Financial Management, Work Force, and Operations at the SEC: Who’s Watching Wall Street’s Watchdog?

[Unofficial Transcript] [Mr. McHenry] The committee will now come
to order. I will start today’s hearing by reading
the Oversight and Government Reform Committee’s Mission Statement. We exist to secure two fundamental principles.
First, Americans have the right to know that the money Washington takes from them is well
spent. Second, Americans deserve an efficient, effective government that works for them. Our duty on the Oversight and Government Reform
Committee is to protect these rights. Our solemn responsibility is to hold government
accountable to taxpayers because taxpayers have a right to know what they get from their
government.

We will work tirelessly in partnership with
citizen watchdogs to deliver the facts to the American people and bring them genuine
reform to the Federal bureaucracy. This is the mission of the Oversight and Government
Reform Committee. Today, we are here for a joint hearing between
the Oversight and Government Reform Subcommittee on TARP, Financial Services and Bailouts of
Public and Private Programs and the Subcommittee on Government Organization, Efficiency and
Financial Management on “SEC: Who’s Watching Wall Street’s Watchdog.” When we called this hearing originally, we
were concerned about capital formation and accountability at the SEC. A number of management
practices had come to light at that point that we thought it would be important to discuss,
but a lot has changed just in the last two weeks in terms of disclosures of what is happening
at the SEC and larger issues of concern with management that strike the agency’s credibility.
So there will be a lot of questions to that regard in today’s hearing.

[Mr. McHenry] I welcome the panel. I thank
you for being here and with that, I yield to the Chairman of the full committee, my
customary five minutes as Subcommittee Chair, for his opening statement. [Chairman Issa] I thank the Chairman and I
thank him for his generosity with the opening statement. I, too, thought this hearing would be about
slightly different matters, but in recent days, the committee has become aware of what
could be the greatest challenge to the SEC’s credibility since Bernie Madoff managed to
dup so many Americans, steal so much money with his ponzi scheme, and escape the proper
scrutiny of the SEC for so long.

As we have learned, in 2009, the former General
Counsel, Mr. Becker, came to the SEC and informed the Chairman that he had a potential conflict
of interest. We hope to learn exactly how that was expressed, but in fact, he had received,
along with his siblings, $2 million that came from the liquidation of a Bernie Madoff fund
in 2005. That would be serious enough that anyone would normally consider that he should
be recused from any activity related to the Madoff after action. Notwithstanding that, Mr. Becker, feeling
that this was, as we have understood it, a de minimis amount relative to his estate,
in fact, not only continued to be involved, but was instrumental in having the SEC inserted
into the process of trying to change how the determination of how much money would be considered
to be eligible to be retained by those who got their money out before the collapse versus
how much would be clawed back for the greater good of all those involved and victimized
by the ponzi scheme.

Had Mr. Becker’s suggestions been taken,
in fact, Mr. Becker’s mother’s estate of $2 million would have benefited well all
those who were there to the end and lost so much would have been victimized. The problem we are going to be probing in
this hearing, in addition to others, is can we trust an SEC where the process allows an
individual to inform the Chairwoman, to inform the ethics individual who actually reports
to the General Counsel, and get effectively a clean bill of health not to disclose and
not to recuse and even to be involved in an action that had it been accepted, as our understanding
is, by the trustees, would have led to a distortion of process in favor of Mr. Becker’s family. We take Mr. Becker at his word that, in fact,
he intended no wrong.

We are willing to take factually in 25 minutes, the ethics individual
at SEC made a determination there was no problem and stuck by it. We are willing to hear the
Chairwoman here today. What we are not willing to do, as the committee
that deals in waste, fraud and abuse, and as a committee of Congress, all of us being
concerned a great deal about the confidence in what the SEC represents in its oversight,
its fairness and its competence, we are not willing to accept that this can ever happen
again. Mr. Chairman, I am not going to presume any
facts not yet in evidence. So far, we only have a limited amount of reports, a clawback
procedure against Mr. Becker and Mr.

Becker’s own interview here with some of our investigators.
Today, we have an opportunity to listen to the Chairwoman, to realize that she inherited
an organization that had no flaws, but her independent agency has, in fact, been the
subject of the President’s attention, her attention. We have not yet high confidence but high hope
that the SEC will live up to its mandate, not just of having a complex web of rules
that tell public companies that if their own child works for a company, they cannot be
outside or independent officers or directors of the company, or, for example, what a conflict
is to the people who oversee, who can be on the compensation committee, who cannot. It
is a complex business but it relies on a belief that the rules are necessary, they are implemented
in a sensible way, uniformly and that they are for a purpose.

I believe as we look further into the Becker
matter, we are going to find the SEC failed to have the highest level of fear so that
public confidence could be maintained. I can find no way out of this. I hope today we at
least understand how this mistake came to happen. Mr. Chairman, once again, thank you for holding
this important hearing and I yield back. [Mr. McHenry] Thank you, Mr. Chairman. Thank
you for your statement. With that, I recognize the distinguished member from Illinois, the
Chairman of the Subcommittee on TARP, Financial Services and Bailouts of Public and Private
Programs, Mr. Quigley, for five minutes. I am sorry, I just promoted you to Chairman
— Ranking Member, Mr. Quigley. [Mr. Quigley] Thank you so much, Mr.

Chairman.
I soon will be joined by Chairman Platts, as well. I thank our witnesses for their time today
and their contributions. As we all know, in December of 2008, Bernard
Madoff was arrested for running the largest ponzi scheme in American history. Losses from
Madoff’s fraud have been estimated at $18 billion, devastating the savings of many Americans. We all know the SEC missed Madoff despite
being tipped off on several occasions. Although no regulatory agency should be expected to
be perfect, a failure of this magnitude is clearly unacceptable.

How did this happen? Many have blamed the
SEC’s outdated technology, which is woefully behind what the financial firms are using;
many have blamed the SEC’s silo problem which prevents coordination among the SEC’s
many offices. Another culprit that has been cited is the SEC’s workforce which some
argue includes too many lawyers and not enough industry veterans. We have all heard about
the SEC employees viewing pornography instead of doing their jobs. These are reasonable
concerns and all merit oversight from these two subcommittees. We have also heard about a potential conflict
of interest from David Becker, formerly Senior Counsel at the SEC.

It is my understanding
that SEC IG David Katz is investigating this matter. I look forward to his report. Just a few years removed from Madoff and the
worst financial crisis since the Great Depression, we need the SEC to do its job and do it well.
The SEC is Wall Street’s policeman. It was estimated by the 1934 Security Exchange Act
to prevent fraud and abuse in the securities market.

Creating the SEC was essential to
restoring investor trust in our country’s economic system. If our economic system is
going to work, says Nobel laureate, Joseph Stiglitz, then we have to make sure that what
people gain when they cheat is offset by a system of penalties. Each year, the SEC brings hundreds of enforcement
cases against firms that have sold fraudulent financial products. In 2010, for example,
the SEC brought 681 enforcement cases against 1,800 defendants. Just as all of us feel more comfortable in
our neighborhoods when they are well policed, investors feel more comfortable buying financial
products when the SEC is doing its job and prosecuting white collar crime.

The SEC is
more important today than ever before. Trust in our financial system is at its lowest ebb
and this lack of trust is impeding our economic recovery. The financial regulatory reform law passed
here was a step in the right direction, but it alone is insufficient. Laws have to be
enforced and the SEC needs to be a strong enforcer. Unfortunately, the House-passed budget would
reduce SEC funding from its current $1.1 billion. For comparison’s sake, City Bank spent $1.6
billion on marketing alone in 2010. How is the SEC expected to police Wall Street when
its entire budget is less than the marketing budget of one Wall Street Bank? In a May 2010 report, the Minority staff of
the Oversight Committee found that the Commission security disclosure procedures are technologically
backward. Yet, under the House-passed cuts, the SEC won’t be able to continue any improvement
of its IT systems. If the SEC’s budget is reduced to 2008 levels, as some have proposed,
the SEC would have to layoff 600 workers.

My point is this. Just a few years after the
Madoff incident and the worst financial crisis in recent history, should we really be talking
about taking 600 cops off Wall Street? Let us strengthen the SEC, not weaken it. Let
us also ensure that the SEC undertakes common sense report to avoid past mistakes. Put another way, after 9/11, despite our intelligence
failures, we did not cut the intelligence budget, we doubled it. It is my understanding
that the SEC has already reorganized, brought in a COO and designed a new tips referral
system. These are all commendable steps. In the end, our country will be safer from
another financial crisis if the SEC is well organized and well funded.

I look forward to hearing from our witnesses
who I hope will provide some constructive ideas on how to improve the SEC’s oversight
of financial markets. Thank you. I yield back. [Mr. McHenry] I thank the Ranking Member. With prior agreement on our side, Dr. Gosar
from Arizona will have five minutes for an opening statement. [Mr. Gosar] Thank you, Mr. Chairman. Let me preface my comments with the following.
I am not a financial analyst, I am not an accountant and I am not a lawyer, but I do
have skin in the game, as do most Americans. Most Americans are compelled to invest in
the markets through their employer-sponsored retirement plans whether they are 401(k) plans
or public or union pension plans. The money largely goes to Wall Street.

The public needs assurances that those who
handle our money and our retirement futures are playing by the rules and are being fair
and are honoring their fiduciary responsibilities and obligations. The public assurances come from the Securities
Exchange Commission. The SEC is supposed to be guarding the hen house. This hearing raises
troubling questions. Who is watching the hen house — the fox or the guard? Mr. Chairman, recent news reports have focused
on David Becker’s conflict of interest, but this hearing is not about a single incident.
This problem is actually far deeper and goes to the very heart of management practices
at the SEC.

Every organization needs a set of mechanisms
to prevent or detect fraud, waste or mismanagement. These are commonly known as internal controls.
It would appear that internal controls at the SEC are not functioning properly. One, the Government Accounting Office tells
us that the SEC is unable to reliably track its finances because it cannot control its
own financial reporting. Two, the SEC’s Inspector General tells us that 30 employees,
including an assistant regional director, viewed sexually explicit materials at work
and only one was actually fired. Was anyone else ever disciplined? Three, now the news
media tells us that the SEC’s General Counsel was allowed to advise the Commissioners on
the Madoff case when he had a personal, financial interest.

All these matters represent a breakdown in
oversight and management, a failure of internal controls. The sad irony is that the SEC is
the Federal agency in charge of making sure publicly traded companies have effective internal
controls and public governance structures. In fact, Mr. Chairman, if these events happened
at a publicly traded company, the SEC would be investigating itself and what would be
the penalties? Federal agencies are subject to the Federal
Managers Financial Integrity Act which dictates that they provide annual assurances to Congress
that their internal controls are adequate. This law has been in effect since 1982 and
governs not just financial management, but program management as well. The Federal Managers Financial Integrity Act
is within this committee’s jurisdiction. Therefore, this hearing has an important legislative
and oversight purpose in the Commission’s compliance with the law and others. Mr. Chairman,
the anecdotal example of internal breakdowns are symptoms of a much larger systemic breakdown.
Since there is no SEC to investigate the SEC, today I challenge my colleagues.

Thank you, Mr. Chairman. I yield the balance
of my time. [Mr. McHenry] I thank the gentleman. I now recognize the Ranking Member of the
Subcommittee on Government Organization, Efficiency and Financial Management, Mr. Towns, former
Chairman of the full Committee, for five minutes. [Mr. Towns] Thank you very much, Mr. Chairman,
and thank you for holding this hearing today. The SEC is at an important crossroads. It
is successfully emerging from a troublesome period leading up to collapse of the country’s
financial system. It is paused to take the lead in reforming Wall Street and preventing
another financial meltdown through its enforcement of the Dodd-Frank Act. This hearing will example financial management,
the workforce and internal operations at the SEC. It is encouraging to see all the new
initiatives Chairman Schapiro has put in place in the last two years.

