[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
LEGISLATIVE PROPOSALS TO RELIEVE
THE RED TAPE BURDEN ON INVESTORS
AND JOB CREATORS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
MAY 23, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-26
U.S. GOVERNMENT PRINTING OFFICE
81-761 PDF WASHINGTON : 2013
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri
C O N T E N T S
----------
Page
Hearing held on:
May 23, 2013................................................. 1
Appendix:
May 23, 2013................................................. 37
WITNESSES
Thursday, May 23, 2013
Bullard, Mercer E., President and Founder, Fund Democracy, Inc.,
and Jessie D. Puckett, Jr., Lecturer and Associate Professor of
Law, University of Mississippi School of Law................... 7
Ehinger, Ken, Chief Executive Officer, M Holdings Securities,
Inc., on behalf of the Association for Advanced Life
Underwriting (AALU)............................................ 9
Quaadman, Thomas, Vice President, Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce...................... 11
Reich, Marc A., President, Ironwood Capital, on behalf of the
Small Business Investor Alliance (SBIA)........................ 13
Silvers, Damon A., Policy Director and Special Counsel, AFL-CIO.. 15
Smith, Robert, Corporate Secretary, Vice President and Deputy
General Counsel, NiSource, Inc., on behalf of the Society of
Corporate Secretaries and Governance Professionals............. 17
Tharp, Charles G., Chief Executive Officer, Center On Executive
Compensation................................................... 18
APPENDIX
Prepared statements:
Huizenga, Hon. Bill.......................................... 38
Bullard, Mercer E............................................ 39
Ehinger, Ken................................................. 57
Quaadman, Thomas............................................. 67
Reich, Marc A................................................ 106
Silvers, Damon A............................................. 116
Smith, Robert................................................ 126
Tharp, Charles G............................................. 142
Additional Material Submitted for the Record
Hurt, Hon. Robert:
Written statement of the Association for Corporate Growth
(ACG)...................................................... 149
Written statement of the Investment Company Institute (ICI)
and the Independent Directors Council (IDC)................ 151
Maloney, Hon. Carolyn:
Written statement of the California Public Employees'
Retirement System (CalPERS)................................ 158
LEGISLATIVE PROPOSALS TO RELIEVE
THE RED TAPE BURDEN ON INVESTORS
AND JOB CREATORS
----------
Thursday, May 23, 2013
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:31 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, King,
Royce, Huizenga, Stivers, Fincher, Mulvaney, Hultgren, Ross,
Wagner; Maloney, Sherman, Scott, Himes, Peters, Watt, Foster,
and Carney.
Also present: Representative Green.
Chairman Garrett. Greetings. Good morning, everyone. Good
morning to the panel.
The Subcommittee on Capital Markets and Government
Sponsored Enterprises is hereby called to order. Today's
hearing is entitled, ``Legislative Proposals to Relieve the Red
Tape Burden on Investors and Job Creators.''
I welcome the panel to today's hearing. We will begin with
opening statements, and after that, we will turn to the panel.
And with that, I recognize myself for 3 minutes for an opening
statement.
Today's hearing is entitled, as I said, ``Legislative
Proposals to Relieve the Red Tape Burden on Investors and Job
Creators,'' and it will focus on four specific pieces of
legislation that would remove various regulatory impediments
and target red tape that hinders small businesses' ability to
create new jobs and help the economy grow.
The Dodd-Frank Act significantly expanded the SEC's
authority. However, Congress did not first determine that this
unprecedented expansion was necessary to further their mission
or that the SEC was capable of executing its new authorities
and mission.
Despite what my Democratic colleagues are likely to allege,
we are not attempting to deregulate the financial services
industry. Very simply, the bills before us are a series of
targeted and pragmatic fixes to some of the most burdensome and
unnecessary provisions of Dodd-Frank.
In fact, three of the four bills before us today already
enjoyed bipartisan support last Congress. The SEC has a
threefold mission: to protect investors; to maintain fair,
orderly, and efficient markets; and to facilitate capital
formation. So by removing unnecessary and time-consuming
requirements, these bills discussed in today's hearing will
ensure that the SEC has the time and resources to focus on its
core mission and reach other congressional mandates, such as
those outlined in the JOBS Act, which the SEC has failed to
fully implement. Last week, there was a lot of discussion about
the SEC's resources. Now, these four bills fix many of the
unnecessary provisions of Dodd-Frank, freeing up SEC resources
to be devoted to mission-critical rules.
I want to specifically recognize and thank Congressman
Hurt, Congressman Huizenga, and Congresswoman Wagner for their
terrific work on these bills. I commend each of you, and I look
forward to passing these bills through the committee, hopefully
in a bipartisan manner, as we have done in the past.
In conclusion, the Dodd-Frank Act, was not written in stone
or handed down from on high, and Congress has an obligation to
amend or repeal those provisions that did not cause or
contribute to the financial crisis and whose cost outweigh
their purported benefits. That is what we begin with today.
And with that, I now turn to the gentlelady from New York,
Mrs. Maloney, for 4 minutes.
Mrs. Maloney. I thank the gentleman for his leadership, and
I welcome all the witnesses. This hearing will focus on four
bills that are designed, as the title of the hearing suggests,
to relieve what is seen as red tape.
So we have four bills under consideration today. The first
would repeal a section of Dodd-Frank that requires companies to
disclose the ratio of the total compensation of their CEO to
that of the median compensated employees on a quarterly basis.
The intent was to bring transparency to the compensation
process and to encourage fair practices. The SEC has not
written rules yet in this area, and when the committee reviewed
this bill in the last Congress, an amendment was passed that
gave the SEC additional authority to narrow the requirements
while maintaining the intent behind the provision.
The second bill would exempt certain private equity fund
managers from the SEC registration requirement. Private equity
registration was something we incorporated into the Dodd-Frank
Act because many believed there were areas in the industry that
were completely dark, even while recognizing that this was not
the cause of the financial crisis.
The bill this committee reviewed last year included an
amendment from my colleague and friend, Mr. Himes, which said
that only private equity firms that were leveraged more than
two to one would be required to register. Since that time--and
his bill did pass the committee--the SEC has required private
equity firms to register.
The third bill we are looking at would prohibit the PCAOB
from mandating audit firm rotation. I would like to understand
why audit firm rotation is necessary, and I question why we are
interfering with the PCAOB's independent authority.
Finally, a fourth bill would put additional hurdles on the
SEC to interfere with its ability to write rules that would
change the legal standard for broker-dealers. Dodd-Frank
required the SEC to study the fiduciary duty broker-dealers owe
to their clients and that investment advisers have. The SEC
completed the study, and recommended a uniform standard for
broker-dealers and investment advisers. However, they have not
yet proposed a rule that is under comment, and some feel that
this is not a necessary--that there are different duties.
I look forward to hearing from the panelists today and
gaining a greater understanding of this issue. I want to thank
everybody for coming, and I want to thank everyone who authored
these important bills, and I especially thank our chairman for
calling this important hearing. Thank you.
Chairman Garrett. I thank the gentlelady. The gentleman
from Virginia is now recognized for 4 minutes.
Mr. Hurt. Thank you, Mr. Chairman. Mr. Chairman, thank you
for holding today's hearing on these important proposals.
Today, we will discuss several bills that will reduce the
regulatory burdens that restrict the flow of private capital to
small businesses.
In Virginia's 5th District, thousands of jobs would not
exist but for the investment of private equity. These critical
investments allow our small businesses to innovate, expand
their operations, and create jobs. One P.E.-backed company in
my district, Virginia Candle, told me that, ``Without private
investment, we would not have been able to take our business
out of a garage in Lynchburg, and into millions of homes all
across the world.''
The same can be said for many small businesses in the
districts of Representatives here in this room, and all
throughout Congress. Unfortunately, Dodd-Frank placed a costly
and unnecessary regulatory burden on private equity by
exempting advisers to similar investment funds. These
unnecessary registration requirements, which do not increase
the stability of our financial system, impose an undue burden
on small and mid-sized private equity firms, and therefore
decrease capital available to spur job growth.
That is why I have introduced H.R. 1105, the Small Business
Capital Access and Job Preservation Act. This bill is co-
sponsored, as the ranking member said, by Representatives Himes
and Cooper. If enacted, these undue burdens on private equity
advisers will be eliminated, and they will be given the same
exemption that SEC's registration requirements under Title 4 of
Dodd-Frank, that venture capital advisers receive.
Additionally, the bill will specifically limit the exemption to
advisers to private equity funds that have leverage of less
than 2:1.
It is important to note that private equity funds did not
cause the financial crisis. They do not appear to be a source
of systemic risk, as some have suggested. These funds are not
highly interconnected with other financial market participants,
therefore, the failure of a private equity fund would be highly
unlikely to trigger cascading losses that would lead to a
similar financial crisis. By eliminating unnecessary
regulations, this bill seeks to expand capital formation so
that companies can innovate, expand, and create jobs.
In that same vein, I have introduced H.R. 1564, the Audit
Integrity and Job Protection Act, with Representative Meeks.
This bill will eliminate the threat of mandatory audit firm
rotation by prohibiting the Public Company Accounting Oversight
Board, the PCAOB, from moving ahead with its potential
rulemaking.
In 2011, the PCAOB released a concept draft to impose
mandatory audit firm rotation, a directive requiring public
companies to change their independent auditor every few years.
As a result, this proposal would significantly impair the
quality of public audits; reduce the supervision and oversight
of audit committees; and impose significant, unnecessary costs
that impede investment and harm investors and consumers.
A GAO study conducted pursuant to Sarbanes-Oxley found that
initial year audit costs under mandatory audit firm rotation
would increase by more than 20 percent over subsequent year
costs in order for the auditor to acquire the necessary
knowledge of the public company. Beyond harming the competitive
position of American public companies, I have heard from
innovative private companies in Virginia's 5th District,
including many of our research and development bio-tech firms,
that mandatory audit firm rotation would create a further
disincentive to go public in light of the increased costs, and
already complex regulatory scheme.
Both the SEC and Congress have previously rejected
mandatory audit firm rotation, and most recently, the JOBS Act
explicitly banned audit firm rotation for emerging growth
companies. Let me close by saying that unemployment in my
district, Virginia's 5th District, continues to be unacceptably
high. We cannot continue to impose onerous and unnecessary
regulatory requirements that force firms to divert essential
capital from preserving and creating jobs, to needless rules
and regulations.
I look forward to the testimony of each of our
distinguished witnesses today, and I thank them for their
appearance before the subcommittee. Mr. Chairman, thank you,
and I yield back the balance of my time.
Chairman Garrett. The gentleman yields back. And before I
go to Mr. Scott, I yield to the gentlelady from New York for a
unanimous consent request.
Mrs. Maloney. It is done.
Chairman Garrett. I thought you wanted to--
Mrs. Maloney. Oh. I have a legislative proposal here and
statement from Ian Simpson, the director of global governance
for CalPERS, the California Public Employees Retirement System,
and I request unanimous consent to place it into the record.
Chairman Garrett. Without objection, it is so ordered.
Mrs. Maloney. Thank you.
Chairman Garrett. Thank you. Mr. Scott is now recognized.
Mr. Scott. Thank you, Chairman Garrett, and thank you,
Ranking Member Maloney.
