Hearing of the Securities, Insurance and Investment Subcommittee of the Senate Committee on Banking, Housing & Urban Affairs - Strengthening the Sec's Vital Enforcement Responsibilities
Statement
Chaired By: Senator Jack Reed (D-RI)
Witnesses: Richard Hillman, Managing Director, Financial Markets and Community Investment, Government Accountability Office; Robert Khuzami, Director, Division of Enforcement, Securities and Exchange Commission; Professor Mercer Bullard, Associate Professor of Law, University of Mississippi School of Law; Bruce Hiler, Partner and Head of Securities Enforcement Group, Cadwalader, Wickersham and Taft LLP
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SEN. REED: Let me call the hearing to order.
I want to thank you all for coming today and particularly thank the witnesses and thank my colleague Senator Bunning.
Today's hearing examines the important role of the Securities and Exchange Commission in protecting investors by aggressively enforcing federal securities laws. It's no secret that the Securities and Exchange Commission finds itself in a challenging time, facing severe criticism, some fair, some not, for failing to prevent the subprime meltdown and subsequent financial crisis and more recently from its failure to detect and prevent the estimated $60 billion Bernard Madoff Ponzi scheme.
When the SEC falls behind on its responsibilities, these effects are seen not just on Wall Street but on Main Street throughout this country. For instance, the philanthropic foundation that donated over $24 million last year to nonprofits around the country, including $350,000 in my own home state, closed its doors in January because the foundation's donor's funds were being managed by Mr. Madoff.
As the SEC tries to restore its aggressive watchdog capacities, we are grateful that GAO joins us today to share the results of the study Senator Dodd and I requested back in March of last year that provides key in-depth information to help us consider improvements to the Securities and Exchange Commission.
GAO's review of the SEC's Enforcement Division, which included in-depth focus group interviews with staff throughout the division, found that in recent years, significant resource challenges and internal policy changes undermined the agency's ability to bring enforcement actions and these problems occurred at the very time the SEC needed to be more aggressive than ever about overseeing our securities markets.
I just want to highlight a few of the more significant findings in the GAO report. The SEC managers and attorneys throughout the agency agreed that two corporate penalty policies put in place in 2006 and 2007 had the effect of delaying cases and producing fewer smaller penalties, with penalties declining at an accelerating rate, falling 39 percent in 2006, 48 percent in 2007 and 49 percent in 2008.
Staff also felt that the SEC had retreated, in their words, on penalties, and made it more difficult for an investigative staff to obtain formal orders of investigation, which allow issuance of subpoenas for testimony and records. Formal orders decreased 14 percent since 2005. In addition, a burdensome system for internal case review has slowed cases and created a risk-averse culture.
Finally, resource challenges have delayed cases, reduced the number of cases that can be brought, and potentially undermine the quality of some cases. Adjusted for inflation, the Division of Enforcement's fiscal year 2008 budget amount is down 8.2 percent from the fiscal year 2005 peak. Total enforcement staffing has declined 4.4 percent, and the number of front-line investigative attorneys declined 11.5 percent from 2004 to 2008.
I am, however, encouraged by the SEC's steps to address some of these problems, most notably the change policies to take the handcuffs off of enforcement staff, as Chairman Schapiro has described it. I hope today to hear what additional improvements the SEC is considering.
It is clear to me that although you can't address all of the SEC's challenges just by giving them new resources, GAO's report confirms what many of us have known for a while -- the SEC needs more resources to effectively meet its mission of policing large and complex securities markets.
Last week I sent a letter to the Appropriations Committee, co- signed by 12 of my Senate colleagues, requesting an increase in funding for the SEC to hire more examiners and enforcement attorneys and invest in technology that will help get the agency on the same playing field as the institutions that it oversees. I will continue to work with my colleagues to provide these resources and the oversight that is critical to the success of the agency.
At this time, I'd like to call on the ranking member, my colleague Senator Bunning.
SEN. JIM BUNNING (R-KY): Thank you, Mr. Chairman.
I appreciate our witnesses coming out this afternoon to talk about the report being issued by the GAO and about enforcement matters in general. I think the report provides some useful information, such as recommendations to review and revise the structure and policies of the Office of Collection and Distributions.
The report also adds to what we already know: There are real problems at the SEC. Some of those problems may be in the budget, on resources of the agency, but I think the much larger and more significant problems are in the structure and policies of the agency.
For example, there are too many layers in the chain of command. I am also concerned that the tension between the staff of various divisions and the commission itself not only reduces the overall effectiveness of the agency but also leads each to undermine the other.
I do think the new SEC chairman has taken some positive steps since she moved to the commission and her quick action on the recommendations of this report shows that she is willing to attempt to fix problems at the agency. However, we should not kid ourselves that all the agency problems will be fixed by new management. After all, the last agency the new chairman was in charge of did not do anything to stop Bernie Madoff's fraud, as my chairman has also brought out.
I also do not think just adding to the SEC's budget will fix all the problems. Every time this or any agency fails in their mission, they always claim they need more resources. In fact, that's what we heard after WorldCom and Enron.
Yet even after new laws and more staffing and funding, Madoff's Stanford auction rate securities and the whole subprime scandal, just to name a few, still happened under the nose of the SEC.
I think the new management should focus on spending its resources more effectively than rather just increasing its budget. For example, as the GAO report points out, it may make more sense to hire administrative and support staff to help the investigators rather than just adding to the numbers of attorneys.
The agency should also be looking at hiring experts in the field, like accounting and computers, as well as those who have experience in our (ordered ?), complicated markets to support existing investigations rather than hiring new investigators.
If the agency truly needs more resources to accomplish this, Congress should consider the request. But that request should first explain how they will use their resources more effectively. One good place to start is with a flatter chain of reporting.
I look forward to hearing from our witnesses and look forward to more hearings in the future to look into the problems at the SEC and how we can address them. Thank you.
SEN. REED: Thank you very much, Senator Bunning.
Let me now introduce our panel. Our first witness will be Mr. Richard Hillman, the managing director of the Financial Markets and Community Investment Group at the Government Accountability Office. Mr. Hillman has served over 30 years with the GAO and has recently overseen reviews of TARP, regulatory modernization, hedge funds, private equity funds, Basel II capital standards and sovereign wealth funds.
Welcome, Mr. Hillman.
Our second witness will be Mr. Robert Khuzami, the director of the Division of Enforcement at the Securities and Exchange Commission. Before joining the Securities and Exchange Commission, Mr. Khuzami was a federal prosecutor for 11 years with the United States attorney's office for the Southern District of New York, and more recently served as the general counsel for the Americas at Deutsche Bank.
Our third witness today will be Professor Mercer Bullard, associate professor of law at the University of Mississippi School of Law, where he teaches courses in securities, banking and corporate law. He previously practiced in the SEC enforcement and investment management offices of WilmerHale and was an assistant chief counsel in the SEC's Division of Investment Management. He is also the founder and president of Fund Democracy, a mutual fund shareholder advocacy group.
Our fourth witness is Mr. Bruce Hiler, partner and head of the Securities Enforcement Group at Cadwalader, Wickersham and Taft LLP. His practice focuses on securities enforcement and regulatory defense, corporate and regulatory counseling, internal investigations and securities litigation.
Thank you, gentlemen, for joining us today, and we'll begin with Mr. Hillman.
MR. HILLMAN: Chairman Reed, members of the subcommittee, I'm pleased to be here today to discuss the results of our recent study of the Securities and Exchange Commission's Division of Enforcement.