The SEC hired its first
Chief Operating Officer to oversee the accounting functions, financial reporting and internal
controls, and we salute you for that, Madam Chair. The SEC has also hired a new Chief Information
Officer to oversee its information technology functions. The Chairperson has restructured
the entire Enforcement Division, recruited experts and has put a new governing structure
in place. This is commendable as well. As with any organization, lapses can, do and
will occur.

I understand the SEC has taken disciplinary action against those who have
been accused of misconduct at the Commission and that greater accountability has been integrated
into the disciplinary process. The SEC is responsible for safeguarding the
confidence of American investors in the financial markets and I hope our hearing today will
help our financial watchdog fulfill its mission. I now yield the balance of my time to the
Ranking Member of the full Committee. [Mr. Cummings] I thank the gentleman for yielding. This committee is responsible for ensuring
that our government operates effectively and efficiently. That means holding public officials
to the highest standards, demanding excellence at every turn and eliminating even the appearance
of impropriety. Today, the committee intends to examine against
David Becker, the former General Counsel of the SEC. I do not know Mr. Becker, I have
never met him, never talked to him, and the Minority was excluded from Mr. Becker’s
interview when Chairman Issa’s staff interviewed him, but I do want to make sure that everyone
who comes before this committee is treated fairly, including Mr.

Becker, Chairwoman Schapiro
and others. If I understand the facts correctly, Mr. Becker’s
parents invested about $500,000 with Bernie Madoff in 2000. Mr. Becker’s mother died
in 2004 and when her funds were divided among Mr. Becker and his two brothers in 2006, they
had increased to about $2 million. Mr. Becker joined the SEC in 2009, he notified
the SEC officials about his inheritance and when issues arose relating to his inheritance,
he sought advice from SEC ethics officials and received clearance to proceed. Some have
suggested that Mr. Becker may have benefited financially from the SEC’s later decisions,
but it appears that the opposite may be true. The basic question the SEC faced was whether
to support an asset valuation method used by the trustee representing the Madoff victims,
called the cash-in-cash-out method, or a different valuation method proposed by several law firms
called the last statement method. Under the first, Mr. Becker’s inheritance
would be subject to litigation to recover or clawback assets on behalf of the Madoff
victims.

Under the second, it appears that it would not. Based on the court filings,
the SEC chose to support the first method. This meant that the trustee could sue Mr.
Becker and his brothers to recover some of his mother’s inheritance which is exactly
what happened. Mr. Chairman, in your briefing memo for today’s
hearing, you acknowledged that the SEC’s decision was “actually detrimental to Mr.
Becker’s interest.” Nevertheless, I have serious questions about the conclusions of
the SEC’s Ethics Office, Chairman Schapiro, that these issues had no effect on Mr. Becker’s
financial interest. Someone else of questionable character might have tried to take advantage
of this situation. I also have questions about whether Mr. Becker’s interests should have
been disclosed more widely within the SEC and I hope we can learn more about this process
today. I also invite my Republican colleagues to
join us in making sure that the SEC has all the resources it needs. There is a proposed
cutting of $148 million from their budget and we do need a robust SEC.

Chairwoman Schapiro, I read what you have
done and what you have accomplished. You inherited a mess. You inherited an agency that Senator
McCain said the former Chair should resign, so we understand that. Again, I am looking for a fair hearing and
one where we can get to the bottom of all of this. I yield back. [Mr. McHenry] I thank the Ranking Member.

All members may have seven days to submit
opening statements for the record. I will now recognize the panel. We have the
Honorable Mary Schapiro, Chairman, Securities and Exchange Commission; Mr. Jeffrey Risinger,
Director, SEC Office of Human Resources; Mr. Jonathan Jack Katz, the former Secretary of
the Securities and Exchange Commission for 20 years; Mr. Stephen Crimmins, a securities
attorney with K&L Gates — he served as Deputy Chief Litigation Counsel of the SEC’s Enforcement
Division from 1993-2001; and Ms. Helen Chaitman, the attorney representing approximately 350
investors in Mr. Bernard L. Madoff’s investment securities firm. It is the policy of the committee that all
witnesses be sworn before they testify. Please rise and raise your right hands. Do you solemnly swear or affirm that the testimony
you are about to give this committee will be the truth, the whole truth, and nothing
but the truth? [Witnesses respond in the affirmative] [Mr. McHenry] The record will reflect that
all the witnesses answered in the affirmative.

With that, I thank you. We will begin at this time with Chairman Schapiro.
I think you heard the members’ opening statements and we would love to hear your comments, especially
about this conflict that has been discussed. Ms. Schapiro? [Ms. Schapiro] Thank you very much, Chairman
McHenry, Ranking Members Quigley and Towns, members of the Subcommittee. Thank you for inviting me to testify today
regarding the financial management, workforce management and internal operations of the
Securities and Exchange Commission. As you know, I am joined by Jeff Risinger, Director
of our Office of Human Resources.

When I arrived at the SEC two years ago, the
agency was reeling from a variety of economic events and mission failures and in need of
across the board reform. We needed more experts, better training, improved communication among
our divisions and offices and an effective strategy for handling tips and complaints.
These challenges were exacerbated by inadequate infrastructure, material weaknesses in financial
management and a culture that had failed to keep up with an increasingly complex financial
marketplace. We immediately and comprehensively set out to change the way the Commission worked.
My written testimony details the reforms of the last two years, but I would like to highlight
a few. We brought new leadership and senior management
to virtually ever office and hired the Commission’s first Chief Operating Officer. We revitalized
and restructured our enforcement and examination operations and revamped our handling of tips
and complaints.

We broke down internal silos and created a culture of collaboration. We
recruited more staff with specialized expertise and real world experience and expanded our
training. We enhanced safeguards for investors’ assets through new rules and the leveraging
of public accounting firms. Although we have made significant progress,
we continue to seek ways to improve our operations. After all, our core responsibility is pursuing
fraud, reviewing corporate disclosures, overseeing the largest capital markets in the world and
inspecting the activities of thousands of financial intermediaries our essential to
restoring investor confidence in the wake of the financial crisis. Our funding has presented challenges. From
2005 to 2007, the SEC experienced three years of frozen or reduced budgets, forcing a 10
percent reduction in the agency staff. Similarly, the agency’s investment in new or advanced
systems declined approximately 50 percent between 2005 and 2009. While SEC staffing levels are just now returning
to 2005 levels, the securities markets have undergone tremendous growth since then. Indeed,
during the past decade, trading volume has more than doubled, the number of investment
advisors grew by 50 percent and the funds they manage increased to $38 trillion.

Operating
under the continuing resolution only exacerbates the imbalance between our resources and the
magnitude of our mission. At the same time, the Dodd-Frank is significantly
expanding the SEC’s responsibilities for the derivates market, hedge fund advisors
and union support advisors. In addition, we are also charged with enhanced supervision
of rating agencies, heightened regulation of asset-backed securities and the creation
of a new whistleblower program.

For these reasons, I am concerned that without
additional resources, we will not be able to fulfill these responsibilities in the manner
in which Congress intends and the American people deserve. Finally, I would like to address the issue
of former Counsel David Becker’s role in light of his mother’s ownership of an account
at Madoff that was closed years before the fraud was revealed. Mr. Becker informed me, I believe shortly
after he arrived in 2009, that his mother had an account with Madoff before she died
and that it had been closed a number of years before he returned to the agency. It did not
strike me that his mother’s account closed years ago would present a financial conflict
of interest. Mr. Becker was, and is, an experienced attorney
who had served as General Counsel under three chairmen. I relied on him to present any ethics
related issues to the Ethics Counsel and follow the Ethics Counsel’s advice.

I understand
that is what he did. When I returned to the agency in 2009 having
served there in the late 1980s and early 1990s, appointed by President Reagan and President
Bush, I read many letters from Madoff’s victims, people who have lost everything.
My entire focus was on how to fix the SEC to ensure that another tragedy like Madoff
could never happen again, and how to make sure within the contours of the Securities
Investors Protection Act that we could get the most money to people who were literally
losing their homes. I am proud of how much we have accomplished
in the past two years working tirelessly with an extraordinary staff to improve the operation
of the Commission and enhance the public’s perception of the integrity of our work and
the fairness of our decisions. While Mr. Becker did solicit and follow advice
from the ethic’s counsel, I realize in light of this incident that as Chairman, I have
to ensure that we go beyond what may be required in any particular situation.

On matters like
these, I have to be looking around the next corner, looking beyond the horizon and thinking
above and beyond what may be appropriate advice from the Ethics Counsel to make sure nothing
occurs that could raise questions about the Commission’s mission or processes. To ensure that this matter is fully reviewed,
I requested that the SEC Inspector General conduct an independent review and analysis
of all of the relevant facts. In addition, under the leadership of our new Ethics Counsel,
we have been performing a top to bottom review of our ethics program. In the meantime, I look forward to answering
questions about this matter to the best of my recollection, but I can say to this committee
with assuredness, we will learn from this experience and we will take all actions necessary
to earn the trust the public places in us. Thank you. [Mr. McHenry] Thank you, Chairman. I would counsel the committee that the lights
before you, at one minute to go, it will turn yellow and red means stop. With that, if you
could keep your comments to five minutes we would certainly appreciate it. Mr. Risinger? [Mr. Risinger] Mr. Chairman, I am happy to
be before the committee today.

I look forward to taking your questions. I don’t have any
further statements. [Mr. McHenry] Five seconds. That might be
a record. Thank you and congratulations. Mr. Katz. [Mr. Katz] Good afternoon, Chairman McHenry,
Chairman Platz, Ranking Member Quigley, Ranking Member Towns, members of the two subcommittees.
It really is an honor to be invited to testify on the operations of the Securities and Exchange
Commission today. It is a matter of great interest and importance
to me personally because for most of my career, I was an employee of the SEC. For 20 of those
years, I served as the Commission’s Secretary, which was one of those unusual positions that
afforded me a rare opportunity to participate firsthand in virtually every aspect of the
Commission’s responsibilities. I retired from the Commission in January of
2006. In the five intervening years, I have really been fortunate. I have served as a
technical advisor to a variety of securities commissions in governments in emerging market
countries and have also had the opportunity to speak and write about financial regulation
in the United States.

In 2008, the Center for Capital Market Competitiveness
at the U.S. Chamber of Commerce invited me to conduct a study and to write a report on
how to improve the efficiency and effectiveness of the SEC. I wrote this study based upon
interviews with more than 50 current and former SEC staff persons and Commissioners who agreed
to be interviewed and gave me their ideas, insights and criticisms, the best of which
I shamelessly stole. In addition to this report, in 2009, I wrote
a second article for the Pittsburgh Law Review. This article focused primarily on the Enforcement
Division of the SEC, a subject that I did not discuss in the Chamber report. Unlike
the Chamber report which reflected the collective views of a wide range of people, this article
was really my own personal views. In both documents, I attempted to constructively identify
what could be done to make the agency a more effective capital market regulator.

Today, I am aware that one of the focal points
is, of course, the SEC’s budget and question of resources. I have to answer that I, like
most people, agree that the SEC does need more staff to carry out its responsibilities,
but why more money and more staff is necessary, I don’t think it is sufficient. To do the
job well, the agency has to reexamine how it does that job and I think it has to make
changes. I think it is time to critically self examine the core functions and recognize
that most of them just haven’t been very effective.