This is an important subject, and I kind of view these four
bills with a bit of trepidation. I think it is important for us
to be very careful. The Dodd-Frank Act is an extraordinarily
important act to make sure that we never get into a financial
crisis such as we had before.
And I do believe in making the right kind of adjustments.
Oftentimes when we make adjustments, we sometimes can create
unintended consequences, create sometimes more of a problem
than we had before, so we have four bills.
The Audit Integrity and Job Protection Act addresses
questions as to whether or not mandatory audit firm rotation by
the Public Company Auditing Oversight Board is the most
efficient way to enhance auditor independence and audit
quality. I think it is important that we hear from our
accounting firms on that. They are the ones that have to make
all of this work. And we have to make sure that we get the
right answers.
H.R. 1135, the Burdensome Data Collection Relief Act, looks
to repeal disclosure requirements for a public company's ratio
of CEO pay to median employee, as is required under Dodd-Frank.
There are reasons why such language was put into Dodd-Frank.
So, I think we have to be very careful.
H.R. 1105, the Small Business Capital Access and Job
Preservation Act, exempts investment advisers to certain
private equity firms from SEC registration and reporting.
Again, this is required under Dodd-Frank. What does the SEC say
about this? I am saying all of these things were put in for a
purpose.
So, as we move forward to address the many regulatory
issues raised by these pieces of legislation, what I am saying
is, we have to get the right balance, and balance the concerns
on behalf of, yes investors, but also consumers. Also, the
users, and our constituents with the concerns that are raised
by American public companies, many of which are also run by our
constituents and have stakes in our communities.
I believe in transparency, and I am also a pragmatist who
recognizes that while notably improving admittedly less than
satisfactory economic and market conditions that our American
businesses are operating under, we must do everything we can to
improve conditions, and facilitate growth without imposing any
undue, unexpected regulatory burdens. And I am sure my
colleagues share in this evenhandedness. If they are onerous,
we need to say why. Onerous to one person, might not be onerous
to another. So, all I am asking for is that we move with a very
clear, jaundiced eye, and not with an overwhelming zeal to move
in and try to undermine or repeal Dodd-Frank.
With that, I yield back.
Chairman Garrett. The gentleman yields back. Before we go
to Mrs. Wagner, the gentlelady from New York is recognized for
30 seconds.
Mrs. Maloney. I would just like to take this opportunity to
thank Kristin Richardson for her extraordinary work on this
committee, and prior to that, for her work in my district
office in New York. She has done an extraordinary job and will
be leaving to join the private sector. But I am deeply grateful
for her sacrifice, and her devotion, and her hard work. Thank
you, Kristin.
[applause]
Chairman Garrett. So we will be seeing you in New York when
we go up to New York? Great. Okay.
Mrs. Wagner is now recognized for 3 minutes.
Mrs. Wagner. Thank you very much, Mr. Chairman.
The first thing I would like to note is that the discussion
draft amending Section 913 of the Dodd-Frank Act that I have
circulated is just that, a draft. And I appreciate the
opportunity to have it included in this hearing to receive all
of the proper input. The draft is intended to address what has
become one of the biggest issues facing retail investors today.
I guess this has simply become known as the fiduciary issue.
And what we have is two different Federal agencies, the SEC and
the Department of Labor, heading towards a separate and massive
rulemaking that could fundamentally change the way in which
families and investors choose financial products and services,
and not necessarily for the better.
Today, we will focus on the SEC. In January 2011, the SEC
proposed adopting a ``uniform fiduciary standard for brokers
and advisers for their dealings with retail customers.'' While
the SEC claimed this proposal would better protect investors,
the agency failed to provide any evidence to support such a
claim. And in fact, failed to provide any data, or evidence
showing that retail customers were being harmed or
disadvantaged under current standards of conduct.
SEC Commissioner Paredes, and then-Commissioner Casey said
in a joint statement that the study ``failed to justify its
recommendation that the Commission embark on fundamentally
changing the regulatory regime for the broker-dealers and
investment advisers.'' And even though investor confusion
surrounding standards of care was the main rationale behind the
study's recommendation, Paredes and Casey went on to say that
the uniform standard ``may in fact create new sources of
confusion for investors.''
So it seems to me that we have a solution in desperate
search of a problem. And the solution could end up harming
investors more than helping them. The draft that I have
circulated is meant to address the shortcomings of the SEC's
proposal, and to ensure that regulators do not lose focus on
the fact that, at the end of the day, it is everyday Americans
who are harmed most when Federal agencies regulate without
justification.
I hate to break it to you, but it is not the ultra-wealthy,
or the 1 percent who are most affected by this: it is the new
dad looking to buy life insurance so he can sleep better at
night; or the mom looking to set up an education account for
her child who gets turned away because she is told that she is
not sufficiently wealthy; or the grandfather who has fewer
choices when deciding how to pass on wealth to his
grandchildren.
You don't protect investors by simply restricting their
choices and adopting a one-size-fits-all regulatory regime. In
fact, I would submit that this does more harm than good.
The draft legislation would improve the regulatory process
by requiring the SEC to identify whether investors are being
harmed or disadvantaged under current standards of care, and
also require the SEC to conduct a rigorous cost-benefit of any
potential rule.
In addition, the SEC would be required to verify that any
final rule would actually reduce, I underscore, reduce investor
confusion. I think we can all agree that the SEC shouldn't make
the problem worse.
I thank the chairman for the time, and I look forward to
hearing from our witnesses today on this very important matter.
And I yield back my time.
Chairman Garrett. Thank you. And before we get to the
witnesses, one last comment. The gentleman from--
Mr. Hurt. Mr. Chairman, I just have two letters: one from
the Association for Corporate Growth; and one from the
Investment Company Institute and the Independent Directors
Council. And I was wondering if I could have unanimous consent
to make them a part of the record?
Chairman Garrett. Without objection, it is so ordered.
Mr. Hurt. Thank you.
Chairman Garrett. Now, we can go to the panel. And thank
you to the entire panel for being here today. For those who
have not been here before, just recognize that your entire
written testimony will be made a part of the record. We will
now yield to you 5 minutes each.
We also ask that you--we always say this a number of
times--make sure that your button is pushed and that the
microphone, as you have done, is pulled fairly close to you,
otherwise it is sometimes hard to hear you.
So to begin things, from the University of Mississippi, Mr.
Bullard, you are recognized for 5 minutes.
STATEMENT OF MERCER E. BULLARD, PRESIDENT AND FOUNDER, FUND
DEMOCRACY, INC., AND JESSIE D. PUCKETT, JR., LECTURER AND
ASSOCIATE PROFESSOR OF LAW, UNIVERSITY OF MISSISSIPPI SCHOOL OF
LAW
Mr. Bullard. Thank you, Chairman Garrett, Congresswoman
Wagner, and members of the subcommittee for the opportunity to
appear before you today. It is certainly an honor and a
privilege to be back before the committee.
I would like to direct my comments today to the draft cost-
benefit bill, and although I am going to talk about the bill as
if it is final text, I just want you to note that I do
appreciate it is a draft, and certainly I wouldn't be surprised
if there were changes made to the text going forward.
I also want to note that the bill's cost-benefit
requirements, in theory, are certainly unobjectionable. And for
the most part, they describe how the SEC should think about
cost-benefit analysis in doing its rulemaking. However, in
practice, the requirements will have little relationship to how
cost-benefit analysis is actually conducted.
My concern is that they will not improve cost-benefit
analysis. Rather, they will impede or simply prevent needed
rulemaking, add unproductive employees to government payrolls,
and trigger more litigation and more expense for all parties
involved.
Excessive cost-benefit requirements ultimately will turn
government agencies into the Orwellian two factions that
opponents of red tape claim to oppose. Legal challenges to
rules have proven time and time again that there is only one
standard for cost-benefit analysis that is really needed, the
arbitrary and capricious standard under the Administrative
Procedures Act.
Industry participants have been successfully challenging
inadequate cost-benefit analysis under that standard for
decades. One consequence of the regulatory paralysis that
excessive cost-benefit standards create that does not receive
much attention is the problem of unintended consequences.
As every experienced lawyer knows, one response to
regulatory paralysis is always the same--rulemaking through
enforcement. The fiduciary duty is no exception. States bring
State law fiduciary claims against brokers. FINRA brings FINRA
rule-based fiduciary claims against brokers. Fiduciary claims
are the most common claims in FINRA arbitration proceedings
where no one even knows what the standards are that are being
applied because arbitration panels are not required to tell us
what they are.
When you take away the SEC's ability to define the
fiduciary duty, you guarantee that there will be dozens of
versions of fiduciary duties promulgated by dozens of sources
of authority. Excessive cost-benefit standards ultimately
promote the development of non-uniform, enforcement-based law.
Others will also step in and do their own rulemaking. Let
me read you the headline from an article on Rick Ketchum's
speech, delivered only yesterday--``FINRA's Ketchum to SEC: Act
Now on Fiduciary, or We Will Make Our Own Disclosure Rules.''
FINRA rules already have a substantive fiduciary component.
Industry lawyers have characterized its most recent amendments
to a suitability rule as establishing a de facto fiduciary
standard.
The fiduciary duty has already blossomed, gassing 1,000
lights that are anything but illuminating. As an alternative to
rulemaking, the SEC itself has brought a number of claims, for
example, for failures to disclose revenue-sharing payments that
allege what are essentially fiduciary duty violations clothed
in the garb of anti-fraud claims.
In fact, one might even predict that when cost-benefit
requirements threaten to paralyze rulemaking by the SEC or the
CFPB, for example, the Executive Branch might choose to
sidestep rulemaking by appointing prosecutors to run those
agencies.
The cost-benefit bill also requires SEC coordination with
other agencies that may reflect an intent to constrain the
DOL's own fiduciary rulemaking. If so, in light of recent
events, I would say this approach is at least premature. The
DOL's original proposal, which has been roundly criticized by
me in this room itself and others, has been withdrawn.
The DOL is conducting an intensive cost-benefit analysis.
DOL's officials have expressly stated they are crafting
exemptions for reproposal that are designed to accommodate
existing industry practices. And the re-proposal is only a
couple of months off. I would say that Congress should at least
wait to know what the DOL proposal is going to be before
seeking to prevent the rulemaking from going forward.
The bill also includes a provision that requires the SEC to
make a finding, as a condition of adopting a fiduciary rule,
that the rule would reduce investor confusion about the legal
standards that apply to financial professionals. This customer
confusion test does nothing more than hold investors hostage,
denying them the right to an efficient fiduciary standard until
they can prove that they have achieved a higher level of legal
sophistication.
The solution to investor confusion is not to require
investors to become smarter about regulations. It is to make
smarter regulations.
In conclusion, the bill requires that the SEC, again, as a
condition of imposing a fiduciary duty on brokers, to impose
unrelated rules on investment advisers. There is no question
the SEC should consider whether broker rules that apply to
activities that advisers also engage in should be extended to
advisers as well.
But making the adoption of a fiduciary rule automatically
triggers such unrelated rulemaking, creates a strong inference
that this provision is nothing more than rent seeking by an
industry that wishes to regulate its competitors into
submission. Investor adviser rules, like the fiduciary rule,
should stand or fall on their own merits.
Thank you, and I would be happy to answer any questions.
[The prepared statement of Mr. Bullard can be found on page
39 of the appendix.]