While the division plays a key role in helping the agency meet its mission by protecting investors and maintaining fair and orderly markets, in recent years questions have been raised about the capacity of the division to manage its resources and fulfill its law enforcement responsibilities.
My prepared statement discusses the results of our recent study and the major recommendations we made to help ensure that the SEC is effectively and efficiently using its resources in bringing enforcement actions. I would like to focus my opening remarks on two important areas, the first related to the extent to which the Enforcement Division has an appropriate mix of resources, and the second on recent trends and penalties and disgorgement ordered and the effects of adoption and implementation of recent penalty policies.
Overall, enforcement resources and activities have been relatively level recently, but the number of non-supervisory investigative attorneys decreased 11.5 percent during fiscal years 2004 through 2008. Enforcement management told us that resource levels had not prevented the division from continuing to bring cases across a range of violations, but both management and staff said resource challenges had delayed cases, reduced the number of cases that could be brought and potentially undermined the quality of some cases.
Specifically, investigative attorneys cited a low level of administrative, paralegal and information technology support and unavailability of specialized services and expertise. Also, enforcement staff said a burdensome system of internal review had slowed cases and that there was a culture of risk aversion.
During our review, enforcement management had begun to examine how to streamline the case review, but their focus was more processes- oriented and did not give consideration to assessing organizational culture issues. To address these issues we recommended that the chairman further re-evaluate the level and mix of resources dedicated to the Enforcement Division and assess the impact that the division's current review and approval process for investigative staff work has on organizational culture and the ability to bring timely enforcement actions.
Regarding our work on penalties and disgorgements, we reported that the total penalty and disgorgements amounts can vary on an annual basis, based upon the mix of cases concluded in any particular period. However, overall penalties and disgorgements ordered had declined significantly since the 2005/2006 period.
Specifically, total annual penalties fell 84 percent from a peak of $1.6 billion in fiscal year 2005 to $256 million in fiscal year 2008. Disgorgements similarly fell 68 percent from a peak of $2.4 billion in fiscal year 2006 to $774 million in fiscal year 2008.
While a number of factors can affect the amount of penalty or disgorgements that enforcement staff seek in any individual enforcement action, enforcement management, investigative attorneys and others agreed that two recent corporate penalty policies had a significant impact.
In 2006 the commission adopted a policy that focused heavily on two factors for determining corporate penalties: the economic benefit derived from wrongdoing and the effect a penalty might have on shareholders.
Further, in 2007, the commission adopted a policy, now discontinued, that required commission approval of penalty ranges before settlement discussions. On their face, the penalty policies are neutral in that they neither encourage nor discourage corporate penalties. However, enforcement management and many investigative attorneys and others agreed that the two corporate penalty policies, as implemented, delayed cases and produced fewer and smaller penalties. Further, the commission's handling of cases under the policies transmitted a message that the corporate penalties were highly disfavored.
We identified other concerns, including the outward perception by some that SEC had retreated on penalties, which made it more difficult for investigative staff to obtain formal orders of investigation, which allows for the issuance of subpoenas for testimony and records.
Our review also showed that in adopting and implementing the penalty policies, the commission did not act in concert with agencies' strategic goals calling for broad communication with and involvement of the staff, in particular within the Enforcement Division, who had limited input into the policies that they were responsible for implementing. As a result, enforcement attorneys reported frustration and uncertainty in applying the penalty policies.
To begin to address these issues we recommended that the chairman determine that the 2006 corporate penalty policy was achieving its stated goals and that any other effects that the policy may have in adoption and implementation.
We also recommended that the chairman take steps to ensure that the commission, in creating, monitoring and evaluating its policies, adheres to its strategic goals and follows other best practices for communication with, involvement of the staff affected by such changes.
The SEC chairman agreed with each of these recommendations and was taking steps to implement them.
Mr. Chairman, this concludes my prepared statement. I would be happy to answer any questions at the appropriate time.
SEN. REED: Thank you very much, Mr. Hillman, not only for your statement but for your very thoughtful and professional report, which will aid us immensely. I appreciate it.
Now, before I move on, let me say something I should have said initially. Am I pronouncing your name correctly, sir?
MR. KHUZAMI: Absolutely right.
SEN. REED: So it is Khuzami?
MR. KHUZAMI: Correct.
SEN. REED: Well, given my Rhode Island accent, that's amazing. So, Mr. Khuzami -- (laughs) -- would you please now give your testimony?
MR. KHUZAMI: Thank you.
Thank you, chairman, Ranking Member Bunning and members of the subcommittee. Thank you for inviting me to testify on behalf of the Securities and Exchange Commission. I would also like to thank the GAO and its team for its report. I concur completely with their recommendations.
The Division of Enforcement is the public face of the SEC in many ways. Our lawsuits and legal proceedings against those who lie, cheat and steal in our securities markets gives the investing public comfort that their interests are being protected. We have a long and proud history of aggressively pursuing wrongdoers and thus helping to maintain the integrity of our markets.
Now, to echo the comments by Chairman Reed and Ranking Member Bunning in the beginning of this hearing, it is true that many have questioned our effectiveness in light of the revelations surrounding Bernard Madoff and his egregious misconduct. Let me be very clear: We failed in this instance in our mission to protect investors. Whatever explanations eventually surface, be they human failure, organizational shortcomings or shortcomings in process, or all three, there are no excuses and not a day goes by that we in the Enforcement Division do not regret the consequences.
But faced with this, we have done what any responsible public agency should do: We have used this episode as a wake-up call to undertake a rigorous self-assessment of how we do our job. As our chairman, Mary Schapiro, has said, reinvigorating the Enforcement Division is a top priority for the commission.
I am highly confident that we will succeed in this assessment. As a former federal prosecutor, defense attorney and most recently as an in-house general counsel with a financial institution, I have seen the SEC from many different angles. But from whatever angle, I always saw integrity, excellence, dedication and a passion for investor protection. Five weeks into the job, I can assure you and the public that these traits are alive and well at the SEC.
You've asked me to address the issues of changes we are making, resource needs and steps Congress should consider taking to assist us in helping us achieve our mission. With respect to changes, even before I arrived the commission began to initiate changes consistent with GAO's recommendations, first and foremost with respect to the evolution of the penalty pilot program.
And that effort continues uninterrupted. On my first day on the job I asked the staff to embrace four principles. We need to be strategic, swift, smart and successful. To meet those goals, our self-assessment is considering the following: first, to reorganize the division into specialized groups focused on particular markets, products, entities and transactions in order to build expertise that permit us to conduct investigations faster, more thoroughly and with increased understanding in order to enable us to better spot patterns, trends and motives; two, to adopt a more efficient management structure that streamlines our processes and frees up experienced managers to focus on making cases and investigating fraud; three, to adopt new metrics that are less about measuring our performance by the number of cases we file and more about the quality, timeliness and deterrent impact of what we do; four, to revamp our system for handling tips and complaints to better gather, risk-analyze and triage that information; and lastly, to expand our program to reward cooperating witnesses who provide valuable information about wrongdoers.
Now, this self-assessment has not come at the expense of our ongoing investigation. In the past two weeks alone we have brought cases against those involved in the credit default swap markets, subprime mortgages, Ponzi schemes and money market funds, and you can expect to see more of those.
Now, even with these changes, which we believe will make us more efficient, the fact remains that we have suffered from flatter declining budgets in recent years while at the same time the products, the markets, the transactions, the schemes that we are duty-bound to investigate become increasingly complex. The 7 percent increase included in the president's budget released today recognizes this fact, but even with that, the SEC will have significantly fewer resources than it had four years ago. I'm prepared the lead the division under the current measures, but I would welcome additional resources.