My concern is that just having more people
do more of the same thing in the same way is not the best solution. I think we need
fundamental changes in organization and management and mission definition. Chairman Schapiro
has identified a number of the initiatives she has undertaken and I commend her on them. I worked for seven Chairmen and four Acting
Chairmen and I will tell you that with the possible exception of John Schad, the first
Chairman I worked with, Chairman Schapiro has probably focused more of her attention
on management and organization than any of the other intervening Chairmen, but again,
these are first steps and I think more needs to be done.

I want to highlight five points that are contained
in my witness statement. I don’t have time to go through all of them but if people have
questions, I would be happy to do it. I think the agency needs a partial reorganization.
I advocate what is referred to internationally as the Twin Peaks approach, one division that
deals with all aspects of retail financial services regulation and another division that
handles all credential functions, the so-called safety soundness and stability functions. I think the agency needs a Chief Operating
Officer.

I applaud Chairman Schapiro for appointing one, but I think you have to go further. You
need a Chief Operating Officer who really is that and has more than the title. The way
I distinguish it is when you try and build a house, the architect and owner design the
house, but you need a general contractor to actually get it done, to build it well, to
keep you on budget and on time. I see my time is almost up, so I will quickly
identify two other things. I think there needs to be substantial changes in enforcement.
When you look at Madoff, you understand, in my opinion, this was not a question of culpability,
a few bad people doing bad things. Madoff is similar to other failures of the
Commission in the past. These are structural issues that go with how the Division of Enforcement
frames its responsibilities and conducts those responsibilities. It has to be proactive,
not reactive, and its results have to be aimed at remediation, not penalties. Penalties are
the function of the Justice Department.

In that respect, I would advocate very strongly
for beefing up a Criminal Securities Office in the Department of Justice so that the agency
doesn’t have to rely upon the Southern District of New York which has limited jurisdiction. Just in closing, I want to mention what I
think is the most important recommendation of all, the need for a special study of the
securities markets. In 1961, the SEC was similarly troubled, the markets were in similar upheaval. Congress appropriated funds to create a special
study of the securities market. A group of technocrats, experienced people in government
and from industry spent 18 months studying the markets and studying how the SEC functioned.
They issued a five volume report that literally for 25 years was the touchstone for everything
the SEC did. I think we need another one. Thank you very much for the time. I am happy
to answer questions. [Mr. McHenry] Thank you, Mr. Katz. Mr. Crimmings, you are recognized for five
minutes. [Mr. Crimmins] Thank you, Mr. Chairman. Chairman McHenry, Chairman Platts, Ranking
Member Quigley and Ranking Member Cummings, thank you for hearing us today. Over the last decade, we have seen an explosion
and the size and complexity of our capital markets, exponential increases in trading
volume, workers doing thousands of trades in a few seconds instead of maybe a hundred
trades a day, high speed, computer driven trading strategies, fragmentation of trading
away from the exchanges and into dark pools and ECNs and 24/7 globalized stock trading.

We have seen investment products become so
complex that the sophisticated traders that trade them don’t always fully understand
what they are and scary systemic risk that threatens recurring crises. Now after the crash, we see many investors
pulling out and staying out of stocks and mutual funds. Investors are still scared and
sidelined with their decimated 401(k)s. Investor perceptions are critical.

These people will
be unwilling to continue to risk their capital or risk their capital again if Wall Street’s
cop on the beat becomes the cop on furlough. Last summer, in the depths of the worst financial
crisis in 80 years, Congress recognized that the Securities and Exchange Commission needed
twice the budget to be relevant in today’s huge, complex and hyper-charged markets. Whatever
issues anyone in Congress has with the SEC, I would respectfully suggest that the answer
is not to starve in the wake of the crash, the answer is not to create an environment
where it will be easier for the frauds just to prey on investors.

Instead, the answer is for all of us, here
and now, to commit firmly to do whatever it takes to make the SEC the strong and smart
overseer that our capital markets deserve to recover and grow. One thing is of paramount importance. Nobody
is asking the taxpayer for one dime to fund the SEC. What is often forgotten in the discussion
is that American taxpayers pay absolutely nothing to run the SEC each year. Under 1996
legislation adopted by a Republican Congress and a Democratic President, the money to run
the SEC comes entirely from Wall Street transaction fees and assessments designed to cover the
entire cost of the SEC’s budget. Because of this a substantially increased
SEC appropriation paid for with this successful 15-year old funding mechanism would require
no tax dollars whatsoever and would add nothing to the deficit. In short, the Wall Street
user fee money is already there. Congress just has to let the SEC use it to police Wall
Street. Madoff was a tragedy. The SEC missed Madoff
and Chairman Schapiro and others have not tried to evade or run away from that fact,
but so did FINRA whose predecessor installed Madoff as its Vice Chairman, and so did the
Justice Department, and so did the New York Attorney General with Madoff right in his
own backyard, and so did how many others, including the sophisticated financial services
firms that regularly interacted with him.

Madoff was an industry icon and idol and nobody
knew that he was really a crook. Yet, through thick and thin, the SEC was out
there bringing almost 700 complex cases for enforcement every year against almost 2,000
defendants every year and with greater funding, could have brought far more. We hear criticism of the SEC’s recently
departed General Counsel, David Becker. His power, I suggest, is misunderstood. He was
not the Secretary of some Cabinet level department. Instead, he was the General Counsel, one of
multiple senior advisors at a five member, bipartisan commission, composed of two Republicans,
two Democrats and one independent.

Whatever his power, the point is that he did
not use it to benefit himself. The month after he left the agency still to this day, it remains
unclear exactly how any of the Madoff related claims are ultimately going to be calculated.
In any event, the Madoff Trustee, Irving Packard reports to the court, not to the SEC, and
he will make his own decisions on what he wants to claim. Finally, we need some perspective. What we
are talking about is whether the Dorothy Becker estate will get to keep the $500,000 that
Dorothy originally invested or whether it will also get to keep some small amount on
top, the inflation adjustment. That seems to be where this is all breaking down and
being discussed.

The senior ethics official with whom Becker
consulted ruled that whatever theoretical conflict this may actually have presented,
it did not create such a conflict that he needed to recuse himself, based on what was
known at that time. The possibility of a claim against this estate of a particular type at
some future date was at that time speculative. Now we know more, of course. [Mr. McHenry] Thank you for your testimony. Ms. Chaitman, you are recognized for five
minutes. [Ms. Chaitman] Thank you so much for giving
me this opportunity to speak to you. I speak on behalf of approximately 500 Madoff investors
whom I represent and I speak, as well, on behalf of every American who hopes to save
enough money in his lifetime to retire on that money. I speak on behalf of every American
who relies upon the brass plaque on his broker’s desk, SIPC.

We are told when we invest that
every account is insured up to $500,000 and yet, SIPC has taken the position in the Madoff
case that the law doesn’t apply to it. If I had to grade the SEC’s performance
with respect to its essential function of protecting investors with respect to the Madoff
case, I would give the SEC and “F.” The SEC, instead of enforcing the law against
SIPC, which it is charged by Congress with the obligation to do, instead of enforcing
the law, we now know that in January 2009, the SEC agreed with SIPC that for the first
time in its history, it would not pay SIPC insurance to each Madoff victim based upon
the investor’s last statement.

SIPC is an insurance entity established by
Congress which has the power to assess the Wall Street firms who raised the funds to
protect investors. The statute doesn’t give SIPC the right to define how it is going to
allow a claim. The statute mandates that a claim is based upon the customer’s last
statement. Yet, the SEC joined in SIPC’s violation of the statute. This is not just my opinion, this is the opinion
of Chairman Garrett who has proposed H.R. 757 and in proposing H.R. 757, which is simply
a clarification of the law, one could view H.R. 757 as a statement to the SEC, you cannot
avoid the law and SIPC cannot avoid the law.

Mr. Garrett made a statement when he introduced
this bill that SIPC has violated the law and the trustee in the Madoff case has violated
the law. If you recall, in 1970 when SIPC was enacted,
investors were encouraged to relinquish the protection of having certificated securities.
That was something that Wall Street wanted. In exchange for relinquishment of that protection,
investors were promised SIPC insurance. SIPC insurance was raised to $500,000 in 1978;
it was never raised thereafter. In the Madoff case, SIPC decided that was
going to be too expensive for its Wall Street members and so it was going to try to come
with an entirely new basis for insuring accounts. For the first time in SIPC’s history, it
decided it didn’t insure the balance on the last statement, it only insured the net
investment over the life of the account which might have been 20 years, 30 years, 40 years. There is no evidence that any investor in
today’s stock market has or what he owns other than the statements he receives from
his broker.

We don’t have the luxury of going back to certificated securities. The
Internal Revenue Service relies upon those statements, every investor relies upon those
statements for planning their retirement, for their estate plans for their children.
There is no basis in law for what the SEC did in this case. This is not a question of insufficient funding
for the SEC. This is a question of doing its mission which is to protect the investor. I am not here to opine on whether or not Mr.
Becker had a conflict of interest.

I don’t think there can be any doubt about it. Whether
he advocated the constant dollar adjustment, which obviously reduced his own exposure,
or whether he said to the SEC when he came onboard in February 2009, you have made an
illegal agreement with SIPC which would have worked to his advantage, his judgment was
clouded because everyone in the SEC forgot the law. There is one way to remedy this and to restore
confidence in the capital markets for the average American. That is to enact H.R. 757. Thank you. [Mr. McHenry] Thank you for your testimony.
I thank the panel for its testimony. With that, we will begin questioning on our side
by Dr. Gosar of Arizona. He is recognized for five minutes. [Mr. Gosar] Chairman Schapiro, when David
Becker, your brand new General Counsel, first came to you in February 2009 and said, my
mother had an account with Bernie Madoff, why didn’t you ask him any questions about
it? Why didn’t you even ask simple questions like, how much money? [Ms.

Schapiro] Congressman, to the best of
my recollection, and just so I can be clear, I haven’t looked at any emails or whether
there might be any contemporaneous notes or anything like that in this period of time,
so I am recalling back because our Inspector General is looking at all that, so I am recalling
two years ago. The best of my recollection was that Mr. Becker
told me that his mother, who had passed away years ago, had an account at Madoff.

Because
the account was closed years before, I did not think that the account of a long deceased
relative would raise an issue of a conflict of interest in Mr. Becker’s work. I did expect that he would go to the Ethics
Counsel, an experienced government official, a government lawyer who served under three
Chairmen at the SEC, and we use our Ethics Counsel all the time for their advice. I expected
him to run it by the Ethics Counsel and to follow their advice and that is the way it
went forward. [Mr. Gosar] It seems that if the same situation
existed in a publicly trade company that you were investigating, would you have such a
cavalier approach to that? [Ms. Schapiro] It is hard for me to imagine
this situation. These are the government ethics rules. [Mr. Gosar] An ethics rule nonetheless. [Ms. Schapiro] It is very hard to answer in
the abstract. It would depend on the rule. [Mr. Gosar] It just seems there is a very
different aspect that what is good in the private sector and publicly trade situations
is not going well for the government. Let us go to my next question.

Ms. Chaitman,
do you believe the account valuation method that David Becker recommended to the Commission
as its attorney would have befitted his personal financial interest? [Ms. Chaitman] There is no question that the
constant dollar approach, which apparently Mr. Becker invented, would benefit him personally
and reduce his clawback exposure, but the more significant problem with the conflict
of interest Mr. Becker had is that it clouded his judgment. The law is absolutely clear
that ever investor is entitled to SIPC insurance based on his last statement.

