new data will be coming into the agency about hedge 

funds and their investing, over-the-counter derivatives, and in a 

number of other areas, so we will need economists who have analytic capabilities to help us understand what that data is telling us 

and also to do our 10 year review of the Sarbanes-Oxley rules that 

is required under the Regulatory Flexibility Act, which we will 

begin in 2013. We will need economists to do those reviews. 

Mr. GUINTA. Well, if the assumption is that we need additional 

economists and you have an increase in your budget request, to 

help you with that, would you consider freezing certain hiring 

areas, particularly attorneys, in order to fulfill the need on the economic side? 

Ms. SCHAPIRO. Congressman, I don’t think is as simple as saying 

freezing attorneys and hiring economists. We have very broad responsibilities and we are also a law enforcement agency, and we 

cannot bring our cases and do our investigations without our investigative staff and our attorneys. We rely heavily on accountants as 

well at the SEC because of our responsibility for oversight of financial accounting standards. 

So I think we have shifted resources around the agency, as appropriate, to support those divisions that are struggling in particular with the Dodd-Frank rulemaking, and I think the Risk Fin 

division where the economists are housed has particularly been a 

beneficiary of that flexible approach to staffing. 

Mr. GUINTA. Okay, thank you. 

I yield back. 

30 

Mr. MCHENRY. I recognize the gentlelady from New York, Mrs. 

Maloney, for five minutes, co-author of our crowd funding legislation that was included in the JOBS Act. 

Mrs. MALONEY. Thank you, Mr. Chairman, and thank you for 

mentioning that. I enjoyed working with you. 

Welcome, Chairwoman Schapiro. I believe this is the fourth time 

that you have testified before the Oversight Committee or one of 

its subcommittee, but in your opening statement I believe you said 

you have testified 34 times before Congress, is that correct? 

Ms. SCHAPIRO. Forty-two. 

Mrs. MALONEY. Forty-two times before Congress. How in the 

world do you have time to do your rulemaking when you are before 

Congress so many times? 

Ms. SCHAPIRO. Well, I view this as a very important part of my 

job and clearly a very important part of Congress’s job to oversee 

the agency and our activities, so—— 

Mrs. MALONEY. But 42 times. That has to be a record. 

Ms. SCHAPIRO. I work on the weekends. 

Mrs. MALONEY. The SEC’s mission is to protect investors and to 

maintain orderly markets and facilitate capital formation. And 

while some concerns have been raised in the past about the SEC’s 

economic analysis, this hearing’s title suggests that the SEC has 

systematically avoided cost-benefit analysis whenever it is possible, 

so I would just like to ask you, Chairwoman, under your leadership, how many SEC regulations have been overturned due to the 

quality of the economic analysis? 

Ms. SCHAPIRO. In my little over three years at the SEC, we have 

done 51 final substantive rules and one has been challenged and 

overturned. 

Mrs. MALONEY. Well, I think that that is a pretty good record, 

and despite the Majority’s title for this hearing, I do not see any 

evidence of any erosion to cost-benefit analysis or engaging in analysis to understand the impact of the SEC’s rulemaking. And you 

have to realize that the SEC’s rulemaking is being put in place to 

protect this Country and our citizens from the $18 trillion economic 

loss caused by the financial crisis. Economists, government leaders 

have all said this was the first recession that was caused by the 

financial mismanagement of markets. 

Now, I would like unanimous consent to put in the record an article dated March 6, 2012, from Bloomberg, and that article—is 

that all right to put in the record? 

Mr. MCHENRY. Can you give us further reference what that is? 

Mrs. MALONEY. I will give you a copy of it. I will put it in your 

hands. If you don’t want to put it in the record, you can turn it 

down. Anyway, I think—— 

Mr. MCHENRY. What is the title of it? 

Mrs. MALONEY. The title was an article about the ruling in the 

Business Roundtable and the SEC, and it talked about—— 

Mr. MCHENRY. If it pertains to today’s hearing, without objection, we will allow it to be part—— 

Mrs. MALONEY. Fine. Whatever. Whatever. It is an interesting 

article. 

Mrs. MALONEY. Anyway, the article says that it has slowed the 

Dodd-Frank rulemaking process, which I think is really important. 

31 

If it slowed the Dodd-Frank rulemaking process, that means you 

are slowing the protection of the American economy and our citizens from another financial crisis. Now, this article says—and it 

talks about the delayed regulations and he says that these regulations are designed to curb the kind of risky practices that fueled 

the 2008 financial crisis. Some of the SEC’s delayed rules strike at 

the very roots of the causes of the 2008 crisis. One example is a 

rule that would ban firms from designing asset-backed security 

deals that put their interests in conflict with investors. Other rules 

are being drafted and revised in coordination with other regulators, 

complicating the process. These include the Volker rule to ban proprietary trading at banks; the risk retention rule forcing lenders to 

keep a stake in loans they bundle; and several rules defining new 

swap market oversight. 

Now, the risk retention rule, many believe that that would have 

prevented the subprime crisis. So I am concerned that these rules 

are not in place. Chairwoman Schapiro, is this a good summation 

of some of the rules you are working on, rules designed to prevent 

a repeat of the practices that led to the financial crisis? 

Ms. SCHAPIRO. I think so. 

Mrs. MALONEY. How are these rules—you should prioritize your 

rules. You should prioritize that you are taking care of the rules 

that caused the crisis first. You have a lot of responsibility. We 

know your budget has been cut. But the rules that I just mentioned, when are you going to get them completed? 

Ms. SCHAPIRO. We have tried to prioritize the rules. The ones 

that we have done first were those that had the shortest statutory 

deadlines, although admittedly we have missed a number of statutory deadlines. And we are proceeding to work as quickly and as 

deliberately as we can. As I said at the outset, our goal has always 

been to get the rules right, to do adequate analysis of the economic 

impact, and also the usefulness and workability of the rules. 

Mrs. MALONEY. Do you think you will complete these? When do 

you think? Do you think you will complete them this year? 

Ms. SCHAPIRO. I think we will complete the bulk of the rules this 

year, particularly in Title VII, which covers over-the-counter derivatives. And, of course, we have finished a number of rules. The 

whistleblower rules were done; the registration of private funds are 

done. 

Mrs. MALONEY. But the ones that I mentioned that Bloomberg 

News pointed out were the crux of what caused the financial crisis. 

Those, I would venture to say, are the most important. 

Ms. SCHAPIRO. I don’t disagree with you. 

Mrs. MALONEY. I request an additional minute, if I could, from 

the Chairman. 

Mr. MCHENRY. In addition to the minute you have just taken 

or—— 

Mrs. MALONEY. Yes. 

Mr. MCHENRY. One additional minute? 

Mrs. MALONEY. Yes. 

Mr. MCHENRY. Without objection, the gentlelady will have one 

additional minute. 

Mrs. MALONEY. I just want to go back to the hearings that we 

had back in 2008, when President Bush asked for an astonishing 

32 

$700 billion to prevent a contagion spreading through the financial 

markets, and this Congress approved it. And it saved our financial 

markets. And on that day members of this Committee had a very 

important hearing with the former chairman of the Federal Reserve, and it was a shocking hearing. I will never forget what he 

said. He said, ‘‘I made a mistake in presenting that the self-interest 

of organizations, specifically banks and others, was such that they 

were best capable of protecting their own shareholders.’’ This was 

the strongest statement I have ever heard from the former chairman of Federal Reserve that we need to have strong regulations to 

prevent it. After the Great Depression we put some rules in shape. 

We had 60 years of economic prosperity. 

Mr. MCHENRY. The gentlelady’s time has expired. 

Mrs. MALONEY. Please complete your rulemaking. Congratulations on your hard work. 

Mr. MCHENRY. The gentleman from South Carolina is recognized 

for five minutes. 

Mr. GOWDY. Thank you, Mr. Chairman. I was going to use my 

time to ask about the holding in Business Roundtable versus SEC 

because the holding, Mr. Chairman, is very provocative. 

I do want to commend Chairwoman Schapiro for not criticizing 

an unelected group for passing judgment on that law, as has been 

done recently. 

But what I am going to do instead, Mr. Chairman, because you 

inspired me with your line of questioning, is I am going to give you 

my time and perhaps I can ask another panel to work our way 

through the holding in Business Roundtable. 

Mr. MCHENRY. Thank you. I certainly appreciate the gentleman 

yielding. 

To my colleague’s question earlier about the prioritization of 

Dodd-Frank rulemaking, just for the record, the SEC is attempting 

to have rulemaking on conflict minerals in the Congo, so in terms 

of prioritization, I think it would be best for the SEC to attempt 

to do that. 

The question about the cost-benefit analysis, now, understanding 

obviously two sides of the aisle. One says that there are costs and 

wants to focus on the cost of government regulations; the other 

wants to talk about the benefits of government regulation. Perhaps 

we should have some harmony and agree that there are both costs 

and benefits to regulations. 

Now, I am not going to ask the question; it is an economic reality 

and an economic fact that regulation, no matter how beneficial, no 

matter how benevolent, has costs associated with it. Also some regulations have benefits that outweigh those costs. And we all have 

that debate in society on where that line is and there is reams of 

economic analysis about how to balance those cases. The question 

before us is about the guidance memo with the SEC. And I am very 

grateful, Chairman Schapiro, for your leadership on this. The question is is this guidance memo on cost-benefit analysis now binding? 

Ms. SCHAPIRO. Yes, Mr. Chairman, it is. Although I will say that 

I have asked my colleagues on the Commission for their comments 

and input, so it is possible that the memo and the guidance will 

evolve with their comments. But, yes, it is binding. 

33 

Mr. MCHENRY. Will that process be public once this memo is 

fully decided with all input from commissioners? 

Ms. SCHAPIRO. I am sure that there will be opportunities for us 

to make it public, yes. 

Mr. MCHENRY. Okay. And have you directed all offices and divisions within the SEC to adhere to this guidance? 

Ms. SCHAPIRO. I haven’t sent out a specific directive, but everybody understands that this—and it has been distributed to the rule 

writing divisions; they all understand that this is how rule writing, 

economic impact analyses will be conducted, yes. 

Mr. MCHENRY. Okay. Has it been done in writing? 

Ms. SCHAPIRO. Well, it was directed to each of the divisions. 

Mr. MCHENRY. Okay. So there is no doubt from all the staff that 

is working on it that it is binding? 

Ms. SCHAPIRO. I have no doubt at all. And, of course, the Commission is the ultimate arbiter of all of our rule proposals, so I 

would expect that if an analysis did not live up to the expectations 

of the guidance, the Commission would make that clear to the 

staff. 

Mr. MCHENRY. Okay. Now, would you agree—and this is just a 

basic question—that economists should be doing the economic analysis? 

Ms. SCHAPIRO. I think the economists should be deeply involved 

in the economic analysis. I think it should—— 

Mr. MCHENRY. Who should be doing economic analysis if not 

economists? 

Ms. SCHAPIRO. They should be doing the analysis, but I think 

they can’t do it in a vacuum, without consultation and coordination 

with the rule writing teams as well, with analysts and others who 

have expertise, perhaps, in the particular areas, the particular 

product. 

Mr. MCHENRY. So there are exceptions to economists doing the 

economic analysis? 

