[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]









                        LEGISLATIVE PROPOSALS TO
                       ENHANCE CAPITAL FORMATION,
                           TRANSPARENCY, AND
                       REGULATORY ACCOUNTABILITY

=======================================================================

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 17, 2016

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 114-88








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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking 
    Vice Chairman                        Member
PETER T. KING, New York              CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
SCOTT GARRETT, New Jersey            GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas              MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico            RUBEN HINOJOSA, Texas
BILL POSEY, Florida                  WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK,              STEPHEN F. LYNCH, Massachusetts
    Pennsylvania                     DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia        AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri         EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan              GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin             KEITH ELLISON, Minnesota
ROBERT HURT, Virginia                ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana          TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina        BILL FOSTER, Illinois
RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida              PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina     JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri                 KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky                  JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania       DENNY HECK, Washington
LUKE MESSER, Indiana                 JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota

                     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
PETER T. KING, New York              BRAD SHERMAN, California
EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              STEPHEN F. LYNCH, Massachusetts
PATRICK T. McHENRY, North Carolina   ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan              DAVID SCOTT, Georgia
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
STEVE STIVERS, Ohio                  KEITH ELLISON, Minnesota
STEPHEN LEE FINCHER, Tennessee       BILL FOSTER, Illinois
RANDY HULTGREN, Illinois             GREGORY W. MEEKS, New York
DENNIS A. ROSS, Florida              JOHN C. CARNEY, Jr., Delaware
ANN WAGNER, Missouri                 TERRI A. SEWELL, Alabama
LUKE MESSER, Indiana                 PATRICK MURPHY, Florida
DAVID SCHWEIKERT, Arizona
BRUCE POLIQUIN, Maine
FRENCH HILL, Arkansas




















                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 17, 2016.................................................     1
Appendix:
    May 17, 2016.................................................    47

                               WITNESSES
                         Tuesday, May 17, 2016

Bartl, Timothy J., Chief Executive Officer, Center on Executive 
  Compensation...................................................     6
Cherry-Seto, Joshua, Chief Financial Officer, Blue Wolf Capital 
  Partners, LLC, on behalf of the Association for Corporate 
  Growth.........................................................    12
Gallagher, Hon. Daniel M., President, Patomak Global Partners, 
  LLC............................................................     5
Quaadman, Thomas, Senior Vice President, Center for Capital 
  Markets Competitiveness, U.S. Chamber of Commerce..............    10
Taub, Jennifer, Professor of Law, Vermont Law School.............     8

                                APPENDIX

Prepared statements:
    Bartl, Timothy J.............................................    48
    Cherry-Seto, Joshua..........................................    66
    Gallagher, Hon. Daniel M.....................................    71
    Quaadman, Thomas.............................................    92
    Taub, Jennifer...............................................   107

              Additional Material Submitted for the Record

Garrett, Hon. Scott:
    Written statement of the Society of Corporate Secretaries & 
      Governance Professionals and the National Investor 
      Relations Institute........................................   121
    Insert from Ambassador James K. Glassman, Washington, DC.....   129
    Insert from Thomas Quaadman..................................   131
Duffy, Hon. Sean:
    Written statement of the Biotechnology Innovation 
      Organization...............................................   132
    Written statement of John Hayes, Chairman, President, and 
      Chief Executive Officer, Ball Corporation; and Chair, 
      Business Roundtable Committee on Corporate Governance......   133
    Written statement of Nasdaq..................................   138
Maloney, Hon. Carolyn:
    Written statement of Americans for Financial Reform..........   139
    Written statement of the Council of Institutional Investors..   144
    Written statement of the Florida State Board of 
      Administration ................................   160
    Written statement of Glass, Lewis & Co.......................   176
    Written statement of Institutional Shareholder Services, Inc.   191

 
                        LEGISLATIVE PROPOSALS TO  
                       ENHANCE CAPITAL FORMATION, 
                            TRANSPARENCY, AND  
                       REGULATORY ACCOUNTABILITY

