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S. HRG. 112–238 

ENHANCED INVESTOR PROTECTION AFTER THE 

FINANCIAL CRISIS 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

ON 

SURVEYING THE INVESTOR PROTECTION PROVISIONS CONTAINED IN 

THE DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT ONE YEAR AFTER ITS IMPLEMENTATION 

JULY 12, 2011 

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

( 

Available at: http://www.fdsys.gov/ 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

CHARLES YI, Chief Counsel 

DEAN SHAHINIAN, Senior Counsel 

LAURA SWANSON, Policy Director 

LEVON BAGRAMIAN, Legislative Assistant 

ANDREW OLMEM, Republican Chief Counsel 

HESTER PEIRCE, Republican Senior Counsel 

MICHAEL PIWOWAR, Republican Senior Economist 

DAWN RATLIFF, Chief Clerk 

WILLIAM FIELDS, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
(III) 

C O N T E N T S 

TUESDAY, JULY 12, 2011 

Page 

Opening statement of Chairman Johnson ............................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

WITNESSES 

David Massey, NASAA President and North Carolina Deputy Securities Administrator ............................................................................................................ 3 

Prepared statement .......................................................................................... 33 

Response to written questions of: 

Senator Moran ........................................................................................... 85 

Lynnette Hotchkiss, Executive Director, Municipal Securities Rulemaking 

Board ..................................................................................................................... 5 

Prepared statement .......................................................................................... 37 

Response to written questions of: 

Senator Reed .............................................................................................. 87 

Harvey L. Pitt, Former Chairman, Securities and Exchange Commission ........ 6 

Prepared Statement ......................................................................................... 48 

Barbara Roper, Director of Investor Protection, Consumer Federation of 

America ................................................................................................................. 9 

Prepared Statement ......................................................................................... 55 

Response to written questions of: 

Senator Reed .............................................................................................. 89 

Senator Menendez ..................................................................................... 92 

Anne Simpson, Senior Portfolio Manager, Global Equities, California Public 

Employees’ Retirement System ........................................................................... 10 

Prepared Statement ......................................................................................... 66 

Response to written questions of: 

Senator Shelby ........................................................................................... 93 

Senator Hagan ........................................................................................... 94 

Paul S. Atkins, Visiting Scholar, American Enterprise Institute for Public 

Policy Research .................................................................................................... 12 

Prepared Statement ......................................................................................... 71 

Response to written question of: 

Chairman Johnson .................................................................................... 94 

Lynn E. Turner, Former Chief Accountant, Securities and Exchange Commission ........................................................................................................................ 14

Prepared Statement ......................................................................................... 78 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Prepared statement of the American Bankers Association, the Financial Services Roundtable, Financial Services Institute, Insured Retirement Institute, 

and National Association of Insurance and Financial Advisors ....................... 97 

Prepared statement of the Center on Executive Compensation .......................... 111 

(1) 

ENHANCED INVESTOR PROTECTION AFTER 

THE FINANCIAL CRISIS 

TUESDAY, JULY 12, 2011 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 10:02 a.m. in room SD–538, Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of the Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN TIM JOHNSON 

Chairman JOHNSON. The Committee will come to order. 

Today, the Committee will examine ‘‘Enhanced Investor Protection After the Financial Crisis.’’ This hearing will survey the investor protection provisions contained in the Dodd-Frank Wall Street 

Reform and Consumer Protection Act as we approach its 1-year anniversary. 

About one-half of American households are invested in the securities markets, directly or indirectly. During the financial crisis, retail as well as institutional investors suffered financial harm when 

their retirement and other securities accounts lost value. Some had 

invested in companies with compensation systems that encouraged 

executives to take on unmanageable risks. Some had bought assetbacked securities based on inflated credit ratings. Many were victims of the market decline when the public lost confidence in the 

markets and their regulators. 

This last financial crisis highlighted the need for stronger investor protections to mitigate the negative impact of future crises. 

Congress responded by passing the Wall Street Reform Act, 

which contains robust investor protection provisions and other new 

reforms. These provisions sought to strengthen the financial system 

by improving the accuracy of credit ratings, better aligning the economic interests of securitizers and investors, boosting the effectiveness of the SEC, giving shareholders a greater voice over compensation, regulating municipal advisors and hedge fund advisors, 

and encouraging credible whistleblowers to come forward and report fraud and abuse by providing them enhanced protections and 

incentives. 

As we approach this 1-year anniversary, it is timely for us to survey investor protection provisions in the Wall Street Reform Act, 

many of which are still in the process of being finalized. While 

some have criticized reforming Wall Street, I believe we must give 

these provisions a chance to work to protect investors and American families who depend on our financial system. 
2 

I remember the economic nightmare we lived though 3 years ago 

and am proud that the Senate could act to pass these historic reforms last year. I take my responsibility as Chairman of the Banking Committee to oversee implementation of this new law seriously 

and look forward to hearing from the witnesses about these investor protections. 

Now I will turn to Ranking Member Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. Thank you for calling this hearing. 

Mr. Chairman, I noted with interest we have the former Chairman, Mr. Harvey Pitt, among the panelists—all of them are welcome—and also Paul Atkins, former Commissioner. A good panel. 

The title of today’s hearing is ‘‘Enhanced Investor Protection 

After the Financial Crisis.’’ The reality, however, is that the passage of Dodd-Frank did little to improve investor protection. Instead, the act codifies a series of special interest provisions of questionable value to the average investor. In fact, several of these provisions threaten to harm investors. 

For example, under the proxy access provision, the SEC adopted 

a rule that would grant shareholders with a mere 3 percent of a 

company’s shares the special right to have their board of director 

nominees include in a company’s proxy material. Three percent. 

Special interest groups, like unions, State pension funds, and 

hedge funds will now have the leverage to force companies to adopt 

politically motivated agendas, regardless of whether doing so would 

benefit all shareholders. 

As a result, Dodd-Frank’s corporate governance provisions could 

move control of corporations away from average investors to special 

interests with minority positions and political clout. 

Another troubling Dodd-Frank provision is that the mandate 

that the SEC pay whistleblowers. Although encouraging people to 

inform the SEC of corporate misdeeds I believe is a good idea, the 

whistleblower provision in Dodd-Frank is drafted in a way that 

could actually harm investors. Whistleblowers, even those who are 

part of the scheme, will receive 10 to 30 percent of fines that the 

SEC collects as a result of their tips. Rewards in a single case 

could run into tens of millions of dollars. This will be a huge windfall for whistleblowers and their attorneys. It would also be far in 

excess of the amount needed, I believe, to encourage whistleblowers. 

Recent history has demonstrated that the problem has not been 

a lack of tips but, rather, the SEC’s failure to follow up on tips. 

Perhaps the millions that will go to whistleblowers under DoddFrank should be redirected to harmed investors. 

Finally, the Dodd-Frank’s mandated internal changes at the SEC 

I believe are symbolic of the Act’s empty promise of investor protection. Dodd-Frank requires the SEC to set up an Office of Investor 

Advocate and an Ombudsman for that office. 

Think about it. The SEC is supposed to be the investor’s advocate already and has an Office of Investor Education and Advocacy. 

Adding another two layers of bureaucracy I believe is not the kind 

of help that investors need. 
3 

It is now 1 year since the passage of Dodd-Frank, and we can 

see more clearly the consequences of a special interest agenda. The 

Act, I believe, again, has not helped investors but has saddled 

Main Street and providers of capital—the engines of economic 

growth, in other words—with a long list of new regulatory requirements and more to come. At a time when the unemployment rate 

is at 9.2 percent, this hardly seems like a wise course to me. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. Are there any other Members who wish to 

speak? If not, we are fortunate to have a distinguished panel of 

regulators and experts before the Committee today. 

Mr. David Massey is the President of the North American Securities Administrators Association. Mr. Massey is also the Deputy Securities Administrator of North Carolina Securities Division and 

serves as a member of the Financial Stability Oversight Council. 

Ms. Lynnette Hotchkiss is the Executive Director of the Malpractice Securities Rulemaking Board, a self-regulatory organization whose mission is to promote a fair and efficient municipal securities market. 

Mr. Harvey Pitt is currently the Chief Executive Officer of the 

consulting firm Kalorama Partners. Previously he served as the 

Chairman of the SEC from 2001 to 2003. 

Ms. Barbara Roper is the Director of Investor Protection at the 

Consumer Federation of America and has in the past served as a 

member of the Investor Advisory Committee at the SEC. 

Ms. Anne Simpson is Senior Portfolio Manager at the California 

Public Employees’ Retirement System, where she heads the corporate governance program. 

Mr. Paul Atkins is a Visiting Fellow at the American Enterprise 

Institute. From 2002 to 2008 he served as a Commissioner at the 

SEC. 

Our final witness is Mr. Lynn Turner. In addition to his decades 

of experience in the accounting field, from 1998 to 2001 he served 

as the Chief Accountant at the SEC. 

I would like to welcome our witnesses and thank them for their 

willingness to testify at this important hearing. 

Mr. Massey, please proceed with your testimony. 

STATEMENT OF DAVID MASSEY, NASAA PRESIDENT AND 

NORTH CAROLINA DEPUTY SECURITIES ADMINISTRATOR 

Mr. MASSEY. Good morning, Chairman Johnson, Ranking Member Shelby, and Members of the Committee. I am David Massey, 

the Deputy Securities Administrator for the State of North Carolina and the current President of the North American Securities 

Administrators Association, known as NASAA. Thank you for the 

opportunity to offer NASAA’s view of the gains made in investor 

protection since the passage of the Dodd-Frank Act 1 year ago. 

The Wall Street reforms and investor protections in Dodd-Frank 

Act were born out of necessity. The financial crisis made it clear 

that the existing securities regulatory landscape needed an overhaul. 

This comprehensive law was developed to promote stronger investor protection and more effective oversight to help prevent another economic crisis from threatening the financial security of 
4 

Main Street investors. State securities regulators were pleased that 

the Dodd-Frank Act addresses a number of critical issues for investors by incorporating disqualification provisions to prevent people 

who violate securities law from selling unregistered securities offerings under Rule 506 of Regulation D, by strengthening the ‘‘accredited investor’’ definition, and by increasing State oversight of investment advisors. Dodd-Frank also includes a provision to safeguard senior investors from unqualified advisors and creates an investor advisory committee to provide input to the SEC on its regulatory priorities. 

Dodd-Frank took a necessary first step toward reducing risks for 

investors in unregistered private offerings by requiring the SEC to 

write rules to prevent known offenders from using the Regulation 

D, Rule 506 exemption from registration. In 1996, the National Securities Markets Improvement Act curtailed the authority of State 

securities regulators to oversee these unregistered private offerings 

before and while they are being sold to the public. 

In the years since, these private offerings have become a favorite 

vehicle for unscrupulous promoters and brokers with criminal and 

disciplinary records to prey on investors. The SEC recently proposed rules mandated by Dodd-Frank to close this avenue to known 

violators of our securities laws. 

Unregistered private offerings were originally intended only for 

institutional investors and sophisticated individuals. These accredited investors were presumed capable of assessing risks and making investment decisions without the protection of regulatory review and registration. However, the net worth standard the SEC 

uses to determine the eligibility of an investor to participate in private offerings has remained unchanged since 1982. Dodd-Frank improved the way eligibility is determined by excluding the value of 

individual investors’ homes in the calculation of their net worth. 

NASAA will continue to push for additional improvements to the 

accredited investor standard, and we urge Congress to go further 

by reinstating State regulatory authority and oversight of all Rule 

506 offerings. 

Dodd-Frank recognized the strong investor protection record of 

the States with its provision to expand State authority to include 

mid-sized investor advisors with $25 million to $100 million in assets under their management. Investors will benefit from this 

change because it will enable the SEC to focus on the largest investment advisors while mid-sized and smaller advisors will be 

subject to the strong State system of oversight and regulation. 

State securities regulators are preparing for this increased responsibility. We now employ a more automated and uniform exam 

process as well as risk assessment analyses to better prioritize our 

exams. This enables States to do more intelligent and effective 

exams. 

Finally, NASAA members have launched an aggressive outreach 

effort to prepare the investment advisor industry for State oversight and to enable new registrants to set up their business operations the correct way and avoid inadvertent noncompliance. 

Last month, the SEC extended its timeline for the completion of 

this investment advisor switch into the middle of 2012. Dodd-Frank 

outlined many ambitious reforms to be implemented by Federal 
5 

regulatory agencies. Some delay is to be expected. However, State 

securities regulators are concerned about any effort that might derail or delay important investor protections. A lack of adequate 

funding already has forced the SEC to defer a number of valuable 

investor protections promised by Dodd-Frank, such as the creation 

of the Investor Advisory Committee. 

Also, controversies over the Consumer Financial Protection Bureau have indefinitely delayed the creation of a senior investor protection grant program that would support State initiatives to protect vulnerable senior investors from individuals using misleading 

professional designations. 

What NASAA asks of the Congress is simple and clear: Please 

continue your commitment to protecting investors and do not weaken the critical investor protections of Dodd-Frank, either directly 

through legislative repeals or indirectly through a lack of adequate 

funding. 

We look forward to working with the Committee, as well as all 

Members of Congress and fellow regulators, to ensure that the 

Dodd-Frank Act’s investor protections are implemented fully. 

Thank you. 

Chairman JOHNSON. Thank you, Mr. Massey. 

Ms. Lynnette Hotchkiss, please proceed. 

STATEMENT OF LYNNETTE HOTCHKISS, EXECUTIVE 

DIRECTOR, MUNICIPAL SECURITIES RULEMAKING BOARD 

Ms. HOTCHKISS. Good morning, Chairman Johnson, Ranking 

Member Shelby, and Members of the Committee. I appreciate the 

opportunity to testify here this morning on behalf of the Municipal 

Securities Rulemaking Board. 

Congress created the MSRB in 1975 to protect investors in the 

municipal market, and last year, in Dodd-Frank, you expanded our 

jurisdiction to include the protection of State and local government 

bond issuers as well as public pension plans. To the best of our 

knowledge, this is the first time ever that a securities regulator has 

been charged with protecting an issuer of securities. You also gave 

us jurisdiction to regulate municipal advisors in addition to our existing jurisdiction over dealers in this market. We appreciate the 

opportunity to report to you today on how we have responded to 

these increased responsibilities. 

As you can see from the chart, the municipal securities market 

makes up just over $3.7 trillion of the total U.S. debt market. Additionally, about $150 billion is invested in 529 college savings plans, 

another kind of municipal securities which fall under our jurisdiction. 

The second chart shows how the $382 billion of municipal securities issued since the enactment of Dodd-Frank last July are being 

used. It is hard to imagine a street, airport, school, park, or town 

hall in this country not financed through the issuance of municipal 

securities, and I do not need to tell those of you who have served 

in State or local office just how important the municipal bond market is to the continued health and vitality of our States, cities, 

towns, schools, and universities. 

Like every market, transparency and disclosure are critical to investing protectors. Our free online resource called EMMA does ex-
6 

actly that. As you can see, EMMA provides investors with free access to disclosures and pricing data, information they need to make 

informed investment decisions. An example of information on 

EMMA from a recent issuance in your respective States is included 

with my written testimony. 

In fact, a journalist from Reuters reported just last week that, 

and I quote, ‘‘Since the Municipal Securities Rulemaking Board 

made their EMMA system operational, transparency in muni land 

is an order of magnitude better than any other bond market.’’ 

Because retail accounts for two-thirds of all investors and over 

80 percent of all customer transactions in municipal securities, we 

designed our EMMA system to be easily usable by the general public. 

The MSRB has undertaken other substantial initiatives to protect investors. We are in the process of implementing a Federal fiduciary duty standard, additional restrictions on ‘‘pay to play’’ activities, and mandated disclosures of all conflicts of interest. These 

are described in detail in my written testimony. 

In Dodd-Frank, Congress gave the MSRB the authority to regulate municipal advisors and swap advisors. Mr. Chairman, as you 

and Ranking Member Shelby are well aware, the events of Jefferson County, Alabama, made it very clear that vast improvement in 

the municipal derivatives market was needed, and the MSRB has 

already taken significant steps in this area: first, by ensuring that 

State and local governments are given impartial professional advice by qualified advisors; and, second, by ensuring that underwriters that recommend swaps explain in clear language all of the 

risks attendant to that transaction. 

In a similar way, our expanded authority allows us to further 

protect investors in competitive bidding situations. Just last week, 

the SEC and the Department of Justice announced settlements 

with JPMorgan Securities in connection with bid rigging. Earlier 

this year, UBS and Bank of America Securities entered into similar 

agreements. 

Until now, the SEC could only address this egregious behavior 

through its anti-fraud jurisdiction. But now, under recent initiatives of the MSRB, such conduct would be a clear violation of our 

fair dealing and fiduciary duty rules, providing additional fire 

power to the SEC to go after these wrongdoers. 

The MSRB is dedicated to ensuring that the municipal market 

regulations we promulgate and the transparency afforded by our 

EMMA system promote an open, fair, and efficient market, one 

that protects issuers and investors alike, and one that continues to 

fund the critical public infrastructure needs of our country. 

Thank you again for the invitation to testify, and I look forward 

to any questions that you might have. 

Chairman JOHNSON. Thank you, Ms. Hotchkiss. 

Mr. Pitt, please proceed. 

STATEMENT OF HARVEY L. PITT, FORMER CHAIRMAN, 

SECURITIES AND EXCHANGE COMMISSION 

Mr. PITT. Good morning, Chairman Johnson, Ranking Member 

Shelby, Members of the Committee. I am pleased to be back before 

you today to respond to the Committee’s invitation to testify about 
7 

the critical issue of ‘‘Enhanced Investor Protection After the Financial Crisis.’’ 

The Committee has specifically requested that today’s testimony 

focus on Titles IV and IX of the Dodd-Frank Act and the extent to 

which those provisions enhance investor protection or could be improved. 

I would like to highlight five overarching observations about 

Dodd-Frank in Titles IV and IX from my written statement for 

your consideration. 

First, the financial crisis that began in 2007–08 was the product 

of the failure of our outmoded and cumbersome financial regulatory 

system and the lack of adequate tools that would have enabled regulators to respond effectively, efficiently, and with alacrity both to 

the warning signs that a crisis was imminent and to what eventually became a full-blown crisis. I believe that Dodd-Frank unfortunately represents a missed opportunity to fix that which was clearly broken and to provide a better arsenal of regulatory rules to detect and cope with the next financial crisis, which sadly is not all 

that far away. 

Instead of producing a more nimble regulatory regime, we have 

saddled regulators with a more cumbersome regulatory system that 

almost ensures that we will not be any better equipped to respond 

to future financial and capital markets developments than we were 

for this last crisis. And, worse, we have created the possibility that 

the independence of three critical financial regulators—the Federal 

Reserve Board, the SEC, and the CFTC—will be impaired by subjecting these agencies to the dictates of the new Financial Stability 

Oversight Council that is led by the Treasury Secretary and, therefore, must be responsive to policies pushed by whatever Administration is in power at that particular time. 

Second, I am deeply concerned that Dodd-Frank sets financial 

regulators, and particularly the SEC, up for failure. The SEC has 

been saddled with extensive new regulatory obligations, but has 

been denied the necessary resources with which to fulfill those obligations. In particular, the Act imposes or expands SEC jurisdiction 

and oversight over more than 10,000 new and potential regulatees. 

Despite the agency’s good-faith and diligent efforts, the public will 

be lulled into believing that we have solved the problems that 

caused our most recent economic collapse. But in my view, DoddFrank represents only the triumph of optimism over decades of 

hard-learned, real-world experience. 

Third, Dodd-Frank tackles significant and difficult issues of corporate governance in awkward and potentially pernicious ways. 

Among such provisions, Dodd-Frank’s whistleblower bounty program threatens to undermine corporate governance and compliance 

programs by encouraging potential whistleblowers to evade internal corporate policies and ethical precepts in order to maximize the 

potential lucre these whistleblowers may demand from the SEC. 

Similarly, the Act’s say-on-pay provisions have usurped the proper 

province of State corporation laws and potentially subject shareholders to a steady stream of frivolous litigation, which has already 

begun, designed to force those companies whose shareholders object 

to specific compensation programs into treating what was intended 

as an advisory expression of shareholder sentiment into a binding 
8 

declaration that potentially any corporate officer’s or director’s compensation package is too high. 

Equally troublesome is the approach toward proxy access that 

Dodd-Frank has encouraged the SEC to adopt. The solution to 

proxy access issues, in my view, is to permit proxies to be solicited 

electronically rather than by snail-mailed hard copy. That simple 

change would reduce rather dramatically the current fervor with 

which corporate shareholder activists seek to append their agendas 

and proposals onto management’s proxy-soliciting materials. 

But even in the absence of such a change, the easiest solution 

to the so-called proxy access issue is to permit shareholders to 

amend their companies’ by-laws to the extent such power is granted under the law of the State of incorporation by whatever majority 

vote State law requires. All the SEC would need do in such an environment is prescribe the disclosures that must be made as well 

as the length of time and the number of shares any shareholder 

must hold the company’s securities to entitle any shareholder to 

propose a by-law amendment. 

Fourth, Dodd-Frank imposes upon the SEC a new Office of the 

Investor Advocate, a position clearly designed to permit a non-Presidential appointee to second-guess, challenge, and attack virtually 

any action or any inaction of the Commission with which the Investor Advocate disagrees. Investor advocacy is one of the two critical 

objectives of the SEC, the other being to facilitate the development 

of effective capital markets that can compete with markets anywhere in the world. Creating a special position whose principal 

function apparently will be to harangue the Commission without 

any censorship of any kind, including rational and intelligent common sense, is something that can create the seeds of further SEC 

dysfunctionality. 

Fifth, there are ways to ameliorate Dodd-Frank’s unintended 

consequences, but they require this Committee to approach this 

legislation in a nonpartisan and evenhanded manner. Among other 

things that should be considered are: mandating the development 

of an independent compliance audit process, akin to the financial 

audit process that currently exists; ensuring that the SEC has appropriate resources to fulfill its new compliance examination and 

broad regulatory oversight responsibilities; extending the existing 

deadlines for SEC rulemaking beyond their current artificial and 

often impossible dates; and providing a better means for the Government to assess the true costs and benefits of each of the hundreds of new regulations that Dodd-Frank requires. 

Dodd-Frank was intended to address laudable goals. Unfortunately, it creates perverse incentives that will likely undermine the 

intended benefits to investors. With care and a bipartisan effort, 

the Act can be tailored so that it more likely accommodates its 

original objectives. 

Thank you again for the invitation to appear here, and I will be 

happy to respond to any questions the Committee Members may 

have. 

Chairman JOHNSON. Thank you, Mr. Pitt. 

Ms. Roper, please proceed. 
9 

STATEMENT OF BARBARA ROPER, DIRECTOR OF INVESTOR 

PROTECTION, CONSUMER FEDERATION OF AMERICA 

Ms. ROPER. Good morning, Chairman Johnson, Ranking Member 

Shelby, and Members of the Committee. I appreciate the invitation 

to appear before you today. 

Improving protections for average investors has been a priority 

for CFA for roughly a quarter-century. The issue has taken on new 

urgency, however, in the wake of a devastating financial crisis that 

has left average investors, American investors, as fearful for their 

financial security as the events of September 11 left them fearful 

for their physical safety. 

Among the lesser known achievements of the Dodd-Frank Act is 

its creation of a multi-faceted investor protection framework that, 

if properly and effectively implemented, could significantly improve 

regulation of the securities markets and with it protection of investors. My written testimony discusses a broad range of the Act’s investor protection provisions. In my oral testimony, however, I focus 

on just a couple of the bill’s provisions, starting with its provisions 

to strengthen credit rating agency regulation. 

Before the crisis, the entire system of regulating asset-backed securities was built on the assumption that credit rating agencies 

could reliably assess the risks associated with these complex and 

opaque investments, an assumption that proved to be disastrously 

misguided. Title IX of the Dodd-Frank Act seeks to address this 

fundamental weakness in the regulatory system with a package of 

measures designed to make credit ratings more reliable. 

Among the most important are provisions to improve the SEC’s 

oversight of ratings agencies, to strengthen the agency ratings 

agencies’ internal controls over the rating process, to make the assumptions behind the ratings more transparent to users of those 

ratings, to hold rating agencies legally accountable for following 

sound procedures, and to reduce regulatory reliance on ratings. Implementation of these provisions is still a work in progress and we 

would simply note that, with the major ratings agencies still subject to massive conflicts of interest, a lot hinges on the SEC’s ability to provide tough and effective oversight. 

The Act also includes provisions addressing more generic weaknesses in securities regulation, and among these are provisions designed to provide investors with greater input into the SEC’s policymaking process by creating a potentially powerful new Office of 

Investor Advocate within the SEC and establishing a permanent 

Investor Advisory Committee. I think it will come as no surprise 

that I view these provisions very differently than former Chairman 

Pitt. 

Some question the need for these provisions because the SEC is 

supposedly the investor advocate, but it is not. Its job is to protect 

investors, which is different from advocating for investors. And the 

simple fact is that investors lack the organization, manpower, and 

resources to monitor agency actions and effectively interact with 

SEC leaders and staff. As a result, the agency’s agenda is often developed and specific proposals to implement that agenda are developed with minimal impact for investors, at least until the public 

comment process, while industry is involved at every step of the 

process. Once the Office of Investor Advocate and the Advisory 
10 

Committee are up and running, investors should benefit from an 

agency that is more attuned and responsive to their concerns. 

Another set of little noticed provisions in the bill have the potential to transform the disclosures retail investors rely on in making 

investment decisions. The Act requires the SEC to identify ways to 

improve the timing, content, and format of disclosures. It authorizes the agency to engage in investor testing of new and existing 

disclosures to ensure their effectiveness. And it authorizes the 

agency to require pre-sale disclosures with regard to investment 

products and services. Together, these provisions give the agency 

the tools and authority it needs to develop disclosure documents 

that are more timely, relevant, and comprehensible to retail investors. 

All of the many investor protection provisions in the Act will depend for their effectiveness on the SEC’s receiving the funding necessary to carry them out. Unfortunately, after three decades in 

which our securities markets experienced explosive growth in size, 

complexity, technological sophistication, and international reach, 

the SEC today is critically underfunded and understaffed to carry 

out its existing responsibilities, let alone take on the vast new responsibilities entrusted to it in Dodd-Frank. 

Congress attempted to address this problem in Dodd-Frank by 

authorizing funding increases that would roughly double the agency budget by 2015. Unfortunately, the debates over the fiscal year 

2011 and 2012 budgets have already made clear that turning those 

authorizations into appropriations is going to be a tough fight, and 

we appreciate the leadership that you, Chairman Johnson, and 

Members of this Committee have played in fighting for that full 

SEC funding. While we are sympathetic to those who argue that 

money alone cannot solve all the agency’s problems, we also believe 

that without additional funding, the agency cannot reasonably be 

expected to effectively fulfill its investor protection mission. 

In conclusion, the investor protection framework provided in 

Dodd-Frank is a sound one, but it only takes us so far. For it to 

succeed, regulators will have to demonstrate a willingness to use 

their authority aggressively and effectively, and Congress will have 

to provide them with both the resources and the backing to enable 

them to do so. 

Chairman JOHNSON. Thank you, Ms. Roper. 

Ms. Simpson. 

STATEMENT OF ANNE SIMPSON, SENIOR PORTFOLIO MANAGER, GLOBAL EQUITIES, CALIFORNIA PUBLIC EMPLOYEES’ 

RETIREMENT SYSTEM 

Ms. SIMPSON. Thank you. Good morning. Chairman Johnson, 

Ranking Member Shelby, and Members of the Committee, thank 

you very much for the opportunity to come and speak to you this 

morning. My name is Anne Simpson. I am Senior Portfolio Manager in the Global Equity’s Division of CalPERS. So my purpose 

this morning is really to share with you some practical insight into 

how Dodd-Frank is working, emphasize to you how important the 

corporate governance provisions are, and if anything, to remind the 

Committee that there is still further work to be done. 
11 

But let me start at the most important point, which is explaining 

something about CalPERS and the size and significance of our fund 

in the market. As you will be aware, CalPERS is the largest public 

pension fund in the United States. We have approximately $235 

billion in global assets and our equity holdings extend to something 

like 9,000 companies worldwide. 

Now, this money is invested for an extremely serious purpose. 

We provide retirement benefits to more than 1.6 million public 

workers, retirees, and their families. And if you want to think 

about that in terms of its economic impact, this year, we will have 

paid out something in the order of $11 billion in benefits. Seventy 

cents on every dollar that we pay out typically comes from investment return. So think of the number of people reliant on the market through the activities of our investment fund. This is not a theoretical exercise. 

The people that we are investing for, generally, they are on modest incomes. On average, a CalPERS beneficiary will be living on 

benefits from the fund on the order of $2,000 a month. Today, we 

have released a report actually looking at the economic impact 

through those payments, if you would be interested in a copy. 

So for this reason, we have a very serious fiduciary duty to pay 

attention to the safety and soundness of the market, and this is 

why corporate governance is, to us, absolutely fundamental to the 

security of those returns, which we have to think about on a riskadjusted basis over a very long investment time horizon. 

Our size and our very long-term liabilities mean that we cannot 

ignore problems in the market. There is no safe place for CalPERS 

to go when things go wrong. We are simply too big. There is not 

a corner of the stock market where everything is working wonderfully well and you can talk over $200 billion and hope these difficulties will somehow go away. So we have been paying very close 

attention to Dodd-Frank’s reform proposals and we are also very 

glad to be working within the new rigor, the new transparency and 

accountability that this Act is providing. 

I also would like to draw to your attention that in addition to the 

corporate governance reforms, CalPERS has been actively supportive of other elements of Dodd-Frank, the proposals around systemic risk oversight, proper funding and independence for regulators, which has just been touched on, proper derivatives reform, 

credit rating agency overhauls, and consumer protection. We see 

these as a package of measures that need to be carefully coordinated. Corporate governance will not do the job on its own. 

So let me then just turn to a number of corporate governance 

provisions in Dodd-Frank which we see as particularly important, 

and I would be glad in the questions to explain further why that 

is so. 

I think it is fair to say it is almost commonplace now that we 

acknowledge that the financial crisis was fueled by a toxic combination of lax oversight and misaligned incentives. This is why 

governance reform is vital. It is through improved transparency 

and accountability that we will be able to address these sorts of 

systemic weakness. Too many chief executives pursued risky strategies or investments that bankrupted their companies or weakened 

them financially for years to come, and we know the knock-on ef-
12 

fect in the economy has been devastating for millions. Boards were 

often complacent. They were blinded by group-think, which is also 

why we regard board divestiture so important, and unwilling to 

challenge or rein in reckless executives who threw caution to the 

wind. We know that accountability is critical to motivating people 

to do a better job. This is why sound pay is so important. 

We also think it is vital that proxy access is finally introduced 

in order that we can hold boards to account. Our significant and 

most important role is to be able to vote on the hiring, the firing, 

and the removal of board directors, and without proxy access and 

its companion piece, majority voting, we are not in a position to do 

that. We are simply those with bark but no bite. 

Finally, we would like to encourage the further improvement of 

disclosure, which Dodd-Frank has begun, notably around important 

subjects like board leadership, for example, the separation of the 

chairman and the chief executive. And we welcome the efforts that 

are being made to give investors the information they need that is 

critically important, but also it is very important that that information can be matched by appropriate action, which is where proxy 

access will give us an extremely useful tool for improving the situation, not just for the benefit of our beneficiaries, but we think it 

will have a systemically useful impact. 

Thank you. 

Chairman JOHNSON. Thank you, Ms. Simpson. 

Mr. Atkins is a visiting scholar instead of a fellow, as was said 

at the beginning of the hearing. I regret that. 

STATEMENT OF PAUL S. ATKINS, VISITING SCHOLAR, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH 

Mr. ATKINS. That is OK. Thank you very much, Mr. Chairman 

and Ranking Member Shelby and Members of the Committee for 

inviting me to appear today at this hearing. 

I come before you today not only as a former Commissioner of 

the Securities and Exchange Commission, but also a member of the 

former Congressional Oversight Panel for the TARP program and, 

of course, as a Visiting Scholar at AEI. It is a privilege for me to 

be able to participate in the public discussion about the issues of 

the day in the context of my years of work in the public and private 

sectors. 

The news of this past week has highlighted the disappointing 

state of affairs in our economy. The unemployment rate increased 

to 9.2 percent while the labor force itself shrank by more than a 

quarter of a million people. More than 14 million Americans are 

out of work, and almost half of those have been out of work for 

more than 6 months. 

Uncertainty in the legal and regulatory landscape of the financial 

services industry is a major cause of why the economy is doing so 

poorly, because it discourages investment and extensions of credit 

to entrepreneurs. A primary reason for this uncertainty is Government policy, particularly Dodd-Frank, which was ostensibly enacted for the sake of market stability and investor confidence. Because most of the provisions were not directly related to the 

underpinnings of the financial crisis, investors ultimately will pay 
13 

for the increased costs associated with the mandates without receiving commensurate benefits. Further exacerbating uncertainty, 

legal challenges to Dodd-Frank and the rules that the various 

agencies will issue are inevitable, not just as to the technicalities 

of the rules and whether they have been properly promulgated, but 

also as to basic questions of jurisdiction and, yes, constitutionality. 

As the past year has shown, Dodd-Frank also mandates very 

tight deadlines for Federal agencies to draft and implement these 

rules. Members of this Committee have been justifiably concerned 

that Federal agencies are sacrificing quality for speed as they neglect to properly weigh the costs and benefits to the economy of 

their proposed rules. These are complicated concepts with huge 

ramifications and the regulators have got to get it right. 

Today, you have asked specifically that we address Titles IV and 

VII of Dodd-Frank. Title IV and the rules that the SEC adopted effectively force all investment advisors managing more than $150 

million in assets to register with the SEC. Even advisors to venture 

capital funds, which Congress specifically exempted from registration, effectively are caught up in the SEC’s new registration and 

examination scheme. These rules will have a multi-pronged effect. 

They will burden advisors and thus investors with costs, increasing 

barriers to entry. They will strain SEC resources and divert its attentions from protecting retail investors, which is what its primary 

focus should be. And the effect of these two situations will foster 

a mistaken sense of security among investors so that they may 

think that SEC registration means that they can let their guard 

down. Bernie Madoff indicates otherwise. 

Now, moving on to Title IX, which encompasses a wide range of 

issues, including credit rating agencies, whistleblowing, fiduciary 

duties, SEC management, and then a grab-bag of issues that have 

been pushed for years by special interest groups of politicized investors and trial lawyers, I just want to make a few points in the 

time remaining. 

This Committee took action with respect to the Credit Rating 

Agency Reform Act of 2006 to address the troubling oligopoly of 

credit rating agencies and the SEC’s opaque method of designating 

these agencies as nationally recognized statistical rating organizations. Ultimately, unfortunately, Dodd-Frank has taken an inconsistent approach with respect to credit rating agencies. The threats 

currently being levied by Government officials in Europe demonstrate that rating agencies are susceptible to political pressure as 

to the supposed correctness of their ratings. Congress should consistently push transparency, accountability, and competition instead of Government control and second-guessing of ratings so that 

investors can get high quality and objective advice from credit rating agencies. 

Now, with respect to whistleblowers, I agree with the remarks of 

Chairman Pitt. Under Section 913, the SEC has recommended that 

Congress harmonize a standard of care for investment advisors and 

broker-dealers. I think it is important to remember that not all investors are the same. The standard of care as has developed over 

the past 75 years for brokers is robust and has features that vindicate grievances that are more streamlined than what investors face 
14 

in State court with a fiduciary duty standard. In those cases, the 

contract rules—the fine print under the contract, especially. 

Some investors perhaps want and need a fiduciary who possesses 

intimate knowledge of their financial condition and can advise 

them accordingly. On the other hand, some investors would prefer 

to have a true broker who is engaged on a transaction basis and 

is compensated accordingly. These two kinds of activities should 

have different standards of care attached to them. 

Title IX contains many other provisions, most of which have 

nothing to do with the causes of the financial crisis, and in my 

short window of time today, I cannot discuss all of these sections, 

but I do want to make one special plea. I encourage this Committee 

to exercise its oversight over SEC management. Just last week, the 

SEC Chairman testified about the recent leasing decision and suggested that the SEC should no longer have leasing authority. In 

contrast, last year, some were suggesting that the SEC should have 

a self-funding mechanism outside of the normal Congressional appropriations process. 

In the meantime, the SEC has pursued an extremely divisive 

agenda marked by more than a dozen three-to-two votes in the past 

2 years alone. I have never witnessed such a division. This record 

is in marked contrast to my experience of 10 years total at the 

SEC, first as a staffer in two Chairmen’s offices and then as a 

Commissioner under three Chairmen. The dissenters today are reasonable people and their dissents are not always fundamentally opposed to the rulemaking itself. But the sad fact is that it appears 

that the leadership of the SEC does not engage effectively on the 

finer points of the policy issues. Thus, I encourage this Committee 

to continue to exercise oversight of SEC management. 

