[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. 113-26U.S. GOVERNMENT PRINTING OFFICE 81-761 PDF WASHINGTON : 2013 ------------------------------------------------------------------------ For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 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. 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