                              ----------                              


                         Tuesday, May 17, 2016

             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 2:57 p.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Hurt, Royce, 
Neugebauer, Huizenga, Duffy, Fincher, Hultgren, Wagner, 
Schweikert, Poliquin, Hill; Maloney, Sherman, Lynch, 
Perlmutter, Scott, Himes, Foster, Carney, and Murphy.
    Ex officio present: Representative Hensarling.
    Also present: Representative Barr.
    Chairman Garrett. The Subcommittee on Capital Markets and 
Government Sponsored Enterprises will now come to order. 
Today's hearing is entitled, ``Legislative Proposals to Enhance 
Capital Formation, Transparency, and Regulatory 
Accountability.''
    Without objection, the Chair is authorized to declare a 
recess--hopefully we won't need another one for votes--of the 
subcommittee at any time. I thank the panel for their patience.
    I now recognize myself for 2 minutes for an opening 
statement.
    Today, the subcommittee meets to examine three important 
pieces of draft legislation that continue to work over the last 
5 years to modernize our nation's securities laws and promote 
transparency and competition in our capital markets. And 
basically to bring real reform and accountability to the SEC's 
rulemaking process.
    A recent poll indicates that about two-thirds of Americans 
believe our country is headed in the wrong direction. And a 
declining number of people believe that their children will be 
better off financially than they have been.
    So despite the big promises that have come with granting 
vast and, in some cases, unlimited authority to the Federal 
bureaucracy in D.C., most Americans aren't buying the argument 
that a bigger Washington leads to a bigger paycheck at home or 
even any paycheck at all.
    Fortunately, our subcommittee has, for 5 years now, tried 
an alternative approach which seeks to do what? To empower 
entrepreneurs and investors and small businesses, but not the 
bureaucrats. This approach has led to some successes, most 
notably the JOBS Act of 2012.
    But maybe more important than that, it has led Congress and 
the regulators to think in a different way than they have 
historically. So today we continue our important work with 
three pieces of legislation. First, we will consider the SEC 
Regulatory Accountability Act.
    It would require the SEC to determine that the benefits of 
any regulations they are considering actually outweigh its 
cost. Even President Obama, through Executive Order 2011, in 
2011, has recognized the importance of economic analysis in 
rulemaking. And this legislation would codify much of what the 
President's executive order did for the SEC.
    Secondly, we add the Investment Advisers Modernization Act, 
with Mr. Hurt sponsoring it. This is a long overdue piece of 
legislation that would allow private capital to continue to 
play a critical role in our economy which reduces many of the 
unnecessary bureaucratic requirements that have led the effect 
of starving middle market businesses of the capital they need.
    Thirdly and finally, Mr. Duffy has put forward a Proxy 
Advisory Firm Reform Act of 2016, which would, for the first 
time in memory, provide some much needed sunlight to the way in 
which proxy adviser firms develop and distribute their advice.
    So this subcommittee has led the charge in Congress for 
reform of the proxy adviser industry. And this draft 
legislation is the next step.
    So with that being said, I want to thank all of the 
sponsors here for their hard work on all these bills. And I 
look forward to our witnesses today.
    And with that, I yield to the gentlelady from New York for 
5 minutes.
    Mrs. Maloney. Thank you. And I thank the chairman for 
holding this important hearing and for all of our panelists to 
being here today. We are considering three bills, all of which 
deal with different issues.
    First, Mr. Duffy and Mr. Carney have a bill that would 
establish a regulatory regime for proxy advisers. Proxy 
advisers provide recommendations to institutional investors on 
how to vote on Board of Director elections and shareholder 
resolutions.
    Big institutional investors are shareholders of thousands 
of public companies and they simply don't have the time to 
carefully review every single 100-page proxy statement in 
detail. Especially because most public companies hold their 
shareholder meetings in the same 3-month period.
    So institutional investors rely on proxy advisers for vote 
recommendations, which are often tailored to the investor's 
particular corporate governance preference. This is healthy. 
Proxy advisers do have the time to carefully read all of the 
statements and proposals because they have professionals who 
simply read these statements all day, every day. However, this 
means that proxy advisers can be very influential in the 
outcomes of shareholder votes.
    Although the evidence on the influence of proxy advisers is 
mixed, it is probably fair to say that the current regulatory 
regime for proxy advisers is not ideal. Two advisory firms 
account for 97 percent of the market, ISS and Glass Lewis.
    But for some reason, they are regulated differently. ISS is 
a registered investment adviser, while Glass Lewis is not. 
Surely, this is not an ideal setup, so I am absolutely open to 
the idea of a better and more consistent regulatory regime for 
proxy advisers. But there are several things in this bill that 
concern me.
    I don't see why companies should have a statutory right to 
receive and comment on a proxy adviser's draft recommendations 
before they are sent to investors. Proxy advisors aren't 
Federal agencies and a notice and comment period for private 
companies that are providing a valuable service is, in my 
opinion, is not appropriate at all. I don't recall where this 
regulation is on any other private company.
    I am also concerned about giving companies the right to sue 
proxy advisers just because they didn't get a meaningful chance 
to comment on draft recommendations. But I am willing to hear 
other perspectives on this issue because it is an important one 
that Congress has not examined for a long time.
    The second bill is intended to modernize the Investment 
Advisers Act for advisers to private equity firms and funds. 
This bill makes a series of targeted changes to the Advisers 
Act which are intended to make it more compatible with the 
private equity business model. I think there is probably space 
to better tailor the Advisory Act to private equity advisers.
    But I am concerned about making sweeping changes to core 
aspects of a regulatory regime that has been quite successful. 
We need to think very carefully before we make changes to the 
books and records rule, the custody rule or the advertising 
rule. These are core aspects of the Advisers Act and they 
shouldn't be discarded lightly.
    Finally, Chairman Garrett has an SEC cost benefit bill. 
This is similar to a bill that this committee has considered 
before. But I am interested to hear if any of the witnesses can 
offer any fresh perspective on this issue.
    I would like to thank our panelists for appearing before us 
today. And I would like to insert a few statements into the 
record. These are statements from the Council of Institutional 
Investors, the Florida State Board of Administration, ISS, and 
Glass Lewis. And I hope that I will be able to place these 
statements into the record.
    Chairman Garrett. Without objection, it is so ordered.
    Mrs. Maloney. Thank you.
    I yield back.
    Chairman Garrett. The gentlelady yields back.
    We now go to the Vice Chair of the subcommittee, Mr. Hurt, 
for 1\1/2\ minutes.
    Mr. Hurt. Thank you, Mr. Chairman. Thank you for holding 
this hearing today. I think every member of this committee can 
agree that with millions of Americans out of work, our top 
focus in Congress should be enacting policies to help spur job 
creation throughout our country.
    As I travel across my district, Virginia's 5th District, I 
continue to hear hardworking Americans express concern about 
the current state of our economy and the economic uncertainty 
facing their children and their grandchildren.
    Today we will discuss several legislative efforts that, if 
enacted, will encourage economic growth and job creation by 
reducing unnecessary regulatory burdens. In Virginia's 5th 
District, thousands of jobs would not exist without the 
investment from private equity. These critical investments 
allow our small businesses to innovate, expand their operations 
and create the jobs that our communities desperately need.
    Over the past three Congresses, there has been a growing 
concern about the burden that Dodd-Frank unnecessarily places 
on advisers to private equity while at the same time exempting 
advisers to similar investment funds. Over recent years, many 
of us have worked together in a bipartisan way to eliminate the 
registration requirements mandated by Dodd-Frank.
    Today, however, among the legislation we are considering is 
a discussion draft titled, The Investment Advisers 
Modernization Act. This bill would not change the registration 
requirement that Dodd-Frank mandated, but rather would update 
the Investment Advisers Act of 1940, a 76-year-old law, to 
reflect the current business model of private equity. This bill 
would go a long way toward facilitating capital formation while 
maintaining our commitment to investor protection. I believe 
that it is incumbent upon Congress to look for common sense 
solutions to problems caused by regulatory structure.
    And I believe that this legislation is a pragmatic approach 
to addressing some of the concerns with the Investment Advisers 
Act. I look forward to the testimony of our witnesses.
    And I yield back the balance of my time. Thank you, Mr. 
Chairman.
    Chairman Garrett. I thank you, the sponsor.
    I now turn to the other sponsor. Mr. Duffy is recognized 
for the remaining 1\1/2\ minutes.
    Mr. Duffy. Thank you, Mr. Chairman. And thank you for 
holding today's hearing and giving me an opportunity to briefly 
discuss my bill to foster a greater accountability, 
transparency, responsiveness, and competition in the proxy 
advisory firm industry.
    Increasingly, institutional investors rely on the analysis 
and recommendations of proxy adviser firms on key issues facing 
shareholders and public companies. As the share of 
institutional investor ownership has grown from roughly 46 
percent in 1987 to over 75 percent today, the volume of proxy 
votes, which investors are responsible for casting, has grown 
into the billions.
    Just two proxy advisory firms control 97 percent of the 
market. And the writings, analysis reports, and voting 
recommendations affect fundamental corporate transactions like 
mergers and acquisitions, the approval of corporate directors, 
and shareholder proposals.
    I have heard from many companies about their frustration 
with the methodologies used by proxy advisory firms, the 
inaccuracies and inconsistencies in the information they share 
with their clients and, most importantly, the concern for 
conflicts of interest. These are very powerful firms that have 
a huge influence in regard to corporate governance.
    In 2013, Mr. Chairman, you held a hearing and have been 
involved in this issue on the subcommittee. And had respected 
witnesses recommend more oversight of the proxy advisory firm 
industry, which my bill now provides. So I look forward to the 
witnesses' testimony on this issue and the other bills.
    With that, Mr. Chairman, I yield back.
    Chairman Garrett. Thank you. The gentleman yields back.
    We now welcome the panel. Some of you have been here before 
many times. Others are new here. You will be given 5 minutes 
for your oral testimony. And without objection, your entire 
written statement will be made a part of the record.
    I now recognize from Mr. Daniel Gallagher. He is the 
president of Patomak Global Partners, and a former Commissioner 
with the of the SEC. You are recognized for 5 minutes and 
welcome to the panel.