Ms. SCHAPIRO. No. 

Mr. MCHENRY. Okay, okay. I just want to make sure. These are 

very basic questions. 

Now, I understand that the SEC currently has 28 Dodd-Frank 

rules that have been proposed but are not yet final. Will this guidance apply retroactively to those rules that have been proposed but 

are not yet final? 

Ms. SCHAPIRO. You are correct there are 28 rules that have been 

proposed that have not been adopted finally. The staff is analyzing 

all of those cost-benefit analyses for each of those rules because, as 

you know, many of them actually followed much of this guidance, 

because we had adopted in practice Circular A–4 provisions, executive order provisions and so forth. So many of them will not have 

issues, but the staff is going back through each of them to determine whether we need to do any more analysis in light of the new 

guidance. 

I will say, with a rule proposal that we expect to adopt tomorrow, 

we did just that and we reopened the comment period, put new 

data and the economic analysis in the public comment file as a way 

to inform our ultimate final rule adoption. 

34 

Mr. MCHENRY. So this guidance will be binding on those 28 

Dodd-Frank—— 

Ms. SCHAPIRO. Yes, going forward, yes. 

Mr. MCHENRY. Okay. And is there any process or thought of 

looking back at regulations that are on the books and making sure 

this guidance is used? 

Ms. SCHAPIRO. No, I don’t think so. I mean, the rules are final. 

Industry has started to develop its systems operations compliance 

around rules that are already on the books. And, as I said, because 

I think it is so important to understand, we have been doing economic analysis in all of our rules. We haven’t, for example, always 

chosen, as the new guidance requires, a pre-statutory baseline, 

which has been an important point, but we have always done economic impact analysis. And, indeed, the report that one of the witnesses on the next panel will speak to showed that for 54 rules 

that were done by the SEC coming out of Dodd-Frank, we had done 

347 pages worth of cost-benefit analysis. Compare that to the Federal Reserve, which did 24 rules and 12 pages of cost-benefit analysis, or the FDIC with 6 rules and 6 pages of cost-benefit analysis. 

So I would not want it to be lost that this agency has been engaged in significant economic analysis. This guidance gives us clarity and some more specificity particularly around the selection of 

a baseline and the preference or the requirement to use a pre-statutory baseline. 

Mr. MCHENRY. Okay. Now, we have testimony in the second 

panel that says that four of those rules included no cost-benefit 

analysis. 

Ms. SCHAPIRO. Yes, but we should be clear what those were. One 

was a delegation of authority to the chief accountant, one was a 

delegation of authority to enforcement, one was a temporary exemption related to security based swaps, and one was the Reg. FD 

amendment, where Congress said remove from Reg. FD the exemption that exists for credit rating agencies, so we did that quickly. 

We didn’t see what a cost-benefit analysis would yield there, since 

we had no discretion whatsoever in enactment of that rule. 

Mr. MCHENRY. So going back to the Becker Amendment—well, 

actually, why don’t we wrap up this round and we will go to a second round, because the time has expired. With that, we will open 

a second round of questioning and I recognize myself for five minutes. 

So with the Becker memo outlining cost-benefit analysis and the 

idea that if Congress mandates a rulemaking to the SEC, that the 

SEC does not have to do cost-benefit analysis. It sounds like that 

still is in your thinking based on the four that you outlined, two 

of which were mandated by Congress. 

Ms. SCHAPIRO. No, Congressman, not at all. Of course, those 

were done before the new guidance, so they operated under the 

preexisting guidance. What I will say is that the Becker memo was 

advice from a general counsel to an agency that was facing really 

a daunting number of congressionally mandated rules to write, and 

it set forth an initial framework to analyze what needed to be done 

when the Commission exercised discretion. And there was concern, 

frankly, about not second-guessing the judgments that had been 

35 

made by the Congress in the passage of the Dodd-Frank Act about 

what needed to be done. 

That said, going forward, we have clearly said in this guidance 

that we will evaluate the economic impact of the pre-statutory condition, as well as those areas where we are actually exercising discretion. Those four that you mentioned predate this guidance. 

Mr. MCHENRY. Okay, so, to be clear, the new guidance, in effect, 

repudiates the Becker memo that was operational before the guidance. 

Ms. SCHAPIRO. I think there are some things in the Becker memo 

that are actually captured in the new guidance. For example, to the 

extent we are exercising discretion, we should describe that, and 

we should be honest and clear with the Congress and the American 

people that we are doing so because we think it is the right thing 

to do, not because Congress directed us to do it. It calls on us to 

identify the choices that are being made when we have alternate 

ways to achieve the regulatory purpose and to quantify, wherever 

possible. That is incorporated in the new guidance. 

That said, there is much more required in the new guidance than 

was required in the very brief Becker memo, and, of course, one of 

the most important changes is the requirement that we use a baseline that includes the existing state of the world, including the 

state of efficiency, competition, and capital formation; and it is 

against that baseline that we will use consistently through that 

rulemaking that we measure the impact of our rules and the impact of potential reasonable alternatives. 

Mr. MCHENRY. Okay. Now, the JOBS Act was enacted last week, 

signed into law. It has a number of provisions, but one of the provisions that I, along with my colleague, Mrs. Maloney, were highly 

involved in is the so-called crowd funding portion of this, which 

originated out of the House and called the Entrepreneur Access to 

Capital Act. It received over 400 votes in the United States House 

of Representatives, meaning it was a very overwhelming bipartisan 

vote, received a bipartisan vote through both subcommittee and full 

Committee markup; was included as a provision in the JOBS Act. 

It also is commented upon from your March 13th letter to Chairman Johnson in the Senate and Ranking Member Shelby. You outlined your objections, and I assume it is just your objections, to this 

and a number of other provisions. So I am very concerned about 

implementation. 

Now, I am not going to ask you broadly because I have a very 

specific interest on the portion that I authored on crowd funding. 

You have 270 days to write and promulgate rules for crowd funding. Very interested in the process you are taking now, the number 

and type of staff you will have working on this issue, and we would 

like to give you an opportunity to address those things. 

Ms. SCHAPIRO. I am happy to, Mr. Chairman. As you know, as 

we have discussed, the JOBS Act is the law of the land and the 

SEC will implement it and as faithfully to congressional intent as 

we possibly can. A number of the provisions, as you know, are immediately effective: the IPO on-ramp provisions. Those don’t require SEC rulemaking. They have required that we provide some 

mechanisms for filing with the SEC and some clarifications around 

how Reg. A exemption will work—I am sorry, around how some of 

36 

the provisions will work, and we have done that. Within a week of 

the bill being signed, we sent out both a system for processing confidential filings and issued two sets of frequently asked questions 

on the process. 

With respect to crowd funding, there is a 270 day deadline. That 

is very tight, as we know from Dodd-Frank. Congo had a 270 day 

deadline for rulemaking. We know how difficult that is. I would 

have to get back to you on specifically how many people are working on each provision, but I can tell you that because we had significant work underway already at the SEC to work on issues related to small business capital formation and general solicitation, 

the shareholder triggers, and crowd funding, that work is no longer 

necessary and those people can be shifted to the rule writing provisions. 

Mr. MCHENRY. Okay. And I understand from your letter your 

aversion to this crowd funding piece, and I want to ensure that the 

SEC follows the intent of Congress. 

Ms. SCHAPIRO. I can just assure you again that the law of the 

land is the law of the land and we will do what Congress has asked 

us to do, as we have always tried to do. Whether we agree at the 

end of the day or not, we will do our best to fulfill what you have 

intended for us to do. 

Mr. MCHENRY. Thank you. 

With that, Mr. Quigley is recognized for five minutes. 

Mr. QUIGLEY. Thank you, Mr. Chairman. I have no questions of 

Ms. Schapiro at this time. 

Mr. MCHENRY. I recognize the Vice Chairman, Mr. Guinta, for 

five minutes. 

Mr. GUINTA. Thank you, Mr. Chairman. 

I want to follow up on something we were talking about before. 

You mentioned the rulemaking relative to minerals, conflict minerals in the Congo. If we can pull up slide 5 for a moment. 

[Slide.] 

Mr. GUINTA. I want to read to you Section 1502 of Dodd-Frank. 

This is the conflict minerals rule. It says the rule’s stated objective 

to reduce murder and other forms of criminal violence in the 

Congo. When I look at this slide—and I don’t know if you have it 

in front of you, but this is the guidance of cost-benefit analysis— 

can you tell me where in that guidance there is any kind of specificity that we could apply to the conflict minerals rule? 

Ms. SCHAPIRO. I can’t read the whole thing. Let me say that the 

conflict minerals rule, as I said earlier, are very different rules for 

the Securities and Exchange Commission. We generally write rules 

that deal with financial transactions and disclosure requirements. 

This is, in essence, a disclosure rule, but it is really quite a different one, and—— 

Mr. GUINTA. What kind of a social objective? 

Ms. SCHAPIRO. But Congress—so what we have quoted here, I believe—and, again, I would have to go back and look at the full 

page—we have restated Congress’s objective for us, not an objective 

we believe that can be achieved by the conflict minerals rule. We 

have tried to be very faithful, because this is outside of our wheelhouse, to what Congress has said the purpose of this provision of 

the law is, to deal with massive human rights abuses in the Congo. 

37 

That is what we have been given and that is what we are trying 

to work with. 

Mr. GUINTA. Well, I appreciate that and I agree with you. I don’t 

think that your guidance, which is cost-benefit analysis, reducing 

incentives of misalignment, dealing with monitoring costs, lowering 

the cost of capital, I don’t think that has anything to do with the 

social objective that was included in Dodd-Frank. My earlier conversation is the expansiveness of Dodd-Frank and the burden it 

places on the SEC. I think there are many that would like you to 

focus on a certain scope of issues in a reasonable way, and I think 

that you want to try to meet that same objective. This clearly, well, 

at least in my view, takes your limited focus of economics and 

apply it to something that is social in nature. 

So I heard what you said about you will do whatever Congress 

essentially says, but I guess let me ask it this way. Would you prefer that Congress not make these types of decisions and ask the 

SEC to then promulgate rules or address them through a cost-benefit analysis process? 

Ms. SCHAPIRO. I think that is a very hard question and it really 

is a question for Congress. 

Mr. GUINTA. I thought it was an easy question. 

Ms. SCHAPIRO. No. There are no easy questions anymore. I think 

it is really a decision for Congress whether the Federal securities 

laws are an appropriate vehicle for disclosure of this type, and 

there are several. I will say the vast majority of Dodd-Frank rules 

relate to specific financial matters that go to systemic risk, that go 

to investor protection, and we have a high level of comfort with our 

ability to master, do full analysis, and understand the comments 

that we receive before we adopt our final rules. This one is harder, 

there is no question about it. It is one reason we have missed the 

deadline and we have taken so much time. We have had so many 

meetings; we have had roundtables; we have engaged very broadly 

with the corporate community, as well as with the NGOs, the Jesuit Conference, and a number of others to try to understand the 

implications of these rules and to do the best job that we can. 

Mr. GUINTA. Well, how about this. Is it fair to say that the conflict minerals rule is more about social justice than financial analysis? 