Thank you. 

Chairman JOHNSON. Thank you, Mr. Atkins. 

Mr. Turner. 

STATEMENT OF LYNN E. TURNER, FORMER CHIEF 

ACCOUNTANT, SECURITIES AND EXCHANGE COMMISSION 

Mr. TURNER. Thank you, Chairman Johnson and Ranking Member Shelby. It is always a pleasure and, quite frankly, an honor to 

be back here in front of this Committee, and it is especially a pleasure with our distinguished Senator from Colorado. 

I have listened to the comments today and I guess we can all 

agree that we do not all agree. But it is fascinating to me, in light 

of the fact that here we are, 4 years after the subprime crisis imploded on us, the worst since the Great Depression. Investors 

around the globe lost $28 trillion in the capital markets in value. 

That was half of the entire world’s GDP at the time. Ten to 11 trillion was lost here in the United States, and that does not include 

the loss in value of their homes. 

People have said Dodd-Frank was the cause of this. Dodd-Frank 

was not even passed at the time that this occurred. What DoddFrank tried to deal with was the outcome of that. It was the crisis 

that started and caused the lost jobs we have heard about, tens of 

millions of lost jobs, lost wages, and lost homes. 

If Congress had not have acted as it did, I believe we would have 

been in a Hooveresque-type depression at this point in time, and 
15 

it certainly was not brought on by a regulatory structure that was 

out of whack, although certainly I think Dodd-Frank fixed some of 

the problems that are there, and on that point, I think I would 

agree with Harvey that there were some changes that did need to 

be made. But it was regulatory inaction leading up to and throughout the crisis that caused us problems. 

As Dr. Greenspan has noted himself, there were things they 

could have done, they had the power to do. Congress had given 

them the power. This Banking Committee had given the Fed the 

right to regulate those bad loans that were made, and the Fed 

chose not to regulate. That is what has caused the unemployment 

and jobs, and I congratulate Congress for acting on that. 

In my 35 years of experience, though, as a banker, an auditor, 

a regulator, investor, and teacher, I have always found that if you 

are going to have markets work, they have got to have five basic 

fundamental pillars to work. There has got to be transparency. You 

have got to have the information you need to make the investments. You have got to have accountability, the people who take 

that money, including the management teams, the boards, have got 

to be accountable for their actions, as do the regulators. It is up 

to this Committee to oversee those regulators, and I agree with 

Paul that good oversight at the SEC is important. There has to be 

independence. The conflicts that we saw at the credit rating agencies were outrageous and certainly contributed to the problems. 

You have got to have effective regulators. And, finally, you have got 

to have enforcement of the laws. 

Yet, as we look back at the mayhem of this last decade, we see 

that there was absolutely a dearth of transparency, accountability, 

law enforcement by the regulators and investors, and regulators 

alike. No one could decipher the financial statements from an AIG, 

a Lehman, a Merrill Lynch. Assets and capital were inflated, liabilities understated, and profits upon which huge compensation packages were granted were a mirage. 

So in light of that, in this hearing on Title IX, let me get back 

to some of my comments. First of all, the whistleblower issue. A lot 

of people have different views on whistleblowers. Business in general does not like them. Investors like them. Some people think 

they go too far. Some do not. Senator Shelby, you mentioned that 

they could pay out tens of millions, and you are absolutely right. 

But if they are paying out tens of millions, that means the SEC 

will have been imposing fines of $30 to $300 million. That means 

that you have got huge financial restatements out there of the like 

we saw at WorldCom, where it was restated $11 billion. Those financial statements were fictional. They were like watching a movie 

called ‘‘Fantasia.’’ 

If it is that big, I do want to see that whistleblower come in and 

alert the SEC at the earliest possible date. The Association of Certified Fraud Examiners has shown that it takes on average 27 

months to find a fraud. Why would we not, in a situation like that, 

want that tipster to come in at a much earlier date so people do 

not have those great big losses from a WorldCom or an Enron or 

some of these things we have seen in the bank. 

I have served as an audit committee chair on public companies 

overseeing whistleblower and compliance programs. I think the 
16 

SEC was very reasonable in their final rulemaking back in May, 

and if anything, it is going to result in better internal compliance 

and hotlines. They encourage people to go to the business first, 

which is good. But 89 percent of the frauds that the SEC investigated from 1998 to 2007 involved the CEO and/or CFO at the 

company. There is a reason whistleblowers are hesitant, quite 

frankly, to go to the top. So giving them the chance to come into 

the SEC, I think, is great. 

Quickly, on proxy access, it was mentioned that just 3 percent. 

That is actually not correct, because it takes a majority. All I am 

asking for investors is give investors the same right, the owners of 

the business the same right that the management team that they 

have hired has to the proxy to vote the directors. And it is not 3 

percent. The labor unions never will be able to control this. That 

is a figment of someone’s imagination, because it takes a majority 

of the shareholders to put it through. That is excellent. 

As far as the SEC funding, I would just say I totally agree with 

Ms. Roper. From 2005 to 2007, the staff of the SEC was cut by 10 

percent. Its spending was cut by $75 million. As a business executive, I know you cannot shrink to greatness, and that is what people were trying to do at the SEC leading up to the subprime crisis. 

There was some—I was asked to comment just briefly on PCAOB 

and some of the provisions on broker-dealer audits which the 

PCAOB is acting on today, very appropriately. We saw from Madoff 

that audits of these companies were very poor, the audit of the assets was very poor, and this provision of the law helps the PCAOB 

prevent those type of things, which I think will be very good as 

well as work much better with international regulators. 

So I think with that, I will end my comments. But overall, I 

think this Title IX of Dodd was well done. Investors did not get everything they wanted, but, you know, I found that it would be nice 

if people in D.C., rather than thinking about being Democrats or 

Republicans, started thinking like being Americans, and I think in 

Title IX that is exactly what you did as a Congress and I think that 

is great. Thank you. 

Chairman JOHNSON. Thank you, Mr. Turner. 

I will ask the Clerk to put 5 minutes on the clock. 

For any and all witnesses, reflecting on the financial crisis, what 

do each of you feel was the most serious harm it caused to retail 

and to institutional investors? In reflecting on the new law, what 

do you feel are the reforms that will be most helpful to investors? 

Mr. Massey. 

Mr. MASSEY. Senator, in my opinion, the most injury from the 

perspective that we as State securities regulators see is with respect to what we call retail investors, also known as mom-and-pop 

investors, and these are the people that not only have taken big 

hits to their life savings, they have also suffered impacts on their 

financial planning that they were hoping to send their kids to college with. They have lost jobs. They have lost ownership of their 

small firms. The landscape is littered with victims of the financial 

crisis, and these are regular people who depended to a great extent 

for their future on the integrity of the financial system. Now, when 

it fell apart, they took the hit. 

Chairman JOHNSON. Does anyone else care to respond? 
17 

Ms. ROPER. I would just like to add to that. I think, you know, 

there is no question, the financial losses that investors took were 

devastating. I think equally devastating is their loss of confidence 

in the integrity of the financial system, their loss of confidence that 

they can rely on this as a place to save for retirement, to save for 

their long-term goals. 

And I think one thing that contributes to that is that sort of a 

peculiar characteristic of this crisis is that the harm that flowed to 

retail investors was not primarily as a result of anything that was 

done to them directly. They were not defrauded by a broker. They 

are the collateral damage of a regulatory system of a largely institutional market that simply did not function. And so they cannot 

even point to anything that they did. They followed the rules. They 

bought and held and diversified and suffered devastating consequences. So I think it is that sense in which it undermines their 

confidence that they know how to participate safely in these markets and that their regulators will protect them in the future. 

Chairman JOHNSON. Ms. Simpson. 

Ms. SIMPSON. I would like to answer that. This is Anne Simpson. 

In addition to regulators letting people down, let us shine a spotlight on the shareholder community. That is where we sit, as 

CalPERS. The question is, where were the owners? Why were we 

not able to see what the problems were as they were growing? Why 

were we not able or willing to intervene, to do something? And it 

is a simple corporate governance failure in the market which has 

left us powerless to behave as responsible owners. 

Think about two parts of the story. The first is majority voting. 

This is something which we wanted to come out of Dodd-Frank and 

in the end did not survive passage from the early discussions. This 

is a situation where, without majority voting, we cannot remove directors. And second, without proxy access, we cannot put forward 

people who we think are better able to do the job that needs to be 

done. And if we are not able to hold boards of directors accountable 

and regulators are not in a position to intervene, then, really, this 

is how you can have rampant risk running through the system, executive pay that is out of control, and the situation which really 

took us to the brink of the abyss. 

Our portfolio was hit to the tune of $70 billion and we are slowly 

but surely coming back. But it is extremely important that in capitalism, and that is the system we are all relying on, the owners 

have to be in a position to behave like owners, and that means 

being able to hold boards accountable. And if we are toothless, then 

I do not see who else can intervene to do the job. 

Chairman JOHNSON. Mr. Pitt and anybody else on the panel, I 

want you to reflect on say-on-pay. In an interview, you were asked 

whether say-on-pay is going to be an effective tool to prevent excesses, to which you replied, ‘‘I think it will be. I think that this 

will have a very definite impact on how corporations and shareholders view these critical issues.’’ 

In your testimony today, you note that say-on-pay would lead to 

increased shareholder litigation. Is some litigation, which you note 

is finally likely to fail, a necessary consequence of getting the benefits of say-on-pay? Mr. Pitt and other panelists, would you comment 

on this. 
18 

Mr. PITT. Yes. I believe that shareholders have the right to be 

fully informed about compensation, and they have the right to express their views. The difficulty that I see is that there has evolved 

a clear trend already on the part of some lawyers to sue anytime 

a corporation’s shareholders express disagreement with the compensation levels. So what could have been an advisory kind of view, 

which is what the clear intent of Dodd-Frank was, has now been 

converted into a litigation tool, and that costs investors enormous 

expense. It also imposes on investors enormous burdens that I 

think are very difficult. 

I am very much in favor of transparency and having shareholders have the ability to express whatever views they have. But 

I am not in favor of seeing this turned into a referendum and then 

a litigation exercise, which appears to be the direction in which 

this is headed. 

Chairman JOHNSON. Does anyone else care to comment? 

Ms. SIMPSON. Yes, thank you. CalPERS has voted on 4,000 sayon-pay votes in our U.S. portfolio this year, but we have been voting on this same issue in Australia, the United Kingdom, the Netherlands, and Norway for some time. We are a global player, and 

I would say that say-on-pay is simply bringing the United States 

in line with international best practice. 

We have also found it extremely useful, and the reason is this: 

It has meant that companies want to pick up the phone or answer 

the phone and talk. They do not want to lose the vote, they do not 

want a high level of opposition, and they actually are being much 

more attentive to what the owners think, and this is only proper. 

Whatever pay is being paid, guess what? That money is being provided by the shareholders, and it is only good manners, surely, to 

be discussing the amounts and the performance targets. 

So we have seen two good things come out of this: 

One, the performance periods are getting longer. That is extremely important because we need to relieve the short-term pressure on companies, and that in part comes through having shortterm targets for pay. 

Second, we have seen a better alignment of pay and performance, 

and we have been delighted to see companies filing amendments to 

their plans all the way in the run-up to the AGM deadline. The result of that for CalPERS is that we voted against 7 percent of the 

plans that came forward. So we really see this as a good platform 

for dialogue, and thank you very much for the efforts in DoddFrank for doing that. 

I also forgot to mention earlier the importance of the claw-back 

rule in Dodd-Frank. It is extremely important that we have now 

clearly got this ability to retrieve ill-gotten gains. If you know that 

you cannot get away with it and people will come after you to turn 

the money back that you have perhaps bet your company on a 

short-term bet and done well yourself personally, if you know people can come after you and ask for that money back, I think it concentrates the mind wonderfully. So thank you for that. 

Mr. ATKINS. If I could interject one thing. 

Chairman JOHNSON. Yes. 

Mr. ATKINS. The United States is a lot different than other countries around the world. Our litigation system and the shareholder 
19 

rights system is a lot different. And so I think the things that 

Chairman Pitt is pointing out ought to lead to some caution. 

And the other thing that troubles me very much when we talk 

about ‘‘investor rights’’ is that some owners are treated differently 

than others, and the sense that some people can pick up the phone 

and talk to and cut back-room deals or influence things because of 

their special interest or size I think is very troubling. And so what 

we need is more transparency, and to the extent that these special 

rules give certain shareholders more clout than others have I think 

is a very troubling development. 

Chairman JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

Mr. Atkins, in the self-funding situation, some commentators, as 

you well know as a former Commissioner, have advocated selffunding for the Securities and Exchange Commission. Self-funding 

I believe would make the SEC less accountable to Congress, and 

as a former Commissioner, what is your view about how self-funding for the SEC would change the incentive perhaps for Commissioners to properly execute their duties? Would it make them less 

responsible obviously to Congress, you know, if they did not have 

to come before Congress for an appropriation? 

Mr. ATKINS. Yes, sir, I think that is a very important point. I am 

not in favor of the idea of self-funding. If I were to put myself in 

the shoes of you all on the other side of the table and considering 

the responsibility to taxpayers, I think it is incumbent to try to exercise oversight and understand what is going on: To have various 

departments and agencies of the Government go through the normal appropriations process, to justify their budgets and then make 

decisions as to who is more deserving of the capital that is going 

to be allocated. So, I think that transparency is very important, 

and I think it has done the SEC well over the last decade. Accountability is crucial. 

Senator SHELBY. Thank you. 

I would like to address this question to the former Chairman, 

Mr. Pitt, and also to you, Mr. Atkins, as you both are former Commissioners of the SEC. Dodd-Frank enacted, as we all know, a 

number of changes. We have been talking about corporate governance. These changes give shareholders with 3-percent holdings I 

believe substantially more power than the average investors. Could 

these provisions cause companies to defer to the political or financial agendas of certain special interest shareholders at the expense 

of building the company’s value for the benefit of all shareholders? 

And how do these changes benefit individual investors if they do? 

Mr. Pitt, former Chairman. 

Mr. PITT. Thank you, Senator Shelby. I have a basic concern with 

any provision that holds a corporation’s shareholders hostage to the 

views of special interests with respect to a company. The ultimate 

goal of accountability, which is what was behind these provisions, 

is a good one, but the solution was much simpler than the one that 

the SEC has come up with. The solution was simply to allow solicitations electronically so that there would not be the same fervor to 

make use of management’s proxy materials; and, second, to rely on 

State law. The State law determines whether shareholders have 

the right to amend their by-laws, and if State law gives share-
20 

holders that right, then they ought to be able to exercise it subject 

to restraints on inundating the corporation with too many proposals and the like. 

So I think there is a way to achieve the goal, but it is not necessarily the one that Dodd-Frank contemplated. 

Senator SHELBY. Mr. Atkins. 

Mr. ATKINS. Yes, sir. About 5 years ago, at an SEC roundtable, 

in response to a question that I asked, a couple of witnesses basically admitted that these sorts of provisions add more arrows to 

their quiver for them to be able to advance in smoke-filled rooms— 

out of sight of the public and without any transparency—to advance their ulterior motives and their special agendas. And in the 

past, State pension funds have also been basically in cahoots from 

time to time with some of these special interests. 

So I think that lack of transparency is very troubling, and for an 

agency like the SEC, which stands for transparency in the marketplace, I think that is a troubling development. 

Senator SHELBY. Mr. Massey, Dodd-Frank shifts the regulation 

of certain registered investment advisors from the SEC to State 

regulators. Will the State regulators have the resources and expertise necessary to properly oversee the investment advisors that 

would be moved to the States under their jurisdiction? And how 

would investors be helped by the change, if they will? 

Mr. MASSEY. Senator, right now the estimate from the SEC is 

that approximately 3,200 investment advisor firms that are currently federally registered would be shifted over to State registration and regulation in the so-called investor advisor switch. NASAA 

has been preparing for this switch for more than a year now and 

has created a number of tools to make the State’s role in regulating 

these investment advisors much more intelligent and much more 

efficient and much more responsive rather than a rubber stamp 

type of treatment of the examination requirement. 

We have risk analysis software that is distributed to the States 

to let them adjudge the relative risk of the various firms so they 

can set their priorities of examination. We have uniform examination procedures so that every examination is going to ask the same 

question of every investment advisor out there. And, most importantly, the shift has motivated the States to have an outreach program by which road presentations are conducted in major cities for 

not only existing State registered investor advisors but also Federal 

advisors that are coming over, to let the Federal advisors know 

who the regulator is, to establish a positive working relationship 

with the State regulator, and to set up a good working relationship 

with what I refer to as the legitimate side of the industry so that 

the local cops on the beat can take their enforcement resources and 

put them against the Ponzi scheme operators. 

Senator SHELBY. Ms. Roper, recently the National Association of 

Manufacturers estimated that the new Dodd-Frank disclosure requirement with respect to conflict minerals, such as the Congo and 

so forth, would cost between $9 billion and $16 billion—in other 

words, to the industry—rather than the $46 million that the SEC 

estimated. Are you concerned at all that this provision could end 

up costing investors more than the benefit that they will receive 

from disclosure? You know, we are all interested in doing the right 
21 

thing, but we are also interested in some balance of cost here for 

our manufacturers. 

Ms. ROPER. We did no work on that provision. I do not know anything about the provision. I have no basis for analyzing either of 

those cost estimates, so I just do not have a basis for commenting. 

Senator SHELBY. OK. Ms. Simpson, do you have any knowledge 

base on this? 

Ms. SIMPSON. Thank you. Yes, we actually are great fans of getting all relevant and material information properly provided to 

shareholders. But the root is going to be to ensure that, you know, 

the costs do not outweigh the benefits. That is a very sensible point 

of view. 

I have not seen the underlying estimates that you are referring 

to, so I cannot comment on that, but it would seem to me quite extraordinary in this day and age of the Internet that a company 

could not find the relevant information in a cheap and affordable 

way. 

Senator SHELBY. OK. Mr. Turner, one last question. In your testimony here today, among other things, you noted that in the leadup to the financial crisis, and I quote, ‘‘most of the regulators were 

captured by industry.’’ Your words. In your view, which regulators 

were captured by industry or are captured by industry? And if a 

regulator is captured by industry, isn’t the solution to make the 

regulator more accountable to the American people by subjecting 

the regulators to more congressional oversight? That is one way, 

maybe not the only way. In other words, who was captured by industry? 

Mr. TURNER. I certainly think the banking regulators were captured by industry. The Federal Reserve—I have dealt with the Fed 

for much of my career, and I think even Dr. Greenspan has acknowledged, I think, probably the best way to deal with it is 

through much greater transparency on the part of the Fed. I think 

the SEC in the mid-part of the last decade was extremely captured 

by industry, and contrary to what Paul said, the divisiveness at 

that point in time o the Commission was tremendous as well. In 

fact, I think the current Chairman, Chairman Schapiro, should be 

applauded for trying to dial the tone back a little bit. 

But on your point about accountability, I do think both the Fed 

and the securities regulator, as well as the CFTC, all of them need 

to be subjected to much more rigorous oversight. I will tell you 

leading—— 

Senator SHELBY. Like right here. 

Mr. TURNER. Like right here, Senator. You are absolutely right. 

And, in fact, I will tell you that myself and others—and I think 

Barb Roper was included in the group at the time. Just as we were 

getting into the subprime crisis, probably in about January of 2007, 

there was a group of us who came and met with the Banking Committee staff here as well as the House Financial Committee staff 

and members, and we urged at that point in time much greater, 

robust, in-depth oversight of the Commission. And, unfortunately, 

it did not happen in either institution. 

I will say on the funding issue, I believe you have been one of 

the proponents—I have testified before you when you pleaded with 

the SEC Chairman to take more funding, and I greatly applaud 
22 

you, Senator, for that. We probably disagree on the issue of selffunding. I am a strong proponent of self-funding. I think you can 

self-fund and still do the oversight hearing. I understand appropriators, people on the Appropriations Committee, like that oversight, 

so I understand where you are coming from. 

Senator SHELBY. Like the two of us. 

[Laughter.] 

Mr. TURNER. Yes, and I think there is actually—— 

Senator SHELBY. He wants to give up his power. We do not. 

Mr. TURNER. But I think you could have done it. But, you know, 

whether you self-fund or not, the most important thing is that the 

money that you scheduled out in Title IX get delivered to the SEC. 

And my problem and my concern is if you look at the first year, 

2011, which is $1.3 billion, you are not even hitting that target. 

And if you are not even hitting that target, I have no expectation 

that you will get the SEC the funds that it needs. And I think the 

fact that you saw their staff cut by 10 percent from 2005 to 2007, 

$75 million cut in spending, the management was absolutely atrocious at the agency at the time, and I would have encouraged you 

to bring them up, as we did in January of 2007, and ask them what 

they were doing, because they did get the job done. And they did 

a great disservice to investors. 

Senator SHELBY. You are not saying to us today here in the 

Banking Committee that the SEC’s whole problem or the Federal 

Reserve’s whole problem—of course, they have no funding problem. 

Mr. TURNER. Certainly it was not the Fed because they got selffunded. 

Senator SHELBY. It was a lack of money? Or was it a lack of will 

and a lack of action and a lack of diligence? 

Mr. TURNER. I think first and foremost it was a lack of will and 

a lack of diligence. 

Senator SHELBY. Thank you. 

Mr. TURNER. I think in some cases funding contributed to that. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Reed. 

Senator REED. Thank you, Mr. Chairman, and thank you for 

your testimony. 

This issue of funding I think is central because Mr. Pitt expressed a concern I have, that we will give responsibilities to the 

SEC and not the resources to get them done, and that goes for the 

CFTC also. And so I was a strong proponent of self-funding even 

though I am also an appropriator. 

I presume, Mr. Pitt, that ultimately you would be supportive of 

some type of self-funding mechanism? 

Mr. PITT. Yes. I believe that there are a number of financial regulators who have the ability to self-fund, and the SEC should not 

be a stepchild. I think the concerns that have been expressed about 

accountability make it imperative that if self-funding is granted— 

and I believe it should be—that there be complete accountability 

before the appropriate committees, this Committee and others, so 

that you can assess where the SEC proposes to spend its money. 

But you would wind up saving taxpayers a billion plus dollars if 

the money did not come out of the Treasury, as it presently does. 

Senator REED. Thank you, Mr. Pitt. 
23 

The back and forth has revealed the issue of accountability as 

well as funding, and there are ways for accountability. One is this 

Committee—in fact, probably a more effective way, if used correctly, than the Appropriations Committee. But also there is the 

issue of regulatory capture, and as you point out, every other regulatory agency, except the CFTC, financial agency, is self-funded. 

But there is still the issue of regulatory capture. But I think that 

has to be resolved probably in other forums. I do not see anyone 

here—if someone would like to put their hand up and say if the 

Fed should be subject to the appropriation process, do I have any 

takers? Barbara? Not even Consumer Federation of America. 

[No response.] 

Senator REED. So I think this issue of—— 

[Laughter.] 

Senator REED. I think this issue of sort of, well, if they do not 

have appropriate oversight by the appropriators, they just will not 

be accountable to the American people defies the financial system 

we have in place today. 

Ms. Simpson, you talked about majority voting, and I just want 

to clarify because the proposal that we had in the legislation I 

think is essential. It fell out, unfortunately. That would have required a director to receive the majority of the votes cast. Today, 

a director could be elected to a board with 10 percent of the votes 

or one vote if no one decides to cast votes. That happens sometimes 

and leads to anomalies. So effectively without this majority—without the ability to nominate directors and then without the ability 

to insist they at least get a majority vote, the leverage of shareholders is diminished. 

Now, we have made some improvements, but you would suggest 

we should go further in terms of a majority vote. Is that correct? 

Ms. SIMPSON. Yes, thank you. And the situation you describe is 

not that uncommon. We sort of had a look back last year. Just in 

the Russell 3000, there are over 100 directors who did not win a 

majority of the vote and who are still just quietly sitting on the 

board. So far this year, another 36. So this is an environment 

which is really very troubling. You know, this may be a democracy, 

but it is of a very peculiar sort if you do not have to win the election in order to keep yourself in place. And, of course, the comment 

that was made about special interests, I have to say with great respect to be rather like a politician saying we should not trust the 

electorate with something as important as the vote. 

Senator REED. But let me follow up on that line of criticism that, 

well, this creates this lack of transparency because you might have 

big voting blocs doing things. Essentially whatever benefit you gain 

is equally shared by every other shareholder. Is that—— 

Ms. SIMPSON. Yes, that is absolutely right, and two points on 

that. First, CalPERS, being a great champion of transparency, 

thinks that has to apply to us as well. We put all of our votes on 

our Web site. Our policies are there for you to see. And I think that 

is very important, and I would encourage all investors to follow the 

same approach. 

The other issue about the financial benefit is really important. So 

even though CalPERS is so big, typically we will hold about half 

a percent of a company, and if we want to do anything, first of all, 
24 

we have to collaborate with others; and, second, you are quite 

right, the benefit is shared. 

We had a report done for our board just before the end of last 

year looking at 10 years of our investor engagement to see what 

had happened at those companies, and sure enough, you went from 

a situation where that group of companies went from underperforming to producing excess returns. And, of course, that is not just 

going to help CalPERS; it is going to help every other shareholder. 

So there is a net-net gain in the market. 

Senator REED. I think one of the dilemmas or sort of contradictions is that the presumption, of course, is that corporations are 

run for the benefit of shareholders, but I think particularly when 

you look at the companies that failed—Lehman Brothers, Bear 

Stearns—they were not being run for the benefit of shareholders at 

all. They were being run for the benefit of the management, with 

huge rewards to management. In fact, as I sort of look back, it was 

a public ownership model and a private compensation model, and 

it worked very well until, you know, the tide turned. 

In many respects, shareholders are the least powerful people in 

corporations, and they are, according to corporate law—and I will 

defer to Mr. Pitt and others. They are the ultimate owners. They 

are the ones which every director has a fiduciary duty to and manager has a fiduciary duty to. But it appears from what has happened in the lead-up to this collapse that shareholders were sort 

of the last people being considered. Is that your view? 

Ms. SIMPSON. Yes, I do agree with you. You know, we are the 

one-armed paper hanger. We need to have the tools to hold boards 

accountable, and I think what you will find, my conclusion is that 

if shareholders have votes that do not really matter and they do 

not have the ability to intervene in an effective way, they think, 

OK, the system is designed. Either you can sell or you can sue. 

Now, that is not going to work for CalPERS because we are too big 

and we are too long term. But we really do need the tools to be 

able to behave like owners, and that is why—and I know it has 

been said, well, we could go—Mr. Pitt has said we should go door 

to door with companies in different States filing resolutions to have 

amendments. But to be honest, we see this as a market fundamental. If capitalism cannot turn to the owners to hold companies 

accountable, then we should not be surprised when we have the 

problems that we do. 

Senator REED. Thank you very much. 

Chairman JOHNSON. Senator Menendez. 

Senator MENENDEZ. Well, thank you, Mr. Chairman. Thank you 

for holding the hearing. 

I look at this issue, and I think about what is the market. The 

market is a series of investors seeking to invest in companies that 

hopefully will provide them a yield, a return on their investment 

so that they can personally prosper. And the flip side of that is a 

series of companies looking for investors so that they can grow 

their companies and prosper as well. And so there are two essential 

ingredients here, and one of them, but for their investments, would 

really not make the market what it is. Without them there is no 

market. And so investor protection seems to me to be incredibly important. 
25 

And I know that some say that the CalPERS of the world and 

the unions of the world are special interests. They happen to be the 

biggest singular investors along the way in this marketplace. So I 

do not look at them as a special interest. I look at them as a significant part of the marketplace, representing a broad universe of 

individuals at the end of the day who are taking their savings and 

making investments for them. And so ultimately it seems to me 

that investor protection in their respect as well is a very broad one 

because they represent a very large universe of people, and at the 

end of the day, more than ideological issues, I think they want to 

see their investments grow on behalf of the people who they invest 

in. So I have a little different view. 

I have two sets of questions that I want to pursue. One is, Ms. 

Roper, with you. Soon after Dodd-Frank was signed into law, the 

SEC put out a study recommending a consistent best interest of 

the customer or fiduciary duty standard for broker-dealers and investor advisors, a priority that both Senator Akaka and I successfully fought for in the Wall Street reform with our honest broker 

amendment. And I know that the Certified Financial Planner 

Board of Standards recently sent a petition to the SEC with more 

than 5,000 signatures of financial planning professionals who favor 

fiduciary duties for all financial professionals giving investment advice. 

Do you agree with having a high and consistent standard of the 

best interests of the customer for all stockbrokers and financial 

professionals? And if so, why? 

Ms. ROPER. Absolutely, I agree, and any of you who are the recipients of my nearly daily letters on this subject during the legislative battle maybe remember that. This is in many ways the most 

important issue for retail investors. The last investment decision 

most people will make is who to rely on for recommendations. And 

the situation in the marketplace is this. Mr. Atkins says, you know, 

broker-dealers and investment advisors are doing two different 

things, so they should be subject to two standards. But let us review that. They call themselves by titles that are indistinguishable 

to the average investor. They both offer extensive personalized investment advice. And they both market their services primarily 

based on that advice. If they are doing two separately distinctly different things, why has the SEC allowed them to present themselves in a way that makes it impossible for the average investor 

to distinguish between them? 

So if the investor cannot distinguish between them—and we 

know from survey research and focus group research that they cannot. In fact, the RAND study found that investors could not tell 

whether their personal advisor was a broker or an investment advisor, even after the differences had been explained to them. So they 

cannot go into the marketplace and make an informed decision 

based on an understanding of what services are being offered or 

what the standard of conduct is for those services. 

So the reform that is needed is to ensure that when they are 

doing the same thing, when they are providing personalized investment advice to retail investors, they should be subject to the same 

standards. 
26 

Now, the brilliance of the proposal that the SEC has put out 

there is that it recognizes both the need to raise the standard and 

the need to preserve investor access to a transaction-based source 

of advice. Not every investor wants ongoing account management. 

Not every investor wants, you know, comprehensive financial planning. So investors benefit if there is a source of advice available 

that is compensated through commissions, that offers advice on a 

transaction basis. And the SEC uses the authority that DoddFrank gave it to put out a proposal that recognizes this. Brokers 

can still charge commissions. Brokers can still sell proprietary 

products. They can sell from a limited menu of products. And the 

SEC has said they will deal with the principal trading issue. They 

are making every effort to ensure that this advance in terms of the 

standard of conduct nonetheless retains investor choice. 

Senator MENENDEZ. At the end of the day, they can make all of 

their commissions, but they have one standard. That would be the 

best interest of the investor. 

Ms. ROPER. Absolutely. 

Senator MENENDEZ. Otherwise, you could very well lead them to 

investments that would not necessarily be in their best interests, 

but for the standard—— 

Ms. ROPER. Absolutely. Absolutely. There is—you know, there is 

a difference between what you can do to satisfy a suitability standard and what you would have to do to satisfy a fiduciary duty. 

Now, they start from the same basis. You have to know the customer. You have to do that analysis to determine what is appropriate for that investor. The fiduciary duty requires the broker to 

take an additional step and have a reasonable basis for believing 

that what they are recommending is not just appropriate for the 

investor, but in the best interest of the investor within the limited 

menu of options that they have available to sell. 

And where they have conflicts of interest, they are still able to 

operate, but they have to fully disclose those conflicts of interest to 

the investors. So they can no longer make recommendations based 

on their own financial interest because they get higher commission 

without disclosing that conflict to the investor and without then ensuring that that recommendation is also in the best interest of the 

investor, and not just their own bottom line. 

Senator MENENDEZ. Thank you very much. 

I have one other question. I want to turn to Mr. Turner. Mr. 

Turner, one of the provisions that I successfully included in DoddFrank would require publicly listed companies to disclose in their 

SEC filings the amount of CEO pay, the typical worker’s pay at 

that company, and the ratio of the two. Now, over the last few decades, CEO pay has skyrocketed while the median family income 

has actually gone down. 

There are those in the House that have opposed this because 

they say it is too burdensome for companies to disclose that, and 

second, that the information is not useful to investors. I find it 

hard to believe that companies that do all kinds of complicated calculations for everything else involving their revenues and expenses 

would find it difficult to take their 2,000 employees, figure out how 

much employee number 1,000 is paid, and report that one number 

to the SEC. It seems to me that it is much more about hiding the 
27 

fact that, many times, CEOs have 400 times the pay of their typical employee. 

Do you think it would be burdensome for companies to figure out 

how much their median worker is paid and report that number? 

Mr. TURNER. Senator, as you know, I was an executive in a semiconductor company that was international. We were one of the 

larger importer-exporters at the time, in fact, in the country, and 

I do not think—in fact, I would be surprised if for most companies 

that was a difficult thing. First of all, it is something you ought to 

be managing, so you only manage what you measure in the first 

place. And if the compensation committee of a board, and I have 

sat on some of these boards, was not even looking at that ratio, I 

would probably be concerned. It would tell me there is a lack of 

management here, a degree of management that should exist. 

But in terms of just getting the raw data, no, I think there are 

ways you can go about it. The SEC can implement some rules. I 

think they have been encouraged to implement some rules that are 

reasonable that would not have a great deal of cost. And again, let 

us keep in mind, when we talk about cost, this cost global markets 

$28 trillion. It cost U.S. investors $10 to $11 trillion. Much of that 

was due to very, very poor incentive packages. And in light of the 

fact that executive compensation this year—last year was up 23 

percent while Main Street wages went up zero—zero—I think it is 

fair to turn around and start managing and taking a look at that 

issue, and I think compensation committees should. I think they 

can. I think CFOs in the same role I was in can get that number. 

And, no, I do not expect that to be a high-cost number. If it is a 

high-cost number, that company probably has some other management problems, as well. 

Senator MENENDEZ. Thank you. Thank you, Mr. Chairman. 

Chairman JOHNSON. Senator Akaka. 

Senator AKAKA. Thank you very much, Mr. Chairman, and I welcome our witnesses here as we hear what is the latest that has 

been happening to the Dodd-Frank bill and how it has impacted 

our national community. 

Ms. Roper, you have mentioned that the Dodd-Frank bill is a 

multi-protection framework and it provides tools that investors 

need to deal with, and I want to speak toward the Investor Advocate. In the Office of the Investor Advocate, which was created to 

empower retail investors and represent their interests with the 

SEC and SROs, there will now be an independent external check 

that investors did not have during the Madoff or Stanford Ponzi 

schemes or the financial crisis. My question to you is, how will the 

structure of the Investor Advocate affect its ability to achieve its 

purpose? 

Ms. ROPER. I think we know from looking at how Inspector Generals function within agencies that if we want them to have any 

sort of ability to hold the agency accountable, they have to be independent and they have to have the ability to report out when they 

find problems. And the strength, I think, of the investor protection, 

the Office of Investor Advocate provision in this Act are precisely 

those, frankly, that former Chairman Pitt has criticized. They are 

the provisions that ensure that this office does not become just another weak and meaningless addition to the SEC bureaucracy. 
28 

You know, agencies do not like their IGs. They are uncomfortable 

with that function within the agencies. But I think we can all agree 

that they do perform a valuable function in terms of holding the 

agency accountable. The Office of Investor Advocate has exactly 

that same potential, to hold the agency accountable for being responsive to investor concerns. 

Now, I find it interesting that people who say that the SEC’s job 

to be the investor advocate are so threatened by the notion that it 

would be held accountable for listening to investor concerns. The 

Office of Investor Advocate cannot compel them to do anything. But 

they cannot be ignored, because they have to—the Commission has 

to respond. They cannot be denied access to the paperwork that 

they need to analyze proposals. They have to be built into the process of developing the Commission’s rule proposals and agenda. 

You know, I think that it is instructive that these same provisions that are designed to make the agency accountable to investors are viewed as so threatening by some. When I hear these 

words, the SEC, we do not need this because the SEC is the investor advocate, well, I have been an investor advocate for 25 years 

and, you know, I do not think you would find a single investor advocate who would agree with that statement. It is not the SEC’s 

job to advocate on behalf of investors, and in the best of times, investors find it very difficult to have their voices heard. 

So I think this is an important addition to the Act. I look forward 

to having the office established and up and running, and I think 

we can trust—the Chairman said, we will appoint this person. We 

will not put cowboys into that office who will behave recklessly. It 

is not in their interest. 

And just one final note. This question of the—the threat is that 

the Investor Advocate can criticize the agency action. What we are 

talking about here is that they report to their oversight committee. 