Mr. Becker had
an obligation, as General Counsel of the SEC, to make sure that the SEC complied with the
law and enforced it against SIPC. That is the great failure which has caused devastation
to all of my clients. [Mr. Gosar] Chairman Schapiro, your agency’s
Inspector General compiled a 457-page report about the SEC’s failure to uncover Madoff’s
ponzi scheme. That report devotes two sections out of 11 to describing in great detail every
possible connection between SEC employees and Madoff. Do you think that your General Counsel’s
receiving funds from a Madoff account would have been appropriate material, the Inspector
General or not? [Ms. Schapiro] That would be a much better
question for the Inspector General. I have a pretty high level of confidence that he
did quite a thorough report on the agency’s failures with respect to Madoff.

[Mr. Gosar] The Inspector General’s Madoff
report mentions on page 382, that two family members of an employee in the Office of Internet
Enforcement invested $1.5 million and $500,000 respectively with Madoff. The Inspector General
found it necessary to make sure that this employee had no involvement in any Madoff
examination. Do you think that the Inspector General would
have been interested in a similar situation involving your chief lawyer, a senior SEC
official who served as General Counsel from 2000 to 2002 while the SEC was ignoring whistleblower
complaints about Madoff? [Ms. Schapiro] I can’t predict. I can imagine
that he might have been and of course he is looking at all of these issues now.

I expect
that he will thoroughly explore that. [Mr. Gosar] I understand that you inherited
a horrific problem but it always starts with top down. Private sector, businesses always
look at accountability within the hierarchy. It seems like we have a two-edge sword here
that we should have demanded better accountability. Would you agree? [Ms. Schapiro] Congressman, I would agree
that from where I sit now and understanding all the things that I understand now that
I didn’t understand in 2009, having arrived at the SEC and discovered that I had an agency
in absolute ruin in some regards on my hands to manage and not knowing obviously all the
steps that would be taken by the Trustee or the decisions the Commission would make down
the road, but knowing those things now, I wish that Mr.

Becker had recused himself,
absolutely. [Mr. McHenry] The gentleman’s time has expired. The gentleman from Illinois, Mr. Quigley,
is recognized for five minutes. *Mr.Quigley. Thank you, Mr. Chairman. Madam Chairman, the New York Times reported
on March 5 of this year that the SEC has declined to enforce the requirement from Dodd-Frank
that would make rating agencies subject to expert liability under the securities law.
This would make rating agencies liable for faulty ratings.

Could you comment on the timeline
for implementing this measure? [Ms. Schapiro] Yes, I would be happy to. The
way the rule works is that if a rating is included in a registration statement for securities,
then the rating agency must consent to having liability. That is the Dodd-Frank requirement. We had preexisting SEC rules that require
for AXA-backed securities registration statements, that if a rating was used to sell the securities,
the rating needed to be included in the registration statement. Rating agencies have absolutely,
unequivocally — at least the ones that are in existence now — refused to consent. That
made public offerings of AXA-backed securities impossible because they couldn’t get the
consent of the rating agencies to include the ratings, but they used the ratings to
sell the securities. We temporarily set aside our rule, our requirement
that the AXA backed issuers disclose the ratings in the registration statements because we
didn’t want to be holding up all public offerings of AXA-backed securities and pushing
them into the private markets which we felt were not as good for investors.

Right now, our staff is working through reconsideration
of our disclosure requirements. I believe they will recommend that we eliminate our
preexisting requirement for including the ratings and therefore, the liability provisions
can ago forward. We are also hopeful that some of the newer
rating agencies that have indicated an interest in becoming registered with us will actually
be willing to consent, which is I think how Congress hoped the law would work. [Mr. Quigley] Can you guess on the timeframe
for that? [Ms. Schapiro] I can’t but I would be more
than happy to. I would say over the next couple of months, but I would be happy to get you
a more definitive answer right away. [Mr. Quigley] Thank you. You talked about
the agency that you inherited and you talked to a certain extent about the reforms necessary
and those you have implemented. As to Mr. Katz’s point, whether or not more assets,
and I think you need the assets to do your job, help more than the need for in a sense
restructuring, reforming and reinventing yourself. Are you looking at the agency from that perspective
and the broader picture? If you were to start over, what would you do and how would you
do it? [Ms.

Schapiro] Absolutely. I actually would
do again many of the things we have already done. This has been an agency that has been
sort of taken upside down and shaken pretty hard over the last two years — new leadership
across the board in every major office and division, a new Chief Operating Officer, a
new Chief Ethics Counsel, our first ever Chief Compliance Officer. We also restructured our Enforcement Division
and put people into specialized groups where they could get deep expertise to bring enforcement
cases more quickly in particular areas like structured products or the Foreign Corrupt
Practices Act or insider trading.

We have also restructured our examination
program, both of those, enforcement and examination, largely in response to the failures that were
so vividly demonstrated in the Inspector General’s report on Madoff. We have also brought new technology, which
is going to be critical to us. We have too many people doing low value work because we
don’t have the technology. [Mr. Quigley] What do you mean low value work? [Ms. Schapiro] For example, when we bring
enforcement cases, we bring in massive amounts of electronic data so that we can look at
trading records or we can look at email transmissions between parties who might be sharing non-public
information. We need to be able to use analytics to find
the important information and all of that, not have people plowing through all that information.
When the markets fell so dramatically on May 6, it took us five months to reconstruct trading
data because we don’t have the capacity in the SEC. [Mr. Quigley] That was the final question
we have limited time. Are you a technological match for those that you are regulating? [Ms. Schapiro] Not at the moment, we aren’t.
We have a phenomenal new Chief Information Officer who is making real progress, I think,
but we are a long way from the people that we are regulating in terms of our technical
capability, but I think we can get there.

I think we can put up a good fight anyway. [Mr. Quigley] Thank you. I yield back. [Mr. McHenry] I thank the gentleman. I now
recognize the Vice Chair of the TARP, Financial Services and Bailouts Subcommittee, Mr. Guinta
of New Hampshire, for five minutes. [Mr. Guinta] Thank you very much, Mr. Chairman. Mr. Katz, thank you and thank all of the witnesses
for being here today. wanted to direct my first question to you, sir. In your testimony, you talked about the size,
structure and complexity of the U.S.

Capital markets and financial companies that have
grown substantially in the past 30 years. I think your position is that you are comparing
the SEC over that same period of time and the fact that it has not grown, changed or
modified substantially. I wanted to get a little clarification on that first, if you
would. [Mr. Katz] Obviously I think everyone would
agree that the capital markets of today are exponentially greater, but my point was more
directed to the way the SEC is structured. It is not just a question of size; it is a
question of a structure that corresponds to the entities you are regulating. The point
I was making is that in the early 1970s when basically the current organizational structure
of the SEC was last reformed, you had market regulation that focused on stock exchanges
and broke dealers. You had a Division of Investment Management Regulation which focused on mutual
funds and investment advisors.

They were two very separate components of the industry and
there really was very little overlap. That no longer exists. Because of consolidation
in the industry and the blending of the roles, the fundamental distinction between a stock
broker who is a commission-based seller of securities and an investment advisor, who
is an under management advisor on a comprehensive portfolio, is a historical artifact. It doesn’t
exist. Because you have two divisions upon two different
laws, according to a model that no longer exists, you get these anomalies. The fight
over fiduciary duty differential was embedded in the laws but more importantly, you had
two different divisions who had different ways of thinking about it and neither of them
wanted to compromise.

They both wanted to maintain their piece of it. [Mr. Guinta] Does that speak a little bit
to the silo effect that you have been referring to? [Mr. Katz] Absolutely. I used to joke that
the silos at the SEC were so real that in fact, that they had locked doors and that
because all the paper in the agency used to have to come through my office, I actually
had a skeleton key that occasionally allowed me to unlock each of the silo doors and get
inside.

Most people don’t. Turf is a real issue in any organization, no matter what
the size. It is compounded because remember you have different securities laws that were
written at different points of time for different segments of the industry. Each division sort
of jealousy guards the law that it controls. The market has changed. [Mr. Guinta] I listened to what Chairman Schapiro
mentioned in her earlier comments about some of the improvements, modifications and changes
that she has made and they sound laudable and responsible. That being said, I wonder
what type of congressional action may or may not be necessary given the systemic problem
that we have seen within the SEC. I don’t want to get into the specifics, but the things
we have been talking about here.

We have to prevent these from happening again. People
in our Nation need to have confidence, not just in the SEC, but in the markets as well.
I wonder what you could say about the type of intervention you feel Congress should be
considering? [Mr. Katz] That is a very difficult question
for me to answer. The reason is I spent virtually my entire career at the SEC and I think it
is very different for Congress to micromanage the internal organization and operations of
a government agency. You can set policy, you can give direction, but I think it is dangerous
when Congress tells the agency this is how you get it done. I think the agency really
has to take this responsibility on. Chairman Schapiro has brought in an entirely new team
of senior people. I don’t know most of them.

They seem very competent. My hesitation is this. If you rely exclusively
on a team of people coming in to effect change, when those people walk out the door, the change
walks out with them. You need to change the structure, you need to change the culture
and most importantly, you need the agency to define what it is it is trying to do and
how do you measure whether it has gotten it done. You need that discipline, but that is
for the agency to do. [Mr. Guinta] Thank you, sir. Chairman Schapiro, I only have a few seconds
left, but what assurance can you give us that new management team is effectively managing
and maintaining the necessary changes? [Ms. Schapiro] I have to say I think change
starts with leadership absolutely and having a whole new leadership team makes an enormous
difference.

They are very committed to working together and institutionalizing cooperation
and collaboration among all of the divisions. For example, we now have the College of Regulators
for the largest financial institutions. It is no longer just the Trading and Markets
Division that looks at them, it is no longer just the examination group. There is a group
of people drawn from all over the agency who could have potential interest in the health
of that financial institution who meet regularly to talk about what is going on in that company,
to look at the financials, to meet with the staff of that financial institution. So the
College of Regulators is just one example. We have task forces across the agency. We
are merging, in some of our offices and will eventually in all of them, our examination
programs for investment advisors and broker dealers which Mr.

Katz mentioned. Finally, I should say that we have just commissioned,
and I believe it is going to be released today, Dodd-Frank required us to hire an independent
consultant to do a very in-depth study of the SEC’s organizational structure. That
will be released today. I fully expect that there will be some really helpful ideas there
for us to further improve how we operate. [Mr. McHenry] The gentleman’s time has expired.
With that, I recognize the Ranking Member, Mr. Towns. [Mr. Towns] Thank you very much, Mr. Chairman. Let me thank all of you for being here. I
really appreciate you taking the time to come. Chairman Schapiro, the SEC plays a critical
role in protecting investors and ensuring that our financial markets operate effectively.
You have stated that freezing the SEC budget impedes the agency’s ability to meet its
mission, which is to protect investors, to maintain fair, orderly and efficient markets,
and facilitate capital information.

Can you put that in concrete terms for us? If the SEC does not have the budget to properly
oversee capital markets, how would effect your staffing? [Ms. Schapiro] Yes, sir, I would be happy
to. I think the two things that are most severely impacted by a limited budget at the SEC are
capability to hire the new kinds of talent and expertise we need, economists, people
who worked in hedge funds on trading desks, financial analysts, the new expertise that
will help us keep up with what is going on in the marketplace.

The second is the fact that it will slow down
and really hurt our efforts at reforming our technology and bringing it up to speed and
giving us the capacity to do the things we need to do in order to keep up with Wall Street.
I know we will never meet their budgets. I understand that. I have no expectation and
don’t believe the American public should pay for us to have a $3 billion a year technology
budget, but we have to do much better than we have been able to do.

pexels photo 5849561

I think those are the two primary things that
are really impacted. It plays out in lots of other ways. When we don’t have a sufficient
travel budget, examiners can’t travel to go into that mutual fund where most Americans
hold their investing wealth, and examine the mutual fund’s books and records. They can’t
go to the investment advisor or to the broker dealer. In little ways, the lack of resources plays
out but the real fundamental ways are bringing in those people that we need to really reform
and transform the agency so people know that we have at least a fighting chance at staying
on top of what is happening on Wall Street so we can also respond when the emergencies
come along as we saw on May 6 when the market absolutely fell apart, scared people very
badly in the retail investing public and in the institutional investing public as well.
We need the capability to respond to those things very, very quickly.