Ms. SCHAPIRO. I think Congress clearly says that in the language 

that accompanies the debate around the rule, that it is about trying to make better a horrific situation in the Democratic Republic 

of the Congo. 

Mr. GUINTA. But that is not the jurisdiction of the SEC. 

Ms. SCHAPIRO. No, but the disclosure documents filed by public 

companies is the hook here for furthering this goal. 

Mr. GUINTA. Are there other ways in which we could meet that 

objective, outside of the SEC? 

Ms. SCHAPIRO. I assume that there are. I am not an expert on 

those, but I assume so. 

Mr. GUINTA. Okay. Thank you very much. 

I yield back. 

Mr. MCHENRY. With that, Mr. Gowdy from South Carolina. 

Mr. GOWDY. As before, I would give the Chairman my time for 

him to use in such fashion as he sees fit. 

38 

Mr. MCHENRY. All right, thank you. I certainly appreciate that. 

Just to finish out my question on crowd funding, not to belabor 

the point, but I will belabor the point. You know, there is obviously 

a comment period and things of that in the normal process of rulemaking, but I want to make sure that market participants and 

members of Congress that crafted the JOBS bill have adequate opportunity to comment throughout this process to make sure that 

what the SEC enacts is actually Congress’s intent, and, obviously, 

the oversight hearings are an important part of that. So, Chairman 

Schapiro, you have always been willing to give us feedback and be 

very forthright with that, and I thank you for that. I would ask and 

encourage you to continue that process throughout the remainder 

of this year as these rules are enacted. 

Ms. SCHAPIRO. Of course. We would be happy to talk with you 

at any time that you want. Our rules will be published for comment; there will be an economic analysis associated with them; we 

will seek data to support the choices that we make and the alternatives that we offer up. This will be a fully transparent rule writing process, as we always engage in. 

Mr. MCHENRY. Okay. Thank you. You know, with the crowd 

funding piece, there are extraneous provisions put into that section 

that the Senate added and some of these experts have commented 

on. They have concerns with the amendment that the Senate added 

with crowd funding, with their liability provisions are extremely 

confusing and riddled with hypothetical questions that raise some 

liability concerns. Some have called it liability trap. So with that 

concern, do you see it that way? 

Ms. SCHAPIRO. I am not sure I know enough of the detail to answer that. It is something we will be sensitive to. We have also, 

I should say, opened up email boxes to ask for comment, even before we propose any rules, on some of the issues that people feel 

we need to address most quickly, and we have gotten, actually, 

some significant interest from people calling to find out about how 

they can engage and begin to engage in crowd funding. So I think 

whatever the hurdles that were placed into the bill in the Senate 

and the ultimately adopted version, I think there is real interest 

in people using this provision, and we will try to provide the best 

guidance that we can through the rules. 

Mr. MCHENRY. Thank you. How will the SEC ensure that crowd 

funding serves startups and small businesses that are currently 

underserved, that sort of $50,000 to $500,000 equity raising section 

of the marketplace? 

Ms. SCHAPIRO. I don’t know the specific answer to that, but I can 

tell you that if you look back over a number of rules we have done 

at my time at the SEC, we have made use of scaled requirements 

so that smaller companies have a delayed compliance date in some 

areas, they have lesser filing requirements in other areas, and we 

will continue to look at, as the executive order suggests we do, 

scaled requirements for the smallest companies. 

Mr. MCHENRY. Is that really the example to the world? As you 

talk to your peers in other countries around the world, that scaled 

regulations are really the next generation of securities regulations? 

Ms. SCHAPIRO. That is a very good question. I don’t really know 

the extent to which other countries utilize that, but we have been 

39 

doing it with respect to compensation disclosure. If you look at the 

new rules requiring private funds reporting under Form PF, systemic risk reporting, you can see that we exempted funds with assets under management of $150 million or less completely, and 

those up to $1 billion that are hedge funds only report annually, 

instead of quarterly, and much less information. So we are aggressively trying to utilize that kind of a mechanism. 

Mr. MCHENRY. Okay. Now, I am sure you have heard of this, but 

this morning the Investment Company Institute and the U.S. 

Chamber filed suit against the CFTC with their Rule 4.5, and, as 

I understand it, the mutual fund industry claims that the CFTC 

has imposed an additional unnecessary layer of regulations on hundreds of mutual funds that are currently under your purview at the 

SEC, broadly speaking, and the lawsuit says the CFTC made little 

attempt to establish there is any regulatory gap to be filled here 

and that the CFTC failed to conduct an adequate cost-benefit analysis before adopting the amendments. I am not sure if they timed 

this in conjunction with the hearing today, but the cost-benefit 

analysis is interesting. 

But to many market participants it seems that the CFTC’s 

amendments could have an adverse effect on an industry that is 

currently regulated by the Securities and Exchange Commission. 

Was the SEC aware of the CFTC’s actions? 

Ms. SCHAPIRO. I believe we were aware. They are an independent 

agency and, except where we have been directed to write joint 

rules, we aren’t in a position to tell them whether or not to go forward with something, although we do try to consult and coordinate, 

to the extent we possibly can, where our rules may affect the same 

entities. But I just don’t know the details on this. I would be happy 

to try to provide those to you. 

Mr. MCHENRY. Okay. Obviously, with mutual funds, even with 

money market funds, they weren’t the cause of the financial crisis 

and weren’t really the intention of Congress to subject them to additional regulations. But, in closing—I don’t know if my Ranking 

Member has any additional questions. 

Chairman Schapiro, you have been wonderful to submit yourself 

to congressional oversight. I know you spent some time on Capitol 

Hill, but I would say to my colleagues on both sides of the aisle 

that it is important for us to have oversight, to make sure the public knows that Congress, that their servants in Washington, their 

elected officials in Washington are having proper oversight of the 

bureaucracy. 

Now, this has been a problem in all administrations. If you have 

Republicans in Congress, they say Democrats are subjecting that 

Republican President to too much oversight, and vice versa. 

But, with that, with the regulations, with the JOBS Act, the regs 

that SEC has to promulgate, will you be willing to come back before the end of the summer, before this Subcommittee and give us 

an update on those implementations? 

Ms. SCHAPIRO. Of course. 

Mr. MCHENRY. Thank you. I certainly appreciate that. And if we 

could have a regular update from your staff and from you, that 

would be very helpful as well. 

So I certainly appreciate your testimony. 

40 

With that, the Committee stands in recess until we put in place 

the second panel. 

[Recess.] 

Mr. MCHENRY. The Committee will come back to order and have 

witnesses take their seats. Is Mr. Yerret present today? 

All right, the Chair will now recognize the second panel of witnesses and I will begin by recognizing Dr. Henry Manne as the 

Dean Emeritus of George Mason University School of Law; Ms. 

Jacqueline McCabe is the Executive Director for Research of the 

Committee on Capital Markets Regulation; Mr. Mercer Bullard is 

an Associate Professor of Law at the University of Mississippi 

School of Law; Mr. J.W. Verret is an Assistant Professor of Law at 

George Mason University School of Law; Mr. H. David Kotz is the 

former Inspector General of the Securities and Exchange Commission, and current Managing Director of Gryphon Strategies. 

With that, it is the policy of this Committee that witnesses will 

be sworn in before they testify. If you will please rise and raise 

your right hands. 

Do you solemnly swear or affirm that the testimony you are 

about to give will be the truth, the whole truth, and nothing but 

the truth? 

[Witnesses respond in the affirmative.] 

Mr. MCHENRY. You may be seated. 

Let the record reflect that the witnesses answered in the affirmative. 

Members will have five legislative days to submit written opening statements, and in order to allow time for discussion, I ask the 

panel to limit their testimony or to summarize their testimony, and 

if you can keep that to five minutes. The lights are there for your 

instruction, and if you could please adhere to that, we will get time 

for an exchange of ideas and a discussion afterwards. 

After that, we will first recognize Dr. Manne. 

STATEMENT OF HENRY MANNE, PH.D. 

Mr. MANNE. Thank you, Mr. Chairman. 

Mr. MCHENRY. If you will pull the microphone close to your 

mouth. They are very directionally oriented. 

Mr. MANNE. I presume first recognition of me is in recognition 

of age, but I almost believed that I would never live long enough 

to see the day of March 16th, when the SEC put down this new 

memorandum. I have spent my entire career, over 50 years in law 

teaching, pressing the idea of the need for economic analysis in 

legal policy-making. We have had some enormous successes. I don’t 

think there is any law school in the Country today that doesn’t 

have substantial work in law in economics, and, indeed, I think the 

rising popularity of this interdisciplinary field in part accounts for 

what has happened in the SEC now. 

Nonetheless, most of my career was not happy in this regard. In 

1966, I wrote the first book that was fundamentally critical of the 

SEC from the point of view of not using economics. It was a detailed economic analysis of what came to be called insider trading. 

It was studiously ignored by the SEC. In fact, I am told that by 

decision in a staff meeting no one would be allowed to review it 

and, furthermore, that I had the happy position for many years 

41 

that no staff member at the SEC was even allowed to cite any work 

that I had written. 

The following year I edited a conference that I ran that was the 

first comprehensive treatment by economists of securities regulation. There had been one or two spotty articles up to that point, 

but that was the first one. Again, it met with, I would say, resounding hostility from the SEC, as most everything that I did in 

those days was. 

So you can see that having come a long way. I don’t suggest that 

I think that cost-benefit analysis is the be all and end all of correction of problems with securities regulation, but it is very definitely 

a step in the right direction. 

Having said that, I want to say some general things about costbenefit analysis and this in particular. First of all, this cost-benefit 

analysis is merely one part of economic analysis. There are occasions, as was pointed out in that memorandum, when cost-benefit 

analysis is not the most appropriate thing to use. Economic analysis of a non-empirical sort can be used, and each has its appropriate role. 

There are several aspects about overlapping on those, because I 

see I have run out of time much faster than I ever expected to, that 

I raised by way of warning to the agency. I take them in perfect 

good faith that they really mean what they said, but I am not sure 

they know fully what the implications are of what they said. 

First of all, data of the kind they use in many cost-benefit analysis is about as malleable as clay. There is an old saying, if you 

squeeze the data hard enough, you can make it say anything you 

want. Well, what that does is puts a degree of responsibility for objectivity on an agency using cost-benefit analysis that maybe they 

are not even aware of. One of you Congressmen mentioned earlier 

the whole culture of the Securities and Exchange Commission has 

not been the culture of a highly intellectualized economics department in a university; it has been heavily politicized and, indeed, 

hostile to economic analysis because that is a kind of often serves 

to restrict what would be preferred political things to do. 

This came out, I saw, mainly in the memorandum in two places, 

both footnote 16 and footnote 19, which were the principle places 

in which the memorandum actually mentions some of the substantive techniques and problems of cost-benefit analysis. I would 

like really just I will mention one of them as an example that this 

entire list is big enough to run a truck through, doing away with 

sufficient appropriate analysis. 

One is the notion of asymmetric information. This is defined in 

that memo as a market failure. Well, if asymmetric information is 

a market failure, then everything in the world is a market failure. 

Asymmetric information merely means that the two people negotiating don’t have exactly the same information, the same education, 

the same attitudes, the same risk aversion; many differences. And 

to talk about it as a market failure is to, in effect, beg the question 

entirely, even before you get started. 