Now, Members of this Committee just expressed a lot of concern 

about the ability of Congress to provide effective Congressional 

oversight. The fact that the Office of Investor Advocate will be reporting to the oversight committee should ensure that the committees can do a better job of providing oversight to ensure that the 

Commission is effectively protecting the interests of investors. 

Senator AKAKA. Thank you. 

Mr. Massey, you have mentioned that this bill should be implemented fully, and Mr. Turner also said that the law should be enforced. Mr. Massey, NASAA’s statement on an SEC study on the 

obligations of broker-dealers and investment advisors said that a 

uniform fiduciary standard would have a, and I quote, ‘‘significant 

positive impact on investors.’’ Do you have anything to add to Ms. 

Roper’s comments about how investors would be positively impacted by a uniform fiduciary standard? 

Mr. MASSEY. Senator, I agree substantially with what Ms. Roper 

said. I would add that I believe that it is appropriate to introduce 

a fiduciary standard on those brokers who are presenting themselves as purveyors of investment advice. 

The brokerage industry has gone to a marketing mode in which 

it holds itself out to retail investors as being trusted advisors. Surveys have shown that regular retail investors do not know the difference between a stockbroker and an investment advisor, and they 
29 

also believe that when they are sitting in front of a financial professional, that that financial professional is acting in their best interest, but that is not the situation. 

The fiduciary duty that has been discussed would be imposed 

only on the brokers who are providing investment advice just like 

investment advisors provide investment advice. So if you are going 

to present yourself as a trusted advisor, you ought to be held to the 

standards of a trusted advisor and be responsible. The benefits to 

the investors would be a mandatory disclosure of any conflicts of 

interest that might show any kind of bias in that advice that is 

being communicated. The benefits would be to obtain full information about the—enabling the investor to choose the best performing 

product at the lowest expense to the investor. It makes sense to me 

and we fully support it. 

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

Chairman JOHNSON. Senator Hagan. 

Senator HAGAN. Thank you, Mr. Chairman, and thank you for 

holding this hearing on investor protection after the financial crisis. 

I did want to welcome David Massey, who is from my State in 

North Carolina, and he has been a strong advocate for investors, 

especially those who lack the expertise or resources to protect 

themselves, so thank you for being here, too, and all of thee other 

panel members for being here. 

I did want to ask Mr. Pitt, Mr. Atkins, and Mr. Turner a question concerning the Department of Labor. Right now—recently, the 

DOL has unilaterally proposed regulations under ERISA that 

would redefine the term ‘‘fiduciary,’’ and many of my colleagues, I 

know, have expressed concerns about the coordination that is taking place, or the lack of coordination, too, between the SEC and the 

Department of Labor. In light of the SEC’s recommendation that 

the Commission use its authority under Dodd-Frank to promulgate 

a uniform standard, and given you all’s expertise at the SEC, I 

wanted to get your thoughts on this matter. Are you concerned that 

DOL’s changes have not been made in coordination with the SEC, 

and what could some of the consequences of this coordination, if it 

does not take place, if we do not have the coordination? 

Mr. PITT. I believe in requiring coordination between agencies of 

Government. It is one Government, and when Paul Atkins and I 

were there, when we would take enforcement actions that affected 

national banks or affected entities overseas, we would coordinate 

with the Federal Reserve Board or the State Department. I think 

there is no place for unilateral action when other agencies have a 

vested interest. And indeed, in the context of pension investments, 

the SEC has a lot of expertise to offer in that area. 

Senator HAGAN. Mr. Atkins? 

Mr. ATKINS. Yes, Senator. I agree with Chairman Pitt. Both SEC 

and the Department of Labor have overlapping jurisdiction with respect to these pension funds, 401(k) offerings, which touch just 

about everybody in the country. So, it is really vital that they coordinate, and as you are saying, the current situation has been 

characterized apparently by a lack of coordination. What is really 

important here are the consequences of unilateral action. It will 
30 

raise costs and restrict choices that people have with respect to 

their 401(k) programs. The huge liability that will come down to 

peripheral actors will really discourage those people from being involved. 

Senator HAGAN. I have heard that quite a bit. 

Mr. Turner? 

Mr. TURNER. Senator Hagan, the proposals that you refer to relate to a fiduciary standard that, as I recall, was adopted back at 

the time of ERISA, back in 1974. So things have dramatically 

changed since then. I think the Secretary over there is absolutely 

correct that they need to be updated. It has been, what, 35, 36, 37 

years since those things were done, and investment funds like 

401(k)s, IRAs, et cetera, have dramatically changed since then. I 

have served on the board of a mutual fund as a trustee. I currently 

am an independent member of the board of a $40 billion pension 

fund, as well, so have to deal with those fiduciary laws. And I do 

think that they need to be changed and updated. 

The things she is changing to, in fact, are already in many instances incorporated into our contracts, so she is catching up the 

law to already what exists in many of our business contracts. So 

I do not think it is as dramatic a change as what some criticize her 

for. So I think they are good rules. I think she should move forward 

with them. But to the same point that Paul and Harvey say, 

though, in this city, it is always good to have people coordinate 

with one another and be talking with one another. I do not care 

whether it is the banking regulators, the SEC, CFTC. The more 

you can get in the room and hash over things, I think that is good. 

But ultimately, the independence of any agency or any cabinet 

position, I think, is important. Ultimately, it is the Department of 

Labor Secretary that is responsible for those rules. So if she goes 

through consultation, including with the SEC, and then decides 

after that to go ahead and move, I do not have a problem with that 

because I think she is moving wisely in the right direction. But I 

would certainly encourage her to do that after consultation with 

the Commission. 

Senator HAGAN. Well, it seems to me that it would be a problem 

if we have two different definitions of ‘‘fiduciary,’’ one at the DOL 

and then one at the SEC. 

Mr. TURNER. I would say this, that the things she is dealing 

with—there are two different things here. The fiduciary standard 

she is dealing with is dealing with what ultimately runs to the 

trustees on those funds. It will be applied broader, and I think to 

that extent, your concern has got some basis. But I do not think 

it is necessarily going to be the same fiduciary situation that the 

SEC necessarily has, so I do not know that, ultimately, at the end 

of the day, if they all talk to one another, I think you can have 

them talk to one another until they get blue in the face, and they 

may actually find that they do not have the same fiduciary standard at the end of the day. 

Ms. ROPER. Yes. I think there is an issue here. I actually think 

if you look at it, you will find that the changes to the fiduciary definition under DOL actually bring it closer into alignment with the 

definition of fiduciary under securities laws. The problem is not so 
31 

much with the definition, but then what flows from that definition 

under ERISA. 

And when I first started looking at this issue, I assumed, oh, it 

is fiduciary duty. I am all for it. As we have looked at the issues 

more closely, there are issues with the ERISA proposal, I mean, 

with the DOL proposal on fiduciary duty and they are varied. One 

of them is that there is a conflict with the business conduct rules 

for swaps dealers. And I was involved working with the drafters in 

writing that section of the legislation and the clear intent was to 

avoid bringing the ERISA fiduciary duty into this interaction between swaps dealers and special entities because it then brings— 

you know, you cannot have an adverse interest. You basically cannot be a counterparty. 

Now, members worked very hard to draft the legislation in a way 

that did not bring ERISA into play. Under the DOL fiduciary definition, there are things that swaps dealers that would have to do 

to satisfy the business conduct rules that would make them fiduciaries under the DOL definition and then would preclude them 

from acting as counterparties, precisely what Congress was trying 

to avoid. 

There are other problems. I think a legitimate concern about 

what happens in, say, the individual retirement account context—— 

Senator HAGAN. I am hearing a lot of concerns on that. 

Ms. ROPER. Right. If you bring into play the DOL, the ERISA restrictions on any third-party compensation, say, 12(b)(1) fees, they 

are not—these are not irresolvable problems. I mean, you can—but 

the real issue here is so DOL rolled out what I think is a very well 

intended definition and one that does, in fact, come closer to the 

SEC definition, but it rolled them out without putting out the prohibited transaction exemption explanations at the same time. So 

people do not know how it is going to work in the real world. And 

all of ERISA seems I am not an ERISA expert, but all of it seems 

to be devoted to figuring out what the prohibited transaction exemptions are. 

And so you cannot sort of reasonably comment on the DOL proposal of the fiduciary definition unless you know how it is going to 

interact with those exemptions. So while we would very much like 

to see the agency move forward with a proposal that is designed 

to benefit investors, there are issues with that definition that need 

to be resolved before it is finalized. 

Senator HAGAN. I see that my time has expired, but I do have 

other questions that I will submit to the record. Thank you, Mr. 

Chairman. 

Chairman JOHNSON. Thank you. 

Senator Shelby has one last question. 

Senator SHELBY. Just a few observations. Thank you, Mr. Chairman, for calling this hearing. I think it is important. 

One of my observations, and I have asked everybody that has 

come before this Committee for the last 25 years that were nominated for the Securities and Exchange Commission, a Commissioner and the Chairman, who owns a corporation? Who does? And 

what does a corporation exist for, for whom? The shareholder. Who 

owns it? The shareholder. Not management. Not special interests 
32 

and so forth. In other words, shareholders, the investors, certainly 

not the directors or management. 

I believe that we need to have—create conditions, that is, our 

regulators and so forth, where a corporation cannot be hijacked for 

financial reasons by management or by special interests also hoping to advance a political agenda, because why do you buy stock? 

To make money, for it to grow and so forth. 

So our challenge, I believe, is how do we balance all of this without destroying something. We certainly do not want to give management a free pass. On the other hand, I do not think we ought 

to give special interests a free pass to hijack a company to advance 

something other than making money for me or my pension fund or 

my mutual fund or whatever. That is my observation. That is a 

challenge for us, as I know, and I do appreciate all of you coming 

here today. I think we had a lively discussion and a very important 

one. 

Thank you, Mr. Chairman. 

Chairman JOHNSON. I thank each witness for testifying and we 

appreciate your concern for the protection of investors in the 

United States securities markets. 

I ask all the Members of the Committee to submit any questions 

for the record by close of business next Tuesday, and I ask the witnesses to submit your answers to us in a timely manner. 

This hearing is adjourned. 

[Whereupon, at 11:58 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 
33 

PREPARED STATEMENT OF DAVID MASSEY 

NASAA PRESIDENT AND NORTH CAROLINA DEPUTY SECURITIES ADMINISTRATOR

JULY 12, 2011 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee, I’m 

David Massey, Deputy Securities Administrator for North Carolina and President 

of the North American Securities Administrators Association, Inc. (‘‘NASAA’’). I am 

honored to be here today to discuss how the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (the ‘‘Dodd-Frank Act’’) is providing enhanced protection 

to investors, particularly Main Street Americans who are looking to lawmakers and 

State and Federal regulators to help them rebuild and safeguard their financial security. 

The Wall Street reforms and investor protection provisions in the Dodd-Frank Act 

were born out of necessity. The financial crisis made it clear that the existing securities regulatory landscape required an overhaul. NASAA sincerely appreciates the 

work of Chairman Johnson and Members of this Committee to ensure that investor 

protection remained the foremost goal of the legislative effort to usher in the next 

generation of financial services regulation. 

This comprehensive law was crafted to promote stronger investor protection and 

more effective oversight to help prevent another economic crisis and restore the confidence of Main Street investors. The Dodd-Frank Act addresses a number of critical 

issues for investors by incorporating disqualification provisions to prevent securities 

law violators from conducting securities offerings under SEC Regulation D, Rule 

506; strengthening the accredited investor standard; and increasing State regulatory 

oversight of investment advisers. Dodd-Frank also includes a provision to safeguard 

senior investors from unqualified advisers and creates an investor advisory committee to advise the SEC on its regulatory priorities. In two other priority areas for 

investors, fiduciary duty and arbitration, the law authorizes the SEC to take action 

to provide enhanced protections and remedies for investors. 

Role of State Securities Regulators 

State securities regulators have protected Main Street investors from fraud for 

the past 100 years, longer than any other securities regulator. From the enactment 

of the first blue sky securities law in Kansas in 1911, State securities regulators 

continue, more so than any other kind of regulator, to focus on protecting retail investors. Our primary goal has been and remains to advocate and act for the protection of investors, especially those who lack the expertise, experience, and resources 

to protect their own interests. 

The securities administrators in your States are responsible for enforcing State 

securities laws, the licensing of firms and investment professionals, registering certain securities offerings, examining broker-dealers and investment advisers, pursuing cases of suspected investment fraud, and providing investor education programs and materials to your constituents. Like me, 10 of my colleagues are appointed by State Secretaries of State, five come under the jurisdiction of their 

States’ Attorneys General, some are appointed by their Governors and Cabinet officials, and others work for independent commissions or boards. Many call us ‘‘local 

cops on the securities beat.’’ I think of my State colleagues at NASAA as a national 

network of local crime fighters working to protect investors. 

Securities regulation is a complementary regime of both State and Federal securities laws, and we work closely with our Federal counterparts to uncover and prosecute violators of those laws. 

States have been the undisputed leaders in criminal prosecutions of securities violators because we believe in serious jail time for securities-related crimes. Over the 

past few years, ranging from 2004 through 2009, State securities regulators have 

conducted nearly 14,000 enforcement actions, which led to $8.4 billion ordered returned to investors. And, we have worked to secure convictions for securities laws 

violators resulting in more than 6,000 years in prison. 

Traditionally, State securities regulators have pursued the perpetrators at the 

local level who are trying to defraud the ‘‘mom and pop’’ investors in your States. 

That allows the SEC to focus on the larger, more complex fraudulent activities involving the securities market at a national level. 

Even so, States have successfully exposed and addressed the conflicts of interest 

among Wall Street stock analysts by requiring changed behavior. We led all regulators on late trading and market timing in mutual funds. And State securities regulators continue to lead the nationwide effort to address problems related to the 

offer and sale of auction rate securities, an effort that has resulted in the largest 

return of funds to investors in history. As regulators, we are convinced that every 

investor deserves protection and an even break. 
34 

Enhanced Investor Protections in Dodd-Frank 

As we enter our second century of investor protection, State securities regulators 

are at the forefront of investor protection. By passing and signing the Dodd-Frank 

legislation into law, President Obama and Congress signaled the beginning of a new 

era of investor protection and financial market oversight. Reforms now taking shape 

at the national level are giving new authority to State securities regulators to address the challenges facing 21st century investors. 

Trust in the markets must be restored if our system of capital formation is to 

thrive. The Dodd-Frank Act helps restore investor trust by enacting a number of 

much-needed investor protections that empower State securities regulators to protect citizens from fraud and abuse in the financial markets. 

Reducing Investor Risk in Rule 506 Offerings 

Section 926 of the Dodd-Frank Act took a necessary first step toward reducing 

risks for investors in private offerings by requiring the SEC to issue rulemaking excluding securities law violators from utilizing the Regulation D, Rule 506 exemption 

(‘‘Rule 506’’) from securities regulation. In 1996, the National Securities Markets 

Improvement Act dramatically curtailed the authority of State securities regulators 

to oversee these unregistered private offerings. Rule 506 offerings are also exempted 

from Federal oversight and the SEC generally does not review them, so they receive 

virtually no regulatory pre-screening. 

These unregistered private offerings naturally have become a favorite vehicle for 

unscrupulous promoters, who use the Rule 506 exemption to fly under the radar. 

In 2009, more than 26,000 of these offerings were filed with the SEC with an estimated offering total of $609 billion. Section 926 took the important step of ensuring 

that promoters and brokers who have a criminal or disciplinary history will no 

longer be able to prey on investors by using this exemption from registration. 

We appreciate the inclusion in the Dodd-Frank Act of the so-called ‘‘bad actor’’ 

disqualifier language to prevent recidivist securities law violators from conducting 

securities offerings under Rule 506. However, we continue to believe the best way 

to deter fraud is to fully reinstate State authority over these unregistered offerings 

through the repeal of Subsection 18(b)(4)(D) of the Securities Act of 1933. Allowing 

State securities regulators to review these offerings provides regulators with a powerful weapon to detect and prevent fraud. 

As required under Section 926, the SEC recently proposed rules mandated by the 

Dodd-Frank Act to disqualify known securities law violators from using the exemption contained in Regulation D, Rule 506. The proposed rules protect investors without hampering legitimate capital-raising by disqualifying felons and other ‘‘bad actors’’ from evading registration and review. Under the proposal, an offering would 

not qualify for the exemption from registration if the company issuing the securities 

or any other person covered by the rule had a specified ‘‘disqualifying event.’’ 

NASAA is a long-time supporter of the adoption of disqualification provisions for 

securities offerings under Rule 506. We commend the SEC for proposing disqualification provisions that are in line with many of our concerns and will continue to 

work with the SEC to strengthen the proposal. 

Strengthening the ‘‘Accredited Investor’’ Standard 

Private offerings were originally intended only for institutional investors and sophisticated individuals who were presumed capable of assessing risks and making 

investment decisions without the benefit of regulatory review and registration. The 

‘‘accredited investor’’ standard, which sets out certain financial thresholds that must 

be met before an investor can purchase private offerings, was adopted as a means 

of assessing which investors could presumably fend for themselves. The standard as 

adopted by the SEC in 1982 has remained unchanged. Inflation has severely diminished the standard and eroded the investor protection goals it was meant to serve. 

To make matters worse, investors, and particularly retirees, with much of their net 

worth tied to their homes have been able to meet these diminished standards and 

purchase risky private placements that they may not fully understand. 

NASAA has long advocated for adjusting the definition of ‘‘accredited investor’’ in 

light of inflation and has expressed concern at the length of time the thresholds contained in the definition have remained static. 

Section 412 of the Dodd-Frank Act addressed this problem by adjusting the financial thresholds in the definition of an ‘‘accredited investor’’, and by removing the 

value of the investor’s primary residence from the net worth calculation. DoddFrank also directs the SEC, 4 years after enactment, and once every 4 years thereafter, to review the definition of ‘‘accredited investor’’ to determine whether the requirements of the definition should be adjusted or modified for the protection of in-
35 

vestors, in the public interest, and in light of the economy. Upon completion of the 

review, the SEC may adjust the other economic elements of ‘‘accredited investor’’. 

Raising the standard for individual investors will provide greater protection for 

investors and will aid State regulators in enforcement activities by furthering more 

accurate suitability determinations for those individuals who choose to take greater 

risks by investing in unregistered securities. 

Expanding State Oversight of Investment Advisers with the IA ‘‘Switch’’ 

The oversight of investment advisers has always been a partnership between 

State and Federal regulators, both of which are directly accountable to the investing 

public. Congress recognized the strong record of the States in this area when it enacted Section 410 of Dodd-Frank to expand State authority to include mid-sized investment advisers with $25 million to $100 million in assets under management. 

By the time this provision takes effect in mid-2012, State securities regulators 

will oversee the majority of all registered investment adviser firms. Having the 

States assume responsibility for mid-sized advisers will allow the SEC to focus on 

larger advisers. Investors will benefit from this change because it will enable the 

SEC to focus on the largest investment advisers, while mid-sized and smaller advisers will be subject to the strong State system of oversight and regulation. 

States continue to prepare to receive oversight of approximately 3,200 mid-sized 

investment advisers from the SEC. Over the past year, NASAA members have been 

hosting a series of workshops for investment advisers in their jurisdictions. This 

outreach program is helping to educate federally regulated advisers about State registration and examination requirements. In addition, NASAA developed a memorandum of understanding calling for State securities agencies, when necessary, to 

assist one another with examinations of investment advisers. This MOU embodies 

the long-standing practice among NASAA members to work together to protect investors. NASAA members are actively engaged in sharing resources, including staff 

expertise, in an effort to bolster examination programs. 

Last month, the SEC extended its timeline for this ‘‘investment adviser switch’’ 

from later this year into the middle of 2012 to accommodate the reprogramming of 

the Investment Adviser Registration Depository (IARD) system and to give investment advisers sufficient time to transition from SEC to State registration. NASAA 

remains committed to coordinating the actions of the States in response to the 

SEC’s timetable and we will continue to work with the SEC, as well as industry, 

to see that the switch by investment advisers from SEC regulation to State regulation goes as efficiently and seamlessly as possible. 

Extending the Fiduciary Duty 

State securities regulators routinely see the financial devastation caused when the 

interests of investors do not come first. That is why NASAA has consistently urged 

policymakers to protect investors by requiring all who provide investment advice 

about securities to be held to the fiduciary duty currently applicable to investment 

advisers under the Investment Advisers Act of 1940. 

Section 913 of the Dodd-Frank Act called for the SEC to examine the obligations 

of brokers, dealers, and investment advisers. We support the recommendations of 

the SEC staff report to apply a fiduciary duty to broker-dealers who provide personalized investment advice about securities to retail customers and believe it will have 

a significant positive impact on investors. NASAA looks forward to assisting the 

Commission as it develops rules to apply a fiduciary standard of care and loyalty 

to all who provide investment advice to ensure that this standard is as strong as 

the existing fiduciary duty of the Advisers Act. 

Delays to Important Investor Protections 

As with the fiduciary duty provision, Dodd-Frank shifts the ultimate responsibility to decide whether, and in what form, several important investor safeguards 

will be delivered. For example, the SEC and the Commodity Futures Trading Commission were given broad and sorely needed regulatory authority over certain segments of our marketplace, such as over-the-counter derivatives and private funds. 

Yet in spite of their increased responsibility, the agencies are operating at inadequate funding levels. NASAA has consistently urged Congress to support funding 

the SEC at the level requested by the Administration so that the agency can fully 

implement its responsibilities mandated by Dodd-Frank. We support funding the 

SEC at the $1.3 billion level authorized by Dodd-Frank to carry out the functions, 

powers and duties of the Commission for FY 2011. 

Giving Investors a Voice at the SEC 

The SEC has already deferred action on a number of new activities, such as the 

creation of the Office of Investor Advocate and the Investor Advisory Committee. In 
36 

2009, the SEC established an Investor Advisory Committee to provide the Commission with a variety of viewpoints regarding its regulatory agenda. The committee 

included a State securities regulator, along with other investor advocates, to make 

certain that all SEC regulatory actions serve the best interests of investors. 

This committee wound down in anticipation that legislation, ultimately the DoddFrank Act, would resurrect it under a statutory mandate. Indeed, Section 911 of the 

Dodd-Frank Act did require the SEC to establish and maintain a committee of investors to advise the SEC on its regulatory priorities and practices and also designated that a State securities regulator continue to serve as a member. SEC Commissioner Luis Aguilar recently said that this committee is of ‘‘critical importance 

to ensuring that the SEC is focused on the needs and the practical realities facing 

investors.’’ Unfortunately, budget uncertainty has forced the SEC to defer the creation of the Investor Advisory Committee. 

Providing Choice of Forum for Investors and Promoting Transparency 

Every year thousands of investors file complaints against their stockbrokers. Almost every broker-dealer presently includes in their customer agreements a mandatory pre-dispute arbitration provision that forces those investors to submit all disputes that they may have with the brokerage firm or its associated persons to mandatory arbitration. If cases are not settled, the only alternative is arbitration. For 

all practical purposes, the only arbitration forum available to investors is one administered by the Financial Industry Regulatory Authority (FINRA). 

Arbitration has been presented to the investing public as an inexpensive, informal, totally private process that results in a speedy resolution of cases. However, 

the mandatory arbitration provisions in contracts take away the ability of a harmed 

customer to ‘‘have their day in court’’ by forcing investors into a forum that limits 

discovery, reduces the pleading standards and allows decisions in which there is severely limited appeal. Arbitration as it exists does not treat the investing public 

fairly. If the system were a level playing field, arbitration probably would not be 

a universal requirement of the brokerage industry, and the investing public likely 

would embrace it voluntarily. Not surprisingly, studies have confirmed the belief 

that the securities arbitration forum is not perceived as fair to investors, and recovery rates in fact favor the securities industry. 

In February, the SEC approved a FINRA rule proposal that would allow all investors filing arbitration claims the option of having an all-public panel, thus expanding a pilot program to all investor claims. Historically, the panels had been comprised of two public arbitrators and an arbitrator who had worked in the securities 

industry. The FINRA rule change was an important step toward leveling the playing field for investors and improving the integrity of the arbitration system. However, with the economy as it is today, investor confidence remains very low. Another 

major step in restoring investor confidence and industry integrity would be to restore investor choice in their agreements with their brokerage firm. 

Section 921 of Dodd-Frank provides the SEC with rulemaking authority to prohibit, or impose conditions or limitations on the use of mandatory predispute arbitration agreements if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors. Pursuant to 

this provision, Congress should urge the SEC to use the authority provided the 

agency in Section 921 and impose rules prohibiting the mandatory nature of predispute securities arbitration. This would allow investors the choice they ought to 

have between arbitration and litigation in an independent judicial forum. 

Funding the Grant Program to Safeguard Senior Investors from Unqualified Advisers 

One of the highest priorities of NASAA’s membership is to protect vulnerable senior investors from investment fraud. We have long been concerned with the use of 

misleading professional designations that convey an expertise in advising seniors on 

financial matters. Many of these designations in reality reflect no such expertise. 

Our concern led us to promulgate a model rule designed to curb abuses in this area, 

and 27 States have adopted rules or laws governing the use of these designations. 

Section 989A of Dodd-Frank recognizes the harm to seniors posed by the use of 

such misleading activity and establishes a mechanism for providing grants to States 

as an incentive to adopting provisions meeting the minimum requirements of 

NASAA’s model rule on the use of designations in the offer or sale of securities or 

investment advice. The law provides parallel incentives for States that have adopted 

provisions meeting the minimum requirements of the National Association of Insurance Commissioners’ model rule on the use of senior designations in the sale of life 

insurance and annuities. 
37 

1The size of the municipal market is approximately $3.7 trillion. See Bloomberg L.P., Municipal Market: Bloomberg Brief (June 21, 2011). It is estimated that approximately two-thirds of 

the municipal market is comprised, directly or indirectly, of retail investors. See SIFMA Statistics, U.S. Municipal Securities Holders, Quarterly Data to Q1 2011. 

The grants are designed to give States the flexibility to use funds for a wide variety of senior investor protection efforts, such as hiring additional staff to investigate 

and prosecute cases; funding new technology, equipment, and training for regulators, prosecutors, and law enforcement; and providing educational materials to increase awareness and understanding of designations. 

Unfortunately, disputes over the funding and leadership of the Consumer Financial Protection Bureau (‘‘CFPB’’) not related to investor protection have indefinitely 

delayed the creation of the senior investor protection grant program under Section 

989A. The CFPB Office of Financial Literacy must be fully funded and operational 

to begin issuing grants of up to $500,000 to States that have adopted the NASAA 

and NAIC model rules on misleading senior designations. These important senior 

investor protections should not be delayed because Congress has not provided sufficient funding for the Federal financial regulatory agencies. 

Conclusion 

As discussed above, the Dodd-Frank Act provides meaningful, tangible benefits to 

investors. It requires the SEC to raise standards that are long overdue and blocks 

fraudulent actors from taking advantage of exemptions that should be reserved for 

reputable issuers. The Dodd-Frank Act empowers the SEC to raise the standards 

under which broker-dealers provide investment advice to ensure that the interests 

of investors come first. The law also recognizes the investor protection contributions 

of State regulators by increasing our authority over the regulation of investment advisers and by ensuring we have a voice on both the SEC’s investor advisory committee and the Financial Stability Oversight Council. I am honored to serve on the 

FSOC along with my State banking and insurance colleagues. State regulators bring 

to the FSOC the insights of ‘‘first responders’’ who see trends developing at the 

State level that have the potential to impact the larger financial system. 

I want to thank Chairman Johnson for his consistent support for the important 

investor protections included in the Dodd-Frank Act. I appreciate your comments, 

Senator Johnson, that it ‘‘would be dangerous and irresponsible,’’ to rollback these 

hard-won reforms. 

Our message to Congress is simple and clear: Please continue your commitment 

to protecting investors and do not undermine the Dodd-Frank Act’s regulatory authority either directly through legislative repeals or indirectly through a lack of appropriate funding or delayed execution. 

We look forward to working cooperatively with the Senate Banking Committee, 

as well as all Members of Congress and fellow regulators to ensure full implementation of the investor protections included in the Dodd-Frank Act. 

PREPARED STATEMENT OF LYNNETTE KELLY HOTCHKISS 

EXECUTIVE DIRECTOR, MUNICIPAL SECURITIES RULEMAKING BOARD

JULY 12, 2011 

Good morning Chairman Johnson, Ranking Member Shelby and Members of the 

Committee. I appreciate the invitation to testify today on behalf of the Municipal 

Securities Rulemaking Board. 

Since the MSRB was created by Congress in 1975 as the principal regulator for 

the municipal securities market, the MSRB has placed investors front-and-center in 

all of our market initiatives. Through our rulemaking over municipal market intermediaries as well as our ground-breaking market information systems, we have put 

in place protections for the significant U.S. retail market for municipal securities.1

While the MSRB’s original jurisdictional authority was limited to the regulation 

of broker-dealers and banks that buy, sell, trade and underwrite municipal bonds 

(referred to herein as ‘‘dealers’’) with the principal purpose of protecting investors, 

Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DoddFrank Act) greatly expanded our ability to protect investors and increased our responsibilities to the marketplace by vesting us with the duties of regulating municipal advisors and protecting State and local government issuers, public pension 

plans and obligated persons. Over the past year, the MSRB has undertaken substantial rulemaking and transparency efforts to promote high standards of professional conduct and market disclosure aimed at creating conditions for fair, well-informed financial decisions by all market participants. 
38 

2Pub. L. No. 111–203 §975, 124 Stat. 1917 (2010). 3Pub. L. No. 111–203 §§942–943, 124 Stat. 1897 (2010). 4Pub. L. No. 111–203 §932, 124 Stat. 1872–1888 (2010). 5Pub. L. No. 111–203 §764, 124 Stat. 1785 (2010). 6Pub. L. No. 111–203 §975, 124 Stat. 1918 (2010). 7Pub. L. No. 111–203 §975, 124 Stat. 1917 (2010). 8Pub. L. No. 111–203 §975, 124 Stat. 1919 (2010). 

The MSRB cannot act as a guarantor against poor decisions by either investors 

or issuers, or guard against the occurrence of adverse events in the market. However, we believe that a principles-based approach to regulating market intermediaries leads to the best possible outcome in terms of market fairness and efficiency. Key elements to ensuring such a fair and efficient market are such principles 

as suitability, disclosure, pricing and liquidity for investors. These elements also can 

have a substantial impact on the taxpayer’s wallet and the public’s confidence in 

the municipal market. 

Since Dodd-Frank was signed into law, the MSRB has been operating under the 

leadership of its first majority-public Board of Directors, which represents the interests of the public and municipal market investors and issuers, in addition to regulated entities. This public Board has moved decisively but carefully to put in place 

safeguards that more fully protect the municipal market that is so fundamental to 

the public interest. 

Since last October, MSRB rulemaking initiatives have addressed fiduciary duty, 

fair dealing, municipal advisor registration, pay-to-play, gift-giving and supervision. 

We are also developing municipal advisor professional qualifications requirements, 

including appropriate licensing examinations, and have enhanced our Electronic 

Municipal Market Access (EMMA) Web site to allow investors unprecedented access 

to market data and disclosures. These are the initiatives I would like to discuss with 

you today. 

The Dodd-Frank Act and the Municipal Market 

First, I would like to address the impact of the Dodd-Frank Act on the municipal 

market. This piece of legislation represents the most significant change affecting the 

municipal market since 1986—including key changes in the regulatory landscape for 

municipal advisors,2 asset-backed securities,3 credit rating agencies 4 and derivatives.5 Furthermore, to our knowledge, this is the first time Congress has enacted 

a law to protect issuers of securities.6

The MSRB’s expanded authority falls under Title IX of the Dodd-Frank Act, 

which covers investor protections and improvements to the regulation of securities 

intermediaries. The Dodd-Frank Act granted the MSRB regulatory jurisdiction over 

municipal advisors.7 It also provides that MSRB rules for municipal advisors are to, 

among other things: (1) promote fair dealing, the prevention of fraudulent and manipulative acts and practices, and the protection of investors, municipal entities, and 

obligated persons; (2) prescribe means reasonably designed to prevent acts, practices, and courses of business that are not consistent with a municipal advisor’s fiduciary duty to its municipal entity clients; (3) prescribe professional standards; (4) 

provide continuing education requirements; (5) provide for periodic examinations; (6) 

provide for recordkeeping and record retention; and (7) provide for reasonable fees 

and charges necessary or appropriate to defray the costs and expenses of operating 

and administering the Board.8

The establishment of a comprehensive set of rules for the activities of municipal 

advisors will provide significant protections to State and local governments and 

other municipal entities and will greatly enhance the existing protections afforded 

to investors beyond the protections already provided by the MSRB’s longstanding 

investor protection rules covering broker-dealers and banks. By way of illustration, 

the MSRB has previously established a series of investor protection rules covering 

the activities of brokers marketing 529 college savings plans, which are investments 

sold exclusively to parents, grandparents and other retail investors, many of whom 

may have little or no prior experience as investors. With the enactment of DoddFrank, the MSRB now has authority to adopt a more comprehensive set of rules 

that go beyond the brokers marketing 529 plans to professionals that advise the 

States on the structure and related fundamental matters relating to the operation 

of such 529 plans that have a direct impact on investors and beneficiaries of the 

plans. 

The MSRB has undertaken its Dodd-Frank responsibilities in a deliberate and 

thorough manner, recognizing that many of these financial professionals and products are falling under regulation for the first time. With respect to the Dodd-Frank 

provisions that affect the municipal market, but that come under the purview of 

other Federal regulators, the MSRB has provided input and coordinated with other 
39 

9See, e.g., MSRB Comment Letter Re: SEC Proposed Rules on Registration of Municipal Advisors, File No. S7–45–10 (February 22, 2011). 10MSRB Notice 2011–14 (February 14, 2011). 11Section 4s(h)(5) of the Commodity Exchange Act, as amended by the Dodd-Frank Act, requires that a swap dealer with a special entity client (including States, local governments and 

public pension funds) must have a reasonable basis to believe that the special entity has an 

independent representative that satisfies these criteria, among others. Section 15F(h)(5) of the 

Exchange Act, as amended by the Dodd-Frank Act, imposes the same requirements with respect 

to security-based swaps. 12Pub. L. No. 111–203 §975, 124 Stat. 1922 (2010). 13SEC Complaint ¶ 1, SEC v. J.P. Morgan Securities LLP, Case No. 2:11–cv–03877 (D.N.J. 

July 7, 2011) (alleging fraudulent bidding practices by J.P. Morgan Securities in at least 93 municipal bond reinvestment transactions); SEC Litigation Release No. 21956, Securities and Exchange Commission v. UBS Financial Services Inc. (May 4, 2011) (alleging fraudulent bidding 

practices by UBS Financial Services in at least 100 municipal bond reinvestment transactions); 

In the Matter of Banc of America Securities LLP, Exchange Act Release No. 63451 (December 

7, 2010) (alleging fraudulent bidding practices by Banc of America Securities in at least three 

municipal bond reinvestment transactions) [hereinafter Bid Rigging Enforcement Actions]. 

municipal market authorities to create consistent and well thought-out regulatory 

decisions.9 We would especially like to recognize the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority and the Commodity Futures Trading Commission in these coordination efforts. 

Fiduciary Duty 

I would now like to turn our attention to MSRB rulemaking efforts since the 

Dodd-Frank Act became effective. The Dodd-Frank Act has fundamentally altered 

the relationship of municipal advisors and municipal entities. As of October 1, 2010, 

municipal advisors owe a Federal fiduciary duty to their municipal entity clients 

under the Dodd-Frank Act. The MSRB has proposed a rule and interpretive guidance to provide the underpinning for this fiduciary duty.10 The MSRB’s interpretive 

guidance would provide that a municipal advisor has a duty of loyalty to its municipal entity client, which requires the municipal advisor to deal honestly and in good 

faith with the municipal entity and to act in the municipal entity’s best interests. 

This duty of loyalty would also require municipal advisors to make clear, written 

disclosure of all material conflicts of interest and to receive written, informed consent from appropriate officials of the municipal entity. 

The MSRB’s interpretive guidance would also require municipal advisors to exercise due care in performing their responsibilities to municipal entity clients. That 

means that a municipal advisor should not undertake a municipal advisory engagement for which the advisor does not possess the degree of knowledge and expertise 

needed to provide the municipal entity with informed advice. For example, a municipal advisor should not undertake a swap advisory engagement or security-based 

swap engagement for a municipal entity unless it has sufficient knowledge to evaluate the transaction and its risks, as well as the pricing and appropriateness of the 

transaction.11

We believe investors will benefit from ensuring that municipal advisors act in 

their clients’ best interest. Municipal securities offerings borne from self-interested 

advice or in the context of conflicting interests or undisclosed payments to third-parties are much more likely to be the issues that later experience financial or legal 

stress or otherwise perform poorly as investments, resulting in significant harm to 

investors and increased costs to taxpayers. 