Chairman Garrett. I thank the gentleman. Next, from the
Association for Advanced Life Underwriting, Mr. Ehinger, you
are recognized for 5 minutes, and welcome to the panel.
STATEMENT OF KEN EHINGER, CHIEF EXECUTIVE OFFICER, M HOLDINGS
SECURITIES, INC., ON BEHALF OF THE ASSOCIATION FOR ADVANCED
LIFE UNDERWRITING (AALU)
Mr. Ehinger. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. I am Ken Ehinger,
president and chief executive officer of M Holdings Securities,
Inc. I am testifying today on behalf of the Association for
Advanced Life Underwriting.
We appreciate the opportunity you have given us to testify
on draft legislation by Representative Wagner. Her draft
legislation would, in essence, require the SEC to identify a
real need and determine that there will be real benefits
outweighing the costs before upending the current standards
that apply to broker-dealers.
While we understand the Wagner proposal is a discussion
draft at this point, we support her effort as a sensible
proposal that we believe will lead to better rulemaking by the
SEC.
I have spent more than 3 decades in the securities and
insurance business. I was honored to share that experience with
this subcommittee when I testified more than a year-and-a-half
ago.
As I said then, a standard of care for financial
professionals that sounds good in theory may fail in practice
if it is vague and amorphous and provides no guideposts for
compliance. And, a fiduciary duty offers little protection if
regulators do not have the tools and resources to effectively
oversee the financial professionals who are subject to it.
I reiterate those statements today.
During consideration of Dodd-Frank, the then-Chairman of
the SEC advocated that the bill include a legislative mandate
to the SEC to impose a new standard on broker-dealers. Congress
rejected that approach and directed the SEC to study whether
there were gaps in existing investor protection before acting
on any new rule.
The 2011 SEC study was criticized on all sides because of
the lack of economic analysis and findings of specific harm and
market failure supporting its conclusions. The SEC says that it
needs to address investor confusion. A 2008 Rand Corporation
report found that investors were confused about the legal
differences between brokers, dealers, and investment advisers,
although they were very satisfied with their own financial
professionals.
But instead of addressing the confusion issue by developing
better, clearer, and more concise disclosure about the role in
which a financial professional serves, the SEC took a different
path. Over the past 5 years, it has used precious time and
staff resources to continue to press for a change in the
broker-dealer standard of care to conform to the standard that
applies to investment advisers.
The SEC most recently set out various options for reform in
this area in a 72-page release requesting a mountain of data,
little of which relates to whether investors are being harmed.
I have great respect for the SEC and for its dedicated
staff. But, the Commission has detailed dozens of staff to work
on this discretionary rulemaking project over the last few
years.
I believe the SEC could make much better use of those
staff, if it would do two things. First, direct two or three to
develop a targeted disclosure rule that addresses any issue of
investor confusion. And second, reassign the others to fill
what continues to be a monumental gap in investment adviser
inspections and oversight.
Representative Wagner's bill would address these issues
very directly. If the criteria in her discussion draft had been
in place from the outset, precious time and resources would
have been saved by the SEC. The focus on the SEC's regulatory
effort would have been to identify real and specific harm, and
then to craft a rule or other remedy to address that harm cost-
effectively. Investors would have been far better off.
AALU's members are licensed life insurance professionals.
Many are licensed in multiple States. Most AALU members are
registered representatives at SEC and FINRA-registered broker-
dealers, and/or are investment adviser representatives of SEC-
registered advisers. Our members are subject to multiple layers
of Federal and State regulation and oversight.
The variable insurance products our members sell, which
trigger broker-dealer registration, give customers investment
choices and an insurance guarantee, which has been recognized
as even more important in recent years of market volatility.
The range and features of products such as variable life
and variable annuities make it difficult to determine which
product is ``best,'' and a ``best interest'' standard almost
certainly would lead to increased litigation. Determining what
is ``best'' would be highly subjective, opening a producer to
second-guessing and liability, often years after the sale of
the product.
Life insurance enables individuals and families from all
economic brackets to maintain independence in the face of
potential financial catastrophe. The life insurance industry,
through permanent life insurance and annuities, provides 20
percent of Americans' long-term savings.
Two out of three American families--that's 75 million
families--count on the important financial security that life
insurance products provide. Therefore, any proposed change in
regulation that could limit consumer choices and access to
these critical protection and savings vehicles should meet a
high burden with respect to the need for the changes.
I want to thank you again for the opportunity to testify.
AALU looks forward to continuing to work with you on these
critical issues.
[The prepared statement of Mr. Ehinger can be found on page
57 of the appendix.]
Chairman Garrett. And I thank the gentleman. It is good to
see you back here again.
Mr. Quaadman from the U.S. Chamber of Commerce, welcome to
the panel.
STATEMENT OF THOMAS QUAADMAN, VICE PRESIDENT, CENTER FOR
CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE
Mr. Quaadman. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee.
If you take a look at the four issues that are before us
today, there is a common thread that runs throughout them.
There is a lack of benefit for investors and businesses. There
are large costs that are imposed on businesses. And there is a
mode of government micromanagement that inhibits investors and
the ability for businesses to grow and create jobs.
That is why the Chamber, in releasing our Fix, Add, Replace
(FAR) agenda earlier this year, included these four issues as
those that should be addressed. The FAR agenda was specifically
designed to fix the flaws in Dodd-Frank, add the issues that
were left unaddressed in Dodd-Frank, and replace those
provisions that are unfixable.
In looking at the specifics of the four issues before us,
the Chamber supports H.R. 1135, the Burdensome Data Collection
Relief Act, which would repeal Section 953(b) of the Dodd-Frank
Act. The pay ratio disclosure in Section 953(b) in Dodd-Frank
creates a corporate disclosure that forces businesses to
disclose irrelevant information for investors. It doesn't
convey information to investors as to company performance,
their long-term prospects or its management.
Instead, it imposes costly compliance burdens that, if you
take a look at a public company that may be operating in
dozens, if not in over 100 countries, they have to reconcile
differing definitions of compensation, employees, and benefits,
quantify those, and then take into account currency
fluctuations over all those different borders.
So if you take a look at the information provided by the
Center On Executive Compensation, one company has estimated it
will cost almost $8 million to comply with this provision;
another company has estimated it will cost $2 million just to
determine the pension benefits that could be subject to this
provision.
When you start to extrapolate those numbers across the more
than 10,000 public companies in the United States, you are
looking at costs well into the hundreds of millions of dollars.
The Chamber also supports H.R. 1105, the Small Business
Capital Access and Job Preservation Act. This solves the
problem, the classic problem, of trying to pound a square peg
into a round hole. The SEC has created a mismatch of trying to
impose public investor disclosures upon private investors.
Therefore, private equity funds, which are important
sources of capital for the business community, have to
safeguard untradeable securities and also have to start to
engage in expensive periodic valuations of businesses that are
in their portfolio.
It has been estimated by the Association for Corporate
Growth that for each of these businesses in a portfolio, it
will cost the fund between $500,000 and $1 million. When you
take a look at a private equity fund that could be invested in
20, 30, or 50 businesses, that starts to actually sideline a
sizable amount of capital that could be used for productive
purposes.
The Chamber also supports H.R. 1564, the Audit Integrity
and Job Protection Act. The Chamber agrees that Congress should
not legislate independent standard setting standards and that
there should be independent standard setting. But this is an
example where the PCAOB has left its field of audit region and
got into corporate governance. With possibly only two to three
audit firms engaged in audit activities in an industry, it
could actually turn into a government mandate as to what vendor
a company should use and when they should use them.
Furthermore, this will diminish audit committee oversight.
The GAO, as has been noted, has estimated this would raise
audit costs by at least 20 percent and it would harm audit
quality. Over 90 percent of the commenters to the PCAOB over
the last 2 years have opposed this provision and then, in fact,
the majority of investors have also done so.
The Chamber is also very appreciative of Congresswoman
Wagner's discussion draft on Section 913 of Dodd-Frank. The
Chamber echoes the concerns of over 150 Members of Congress on
a bipartisan basis who have raised concerns about fiduciary
duty roles.
We agree that there needs to be a coordinated effort
amongst the SEC and other Federal agencies to look at the issue
and then determine what the problems are, what the solutions
are, and what the cost-benefit should be.
Unfortunately, what we have seen with the history of joint
rulemakings under Dodd-Frank, is they have happened in a
disjointed manner. They have happened out of sequence and they
have created market confusion in and of themselves.
That, we think, is something that would harm investors and
the businesses that they help capitalize.
Finally, I would just like to say if you take a look at
each of these issues and bills in the abstract, they are trying
to address costs and burdens, as I mentioned, but we also need
to look at them on a much broader and global basis.
We would also support consideration of Congressman
Fincher's bill, H.R. 1221, the Basel III Capital Impact Study,
which would look at a cumulative impact study of various Dodd-
Frank rulemakings.
Finally, I would just like to say we commend Congress for
the bipartisan action it took last year in passing the JOBS
Act. And we think that the passage of these four bills is a
page from the same playbook and would support that. Thank you.
[The prepared statement of Mr. Quaadman can be found on
page 67 of the appendix.]
Chairman Garrett. And I thank the gentleman.
Now, on behalf of the Small Business Investor Alliance, Mr.
Reich. Welcome, and you are recognized for 5 minutes.
STATEMENT OF MARC A. REICH, PRESIDENT, IRONWOOD CAPITAL, ON
BEHALF OF THE SMALL BUSINESS INVESTOR ALLIANCE (SBIA)
Mr. Reich. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. Thank you for the
opportunity to testify today.
My name is Marc Reich, and I am president of Ironwood
Capital, a private equity firm in Avon, Connecticut. I
represent the Small Business Investor Alliance, the trade
association of lower middle market private equity firms, and
the many institutional investors that provide the capital that
we, in turn, invest in small and medium-sized businesses
nationwide.
My firm manages six private equity funds, four of which are
organized as small business investment companies, investment
funds that are licensed and regulated by the U.S. Small
Business Administration. We invest subordinated debt and equity
in amounts ranging from $5 million to $12 million to support
small business owners in growth financings, recapitalizations,
and buyouts. I strongly support H.R. 1105, the Small Business
Capital Access and Job Preservation Act, introduced by
Representatives Hurt, Himes, Garrett and Cooper. Thank you to
the committee for examining this bill today, and especially to
the sponsors of the legislation for working so diligently to
bring it to this point.
H.R. 1105 strengthens the ecosystem of the private equity
marketplace by reducing overregulation that threatens capital
access for small businesses. The Investment Advisers Act of
1940 as modified by Dodd-Frank requires private fund advisers
to register with the SEC if they manage more than $150 million
of capital.
Since the Act became effective, over 1,500 private equity
funds have registered with the SEC.
My testimony today will be brief and pointed, focusing on a
few of the most common and vexing problems experienced by
managers of middle market private equity funds as a result of
SEC registration and regulation, in my view, the potential
negative impact on small businesses if H.R. 1105 does not
become law.
First, however, I would like to speak to the issue of
middle market private equity and systemic risk to the financial
system. The global economic downturn was a tremendous stress
test for the financial system. The middle market private equity
industry weathered the downturn in good shape.
In fact, private equity saved many small businesses during
the financial crisis when their access to capital was severely
curtailed.
Middle market private equity doesn't create systemic risk
by trading in synthetic financial instruments. We don't
speculate on currency or commodities. We don't put the
retirement funds of individuals at risk. We invest directly in
small businesses, the backbone of our economy and the growth
engine for job creation.