There are several other places in that memo that, if you want to 

talk about later, we can, which I haven’t gone into. 

If I may take just a minute, I have a list of—— 

42 

Mr. MCHENRY. If you are able to summarize. We have a large 

panel. If you are able to summarize in another 30 seconds, that 

would be very helpful. 

Mr. MANNE. I would just mention and list some practical consequences that I think should grow out of this. One, I think the 

SEC is totally fooling itself when it talks about 17 or 20 new economists. For the job that they really presented themselves, to do well 

and to do adequately, I think is a minimum of 150 economists. I 

don’t think small numbers even begin to grab at it. And you should 

pursue the number of laws they have because it has long been a 

lawyers agency with no input from the economists, and that ought 

to change. The culture and the internal dynamics of that agency 

should be changed because it is an economic regulatory agency. 

And it is not true, as I am afraid Mrs. Maloney said, that the 

important thing is to get those regulations out. No. The important 

thing is to get regulations right. Better to get two correct, really 

effective regulations under Dodd-Frank than to get 150 out that 

are random, that you don’t know what the impact is or what the 

cost-benefit is, or anything else. 

[Prepared statement of Mr. Manne follows:] 

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Mr. MCHENRY. Dr. Manne, we will have to leave it there. I could 

listen to you all day; you are speaking my language. Or, I am trying to understand the depth of your language I think is probably 

a better way to say it. 

With that, we will have to recognize Ms. McCabe for the purposes of her opening statement. 

STATEMENT OF JACQUELINE MCCABE 

Ms. MCCABE. Thank you, Chairman McHenry, Ranking Member 

Quigley, and members of the Subcommittee, for permitting me to 

testify before you today on cost-benefit analysis conducted by the 

SEC. I am speaking today on behalf of the Committee on Capital 

Markets Regulation, of which I am the Executive Director for Research. 

The Committee has, since 2006, strongly supported improved 

cost-benefit analysis by both the SEC and other agencies. Today 

the need for improved cost-benefit analysis is particularly evident 

in the agency’s respective rulemaking under Dodd-Frank. We are 

deeply concerned that the inadequate cost-benefit analysis could 

expose these rules to judicial challenge, particularly in light of the 

Business Roundtable decision and a current lawsuit seeking to 

strike down the CFTC’s recently promulgated position limits rule. 

The Committee studied cost-benefit analysis provisions in 192 

proposed and final rules issued by 15 regulators under DoddFrank. Here are the numbers. Our analysis found that of these 192 

rules, the vast majority do not discuss the expected broader economic impact of the rule; 57 of the rules contain no cost-benefit 

analysis; 85 of the rules contain entirely non-quantitative cost-benefit analysis; 50 of the rules contain quantitative cost-benefit analysis; however, most of this analysis is limited to the costs of paperwork, legal and compliance review, technology enhancements, and 

the like. 

We found that, relative to other agencies, including the CFTC, 

the SEC’s analysis was generally more thorough and included more 

quantitative analysis; however, there is still significant room for 

improvement. Of the 54 SEC rules we reviewed, 4 contained no 

cost-benefit analysis, 26 contained non-quantitative cost-benefit 

analysis, and 24 contained quantitative cost-benefit analysis, although of these 24 rules only about half discussed any economic 

impact broader than paperwork, labor, compliance costs, and the 

like. 

The SEC has recently issued guidance to its staff that outlines 

best practices for economic analysis in rulemaking. We applaud the 

SEC for taking this step. The SEC has noted that analyses of costs 

cannot be limited to compliance costs or hourly wage rates. Broader 

analysis will usually require additional data collection and may necessitate that the SEC hire additional economists. We fully support 

the necessary funding for the SEC to obtain these resources. 

We are also pleased that the SEC has recognized the need to consider overall economic impact of its rules, including its rulemaking 

pursuant to congressional mandates, as well as entirely discretionary rulemaking. Even where Congress mandates a rule, it is 

important to assess the costs and benefits of both the rule and alternative approaches. We note the SEC’s approach here stands in 

55 

contrast to that approach taken by the CFTC, and we strongly encourage the CFTC to rethink its position. 

The SEC has stated that in measuring the benefit of a regulation 

it will look to the benefit of improving matters from the prior state 

of affairs, what it calls the pre-regulation baseline. We would caution that the agency cannot merely assume that a new regulation 

will necessarily avoid the past loss, as it could have been due in 

whole or in part to matters not affected by or improved by the rule. 

We commend the SEC on its focus in assessing the tradeoffs 

among reasonable alternatives to its proposed rules. Whatever the 

benefit of a proposed regulation, it is best to achieve this benefit 

at the least cost, and this can be determined by comparing alternatives. 

We have observed that regulators, including the SEC, have requested input on cost-benefit analysis from industry in many of the 

rules. We caution, however, that when a regulator does not receive 

the information it has requested, this does not relieve it of its duties to conduct cost-benefit analysis. Rather, there are numerous 

other avenues regulators can pursue. First, they may develop data, 

estimates and data based on assumptions may serve this purpose. 

If the regulator is unable to develop data internally, it must obtain 

the information from third parties, for example, other agencies, 

self-regulatory organizations, trade organizations, or industry participants. Finally, regulators can request the data directly from 

firms that will be impacted by such proposed regulation. Any such 

data request should be made with an eye to minimizing the imposition on market participants. 

In closing, we recommend that with respect to any outstanding 

proposed rules that have been presented for comment but not yet 

finalized, the SEC apply its new guidance to these proposed rules, 

and the SEC has indicated it will do so. But the SEC must also 

review all of its final rules to ensure that they can withstand legal 

challenge. We note that approximately half of the SEC rules we reviewed were in final form, including rules with non-quantitative 

cost-benefit analysis. 

In closing, again, we commend the new direction the SEC has 

taken on this issue and we hope that other agencies would follow 

suit. Thank you. 

[Prepared statement of Ms. McCabe follows:] 

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Mr. MCHENRY. Thank you, Ms. McCabe. 

Mr. Bullard. 

STATEMENT OF MERCER E. BULLARD 

Mr. BULLARD. Chairman McHenry, Ranking Member Quigley, 

members of the Subcommittee, thank you for the opportunity to appear before you today to discuss cost-benefit analysis in SEC 

rulemakings. 

There is general agreement that in the past the SEC has afforded the economic costs and benefits of its regulations too little 

consideration. However, it has made significant improvements in 

this area and it plans to make additional improvements in the future. In my view, the SEC is well on its way to establishing the 

kind of deeply embedded institutional processes that will ensure 

that economic analysis plays a central role in the agency’s rulemaking. 

The Commission has hired a strong contingent of economists and 

plans to hire many more. Its Division of Risk Strategy and Financial Innovation now plays a key role in all rulemaking. Reports recently issued by the SEC’s Inspector General paint a generally 

positive picture of the SEC’s cost-benefit analysis in action. Nonetheless, I would like to address four concerns regarding the SEC’s 

cost-benefit analysis going forward. 

First, I am concerned the SEC’s cost-benefit analysis may become 

too focused on economic factors. Cost-benefit standards are naturally inclined to favor analysis that produces quantifiable, reducible 

results. Costs and benefits that can be monetized will generally be 

favored over those that cannot because monetized factors can be 

more easily compared; they use a common unit of measure. For example, monetized estimates of compliance costs are consistently afforded disproportionate weight not because they are more important, but because they are precise and reducible. As discussed in 

the OIG’s report, Professor Kyle observed instances of this bias at 

work where micro considerations were afforded greater weight and 

some macro costs were ignored or under-emphasized. 

Second, the ultimate solution must lie with the SEC’s lawyers. 

The lawyers exercise ultimate staff authority in the rulemaking 

process and it is, therefore, lawyers who will decide the extent to 

which economic analysis is reflected in a rulemaking. Lawyers tend 

to imply an overly legalistic analysis to what are ultimately nonlegal issues. This problem can be mitigated somewhat by hiring 

lawyers with industry experience and expertise in business, accounting, and finance. The SEC should, and I believe already may, 

incorporate these criteria into its hiring practices. It should consider encouraging junior and senior staff to leave the SEC to obtain 

industry experience, while seeking out lateral hires from industry 

to replace them. 

Third, the Commission should attend to the risk of administrative paralysis. The rulemaking process, like any forward looking 

process, is inherently uncertain; it is necessarily based on incomplete information; and cost-benefit analysis is ultimately inherently 

subjective. Many criticisms of the SEC’s cost-benefit analysis simply reflect unreasonable expectations. The Commission must enVerDate Aug 31 2005 12:13 Jun 25, 2012 Jkt 000000 PO 00000 Frm 00074 Fmt 6633 Sfmt 6633 C:\DOCS\74375.TXT APRIL
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sure that it does not avoid rulemaking altogether out of fear that 

its rules will be attacked and even vacated by courts. 

And, finally, the Commission should consider reforming the rulemaking process to be more like the creative, somewhat risk-taking 

process that it is. In my view, any cost-benefit aversion the SEC 

may have may be more a reflection of a 20th century workplace 

culture in charge of regulating a 21st century industry. Although 

some rulemaking initiatives are preceded by a concept release, 

most begin with a commitment of a team to the goal of producing 

a proposal. It is not really a proposal, at least not in the sense of 

a business would develop internal proposals for a new business initiative, it is a full-blown rule based on extensive analysis and a set 

of assumptions. It reflects the incorporation of different viewpoints, 

but not in the sense of competing viewpoints. It is subject to 

change, but it still reflects, to some degree, the vested interest of 

its creators, including cost-benefit analysis done by economists. 

The Commission should consider workplace processes that will 

produce more robust collaborative analysis. For example, it could 

issue initial precis, a short umbrella proposal that outlines the 

problem, lists potential solutions, and makes a first cut at the 

types of costs and benefits that it expects the proposal to implicate, 

before deeper analysis has been conducted, substantial resources 

have been committed, and vested interests have begun to set. It 

could issue multiple proposals so that, as with movies, with multiple outcomes, there is a genuine doubt as to how it would end. 

Proposals are often viewed as positions from which the Commission must be moved, as if anchored to vested staff interests. Multiple proposals could be issued by competing teams within the SEC, 

created through a competitive process. Rulemaking staff could submit their own proposals that, if approved for further develop, could 

entitle them to devote a certain number of workdays to take it to 

the next level. The staff could appoint red and blue teams whose 

job it would be to tear apart proposals in mock cost-benefit challenges. For example, the staff has 270 days to adopt rules for crowd 

funding that it address 15 or 20 or so requirements. Why not start 

by assembling the entire rulemaking staff in trading and markets 

and give each one two hours to sketch out the essential elements 

of the rules and then to present their ideas to a group for a no 

holds barred brainstorming session? A series of face-offs could winnow down the pile with winners allowed to cannibalize elements 

from their defeated opponents’ proposal, or maybe put them all on 

a remote island where one is voted off every day. 

When I see pictures of successful startups’ offices engaged purely 

in the business of creating intellectual property, they are not working in separate offices or even separate cubicles, but lined up in a 

row, at a long table, elbow to elbow, much like, and not coincidentally, the trading desk of large broker dealers. 

