Hearing Of The Senate Banking, Housing And Urban Affairs Committee - Enhancing Investor Protection And The Regulation Of Securities Markets - Part II

Statement

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SEN. DODD: (Sounds gavel.) Good morning. The Committee will come to order. And let me welcome my colleagues who are here as well as our witnesses in the room.

We've got a very busy morning today. We've got a long list of very distinguished witnesses to appear before us this morning on the subject matter of enhancing investor protection and regulation of the securities market. This is the ninth, I think the ninth -- it's the ninth or 10th -- hearing on the general matter of the modernization of federal regulations, and the second very specific hearing on the securities industries itself. And there's an awful lot of ground to cover here.

We have three panels this morning. The first of course involving Mary Schapiro, the chairman of the Securities Exchange Commission and Fred Joseph who's the president of the North American Securities Administrator -- Administration Association.

Our second panel of members of witnesses that have been before this committee on numerous occasions. Of course, the previous chairs -- I see Mr. Breeden's here already this morning and Arthur Levitt and others along with Paul Atkins who will be testifying about their experience background, how this all emerged and their thoughts on how we move forward.

And then a third panel of witnesses who will give us some very current experiences they're going through and ideas and thoughts as to how we ought to proceed. So I appreciate, because what I want to do is have opening statements by just Senator Shelby and myself, although Senator Warner's here and as long as no one else shows up, you can make an opening statement because I worry about if we have everybody show up and -- (laughter) -- we'll be here until midnight tonight.

SEN. RICHARD SHELBY (D-AL): Governor Warner, he's used to those opening statements.

SEN. DODD: Yeah, I know. Well, he's a good governor, he's a good Senator. We welcome him to this committee.

And then I'm going to try and ask my colleagues, we're going to have one round on the first panel, as much as -- there are many questions obviously we have for both of you. But if we end up with too many rounds, we'll never get to the second and third panels and colleagues have busy schedules as well as do our witnesses. So we'll cut it off after one round, and then we'll go to the third -- to the second panel which I'll leave a little more open, given the backgrounds of our witnesses and the third -- the third panel.

With that, let me share some opening comments and then turn to Senator Shelby and then we'll go right to our witnesses this morning. Today the committee meets for our -- as I said -- our second hearing to examine the securities market regulations, the ninth hearing on this general matter of modernization of federal regulations. This hearing is to discuss how our investors and our entire financial system are protected -- or lack of protection -- in the future from the kind of activities that led to the current crisis. This hearing is one of a series, as I mentioned, of nine we've already convened to modernize the overall regulatory frame work and to rebuild our financial system.

And I saw this morning the headlines of our local newspaper here, the direction that the secretary of the Treasury is heading. I welcome that. This is all within about 60 days of this administration coming to office. We won't have all the time this morning to go over that. This committee will be meeting at the request of the Treasury tomorrow with Democrats and Republicans to listen to some of these thoughts. It's not a formal hearing -- we'll have one of those. But given the time constraints and the fact that the administration is heading overseas to the meeting coming up in -- with the G-20, we thought it'd be worthwhile to have at least a briefing as to where this thing is heading.

So we'll welcome that and excited over the fact that they're going to be proposing some thoughts in this area as well.

We're also very excited to have two witnesses who are not only former chairman of the SEC but also I might add residents of my own state as well, and having Arthur Levitt and Richard Breeden with us. From the outset, I've argued that our financial system is not really in need of reform but modernization, that truly protecting consumers and investors in the decades to come will require a vast overhaul of our financial architects that recognizes the extraordinary transformation that has occurred over the last quarter of a century. And it is extraordinary.

And nowhere has that transformation been clearer than in the area of securities, which have come to dominate our financial system, now representing 80 percent of all financial assets in the United States. The pension funds, the proliferation of 401Ks and the like, today half of all households in the United States are invested in some way in the securities markets. As Federal Reserve Governor Dan Turillo said at our last hearing on this subject matter, "the source of systemic risk in our financial system has to some considerable extent migrated from traditional banking activities to markets over the last 20 or 25 years," end of quote.

In essence, as the assets of our financial system have shifted from banking deposits to securities, so too have the dangers posed to our economy as a whole. We need regulators with the expertise, tools and resources to regulate this new type of financial system. At our last hearing on this subject, this committee heard about the need to watch for trends that could threaten the safety of our financial system.

Our witnesses had different views on what regulatory body should perform that function. Some felt it should be given to a special commission made up of the heads of existing agencies. Others have argued for a new agency or to give that authority to an existing regulator. As I've said, given the regulatory failures we saw in the lead-up to this crisis, I have concerns, I think many of my colleagues have also expressed, about this authority residing exclusively within one body. And I re-express those views this morning.

For instance, we've seen problems with the regulated bank holding companies where they have not been well regulated at the holding company level. And while there are many aspects to our financial system, systemic risk itself has many parts as well. One is the regulation of practices and products which pose systemic risk from subprime mortgages to credit default swaps, and that is why I remain intrigued by the idea of a counsel approach to address this aspect of systemic risk. And I know our previous witness Paul Stevens with the Investment Company Institute and Damon Silvers with the AFL-CIO have both recommended this type of concept.

Of course, systemic risk is only one issue of which we are examining. At our last hearing on this subject matter we heard how we could increase transparency by addressing the risk posed by derivatives. We heard ways to improve the performance of credit rating agencies who failed the American people terribly by requiring them to verify the information they use to make those ratings. And more recently, Secretary Treasury Geithner proposed as proposed the creation of a resolution mechanism for systemically important non-bank financial institutions. And I'll be very interested in hearing the view of Chairman Schapiro on that subject matter, what your thoughts are and how the SEC, the role they should play.

And in providing this authority to the FDIC I'm pleased that they have recognized the need to ensure that powerful new tools do not all reside again within a single agency.

These are all ideas that deserve careful examination which we will engage in here at this committee. Today's diverse plan including representatives from hedge funds, credit rating agencies, retail investors, industry self-regulatory organizations, paints a very vivid picture of the numerous issues facing the securities markets at this moment.

The goal of modernization -- or the goals, rather, of modernization -- are clear in my view, consistent regulations across our financial architecture with strong cops on the beat in every neighborhood, checks and balances to ensure our regulators in the institutions that oversee them are held accountability and transparency so that consumers and investors are never in the dark about the risks they'll be taking on.

The time has come for a new era of responsibility in financial service that begins with the rebuilding of our 21st century financial architecture from the bottom up with the consumer clearly in our minds and in the forefront. It begins with the work of this committee, and again this is now almost the 10th hearing on the subject matter. Senator Shelby and I and our colleagues here are determined to play a constructive and positive role as we help shape this debate in the coming weeks.

And with that, let me turn to Senator Shelby.

SEN. SHELBY: Thank you, Mr. Chairman.

I look forward to hearing from our witnesses today. I'm particularly interested in hearing from SEC Chairman Schapiro about the steps that she's taking to address the agency's recent regulatory failures. This includes the disappearance of the investment banks -- the SEC's largest regulated entity is there -- the systemically devastating failures by the credit rating agencies that enjoy the SEC's implicit seal of approval and the Madoff fraud.

I believe that changes in the way the agency is managed and how its resources are used will be of utmost importance in getting the SEC back on the right track. The insights of former SEC chairman and commissioners, securities regulators and self-regulatory organizations will also be useful in determining what changes may be needed. For that reason, I'm pleased that we have representatives of each of these groups here today. Only by hearing a wide range of perspectives and by digging deep inside these agencies and failed financial institutions will we be able to fully understand how we got into this crisis, how we can get out of it, and how we can prevent them in the future.

Mr. Chairman, I think we're on the right road here, breaking all this down into the various parts. And I commend you for that.

SEN. DODD: Thank you very much. I only see a couple of our colleagues and I know that Senator Corker likes to give long opening statements -- (laughter) -- so I'm going to presume we're going to pass and go right to our witnesses. All right. Senator Tester any quick comment?

SEN. JON TESTER (D-MT): Yes, since Senator Corker's here I want to give a long opening statement. (Laughter.) I pass.

SEN. DODD: All right. Well, again, Chairman Schapiro and Mr. Joseph, we thank you for coming before the committee. And let me just say to my colleagues and witnesses -- I always say this but it needs to be said -- that any supporting documents and information you think would be helpful in expanding your answers to questions or comments or full opening statements my colleagues would like to make will be included in the record as we go forward. And we'll leave the record open for several days because invariably there'll be additional questions I think my colleagues would like to ask and we'll leave that record open and ask you to respond as quickly as possible.

And with that, Chairman Schapiro, we welcome you before the committee again.

MS. SCHAPIRO: Thank you very much, Chairman Dodd.

Ranking Member Shelby and members of the committee, I appreciate the opportunity to testify as we face a critical juncture in the history of our nation's financial markets. It's a particular pleasure to appear with Fred Joseph, Securities Commissioner from the state of Colorado and the head of NASAA.

I'm testifying today on behalf of the commission as a whole. The commission agrees that our goal is to improve the financial regulatory system, so we will work constructively to that end and that we are all fully committed to the mission of the SEC.

In light of the recent economic events and their impact on the American people, I believe this committee's focus on investor protection and securities regulation as part of a reconsideration of the financial regulatory regime is timely and critically important. I strongly support the view that there is a need for system-wide consideration of risks to the financial system and for the creation of mechanisms to reduce and avert systemic risks.

I am equally convinced that regulatory reform must be accomplished without compromising the integrity of our capital markets or the protection of investors. This is the SEC's core mission and we believe that an independent agency with this singular focus is an essential element of an effective financial regulatory regime.

I believe that three general principles should feature prominently in regulatory reform. The first is that an integrated capital markets regulator that focuses on investor protection is indispensible to restoring investor trust and confidence which is in turn indispensible to the recovery of our economy.

Second, that regulator must be independent.

And third, a strong and investor focused capital markets regulator compliments the role of a systemic regulator resulting in a more effective oversight regime.

The SEC's regulation of the nation's capital markets involves an integrated set of functions that promote the efficiency, competition and fairness of our markets for the benefit of investors.

Through the regulation of exchanges, clearing agencies and transfer agents that provide the infrastructure that makes our markets work at lightening speed with remarkable efficiency and at low cost to investors.

Through the provision of accurate, meaningful and timely corporate information, which allows investors to allocate capital efficiently.

Through the independence of expert accounting standard setters to ensure that the primary focus in standard setting is investors reading financials, not the companies preparing them.

Through the rules of ensure that mutual and money market funds which hold over $9 trillion of assets are operated for the benefit of investors and only investors.

Through the oversight of 5,500 broker dealers and over 11,000 investment advisors to whom investors turn for guidance when accessing our capital markets.

And finally, through enforcement done aggressively and without fear or favor.

Each of the SEC's core functions interacts with the others. As an aggregated set, they provide for strong capital markets oversight. Take any function away and the investor protection mission suffers. If the functions are disaggregated, capital markets oversight become deluded and investors suffer.

As we look to the future of securities regulation, we believe that independence is an essential attribute of a capital markets regulator. Congress created the SEC to be the investor's advocate and Congress did so precisely so that we can champion those who otherwise would not have a champion and when necessary, take on the most powerful interests in the country. Regulatory reform must guarantee that independence in the future.

Finally, the SEC is a strong and independent capital markets regulator. We'll work cooperatively to support the mission of systemic risk regulation, whether it is accomplished at the designation of a single entity to monitor and control risk, or through a college of regulators approach.

When I returned to the SEC as chairman in January, I appreciated the need to act swiftly to help restore investor confidence in our markets and in the SEC. In less than two months, we've instituted important reforms to reinvigorate our enforcement program, better train our examination staff and improve our handling of tips and complaints. To address short selling, the commission will consider proposals early next month to reinstate the Uptick Rule. And on April 15th, the commission will hold a public roundtable on possible credit rating agency reforms.

This spring, I will ask the commission to consider proposals to strengthen money market funds through improvements to credit quality, maturity and liquidity standards, improve investor access to public company proxies, and significantly enhance controls over the safe keeping of investor assets.

But, we cannot do everything alone, and this crisis highlights several pressing needs. I expect to ask for the committee's help with legislation that would require registration of investment advisers who advise hedge funds, and likely of the hedge funds themselves; legislation to break down statutory barriers between broker-dealers and investment advisers; and to fill other gaps in regulatory oversight, including those related to credit default swaps and municipal securities, an area that has far too long needed more robust oversight.

Every day when I go to work I'm committed to putting the SEC on track to serve as a forceful regulator for the benefit of America's investors. Today, the SEC's coordination of capital markets oversight and investor protection is as fundamentally important as it ever was, and I'm fully committed to ensuring that the SEC carries out that job in the most effective way it can.

Thank you, again, for the opportunity to share the SEC's views. We very much look forward to working with committee on financial reform efforts in the months ahead, and I, of course, would be pleased to answer any questions.

SEN. DODD: (Off mike.) Thank you very much -- (inaudible) -- thank you very much, Chairman Shapiro.

Mr. Joseph, thank you very much for being with us.

Just try it out here. There's a -- (off mike commentary) -- there you go.

MR. JOSEPH: It's that new technology. (Laughs.)

SEN. DODD: You're all set. Go ahead.

MR. JOSEPH: I must have -- okay. Thank you, Mr. Chairman.

Chairman Dodd, Ranking Member Shelby, and members of the committee, I am Fred Joseph, the Colorado securities commissioner and president of the North American Securities Administrators Association, NASA. I'm honored to be here today to discuss legislative and regulatory changes that are most relevant to Main Street Americans who are looking to regulators and lawmakers to help them rebuild and safeguard their financial security.

In November, 2008, NASA released its Core Principles for Regulatory Reform in Financial Services, and subsequently issued a pro-investor legislative agenda for the 111th Congress. Today, I'd like to highlight the recommendations that we feel are most vital to sound regulatory reform and strong investor protection. NASA's top legislative priority is to protect investors by preserving state regulatory -- state securities regulatory and enforcement authority of those who offer investment advice and sell securities to their residents

Just one look at our enforcement data shows the effectiveness of state securities regulation. Last year, in Colorado alone, my office conducted investigations that led to 246 enforcement actions, resulting in $3 million ordered to be returned to investors; and 434 years of prison time for fraudsters. And just last month a Ponzi scheme investigation launched by my office resulted in a prison sentence of 132 years for this -- for the main perpetrator.

And yet, over a number of years there have been calls for preemption of state regulation and enforcement. The National Securities Market Improvement Act of 1996, NSMIA, preempted much of the state's regulatory authority for securities traded in national markets. Although it left state antifraud enforcement largely intact, it limited the state's ability to address fraud in its earliest stages, before massive losses had been inflicted on investors.

An example of this is the private -- area of private offerings under Rule 506 of Regulation D. These offerings enjoy an exemption from registration for federal securities laws, so they receive virtually no regulatory scrutiny. As a result, we've observed a significant rise in the number of offerings made, pursuant to Rule 506, that are later discovered to be fraudulent.

Although Congress preserves the state's authority to take enforcement action for fraud, this power is no substitute for a state's ability to scrutinize the offerings for signs of potential abuse and to ensure that disclose is adequate before harm is done to investors. NASA believes the time has come for Congress to reinstate state regulatory oversight of all Rule 506 offerings.

Next, the Madoff case illustrates the horrific consequence we face when an investment adviser's illegal activity goes undetected and unchecked for an extended period. NASA recommends two changes to enhance the state's role in policing investment advisers.

First the SEC should expand the class of IAs that are subject to state registration oversight. In NSMIA, Congress provided that the states would regulate IAs with up to $25 million in assets under management, while the SEC would regulate the larger IAs. Congress further intended (that) the SEC would periodically review this allocation of authority and adjust it appropriately.

The time is now for the $25 million asset-under-management test to be increased, possibly to $100 million. Congress should also consider enhancing the state's enforcement authority over large IAs. Currently, a state can only take enforcement action against a federally registered investment adviser if it finds evidence of fraud. This authority should be broadened to encompass any violations under state law, including dishonest and unethical practices. This enhancement will not interfere with the SEC's exclusive authority to register and oversee the activities of large IAs.

NASA also urges Congress to apply the fiduciary duty to all financial professionals who give investment advice regarding securities -- broker-dealers and investment advisers alike. This step will enhance investor protection, eliminate confusion, and even promote regulatory fairness by establishing conduct standards according to the nature of services provided and not the licensing status of the provider.

The fiduciary duty has the obligation to place a client's interests first, to eliminate any conflicts of interest, and to make full and fair disclosure to clients. We recommend that Congress ratify the highest standard of care. For all financial professionals, the interests of the clients must come first at all times.

Many observers believe that private actions are the principal means of redress for victims of securities fraud. But they also play an indispensable role in deterring fraud and complementing the enforcement efforts of government regulators and prosecutors. The problem is, the Congress and the U.S. Supreme Court have restricted the ability of private plaintiffs to seek redress in court for securities fraud.

These restrictions have not only reduced the compensation available to those who have been the victims of securities fraud, but they've also weakened a powerful deterrent against misconduct in our financial markets. Removing excessive restrictions on access to the courts would not only provide just compensation for investors, it would also benefit regulators by restoring a powerful deterrent against fraud and abuse -- that is, the threat of civil liability.

In conclusion, state securities regulators believe that enhancing our securities laws and regulations, and ensuring they are being vigorously enforced, is the key to restoring investor confidence in our markets. NASA and its members are committed to working with the committee to ensure that the nation's financial services regulatory regime undergoes the important changes that are necessary to enhance Main-Street investor protection which state securities regulators have provided for nearly 100 years.

Thank you very much.

SEN. DODD: Thank you very much, Mr. Joseph -- appreciate that very much.

And we'll begin with the first round, and I'll ask the clerk to keep an eye on this -- on this clock here, so we make sure we get to everybody, and move along with as many witnesses as we have.

Madame Chairwoman, thank you again for being with us here this morning.

Lehman Brothers Financial Products Division and AIG, among others, I guess -- you've heard Secretary Geithner and Fed chairman, Bernanke, propose the creation of a resolution mechanism for non-bank entities as a way to move things forward. And, obviously, you're talking about an area in which the SEC plays a very critical role.

So -- (inaudible) -- to know whether or not you were (ever were ?) consulted to fix it all -- we've talked about the Treasury secretary and the chairman of the Federal Reserve, but given the fact we're talking about entities that would normally fall under the jurisdiction of the SEC, or the state regulators, were you at all consulted by this Treasury and the Fed? What role do you think the SEC should play in this resolution mechanism, given the oversight and regulatory responsibilities?

And let me take advantage of the moment, as well, to ask if you would, to comment on the reports of the regulatory changes that Secretary Geithner has mentioned this morning.

In fact, I'll ask both of you to do that, but let me begin with Chairman Shapiro.

MS. SCHAPIRO: Thank you, Mr. Chairman.

I would say, broadly, and quite generally, there was consultation with respect to the concept of filling the gaps in the existing resolution regime, but really very little conversation about what that would look like and what the legislative proposal ultimately would propose.

We clearly have gaps in our resolution regime for large financial institutions. CPIC obviously handles the unwinding and the liquidation of a broker-dealer. FDIC is empowered to handle the unwinding, or the resolution of a bank. But, we have bank holding companies and other large financial institutions for which there really is no organized resolution regime. And I do think that that was an issue -- clearly, an issue with AIG, but also an issue with Lehman Brothers and the other institutions.

So, I fully support the concept of closing the gap in resolution regime so that we have a more coherent approach. Whether that ultimately rolls CPIC -- over which the SEC has authority, into it, or it works to be highly coordinated and cooperative with an entity like CPIC, I think is something we should probably discuss as this legislation moves forward.

SEN. DODD: Let me just say, before you move to the second question, whether they've consulted with you or not, I would hope that you'd demand to be consulted on this.

I mean, this is something where, clearly -- that this is -- If you're going to have a resolution of these entities here, given the role of the SEC, and the regulation of them, and your oversight of them -- and I'm very much supportive of the idea of having a resolution mechanism, I don't want to suggest I'm not -- but it seems to me you've got to be involved in this.

MS. SCHAPIRO: There is absolutely no question but that we have to be involved in this. The SEC has enormously important role to play here as the expert.

But, again, as I said in my opening statement, as the advocate for the investor whose funds are in potentially multiple components of a large financially -- a financial firm, and most particularly, of course, the broker-dealer, and our concern will always be the protection of investor's assets in the broker-dealer.

So, I'm not known for being shy. I have no intention of being shy --

SEN. DODD: Kick down the door, if you have to.

MS. SCHAPIRO: I will kick down the door. (Laughter.)

SEN. DODD: Mr. Joseph? Let me come back.

Let me have you respond to this quickly, and then I want to get back to this. Don't take a long time with me on the second part of that question, but I'd be interested in your general reaction to what you've heard this morning from Treasury and others on the modernization.

MS. SCHAPIRO: With respect to a systemic risk regulator?

SEN. DODD: Yeah.

MS. SCHAPIRO: Again, there's -- the devil is in the details on this one for sure.

And my concern is that in the creation of a systemic risk regulator we don't create a monolithic entity that supplants the important functions that are served by multiple other agencies, and most especially, in my view, the Securities and Exchange Commission and our role as a regulator of the capital markets with a focus, again, solely on investors and investor protection.

So, while I support the concept of either a systemic regulator or a college of regulators -- which I think is a concept you have talked about. I know there's at least one bill proposed that would create that sort of a mechanism. And I think it's well worth exploring, because I think multiple regulators bring a lot to the table in multiple perspectives.