I support having a strong body of regulation within which
to operate. Good government regulation is, in fact, the
strength of our system. But that regulation must be appropriate
to the context to which it is applied, should not be redundant
with or in conflict with other regulations, and should not
adversely impact the flow of capital--in our case, again, the
flow of capital to U.S. small businesses.
SEC compliance and regulatory costs are especially high for
small investment funds. At Ironwood Capital, we already spend
approximately $250,000 annually on SBA compliance costs.
Initial SEC registration costs us $100,000, plus an additional
$250,000 annually thereafter.
In addition to the actual dollar cost of additional
compliance, having a second Federal regulator removes fund
managers from their primary role of investing in and coaching
small businesses. While this is true for both large and small
funds, there is a disproportionate impact on smaller funds
since they have smaller chains, teams, and operate in very lean
environments, but face the same array of regulations.
Many of the regulatory requirements we now face under SEC
rules are inappropriate to the nature of our business. We
invest almost exclusively in privately held companies and hold
securities which are not readily marketable or otherwise
transferable. Nonetheless, we are now subject to the SEC
custodial rules, which require us to hire a third-party
custodian to hold onto untradeable securities.
If our securities ended up in the hands of unscrupulous
people seeking to profit from them, nothing would happen.
Likewise, we are now required to retain and archive all e-
mail messages, then review them to detect illegal activity,
such as insider trading. Again, we don't hold anything that is
tradable. But we are subject to this rule. This is a purely
regulatory exercise with no benefit to investors, nor does it
contribute to the safety and integrity of the overall financial
system.
Having two regulators overseeing substantially the same
segment of the market has resulted in several unnecessary and
costly situations.
In one case, the manager of multiple SBICs now regulated by
the SEC has been preparing its financial statements for years
in accordance with SBA regulatory accounting standards, but was
required by the SEC to restate all of their financial
statements on a GAAP basis, which cost them about $500,000.
The effect of relatively high compliance expenses and
conflicting regulation motivates managers of small funds to
either exit the business or raise far more capital for their
next fund to offset the cost of double regulation, which, in
turn, has the effect of causing those funds to now invest in
bigger companies, leaving the smaller companies significantly
out in the cold. Neither option is good for the sustained flow
of capital to small businesses.
Thank you to the committee for holding this hearing on H.R.
1105, a bill that removes overregulation and helps small
business. The SBIA looks forward to working with you to craft
better legislation and the appropriate modifications. I am
happy to answer any questions you may have.
Thank you.
[The prepared statement of Mr. Reich can be found on page
106 of the appendix.]
Chairman Garrett. I thank the gentleman.
From the AFL-CIO, welcome back, Mr. Silvers.
STATEMENT OF DAMON A. SILVERS, POLICY DIRECTOR AND SPECIAL
COUNSEL, AFL-CIO
Mr. Silvers. Good morning, Chairman Garrett. It is a
pleasure to be with you again. And good morning to you, Ranking
Member Maloney.
I am Damon Silvers, the policy director and special counsel
to the AFL-CIO. I want to thank you and the committee for the
opportunity to appear today.
Since 1980, the United States has gone through several
cycles of financial deregulation, each of which was followed by
speculative bubbles and mass unemployment. The Bank of England
has estimated that the worldwide costs of the collapse of the
most recent U.S.-centered financial bubble driven by
deregulation is in excess of $60 trillion and rising.
Today, this committee is considering a package of bills,
each of which is wrong-headed in its own peculiar way, but when
taken as a package, together with other measures being taken up
by the House such as derivatives deregulation, constitute the
House seeking to initiate yet another round of financial
deregulation. If successful, there is no reason to believe that
the outcome of this effort will be any different than the
outcomes of the last 3 times that Congress went in this
direction.
Now, I am going to take up briefly each of the four bills.
In my written testimony, there is a detailed analysis.
H.R. 1135, the Burdensome Data Collection Relief Act, seeks
in truth to keep secret the relationship between CEO pay and
the median pay of other employees at public companies by
repealing Section 953-b of the Dodd-Frank Act, which requires
such disclosure. The AFL-CIO strongly opposes H.R. 1135. It is
a bill designed to hide material information from investors, to
encourage runaway CEO pay, and to increase economic inequality.
Each of these outcomes of this bill will feed systemic risk.
H.R. 1105, the Small Business Capital Access and Job
Preservation Act, as drafted now--it could be drafted to
narrowly address the concerns the previous witness, Mr. Reich,
has raised, which I think are legitimate--has nothing to do
with small business. It exempts leveraged buyout firms. That is
what private equity is code for. It exempts leveraged buyout
firms from the registration and reporting requirements in the
Dodd-Frank Act.
This bill would increase systemic risk, weaken investor
protections, and offer further regulatory subsidies to
leveraged buyout firms, a portion of Wall Street that is
already the beneficiary of inexcusable tax subsidies. And it is
drafted in a manner aimed at misleading Members of this House
into thinking the bill has meaningful protection against
leverage when it does not, because the firms do not incur
leverage at the firm level. They do so at the investment level.
For all of these reasons, the AFL-CIO strongly opposes H.R.
1105.
The draft legislation to amend Section 913 of the Dodd-
Frank Act places a number of unusual procedural obstacles in
the way of the SEC strengthening the standard of conduct that
is applied to broker-dealers' treatment of their clients.
Currently--and this has not come out yet, despite the amount of
time spent in this hearing on this bill--brokers have no legal
duty to give investors advice that is actually in the client's
interest.
This fact was at the heart of Goldman-Sachs' defense when
the SEC charged Goldman with selling credit default swaps in
the Abacus transaction to clients without telling them the
swaps had been designed by the party on the other side of the
transaction. In a sense, this draft bill is designed to
facilitate Goldman-Sachs and their future imitators continuing
treatment of their less favored clients as feedstock for their
most favored clients. The AFL-CIO strongly opposes this bill.
H.R. 1564, the Audit Integrity and Job Protection Act,
seeks to prevent the Public Company Accounting Oversight Board
(PCAOB) from placing limits on the length of time a public
company can use the same audit firm, audit firm rotation. H.R.
1564 both substantively weakens the ability of the PCAOB to
play its role in protecting our economy against systemic risk,
and it weakens the independence of the body. Both results are
contrary to the public interest, and will significantly
increase the risk of financial crisis, and the AFL-CIO opposes
this bill.
I should note that the subcommittee does not possess the
information the PCAOB has as a result of its inspection
process. I would suggest the subcommittee consider seeking to
grant itself that authority so it can have the information the
regulator has, as the regulator considers whether or not to do
this, from the inspections.
Now, in conclusion, there is an urgent financial regulatory
agenda, and it is not this one. That agenda is completing the
Dodd-Frank rulemaking process, really taking on too-big-too-
fail institutions, as Senators Brown and Vitter are attempting
to do, and fairly taxing the financial sector, starting with
ending the carried interest loophole and enacting a financial
transaction tax.
This subcommittee should turn away from yet another costly
indulgence in the delusions of deregulation, and instead focus
on how to strengthen our statutory and regulatory protections
against systemic risk and the exploitation of investors.
Once again, on behalf of the AFL-CIO, I want to thank the
subcommittee for the opportunity to appear. I look forward to
your questions.
[The prepared statement of Mr. Silvers can be found on page
116 of the appendix.]
Chairman Garrett. Thank you.
On behalf of the Society of Corporate Secretaries and
Governance Professionals, Mr. Smith, you are recognized for 5
minutes.
Thank you.
STATEMENT OF ROBERT SMITH, CORPORATE SECRETARY, VICE PRESIDENT
AND DEPUTY GENERAL COUNSEL, NISOURCE, INC., ON BEHALF OF THE
SOCIETY OF CORPORATE SECRETARIES AND GOVERNANCE PROFESSIONALS
Mr. Smith. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. I am here today in my
capacity as director of the Society of Corporate Secretaries
and Governance Professionals, and I appreciate the opportunity
to participate in this hearing. And I will jump right in to the
heart of the issues.
My comments this morning will be limited to the CEO pay
ratio disclosures and potential audit firm rotation issues. We
believe these issues, if implemented, would be detrimental both
to companies and their investors. With respect to H.R. 1564, we
believe that the exclusive authority to hire and retain an
audit firm should remain with the company's independent audit
committee.
The audit committee remains tasked by Congress and the SEC
with the responsibility of selecting a company's audit firm,
and we believe the audit committee is best able to judge if the
audit firm is bringing the right level of technical competence,
objective, and professional skepticism to its work. Mandatory
rotation would unnecessarily impinge on the audit committee's
independent judgment and fiduciary duties, and it would replace
this with an arbitrary one-size-fits-all requirement.
Second, we believe that the costs of mandatory rotation
outweigh any benefits from a blanket rule. The costs associated
with mandatory audit firm rotation are considerable, entailing
as much as 2,600 to 3,700 hours of audit committee, senior
management, and staff time.
Additionally, approximately half of our surveyed members
indicated they believe fees for audit committee and audit-
related services would increase 20 percent or more in the
initial years following the auditor change. In addition, the
GAO also estimated that additional costs would average
approximately 80 percent higher than the audit costs had there
been no change.
Furthermore, we believe that the benefits of forced
rotation would be minimal and that rotation would likely have a
negative effect on audit quality. More than 85 percent of our
members surveyed were very concerned about the loss of the
audit firm's institutional knowledge of the company and
industry if required to switch auditors. And 70 percent of the
responding members that had experienced an auditor change in
the last 10 years indicated that they had noticed a change in
the audit quality as a result of the new engagement.
Finally, we believe that mandatory auditor rotation would
leave many public companies with few experienced and eligible
audit firms. Many public companies in certain industries have
very limited choices with respect to audit firms with
appropriate expertise.
Many, again as a practical matter, only use one or two of
the big four firms to provide their audit services. Nearly 90
percent of our members surveyed indicated that their company's
audit committee evaluates audit firms based on industry
knowledge or international scope, and considered these items
very important in the selection of the audit firm.
Requiring a company to choose a less qualified, less
experienced firm seems significantly less than ideal from a
governance perspective. For these reasons, we oppose mandatory
audit firm rotation.
With respect to CEO pay ratio, we believe the requirement
that the ratio be based on the median employee is simply
unworkable. In order to know who the median employee is, each
company in the United States would have to calculate the cash
and non-cash compensation for every employee: full time; part
time; domestic; international; hourly; and salaried.
Pension accruals would have to be calculated by actuaries
and H.R. professionals for no productive purpose other than to
determine the median employee. International companies face an
even more daunting task. They have foreign subsidiaries that
have completely different computer systems, pay scales,
compensation structures, and laws, including privacy laws in
some jurisdictions that could prohibit the transfer of personal
compensation information across borders without express consent
of that employee. The potential issues with pay ratio are
significant and numerous.
Additionally, this type of disclosure does not appear to be
desired by shareholders or investors. The 12 shareholder
proposals of which we are aware that have been voted on since
2010 on average received less than 7 percent support. The
bottom line is that there are already a lot of disclosures on
compensation and shareholders have a regular venue and voice in
the compensation process through say on pay.
The disclosure is not meaningful. The skewed results that
would result where two similar companies produced the same
equipment, but one outsources the production of its products
and the other one does not, clearly demonstrates the non-
materiality and even potentially misleading nature of the
disclosures.