We sincerely appreciate the support of Chairman Reed and many others on this panel who have been strong advocates on this front, most recently by advocating for additional appropriations in fiscal years 2010 and '11.
And I also thank Senators Schumer, Dodd and Shelby for their recent successful amendment to authorize additional enforcement funds. And if we were to get those funds, we would use them in the following way: first, as mentioned previously, administrative and paralegal support for our investigations and trials -- too much time is spent by lawyers and investigators in tasks more efficiently handled by others; a new information technology and databases to collect and analyze our documents; more lawyers in our trial unit to litigate cases. We need to have a strong courtroom capability to secure favorable settlements or win in court. Lastly, I believe there may be some legislative changes that could clarify our authority so that we can better enforce the laws. This includes legislation to broaden our jurisdiction over hedge funds, security-based swaps agreements and to expand our whistleblower program.
I am confident that through this self-assessment we will emerge stronger, bolder and more effective in our mission. The source of my confidence is the men and women of the Division of Enforcement since what has not changed at the division is what they offer: an abundance of talent, core values of professionalism and fairness, and a total commitment to mission.
I'd like to thank you again for inviting me today and the opportunity to appear before you, and I look forward to answering your questions.
SEN. REED: Thank you very much.
Professor Bullard.
MR. BULLARD: Chairman Reed, Ranking Member Bunning, member of the subcommittee, thanks very much for the invitation to appear before you today to discuss the SEC's enforcement program. It's an honor and a privilege to appear before the subcommittee today.
The GAO report that was released yesterday provides strong evidentiary support for what many of us have suspected for quite some time: The SEC Enforcement Division's effectiveness has been compromised, both by a lack of resources and by poor leadership by the commission itself.
The appointment of Mary Schapiro as chairman is a strong step towards solving the problem of leadership at the commission. Throughout her career, Chairman Schapiro has demonstrated a solid commitment to a vigorous and effective enforcement program. In her very short tenure, she's already taken decisive steps to end some of the practices that have hindered the commission's enforcement program in recent years.
The problem of inadequate resources, however, remains unsolved. The commission does not have the funds to provide the level of enforcement necessary to protect investors and promote efficient capital markets.
I strongly recommend that Congress substantially increase the SEC's appropriation to enable Chairman Schapiro and the SEC's enforcement staff to do the job that they are better at than anyone else.
This is not just a matter of adequate enforcement. It is also a matter of justice for investigated entities. Inadequate resources often have the effect of unfairly increasing burdens on parties defending SEC investigations. The importance of the SEC's enforcement program cannot be underestimated. The commission is the leading voice for the enforcement of securities laws and the development of free capital markets not only in the United States but worldwide.
When the commission speaks, it makes uniform law across all 50 states that private actors can rely on to guide their business practices. When the commission remains silent, the void is filled with the noise of dozens of regulators and courts and private actions creating a patchwork of rules.
It is incumbent on the commission to provide the coherence and uniformity in the securities laws that only it can provide, and it is incumbent on Congress to provide the commission with the resources it needs to do so.
In addition, the GAO report has highlighted certain problems that are internal to the commission. First, the report shows that part of the SEC's resource problem may actually be an allocation problem. When there is inadequate administrative personnel or accountants or technology to support the lawyers working on a case, the solution may be to spend less money on the lawyers and more on the areas that are creating the resource imbalance.
Second, the report confirms the SEC's internal review process and multilayered staffing hinders its effectiveness. The SEC should eliminate one or more supervisory layers and streamline its review process. Third, the SEC should not shy away from bringing cases involving industry-wide misconduct, but it does not need to bring every case.
When industry-wide misconduct does not constitute a clear violation of the securities laws, however, no enforcement action should be brought. Instead, the SEC should clarify the law and conduct rulemaking as appropriate.
The most distressing aspect of the GAO report is the substantial evidence that individual commissioners were committed to effectively subvert the SEC's enforcement program. These commissioners may have been motivated by genuine ideological differences with SEC policies, but their approach, coupled with a well-meaning desire for consensus, materially damage staff morale and the SEC's authority and undermined the SEC's enforcement program.
Chairman Schapiro has indicated that she will not sacrifice the agency's mission at the altar of consensus. I hope that future 4 to 1 and 3 to 2 votes on enforcement and regulatory matters will not be interpreted as a failure to fully consider all viewpoints on the commission.
I also hope the commissioners who find themselves in the minority will not feel it necessary to undermine the commission's authority by publicly attacking its positions, even after they have been given a full and fair internal hearing.
In conclusion, I would like to make a general observation. It may relate to the friction that the GAO has identified between individual commissioners and the staff. There is an illusion among some well-meaning proponents of free markets that when the SEC refrains from action, whether it be enforcement action or regulatory action, free markets are allowed to operate with greater freedom. This is not the case.
When the SEC refrains from action the result is often to impede the operation of free markets. SEC inaction creates a void that is filled by dozens of other private and public actors all following their own conception of the meaning of the securities laws. Like many securities lawyers, I began my career reviewing documents pursuant to requests from the SEC's Enforcement Division and from a state securities administrator and from a U.S. attorney and from 22 private litigants.
There are many sources of law that are waiting to step in when the SEC abdicates its responsibilities. The only free market that is invigorated by SEC inaction is the free market for competing sources of regulatory authority, which for financial services firms means regulatory chaos.
The SEC alone has the authority to establish uniform regulatory policy and avoid the inefficiencies of legal uncertainty. I hope that the proponents of free markets, among which I include myself, will keep this in mind. Thank you, and I'd be pleased to answer any questions you may have.
SEN. REED: Thank you very much.
Mr. Hiler -- and again, I'm pronouncing your name correctly, I hope.
MR. HILER: Absolutely.
SEN. REED: Thank you, Mr. Hiler.
MR. HILER: Thank you, Chairman Reed, Ranking Member Bunning and members of the subcommittee.
I'm pleased to have the opportunity today to testify concerning the responsibilities of the Securities and Exchange Commission in policing our financial markets and protecting investors.
I formally served as an attorney in the Division of Enforcement and as an associate director. I left the commission in 1994 and since have represented clients in SEC and other governmental investigations, internal investigations and securities litigation.
Although recently the commission has come under fire for reported lapses in detecting the activities of some individuals in the marketplace, the commission has long been viewed as a premier regulatory enforcement agency. If there had been lapses, I am confident that the commission will evaluate those situations and develop new policies and procedures to avoid them in the future.
In this regard I think it's important to understand the effects that the vagaries of funding and resource allocation, the exponential expansion both of market activity and of sophisticated instruments and investment strategies and the day-to-day pressure of operating under the glare of public scrutiny can have on any organization.
With that said, there still are a number of areas I believe the commission's enforcement efforts could or should be modified or improved in. There are three areas which I would like to discuss today.
First, I believe that the efficient and speedy resolution of SEC investigations is important both for effective protection, investor protection and enforcement efforts, as well as for ensuring fairness and justice to the subjects of the investigations. In my view, these goals could be enhanced by having fewer layers of management between those working day to day on investigations and those who ultimately must recommend to the division director whether an investigation should be moved forward or closed.
Currently in the commission's D.C. headquarters, the division has five associate directors indirectly supervising hundreds of attorneys and cases. The associate directors typically are among the most experienced professionals in the division and they are looked upon internally as having the judgment and expertise to make appropriate case recommendations.