  STATEMENT OF THE HONORABLE DANIEL M. GALLAGHER, PRESIDENT, 
                  PATOMAK GLOBAL PARTNERS, LLC

    Mr. Gallagher. Good afternoon and thank you, Chairman 
Garrett, Ranking Member Maloney, and members of the 
subcommittee for inviting me to testify today. My name is Dan 
Gallagher, and I am president of Patomak Global Partners.
    From 2011 through 2015, I served as an SEC Commissioner. 
And from 2006 until 2010, I served on the Commission staff in 
various capacities, ultimately as Deputy Director of the 
Division of Trading and Markets. I am testifying today in my 
own capacity.
    Let me begin by expressing my appreciation for the work 
this committee has done over the last 5\1/2\ years on 
legislation to rationalize and remove regulatory obstacles 
standing in the way of small businesses, as well as your 
initiatives to enhance investor choice.
    During my time as a commissioner, this committee regularly 
challenged the commission to satisfy its statutory mission to 
facilitate capital formation, whether through the legislative 
process or through constructive and insightful hearings and 
roundtables. In an era of unbridled misguided regulation, this 
was truly a breath of fresh air. And I deeply appreciated the 
opportunity to have worked with many of you on both sides of 
the aisle on these important issues.
    Mr. Chairman, having spent 4 years as a commissioner 
focusing on Dodd-Frank Act rulemakings, it is particularly 
refreshing to testify today on three bills which I believe will 
help the SEC get back to the basic blocking and tackling 
responsibilities of securities regulation that advance the 
agency's core mission.
    First, Congressman Duffy's bill will bring much needed 
transparency, oversight and accountability to the proxy 
advisory industry. Due in large part to the unintended 
consequences of the SEC's own rules, proxy advisory firms now 
play an outsized role in the shareholder voting process, often 
to the detriment of public companies, investors, and the 
American system of corporate governance.
    Representative Duffy's legislation would help resolve many 
issues, which apparently remain unresolved despite recent SEC 
staff guidance, through a comprehensive registration and 
examination regime for proxy advisory firms.
    I applaud Representative Duffy for taking an incremental 
legislative approach that is similar in many important ways to 
the framework for the Credit Rating Agency Reform Act, which 
enjoyed bipartisan support and passed the Senate by unanimous 
consent.
    Second, Chairman Garrett's SEC Regulatory Accountability 
Act would promote and improve economic analysis at the SEC and 
make the agency even more accountable to the investing public. 
While the SEC has dramatically improved the economic analysis 
supporting its rules, there remains room for improvement.
    In particular, I believe that in certain mandated 
rulemakings, the SEC's lawyers have played an outsized role in 
interpreting congressional intent thereby setting the ground 
rules by which the economists are expected to operate.
    The CEO pay ratio rulemaking is the best example of this. 
Finding benefits when Congress described none may help get a 
rule done. But it ensures that the economic analysis is not 
done right. This trend needs to stop before it becomes the 
loophole that devours the SEC's 2012 commitment to proper 
economic analysis. Ultimately, Chairman Garrett's bill will 
help ensure that economic analysis conducted by economists is 
firmly entrenched in every rulemaking the SEC conducts under 
the Federal securities laws.
    Last, but certainly not least, Vice Chairman Hurt's 
Investors Advisers Modernization Act would preserve the 
registration regime for private fund advisers, while at the 
same time removing or modernizing some of the more unnecessary 
and overly burdensome requirements in the Advisers Act that 
serve only to drive up the costs for funds and investors and 
hinder the efficient allocation of capital that helps 
businesses and jobs grow.
    Since the passage of Dodd-Frank, the SEC has devoted a 
significant amount of its limited resources towards overseeing 
and examining advisers to private funds, who primarily serve 
sophisticated investors, such as pension funds and endowments.
    During this non-recovery recovery, to borrow Chairman 
Hensarling's words, and given that there are over 11,000 SEC 
registered investment advisers and just hundreds of SEC 
staffers to examine them, the SEC should be focusing its 
attention less on funds serving sophisticated investors who are 
better able to fend for themselves and more on making U.S. 
capital markets more efficient and competitive, promoting small 
business capital formation and protecting mom and pop 
investors. Vice Chairman Hurt's sensible legislation will help 
the SEC do just that.
    Thank you again for the opportunity to testify today.
    [The prepared statement of Mr. Gallagher can be found on 
page 71 of the appendix.]
    Chairman Garrett. Thank you very much.
    Next, from the Center on Executive Compensation, Mr. 
Timothy Bartl. Welcome. You are recognized for 5 minutes.