The SEC is also engaged in a kind of collaborative, complex intellectual property creation, as am I as a law professor, and as are 

members of Congress as lawmakers. What should our collaborative, 

complex intellectual property places look like? Probably not the 

way they look today. 

In conclusion, rulemaking is, no matter how thoroughly analyzed 

by economists, a venture into the unknown. It is a creative process 

72 

in which one must assume, indeed, embrace, the risk of getting it 

wrong if change can ever happen. Let’s ensure that all reasonable 

costs and benefits are considered before acting, but let’s not impose 

so many burdens that action becomes impossible. 

Thank you again for inviting me to testify, and I would be happy, 

of course, to try to answer any questions you might have. 

[Prepared statement of Mr. Bullard follows:] 

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Mr. MCHENRY. Thank you, Mr. Bullard. 

Mr. Verret. 

STATEMENT OF J.W. VERRET 

Mr. VERRET. Chairman McHenry, Ranking Member Quigley, and 

members of the Committee, I really appreciate the opportunity to 

join you today. As mentioned, I teach corporate and securities law 

at George Mason Law School and am a senior scholar with the 

Mercatus Center. 

In September 2011, I had the opportunity to testify before the 

House Committee on Financial Services on this issue. SEC staff 

and Chairman Schapiro were present, and it was argued there that 

economic analysis is not always required when rules are mandated 

under legislation. In any event, measuring the impact of new rules 

can be prohibitively difficult. 

I am aware that staff have prepared a memo that represents an 

about-face in terms of this thinking. I want to congratulate the 

Commission and the staff and Chairman Schapiro and this Committee and the various oversight committees of Congress and, 

frankly, the judiciary for their oversight on that issue. 

It remains to be seen whether this memo is just a memo or it 

will be put into place in future rulemaking. 

After careful review of the legislative requirements that the SEC 

consider investor protection, efficiency, competition, and capital formation in adopting new rules, I would like to offer a list of eight 

items that I think would demonstrate a sincere commitment by the 

SEC to fulfill its statutory mission in this regard. The first five, in 

fact, are mandated by law, if one carefully reads the judicial interpretations in the legislative history of this issue. 

I offer this list as a test of their resolve, the SEC’s resolve to 

make economic analysis a sincere constraint on SEC rulemaking 

and a limit on any political pressures it might face to politicize its 

activities in a way that might undermine investor protection. 

First, rules must have sunsets and look-back requirements. 

When the agency represents in a rulemaking that costs and benefits are difficult to estimate, as it represented in rulemaking pursuant to Section 404(b) of Sarbanes-Oxley. At times, data relevant to 

rules, costs and benefits might not be available until years after 

implementation. When this is true, as it was under Sarbanes-Oxley 

404(b), where the SEC initially estimated implementation costs of 

$90,000 per company, later estimated at $1.8 million per company, 

sunsets and look-back requirements that automatically stop the 

rule and urge a reconsideration and re-adoption of the rule are necessary. 

Number two, the SEC has to consider the costs of a new rule 

against any alternatives advanced by dissenting commissioners. 

This is required under various interpretations from the D.C. Circuit. 

Number three, mandatory disclosure rules must be subject to the 

same materiality standard as private plaintiffs in 10b-5 cases. A 

disclosure not material to investors cannot be legitimately said to 

further the goals of investor protection. 

Four, the agency must, in order to meet its requirement to consider the impact of a rule on competition, capital formation, and efVerDate Aug 31 2005 12:13 Jun 25, 2012 Jkt 000000 PO 00000 Frm 00094 Fmt 6633 Sfmt 6633 C:\DOCS\74375.TXT APRIL
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ficiency, estimate the impact of a rule on the competitiveness of 

U.S. exchanges against foreign exchanges for new listings, the competitiveness of U.S. issuers, the risk that proprietary information 

might be revealed, and the impact of a rule on the stock prices of 

affective companies. The agency must also estimate the impact of 

a role on items like job creation and GDP, economic factors, in sum. 

Five, the agency must retract and re-propose rules advanced pursuant to the Dodd-Frank Act to reflect the agency’s new policy on 

cost-benefit analysis and its about-face shift on this issue. The 

SEC’s rule proposal under Section 1504 of Dodd-Frank is a case in 

point, where it fails to consider the impact of disclosures on the 

risk that it will reveal proprietary exploration plans of U.S. energy 

companies. 

Six, the agency has to freeze attorney hiring until it hires at 

least 200 more economists. And I know that sounds like a lot but, 

in fact, it is not when you compare the SEC against its sister agencies. The FTC staff, very similar market-based mission. In fact, the 

securities laws were originally placed in the jurisdiction of the FTC 

in 1933, until the SEC was created in 1934. The FTC has about 

10 percent PhD economists. At the CFTC it is less than 5 percent, 

and at the SEC that number is less than 1 percent. Ten percent 

at the FTC; less than 1 percent at the SEC. In order to be on par 

with sister agencies like the FTC, the SEC has to hire at least 400 

new economists. I think 200 would be a modest commitment in this 

regard. The fact that it has misallocated resources in the past 

should not justify added appropriations but, instead, suggests a 

need for reallocation of present resources. 

Seven, the Division of Risk Fin should get authority in rulemaking. And I know the Chairman has indicated in testimony 

today and in the memo they have indicated that this is the case, 

but until I see a changed SEC internal official operating procedures, I question that observation, the continuance of that observation. 

Number eight, the Risk Fin must be given a role in rating the 

impact of cases brought by enforcement lawyers in their personnel 

reviews. The agency’s existing metric, which focuses on size of recovery and number of cases resolved, can distort incentives and 

lead to missed opportunities to stop ongoing fraud like that seen 

in the Madoff case. If we had economists measuring the rate of 

fraud, one example, the rate of fraud prior to a case being brought, 

we can estimate the rate at which it grows and estimate the 

amount saved to investors. And I think though the internal enforcement staff will be resistant to this, it could be very beneficial. 

So I thank you for the opportunity to testify and I really look forward to answering your questions today. 

[Prepared statement of Mr. Verret follows:] 

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Mr. MCHENRY. Mr. Kotz. 

STATEMENT OF H. DAVID KOTZ 

Mr. KOTZ. Thank you for the opportunity to testify before this 

Subcommittee. I served as the Inspector General for the SEC from 

December 2007 through January 2012. I am currently the managing director of a private investigations firm called Gryphon 

Strategies. 

Prior to my leaving the SEC on January 27th, 2012, my former 

office issued a report entitled Followup Review of Cost Benefit 

Analyses in Selected Dodd-Frank Act Rulemakings. In connection 

with this report, we retained an expert, Dr. Albert S. Kyle, to assist 

with our review. In this review, our objectives were to assess 

whether the SEC was performing cost-benefit analyses for DoddFrank rulemaking initiatives in a consistent manner and determine whether problematic areas existed and where improvements 

were needed to enhance the overall methodology used to perform 

cost-benefit analyses. 

In the course of the review, we learned that when questions 

arose in 2010 about the extent to which cost-benefit analyses 

should be conducted for Dodd-Frank Act rulemakings, rulemaking 

teams and the Division of Risk Fin consulted with the then SEC 

general counsel. On September 27, 2010, following these consultations, the former general counsel, in a memorandum to rulemaking 

teams and Risk Fin, advised that where the Commission has a degree of discretion, the release should discuss an attempt to quantify 

the costs and benefits of the choices. However, where the Commission has no discretion, the memorandum advised that the release 

should say so and that, because the Commission is making no policy choices, there would be no choices to analyze or explain. 

We found that the approach articulated by the former general 

counsel dovetailed with the approach utilized by the SEC rulemaking teams in the cost-benefit analyses we reviewed. For example, the introduction to the cost-benefit analysis section of the 

adopting release for the shareholder approval of executive compensation in Golden Parachute Compensation Rule stated the following: The discussion below focuses on the costs and benefits of 

the amendments made by the Commission to implement the Act 

within its permitted discretion, rather than the costs and benefits 

of the Act itself. 

The January 27th, 2012, report describes how, pursuant to OMB 

guidance, a cost-benefit analysis is intended to inform the public 

and other parts of the government, including Congress and the regulating entity itself, of the effects of alternative regulatory actions. 

This OMB guidance also specifies that agencies should establish a 

baseline for use in defining the costs and benefits of alternative 

regulatory actions and the baseline will be a no action or pre-statute baseline. 

We found that to the extent that the SEC performed cost-benefit 

analyses only for discretionary rulemaking activities without a prestatute baseline, the SEC may not be providing a full picture of 

whether the benefits of a regulatory action are likely to justify its 

costs and which regulatory alternatives would be the most cost-effective. 

95 

In addition, based on an examination of several Dodd-Frank Act 

rulemakings, the review found that the SEC sometimes used multiple baselines in its cost-benefit analyses that were ambiguous or 

internally inconsistent. The review also found that there was often 

considerable overlap between the cost-benefit analyses and efficiency, competition, and capital formation sections of the releases 

for Dodd-Frank Act regulations and that such redundancy could be 

reduced by combining these two sectors. Further, we found that 

some Dodd-Frank Act rulemakings lacked clear, explicit explanations of the justification for regulatory action. The report found 

that a more focused discussion of market failure in cost-benefit 

analyses would lay out the rationale for regulation more clearly to 

Congress, the general public, and the SEC itself. Finally, the review found that although some of the SEC’s Dodd-Frank Act 

rulemakings may result in significant costs or benefits to the Commission itself, internal costs and benefits were rarely addressed in 

the cost-benefit analyses. 

Based on the results of our review, the report made several recommendations for improvements to the SEC’s practices. These recommendations included, one, considering ways for economists to 

provide additional input into cost-benefit analyses; two, reconsidering the approach that the SEC only perform cost-benefit analyses 

for rulemaking activities to the extent that the SEC exercises discretion; three, using a single consistent baseline in the cost-benefit 

analyses; four, discontinuing the practice of drafting separate costbenefit analysis and efficiency, competition, and capital formation 

sections; five, directing rulemaking teams to explicitly discuss market failure as a justification for regulatory action in the cost-benefit 

analysis of each rule as appropriate; and, six, including internal 

costs and benefits in the cost-benefit analyses of rulemakings. 

While I left the Commission shortly after the report was issued, 

I understand that the SEC has now taken significant steps to implement the report’s recommendations. 

Thank you again for the opportunity to testify, and I would be 

happy to answer any questions. 

[Prepared statement of Mr. Kotz follows:] 

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Mr. MCHENRY. I thank the panel and, with that, I would like to 

yield to my colleague, the Ranking Member, to ask questions first. 

Mr. Quigley. 

Mr. QUIGLEY. Thank you, Mr. Chairman. 

Lady and gentlemen, as I listen to your testimony, I am struck 

by the questions I asked the Chairman, and that is this is important and very dry, mind you, but you get stuck with the emotional 

aspects and the real world pain caused by what happens when we 

don’t capture this Worldcom, Enron, Madoff, and the 2008 crisis. 

Dr. Manne, is it your assumption or your belief that those are 

happenings that regulation couldn’t have caught, that a good regulation or good practice wouldn’t have caught? Could an economist 

catch that or where did we miss that? And isn’t that our main concern when we determine what the benefit is in a cost-benefit analysis? Doctor, how do you measure the thousands of people who 

were pained and the millions of dollars that were lost when you do, 

in your minds, a good cost-benefit analysis? 