Yet these are also the individuals who have the least amount of time to be involved in the day-to-day decision making and the day-to- day review of facts on any particular matter as those facts are being discovered and analyzed.
I believe there should be fewer layers between the associate directors and those directly working on investigations. This does not mean necessarily fewer management slots. Rather, I believe the number of senior, experienced officials in the Enforcement Division should be dramatically increased.
These managers should be charged with direct involvement in the day-to-day activities of the matters under their supervision, and such matters should be kept to a reasonable caseload so that they can become familiar with the key facts and issues as they develop, not only at the recommendation stage.
Second, efficiency must not be achieved at the expense of fairness or thorough evaluation. SEC investigations can involve sophisticated instruments and trading strategies as well as complex issues such as accounting, risk analysis and economic modeling, all of which fall outside of the normal expertise of attorneys. These investigations do take time, but I do believe that the addition of a cadre of experts in a variety of fields such as I mentioned to assist in enforcement inquiries will lead to more efficient and better- informed decision making.
Third, I believe that the detection of fraud and fraudulent conduct is an extremely difficult task and that no one can expect the SEC or any agency will be able to anticipate specific frauds and specific entities. However, a regulator may be able to get an early warning sign of conduct, which, though not illegal, on close examination the regulator may determine needs additional regulation or is not sufficiently understood that it poses unknown dangers to the financial system.
To do so, to get this early warning, I think a regulator must reach out to and foster an open line of communication with those in charge of compliance and management at the relevant entities. It is difficult to maintain open and timely communication where the regulator or the regulated views the other in an atmosphere of suspicion.
I believe that in the last decade, increased scrutiny by criminal authorities of securities law matters and public pressure on the SEC to hold anyone and everyone responsible for the stock market crash in 1999, for corporate bankruptcies and defalcations and, more recently, for the current economic turmoil have contributed to such an atmosphere.
I believe that the line between civil and criminal cases has been blurred and that there has been a shift to an inappropriately low level in what authorities view as conduct that demonstrates efficient scienter or state of mind to make even a civil securities case.
It is possible for the commission to adopt substantive internal guidelines to ensure it is making consistent, fair and efficient decisions and judgments on the subjective judgments that are required to bring an enforcement action. I also believe that the commission should have a major role in determining whether cases which predominantly involve federal securities law issues and our capital markets should be pursued by criminal authorities.
Efforts in these two areas I think would help promote an atmosphere of communication and openness that could assist the commission in all of its regulatory roles.
I'm sure there are others areas that members of the subcommittee are interested in. I hope that I'm able to be of assistance to you, and I will be happy to answer any of your questions. Thank you.
SEN. REED: Well, thank you very much, Mr. Hiler.
And thank you all, gentlemen, for very, I think, fine testimony.
Let me begin to address the question first to Mr. Khuzami but also to ask everyone to respond.
Inherent in the GAO report is a recommendation of which Chairman Schapiro has already taken to take the handcuffs off the Enforcement Division. One issue is how is that posture maintained, not just for the next few months or years but going forward? But second, it raises, I think, a more fundamental issue, which is the relationship and the appropriate oversight of the commission and the commissioners and the Enforcement Division.
So if you have some thoughts about that, Mr. Khuzami, please begin, and I'll call on your colleagues also.
MR. KHUZAMI: Thank you, Mr. Chairman.
From my experience since I've arrived at the commission, which is approximately five weeks now, I have seen nothing but a great deal of interaction, discussion and shared views between the commissioners, the chairman, myself and the staff of the Division of Enforcement.
To bring it down to practicalities, we have been in Chairman Schapiro's office on many occasions to discuss cases. The commissioners have invited me into their offices to discuss their views and share them with me. And I can't speak to the environment that existed prior to my arrival, but everything I have seen since then indicates that any policy matters or judgments are going to be fully informed with the views of the enforcement staff.
SEN. REED: Thank you.
The same general question, Professor Bullard, about in the long term how do you balance between the commission's appropriate role and not handcuffing the Enforcement Division and initiative at the lower level?
MR. BULLARD: I think I can really only just echo what the enforcement director has said, but I think I would add that it's important that Chairman Schapiro encourage strongly the members of the commission, regardless of whatever ideological positions that they bring to the table, to work out those issues they might have in the Enforcement Division internally. And I would encourage the enforcement staff to be very aggressive in communicating with those commissioners, keeping them apprised of the development of cases to try to reinvigorate the internal vetting of issues within the commission.
The commission has always had a very good practice of a healthy, vigorous internal debate, but as soon as that turns into what the GAO described as a situation where you had the staff cut off, not only from some key decisions but from the development of policies that really should have been conceived in the staff, then you have a staff that is working against the commission and no longer can really function effectively as an agency.
SEN. REED: Your comments, Mr. Hiler?
MR. HILER: Yes, thank you.
SEN. REED: Could you activate your mike?
MR. HILER: Sorry. You know, I think in every organization or agency there are going to be different points of view. I can't say that I or my clients have felt that the Division of Enforcement staff has been shackled, unfortunately.
But I wanted to go to one thing in the GAO report in this regard. I noted that staff members had talked about other divisions hampering their enforcement activities and having to be -- and that they did not like other divisions having to review aspects of their cases.
And we laugh out here in the private bar when people like me say "When I was at the commission," but I'll say it anyway. When I was at the commission, I and my staff in enforcement, when I was a branch chief and assistant director, we happily sought out the views of the other divisions at the beginning of our investigation, throughout our investigation and at the end of our investigation. And we did that because those divisions have extreme expertise in the rules and regulations that we in enforcement were trying to interpret, apply and enforce. And so by the end of the investigation, we were probably all on the same page, and I don't recall many times, although there probably were some, where at the end of an investigation where I was trying to make a recommendation I felt that another division was opposing me, to some extent.
But if they were going to oppose me, I had my view and I felt completely confident that we could express our view to the commission. So I think it's just very important that there not be a sense of competition in the commission between divisions and that the Division of Enforcement also should feel free and should consult with those other divisions right at the beginning of an investigation.
SEN. REED: Mr. Hillman, your comments.
MR. HILLMAN: I share many of the comments that have been discussed associated with this question. One in particular that I believe is very important is that there seems to be a difference of view regarding the commission's perspectives on penalties and that of the Enforcement Division.
And in going forward, I think it would be very important for the commission and the division to come up with a shared set of goals and ideals for moving forward in the penalty and disgorgement area.
Once that vision is established, then the commission should seek out regular input from enforcement management and staff on policies and procedures in order to implement those goals.
SEN. REED: Thanks very much.
I anticipate, since we're fortunate that we have three members here, several rounds, but let me now yield to the ranking member for his round of questioning, and then Senator Johanns, and then I have other questions.
Senator Bunning.
SEN. BUNNING: Thank you, Mr. Chairman.
Mr. Kuzeman (sic)?
MR. KHUZAMI: Khuzami.
SEN. BUNNING: Khuzami . I'm sorry. I should pay attention. (Laughs.)
Let me just on the surface -- some of the worst cases of fraud have been hiding in plain sight -- plain sight -- the Madoff, Stanford subprime mortgage practices and auction rate securities.
What are you doing differently now so that these things in plain sight are observed and treated quickly?
MR. KHUZAMI: Well, Senator, we're taking a number of initiatives. I'm not sure that in many of the matters that have been publicly identified that they are necessarily frauds that are in plain sight. Some of them are fairly difficult in terms of attempting to investigate them.