STATEMENT OF TIMOTHY J. BARTL, CHIEF EXECUTIVE OFFICER, CENTER 
                   ON EXECUTIVE COMPENSATION

    Mr. Bartl. Thanks, Mr. Chairman, Vice Chairman Hurt, and 
Ranking Member Maloney. I appreciate the opportunity to 
testify. My name is Tim Bartl and on behalf of the Center on 
Executive Compensation, I am pleased to share our experience 
with proxy advisory firms and to testify in favor of the Proxy 
Advisory Firm Reform Act.
    As I think you know, the center is a research and advocacy 
organization. We represent over 125 companies and the senior 
human resource officers of those companies across a broad 
spectrum. And we have daily interaction with those companies 
and, therefore, have firsthand knowledge of their experience 
with proxy advisory firms.
    You know, at the end of the day, companies seek accurate 
and fair assessment of their pay programs. And when you look at 
the fact that, as Congresswoman Maloney indicated, proxy 
advisory firms do perform a necessary function in the proxy 
advisory and the proxy voting regime.
    But unfortunately the timeframe and the lack of oversight 
leads to a check the box mentality that is really a poor fit 
for pay programs which are individualized, complex and lengthy. 
And, you know, when you look at the influence the proxy 
advisory firms hold over the regime, I think it is important 
that we take a look at that as we look at Congressman Duffy's 
bill.
    As of May 13, companies holding say on pay votes this year 
who received a negative ISS recommendation, experienced a 31 
percent reduction compared to the previous year for a mean 
support of somewhere around 61 percent. Those receiving a 
positive recommendation had an average result of 93 percent.
    A 2014 center survey found that 74 percent of respondents 
indicated that they had changed or adopted a compensation plan, 
policy or practice in the previous 3 years primarily to meet a 
proxy advisory firm policy.
    And research that we cite in our testimony by Professor 
Larcker, McCall and Ormazabal, suggested that the adoption in 
advance of a proxy advisory firm policy actually had a negative 
impact on shareholder value.
    Both the Congresswoman Maloney and Mr. Chairman, you 
mentioned the impact of conflicts of interest, as did 
Congressman Duffy. And because proxy advisory firms are 
accorded significant deference in light of their independent 
status, the conflicts are a big deal and need to be addressed.
    ISS, the largest and most influential firm, consults with 
investor clients regarding shareholder proposals that the 
investors sponsor while at the same time, making 
recommendations on those same proposals to other investor 
clients. This leads to the perception that ISS may favor such 
proposals in making recommendations.
    ISS also continues to make recommendations and provide 
analysis of proxy issues to be put to a shareholder vote on the 
research side of the operation, while providing consulting 
services to corporations whose policies and shareholder 
proposals they evaluate. And that is on the consulting side. 
The aggressive marketing from the consulting side has left 
impressions on several occasions that it is privy to the 
information or the decisions on the research side.
    And as an example, back in 2013 there was a company that 
was contacted by an ISS consulting representative after the 
company received a negative ISS recommendation that had a low 
say on pay vote, around 68 percent.
    In an email to the company, the representative said that 
she would provide the company with a better understanding of 
the reasons for ISS' negative vote recommendation and what to 
expect in terms of additional scrutiny from ISS' research side 
in the next year.
    After a call was set up, during the call, the 
representative indicated that the information provided by the 
consulting side was not available elsewhere and that the 
success of companies that had engaged with the consulting side 
were over 90 percent because of its knowledge of the research 
side.
    At the SEC roundtable, even Gary Retelny, ISS' president, 
indicated that he was disappointed with the approach the 
representative had taken. But it indicates the leverage.
    In addition to operational conflicts, there are also 
ownership conflicts. We have talked in this committee before 
about this, in the subcommittee. Glass Lewis is owned by the 
$170 billion Ontario Teachers' Pension Plan Board, which 
engages in public and private equity investments in which Glass 
Lewis makes recommendations.
    And in addition to that, there are issues around errors and 
inaccuracies. And a 2014 center survey I cited earlier 
indicated that a final report had one or more errors.
    Mr. Chairman, as I conclude, we believe that a more formal 
and appropriate regulatory regime, such as that included in the 
Proxy Advisory Firm Reform Act would help address the conflicts 
of interest. And we have seen before that where there has been 
specific oversight of the regime and of the issues, it has had 
an impact on the conduct of proxy advisory firms.
    And I would be happy to talk more about that during the 
question and answer period. But we believe that the structure 
is definitely worth considering and a worthwhile initiative. 
Thank you for the opportunity to testify, and I look forward to 
your questions.
    [The prepared statement of Mr. Bartl can be found on page 
48 of the appendix.]
    Chairman Garrett. Thank you.
    Next up, from the Vermont Law School, Professor Taub. 
Welcome. You are recognized for 5 minutes.