Similarly, the inclusion of part-time employees and
international employees yields absurd results, where a full-
time executive would be compared with a part-time employee who
may only work 20 hours per week, or with international
employees who may live in a third world country.
Lastly, we agree with the Chamber's earlier comments that
these additional disclosures could be incredibly costly without
an offsetting benefit that would justify the cost. Hiring staff
to perform the detailed calculation and then audit it and
confirm it so that it is reliable and accurate would be
daunting and overly burdensome. For these reasons, we believe
that the requirement should be repealed.
Thank you very much.
[The prepared statement of Mr. Smith can be found on page
126 of the appendix.]
Chairman Garrett. Thank you.
And representing the Center On Executive Compensation, Mr.
Tharp.
Welcome.
STATEMENT OF CHARLES G. THARP, CHIEF EXECUTIVE OFFICER, CENTER
ON EXECUTIVE COMPENSATION
Mr. Tharp. Thank you. Thank you, Chairman Garrett, Ranking
Member Maloney, and members of the subcommittee. My name is
Charlie Tharp, and on behalf of the Center On Executive
Compensation, I am pleased to provide our views on Section
953(b) of the Dodd-Frank Act, commonly known as the pay ratio
mandate, and to express our strong support for Congressman
Huizenga's bill, H.R. 1135, which would repeal the pay ratio.
As was commented earlier, we believe that it would impose
significant costs on organizations, especially global
employers, and would divert resources from more productive uses
such as job creation and investment without providing
meaningful information to investors.
The Center On Executive Compensation is an advocacy and
research organization. And we are a division of the H.R. Policy
Association, which represents human resource executives of over
340 large companies, 100 of whom are members of the Center.
I would like to make four key points in support of our
review for the repeal of Section 953(b). The first is that the
pay ratio calculation is overly complex. As was mentioned, the
law would require that a company find the median compensation--
not the average--of employees using the definition of pay that
is used for the summary compensation table in the proxy
disclosure.
Companies don't keep that information except for the
calculation of the high five executives, and this is something
that would have to be gathered manually and calculated. And as
was pointed out, there is really no other legitimate business
reason to collect the information in this way, so it would be a
redundant effort.
Second, there is a requirement that it be conducted on all
employees. And that would include part-time and full-time
employees. And as it is literally read, that could be employees
around the world in various locations, no matter how many hours
they work for the company. Again, this data is not housed in
any accessible way by companies.
And third, there would be a burden to conduct this
collection of data. In our survey, half of our companies said
it would take 3 months to collect this data. Another 20 percent
said it would take 5 months. And this is information that would
have to be disclosed in each SEC filing from a company, which
are numerous.
I would offer one example from one of our subscribers that
said they have no existing way to calculate the annual total
compensation of every employee around the world. They have 101
payroll systems. They have 3,600 employees who are paid in 2
different countries because of the nature of their assignment.
Six countries that use noncalendar tax years. And it was
mentioned earlier that many countries have privacy rules that
inhibit the ability to share this information.
There is also a tremendous expense, as Mr. Quaadman pointed
out, since the cost of implementation would be millions of
dollars. The two examples used, one company would be $7.6
million as their estimate just to collect this data. And the
pension calculations, again, would be over $2 million.
The final point is that it is information which isn't
useful to investors and which investors haven't asked for. If
you look at the differences between company structures, the
labor markets in which they operate, the product markets, it
would be very difficult to compare information across
companies.
And in those cases where shareholders have had an
opportunity to vote on the pay ratio, the 9 that were in 2010,
none received support of over 10 percent by investors, and the
average support was just a little over 6 percent. And it is
clear that when given the opportunity to request this
information--over 90 percent of investors have voted against
it.
In conclusion, we believe that the pay ratio wouldn't be
helpful to investors, would be potentially confusing, and would
be overly costly and burdensome to implement. And that is why
we support repeal. Again, thank you very much for the
opportunity to offer our views.
[The prepared statement of Mr. Tharp can be found on page
142 of the appendix.]
Chairman Garrett. Thank you. Just so the panel knows, votes
have been called, but I think we will get in at least one
series of questions, and then close after that. I am not going
to go next, as I normally would as Chair. I am going to defer
to the vice chairman. The gentleman from Virginia is recognized
for 5 minutes.
Mr. Hurt. Thank you, Mr. Chairman. Again, I thank each of
the panelists for being here. I guess I wanted to first talk
about the private equity registration bill, and wanted to first
turn my attention to Mr. Quaadman. Obviously, the purpose of
Dodd-Frank is to get at the idea of systemic risk. How do we
prevent systemic risk and prevent another financial crisis?
Obviously it strikes me, as the chairman said, that the
implementation of Dodd-Frank and the enactment of Dodd-Frank is
not something that should prevent us in and of itself from
looking at ways to make Dodd-Frank more useful or to make it
less harmful, especially to those who are trying to create
jobs.
And jobs is obviously--if you look at my rural Virginia
fifth district, there are places in my district where we have
had unemployment as high as 15 percent. So this is a very real
issue, and capital formation is very important.
I was wondering if you could maybe talk a little bit about
the importance of private equity in capital formation, and then
also address the issue of systemic risk and whether or not the
investment that takes place as a consequence of that really
presents any systemic risk as contemplated by Dodd-Frank.
Mr. Quaadman. Thank you, Mr. Hurt. First off, in the United
States we have an extremely diverse set of capital financing
for businesses. So, private equity is a very important part of
that.
Private equity obviously can be where a fund comes in and
takes a troubled company and turns it around. On the other
side, they can take a smaller company that is looking to grow
and provide them with the basis to do so. So private equity in
that regard is a very critical part of the funding structure
that businesses have.
In terms of systemic risk, private equity was not a cause
of the financial crisis. In fact, when you take a look at Title
I of Dodd-Frank through the prior Vitter Amendment, which was
the last amendment agreed to in the Senate, the Senate on a
bipartisan basis put a very strong line around what systemic
risk can actually be in order to keep as many non-financial
companies out of it.
So when you take the fact that private equity was not a
part of the financial crisis, where you actually have Congress
and Dodd-Frank trying to restrict systemic risk regulation,
clearly this is--private equity should not fall within the
focus of this.
Mr. Hurt. Thank you. Mr. Reich, I wanted to see if you
could also address the issue of systemic risk, and then also
talk about whether or not this added regulation has the
potential of perhaps creating more systemic risk, more too-big-
to-fail. I think you addressed that a little bit in your
comments, but maybe you could address that issue?
Mr. Reich. I would be happy to. Thank you for the question.
As I said in my comments, it has been demonstrated that private
equity hasn't contributed in any meaningful way, and maybe
perhaps not at all, to the systemic risk.
Part of that is because of structure. And the private
equity industry, whether by design or through evolution, is a
very, very stable system. Our investors are not individuals.
They are large financial institutions. We have California State
Teachers. We have New Hampshire Prudential, MetLife, all major
investors. It is not Ma and Pa Kettle showing up with their
savings in a coffee can asking to invest in private equity. But
the structure is such that when our investors are in, they are
in. They can't exit. They commit to a 10-year period, which
creates real stability in the system. We all saw what happened
with the hedge funds. They have quarterly redemption rights,
and people were running for the door and created tremendous
problems. Private equity, again, is very, very stable--
structurally very stable.
As to the systemic risk, it is interesting when you take a
look at Dodd-Frank and H.R. 1105 and what has gone on--and by
the way, I don't view this as a step towards deregulation.
Mr. Hurt. Yes. But my time is running out, and I really
want you to address what the implication for capital formation
for small businesses could be?
Mr. Reich. Certainly. What happened is because of the cost
of regulation, the players that continue in the industry have
had to raise more capital to cover the increased costs. That
creates some systemic risk in itself because it is forcing more
capital into the hands of fewer. So we have less
diversification. And by moving up in size, they can't invest in
the smaller businesses. So the smaller businesses really get
hurt in the process.
Mr. Hurt. Excellent. Thank you. I yield back the time I
don't have.
Chairman Garrett. The gentleman yields back.
Votes were called about 7 minutes ago, so let's go into
recess. We only have two votes, so it should not take long. As
a matter of fact, after they vote the first time, we move right
into the second vote, and then we will whip back here. So we
will be in recess until that second vote is over. Thank you.
[recess]
Chairman Garrett. The hearing is called back to order. And
at this time, I yield to the gentlelady from New York.
Mrs. Maloney. I would like to follow up on the question by
my good friend, Mr. Hurt, who is very sensitive, and I respect
his sensitivity to being sensitive to the really burdensome
requirements on smaller firms. But also to involve in the
conversation Mr. Quaadman and Mr. Silvers, who had really
competing statements on the bill. Already, people have started
registering in these private equity firms with the SEC.
And now, firms under $150 million are exempted from
registration. Yet Mr. Silvers, in your testimony, you said the
way that this is written is that it applies to the leverage at
the fund level, and only to private equity funds, and that it
would exempt many private equity funds. Could you explain that
further? You made it sound like the leverage argument doesn't
really apply to the private equity funds. Maybe a better way to
help the small firms would be to raise the ceiling as opposed
to going into the leverage idea? I would like the comments of
the panel on that. Mr. Silvers, and then Mr. Quaadman, and Mr.
Reich, or anybody who would like to respond.
Mr. Silvers. Congresswoman, what my testimony addresses is
that leverage, which is the systemic risk issue associated with
leverage buyout firms or private equity firms. Leverage in
these firms is incurred not at the firm, but at the level of
the partnership. So if you put in the bill language as is
currently in the bill that says, we are not exempting firms
with leverage, that language is completely misleading because
it measures the leverage at the investment fund level, and not
at the level of the companies the investment fund controls.
Leveraged buy-outs are done at the company level, right? So
that in a given leverage buy-out, a private equity firm might
own the equity, the controlling share in 10 operating
companies. Each of those operating companies will have done the
borrowing. The way the language is written right now, you can
have vast amounts of leverage in the total portfolio controlled
by that leverage buy-out fund, and it would register the way
leverage is measured in this bill as none whatsoever. Now your
question about size? My reaction to Mr. Reich's testimony was
that he was describing the concerns of funds that were somewhat
larger than the $150 million level, but were not in the big-
time of private--in the world of leverage buy-outs and private
equity.
And also, funds that were perhaps less leveraged than the
typical large player in the business. Now, I would agree with
you that I think that his testimony raises a question of
whether the $150 million limit is the right number. I am not
going to express a view on that today. I am somewhat skeptical,
but I think it would be worth looking into. But the way this
bill is written, it is very easily a blanket exemption for
funds that definitely represent systemic risk.
Mrs. Maloney. Okay. Mr. Quaadman?
Mr. Quaadman. Mrs. Maloney, thank you for the thoughtful
question. I think first off, some of the work that Mr. Himes
has done, which was incorporated with this bill has been very
helpful. I do think Mr. Hurt's approach is actually a very
thoughtful way forward. What we are seeing with the SEC is that
you have an agency that is really geared toward public company
disclosures and regulations. And that while Congress made a
decision that there should be more oversight over private
equity firms, the way that it is being done, it is being done
through a check-the-box mentality that neither benefits the
regulators nor does it help the P.E. firms themselves.
So I think there is an appropriate balance here where you
can have P.E. firms that can go out there and help businesses
with capital, and with management, and not necessarily put
onerous regulatory burdens on them. And it is just a matter of
that balance.