But no matter, we are establishing -- for example, we have a series of working groups set up nationwide focusing on specific areas of conduct, including subprime, hedge funds, option rate securities and historically options back-dating and other matters so that we can gather the necessary expertise and target our energy and resources into particular areas.
In the Ponzi scheme area, which is an area that we have focused our efforts on for a long period of time, the challenge there, of course, is to make sure that you can find credible evidence of the wrongdoing. And unfortunately, often investors aren't a good source of that because they are receiving their outsized returns and don't identify any wrongdoing. So the challenge there is to get inside the organizations and get credible evidence so that we can stop them.
But we are, with a renewed focus across all the areas that you've identified, dedicating our resources and sharpening our tools.
SEN. BUNNING: Same person -- what changes are being implemented to allow or encourage staff to bypass the normal chain of command if they feel serious issues or cases are not being properly addressed? That's where I hear we've had a problem.
MR. KHUZAMI: Well, Senator, we are, as I indicated in my testimony, undertaking a review of the entire management structure. And so that will hopefully result in streamlined processes. The other thing I would point to is simply I've appeared before the staff on numerous occasions already and made it very clear to them that we are focused on these cases and that they should be free to raise their hand and bring forth any issue that they feel needs attention with respect to their cases.
I don't sense any reluctance on the part of the staff to identify questions or issues in their cases. If anything, I think they feel a renewed sense of vigor and the importance of bringing cases in a timely manner.
SEN. BUNNING: In your testimony, you mentioned that the commission has filed 23 cases involving Ponzi schemes or Ponzi-like payments. With the report just now coming out that the SEC received warnings back in 2002 regarding the Stanford fraud investigation, how long was the SEC aware of these 23 or so particular cases before formal filings were charges made?
MR. KHUZAMI: Senator, I'd have to, in order to provide a thoughtful answer to you, perhaps have the -- (inaudible) -- respond.
SEN. BUNNING: I'd rather have a factual answer.
MR. KHUZAMI: (Laughs.) How about thoughtful and factual?
SEN. BUNNING: Okay.
MR. KHUZAMI: I would like to be thorough in my response. I can't tell you as I sit here right now what the history was, if any, with respect to these actions that we have brought. I will say with respect to the Stanford matter --
SEN. BUNNING: Could you really get that to us? Get the chairman and myself in writing a report on those 23?
MR. KHUZAMI: Certainly.
SEN. BUNNING: I would appreciate that very much.
Do you agree with Mr. Hiler's recommendation to increase a number of senior officials with smaller caseloads who can get more involved in individual cases? In other words, providing investigators with more access to key gatekeepers?
MR. KHUZAMI: As a general matter, I agree that a streamlined and targeted management system that has no more managers than are necessary and those that exist have the resources and the time to dedicate to properly reviewing cases early on so that we don't waste resources on cases that are not worth pursuing, and that we can focus on moving those cases that we should be bringing in a faster manner.
Now, whether or not that means adding resources at the associate level or a different level, those details remain to be seen. But I certainly agree with the general principle.
SEN. BUNNING: Thank you, Mr. Chairman.
SEN. REED: Thank you very much, Senator Bunning.
Senator Johanns?
SEN. MIKE JOHANNS (R-NE): Mr. Chairman, thank you.
And to every member of the panel, thank you for being here today.
Mr. Hillman, if I could start with a few questions for you. I read the summary, if you will, of the recommendations from your report, and having been in charge of a complex government organization I have to tell you, to be very candid with you, I could pick up that language and I think drop it into every federal department.
Here's what I'm saying to you: I think every federal department would say we don't have enough resources. They would probably say yes, sometimes we don't even pay attention to our internal goals. The right hand doesn't always know what the left hand is doing. And I'm not saying that to justify it, I'm just saying that your findings here leave me asking the question, is there a story within the story?
And then I listened to the testimony about Mr. Madoff.
You know, I said at the first hearing on that, I don't get it. I really don't understand it. You had a whistleblower that pretty well called this guy out, kind of laid the road map for what was going on, and yet there wasn't follow-up and people really, really were hurt by that.
So what I want to try to examine with my questions is what is the story within the story? Is this a situation where you have a piece of the federal government that isn't getting along with the commissioners? Is there a personality conflict? Is there a difference of opinion as to what the goals of the SEC are?
Mr. Hillman, let me start with you. Is that the case here?
MR. HILLMAN: I think you raise an excellent question about what the real root causes are associated with the difficulties that we've found within the Enforcement Division. We've pondered that thought many times during the course of our review as well.
You're absolutely correct: Many of the examinations that we've conducted at SEC and other regulatory agencies, banking regulators and others, we uncovered very similar practices. What I think was most startling by this review, however, was that the unanimity of views from the enforcement management, from their middle management, from their investigative attorneys as to the problems that they were seeing within the Enforcement Division, which was startling and clearly in need of some attention to address organization culture issues, to address organization communication issues, and to really set a tone at the top as to how penalties and disgorgements were going to be ordered.
SEN. JOHANNS: See, and here's what worries me about that. I think the easy answer is always "I need more resources." But then I kind of dig deeper into the report here and on Page 5 you say, you know, but the enforcement cases are about where they were; when we talked to the attorneys involved, what they bring up is they need more support staff -- the paralegals, et cetera. It's not like they're asking us to double the number of attorneys, although I suspect they would like additional help with attorneys.
So again, Mr. Khuzumi (sic)?
MR. KHUZAMI: Khuzami.
SEN. JOHANNS: Khuzami. (Laughs.) Everybody botches Johanns, too, so.
MR. KHUZAMI: My mother sometimes --
SEN. JOHANNS: Although the chairman got it right.
MR. KHUZAMI: My mother sometimes mispronounces it. That's okay.
SEN. JOHANNS: Here's what I'm trying to figure out with you. I think there is always a new energy with new people. There was when I went to the USDA, and I don't know that I was any better or worse than the person before me.
But it is culture and processes and not necessarily building more staff or whatever that solves problems. Dig there with me. What's wrong with culture? What isn't working over there that literally you could have a whistleblower drop Madoff on somebody's desk and nothing happens?
For me, as a former Cabinet member, that would have been a grenade. I would have been on the phone to GAO, to my committee of jurisdiction, to the solicitor general, to everybody I could get on the phone, saying, "Oh, my lord, what are we going to do about this?" And yet this just seemed to go on.
What's wrong? What do you see?
MR. KHUZAMI: Well, Senator, you know, due to an ongoing inspector general's report, I don't have the answers yet as to the sequence of events and what actually happened with respect to the complaints regarding Mr. Madoff. I don't know if it's predominately the failings of a single or small number of staff members, which would be one thing, whether or not it represents a failure in process or organization.
So when we get those findings we will certainly look at them closely, but we're not waiting for them, either. My sense is that there has been a certain lack of urgency about the mission. My sense is that, as Mr. Hillman has pointed out, that there are policies or approaches that may not have been intended to be anti-enforcement or to discourage enforcement, but they were perceived as such or taken as such, and that sends a message down the line.
I think that the division needs to do a better job to maintain current with the markets and the products and the transactions that they're obligated to investigate. Just for a simple example, if the person who reviewed the Madoff complaint or any other complaint had specialized training in certain types of training strategy, that might have resulted in a different result. And we do much more of that now than we did previously.