[Mr. Towns] What about the flexibility? Do
you have that? For instance, if there is a crisis situation and you need a specific type
of person and in order to get that person, you might need additional resources to be
able to track who you need to do the job at that particular time, do you have that kind
of flexibility? [Ms. Schapiro] We have had some flexibility
over the last two years because Congress has been generous in our budget, but if we continue
with the CR level or are cut, the answer to that is no. May 6 required us to go out and
bring in experts to help us analyze and go through all the trading data so we could reconstruct
for the public to see what was happening every second in the marketplace when the Dow dropped
500 points in a matter of a few minutes.

Responding to emergencies is one of the things
I do worry about. That is where we lose flexibility if we don’t have a sufficient appropriation. [Mr. Towns] Thank you, very much. On that
note, I yield back. [Mr. McHenry] Thank you. With that, I recognize
Mr. Mack from Florida for five minutes. [Mr. Mack] Thank you, Mr. Chairman. I also
want to thank the panel for being here today to give us an opportunity to get your insights
and to ask a few questions on a very serious topic.

I would like to start with Chairman Schapiro,
if I might. Do you feel as Chair of the agency that ultimately it is your responsibility
to ensure that all of the employees are acting in accordance with SEC employee conduct standards? [Ms. Schapiro] I have responsibility for the
agency in that sense. I cannot tell you that with 3,800 employees, I can take individual
responsibility for each and ever one to ensure that they are following the requirements the
way they should be. [Mr. Mack] Ultimately, it is your responsibility
as the Chair of the SEC? [Ms. Schapiro] Ultimately, I am responsible
for the agency’s conduct. [Mr. Mack] If I could direct your attention
to slide number four, Chairman Schapiro, are you familiar with the rule that is being presented
on the screen? [Ms. Schapiro] Yes. [Mr. Mack] After reading through my material
and hearing your testimony, it seems to me that you weren’t completely knowledgeable
of this rule at the time you hired David Becker. Please allow me to read it so everyone in
the room can understand the entire rule. “The Securities and Exchange Commission
has been entrusted by Congress with the protection of the public interest in a highly significant
area of our national economy.

In view of the effect which Commission action frequently
has on the general public, it is important that members, employees and special government
employees maintain unusually high standards of honesty, integrity, impartiality and conduct.
They must be constantly aware of the need to avoid situations which might result either
in actual or apparent misconduct or conflicts of interest and to conduct themselves in the
official relationships in a manner which commands the respect and confidence of their fellow
citizens.” Chairman Schapiro, were you familiar with
this rule at the time that you received David Becker as your General Counsel? [Ms. Schapiro] I can’t tell you whether
I had read it. I have been in and out of government most of my career, so I am generally aware
of the ethics rules. [Mr. Mack] I only have a little bit of time.
A moment ago, you said you were familiar with the rule. [Ms. Schapiro] I am but you just asked me
was I aware of it at the time that David Becker arrived at the Commission.

I am telling you
I can’t recall whether I had reread the rule recently at that point or not. [Mr. Mack] Throughout your time in the 1980s
and 1990s, you were familiar with this rule? [Ms. Schapiro] Yes, I am generally aware of
the ethics rules and that it is each employee’s obligation. [Mr. Mack] Regarding David Becker’s work
with the Madoff case, do you believe that Mr. Becker was sufficiently aware of the need
to avoid actual or apparent conflicts of interest? [Ms.

Schapiro] I want to be very careful.
I believe he did what he thought was appropriate and what was required of him, going to the
Ethics Counsel and seeking advice, getting that advice and following it. Do I wish now
that he had been more sensitive to the potential for this issue to raise an appearance of a
conflict? Yes, I wish that had happened. [Mr. Mack] A few more questions. Do you think
that you were sufficiently aware of the need to avoid actual or apparent conflicts of interest? [Ms.

Schapiro] On my part, yes. I believe
I am. [Mr. Mack] You said now a couple times, I
think, that you wished Mr. Becker would have recused himself. Is that because of the fallout
or do you really believe he should have recused himself? [Ms. Schapiro] I believe, as I said, at the
time from my perspective, a close account from a long since deceased relative didn’t
appear to me to raise a conflict of interest, but I believe now, knowing what we know now,
not because of the fallout, though that is very real, but because if we could connect
the dots and look ahead and see what all the steps would have been, yes, it would have
been appropriate to have recused.

[Mr. Mack] Let me say this. Also earlier,
you kind of referred to the budget as kind of the reason why some of these mistakes happened.
How much does it cost to follow that rule? [Ms. Schapiro] That is a personal initiative.
It doesn’t really cost anything. [Mr. Mack] So the argument about the budget
as it pertains to this rule, doesn’t hold water? The argument about the budget in your
opening statement that you talked about really doesn’t pertain to this rule? [Ms. Schapiro] No, and I didn’t mean to
suggest in any way that it did.

[Mr. Mack] Thank you. [Mr. McHenry] The gentleman’s time has expired.
With that, I recognize the Ranking Member of the full committee. [Mr. Cummings] I don’t want that to be left
hanging. I never heard you, and I heard all of your testimony and I have read your testimony,
Ms. Schapiro, you never made that allegation. I want to make that clear. I haven’t heard
it. I think it is a very unfair statement. Let me go on. Chairman Schapiro, I must tell
you that when I was talking to my staff — as a matter of fact, when we were emailing back
and forth at 4:00 a.m. this morning about this case, because it does trouble me to a
degree with regard to the appearance of a conflict of interest. I think when we hear what Ms. Chaitman had
to say, that shows you why, and I am sure you see it, we have to make sure that we don’t
even have the appearance because what happens is that every decision made by Mr.

Becker
then becomes suspect. It is my favorite author, Covey who in the book, “The Speed of Trust,”
says that “Once trust is lost, everything moves more slowly.” So I cannot begin to
tell you how pleased I was when you walked in here today and said we will go beyond what
may be required. That is so very, very important. In my office, I have five people that whenever
there is an ethics question, they all have to agree and if one vetoes, it is out the
door. Why? Because the public is looking over our shoulders, we want to do the right thing
and we want to make sure that it is right.

This has been a major wake up call, hasn’t
it. Here in this committee, it is so easy for us to get into a gotcha mode, but I must
tell you, after I read about what you had done at the SEC since you have been there,
and having sat on this committee and watched Mr. Cox and what he did with this organization
and how it went down under him, to see you come and try to sweep up the mess, I must
commend you.

The sad part about it is that one of these
little incidents basically can almost destroy that trust. Do you understand what I am saying? So I want you to commit to this committee,
if you will. Tell me, if these incidents come up again, tell us the difference in how you
might approach it. I understand what you did. A fellow comes to you, he tells you, years
ago, I got an inheritance and he wants to know about a conflict. You listened to it
for a while. You have 3,800 employees to deal with, you hear him and then you say, you know
what, the expert on this is the ethics guy. Make sure you check with him and he got an
opinion. How would you deal with this differently now,
looking backwards? [Ms. Schapiro] We have a new Ethics Counsel,
first of all, who is doing sort of a top to bottom review of our program, but I think
I need to work with all of our employees and communicate with all of our employees about
a heightened sensitivity to issues like this.

I have worked so hard in the last two years
to try to put this agency back on the right path and to earn the trust of the public.
You are right, a small thing like this, not so small thing like this, can really set us
back. It is not fair to 3,800 hardworking employees. It is just like when somebody mentioned in
their opening statement that employees had viewed pornography at the SEC. It infuriates
me because most people there are working their hearts out day and night to try to do the
right thing. It hurts the reputation of every single one of us. I have to work with our employees to make
sure that we increase their sensitivity to issues like this. I think with our new Ethics
Counsel and their review of the program and how it might be strengthened, we will get
some good advice. I think the Inspector General is likely to have some recommendations that
will be very helpful too. [Mr. Cummings] I read in your testimony where
you talked about technology and trying to keep up with these ever changing transactions
and how complicated they have become.

I want to make sure you have all the resources you
need to address this because so many of our constituents on both sides lost a lot of money.
Like Mr. Crimmins said, they need confidence to reenter this system of stocks. [Ms. Schapiro] I agree. [Mr. Cummings] Thank you. [Mr. McHenry] I thank the Ranking Member.
With that, we yield for five minutes to Mr. Ross of Florida. [Mr. Ross] Thank you, Mr. Chairman. As a kid, I always wanted to be a lawyer and
fortunately I found a law school that would take me. I went to law school and I always
had a deep seated respect for the sanctity of the law, so much so that I was gratified
that the American Bar Association and my state bar association required not only a course
but an examination on the Code of Professional Responsibility.

Ms. Schapiro, I understand that you too are
a lawyer and that even though you inherited quite a mess at a time of great disarray at
the SEC, my question is as a lawyer, when Mr. Becker came to you, did you not think
that a further investigation should be made? As a lawyer, we do conflicts checks, we make
sure of that and it just seems to me that if further inquiries had been made at that
time, this might have been avoided. [Ms. Schapiro] I don’t disagree with you
that if further inquiries had been made, this might have been avoided. I can only say what
I said at the beginning, that when he raised it with me, that he had a closed account,
I didn’t know if it had been a net winner account, a net loser account or anything else,
from a deceased relative, it didn’t raise for me a conflict of interest question. [Mr. Ross] The fact that he asked for a waiver
from his subordinate is indicative of a problem, an inherent internal problem there from an
ethical standpoint. [Ms. Schapiro] I don’t know that he asked
for a waiver and I again, I have no access to any contemporaneous documents of any sort.
He asked whether or not he had a conflict and was advised that he did not have a conflict.

[Mr. Ross] Did you know who was advising him
that there was no conflict? [Ms. Schapiro] It was the Ethics Counsel of
the SEC at that time who is no longer the Ethics Counsel. [Mr. Ross] As General Counsel, that would
be under him, would it not? [Ms. Schapiro] I believe that is the case
in most agencies. [Mr. Ross] Do you feel this would be avoided
again in the future? [Ms. Schapiro] I would love to say absolutely
without a doubt, but it would be my very strong hope that with a very strong new Ethics Counsel
that we hired from the Treasury Department with long government experience, with a revamping
of our programs and with some additional education and training for our people, I would hope
and expect that we could avoid this. [Mr. Ross] I think the American public needs
that assurance that credibility is going to be there. Mr. Risinger, with regard to human resources,
are your employees all part of the general schedule in terms of compensation? [Mr. Risinger] Congressman, actually we have
a separate pay schedule that we received from legislation of Congress back in 2001, 2002. [Mr. Ross] Were you subject to the pay freeze
that the President issued? [Mr.

Risinger] Yes, we are. [Mr. Ross] That just really affected the cost
of living increases, didn’t it? [Mr. Risinger] It does affect the cost of
living increases. [Mr. Ross] What about within pay grade or
step increases? Did it affect that? [Mr. Risinger] We have a merit pay process
that is the equivalent of step increases for the rest of the government, so that is technically
affected by the pay freeze. [Mr. Ross] In your disciplinary procedures,
let me ask you this. What is the probationary period for any employee? [Mr. Risinger] It is generally a year. [Mr. Ross] One year. After one year, if there
is a disciplinary situation, is a presumption in favor of the employee if they have been
found in violation or alleged violation of any personnel policies? [Mr.