Nonetheless, whichever way we end up going, I think there's value to a view, across the markets, of large or rapidly increasing exposures can threaten the health of the financial system. I think there's an important focus on evaluation of risk management procedure within large firms. I think there are certain prudential standards that ought to be established for very important systemic institutions. And I think a risk regulator can help the appropriate resolution of authority in their functions.

But, I think what is really important is that while we try to create a mechanism like this, that we don't try to supplant the very important functions that are engaged in by agencies like the SEC in the regulation of markets' clearance and settlement systems, brokerage firms, mutual funds -- where Americans entrust their savings, and so forth.

SEN. DODD: Let me just say -- the time is up here, and I -- and, again, I think Senator Shelby and I are both very determined to work very closely together on this, so I wouldn't want any of my statements to be taken as a final conclusion on this, but as we talk about a systemic risk regulator and a prudential regulator, my own view is we put that together.

I get somewhat uneasy about consolidation of a lot of this. It sounds -- looks great on a sheet of paper, in terms of doing the efficiencies of it, but I, for one, feel very strongly -- at least at this point, that the SEC, and the function of the SEC, ought not to be so incorporated in something that it ends up diminishing the role of the Securities and Exchange Commission and investor confidence -- investor confidence, investor confidence.

MS. SCHAPIRO: I completely agree with you.

My fear is that a systemic risk regulator, and systemic risk concerns, will always trump investor protection. And, given the structure of our markets, and the broad participation of the public in our markets, that would be a terrible result.

SEN. DODD: (So, we're interested in ?) your thoughts and views on this as well, but I wouldn't want the moment to pass without expressing my reservations about moving a lot of boxes around and consolidating things, and assuming you're getting something better because you've got fewer boxes. (Laughs.)

MS. SCHAPIRO: Thank you.

SEN. DODD: In fact, the goal is -- that consumer, that investor, that shareholder, that 'users of the system,' what is in their interest? You begin there.

Senator Shelby.

SEN. SHELBY: Thank you, Mr. Chairman.

Picking up on the area that Senator DOD was in, Chairman Shapiro, the SEC's Consolidated Supervised Entity Program I believe was not a success. What role, if any, should the SEC -- you're the chairwoman of SEC, play in prudential supervision?

MS. SCHAPIRO: I think it's --

SEN. SHELBY: Can you bring the mike up closer?

MS. SCHAPIRO: Sure. I'm sorry. Is that better?

SEN. SHELBY: Yes.

MS. SCHAPIRO: I think the SEC's Consolidated Supervised Entity Program was not a success. I think that's a fair evaluation. It's been replaced now -- because we obviously still have very important oversight of brokerage firms that have financial and operational issues, that need the close supervision of the SEC -- and it's been replaced by an Office of Broker-dealer Risk Management.

Nonetheless, our focus on the broker-dealer is very important and it is well ingrained in the SEC. But, you can't effectively oversee the broker-dealer and its operations if you don't also have the ability to understand what's going on in a holding company or in affiliates -- and including overseas affiliates, whose activities can very, very directly impact the broker-dealer and the safekeeping of customer assets at that broker-dealer.

So, my view is that we have responsibility for brokerage firms, but we also have to have what we call a "touch" at the holding company level and at the affiliate level, to understand risk management, exposures, leverage, and other issues that have implications for the broker-dealers' health.

SEN. SHELBY: You've announced plans to consider reinstating the Uptick Rule, or a variation of the rule, at an open meeting next month. A lot of economic analysis was done before the rule was eliminated in 2007. How are you incorporating economic analysis into the decision about whether, and if so, how, to reinstate an uptick rule?

MS. SCHAPIRO: Senator, you're absolutely right. We are going to consider, at an April 8th Commission meeting, proposing to reinstate the Uptick Rule, or -- (inaudible) -- test, or a circuit breaker, or some combination of those as a mechanism for controlling short selling to some extent.

And we are obviously acutely aware of the tremendous interest in this issue -- on both sides. Economic analysis did play a very important role in the elimination of the uptick test, and we would expect that our economists at the SEC are looking at data now, in the context of the changes in the markets, to understand what the impact of an uptick rule might be.

And I would expect that we will make data available, to the extent we can, to independent economists to do some analysis as well. We will also hold, in conjunction with the (open-meeting ?) where we'll consider the uptick test -- a public roundtable where we'll solicit views more broadly about, not just the uptick test, but other potential governors on short selling.

SEN. SHELBY: The SEC's examination function used to be integrated into each of the rulemaking divisions. Over 10 years ago it was split off into a separate office. Some people have argued that this structure creates a dangerous wall between those who write the rules and those who monitor how firms are implementing them.

Are you, at the SEC, reviewing this structure and how it continues to make sense, especially in light of the Madoff, Stanford Financial and market timing scandals?

MS. SCHAPIRO: Well, Senator, we are. I've only been on-board about two months, not quite two months, and --

SEN. SHELBY: I know that.

MS. SCHAPIRO: -- we're reviewing the structure of the agency broadly, it's high on my list of things to get done..

It's really critically important that we have an examination staff that has the tools and the skill sets to do a more effective job -- the most effective job possible, but that it's also linked back to the policymaking parts of the organization, so that they can inform policymaking and they can also inform the Commission about areas where we may need to take further action.

So, I'm looking very broadly at the structure to the entire agency, and of course the OC is a component of that.

SEN. SHELBY: You've also noted that the SEC may ask Congress for a statutory mandate that hedge fund advisers register. Would your request also extend to venture capital and private equity advisers? And how would the influx of new advisers affect the frequency with which advisers get inspected?

MS. SCHAPIRO: Well, it's a terrific question, because right now we have something on the nature of 400 examiners to cover 11,300 advisers and more than 8,000 mutual funds. So, without additional resources we could not make -- even given the authority to regulate hedge funds, we couldn't make that a reality in a very effective way.

SEN. SHELBY: How much money you going to need there? I know this isn't the Appropriations committee question, but I'm also on that committee.

MS. SCHAPIRO: We are working on that analysis right now and we'd be happy to provide it to the committee as soon as possible.

SEN. SHELBY: Okay.

MS. SCHAPIRO: But, also it's important, though, that in addition to resources we need to have the skill sets that are appropriate in order to do an effective job with hedge fund regulation.

SEN. SHELBY: Thank you, Ms. Shapiro.

SEN. DODD: Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman. Thank you for holding the hearing.

Thank you, witnesses.

My first question deals with executive compensation. It's become clear that something's out of whack with executive compensation. I think we all believe people should be rewarded for good performance. That's not the problem.

But, what we've seen in many instances -- that has enraged Americans, is a "heads, I win; tail, you lose" system, in which executives are rewarded for flash-in-the-pan, short-term gains, or even worse -- rewarded richly when the company does poorly and the shareholders have been hammered. I think that's what most confounds people -- bad performance, higher salary.

Corporate boards are supposed to keep an eye on compensation. They're supposed to keep it aligned with shareholder interests. Lately, they've seemed more interested in keeping these CEOs and top managements happy than carrying our fiduciary responsibilities. So, I think we have to address that.

We've learned a lot about this in the last while.

Well, last year when he was senator, President Obama sponsored an advisory say on pay proposal, and I think we have to look at this. I'm for it. But for say on pay to have teeth, it seems pretty clear it requirems shareholders have a stronger voice in regard to corporate management. This obviously means shareholders need to have a real voice in the election of directors. Right now, given the fact it's so hard to get access to the proxy materials for non-management shareholders, this isn't true. So I was encouraged to hear in your testimony you don't believe the SEC has gone far enough in this area.

First, how are you proceeding to correct this? And do you agree with me that in conjunction real proxy access along with say on pay would have some real impact on compensation practices and on enhanced board responsibility more generally?

MS. SCHAPIRO: Senator, I agree with everything you've said.

SEN. SCHUMER: Oh, oh. Maybe we should stop right now.

MS. SCHAPIRO: I could stop right there in the interest of time. Let me say quickly, I think there has been a lot of effort to link pay to performance, but there's been a non-successful effort to link pay to risk taking. And that's a responsibility for boards to understand the appetite for risk within the organization and to control it. And one way to control it is through linkage to compensation practices for senior management.

We will move ahead this spring to propose greater access to the proxy for shareholders. As a mechanism both to empower shareholders who are in fact the owners of a corporation but also as a mechanism to help provide greater discipline with respect to compensation and risk- taking.

SEN. SCHUMER: Okay. Thank you. And I look forward to working with you on this area. I think we need some to move forward. Second is enforcement funds. We know, everyone knows about the Madoff case, but it's emblematic of a broader trend of fraud that's going to be uncovered in the aftermath of financial crises. Back in the S&L crisis I helped push a law that would get special prosecutors, FBI agents and bank examiners to go after that fraud. MR. Breeden is shaking his head because we worked together on that. And we need to do that again, particularly now. If you saw yesterday's newspaper, the administration correctly doesn't want to reduce anti-terrorism efforts in the Justice Department, but that squeezes new needs such as financial.

In conjunction with my colleagues on this committee, we're trying to increase the SEC enforcement budget. I proposed legislation to do that with Senator Shelby, which we are going to try to do in the Appropriations Committee.

Can you give us a sense of what improvements you could make with a stronger enforcement budget?

MS. SCHAPIRO: I would be happy to.

SEN. SCHUMER: An increased budget in general too.

MS. SCHAPIRO: But it would be grateful to have an increased budget and particularly an increased enforcement budget. We have a new enforcement director beginning on Monday. He spent 11 years as a prosecutor and head of the Securities and Commodities for our task force in the Southern District in New York. He's coming in with a renewed commitment to the SEC's focus on bringing the most important cases, the most meaningful cases in the quickest time possible in order to protect investors more effectively.

We are also looking at technology improvements to support our enforcement and examination staff. The SEC's technology is light years behind Wall Street and frankly light years behind everybody else.

SEN. SCHUMER: Okay.

MS. SCHAPIRO: We've enhanced our training prograMS. We have a number of people who are now taking the certified fraud examiner program as well as enhancing dramatically our internal training programs, and we are actively seeking new skill sets including in financial analysis forensic accounting, trading and other areas so that we are better able to keep up with what's going on and what the fraudsters are up to.

SEN. SCHUMER: Thank you. So I see you need the money. Ccould I ask one more, Mr. Chairman?

SEN. DODD: Okay.

SEN. SCHUMER: Okay. Quickly, on derivatives clearing. For awhile I've been advocating that derivatives ought to be traded whenever they can. Some are very complicated, and there's no market in either the clearinghouse or for me preferably in exchange. I know that this morning Secretary Geithner is going to mention that in his testimony, at least as I understand it, on the other side. What steps is the SEC encouraging to take -- to encourage the use of central counter parties? Do you have the authority to require clearing of certain types of derivatives now? If you don't, is it the kind of authority that you want? And if not, what other kinds of authority do you need?

MS. SCHAPIRO: I believe that --

SEN. SCHUMER: You deal with the general thrust?

MS. SCHAPIRO: Yes. CDS should be centrally cleared. We do not have the authority right now to require that. We have facilitated the approval of three central counter parties for CDS clearing that we have done jointly with the Fed and with the Commodity and Futures Trading Commission. And we would strongly recommend that Congress require central clearing of CDS. I'm not a big believer in voluntary regulation, and I think that this is the area where we need authority.

SEN. SCHUMER: Thank you.

SEN. DODD: Thank you very much. Did I hear you say in response to Senator Schumer that on the say on pay that you're inclined to be supportive of that in terms of --

MS. SCHAPIRO: I do support say on pay. The advisory vote by shareholders of pay, yes.

SEN. DODD: Good. Thank you for that. And let me just say too as I turn to Senator Corker, there's some wonderful people who work at your organization, and I wouldn't want our comments -- we talk about needs and resources and so forth -- to be reflective of how many of us feel about how hard working people are at the SEC. They need the tools, as Senator Schumer points out the resources and so forth there. But it's not for lack of determination of good people who want to do a good job. And I think that needs to be said. It can't be said often enough.

MS. SCHAPIRO: I appreciate that very much.

SEN. DODD: Senator Corker.

SEN. BOB CORKER (R-TN): Thank you, Mr. Chairman, and thank you all for being here and for your testimony. I just am going to look at my Blackberry a second and recite a quote from Secretary Geithner this morning on the other side of the Capitol. "We have a moment now where there is broad-based will to change things that people did not want to change in the past."

And those -- I'm getting a little feeling of nervousness just about the pace at which change is taking place. Typically when you know you're in crisis you end up with not having a cause neutral solution, okay? I would just say to you, if you're going to be kicking the door down, the kicking is good right now. I mean, you're going to miss an opportunity if that doesn't happen very quickly.

And I would just ask your opinion of some of the resolution authority concepts that were laid out in the last 24 hours. It feels to me like a codification of TARP. And the very powers that the Treasury has now under TARP it seems to me they are codifying under this proposal they've put in place, which allows them to not only take companies now but to decide to invest in companies.

I just wonder if you have any thoughts there, and does that concern you in any way?

MS. SCHAPIRO: It does concern me. I think any time we write "blank check legislation" as I sometimes call it, we have to be very conscious of the fact that we could set in motion a complete rewrite of the regulatory regime without perhaps truly intending to do that.

So I think it's really critically important that Congress stay deeply involved in this discussion and this debate and sets the parameters.

So, for example, the definition of a systemically important institution is absolutely essential. And if it's very, very broadly defined that resolution regime or the systemic risk regulator could usurp the functions of multiple other regulators and as you know my concern is also usurp the importance of investor protection and capital markets regulation in doing so.

So I think it's really an area where Congress needs to stay involved so that we don't end up with such broad legislation that we define the regulatory regime without the input of the broadest number of perspectives and without more careful thought to what the implications are to the other functions that are important in financial regulation.

SEN. CORKER: Mr. Chairman, I think you explained that TARP was set up for an intended purpose, and we've moved into industrial policy. The last administration did that. This administration looks like it's going to move more deeply into industrial policy. And it seems to me that what the secretary has outlined this morning clearly gives them the ability to move into any sector of our economy that they choose that they decide might be systemically putting our economy at risk. And I think we should heed Ms. Schapiro's comments here. This is a fearful time. The public is concerned, and lots of time bad things happen legislatively as a result of people being concerned.

Let me ask you this. Do you agree or disagree that hedge funds, derivatives, private equity ought to be regulated?

MS. SCHAPIRO: I do not disagree. I've stated they should be regulated.

SEN. CORKER: Okay. And to follow up on Mr. Schumer's comment -- and obviously how they are regulated makes a huge difference. Would you not agree?

MS. SCHAPIRO: Absolutely.

SEN. CORKER: I mean, we could in fact I guess run all three of those enterprises through other places if we regulate them inappropriately. Is that correct?

MS. SCHAPIRO: That's right. And so we need to be sensitive to the fact that a hedge fund is not a mutual fund. And we need to understand the differences in how those investment vehicles work and tailor the regulation appropriately.

SEN. CORKER: And we still want private equity to take risk, right?

MS. SCHAPIRO: Absolutely.

SEN. CORKER: I know it's not time right now, but I'd love to hear your thoughts on how you regulate private equity in such a way as to allow them to continue to take risk, which is what we want them to do, and yet be somewhat under their hood. So maybe you'll answer that a little bit later.

I want to ask you one last thing because time is so short. We have so many panel members.

Credit default swaps. I think we all understand some of the problems that have occurred, but midland people have advocated that credit default swaps are like off-track betting if you don't have any skin in the game. And so I'd love to hear your thoughts as to whether credit default swaps should only be used when you have some collateral that you're actually insuring against, or whether you ought to be able to just make bets with no collateral.

MS. SCHAPIRO: It's a terrific question, and it's one with very strongly held views on both sides, whether there should be skin in the game in the sense that you have an insurable interest before you engage in a credit default swap.

We don't have an agency perspective on that. I think it's actually an issue very much worth exploring as a mechanism to control some of the risk in the system. I can't tell you I'm sophisticated enough to know all of the implications of requiring an insurable interest before engaging in a credit default swap and exactly how you would define that. But I think it's an issue that's worthy of consideration.

SEN. CORKER: Well, my time is up, but my sense is that you feel like the Treasury's proposal as outlined in the last 24 hours could be very much a power grab. Is that correct?

MS. SCHAPIRO: I certainly wouldn't use those words.

SEN. CORKER: But I'm using them, and I'd love to have a yes or no on that. (Laughter.)

SEN. DODD: Nice try, Senator Corker. (Laughter.)

MS. SCHAPIRO: I think the devil -- I believe the devil is in the details. I believe it's really important to understand what it is exactly that we're proposing to do and what the implications are for the regulatory regime and for investors broadly.

SEN. DODD: Thank you, Senator. Let me just say too to my colleague from Tennessee whose judgment and counsel I take very seriously as well, but this could be very involved as we listen to the proposal on the resolution mechanism. I'm generally supportive of the idea of having some sort of a resolution mechanism. What shape that takes and how it's organized and structured is something this committee would be deeply involved in.

SEN. CORKER: I sure hope so. I would rather be Treasury Secretary than Chairman of the universe. So I hope we will be involved.

SEN. DODD: Well, be careful what you wish for.

Senator Warner.

SEN. MARK WARNER (R-VA): Better than chairman of the universe. A high standard. Well, thank you, Mr. Chairman. And I know my time is short but I would like to echo what my colleague said. I -- in the chairman's response to the skin in the game question about credit default swaps, I know there are a number of other arguments on the other side. I'd like to hear out those arguments because it does seem to me at least a broader based societal standpoint the outside risk and the downside risk that we as a society in fact have taken on by these non-skin-in-the-game off-side bets, we're sure seeing the downside of that.

I'd like to come at this maybe -- look at it from the top and maybe from the bottom and one of the questions, bottom-up, and you having served in the role of FINRA, I understand the need for self- regulatory organizations in light of the limited resources you have at the SEC to have the oversight on the number of institutions you have to cover. But we had a previous hearing here a month or so back on the Madoff schedule and it seemed where there were kind of passing responsibility between representatives from the SEC and FINRA about where boundaries ended and how far you could go and at what point an operator of an institution could by simply defining that this was off limits could stop investigations. As you look through your overview, Chairman Schapiro, have you looked at kind of a fresh-eyed look at all the SROs and what their function should be going forward?

MS. SCHAPIRO: We have not, that is something we will do because I think it's very important. The SEC is responsible for about 30,000 regulated entities including about 12,000 public companies. We have a staff of 3,600 people. We have got to have the ability to leverage third parties in order to do our job, which is not to say in any way that we would ever abdicate our responsibility or delegate our responsibility away. But whether it's accounting firms or SRO, the PCAOB or other entities, we need the ability to utilize them to help us get our jobs done.

I think what the Madoff matter points out to me that I think is something that we need to focus on, and I alluded to in my oral testimony and in more detail in the written, is that we do have gaps in the regulatory regime, and the particular area of concern and Fred Joseph (ph) raised this as well, is the different stages of care and the different regulatory regimes that govern investment advisors and broker dealers when they are providing largely the same service. And investors clearly don't understand that there's either a different standard of care or a different regulatory regime in place.

Those are the kind of gaps that we absolutely need to fill, and we need to do so from the perspective of the investor so that they are getting uniform protections in standard of care and regulatory oversight regardless of what the title is of the person who's offering them financial services. And that's an area where I think we need to be very focused.

SEN. WARNER: I'd love to come back and pursue that more. But I've got two other areas and my time is short. One is, following up on Senator Schumer's comments, and I was appreciative of your comments that the chairman brought out as well on say on pay. But I do think that at some point this committee also needs to take a look at corporate governance.

I believe a lot of good things may have come out of Sarbanes Oxley -- actually one of the challenging things that came out of Sarbanes Oxley is that it gets even tougher to get good quality board members to serve on public companies. And I would actually believe that one of the unintended consequences of Sarbanes Oxley may be that chairmen of companies end up getting even more captured board members because so few folks other than maybe their friends would want to serve on a public board at this point. So, you know, I've explored the option of looking at institutional investors -- could we create in effect a cadre of qualified potential board members so that we really could look at the issue of how we bring some real independence and broader-based oversight on corporate governance.

And I just wondered if you had any kind of, what your thoughts are.

MS. SCHAPIRO: We would love to work with you on that. We are engaged right now in a pretty complete review of what the governance issues at the SEC, everything from linking -- disclosure concerning pay and its linkage to risk-taking; risk-disclosure more generally, qualifications of board members and access to the proxy as a way to try to facilitate more independent boards that are more responsive to shareholders. And my view is we'll take all good ideas and put them into the mix and see if we can come up with a system that works better for the U.S. shareholders.

SEN. WARNER: I take it we need something to make sure that board members don't get captured as quickly and often as they do.

One last question -- and I know my time is up -- but just this could be perhaps an easier one. I know you're going to deal with the uptick rule. But I'm one of those if you're looking in terms of short-selling at some type of real-time disclosure component for short sale so that the market could know on a real-time basis the position of a number of shorts.

MS. SCHAPIRO: We are, as you pointed out correctly, talking about the uptick rule and -- (inaudible) -- commissioning. And we're looking at a wide range of possibilities. Disclosure is certainly one of them with respect to short sell and hard borrow, just the broad panoply of possibilities in this area. The one that's most advanced is the possibility of reinstating the uptick rule at this point.