Mr. MANNE. Well, I think there certainly may be aberrations all 

over the place. Some of the episodes you mention can partially be 

put at the foot of the SEC, some of it elsewhere. Some of it is omission. Certainly in the case of Madoff that seems to be clear. Others 

of it may strangely be results, unforeseeable results of actually regulations in effect. There is a very strong view, for instance, that if 

insiders in a corporation were allowed to engage in insider trading, 

instead of doing whistleblowing, the Enron thing wouldn’t have 

shown up, because very early on people would have made a lot of 

money by, in effect, letting that information out into the market by 

selling shares. 

So there are a variety of different ways, and that brings me to 

the point of this discussion, that there are many different forms of 

economics. You made the point about cost-benefit analysis being 

merely one form of analysis. There are economists and then there 

are economists. The SEC could hire 200 economists whom I would 

not think qualified, really, to do the job I want them to do. A lot 

of it, I think the heavy work still remains not in the cost-benefit 

and empirical data business, but, rather, in terms of getting the 

analytical model straight. I don’t think that anyone has ever devoted themselves to that kind of problem in connection with this 

regulation. 

Mr. QUIGLEY. Doctor, let me move on because I have somewhat 

limited time. 

Mr. Verret, could you comment? I understand your answer and 

what you talked about in your five minutes, but how do you measure what the benefit is if the risk could potentially be so great? 

Mr. VERRET. I think you have to do the best job you can to measure the costs and benefits, and that may be a dry phrase. I think 

you can rephrase it accurately to be the regulatory taxes that get 

passed through to American consumers, American investors. And 

one way that we have estimated this is with respect to the first 

rulemaking the SEC did pursuant to Dodd-Frank, the rulemaking 

that was struck down in the D.C. Circuit case, the Business Roundtable case. 

My coauthor, Professor Stratman and I, are publishing a peer review article in the Stanford Law Review that estimates just a small 

103 

subset of the firms that were affected by that rule. So, in fact, the 

proxy access amendment to Dodd-Frank requires the SEC to consider the impact on small firms and consider an exemption for 

small firms, and the SEC, despite the will of Congress, the SEC did 

not provide an exemption for small firms. We measure what impact 

did that have on small firms, or was it just delayed for them a couple of years, rather than a full exemption. We find it caused almost 

half a billion dollars in shareholder losses just for that small group. 

You extrapolate that out to all the companies affected by that 

proxy access rule that was struck down by the D.C. Circuit, we are 

talking about billions of dollars in regulatory taxes. 

So I think it is important to estimate that and to include it at 

the benefits of preventing long-tail risk. But I wouldn’t always assume that regulations are going to prevent it. Sarbanes-Oxley certainly didn’t prevent the financial crisis of 2008. 

Mr. QUIGLEY. Sure. 

Mr. Kotz, let me throw in this quote from Chairman Greenspan’s 

testimony before the full Committee. He said it was a mistake to 

presume ‘‘that the self-interest of organizations, specifically banks 

and others, was such that they were best capable of protecting 

their own shareholders.’’ 

Getting to the points I raised before, how do you strike this balance? I understand, as you suggest, that we want to avoid ambiguity, overlap, and redundancy, and we need to do this as best as 

we possibly can. How much faith do you have in the market policing itself that we don’t need to be very strong, the SEC doesn’t 

need to be very strong with its regulatory measures to protect the 

public? 

Mr. KOTZ. Absolutely I think that the SEC needs to be strong, 

and that is the reason why it is so important to do a thorough costbenefit analysis; to look not only at the costs, but also the benefits. 

There are situations where there is market failure, and one of the 

points that we made in the report was the SEC should point that 

out and explain that. So our focus in the Office of Inspector General report was to ensure that they do the best job possible to look 

at the benefits that you articulated, as well as the costs. 

Mr. QUIGLEY. Mr. Bullard? 

Mr. BULLARD. I thought the question was about fraud, and I was 

looking forward to Professor Verret explaining his rate of fraud 

analysis. I would be interested how one could quantify the costs of 

the rate of fraud. It is an extremely difficult problem, I found, and 

one is exactly the kind of benefit of regulation that is hard to put 

your finger on, and that economic analysis invariably downplays. 

I also can’t help but respond to Dr. Manne’s analysis. His insider 

trading analysis I found to be brilliant, but the fact is Enron executives were selling and they weren’t telling anyone, and one of them 

stood in front of a roomful of employees and told them that they 

should buy more shares as the company was sinking, and those 

people testified before committees of Congress about how their entire retirement had been destroyed. And, in fact, fortunately, this 

Country has never adopted the idea that insider trading should be 

a permissible course of action. So I think it is a classic example of 

where economics takes you if you don’t also consider the social construct within which law is made. 

104 

The problem from an investor advocate point of view, Ranking 

Member Quigley has put his finger right on the point, which is it 

is extremely difficult to quantify what the cost is when an 85-yearold man suffering from dementia is sold a valuable annuity, or 

when somebody who has a $20,000 income is defrauded in a $2,000 

offering over the Internet. That is tough to measure. If someone 

has a quantification analysis they can provide that will allow the 

SEC to do that, then I would like to know about it. But the SEC 

has to be allowed to make those calls. That is its job; it is the job 

Congress gave it to do. And at some point the cost-benefit analysis 

requiring quantification of every piece of analysis makes that virtually impossible to do. 

Mr. QUIGLEY. Ms. McCabe, I don’t want to be rude. I had limited 

time, but, please, if you would give us your thoughts. 

Ms. MCCABE. Sure. Yes, just very briefly. I acknowledge that the 

benefits of different rules will be certainly difficult to measure, but 

as I mentioned earlier, I think it is important that the analysis not 

be conclusory and we don’t assume that a regulation will have a 

benefit equivalent to the value of the crisis that had occurred prior 

to the regulation. 

Secondly, and I discuss this more extensively in my written testimony, but there are rules like the Volker Rule, for instance, proposed by five different agencies with five different sets of cost-benefit analysis requirements with zero cost-benefit analysis. So, 

again, we would just encourage that there needs to be thoughtful 

cost-benefit analysis. 

Mr. QUIGLEY. Thank you. And I appreciate your efforts and the 

Chairman for letting me speak. I need to get to the floor. Thank 

you. 

Mr. MCHENRY. I certainly thank my colleague for his questions. 

This is a fascinating subject matter and certainly appreciate the 

answers and the testimony this panel has given. 

Mr. Kotz, I want to begin with you. Now, you are the former Inspector General for the Securities and Exchange Commission and 

certainly appreciate your service in government, especially the final 

report before you went to the private sector. In your final report 

you call into question the cost-benefit analysis and the use of it 

with the Securities and Exchange Commission. 

Out of that report Chairman Issa and I wrote a letter to the Securities and Exchange Commission, and they have acted relatively 

quickly, in the world of the Securities and Exchange Commission, 

with new guidance incorporating many of the provisions that you 

called into question, the solutions to those issues you called into 

question, and answering a number of the concerns that Chairman 

Issa and I have about the importance of cost-benefit analysis to all 

rules that go through the whole process. 

So I want to thank you for that. You have done a good service 

for your government to draw this report to people’s attention and 

actually getting it changed based upon a good work. 

Mr. KOTZ. Thank you. 

Mr. MCHENRY. So in discussion with that, you reviewed the Securities and Exchange cost-benefit analysis and the cost associated 

with their failure to follow the letter of the law and the direction 

of Congress, and the regulatory costs and the staff time. Can you 

105 

discuss that cost of their failure to use cost-benefit analysis, the 

cost to the taxpayer and to market participants? 

Mr. KOTZ. Yes. We didn’t quantify it specifically, but clearly if 

you have a regulation and you just assume, without doing a costbenefit analysis, that the benefits outweigh the costs, and you don’t 

provide that information to Congress, to the public, then you set up 

a situation where the information isn’t out there about whether 

this regulation is useful or not, and that is something that is a concern. 

In my time as Inspector General of the SEC there have been occasions where we found that there were certain rules put into place 

and the rules required certain disclosures, certain filings, and yet 

the documents that were filed were not really used by the SEC, 

they were put in a drawer. So you have certainly a cost that is associated with it on the part of a company, for example, in having 

to do this filing, but then you don’t really have any use of it by the 

SEC. 

So notwithstanding the fact that it was mandatory or whether 

the SEC had any discretion or not, it is very important for the SEC 

to assess that. And if they don’t assess that, then Congress doesn’t 

have the information to know whether this rule that was put in 

place is actually working and is actually cost-beneficial. 

Mr. MCHENRY. Is there a need for a wholesale cultural change 

in order to incorporate this, the cost-benefit analysis at the SEC? 

Mr. KOTZ. I think that this March 16, 2012 memo is a very good 

start. As you said, it really changes the way things are done completely. The differences between the Becker memo that you discussed before that I mentioned in my testimony and this one are 

very great. So I think the proof will be in the new rules. Clearly, 

I am not the Inspector General anymore, but, if I were, I would certainly look at the new rules to make sure that it is not just guidance that is put forward, but that there is actual application of that 

guidance in the new rules. 

I do think that if the SEC, when they issue the new rules, follow 

the latest guidance, as opposed to the Becker memo, I think you 

will see a significant difference in how they do their cost-benefit 

analysis. 

Mr. MCHENRY. So, Mr. Bullard, is that an essential ingredient 

to rulemaking, a cost-benefit analysis? 

Mr. BULLARD. Yes, absolutely. And I think that one thing we can 

probably all agree on is that by the end of the year we will probably be able to say that Chairman Schapiro has done more to improve cost-benefit analysis in SEC rulemaking than every SEC 

chairman in history combined, and I think those are critical steps. 

Mr. MCHENRY. I would like that to be the case. I would like that 

to be the case. 

Mr. BULLARD. I think you might even be able to say that today. 

I agree with my other panelists that, historically, this has been a 

major inadequacy, and Dr. Manne is one of those leaders in moving 

the SEC toward much more economic analysis. 

But I would like to just warn my colleagues. Speaking from having been inside the SEC, hiring more economists is not going to fix 

the problem any more than hiring more workers would change the 

architecture of the pyramid. You have to get the lawyers on board. 

106 

As I noted in my written statement, part of the problem is our 

American legal education, is that lawyers do not have the competence in business, finance, accounting, and industry in order to 

do the job. And I think the SEC is already, based on my anecdotal 

experience, doing something, hiring people with more of that kind 

of experience. It has to be the lawyers; the economists won’t do it. 

Mr. MCHENRY. With all due respect, is this really a moment to 

insert a lawyer joke? 

Mr. BULLARD. Please. Feel free. 

Mr. MCHENRY. Because I think it might be, as a non-lawyer. 

Mr. VERRET. I would take this opportunity to emphasize that at 

George Mason Law School, founded by Dean Manne, we have, as 

part of the first year curriculum, an economic analysis course for 

law students, and we do have law students interested in working 

at the Securities and Exchange Commission. 

Mr. MCHENRY. I knew that pitch was coming. I just knew. 

[Laughter.] 

Mr. BULLARD. But for half the price you can go to Ole Miss and 

get a law degree as well. 