Importantly, under the Dodd-Frank Act, ‘‘municipal advisor’’ was defined to include guaranteed investment contract (GIC) brokers.12 That means that GIC brokers now have a Federal fiduciary duty to their municipal entity clients and a duty 

of fair dealing to other clients, as described below. The proposed MSRB interpretive 

guidance on fiduciary duty would provide that they could not receive payments from 

other parties in return for giving them favorable treatment in what is supposed to 

be a competitive bidding process, even if they disclosed such payments. This is a 

major increase in the arsenal of enforcement agencies that, until now, have had to 

address this conduct through their anti-fraud jurisdiction. 

We believe that the new Federal fiduciary duty, and the MSRB’s proposed guidance with respect to that duty arising from our new grant of authority under DoddFrank, would have squarely addressed much of the wrongdoing uncovered by the 

SEC, Internal Revenue Service and Department of Justice in their major GIC bid 

rigging investigation 13 had this Dodd-Frank provision been in place when the 

wrongdoing occurred. In light of these allegations concerning the conduct of GIC 

brokers, the MSRB Board of Directors will discuss whether additional guidance specifically directed at such conduct is warranted. 
40 

14See, e.g., In the Matter of J.P. Morgan Securities Inc., SEC File No. 3–13673 (October 7, 

2010) (providing a plan of final distribution for the disgorgement and civil penalty paid by J.P. 

Morgan Securities for violating MSRB Rule G–17 and other Federal securities laws). 15 17 C.F.R. § 240.10b–5, 15 U.S.C. 78j (2010). 16MSRB Notice 2010–37 (September 20, 2010). 17 Pub. L. No. 111–203 §975, 124 Stat. 1918 (2010). 18MSRB Notice 2010–59 (December 23, 2010). 19MSRB Notice 2011–12 (February 14, 2011). 20 Bid Rigging Enforcement Actions, supra note 12. 21MSRB Notice 2011–13 (February 14, 2011). 

Fair Dealing 

MSRB Rule G–17 provides that, in the conduct of its municipal securities and municipal advisory activities, each dealer and municipal advisor must deal fairly with 

all persons and may not engage in any deceptive, dishonest or unfair practice. This 

‘‘fair dealing’’ rule is key to defining the relationships of dealers and municipal advisors with investors and issuers, and has served as the basis for numerous enforcement actions.14 The MSRB’s rule goes further than SEC Rule 10b–5 15 in that it imposes an affirmative duty to supply investors and issuers with disclosure about their 

transactions. This duty exists under the MSRB’s rule even in the absence of fraud. 

Last fall, the MSRB reminded dealers of their fair dealing obligations,16 including 

their duty to disclose to customers all material facts known by the dealer and those 

reasonably accessible to the market prior to or at the time of sale of a municipal 

security. The MSRB also stated that firms must analyze and disclose credit risks 

and other material information about a bond, such as redemption options or features that would affects its tax status, in order to meet their fair dealing obligations. For example, if the credit rating of a municipal issuer was recently downgraded, the dealer must provide an investor with this information. The MSRB made 

clear to the dealer community the critical importance of sharing with investors such 

key information so they are able to make the best possible decision based on their 

individual circumstances and risk tolerance. 

As I mentioned earlier, Congress expressly directed the MSRB in the Dodd-Frank 

Act to protect municipal entities.17 As one of the MSRB’s initial municipal advisor 

rules, the MSRB extended its fair dealing rule, MSRB Rule G–17, to cover the actions of municipal advisors.18 The MSRB has proposed two pieces of interpretive 

guidance under Rule G–17, which apply this basic principle of fair dealing to municipal advisors and to underwriters of municipal securities in their interactions with 

municipal entities, as well as with organizations such as hospitals and colleges that 

borrow through municipal entities (referred to in the statute as ‘‘obligated persons’’). 

The MSRB’s proposed interpretive guidance on fair dealing obligations for underwriters 19 states that representations made by underwriters to issuers of municipal 

securities in connection with municipal securities underwritings must be truthful 

and accurate. It also requires an underwriter of a negotiated issue that recommends 

a complex municipal securities financing (e.g., a financing involving a swap) to disclose all material risks and characteristics of the financing, as well as any incentives 

for the underwriter to recommend the financing and any other conflicts of interest. 

The guidance also contains pricing and compensation standards. 

We note that, if true, the fraudulent and deceptive conduct of some major underwriters alleged to have occurred in actions brought by the SEC and Department of 

Justice as a result of their GIC bid rigging investigation 20 would be considered a 

clear violation of Rule G–17 under this proposed interpretive guidance. 

The MSRB’s proposed interpretive guidance on fair dealing obligations for municipal advisors 21 covers a municipal advisor’s duties to obligated persons in a municipal securities or financial product transaction, as well as duties to municipal entities (such as public pension funds) when the advisor is soliciting business from a 

municipal entity on behalf of a third party. This guidance contains disclosure and 

competency requirements, as well as prohibitions on engaging in municipal advisory 

business in certain conflict of interest situations, such as those involving kickbacks. 

This interpretive guidance would offer protections to market participants when a 

stronger fiduciary duty does not exist. 

A dealer’s or municipal advisor’s compliance with its fair dealing obligations to 

municipal entities creates uniform practices and fair pricing methods that improve 

market efficiency and have cascading benefits to investors in terms of receiving a 

fair return on their investment. We believe our revised fair dealing rule to be a pillar in investor protection. 
41 

22MSRB Rule G–37 was adopted by the MSRB in 1994 due to concerns about the opportunity 

for abuses and the problems associated with political contributions by dealers in connection with 

the award of municipal securities business, known as ‘‘pay to play.’’ See MSRB Reports, Volume 

14, Number 3 (June 1994). 23MSRB Notice 2011–04 (January 14, 2011). 24MSRB Notice 2011–16 (February 22, 2011). 

Pay to Play 

As the first regulator to adopt a ‘‘pay to play’’ rule,22 the MSRB recognized the 

potential for market abuse that can arise as a result of market professionals using 

political contributions to influence the award of business by public officials. The 

MSRB has curbed potential abuses by underwriters of municipal securities that 

made political contributions to win business and is seeking to do the same for municipal advisors. 

Municipal advisors that seek to influence the award of business by Government 

officials by making or soliciting political contributions to those officials distort and 

undermine the fairness of the process by which Government business is awarded. 

These practices can harm municipal entities and their citizens by resulting in inferior services and higher fees, as well as contributing to the violation of the public 

trust of elected officials. The MSRB has proposed a rule that would, for the first 

time, regulate pay to play activities of firms and individuals that advise municipal 

entities, such as State and local governments and public pension plans, on municipal securities and municipal financial products, including derivatives.23 The rule 

would also cover firms and individuals that solicit investment advisory business 

from municipal entities, such as public pension plans, on behalf of others. 

Draft MSRB Rule G–42 would require quarterly disclosure of certain campaign 

contributions and would prohibit a municipal advisor from: 

• Engaging in ‘‘municipal advisory business’’ with a municipal entity for compensation for a period of time beginning on the date of a non-de minimis political contribution to an ‘‘official of the municipal entity’’ and ending 2 years after 

all municipal advisory business with the municipal entity has been terminated; 

and 

• Soliciting third-party business from a municipal entity for compensation, or receiving compensation for the solicitation of third-party business from a municipal entity, for 2 years after a non-de minimis political contribution to an ‘‘official of the municipal entity.’’ 

Furthermore, draft MSRB Rule G–42 would prohibit municipal advisors and municipal advisor professionals from: 

• Soliciting contributions, or coordinating contributions, to officials of municipal 

entities with which the municipal advisor is engaging or seeking to engage in 

municipal advisory business or from which the municipal advisor is soliciting 

third-party business; 

• Soliciting payments, or coordinating payments, to political parties of States or 

localities with which the municipal advisor is engaging in, or seeking to engage 

in, municipal advisory business or from which the municipal advisor is soliciting 

third-party business; and 

• Committing indirect violations of Rule G–42. 

MSRB pay to play restrictions have served as a model for Federal and State regulators imposing restrictions on pay to play activities in other areas and play a vital 

role in preserving market integrity. The MSRB has served as a key resource to such 

other regulators as they have developed and administered their rules. 

Gifts 

Gifts to employees controlling the award of municipal securities business by market professionals can similarly harm investors. The MSRB limits these gifts by dealers and recently proposed to extend the restrictions of MSRB Rule G–20 to municipal advisors.24 Just as the existing rule helps to ensure that dealers’ municipal securities activities are undertaken in arm’s length, merit-based transactions in which 

conflicts of interest are minimized, amendments to Rule G–20 would help to ensure 

that engagements of municipal advisors, as well as engagements of dealers, municipal advisors, and investment advisers for which municipal advisors serve as solicitors, are awarded on the basis of merit and not as a result of gifts made to employees controlling the award of such business. 
42 

25MSRB Notice 2011–28 (May 25, 2011). 26Pub. L. No. 111–203 §975, 124 Stat. 1917 (2010). 27MSRB Press Release, MSRB Assumes Expanded Mission and Establishes Public Majority 

Board of Directors (October 1, 2010). 28Pub. L. No. 111–203 §975, 124 Stat. 1919 (2010). 

Supervision 

The establishment of a basic supervisory structure for municipal advisors is particularly important as the MSRB adopts new rules for municipal advisors that municipal advisors must understand and comply with in order to avoid possible enforcement actions and to effectively put in place practices that serve to protect investors. The MSRB recently requested comment on a supervisory rule, draft MSRB 

Rule G–44, to require that each municipal advisor firm establish a supervisory 

structure to oversee compliance with applicable MSRB and SEC rules.25

Draft Rule G–44 would require a municipal advisor to establish and maintain a 

system to supervise the municipal advisory activities of each associated person designed to achieve compliance with applicable rules. Draft Rule G–44 would also require municipal advisors to adopt, maintain and enforce written supervisory procedures designed to ensure that the conduct of the municipal advisory activities of the 

municipal advisor and its associated persons are in compliance with applicable 

rules. 

Board of Directors 

The new composition of the MSRB’s Board of Directors has assisted us in carrying 

out our regulatory actions over the past year. The Dodd-Frank Act requires the 

MSRB’s governing Board to be majority-public and to include municipal advisors.26

On October 1, 2011, the MSRB seated a 21-member Board with a majority of public members, including three municipal advisors.27 The Board also includes representatives of issuers and investors, as well as members representing securities 

firms and banks. We have a newly structured majority-public Nominating Committee chaired by a public member. 

We believe this Board of Directors reflects the benefits of a self-regulatory organization and, at the same time, the wisdom of increasingly diverse and public membership. Our rulemaking—and the public’s interest—has benefited from the many 

perspectives offered by our Board members. The Board vigorously debates issues, 

carefully considers the experience and insight of each of its members and then proceeds with the best possible course of action. We believe the progress we have made 

over the last 9 months in further protecting the market has been unprecedented. 

The rules I have mentioned are just a small part of the regulatory backbone that 

helps support a fair and efficient municipal market. 

Professional Qualifications 

It is vital to our mission that municipal market professionals can competently provide their services to investors and municipal entities. The MSRB Professional 

Qualification Program fosters competency of municipal professionals and compliance 

with MSRB rules through required examinations and continuing education. The 

Dodd-Frank Act requires the MSRB to set standards of professional qualification for 

municipal advisors.28 The MSRB has been conducting outreach events and focus 

groups to gather input from municipal advisors and others about the development 

of a professional qualification examination to assess the competency of entry-level 

municipal advisors. 

The MSRB recently organized a municipal advisor examination working group to 

consider all comments received by the MSRB, assess commonalities in municipal advisory activities and provide additional input. The working group expects to survey 

registered municipal advisors about the proposed examination content in late 2011 

and use the results of the survey to prepare a draft examination content outline. 

We will continue to keep interested parties apprised of our progress in this area as 

we proceed. 

EMMA and Market Transparency 

I would now like to discuss another top priority of the MSRB—market transparency. Beginning as a pilot program in 2008, our EMMA system, at 

www.emma.msrb.org, has transformed the transparency of the municipal market. 

Any investor can now access from anywhere hundreds of thousands of disclosure 

documents and real-time trading information on 1.5 million outstanding municipal 

bonds. We provide all of this information to the public for free. 
43 

29This statistical information may be found by searching EMMA’s Market Statistics tab at 

http://emma.msrb.org/MarketActivity/ViewStatistics.aspx. 30Transparency and Regulation in the Municipal Securities Market Hearing Before the U.S. 

Senate Committee on Banking, Housing, and Urban Affairs (2009) (statement of Ronald A. 

Stack, Chair, Municipal Securities Rulemaking Board). 

EMMA was created for the purpose of providing retail investors with easy access 

to key market information that was previously unavailable or difficult to find. Retail 

investors are heavily involved in the municipal market, with retail trades (generally 

viewed as trades of $100,000 or less) accounting for over 80 percent of the approximately 7.3 million customer transactions in municipal securities over the past 

year.29 The MSRB’s EMMA Web site supports well-informed decisionmaking by 

these investors. 

Over the past year, the MSRB has greatly expanded the amount and type of information available to investors on EMMA. The MSRB began providing interest rate 

information on EMMA about auction rate securities (ARS) and variable rate demand 

obligations (VRDO) in 2009, after instability in these markets raised significant disclosure and market transparency concerns. Today EMMA remains the only source 

of current, market-wide interest rates for variable rate securities available to the 

general public. In May 2011, the MSRB enhanced EMMA to provide public access 

to key ARS auction and VRDO liquidity information, including actual copies of liquidity documents such as a letter of credit. Providing investors with easy access 

to these documents and data increases their ability to make informed decisions 

about investing. The MSRB testified before you in 2009 regarding our plans to increase the information and documents available about ARS and VRDOs 30 and I am 

happy to report that this increased transparency has been accomplished. 

EMMA also is a tool for issuers to communicate important information about their 

bonds and their finances to investors. The MSRB received requests from State and 

local government issuers to provide the ability for issuers to voluntarily post pre-
44 

liminary official statements to EMMA. We are happy to announce that, as of May 

2011, we have made this possible. Preliminary official statements can provide potential investors with the details of a new issue before it comes to market. Issuers in 

several States have already taken advantage of this new EMMA feature—including 

South Carolina, Utah, Kentucky, Florida and Wisconsin—and we expect its use to 

increase over time. 

As part of its investor protection rules, the MSRB requires timely disclosure by 

our regulated entities and promotes good continuing disclosure practices by issuers. 

Issuers provide some types of continuing disclosure information under SEC Rule 

15c2–12. The MSRB has added the ability for issuers to submit numerous voluntary 

disclosures that go beyond this SEC baseline. Most recently, the MSRB enhanced 

EMMA to allow issuers to submit information about the timing and accounting 

standard used to prepare annual financials. This helps investors acquire a more 

complete picture of the issuers and issues in which they are investing. As EMMA 

provides a centralized location for disclosures, investors and others interested in the 

disclosure practices of issuers and trading activity of bonds can easily use EMMA 

to access and compare the available information. 

The MSRB will continue to improve EMMA. This fall, EMMA will display credit 

ratings from one or more of the Nationally Recognized Statistical Rating Organizations. These ratings will be available on the EMMA Web site, for free, and updated 

in real-time. 

Conclusion 

The municipal market funds much of this nation’s health, education and transportation infrastructure. It is the MSRB’s role to balance and protect the competing interests in this public-purpose market. Where we have the jurisdiction and ability 

to act, the MSRB has raised the bar on professional conduct by financial professionals and advanced market transparency in many significant ways. The benefits 

of these efforts ultimately flow to the investor and taxpayer. 

The MSRB is dedicated to a thoughtful, thorough rulemaking process that involves significant input from municipal market participants. We depend on input 

from investors, issuers, industry members and others to ensure MSRB rules are 

timely and appropriate. We believe that this widespread participation in rulemaking 

makes both the process and the product at the MSRB as balanced as possible and 

in the best interests of investors and municipal entities. 

We believe we not only have a responsibility to write regulations and provide 

transparency, but also a corresponding responsibility to educate market participants 

on the progress of these efforts. Since the Dodd-Frank Act, the MSRB has conducted 

outreach events across the country to provide a forum for education and input regarding our new mission and jurisdiction. We appreciate the opportunities provided 

by the Dodd-Frank Act to improve the municipal market and look forward to continuing to work with Congress, industry members, issuers and investors with this 

goal in mind. 

I thank you again for the invitation to speak today and will take any questions 

you may have. 
45 
46 
47 
48 

1Mr. Pitt is the Chief Executive Officer of Kalorama Partners, LLC, and its law-firm affiliate, 

Kalorama Legal Services, PLLC. Prior to founding the Kalorama firms in 2003, Mr. Pitt served 

as Chairman of the U.S. Securities and Exchange Commission (2001–2003), was a senior corporate law firm partner (1978–2001), and served for over 10 years as a member of the Staff 

of the SEC (1968–1978), the last 3 years of which he served as the Agency’s General Counsel. 2 As a matter of policy, the Kalorama firms do not engage in adversarial efforts vis-a-vis the 

SEC; rather, they assist companies, firms, governmental entities and individuals that are committed to enhancing their fidelity to important fiduciary and governance principles, internal controls and compliance programs. 

PREPARED STATEMENT OF HARVEY L. PITT1

FORMER CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION

JULY 12, 2011 

Introduction 

Chairman Johnson, Ranking Member Shelby, Members of the Committee: 

I am pleased to appear before you today to respond to this Committee’s invitation 

to testify about the critical issue of ‘‘Enhanced Investor Protection After the Financial Crisis.’’ The financial crisis that began in 2007–2008 was, as we know only too 

well, one of the worst economic collapses this Country has experienced. The failures 

that led to that collapse are manifold, but principal among them, in my view, was 

the failure of our regulatory system (and financial regulators) to respond effectively, 

efficiently and with alacrity to both the warning signs that a crisis was imminent, 

and to cabin what eventually became a full-blown crisis. 

Thus, I strongly believe this Country needed (and still needs) to reform its financial regulatory apparatus, and that was clearly the impetus behind the adoption and 

enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘D– 

F’’). The Committee has specifically requested that testimony today focus on Titles 

IV and IX of D–F, which were intended, among other things, to enhance ‘‘investor 

protection.’’ While Congress’ intent in passing D–F was laudable, and while there 

was a compelling need to reform our financial regulatory system, D–F unfortunately 

did not provide the regulatory reform that our financial and capital markets, and 

those who invest, so urgently needed, and still require. 

Notwithstanding my belief that D–F falls short of what we need, I believe the 

principal effort at this point should be to figure out what it will take to make the 

substance of D–F workable. Thus, my testimony is directed at the changes needed 

to enable D–F to fulfill its goals, without incurring many of the unintended consequences that I believe plague so much of this legislation. The views I set forth 

are solely my own, formed on the basis of an aggregate of over 43 years experience 

in the financial and capital markets, both as a regulator, as a counselor to those 

in the financial services industry and, for the past 8 years, as the Chief Executive 

Officer of Kalorama Partners, LLC and its law-firm affiliate, Kalorama Legal Services, PLLC.2 My views do not reflect the views of any past or current clients of the 

Kalorama firms, and do not reflect the views of the SEC. 

Summary 

There is no question that, in the wake of the financial crisis that began in 2007– 

2008, financial regulatory reform was needed. We needed a more nimble regulatory 

regime. However, the legislation passed nearly 1 year ago did not provide the reform 

the Country needed. While this is not the forum in which to revisit all the problems 

with D–F, in brief, I believe the Country required that financial regulatory reform 

provide three critical elements: 

• A steady flow of significant, current information on the activities of anyone 

playing a meaningful role in our financial and capital markets; 

• The imposition on Government of a duty to analyze the information it receives 

to discern trends and developments, along with the obligation to publish, generically, the trends and developments Government discerns; and 

• The grant to the Government of the ability to create so-called tripwires, so that 

as trends start to become apparent, Government can halt those trends until it 

determines (subject to appropriate Congressional oversight) whether these 

trends are potentially harmful and, if so, what steps should be taken to cabin 

their further development. 

D–F did not achieve these goals. Worse, the Act is unduly complex, adds more 

layers of regulatory bureaucracy to an already over-bloated bureaucracy, makes financial regulation more cumbersome and less nimble than it already was, and contains the seeds for destroying the independence of three regulators whose independ-
49 

3Through the creation of the Financial Stability Oversight Council, which is led by the Treasury Secretary, the independent views of the Fed, the SEC and the CFTC, as well as their functions, can effectively be overridden. 4See IFSL Research, ‘‘Hedge Funds 2010’’ (Apr. 2010), available at http://www.scribd.com/ 

doc/36124567/Hedge-Funds-2010. 5 Because hedge funds were, initially, marketed only to highly sophisticated investors, in denominations that placed these funds beyond the reach of ordinary investors, it was not deemed 

sufficient to require detailed regulation of those who managed these funds. As hedge fund advisers have become publicly traded entities, and pension funds have turned more and more frequently to hedge funds to increase their returns, this justification for the absence of regulation 

Continued 

ence was always a strength of our existing regulatory system-the Federal Reserve 

Board, the SEC, and the CFTC.3

Notwithstanding these impediments, the SEC and other financial regulators have 

been working assiduously to adopt hundreds of new rules, and produce a plethora 

of written studies, often without being afforded the necessary time to achieve the 

demands imposed by D–F, including rules to implement provisions under Titles IV 

and IX of D–F—the Committee’s current focus—as well as Title VII and other provisions of the Act, and many more rules are in process. While the SEC has valiantly 

attempted to address, through its rulemaking, many of the concerns that I and others have raised regarding the potential for mischief contained within the 2,300+ 

pages of D–F, there is only so much the Agency can, or should, do once Congress 

has expressed its judgment on important policy issues. 

Without attempting to be exhaustive regarding the myriad problems I perceive in 

Titles IV and IX of D–F, there are four provisions that particularly deserve this 

Committee’s attention if D–F is to serve its intended investor protection purposes: 

• The expansion of the SEC’s examination and regulatory responsibilities over 

hedge funds, private equity firms, and some venture capital firms (as well as 

enhanced obligations regarding credit ratings agencies) that the SEC cannot 

possibly fulfill given the current wording of D–F and the lack of appropriate resources; 

• The establishment of a whistleblower ‘‘bounty’’ program that: 

• creates negative incentives that threaten to undermine corporate compliance 

programs; 

• threatens to make every ‘‘tip’’ of which both the SEC and private sector firms 

become aware a ‘‘Federal case’’; and 

• sets the SEC up for failure by likely causing it to be inundated with a slew 

of ‘‘tips,’’ without giving it the resources necessary to ‘‘separate the wheat 

from the chaff’’; 

• Corporate governance provisions that: 

• intrude on the traditional province of State corporate law; 

• favor certain special interests at the expense of rank and file shareholders; 

and 

• impose significant unanticipated costs on corporations, and thus shareholders; 

and 

• Provisions that establish a new Office of Investor Advocate that: 

• Undermine the authority not only of the Staff but of the Commission itself 

with respect to both enforcement and rulemaking decisions; and 

• Create a potentially divisive source of internal second-guessing that may actually slow down, rather than facilitate, regulatory reforms that protect retail 

investors. 

Discussion 

1. Increasing the SEC’s Examination Responsibilities 

As a result of Title IV of D–F, and especially D–F §§402 & 403, the SEC’s jurisdiction over hedge funds, private equity funds and certain venture capital firms has 

increased exponentially. While there is a paucity of precise data, it appears that, 

as of the end of 2009, there were over 9,000 hedge funds in existence.4 The Commission already oversees approximately 11,000 registered investment advisers and 

6,000 registered securities broker-dealers, beyond which D–F imposes on the SEC 

new oversight responsibilities for credit ratings agencies, municipal securities dealers and a host of swaps professionals and participants. 

Putting to one side the substance of D–F’s creation of a new regulatory regime 

for hedge funds and other private fund investment advisers,5 the grant of this au-
50 

disappeared. But, no nexus has ever been suggested between the economic crisis that began in 

2007–2008 and the market/investment activities of hedge funds. 6See Compliance Programs of Investment Companies and Investment Advisers, Investment 

Company Act Rel. No. 25925, Investment Advisers Act Rel. No. 2107, 79 SEC Docket 1696 (Feb. 

5, 2003). 7 ‘‘Enlisting’’ third-party expert examiners is not a guarantee against future Madoffs, but it 

will equalize the sophistication gap that exists between the young men and women who perform 

examinations for the SEC, on the one hand, and the experienced money managers whose operations the SEC Staff must examine. 

thority begs the question: How will the SEC exercise its oversight and compliance 

examination responsibilities once it has registered these new entities? It seems rather clear that the SEC’s own compliance and examination efforts cannot match the 

number of entities requiring examination, or the sophistication and diversity of investment strategies with which the SEC’s Staff will be confronted. Despite promises 

of new funding that were made when D–F was first enacted, the current budget crisis makes it impossible that the Commission will have sufficient resources to enable 

it to: 

• Develop the necessary expertise to permit it to examine an additional 9–10,000 

new entities subject to its jurisdiction; 

• Deploy such expertise as it has to perform regular compliance examinations; or 

• Provide investors with appropriate confidence that the funds in which they invest are subject to extensive compliance oversight by the Federal Government. 

In February 2003, under my direction, the SEC proposed to require all investment 

advisers to undergo an exemption every year, or in the case of smaller advisers, 

every 2 years, by an independent, expert, private-sector entity that would perform 

a detailed compliance ‘‘audit’’ akin to the annual financial audits performed by independent outside public accounting firms.6 The Commission would define requisite 

independence and expertise, and would dictate the substance of the annual (or biennial) compliance audit, and these audits would result in the preparation of a detailed report of findings that would be submitted both to the SEC and to the governing board of the funds whose advisers are examined. 

Although this is a proposal that could address the serious problems that inhere 

in the SEC’s existing compliance examination process, this proposal—or anything 

comparable—has not yet been adopted by the Commission. It is, in my view, long 

overdue, and should be mandated by Congress, to reduce the likelihood of future 

‘‘Madoff-like’’ situations.7

2. Whistleblower Provisions 

D–F §922 creates a new SEC whistleblower program that was intended to increase both the number and quality of ‘‘tips’’ received by the SEC from anyone who 

becomes aware of ‘‘possible’’ misconduct that could adversely affect our capital markets. It cannot be gainsaid that a well-designed whistleblower program that 

achieves the goal of providing the Commission with better access to quality indications of potential wrongdoing is a proposal that could benefit investors enormously. 

But, as D–F was enacted, this provision threatens to undermine corporate governance, internal compliance and the confidence of public investors in our heavily regulated capital markets. 

a. Impact on Corporate Governance and Internal Compliance Programs 

Over the last half-Century, great strides have been taken to provide investors 

with the most valuable first-line of defense against securities fraud and other forms 

of misconduct—internal corporate governance has been improved to ensure that corporate employees inculcate and adhere to proper values, while internal compliance 

processes at the firms of securities professionals have been strengthened and expanded to nip nascent potential frauds in the bud. While it is undoubtedly beneficial 

to encourage those who become aware of possible misconduct to report to their firms 

and corporations any perceived instances of misconduct, and to encourage those 

firms and corporations to inquire into perceived instances of misconduct, D–F and 

the rules it compelled the SEC to adopt threaten to have exactly the opposite effect. 

D–F, and the SEC rules adopted under it on May 25, 2011, may incentivize tipsters to submit unsupported—and possibly speculative or even frivolous—‘‘tips’’ directly to the SEC, rather than to the companies or firms to which their ‘‘tips’’ relate. 

More significantly, the system created threatens to divert the SEC Staff’s attention 

away from more productive investigations. This is a logical outcome of the fact that 

the D–F whistleblower provisions give formal legal rights to those who claim their 

‘‘tips’’ were significant factors in the SEC’s ability to recover monetary payments in 

excess of $1 million, as a result of alleged securities-related misconduct. I believe 
51 

that the potentially huge amounts at stake—a bounty ranging from between 10 and 

30 percent of the monetary sanctions recovered in any successful enforcement action 

that resulted from the tip—and D–F’s unfortunate premium for being ‘‘first in line,’’ 

will at best undermine, and at worst eviscerate, companies’ existing internal compliance programs. 

Sound risk management practices as well as legal requirements, such as the Sarbanes-Oxley Act (‘‘S–Ox’’), place great emphasis on companies’ implementation of robust compliance programs to help ensure that wrongdoing is prevented or detected, 

and if detected, stopped and remedied as quickly as possible. Companies with strong 

compliance programs may be able to detect and remedy misconduct more quickly 

and more effectively than the SEC can, given the Commission’s many other responsibilities and its need to comply with the legal formalities required of Government 

actors. Public investigative and enforcement processes simply take more time than 

internal action. 

However, D–F §922 and the SEC’s implementing rules do not require an employee 

first to report internally the suspected wrongdoing. Instead, they create overwhelming financial incentives to bypass internal reporting mechanisms and requirements, and go directly to the SEC with their tips. As a result, they may effectively 

deny companies the opportunity to detect and take prompt remedial action in response to internally reported tips from employees. They also reduce the likely quality of any tips received by placing more importance on speed than factual support. 

By diverting tips and complaints from internal compliance and legal channels to the 

SEC, the whistleblower provisions paradoxically may result in violations continuing 

and becoming more serious. This is the very opposite of the result intended by Congress in enacting both S–Ox and D–F. 

In response to comments prior to the promulgation of the final rules, the Commission acknowledged the potential of §922 to undermine internal compliance programs, and adopted certain measures that are intended to ‘‘encourage’’ employees 

to report wrongdoing to their compliance or legal departments, before or at the same 

time they report to the SEC. These are: 

• A provision granting an employee whistleblower status as of the date the employee reports the information internally, if the employee provides the same information to the SEC within 120 days, thereby affording employees the ability 

to report the alleged wrongdoing internally first, without losing their ‘‘spot in 

line’’ for a possible award from the SEC. 

• A provision that credits employees who report their suspicions internally first 

with information obtained from a company’s internal investigation, that resulted (in whole or in part) from information that was reported internally by 

the whistleblower, even if the internal report, by itself, would not have been 

‘‘sufficiently specific, credible, and timely’’ to ‘‘commence or reopen an [SEC] investigation . . . ’’ 

• A provision permitting the SEC to consider initial internal reporting as a factor 

weighing in favor of larger whistleblower awards. This provision, however, is 

permissive, not mandatory. Indeed, the failure to report suspicions internally 

will not necessarily result in a lower bounty, and whistleblowers who fail to report internally are still eligible to receive the highest possible bounty—30 percent. 

I do not believe these measures, taken together, create sufficient affirmative incentives to ensure that employees will actually report their suspicions internally 

first. Tipsters who bypass internal compliance procedures and report to the SEC in 

the initial instance—even after they become aware of an internal investigation 

about the alleged wrongdoing—are still eligible for a 30 percent award, and tipsters 

who do report internally first are not assured of receiving the highest level award. 

Further, with the lure of million-dollar bounties, it is unlikely that potential whistleblowers will consider (assuming they understand) the prospect that they will be 

credited with the additional information generated by an internal investigation initiated as a result of an internal report. I believe that, notwithstanding the SEC’s efforts to incentivize initial internal reporting, the overwhelming majority of tipsters 

will report directly to the SEC, bypassing their companies’ internal reporting mechanisms and compliance departments. 

Other provisions of the rules exacerbate the potential for damage to corporations’ 

existing internal compliance programs. Specifically, the exclusion from eligible whistleblower status of internal compliance and internal audit personnel—including lawyers who receive tips in the context of a privileged attorney-client communication— 

is not meaningful. This is because the ‘‘exclusion’’ carves out, and thus makes eligible for whistleblower status, internal compliance, internal audit and legal personnel 

who claim ‘‘a reasonable basis to believe that disclosure of the privileged informa-
52 

tion is necessary to prevent substantial injury to the financial interest or property 

of investors.’’ 

As both Commissioners Casey and Paredes have observed, these exceptions effectively swallow the rule. Consequently, as a practical matter, such personnel are eligible to receive a bounty without taking any further internal action; like all other 

persons eligible for whistleblower status, these persons are not subject to a prior internal reporting requirement, despite being the very individuals directly charged 

with responsibility for the company’s internal compliance, internal audit and legal 

functions. 

By effectively negating the exemption of internal compliance and audit personnel 

from eligibility for whistleblower status, the rules: (1) create additional disincentives 

for both business heads and other employees to bring problems to the attention of 

internal compliance personnel, for fear that they will turn around and go directly 

to the SEC; (2) engender mistrust of internal compliance and audit personnel; and 

(3) otherwise create internal divisiveness between business lines and internal control support functions. 

b. Transforming Every ‘‘Tip’’ into a Federal Case 

Whether or not a tip is first reported to the tipster’s employer, a likely consequence of this provision of D–F will be to convert every tip into a significant ordeal for those companies that learn of them. This is so for several reasons. 

• Depending on the volume of tips received, but even if the Agency is not inundated with tips, it is in the SEC Staff’s interest to refer every tip to the company or firm to which the tip relates, for initial review. In that way, the SEC 

Staff will not run the risk that they may mistake a valuable tip they receive 

for something of no real consequence. 

• Once a tip is referred to a company—either by the tipster or by the SEC Staff— 

companies will have little choice but to elevate every tip to a higher level of attention than would otherwise be appropriate. After all, if a company investigating a tip wants to avoid having to go through at least two investigations— 

one by the company itself, and one by the SEC Staff—it will want to be able 

to document precisely how a spurious tip misses the mark in reality. This will 

add extensively to the cost of handling these kinds of tips, whether or not the 

tip has any merit at all. 

• Because the tipster will have legal rights to recover money if it turns out the 

tip has merit and leads to a recovery in excess of $1 million, the company may 

feel the necessity of expending undue resources on even frivolous tips, since a 

company determination the tip is frivolous that persuades the SEC Staff may 

result in litigation brought to contest the company’s bona fides in reaching it 

conclusion that the tip had no merit. 

This is a hidden ‘‘cost’’ of this provision of D–F that will elevate the price extracted for those who seek, in good faith, to comply with the statute. 

c. Impact on SEC Resources and Efficiency 

In addition to the concerns I have about the whistleblower provisions’ potentially 

devastating consequences for internal compliance programs, I am also concerned 

about the potentially impact of these provisions on the SEC itself. The prospect of 

huge bounties merely for reporting a ‘‘possible’’ violation will spur an excessive flow 

of whistleblowing claims to the SEC, with people reporting claims based on weak 

or speculative information or reporting wholly spurious claims ‘‘just in case.’’ And, 

while responsible counsel for whistleblowers could serve as effective gatekeepers, 

there is no assurance they will do so. D–F §922 specifically provides that any whistleblower, who makes a claim, may be represented by counsel, and must be represented by counsel if he or she wishes to submit the claim anonymously. 

It is therefore not surprising that the Commission, in its adopting release, estimated that it will receive approximately 30,000 tips, complaints and referral submissions each year. Further, despite the extraordinary number of tips expected, neither the statute nor the rules ensure that the quality of tips is commensurately 

high. To the contrary, as the adopting release acknowledges, the standards for 

qualifying for a bounty under the False Claims Act are much higher than those 

under D–F. Yet, the SEC has been given relatively few additional resources with 

which to ‘‘separate the wheat from the chaff,’’ and has set aside $450 million to fund 

a pool from which rewards can be paid. D–F requires the SEC to establish a new, 

separate office within the agency to administer and enforce the whistleblower provisions. This new office will report annually to House and Senate committees on its 

activities, whistleblower complaints, and the SEC’s response to such complaints. 
53 

However, due to funding constraints, that office is being staffed out of existing SEC 

personnel—diverting them from other responsibilities. 

In short, the SEC is being set up for failure. That serves no one’s interests, let 

alone that of investors. Somewhere, somebody should step back and say, ‘‘We are 

piling all these responsibilities on, creating all these new provisions, but how do we 

expect the agency to cope?’’ The SEC has been given more rulemaking, more studies 

and more demanding responsibilities under D–F than any other financial regulator, 

but was denied what many other financial regulators have—the ability to self-fund 

its operations (with accountability to Congress for the policy decisions it makes). 

The SEC should be given this authority, provided there is full and complete accountability to Congress on the uses to which the SEC proposes to put the funds available 

to it through this mechanism. 

d. Proposed Amendment 

On May 11, 2011, Rep. Michael Grimm of New York circulated draft legislation 

that would amend D–F to require a whistleblower to first report fraud through an 

internal compliance program before being eligible to receive an award under the 

program. I strongly support such an amendment. Indeed, I would go further and advocate that the ‘‘carve-out’’ from the exemption for whistleblower eligibility for internal compliance, audit and legal personnel be tightened, if not completely eliminated. 