SEN. WARNER: Thank you. Thank you, Mr. Chairman.

SEN. DODD: Thank you very much. Just on that last point Senator Warner has raised as well, I wonder if you'll also look at margin requirements. The difference between exposing weakness, which short selling does and has very great value, versus speculation which has been I think -- (inaudible) -- talked about mark to market. The quickest thing you might do about mark to market is get this uptick rule in place, in my view. And then look at the margin requirements. This is something Richard Breeden talked about.

MS. SCHAPIRO: It's in former Chairman Breeden's testimony.

SEN. DODD: Yes. Senator Johanns.

SEN. MIKE JOHANNS (R-NE): Thank you, Mr. Chairman. And let me just say to the chairman and ranking member, this is another excellent hearing. If I could I would like to focus our attention in my limited time on Mr. Madoff and his Ponzi scheme.

And I'll offer an observation to start out with. And I don't suggest this in a necessarily critical way, but I'm very skeptical. And I think there is reason for that skepticism. I hear your need for more people, more money, more staff. The vast regulatory responsibility you have.

But I look back on the Madoff case and there's, I think, a fair amount we know today. There's a fair amount we probably don't know, because of the ongoing investigation that we'll learn as time goes on. But you have a gentleman out there -- for lack of better terminology I'll call him a whistleblower -- who I think pretty effectively blew the whistle.

And having been in your position as a Cabinet member and having regulatory responsibilities also, I read through that information that he provided to you folks and boy, I would liken it to dropping a grenade in the secretary's office. I mean, it's explosive. It sets up the possibility that everybody's investment is at risk -- if not literally disappearing. And I put myself in that position and I think about, boy, I would've had the inspector general, the Department of Justice -- anybody I could've reached out to and grabbed onto to try to help me deal with that issue. And yet, we went along here and now today we learn that maybe $1 billion will be recovered out of some $65 billion.

Now, I'm very mindful of the ongoing investigation. I don't want to interfere with that, certainly understand that. But what I want to start to understand is what went wrong, because if we don't understand what went on, then we can't be very effective in designing a regulatory framework that protects the consumer.

What assurance can we have as a committee that when the next whistleblower shows up it will be different, because of some action taken as the United States or as a Congress to try to deal with these issues? So help me start to understand that.

MS. SCHAPIRO: I'd be happy to.

And let me say very clearly that I don't lay the blame for the SEC's failure to respond appropriately to the Madoff -- the whistleblower's information provided to the agency -- at the feet of a lack of resources. As you rightly point out, a fairly complete set of information was provided over a period of years to the agency and wasn't followed up on appropriately.

So in this instance -- we do have resource issues. In this instance I'm not sure we can blame resource issues.

The inspector general, as you correctly pointed out, is investigating. But my view -- and that's going to take a number of additional months. My view is I need to run this agency in the meantime, and I'm not really anxious to wait four or five additional months to find out what went wrong and then start to fix our problems. Because as you also point out correctly, we can't fix it if we don't understand how we failed.

My belief is that there are multiple things that contributed to the agency's failure to act and there are a number of things that we can do and have started to do in response. (There ?) is a stovepiped approach within the Securities and Exchange Commission where information is not freely shared across offices and among departments and divisions the way it ought to be and the way that you would hope for in an agency that was really operating officially.

We have very disparate processes for handling between 700,000 and 1.5 million tips and whistleblower complaints that are coming to the agency on an annual basis and we don't have all the right skill sets. So that information may well have landed with somebody who didn't understand at all what they were looking at. And because the culture isn't normally one of sharing information easily, it didn't get sent necessarily to the right place.

Those are all things that we can do something about. We've engaged the Center for Enterprise Modernization to come in and review all of our processes for handling those 700,000 tips and complaints and helping us build the technology that will allow us to mine those that are most productive. We will come back to this committee and ask for whistleblower legislation that will allow us to compensate people who've given us fully formed, well-documented instances of abuse and fraud that we can then pursue from a law enforcement perspective.

We are bringing in new skill sets and people with the ability to look at and understand the data that they're looking at. And finally, it is the job of the leaders in the agency -- myself most especially -- to try to break down the walls that exist between departments and divisions so that sharing information and -- (inaudible) -- have engaged in a common enterprise is the way we approach our work, not as divisions competing sometimes with each other.

So we have a lot to do in this area. I'm fully committed to fixing every problem that we have as best as I possibly can. I've only been there two months. I think we've gotten a lot of things started, but it's going to take time and effort to refocus the efforts and the energies of the agency of protecting investors from exactly this kind of conduct.

I will say that in the last couple of months the ponzi scheme TRO machine has been fired up and you will not see a week go by where we are not bringing several court cases against ponzi-scheme operators and trying to stop them at a much, much earlier time.

SEN. JOHANNS: I appreciate the candor of the answer. I think you acknowledge there were some things here that just simply were missed.

My time is up. Here's what I'd ask for, because this is going to unravel over time. The investigation will continue, but at some point will continue. My hope is that when there's a full and complete picture, and we can have an open and candid discussion about what the investigation showed, et cetera, that we do that. We owe that to the people who have lost so much. And so I hope you'll work with the chairman and the ranking member and the committee members to help us just nail this thing down in terms of what happened and why it isn't going to happen in the future.

MS. SCHAPIRO: I completely agree that the Congress as our oversight body is entitle to understand that and the American public is entitled as well.

SEN. JOHANNS: Great.

Thank you.

SEN. DODD: Let me just say in that regard too -- and Jack Reed and Senator Bunning are the chair and ranking members of the subcommittees dealing with securities. And today, it's an abbreviated session with the chairperson of the SEC, but I commit to my colleagues this will be an ongoing conversation both formerly and informally. We'll find means by which we can have these -- pursue these matters.

And certainly, as Chairman Schapiro knows, we've made some requests which the SEC -- the chairman indicated this morning -- will be getting back to us immediately on some of the requests the committee has made regarding this matter and we welcome that. That's very much in line with what the Senator requested this morning.

With that, Senator Tester.

SEN. TESTER: Thank you, Mr. Chairman, Ranking Member Shelby. I appreciate the hearing. Thank you both for being here.

This is a question for both Chairwoman Schapiro and Mr. Joseph. I had conversations around the state, as I'm sure we all have, with constituents, regulators, finance professionals in Montana. And there's pretty much unanimous consent that one of the biggest, if not the biggest, threat to our economy right now is the lack of confidence in the marketplace.

They fear -- families fear their retirement accounts and all their investments are not as safe as they once were.

What do you feel in your individual capacities is the most critical step that we can take to restore consumer customer confidence.

You'll both get a chance. So go ahead, Chairwoman.

MS. SCHAPIRO: You know, there are so many pieces to restoring investor confidence from the perspective of the SEC. And we really have to show a single-minded commitment to putting investors first in every single thing we do. That means aggressive enforcement so that investors understand that there is a penalty and a price to pay for abusing investor trust. It means ensuring that the corporate disclosure that investors get so that they can make rational decisions about how to allocate their capital, whether to buy a stock or to buy a mutual fund, is absolutely honest and transparent and readily available to them.

It's ensuring that the host at the reserve fund breaking the (back ?) and scaring everybody about the resilience of money market funds, that we understand those issues and that we move quickly to enhance the liquidity and quality of paper that's held in money market funds.

And then for us, it's really what we do every single day with a single-minded focus on investors, and ensuring that our efforts are urgent and aggressive.

And beyond that, I think obviously, the economic stabilization programs need to play out. People need to see credit flowing again. They need to have faith that the people that they're dealing with are going to be honest. And enforcement's obviously a huge component of ensuring that.

SEN. TESTER: Okay, thank you.

Mr. Joseph.

MR. JOSEPH: Thank you, Senator.

I agree with the chairman. Her comments are right on.

And you are correct. The whole system -- the whole system is built on trust and confidence. And at the moment, I think that's a little bit shaky. If people don't know that -- well, they have to believe they're on a level playing field. And if that doesn't happen, obviously, they're not going to invest.

And I agree that we need to focus on investor protection. I believe that we need to be certain that people who are licensed to sell securities are adequately prepared and qualified to do so. The securities that they are selling should probably -- some of them, as I said, the Rule 506 offerings need more regulatory scrutiny. Otherwise, in some cases it's just pure gambling.

Senator Dodd also pointed out that in some cases its speculation. Senator Dodd, I would say it's speculation at best and gambling at worst in some cases.

And lastly, we need to, obviously, enforce and enforce strongly. And I believe, obviously, the SEC and the states would like to continue on that role and we take our role very seriously.

SEN. TESTER: Okay. Thank you.

One quick comment, before -- (inaudible) -- Chairman Shapiro, and I appreciate your consideration of the uptick rule on this bill that Senator Isakson, Senator Kaufman, myself are on to reintroduce it. And I think that could help reinstituting that rule that was taken away after 80 years. I appreciate you taking that up.

I want to talk just very briefly -- because I've only got a minute left -- about the power of a monolithic regulatory scheme, versus a patchwork scheme that we have now of regulation that quite frankly -- and I think as your predecessor said -- that there was no regulation in some of these financial instruments. And it's one of the reasons we are at this point, at least from my perspective.

There seems to be a lack of consistency with the patchwork scheme, because of gaps that inherently open up. Then on the other side of the coin -- I don't want to put words in your mouth, but you talked about one agency could get too powerful and I agree with that too. So how do we solve the problem? How do we solve the problem with gaps and people saying, well, I really don't have authority to regulate this. It's somebody else's authority. They're saying the same thing and things are falling through the cracks.

MS. SHAPIRO: (Off mike.) I think it's critically important that we will fill the gaps first and foremost. We will have overlap, and I think that does create some tension among regulators, but as compared to gaps, that's a pretty manageable process. And sometimes the creative tension that evolves between banking and securities regulators is actually resulted in a positive.

But as we identify those areas of the financial system that have not been subject to regulation -- hedge funds, credit default swaps, other kinds of pooled investment vehicles -- it's important that we decide that if they're important to investor protection, if they are important to the financial system, that they be brought under the federal regulatory umbrella with support, obviously in multiple areas, of state regulators as well. And that those gaps basically be filled by a functional regulator.

I think there's also a way for systemic risk regulator -- again, whether it's done by an individual institution that has responsibility for monitoring exposures and working on prudential regulatory standards and working with a resolution regime or with a college of regulators, there has to be heightened sensitivity to these components of the financial system that haven't been regulated.

SEN. TESTER: In a regular system, you're right. But what happens when you have a lack of resources? How anxious are you to jump on some other regulatory financial mechanism out there if you can say, well, gosh, this isn't really my job anyway and I'm limited to financial resources. We'll let somebody else take care of it?

MS. SCHAPIRO: It's really our responsibility and we shouldn't be in these roles if we're not willing to come to Congress and say, this is a problem. We need your help. We need legislation. We need resources.

SEN. TESTER: Okay. Thank you.

Thank you, Mr. Chairman.

SEN. DODD: Thank you very much, Senator.

Senator Martinez.

SEN. MEL MARTINEZ (R-FL): Thank you, Mr. Chairman.

Madame Chairwoman, I wanted to follow up on a question that Senator Johanns had asked regarding the Madoff situation. And that's just -- it's not really where I was going, but I heard your response and it sparked the old lawyer in me.

I just wanted to ask, when you said that if not resources -- it was not resources that prevented the SEC from more aggressively pursuing the Madoff matter. You went into a series of more technical issues involving that. But if it wasn't resources, that goes to some other motivation. What do you attribute that to?

MS. SCHAPIRO: What I intended to say is that I don't lay the problems with Madoff solely at the foot of a lack of resources. The information came into the agency over a period of years. It is not clear to me yet -- and we have obviously an inspector general review ongoing right now -- whether it was people who received the information, didn't understand the import of it and therefore didn't pursue it, or they didn't send it to the right people who could understand it and analyze the data that was contained therein. We have very disparate processes throughout the agency, around the country in all of our offices for how we handle the massive amounts of data that come into the agency. Whether it fell through the cracks or somebody just didn't understand what they were doing, I can't -- I don't know. I would tell you --

SEN. MARTINEZ: What do you know at this point? There's still an ongoing investigation, but you haven't reached a conclusion.

MS. SCHAPIRO: No, no.

SEN. MARTINEZ: You just don't think it was a lack of resources or such -- it was more about either an understanding of it or an unwillingness to understand it or it just didn't get to the right person.

MS. SCHAPIRO: I think it -- it's one of those things, and my view is that we will fix all of those things, under the assumption that it is one of those things that has caused the agency not to pursue that information when it came in the door.

SEN. MARTINEZ: The issue I really wanted to get to is the issue of systemic risk. And I know that there has been some commentary from the secretary of the Treasury about this as part of this new regulatory situation, and I wondered if you could define for us how you view systemic risk. I -- in the old days of Fannie and Freddie concerns, obviously their size was a concern, and (viewed ?) them by size alone as perhaps posing a systemic risk. I think that's been proven all too much to be true. And also their capital requirements were fairly thin, which I think also made them, again, a systemic risk. How you define what is the systemic risk that we need to be looking for?

MS. SCHAPIRO: That's probably the $64,000 question because I think how we define it matters very much and how we ultimately structure any kind of a systemic risk regulator. Surely size would be a component; relationship to other important financial institutions within our economy --

SEN. MARTINEZ: And a link between them.

MS. SCHAPIRO: Right, interdependency or interlinkage; the amount of leverage. I think -- I think it matters very much how we define it because there are a lot of criteria that can go to this issue, and how we define it will define how we regulate it and whether we have a monolithic approach, a college of regulators approach, or a functional approach with some kind of overlay of systemic risk oversight that monitors exposures, perhaps requires a reduction of leverage, requires other prudential capital or other standards to be put in place. Those definitions matter greatly.

SEN. MARTINEZ: How do you think we'll come to a definition? I mean, is this something that secretary of Treasury is going to define for us, or is that part of what we --

MS. SCHAPIRO: I hope that Congress will be very much engaged in coming to that definition and that the other regulatory agencies would have profound responsibilities for components of the financial regulatory system. We'll be engaged in that process as well.

SEN. DODD: Let me say something. We had a witness the other day that said something I think was very important. I think we talk about this in the singular, and I think that's sometimes -- we're narrowing ourselves. He called it systemic risks, and I think that's a more appropriate wording because there are numerous risks. It can be the size of the operation, the practices and products of the -- a lot of -- there are a lot of systemic risks that we ought to be looking at. It's one of the reasons why I'm gravitating towards this college idea or commission idea rather than a single regulator idea, so that we have the ability to understand the risks that are posed to our system, in a sense. I don't know if you would agree with that.

MS. SCHAPIRO: I do agree with that. I think there are many, many small risks that accumulated become systemically threatening. And so I think --

SEN. DODD: I didn't mean to interrupt. I apologize.

SEN. MARTINEZ: No, that's fine. I appreciate it.

MS. SCHAPIRO: -- (inaudible) -- process is very, very difficult here.

SEN. MARTINEZ: But as a result of having a regulator in place that would be strong enough to then monitor -- (inaudible) -- that we will have defined, we will then be able to -- (inaudible) -- to probably have a better handle on this. How do we at this point regulate those entities that appear to be systemically riskier -- provide systemic risks? I mean, is there anything we can do at the moment going forward, prior to a regulatory system being redeveloped?

MS. SCHAPIRO: Well, what I think we've seen develop over the last year is a bit of a patchwork and an ad hoc approach to dealing with institutions like Lehman Brothers and Bear Stearns and obviously, as playing out very much right now, AIG, where it is an effort on the part of multiple regulators to use whatever tools they have available to them to try to reduce the risk or resolve the issues with respect to particular institutions.

SEN. MARTINEZ: But is there a coordinating -- I'm out of time, but is there a coordinating point? Is there someone -- I mean, in other words, it seems to me that with AIG, you know, is it Treasury? Is it --

MS. SCHAPIRO: It has largely evolved to be the Treasury working most closely with the Federal Reserve, in some instances with the FDIC, in some instances with the SEC.

SEN. DODD: Okay.

SEN. MARTINEZ: But that's my concern is that it's -- (inaudible) -- clear to me when something like bonuses go out the door -- which may, by the way, be perfectly a legal obligation that the company had -- but there doesn't seem to be a clear understanding of who was at the end of the day providing the oversight that would have known precisely what has happening. And that -- we're talking so many billions of dollars. It seems to me that that needs to be defined before we get to a more permanent regulator.

MS. SCHAPIRO: I agree.

SEN. DODD: Thank you very much.

Senator Menendez.

SEN. MENENDEZ: Thank you, Mr. Chairman.

Madame Chairlady, I appreciate your statement, particularly where you said if there ever was a time investors needed and deserve a strong voice and a forceful advocate in the federal government, that time is now. And you went on to make a series of positive statements that I think are very powerful, and I appreciate that.

In pursuit of those statements and in pursuit of what I asked you during your confirmation process, could you tell me what, since your confirmation -- and I understand it's been about two months or so -- what steps you've taken within the Securities and Exchange Commission to increase enforcement and investor protections?

MS. SCHAPIRO: I'm happy to do that. We've announced the appointment of the new enforcement director, who begins on Monday -- a longtime federal prosecutor who also ran the Commodities and Securities Task Force in the Southern District of New York.

We've retained the Center for Enterprise Modernization to help us overhaul tips and complaints as they come into the agency so that we can have a better handle on and pursue those tips and complaints that are most likely to produce important investor protection enforcement cases for the agency.

I ended the penalty pilot program, which required that the commission's enforcement staff pre-negotiate with the commission before they could suggest a fine against a public company. We've speeded up dramatically the process which authorizes the staff to issue subpoenas in enforcement investigations. We've instituted new training programs. Our hiring now is focused on bringing in people with new skill sets that are in forensic accounting, financial analysis, and training and operations. We are working on our technology; we have a long way to go there. And we've been very fortunate to have sufficient resources this year to actually do some hiring in the enforcement program, which had declined, as you may know, by about 5 (percent) or 6 percent over the last couple of years.

So we have a new sense of urgency, and we have started to put into place tools that I think will really result in much more aggressive, much faster enforcement.

SEN. MENENDEZ: Well, I appreciate that you were ready for my question. So --

MS. SCHAPIRO: I remembered the confirmation hearing.

SEN. MENENDEZ: And I'm happy to hear your answer, to be very honest with you, so I appreciate your progress there.

I have told some of those in the investor community that you have only been there two months and that -- give it time. You know, some of them are worried that you will not take tougher steps that are necessary and -- particularly on proxy assets. I saw that you mentioned that in your statement, and I think Senator Schumer asked you a question on this. I -- and I appreciate what you said. I just want to visit with you on that issue. Is this something that you still remain committed to offering investors -- a path to nominate their own candidates for board seats on company proxy ballots? And if so, give us a sense of your timeline for addressing what is a very important investor issue.

MS. SCHAPIRO: I remain very much committed to that, and it's my expectation that -- I believe we tentatively scheduled the commission to consider this issue in May -- if not May, June, but certainly in the first half of this year.

SEN. MENENDEZ: Let me ask you one other question. Have you had the chance to look at the question that many of the enforcement division of the SEC move on to be employed by Wall Street firms, and there is some concern that there may be a conflict of interest there. Is that a revolving door, or is that something that you feel is okay?

MS. SCHAPIRO: It is a revolving door, and we talked about this at my confirmation hearing. And I have made a commitment to talk with the bank regulators who actually have in place some limitations on their examination staff's ability to move freely from the agency to an entity that was (otherwise ?) examined by the agency.

My counterbalance and concern is that I want to attract the best and the brightest people to the SEC, and if I make it too hard for them to leave, I may not get them in the first place. So from my perspective it is a balancing act, but it is something I continue to be committed to looking at and hopefully will get to before terribly long.

SEN. MENENDEZ: Finally, let me ask you, in light of the recent intense pressure from financial services lobbyists on accounting standards setters over fair value accounting, what will you and the commission do to ensure that accounting standard setters remain independent so that they can fulfill their mission of serving the needs of investors rather than the short term interests of some of the industry?

MS. SCHAPIRO: Well, I completely agree that that is a critical function for the SEC, to help protect the independence of FASB and the accounting standards setters. And I understand there's tremendous emotion and concern about fair value accounting right now and the impact that it may be having.

But our guiding light on this is that investors have told us that fair value accounting is important to them. It's important to their understanding of financial statements and their confidence in the honesty of those statements, and that is critical for them to make decisions about the allocation of capital. So we will continue to be vocal proponents of the independence of FASB. I think it is one of the tremendous strengths of our corporate disclosure system, which is unsurpassed in the world, and largely as a result of having an independent, highly expert body that sets accounting standards.

SEN. MENENDEZ: All right. Well, so far, so good. Thank you, Madame Chairlady. (Laughter.)

Thank you, Mr. Chairman.

SEN. DODD: Thank you very much.

Senator Bennet.

SEN. MICHAEL BENNET (D-CO): Thank you very much, Mr. Chairman.

And Madame Chairman and Mr. Joseph, we welcome you here and appreciate your public service and the efforts that you're doing. And yours, Mr. Joseph, is public service too, even though you're not on the federal payroll.

MR. JOSEPH: I'm here for you.

SEN. BENNET: We're grateful for people who serve who are not on the federal payroll. (Laughter.)

Madame Chairman, you talked about balance, and as I listened to all of this, I think balance is a word we need to keep very much in front of us: the balance to get the good people and at the same time try to keep our eye on potential conflict of interest.