Mr. MCHENRY. Mr. Bullard, are you trying to change the culture 

of Ole Miss so that your lawyers come out? 

Mr. BULLARD. I am not trying to highlight Ole Miss, and I am 

not suggesting that there isn’t more that I could do personally, and 

I always strive to do more personally in order to integrate these 

issues into the curriculum, but there is a major systemic problem 

in American law schools. 

Mr. MCHENRY. But it is also a cultural problem. 

Mr. BULLARD. It is a cultural problem. It is an aversion to—— 

Mr. MCHENRY. So this process, and I asked Chairman Schapiro 

about this, I said, in essence, does the economic analysis, the costbenefit analysis, can that be a veto. 

Mr. BULLARD. And I was interested by your question because it 

depends what veto means. I think the Chairman was fair in trying 

to get at that. 

Mr. MCHENRY. She was saying that it has to be signed off by 

Risk Fin, so you are going to have to have the economists sign off 

on rules, which I think is structurally a very different concept than 

what we have seen, as you said, with SEC over the last, let’s just 

say, 50 years. We could say 80. 

Dr. Manne, in terms of this discussion, you have followed this extensively, obviously, but when we have this discussion about a 

market failure, this has been used. You mentioned this in your testimony; it has been mentioned a couple times on this panel. How 

common is a market failure, just to understand this discussion? 

Mr. MANNE. Well, as I said, there are economists and economists. 

My own sense about it is that true market failures are extremely 

rare, and particularly among some of the kind that are listed in the 

March 16th memo. For instance, they talk about market power. I 

presume they mean monopolistic organization of the market. 

Well, that is a very unusual kind of market failure for the SEC 

to confront. Historically, they supported the most famous market 

failure of all, and that was the fixed commission rate structure in 

the New York Stock Exchange for many, many, many years. I 

107 

couldn’t really think, even, of what they had in mind in that connection. 

Then they talked about a negative and positive externalities. 

Now, that is sort of a cop-out because it was in the context of explaining when it would be difficult to get good quantifiable data on 

these externalities. And that is why I say that that kind of thing, 

if you assume that a negative externality is a market failure and 

you start regulating to prevent the externality, you can make a big 

mistake because the market almost always finds a solution to these 

negative externalities, just as it does to the problems we talked 

about, I mentioned before of asymmetric information. 

The most famous work on that subject is by a man who got a 

Nobel Laureate in economics, David Akerlof, who talked about the 

market failure in the market for used cars, and he theoretically 

showed that if systematically people don’t have good information, 

that the entire market could collapse for what is obviously an economically good product, but people wouldn’t have the information 

and, therefore, the market would collapse. 

The odd thing about it is that when that lemons problem is mentioned over and over and over and over again in economics, very 

few writers even notice the market had already provided a solution 

to that problem before Akerlof even identified it. There was no failure in the market of used cars. 

That is the same thing here if they talk about asymmetric information. The market deals with those issues maybe in ways that we 

can’t even project at this point. But that is the virtue of a free market, that new innovations will constantly come up. And if there are 

real costs, the market will always provide a good solution. 

Mr. MCHENRY. So to that question, and this is a discussion, Mr. 

Bullard asked you this when we had our crowd funding hearing, 

with securities regulation, no matter how perfect the rulemaking of 

any regulatory body, there will be fraud in the marketplace. Does 

the whole panel agree? Actually, should I say do you disagree? 

So with this, all rules, all securities regulations bear a cost, do 

they not? Okay. So everyone agrees. 

Okay. I don’t know if it is all, but with some there are benefits 

that outweigh those costs, right? Okay. 

So I just want to make sure that we are all in agreement. There 

is no sort of disagreement with those basic notions of this when we 

have this discussion. 

Mr. Verret, you mentioned, you ticked through a number of interesting pieces with your testimony and you talk about a few recommendations, and you note that the first five of these recommendations are already existing law that the Securities and Exchange Commission is required to abide by, right? 

Mr. VERRET. Particularly in the fifth one, where I mentioned reproposal. Maybe not necessarily every single rule, but any rule that 

doesn’t abide by the operating guidance and the about-shift in the 

agency’s position I think has to be re-proposed, absolutely. It runs 

a very high risk of being overturned in the D.C. Circuit. 

Mr. MCHENRY. Okay. So what is the time frame that they should 

undertake in order to do that? 

Mr. VERRET. I think that they should address these issues in the 

memo right away, would be my suggestion. 

108 

Mr. MCHENRY. Okay. 

Mr. VERRET. And also, in addition, change SEC operating procedures to delegate authority to Risk Fin. The agency frequently delegates authority within its operating procedures to the various divisions, and I would suggest keeping an eye on whether the SEC 

does any actual amendment to its internal operating procedures 

with respect to Risk Fin’s authority. 

Mr. MCHENRY. Interesting. So what you are suggesting is that 

the SEC needs to go back through their existing regs. 

Mr. VERRET. And delegations of authority in the operating procedures, yes, internal operating procedures of the Commission. 

Mr. MCHENRY. Mr. Kotz, in your experience with the SEC, that 

seems very far-reaching, what Mr. Verret just suggested. 

Mr. KOTZ. I don’t know that the SEC plans to go back and look 

at the regulations that they already did; I think the Chairman 

seemed to indicate that they would not. So I am not saying anything about the idea, but I don’t know that that is actually going 

to happen. 

Mr. VERRET. I was referring to the operating procedures of the 

SEC. 

Mr. MCHENRY. The operating procedures. 

Mr. VERRET. Asserting certain authorities delegated to Division 

of Corporate Finance or IM, or something of that nature. 

Mr. MCHENRY. Okay. So not full-scale, all the regs that on the 

books. 

Mr. VERRET. Although I won’t say that there aren’t regs on the 

books that are subject to significant challenge, just as Business 

Roundtable was. Frankly, I would question the SEC’s taking credit 

for regs that aren’t challenged, because not everyone has the funding to challenge the regs. It is very expensive to challenge a regulation in the D.C. Circuit. I am sure that was very expensive, and 

average investors don’t have the funding to go all the way through 

a D.C. Circuit challenge, necessarily. 

Mr. MCHENRY. Ms. McCabe, in your testimony you outline that 

192, if I find my notes correctly, 192 proposed rules across the government are required by Dodd-Frank, and it appears that a great 

majority of these rules either had no or deficient cost-benefit analysis performed on them, according to your testimony, according to 

the work that you have done. Could you go into some detail about 

the problems that you found in the study you performed? 

Ms. MCCABE. Sure. And just to clarify, it was 192 of the proposed 

and final through last November that we looked at, so obviously 

there will be more eventually. 

And we didn’t attempt in any individual case to really weigh in 

on whether we thought the cost-benefit analysis was adequate or 

inadequate, we tried to keep it very objective; and obviously in 

some cases where there is no cost-benefit, for instance, clearly 

would be inadequate. 

In the rules with no cost-benefit analysis, a number of rules reference that OMB had provided analysis, but the rules themselves 

contain no detail, which again I think doesn’t absolve the issuing 

regulator of their responsibility. Other rules we found suggested 

that cost-benefit analysis was not required because the rules were 

109 

not discretionary; and we have seen the SEC reverse coarse on that 

issue at this point. 

Regarding the rules that have non-quantitative cost-benefit analysis, we saw a number of rules where regulators simply stated they 

expect costs to be insignificant or minimal, and just said that in a 

conclusory way, with no further explanation. And then of the rules 

with quantitative cost-benefit analysis, again, we didn’t look specifically at whether the quantitative cost-benefit analysis was adequate, but the vast majority contained just compliance, labor, technology costs, and that sort of thing. 

And where there is quantified cost-benefit analysis, you know, it 

in many cases would relate only to one aspect of the rule or to one 

specific question in the rule, and it wouldn’t be an overall view of 

the economic impact of the rule, which is clearly what the cost-benefit analysis is aimed to get at. 

Mr. MCHENRY. So to this point, in essence, the practice we see 

from regulators is to only do basic fixed costs that are the easiest 

to analyze, paperwork functions and—— 

Ms. MCCABE. In the vast majority of cases, yes, that is what we 

found. 

Mr. MCHENRY. Right. So they wouldn’t analyze, for instance, impact of a company to go public. That would not be something 

that—— 

Ms. MCCABE. No. 

Mr. MCHENRY.—in most of these? 

Ms. MCCABE. That is correct. And I am speaking in generalities 

again, but, yes. There were a few instances where there were attempts to look at broader economic impact of a proposed rule, but 

it tended to be focused on a single aspect of the rule, not sort of 

looking across the board at impact. 

Mr. MCHENRY. Right. So with the JOBS Act, which is the largest 

rewrite of securities laws since the 1970s, by any fair view, with 

the JOBS Act, which is in essence so much about securities regulations, essential parts of this bill are securities regulations, the impact on the ability of a small company to go public—and this is not 

just Sarbanes-Oxley, it is a whole litany of the regulatory processes—that in essence we price out the ability for small companies 

to go public. 

Ms. MCCABE. Sure. That would be one piece. 

Mr. MCHENRY. So there is no real duty for a regulator to even 

be concerned, with the SEC to even be concerned about the impact 

they have. So we have fewer IPOs than we did a generation ago; 

we have fewer public companies than we had a generation ago; and 

in essence we have the Securities and Exchange Commission say 

that is of no cost. Is that basically the practice we are seeing, Mr. 

Verret? 

Mr. VERRET. I think it is a fair representation of the practice, 

and I think it violates the SEC’s obligations under the 1996 amendments to NSMIA, the National Security Markets Improvement Act, 

the required consideration of efficiency and capital formation in 

particular. 

Mr. MCHENRY. So how do we fix this? Beyond cost-benefit analysis, obviously. This is certainly an ingredient, don’t you think? But 

what else? 

110 

Mr. VERRET. Well, I would continue to urge the eight suggestions 

that I have given for consideration. I would urge a more expansive 

view of economic analysis, along the lines of what Dean Manne 

suggested, that you look at empirical observations when they are 

available, when they are useful; you look at non-empirical, but still 

economic concepts when they are useful; the ability of parties to 

transact around things. But you are not permitted to look at noneconomic variables. 

So despite Professor Mercer has argued in favor of that, but the 

1996 NSMIA amendments not only just on their face, but in their 

legislative history make clear that isn’t at all what was intended. 

So if you want to talk about a new statute, maybe that might be 

an interesting debate we could have, but under the present rules 

it is not permitted. 

But to do the best job you can, I would try to urge continued investment in the economic analysis function at the SEC, giving 

more authority and transferring resources from other places to 

there. 

Mr. MCHENRY. Okay. So we have a number of questions, but one 

final question from me, then I have a broad request for the whole 

panel. 

If the SEC fails to require both PCAOB and FINRA to adhere to 

these updated guidelines for incorporating cost-benefit analysis, do 

you think that is regulatory failure? We can begin with Mr. Kotz 

and go across the panel. 

Mr. KOTZ. That wasn’t a specific area that I looked at, but it 

would seem as though that would be a significant problem, certainly. 

Mr. MCHENRY. To not include FINRA and—— 

Mr. KOTZ. Right. 