   STATEMENT OF JENNIFER TAUB, PROFESSOR OF LAW, VERMONT LAW 
                             SCHOOL

    Ms. Taub. Chairman Garrett, Ranking Member Maloney, and 
distinguished members of this subcommittee, thank you for this 
opportunity to testify today. My name is Jennifer Taub. I am a 
professor at Vermont Law School, where I teach business law 
classes, including corporations and securities regulation.
    Before joining academia, I was an associate general counsel 
at Fidelity Investments. I offer my testimony today solely as 
an academic and not on behalf of any other association.
    In this brief opening statement, I will highlight the 
concerns that I have with each bill. For a more comprehensive 
exposition, I would refer you to my written testimony.
    First, the Investment Advisers Modernization Act allows 
private funds to retreat into the shadows once again. The word 
private is somewhat misleading these days. Consider that one-
quarter of the equity in private equity funds comes from public 
pension retirement funds. And please recall that private funds, 
including hedge funds, can now be marketed through general 
solicitations to the public.
    It is odd. Just when private equity funds are in the 
sunlight, thanks to Dodd-Frank, and many have been exposed in 
SEC examinations as in violation of the law, including for 
misallocating expenses, you are now proposing that they be able 
to hide their tracks.
    Instead of encouraging a culture of compliance, this bill 
would provide a loophole for investment advisor record keeping 
requirements. Subjecting communications to confidentiality 
agreements, or keeping them in house, would allow advisers to 
destroy critical investment records.
    This bill would also exempt all private equity fund 
advisers and many hedge fund advisers from submitting a 
completed Form PF. This information that would be withheld is 
important to monitor for systemic risk and to protect 
investors.
    This bill would block the SEC from broadly banning 
materially misleading statements in private fund sales 
literature, including concerning fund performance. This is 
backwards. The SEC should be encouraged to, not discouraged 
from, making rules against fraud.
    With Rule 506(c), pursuant to the JOBS Act, private funds 
can now be advertised through general solicitations to the 
public. Public offerings were supposed to come with 
commensurate broad protections against fraud.
    This bill would also weaken the SEC's ability to stop false 
advertising by advisers generally, including to certain retail 
investors. And it would shockingly eliminate the annual 
independent audit of certain fund advisers to ensure they 
actually have the assets and securities they claim to hold. 
This should be called the Madoff loophole.
    Next, the SEC Regulatory Accountability Act would limit the 
agency's ability to protect the investing public. Prior to 
issuing most regulations, the SEC would have to engage in a new 
cost-benefit process. Yet the SEC already conducts economic 
analysis and the securities laws already require the 
consideration of the promotion of efficiency, competition and 
capital formation. The SEC is already subject to the Paperwork 
Reduction Act, the Regulatory Flexibility Act, the 
Congressional Review Act, and the APA.
    The existing requirements set out several speed bumps. 
These proposed requirements are tire shredders designed to 
bring progress to a crashing halt. Notably, this bill would 
require the SEC to consider endless alternative approaches and 
only select the one that maximizes net benefits. How could this 
be measured with any precision? It can't.
    As Harvard Professor John Coates notes, it is not possible 
to specify and quantify all benefits and all costs in a single 
uniform bottom line metric representing the net welfare effects 
of a proposed rule. The results are not precise, but instead 
what he calls guesstimations. What this bill mostly creates is 
opportunities for litigation and legal fees to be generated.
    Finally, the Proxy Advisory Reform Act represents 
fraternalistic over reaching that is unnecessary and could 
entrench existing firms. These firms are business success 
stories. They help institutional investors cast votes on 
important corporate governance matters at the portfolio 
companies they own.
    The SEC already has the authority to examine and discipline 
any institutional investors who mindlessly follow advice 
without considering their fiduciary duty to underlying 
investors. And the SEC has authority under the Exchange Act and 
the Advisers Act to address conflicts of interest.
    Thank you for this opportunity to speak. I look forward to 
your questions.
    [The prepared statement of Ms. Taub can be found on page 
107 of the appendix.]
    Chairman Garrett. Thank you.
    From the U.S. Chamber of Commerce, Mr. Quaadman, welcome 
back to the panel. You are recognized for 5 minutes.

STATEMENT OF THOMAS QUAADMAN, SENIOR VICE PRESIDENT, CENTER FOR 
   CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE

    Mr. Quaadman. Thank you very much, Mr. Chairman, Ranking 
Member Maloney, and members of the subcommittee. Thank you for 
the opportunity to testify today. The SEC's domain are the 
public capital markets and its mission is to promote investor 
protection, competition and capital formation.
    By many metrics, the SEC is missing the mark. For 19 out of 
the last 20 years, we have seen a constant decline in the 
number of public companies in the United States to the point 
that we have fewer than half of the public companies today than 
we did in 1996.
    The bills that are before us today are for smart regulation 
to have appropriate oversight for the benefit of investors and 
the businesses that they invest in. The SEC Regulatory 
Accountability Act is based upon the Executive Orders issued by 
President Reagan, President Clinton, and President Obama. It 
enshrines those Executive Orders into the SEC rulemaking 
process.
    This bill also has some very innovative means to make 
rulemaking even more successful. As an example, the post-
implementation economic analysis allows for the use of precise 
economic data 2 years after the rule writing to look at exactly 
what the costs are, what the benefits are, if the rule is 
working, and, if not, what changes need to be made to the rule.
    Additionally, the mandatory look back to reassess major 
rules allows the SEC to separate the wheat from the chaff. That 
is, for those rules that are obsolete, to take them off the 
books. Those rules that need to be tweaked should be tweaked. 
And for those issues that are looming, have the SEC actually 
write rules before they become a problem.
    So in short, this bill is designed to impose rigor and 
discipline in the rule writing process for the benefit of both 
investors and businesses.
    The Proxy Advisory Firm Reform Act of 2016 that has been 
introduced by both Duffy and Congressman Carney is an important 
step forward. Proxy advisory firms are necessary because we 
have institutional investors who can invest in thousands of 
companies. As has been noted, we have two firms that cover 97 
percent of the market share, and they have become de facto 
corporate governance regulators.
    However, proxy advisory firms are also beset by many 
problems. One firm has 180 analysts looking at tens of 
thousands of companies globally and making recommendations in 
250,000 shareholder proposals and director elections. Proxy 
advisory firms have been beset by conflicts of interest and 
lack of process and transparency in how they develop their vote 
recommendations and voting policies. There are questions about 
their error rates, as well as lack of input.
    Some institutional investors use proxy advisory reports as 
data points in their independent judgment of how they execute 
their votes in shareholder proposals. Other investors, however, 
outsource their corporate governance voting responsibilities in 
total. For those investors, that becomes a difficulty in 
determining how they can meet their fiduciary obligation to the 
people who invest in those funds.
    The 2014 SEC guidance, which was only issued as a result of 
the 2013 hearing of this subcommittee, is a step in the right 
direction. But this bill provides more oversight. This bill 
would have proxy advisory firms create transparent processes 
for the development of voting recommendations and policies. It 
would allow for further disclosure and management of conflicts 
of interest. And it would have the proxy advisory firms 
demonstrate to the SEC that they have the resources needed to 
meet their due diligence.
    Furthermore, to give one example, proxy advisory firms make 
recommendations on shareholder proposals when a proponent is a 
client. That is no different than the problems 10, 12 years ago 
with the conflicts of interest of financial analysts.
    Finally, the Investment Advisor Modernization Act by 
Congressman Hurt is an important step forward. The Dodd-Frank 
Act requires the SEC to build transparency around private 
equity firms. However, there has been a regulatory mismatch.
    The SEC is imposing public company tools on private equity 
partnerships. That is like using a meat cleaver when we should 
be using a scalpel. The bill would allow the SEC to tailor 
regulations.
    So in conclusion, Mr. Chairman, we would have liked to have 
seen the SEC move forward on these issues on their own. 
However, we believe that, at a minimum, congressional pressure 
is needed to make the SEC move forward. But if the SEC is not 
willing to move forward, we look forward to working with you, 
the co-sponsors and members of this subcommittee, to have these 
bills become law. Thank you.
    [The prepared statement of Mr. Quaadman can be found on 
page 92 of the appendix.]
    Chairman Garrett. All right, thank you.
    And last, but not least, from Blue Wolf Capital Partners, 
Mr. Cherry-Seto. You are recognized for 5 minutes.

STATEMENT OF JOSHUA CHERRY-SETO, CHIEF FINANCIAL OFFICER, BLUE 
 WOLF CAPITAL PARTNERS, LLC, ON BEHALF OF THE ASSOCIATION FOR 
                        CORPORATE GROWTH