Mrs. Maloney. Mr. Reich, and anyone else who would like to
comment? Mr. Bullard? Mr. Reich, please, if you could comment
on this discussion?
Mr. Reich. On that specific point, you are certainly
correct. There is leverage both at the firm level, the fund
level, and at the company level. But again, I think it is best
covered just by disclosure. And I think there is adequate
disclosure that is required right now by the SEC and the
government in general to assess the systemic risk. I don't see
it as a big problem, however.
Mrs. Maloney. Okay. Mr. Bullard?
Mr. Hurt [presiding]. Just briefly.
Mr. Bullard. I would just like to point out that the SEC
dealt with this issue in its venture capital rulemaking, which
is the other major category that is exempted. It dealt
specifically with the leverage requirements that are imposed on
venture capital. It seems to me that looking at this bill, the
2:1 ratio doesn't really do the kind of leverage restriction
that you are looking for, simply--but directing the SEC to do
the leverage restrictions itself would solve the problem. And
the venture capital rulemaking seemed to be the one the
industry was happy with the resolution. It is one that people
were happy with the way the SEC dealt with leverage--
Mr. Hurt. Thank you.
Mr. Bullard. --I think that might be a better fix to that
approach.
Mr. Hurt. The gentlelady's time has expired. The Chair now
recognizes Mrs. Wagner for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman. And thank you all for
being here today. Mr. Ehinger, I want to begin with just a
general question, sir. What effect do you believe a broad,
loosely defined fiduciary standard will have on retail,
investors, and families who purchase insurance or other
financial products?
Mr. Ehinger. Thank you, Congresswoman Wagner. I appreciate
the question. I also wanted to repeat one of your statements,
that this is a solution in search of a problem, for sure. But I
think in answer to your question, almost certainly it could
create some increased liability. My concerns would be that
particularly with respect to the life insurance business, there
would be a shift to other kinds of products, non-bearable
products, which in essence means less choice. I also think many
insurance agents may choose not to stay registered, again not
offering the opportunity to their clients perhaps to have the
choices that are available at this point today.
So I think that, coupled with higher costs, that again will
be passed on in some regard could have a detrimental effect on,
really the accessibility for products and services to all--
Mrs. Wagner. I couldn't agree more. Again, Mr. Ehinger, in
the Section 913 study, the SEC failed to identify any kind of
systemic harm or disadvantage being done to investors under
current standards of conduct. How do you feel that omission
undermined, or misinformed the study's recommendations to adopt
a uniform fiduciary standard?
Mr. Ehinger. I think the only thing that has been found--
and I will reference back to the 2008 Rand study--with respect
to the concerns about not understanding the legal
responsibilities is confusion. And it is our view, our position
that confusion is not resolved by changing legal structures,
and creating more confusion, by having multiple definitions of
what, even the term fiduciary means.
Confusion is resolved by proper, simplified disclosures, we
think with access to better information in a more in-depth way.
And in addition, education, and the SEC has a division really
set up to address that, as well.
Mrs. Wagner. I think those are the two big takeaways. I
know you have mentioned the 2008 Rand study, as have I, about
the confusion issue. But to me, the most interesting thing
about that study is that they said that generally, most
investors and families were very happy with the services that
financial professionals were in fact providing them. So I think
those are the two big interesting takeaways there. So then it
would seem, as the SEC pointed out in their study, that
investor confusion is the real issue to be addressed.
And for the record here, I do want to state that I do
believe it is a completely legitimate concern. But, do you feel
that there are better ways for the SEC to address investor
confusion, as opposed to making wholesale changes in the way
that financial professionals are regulated?
Mr. Ehinger. I do, absolutely. And so I am reiterating what
I mentioned before and that is to more properly and in a simple
way, disclose really the roles and responsibilities of the
investment folks who are working with individuals. And also to
really support the educational efforts, as well. I think the
other side of that is really if there is some concern about
that confusion, one of the things that ought to be understood
is really what the gaps truly are between the different ways
that regulators, whether it is the B.D. regulators, or whether
it is the SEC regulators act in practice.
Mr. Ehinger. Because the term, fiduciary, while it may
appear, and it may sound as a higher standard, in practice that
standard really depends on how it is really enforced, how it is
really complied with.
Mrs. Wagner. I appreciate that. I have limited time. Mr.
Quaadman, you used a phrase in your testimony that caught my
eye. You stated that the SEC has shown benign neglect to retail
advisers through past rulemakings. Who will ultimately pay the
price if fiduciary standards are broadly applied with little
regard to the cost or restrictions on choice that would come
with it?
Mr. Quaadman. Thank you for asking that question. First
off, in terms of investor confusion that you were talking about
and the increased cost, it is going to be the retail investor
that is going to face that confusion, face that cost. And, in
fact, they actually may have less products to choose from if we
don't have coordinated rulemaking.
What has also been clear with the SEC, in terms of their
policies over the last several years, which is why we use that
term, in terms of enfranchising retail investors or retail
investor protections, whatever, they have always gone down to
the bottom of the list in favor of institutional investors and
others, so that, unfortunately, it is the mom-and-pop
shareholder who has really been neglected and is unfortunately
going to pay a price at the end of the day.
Mr. Hurt. Thank you, Mr. Quaadman.
Mrs. Wagner. Thank you.
Mr. Hurt. I thank the gentlelady, and the Chair now
recognizes Mr. Scott for 5 minutes.
Mr. Scott. Thank you very much. As I said in my opening
statement, we have to get sort of a delicate balance on many of
these issues. Let me talk about the first one. We have a
serious problem in this country and that problem is this wide
gap between what those at the top are making and those in the
middle are making in terms of income. And so, Dodd-Frank
attempts to address that.
I heard some of the same arguments against that, that we
had on say on pay. I have nothing against people making as much
money as they want to make, and can make. And I don't think
there is anything in this section that does that. But we have a
serious problem. And the country cannot go on with this huge
wage and income gap between the top half of 1 percent, our CEOs
making gobs of money, which they have a right to do, I don't
question that. But when you get to the middle class, this
country's heart and soul is based on the middle class, and it
is shrinking.
And so, Mr. Silvers, I would like for you to address for a
moment why this is so important and how we can remove some of
the arguments--and Mr. Smith, you make good arguments, and I
want to come to another point, because I think I agree with you
on this necessary audit rotation, which I want to get to, as
well.
But Mr. Silvers, please address why this is really, really
important and give some factual information as to where we are
going if we don't address--we will not have a middle class.
The other point I want to make is that these people, these
are public companies. And these individuals of the middle class
make investments in these companies. They have a right to know,
and I think what we are trying to do with this ratio is to try
to come up with some mechanism that would encourage a fairer
deal in compensation for the middle class.
Mr. Silvers?
Mr. Silvers. Thank you, Congressman Scott. Let me begin
with your point about income inequality.
CEO pay, at the height of the post-war economic boom, when
corporate profits were highest and when middle-class income
growth was strongest, was 24 times that of the pay of the
average worker. Now today, there are different studies with
different numbers, and my testimony cites a study by Bloomberg,
the news organization, which finds that average CEO to worker
pay ratio in the S&P 500 is 204 to 1.
Other studies have found in varying years in the last
decade, the ratio is as high as 500 to 1. There are two things
about these studies, though, that make them limited in
understanding just how bad the problem is that would be
corrected if the SEC were to issue the implementing rules on
the Dodd-Frank measure that we are discussing this morning.
The first problem is that these numbers are actually not
firm-specific, meaning it is impossible for anyone--you, in
your role as a legislator, an investor, an employee, anyone--to
know what those numbers are company by company and to make
judgments based on what those numbers are.
And this is important because academic study after academic
study cited in my written testimony, and the wisdom of
management experts like Peter Drucker, is that this ratio is a
key window into whether or not companies are actually being run
as teams and whether or not they are going to be capable of
generating long-term value over time.
The other issue, and it has been cited by several of my
fellow witnesses in a kind of upside-down way, but the other
issue is we live in a global economy. If you want to understand
how a global public firm is being run, and whether it is being
run in a manner that is sustainable and is likely to produce
maximum effort on everyone's part, you need to know what the
executive pay--how the executive pay looks for the firm
globally.
I'm sorry, sir.
Mr. Scott. I only have 20 seconds, and I think those are
excellent points. We have addressed that a little.
But Mr. Smith, I think your point is well-taken. I have
concerns about this mandatory rotation of audit firms. Auditing
and accounting firms get right to the skeletal operations, the
intricacy, the complexities of companies in dealing with taxes,
audits, all of that. You can't get more deep penetration.
And I think there is something lost if we try to mandate
that industry, put a time scope on how long or what accounting
companies can do and then they must rotate when the whole
purpose in the accounting firms is familiarity. So I am with
Mr. Silvers and with Mr. Smith, I think those are the two major
bills that we have to examine closer. Thank you, Mr. Chairman.
Mr. Hurt. I thank the gentleman. The gentleman's time has
expired. The Chair now recognizes Mr. King from New York for 5
minutes.
Mr. King. Thank you, Mr. Hurt. And I intend to yield time
back to you. But first, I would like to ask Mr. Quaadman
whether he believes there is a need to study the cumulative
impact of the Dodd-Frank rulemakings? And are you aware of any
estimates regarding their impact to date?
Mr. Quaadman. Thank you, Mr. King. If you just take a look
at some of the bills here, as I mentioned before, pay ratio
could cost $7 million for a large company. If you take a look
at audit firm rotation, you could have a firm that spends $100
million on audit costs, and that could go up by at least $20
million. Just those two bills alone could cost a company $27
million.
We also have to take a look at the Volcker Rule and others,
to take a look at the money market fund regulations that are
coming down that could boost the cost of capital for some firms
by 400 basis points. So we think that a study like that is
needed.
Mr. King. Thank you. I yield the balance of my time to Mr.
Hurt.
Mr. Hurt. Thank you, Mr. King. I would like to just focus a
couple of questions on the audit firm rotation bill. Obviously,
investor protection is an extremely important jurisdiction of
this committee and the SEC and the PCAOB.
But I was wondering if I could get Mr. Quaadman just to
talk briefly about the protections that are already organically
found within the corporate audit committee process. And what
are the incentives? If you could just talk about that broadly
in terms of investor protection?
Mr. Quaadman. Thank you, Mr. Hurt. First off, Sarbanes-
Oxley greatly strengthened audit committees and the role that
they have and the independence that they have. So Congress,
through its directive, has actually authorized the audit
committee to really be the overseer of financial reporting for
a company.
What is happening here is that what the PCAOB has been
looking at for 2 years, despite overwhelming opposition, is to
actually neuter the audit committee, go against what Congress
wanted to do and really start to create rotation.
What is also going on, and I just want to throw this out
there, is this isn't happening in a vacuum because in the
European Union, they are not only looking at mandatory audit
form rotation, but they are also looking at something known as
mandatory re-tendering, which means that every couple of years,
a company has to go out regardless and just solicit new bids.
This is just going to create a vicious cycle where there is
going to be constant marketing going on and actually
everybody's--their eyes are going to be taken off the ball of,
in terms of good financial audited financial statements.
Mr. Hurt. Thank you. Mr. Smith, over the years this issue
has been looked at before, the audit firm rotation. Could you
talk a little bit about what findings and conclusions have been
made in previous bodies that have examined this issue?