2. Corporate Governance 

a. Proxy Access. 

D–F’s proxy access provisions are intended to promote shareholder democracy by 

requiring companies to include board candidates in management’s proxy materials 

if nominated by shareholders holding at least 3 percent of the voting equity for at 

least 3 years. As a practical matter, however, the proxy access provisions, which 

have been stayed by the SEC pending the outcome of litigation over the validity of 

the Commission’s rule, give disproportionate influence to certain shareholder constituencies—such as unions and pension funds—that have special interests that 

may be different from, or even adverse to, rank and file investors. Given that these 

special shareholder constituencies already usually possess significant leverage to affect corporate policy through the power of collective bargaining, it is not clear why 

providing them with an additional means of advancing their interests promotes 

shareholder democracy. 

And, it follows that, if the benefits of the new rule were overstated, the likely 

costs of the rule were not properly considered. Contested elections are expensive, 

and shareholders ultimately bear their cost. While the SEC said in its adopting release that it expects about 51 proxy contests a year as a result of the new rule, that 

would mean a drop from the 57 contested corporate elections in 2009. It is not clear 

how a rule designed to facilitate shareholder nominees can lead to fewer contested 

elections? 

While recognizing that some companies likely would oppose a particular shareholder nominee, and incur the consequent expenses, the Commission assumed that 

these costs would be limited because the directors’ fiduciary duties would prevent 

them from using corporate funds to resist shareholder director nominations in the 

absence of any good-faith corporate purpose. Even if this assumption were true in 

an abstract sense, there is no way to quantify it sufficiently to support the Commission’s estimates of the number of proxy contests likely to result from the new rule. 

Quite apart from the flaws in the Commission’s cost-benefit analysis, the new 

rules reflect an unnecessary and ill-advised change in shareholders’ rights, by preempting State law—the traditional source of such rights—in favor of imposing a 

new, one-size-fits-all regime on corporations from which they cannot opt out, even 

if their shareholders would prefer to do so. In 1934, when this Committee’s predecessors passed the Securities Exchange Act, power over proxy contests was divided 

between the Federal Government and the States. State law determines what substantive rights a corporate shareholder may claim, while Federal regulation was intended to govern the disclosure applicable to, and the mechanics of, shareholder 

votes. 

In stark contrast, this provision of D–F turns the traditional situs of legal authority over shareholder voting power on its head. And, it ignores the most efficient 

ways to have resolved the thorny issue of proxy access: 

• Given the current ubiquitous state of computer facilities, proxy materials should 

no longer be required to printed and mailed to corporate shareholders. Instead, 

the Commission should permit proxy solicitations to occur utilizing electronic 

communications. This change alone would diminish much of the effort on the 
54 

part of corporate insurgents to utilize management’s proxy materials to further 

their own policy choices. 

• Even in the absence of a shift to electronic proxy solicitations, all the SEC need 

do is provide that shareholders have the right to amend their corporation’s bylaws in whatever way State law permits, including an amendment to permit 

whatever form of proxy access the requisite number of shareholders approves. 

By dictating the mechanics of how this issue would be presented to shareholders (in particular, limiting the number of such proposals as well as the size 

and length of shareholdings entitling a shareholder to make such a proposal in 

management’s proxy materials), the SEC has a relatively non-controversial way 

to resolve the thorny issue of proxy access without turning the supremacy of 

State law over shareholder voting rights on its head. 

• This approach would take advantage of changes to State laws regarding proxy 

access. In 2007, the Commission considered amending Rule 14a–8(i)(8) to permit shareholders to propose binding shareholder resolutions to amend a company’s by-laws to require the company to grant proxy access. Since 2007, the 

Delaware General Corporation Law and the ABA’s Model Business Code have 

been amended to include provisions that explicitly permit proxy access bylaws 

and proxy reimbursement bylaws. 

• This would have been (and still would be) an appropriate approach to proxy access. An enabling proxy access rule would avoid discriminatory distinctions 

among shareholders—potentially pitting self-interested groups, like unions and 

pension funds, against the average rank and file investor—in favor of true 

shareholder suffrage. Such an approach would facilitate companies’ and shareholders’ State-given rights to determine the processes that govern the nomination and election of directors, based on their unique circumstances. This approach would also, of course, facilitate shareholders’ ability to avail themselves 

of the rights afforded by those processes. 

b. Say-on-Pay 

D–F §951 requires public companies to solicit non-binding shareholders’ votes at 

least once every 3 years on the compensation of their highest paid executive officers. 

This new requirement has been referred to as say-on-pay. The first proxy season 

with say-on-pay votes has passed, and the overwhelming majority—88 percent—of 

these votes were positive, with more than 80 percent of these resolutions garnering 

at least 80 percent positive votes. 

However, shareholders in at least 39 companies voted ‘‘no’’ on executive compensation. At least six of these ‘‘no’’ votes have been followed by derivative claims 

against those companies and their boards, claiming the pay packages awarded effectively breach the fiduciary duties owed to shareholders who have rejected the specific executive compensation involved, as well as corporate waste, in awarding the 

rejected pay packages. Other ‘‘investigations’’ have been announced into the approval of pay packages that presumably will lead to litigation. 

The first wave of post-say-on-pay lawsuits lends credence to the warnings of those 

who predicted that the provision would lead to increased shareholder litigation, despite the express provision in D–F §951(c) that the results of a say-on-pay vote do 

not create or imply any additional fiduciary duties on the part of the company’s 

board, nor change the scope of any existing fiduciary duties. While most legal commentators expect these suits to fail, given not only the language of §951(c) but also 

the high burden of proof set by the corporate law of most States with respect to 

breaches of fiduciary duty and corporate waste in the area of executive compensation, that only makes the litigation costs that say-on-pay is likely to impose on corporations—and thus their shareholders—even harder to justify. 

3. Office of the Investor Advocate 

Another example of D–F’s unintended consequences is found in §915, its directive 

that the SEC establish an Office of the Investor Advocate. Putting to one side the 

fact that it is the SEC as a whole that is the ‘‘Investor’s Advocate,’’ this provision 

contains the seeds of unnecessary conflict and adversarial posturing that will, ultimately redound to the disadvantage of investors. The statute empowers the Investor 

Advocate publicly to criticize and challenge agency actions or inactions, without any 

obligation to seek the input of—or even give notice to—the agency officials whose 

judgments may be publicly challenged. 

Moreover, at a time that the SEC’s resources are strained to the limit (and beyond) by the imposition of D–F’s other mandates, coupled with the denial to the 

SEC of the ability to self-fund (but with accountability to Congress), the Investor 

Advocate is expressly entitled to retain or employ independent counsel—that is, 

counsel not already a part of the SEC’s staff—as well as its own research and serv-
55 

ice staff, as the Investor Advocate deems necessary to carry out the duties of the 

office. It is true that D–F §915 requires the Investor Advocate to ‘‘consult’’ with the 

SEC’s Chairman before making any such expenditures, but there is no requirement 

that the SEC Chairman’s views be given any deference whatsoever. 

In short, the statute creates an independent bureaucracy within the SEC that is 

inherently adversarial to both the Commission and its other Staff, rather than collaborative. Indicative of the adversarial nature of this position is the requirement 

imposed on the Commission to establish procedures requiring a formal response to 

all recommendations submitted to the Commission by the Investor Advocate. Such 

responses must be received within 3 months, and then trigger the Investor Advocate’s ability to criticize the Commission’s or Staff’s failure to implement the Investor Advocate’s agenda of recommended action. This is the same obligation that is 

imposed upon the Commission in the face of any Inspector General ruling or criticism of the Agency or its Staff. The creation of this Office threatens to disrupt, rather than facilitate, the SEC’s investigative, enforcement and rulemaking functions. 

The ostensible purpose of creating the Office of Investor Advocate is to ensure 

that the interests of retail investors are built into rulemaking proposals from the 

outset and that agency priorities reflect the issues confronting investors. But, in 

order to achieve that objective, it was not necessary to create an entire new bureaucracy in order to achieve that end, nor was it necessary to give the Investor 

Advocate the effective ability to second-guess every judgment made by the Commission and its Staff as to how best to set priorities, balance competing interests and 

allocate scarce resources. The Office of Investor Advocate, far from being a resource 

to the Commission and its Staff in fulfilling the Agency’s mission to protect investors, will be unnecessarily divisive. 

Conclusion 

The purposes behind D–F were surely laudable. But, in the critical area of investor protection, the provisions of the Act leave a great deal to be desired, and ultimately threaten to have adverse consequences on investor protection. It is possible 

to cure these problems, but that will require a determination by Congress, and resolve by the Agency, to implement that regulation which will indeed be likely to promote the needs of all investors. 

I will be happy to respond to any questions the Members of the Committee may 

have. 

PREPARED STATEMENT OF BARBARA ROPER 

DIRECTOR OF INVESTOR PROTECTION FOR THE CONSUMER FEDERATION OF AMERICA

JULY 12, 2011 

Chairman Johnson, Ranking Member Shelby and Members of the Committee: 

My name is Barbara Roper, and I am Director of Investor Protection for the Consumer Federation of America (CFA), where I have been employed since 1986. CFA 

is a non-profit association of approximately 300 national, State and local pro-consumer organizations founded in 1968 to advance the consumer interest through research, advocacy, and education. I appreciate the invitation to appear before you 

today to discuss enhanced investor protection after the financial crisis. 

Introduction 

Improving protections for average investors has been a CFA priority for roughly 

a quarter century. During that time, experience has taught us that it often takes 

a crisis, or at least a scandal of major proportions, to highlight the need and provide 

the momentum for investor protection reforms. The recent financial crisis was traumatic event for U.S. investors that revealed serious shortcomings in the regulation 

of certain securities markets and market players. In particular, regulatory failures 

with regard to the market for asset-backed securities (ABS) and the credit ratings 

on which their sales depend were contributing causes of the crisis. Those regulatory 

shortcomings resulted in serious harm even to investors with no direct investments 

in ABS and no direct reliance on credit ratings. Indeed, many individuals with no 

investments at all nonetheless suffered devastating consequences in the form of lost 

jobs and lost homes. 

The crisis and events that occurred in conjunction with the crisis—such as the exposure of the Madoff Ponzi scheme—also revealed more general short-comings in the 

quality of regulatory oversight provided by the Securities and Exchange Commission 

(SEC). In some cases, those regulatory shortcomings can be attributed to lack of 

needed enforcement tools or authority. In others, inadequate resources appear to be 

the cause. But recent events have also revealed regulatory stumbles at the SEC that 
56 

cannot be blamed on either of these causes but must instead be acknowledged as 

operational failures of the agency staff or a failure of will to regulate on the part 

of its leaders. 

Since Congress began consideration of financial regulatory reform legislation, a 

great deal of attention has been given to reforms designed to improve our ability 

to identify and address systemic threats, bring long-overdue regulatory oversight to 

the over-the-counter derivatives markets, and even to improve consumer financial 

protections by creating a new independent agency devoted to this task. Among the 

lesser known achievements of the Dodd-Frank Act is its creation of a framework 

that, if properly and effectively implemented, could significantly improve investor 

protections. Dodd-Frank takes a multi-faceted approach to bringing about this improvement in investor protections. Responding to abuses directly related to the crisis, it includes sweeping proposals to address flaws in both the asset-backed 

securitization process and in credit ratings, flaws that created incentives to write 

risky mortgages and helped mask those risks from investors. In addition: 

• Dodd-Frank includes a suite of provisions designed to improve the 

quality of regulatory oversight provided by the SEC. 

These include enhanced regulatory and enforcement tools and the potential for increased resources to enable the SEC to carry out its investor protection mission 

more effectively. Responding to recent problems in the operations of the SEC, the 

Dodd-Frank Act also includes provisions to improve outside oversight of the agency. 

And recognizing that investor voices are too often drowned out by industry in debates over agency policy, it includes mechanisms to increase investor input in the 

policymaking process. 

• Dodd-Frank includes another set of provisions designed to strengthen 

specific protections for average retail investors. 

Among these, the provision to raise the standard of conduct that applies to brokers when they give investment advice has received the most attention, both during 

the legislative debate and since. However, Title IX of Dodd-Frank also includes a 

number of other important investor protections, including provisions to strengthen 

the ability of defrauded investors to recover their losses, authority to address severe 

conflicts of interest in industry compensation practices, and provisions with the potential to dramatically improve the quality of disclosures investor receive regarding 

both investment products and services and the investment professionals who provide those services. 

While Dodd-Frank creates a broad framework to improve investor protections, investors will only reap the benefits if the SEC uses its new tools and new authority 

effectively and if Congress provides it with the resources necessary to enable it to 

do so. It is too soon to tell whether that is likely to occur. To date, the SEC has 

appropriately focused its implementation efforts on those aspects of Dodd-Frank 

where it is required to act, leaving for another day areas where it has been given 

new authority but no such mandate. Many of the provisions in the Investor Protection Title fit in the latter category. Moreover, the agency’s funding status is far from 

clear. While the Senate secured a welcome funding increase for the agency in 2011, 

the House has been reluctant to provide 2012 funding for the agency that is commensurate with its broadly expanded authority. Not only does this put at risk the 

high profile Dodd-Frank provisions related to derivatives, hedge funds, 

securitization, and credit ratings, but, if the agency is forced to rob Peter to pay 

Paul, the lower profile investor protection issues would also suffer. If that happens, 

average retail investors will not only fail to reap the strengthened investor protections promised by Dodd-Frank, they will see those basic protections diminished and 

will inevitably suffer the consequences. 

The investor protection provisions of Dodd-Frank are too numerous to discuss 

each in detail here. Instead, my testimony will provide a broad overview of significant reforms and highlight a few areas of particular importance. My primary focus 

will be on topics of particular relevance to retail investors. Some issues with implications for retail investors, including municipal securities and whistleblower reforms, are not included in this testimony, not because they are not important, but 

because we lack the relevant expertise to provide informed commentary regarding 

the legislative provisions on these topics. Similarly, this testimony does not cover 

Dodd-Frank provisions to improve corporate governance. Although CFA strongly 

supported those reforms, others on the panel are better equipped to discuss their 

particulars. On the other hand, two other issues that aren’t primarily retail investor 

issues—securitization reforms and credit rating agency reforms—are discussed 

briefly here because they so clearly illustrate the harm that can come to retail investors when institutional markets are not regulated effectively. 
57 

I. Improving the Quality of Regulatory Oversight 

Dodd-Frank includes a suite of provisions intended to improve the overall quality 

of regulatory oversight provided by the SEC. These include general provisions to enhance the tools available to the agency to enforce the securities laws, provide better 

independent oversight of the agency, increase investor input into the agency’s policymaking process, and authorize an increase in its funding. They also include a provision designed specifically to strengthen regulatory oversight of investment advisers, 

an area that has long been lacking. These provisions should help to improve the 

quality of regulatory oversight across the broad range of the SEC’s responsibilities. 

The following section describes some of those provisions in greater detail. 

A. Enhancing the SEC’s Enforcement Tools (various sections from 925 through 

929Z) 

Title IX of the Dodd-Frank Act provides the SEC with a whole host of fairly technical but important enhancements to its enforcement tools. These include provisions 

that: give the SEC broader authority to bar bad actors from the industry (Section 

925, collateral bars); ensure that the SEC has the ability to exercise its anti-fraud 

authority with regard to conduct that occurs overseas but significantly affects U.S. 

investors or conduct that occurs in the United States but involves transactions executed elsewhere (Section 929P, extraterritorial jurisdiction); enable the PCAOB to 

share information with foreign jurisdictions (Section 292J); clarify that the SEC’s 

authority to act against those who aid and abet securities violations is satisfied by 

a showing of recklessness (Sections 929M–O); and allow for the ability to hire specialist personnel outside the usual hiring system (Section 929G). These are sensible 

reforms that should strengthen the SEC’s ability to provide effective enforcement of 

the securities laws. Several of them deserve extra mention. 

Expert Staff: The SEC’s failure to uncover the Madoff fraud has been blamed in 

part on its lack of staff with the sophisticated financial knowledge needed to understand the mechanism of the fraud. The need to enhance the technical expertise of 

the staff, already great, takes on added urgency as the agency assumes responsibility for oversight of securities-based swaps, credit rating agencies, and hedge 

funds and private equity funds—all highly complex and technical areas that will demand staff with specialized expertise to enforce them effectively. Giving the agency 

the ability to hire specialist personnel outside the usual hiring system should assist 

the agency in building the technical expertise necessary to fulfill these functions and 

provide more effective regulatory oversight of an increasingly complex market. 

Extraterritoriality: The Supreme Court decision in Morrison v. National Australia 

Bank left a gaping hole in SEC enforcement authority with its ruling that Section 

10(b) of the Securities Exchange Act applies only to ‘‘transactions in securities listed 

on domestic exchanges, and domestic transactions in other securities.’’ Had this decision gone unaddressed, the SEC’s ability to protect investors in an increasingly 

international marketplace would have been severely compromised. Moreover, the 

ability to evade U.S. fraud claims simply by moving transactions off-shore would 

have created a strong incentive for companies to avoid a U.S. listing and to execute 

transactions on foreign exchanges. 

Unfortunately, Dodd-Frank did not provide the same fix for private actions under 

Section 10(b) and Rule 10b–5, deferring a decision until after an SEC study of the 

issue. That study is currently underway. We are hopeful that the SEC will recommend that Congress amend the Exchange Act to ensure that Section 10(b), and 

the rules thereunder, are applicable to all purchases and sales of securities by U.S. 

financial institutions and individual investors residing in the United States. This is 

an important addition to the authority already provided to the SEC in the Act, first 

because private actions serve as an important supplement to SEC actions, particularly in light of limited agency resources, and second because there will still be an 

incentive for companies to avoid a U.S. listing and execute transactions overseas 

until the protections of U.S. law are fully restored for U.S. investors. 

PCAOB Sharing of Information with Foreign Authorities: Limits on the PCAOB’s 

ability to share information with foreign regulators have been cited by some foreign 

jurisdictions as a reason not to permit PCAOB to inspect auditors within their jurisdiction. But the Sarbanes-Oxley Act requires PCAOB to inspect all auditors, including foreign auditors that play a significant role in the audits of U.S. listed companies. The PCAOB has sought to satisfy this requirement by developing a program 

of joint audits with foreign jurisdictions, with mixed results. While it is not likely 

to immediately remove all impediments, the provision in Dodd-Frank permitting 

this sharing of information should help open the way to greater cooperation in inspections of foreign auditors. Given the important role that foreign audit firms play 

in the audits of large multi-national companies as well as foreign companies listed 

in the United States, ensuring that these auditors comply with U.S. audit standards 
58 

1 ‘‘U.S. Securities and Exchange Commission Organizational Study and Reform,’’ Boston Consulting Group, March 10, 2011. 2These include reorganization of the Division of Enforcement and the Office of Compliance 

Inspections and Examinations, the rollout of the new Tips, Complaints and Referrals program, 

and hiring of a Chief Operating Office and a new Chief Information Officer. 

is an important investor protection priority. We are encouraged that the new leadership at the PCAOB has made this a priority and appears to be working effectively 

to make progress in this area. 

B. Strengthening Oversight of the SEC (Subtitle F) 

Dodd-Frank also includes a package of reforms designed to improve outside oversight of the SEC. It achieves this primarily through a series of Government Accountability Office (GAO) reviews and reports to Congress. These include an annual 

financial controls audit of the agency, a triennial report by GAO on the quality of 

the agency’s personnel management, triennial GAO reports on the SEC’s oversight 

of SROs, and a GAO study of the revolving door between the SEC and the securities 

industry it regulates. Perhaps most significantly, Section 961 of Dodd-Frank requires the SEC to report to Congress each year on its examinations of regulated entities and, in doing so, to certify the adequacy of its supervisory controls to carry 

out these exam functions. Effective exams are central to the agency’s ability to detect and deter wrong-doing. This annual reporting requirement, subject to GAO and 

congressional review, should help to quickly identify any weaknesses in the exam 

program and focus agency attention on improving the quality of these examinations. 

That has the potential to significantly enhance investor protection. 

An organizational study of the agency required by Dodd-Frank has already been 

completed.1 The purpose of the study was to examine the internal operations, structure, and the need for reform at the SEC. In addition to praising recent initiatives 

undertaken by the agency to improve its efficiency and effectiveness,2 the report 

suggests additional steps for the agency to take to improve efficiency. Among its 

more substantive recommendations are for the agency to play a more active role in 

overseeing the self-regulatory organizations (SROs) under its jurisdiction, to upgrade its information technology, and to hire staff with risk management and other 

high-priority skills. Ultimately, however, the report concludes that agency is unlikely to be able to fulfill even its high priority functions without additional resources. We share that conclusion, as we discuss in greater detail below. 

C. Providing Investors with Greater Input into Agency Policy Decisions 

(Sections 911 and 915) 

The SEC decides issues of enormous import to investors every day, often with little or no input from the investors affected by those decisions. This does not reflect 

any intent to shut investors out of the process. Rather, it reflects the simple fact 

that investors often lack the organization, manpower and resources to monitor agency actions and interact effectively with SEC leaders and staff as they set the agency’s agenda and develop specific proposals to achieve that agenda. In contrast, industry is well funded and organized to perform this function, giving market participants an advantage in communicating with the agency that is further magnified by 

the revolving door that exists between the SEC and the securities industry. The inevitable result is that industry concerns tend to dominate the policy debate, while 

investor concerns can too easily be drowned out. 

The Dodd-Frank Act includes two provisions specifically designed to increase investor input into the agency’s policymaking process and ensure that investor concerns are heard. Section 915 creates a new Office of Investor Advocate within the 

agency, while Section 911 establishes a permanent Investor Advisory Committee. 

Properly implemented, these provisions have the potential to make the agency more 

aware of and thus more responsive to investor concerns and priorities. The result 

should be an agency that more effectively fulfills its mission to protect investors and 

promote the integrity of the capital markets. 

The Office of Investor Advocate: The legislation seeks to ensure that this office will 

truly and effectively serve the interests of investors by requiring that the Investor 

Advocate be an individual with a background representing the interests of investors, 

by providing the office of the Investor Advocate with appropriate staffing and with 

unimpeded access to agency and SRO documents, by ensuring that the Investor Advocate reports directly to the Chairman, and by requiring that the Commission respond promptly to recommendations of the Investor Advocate. 

Moreover, several important functions are entrusted to this office, including: 

• Identifying areas in which investors would benefit from changes in the regulations of the Commission or industry self-regulatory organizations (SROs); 
59 

3These calculations are based in large part on numbers from a ‘‘Self-Funding Study,’’ prepared by the Office of the Executive Director of the U.S. Securities and Exchange Commission 

and submitted in partial response to the request of the Securities Subcommittee of the Senate 

Committee on Banking, Housing and Urban Affairs S. Rpt. 100–105), December 20, 1988 as well 

as on more recent speeches by and testimony of SEC Chairman Mary Schapiro. 

• Identifying problems investors have with financial service providers and investment products; 

• Analyzing the potential impact on investors of proposed Commission and SRO 

rules and regulations; and 

• Assisting retail investors in resolving problems with the SEC and SROs. 

If the Commission follows through by appointing an energetic, effective and 

knowledgeable individual to this position and staffing the office appropriately, investors should benefit from an agency that is more attuned and responsive to their concerns. 

This provision also has the potential to improve the quality of congressional oversight of the SEC. That is because Dodd-Frank requires the Investor Advocate to report directly to Congress without prior review or approval by the Commission or its 

staff. This should enhance Congress’s ability to assess the effectiveness of the agency in serving the needs of investors, particularly in administrations that are less attuned to those concerns. 

So far, however, this provision of the legislation has not been implemented. Implementation was delayed first by the hold-up in finalizing a 2011 budget. Now that 

the SEC’s 2011 budget has been set, we understand that the Commission is awaiting approval by the House and Senate appropriations committees of its plan to reprogram funds for this purpose. We hope that any questions about this reprogramming plan can be resolved without difficulty so that this potentially powerful ally 

for investors can be put into place. The need for this investor input is particularly 

pressing given the importance of the issues currently being decided by the agency 

and the intensity of industry lobbying to weaken or water down many of those proposals. 

The Investor Advisory Committee: When SEC Chairman Mary Schapiro took office, 

she made it an early priority to establish an Investor Advisory Committee to provide 

input on investor priorities to the Commission and its staff. Recognizing the potential benefits of this committee, the Dodd-Frank Act formalizes its existence as a permanent advisory committee to the Commission. As with the Office of Investor Advocate, however, implementation of this provision is awaiting approval of the Commission’s funding reprogramming plan by congressional appropriators. Meanwhile, the 

existing committee has been disbanded in order to allow for changes in its makeup required by Dodd-Frank. Because this committee has the potential to enhance 

the agency’s understanding of and responsiveness to investor protection concerns, 

we urge a speedy resolution to any remaining impediments to its implementation. 

D. Increasing SEC Funding (Subtitle J) 

Over the course of the past three decades, U.S. securities markets have exploded 

in size, complexity, international reach, and technological sophistication, all the 

while becoming the primary means by which Americans fund their retirement. 

Meanwhile, with the exception of a one-time major funding boost after the Enron 

and WorldCom accounting scandals, the staffing level of the SEC has grown slowly 

if at all. To be specific, staffing at the agency has grown roughly 85 percent from 

2,050 FTEs in 1980 to 3,800 FTEs today, but the workload of the agency has grown 

many times faster. For example, based on my rough calculations, since 1980: 

• the number of investment adviser firms overseen by the agency has grown by 

more than 150 percent, and the assets managed by these professionals has 

grown by roughly 7,400 percent; 

• the number of mutual funds overseen by the agency has grown more than 430 

percent; and 

• while the number of broker-dealer firms has decreased by 20 percent, the number of registered representatives they employ and the number of branch offices 

from which they operate has skyrocketed, by roughly 225 percent and 2,100 percent respectively.3

The result is that the SEC today is critically under-staffed to carry out its existing 

responsibilities, let alone take on the vast new responsibilities entrusted to the 

agency in Dodd-Frank. And that doesn’t take into account the woeful state of the 

agency’s technology. 
60 

4A group of independent FINRA board members, led by Charles Bowsher, has since conducted 

a very credible examination of FINRA’s failure to uncover both the Madoff and the Stanford 

frauds, and FINRA has reportedly begun to implement the recommendations of that study to 

improve the quality of its broker-dealer oversight. 5 At the time, SEC staff members estimated that it small advisers were on a once every 40 

years inspection cycle. 6 ‘‘Study on Enhancing Investment Adviser Examinations,’’ by the staff of the Division of Investment Management of the Securities and Exchange Commission, January 2011. The study 

is available here: www.sec.gov/news/studies/2011/914studyfinal.pdf. 

In Dodd-Frank, Congress recognized the need for increased SEC resources by authorizing funding increases that would roughly double the agency budget by 2015. 

Specifically, the bill authorizes funding of $1.3 billion in 2011, $1.5 billion in 2012, 

$1.75 billion in 2013, $2 billion in 2014, and $2.25 billion in 2015. We strongly support fully funding the agency at these levels as an essential component of any effort 

to increase investor protections, and we greatly appreciate the leadership that 

Chairman Johnson and Members of this Committee have shown in fighting for increased funding. Unfortunately, the debates over the FY 2011 and 2012 budget have 

already made clear that turning those authorizations into appropriations is going 

to be a tough fight. Some in Congress continue to resist these funding hikes, even 

though the agency’s budget is fully offset by user fees and, since fees have to be 

adjusted to match the appropriation, there is no deficit reduction benefit from reduced funding. Indeed, even if the agency were fully funded at the authorized level 

for 2012, user fees would be reduced, since they currently bring in well over the authorized amount. 

While we are sympathetic to those who argue that money alone cannot solve all 

of the agency’s problems, we also believe that, without additional funding, the agency cannot reasonably be expected to effectively fulfill its investor protection mission. 

We urge Members of this Committee to continue to fight for full funding, and we 

offer our full support for those efforts. 

E. Improving the Quality of Investment Adviser Oversight (Section 914) 

One area where the funding shortfall is particularly critical is in the regulatory 

oversight of investment advisers. This issue received heightened attention as a result of the unraveling of the Madoff Ponzi scheme. This is ironic, since Madoff was 

a broker-dealer regulated exclusively as a broker-dealer up until just 2 years before 

his fraud was uncovered. If the Madoff scandal was an indictment of anything, 

therefore, it was an indictment of the effectiveness of broker-dealer oversight.4 That 

said, the problem of inadequate investment adviser oversight is quite real. And it 

is first and foremost a resource problem, a problem that began to emerge in the late 

1980s at a time when both mutual funds and investment advisers were growing at 

an extremely rapid pace and agency staffing to oversee these areas was growing 

slowly if at all. By the early 1990s, the problem had reached crisis proportions, with 

inspections so infrequent that a small adviser might reasonably expect to set up 

shop and reach retirement without ever seeing an SEC inspector.5

Over the years, CFA has supported a variety of approaches to solve this resource 

problem, including increased appropriations to the SEC, self-funding for the agency 

to free it from the appropriations process, and user fees on investment advisers to 

pay for increased oversight. None has been adopted. While the resource problem ultimately rests with Congress to resolve, Section 914 of the Dodd-Frank Act required 

the SEC to conduct a study assessing the need for additional resources for investment adviser examinations and options available to Congress to address this issue, 

including by delegating this responsibility to a self-regulatory organization (SRO). 

Earlier this year, the SEC issued its Section 914 study.6 In it, the staff documented a decline in the number and frequency of inspections of registered investment advisers over the past 6 years and described new challenges the Commission 

will face as it takes on responsibility for registration and oversight of private fund 

advisers. We share the study’s conclusion that, ‘‘The Commission’s examination program requires a source of funding that is adequate to permit the Commission to 

meet the new challenges it faces and sufficiently stable to prevent adviser examination resources from periodically being outstripped by growth in the number of registered investment advisers.’’ 

The study outlines three options for Congress to consider adopting to address this 

‘‘capacity constraint:’’ 

• imposing user fees on SEC-registered investment advisers to fund their examinations by SEC inspection staff; 

• authorizing one or more SROs to examine, subject to SEC oversight, all SECregistered investment advisers; or 
61 

7 ‘‘Consumer Finance: Regulatory Coverage Generally Exists for Financial Planners, but Consumer Protection Issues Remain,’’ Government Accountability Office, January 2011. The report 

is available here: http://www.gao.gov/new.items/d11235.pdf. 8The problems with the GAO study are summed up well in a Morningstar article by University of Mississippi Law Professor Mercer Bullard, ‘‘The Future of Financial Planning Regulation.’’ The article is available here: http://news.morningstar.com/articlenet/article.aspx?id=386262 

• authorizing FINRA to examine dual registrants for compliance with the Advisers Act. 

In the past, CFA has categorically opposed delegating investment adviser oversight to an SRO, particularly one dominated by broker-dealer interests and particularly if that SRO were given rulemaking authority. We continue to believe the userfee approach outlined in the SEC report offers the best option for funding enhanced 

inspections in a way that promotes investor protection while minimizing added costs 

to industry. 

However, having spent the better part of two decades arguing for various approaches to increase SEC resources for investment adviser oversight with nothing 

to show for our efforts, we have been forced to reassess our opposition to the SRO 

approach. Specifically, we have concluded that a properly structured SRO proposal 

would be a significant improvement over the status quo. Too often, however, the 

SRO approach is presented as an easy solution by individuals who have not adequately confronted the many thorny issues it presents. The SEC study does an excellent job, in our view, of laying out the issues that would need to be addressed 

if Congress were to pursue this approach. Only by answering the following questions 

can Congress develop an SRO proposal that adequately protects investor interests 

while avoiding imposing undue costs on small advisers. 

• How should such an approach be structured in light of the diversity in the investment adviser community? 

• How can the risks of industry capture be avoided? 

• What are the implications of strong industry opposition to such an approach? 

• What would the costs of effective SRO oversight be, and how would they be 

borne by the many small investment adviser firms? 

• What resources would the SEC need in order to provide effective oversight of 

any such SRO or SROs to which this responsibility might be delegated? 

• Should an SRO be an inspection-only SRO, or should it also have broader rulemaking authority? 

• What entity (or entities) is best suited to this task? 

Ultimately, whatever approach Congress chooses to take, we share the view expressed by SEC Commissioner Elisse Walter in her statement on the study, ‘‘that 

the current resource problem is severe, that the problem will only be worse in the 

future, and that a solution is needed now.’’ We urge you to act to resolve this problem sooner rather than later. 

F. Improving Regulation of Financial Planners (Section 919C) 

Section 919C of Dodd-Frank required a GAO study of the adequacy of financial 

planning regulation. Deferring to a study was a reasonable approach for Congress 

to take, since the crowded legislative calendar in the midst of the crisis did not 

allow for an adequate review of the issues or of various proposals that have been 

put forward to improve financial planning regulation. Unfortunately, the GAO study 

on financial planning regulation,7 which was released in January, represents a real 

missed opportunity. While it correctly highlights problems with the weak conduct 

standards that apply to insurance agents, it fails to address the basic question of 

how best to regulate activity that cuts across a variety of regulatory domains.8 This 

is an important question that deserves more thoughtful analysis than it received in 

the GAO study. Indeed, we would encourage this Committee to look into the issue 

once the press of overseeing implementation of Dodd-Frank has passed. 

II. Strengthening Protections for Retail Investors 

As the financial reform legislation worked its way through Congress, it became 

a vehicle for several specific measures to improve investor protections. These are not 

for the most part directly related to the causes of the crisis (though some are directly related to the Madoff scandal). Instead, they address long-standing weaknesses in protections for retail investors. The issues covered by these provisions 

range from the protections that apply to investors’ interactions with those they rely 

on for investment advice, the quality of disclosures investors receive regarding in-
62 

9 ‘‘Study on Investment Advisers and Broker-Dealers,’’ by the staff of the U.S. Securities and 

Exchange Commission, January 2011. The report is available here: http://www.sec.gov/news/ 

studies/2011/913studyfinal.pdf. 10 Unfortunately, a relatively small but vocal segment of the broker-dealer community, in particular those whose business model is dependent on the sale of high-cost variable annuities, has 

continued to oppose any Commission action to raise the standard of conduct for brokers. In voicing their opposition, they rely on arguments that are at best misinformed, at worst are outright 

deceptive, that requiring brokers to act in their customers’ best interests would somehow harm 

middle income and rural investors. Contrary to the claims of these critics, the proposal put forward by the SEC offers middle income investors the best of both worlds, preserving their access 

to commission- and transaction-based services while simultaneously helping to ensure that those 

services are delivered with the investor’s best interests in mind. 

vestment products and services, and the ability of defrauded investors to recover 

their losses. For the most part, these Title IX provisions authorize rather than require the SEC to act. With the agency so far occupied primarily with Dodd-Frank 

mandates, and appropriately so, progress to date has been minimal. Once the agency has an opportunity to turn its attention to these issues, however, these provisions 

have the potential to dramatically improve protections for retail investors in areas 

long identified as high priorities by investor advocates. 

A. Raising the Standard for Brokers’ Investment Advice (Section 913) 

Improving the protections that apply to investors’ interactions with the financial 

intermediaries they rely on for investment advice and recommendations has long 

been a priority for CFA and other investor advocates. There are several reasons for 

this. Research suggests that investors are ill-equipped to make an informed choice 

among investment professionals, since they typically cannot distinguish between 

brokers and investment advisers, do not realize that their recommendations are subject to different legal standards, and do not understand the difference between those 

standards. Moreover, additional research has found that investors rely heavily, if 

not exclusively, on the recommendations they receive from investment professionals, 

typically doing little if any additional research on the investments recommended. 

This makes them extremely vulnerable to investment professionals who take advantage of that trust. That is why ensuring that these investment professionals act in 

their customers’ best interests—both by raising the standard of conduct that applies 

to broker dealers when they give investment advice and by improving the quality 

of regulatory oversight for investment advisers—is such a high investor protection 

priority. 

Section 913 of Dodd-Frank advances this goal by authorizing the Securities and 

Exchange Commission to impose a fiduciary duty on brokers when they give personalized investment advice to retail investors. In January, the Commission released 

the study required by the Act as a predicate to any regulatory action in this area.9

In it, the Commission proposes to impose a uniform fiduciary duty on brokers and 

advisers through dual rules under the Securities Exchange Act and the Investment 

Advisers Act. This approach, which preserves the broker-dealer business model 

while raising the standard that applies to broker recommendations, has won enthusiastic praise not only from traditional proponents of a fiduciary duty, such as CFA, 

but also from the leading broker-dealer trade associations.10

The fact that the SEC has identified an approach to this issue that has won such 

broad support offers an opportunity for long-overdue progress on this key investor 

protection priority. SEC Chairman Mary Schapiro has indicated that the Commission is likely to move forward on rulemaking later this year. CFA strongly supports 

the Commission on this and urges Members of this Committee to do so as well. 