    Mr. Cherry-Seto. Chairman Garrett, Ranking Member Maloney, 
and members of the subcommittee, thank you for this opportunity 
to testify today on important legislation that, if passed, 
provides a modernized regulatory framework that is efficient 
and meaningful allowing private equity advisers to continue to 
focus on growing companies, providing important returns to our 
investors, most importantly, working families counting on a 
secure pension when they retire while helping to create jobs 
now and in the future.
    On a personal note, good jobs are something that I care 
deeply about. As I began my career as a union organizer with 
SEIU and the ability of private equity firms to be strategic 
partners and investors in creating and sustaining good jobs is 
what brought me to work in this industry.
    My name is Joshua Cherry-Seto. And I am the chief financial 
officer of Blue Wolf Capital Partners. Blue Wolf provides 
investment and strategic support to good, small to mid-size 
companies, often not served well by public markets because of 
challenges they face.
    We take seriously our fiduciary responsibility to our 
investors, as stewards of their capital and managers of our 
portfolio companies. We invest responsibly and believe strongly 
in a culture of compliance and transparency.
    I am also honored to be testifying on behalf of the 
Association for Corporate Growth, a global trade association 
created to drive middle market growth on Main Street, focused 
on companies with revenues between $10 million and $1 billion. 
The Association directly serves 90,000 M&A professionals within 
the middle market. Including more than 1,000 private equity 
firms like ours, which invest in local communities and help 
create jobs throughout Main Street America.
    Let me briefly share an example. Healthcare Laundry System 
is a leading provider of hospital-grade laundry service to the 
Chicago area, spanning more than 550 healthcare providers, 
including more than 40 hospitals and employing more than 500 
people.
    Despite the firm's compelling market position, it had 
challenges precluding it from raising capital from the public 
markets. Blue Wolf, by working in partnership with management, 
government, the employees and the multiple unions representing 
them, we were able to provide capital and strategic support to 
create a stronger business with more quality and stable jobs.
    Having addressed these challenges, Healthcare Laundry 
System was later sold to a public company, providing long-term 
stability to the company and its employees. I am here today to 
support the Modernization Act that would modernize the 1940 Act 
so that the law better reflects the vast market and 
technological and structural changes that have taken place over 
the past 76 years.
    Due to the 1940 Act's ambiguity in today's world, firms 
like ours spend many hours and significant dollars trying to 
comply with ill-fitting rules for our industry that don't 
further the intent to protect investors, including on advisers 
and lawyers trying to interpret regulations not specifically 
written with our industry in mind.
    An example of the bill's common sense approach is the 
advertising rule, an outdated provision from 1961, designed for 
public retail marketing. Private equity advisers advertise 
exclusively to qualified sophisticated investors and already 
have a robust private placement disclosure process, which 
should continue to be regulated and reviewed. However, the 1940 
Act did not contemplate, and could not foresee, how to regulate 
technology advances such as websites.
    Unlike the retail market, private equity websites are not 
aimed at investors but are instead are used to more efficiently 
connect with companies and management teams looking for an 
investment partner. It is important to note that basic anti-
fraud provisions of the Federal securities laws would remain in 
effect for all private fund advisers. Just imagine if you were 
asked to operate under the House rules of 1940, restricting 
communications to your constituents to the regular mail.
    We recognize and value transparency, accountability to 
regulators, operating in the open, but most importantly today, 
we seek to update the regulatory framework to increase our 
focus on growing companies on Main Street across the country. 
For Blue Wolf, that means from Madawaska, Maine, to Suwanee, 
Florida, to Chicago, Illinois, to Santa Barbara, California, 
creating good, sustainable, American jobs.
    Thank you for this time this afternoon, and I look forward 
to answering your questions.
    [The prepared statement of Mr. Cherry-Seto can be found on 
page 66 of the appendix.]
    Chairman Garrett. Thank you. The gentleman yields back. And 
I thank all the members of the panel.
    At this point we will turn to questions, and I will 
recognize myself for 5 minutes. I guess I will start with Mr. 
Gallagher. So you heard my opening comment talking about our 
legislation dealing with the cost-benefit analysis and what 
could be the benefit of having such an analysis. What does it 
do?
    It gives the opportunity or the requirement to an agency, 
which is what the President basically has already asked 
agencies across the spectrum to do and what the SEC has already 
said they would do.
    And all we are doing is now trying to do what? Codify that 
and say going forward you always have to do it, to look at 
every angle, if you will, every permutation, see what can be 
the benefits and the consequences of a rule. And that is all 
well and good, but there is another angle to this I want you 
get into if you can, joint rulemaking.
    So we have seen some joint rule making for the various 
agencies in the past. Most notably is in the area of the 
Volcker Rule. And when that is done, you have various agencies 
doing it. When that was done, SEC looked at analysis. Other 
agencies look at it and some don't.
    Talk about if this legislation were to pass, or had been 
passed, what would be an effect on joint rulemaking? Could the 
agency get out of it or what happens?
    Mr. Gallagher. Well, thank you for the question, Mr. 
Chairman. In practical effect, the legislation, as you point 
out, because it would make years of guidance and disparate 
regulatory and legislative requirements binding in the U.S. 
Code, I think it would cause the SEC, in the context, let us 
use the Volcker Rule, since you mentioned it, to actually not 
be able to lawyer the situation in a way that I cautioned in my 
opening comments.
    And so, as you might recall in the Volcker Rule, the 
Volcker Rule was promulgated even by the Securities and 
Exchange Commission under the Bank Holding Company Act, not the 
Securities and Exchange Act of 1934.
    Chairman Garrett. Okay.
    Mr. Gallagher. So the various disparate legislative 
requirements, you know, in the Exchange Act, the APA, 
everything else, didn't apply because the lawyers determined 
that pursuant to the Dodd-Frank mandate on the Volcker Rule 
that it was legal and permissible for the agency to promulgate 
the rule--
    Chairman Garrett. So I guess I want to be clear, and I will 
go to Mr. Quaadman, if you want to jump in here. If we have 
this law now and you go into a joint rulemaking territory, and 
the SEC has to do it--I will throw it at Mr. Quaadman.
    Would you say that the SEC has the--they would do the joint 
rulemaking, but would they have the--they would do the 
analysis. Would they have the ability basically to stop the 
joint rule from going forward then?
    Mr. Quaadman. No. So in fact, we have a situation right now 
with the Incentive Comp Rules, which are being released, where 
you have five agencies that have not done any sort of analysis 
and the SEC has.
    I think also, to Commissioner Gallagher's point with the 
Volcker Rule, no agency did an economic analysis with the 
Volcker Rule. So what we have now are markets where we have 
liquidity stresses, which should have been picked up in the 
economic analysis of that rulemaking.
    Chairman Garrett. Did you have a last point on that?
    Mr. Gallagher. Yes, I think, so basically this stand-alone 