Risinger] The Federal laws that we have
to follow in terms of disciplining employees set out a number of standards that we have
to go through. There are actually 12 factors that you have to look at when you are issuing
discipline and one of them is a factor that says, is this the level of discipline that
is necessary to stop the behavior and not more than that. So there is a presumption
that you are taking a preventive or corrective step, not necessarily a punitive step. [Mr. Ross] These would have been the same
procedures employed in those involved in the viewing of pornography, correct? [Mr. Risinger] That is correct. [Mr. Ross] Only one person was fired as a
result of that? [Mr.

Risinger] Of the cases we have had since
2005, 50 percent or 51 percent have either resigned, retired or have proposed removals
in place. We have had a number of suspensions and reprimands as well. [Mr. Ross] What is the attrition rate in your
agency? [Mr. Risinger] In the agency, in normal years,
it is 7 to 8 percent. In the last couple of years because of the economy, it has been
in the 3-1/2 to 4 percent range. [Mr. Ross] How does that compare with Federal
agencies overall? [Mr. Risinger] If we are talking just attrition
in general, I think that is pretty equivalent with other agencies. [Mr. Ross] Last question. Ms. Chaitman, with
regard to the Madoff situation specifically, I saw where you put them on notice, what was
going on. What action do you think would have requested be done in order to avoid this conflict? [Ms. Chaitman] Under the statute, Congress
mandated that the SEC go into court and enforce the law against SIPC.

That is precisely what
I asked Ms. Schapiro to do in my April 2, 2009 letter. In fact, when Ms. Schapiro testified
on July 14 before the Subcommittee on Capital Markets that she was going to do everything
in her power to provide the maximum SIPC coverage for all investors, I assumed that she was,
in fact, going to follow my request. Now I have learned that in January 2009, the SEC
had already agreed with denial of SIPC insurance to more than half of the victims. [Mr. Ross] Thank you. I yield back. [Mr. McHenry] Thank you. Mr. Yarmoth of Kentucky
for five minutes. [Mr. Yarmoth] Thank you, Mr. Chairman. Thanks to all the witnesses for your testimony. Over the last couple weeks I have been plowing
my way through the Financial Crisis Inquiry Report which is anything but bedtime reading.
It will not put you to sleep, I guarantee you that — as a matter of fact, quite the
contrary. I am sure, Chairman Schapiro, that you are
aware of what the report concluded, particularly with regard to the SEC. I was interested in
an assessment of where you think you still need to go to make sure that the failings
in the system as it concerned your agency won’t recur? [Ms.

Schapiro] As I have not looked at the
report recently, it obviously focused a lot on the failures of the SEC’s Consolidated
Supervision Program for the five largest investment banks, all of which during the financial crisis
essentially disappeared or converted to bank holding companies under the regulation of
the Fed. I think there are a lot of lessons. I testified before the FCIC about the failures
of the agency with respect to that program. There are a couple of things. One is that
it was a voluntary program, a voluntary regulatory program which, in my view, doesn’t work
very well. We had insufficient resources devoted to the regulation of the five largest investment
banks. We didn’t have people with the right kind of expertise and I think in some ways
perhaps the most important thing is it required a very different kind of supervision than
the SEC has traditionally done.

It required prudential supervision as opposed to the SEC’s
going on-site, doing an examination, leaving and then perhaps bringing an enforcement case. We didn’t have the right mindset within
the agency I think for that kind of constant prudential oversight approach that was really
necessary. There was a lack of management focus, I think, with respect to the program.
There was a willingness to believe what our people were being told by some of the leaders
in some of those financial institutions that failed, a lack of skepticism which I think
really hurt us as well. That program was discontinued by my predecessor, Chairman Cox. [Mr. Yarmoth] With regard to the present situation,
because most people who observe the situation now, agree I think that the situation in terms
of too big to fail, the largest investment banks have, in fact, gotten larger and that
the wild west atmosphere in terms of risk taking and so forth may not have been curtailed
at all.

Is this a concern that you share? Anyone else on the panel is welcome to respond
as well. Looking at the Wall Street profit picture
and so forth, it looks like there hasn’t been a whole lot of change in behavior. [Ms. Schapiro] I do think I can speak perhaps
most particularly to the over-the-counter derivatives market where we have a very direct
responsibility, although much progress is being made internationally with respect to
accounting standards and other prudential measures. Getting the over-the-counter derivatives market
into a transparent marketplace so that regulators can understand the build up and concentration
of risk in financial institutions I think is going to be a very, very important piece
of this.

We are working through those rules as is the Commodities Futures Trading Commission.
About half of them or so have been proposed and I would expect while we are going to miss
for some of them the July 21 deadline, we will get them over the finish line over the
course of the rest of this year. Then there will be implementation and phasing periods
to go through. I think that will make a difference. I think the work the FDIC is doing with the
Fed and others on living wills and plans for financial institutions to wind down their
business appropriately will also make a very big difference and then, of course, the capital
requirements. [Mr. Yarmoth] A final question on that subject.
We talked about the problem potentially with resources and the dangers that would ensue
if your budget was cut.

Are you confident that the legislative action that was taken,
Dodd-Frank, is sufficient or that there are things that we yet need to do to make sure
that we don’t have a situation recur as it did two years ago? [Ms. Schapiro] I think it makes large strides
towards filling the gaps that existed in the regulatory regime. I will say that one of
my concerns about the budget is that we don’t have the capacity to operationalize the rules
that we are putting into place — getting swap markets participants registered and the
swap data analyzed and market surveillance taken care of. Those are things that we will
have to put off, but I think it is incumbent upon all of us as regulators who see these
markets close up to continue to tell Congress where we think the issues are, where perhaps
Dodd-Frank wasn’t the right approach and where we think there are still gaps. [Mr. Yarmoth] Thank you very much. [Mr. McHenry] I thank the gentleman. With
that, I yield five minutes to the Chairman of the Full Committee, Mr.

Issa. [Mr. Issa] Thank you, Mr. Chairman. Madam Chair, I just went over to the Business
Roundtable and back, so I had the opportunity to see about one-third of corporate America’s
profits in that room, almost all public companies, probably all public companies except one,
all regulated by the SEC. I was there talking about impediments to job creation. I am going to give you a little relief from
the question de jour for a moment and ask, Dodd-Frank is not perfect and it was not what
you might call a low cost, low budget way to get better performance with less cost.
You have asked for 28 percent budget increase. In fact, if you had only the budget increase
necessary to do the work you were not doing as well as you wanted to without all the new
losses, what would that budget increase be in your estimation? In other words, what would
it cost to do it right without piling on new regulations when there is no question there
have been problems properly enforcing your existing portfolio? [Ms. Schapiro] Mr. Chairman, I would have
to actually do the math but maybe this helps. When we did our 2012 request, we viewed 40
percent of the positions and it was a total of 780 positions or 584 full-time equivalents.
We viewed 40 percent of those as going to our ongoing programs — that is 312 positions
— and 60 percent going to Dodd-Frank in limitations, so hedge funds, oversight, over the counter
derivatives, municipal advisors, whistleblower programs, clearing agencies and so forth.

[Mr. Issa] To follow up on that quickly, the
transparency elements that were asked for and agreed on by SEC and other agencies never
got into Dodd-Frank, so you don’t have a common mandate for reporting for transparency
that had been worked out in the conference and then didn’t happen. From this committee’s standpoint we are
interested, and you can answer for the record if you are not completely ready today, how
much savings could you get if, in fact, there was transparent interoperability both inward
and whenever possible, out to the public for oversight? [Ms. Schapiro] That is a great question and
I would like to answer it for the record because I do think it is important, particularly when
you have a market like the over-the-counter derivatives market with two regulators in
the same space, that we try to be as consistent as we possibly can and leverage each other
as effectively as we can.

If I can come back to you on that, I would like to. [Mr. Issa] I appreciate that and I want to
give you an opportunity to be thoughtful because that is a major initiative of this committee
on a bipartisan basis in the last Congress that didn’t happen and we would like to
renew it but would certainly take your input.

In the remaining two minutes, I do want to
ask, Mr. Becker’s conduct in retrospect was not a good idea. It certainly has not
led to confidence in the independence, transparency and non-biased behavior of the SEC when we
look through the tail light. How can we know that the changes you are asking
to be reviewed are going to clearly eliminate anything like this in the future? Where do
we get the confidence in that? [Ms. Schapiro] Mr. Chairman, I think it is
a fair question. You and I have had many conversations and I try to be very transparent and up front.
We will obviously be public about what our Inspector General finds and what recommendations
he makes, what our new Ethics Counsel finds as she reviews our program and recommendations
she makes.

We will be happy to come back and talk to Congress about those findings and
those recommendations and see if we can develop some metrics that would actually help us figure
out whether we are getting it right. [Mr. Issa] Your Ethics Counsel served under
the General Counsel, a career position but under the General Counsel, correct? [Ms. Schapiro] Yes. [Mr. Issa] Would you consider moving that
to be independent direct report so that there would only be one person, a political appointee
like yourself, that would be between the public and ethics questions rather than having a
General Counsel who has a number of jobs? You don’t have to answer that today but
I would like you to consider that.

In so many different HR situations in the private sector,
there is a clear independence of HR which is a lot of the questions. A question of conflict
was more than a legal questions, particularly when it included somebody who was the boss
of the person they went to for this 25 minute session and clearance, so give that some thought.
I won’t ask for an answer today. [Ms. Schapiro] I will do that. [Mr. Issa] Finally, as the time runs out,
we on the committee want to work to try to be helpful. We realize we only have a portion
of the portfolio that you see; you see much more of the regulatory and financial oversight
of another committee, but the question I have for you is, in our conduct of this investigation,
as we look at Mr.

Becker’s total portfolio of money, other things he may have done and
how this might have affected or not affected the Madoff Trust, will you promise your cooperation
to this committee today? [Ms. Schapiro] I will promise my cooperation
to the fullest extent I can. I don’t know that I can compel him in any way to do anything. [Mr. Issa] He has already come in voluntarily.
We have the ability to compel him but it is really making sure that we can have a quick
and transparent. Your IG would normally be willing to share any information that was
not directly related to a criminal referral and so on. Anything you can do to pledge to
help us will allow us to move from where we are as quickly as possible onto something
else. That is why I ask today. [Ms. Schapiro] Yes, of course I will help. [Mr. Issa] Thank you. I thank you all for
your indulgence and I yield back. [Mr. McHenry] Thank you. Mr. Connolly of Virginia for five minutes. [Mr. Connolly] Thank you, Mr. Chairman. Chairman Schapiro, aren’t you the Chairman
who appointed the Inspector General who, in fact, is charged with investigating Mr.

Becker? [Ms. Schapiro] No, sir. He was appointed by
my predecessor. [Mr. Connolly] By your predecessor. That investigation
continues? [Ms. Schapiro] Yes. I requested the investigation. [Mr. Connolly] You requested the investigation? [Ms. Schapiro] Yes. [Mr. Connolly] We just heard a line of questioning
asking you to look at a budget without additional regulation that was burdensome and so forth.
The Dodd-Frank legislation added some regulation in areas that heretofore had not been regulated
at all, is that correct, Chairman Schapiro? [Ms. Schapiro] Yes, that is absolutely correct. [Mr. Connolly] For examples, take derivates.
How big are derivates? What is the value of the derivatives market? [Ms. Schapiro] The last number I saw was $600
trillion, I believe. [Mr. Connolly] I am sorry, did you say trillion? [Ms. Schapiro] Yes, sir. [Mr. Connolly] It is entirely unregulated
until Dodd-Frank passed, is that correct? [Ms. Schapiro] Yes, it is largely unregulated.