B. Improving Disclosures (Sections 912, 917, 919, 919B) 

In a number of areas and to a large extent, our system of investor protection is 

predicated on the notion that investors who are armed with complete and accurate 

information will be able to look out for their own interests. This concept, which predates the democratization of securities markets that has occurred over the past several decades, may be overly optimistic in its assumptions about the financial sophistication of average retail investors. At the very least, it puts a premium on our ability to deliver the information investors need, in a form they can access and understand, at a time when it is useful to them in making their investment decisions. 

I suspect that, if the SEC were to make extensive use of the disclosure testing authority provided to the agency in Dodd-Frank, it would find that few if any of the 

disclosures currently provided to investors satisfy this three-part test for effectiveness. In short, much can and should be done to improve the content, format and 

timing of disclosures, and the Dodd-Frank Act provides the SEC with a sound 

framework for making those improvements. 
63 

Section 917, for example, requires the SEC, as part of its study of financial literacy, to look at a variety of issues that are central to developing effective disclosures. These include identification of the key information investors need to make 

sound investment decisions as well as ways to improve the timing, content and format of disclosures. By requiring this analysis in the context of a study of financial 

literacy, this provision highlights the need to design disclosures with a realistic understanding of the financial sophistication of investors in mind. Section 912 builds 

on this study by authorizing the agency to engage in investor testing of disclosures. 

This authority can be used both to learn what methods and formats of disclosure 

generally are most effective in conveying information to investors and to test specific 

disclosure documents for clarity and effectiveness. It can and should be used both 

to help in the development of new disclosures and to improve existing disclosures. 

It is our understanding that the agency has begun to make at least limited use of 

this new authority, and we hope that is a trend that will continue and grow. For 

that to happen, however, the SEC must receive adequate funding for this purpose. 

Timing of disclosures can determine whether or not they play a significant role 

in conveying important information to investors. Information received after the sale 

is of little if any use, but that is the current norm in all too many situations. Even 

information delivered at the point of sale may be of little value, if the investment 

decision has already been reached. To really benefit, investors must receive the key 

information when they are still evaluating their investment options. That argues for 

delivery at the point of recommendation, a goal that may be more easily achieved 

as we move toward greater use of the Internet to satisfy disclosure requirements. 

Section 919 of Dodd-Frank provides the SEC with tools to achieve this goal of 

timelier disclosures, by authorizing the agency to require pre-sale disclosures with 

regard to both investment products and services. We especially appreciate the decision to expand this provision beyond just mutual funds to include all investment 

products and services. This will give the agency the ability to take what it learns 

from its study on financial literacy and from any disclosure testing it conducts and 

use it to develop disclosure documents that are much more useful to retail investors. 

C. Strengthening Protections for Defrauded Investors (Sections 921, 929B, 

929H, 929Y, 929Z) 

Title IX of Dodd-Frank also includes several provisions that could be used to improve, or at least protect, the ability of defrauded investors to recover their losses. 

These include provisions in Section 929B to expand the Fair Fund to include civil 

penalties, the Section 929Y study of extraterritoriality and private rights of action, 

and the Section 929Z study of private rights of action against those who aid and 

abet securities fraud. For investors to benefit from the latter two provisions, however, Congress will need to follow up on these studies and amend the Securities Exchange Act to provide U.S. investors with the ability to pursue private actions under 

Section 10(b) for foreign transactions and against those who aid and abet securities 

fraud. A series of recent court decisions have significantly limited defrauded investors’ right to recovery. We urge Congress to redress that imbalance by restoring 

basic private rights of action in these areas. 

Perhaps more significantly, Section 921 of Dodd-Frank authorizes the SEC to 

limit or restrict the use of forced arbitration clauses in brokerage contracts. CFA 

is a strong support of alternative dispute mechanisms. We believe it is absolutely 

essential the investors retain access to an arbitration system that is fair, efficient 

and affordable. It is precisely for this reason that we oppose pre-dispute binding arbitration clauses. Certain cases simply are not suited for resolution through arbitration, particularly complex fraud cases that require extensive discovery proceedings 

and a sophisticated reading of the applicable law. When forced into arbitration by 

pre-dispute binding arbitration clauses, these cases can both clog the arbitration 

system and increase its costs. Those operating the arbitration forum, in this case 

FINRA, come under pressure to adopt more formal, court-like proceedings to ensure 

that such cases can be dealt with fairly. And the goals of a fast, efficient, affordable 

system to resolve disputes end up being undermined. CFA therefore supports a careful approach to limiting the use of binding arbitration clauses that preserves investor access to arbitration but doesn’t force cases into arbitration that don’t belong 

there. So far, however, the SEC does not appear to have taken up this issue. 

D. Strengthening Protections Regarding Custody of Client Assets 

(Section 411) 

Responding at least in part to concerns raised by the Madoff scandal, Section 411 

of the Dodd-Frank Act requires investment advisers to have appropriate protections 

in place to safeguard client assets held in custody, including by requiring an independent auditor to verify the assets. While we believe this is a useful requirement, 
64 

11Mendales, Richard E., ‘‘Collateralized Explosive Devices: Why Securities Regulation Failed 

to Prevent the CDO Meltdown, and How to Fix It,’’ University of Illinois Law Review. 12 Investors Working Group, U.S. Financial Regulatory Reform: The Investors’ Perspective, 

July 2009. (The Investors Working Group is an Independent Taskforce Sponsored by CFA Institute Centre for Financial Market Integrity and Council of Institutional Investors.) [Hereinafter, 

The Investors’ Perspective] 

it is worth noting that Madoff was a broker, not an investment adviser, for the bulk 

of the period covered by the scandal. Any Madoff-related reforms to address weaknesses in custody requirements would more appropriately focus on strengthening 

protections with regard to brokers who self-custody. 

E. Adjusting the Definition of Accredited Investor (Section 413) 

Several definitions in our securities laws seek to draw a line between sophisticated investors capable of looking out for their own interests and others who require 

the protection of the securities laws. One such is the accredited investor definition. 

While we question the validity of any definition based primarily on net worth or income, the validity of the definition is particularly questionable when it is not regularly adjusted to keep pace with inflation. Such has been the case with the accredited investor definition. Section 413 of Dodd-Frank significantly improves the definition by adjusting the net worth trigger upward, excluding the value of the primary 

residence from that calculation, and providing for periodic reviews and adjustments 

of the standard. 

III. Addressing Securities Regulation Failures Related to the Crisis 

While they fall somewhat outside the range of topics typically thought of as retail 

investor protection issues, two investor protection issues directly related to the financial crisis deserve at least a mention here—securitization reform and strengthened regulation of credit rating agencies. These issues perfectly illustrate how a failure to regulate effectively in largely institutional markets can have devastating consequences for retail investors. 

A. Reforming the Asset-Backed Securitization Process 

As the crisis unfolded, much attention was given to the way securitization had 

fundamentally changed incentives in the mortgage markets, making lenders far less 

concerned about ensuring the borrower’s ability to repay. One reason this occurred 

was that the mortgage-backed securities (MBS) and collateralized debt obligations 

(CDOs) based on those securities were both incredibly complex and almost completely opaque, leaving investors in the securities with little or no information about 

the quality of underlying loans. As Penn State Visiting Law Professor Richard E. 

Mendales put it, ‘‘The many layers between debt instruments providing the underlying cash-flow for such instruments and the final instruments sold on world markets destroyed the transparency that the securities laws are designed to create . . . 

’’11

The diligent investor who attempted to conduct due diligence on these securities 

got no assistance from securities regulations, which allowed the sale of MBS with 

minimal disclosures through the SEC’s shelf-registration process. As a result, even 

those MBS that were registered with the SEC could be sold based ‘‘not upon a detailed prospectus but rather on a basic term sheet with limited information.’’12 Regulation A/B also eliminated underwriters’ obligation to perform due diligence to confirm adequate loan documentation. Bad as disclosures were for more traditional 

MBS, they were often even worse for CDOs, which were typically sold in private, 

144A sales to Qualified Institutional Buyers (QIBs) with even less information on 

underlying assets. 

Subtitle D of Title IX includes a broad set of provisions to reform the asset-backed 

securitization process. The legislation attempts to address the securitization’s deleterious effect on incentives to ensure borrowers’ ability to repay by requiring 

securitizers to have some ‘‘skin in the game’’ with regard to the asset-backed securities they issue. Just as important, Section 942 of Dodd-Frank requires more extensive disclosures of information necessary to permit investors to conduct a reasonable 

due diligence review of the securities. Section 945 requires issuers of asset-backed 

securities to perform a review of the assets underlying the security and to disclose 

the nature of that review to investors. Importantly, in issuing its rules implementing Section 945, the SEC appropriately specified that the due-diligence reviews 

must be adequate to provide reasonable assurance that the disclosures provided to 

investors are accurate. Meanwhile, the broader ABS disclosure rules required by the 

Act have been proposed but not yet adopted. When they are fully implemented, 

these provisions should go a long way toward making it possible for the institutional 

investors who participate in this market to make better informed investment deci-
65 

13 Collateralized Explosive Devices. [footnotes omitted] 

sions, and that should benefit retail investors by reducing risks in the financial system. 

B. Strengthening Regulation of Credit Rating Agencies 

One justification given for allowing sale of MBS and CDOs without adequate disclosures was that they were highly rated by the credit rating agencies. In fact, the 

entire system of regulation for the securitization process was built on the assumption that ratings could reliably assess the risks associated with these investments. 

Special Purpose Vehicles set up to issue the securities were exempt from regulation 

under the Investment Company Act by virtue of their investment grade ratings. Eligibility for sale through the shelf registration system was also based on ratings, as 

was favorable treatment under financial institution capital standards. Mendales 

summed up our regulatory reliance on ratings this way: ‘‘Unregulated ratings for 

asset-backed securities became proxies for the full disclosure required by securities 

law. Thus, when they were repackaged into more complex CDOs or used indirectly 

to create derivative obligations such as default swaps, participants in transactions 

and institutions holding the securities as part of their required capitalization relied 

on the high ratings given to component asset-backed securities rather than looking 

at the assets underlying them.’’13 As events later demonstrated, the reliance on ratings by investors and regulators alike proved to be disastrously misguided. 

Subtitle C of the Dodd-Frank Act seeks to address this fundamental weakness in 

the system through a multi-faceted approach to credit rating agency reform. This 

includes: improving regulatory oversight of credit ratings agencies, strengthening internal controls over the rating process, making the assumptions behind the ratings 

more transparent to users of those ratings, making the ratings agencies more accountable for following sound procedures, and reducing regulatory reliance on ratings. 

Implementation of the reforms is still very much a work in progress. Still awaiting approval by House and Senate appropriators of its funding reprogramming plan, 

the SEC has not yet been able to create the new Office of Credit Ratings required 

by Dodd-Frank. However, it has reportedly begun the stepped up inspections of rating agencies required under the Act. In addition, the SEC recently issued the rule 

proposals implementing the operational reforms required by the Act. Meanwhile, the 

agency has put on hold provisions designed to increase legal accountability of ratings agencies by subjecting them to the same expert liability that auditors and underwriters face when their ratings are used in prospectuses. Faced with a threatened boycott by ratings agencies and fearing a shut-down of the still struggling 

MBS market, the SEC has issued a no action letter permitting asset-backed securities to be issued without inclusion of a rating in the prospectus. While we believe 

ratings agencies ought to be held legally accountable for following reasonable ratings procedures, we understand the rationale behind the SEC action. 

The SEC has also begun the difficult task of reducing regulatory reliance on credit 

ratings. CFA strongly supports the concept behind this proposal, but we preferred 

the more flexible approach contained in the original Senate bill. Had that approach 

prevailed, Federal financial regulators might not be in the situation in which they 

now find themselves—forced to remove regulatory references to credit ratings without having identified any acceptable alternative measures of creditworthiness to put 

in their place. We are deeply concerned that this well-intended provision of the legislation may end up increasing risks in the financial system. We strongly encourage 

this Committee to take a closer look at how this provision is being implemented and 

what the implications are for the safety and stability of the financial system. 

Conclusion 

With the exception of the September 11 terrorist attacks, I can think of no events 

in recent history that have been as frightening for, or as devastating to, investors 

as the recent financial crisis. For several months, the markets appeared to be in 

free-fall. As the Dow plunged ever lower, hard won retirement savings accumulated 

over many years were vaporized overnight. No one knew when, of where, the market would finally reach bottom. Some who had planned to retire had to put those 

plans on hold. The least fortunate lost their jobs and their homes as the credit markets froze and the economy tanked. With unemployment still topping 9 percent, 

many Americans are still feeling those ill effects today. In short, the financial crisis 

has left Americans feeling as fearful of financial disaster as the events of 9/11 left 

us fearful of another terrorist attack. 

A peculiar characteristic of the crisis for retail investors is that they suffered 

these devastating effects despite the fact that they had never invested in the toxic 
66 

1 Approximately three-quarters of CalPERS global equities portfolio is managed by internal investment professionals. 

but nonetheless AAA-rated mortgage-backed securities that were a root cause of the 

crisis and had probably never even heard of the credit default swaps that helped 

spread that risk throughout the global economy. Instead, retail investors suffered 

the collateral damage of regulatory failures in markets to which they had no direct 

exposure. The bulk of Dodd-Frank is dedicated to rectifying those broader market 

failures, and appropriately so. Although most investors are unlikely to understand 

the cause and effect, reforms designed to improve the overall effectiveness of regulation in the financial markets should benefit these investors indirectly both by promoting the financial stability that is crucial to their financial security, but also by 

making the regulators (in this case the SEC) more effective in carrying out their 

basic investor protection functions. In addition, Dodd-Frank includes a number of 

provisions designed to address long-standing weaknesses in our system of protections for unsophisticated retail investors. If these provisions are implemented effectively, the SEC and our system of investor protection generally could emerge stronger than before. 

The investor protection framework provided in Dodd-Frank is a sound one. But 

it only takes us so far. For it to succeed, regulators will have to demonstrate a willingness to use their authority aggressively and effectively, and Congress will have 

to provide them with both the resources and the backing to enable them to do so. 

PREPARED STATEMENT OF ANNE SIMPSON 

SENIOR PORTFOLIO MANAGER, GLOBAL EQUITIES

CALIFORNIA PUBLIC EMPLOYEES’ RETIREMENT SYSTEM

JULY 12, 2011 

Chairman Johnson, Ranking Member Shelby, and Members of the Committee: 

Good morning. I am Anne Simpson, Senior Portfolio Manager, Global Equities at 

the California Public Employees’ Retirement System (CalPERS). I am pleased to appear before you today on behalf of CalPERS and share our views on a number of 

important investor protections included in Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). 

My testimony includes a brief overview of CalPERS, including how we participate 

in corporate governance and make investment decisions. My testimony also includes 

a discussion of our views on those key provisions of the Dodd-Frank we believe significantly enhance corporate governance and thereby contribute to the quality of 

risk adjusted returns in our portfolio. 

Some Background on CalPERS 

CalPERS is the largest public pension fund in the United States with approximately $232 billion in global assets and equity holdings in over 9,000 companies 

worldwide. CalPERS provides retirement benefits to more than 1.6 million public 

workers, retirees, their families and beneficiaries. We payout some $15 billion in 

benefits a year, and 70 cents on the dollar comes from investments, a significant 

portion of which in internally managed.1

Those we support are on modest incomes: typically, $2,000 in benefits a month. 

For that reason, as a significant institutional investor with a long-term investment 

time horizon, CalPERS has a vested interest in maintaining the integrity and efficiency of the capital markets. Moreover, size and long term liabilities mean we have 

to look for market solutions. We cannot simply sell our shares when things go 

wrong. As a result, corporate governance issues are of great concern to us and those 

on whose behalf we are investing: the public servants such as the police officers, 

firefighters, school employees and others who rely on us for their retirement security. 

Participation in Corporate Governance Decisions 

CalPERS has been a long-time proponent of good corporate governance, which 

serves to protect, preserve and grow the assets of the fund, and we strongly support 

the corporate governance reforms found in Dodd-Frank. We have also strongly supported other measures which are vital to a coordinated and comprehensive reform 

effort. These are not the focus of today’s discussion, but they are critical to the 

project: systemic risk oversight, proper funding and independence for regulators, derivatives reform, credit rating agency overhauls among them. 

As a shareowner of each of the stocks held in its portfolios, CalPERS has developed, and periodically updates, a comprehensive set of corporate governance prin-
67 

2See The CalPERS Effect on Targeted Company Share Prices, Wilshire Associates, (November 

2010). http://www.calpers.ca.gov/eip-docs/about/board-cal-agenda/agendas/invest/201008/ 

item05a-2-02-01.pdf. 3See Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report xviii (Jan. 

2011), http://www.gpoaccess.gov/fcic/fcic.pdf (‘‘We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key 

cause of this crisis’’ ) [hereinafter FCIC Report]; Investors’ Working Group, U.S. Financial Regulatory Reform, The Investors’ Perspective 22 (July 2009), http://www.cii.org/UserFiles/file/ 

resource%20center/investment%20issues/Investors’%20Working%20Group%20Report%20(July% 

202009).pdf (‘‘The global financial crisis represents a massive failure of oversight’’) [hereinafter 

IWG Report]. 4 IWG Report, supra note 1, at 22. 5See Staff of S. Permanent Subcomm. on Investigations, Wall Street and the Financial Crisis: 

Anatomy of a Financial Collapse 185–86 (Apr. 13, 2011), http://hsgac.senate.gov/public/lfiles/ 

FinanciallCrisis/FinancialCrisisReport.pdf (providing evidence that board oversight of Washington Mutual, Inc., including oversight of enterprise risk management, was ‘‘less than satisfactory’’); IWG Report, supra note 1, at 22. 6FCIC Report, supra note 1, at xix (‘‘Compensation systems-designed in an environment of 

cheap money, intense competition, and light regulation-too often rewarded the quick deal, the 

short-term gain-without proper consideration of long-term consequences); see also Deputy Secretary of the Treasury Neal Wolin, Remarks to the Council of Institutional Investors 4 (Apr. 

12, 2010), http://www.ustreas.gov/press/releases/tg636.htm (noting that ‘‘irresponsible pay 

practices . . . led so many firms to act against the interests of their shareholders’’); IWG Report 

supra note 1, at 22. 

ciples and detailed guidelines that govern the voting of the related proxies. These 

principles and guidelines focus on a broad range of issues including how we will vote 

on director nominees in uncontested elections and in proxy contests. 

CalPERS votes its proxies in accordance with our guidelines. Both the CalPERS 

proxy policy and the actual proxy votes cast are published on our Web site, so that 

all constituents and interested parties can know our positions on these important 

issues. Moreover, as part of our proxy voting diligence process, we have detailed discussions with many companies in our portfolio. We engage underperforming companies in extensive dialogue through our Focus List program, which was found to 

produce superior returns over a 10-year period.2

Shareowner proxy voting rights are considered to be valuable assets of the fund. 

Attention to corporate governance promotes responsible business practices that 

serve as an integral component to a company’s long-term value creation. In instances where guidelines are not dispositive on shareowner or management proposals, the Office of Corporate Governance, which I oversee, reviews and makes 

proxy voting recommendations that are consistent with the best interests of the 

fund and our fiduciary duties. 

Investment Decision Making Process 

As indicated above, CalPERS takes a long-term strategic approach to its investment decisionmaking process. Annually, a comprehensive ‘‘Strategic Investment 

Plan’’ is developed jointly by CalPERS’ investment staff and its external consultants, with input from and subject to final approval of the 13-member board. The 

plan is based on careful analysis of the long-term outlook for the capital markets 

and major qualitative and quantitative factors including the unique needs, preferences, objectives and constraints of CalPERS. This detailed investment plan manifests itself in the development of an asset allocation framework designed to achieve 

the ongoing commitment to diversification and provide guidance in the investment 

decisionmaking process including advancing investment strategies, the hiring and 

monitoring of external investment advisors, portfolio rebalancing and meeting cash 

needs. 

How Inadequate Corporate Governance Contributed to the 2008 Financial 

Meltdown 

It is widely acknowledged that the 2008 financial crisis was fuelled by a toxic 

combination of lax oversight and misaligned incentives.3 Too many CEOs pursued 

excessively risky strategies or investments that bankrupted their companies or 

weakened them financially for years to come.4 Boards of directors were often complacent, failing to challenge or rein in reckless senior executives who threw caution 

to the wind.5 And too many boards approved executive compensation plans that rewarded excessive risk taking.6 Others simply did not have robust risk management 

systems in place, or had these subservient to short term revenue chasing. The DoddFrank focus upon improving transparency around incentives and giving 

shareowners the tools to improve oversight of boards is therefore absolutely on target. We look forward to further improvements in disclosure also under discussion 

by financial regulators, for example to ensure that compensation below board level 
68 

7See, e.g. Press Release, CalPERS, Investors Speak Out on Dodd’s Financial Reform Bill— 

Offer Do’s, Don’ts as Bill Reaches Critical Stage 2 (Mar. 19, 2010), http://www.calpers.ca.gov/ 

index.jsp?bc=/about/press/pr-2010/mar/investors-financial-reform-bill.xml. 8Letter from Warren E. Buffett, Chairman of the Board, to the Shareholders of Berkshire 

Hathaway, Inc. 16 (Feb. 26, 2010), http://www.berkshirehathaway.com/letters/2009ltr.pdf. 9Press Release, supra note 5, at 2. 10 Id. 11 IWG Report, supra note 1, at 22 (‘‘shareowners currently have few ways to hold directors’ 

feet to the fire’’). 12S. Comm. On Banking, Housing, & Urban Affairs, Rep. On The Restoring American Financial Stability Act 30 (Mar. 22, 2010), http://banking.senate.gov/public/lfiles/ 

RAFSAPostedCommitteeReport.pdf. (Noting that the Senate version of Dodd-Frank contained 

provisions designed to give investors ‘‘more protection’’ and shareholders ‘‘a greater voice in corporate governance’’) [hereinafter S. Rep.]. 13See IWG Report, supra note 1, at 22. 

is disclosed for those who can have an impact upon the company’s over risk profile, 

and also to improve understanding of pay equity across companies. 

More specifically, a common element in the failure of Lehman Brothers, American 

International Group, Fannie Mae, Washington Mutual, and many other companies 

implicated in the 2008 financial meltdown, was that their boards of directors did 

not control excessive risk-taking, did not prevent compensation systems from encouraging a ‘bet the ranch’ mentality, and did not hold management sufficiently accountable.7 As famed investor Warren Buffett observed in his 2009 letter to the 

shareowners of Berkshire Hathaway Inc.: 

In my view a board of directors of a huge financial institution is derelict 

if it does not insist that its CEO bear full responsibility for risk control. If 

he’s incapable of handling that job, he should look for other employment. 

And if he fails at it—with the Government thereupon required to step in 

with funds or guarantees—the financial consequences for him and his board 

should be severe. 

It has not been shareholders who have botched the operations of some of 

our country’s largest financial institutions. Yet they have borne the burden, 

with 90 percent or more of the value of their holdings wiped out in most 

cases of failure. Collectively, they have lost more than $500 billion in just 

the four largest financial fiascos of the last 2 years. To say these owners 

have been ‘‘bailed-out’’ is to make a mockery of the term. 

The CEOs and directors of the failed companies, however, have largely gone 

unscathed. Their fortunes may have been diminished by the disasters they 

oversaw, but they still live in grand style. It is the behavior of these CEOs 

and directors that needs to be changed: If their institutions and the country 

are harmed by their recklessness, they should pay a heavy price—one not 

reimbursable by the companies they’ve damaged nor by insurance. CEOs 

and, in many cases, directors have long benefited from oversized financial 

carrots; some meaningful sticks now need to be part of their employment 

picture as well.8

Accountability is critical to motivating people to do a better job in any organization or activity.9 An effective board of directors can help every business understand 

and control its risks, thereby encouraging safety and stability in our financial system and reducing the pressure on regulators, who, even if adequately funded, will 

be unlikely to find and correct every problem.10 Unfortunately, long-standing inadequacies in corporate governance requirements and practices have limited 

shareowners’ ability to hold boards accountable.11

Fortunately, Dodd-Frank contains a number of corporate governance reforms that 

when fully implemented and effectively enforced will reduce those inadequacies by 

providing long-term investors like with better tools, including better information, to 

hold directors more accountable going forward.12

The remainder of my testimony highlights some of the key corporate governance 

provisions of Dodd-Frank and why CalPERS believes those provisions are beneficial 

to investors in terms of improving the accountability of boards and enhancing investor protection. 

Dodd-Frank Corporate Governance Provisions 

SEC. 971 Proxy Access 

The most fundamental of investor rights is the right to nominate, elect and remove directors.13 Anything less provides a fundamental flaw in capitalism. The providers of capital need to be able to hold boards accountable, and boards in turn need 
69 

14 Id. 15 Id. 16 Id. 17We note that a second roadblock to the fundamental right of investors to nominate, elect, 

and remove directors—‘‘plurality voting’’—was not addressed by Dodd-Frank and remains a significant impediment to improving board accountability. More specifically, most companies elect 

directors in uncontested elections using a plurality standard, by which shareowners may vote 

for, but cannot vote against, a nominee. If shareowners oppose a particular nominee, they may 

only withhold their vote. As a consequence, a nominee only needs one ‘‘for’’ vote to be elected 

and, therefore, potentially unseating a director and imposing some accountability becomes virtually impossible. We would respectfully request that the Committee consider stand alone legislation to remove this roadblock. Id. 18Facilitating Shareholder Director Nominations, 74 Fed. Reg. 29,024 (proposed rule June 18, 

2009), http://www.sec.gov/rules/proposed/2009/33-9046.pdf. 19Facilitating Shareholder Director Nominations, 75 Fed. Reg. 56,668, 56,674 (final rule Sept. 

16, 2010), http://www.gpo.gov/fdsys/pkg/FR-2010-09-16/pdf/2010-22218.pdf (‘‘Several commentators challenged our authority to adopt Rule 14a–11’’). 20See id. 21 Id. at 56,668. 22 Id. 23Ted Allen, U.S. Appeal Court to Hear Proxy Access Lawsuit, ISS (Apr. 6, 2011), http:// 

blog.riskmetrics.com/gov/2011/04/us-appeals-court-to-hear-proxy-access-lawsuit.html. 24 Id. 25 Id. 

to have effective oversight of management. The United States is virtually alone in 

world markets by not providing capital providers the ability to hold their stewards 

to account. Several roadblocks, however, have prevented this fundamental right 

from being an effective remedy for shareowners dissatisfied with the performance 

of their public companies.14

One of the most significant roadblocks is that Federal proxy rules have historically prohibited shareowners from placing the names of their own director candidates on public company proxy cards.15 Thus, long-term shareowners who may 

have wanted the ability to run their own candidate for a board seat as a means of 

making the current directors more accountable have only had the option of pursuing 

a full-blown election contest—a prohibitively expensive action for most public pension funds like CalPERS.16

Fortunately, due to the extraordinary leadership of this Committee and the U.S. 

Securities and Exchange Commission (‘‘Commission or SEC’’), this roadblock—the 

inability for shareowners to place director nominees on the company’s proxy card— 

we hope will soon be lifted.17 As background, in June 2009, the Commission issued 

a thoughtful proposal providing for a uniform measured right for significant longterm investors to place a limited number of nominees for director on the company’s 

proxy card.18 Some opponents of the proposal subsequently raised questions about 

whether the Commission had the authority to issue a proxy access rule.19 In response, Senator Schumer introduced, what would later become Section 971 of DoddFrank, removing any doubt that the Commission had the authority to issue a proxy 

access rule.20

After careful consideration of the input received in response to two separate comment periods on the proposal, the SEC issued a final rule on September 16, 2010.21

The final rule provides the ability for CalPERS, as part of a larger group of longterm investors, to place a limited number of nominees for director on the company’s 

proxy card and, thereby, effectively exercise its traditional right to nominate and 

elect directors to company boards.22

Unfortunately, despite Section 971 of Dodd-Frank, opponents of the Commission’s 

final rule have chosen to sue the SEC to delay its implementation.23 The legal challenge, based largely on Administrative Procedure Act grounds, is currently before 

the D.C. Circuit Court of Appeals (‘‘Court’’) on an expedited review.24 A decision is 

expected this summer.25 Whatever the Court’s decision, we fully expect that the 

Commission will, after curing any administrative deficiencies, promptly implement 

the final rule and remove this long-standing roadblock to the exercise of 

shareowners’ fundamental right to nominate, elect, and remove directors. 

SEC. 951 Shareholder Vote on Executive Compensation Disclosures 

As described by the Financial Crisis Inquiry Commission, the financial crisis revealed compensation systems: 

[D]esigned in an environment of cheap money, intense competition, and 

light regulation—too often rewarded the quick deal, the short-term gain— 

without proper consideration of long-term consequences. Often those systems encouraged the big bet—where the payoff on the upside could be huge 
70 

26FCIC Report, supra note 1, at xix. 27S. Rep., supra note 10, at 109. 28 Id. 29Letter from Justin Levis, Senior Research Associate, Council of Institutional Investors to 

Mr. Mike Duignan, Head of Market Supervision, Irish Stock Exchange 1–2 (Aug. 11, 2010), 

http://www.cii.org/UserFiles/file/resource%20center/correspondence/2010/8-11-10CIILetter 

IrishCorpGovCode%20.pdf. 30 Commissioner Luis A. Aguilar, U.S. Securities and Exchange Commission, Speech at the Social Investment Forum 2011 Conference 3–4 (June 10, 2011), http://www.sec.gov/news/speech/ 

2011/spch061011laa.htm. 31See, e.g., Letter from Laurel Leitner, Senior Analyst, Council of Institutional Investors to 

Robert E. Feldman, Executive Secretary, Federal Deposit Insurance Corporation 1–2 (May 19, 

2011), http://www.fdic.gov/regulations/laws/Federal/2011/11c07Ad73.PDF. 

and the downside limited. This was the case up and down the line—from 

the corporate boardroom to the mortgage broker on the street.26

During the development of Dodd-Frank, this Committee concluded that ‘‘shareholders, as the owners of the corporation had a right to express their opinion collectively on the appropriateness of executive pay.’’27 The result was Section 951 of 

Dodd-Frank that provides that any proxy for an annual meeting of shareowners will 

include a separate resolution subject to shareowner advisory vote to approve the 

compensation of executives.28

We agree with the Council of Institutional Investors that Section 951 provides 

with: 

a tool . . . [to] effectively, efficiently and regularly provide boards with useful feedback about whether investors view the company’s compensation 

practices to be in shareowners’ best interests. Nonbinding shareowner votes 

on pay offer a more targeted way to signal shareowner discontent than 

withholding votes from compensation committee members, and can serve as 

a helpful catalyst and starting point for dialogue on excessive or poorly 

structured executive pay. Also, the possibility of a majority ‘‘against’’ vote 

might serve as an additional deterrent against devising incentive plans that 

promote excessive risk-taking and/or enrichment.29

Section 951 became effective for the first time this proxy season. As recently discussed by SEC Commissioner Luis Aguilar, it appears that the new requirement is 

benefiting investors in at least three ways: 

First, say-on-pay seems to have resulted in increased communication between shareholders and corporate management. Reports seem to indicate 

that both shareholders and corporate management are pro-actively initiating discussions regarding executive compensation, which is far from the 

predictions that say-on-pay would lead to disrepair or at best be ineffective—this sounds like a positive development to me. 

Second, the reports indicate that shareholders are making their voices 

heard. For example, as of this month, 31 public companies have failed to 

obtain majority support for their executive compensation packages. 

Lastly, some pay practices appear to be changing in deference to shareholders’ views. Some companies have actually altered the pay and benefits 

of top executives. Many companies are putting in more performance-based 

compensation plans and they are addressing items that shareholders often 

criticized, such as: excessive severance; perks; Federal income tax payments; and pensions. For example, approximately 40 of the Fortune 100 

companies have eliminated policies that had the company pay certain tax 

liabilities of executives. As another example, General Electric modified the 

pay of its CEO 2 weeks prior in anticipation of the shareholder vote, deferring the vesting of certain options and conditioning the vesting on whether 

the company meets certain performance targets. According to news reports, 

this was apparently done to avoid losing a say-on-pay vote.30

Section 954 Recovery of Erroneously Awarded Compensation 

Another means identified by this Committee, the Investors Working Group, the 

Council of Institutional Investors, and many other parties to combat poorly structured executive pay plans that rewarded short term but unsustainable performance 

was to enhance current clawback provisions on unearned executive pay.31 In response, Section 954 of Dodd-Frank strengthens the existing clawback provisions in 

three important ways: First, it expands the application of the existing clawback re-
71 

32 John E. McGrady, III, & Kristen R. Miller, Executive Compensation Clawbacks—Effective 

Deterrent or Effective Remedy?, BNA Insights, Daily Rep. Executives, at B–4 (July 7, 2011). 33 Id. 34 Id. 35Letter from Laurel Leitner, supra note 29, at 1. 36 Id. 37Letter from Justin Levis, Senior Research Associate, Council of Institutional Investors, to 

Jose Manuel Barroso, President, European Commission 1–2 (Aug. 31, 2010), http:// 

www.cii.org/UserFiles/file/resource%20center/correspondence/2010/CII%20Letter%20on%20EC 

%20Green%20Paper%20on%20Bank%20Governance%208-31-10%20final.pdf. 38 Id. 39S. Rep., supra note 10, at 119. 

* The views expressed in this testimony are those of the author alone and do not necessarily 

represent those of the American Enterprise Institute. 

quirements to any current or former executive officer (not just the CEO or CFO).32

Second, it clarifies that a clawback is triggered by an accounting restatement due 

to material noncompliance without regard to the existence of misconduct.33 Finally, 

it strengthens the existing clawback requirements by extending the clawback to 3 

years from the existing 12-month period.34

CalPERS’ support for Section 954 is based on our belief, shared by the Council 

of Institutional Investors, and many other corporate governance and compensation 

experts, that a tough clawback policy is an essential element of a meaningful pay 

for performance philosophy.35 If executives are rewarded for hitting their performance metrics—and it later turns out that they failed to do so—they should return 

to shareowners the pay that they did not rightly earn.36 We look forward to the 

Commission’s proposed and final rules to implement Section 954 scheduled for later 

this year. 

Section 973. Disclosures Regarding Chairman and CEO Structures 

Finally, as indicated, the financial crisis represented an enormous failure of board 

oversight of management. We share the view of the Council of Institutional Investors, the Investor’s Working Group and many others that board oversight may be 

weakened by forceful CEO’s who also serve as a chair of the board.37 In our view, 

Independent board chairs are a key component of robust boards that can effectively 

monitor and, when necessary, rein in management.38 To have the CEO effectively 

running the board means the oversight process is fundamentally comprised. No one 

can grade their own performance objectively. Independent board oversight of the 

CEO is vital. 

While not requiring the separation of the role of the chair and CEO, Section 973 

of Dodd-Frank provides an important step forward by directing the SEC to issue 

rules, which are already in place, requiring those companies who have a Chairman/ 

CEO structure to disclose an explanation of the reasons that it has chosen that 

structure.39 This is an important advancement in corporate governance disclosure 

that we continue to support. 

That concludes my testimony. Thank you, Mr. Chairman for inviting me to participate at this hearing. I look forward to the opportunity to respond to any questions. 

PREPARED STATEMENT OF PAUL S. ATKINS * 

VISITING SCHOLAR, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

JULY 12, 2011 

Thank you very much, Mr. Chairman, Ranking Member Shelby, and Members of 

the Committee, for inviting me to appear today at your hearing. It is an honor and 

privilege for me to provide information for your deliberations on Dodd-Frank and 

the SEC. 

Dodd-Frank Overview 

I come before you today not only as a former Commissioner of the Securities and 

Exchange Commission and member of the former Congressional Oversight Panel for 

the TARP, but also as a visiting scholar at the American Enterprise Institute for 

Public Policy Research. AEI has a long history of focus on the economic and psychological fundamentals of entrepreneurism, economic development, and the political 

economy. It is a privilege for me to be able to participate in the public discussion 

about the issues of the day in the context of my years of work in the public and 

private sector. 

The news of this past week has highlighted the disappointing state of affairs in 

our economy. The data released by the Bureau of Labor Statistics show the unem-
72 

1See Promoting Economic Recovery and Job Creation: Hearing before the H. Comm. on Financial Services, 112th Cong., 1st Sess. (Jan. 25, 2011) (statement of Hal H. Scott, Professor, Harvard Law School). 2 Id. 