In times of crisis the impulse is always to go absolutely in the direction of protection against everything else. And the ultimate protection of investors to make sure that they don't lose any money would be to shut down the market because as long as there's no market then nobody's going to lose anything. And obviously we don't want to do that because it's the power of the American market that has allowed entrepreneurs to make America not only very profitable but truly unique. I've done business around the world. I've owned businesses in other countries and done business with companies from other countries, and the American entrepreneurial spirit is indeed unique and the driving force I think behind our long-term prosperity.

So striking the balance between regulation that will find the Bernie Madoffs and get rid of them, which the public clearly needs to do, and allowing the markets to work is I think philosophically your biggest challenge.

MS. SCHAPIRO: I couldn't agree more.

SEN. BENNET: Do you want to respond to that? And have you had any late night thoughts in a quiet room about that or have you been so overwhelmed with the details you haven't gotten around to thinking about it?

MS. SCHAPIRO: It's a question we confront really every single day, in small issues and large. How do we keep the balance right? How do we do exactly as you say: assure the protection of investors and the integrity of the marketplace, but not regulate everything within an inch of its life so that we don't have any more (motivation ?) and we don't have any more opportunity for people with great ideas to bring them to the marketplace?

And I don't have any wisdom -- certainly no more wisdom than you have on this. I just think it's something we have to think about as we approach every single issue, and it's one reason I like very much to have a broad and diverse group of people within the agency and on my personal staff to consult with more on issues, because they bring those different perspectives and they'll tell me to slow down, not to get caught up in the moment and think about the implications of each and every thing we're doing. And I hope we will bring that very deliberative process to all of the issues -- which is not to say we won't have lots of disagreements with different constituencies, but we will always try to get the balance right.

SEN. BENNET: That's my concern with respect -- one of my concerns with respect to the proposals that we have before us to restructure our whole regulatory system. Systemic risk -- let's give that to the Fed; safety and soundness -- let's give that to FDIC; and then transparency and business practices -- let's give that to the SEC; and you will all see to it that there is no problem of any kind anywhere else.

And I was a new member of this committee right after the RTC circumstance, and there was an overreaction to the question of making sure every institution is safe and sound. And I remember sitting in this room as members of this committee were beating up bankers about, "You're not making enough loans. You're not making any money available to people." And the reaction of the bankers was, "Are you kidding? What we've just been through, where we were beaten up for being too open in making money available that went out to people who went out and lost it? And you're darn right we're not making any loans because the regulators will kill us if we do. We're threatening safety and soundness if we make loans."

You are now in an atmosphere very similar to that atmosphere, where the populist reaction to things is, shut everybody down. And my only concern is that if we overreact and do shut everybody down, we make the recession longer, we hurt the country, and all of the rest of it.

One last quick comment: I understand before I came in you did speak about the uptick rule and are looking at the (locator ?). You and I have had these conversations. I'm very grateful to you that you've now gone public with our private conversations because I still believe the issue of naked short selling is a genuine issue that too many people have said for too long doesn't really exist and if it does, it doesn't really matter because it's really very small. And to those investors who have seen their companies destroyed as a result of it, it is a big deal.

Mr. Joseph, did you want to comment on the short selling thing? You looked expectant there and I didn't want to cut you off.

MR. JOSEPH: No, I agree, Senator. Naked short selling should be curtailed, period, end of story.

SEN. BENNET: Good.

Thank you, Mr. Chairman.

SEN. DODD: Thank you, Senator Bennet. And I have -- (inaudible) -- Senator Bayh, I think the -- Senator Corker raised the issue; you have, as well. That sense of balance is critical. We've all -- I've been here as a member of this committee -- not as chair of the committee, as a member of this committee -- during those periods we talked about, and there can be, in the exuberance of the moment, overreactions.

Someone once said to me -- pick up on your point -- what is it -- why have we done as well as we have -- putting aside, obviously, the recent crisis we're in in the world -- that we're very good and this country's been very good and very creative at creating wealth. But secondly and as importantly, it's been safe. If you park your resources here -- your hard-earned money -- that the system instructs you -- you may lose -- there's no guarantee of winning -- but you don't have to worry about your system. It's pretty good. We've lost that reputation. And that's striking that balance about being creative and imaginative and creating wealth, and being safe. And it's not always easy to strike that perfect balance that you talk about, but that's the goal.

If we lose that reputation of being a safe place to be because we have a system in place that will not allow fraud and deceit and deception to occur, and simultaneously to encourage the kind of imagination and thoughtfulness that goes into wealth creation is a challenge, always will be a challenge, we're not going to resolve it.

I think one of the things -- we're raising expectations maybe here that somehow we're going to take care of every and all problem that will ever happen again. We're not. There's someone out there right now imagining how they can circumvent the system. And the job of this committee, this Congress and succeeding ones will be to be vigilant as these new ideas emerge to make sure they -- (inaudible) -- end up in the marketplace without someone putting the brakes on and saying, "What the hell are you" -- excuse me -- "What are you doing with this?" In a way, what does it really do, and what are the implications of it, and what risk does it pose?

So I appreciate the senator from Utah raising that sense of balance. It's important. Senator Corker raised it earlier, and I agree with him.

Senator Bayh.

SEN. EVAN BAYH (D-IN): Thank you, Mr. Chairman.

And thanks to both of you.

Chairman Schapiro, I have two questions. One we discussed in my office prior to your confirmation, and it relates to the importance of accurate information for investors making decisions and for markets to function. And that implicates the role of the rating agencies, which is what I'd like to ask you about.

With the benefit of hindsight, it appears that many of the more exotic instruments were rated too highly. Their ratings were not adjusted in a timely manner. And some have raised questions about the way in which the rating agencies are compensated for making their ratings, paid by the issuers of the securities as opposed to those who purchased them or by the government itself.

I'd like to ask you, do you have any thoughts or can we take any additional steps to promote accurate ratings of financial instruments so that investors can make decisions in accordance with their risk tolerance and not be unpleasantly surprised by buying AAA-rated instruments that turn out to be anything but?

MS. SCHAPIRO: I think accurate information is absolutely the life blood of our markets. And whether it's corporate disclosure ratings, they are incredibly important to investors.

The SEC, over the last couple of years, since Congress gave it authority in the Credit Rating Reform Act in 2006, has done a number of things to try to bolster the regulatory regime around rating agencies. I'm not sure that we've gone far enough. And on April 15th, we're actually holding a roundtable to discuss further rating agency reform.

We will have rating agencies there to talk about what went wrong and why. We will have large users of ratings, institutional and other investors to talk about it. And we will have people there who are going to talk about some of the more creative ideas we've heard about how to change the model of issuer pays, to try to alleviate some of the conflicts of interest. And there have been some very creative ideas expressed.

So we expect to have a very public day-long session talking about all of these issues, the goal of which is to inform the commission's next steps with respect to either rule-making or the potential to come back and ask the committee for further legislation.

SEN. BAYH: I would encourage you in this direction. I mean, a big part of what we're trying to do now is to reinstill confidence in a whole number of ways. And if people simply don't believe the information they're receiving, if they think they're buying instruments that are AAA-rated and they turn out to be anything but that, what are they to do going forward in terms of making decisions? It really undermines confidence.

MS. SCHAPIRO: Yeah.

SEN. BAYH: And so I look forward to getting the benefit of your further input on that, and really encourage you to focus on that.

Secondly, and my final question, has to do with, in addition to accurate information making markets function efficiently, incentives are important in terms of human behavior. And I think, again, with the benefit of hindsight, we can see that a lot of the incentives for people who are running publicly held companies promoted short-term decision-making, and there was a decoupling of the potential rewards of running risks and bearing the full consequences of those risks, which does lead to skewed decision-making; let's just put it that way.

For example, you know, executives at some firms -- (inaudible) -- if the things held together, and they ran significant risks. If it held together for just a year or two, they became fabulously wealthy, could take some of the chips off the table. And then if the wheels came off, well, it was the shareholders who ended up holding the bag. So, I mean, there was a decoupling. There was short-term decision- making as opposed to long-term decision-making and a decoupling of risk and the consequences of running those risks, which promotes the kind of decisions that are made.

So my question to you, in terms of the incentives that exist, what can we do to promote long-term decision-making and real adding of value as opposed to the sort of short-term gambling mentality that took hold for a period of time and has now come back to haunt us?

MS. SCHAPIRO: I think there's really multiple avenues for us to pursue in that regard. One is much better disclosure about how risk is tied to compensation. We talked a lot about compensation for performance, but it's been noticeably absent; (hasn't ?) been a real discussion about how compensation has been tied to risk-taking and the implications of that.

SEN. BAYH: Well, if I can just interject, I mean, it's tied in some cases to short-term performance, which then comes back to haunt us because short term can fluctuate up and down.

MS. SCHAPIRO: Exactly right. And risk-taking reveals itself over the long run, and so compensation decisions need to be tied to that longer-run perspective. I think also we need better disclosure of risk, of holding certain financial instruments, and just generally better risk disclosure for investors.

And finally, (a point ?) we've talked about a bit is the ability of shareholders to influence more directly who serves on corporate boards. And tying the responsibility of board compensation clearly resides there, making boards explain how they closed the circle with risk-taking in compensation, but giving investors greater access to determining who sits on corporate boards is an important component of that as well.

SEN. BAYH: Thank you, Madame Chairman.

Mr. Joseph, I hope you don't feel slighted that my time has run out, but I thank you for being here as well.

Thank you, Mr. Chairman.

SEN. DODD: Senator Bayh, thank you very, very much.

And let me thank both of you.

Mr. Joseph, let me just tell you, we're going to have a series of questions to submit to you, because obviously some of your proposals raise issues as well regarding resources and tools. There's a valuable role to be played by the states. And, in fact, as you pointed out in your opening statement, because you are as close to the investor community as you are at that level, it provides an avenue for people to be able to express themselves and bring matters to public attention. So we see a real value in what you do.

I think we all have some questions about various proposals and raising from $25 (million) to $100 million and so forth, what that involves; obviously the compatibility as well between the SEC and the states are very important. So I regret we didn't get some more time with you. But obviously having the chairperson here obviously focused a lot of attention on these current issues before us. So we'll submit some questions to you and look forward to having you back before the committee as well.

MR. JOSEPH: Thank you, Mr. Chairman.

SEN. DODD: And Madame Chair, we thank you very much.

MS. SCHAPIRO: Thank you.

SEN. DODD: And -- (inaudible) -- we're getting a lot of interest in this subject matter, so we'll have you back up formally and informally as well.

MS. SCHAPIRO: Thank you.

SEN. DODD: Let me quickly invite our next panel, and they've been very patient and had the benefit of sitting and listening to all of this as well, so they may want to have some addendums to their own testimony. But I'm very honored and pleased to present two -- three witnesses, rather -- who are very familiar with this committee, have been before us, some of us here on this committee over the years.

Richard Breeden, who served as chairman of the Securities and Exchange Commission between 1989 and 1993. In July of 2002, Mr. Breeden was appointed to act as the corporate monitor of WorldCom on behalf of the U.S. district court overseeing the case involving history's largest corporate fraud and largest bankruptcy.

Arthur Levitt, Jr. was the 25th and longest-serving chairman of the SEC from 1993 to 2001. As chairman, he created the Office of Investor Education and Assistance, established a website which allowed the public free and easy access to corporate filings and investor education materials.

Both chairmen assisted our work, by the way, in Sarbanes-Oxley, going back. And I know both these individuals very, very well. And if you needed to have examples, if you wanted to just say, "Give me an example of good public servants," I offer up the names of Arthur Levitt and Richard Breeden. And a look at their work would define, I think, what has been remarkable public service, and successful in the private world as well. And so you bring a wonderful wealth of experience from both sides of the equation, as you heard Senator Bennett use the word balance and others talk about how we strike those balances of wealth creation and having safe and sound financial institutions and a regulatory process.

Paul Akins (sic) -- Atkins, excuse me -- is a former commissioner of the Securities and Exchange Commission; served from 2002 to 2008. And we thank you very much as well for joining us, and we thank you for your service on the commission during those years.

I guess we'll begin on a seniority basis here. By seniority, I guess you were the earlier serving, Mr. Breeden. So unless you've worked out something else, we'll begin with you and then move right down the line.

Thank you all very much, and thank you for your patience in listening to the first panel.

MR. BREEDEN: Thank you very much, Chairman Dodd, Ranking Member Shelby, members of the committee, for the opportunity to offer my views on enhancing investor protection and improving financial regulation. These are really, really critical subjects, and it's a great pleasure to have a chance to be back before this important committee.

I was privileged to serve as SEC chairman from 1989 to '93. My views here today reflect that experience at the SEC, as well as my White House service in 1989, when we had to craft legislation to deal with an earlier banking crisis, that involving the savings and loans.

In subsequent years, my firm has worked on the restructuring of many, many companies and encountered financial difficulties, most notably WorldCom, in the 2002 to 2005 range.

Today I'm an investor, and my fund manages approximately $1.5 billion in equity investments in the United States and Europe on behalf of some of the nation's largest pension plans.

By any conceivable yardstick, our nation's financial regulatory programs have not worked adequately to protect our economy, our investors or our taxpayers. In little more than a year, U.S. equities have lost more than $7 trillion in value. Investors in financial firms that either failed or needed a government rescue have alone lost about $1 trillion in equity. These are colossal losses, without any precedent since the Great Depression.

After the greatest investor losses in history, I believe passionately that we need to refocus and rededicate ourselves to putting investor interests at the top of the public policy priority list. We have badly shattered investor confidence at a time when we have never needed private savings and capital formation more.

There is much work to be done to restore trust. And I must say, in public policy debates we seem to worry endlessly about the banks that created this mess, and I believe we need to focus a little more on the investors who are key for the future to get us out of it.

Many people today are pointing at gaps in the regulatory structure, including systemic regulatory authority. But the Fed has always worried about systemic risk. I remember, back in the Bush task force back in 1982 to '85, the Fed talking about its role as the lender of last resort and that it worried about systemic risk. And they've been doing that and we still had a global banking crisis.

The problems like the housing bubble, the massive leverage in the banks, the shaky lending practices and subprime mortgages, those things weren't hidden. They were in plain sight. And except for the swaps market, where I agree with the previous witnesses that there is a need for extending oversight and jurisdiction, but for the most part the banking and securities regulators did have tools to address many of the abusive practices but often didn't use their powers forcefully enough.

Creating a systemic or super regulator, in my view, is a giant camel's nose under the tent. It's a big, big step toward industrial planning, toward central planning of the economy. And I think the very first thing that creating a systemic regulator will do is to create systemic risk. I fear very much that if you are not extremely helpful, we will have more too big to fail, more moral hazard, and more bailouts. And that is not a healthy path for us to move forward.

I'm very concerned that we not shift the burden of running regulated businesses in a sound and healthy management -- sound and healthy manner from management and the boards of directors that are supposed to do that. Unfortunately, in the wake of this crisis, we've seen boards of directors that failed miserably to control risk-taking, excessive leverage, compensation without correlation to performance, misleading accounting and disclosure, overstated asset values, failure to perform due diligence before giant acquisitions.

These and other factors are things that boards are supposed to control. But over and over again, in the big failures, the boards of AIG, Fannie Mae, Lehman Brothers, Citigroup, Bank of America, Wachovia, WaMu, in those cases boards were not doing an adequate job. And so my view is that we need to step back as part of this process and look and say why are boards not doing what we need them to do?

I think one of the important answers is that we have too much entrenchment of board members, too many staggered boards, too many super-voting shares, too many self-perpetuating nominating committees, and a very, very high cost to run a proxy contest to try and replace directors who are not doing their jobs.

So I think one of the important things that Congress can look at, and I hope you will look at in the future, is to enact a shareholder voting rights and proxy access act that would deal with proxy access; uninstructed votes by brokers, which is corporate ballot stuffing; majority vote for all directors every year; one share, one vote. There are a number of things where, if we give a little more democracy to corporate shareholders we can bring a little more discipline to misbehavior in corporations and not put quite so much on the idea that some super-uber-regulator somewhere is going to save us from all these problems.

Thank you very much.

MR. LEVITT: Thank you, Chairman Dodd --

SEN. DODD: Arthur Levitt.

MR. LEVITT: -- and Ranking Member Shelby for the opportunity to appear before the committee this morning. Thank you for your kind words. It's good to be back with former friends and colleagues.

When I last appeared before this committee, I focused my remarks on the main causes of the crisis we are in and the significant role played by deregulation. Today I would like to focus on the prime victim of deregulation -- investors. Their confidence in fair, open and efficient markets has been badly damaged and, not surprisingly, our markets have suffered.

Above all the issues you now face, whether it is public fury over bonus payments or the excesses of companies receiving taxpayer assistance, there is none more important than investor confidence. The public may demand that you act over some momentary scandal but you must not give in to bouts of populist activism. Your goal is to serve the public not by reacting to public anger but by focusing on a system of regulation which treats all market actors the same under the law, without regard to their position or status.

Many are suggesting we should re-impose Glass-Steagall rules. For six decades, those rules kept the nation's commercial banks away from the kinds of risky activities of investment banks. While it would be impossible to turn back the clock and re-impose Glass- Steagall, I think we can borrow from some of the principles and apply them to today's environment.

The principles, in short, are: Regulations need to match the market action. Entities engaged in trading securities should be regulated as a securities firms while entities taking deposits and holding loans to maturity should be regulated as a depository banks. Regulation I think is not one size fits all.

Accounting standards must be consistent. The mere mention of accounting can make the mind wander, but accounting is the foundation of our financial system. Under no circumstances should accounting standards be changed to suit the momentary needs of market participants. This is why mark-to-the-market accounting should not be suspended under any condition.

The proper role of a securities regulator is to be the guardian of capital markets. Of course there is an inherent tension at times between securities regulators and banking supervisor, but under no circumstances should securities regulators, especially those at the SEC, be subordinated. You must fund them appropriately, give them the legal tools they need and hold them accountable to enforce the laws you write. And finally, all such reforms are best done in a complementary, systemic way. You can't do regulation piecemeal.

Allow me to illustrate how these principles can be put to work, in specific regulatory and policy reforms. First, some have suggested that you create a super-regulator. I would suggest that a diverse approach, using the existing strengths of our existing regulatory agencies. For example, the Federal Reserve, as a banking supervisor, has a deep and ingrained culture that is oriented towards the safety and soundness of our banking system. Ultimately, the only solution to the tension is to live with it. When I was at the SEC there was tension between banking regulators and securities regulators all the time. While this was frustrating for the regulators and the financial institutions themselves, I think it served the overall purposes of reducing systemic risk. Regulatory overlap is not only inevitable, I think it may be desirable.

Second, mark-to-the-market, or fair value standards, should not be suspended. Any effort that seeks to shield investors from understanding risk profiles of individual banks would, I believe, be a mistake and contribute greatly to systemic risk. The chairman of the Federal Reserve, the heads of the major accounting firms maintain that maintenance of mark-to-the-market standards is essential.

Third, this committee and other policymakers seek to mitigate systemic risk. I would suggest promoting transparency and information discovery across multiple markets, specifically credit rating agencies, municipal bond issuers and hedge funds. For years, credit rating agencies have been able to use legal defenses to keep the SEC from inspecting their operations even though they dispense investment advice and sit at a critical nexus of financial information and risk. In addition, these rating agencies operate with significant protections from private rights of actions. These protections need to be reconsidered. In the same manner, the SEC should have a far greater role in regulating the municipal bond market, which consists of state and local government securities. Since the New York City crisis of '75, this market has grown to a size and complexity that few anticipated. It is a ticking time bomb. The amount of corruption, the amount of abuse, the amount of pain caused to municipal workers and will be caused to municipal workers in an environment that is almost totally unregulated is a national scandal.

Because of the Tower Amendment, many participants -- insurers, rating agencies, financial advisors to issuers, underwriters, hedge funds, money managers and even some issuers -- have abused the protection granted by Congress from SEC regulation. Through multiple scandals and investment debacles hurting taxpayers, we know self- regulation by bankers and brokers through the Municipal Services Rulemaking Board simply does not work. We must level the playing field between the corporate and municipal markets and address all the risks of the financial system.

In addition, I would also recommend amending the Investment Advisors Act to give the SEC the right to oversee specific areas of the hedge fund industry and other pockets of shadow markets. These steps would require over-the-counter derivatives market reform, the outcome of which would be the regulation by the SEC of all credit and securities derivatives. To make this regulation possible and efficient, it would make sense, as my predecessor Chairman Breeden has said so often, to combine the resources and responsibilities of the SEC and CFTC. Under no condition should the SEC lose any of its current regulatory authority. The commission is the best friend investors have.

The resulting regulatory structure would be flexible and effective in identifying potential systemic risk and supportive of financial innovations and investor choices. Most importantly, these measures would help restore investor confidence by making sure rules are enforced equally and investors are protected from fraud and outright abuse. As we've seen in the debate over mark-to-market accounting rules, there will be strong critics of a strong and consistent regulatory structure. But someone must think of the greater good. That's why this committee must draw on its heritage of setting aside partisanship and the concerns of those with single interests and affirm the rights of investors whose confidence will determine the health of our markets, our economy and ultimately our nation.

Thank you.

SEN. DODD: Thank you very much, Mr. Levitt. We thank you for being here. Mr. Atkins, we welcome you to the committee.

