Directors of five SEC divisions testified before Congress on the Commission’s funding for fiscal 2012. The directors’ joint statement advised that their divisions are reforming and improving operations. As part of that effort, they have revitalized and restructured enforcement and examination functions, revamped the handling of tips and complaints, taken steps to break down internal silos and create a culture of collaboration, improved risk assessment capabilities, recruited more staff with specialized expertise and real world experience, and enhanced safeguards for investors' assets.

In response to questions from members of the House Capital Markets Subcommittee, Meredith Cross, the director of the Division of Corporation Finance, said that the Commission is very carefully reviewing the recommendations of a recent internal study. She reported that the SEC conducts a robust cost-benefit analysis and often changes final rules based on that analysis. Robert Cook, the director of the Division of Trading and Markets, testified that when and if the SEC adopts rules on a uniform federal fiduciary standard for advisers and brokers, it will include a strong cost-benefit analysis. Cook pledged that the SEC will work with economists on the rule proposal.

In the joint statement, which also included Eileen Rominger, the director of the Investment Management Division, Carlo di Florio, the director of the Office of Compliance Inspections and Examinations, and Enforcement Director Robert Khuzami, the officials said that current SEC staffing levels are just now returning to the fiscal 2005 level, despite the enormous growth in the size and complexity of the securities markets. During the past decade, for example, trading volume has more than doubled, the number of investment advisers has grown by 50%, and the assets they manage have increased to $38 trillion.

The SEC has proceeded with the first stages of implementation of the Dodd-Frank Act without additional funding, but the next step of making operational the new oversight regimes mandated by the Act, such as derivatives, will require significant additional resources. For example, Cook pointed out that his division will be responsible for the oversight of four entirely new categories of entities: security-based swap execution facilities, security-based swap data repositories, security-based swap dealers and major security-based swap participants.

Khuzami testified that the SEC’s enforcement program continues to face challenges in securing the necessary expertise, human capital and technology resources. The division must be current with market developments. For example, in the market abuse area, the division needs the expertise and human capital to understand and analyze new trading technologies such as high-frequency and algorithmic trading, and large volume trading, as well as systemic insider trading and manipulation schemes. In the asset management area, the division must increase its understanding of issues related to the valuation of illiquid portfolios.

Cross cited the Sarbanes-Oxley Act mandate that the Division of Corporation Finance review the financial statements of all reporting companies at least once every three years. This requirement, coupled with limited resources, constrains the division's ability to devote sufficient resources to the review of companies that represent the largest portion of U.S. market capitalization. The division's limited staff is responsible for reviewing the disclosures of approximately 10,000 reporting companies under this mandate, she noted, and also for reviewing registration statements and other transactional filings made under the 1933 and 1934 Acts, such as filings related to capital raising and business combinations.

Cross said the challenges of staffing the review program are even greater in light of the division's new responsibilities under the Dodd-Frank Act. The division is evaluating its review program with the goal of increasing its focus on large and financially significant registrants and assessing whether additional efficiencies might be gained with regard to its reviews of smaller reporting companies, consistent with its Sarbanes-Oxley obligations.

Under Section 953 of the Dodd-Frank Act, the Commission must adopt rules requiring new disclosures about the relationship between executive compensation and company performance, and the ratio between the median of the annual total compensation of an issuer's employees and the annual total compensation of the issuer's chief executive officer.

Rep. Nan A.S. Hayworth (R-NY) questioned the usefulness of Section 953 and whether there were any reasonable changes Congress could make to the section to make it less burdensome. Cross replied that the usefulness of the pay ratio is a call for Congress to make. She said that Congress could make the pay ratio disclosure more manageable by changing the median of the annual total compensation of an issuer’s employees to the average annual total compensation. She added that it is the SEC’s job to implement the statute in a workable manner. The SEC has yet to propose rules under Section 953 since the Act set no deadline for SEC rulemaking. She said the statute is fairly prescriptive and leaves no leeway for the SEC in the rulemaking process.