[Mr. Connolly] Whatever could go wrong with
an entirely unregulated $600 trillion market? [Ms. Schapiro] We saw some things that went
wrong and presumably that is what motivated the Dodd-Frank Act. [Mr. Connolly] So maybe that is one of those
burdensome additional pieces of regulation we are just going to have to put up with.
That burdensome additional regulation requires SEC to staff up and to acquire the requisite
expertise to enforce the regulation you are now charged with, is that correct? [Ms. Schapiro] Yes, we believe so. We are
able to do the rule writing that has been ongoing this year but to operationalize those
rules, we need additional staff. [Mr. Connolly] We heard Mr. Katz in his testimony
say that simply having more SEC staffers do the same thing would not protect investors
or promote capital formation. How many areas of additional or new regulation are requiring
you to ramp up in terms of expert staffing? [Ms.

Schapiro] We obviously have derivatives,
hedge fund regulation, we are creating a new whistleblower office although that is work
that we need more help with but it is not unknown to us. We have to increase our oversight
of credit rating agencies under the Act and we have to register a whole new category of
registrant in the municipal securities markets called municipal advisors, so there are half
a dozen or so new areas for us to undertake regulation. [Mr. Connolly] Just listening to you tick
off that list, none of those sound like frivolous burdensome additional pieces of regulation.
They sound like thoughtful additions to the regulatory framework in light of the biggest
meltdown on Wall Street in 80 years. Would you share that view? [Ms. Schapiro] I do think all of these areas
are ones that needed to be addressed. As we write the rules, we are working very hard
in collaboration with other regulators, but also with the public, with investors and the
industry to make sure that we write as sensible rules as we possibly can. [Mr. Connolly] Mr.

Katz, would you share that
view or is this just another example of having simply “more SEC staffers doing the same
thing”? [Mr. Katz] There is a quantitative nuance
difference in what I said and the way I think you characterized it. The agency has an enormously
large number of new areas of regulatory authority. The question is, when you go about regulating
hedge funds, or regulating municipal securities markets, are you going to regulate hedge funds
exactly the way you regulate investment advisors, which is arguably what they are, or investment
companies, which is sort of a close cousin? My point is that if you look at the way the
Commission has regulated advisors, and regulated mutual funds, it hasn’t been terribly effective.
If you take the same approach for hedge funds, yes, that would be doing the same thing in
those approaches, even if it is a new substantive responsibility with a new category of registrant.

[Mr. Connolly] Would you say, Mr. Katz, that
some of the problem preceding the Wall Street meltdown in September 2008, for example, had
to do frankly with the quality of the appointees, namely a whole bunch of people who didn’t
believe in regulation in the first place and therefore, didn’t do it? [Mr. Katz] I have to tell you that there is
an old saying at the SEC that the Commissioners decide the policy, but ultimately, it is the
staff that decides what it means and how it gets done. One of the interesting things about
the SEC, the relationship between Commissioners and the staff is that it is a close relationship.
Because the Commission is a bipartisan body, you are always going to get five people with
diverging points of view, some of whom will support the staff, some of whom will disagree
with the staff. I can’t think of an occasion where you had
five Commissioners on one side of the table and the staff on the other side at loggerheads.
That doesn’t happen.

You invariably get some supportive of Commissioners, some Commissioners
who are critical and you also get that divergence of view among the staff. Financial regulation is never a question of
identifying a single right answer. [Mr. Connolly] Thank you, Mr. Katz. Unfortunately,
my time is up but I would love to pursue this further, but I certainly believe that the
narrative that somehow SEC is treading into waters it has no business treading into is
fallacious. If anything, we needed more people guarding the hen house. If we are going to
talk about the fox guarding the hen house, that may have been true in the 2008 period
of time but is not true today. I thank the Chair. [Mr. Katz] Excuse me, Mr. Chairman, if you
might indulge me? There is one very quick point I wanted to make that Mr. Yarmoth brought
up. [Mr. McHenry] Please. [Mr. Katz] That was the question of the consolidated
supervised entities regulatory process at the SEC. There is a lot of confusion about
that. There was a voluntary process. The reason it was a voluntary process is not because
of a deregulatory attitude at the SEC; it is because the Commission sought from Congress
the authority to make it a mandatory process as part of the Gramwich Bill, which eliminated
glass eagle.

Congress explicitly prohibited the Commission
from making it a mandatory process. The Commission had a weak hand, it played the weak hand as
best it could. [Mr. Platts] Thank the gentleman. I will yield five minutes to myself. I chair the Subcommittee on Government Organization,
Efficiency and Financial Management, so I am going to focus on a related but slightly
different area that relates to our jurisdiction. I had the privilege of chairing the same Subcommittee
from 2003 to 2007. We had a subcommittee hearing July 2003 about
the SEC, about financial management at the SEC, about internal controls and we heard
testimony at that point they had just put in a new financial management system in 2002.
In the testimony of the Executive Director, James McConnor at the time in July 2003, he
said we have this new system and we are going to be certified basically in January 2004
for audited financial statements.

Here we are seven years later, plus, and we are now
talking about the same thing, a new system using DOT Enterprise system to put in place
a new system. Chairman Schapiro, I appreciate the changes
you have made, the COO, the new Chief Operating Officer and other leadership changes and systemic
changes within the SEC. Why should the American people believe when we were told seven years
ago we got it right and we were going to be able to go forward; how is it different today? [Ms. Schapiro] Thank you. My understanding
is that was the Momentum system, I believe, and it was deployed nine or ten years ago
and in the beginning, it did meet the agency’s needs, but then over time, the agency deferred
upgrading over many years and as a result, it began to lack the functionality that was
necessary to do the job.

Gaps were created, work arounds were developed and as a result,
the SEC ended up with two material weaknesses in its controls over financial reporting in
our audit which is a disgraceful position for the Securities and Exchange Commission
to be in. With our new Chief Operating Officer, our
new Chief Financial Officer and our new Information Officer, we made the decision that rather
than incur the risks of developing a new system at the SEC, perhaps not really a core competency
for us, that we would be better served by outsourcing financial management. We went through a process and identified the
Department of Transportation, which is an authorized Federal Share Service provider
used by the GAO for their financial management system, and made the decision that the best
way for us to remediate our material weaknesses, generate the kind of reporting that we need,
minimize all these manual workarounds and all of this would be to outsource to them.
I think it is the right decision for the taxpayer, I think it is the right decision for the SEC.

[Mr. Platts] The follow-up related to that
is, in the audit that was done at the end of this past year, a clean opinion, but failure
to sign off on the internal controls, two related questions. First, how would you describe the internal
effort to get the clean opinion other than the internal controls and I ask in the sense
of in July 2003, SEC said it was a heroic end of the year effort, it wasn’t because
we had a system in place, here is the data, we are ready to go. Was there again a heroic
end of the year effort to be able to have that audit? [Ms.

Schapiro] I think there were some heroics
involved. I can’t compare to 2003 but I think we did put together a senior team of
people to really shepherd the process through. They were diligent and they stuck with it,
but they are also very much onboard for this decision to outsource. [Mr. Platts] Interim controls, not until last
year in Dodd-Frank did it require the auditor to sign off on the internal controls.

For
almost 20 years under the Federal Managers Financial Integrity Act adopted in 1982, actually
over 20 years, that we have to have strong internal controls. Although that wasn’t
required to be signed off, I assume you are really conscious of the fact that it wasn’t
a new requirement that you have good internal controls, it was just a new requirement that
it be signed off by the auditor and whoever has been overseeing those internal control
systems, clearly were not fulfilling their responsibilities? [Ms.

Schapiro] Absolutely, and under our Chief
Operating Officer, we will deal both with the audit issues with respect to internal
controls, but also the attendant business processes, so it is not just a technology
answer for us. It is going to have to be business process, free engineering process as well. [Mr. Platts] I am going to try to squeeze
in two more questions in 20 seconds. In your testimony, you talk about the follow-on
person that you have for the audit recommendations of your IG and GAO.

In your testimony, you
state that you appointed an audit follow-up official and empowered her to ensure that
agency managers are held accountable for timely and appropriate follow up. How are they being held accountable? One thing
that frustrates me is when we find something that went wrong and I have asked for many
years now, was anyone disciplined, was anyone fired for not doing what they were supposed
to do? In what way are they being held accountable? [Ms.

Schapiro] We are very closely tracking
audit recommendations, both from GAO and from our Inspector General. I can tell you that
in my two years as Chairman, we have successfully closed 350 Inspector General recommendations
compared to 190 in the prior two years. We are aggressive about doing it and I will tell
you that in the Inspector General’s semiannual report, he also talks about our progress with
respect to closing recommendations and whether there has been any management disagreement
with his recommendations. He is quite on top of it and quite transparent. [Mr. Platts] I think that is critical going
forward. My subcommittee is especially going to look at staying on top of those recommendations
and special internal controls. It goes to the broader issue discussed here about ethics
and if you don’t have internal controls, that is the foundation for not just good financial
management, but for a good ethics environment. [Ms. Schapiro] I agree completely. [Mr. Platts] We, as a subcommittee, and partner
with Chairman McHenry here today, that is what we are going to be looking at. I will yield back and yield now to Ms. Speier
from California for five minutes.

[Ms. Speier] Thank you, Mr. Chairman. I thank you all for your participation in
this hearing. I was particularly impressed by the testimony of Mr. Katz and Mr. Crimmins. I am somewhat surprised because I am looking
at the title of the hearing and the sign above the Chairman’s head that reads, “Can American
Taxpayers Trust Today’s SEC to Manage Itself and Do Its Job.” I thought it might be interesting
to substitute Congress and ask the same question and see if we would fare as well. Chairman Schapiro, having served over two
years on the Financial Services Committee, I have watched you and I think you are truly
committed to doing the right thing. Before you came back as Chair, under Chairman Cox,
the number of actual enforcement actions at the SEC was reduced by 80 percent and the
number of disgorgement actions were reduced by 60 percent — a stunning failure at a time
when all the mischief was going on with Wall Street.

We look back at the savings and loan crisis
and we recognize that referrals from various regulators, there were 10,000 of them, and
of those 10,000, there were 1,000 that turned into convictions and 500 people went to jail.
These were CEO level folks that went to jail. The American people are looking at us, looking
at Congress, looking at you and saying, who is going to jail? Who is being charged? The
truth is there hasn’t been a lot. My first question is, have you made any referrals
to the Justice Department, to the U.S.

Attorney, as a result of the Wall Street meltdown? Ms. Schapiro. I am confident that we have.
I guess I would like to supplement the record, if I might, on that. I just don’t know the
numbers or the details about it because, as you know, we don’t have criminal prosecution
authority, although we have continued to bring a relatively high number of cases and some
very large impact cases coming out of the financial crisis in the past year. [Ms. Speier] So you will get back to the committee
and actually tell us how many referrals you have made? [Ms. Schapiro] I would be happy to. [Ms. Speier] The CEO of Galian is being tried
now. Mr. Kupta who is a director of a significant Wall Street firm, evidently is being looked
at as having shared insider information, although he didn’t appear to have acted on it. Have
any actions by the SEC been taken against those two individuals? [Ms. Schapiro] We filed a proceeding against
Mr. Kupta last week and we have filed multiple proceedings coming out of the Galian investigation
over the course of the last six months or so.

[Ms. Speier] In 2004 and 2005, the GAO said
to the SEC that it should take a look at and close its revolving door. The SEC then reported
back to the GAO that it had done that, although the GAO now says that never happened. The
reverse situation of Mr. Becker is the fact that you have staff that work within the SEC
and then they are lured away by lucrative salaries outside and oftentimes, the people
that are lured away are lured away by the companies that they were actually investigating.