PAUL ATKINS: Thank you very much, Chairman Dodd and Ranking Member Shelby and members of the committee, for inviting me here today in this hearing. It's a great honor for me to be here today and especially with two great public servants that I know very well and admire.

This committee has had a long history of careful study and analysis of matters relating to the financial markets and the financial services industry, and as you've already heard in your hearings there are multiple, complex and interrelated causes for the current situation of the global financial market.

I believe that these causes are more than the competence or incompetence of individuals in particular roles but have more to do with fundamental principles of organizational behavior and incentives. Your topic for today is rather broad so I would like to touch on a few specific items that go to the heart of an agency that I know very well, the Securities and Exchange Commission.

With respect to the subject of regulatory reform, your --

SEN. DODD: Mr. Atkins, can you pull that microphone a little closer to you?

MR. ATKINS: I'm sorry.

SEN. DODD: Thank you very much. I appreciate that.

MR. ATIKINS: With respect to the subject of regulatory reform, your hearings have so far been a very good start, and I would suggest that you ask some very hard questions in subsequent hearings. For example, why was the SEC, in the course of the last dozen years or so -- why have they experienced such catastrophic failures in basically every one of its four competencies: rulemaking, filing review, enforcement and examinations? What led to the failures of the SEC and other regulatory agencies, both in the United States and globally, to discern the increasing risk to financial institutions under their jurisdiction? What led to failures at financial institutions to recognize the inadequacy of their own risk management systems and strategy in time to avert a collapse? How did many investors get lulled into complacency and not adequately do their own due diligence? What is the proper role of credit rating agencies, and has regulation in fact fostered an oligopoly by recognizing the opinions of a few as being more privileged than the rest?

These are hard questions, and if there are to be changes to the federal securities laws, I think they need to be made carefully through a robust analysis of the costs and benefits of various potential actions and how those actions might affect human behavior in the market. The current situation is certainly no time to wing it or to act on gut instincts because investors ultimately pay for regulation.

If Congress doesn't get it right, severe consequences could be in store for the U.S. Once on the books, laws, especially in this area, seem to be very hard to change and unintended consequences live on. Prior to the recent crisis, the subject of regulatory balance was being discussed. Senator Schumer and Mayor Bloomberg, the U.S. Chamber of Commerce and others cited many reasons why the U.S. as a marketplace was not so competitive. In fact, in 2006, the value of 144A unregistered offerings in the U.S. for the first time exceeded that in the public offerings. That seems like a long time ago but it still is a valid concern.

The worrisome thing to me is that if care is not taken to have solid analysis, the wrong lessons may be gleaned from this latest crisis that will ultimately hurt investors. It takes a long time, as I said, to change legislation in this area. So what we need is an analysis to determine how we can effectively and efficiently promote honestly and transparency in our markets and ensure that criminality is not tolerated. For example, I disagree with the assertion that deregulation in the past four, eight, 10 or what have you years has led to the current problems in the financial markets. One can hardly say that the past eight to 10 years have been deregulatory. More regulation for regulation's sake I think is not the answer. What we need is smarter regulation.

The global crisis has primarily affected regulated versus non- regulated entities all around the world, not just in the supposedly deregulatory United States. The question is, how did so many regulators around the world, operating under vastly different regimes with differing powers and differing requirements all get it wrong? Indeed, how did so many firms with some of the best minds in the business get it wrong?

During the past dozen years, the SEC has experienced catastrophic operational failures in its four core functions of filing review, rulemaking, enforcement and examinations. Enron's corporate filings were not reviewed for years in the 1990s; tips were not pursued regarding Bernie Madoff and the late trading of mutual funds. It took, literally, an act of Congress led by this committee to get transparency with respect to credit rating agencies.

These mistakes I think were caused by failures of senior management rather than staff members of the SEC. First, management applied faulty motivational and review criteria, and second, since resources are always limited, there's an opportunity cost in choosing to spend time and resources on one thing because then of course there's less time and less resources to spend on other things.

With respect to opportunity costs, I believe that the SEC, especially in the years 2003 to (200)5 were distracted by controversial, divisive rulemaking that lacked any grounding in cost- benefit analysis during this very crucial period right when many instruments like CEOs and CESs took off and established their trajectory. And because these rules were -- and the arguments there were ultimately invalidated by the courts after both long litigation and much distraction for the agency and the industry, a lot of essential time was wasted.

And because life is full of choices, if you devote resources to one thing, you have less to devote to another, and the one risk that you haven't focused on just may blow up in your face. And I think that's in fact exactly what happened to the SEC. And it was really through back office processes and documentation that weren't attended to that led to the current crisis.

There are other things that I'd be happy to talk about that I've put into my written testimony and I ask with respect to -- I had mentioned in the testimony an article on enforcements and the processes at the SEC -- I ask that I be able to submit that for the record.

SEN. DODD: Consider that done and it'll be certainly true of both of us, Mr. Breeden, and Mr. Levitt, as well. Any additional comments and thoughts, and obviously we're in -- I've already had conversations with Richard Breeden and Arthur Levitt and I expect I'll have a lot more in the coming weeks. And we invite -- Senator Shelby and I -- we invite members of the committee as we work our way through this and we're very conscious -- both Senator Shelby and I are -- of the importance of the matter and how well we handle this. And so we're very interested in getting as much council and advice, particularly from people who have been though this and have been around over the years to watch a lot of what's occurring.

Let me ask you, if I can -- start out with -- get your -- the panel's views on two proposals from the current administration: the proposal to establish a resolution authority of non-bank institutions. And I'd also like to ask you'd to comment on the public-private plan to purchase toxic assets. You've all got tremendous experience in this area as well and a little (field ?).

First, regarding resolution authority -- it was the first question I raised with Chairwoman Schapiro. Arthur Levitt noted, and I quote him, that "regulation needs to -- rather, to match market action and that if we -- if an entity is engaged in trade and securities, it should be a regulated securities firm." And I certainly -- almost a self-evident statement, but nonetheless deserves being repeated. And so obviously it begs the question, if we're going to have a resolution operation of nonbanks, to what extent then are we going to involve the agency or agencies that are -- bring the most expertise and background of the issues so they have some ability to manage that kind of an event? And then, secondly, so what should the role of the securities regulator be in an orderly resolution of these securities entities?

And then I'd like you to describe, if you could briefly, what features are necessary in the public-private plan to protect taxpayers and restore public confidence in the banking system? It seems to me, I think many of them -- my general reaction to this, with all of its shortcomings -- it's a idea that I think they needed to pursue. Whether or not this is exactly right or not, I don't know; time will tell. But I like the thrust of it, it seems to me, because I share the view that unless you get rid of these assets, this is going to continue to clog up the system and the credit freeze will continue. And then, well, the answer seems to be is to pour capital back into the institutions, and we've just run out of patience and resources to do that. So you've got to try something else to move this along. And while there are questions legitimately about what the valuation will be on these, whether not sellers will sell, buyers will buy -- it seems not trying to do something like this is a far greater mistake, in my view, than trying something.

So at least my general reaction is a positive one. That doesn't mean I'm buying into every dotted i and crossed t, but I'd be very interested in getting all your background and experience to comment on that as well.

So, Richard, do you want to start?

MR. BREEDEN: Yes, sir. Let me start with the resolution question. There's an old saying that you can't really have Christianity without the devil, and capitalism doesn't work if you don't have failures. I mean, we have a competitive system and some people win and some people lose. And if we close the door -- one of the things that has traditionally been one of the greatest strengths of the U.S. economy has been Chapter 11 and our willingness to let companies fail and then restructure them.

And I went through the largest one in the history of this country, WorldCom, where we took a company that had $35 billion a year in revenue, 75,000 employees, a mere $85 billion worth of missing assets, and all kinds of problems -- a catalog longer than anybody could dream of -- and over a three-year period we restructured it. It came out of bankruptcy with 66,000 employees still there, business intact, and what was worth when it went down probably 3(00 million dollars) or 400 million (dollars) was eventually sold for 12 billion (dollars) and creditors came out with a very good recovery. You can fix -- if you can fix WorldCom, you can fix anything.

Our problem in the financial space -- so I think when you talk about nonfinancial institutions -- airlines, car companies, whatever -- bankruptcy is there. It's a good, workable structure, and we have a problem where we seem to have policymakers who either don't understand it or are afraid to use it. And that's why we have the courts and they can restructure companies. It's a very, very good thing.

In the financial world we've been afraid to use it, and one of the things I suggested in my testimony was that Congress think about something like the national security surveillance courts you have created over in the terrorism side. Create a court composed of senior judges who have actually handled big multibillion dollar collapses and restructuring and have expedited processes so that an AIG could -- that there would be a structure to handle it.

Throwing it into bureaucracies, whether it's the Treasury or the Fed, to me is the wrong approach because you're going to get ad hoc decisions. And frankly, part of the reason we had so much panic in the market, loss of confidence last fall was that every Sunday night you'd get out of the blue a decision coming out of the one of the administrative agencies about how they were handling Fannie Mae and Freddie Mac, Bear Stearns, Lehman Brothers and so on -- and every one of them was different. There was no consistency. In one of them the preferred stock would be wiped out; the next one, it would be protected. In one of them, the debt was okay; in the next one it'd be wiped out. And there was no real way to predict it, and when investors can't predict what's going to happen then you're not going to lend credit because you can't make a sensible decision.

So I think the rule of law is a very, very healthy thing in the resolution area, and creating a court aimed at handling large financial institution failures with lots of input from the Fed and the Treasury and the SEC, but where it's done in a judicial context would be very helpful.

Mr. Chairman, we had the failure of Drexel Burnham when I was at the SEC and we also had a restructuring of Salomon Brothers -- two of the largest securities firms of the time. Drexel had a registered, regulated broker dealer, and its holding company was off doing everything under the sun. When they got in trouble we seized the broker dealer; we sold it to Paine Webber. And we took the unregulated holding company and we sent them down to the local bankruptcy court, and they spent the next three or four years sorting it out and it was just fine. The market wasn't interrupted in any way.

The same technique could have been used at AIG. You could have taken the regulated insurance companies, sold them to other companies instead of sitting there with them and put the unregulated activities, swaps or anything else -- put them into a bankruptcy proceeding and wind them down, and that would be a much better mechanism for dealing with all the issues that come along.

So I think the topic of having a resolution mechanism that works for a big financial institution is a good topic, and I -- but I would urge that we spend a little more time looking at the range of alternatives rather than just throwing them into the Treasury Department where I'm not sure they have the institutional knowledge to make good decisions.

SEN. DODD: Arthur Levitt -- and let's act as quickly on this subject matter.

MR. LEVITT: Generally speaking I associate myself with Richard's views, although in this case because the nature of the crisis is so different than it was at the time of Drexel Burnham or elsewhere, morphing over into economic Darwinism I think is a mistake.

We are operating in a polarized environment -- highly polarized. And because of that, the notion of these public-private partnerships will be met with a measure of skepticism in terms of what the government may extract once more from any private-sector entity that wants to deal with the bureaucracy.

I agree that the approach has to be more comprehensive, less at the edges, more directly in terms of determining who's going to make it and who is not going to make it. And the notion of adding bureaucratic layers of control and judgment and dispensation I think will slow the process and slow the eventual outcome.

SEN. DODD: Let me just ask you because, Richard, you're one of the architects of the Resolution Trust Corporation in the '80s. And there, there was -- being a bit of a devil's advocate with you here, and certainly your approach I think has some -- it's interesting -- but there, there was the creation, and it did work. I mean, we didn't get everything back, but we got a lot back. And your idea had great value and merit.

And given Arthur's point here, this is arguably a time when the tentacles of this are far more far reaching in many ways; the issues are not sort of stovepiped, not that it would have been either, but nonetheless the case. Is that a change of view if you to go back and -- to go back to the 1980s, would you be sitting here offering something different than what you suggested at the time?

MR. BREEDEN: Thank you, Mr. Chairman.

I have thought a lot about our experiences creating the RTC and dealing with the savings and loan crisis as I've watched the current crisis unfold. You know, our -- in a nutshell our philosophy back then was no bailouts but fast funerals.

SEN. DODD: (Laughs.)

MR. BREEDEN: And it worked pretty darn well.

SEN. DODD: That's an Irish expression --

MR. BREEDEN: Yeah. (Laughter.) It worked pretty darn well.

There is similarity in the public-private partnership that the Treasury is trying to establish for the troubled assets and the RTC. RTC was an entity that just stripped all the assets out of every firm that failed --

SEN. DODD: Right, right.

MR. BREEDEN: -- and then repackaged them and tried to sell them back out to the market as quickly as you possibly can. These assets don't get better when they're owned by the government. Get them back in private hands where they can be managed effectively. And I think that's what Treasury's public-private partnership is trying to do without creating an agency, if you will, to do it.

And I think it'll work. It's -- they're on the right path. I haven't looked at all the details of it. It is critical that you have price exposure, that you let people bid on these packages, that they not be directed to individual purchasers. It's important that you have transparency. And the key to all of it is that -- and the big difference between the current plan is, we were dealing with dead institutions. They were closed and then we took the assets out and repackaged them.

SEN. DODD: Right.

MR. BREEDEN: So they didn't care what price they got because they weren't in existence anymore. We, on the other hand, would sell assets to maximize recovery for the taxpayers, and we got a lot of it back.

The whole -- this plan, one of the critical issues will be at what price will a bank that's still doing business, that's carrying stuff on its books at 60, that maybe is worth 15 -- are they going to be willing to sell it into one of these public-private partnerships --

SEN. DODD: Right. I agree.

MR. BREEDEN: -- that's at a realistic --

MR. LEVITT: That's absolutely critical. And in a globalized electronic market the margin of error is so much narrower than it has ever been in the history of commerce. A mistake now is measured in milliseconds.

SEN. DODD: Yeah. Right.

Yeah. Let me ask -- I mean, I agree with that.

Let me turn to Senator Shelby.

I agree and I think that's a very good point not made often enough. Everyone's wondering whether there'll be buyers; I think the issue is whether or not there'll be sellers. And that's really going to be the issue -- will you sell?

And I'm just imagining this, and, again, let's listen to some folks. We've got a panel coming up who can maybe shed some more light on this -- my guess is if you're the board of a bank and you're sitting there and someone's saying, you know, we think this thing's worth more than what they're offering, my reaction might be, "You know what, get rid of this stuff. Let's move along. The credit markets are not going to open up until we get this unclogged. And while you may be right, I'm sure it's worth more than what they're offering here, let's move along." And I've got to believe that thinking may have some influence on the decision on sellers to move the product along. I know it takes balance sheet stuff, but the larger good here is, get this moving. And so I don't know if that's going to be the case or not, but that's the counterargument I've heard about whether or not sellers will sell. I don't mean to dwell on all this but it's an interesting point.

Let me turn to Senator Shelby. I've taken way too much time here. I apologize.

SEN. SHELBY: Thank you.

Mr. Breeden, you were chairman of the SEC from '89 to '93. Mr. Levitt, you were chairman of the SEC from '93 to 2001. We know Mr. Atkins was commissioner there for some eight years, I believe it was. In looking back at your time at the SEC, what could each of you have done differently that would have helped to prevent the roots of the current crisis from growing?

Mr. Breeden? You were there a while back; I know that.

MR. BREEDEN: We did everything we could, and I suppose you can always do more --

SEN. SHELBY: Sure.

MR. BREEDEN: -- to maintain market discipline. I have a deep faith that continues to this very day that markets do a better job disciplining risk than bureaucrats do. And so I didn't want the SEC trying to figure out if Drexel Burnham was safe or not and should stay in business or not; I wanted the market to decide that. And we tried to draw the line and make clear that "too big to fail" did not include the securities industry -- that if you extended credit to a securities firm, do it on the basis of their credit worthiness because we weren't going to bail you out if you got it wrong.

I wish we had established that principle more clearly because to the extent that anybody out there thought Lehman Brothers or Bear Stearns was inside a taxpayer protection umbrella, that would have allowed them to borrow more money, get more credit than they -- than their own balance sheet warranted. And I think we get into so many problems of distortion in the marketplace. You saw it with Fannie and Freddie; you see it with any area where you have moral hazard where people are thinking, well, I can lend money here because if it goes wrong, taxpayers -- the government will somehow step in and bail it out.

SEN. SHELBY: Sure. Right.

MR. BREEDEN: And I -- we did the right things when I was there to try to make sure we drew the line and said, "In the securities industry you're on your own," but I suppose we could have done it better.

SEN. SHELBY: Mr. Levitt?

MR. LEVITT: A day doesn't go by when I don't think about this very question.

The first mistake I made was not pressing harder for an immediate resolution of the issue of expensing stock options. We're now entering a decade of transparency where every rule, every regulation, every judgment will be judged by the metric of how transparent it is. That was a case in point.

Secondly was maybe the most important issue of all: There came a time when the chairwoman of the CFTC came to the President's Working Group and said, "It's time to regulate swaps." And Alan Greenspan, Bob Rubin and others said, "That's impossible; you can't do it. We have trillions of dollars of outstanding contracts. It's the wrong thing to do; don't do it."

I went along with it. I went along with it without taking the additional step of saying, "Wait a second; maybe we have those contracts out there. Let's grandfather them. And going forward, let's regulate them, mandate them to go on and exchange, give them transparency." I didn't call for a mandated central clearing facility. And that was a mistake that I will regret as long as I think about these things.

SEN. SHELBY: But there's nothing like transparency in anything, is there?

MR. LEVITT: Absolutely.

SEN. SHELBY: And confidence to bring trust back to the markets.

MR. LEVITT: Essential.

SEN. SHELBY: Essential.

Mr. Atkins?

MR. ATKINS: Well, I thank you, Senator Shelby. You know that commissioners tend to be literally the fifth wheel at the SEC but --

SEN. SHELBY: But you're part of the system.

MR. ATKINS: Definitely. And I tried to -- tried to ring the gong down through the years.

I think one thing is that the SEC probably became a little bit too focused on the equity markets and, to a lesser extent, option markets and not paying enough attention to the debt side, as Chairman Levitt was just talking about with munis. And the real question is, do equity markets still function as the primary crisis recovery mechanism because a lot of that has shifted to the other side? So I think there needs to be new types of skill sets at the SEC.

Second was maybe not speaking out more loudly and often about some of the back office and documentation issues for CDOs and CDSs down through the years. And then finally, with respect to the enforcement program at the SEC, I think what's happened over the years is that the staff has been tending to chase headlines rather than to look at real cases that hurts real investors -- Ponzi schemes and stock manipulations -- really calling them slip-and-fall cases.

SEN. SHELBY: Mr. Breeden, you know as well as everybody does that the Federal Reserve is not only the central bank but it is the regulator of our holding companies -- our largest banks. I believe myself that they've utterly failed as a regulator -- utterly -- because most of our Wall Street banks that are -- got in trouble and are some of them in trouble today still were regulated by the Federal Reserve. So that causes me great heartburn, you know, when we start talking about the Federal Reserve as the systemic risk regulator -- you know, the all-powerful thing.

Explain your concerns about having the Fed serve in the role as a systemic regulator.

MR. BREEDEN: Well, Senator, I think this is a terribly important subject, and I really hope people stop and think about this. You know, the Fed does, as lender of last resort -- and I hope we'll always have a central bank, not the world's largest hedge fund over at the Federal Reserve. But as lender of last resort and -- well, you can only cram so many -- every time the Fed buys everybody else's broken assets, you're not really fixing those assets, you're just moving them over to the Federal Reserve. And there are limits to how much --

SEN. SHELBY: And they seem to be keeping a lot of them too long.

MR. BREEDEN: Well, they don't get more valuable as you hold them.

SEN. SHELBY: I know.

MR. BREEDEN: So this lender of last resort role has always given the Fed a stature and an importance in the system, and it's quite genuine. Central banks do play a critical role. But their primary role is of course monetary policy, stability of the currency, and you will always pick Fed chairmen and Fed governors to get good economists who will do that role well.

Regulation is kind of off on the side. Who really runs regulation in the Fed? I'm not sure anybody ever really knows. And as you --

SEN. SHELBY: Maybe they didn't have anybody running it.

MR. BREEDEN: Well, bottom line, there was probably $800 billion in equity losses at Citicorp, B of A, WaMu, Wachovia -- all institutions which, as you point out, were regulated by the Fed. So the idea that we're going to now add to their plate GE and IBM and General Motors and every other -- you know, United Technologies and anybody else who makes something important -- say, "Well, they make elevators and elevators are certainly systemically important; we can't get around without them." Who knows what ends up in that --

SEN. DODD: Just be careful the names you use here that you're talking about.

MR. BREEDEN: That's -- well, I thought you might notice, Mr. Chairman. (Laughs.)

So I worry you're creeping very far into industrial policy, and I go back to my comment earlier -- you can't stop everybody from failing. You have to have a mechanism where the people who are unsuccessful are taken over and replaced by people who are successful.

So the farther we go into saying the Fed will oversee everybody big in the economy -- their expertise is looking at banks, not other kinds of firms. And so you're putting people who don't have the experience and don't have the expertise in charge of regulating people and you'll get bad regulation. You'll have the illusion of regulation but maybe not the successful outcome.

SEN. SHELBY: You said their expertise was looking at banks. Now that's very debatable today because if they're the regulators, I said earlier, and they are, of our holding companies and our banks -- our big -- so many of our big banks failed under their supervision, that says a lot to me about the Fed's inadequacies.

Thank you, Mr. Chairman.