3 Id. 

ployment rate increasing to 9.2 percent, while the labor force itself shrank by more 

than a quarter of a million people. Basically, unemployment has risen as the supply 

of available workers has shrunk. More than 14 million Americans are out of work— 

and almost half of those have been out of work for more than 6 months. 

In a productive economy, jobs are normally created by people with entrepreneurial 

spirit—whether small businesses or large corporations. Starting with an idea for a 

product or service and the risk appetite to make it a reality, the entrepreneur will 

need to engage the help of others to make it a reality. To hire people and develop 

their product, entrepreneurs of course need money. The money has to come from 

somewhere, and with efficient financial markets, an entrepreneur should be able to 

borrow the money or find others willing to invest in the idea—risk their own capital 

for an interest in the potential profits. 

We have a great debate in this country as to whether there is a shortage of credit 

supply or demand. Last year, as a member of the Congressional Oversight Panel, 

I had the privilege of testifying before the House Financial Services Committee regarding small business lending initiatives. The debate was then, as it is now, whether the issuance of credit is constrained because of a lack of demand or a shortage 

of supply. Regardless of the cause, in the current regulatory climate it is difficult 

for lenders to increase their small business lending. Small businesses produce most 

of the new jobs in the country. From my work on the Congressional Oversight 

Panel, we heard many anecdotal reports from our field hearings and elsewhere that 

bank examiners have become more conservative and have required increasing levels 

of capital since the advent of the financial crisis. The balance between sufficient regulation and over-regulation is often a fine one. We have to remember that it is the 

investors who pay for regulation—effective or otherwise—through higher prices, diminished returns, or restricted choices. 

Why do I go through this description of how jobs are created? Because confidence 

and certainty are crucial to fostering a business climate that creates jobs. It is my 

belief that a major cause of the uncertainty handcuffing our economy today is in 

fact Government policy, particularly the sweeping new financial law enacted last 

year ostensibly for the sake of market stability and investor confidence. Because 

many of the provisions were not directly related to the underpinnings of the financial crisis, investors ultimately will pay for the increased costs associated with the 

mandates without receiving commensurate benefits. 

That is the single tragedy of Dodd-Frank. It is a calamity—2,319 pages are aggravating uncertainty and undermining the climate necessary for economic growth. Yet 

considering its length and scope, the Dodd-Frank Act was passed with relatively few 

hearings and no real debate about provisions that now threaten economic growth. 

In contrast, following the market crash of 1929, Congress attempted comprehensive 

reform over a period of a decade, involving extensive hearings and public debate. 

Dodd-Frank calls for the creation of anywhere between 243 and 533 new rules, depending on how you count them, and 84 rules by 3 new agencies alone—the Consumer Financial Protection Bureau (CFPB), the Office of Financial Reporting (OFR), 

and the Financial Stability Oversight Council (FSOC). Each of these new agencies 

has far-reaching powers, and we will not know for years how they will develop. 

Legal challenges are inevitable, not just as to the technicalities of the rules and 

whether they have been properly promulgated, but also as to basic questions of jurisdiction and constitutionality. 

As the past year has shown, Dodd-Frank also mandates very tight deadlines for 

Federal agencies to draft and implement these rules. In this quarter alone, DoddFrank mandates more than 100 rules to be finalized.1 As some experts have noted 

previously,2 this rate of rulemaking required by Dodd-Frank far outpaces the agencies’ respective historical workloads. From 2005–2006 the SEC annually averaged 

9.5 new substantive rules, while the CFTC averaged 5.5. Post-Dodd-Frank those 

numbers have soared to an average of 59 new rules for the SEC and 37 for the 

CFTC.3 Members of this committee have previously expressed concern that Federal 

agencies are sacrificing quality for speed as they neglect to properly weigh the costs 

and benefits to the economy of their proposed rules. In these circumstances, something has to give, and so far we have seen very little in the way of cost benefit analysis (some agencies’ inspectors general are investigating whether this lack of analysis may have violated the Administrative Procedure Act and other mandates), contracted timelines for the public to comment on proposed rulemakings (most com-
73 

4See Andrew Ang, et al., Hedge Fund Leverage 19 (Jan. 25, 2011) available at http:// 

www2.gsb.columbia.edu/faculty/aang/papers/HFleverage.pdf. 

ment periods are about 20 days shorter than usual), missed deadlines (right before 

the statutory effective date, registration requirements under Title IV had to be delayed by 8 months because the rules were finalized so late), and proposed rulemaking that is vague or overly broad. Taken together, the ability of stakeholders 

to provide input on matters directly impacting their business is severely impaired. 

An example on the latter point can be found with the Financial Stability Oversight Council (FSOC), a new agency created by Title I to identify threats to the financial stability of the United States. While this seemed like an attractive idea to 

officials who wish never to relive the anxiety of the ‘‘Too Big to Fail’’ era, the realities and impracticalities of such a Council have already started to reveal themselves. 

The principal new authority assigned to FSOC is to identify systemically important financial institutions. FSOC’s proposed rulemaking in January 2011 regarding 

this process was roundly criticized by the public and bipartisan Members of Congress for merely parroting the broad statutory language. This lack of transparency— 

magnified by leaks to the media about the staff’s methodology under consideration— 

has only compounded market uncertainty. FSOC recently announced plans to provide further guidance of this most important authority of the new systemic risk regulatory regime—although the form and extent of that guidance remains to be seen. 

The activities of the Financial Stability Oversight Council (including OFR) and 

the Bureau of Consumer Financial Protection have received much scrutiny over the 

past year, and for good reason. They comprise just 2 of the Act’s 16 Titles, however, 

and so I welcome today’s hearing on the subject of the investor protection provisions. 

As I intend to make clear today, many of these provisions impose sweeping changes, 

yet received relatively little attention during consideration of last year’s Dodd-Frank 

Act, which naturally raises the likelihood of unintended consequences. 

Title IV: The Private Fund Investment Advisers Registration Act of 2010 

Under Title IV of Dodd-Frank, investment advisers to hedge funds and private equity firms are required to comply with a set of registration rules, which hinders the 

success of both investors in the funds by adding administrative costs and potentially 

keeping competitors out of the market, and the SEC by spreading its resources too 

thinly and diverting its attention from protecting retail investors. This situation, together with the likely mistaken sense of security that investors might infer from 

SEC registration, endangers all investors. 

By repealing the ‘‘15-client’’ exemption, Title IV effectively forces all investment advisers managing more than $150 million in assets to register with the SEC. The 

Commission estimates that this will bring 3,200 advisers under its supervision. The 

rules recently finalized by the SEC specify the exemptions provided by Dodd-Frank 

for advisers solely to venture capital funds, foreign private advisers, and family offices. The rulemaking was not completed until close to the deadline before which 

advisers were originally required to register. Prior to the adoption of the rule, the 

SEC allowed the affected entities to wonder for several months through rumor and 

staff statements if, when, and in what form the requirement might come into effect. 

Why do we have this new registration process? One narrative has been that supposed ‘‘deregulation’’ during the past 6, 10, or 15 years—you pick the time period— 

led to the crisis. But, one can hardly say that the past 6–15 years have been deregulatory. In the United States we had Sarbanes-Oxley, new SEC rules, new stock exchange and NASD/FINRA rules, and new accounting rules. We saw the financial crisis hit regulated entities around the world, even in countries like Germany and 

France that one could hardly characterize as deregulatory. 

Regulators and lawmakers abroad, especially in Europe, have tried to blame 

hedge funds and short selling. Hedge funds were supposedly over-leveraged and 

drove the demand for esoteric securities. This narrative claims they shorted all 

kinds of assets during the 2008 crisis, driving the market down and creating panic. 

It will be surprising for subscribers to the popular narrative to learn that hedge 

funds overall had the least leverage, at 2:1.4 Compare that to other financial institutions at the time, which had significantly higher leverage ratios. Taking short positions, in turn, is an important investment activity as it helps to provide liquidity 

and points out excessive valuations. I have yet to see a compelling argument for 

why the price declines and flagging investor confidence experienced in 2008 might 

be attributed to hedge funds’ shorting activities rather than the obvious decline in 

economic and business fundamentals. 

The costs borne by registering advisers, and in turn by their pension, institutional 

and private individual investors, are real and significant. Sending off the registra-
74 

5See United States Securities and Exchange Commission, Study on Enhancing Investment Adviser Examinations 15 (Jan. 2011) available at http://www.sec.gov/news/studies/2011/ 

914studyfinal.pdf. 

tion form is the deceptively easy part. Registered advisers will have to bear numerous administrative, legal, and personnel costs. 

In the recently adopted rules, advisers exempted from registration requirements 

would still be required under Sections 407 and 408 to comply with some of the same 

reporting requirements as registered advisers. For example, venture capital advisers 

would be subject to examination and recordkeeping requirements. For venture capital firms especially, it is not clear what the investor protection rationale is. This 

construct seems to be contrary to the intent of Section 407; if so, this committee 

has an oversight interest in the new rules for exempt reporting advisers. 

Obviously this shakeup will be particularly hard on smaller hedge funds and private equity firms, which have fewer resources all around. As some have already argued, this new regulatory structure has the potential to raise barriers to entry and 

drive segments of the industry overseas. In the end, all of this may add many more 

costs to an economy that can scarcely afford it. 

Under proposed rulemaking passed earlier this year, a new reporting requirement 

will be imposed on all registered advisers known as Form PF. As proposed, Form 

PF is unprecedented in scope and detail: it is 44 pages long in its entirety. All registered private fund advisers would be required to file Form PF at least annually, 

and large advisers would be required to file quarterly. Advisers will be required to 

complete different sections based on their fund type and size, and the reporting burden increases exponentially for large firms. For example, advisers to private equity 

funds of at least $1 billion would have to file Form PF within 15 days of quarter’s 

end, including possibly detailed information on their portfolio company holdings. 

Requiring registered advisers to compile and report all this detailed information 

represents an enormous regulatory burden that provides no appreciable benefit to 

investors. Demonstrably, much like many other Federal agencies, in the SEC’s rush 

to draft and implement rules in accordance with Dodd-Frank’s statutory deadlines, 

it has not properly weighed the costs and benefits. The industry has raised numerous concerns with the draft rule, and I hope the SEC will consider the implications 

of Form PF carefully. 

As the following chart 5 illustrates, since 2008 the number of examinations has 

actually been decreasing because of management priorities and allocation of resources. The flood of new registrants will only dilute the SEC’s resources, and further reduce the frequency or scope of examinations. The allocation of resources in 

this area is critical—it should not be forgotten that in the case of the largest Ponzi 

scheme ever perpetrated, Bernard L. Madoff Investment Securities was both a registered broker-dealer and a registered adviser subject to regular SEC examinations. 

Title IX: The Investor Protection and Securities Reform Act of 2010 

Moving on to Title IX. Title IX encompasses a wide range of issues including credit rating agencies, whistleblowing, fiduciary duties, and SEC management. 
75 

6Section 922 provides for the SEC’s whistleblower program. Section 748 provides for the 

CFTC’s whistleblower program. 

Credit Rating Agencies 

This Committee took action with the Credit Rating Agency Reform Act of 2006 to 

address the troubling oligopoly of credit rating agencies and the SEC’s opaque method of designating nationally recognized statistical rating organizations (NRSROs). 

Unfortunately, the SEC had never addressed these issues in the 30 years after instituting the NRSRO designation. The framework adopted in 2006 (unfortunately too 

late to forestall the crisis) aimed to encourage transparency and competition among 

rating agencies. That approach, unfortunately, has been undermined by some provisions of Dodd-Frank that set up an expectation for ultimately unachievable regulatory control. 

After the financial crisis, credit rating agencies were under fire for their faulty 

methodologies and conflicts of interest. To combat this, the SEC has requested comment for a study on the feasibility of standardizing credit ratings and has proposed 

hundreds of pages of new rules. Addressing problems of faulty methodologies and 

transparency, the SEC has proposed rules requiring internal controls for determining ratings, establishing professional standards for credit analysts, and providing for greater public disclosure about credit ratings. 

Dodd-Frank also gives the SEC the power to penalize credit rating agencies for 

consistently inaccurate ratings. Further, Dodd-Frank also raises the dubious possibility that the SEC would assess the accuracy of ratings. It is unclear how that 

could ever be accomplished. 

In an attempt to break up the oligopoly imposed by the three largest credit rating 

agencies, the SEC has proposed rules to remove references to credit ratings from 

regulations, pursuant to authority under Section 939. In addition, the SEC has alleviated the problem of conflicts of interest by precluding ratings from being influenced by sales and marketing and by enhancing a ‘‘look-back’’ review to determine 

whether any conflicts of interest influenced a rating. 

Unfortunately, Dodd-Frank has taken an inconsistent approach with respect to 

credit rating agencies. With respect to sovereign debt, the threats currently being 

levied by government officials in Europe demonstrate that rating agencies are susceptible to political pressure as to the ‘‘correctness’’ of their ratings. Congress should 

consistently push transparency and competition so that investors get high-quality 

and objective advice from credit rating agencies. 

Whistleblower Programs 

Dodd-Frank provides that the SEC and the CFTC may award whistleblowers from 

10 percent to 30 percent of monetary sanctions collected in enforcement actions.6

Two special funds of $300 million and $100 million are set up for the SEC and 

CFTC, respectively, to ensure payment of whistleblowers. Dodd-Frank provides that 

whistleblowing employees can hire attorneys and that they must hire an attorney 

if they wish to remain anonymous. One can imagine what percentage of the 10 percent–30 percent take the lawyers will demand from the whistleblower. 

Dodd-Frank clearly aims to encourage whistleblowers and ease their fears of retaliation, ostracism, and reputational damage for future employment-all authentic 

concerns for legitimate protesters. But it creates perverse incentives as well, and 

sets up a system that has many inherent problems. For example, if an employee 

approaches an attorney with a potential claim of less than $1 million, what will the 

attorney advise if the problem is ongoing and is likely to result in a settlement of 

more than $1 million at some time in the future? Will the attorney advise the employee to report it immediately, or to remain quiet until the problem crosses the 

compensation threshold? Moreover, the unintended consequences of unfounded 

charges from disgruntled employees with ulterior motives will be devastating for 

shareholders. Of course, this only considers the employee side of the system. From 

the SEC’s side, how will it cope with effectively investigate the potentially overwhelming number of tips? The Bernie Madoff case is again an apt reminder. 

Already, a company must hire attorneys and accountants to investigate almost 

any purported complaint, with strict policies and procedures to ensure due process. 

The injection of plaintiffs’ attorneys into the mix increases the potential for specious 

claims to get traction and win a settlement, especially if the complainant is anonymous. Congress has skewed the delicate balance between good policy and over-indulgence of accusations. 

Despite comments to the contrary, the SEC chose not to make mandatory internal 

reporting to a company’s own compliance program. Because the bounties available 

to whistleblowers (and their attorneys) are so large, and because the SEC chose not 

to make internal reporting mandatory, whistleblowers are incentivized to ‘‘report 
76 

out’’ directly to the SEC rather than to ‘‘report up’’ through their companies’ compliance programs. Thus, the rule undermines internal compliance programs. Moreover, 

companies have no protection from disclosure of confidential information, and there 

is no real way to sanction a false whistleblower, absent ‘‘bad faith’’—which is a 

tough standard to meet. 

Fiduciary Duty 

Under Section 913, the SEC was required to conduct a study on harmonizing the 

standard of care for investment advisers and broker-dealers. Under the Investment 

Advisers Act of 1940 and Supreme Court precedent, advisers have been deemed to 

owe a ‘‘fiduciary duty’’ to their clients whereas broker-dealers are subject to standards imposed by the Securities Exchange Act of 1934 and their self-regulatory organizations. The SEC has recommended to Congress that it harmonize these concepts 

into a uniform standard. 

Under the 1934 Act and SRO rules, broker-dealers ultimately are held to a very 

high standard of care that has benefited investors for many years. With respect to 

an advisory relationship, any dispute ultimately will likely be judged through a lawsuit in State court under terms of the advisory contracts, which tend to be long and 

include many disclaimers of conflicts of interest. On the other hand, broker-dealers 

are subject to broad standards of practice that the SEC and FINRA have adopted 

and interpreted over the years, as well as a low-cost arbitration system. 

It is important to remember that not all investors are the same. Some investors 

perhaps want and need a fiduciary who possesses intimate knowledge of their financial condition and can advise accordingly. On the other hand, some investors would 

prefer to have a true broker who is engaged on a transaction basis and is compensated accordingly. These two kinds of activities should have different standards 

of care attached to them. When the SEC turns to rulemaking later this year, as it 

has indicated it plans to do, it should respect the different needs of different investors. 

At the same time, the Department of Labor is pursuing a separate rulemaking 

that aims to increase the ambit of fiduciary duty within the context of ERISA plans. 

Unfortunately, this Labor Department initiative does not seem to be coordinated 

with the SEC and carries potentially profound effects for the retirement plan market and the availability of product offerings. 

SEC Management 

Title IX contains many other provisions, most of which have nothing to do with 

the causes of the financial crisis. In my short window of time before you, I cannot 

discuss all of these sections. Suffice it to say that many sections respond to longstanding requests of special interest groups. The SEC’s compliance with these provisions has been spotty: The ink was not even dry on Dodd-Frank when the SEC gave 

a new Federal right for some shareholders to be able to nominate corporate board 

members directly instead of going through the normal process by which directors 

are nominated. This rulemaking is being challenged in Federal court. Yet, the SEC 

has neglected Section 965, the intent of which was to direct the SEC to disband the 

Office of Compliance Inspections and Examinations and return the examiners to the 

Divisions of Investment Management and Trading and Markets. 

Just last week the SEC chairman testified about the recent leasing decision and 

suggested that the SEC should no longer have leasing authority. In contrast, last 

year, some were suggesting the SEC should have a self-funding mechanism outside 

of the normal congressional appropriations process. In the meantime, the SEC has 

pursued an extremely divisive agenda, marked by more than a dozen 3–2 votes in 

the past 2 years alone. I have never witnessed such division—this record is in 

marked contrast to my experience of 10 years as staffer in two chairman’s offices 

and as a commissioner under three chairmen. The dissenters are reasonable people 

and their dissents are not always fundamentally opposed to the rulemaking itself. 

The sad fact is that it appears that the leadership of the SEC does not engage effectively on the finer points of the policy issues. Thus, I encourage this Committee to 

continue to exercise oversight of SEC management. 

Dodd-Frank attempted to focus on organizational and managerial issues at the 

SEC, but it wound up, in effect, micro-managing and making things more complicated. Section 911 codifies in statute the Investor Advisory Committee that the 

current chairman established, which itself was similar to the Consumer Affairs Advisory Committee that I helped Chairman Levitt establish when I worked in his office in the mid-1990s. This statutory provision etches in stone one way of doing 

things to the exclusion of others. We shall see how the Investor Advocate, an independent office established under Section 915, ultimately develops. The statute thus 
77 

7See Paul S. Atkins and Bradley J. Bondi, ‘‘Evaluating the Mission: A Critical Review of the 

History and Evolution of the SEC Enforcement Program,’’ 8 Fordham Journal of Corp. & Fin. 

Law 367 (2008). 

adds yet another direct report to the chairman, who already has more direct reports 

than is practicable. 

Management philosophies like Total Quality Management and Six Sigma teach 

that in any organization, measurement drives human behavior because the incentive is to try to meet the measurement criteria (‘‘You get what you measure’’). 

For example, Enron was not reviewed for years because review personnel were 

judged by how many filings they reviewed, not necessarily by the quality of their 

review. The incentive was to postpone review of the complicated Enron filing because one could review many others in the time it would take to review Enron. By 

the late 1990s, this focus on numbers more than quality had decreased staff morale 

so much that employees began to organize to form a union. Despite management’s 

campaign to thwart it, in July 2000, SEC employees voted overwhelmingly to 

unionize the workforce. 

The emphasis on numbers over quality also affects behavior in the enforcement 

division and examination office. Every enforcement attorney knows that statistics 

(or ‘‘stats’’) help to determine perception and promotion potential. The statistics 

sought are cases either brought and settled or litigated to a successful conclusion, 

and amount of fines collected. These statistics do not necessarily measure quality 

(such as an investigation performed well and efficiently, but the evidence ultimately 

adduced did not indicate a securities violation). Thus, the stats system does not encourage sensitivity to due process. 

In addition, the stats system tends to discourage the pursuit of penny stock manipulations and Ponzi schemes, which ravage mostly retail investors. These frauds 

generally take a long time and much effort to prove—the perpetrators tend to be 

true criminals who use every effort to fight, rather than the typical white-collar corporate violator of a relatively minor corporate reporting requirement who has an incentive to negotiate a settlement to put the matter behind him and preserve his reputation and career. Thus, over the years several staff attorneys have told me that 

their superiors ‘‘actively discourage’’ them from pursuing Ponzi schemes and stock 

manipulations, because of the difficulty in bringing the case to a successful conclusion and the lack of publicity in the press when these cases are brought (with the 

exception of Madoff, these sorts of cases tend to be small). Some senior enforcement 

officers openly refer to these sorts of cases as ‘‘slip-and-fall’’ cases, which disparages 

the real effect that these cases have on individuals, who can lose their life savings 

in them. Because of the interstate and international aspect of many of these cases, 

if the SEC does not go after them, no one can or will. 

Sadly, this attitude is reflected even outside the SEC. Just last week, I saw a 

quotation in an article regarding the steps that the SEC needs to take to collect on 

the settlements that it has entered into. The sentiment expressed by the commenter 

was that many of the cases are very small, but that the agency is under political 

pressure to go after the smaller schemes. Not to discount the importance of combating any fraud, we need to remember that one individual losing his entire life’s 

savings is extremely serious, even if it is ‘‘only’’ 5-digits in size. 

During my tenure as commissioner, I emphasized the need to focus from an enforcement perspective on microcap fraud, including Ponzi schemes, pump-and-dump 

schemes, and other stock manipulations. I was a strong advocate for the formation 

of the Microcap Fraud Group in the Enforcement Division, which was finally formed 

in 2008. I had also strongly supported the good efforts of the Office of Internet Enforcement, established under Chairman Levitt in the late 1990s, which worked 

closely with other law enforcement agencies to tackle Internet and other electronic 

fraud. Unfortunately, it appears that while the administrative overhead functions 

within enforcement are gaining resources, insufficient attention is being paid to 

‘‘boots-on-the-ground’’ investigative resources to combat the pernicious frauds that 

prey on individual investors. 

There are many intelligent, competent, dedicated, hard-working people at the 

SEC. It is the management system and how it determined priorities over the past 

decade that has let them down. Three years ago, in an article published in the Fordham Journal of Corporate and Financial Law, 7 I called for the SEC to follow the 

example from 1972 of Chairman William Casey, who formed a committee to review 

the enforcement division—its strategy, priorities, organization, management, and 

due-process protections. Thirty-seven years later, and especially after the Madoff incident, this sort of review is long overdue. 
78 

Conclusion 

Dodd-Frank overall is a poorly drafted statute that drastically expands the power 

of the Federal Government, creates new bureaucracies staffed with thousands, and 

does little to help the struggling American citizen. Ambiguous language will result 

in frivolous and unnecessary litigation. Huge amounts of power and discretion have 

been ceded to regulators, who were given the impossible task of about a year or two 

to put things in place. All of these costs and distractions will further stifle economic 

growth. Consumers, investors, and workers will pay the price. That is certainly not 

the best way to get the economy up and running! 

The Dodd-Frank Bill started out as a bill to ‘‘get’’ Wall Street and morphed into 

a bill that sticks it to everyone—Wall Street, Main Street, consumers, entrepreneurs, shareholders and taxpayers alike. The financial markets are critically important to America. They raise capital for businesses producing good and services. 

They create jobs, fund ideas and increase wealth for all Americans. When Americans save and invest, they are putting their capital to work, building their nest egg 

and that of others, too. We need a more thoughtful, balanced plan to make sure that 

the nest egg is as safe as it can be, but also to ensure the we are not killing the 

proverbial, golden egg-laying goose. The arguments over Dodd-Frank will continue. 

Regulators will continue to grind away at implementing its provisions. There will 

continue to be calls for repeal of all or parts of it. This will be a vital topic to follow 

for the foreseeable future. 

Thank you again for the invitation to come here and testify before you today. 

PREPARED STATEMENT OF LYNN E. TURNER 

FORMER CHIEF ACCOUNTANT, SECURITIES AND EXCHANGE COMMISSION

JULY 12, 2011 

Thank you Chairman Johnson and Ranking Member Shelby for holding this hearing and it is an honor to be invited to testify before you. Our capital markets in 

the United States have been the crown jewel of our economy for over two centuries. 

But in the last decade, they have been the source of great scandal, resulting in investors questioning whether they are on a level playing field or sitting across the 

table at a casino where the odds are greatly stacked against them. This along with 

a declining U.S. economy has led investors to invest increasing amounts of capital 

overseas, with less available here for jobs, investment in plant, and research and 

development. If that trend is to be reversed, investors must know they will be afforded reasonable protections and have regulators who serve as their advocates. 

Background 

Before I start, it might be worthwhile to provide some background on my experience. I have held various positions in the accounting profession for some 35 years. 

I started my career with one of the world’s largest international accounting and auditing firms where I rose to become an audit and SEC consulting partner. I served 

as a CFO and vice president of an international semiconductor company as well as 

a business executive in a venture backed newly formed startup company. I have had 

the good fortune to be the Chief Accountant of the Securities and Exchange Commission (‘‘SEC’’). In addition, I have been: a member of and chaired audit committees of corporate boards of both large and small public companies; a trustee of a 

mutual fund and a public pension fund; and a professor of accounting. In 2007, 

Treasury Secretary Paulson appointed me to the U.S. Treasury Advisory Committee 

on the Auditing Profession (‘‘ACAP’’). I have also served on the Standing Advisory 

Group (‘‘SAG’’) and Investor Advisory Group (‘‘IAG’’) of the Public Company Accounting Oversight Board (‘‘PCAOB’’). 

The Financial Crisis 

It has now been over 4 years since the worst post Great Depression financial crisis imploded in this country and around the globe, resulting in the Great Recession. 

The financial damage to civilization was tremendous as Exhibit A illustrates; investors in the global markets lost over $28 trillion in the value of their holdings. In 

the United States, investors saw approximately $10–11 trillion in value disappear, 

not including the value of their homes which continue to depreciate. And consider 

the numbers: in 1930, 1.2 percent of the population owned stock; in 2008, the number invested in the markets through stock, mutual funds or retirement accounts approximated 110 million. 

To put the damage to investors and the capital markets in greater perspective, 

the Dow Jones Industrial Average closed on October 9, 2007 at 14,164.53 but then 

proceeded to plunge as fear grasped investors to close at 6547.05 on March 9, 2009. 
79 

That represents a fall during the financial crisis of 7839.88 points or 54.9 percent. 

The S&P 500 closed on October 9, 2007 at 1565.15. On March 9, 2009, it would close 

at 676.53, representing a fall of 898.36 points or 57.4 percent. By this point in time, 

investors and the American public had lost confidence in the capital markets, no 

longer trusted business executives, and believed Wall Street had become a casino 

where the house odds were overwhelming in favor of Wall Street, not Main Street. 

Congress had to act. 

Sound Financial Markets and Capitalism 

My 35 years of experience as a businessman, regulator, and investor have taught 

me that sound financial markets and efficient capitalism, can only exist if built upon 

five fundamental bedrock pillars. These pillars are: 

1. Transparency—Investors must receive unambiguous financial information that 

allows them to make fully informed decisions as to which companies they 

should invest in. 

2. Accountability—Those entrusted with the money millions of Americans invest 

must be held accountable for how they use that money. Business executives 

should be rewarded for sound business decisions and long term performance. 

Their compensation should be cut or they should be replaced when underperforming. And investors must have redress when they have been recklessly or 

worse yet, fraudulently wronged, such as when credit rating agencies or public 

companies issue misleading reports. 

3. Independence—A lack of conflicts and where conflicts do exist, clear and timely 

disclosure of those conflicts prior to solicitation of investor’s money. 

4. Effective Regulators—Independent, strategic and balanced regulators who understand their mission is necessary to protect investors, create confidence in 

the markets and attract capital. Effective regulation also requires that regulators be held accountable by Congress in a timely manner. 

5. Enforcement of the Laws—In the past, the United States has prided itself as 

being a nation of laws. Those who break the laws, should be held accountable 

so that the markets and all market participants operate in a fair market place, 

and the playing field is not tilted to any one party’s advantage. 

Yet when we look back of the mayhem of the past decade, we see that: 

• There was a dearth of transparency as investors and regulators alike could not 

decipher the financial statements and financial condition of institutions such as 

AIG, Lehman Brothers and many of the largest banks in the country. Assets 

and capital were inflated, liabilities understated and profits upon which huge 

compensation packages granted, a mirage. 

• Regulation was most ineffective under the onslaught of those who mistakenly 

thought the markets and market participants could police themselves. These 

disciples of laissez faire failed to understand the culture of markets and power 

of greed and megalomania. At the same time, most of the regulators were captured by industry, lacked adequate funding and resources in the case of the 

SEC and CFTC, and lacked authority to regulate such markets as derivatives 

which had become increasingly toxic as they grew close to 10 times the GDP 

of the entire world. 

• As the Senate’s own investigations have illustrated, conflicts abounded as institutions collected fees for originating loans aptly named ‘‘Liars’’, ‘‘No Doc’’, or 

‘‘NINJA’’, packaged them up for another fee, and then collected even greater 

fees when they sold them off to an unsuspecting, and poorly informed investing 

public. Conflicts were rampant among credit rating agencies, the lawyers who 

drafted and reviewed all these agreements, and auditors. 

• Things falsely done in the name of capitalism or entrepreneurship, had nothing 

to do with them. As Charlie Munger, Vice Chairman of Berkshire Hathaway recently said: ‘‘None of us should fall for the idea that this was constructive capitalism. In the 1920s they called it bucket shops—just the name tells you it’s 

bad—and they eventually made it illegal, and rightly so. They should do the 

same this time.’’ 

• And the public now questions whether the law enforcement agencies have created a two tier justice system; one for Wall Street and business executives and 

one for Main Street. 
80 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 

(‘‘The Act’’) 

With that as a backdrop, Congress chose to act passing the Dodd-Frank Wall 

Street Reform and Consumer Protection Act. I believe doing nothing was not an option even though some have suggested that, or something akin to fringe changes, 

more intent on maintaining the status quo then protecting investors and consumers. 

And while I would have preferred a Pecora style investigation as Senator Shelby 

had urged, it is abundantly clear that was not going to happen in this city. Accordingly, I applaud Congress for acting. 

Within the Act, are Title IV, Private Fund Advisors and Title XI, Investor Protection and Securities Regulation. I shall confine my remarks to Title XI and certain 

of the strong investor protections afforded within that section. 

Whistle Blower Protection—Sections 922, 923, and 924 

It is important the SEC become aware of securities law violations at the earliest 

possible date, so that it can act to stop the violation before further harm to investors 

and the markets occur, and it can hold people accountable. Obtaining credible information is vital to early action and successful prosecution by law enforcement agencies. 

In its 2010 Global Fraud Study, The Association of Certified Fraud Examiners 

stated that on average, it took 27 months for companies to detect financial statement fraud. That’s over 2 years investors would be unknowingly investing based on 

false and misleading financial information. The report also notes that the number 

one way in which frauds are detected is not a management review, internal audit 

or external auditors. Rather it is through tips. 

Consistent with these findings, Dodd-Frank allows the SEC to reward those who 

provide it with a wide range of information of securities laws violations resulting 

in successful prosecutions. The SEC had very limited authority to do so before passage of the Act. In fact, since 1989 and prior to Dodd-Frank, the SEC had only made 

seven payouts to five whistleblowers for a total of $159,537. 

The SEC adopted rules implementing the whistle blower sections of Dodd-Frank 

in May of this year, after soliciting and receiving public comments on the issue. 

While some from the business community feel the rules as proposed will encourage 

people to report to the SEC without going through the normal hot lines and compliance program a company sets up, others felt they would cause some to avoid providing useful tips to the SEC and result in tips showing up on the Internet at sites 

such as Wiki Leaks. 

Having served on audit committees of public companies, I believe the SEC took 

a reasonable and balanced approach to the final rules it adopted. Hot lines will not 

work unless employees have confidence their identity will remain anonymous and 

protected, and the complaint will be addressed in an unbiased thorough manner. 

This is especially important as the business groups forming the Committee of Sponsoring Organizations of the Treadway Commission (COSO), noted in a May 2010 report that in the 347 cases of fraudulent reporting brought by the SEC from 1998 

through 2007, the CEO and/or CFO were named in 89 percent of the cases, up from 

83 percent in the prior decade. I believe Dodd-Frank and the new SEC rules will 

result in companies reexamining their hot lines and compliance programs, ensuring 

employees can put their faith in them. 

The SEC provided reasonable protections for public companies. The SEC encouraged those who provide tips, to go through the normal company compliance channels. It did so stating that reporting internally will be considered when the size of 

an award is determined by the SEC. The Commission also provided individuals the 

opportunity to first report to the company, and then if they chose, reporting to the 

SEC. This is very beneficial from my perspective as it allows the company to act 

on the information and where appropriate, self report to the SEC. In addition, the 

SEC excluded payments to certain employees such as in house counsel, compliance 

personnel, internal auditors, certain executives and external auditors. 

Enhanced Law Enforcement—Sections 925, 926, 929E, and 929KLMNOP 

Dodd-Frank includes a number of beneficial provisions that will enhance law enforcement giving investors greater protections and ensuring fair markets. For example, under prior law, a securities professional who had been barred by the SEC as 

a result of serious misconduct as an investment advisor, could simply participate as 

a broker dealer, offering similar services. Dodd-Frank appropriately addressed this 

issue by giving the SEC the authority it sought to impose collateral bars against 

regulated persons. Likewise, Dodd-Frank prohibits someone already convicted of a 

felony in connection with a securities offering, from offering securities under Rule 

506 of Regulation D. While the Act allows critical financing for startups, it keeps 
81 

felons from gaining a foothold in the process, reducing the likelihood of fraud being 

perpetrated by repeat offenders. 

Previously the SEC did not have the authority to bring claims and seek penalties 

against those who recklessly and knowingly aided or abetted others in a violation 

of the Securities Act of Investment Company Act. In essence, certain individuals 

could ‘‘drive the getaway car’’ when it came to a securities law violation and know 

they were beyond the reach of the regulator and law. Dodd-Frank addressed that 

problem. It also called for a study by the SEC on whether investors should be given 

redress against these individuals. Today, professionals including gatekeepers and investment bankers critical to a fair and orderly market, can assist an individual in 

the commission of a securities law violation. Such actions have contributed to great 

damage being inflicted on shareholders, but the person aiding or abetting the crime 

here in the United States knows the shareholder has no right to sue them, unless 

the person aiding and abetting the crime tells the public they are doing so. Such 

a ridiculous standard, which fails any test of common sense, needs to be corrected. 

And as is discussed later on, regulators often have not had the resources or the will 

to pursue such cases. 

The Act further enhances investor protections by giving the SEC enforcement authority in key areas, and giving the SEC greater ability to hold market participants 

accountable for violations of the law. Under the Act, civil money penalties may now 

be imposed by the SEC in cease and desist proceedings. This should serve as a further deterrence to fraud. The SEC enforcement director has stated this will also enhance the effectiveness and efficiency of the Division’s enforcement efforts, a view 

I agree with. 

With the growing number of global markets, the legislation amends the 1933 Securities Act and 1934 Exchange Act to give U.S. district courts’ jurisdiction over violations of the antifraud provisions when there is conduct in the United States that 

furthers the fraud, even if the securities transaction occurs outside the United 

States. Being able to have redress in these situations is critical to investor confidence and ability to invest safely. It is also important to ensure accountability on 

the part of those who engage in such unlawful behavior. 

Dodd-Frank also requires the SEC to study the extraterritorial application of the 

securities laws to actions that would be brought by investors. This is in response 

to the U.S. Supreme Court ill advised opinion in the case of Morrison v. National 

Australia Bank, Ltd. In November, 2010, a number of public pensions, including one 

for which I serve as a trustee, wrote this Committee urging them to reverse this 

opinion. Investors must have an opportunity to obtain redress in the U.S. courts for 

fraud committed in the United States by foreign entities which seek capital from 

U.S. investors, and U.S. Federal securities laws should deter fraudulent statements 

by foreign entities to investors. 