Mr. Smith. Yes, thank you. When I looked at it--I am trying
to remember the exact years, but it is in my written
testimony--there were findings that showed several failures
that were the result of the weakened state of the audit
committee, as the reports were--I am sorry, not of the audit
committee, of the audit firms, in doing their audit in those
reports as they were considering this rulemaking 3 separate
times over the last decade or so.
So the record is clear in those committee reports with
respect to the weakening of the audit committees.
Mr. Hurt. And can you talk a little bit about the actual
costs that this suddenly accrues to the company, and are there
any benefits? If we are going to talk about the cost-benefit
side of this, in your opinion, do the benefits, if there are
any benefits, outweigh the costs?
Mr. Smith. Sure. As we surveyed our members, the members
responded that they would expect to see at least a 20 percent
increase in the audit costs over--
Mr. Hurt. Which is consistent with the GAO study.
Mr. Smith. And the GAO even went further and they had a
range that averaged approximately 80 percent of an increase
just in the first year alone. And so what happens is you
combine that increase in costs and the perceived benefit of
independence and audit skepticism. But what really happens as
we sieve through those concept releases is that not only do you
have the increased costs but you also have a deterioration and
a learning curve that is going on at the audit firms, which is
substantial, and creates risks that an audit committee should
be--I believe, have a choice and exercise their fiduciary
duties in order to make that decision as opposed to having it
mandated.
Mr. Hurt. You think that the imposition of such a rule
would affect your company's competitiveness and the
competitiveness of American companies generally?
Mr. Smith. I think it would be hard to say that increasing
our costs by a substantial amount in the millions of dollars,
which would be money that otherwise would be used for capital
improvements and capital investments on infrastructure or
creation of jobs through other investments, would not harm the
economic state of our company or any other--
Mr. Hurt. Thank you, Mr. Smith. And I think the gentleman's
time has expired.
I recognize Mr. Himes for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman. I was moved by
Congressman Scott's comments and want to associate myself with
those comments. I honestly don't know whether disclosure is
going to fundamentally alter compensation in this country. But
I know that in addition to the economic challenges that the
disparity creates, there is a perception of fairness issue that
is terribly important.
And in the presence of members of the industry, I have been
in those meetings where compensation is determined always with
an eye to comparability, comparable pay. I would suggest that
we have to start going to fairness or we will be in a lot of
trouble.
Mr. Silvers, on H.R. 1105, you talked about the leverage
limitation, the 2X leverage limitation. You said this
limitation was clearly drafted in bad faith. Mr. Silvers, I
drafted that limitation, and I object on two counts. One, I see
what happens to this institution when we challenge each other's
good faith or thereof, and I also see what happens when we get
to each other's motivations.
But more importantly, I drafted this leverage limitation
because of a criticism that you raised 2 years when you came
before this committee and said these are large leveraged pools
of capital. Now in discussion, we ultimately determined that
they are not large leveraged pools of capital, that in fact
they create leverage at the industrial company level that they
purpose.
But I thought, gosh, a lot of people out there think that
they are a large leveraged pool of capital, and perhaps we
ought to address that by saying that if they were to become
such, we should put a limitation on them. Mr. Silvers, since
you got this personal, I would point out that I have about a 95
percent AFL-CIO voting record. So I suspect that we can
philosophically find agreement on many issues. But I do want to
pursue this issue now that we have moved the discussion to the
sponsored companies, the Burger Kings, and the car wash
companies that LBO firms, love them or hate them, invest in.
I am wondering whether anybody on the panel can point to a
Burger King--and by the way, there have been monumental
failures, for example, Federated Department Stores. Can anybody
on the panel point to an LBO'd or an MBO'd company that went
down because their banks made unwise decisions or because
bondholders made unwise decisions that created systemic risk?
An LBO private equity purchased company that got leveraged the
way companies do every single day in our economy, that went
down and created a systemic problem for the United States of
America. Okay. That is a lengthy period of silence.
So what I--Mr. Silvers, you move on to the bond market. And
I have two questions. You move on to the bond market in your
testimony here. And I agree with you, by the way. I suspect
that there may be a bubble developing in the high-yield market.
But I am puzzled by using that as an argument against a
bill which simply attempts to take the smaller private equity
companies, unleveraged by definition because of that limitation
that I put in, and not have them sending reams of data to the
SEC that is a burden to them and which we have acknowledged
doesn't create systemic risk.
How does the existence of H.R. 1105 or the nonexistence of
H.R. 1105 in any way impact the bond market, and in particular
the high-yield market? If H.R. 1105 passes, is the high-yield
market going to be any different?
Mr. Silvers. Congressman?
Mr. Himes. Yes.
Mr. Silvers. Your statement ratifies my criticism of your
bill because you make clear that you understand that the issue
of leverage in the leveraged buyout or private equity business
is an issue of portfolio leverage and not of firm leverage, and
that you understood that when you wrote the bill. I think that
is all there is to be said about this.
Mr. Himes. You and I both know that these entities don't
take on leverage. By the way, 2 years ago you testified that
they were highly leveraged pools of capital.
Mr. Silvers. No. I disagree with that, Congressman.
Mr. Himes. Well, the record will show it. But I--out of an
abundance of caution--put in that limitation. I was on the
high-yield market. I have one other question, though. H.R.
1105--this is your testimony--would deny investors and private
equity funds, including worker's pension funds, protections of
investing with a registered investment adviser. And I take that
very seriously.
My understanding is that investors like the AFL-CIO pension
funds and others which invest in these funds are accredited
institutional investors, that is to say, sophisticated
investors. And my understanding further is that they negotiate
partnership agreements with these funds in which they say, we
want this kind of disclosure.
We want this--that there is a negotiation in which those
accredited and institutional investors receive protections that
a retail investor couldn't possibly hope to negotiate with
respect to a company they may invest in. So where is the
investor protection angle here?
Mr. Silvers. Congressman, you rightly point out that there
are some pension funds that are large enough dealing with large
leveraged buyout firms or hedge funds or venture capital firms
in certain market conditions to effectively negotiate bespoke
or customized terms. That is true.
Our concern is that those funds are not the only funds that
are out there. There are many smaller funds, and there have
been market conditions over the last 15 years in which even
large funds had effectively no ability to negotiate fundamental
investor protections such as the ones that you cited from my
testimony.
Registration with the SEC as an investment adviser protects
all of those funds, right? And as we both know, the limitations
on who can invest in a private equity fund, a leveraged buyout
fund, a hedge fund, a venture capital fund, those limitations
ensure that we are not talking about mom-and-pop investors
anyway.
Mr. Hurt. The gentleman's time has expired.
Mr. Himes. Thank you, Mr. Chairman.
Mr. Hurt. The Chair now recognizes the gentleman from South
Carolina, Mr. Mulvaney, for 5 minutes.
Mr. Mulvaney. Thank you, Mr. Chairman. I intend to yield my
entire 5 minutes to the gentlelady from Missouri, Mrs. Wagner.
Mr. Hurt. Mrs. Wagner is recognized.
Mrs. Wagner. Thank you very much, Mr. Mulvaney, and Mr.
Chairman. Mr. Ehinger, just in follow up here, in the Section
913 study, the SEC staff claimed that it is not likely that
many broker-dealers would ``implement major changes to their
businesses in response to the imposition of a uniform fiduciary
standard.'' And it also went on to say that the uniform
standard would ``not require that broker-dealers limit the
range of products and services they currently offered to retail
investors.''
I guess I would be interested in both Mr. Ehinger and Mr.
Quaadman, do you agree with either of these assessments?
Mr. Ehinger. I do not agree. I think having the experience
of 3 decades, as I said, of being involved in the broker-dealer
securities and insurance business, I can say that the changes
would be many.
First of all, compliance oversight, and perhaps even
expectation of plans for any and all transactions, whether they
were solicited or unsolicited types of transactions, would
probably come into place: disclosure document requirements;
more complex audits; and supervisory reviews.
The supervision that we do in our firm, we will look at the
transactions and the insurance products that are sold in
particular on a one-on-one basis specific to that situation.
And if we are looking at that relative to plans as such, it
could be very difficult to discern what is best.
We have already spoken to some of our liability insurance
organizations, errors and omissions insurance in particular,
who estimate that costs would increase as much as 20 to 30
percent to anticipate this. Not to mention what I mentioned
earlier, and that is the unknown. That is the legal liability
cost that there is, as well. I think there would be many
changes.
Mrs. Wagner. Mr. Quaadman?
Mr. Quaadman. I echo the same concerns. We have talked to
our members about this, and we are getting a lot of the same
feedback also.
Mrs. Wagner. Great. Wonderful. Thank you. I yield back my
time to the Chair. Mr. Hurt, if you have any--
Mr. Hurt. I thank the gentlelady. The gentlelady yields
back. The Chair now recognizes Mr. Carney for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. Thank you to the
panelists for coming in. I would like to go back to the
discussion about costs of audit rotation. Mr. Smith, there was
some discussion a couple of questioners ago about those costs.
Could you summarize them again and talk specifically about
what the costs--what drives those higher costs from the GAO
study and the survey, I think that you said you did, of
corporate secretaries? What are the elements of those higher
costs? Eighty percent in the one case, and I think you said 20
percent in terms of your corporate secretaries. If that wasn't
the number, whatever that number is.
Mr. Smith. It was 20 percent and 80 percent, respectively.
One example of one of our members that we have documented in
the written testimony is a large global company that
voluntarily rotated its audit firm within the past 10 years.
And I have ballparked its numbers, but in the written
testimony, I break it down showing that they estimated that
there were approximately 100 hours of audit committee time that
were utilized, 500 to 600 hours of senior management, and 2,000
to 3,000 hours of finance, legal, tax, accounting, and internal
audit employee's times. And so, if you think about--
Mr. Carney. So as you transition from one firm to another,
it involves a lot of extra time of staff to bring that firm up-
to-speed on the particularities of that company's operation.
Mr. Smith. Absolutely. So if you picture an audit committee
who is independently charged with making sure that the audited
financials are correct and accurate, and they are thinking
about making a change, they have to go through for the
shareholder's benefit, and we are all happy that they have to,
to examine any potential firms that are coming in to make sure
that they can get the same high level of comfort that they have
with their current firm in order to make a decision to transfer
it.
They would also then have to go through a process of
documenting and making sure that reports were put into place
and transition plans were put into place that begin the
transition. And then afterwards, there are heightened levels of
double-checking to make sure that everyone followed the
processes needed to do that. So, it is just a tremendous amount
of work.
Mr. Carney. Presumably, there are some benefits involved in
the rotation. Mr. Silvers expressed his objection to the bill.
And I guess I would ask you, Mr. Silvers, what the benefits are
opposite those costs and why you think they are justified?
Mr. Silvers. In my written testimony, I--
Mr. Carney. And I think there was other testimony, and
somebody can correct me if I am wrong, that there are really
effectively only two or three firms that actually do this.
Mr. Silvers. Congressman, in my testimony, I go into, at
some length, the challenges of this issue. Because there are
currently really only four global audit firms, and some of them
have specialties, and companies can find themselves in really
challenging spots. The issue on the other side, though, is the
question of auditor independence. And the issue of whether or
not the same company has had the same auditor for decades, for
example, which is true in the case of some long-lived
companies, whether there really can be the requisite level of
independence at that point?