But the best way I know to change culture is, as was mentioned, to start with a tone at the top, which the chairman and the commissioners have done, to set policies that are fair and appropriate and that allow the Enforcement Division to do its job, because those policies will live far beyond my tenure or the tenure of any staff attorney, but they will continue to pollinate the division with the sense of urgency and mission that it needs to effectively do its job.
SEN. JOHANNS: Thank you, Mr. Chairman.
SEN. REED: Thank you, Senator Johanns.
And again, I think we have the luxury of continuing on our questioning, and so let me initiate another series of questions, and that is, we've talked about this issue of resources and I think there's a general consensus agreement that additional resources, and perhaps more appropriate with respect to paralegals and investigative personnel and others, is appropriate.
But there's another aspect of resources -- that is predictability. Given that you are subject to the appropriations process, that's not entirely predictable. There are other federal regulatory agencies -- FDIC being one -- who has essentially a claim through their supervised entities on funds.
And I just want your thoughts whether that model or some form of that model might be appropriate with the SEC. That it would be, in fact, some type of funds that are always there, not subject to appropriations, that would provide the certainty for infrastructure improvements, technology improvements, hiring specialists, et cetera.
So let me begin with Mr. Hillman, your thoughts, and then move down the line.
MR. HILLMAN: We had done a study earlier looking at self-funding mechanisms of the regulators across the banking regulators and securities regulators, and identified advantages and disadvantages of alternative approaches.
SEC, as you may know, is collecting fees associated with activities occurring within the financial markets. They receive registration fees for new stocks and bonds; they receive transaction fees paid over by national securities exchanges; they also have fees from proxy solicitations for mergers and acquisitions and the like.
These fees don't come directly to the SEC. They are put within the Treasury's accounts and the SEC has its own appropriations. Some of the advantages of having SEC being removed from the appropriations process and going to a self-funding basis based off of the fee income which they are receiving would be to have greater control over their budgets, have an ability to plan for their activities over a longer period of time -- five years or more, perhaps -- and having a greater ability to address its challenges in their workload areas.
Some of the disadvantages, however, have to do with the fact that a self-funding structure isn't going to deal with all the problems that we're seeing within the SEC associated with, in the past, retention issues within their control, changing the mix of their resources and the like. It also significantly reduces the checks and balance systems that currently exist within the budgetary and appropriations process.
SEN. REED: Thank you very much.
Mr. Khuzami, your comments and thoughts?
MR. KHUZAMI: Well, Mr. Chairman, I agree with your point, absolutely, about appropriations and resources. I told my staff on the first day the appropriations was a little like the cavalry: You don't know if they're going to show up, when they're going to show up and how long they're going to stay. And that's why it was incumbent upon us to organize our own house as efficiently as possible to make sure that the taxpayers received value for their dollar.
With respect to the issue of self-funding, I must say I haven't spent really any time studying it. The obvious advantages are very appealing to me, but I think I will defer while the chairman and the commissioners consider those issues.
SEN. REED: Professor Bullard and Mr. Hiler? Professor Bullard first.
MR. BULLARD: I've spent a fair amount of time thinking about this issue, but it's not necessarily going to help you any because I haven't really reached a firm conclusion what the best model is. I think the checks and balances point is right on the money. There's a lot of benefit to the political accountability the SEC must demonstrate in contexts such as this one when it's going back to the hand that feeds it. On the other hand, having a more reliable source of income that is industry-based has certain efficiencies.
I'm sorry I can't give you much of an opinion on that.
SEN. REED: That helps.
Mr. Hiler.
MR. HILER: Yes, I think that having some consistency at a certain level of funding is really imperative and would be extremely helpful for the commission. In terms of the checks and balances, I assume that -- I'm a securities lawyer, but I assume that Congress could deal with that by calling the commission and asking them to come over, submit their budgets, see what's going on.
But I think that would be a very good turn of events if the commission could know from year to year that at least it had some sort of funding and it does collect fees. I think years ago it used to be basically a surplus to the Treasury from when you balanced out what it was collecting on fees and so forth and what it was spending.
And I think that some of the funds really, really should be best spent on paralegals, document control issues and document control assistance, IT and experts, like we've all talked about in the GAO report and that I've talked about. I think that document control, knowing the size of these cases the SEC works on, that is one of the biggest consumers of time of an attorney and they just don't have people there to help with that, and IT as well, and paralegals.
SEN. REED: Can I just make the point that it might be in your expertise as a practitioner. On the other side, the technology, both in the regulated industries and their attorneys, must be phenomenal relative to the SEC. It's like some of those Civil War militias going up against the 82nd Airborne.
MR. HILER: Well, I will say that I don't feel that we have that much of an advantage. There are some very good attorneys and they know their cases when we go up against them. They really know their cases. They know every document and they've looked at it sideways and on the creases. So they make up for it in certain ways, but yes, I think they're lagging behind in the technology and in the document control area for certain.
SEN. REED: And just another point, too, and then I'm going to recognize Senator Bunning and we've been joined by Senator Schumer, is that in terms of understanding some of these new products, et cetera, the sophistication and the computer modeling is so significant that I would assume even if you have suspicions, or one of your attorneys, Mr. Khuzami, had suspicions, that to be able to understand what they're doing and feel that it is clearly wrong is a challenge without not only the computer technology but the market expertise that is on the other side. Is that a fair insight?
MR. KHUZAMI: That's correct, Mr. Chairman.
The challenge comes in a couple of different areas. One is it's understanding the markets. Two, it is being able to get the kind of training and other information that you need, particularly in the unregulated markets such as hedge funds and derivatives, in order to get the information and have it reported in a uniform way so you can put the story together and see whether or not there is suspicious or wrongful activity, and it's then the resources and the technology to be able to do that.
So as you say, it's a technological challenge across a number of fronts.
SEN. REED: Thank you.
Senator Bunning for questions?
SEN. BUNNING: Yes, thank you very much.
Mr. Khuzami, I'd like to just ask you what is a better measure of enforcement success, the amount of fines or the amount of cases handled? Or whatever else that might come?
MR. KHUZAMI: Well, yeah, I think that would be a hard choice between the two of them because I think they both have some inadequacies.
From my perspective, the best measure of both the performance of an individual attorney at the commission as well as the overall program would be to focus less on quantity -- although that still matters -- but more on things like timeliness, how quickly do you bring a case. The gap between conduct and atonement, if you will, the longer that stretches out, the less of a deterrent message you're able to send.
Two, you want to look at programmatic priorities. If the Enforcement Division decides that we see a lot of suspicious activity and insider trading by hedge funds, then we should be setting that as a priority and measuring our success on whether or not we're achieving results in that area.
The third area that is of interest to me is really the deterrent impact, probably maybe the most important but the most difficult to measure. How do you decide whether or not a case you bring has prevented others from doing the same thing? That's a big challenge, and one of the ways I've seen it done successfully was by one of my predecessors and it wasn't even in an enforcement case.
But he announced to the Wall Street firms and said, "You have to scrub your own institutions and your own businesspeople and your own desks to look for conflicts of interest, and you'd better find them and identify them and remediate them or we're going to come in and do it for you."
And I was at one of those financial institutions when that word came down, and we spent an enormous amount of time and money doing exactly that. We looked at our conflicts; we made disclosures; we cured some; we exited certain businesses.
Now, that -- there was never a single case that was brought, right? We didn't show up on anybody's statistics. But the amount of good and effective deterrence that that achieved is probably immeasurable, and so I would like to see us moving, in some cases, to more of a model like that where we can achieve that kind of deterrence, because ultimately, you know, we can sue people and try and get their money back, but we're all in a much better position if we stop it before it starts.