Improvements to the Management of the Securities and Exchange Commission—Sections 961, 962 963, 964, 966, 967, and 968 

Leading up to and during the subprime financial crisis, the SEC has been the subject of much public criticism of its management. Most notably have been complaints 

for its failure to investigate whistleblower complaints on Madoff and the Stanford 

Group, a failure to adequately supervise market participants such as Bear Stearns, 

Lehman and Merrill Lynch, questionable investigations such as in the Aguirre matter, the leasing matter that has now been referred to the Department of Justice by 

the Inspector General, poor internal controls and lax enforcement actions such as 

the one against Bank of America which the judge was extremely critical of. I can’t 

help but believe some of these criticisms are the result of very poor leadership and 

management of the agency during the later half of the past decade. Leadership that, 

in my opinion, failed to foster the right tone at the top, culture and investor advocate mission that had long been the mantra of a proud agency and its staff. 

In the past, the SEC has had a reputation as the gold standard among regulators. 

But that image has been tarnished by the criticisms noted. Yet a well managed and 

run, independent SEC is vitally important to the capital markets. Investors over the 

years have had confidence in the markets, firmly believing the SEC ensured confidence could be placed in financial disclosures, that the markets were fair and the 

playing field level. I can tell you from personal experience, many an employee of 

the SEC has taken great pride in providing outstanding public service and their efforts to ensure the agency was indeed the public watchdog, the one true investors 

advocate. 

There are a number of provisions in Dodd-Frank that I believe, as a former business executive, will contribute in a positive manner to the SEC restoring public confidence in the agency. I have found one manages what one measures, and does not 

manage what one does not measure. While the SEC has required public companies 
82 

to increase their transparency, controls, monitoring and accountability, it has fallen 

short of adopting some of its own recommendations in a timely manner that could 

have been beneficial, such as reporting on internal controls. Accordingly, enhancements to the SEC’s management and structure that will in the long run benefit it, 

include: 

• An assessment of its overall structure and personnel; 

• Enhanced monitoring, assessment and transparency of supervisory controls; 

• Greater accountability for supervision through certification of the effectiveness 

of controls; 

• Increased evaluation, monitoring and transparency of personnel management 

including actions taken with respect to those who have failed to perform their 

duties; 

• A suggestion program and hotline for the employees of the agency; and 

• Taking a long hard look at its ‘‘revolving door.’’ Unfortunately, the study mandated by Dodd-Frank only requires a study of employees leaving the SEC for 

financial institutions and not the largest and fastest spinning revolving door— 

employees who leave the SEC bound for legal firms that represent individuals 

and public companies before the SEC. 

Securities and Exchange Commission Funding—Section 991 

The SEC has sought now for over two decades, the same types of self-funding 

mechanisms that banking regulators have. Unfortunately, Senate conferees rejected 

such a provision, which in June, 2010, the Federal Bar Associations securities law 

committee stated was ‘‘critical’’ to the ‘‘chronic underfunding’’ of the SEC. 

Current and former SEC Chairmen such as Arthur Levitt and Richard Breeden 

have urged Congress to increase the SEC’s funding so that it can do the job Congress and investors expect of it. Those who represent investors such as the Council 

of Institutional Investors have also called for increased funding of the SEC. Investors have always voiced support for adequate funding of the SEC and ultimately, 

the money comes out of their pockets. 

As the GAO has noted in prior reports, the SEC was essentially starved by Congress of necessary resources during much of the 1990s. During this time period the 

markets experienced fast growth as millions of Americans invested through their retirement accounts. After this underfunding contributed to and played a role in the 

corporate scandals of a decade ago, Congress increased the funding of the agency. 

But during the period from 2005 to 2007, as the subprime market bubble was growing toward an implosion, the SEC staff was again reduced by over 10 percent and 

its spending reduced by some $75 million as a result of actions by Congress and 

management of the agency. 

Despite the fact no taxpayer dollars are used to fund the SEC, but rather it is 

funded through user-based fees, it seems as if Congress has been bent and determined to somehow shrink the SEC to greatness. The fact of the matter is that congressional approach at times over the past two decades has been an absolute miserable failure. 

Congress through Dodd-Frank, as well as the public has upped the bar for performance by the SEC and rightly so. The SEC is being asked to increase its inspections, its enforcement, the number of entities and the types of transactions it regulates. Dodd-Frank also requires the SEC to establish several new offices such as the 

office of the Investor Advocate and Ombudsman, the Office of Credit Ratings and 

the Whistle Blower office. I believe investors in general are strong proponents of 

these new functions at the SEC. At the same time, the SEC is being asked to do 

a much better job of market surveillance and take proactive steps to identify and 

address in a timely manner future market problems, before they become a crisis. 

To accomplish all of these tasks takes top notch people with the requisite experience, and very significant investment in technology, training and support services. 

And that takes money. 

Dodd-Frank specified acceptable levels of funding, which have been applauded by 

many investors. Those levels are as follows: 

• 2011—$1.3 billion 

• 2012—$1.5 billion 

• 2013—$1.75 billion 

• 2014—$2 billion 

• 2015—$2.25 billion 

Unfortunately, Congress is already breaking its promise to investors and the SEC 

for the year 2011 as its funding is below the $1.3 billion level. If such funding is 
83 

not forthcoming, and there are further crisis in the capital markets, such as has 

been seen with the flash crash, a good deal of the blame will rest squarely on the 

shoulders of Members of Congress. 

Expansion of Audit Information to Be Produced and Sharing Privileged Information with Other Agencies—Section 929, and 929 K 

The Act expands the power of the Public Company Accounting Oversight Board 

(‘‘PCAOB’’) by: 

1. Broadening the PCAOB’s authority to include independent audits of broker 

dealers; 

2. Enhancing the PCAOB’s access to work papers of foreign auditors; and 

3. Share information with foreign regulators. 

The Madoff ponzi scheme brought to light a gaping hole in the regulation of independent audits investors rely upon. The PCAOB did not have the authority to inspect the audit of the Madoff fund, and the auditor was not subject to inspection 

by the accounting professions peer review program. To this day, the Madoff auditor 

would not be subject to inspection by the State regulator as he was a sole practitioner. Dodd-Frank rightly remedies this shortcoming by giving the PCAOB the 

right to inspect such audits and ensure the firms providing such audits have effective systems of quality controls. 

More recently, scandals resulting from flawed audits of Chinese companies have 

also come to light, resulting in large losses for investors. Much of the audit work 

has been performed by Chinese auditors, although a U.S. audit firm may issue the 

audit report read and relied upon by investors. At the same time, with U.S. companies increasing their global operations, a growing portion of their audits are performed by foreign audit firms, many of which are affiliated with U.S. audit firms. 

If the PCAOB is to carry out its mandate of providing investor protections, it must 

be able to inspect the auditor work, and documentation of that work, regardless of 

where it is performed. 

For example, frauds at such companies such as Satyam, Enron, Xerox, and the 

now infamous Lehman Repo 103 transactions involved transactions and related 

audit work executed in foreign countries. Without the access to audit work papers 

for this audit work, the PCAOB cannot ensure that the work supports the overall 

opinion the auditors are providing on the consolidated financial statements of the 

company. Nor can they inspect audit quality for a significant portion of the audit, 

leaving investors exposed to a portion of an audit where quality may be substandard 

at best. 

Ensuring international audit quality, especially with respect to large international 

conglomerates that can attract hundreds of billions in capital from investors, is critical to confidence in financial disclosures that are the life blood of any capital market. It is important the PCAOB be able to share information, work and cooperate 

with its counterparts in carrying out this mandate. But I have talked to foreign regulators who expressed criticisms of the PCAOB, and a reluctance to work with it. 

That was because while they could share information with the PCAOB, it was a one 

way street because the prior law prevented the PCAOB from sharing information 

with them. The prior law had been adopted when the PCAOB was new and its counterparts in foreign jurisdictions did not exist. But that has changed and once again, 

to its credit, Dodd-Frank has updated the law and corrected this deficiency. It did 

so by giving the PCAOB the ability to share information with foreign regulators on 

a confidential basis. This was a badly needed reform to ensure regulatory cooperation on an international basis. 

At the same time, the PCAOB has also called upon Congress to allow it to enhance the transparency of its enforcement program. It would do so by making its 

enforcement actions public, at an appropriate time, consistent with the way the SEC 

handles its 102(e) enforcement actions. Having been involved with the development 

of the current SEC 102(e) rule, I applaud the PCOAB for working to enhance its 

transparency. Without such a rule change, as evidence is now starting to show, 

audit firms will take every action available to them to seriously delay enforcement 

actions, during which time they continue to issue audit reports while their quality 

controls and audit work may suffer from serious deficiencies. This exposes investors 

and the capital markets to great risks which lack any transparency whatsoever. 

Other Sections 

There are many other important sections of Title IX of the Act which I also 

strongly support. The governance provisions granting investors the same access to 

the proxy for nominating directors as management has, is a great tool for establishing accountability over entrenched and underperforming boards. Creating inde-
84 

pendent compensation committees, enhancing the transparency of compensation and 

incentives, and giving shareholders an advisory vote on pay should all prove to be 

beneficial to ensure destructive risks taking is not rewarded, and executives compensation is based on performance. Already investors have shown they can use such 

rights in a wise and reasoned manner. And while investors did not get all that they 

wanted in this section of the bill, it was a very positive step forward. 

The enhanced regulations of credit rating agencies should also improve the quality of credit ratings. Especially important is the private right of action granted investors, a useful mechanism to hold credit rating agencies accountable. 

Closing 

I believe the sections of Dodd-Frank I have discussed all help build and contribute 

to a stronger foundation upon which the capital markets can function more effectively. They increase transparency and accountability, they enhance independence 

including that of the regulator, they will improve the effectiveness of the SEC and 

PCAOB, and they certainly give these agencies greater authority necessary to enforce the laws and protect investors. That in turn should give a boost to investors 

confidence in the markets which is necessary if the capital markets are to continue 

to be the crown jewel of our economy. 

Thank you and I would be happy to take any questions. 
(85) 

1 Available at http://www.sec.gov/comments/4-606/4606-2789.pdf. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MORAN 

FROM DAVID MASSEY 

Q.1. Mr. Massey, as you know Section 410 of the Dodd-Frank Act 

will shift between 3,000 and 4,000 registered investment advisors 

from SEC regulation to State regulation. However, this shift is 

coming at a time when States are struggling with major budget 

deficits and dwindling resources. How can we be certain that State 

regulators will have the resources necessary to properly regulate 

investment advisors and protect investors? How will States meet 

this challenge and increase their examination and regulatory resources? 

A.1. Senator, the States have been presented with a unique regulatory challenge—an increase of approximately 25 percent in the 

number of investment advisers subject to State regulation that will 

result from the increase in the assets-under-management threshold 

from $25 million to $100 million, mandated under Section 410 of 

the Dodd-Frank Act (‘‘Act’’). Fortunately, the States and the North 

American Securities Administrators Association (‘‘NASAA’’) have 

been preparing to meet the challenge of regulating an additional 

3,200 investment advisers for over a year, and I am confident that 

these preparations will permit State regulators to implement intelligent, efficient and responsive regulation. 

As I testified during the Senate Banking Committee hearing of 

July 12, the States have a proven track record in the area of investment adviser regulation. Further, NASAA is confident that 

State securities regulators will continue to marshal the examination and enforcement resources necessary to effectively regulate the 

investment adviser population subject to their oversight. While 

State investment adviser examination programs and resources are 

documented in significant detail in the comprehensive report that 

NASAA provided the Securities and Exchange Commission in support of the Act’s Section 913 study,1 some significant findings from 

that report include: 

• States employ more than 400 experienced employees dedicated 

to the licensing and examination function, including field examiners, auditors, accountants, and attorneys. More than half 

of the States that reported qualitative staffing data indicate an 

average staff experience exceeding 10 years, with a heavy concentration of personnel in the 5- to 14-year range. 

• State investment adviser examination totals have progressively 

increased each year for the past 5 years, resulting in a 20 percent increase in the total number performed through the first 

three quarters of 2010 as compared to 2006. As of August 
86 

2010, States had completed 2,463 onsite examinations of investment adviser registrants. 

• The majority of State routine (non-cause) investment adviser 

examinations are performed on a formal cyclical basis. All 

States that adhere to a formal cycle audit their entire investment adviser registrant populations in 6 years or less. Half of 

the States complete the examinations on 3-year-or-less cycles. 

Memorandum of Understanding (MOU) for the Sharing of Resources 

Even a highly skilled workforce cannot succeed absent adequate 

resources, and the need for additional resources is a natural consequence of additional responsibility. To that end, the 50 States 

have agreed through a formal MOU to work together and share resources as needed to regulate the expanded State investment adviser population. Pursuant to this MOU, all States will work to ensure that examination resources are augmented, and that schedules are coordinated, to allow for maximum coverage and consistent 

audits. The MOU also provides for the possibility of joint exams 

funded by NASAA. The MOU will bridge the gap while and until 

State regulators acquire any necessary additional resources. 

Frequency of Examinations 

In recent years, the States have undertaken to increase the frequency of investment adviser examinations. In 2006, States reported 2,054 examinations of investment advisers, while in 2007 

and 2008 that number increased to 2,136 and 2,389 examinations 

respectively. In 2009, State regulators performed 2,378 onsite examinations of investment advisers, not including the countless 

number of regular-desk, registration, and other abbreviated examinations that States perform every day. As of August, 2010, the 

States had performed 2,463 investment adviser audits, putting 

them on pace to again increase the total number of investment adviser examinations relative to the previous year. This trend constitutes a material and progressive increase, year over year, for five 

consecutive years. 

The States stand ready and able to take on these new examination duties, and State securities administrators have been proactive 

in their preparation, as outlined below. 

Development of Uniform Exam Procedures 

Another important step that the States have recently undertaken 

to prepare for the switch-over has been to develop uniform examination procedures. These new procedures will promote and guarantee a consistent and high standard of examination at the State 

level, effectively ensuring that all State examinations—whether 

conducted in North Carolina, North Dakota, or Kansas—ask the 

same questions of investment advisers. 

Utilization of New Risk Analysis Tools 

NASAA has invested in new tools that will permit States to continue to do an even better job of leveraging their resources in the 

examination of investment advisers. Specifically, NASAA has acquired advanced risk-analysis software and has made this software 
87 

available to all State regulators. The software will provide States 

a mechanism to rapidly review their investment adviser registrants, and rank the individual risk factors associated with each 

registrant. This tool will evolve as time goes on, but the bottom line 

is that the new software will permit States to better evaluate the 

risks associated with various firms and allocate their examination 

resources accordingly. 

Industry Outreach Campaign 

NASAA members have in the past year initiated an aggressive 

industry outreach campaign to prepare the industry for State oversight and to enable new registrants to set up their operations properly in order to avoid inadvertent noncompliance. The goal of this 

outreach campaign is to bring the legitimate investment advisers, 

the State regulators, and NASAA together, prior to the switch-over, 

so that all parties can establish a positive and constructive working 

relationship. By facilitating a partnership among the States and 

the many investment advisers who conduct their businesses in a legitimate and professional manner, this initiative will maximize the 

time and resources that State regulators can devote to protecting 

investors. 

Senator, I would be pleased to answer any additional questions 

you may have. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM 

LYNNETTE HOTCHKISS 

Q.1. Ms. Hotchkiss, the Board through the EMMA Web site makes 

a large amount of municipal bond market information freely and 

instantly available to investors. Do you feel that the availability 

and use of EMMA impacted the stability of the municipal market 

during the recent financial crisis and, if so, how? Does the Wall 

Street Reform Act impact the ability to operate and expand 

EMMA? 

A.1. Of course it’s impossible to know the precise effect that EMMA 

may have had in helping the municipal market weather the financial crisis, but I do know that it has had a considerable impact in 

raising the level of confidence in the municipal marketplace and 

giving all market participants equal access to the critical information needed to make informed investment decisions. EMMA came 

just when it was most needed, as the full impact was being felt of 

the municipal bond insurance downgrades resulting from the 

spreading financial devastation of the mortgage-backed securities 

collapse. We launched EMMA as a pilot disclosure utility in March 

2008, for the first time making the full library of basic bond offering documents for most outstanding municipal securities issued 

since 1990, along with real-time trading information, available for 

all market participants at no cost. We have received highly complementary feedback from many retail investors attesting to the 

value of the information they find on EMMA and on their increased 

confidence in investing in the municipal securities market as a result of such availability. 

As to the effect of the Dodd-Frank Act, we believe it was important to have our information dissemination function clearly delin-
88 

eated in our authorizing statute, and we look forward to working 

with other regulatory organizations in creating cross-market information systems as contemplated under Dodd-Frank. The ability to 

fully fund future enhancements to EMMA and to ensure secure and 

reliable operations of the system are the biggest barriers we see to 

realizing EMMA’s full potential. Given that the information available through EMMA is a significant benefit to all market participants, we believe it is crucial that funding for the system be as 

broad-based as possible. We believe that Dodd-Frank struck the 

delicate—and right—balance of preserving free public access to 

EMMA’s core collection while providing the MSRB with the ability 

to provide for the financial viability of our information systems 

through commercially reasonable fees for subscription or similar 

services as well as for customized data and document products and 

services. So long as we maintain the free core collection through 

EMMA, we think it is crucial for the health of the system and the 

benefit of marketplace that our ability to charge such commercially 

reasonable fees not be read too restrictively. 

Q.2. Section 975(c)(8) of the new law created Section 15B(c)(9)(A) 

of the Exchange Act, which states that ‘‘Fines collected by the Commission for violations of the rules of the Board shall be equally divided between the Commission and the Board’’ and 

Fines collected by a registered securities association under section 15A(7) 

with respect to violations of the rules of the Board shall be accounted for 

such registered securities association separately from other fines collected 

under section 15A(7) and shall be allocated between such registered securities association and the Board, and such allocation shall require the registered securities association to pay the Board 1⁄3 of all fines collected by 

the registered securities association reasonably allocable to violations of the 

rules of the Board, or such other portion of such fines as may be directed 

by the Commission upon agreement between the registered securities association and the Board. 

Have fines subject to this provision been collected thus far? If so, 

how have these fines been allocated? Please describe how this process will work going forward. 

A.2. With respect to fine collections by a registered securities association—which means the Financial Industry Regulatory Authority, 

or FINRA—our two organizations have worked through an initial 

process for allocating fines and the MSRB began receiving monthly 

remittances earlier this year. The current allocation is based on the 

1⁄3 apportionment formula set out in the statute and our two organizations continue to review how that apportionment is applied in 

situations where a broker-dealer may have violated both MSRB 

and FINRA rules, and we will make any adjustments that may be 

necessary if we find that some situations call for a different manner of application on overlapping violations. We are in the final 

stages of memorializing the allocation in a memorandum of understanding between our two organizations. 

As of now, the Commission has not yet collected any fines since 

October 1, 2010, that it has attributed to a violation of MSRB 

rules, but we expect that the Commission will be stepping up its 

enforcement activities with respect to MSRB rules, particularly in 

light of the additional areas of MSRB rulemaking and the broader 

scope of the protections of those rules called for under the DoddFrank Act. One complicating factor that has delayed our establish-
89 

ment of a precise allocation process is that most fines levied by the 

Commission are paid directly to the U.S. Treasury, which could result in significant complications in having the MSRB allocable portion paid to us. It is our understanding that the Commission is considering providing for a separate levy of the MSRB allocable portion on any broker, dealer, municipal securities dealer or municipal 

advisor found to be in violation of MSRB rules, with payment of 

the MSRB allocable portion mandated under the Dodd-Frank Act 

to be made directly from such entity to the MSRB. We hope that 

the Commission is able to come to resolution on this process in the 

very near future so that we can proceed to document this allocation 

process. 

Q.3. Earlier this month, the U.S. Securities and Exchange Commission (SEC) charged a division of JPMorgan Chase with fraud in 

connection with rigging of 93 municipal bond transactions in 31 

States. What proactive steps has the MSRB taken to address conduct similar to that uncovered by the SEC? 

A.3. The MSRB has been extremely active in undertaking rulemaking that covers the behavior of bond underwriters and municipal advisors to issuers in connection with questionable or illegal 

activities such as bid rigging. We proposed in February and are 

nearing the completion of the rulemaking process on guidance 

under both our general fair practice rule, Rule G–17, and a new 

Rule G–36, implementing the new Federal fiduciary duty of municipal advisors under the Dodd-Frank Act, that would squarely prohibit the key wrongful actions undertaken in this case. For example, under the Dodd-Frank Act, ‘‘municipal advisor’’ was defined to 

include guaranteed investment contract brokers, or GIC brokers, 

who now have a Federal fiduciary duty to the issuer. The MSRB 

guidance on fiduciary duty would prohibit receipt of payments from 

other parties in return for giving favorable treatment in what is 

supposed to be a competitive bidding process, even if they disclosed 

such payments. In addition, the proposed MSRB fair practice guidance for underwriters would establish significant new disclosure 

obligations to issuers, including specifically disclosures on conflicts 

of interest. That guidance would require that underwriters not 

charge excessive compensation. In determining whether compensation is excessive, underwriters would have to include payments 

from third parties, such as payments from swap providers or GIC 

brokers paid to the underwriters for recommending those parties to 

the municipal issuer. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED FROM 

BARBARA ROPER 

Q.1. In your written testimony, you state that credit rating agencies should be held to the same accountability standards faced by 

auditors and underwriters. Could you go into a little more detail 

about what you mean by this? What are the strengths and weaknesses of this approach? How should the SEC address the current 

state of relief (no-action letters) to issuers that do not disclose ratings in their prospectuses? 
90 

A.1. Much like auditors, credit rating agencies operate as private 

gatekeepers in our financial system. In fact, much as our system 

of financial disclosure rests on the assumption that auditors can 

provide reasonable assurance of the accuracy of those disclosures, 

the entire system of regulation for the securitization process was 

built on the assumption that ratings could reliably assess the risks 

associated with these investments. 

• The special purpose vehicles that purchase the assets and 

issue the asset-backed securities (ABS) were exempted from 

the Investment Company Act based on credit ratings. 

• ABS, including mortgage-backed securities (MBS), qualified for 

sale through shelf registration based on credit ratings. 

• Under the Secondary Mortgage Market Enhancement Act, 

MBS that received ratings in one of the two highest categories 

were deemed acceptable investments for Federal savings and 

loan associations and credit unions and for State-regulated entities, such as insurance companies, unless the State opted out. 

• Other Federal and State regulators of financial institutions 

counted asset-backed securities that received top ratings from 

an NRSRO at face value toward minimum capital requirements. 

Just as auditors’ failure to serve as effective gatekeepers was a 

key contributing cause of massive accounting scandals a decade 

ago, the rating agencies’ failure to serve that gatekeeper function 

effectively was a key contributing cause of the 2008 financial crisis. 

One way Dodd-Frank deals with that failure is by eliminating 

regulatory references to ratings. While this is an appropriate step, 

in our view, the regulators have struggled to find a way to implement it without inadvertently introducing new risks into the financial system. Even the harshest rating agency critics have failed to 

identify alternative measures of creditworthiness to serve as effective substitutes for credit ratings. As a result, for better or worse, 

credit rating agencies are likely to continue to play an important 

role in the financial system as arbiters of credit risk. Their gatekeeper function, while diminished, is therefore expected to continue. The clear implication is that it is not enough simply to reduce regulatory reliance on ratings, it is also essential to take steps 

to increase rating agency reliability. 

In seeking an explanation for the rating agencies’ failure to perform as effective gatekeepers, it quickly becomes apparent that 

they lack two of the most important characteristics we look for in 

a gatekeeper: independence and accountability. Their lack of independence is well documented in the recent bipartisan report on the 

causes of the financial crisis by the Senate Permanent Subcommittee on Investigations. With voluminous evidence taken from 

internal emails and witness testimony, the report shows rating 

agencies well aware of growing risks in the housing market but reluctant to reflect those risks in their ratings out of concern that it 

would cost them market share. In short, the major rating agencies 

prioritized profits over rating accuracy, and nearly brought down 

the financial system in the process. 

The fundamental conflict at the heart of the credit rating agencies’ issuer-pays business model creates a strong incentive for rat-
91 

ing agencies to under-invest in analysis, to assign ratings even 

where the credit risks are unknown, and to inflate ratings in order 

to protect their market share and maximize profits. In the past, 

they have faced no comparable countervailing pressure to promote 

rating accuracy. Given the scale of the conflict, we share the view 

expressed by Columbia University law professor John Coffee in 

March 10, 2009 testimony before this Committee, that, ‘‘The only 

force that can feasibly induce’’ credit rating agencies to perform the 

kind of independent verification and analysis demanded of gatekeepers ‘‘is the threat of securities law liability.’’ While enhanced 

regulatory oversight can help, past experience suggests that the 

SEC is likely to be too timid in exerting its authority to serve as 

an effective deterrent, particularly if Congress fails to come 

through with the increased funding the agency needs to implement 

the law effectively. 

In order to strike the right balance, credit ratings should be liable not simply for getting it wrong but rather when they show a 

reckless disregard for the accuracy of their ratings. As noted above, 

the Permanent Subcommittee on Investigations Report is full of examples of these sorts of abuses, as is the early study by the staff 

of the Securities and Exchange Commission. That is the balance 

struck in Dodd-Frank, which establishes recklessness as the standard of proof in private actions. It remains to be seen, however, 

whether courts will accept that approach, or will continue to view 

ratings as protected by the First Amendment, even where the 

‘‘opinion’’ in question does not reflect the actual views of the rating 

analyst of credit risk. If courts do begin to hold rating agencies liable, it should make the rating agencies less likely to assign ratings 

to securities (such as CDOs-squared) whose risks they do not understand and cannot calculate. Likewise, it should make them less 

willing to override their rating criteria to assign inflated ratings or 

to delay updating their rating criteria to reflect emerging risks out 

of a concern that it could cost them business. 

The SEC no action position with regard to issuers who do not 

disclose ratings in their prospectuses raises a somewhat different 

set of issues. In keeping with its goal of reducing reliance on ratings, Dodd-Frank eliminated the special exemption from expert liability that was granted to rating agencies specifically to encourage 

the use of their ratings in prospectuses. When the provision took 

effect, however, the major rating agencies threatened to shut down 

the still fragile securitization market by refusing to allow their ratings to be published in prospectuses. Under pressure to revive 

securitization, the SEC issued a no action letter, later indefinitely 

extended, permitting issuers to forego disclosing ratings in the prospectus. Because of the separate Dodd-Frank provisions requiring 

financial regulators to eliminate all regulatory references to credit 

ratings, the requirement to disclose ratings was presumably on its 

way out anyway. 

Under the circumstances, we did not come out in strong opposition to the SEC action, despite our support for making ratings 

agencies legally accountable for their actions. Once the regulatory 

requirement to disclose ratings in the prospectus is eliminated, 

however, the Commission should rescind its no action letter so that 

only the ratings of ratings agencies willing to stand behind their 
92 

work would be disclosed in prospectuses. Under no circumstances 

should the special exemption from liability be reinstated. To do so 

would encourage reliance on ratings by encouraging their inclusion 

in prospectuses and would do so without subjecting them to appropriate legal accountability when they show reckless disregard for 

the accuracy of their ratings. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ 

FROM BARBARA ROPER 

Q.1. A provision that I successfully included in Dodd-Frank would 

require publicly listed companies to disclose in their SEC filings 

the amount of CEO pay, the typical workers’ pay at that company 

and the ratio of the two. The past few decades, CEO pay has skyrocketed while the median family income has actually gone down. 

The House Financial Services Committee voted to repeal the provision last week under the guise of two arguments, first that it was 

‘‘too burdensome’’ for companies to disclose that and second, that 

the information wasn’t useful to investors. 

I believe the real reason some companies don’t want to reveal it 

is because they would find it embarrassing to reveal that they pay 

their CEO say 400 times what they pay their typical employee. 

And I find it very hard to believe that companies that do all kinds 

of complicated calculations for everything else involving their revenues and expenses would find it difficult to take their 2,000 employees, figure out how much employee number 1,000 is paid, and 

report that one number to the SEC. It seems to me that a company 

that can’t manage to do that needs a new H.R. Department. 

Do you believe such information would be useful to investors? 

These same investors are now often voting on an annual basis in 

say-on-pay votes. Would it be useful for them for example to know 

that in the past few years, a company has increased its CEO’s pay 

by 50 percent while decreasing its typical worker’s pay by 10 percent? Would it help investors to determine what a company’s philosophy is, such as whether it is following Peter Drucker’s theory 

that there should not be huge pay disparities between the executives and the typical worker for morale, inherent fairness, or other 

reasons? 

A.1. Investors have an interest in CEO pay disclosures for a variety of reasons. First, excessive CEO compensation comes at the expense of shareholders of publicly traded companies. Second, excessive compensation may encourage executives to take undue risks. 

Ironically, existing compensation disclosures have been criticized 

for inadvertently promoting excessive compensation by encouraging 

competition among executives for more generous pay packages. In 

addition, while they provide a certain amount of data, existing disclosures fail to put that data in context. One of the best measures 

of executive compensation that is out of line can be found by comparing it to the pay of average workers, as your provision would 

require. Where CEO compensation is many times higher than that 

of the average worker, investors may reasonably conclude that the 

company is being run for the benefit of executives rather than for 

the benefit of shareholders. That may affect how they vote, not only 

on say-on-pay votes, but also how they vote in director elections. 
93 

That may help to encourage compensation committees to be more 

responsible when doling out CEO pay. The required disclosures 

also provide information about typical employee compensation 

packages, information investors are likely to find relevant in light 

of the fact that compensation is the biggest single expense at many 

public companies. For all these reasons, we oppose efforts to repeal 

the enhanced CEO compensation disclosures provided by DoddFrank. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM ANNE SIMPSON 

Q.1. Section 953 of Dodd-Frank requires companies to disclose the 

ratio between the compensation of the chief executive officer and 

that of the median employee. Are you aware of any evidence that 

links relative pay ratios to corporate performance? Is this ratio material for making investment decisions? 

A.1. We are unaware of any research on this specific topic. However, this should not come as a surprise since issuers do not presently disclose these ratios. As far as whether an investor would 

find this information material, it probably depends on the investor. 

Similar to disclosures by an issuer’s highest paid executives, the 

ratio between a company’s CEO and a typical employee would be 

yet another metric for measuring assessing the reasonableness of 

executive compensation in the context of the company’s performance. 

Q.2. In your testimony, you observed that a ‘‘a common element in 

the failure of . . . many . . . companies implicated in the 2008 financial meltdown, was that their boards of directors did not control 

excessive risk taking, did not prevent compensation systems from 

encouraging a ‘bet the ranch’ mentality, and did not hold management sufficiently accountable.’’ A recent European Corporate Governance Institute paper reported that financial firms with more 

independent boards and higher institutional ownership suffered 

larger losses during the crisis period and that these losses were related to executive compensation contracts that focused too much on 

short-term results. Why do institutional investors such as 

CALPERS endorse executive compensation contracts that focus on 

short-term results and encourage aggressive risk-taking? 

A.2. Institutional investors such as CALPERS do NOT endorse executive compensation contracts that focus on short-term results 

and encourage aggressive risk-taking and we reject the conclusion 

in the referenced working paper. The fatal flaw of the paper is that 

it includes exactly one corporate governance factor—board independence. Although the independence of the board of directors is a 

key governance consideration, it is certainly not the only consideration. See CalPERS Principles of Accountable Corporate Governance (http://www.calpers-governance.org/docs-sof/principles/2010- 

5-2-global-principles-of-accountable-corp-gov.pdf. I also would refer 

you to an October 2010 report by Wilshire Associates (http:// 

www.calpers-governance.org/docs-sof/principles/2010-5-2-globalprinciples-of-accountable-corp-gov.pdf) which concluded that engagement by institutional investors with corporate boards/manage-
94 

ment has resulted in long-term performance superior to market 

benchmarks. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGAN 

FROM ANNE SIMPSON 

Q.1. Many witnesses addressed the fact that the Department of 

Labor (‘‘DOL’’) recently proposed regulations under ERISA that 

would redefine the term ‘‘fiduciary’’. Many Members of the Committee have expressed concerns about the coordination that is taking place between the DOL and SEC. 

As an investor at a large pension system, do you have concerns 

about the DOL’s changes or concerns about the interaction that is 

taking place between the DOL and other agencies on this issue? 

A.1. As a Government-sponsored plan, CalPERS is not governed by 

ERISA. Instead, CalPERS is regulated by State law. As such, 

CalPERS has no opinion as to DOL’s definition of fiduciary duty. 

Q.2. In your testimony you stated that ‘‘a tough clawback policy is 

an essential element of a meaningful pay for performance philosophy.’’ It is my understanding that, in addition to internally managed equity investments, many State retirement systems such as 

CaIPERs, may allocate to external alternative investment managers. 

Does your support for ‘‘tough clawbacks’’ extend to compensation 

arrangements with external managers? 

A.2. Compensation arrangements between a corporation and its executives are quite different than those between an Institutional investor and its external money managers. However, in the spirit of 

protecting long-term shareowner value, CalPERS supports the notion of accountability by both corporate executives and its external 

money managers. Accountability for money managers comes in the 

form of agreements whereby contractual rights and obligations are 

imparted upon each party. Fortunately, CalPERS has not needed 

to seek judicial redress with any external manager. 

Q.3. Is it common for pension funds to negotiate compensation arrangements with external managers that contain performance 

clawbacks as way deter managers from prioritizing short-term 

gains over long-term alignment? If not, what have been the hurdles? 

A.3. CalPERS is unfamiliar with how other plans negotiation 

money management agreements, so we are unable to opine on 

whether a particular practice is common for public pension funds. 

However, when we negotiate such agreements, we insist that they 

include legal protections for the plan. We would expect other prudent fiduciaries would demand similar protections. 

RESPONSE TO WRITTEN QUESTION OF CHAIRMAN JOHNSON 

FROM PAUL S. ATKINS 

Q.1. Mr. Atkins, in your testimony you stated that, ‘‘Congress 

should consistently push transparency and competition so that investors get high-quality and objective advice from credit rating 

agencies.’’ 
95 

Section 932 of the Dodd-Frank Act contains many provisions that 

promote transparency for the benefit of investors, including requirements that: 

• NRSROs publish a form accompanying their ratings that will 

include the assumptions underlying the credit rating procedures and methodologies, the data that were relied on to determine the credit rating, and any problems or limitations with 

those data; 

• NRSROs publish the initial credit ratings determined for each 

type of obligor, security and money market instrument, and 

any subsequent changes to such credit ratings, for the purpose 

of allowing users of credit ratings to evaluate the accuracy of 

ratings and compare the performance of ratings by different 

NRSROs; and 

• NRSROs publicly disclose the reasons when they make material changes to credit rating procedures and methodologies, 

and notify users of credit ratings of the version of a procedure 

or methodology used with respect to a particularly credit rating, when a material change is made to a procedure or methodology, and when a significant error is identified in a procedure 

or methodology that may result in credit rating actions. 

Subtitle D of Title IX of the Act contains new disclosure requirements including Section 943, the requirement that each NRSRO include in any report accompanying a credit rating a description of 

the representations, warranties and enforcement mechanism available to investors. 

Do you feel that such transparency requirements could be useful 

to investors? 

A.1. Yes, Mr. Chairman, I agree that transparency requirements 

for credit ratings can be useful to investors, especially if they can 

help investors discern for themselves which ratings deserve more 

credence. Ratings, after all, are professional opinions, and the key 

to evaluating such an opinion is understanding the qualifications 

of the person propounding the opinion, the reasoning underlying 

the opinion, and any influences that might affect the opinion one 

way or another. But, we must recognize that any regulation can 

have unintended consequences and should be subjected to a costbenefit analysis, since investors invariably pay for regulations one 

way or another, through higher prices or reduced choices. Because 

the credit-rating business has suffered from concentration and lack 

of competition, largely due to a non-transparent ‘‘no-action’’ process 

that the Commission permitted to exist for three decades, which 

this Committee in 2006 wisely prompted Congress to take strong 

steps to reform, the SEC must be very careful to ensure that regulations in this area do not further restrict competition or the ability 

of new entrants to compete against the more established firms. 

For example, the burden and costs of required disclosure must be 

carefully weighed, as should the usefulness of the required disclosure to investors. Ironically, the more disclosure around ratings 

that make them seem more authoritative, the more investors (especially retail investors) may rely on them, discounting the fact that 

the ratings are opinions at the end of the day. 
96 

In addition, the SEC should be careful to avoid influencing the 

ratings themselves or consciously or inadvertently being a judge as 

to supposed ‘‘quality’’ of ratings. Those sorts of decisions are best 

left to the marketplace and investors themselves. Finally, the SEC 

also must be careful, through requirements that are one-size-fitsall, not to lead ratings into the same general mold, reducing diversity of opinion. The market thrives on diverse opinions—those who 

can warn of anomalies that they perceive versus the ‘‘group think’’ 

of consensus or conventional wisdom. Thus, in credit ratings, 

standardization may not be necessarily helpful to investors, although diversity of viewpoint is critical. 
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ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD
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