SEN. DODD: Thank you very much.

Senator Warner.

SEN. WARNER: Thank you, Mr. Chairman.

I think Senator Shelby asked a very good question in terms of what mistakes were made, and I appreciate the candor of the witnesses. I do think one of the things that Mr. Atkins said was -- struck home to me that, as someone who has been around the markets for some time -- over the last 10, 15-plus years, the enormous focus on the equity side as opposed to the debt side. And as the debt side got more and more complicated, I think it even got perhaps less focused. So that -- I think a very valid point.

And following up on the chairman's comment as well about whether we're going to have willing sellers, I do think there's a -- and I know you've had these meetings; Senator Shelby and Senator Corker's had these meetings as well where you've got the hedge fund community saying everything's melting down and the banks say, no, we're actually fine. Maybe the stress tests will give us -- and if they are applied with some rigor, some winnowing out process and push those who fall below to -- into the (fails ?) procedure.

I just got word that the Budget Committee, of which I'm on, is going to -- is in the mark-up, so I just -- let me just ask the question and not be able to stay for the answer. But I'd like to start with Chairman Levitt, I guess. Earlier we had Chairman Schapiro in and we were asking about say-on-pay. I'd be curious to have your and your colleagues' comments on say-on-pay. And I'd also love to hear just your more general comments -- nobody thinks we're going to unscramble the eggs post -- (inaudible) -- but I would like your comments about what should be some of the underlying principles. Should we acknowledge that all institutions are going to be able to do all things on a going-forward basis, and what challenges and opportunities would that present us in terms of a new regulatory structure?

And again, my apologies to the members that I have to go down and vote on these -- in this markup.

Thank you, Mr. Chairman.

SEN. DODD: Thank you very much, Senator Warner.

Senator Corker.

SEN. : (Off mike.)

SEN. DODD: Oh. Oh, I see.

SEN. WARNER: (Off mike.)

SEN. DODD: Oh, I thought you were walking out, so I apologize.

SEN. SHELBY: Well, he's got to go vote.

MR. LEVITT: Well, with respect to say-on-pay, what I would say about this -- it sounds like an easy call. How can you be against it? And I'm not, but I think it's simplistic. It can be a check-the-box kind of mentality, which businesses can easily incorporate and just move on. I urge any legislation to allocate to the SEC their responsibility of defining what -- exactly what that means under what circumstances, how it is done, how far down it goes, what the details should be, what the explanation should be, what the history should be -- not simply pass a rule, because I assure you it looks differently than if you refine it in a way that I think the commission should be charged with doing.

MR. BREEDEN: Just on say-on-pay real briefly, I'm chairman of the board of H&R Block, and we put say-on-pay in voluntarily last year. It works fine. It's good to let shareholders express their views. If they don't like your pay policies then you ought to find out about it sooner rather than later. And we did the same thing at Zale Corporation, where I'm on the board. We put it in voluntarily. I think the American business community has been resisting something that is simple, easy and an appropriate step to take.

I share Arthur's concerns that say-on-pay alone is not going to fix our compensation problems. You really have to have some ability -- if compensation committees do outrageous things, and we've all seen examples of profligate compensation that can get seriously out of whack, you have to go beyond that and have either majority voting every year where shareholders can try and withhold votes or vote against members of a compensation committee. And ultimately you have to have the threat that if boards don't do a good job managing compensation policy that they could be replaced. And until you do that, an advisory vote that just every year says you're doing a terrible job isn't going to solve the problem.

SEN. DODD: Yeah. Well said.

MR. ATKINS: Well, with respect to say-on-pay, I just -- I'm an advocate, I guess, for federalism. I just -- I think that Congress needs to be or should be a little bit leery of wading into this issue. We don't have a federal corporate code or anything like that, and I think once you start wading into it, you know, where do you stop? And maybe just concentrate like you did on Sarbanes-Oxley of empowering the SROs of the stock exchanges and others and then maybe leave it to the states to do it -- states acting and shareholders acting within the confines -- the ambit of the state laws and regulations.

SEN. DODD: Senator Corker.

SEN. CORKER: Thank you, Mr. Chairman.

I thank you. The testimony you all have given I think has been outstanding this morning, and I couldn't agree more with you, Mr. Breeden, about the boards. I think that there's a lot of reforms that need to take place to strengthen boards' responsibility to oversee and to give, I think, shareholders some powers that they now don't have. And we've had numbers of conversations regarding that. I couldn't agree more.

And Mr. Levitt, I -- it's amazing to me, this fascination with somehow or another changing accounting rules -- actually changes the status of an entity. And while I do think there should be some degree of judgment, which I know the SEC ruled upon it anyway several months ago, it hasn't had the uptake from the public accounting entities yet. But I think your comments are right on, and it's amazing to me that people would think that an accounting rule would actually change the actual status of an entity. But I thank you for that.

And then Mr. Chairman, I -- the -- I do think the seller issue you talked about is real. The securities will fly out the door because they've already been marked to market and, you know, people sort of know what -- they've marked them down to realistic -- I think on the whole loans of the assets, we are going to have a serious problem, and I think that piece has got to be worked through. And certainly if those assets are sold at below where they are, of course there's a different set of accounting standards that go there. We're talking about with -- in combination with the stress test, additional capital going into these entities, right? And it could be coordinated in a way that I think could be very helpful.

But let me go back to Mr. Breeden. You mention having this special court to deal with some of these complex entities, and then on the other hand there is the whole issue of protecting citizens for those that aren't ready to go into that. So a resolution entity of some kind may be necessary even if you had a structure for entities to move into Chapter 11. Is that true or false?

MR. BREEDEN: Senator, I would say if you had the right Chapter 11 mechanism, you wouldn't need an intermediate step. Companies would operate as long as they could get the liquidity and the credit to operate. If they got to a point where they couldn't, bang, you would make a filing that -- like Chapter 11 does, you stop the ability of people to shut an entity down while it goes through this reorganization process.

So I don't think you would need an agency as a sort of warming tent for the special court. I think if you do it right that court would be able to do things earlier. And one of the problems with Chapter 11 and financial institutions is it is loaded under current law towards liquidation, and that's what I think you've got to fix.

MR. BREEDEN: I'd like to add one point to that, and it goes to the general tone of all of this testimony. Whether we have a court, whether we have a resolution, whether we have new rules, and whether we have a systemic regulator, do not under any circumstances allow that to diminish the investor protections offered by the SEC. The consequence of that kind of action, no matter how nice it sounds, no matter how pretty its dressing may look, would be to turn that agency into a Betty Crocker kind of agency, which does nice things for investors but has no bite, has no power, has no authority. It just stands up there as an empty symbol. That's the danger of creating these systems of oversight and systemic risk and whatever it is that you call it. Do not allow investors to be hurt by this process.

SEN. CORKER: Thank you very much.

Let me -- so let me move on. So this economic Darwinism that Mr. Levitt referred to earlier, we see -- I think we're going to have a task force report on the automotive industry. It's going to come out and they're going to lay out what futuristic things need to occur.

Does the fact that debtor-in-possession financing is difficult to get today -- does that in any way affect your view of economic Darwinism, if you will?

MR. BREEDEN: Senator, I --

SEN. CORKER: I mean that if somebody goes into Chapter 11 -- under the WorldCom scenario, you had the ability to finance assets that were of value. There are people that I think would argue very strongly and probably have a great point as we see what's happening that there isn't financing available for that kind of thing. Does that in any way affect your thoughts on entities like that?

MR. BREEDEN: Senator, I think you have put your finger on a terribly important issue -- the availability of debtor-in-possession financing. In that scenario, where a resolution authority might be able to -- I mean, that's finding liquidity for those facilities, particularly if you suddenly need a giant one, to deal with an AIG or something of that magnitude would be an area that could conceivably be very helpful in working out with the Federal Reserve and what form of public-private financing if we're having inadequate liquidity in debtor-in-possession financing because without that -- (background noise) -- reorganization doesn't work.

Also, Arthur was being a little critical of my economic Darwinism, but I'm really unrepentant on this. If companies fail, you need to let them fail and you need to let them be replaced by people who do a better job of managing. It doesn't mean that they'll disappear from the face of the earth. What we call Bank of America today is really -- was once North Carolina National Bank. And a lot of other banks failed and they got put together and it grew and grew. Well, you can put these institutions together by acquisitions; you can also take them apart by divesting things, making them smaller and more manageable, and arguably you sometimes make companies a lot better and a lot more valuable when they get back to a more manageable focus and size.

So you do need the DIP financing. That's a critical role.

SEN. CORKER: So you would advocate, then, I -- potentially instead of all the activism that we've had through Treasury and TARP, and certainly now Treasury secretary, it appears, that wants to codify TARP -- you would actually argue instead that we consider as a body creating a debtor-in-possession financing mechanism that would allow people to go into an orderly Chapter 11 and have the ability to finance out in lieu of that. Is that what you're arguing?

MR. BREEDEN: I -- you've done a better job than I could of articulating that, but I think that coupled with having the ultimate decisions not made by a Cabinet secretary but by -- made by somebody wearing a black robe. I think having the courts be involved -- because then you have the ability to deal with contracts for bonuses and to deal with the fact that the entity has more obligations than it has money to pay for them. And so they all need to be restructured, and doing that through the rule of law rather than every Sunday night somebody in an administrative agency makes a decision and announces it and it stuns the market, I really like the protections -- as an investor I like the protections that come from knowing if I make an investment, what rights do I have and who's going to back them up and that that's going to be done through the court -- the judicial system ultimately. So I'd marry up your suggestions with the financing facility, if you will, with the judicial oversight, and I think we'd then have something that would be very workable.

SEN. CORKER: Mr. Chairman, I know my time is up. I want to say that Mr. Breeden's opening comments to me were pretty clairvoyant and somewhat chilling in light of what we see happening. And we have this Trojan horse -- you know, it looks really pretty and it sounds really pretty -- and I'm talking about the systemic regulator being an entity. I know that you, for what it's worth, have looked at -- I know you talked with Susan Collins the other day about something she's put forth. I have to tell you, based on what I sense and feel, I think it would be one of the worst mistakes we could possibly make to put the -- in one person's hands that ability.

I do think, very quickly, we would move into industrial policy issues, things way beyond -- I mean, we'll never define properly systemic risk. I mean, it could move into all kinds of things like WorldCom or other things, and I just -- I thank you for pursuing that route. I see Senator Shelby nodding. But I hope we will resist any move -- any move that gives anybody that kind of power and basically renders almost every other entity in government useless.

SEN. DODD: Well one of the things we learned going back in Richard Breeden's day is that you can't have the regulator, in a sense, also be responsible for the resolution of these matters. What I said the other day is, an entity that only talks to itself is dangerous, in a sense, when you get to these matters. And so that's why I for one -- again, I'm -- I want to make it clear as well, I haven't written anything I haven't -- I'm just listening and, as we all are, to these various ideas and what makes sense. And I like Richard Breeden's idea of this -- whether or not you could do this kind of a thing. But I agree with him the notion of getting -- so you get resolution. I mean, the whole idea of calling it resolution is to get to a resolution of these matters.

MR. BREEDEN: Absolutely Mr. Chairman.

SEN. DODD: And so we need to think carefully how we do it. But I agree with you, Senator, that this has got to be one that's thought out and have balance to it. These are complicated institutions today, either by design or acquiescence. And so, therefore, to look at them and how you unwind requires a lot more eyes on this than would come from one single entity. And that's -- and the danger of doing that seems to me only complicate the problem to some degree. So I think we sort of agree on that.

I just want to make -- and we've got to go to that -- Jack Reed has shown up. He's done a terrific job as the chairman of the Subcommittee on Securities and -- I invoked your name earlier without your permission and that is that this was a lot of interest in Chairwoman Schapiro's testimony today in suggesting that maybe the subcommittee would continue formally or informally following up the conversations with the SEC.

I wanted to mention a subject matter -- and just because it's come to my attention -- and that is this resetting or re-pricing of options. I've been reading some stories about how, obviously with the decline in the price of various stocks where options were taken on them on the assumption, of course, their value would continue to increase and it has done exactly the opposite. But whether or not certain people at a certain level are resetting the option at the lower price at the expense of shareholders who don't have that same ability raises some serious issues from my view.

And I was going to raise it with Jack, I may draft a letter, in fact, to the SEC and others to find out what is going on with this. Again, I'm reading news reports about it so I want to be careful about suggesting something's absolutely the case. But nonetheless it's disturbing to me that that may be happening. And so we may want to look at that. We'll draft something along those lines and get some answers very quickly. But I don't know if you've seen anything like this, I don't know if either of our witnesses have seen any reports on the resetting of options or not at a certain level. Have you seen this as well?

MR. LEVITT: Yeah, through the years this has occurred. This is part of the compensation issue and it's something that --

SEN. DODD: Well it's huge. You go from something that was $100 and it moves to 5 (dollars) or $10 more, that's value. If you're going from $100 down to $10 and all of a sudden that stock goes to $20 and you've reset it at 10 (dollars) for a handful of people that makes some of these other issues pale by comparison.

MR. LEVITT: Some companies have set and reset and reset and reset again.

SEN. DODD: Well, I don't know how my colleagues feel but it's something we ought to look at.

SEN. SHELBY: Absolutely.

MR. BREEDEN: Mr. Chairman, it's another area where having large shareholders being able to be on the board would put -- I guarantee that in companies where our fund sits on the board of director there will be no re-pricing of options. And, you know, shareholders are the ones who are hurt by that because nobody re-priced for us the cost of our shares and so management, yes, going forward there may be new options granted each year in prices but it's really a terrible abuse when people go back and rep-rice from the past. It was an incentive to make the stock worth more, grow value for the shareholders and really you're jumping off the train and saying I'm going to go give myself a special deal. And that's a very serious problem.

SEN. DODD: Well, I'm hearing sort of --

MR. ATKINS: One note of caution there is that, you know, it's not just a monolithic type of thing with -- every company is different, every situation might be different. I think you'll probably hear that when, if you write the letter to the SEC, the response will be, you know, in various situations it might be justifiable and the shareholders might have approved it.

SEN. DODD: Well, again, it's certainly worthy of quick examination because this is the kind of thing that, again, in a week or two from now we'll pick up our newspapers and discover that this has gone on and no one's paid attention to it and it will pale -- if you think you had a furor over what happened last week, watch this one.

And so, let me just use this forum as an opportunity to send a message before we get a letter written that someone ought to be looking at it immediately and I'd like to hear back what steps, if any, are being taken to deal with it. And then we'll respond accordingly. Maybe we'll get some people in front of us to talk about it. And, you're right, there may be different circumstances. I'm not trying to have a sweeping statement here but I'm, nonetheless, you're hearing from witnesses and others this is troubling, to put it mildly. So, we'll take a look at it.

Anyway, we're going to keep the questions open. I could -- we could have you here virtually all day, the three of you, it's so valuable. I can't thank you enough for appearing this morning and we'll submit some additional questions, there's an awful lot to ask you just in the securities field the number of issues.

I appreciate, by the way, Arthur, you're comment on the immunity issue, the bond issue. This is very important, you're language was very strong, in our private conversations you've expressed this to me as well. And certainly this committee will take a look at it. A completely very unregulated area and one that poses some real risk. And I appreciate you bringing that point up.

MR. LEVITT: Thank you.

SEN. DODD: With that, this panel will be excused and we thank you for coming.

And I'm going to introduce the next panel and I'm going to thank them for their testimony in advance.

I want to thank Jack Reed for his willingness to chair -- I'm going to not be here for all of this, I'll be here for a few minutes of it anyway. But let me begin and I'll introduce them.

Richard Ketchum is the chairman, CEO of FINRA. He's also chairman of the World Federation of Exchange -- the Exchange's Regulatory Committee.

Ronald Stack, who has served on the Municipal Securities Rulemaking Board since 2006 and is managing director of Barclay's capital with responsibility for the firm's national public sector investment banking effort.

Richard Baker is president and chief executive officer of the Managed Funds Association, a former colleague of ours, served in the other body. Previously a member of the U.S., as mentioned previously, a member of the House of Representatives, chairman of the subcommittee on Capital Markets for 12 years.

Jim Chanos is chairman of the Coalition of Private Investment Companies. Mr. Chanos is also president of Kinkos Associates, a New York private investment management company.

Barbara Roper is the director of Investor Protection for the Consumer Federation of America.

David Tittsworth is the executive director and executive vice- president of the Investment Adviser Association.

Dan Curry is the president of DBRS' U.S. affiliate. Previously, he spent 22 years at Moody's Investor Service.

And Rita Bolger, our last witness, is the senior vice-president of Global Regulatory Affairs, associate general counsel for Standard and Poor's and has served as the head of Global Regulatory Affairs.

(Off mike consultation.)

Let me thank all of you and we're packing you in here, I apologize. I hope you found this morning interesting. At least you've been sitting here and listening to the chairman of the Securities Exchange Commission and then our last panel so it's -- I'm sure you would've paying very close attention had you not been asked to be here. But having you in the room, I kept on looking out to see how you were reacting to some of the things that were being said. I didn't see -- I saw some commonality of interest being expressed but, on certain matters, and some dismay at others, I guess, along the way. So I was watching the nodding heads along the process.

Let me turn to Senator Shelby for some comments quickly and then we'll get to our panel and ask you to share some thoughts with us on the subject matter before us.

SEN. SHELBY: Chairman, I appreciate these hearings that you're putting together. And gosh, we could be here all week and learn a heck of a lot.

I've reviewed this testimony of the third panel -- a very, very impressive panel and a lot of you I know. And all of your testimonies is interesting.

Jim Chanos' testimony, I think, goes right to the heart of a lot of things that's what's wrong. And I think we ought to pay particular attention to that.

Now, the reason I'm bringing this up, I too have got a luncheon I've got to speak at, you know. I'm not leaving yet but I might miss some of you. But I want to thank you, like Senator Dodd did, for your contribution. And as we go through this trying to find out what went wrong and trying to do what should be right in the future, I think we're going to be very careful and very comprehensive, aren't we Senator?

SEN. DODD: I thank you for that.

Richard Baker, it's good to have a former colleague -- you get to be on this side of the desk now this side of the desk. For 12 years you were on this side so -- I've gotten to know Richard very, very well and does a fine job on behalf of the people he represents as well.

And Jim Chanos I know. And like all of us here many of you we know and have worked with in the past at various times. So we thank you for coming before us.

Jack, any opening comments you want to make?

SEN. JACK REED (D-RI): No.

SEN. DODD: Well let's get right to it. And again, we'll just here from Mr. Ketchum, we thank you. And we'll take your full testimony, if you'll try to move along.

MR. KETCHUM: Chairman Dodd, thank you and it was a morning well spent so it was good to be there with you.

Chairman Dodd, ranking member Shelby, and members of the committee I am Richard Ketchum, chairman and the CEO of the Financial Industry Regulatory Authority or FINRA. On behalf of FINRA I would like to thank you for the opportunity to testify.

And I commend you, Mr. Chairman, for having today's hearing on the critically important topic of reforming our regulatory structure for financial services.

As someone who has spent the great majority of my career as a regulator, dedicated to protecting investors and improving market integrity, I am deeply troubled by our system's recent failures. The credit crisis and scandals of the last year have painfully demonstrated how the gaps in our current fragmented regulatory system can allow significant activity in misconduct to occur outside the view and reach of regulators.

FINRA shares this committee's commitment to indentifying these gaps and weaknesses and improving the system for investors.

Let me briefly talk about FINRA and our regulatory role. FINRA regulates the practices of nearly 49,000 securities firms and more than 650,000 registered securities representatives.

As an independent regulatory organization, FINRA provides the first line of oversight for broker dealers.

FINRA augments and deepens the reach of the federal securities laws with detailed and enforceable ethical rules and a host of comprehensive regulatory oversight programs.

We have a robust and comprehensive examination program with dedicated resources of more than 1,000 employees.

FINRA has the ability to bring enforcement actions against firms and their employees who violate the rules.

Mr. Chairman, as I said earlier, the topic of today's hearing is critical. The failures that have rocked our financial system have laid bare the regulatory gaps that must be fixed if investors are to have the confidence to reenter the markets.

Our current system of financial regulation leads to an environment where investors are left without consistent and effective protections when dealing with financial professionals. At the very least, our system should require that every person that provides financial advice and sells a financial product be licensed and tested for competence; that advertising for products not be misleading; that every product marketed to an investor is appropriate for that particular investor; and comprehensive disclosure exists for services and products.

I'd like to highlight the regulatory gap that, in our view, is among the most glaring examples of what needs to be addressed; the disparity between oversight regimes for broker dealers and investment advisors. The lack of a comprehensive investor level examination program for investment advisors impacts the level of protection for every person that entrusts funds to an advisor. In fact, the Madoff Ponzi scheme highlighted what can happen when a regulator like FINRA has only free reign to see one side of the business.

Let me be clear. I mentioned this example not because FINRA is sanguine with its role in the Madoff tragedy. Any regulator who had any responsibility for oversight for Madoff must accept accountability and search diligently for lessons learned.

But the way to identify fraud, just as with sales practice abuse, is not through the fog of jurisdictional restrictions. Fragmented regulation provides opportunities to those who would cynically game the system to do so at great harm to investors and it must be changed.

The regulatory regime for investment advisors should be expanded to include an additional component of oversight by an independent regulatory organization, similar to that which exists for broker dealers.