SEN. BUNNING: To follow up, last year there were 700,000 complaints that were sent to the SEC that weren't investigated or followed up on. How can you or how can the SEC account for that?
MR. KHUZAMI: Senator, I don't think it's the case that they were not followed up on. I think that's simply the raw number that was received by the commission.
SEN. BUNNING: Received.
MR. KHUZAMI: There was in fact and is in fact a rigorous program for collecting, investigating, monitoring and referring those complaints that's in place.
Now, having said that, we all recognize that we can do a better job here, and one of the first things that Chairman Schapiro did was to order an independent vendor to study our processes, where we would be collecting all of these complaints in one area. Now it simply comes into too many different areas within the commission.
To collect it in one place, log it, analyze it, review it, look for patterns and trends across complaints to see if it tells a story, refer it out to the proper area, perhaps combine it with specialized units so that the people looking at these will have good eyes.
SEN. BUNNING: But you have no idea how many were followed up on or weren't followed up on out of the 700,000?
MR. KHUZAMI: I'm sure many, many, many of them were. I'm happy to get those statistics.
SEN. BUNNING: Okay, I would appreciate that.
MR. KHUZAMI: Sure.
SEN. BUNNING: About more money and about better enforcement, you know, you were about to say something, I probably cut you off, on the Stanford thing, and I didn't mean to do that. If you have something to expand on that, now's the time. But a whistleblower on Madoff, and it took so long to get to the problem? You know, to the ordinary citizen and to us sitting back who are watching SEC to enforce, we can't imagine that happening.
MR. KHUZAMI: I understand that, Senator. I mean, in the particular Stanford case you're referring to, I mean, there were -- we did receive complaints early on -- not necessarily particularly detailed or specific, but complaints. And there were a number of challenges in that case having to do with the cooperation not only of Mr. Stanford but the inability to obtain documents from offshore, the cooperation of the Antiguan authorities and the lack of witnesses from the investors.
And we continually, starting in approximately 2005, looked at that case going forward and continued to investigate it. It was not a situation where someone gave us a complaint and we looked at it and decided there was nothing to do and moved on. We were continually investigating the case. It just took an extraordinarily long period of time in order to gather the evidence to bring the case. And once we did, we moved very quickly.
I agree that these cases should be brought as timely as you can and we are focused on that. But sometimes, it just takes a considerable period of time to make a case.
SEN. BUNNING: Good luck.
SEN. REED: Thank you, Senator Bunning.
Senator Schumer?
SEN. CHARLES E. SCHUMER (D-NY): Thank you.
And I thank the witnesses.
My first bunch of questions, maybe all, are for Mr. Khuzami, but after he finishes anyone can chime in.
The first one is about industry experts. The SEC, known as the gem of the financial regulatory world a long time ago, and the SEC's police, your division, the Enforcement Division, was its public face and its iron fist.
And now what we've seen after the financial crisis is how understaffed, inexperienced and underfunded the Division of Enforcement has been under the previous administration. It's the idea government's bad, cut it back, you know.
To oversee 30,000 registrants, 12,000 public companies, 4,600 mutual fund families, 11,000 investment advisers, et cetera, the Enforcement Division has a staff of 1,100. That's 10 percent less in absolute numbers than the staff it had in 2005.
That's why Senator Shelby and I introduced the Safe Markets Act to give the Enforcement Division the additional resources it needs, and Senator Reed, of course, has been a long-time champion of increased SEC funding.
It's also why I fought so hard for an amendment to the Fraud Enforcement Act on the floor last month to ensure that the SEC get the funding it desperately needs. That amendment passed and a version of the bill with SEC funding intact, I'm proud to say, just passed the House yesterday. So the SEC should be seeing the extra $40 million we fought to get you pretty soon.
Now, I want to know with some specificity how the SEC plans on using the $40 million, and I know Senator Bunning touched on this but I'd like to go a little bit further. The Enforcement Division is almost exclusively staffed by attorneys, not by investment analysts who know how to crunch the numbers and analyze complex financial data and trades.
You've announced a plan to reorganize the division into specialist teams and give the enforcement attorneys more autonomy, along the line of prosecutors at the U.S. attorney's office, and I applaud that; I think that's a good idea.
But do you plan to hire financial analysts, traders and accountants with real industry knowledge and experience to help you investigate and oversee today's increasingly complex capital markets? And if so, give me some top of the envelope idea of how many.
MR. KHUZAMI: Senator, we absolutely do plan on doing that. One of the advantages of having specialized groups is that you will now have a fixed point within the organization where you can actually hire and assign these market specialists to particular ones. So if you have a structured products and securitization group, you can go out and hire structurers or traders, many of whom are currently unemployed, and bring them into the division.
The numbers that we plan on hiring, you know, I don't have a firm number yet but it depends in part on which kind of units we set up. But we get many inquiries from folks who want to help, retired traders --
SEN. SCHUMER: But is it going to be a significant percentage, not one here or one there? I think there's been too much of a reliance on lawyers -- I'm not against lawyers; I am one -- and not enough on the investigative type people who have had experience in the financial world.
MR. KHUZAMI: It will be a significant number.
SEN. SCHUMER: Okay, good. When do you expect all of this to happen, your reorganization plan, including these new people?
MR. KHUZAMI: Well, it's somewhat of an execution challenge to roll this out, obviously, when you talk about restructuring a large part of the division. But we are going to start doing the initial planning stages very soon. We've identified a small number of specialized groups that we want to start out with, and I suspect that we will start this process in a matter of weeks.
SEN. SCHUMER: Good. Okay.
Next question deals with sort of a "siloization" of investigations, which is not your fault; that's what Congress has done because of all our jurisdictional turf battles.
Last year, the Enforcement Division received 700,000 tips, complaints and referrals from the public and federal agencies. When the Enforcement Division receives a tip it now only has the ability to investigate SEC-regulated activities or entities.
Do you think this is sufficient in protecting our markets or do you think the SEC should also have investigative powers over currently unregulated entities -- hedge funds and unregulated products like credit default swaps -- to ensure the integrity of our capital markets?
MR. KHUZAMI: My answer to that, Senator, is a strong yes. My view is that we need access to hedge funds, credit derivatives and other products, particularly the trading information, so that we can combine that with other information that we see in the regulated entities to make sure that we have a full picture of what's going on and to be able to detect wrongdoing.
SEN. SCHUMER: Okay, good.
Next one: You know, the SEC has limited resources, but they may not be used most effectively. According to the data provided by the SEC, 40 percent of enforcement personnel and 20 percent of examinations personnel are based in Washington, D.C., which until last fall wasn't the financial center of the country and still isn't the financial center. Won't be again soon -- New York's coming back.
But despite the overwhelming concentration of financial entities in the New York City metropolitan area, the SEC has stationed only 15 percent of its enforcement personnel, a quarter of its examinations personnel, there. That seems to me a misallocation of resources.
While I think we need to put in certain rules and regulations to ensure that the relationship between regulators and the regulated doesn't become too close, I also think agents have a much harder time staying on top of what's going on in the capital markets when they're 200 miles away.
Do you agree? Will you consider reallocating some of the personnel to New York City as part of the shake-up of your enforcement division?
MR. KHUZAMI: Senator, I haven't looked specifically at that issue but I will certainly consider it. The one thing I will say is that our specialization effort will result in nationwide teams of investigators and attorneys looking at particular areas, so that in some sense geographical location will become less important because you will have a team across the nation.