Mr. Carney. Yes, I understand that. Is there anything in
Sarbanes-Oxley, for instance, that puts something in the audit
committee to balance that out? You, or Mr. Smith, either one?
Mr. Silvers. Congressman, there is no question, as one of
the prior witnesses said, Mr. Quaadman I believe, that
Sarbanes-Oxley strengthened auditor committee independence, and
made the relationship between auditors and issuers more
independent. We have been though for the last 10 years since
Sarbanes-Oxley passed, more than 10 years we have been in this
environment with only 4 major audit firms. And we have been
through a major financial crisis that raised serious issues
about whether the current--about whether the audit firms really
performed their roles properly.
In my written testimony, and earlier in this hearing, I
mentioned that the PCAOB has done extensive examinations of
what occurred during that crisis. And they are in relation to
auditor independence. The PCAOB's interest, as I understand it,
and I serve on the standing advisory group for the PCAOB's
interest in auditor rotation is, I believe, based significantly
on the results of those inspection reports. And I would urge--
before this subcommittee moves on this bill--
Mr. Carney. I am running out of time, and I would have
liked some time to talk a little bit about the systemic risk
that--and some of the other bills, but did you have something
else, Mr. Smith, you wanted to add?
Mr. Smith. If I could. Your question was on what Sarbanes-
Oxley did to strengthen--
Mr. Carney. Right. Does it counterbalance this issue of
independence?
Mr. Smith. --and so the audit committees were strengthened.
There is a requirement that they be completely independent, and
that is modified in the major exchange rules as well. There is
also partner rotation that must occur on a regular basis. And
so, if you think about what partner rotation does, it brings a
fresh set of eyes. Someone who presumably is not cozy with
management, if that were the case anyway, to make sure, and to
have that fresh look. So--
Mr. Carney. And presume, actually, some additional cost.
Thank you.
Mr. Smith. Correct.
Mr. Carney. I see my time has expired.
Mr. Hurt. The gentleman's time has expired. The Chair now
recognizes the gentleman from Michigan, Mr. Huizenga, who is
also the patron of H.R. 1135, for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman, I appreciate that.
And I would be more than willing to grant my friend 30 seconds
if he wanted to pursue that line of questioning on the systemic
risk? It may be a continuation of a conversation we already
started.
Mr. Hurt. The gentleman is recognized for--
Mr. Carney. Yes, I just wanted--
Mr. Hurt. --30 seconds?
Mr. Carney. --to go back to the back-and-forth with my
colleague Mr. Himes, Mr. Silvers. And I am at a loss to
understand how the two pieces of legislation that are being
discussed implicate systemic risk? And maybe you could
summarize that briefly?
Mr. Silvers. Congressman, you mean the registration--
Mr. Carney. Both the registration one and the pay ratio
one.
Mr. Carney. I understand the overall purpose in pay ratio
in particular. But I don't understand how it implicates
systemic risk.
Mr. Silvers. I will start with CEO pay, okay?
Mr. Carney. All right.
Mr. Silvers. As I stated in my written testimony, the CEO
pay rule does 3 things. It proves the ability to look at firms
and whether they are essentially unbalanced in the way they are
managed, right? Such that CEO--
Mr. Huizenga. Before I reclaim my time, I am going to have
you hurry that up very quickly, because it is eating into my
time, and I have some questions, as well. Because I am at a
loss, as well.
I appreciate that. I am at a loss as to how this possibly
puts companies, or a system at risk. Systemic risk was
something that you were talking about, and it seems to me--and
we had some conversations here about Dodd-Frank not only being
a regulatory bill, but it is a social engineering document, I
understand that might have been the motivation for some in the
drafting of it. I am just afraid that this is more of a knee-
jerk reaction to any kind of discussion about changing,
improving, or looking at, or opening up Dodd-Frank. And we saw
that 2 weeks ago when the Administration, through Secretary
Lew, opposed all of the bipartisan derivatives bills.
We are seeing that now, I think. And it seems to me that
this is part of the problem with Washington, D.C. We can't have
a rational conversation without somebody having a knee-jerk
reaction. But Mr. Quaadman, Mr. Smith, Mr. Tharp, obviously you
heard Mr. Silvers report that my legislation specifically would
significantly increase this risk, and I am very curious to see
whether you agree with that. And whether that creates pitfalls
in our economy? And how disclosing CEO to worker pay ratio
determines the performance of these companies with a particular
sector in the market?
So if you don't mind, in my remaining 2 minutes?
Mr. Quaadman. Okay Mr. Huizenga, if I could answer that in
two ways, and also to take up something that has been discussed
by both Mr. Silvers and Mr. Scott, Dodd-Frank actually mandates
that there is a joint rulemaking, which is not yet complete, on
intent of compensation rules, which is supposed to look at
excesses in compensation, and to deal with potential issues of
compensation in the financial crisis. So regulators are already
looking at that. Pay ratio in and of itself isn't designed to
deal with those systemic risk issues.
Second, in answer to your question, let me just give two
examples. If you were to take a company, let's say a retail
chain or a fast-food chain or whatever, that has a lot of
hourly workers, they are going to have a high differential. If
you take a Wall Street firm where you could have a lot of
employees making comparable pay to a CEO, they are going to
have a very low ratio. So what does that ratio tell you about
the company? About the industry? It doesn't convey anything
that is material to investors. And materiality should be the
test.
Mr. Huizenga. And Mr. Tharp?
Mr. Tharp. Congressman, I think it is a great question that
there should be an assessment to the extent to which the
purported relationship between pay ratio and risk would be a
factor. And in fact, in the written testimony from Mr. Silvers,
he cites James Collins' work on ``Good to Great.'' And we did a
little research. Those companies in fact have a higher pay
ratio than the average company, and of the 11 cited--in fact
one went bankrupt and the other was Fannie Mae, but their ratio
is 412, versus the--and this is AFL-CIO data, versus the data
of the average CEO, which is 354, according to their data.
Mr. Huizenga. Yes.
Mr. Tharp. So, I think there should be challenges to the
basic assumption that it does lead to better performance, or--
Mr. Huizenga. I agree, and I am very familiar with ``Good
to Great.'' I came out of an organization which used that book
as a basis of how it operated. And, I am tempted to take a
friendly amendment from somebody that would require union
executive pay to be compared to union membership pay. And then
maybe we should expand that to who they are affiliated with in
France, the Philippines, Greece, and others, to get a better
picture, rather than hiding ``material information.''
And I think that everybody would realize that with 57
unions, and 12 million members, even the AFL-CIO would have
some difficulties in doing that. Mr. Chairman, my time is up,
and I appreciate that.
Mr. Hurt. Thank you. The gentleman's time has expired. The
Chair now recognizes the gentleman from California, Mr.
Sherman, for 5 minutes.
Mr. Sherman. Thank you. Mr. Quaadman, we have been working
on a separate issue, which is the proposal of the FASB to
require the capitalization of leases. They are supposed to
define Generally Accepted Accounting Principles (GAAP). It has
been generally accepted for 200 years that you don't do that,
where our profession is only 200 years old. Why don't I ask you
to just spend a minute explaining what the harm would be if
that proposal goes forward?
Mr. Quaadman. Thank you, Mr. Chairman. Thank you for your
leadership on this issue, along with Mr. Campbell. What this
would do is it would--number one, it would actually boost up
the liabilities that are on balance sheets of companies by
trillions of dollars. That would actually impact their ability
to raise debt. It would also increase reporting requirements as
well as onerous requirements. It would also shut down the
ability of companies to get equipment. And also for commercial
real estate tax refunction.
What is more important, however, is that the investor
community 3 years into this project has said that this exposure
draft will not provide any more additional information than
they already have today. So while you have all of the costs
that are going to be borne by businesses, investors aren't
going to be benefited. So it is really a question of why are we
even doing it?
Mr. Sherman. And wouldn't we be penalizing those companies
that enter into 5- and 10- and 20-year leases, and give a push
towards less certainty in stability in leases, communities,
shopping centers, et cetera?
Mr. Quaadman. That is correct. It actually will focus
business activities on a much shorter-term basis and less on a
long-term basis. And it will also artificially force an earlier
recognition of expenses than actually happen.
Mr. Sherman. I want to turn to, I guess, Mr. Smith, on the
audit rotation. One concern I have is, we only have, as you
point out, four firms. Could there be a circumstance where
there are only two firms with the capacity, both in terms of
having offices in the right place, if you are headquartered in
Wichita, only one of those firms may have an office in Wichita.
You may be in an industry that only a couple of firms have
specialty in.
So if we currently return Firm A, and the only other firm
in the world that can do it is Firm B, and we have to abandon
firm--right now we can always tell Firm A to keep their fees
down, otherwise we will go to B. If you require me to go with
B, how high will the audit fee be then?
Mr. Smith. Yes, and even more troubling is that it takes
away the competitive nature of the transfer for sure, right?
Because they know that you are going to be coming to them, so
there would be no competitive negotiation of the transfer fee,
presumably. But even additionally, the feedback from our
members is--and specifically in certain industries where you
only have two audit firms that would be qualified, or expertise
to the level that would make an audit committee comfortable,
both of those firms may be engaged by that company in the first
instance, right?
Because there are non-audit fees that are being used, and
so you could already have them engaged on matters that--you are
already working with them, so is there really that transfer you
are looking at? So I think there is a hyped--
Mr. Sherman. Now--
Mr. Smith. --perception that there would be an independent
shift in that case. Having said that--
Mr. Sherman. --you pointed--
Mr. Smith. --the firms--the large firms work closely with
those companies anyway.
Mr. Sherman. --you pointed out that currently there is at
least rotation of the engagement or audit partner?
Mr. Smith. Correct.
Mr. Sherman. One thing I bored my colleagues with is--and I
don't know whether this has become just practice or whether it
is mandated, that the technical review department of the audit
firm actually sign off. Arthur Andersen had a policy of don't
ask, don't tell, that is to say, the technical review
department, if they weren't asked, they didn't tell.
With the four firms that still exist, is there at least a
practice and is there a mandate that the technical review
department actually review the audit before the sign-off?
Mr. Smith. My understanding is that the concurring partner
relationship has been significantly strengthened as a result of
the audit changes that took place through 2003 in Sarbanes-
Oxley.
Mr. Sherman. And then, finally, you quantified the
additional work that the company has to do when they change
auditors. What is the increased fee likely to be? It is not
only the time of their own employees, but they are going to
have to write a bigger check. Any idea what the start-up fee,
changeover fee, additional fee is as a percentage?
Mr. Smith. Other than those percentages, I really don't
have hard numbers at my fingertips right now. But they would be
expected to be very significant and--
Mr. Sherman. Half a year about?
Mr. Smith. At 80 percent, according to the GAO study. You
are really looking at almost double the audit fees, which--
Mr. Sherman. So you pay 108--
Mr. Smith. --if you have a $8 to $10 million audit fee,
then you are looking at almost $6 to $8 million in increased
costs.
Mr. Sherman. Thank you.
Mr. Hurt. The gentleman's time has expired.
Let me again thank the witnesses for their testimony today.
I also thank you, in addition to your insights, for your
patience as we had to work through our voting schedule.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
With that, the hearing is adjourned. Thank you.
[Whereupon, at 1:52 p.m., the hearing was adjourned.]
A P P E N D I X
May 23, 2013
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