The SEC and state securities regulators play vital roles in overseeing both broker dealers and investment advisors and they should continue to do so. But it's clear that dedicating more resources to regular and vigorous examination and day-to-day oversight of investment advisors could improve investor protection for their customers just as it has for customers of broker dealers.

Broker dealers are subject to rules established and enforced by FINRA that pertain to safety of customer cash and assets, advertising sales practices, limitations on compensation, and financial responsibility. FINRA ensures firms are following the rules with a comprehensive exam and enforcement regime. Simply put, FINRA believes that the kind of additional protections provided to investors through its model are essential.

Does that mean FINRA should be given that role for investment advisors? That question must ultimately be answered by Congress and the SEC, but we do believe FINRA is uniquely positioned, from a regulatory standpoint, to build an oversight program quickly and efficiently.

In FINRA's view, the best oversight system for investment advisors would be one that is tailored to fit their services and role in the market, starting with requirements that are currently in place for advisory activity. Simply exporting in wholesale fashion the broker dealer rulebook or current governance would not make sense.

We stand ready to work with Congress and the SEC to find solutions that fill the gaps in our current regulatory system and create a regulatory environment that works properly for all investors.

Thank you, Mr. Chairman, I would be happy to answer any questions.

SEN. DODD: Thank you very much and we'll look forward to some question for you too.

Mr. Stack.

MR. STACK: Thank you very much. Good morning Chairman Dodd, ranking member Shelby, and members of the committee.

I'm Ronald Stack, chair of the Municipals Securities Rulemaking Board. I've been -- by way of background, I've been involved in municipal markets since 1975 when I was a member of the staff of Governor Hugh Carey during the New York City fiscal crisis.

I am pleased today to testify on behalf of the MSRB at the committee's second hearing on enhancing investor protection --

SEN. DODD: Why don't you pull that microphone a little closer to you. Thank you very much.

MR. STACK: I am pleased today to testify --

SEN. DODD: I think you had it on but -- try it again.

MR. STACK: Am I on?

SEN. DODD: Yeah.

MR. STACK: Okay, thank you.

Like I said, I started my career in the municipal industry working for Senator -- Governor Carey in New York during the city fiscal crisis. I'm pleased today to testify at your hearing.

The MSRB was created actually by the Congress in 1975 to write rules for municipal securities dealers, at that time many of whom were unregulated, unsupervised, and not even registered by the SEC. Our mission was set in statute, and it remains clear and unambiguous, and that is to protect investing public and to promote a fair and efficient market for municipal securities.

This is a $2.7 trillion municipal market and it is fundamental to financing our nation's infrastructure. Indeed, over 55,000 entities issue $400 billion in municipal securities each year.

We are absolutely committed to preserving municipal access to capital, the municipal market's integrity, and investor protection. This is our mission, this is our commitment.

We believe one of the most important ways to protect investors and preserve market integrity is through a culture of transparency, one that makes information available to all. Historically, access to public disclosure about municipal bonds has been hindered by a severely fragmented disclosure system that was cobbled together over the years. This system did not promote public access to disclosure documents and it did nothing to shine a light on the disclosure practices of issuers, good or bad.

So what have we done? The MSRB has developed a comprehensive website that is transforming municipal disclosure and transparency for all investors, large and small, institutional or retail. The MSRB -- it's called the Electronic Municipal Market Access system, which we call EMMA -- is so advanced that we believe it exceeds disclosure systems for any other fixed income market, and that includes corporate bonds. With EMMA, all investors have free access on the web to an incredible amount of information about municipal securities.

We've had real-time trading information up since 2008 -- 2005. We've added official statements, information about option rates, starting next week we added --(audio break) -- requiring them to take education courses. We have a complete set of rules regulating municipal dealers that we constantly view, modify and change as necessary. And I emphasize, all of our rules are sent out for comment and then are all approved, strictly viewed and then approved by the SEC itself.

Unfortunately, we continue to read reports -- and I think this is something that Chairman Levitt was referring to -- about other municipal market participants that engage in pay to play and similar activities. Some are alleged and some are still under investigation, but whatever the outcome, the market suffers from an appearance problem and that's not good for the muni market or for any market.

Early this year we wrote to you and your colleagues in the House Financial Services Committee about the potential for regulation of some or all of these other market participants. They serve critical roles in many of the complex finances and related derivatives transactions that have become commonplace. They advised state and local governments, big and small, on how to structure a bond issue, how to sell it, how to market it, why type of security to sell, how to invest bond proceeds, whether to use swaps or other related derivatives.

We believe these and other similar market participants should be registered with the SEC and regulated by the MSRB with rules similar that were already applied to dealers. Many of these people are fiduciaries and they should be subject to standards of professional conduct. Pay to play should be prohibited, just like it was prohibited for dealers by the MSRB in 1994.

I want to emphasize that I know many of these participants and many of them are individuals who are ethical and well-qualified but, unfortunately, not all of them are and the activities of few can taint the entire market, if not by fact but by appearance. That's something we can't afford especially in the current crisis.

During the time, it's just as crucial that we have clear guideposts and that investor confidence in municipal security markets is not undermined by questionable practices.

Also, as Treasury seeks to find solutions to assist the municipal market through the crisis ensuring all market participants adhere to the highest professional standards is essential.

The MSRB looks forward to working with the committee as well as other regulators and market participants to ensure that the level of investor protection provided in the municipal market is second to none.

Senators, thank you for inviting the MSRB to participate in this very important hearing. Thank you.

SEN. DODD: Thank you very much, Mr. Stack. And Richard Baker, we welcome you to the committee.

MR. BAKER: Thank you, Mr. Chairman. Ranking Member Shelby, members, I am indeed delighted to be back after the prohibited period from my engagement with policy makers and for the record to reflect, I did not engage anyone during the prohibited period. Delightful to be here today.

The MFA represents a majority of the world's largest hedge funds and is a primary advocate for sound business practices for industry professionals. We appreciate the opportunity to be invited and to comment today about the systemic risk concerns and we are committed to being a constructive participant in the discussion going forward.

Hedge funds do provide liquidity and price discovery to markets, capital to allow companies to grow or turn their businesses around, and sophisticated risk management tools for investors, such as pensions, to allow them to meet their obligations. To form these functions we require sound counterparties and stable market structures. The current lack of certainty regarding financial condition of major financial institutions has limited the effectiveness of the stabilization efforts and this uncertainty inhibits investor's willingness to put their capital at risk or transact with these firms. The relative size and scope of the industry helps explain why, we believe, hedge funds do not pose significant systemic risk, despite the current market environment.

With an estimated 1.5 trillion (dollars) under management the hedge fund industry is significantly smaller than the $9.4 million mutual fund industry or the $13.8 trillion banking industry.

Because many hedge funds use little or no leverage, contrary to many public comments, their losses did not pose the same potential systemic concerns that losses are more highly leveraged institutions presented. One recent study found that 26.9 percent of hedge funds do not deploy leverage at all. And a recent 2009 report by the FSA, the Financial Services Authority, indicated that the leverage of hedge funds was on average less than three to one.

Mr. Chairman, the regulated -- the hedge fund industry was not the root cause of the ongoing difficulties in our financial markets but we have a shared interest with all other market participants in reestablishing sound financial system. To that end, restoration of stability can be accomplished through careful, deliberate approach towards a goal of a smart financial regulatory construct, one which would include investor protections as well as a systemic risk analysis.

Smart regulation means improving the overall functioning of the financial system through appropriate, effective and efficient regulation, while encouraging adoption of industry best practices which promote efficient capital markets, integrity, investor protections, and enabling better monitoring of potential systemic risk events.

We believe that a single systemic risk organization -- and I've not been absent during the preceding discussions, I would merely want to point out that an organization charged with this responsibility would be better than multiple systemic regulators which would likely have difficulty because of jurisdictional conflicts, unintended regulatory gaps, inefficient and costly redundancies. So to the extent a regulatory shop can be constructed it should be a single entity to have that responsibility.

We do support confidential reporting to that systemic regulatory structure by entities the regulator deems to be of systemic relevance, any information the regulator deems necessary or advisable for it to assess systemic risk potential.

It is important for this authority to allow the regulator to be forward looking and adaptable to ever changing market conditions.

It is critical the reported information be granted full protection from public disclosure, which we believe can be done without inhibiting the ability of the regulator to protect the overall system.

In our view, the mandate of this entity should be protection of the financial system and not include investor protection or market integrity, a role already that exists in the hands of multiple existing regulatory bodies.

With respect to that mandate, because systemically relevant firms likely would not pose the same risk in all circumstance, we also believe the regulator should not focus on preventing the failure of a particular firm but rather only in the event that firm's failure would be likely to bring about adverse financial system consequences.

We strongly believe the systemic risk regulator should implement its authority in a way that avoids competitive concerns and moral hazards that could result from a firm having an ongoing established government guarantee against its failure. Therefore, we believe a systemic risk regulator would need authority to seek to prevent systemic risk in a forward looking manner, address systemic concerns once they have arisen in a manner it deems appropriate, the ability to ensure that a failing firm does not threaten the financial system. And we know that policy makers are also contemplating concurrently a notion of a prudential regulatory framework, including mandatory registration.

We believe that well advised regulation should be based on the following principles; regulation that is tailored to meet indentified needs, not nebulous in construct; secondly, ongoing public private exchange with notice comment and implementations so that appropriate comment may be made on proposed regulatory interventions; reporting of appropriate information, which could be left to the regulator with confidentiality of sensitive and proprietary always being protected; regulatory distinctions to be recognized between the various nature of the differing market participants; and encouragement of strong industry practices and robust investor diligence.

I would like to mention, just briefly, one other area I know of concern, short selling facilitates price discovery, mitigates asset bubbles, and increases market liquidity. It is a critical risk management tool for investors which allows them to take long positions in the market. We believe there is absolute solutions to address stated concerns about short selling that would enable us to continue in our current market practices without jeopardizing the important market benefits.

We look forward to continued discussion and answering any questions you may choose to pose.

Thank you, Mr. Chairman.

SEN. DODD: Thank you Congressman Baker.

Mr. Chanos.

MR. CHANOS: Thank you. Good afternoon, Mr. Chairman, Senator Shelby and members of the committee.

My name is Jim Chanos. I'm here today testifying as chairman of the Coalition of Private Investment Companies.

I thank you for the opportunity to testify on this important subject today.

The damage done by the collapse of global equity credit and asset backed markets has been staggering in scope. The plain truth is that there's not a single market participant, from banker to dealer to end user and investor, that does not share -- have to absorb some degree of responsibility for the difficulties we are confronting today. And while there's plenty of blame to spread around, there's little doubt that the root cause of the financial collapse lay at the large global diversified investment and commercial banks, insurance companies, and governing sponsored enterprises under direct regulatory scrutiny.

Notably, hedge funds and investors have generally absorbed the painful losses of the past year without any government cushion or taxpayer assistance.

While hedge funds and other types of private investment companies were not the primary catalyst for our current situation, it is also true that these private pools of capital should not be exempt from the regulatory modernization and improvement that will be developed based on lessons learned from financial calamities of the past 20 months.

CPIC believes that there are a few key principles that should be followed in establishing a regulatory regime for monitoring systemic risk.

First, regulatory authority should be based upon activities and not actors. The same activities should be treated similarly regardless of where it takes place. Proprietary trading at a major bank should not receive less scrutiny than the trading activity of a hedge fund.

Second, the system should be geared to size, meaning overall size or relative importance in a given market and complexity.

Third, all companies performing systemically important functions, such as credit agencies and others, should be included in this regime.

Fourth, the accuracy of required disclosures to shareholders and counter-parties should be considered systemically significant.

Fifth, the regulatory regime should be able to follow activities of systemically important entities, regardless of the affiliated business unit in which the entity conducts these activities.

Sixth and finally, the regulatory regime itself should be clear and unambiguous about the criteria that brings an entity under the new oversight regime.

Increasing the financial regulation of hedge funds and other private investment companies carries both risks and benefits. I'd like to chat about that for a few seconds. Relying on the fact of direct regulation in lieu of one's own due diligence will undermine those parts of the private sector that continue to work well and thus hamper the goal of restoring market strength and confidence. While it is clear that our regulation should have the ability to examine the activities of significant pools of capital to help mitigate against activities that would disrupt the markets, simply trying to wedge hedge funds and other private investment funds into the Investment Company Act or Investment Advisors Act is not likely to achieve that goal.

If direct regulation is deemed necessary, Congress should consider a standalone statutory authority for the SEC or other regulator that permits the commission to focus on market-wide issues that are relative to managers of institutional funds while not undermining essential investor due diligence.

Perhaps the most important role that hedge funds play is as investors in our financial system. To that end, CPIC believes that maximum attention should be paid to maintaining and increasing the transparency and accuracy of financial reporting to shareholders, counter-parties and the market as a whole. Undermining accounting standards may provide an illusion of temporary relief, but will ultimately result in less market transparency and a much longer recovery.

Private investment companies play an important role in the market's efficiency and liquidity. They help provide price discovery, but they also play the role of financial detectives. Government actions that discourage investors from being skeptical, from being able to hear from differing opinions, or to review negative research, ultimately harms the market. Indeed, some say that if Madoff Securities had been a public entity, short sellers would have blown a market whistle long ago.

Honest and fair dealing are at the foundation of investor confidence our markets have enjoyed for so many years. A sustainable economic recovery will not occur until investors can again feel certain that their interests come first and foremost with the companies, asset managers and others with whom they invest their money and until they believe that regulators are effectively safeguarding one against fraud.

CPIC is committed to working diligently with this committee and other policymakers to achieve that difficult but necessary goal. Thank you very much.

MS. ROPER: Thank you for the opportunity to testify here today regarding the statutes that the Consumer Federation of America believes are necessary to enhance investor protection and improve regulation of the securities market.

My written testimony describes a dozen different policies in a dozen different areas. Out of respect for the length of today's hearing, I will confine my oral comments to just two of those: bringing the shadow banking system within the regulatory structure and reforming credit rating agencies.

Before I get into the specific of those issues however, I would like to spend a brief moment discussing the environment in which this policy review is taking place. For nearly three decades, regulatory policy in this country has been based on a fundamental belief that market discipline and industry self-interest could be relied on to rein in Wall Street excesses. That was the philosophy that made the Fed deaf to warnings about unsustainable subprime mortgage lending. It was the philosophy that convinced an earlier Congress and administration to override efforts to regulate over-the-counter derivatives markets, and it is the philosophy that convinced financial regulators that financial institutions could be relied on to adopt appropriate risk management practices.

In short, it was this misguided regulatory philosophy that brought about the current crisis, and it is this philosophy that must change if we are to take the steps needed to prevent a recurrence.

In talking about regulatory reform, many people have focused on the creation of a systemic risk regulator. And that is something CFA supports, although as others have noted the devil is in the details. We believe it is at least as important, however, to directly address the risks that got us into the current crisis in the first place. And that includes bringing the shadow banking system within the regulatory structure.

Overwhelming evidence suggests that a primary use of the shadow banking system, and indeed a major reason for its existence, is to allow financial institutions to do indirectly what they would not be permitted to do directly in the regulated markets. There are numerous examples of this in the recent crisis, including for example banks holding toxic assets through special purpose entities for which they would have had to set aside additional capital had they been held on balance sheet; or AIG offering insurance in the form of credit default swaps without any of the protections designed to insure their ability to pay claims.

The main justification for allowing these two systems to operate side by side, one regulated and one unregulated, is that sophisticated investors are capable of protecting their own interests. If that was true in the past, it is certainly not true today. And the rest of us are paying a heavy price for their failure to protect their interests.

To be credible therefore, any regulatory reform proposal must confront the shadow banking system issue head-on. This does not mean that all financial activities must be subject to identical regulations, but it does mean that all aspects of the financial system must be subject to regulatory scrutiny.

One focus of that regulation should be on protecting against risks that could spill over into the broader economy. But regulations should also apply basic principles of transparency, fair dealing and accountability to these activities in recognition of two basic lessons of the current crisis: one, protecting investors and consumers contributes to the safety and stability of the financial markets; and, two, the sheer complexity of modern financial products has made former measures of investor sophistication obsolete.

Complex derivatives and mortgage backed securities were the poison that contaminated the financial system. But it was their ability to attract high credit ratings that allowed them to penetrate every corner of the market. Given the repeated failure of the credit rating agencies in recent years to provide timely warnings of risk, it is tempting to conclude, as many have done, that the answer to this problem is simply to remove all references to credit ratings from our financial regulations.

We are not yet prepared to recommend that step. Instead, we believe a better approach is found in simultaneously reducing but not eliminating our reliance on ratings, increasing the accountability of ratings agencies by removing First Amendment protections that are inconsistent with their legally sanctioned status, and improving regulatory oversight.

While we appreciate the steps Congress, and this committee in particular, took in 2006 to enhance SEC oversight of ratings to agencies, we believe the current crisis demands a more comprehensive response.

As I said earlier, these are just two of the issues CFA believes deserve congressional attention as part of a comprehensive reform plan. Nonetheless, we believe these two steps would go a long way toward reducing systemic risks, particularly combined with additional steps to improve regulatory oversight of systemic risks going forward. Bold plans are needed to match the scope of the crisis we face. CFA looks forward to working with its commission to craft a reform plan that meets this test and restores investors' faith both in the integrity of our markets and in the effectiveness of our government in protecting their interests.

SEN. REED: Thank you very much.

Mr. Tittsworth.

MR. TITTSWORTH: Thank you, Senator Reed. We really appreciate the opportunity to testify today.

The Investment Adviser Association represents the interests of SEC registered investment advisers. The advisory profession serves a wide range of clients, including individuals, trusts, families, as well as institutions such as endowments, foundations, charities, state and local governments, pension funds, mutual funds and hedge funds. There are about 11,000 SEC registered advisers. Most of these are small businesses. About 7,500 employ 10 or fewer employees, and 90 percent employ fewer than 50.

Our statement outlines our views on broad regulatory reform topics, but I'm just going to emphasize one point, the need to address true regulatory gaps in two situations.

First, we continue to support the registration, regulation of hedge fund managers by the SEC. We believe that investors in the markets will benefit from the disclosure, compliance protocols, record-keeping, examinations, and other requirements that accompany SEC registration.

We also support regulation of credit default swaps and other derivatives. Action must be taken to ensure that they can no longer exist outside of the regulatory system.

Our testimony also addresses two issues that directly relate to the Investment Advisers Act. The first is the so-called 'harmonization' of broker and advisor regulation. This idea seems to be predicated on the notion that brokers and advisors do exactly the same thing, and that one set of laws and regulations should apply to both. We respectfully disagree.

There are differences between most broker dealers and most investment advisers. Brokers are the sell side, typically execute securities transactions and sell financial products. Investment advisers, the buy side, provide advisory services, including managing client portfolios. Brokers often are compensated by commissions from selling products or executing trades, and any related financial advise is nondiscretionary; that is, requires customer consent to buy or sell.

In contrast, advisers generally are compensated by fees and provide ongoing discretionary management of client assets. Finally, brokers generally have custody of customer assets; whereas, most investment advisers use the services of independent third party custodians.

Because of these and other differences, it doesn't make sense to impose rules on investment advisers that are tailored to product sales. In recent years, brokers have migrated toward the investment advisory business, blurring some of the traditional lines and creating investor confusion. Accordingly, we believe that fiduciary standards should apply to anyone who offers investment advice.

This week we joined with the State Securities Organization, NASAA and the Consumer Federation of America in a joint letter to the committee to underscore this very important point.

The second issue addressed in our testimony is the proposed creation of a self-regulatory organization, or SRO, for investment advisers, which we oppose. Our statement outlines drawbacks to an SRO, including: inherent conflicts of interest; questions about transparency, accountability and oversight; and added costs and bureaucracy. We particularly oppose the idea of FINRA as the SRO for investment advisers, given its governance structure, costs, track record, and its bias favoring the broker/dealer regulatory model.

In closing, we believe the SEC has the expertise and experience to best regulate our profession, and it should have appropriate resources to do its job. Instead of creating an SRO for investment advisers, the following alternatives should be pursued.

First, the SEC should be fully funded, and Congress should examine alternatives to allow it to achieve long-term and more stable funding including self-funding mechanisms.

Second, as NASAA testified, the SEC should increase the $25 million threshold that separates SEC and state registered advisers.

Third, the SEC should improve its inspection program to better leverage and focus its resources.

We would be pleased to work with the committee and the SEC to explore additional ways to ensure the appropriate and effective regulation and oversight of investment advisers, and I'd be happy to respond to any questions. Thank you.

SEN. REED: Thank you very much.

Ms. Bolger?

MS. BOLGER: Thank you, Senator Reed. Good afternoon.

SEN. REED: Could you make sure that's on and bring it closer to her?

MS. BOLGER: Is that better?

SEN. REED: I think so, yes. I'm kind of deaf. So.

MS. BOLGER: I'd like to state at the outset that we at S&P appreciate the seriousness of the current dislocation in the capital markets and the challenges it poses for the American and global economies. Restoring confidence is critical, and workable solutions will involve both governmental action and private initiative.

S&P has a long tradition of, and a strong cultural commitment to, integrity and professionalism. We recognize however that a number of our recent ratings in the structured finance area have not performed in line with our historical standards. We have reflected on these events, and we have made a number of changes to enhance our processes.