SEN. SCHUMER: Yeah, I don't agree with -- I know, but when the team is having lunch in Phoenix, they don't pick up as much information as when they do in downtown Manhattan. So I'm going to ask you again: What are you going to do about reallocating personnel to New York City?
MR. KHUZAMI: I have not considered that in my five weeks, but I will certainly take that under advisement.
SEN. SCHUMER: I think the SEC should move to New York City -- at least the Enforcement Division as a whole. I do. I think it would do a much, much better job.
I also think the New York regional offices are badly in need of permanent leadership, and soon. I'd urge you to act quickly and consider naming someone like yourself, who's a former federal prosecutor with securities experience. How close are you to naming someone, and are you considering the kind of people of the background I mentioned? I don't have anyone specific in mind.
MR. KHUZAMI: We are in the very final stages of that process and we have an abundance of highly qualified candidates, including those with the profile that you mention.
SEN. SCHUMER: What's the likelihood one of them is going to be picked with that profile? You're a lawyer. I can ask questions, too.
MR. KHUZAMI: (Laughs.) Well, I don't want to pre-judge the process.
SEN. SCHUMER: Okay.
MR. KHUZAMI: But I hear what you're saying.
SEN. SCHUMER: Okay, thank you.
Finally -- let's see, I have two more, with the chairman's indulgence. Okay.
Unlike the other divisions at the SEC -- this is about small- investor protection -- the Division of Enforcement doesn't have a hotline the public can call. For instance, one of my constituents is a victim of one of the reserve funds. You charged their directors with fraud this week.
The constituent has contacted my office regularly since the fund broke the buck last fall because there's no other place he can turn to ask questions, get status updates, register complaints about the way the situation is being handled, and that's an unacceptable situation.
I hear that the Office of Investor Education and Advocacy, which was charged with the mission of advising the small investor, has received so many calls it maintains a database of investor complaints of fraud.
Do you agree that the Enforcement Division should have a hotline?
MR. KHUZAMI: Senator, our entire complaint, tip and referral process is under investigation. A hotline certainly sounds like a pretty good idea. I have no idea if that's in the works, but I will pass that suggestion along the line.
SEN. SCHUMER: Could you, please? Yes, and get back to me. And all these, if you could get back to me in writing within five days, is that okay? A week? Okay, great.
Can you explain to me how the Enforcement Division coordinates with the Office of Investor Education and Advocacy and other divisions who receive calls about fraud and violations?
MR. KHUZAMI: Senator, the complaints, tips and referrals that we get come in from many different portals within the SEC and that's one of the things that we're trying to consolidate.
But they come in but they are all collected in central areas and analyzed and triaged and referred. We're going to be doing a better job of that, but that's the current structure.
SEN. SCHUMER: So who receives the calls about -- I mean, again, they're all referred or triaged and referred?
MR. KHUZAMI: Yes, yes.
SEN. SCHUMER: So if you're two out of the three, you don't get any response?
MR. KHUZAMI: I'm sorry, I don't follow.
SEN. SCHUMER: Well, if it's triage, that's one --
MR. KHUZAMI: Well, by triage I mean spam and kind of the nonsense --
SEN. SCHUMER: Okay. But anyone who calls with an actual complaint or whatever will be given a call back?
MR. KHUZAMI: They'll be referred to the appropriate area and the complaint will be followed up on.
SEN. SCHUMER: Okay, thanks.
Finally, last but not least, rulemaking consultation. The divisions of Corporation Finance, Trading and Markets and Investment Management are the rulemaking divisions while enforcement enforces the rules.
During the rulemaking process, the industry and the public are consulted and have the opportunity to submit comments. Are you consulted? Is the Enforcement Division consulted on the enforceability of the rules the other divisions are writing?
MR. KHUZAMI: Yes, Senator. When new rules are being proposed, the views of enforcement, particularly with respect to whether or not the proposed rules have an enforcement impact, we are consulted and permitted to voice our views in the same way that these other divisions voice their views on our enforcement cases.
SEN. SCHUMER: Permitted, but is it part of the process?
MR. KHUZAMI: Yes.
SEN. SCHUMER: Good.
And finally, last question, can you explain to me how the other divisions train and assist the enforcement attorneys?
MR. KHUZAMI: Well, all of our cases -- well, first of all, we're well aware within the division of the expertise in our other divisions, so if we have a question we just pick up the phone and call them.
There's a more formalized process that's part of our case review where they get to review proposed actions and comment on them. One of the benefits of specialization, we hope, is that we can get that expertise in sooner to our investigations in order to take advantage of it. You know, why go outside first when you've got some of the best experts in the country in-house?
SEN. SCHUMER: Okay. Anyone else have a comment on any of the things I mentioned?
If not, then thank you all for being here.
And thank you, Mr. Chairman.
SEN. REED: Thank you, Senator Schumer.
I have two statements, one from Chairman Dodd and one from the president of the National Treasury Employees Union, to include in the record, and I've checked with minority staff, and without objection, I would order these statements be made part of the record.
Let me just raise one question. Senator Schumer has highlighted a question about competition among the divisions, Mr. Khuzami, and Mr. Hiler made that point, too, and you've responded. Is there anything else you'd like to say about this issue of competition among divisions?
MR. KHUZAMI: Candidly, Mr. Chairman, I haven't seen evidence of that. We really, to some degree, my view at this point is that it's a highly collegial environment. We kind of operate in similar but different spheres, so it is not the case that we are focused on the same issues. We get their input, they give us their input, and to me it's a very collaborative process that works well.
The only issues I've seen of it is whether, you know, sometimes things take too long to move through the process as you consult multiple divisions, and we hope to be able to streamline that.
SEN. REED: And let me ask another question which was suggested by one of Mr. Hillman's comments. That is the retention of qualified attorneys. It might be easier now, given that competing private companies are not as flush or lush, but that issue is always there in terms of maintaining highly qualified personnel.
I think both Professor Bullard and Mr. Hiler worked for the commission, and then there are academic and professional challenges left. Your comments on what we can do, and you might want to even think about this and get back to us about providing appropriate incentives to attract the right people and then keep them there to provide long-term expertise. If you have any comments?
MR. KHUZAMI: Well, Senator, you know, the pay parity rules that were passed a few years ago that increased the salaries were very helpful in terms of retaining talent. We do fluctuate as markets fluctuate and the demand changes. I think that one of the great benefits of refocusing on enforcement and specialization and the other things we're considering is that the division, I think, is just going to be a more attractive place for people to work, and they will stay longer because they're doing good cases in an active way and their contributions are valued.
And if the gentlemen to my left want to return to the division to work, we'd be more than happy to consider it.
SEN. REED: I'm surprised to hear that, actually. (Laughter.)
I'm glad we're able to have a job fair as well as a hearing. (Laughter.) This is sort of doing double duty today.
Gentlemen, thank you very much for your very insightful testimony. I would ask that if any of my colleagues, you know, have additional questions they would submit them no later than May 13th so that we could get them to the witnesses. And I know some of the witnesses have suggested that they'll respond.
Is a week appropriate, Mr. Khuzami, given your -- or we could make it two weeks, I think.
MR. KHUZAMI: Two weeks would be fine, if that's --
SEN. REED: Let us just suggest that any request for information by the ranking member or Senator Schumer or anyone on the committee, if you could comply within two weeks, I would appreciate it very much.
That concludes the hearing.
Thank you very much, gentlemen. (Sounds gavel.)
END.
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