Mr. VERRET. I would classify that as a regulatory failure. And I 

am aware that this item is, I believe, included in the SEC Regulatory Accountability Act, which I think goes a long way toward 

getting at this issue. I would also urge consideration of the impact 

of not only on SROs, but the impact of preemption on a State lawbased incorporation system in the competition, and the innovations 

around market failure that take place at the State level that the 

SEC can at time impede by preemption. 

Mr. MCHENRY. Mr. Bullard? 

Mr. BULLARD. I would like to look back at the actual SEC authority to oversee FINRA in that way before answering that question. It is not immediately clear to me that they can delve into rulemaking in that way. As a matter of policy, I think they should attempt to impose those standards, but I can’t say, offhand, whether 

legally they have the authority to do so. 

I also want to note the Chamber of Commerce has directly commented on the issue of FINRA’s cost-benefit analysis and was very 

critical of it; yet, the House Financial Services Committee, probably 

either this week or next, will be dropping a bill that will create an 

entire new SRO that will not be subject to these cost-benefit analyses, and it will raise exactly the issue that you are raising here 

today. 

Mr. MCHENRY. That bill, by the way, has not gone through the 

markup process, so you will hear otherwise. 

111 

Ms. MCCABE. I would comment that the Committee, in its comment letter on the PCAOB’s proposed rules on audit firm rotation, 

discussed this issue specifically and said that the SEC having oversight over the PCAOB should encourage more thoughtful cost-benefit analysis. In that rule, again, there was very minimal analysis. 

Mr. MCHENRY. Thank you. 

Mr. MANNE. I would like to address a tangential aspect of that, 

and that is that anything the SEC does under present jurisprudence given down by the Supreme Court in the Chevron case, the 

courts often simply dodge, really, overseeing this task in the sense 

of giving deference to the agency’s discretion. This is particularly 

true if the agency shows up with a highly complex mathematical 

cost-benefit econometric study. 

I think that congressional legislation beefing up the standard the 

courts ought to use in reviewing these agency rulings would be 

very much in place. I think an increase in civil actions, complaining 

about errors and mistakes made in various cost-benefit analysis or 

other economic analysis would certainly be true. I would have a review of not merely the coming rules that are on the Floor now; I 

would have them go back over many years and do a different kind 

of analysis that they did. There is very, very little academic work 

over many years empirically justifying the vast bulk of rules that 

the SEC has promulgated. Maybe they ought to be looked at; 

maybe the findings would be of a different sort. 

Finally, I would suggest, and this is the hardest one of all, that 

the agencies, in explaining the economic rationalization of whether 

it is cost-benefit analysis, an econometric analysis, or whatever, 

they be required to do it in plain English. I don’t think there is any 

good economics that cannot be understood in English. But I think 

that lawyers and judges, for some good reasons, some bad reasons, 

simply can’t handle the level of sophistication and mathematics 

and complex economics that economists engage in among themselves, and it would be tragic if that was used as a coverup for 

what was going on here. 

Mr. MCHENRY. Fascinating. Well, it is an interesting perspective 

that you share here today. 

I typically like to end a hearing, when we have a moment, to ask 

a broad question of what we can do to fix the state of the economy 

today. Now, we are talking in light of securities regulations. If 

there is one thing that we can do, that you would recommend. And 

if you don’t want to engage in it, that is fine, you can pass, but this 

is the one opportunity to say here is one interesting thing we can 

do to update securities laws that would have a beneficial impact on 

the economy. 

So we will start with Mr. Kotz. If you want to pass, I certainly 

understand; I know you have moved to the private sector. 

Mr. KOTZ. I would just say that I think the issue we are talking 

about today is important. Clearly, when you have a problem, a financial crisis, there is an interest in deciding to put forth regulations to try to fix that. But I think we need to figure out whether 

these make sense, whether they are actually beneficial, and I think 

that would help benefit the overall economy and things as we go 

forward. 

Mr. MCHENRY. Mr. Verret? 

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Mr. VERRET. I would suggest that I think one of the fundamental 

ironies of securities regulations since its inception in the 1930s has 

been that security regulation is designed around the idea, and the 

SEC has always assumed, that investors are intelligent and sophisticated enough to be able to process the mandatory disclosures that 

they get, but they are not intelligent and sophisticated enough to 

exercise choice in opting out of those disclosures, or any other rules 

for that matter. 

Specifically I would consider the issues of permissive securities 

arbitration in charters of companies going public. The Carlyle 

Group tried to insert one and was very quickly beaten down by institutional investor groups and by the SEC to allow shareholders 

the choice of opting for securities arbitration rather than securities 

litigation, and the SEC would have none of it. 

I think it is something worth considering. I think there is something to the securities litigation system, of course, and to tinkering 

with it and reforming it, but I think there is also no reason not to 

give investors the choice to opt out of it altogether. 

Mr. MCHENRY. Well, in essence, the market, not to interrupt, but 

the market has already spoken. If you look at Facebook, those folks 

that had the opportunity to invest, they are actually foreign investors, that invested through Goldman’s conduit to invest in a privately held company, that means they didn’t get all the mandated 

disclosures that a public company would have to give, and yet they 

were able to raise billions of dollars worth of capital for a privately 

held company outside of those mandatory public disclosures. 

So your point is very fascinating because it seems as though the 

market has looked for a way to opt out in certain circumstances. 

Mr. Bullard. 

Mr. BULLARD. I also have a somewhat related comment to the sophistication issue. There has been a longstanding problem with the 

disclosure regime, and that what triggers being a public company 

is essentially sales to unsophisticated investors. And the way the 

structure of the law responds to that is to give them company-specific information that not allowing them to buy in private offerings 

assume they can’t handle and make decisions on the basis of anyway. 

So there is a deep sort of contradiction in the whole structure 

where one should really think that if those investors are allowed 

to invest at some point, it should be diversification and sort of basic 

ideas of what nature of risk you are taking on when you are investing in this company, not company-specific information that the regulatory structure assumes that they are least capable of doing, and 

that by engaging in that market they are most likely to lose their 

shirts. 

So my approach to that would be more try to move away from 

disclosure regimes, increase private markets, and at the same time 

shift, to the extent you are going to have regulations protecting investors, to the intermediary stage. It is much more efficient to do 

that and we had that discussion in connection with crowd funding, 

the idea of the fixed costs and standardization happening at one 

place, rather than lots of different issuers. Saves everybody a lot 

of money and I think it is much more consistent with the idea of 

protecting the people that you want to protect. 

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Mr. MCHENRY. Thank you. 

Ms. McCabe? And I am not sure if in your position you want to 

advocate anything beyond that, but you are more than welcome to. 

Ms. MCCABE. Thank you, that is exactly what I was going to say, 

is I am speaking today on behalf of the Committee, I can’t really 

speak to a single issue that would be most important to everyone 

on the Committee. But I would like to echo former Inspector General Kotz’s comments that we have long believed that thoughtful 

cost-benefit analysis would really benefit and improve the competitiveness of the U.S. capital markets, which is obviously the longtime cause of the Committee. Thank you. 

Mr. MCHENRY. Thank you. 

Dr. Manne? 

Mr. MANNE. I would like to see some real beefing up of judicial 

review of regulatory actions. Whether that would take the form of 

overturning the Supreme Court’s case in the Chevron case or simply affirmatively mandating that the courts do review these things, 

in time I think we can solve a lot of the technical problems of costbenefit analysis by building up the kind of common law of what is 

good analysis and what is bad analysis. I don’t see any agency 

other than the courts that could do that. 

Now, courts tend to fight off these highly technical cases, but we 

have schools for judges. We can help them in many ways. As far 

as I can see, that is the last possible monitor to really ratchet in 

this thing and guaranty that it builds in the right direction. 

Mr. MCHENRY. Mr. Verret wants a mulligan here. 

Mr. VERRET. I just want to add one more second observation, if 

I can pick two things for Christmas, rather than just one. Reconsideration of not even the Dodd-Frank Act, that I think actually 

points out an inconsistency, a very strong inconsistency in the 

Obama Administration’s rhetoric on a number of items recently. 

The Obama Administration has emphasized, for example, the Buffet Rule, an increase in taxation on individuals making more than, 

millionaires, essentially. 

Well, a little-known provision of the Dodd-Frank Act signed by 

President Obama actually secures and maintains special investment opportunities in private equity funds and hedge funds and 

other vehicles, only provided that those investors are worth $1 million. This is an exemption that pre-existed Dodd-Frank, but was 

made even more difficult, and it preserves investments for people 

only in the top essentially one percent, as estimated by the SEC. 

I would reexamine that. I would reexamine the idea generally of 

using wealth as a proxy for sophistication. I think that we could 

all name a movie star that may be wealthy, but might not necessarily be a sophisticated financial investor. I would consider also 

maybe a financial literacy test to let investors access these opportunities, but I would certainly point out that severe inconsistency in 

the Obama Administration’s rhetoric on this issue. 

Mr. MCHENRY. Now we are opening up a whole new ball of wax, 

but, Mr. Bullard. 

Mr. BULLARD. I will only respond very briefly to recommend to 

Professor Verret a close reading of the Crowd Funding Act. It allows access to precisely those low income investors. I think it has 

a lot of good aspects to it and I would be interested to know what 

114 

he thinks about that as at least the beginning of trying to break 

down that barrier. 

Mr. VERRET. Well, the Crowd Funding Act, as useful as it is, 

doesn’t deal with this issue of investments. Crowd funding is not 

permitted for hedge funds and private equity funds; this is a different animal altogether. 

Mr. MCHENRY. But hopefully what this will exhibit with the 

crowd funding legislation we are able to get passed, even with the 

flawed portions that the Senate added to the legislation that we 

wrote here in the House, and I will repeat that again, the flawed 

elements the Senate added as the Senate is apt to do, I think this 

will be a useful market to see if you have average everyday investors are able to function in a free marketplace of exchange and buy 

equity and be a part of the equity side of businesses in a larger 

mass sort of way, with a light touch level of regulation. I think this 

could show the Securities and Exchange Commission how many of 

their existing preconceived notions about investors are simply 

wrong. 

So we have a couple generations of securities law in this Country 

that assume, based on wealth, that you are sophisticated, which is 

absolutely absurd, absolutely absurd, especially in the Internet age, 

especially in the internet age, when information is more diffuse, 

more variable for individuals than in the history of mankind. Truly 

in the history of mankind. 

So, with that, I certainly appreciate your testimony. I appreciate 

the panel’s willingness to engage in these idea. 

Mr. Kotz, I certainly appreciate your service in government, and 

thank you so much for the hard work you put in, especially with 

this final report that has culminated in this hearing today. Thank 

you. 

And thank you to the rest of the panel. Very interesting ideas 

and very serious thought you have given to your testimony and the 

words you have offered today. 

Today was really about the cost-benefit analysis of the SEC and 

the larger ramifications it has on the marketplace, and the importance of a cost-benefit analysis when you are in the rulemaking 

process. Whether it is mandated by Congress in law that a regulator write rules or the regulator takes it upon itself to write new 

rules, a cost-benefit analysis has to be an essential ingredient before a rule is put into place. Even the best of rules do have a cost 

and a benefit that need to be analyzed and weighed. So thank you 

for being here today and thank you for your testimony. 

This hearing is now adjourned. 

[Whereupon, at 12:35 p.m., the subcommittee was adjourned.] 

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