Recent calls for increased regulation of credit rating agencies have arisen in large part out of the poor performance of structured finance securities issued between the middle of 2005 and the middle of 2007, the years in which subprime lending was at its peak. From a regulatory perspective, it continues to point out that the world in which virtually all of these structured finance ratings were issued is not the world that we live and find ourselves in today.

NRSROs rose such as S&P are now subject a robust regulatory regime. That regime starts with the Credit Rating agency Reform Act which went into effect in June '07 and the rules promulgated by the SEC under it. Those rules deal with important topics such as resources, potential conflicts of interest, misuse of nonpublic information, and potentially abusive and unfair practices.

The SEC also has broad enforcement powers over NRSROs. Not only does the SEC have extensive examination and inspection authority, but it can take disciplinary action against NRSROs. Those include censure, fines, or even revocation of registration if deems such action to be in the interest of investors.

From my perspective as a participant in the process, the SSEC has been an extremely active regulator in exercising its oversight authority. Last year the SEC conducted an extensive examination of S&P, focused on our structured finance ratings. The exam, which lasted several months, involved dozens of meetings and interviews, production of a significant volume of documents, and resulted in a number of recommendations that we are implementing.

While the current regime has accomplished much in the short time it has been in place, we do believe additional measures could play a meaningful role in restoring investor confidence. Appropriate regulation can provide a level of comfort to investors that policies are being enforced and that there is consistency and integrity in the rating process. I also do want to note that we are pleased to be participating in the SEC's April 15th roundtable on rating agencies which Chairman Schapiro referenced this morning.

We also believe in an end-to-end approach for legislation and regulation. That is, it should be designed to cover all aspects of the capital markets that, when taken together, contribute in a systemic way to their functioning. With particular regard to ratings, such an approach would include not just oversight of rating agencies but also appropriate measures for those involved in generating the information that's used in the analysis, the sale and the marketing of the rated securities, and the use of ratings.

For example, an important factor in ratings quality is the quality of information available to be analyzed. That information is not generated by rating agencies but by others such as in the (RNBS) (ph) area, mortgage originators and lenders. In our view, oversight of these entities and the roles they perform should be part of any regulatory approach.

As detailed in my written statement earlier this month, S&P published an article reflecting our thoughts on what a regulatory framework for rating agencies might look like. I have included a copy of that for the record. I would like to highlight here just two particular features.

The first is analytical independence. For the markets to have confidence in ratings, they must be made independently. That means of course that the judgments must be free of conflicts of interest and undue commercial considerations. We are fully committed to that principle. It also means that the judgments must truly reflect the substantive views of the analysts making them and not directed by a regulator or other external authority.

The second point is the need for international regulatory consistency. Ratings are issued and used globally. A rating produced under one set of regulations may not mean the same thing or address the same risks as one produced under another if those regulations are not compatible. Inconsistent ratings regulation could actually promote uncertainty in the markets at a time when it can be least afforded.

In short, the focus should be on promoting consistency and integrity in the ratings process. Many of the steps we have outlined and the measures we have taken are aimed at precisely that goal.

Thank you for the opportunity to participate in the hearing. Let me also assure you again of our commitment to analytical excellence and our desire to continue to work with Congress and all governments world-wide. I'd be happy to answer any questions.

SEN. REED: Thank you. Before I introduce Mr. Curry, I must excuse myself. And Senator Akaka will take the gavel and conclude the hearing. Thank you, Senator Akaka. Thank you, ladies and gentlemen.

SEN. DANIEL AKAKA (D-HI): Mr. Curry.

MR. CURRY: Thank you, Senator Reed. Thank you, Senator Akaka. Good afternoon. My name is Dan Curry, and I'm the president of DBRS, Inc. I am pleased to have the opportunity to present DBRS's views on the regulation of credit rating agencies and investor protector.

But first I'd like to give you some background on our firm. DBRS is a Toronto-based credit rating agency established in 1976 and still owned by its founders. With U.S. affiliate located in New York and Chicago, DBRS is a full-service rating agency that maintains ratings on more than 43,000 securities in 35 countries.

DBRS is committed to ensuring the objectivity and integrity of its ratings and the transparency of its operations. DBRS was designated as an NRSRO in 2003, the first non-U.S. based rating agency to attain that designation. DBRS is now registered under the Credit Rating Agency Reform Act which Congress passed in 2006.

Now I'd like to turn my attention to the important issue of competition. It is no secret that the credit rating industry in the United States is dominated by three large agencies. The market you see today was fostered by a regulatory system that gave special treatment to NRSRO credit ratings, yet made the process of attaining that designation opaque and hard to navigate.

Although the Credit Rating Agency Act has made more competition possible, the actual competitive landscape has been slow to change. We believe that the continued dominance of the three largest rating agencies contributed to the recent turmoil in the structured finance market when changes in the assumptions underlying their rating models led to rapid and dramatic rating downgrades.

As the markets struggle to regain their footing, more needs to be done to open this industry to competition. Although the government can be a catalyst for change, the opposite seems to be occurring.

Recognizing that the securitization markets have ceased to function, the Federal Reserve has created the Term Asset Backed Securities Loan Facility," or TALF. In order to be eligible for this program, the security must receive a AAA rating from Standard and Poor's, Moody's or Fitch, which the Fed calls "major NRSROs." The result of this approach is that DBRS, with over 30 years of experience as a rating agency and more than six as an NRSRO, is unable to rate TALF-eligible securities even though several issuers have asked it do so.

For the foreseeable future, the TALF is likely to be the entire securitization market in the United States. Therefore, by excluding all by the three largest rating agencies from this program, the government may be further entrenching the historic oligopoly for years to come.

The long-term efficiency of the capital markets requires that rating agencies be allowed to compete on the quality of their work, not their size or their legacy. DBRS urges Congress to take whatever steps are necessary to make the Rating Agency Act's promise of competition a reality.

The next issue I'd like to address is that of uniform regulation. Ensuring that NRSRO regulation treats all business models equally is critical to investor protection. This is especially true in the area of ratings transparency. There has been much debate about the relative accuracy of ratings determined under the issuer pay model and subscriber pay models.

This debate cannot be resolved so long as investors and other market participants are unable to verify the accuracy claims made by subscriber-based ratings providers. Anecdotal discussions by these firms of where they got it right are no substitute for an objective, independent analysis of the universe of their ratings. DBRS urges policymakers and regulators to recognize the importance of transparency for all rated agencies.

Finally, I'd like to address the need for stable regulation. DBRS sees no need to abandon the regulatory regime established under the Rating Agency Act because this regime is barely 18 months old and no superior alternative has been identified. Moreover, DBRS sees no benefit in transferring jurisdiction over rating agencies from the SEC which has overseen this area for 34 years, to a regulator that has no experience.

Interposing a self-regulatory body between rating agencies and the SEC would be the worst idea of all since this would lead to a duplicative regulation by a costly private bureaucracy that may or may not know anything about the industry. A better approach would be to ensure that the SEC has the necessary resources to effectively examine NRSROs and to enforce the existing laws and rules.

My written statement addresses some additional issues. I'd be happy to answer any questions you may have. Thank you.

SEN. AKAKA: Thank you very much, Mr. Curry. I want to thank all of you for your patience. And also to tell you that all of this, your full statements will be placed in the record.

I'd like to ask my first question to the one who has been an advocate, one that I've been with before. And I want to ask Ms. Roper as an advocate, as an independent entity within the Internal Revenue Service, the National Taxpayer Advocate has evolved into an essential organization that has protected and assisted taxpayers. I have highly valued the dedicated efforts of the National Taxpayer Advocate and Ms. Nina Olson and her staff. Using the Taxpayer Advocate Organization as a model, and creating an investor advocate at the Securities and Exchange Commission has the potential to be an extremely valuable addition to assist and protect taxpayers.

My question to you is, what is your evaluation of creating an investor advocate at the SEC?

MS. ROPER: Thank you, Senator. Ideally, it would be superfluous to have an investor advocate at the SEC. The SEC portrays itself as the investor advocate. My experience working on this issue as an external investor advocate for over 20 years now is that there are many times when we would have benefited from having an advocate on the inside to carry the investor's case.

I can see several different areas where I think this would be particularly useful.

As investor advocates we have often been frustrated that our view is not addressed in the agency policymaking from the outset, that it is something that ends up being incorporated at best later during the comment period, often with very little effect.

Having an internal advocate who could ensure that investors' views are integrated into the rulemaking process, conduct research outreach, I think would be extraordinarily useful.

SEN. AKAKA: Yes. Also Ms. Roper, we share an interest in protecting mutual fund investors. Mutual funds are what average investors rely on their retirement, savings for their children's college education as well, and all the financial goals and their dreams. I have advocated for strengthening the independence of mutual fund boards and improving relevant and meaningful disclosures for investors' transparency.

My question to you is, what must be done to better protect and inform mutual fund investors?

MS. ROPER: Thank you again, Senator. As you know, we have endorsed your legislation on mutual funds and share those goals. And I very much look forward to a time when our primary priorities are helping average retail investors make better informed decisions and have better protection in the marketplace that hasn't been at the top of our agenda with the global economy in crisis.

But I think -- and because the damage that's been done to investors has been, you know, sort of done indirectly through the failure of the system as a whole.

There was a robust mutual fund reform agenda that was put on the table at the SEC in the wake of the mutual fund trading scandals, and then was allowed to, you know, sort of fall by the wayside.

I think it would be extraordinarily useful to bring back some of the ideas that were under discussion at that time, including better point of recommendation, disclosures -- you know, independent governance, as you suggested.

And not just limited to mutual funds, but the entire issue of broker-dealer compensation and how that creates a set of incentives that operate against investor interests, I think, are extraordinarily important issues that it would be nice to be able to get back to at some point in the near future.

SEN. AKAKA: Well, thank you for your responses.

I'd like to ask the next question to Mr. Richard Ketchum.

Our modern, complex economy depends on the ability of the consumers to make informed financial decisions. And as you know, we've been spoting the trend for more financial literacy in our country.

Without sufficient understanding of economics and personal finance, individuals will not be able to appropriately evaluate credit opportunities successfully, invest for long-term financial growth, or be able to manage difficult financial situations.

My question to you is what must be done to ensure that investors have the knowledge and skills necessary to make informed investment decisions?

MR. KETCHUM: Well, thank you, Senator.

SEN. AKAKA: Before you do -- let me say that FINRA has been doing a good job already, that -- and I know that.

Thank you.

MR. KETCHUM: Well, I appreciate that. As you know, the FINRA Investor Education Foundation is the largest foundation solely focused on investor education.

And given that we both feel good about the progress we've made and recognize the enormity of the task, we have tried to, as best we can, to both -- through placing a rich series of informative efforts from the standpoint of our Web site on FINRA.org and efforts to try to attract investors to look at those various different pieces of information, efforts to identify everything from questions to ask with respect to complex products to things to be concerned about with respect to potential scams, as well -- working very closely with some of the most vulnerable constituencies, particularly from the standpoint of our seniors, our military, et cetera.

I think the only answer with respect to investor education is to keep on going on with more and more resources and more and more cooperation between enterprises that have constituencies and concern with respect to this area.

And you're right, it can't just be with respect to investors that exist today; it has to be a strong effort from the standpoint of our schools as well.

We're very much committed to be part of that process. It is something that deserves more attention from a governmental standpoint and more attention across any of us that cares deeply about the quality of our securities markets.

SEN. AKAKA: Thank you very much for that.

And I want to pose this next question to a person that I knew in the House, Representative Baker. And I think you left there -- or you were there when I left there, the House, and moved to the Senate. But it's good to see you again.

MR. BAKER: Thank you, Senator.

SEN. AKAKA: Chairman Breeden said, and I'm quoting, "The disasters we have seen did not arise due to lack of resources for the Federal Reserve, the SEC, or any other agencies that didn't perform as well as needed -- to do, or because of outdated laws from the '30s," unquote.

The banking and securities regulators generally had tools to address the abuse of practices, but didn't use their powers forcefully enough or ask for new authority promptly, when they needed it.

My question to you, how would you recommend addressing this problem so that the regulators will be more effective in the future?

MR. BAKER: Thank you, Senator.

It's a tremendously difficult question, in that if you would go back in time, perhaps 24 months, and look at market conditions and the tremendous profitability that had existed for some number of years, and the expectation by many that it would continue into the foreseeable future, there was, at the same time, columns of regulatory authority that were constructed.

Within each column there may have been particular skills sets which could have been deployed, but because of the lack of information flows between those columns, complex instruments were created that didn't fit neatly within a column and remained outside the transparency required for someone to make an informed decision.

I would say that there were people in the market who exercised analytical skills and who did, in fact, predict that some of these very unfortunate circumstances possibly would occur.

They, for the most part, were in the private sector, who were skilled analysts looking at the financial bubble that was growing in significant size.

How we could construct a new systemic regulatory structure and enable a single person to be able to see the entire view of the market and come to an appropriate and timely decision would probably be almost impossible.

Having an organization of some sort, there has been discussion this morning as to concerns about the SEC, the Federal Reserve, the existing entities. But I think we should be cognizant of the fact that none of those entities had access to the level of transparency that would have enabled them to make that collective, almost omniscient, insight into the coming storm.

So I believe that, as we suggested in our testimony, the construction of a regulatory entity -- I've been very careful not to say a particular agency -- that has access to market information in a timely manner while, at the same time, protecting the privacy of that disclosure by the registered entity, would perhaps -- I'm not sure it would guarantee -- enable that entity to be able to take steps early on and perhaps limit the scale and scope of damage.

Certainly we would like to be a participant in that discussion going forward. We have specific ideas that, at the appropriate time, may be appropriate to consider.

But we recognize that it is a very difficult problem. I'm glad you are where you are, Senator, and I'm glad I'm -- don't have that decision any longer. (Laughter.)

SEN. AKAKA: Thank you very much, Representative Baker. I want to direct my next question to Mr. Stack.

At our last hearing on securities regulation, Thomas Doe, a former member of your board, stated that, and I'm quoting, "the 34- year era of the municipal industry's self-regulation must come to an end," unquote.

In advocating this position, Mr. Doe emphasized that MSRB's structure, two-thirds of which is comprised of either bank dealers or securities dealers, has led to a situation of industry capture where the insurers -- issuers and underwriters are then responsible for regulating their own conduct.

What is your evaluation of these comments?

MR. STACK: Senator, I take extreme exception to Thomas Doe's comments. I believe that the MSRB, which was the first SRO created in 1975, has worked extraordinarily well.

What we -- the measures of an SRO such as the MSRB are, first, do we protect investors? And how we do that is through our ability to ensure immediate and clear disclosure to both retail, institutional, small and large investors. We've established a new electronic system on the Web to ensure the up-to-date investor information that they can get.

We also regulate, up to the extent that the statute allows, very clearly, all of the municipal dealers and brokers. And -- in very strong terms.

For example, we are the only group that prohibits a pay-to-play; that is, that you cannot, if you're involved in municipal securities, contribute to a -- somebody running for office who can issue municipal debt. Okay? No one else has done that.

Interestingly enough, because we are an SRO, we can do something even more -- tougher than, say, than our more -- we'll call it, our parent body, the SEC, because we have the ability to set very, very strong rules.

Another thing I would like to say is that all of our rules that we do governing our brokers and their dealers are sent out for comment by -- to the public, to investors, to everybody around. And then we present our proposed rules to the SEC.

So it isn't that we are off in ether-land (ph) -- you know, just kind of somewhere out there making our own rules for brokers. All of our rules go to the SEC for review, and the SEC decides whether or not to approve it.

Finally, some of the problems that we have, I mentioned in my testimony that we've encountered, are that there are many participants in our market who are right now unregulated -- financial advisers, SWAP advisers, investment advisers -- and they are unregulated -- and they are unregulated, and they are not registered with the SEC, and we have no power to regulate them.

We have written the House committee and we've written your Committee and asked for the ability -- asked for federal regulation of these groups in order that they can meet -- have professional standards, in order that they can meet the kind of stringent requirements that we have for brokers and dealers, including and specifically pay-to-play.

We think if we can regulate those participants, that the market will operate well.

In conclusion, we believe the SRO system does work well and it should not be considered to be absent of the SEC, but as a way to bring in -- I've read the Senate Committee report when the MSRB was set up in 1975 -- of using the expertise of the market participants, and then using that to come up with rules to govern it.

These rules, as I say, can be tougher. And then those rules are submitted to the SEC. And the SEC then approves whether or not those rules then go into effect.

So we think that the SRO is actually a very tough organization, way to organize and to supervise dealers. The SEC's not limited, but it sticks pretty much to anti-fraud issues. We can do much further, and pay-to-play is a perfect example of where we have.

SEN. AKAKA: Well, I thank you so much for that. It's -- (inaudible) -- it personally.

I would rather that we not craft laws just to try to deal with these. But in this particular case, the MSRB should just move, as you said -- what you mentioned, I wish we could do at this time. But thank you so much for your comments on that.

MR. STACK: Thank you --

SEN. AKAKA: Let me direct the next question to Mr. Tittsworth and Mr. -- is it (pronounces Chay-nus) or (pronounces Cho-nus)?

MR. CHANOS: (Pronounces Chay-nus), Senator.

SEN. AKAKA: Chanos. Thank you.

And I'm looking for an important recommendation, and so I'd like to hear from both of you which one recommendation that you feel is the most important legislative or regulatory initiative that this committee must undertake in the modernization of financial market regulation?

MR. TITTSWORTH: I'll take it very quickly, Senator. I think, at the top of our testimony, again --

SEN. AKAKA: (Inaudible.)

MR. TITTSWORTH: -- it's closing what I would call true regulatory gaps, not this perceived regulatory gap that some have talked about, between investment advisers and broker-dealers that's totally nonexistent.

True regulatory gaps, and by that I mean products or services that are unregulated, that are outside the regulatory system -- and the two I mentioned are hedge fund managers and credit default swaps and derivatives.

SEN. AKAKA: Thank you very much. Any other comments?

MR. CHANOS: Senator, I would use my answer to just point out our overriding viewpoint on regulation, current and future, and that is that the current and expected regulatory framework regulates and examines the activities, not the actors; that is, they focus on that which is going on in the marketplace across different corporate and private and public investment lines, and not just be hamstrung to, for example, for the Fed to look at bank holding companies, the SEC look at securities firms.

We need to really focus on how our markets have changed down through the years and have morphed beyond the view of the '33 and '34 and '40 acts, and come up with smart regulation, as someone said earlier, not necessarily more regulation.

SEN. AKAKA: Thank you very much. I wanted to be certain that we would offer every one of you a chance to make comments. So let me direct this question to Ms. Bolger and Mr. Curry.

The Wall Street Journal reported that despite the failure of ratings agencies' models during this financial crisis, Moody's, S&P, and Fitch have, quote, "made few fundamental changes to the way they assess debt," unquote.

Please tell us what you think went wrong in your original assessment of these assets and why we should trust your agencies to weight these same assets again, now that taxpayer money is at risk.

MS. BOLGER: Thank you, Senator.

SEN. AKAKA: Ms. Bolger.

MS. BOLGER: And actually, before answering, I would respectfully request that the white paper on regulation -- I mentioned it in my remarks -- that that be placed in the record. Thank you.

SEN. AKAKA: (Inaudible.)

MS. BOLGER: I think the -- certainly in terms of some of the ratings in structured finance, just stepping back, we have almost a hundred-year history of rating a tremendous amount of securities, and a very good track record.

But in connection with some of those securities, I think the performance that we have seen, that the market has seen, has not been consistent with that historical track record. Some of the assumptions that we used simply weren't borne out.

However, we have stepped back; we've taken a very serious look at our processes, and we have made a number of changes -- changes both that have been required in connection with two -- now two, and actually today is the conclusion of a final draft period for SEC rulemaking, so we have made changes in connection with their requirements. We have also made some changes on our own initiative.

And we think, moving forward, it's important -- again, picking up on the theme of smart regulation -- that we focus on regulation that preserves our analytical independence and also that is globally consistent in connection with some of these actions we have taken.

SEN. AKAKA: Thank you.

Mr. Curry.

MR. CURRY: Thank you, Senator.

I think that at the root of the problem in the structured securities was the reliance on the decisions of just a few people using models to determine these ratings. At the same time, the securities became so complex that investors were really unable to exercise enough judgment around the risks that they were taking.

And we're going through the flip side of that process, I think, right now, where there are some very substantial changes to assumptions -- again, in these models made by a few people -- that lead to massive rating downgrades, but still a lack of understanding of fundamentally what is behind this analysis.

And given that the current rating agency reform act does not extend to the substance of ratings, I think that transparency becomes very critical. And that's going to be a big challenge in how that's managed.

I still don't think that the transparency's adequate, and I worry that a lot of the changes that have taken place are more administrative and don't really prevent us from ending up in this same situation again seven or eight years down the road.

SEN. AKAKA: Well, thank you very much, Mr. Curry.

Without question, all of you have been very helpful to the -- to the Committee. We're looking forward to improve whatever needs that in our nation.

I want to thank all the witnesses for being here. I want you to know that we appreciate the significant time that you, our witnesses, have spent with us today.

This hearing record compiled today will, without question, help us develop policies to better protect investors and improve the regulation of the securities market. And we look forward to continuing to hear from you and, with much hope, we're looking at an improvement in our nation's crisis that we're in at this time.

This hearing record will remain open for a week for members to submit any additional statements or questions that they may have.

Again, thank you very much, and this hearing is adjourned. (Sounds gavel.)

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