Rep. Ed Royce (R-CA) asked how the SEC will approach the uniform fiduciary duty standard for advisers and brokers and whether such a standard is needed. Cook said that there is a need for a uniform standard based on studies showing that investors are confused over what standard of care is owed to them by different financial intermediaries. When investors walk in the door of a broker or adviser, he said, they should not have to be concerned about, or be experts in, the different regulatory regimes. Cook said that any rules in this area will have a scalability element that takes into account different types of businesses.

With regard to implementing the derivatives provisions of Dodd-Frank, Rep. Robert Hurt (R-VA) urged the SEC to provide small banks with an end-user exemption. Cook assured him that the SEC rule proposals contain an exemption for small banks from the mandatory clearing requirement.

The SEC’s proposed rules implementing Section 975 of Dodd-Frank have generated a number of comments, most notably a letter from Financial Services Committee Chair Spencer Bachus (R-AL). Section 975 directs the SEC to set up an effective registration and examination program for municipal financial advisers. In the letter, Bachus urged the Commission to strike a balance to ensure that nonbroker-dealer financial advisers register with the SEC, estimated by an SEC official to be about 260, while not forcing thousands of unsuspecting individuals to comply with another regulatory burden that he feels would be detrimental to the very municipal entities Congress is trying to protect.

Hayworth, echoing the Bachus letter, noted that the proposed rules are overly broad and encompass thousands more individuals than the approximately 260 that the SEC official originally told the Committee would be covered. Hayworth said that fair, rational and reasonable rules are needed in this area. Cook acknowledged that it has been a challenge to get the rules right. The SEC seeks to provide legal certainty, he said, while at the same time not allowing the exemptions to overwhelm the rules.

Cook also testified that the Trading and Markets Division is evaluating whether to make extensive recommendations to the Commission to modernize transfer agent regulations. The division is also working on three studies required by the Dodd-Frank Act relating to the independence of NRSROs, the standardization of credit ratings and the process for rating certain structured finance products. The division plans to continue to advance discussion on equity market structure, including high frequency trading, and will consider appropriate rulemaking responses in the coming months.

The Office of Compliance Inspections and Examinations has developed a more risk-based approach to the examination program that will enable the more effective use of resources, according to di Florio. This approach is necessary, he said, given that the exam program is only able to cover a very small portion of the individuals and entities that register with the Commission. The disparity between resources and responsibilities is growing as a result of the new requirements of the Dodd-Frank Act. In order to operate a risk-based examination program that effectively identifies and carefully reviews the major risks, he added, OCIE will need more examiners, more industry expertise and further technological resources.

The financial crisis revealed the need for better oversight of risk at the board and senior management levels and the need for stronger independence, standing and authority among a firm's internal risk management, control and compliance functions. As a result, OCIE is focusing its exams on the overall governance and risk management framework of a firm in order to assess the firm's system of checks and balances.

The Dodd-Frank Act shifted the responsibility for examining many smaller advisers to the states. Hurt feared that this could burden the states and asked how prepared the states are to handle the new adviser oversight. Rominger replied that the states are in a range of preparedness. Di Florio added that he is conducting an ongoing cross-functional dialogue with the states and with officials at the North American Securities Administrators Association on this matter.

Rominger noted that the Dodd-Frank Act changed the universe of regulated entities for which the Commission is responsible by increasing the statutory threshold for SEC registration by investment advisers to $100 million in assets under management and requiring advisers to hedge funds and other private funds to register with the Commission.

Subcommittee members expressed concern with the private equity registration requirement. They do not see private equity firms as a source of systemic risk. Rep. Gary Peters (D-MI) said that private equity firms are not generally liquid and are not highly leveraged, so do not pose a systemic risk. It makes no sense to treat private equity firms the same as large hedge funds, in his view.

Hurt feared that the over-regulation of private equity firms could lead to less job creation. He asked if the SEC could postpone the private equity regulations until Congress can take further action. Rominger advised that the regulations will be scaled to reflect the complexity and size of the firms and a robust cost-benefit analysis will be conducted.