We need to do something about the lack of
a revolving door and I want to know, first of all, have you made any policy changes in
an attempt to deter these revolving door practices? [Ms. Schapiro] We have instituted requirements
that senior employees seek ethics counseling before they leave the agency. We require all
employees to have a post employment briefing so they don’t violate ethics rules when
they are leaving. Of course we are subject to the government-wide restrictions and we
have some unique to the SEC restrictions, but our Inspector General in looking at a
specific revolving door incident has given us last week some additional recommendations
for tightening up our rules. We are going to look at those very seriously and I hope
to go forward with them. [Ms. Speier] What about a cooling off period?
Why not require that persons within the Commission that have the authority to make determinations
and were investigating are not allowed to be hired by those who they have investigated
for a period of two years? [Ms.

Schapiro] I think there is a lot of appeal
to that. The only hesitation I have is that we are so dependent on getting people to come
to us, even if it is just for a few years just to bring us current industry expertise,
we have to get the balance right. [Ms. Speier] I don’t disagree, because that
is precisely the problem. [Mr. McHenry] The gentlelady’s time has
expired. I recognize myself for five minutes. Chairman Schapiro, I want to get this out
of the way. I know there have been a number of questions about the David Becker conflict
of interest question. I just have a couple of questions, yes or no. I want to proceed
with it because I have some other issues I do want to touch on beyond this. After David Becker told you that he received
proceeds of a closed Madoff account, did you suggest that he recuse himself from the Madoff
case, yes or no? [Ms. Schapiro] I am sorry, the premise isn’t
exactly right. My recollection is that he told me that his mother had a Madoff account
before she died and that it had been closed.

I don’t honestly recall whether he told
me he had received proceeds or not. He may well have, I just can’t recall. As you know,
I haven’t been able to look at anything. [Mr. McHenry] But he brought this up that
he received proceeds from a Madoff account? [Ms. Schapiro] He brought up that his mother
had had a Madoff account. [Mr. McHenry] In light of that, did you suggest
he recuse himself? [Ms. Schapiro] No, I didn’t.

[Mr. McHenry] Did you suggest that he settle
with the Trustee as other Madoff investors were doing at the time? [Ms. Schapiro] No. [Mr. McHenry] Did you suggest that Mr. Becker
disclose his interest to other SEC staff or Commissioners who relied on his advice? [Ms. Schapiro] I did not. I expected him to
go to the Ethics Office and get ethics counsel and follow their advice. [Mr. McHenry] You are aware that the Ethics
Counsel of the SEC reported to the General Counsel? [Ms. Schapiro] Yes, although the Ethics Officer
is a career employee. [Mr. McHenry] But his direct report. [Ms. Schapiro] Yes. [Mr. McHenry] Did you suggest that Becker
do any research to determine the amount or the character of interest that he had? [Ms.

Schapiro] No. [Mr. McHenry] Later when Becker was providing
advice about the net equity evaluation method, did you direct Mr. Becker to take any actions
with respect to this potential conflict of interest? [Ms. Schapiro] No, because it didn’t occur
to me that this long ago closed account would be in any way impacted, it just didn’t occur
to me.

[Mr. McHenry] So he didn’t disclose to you
that he was, in fact, the trustee who closed the account? [Ms. Schapiro] I don’t recall. [Mr. McHenry] I understand. I am just trying
to get to the heart of this. This raises major questions and I think you can understand the
public’s interest and the investors’ interest. To that same degree, when Mr. Becker was filing
briefs in court that took recommendations in terms of the net equity position valuation
method, you didn’t direct Mr. Becker to recuse himself? [Ms. Schapiro] No. [Mr. McHenry] Okay. I just wanted to get those
out of the way.

Obviously we care deeply about transparency and disclosure both here in Congress
and with regulators. Chairman Schapiro, Mr. Risinger, thank you
for your public service, but we need to get to the heart of this issue. I think that is
why we are asking these questions today and why I am. [Ms. Schapiro] I agree, Mr. Chairman. It is
why I have asked the Inspector General to do a review, so we can get all the information. [Mr. McHenry] The point is you said you wish
you had known then what you know now and had you asked any of these questions, you would
have known it then.

That is at the heart of this issue. That is what is disappointing
and of great concern in terms of public policy. Ms. Chaitman, in dealing with this Madoff
valuation question, I understand the insurance piece, I do, would it have changed your dealings
with SEC’s legal counsel had you known that Mr. Becker was the trustee of a Madoff account? [Ms. Chaitman] If I had know that, I would
have, myself, demanded that he recuse himself and that the SEC take steps to clarify its
position because as I say, both Congressman Garrett and I believe that the SEC has taken
an illegal position in supporting SIPC. If I had know that Mr. Becker had a personal
interest, I certainly would have asked Ms. Schapiro to do something about it. [Mr. McHenry] Thank you. Mr. Katz, this raises a larger management
issue. We are talking about capital formation, we are trying to be the world’s markets,
which we have been. When you have a dysfunctional agency like this with these management problems
that you described, you said the SEC has never engaged in serious self examination of its
performance or used appropriate measures of performance.

Is that still the case? [Mr. Katz] Not having seen this Boston consulting
group report that is apparently due out, I think yes, that is the case. It has been a
long time since the agency took a hard look at itself in the mirror. [Mr. McHenry] My time has expired. With that,
I recognize Ms. Maloney for five minutes. Votes have been called on the Floor, we have
11 minutes remaining in the votes, so I would defer to my colleagues on that side of the
aisle if they want to work something out in terms of time. The gentlelady is
recognized now for five minutes. *Mrs. Maloney. First of all, I would like
to welcome all the panelists and thank the Chairman for this important hearing.

Certainly
honesty and transparency is very important in government. I would like to get further clarification
from Chairman Schapiro. As I understand, the controversy around Mr. Becker’s alleged
conflict of interest is about an SEC decision that appears to be against his financial interest.
As I understand it, prior to Mr. Becker’s return to the SEC, he was working at a private
law firm, correct? [Ms. Schapiro] Yes, he was. *Mrs. Maloney. When he arrived at the SEC,
you testified he took steps to notify both you and the SEC’s Ethics Counsel of his
inheritance from his mother which had been liquidated long before Madoff’s ponzi scheme
had been discovered, correct? [Ms.

Schapiro] That is my understanding. *Mrs. Maloney. The ethics official said it
was okay for him to work on Madoff-related issues. That is what is in the memo and information
that I read, that the Ethics Committee is there to be consulted, he consulted them and
they said there was no conflict, that is fine, go to work. Is that your recollection? [Ms. Schapiro] Yes, I believe. *Mrs. Maloney. Your memory is the same as
the Ethics Committee. Chairman Schapiro, it appears that the basic question the SEC faced
was whether to support an asset valuation method used by the Madoff Trustee called the
cash-in, cash-out method, or a different evaluation method used by several law firms called the
last statement method. Is that correct? [Ms. Schapiro] Yes. *Mrs. Maloney. Under the first method, Mr.
Becker’s inheritance would be subject to clawback litigation and under the second method,
his inheritance would not have been subject to clawback.

The SEC choose to support the
first, the decision was against the financial interest of Mr. Becker. This meant that the
Trustee could sue Mr. Becker and his brothers to recover some of his mother’s inheritance
which is exactly what happened, correct? [Ms. Schapiro] That is right. The SEC did
take the position that was cash-in, cash-out in constant dollars to reflect that some very
elderly people who had long held Madoff accounts would be able to get some more money from
SIPC under that formulation, but it was not the final statement approach that you mentioned
that would have potentially prevented the clawback.

*Mrs. Maloney. But the decision was to allow
the clawback, so I assume he participated in a decision allowing the clawback that was
against his financial interest? [Ms. Schapiro] The decision to clawback is
one of the Trustee, not of the SEC. *Mrs. Maloney. The SEC did not make that decision,
the Trustee made that decision? [Ms. Schapiro] The Trustee makes that decision. *Mrs. Maloney. The Trustee makes that decision,
but it was a decision that affected Mr. Becker. [Ms. Schapiro] Yes. *Mrs. Maloney. I would like either you or
Mr. Crimmins to answer. Basically, Mr. Becker or the SEC sided with the Madoff Trustee.
The SEC actually took action that was potentially detrimental to Mr. Becker’s financial interest
and it exposed him to a potential litigation worth roughly $1.5 million because that was
the proceeds, correct, in addition to the $500,000.

Everybody seems to be criticizing
Mr. Becker, but Mr. Becker and the SEC’s decision appears to have been completely against
his financial interest. I understand you have an IG report coming
out and that eventually will clarify things more, but in first reading the information,
it appears that the decision made was against him and against his financial interest and
what he or the SEC thought was the right way to go. If the SEC had supported the banks’ interpretation
or the law firm’s interpretation instead of the Trustee’s interpretation, Mr. Becker
might not have had any exposure at all, is that correct? Mr. Crimmins? [Mr. Crimmins] The point is that the $500,000
that Dorothy Becker invested was going to come back. The $1.5 million, as you indicated,
was the Madoff fictitious profit was going to Picard’s claim as the Trustee, independent
reporting to the court, not to the SEC, that dealt with a little bit of difference is whether
there should be some modest rate of return, whether there should be some adjustment for
inflation.

That is still not finally determined. A month
after Becker has left the agency, it is a small amount and to an individual who was
compensated at $3 million a year, roughly, and gave that up to go work in the public
service, it is totally inconsequential and I would respectfully submit to the Subcommittee,
be a distraction. *Mrs. Maloney. May just complete with one
observation for two seconds. Basically, if someone in Mr. Becker’s position
wanted to help himself financially, he would have taken the opposite point of view than
the one that he took or the one that the SEC took. [Mr. McHenry] The gentlelady’s time has
expired.

We have votes on the Floor, Madam. *Mrs. Maloney. I look forward to the IG’s
report. [Mr. McHenry] I think we all do. I appreciate
the gentlelady wrapping up. We do have votes on the Floor. I want to thank the panel. [Ms. Schapiro] Mr. Chairman, I am so sorry,
I wanted to just say one thing. I want to make it very clear, I don’t recall specifically
whether Mr.

Becker told me he had inheritance from the account or whether his mother had
had an account and I made that assumption. Because it is two years ago, I just don’t
recall. I want to be so clear about that. [Mr. McHenry] We will let the record reflect
that. [Ms. Schapiro] Thank you. [Mr. McHenry] Certainly. I think it is important
the record accurately reflect what happened. The findings of this hearing are very important.
We are interested in management issues. The members certainly took a specific direction
today dealing with this conflict of interest of Mr.

Becker, the General Counsel for the
SEC because of the fact he was a trustee of a Madoff account a few years before, and the
decision, as Ms. Chaitman mentions, that was a very different valuation than was existent
under law and the decision he made that in some ways benefited him disproportionately
than the other two methods. In terms of the budget, I think it is appropriate
that SEC have a sufficient budget and we have strong management practices to make sure there
is transparency and disclosure, safety and soundness in investing in our markets. In the wake of the Enron scandal, in February
2003, the SEC was given the largest spending increase in its history. The GAO said in testimony
before this subcommittee in 2003, it was a 45 percent increase at that time. This was
supposed to prevent a future crisis, yet Madoff still occurred and the excuses cannot always
be based on money.

We would ask that we tighten up management practices, do what is appropriate
in terms of bringing technology to the fore and do the best possible of any regular. It isn’t wrong to use a crisis to request
more. It is wrong to use a crisis just to request more money. So with that, the committee
stands adjourned. Thank you for your testimony. [Whereupon, at 3:40 p.m., the subcommittee
was adjourned].

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