statutory requirement would not allow the commission to seek 
rulemaking authority other than the Federal securities laws. 
And so where the Bank Holding Company Act did not require cost-
benefit analysis, an economic analysis, this standalone would 
force them to do it, even in the context of Volcker.
    And just one little small point, too--
    Chairman Garrett. Yes, sir.
    Mr. Gallagher. --just so this committee knows to keep an 
eye on this. The commission still needs to promulgate a rule to 
make the Volcker Rule enforceable under the Federal securities 
laws under the Exchange Act.
    Chairman Garrett. Yes.
    Mr. Gallagher. Now, that would change the baseline of the 
economic analysis when they conduct that rulemaking because the 
Volcker Rule exists today. If they had done that back in 2013, 
it would not have existed, so the baseline for the economic 
analysis would have been much different than what you are going 
to get whenever this rulemaking happens.
    Chairman Garrett. Right. And I only have a minute left to 
hit 10 more questions. So one question is, so oftentimes the 
charges that we are trying to do is undo regulations or undo 
rules or peel things back. If you do a cost benefit analysis, 
is that really the case?
    Or really what you are doing--I will throw it to Mr. 
Quaadman again. Is that really what you are doing or you are 
trying to get the most efficient, cost-effective approach and 
if helping both the industry and investors, or what have you, 
but also the agency itself to most perform effectively?
    Mr. Quaadman. Yes. No. And I think what your bill does, it 
does in two ways, right? One is not only during the rulemaking 
process do you actually get a sense of what the potential costs 
and benefits are, and then figuring out the right way to get at 
the objective of the rule. But then when you take a look at it 
2 years post-implementation, you are actually looking at real 
numbers that will allow you to get to the point of if the rule 
is working or how you need to change it.
    Chairman Garrett. Okay. I have a whole bunch of questions 
on proxy advisers and I am not going to go over my time. Maybe 
we will circle back.
    With due deference to the other Members here, I now yield 5 
minutes to the gentlelady from New York.
    Mrs. Maloney. Okay. Thank you.
    Professor Taub, I would like to ask you about the private 
equity bill. You noted in your testimony the bill amends the 
books and records rule, which requires investment advisers to 
keep key records of transactions they execute for their clients 
as well as investment decisions.
    The bill would provide a broad exemption to the books and 
records rule. And I am concerned about how that could affect 
the SEC's ability to examine investment advisers and ensure 
that they are complying with the law. Can you discuss a little 
bit more why the books and records rule is important, and 
whether the bill's exemptions to the rule are too broad?
    Ms. Taub. Thank you. That is a really great question. So 
the recordkeeping requirements are basic business records, as 
you have noted. And it includes things like investment advice 
given. And it includes the way that it would interfere with the 
SEC's ability to do examinations is that if these 
communications between employees--they could be communicating 
by email or they could be communicating in writing concerning 
transactions that could now be destroyed, for example.
    Or even external communications, as long as they were 
subject to confidentiality agreement, there would be no record 
of those. And in the first examinations of, for example, 
private equity funds that began in 2012 resulted, by mid-2014, 
there were about 150 of the firms examined and over half of 
them there were either legal problems or problems with 
controls.
    And the SEC found mostly problems with expense allocation 
and also problems with fee disclosure. And all of that, to be 
able to discover whether there has been one story told to the 
investor and a different story communicated in-house, you 
actually need those records. And this would permit those 
records to be destroyed.
    Mrs. Maloney. Okay. You also stated in your testimony that 
the private equity bill's exemption to the custody rule should 
be called a ``Madoff loophole.'' Could you elaborate more? How 
would this exemption have helped Bernie Madoff?
    Ms. Taub. The reason why I called that the Madoff loophole 
is because I was recently rereading the Diana Henriques 
wonderful book called, ``Wizard of Lies'' about Bernie Madoff. 
And one of the things that folks failed to check is actually 
see if the assets and securities he claimed to have were truly 
there.
    And in this bill, there are exemptions from what is now 
required by the SEC, which is an annual surprise audit. So you 
have an independent audit firm, doesn't tell you they are 
coming in. They are supposed to come in and see if you actually 
have your clients' money. And in securities it seems like a 
very sensible thing.
    And the carve-out in this legislation--the reason why I am 
calling it the Bernie Madoff--the carve out is if you only run 
money, you manage money and assets for family members, and 
there is a whole long list. And one is for investors you have a 
relationship with.
    And if you think about Bernie Madoff and other folks, there 
is this affinity fraud. The definition of who you have a 
relationship with. These are all built on relationships. It is 
far too broad.
    And moreover, I don't see why anyone would object to--why 
any honest investment adviser would not want to assure their 
investors that their money is actually there. So it is an 
invitation. It is basically tying the SEC's hands, and it is an 
invitation for fraud to flourish in the shadows.
    Mrs. Maloney. Thank you.
    Mr. Quaadman, I would like to ask you about proxy advisers. 
And I understand that there is still disagreement in the 
academic literature about the influence of these advisers. Some 
studies find them very influential while more recent studies 
find that their influence is limited, and even declining.
    Some of the biggest asset managers tell me that they use 
proxy advisers primarily for their centralized data management 
on all of the shareholder meetings and to help them actually 
cast the thousands of votes that they have to cast every year 
and not as much for their vote recommendations.
    So I would like to ask you, first, how do you respond to 
the studies that show that proxy advisers aren't very 
influential anymore? And secondly, if proxy advisers' vote 
recommendations are less influential than they were a decade 
ago, is there still a need for aggressive oversight of these 
firms?
    Mr. Quaadman. Yes. Let me answer that in a couple of 
different ways, Congresswoman. Number one, you have the Ertimur 
study out of the University of Colorado, which shows that ISS 
and Glass Lewis control about 36, 37 percent of the vote.
    You have the Larcker study, which shows that the ISS 
recommendations are not necessarily geared towards better 
economic return.
    And just lastly, I spoke to a CEO last year who received a 
negative recommendation on a comp plan, and 33 percent of the 
shares were voted within 24 hours of ISS and the Glass Lewis 
recommendations. And 90 percent of those shares were voted 
against the company. I think that, in and of itself, shows that 
they are still pretty influential.
    Chairman Garrett. Thank you. The gentleman yields back.
    The vice chairman of the subcommittee, Mr. Hurt, is 
recognized for 5 minutes.
    Mr. Hurt. Thank you, Mr. Chairman. I had a question for Mr. 
Cherry-Seto and hopefully be able to get to Mr. Quaadman and 
Mr. Gallagher.
    But I wanted to begin with you, Mr. Cherry-Seto. You are 
the CFO of Blue Wolf Capital Partners, is that right? And 
obviously, your firm has to engage in a lot of compliance with 
regulatory agencies. Is that correct?
    Mr. Cherry-Seto. That is right.
    Mr. Hurt. You take--is that expensive?
    Mr. Cherry-Seto. It definitely takes a lot of time and 
attention.
    Mr. Hurt. And it is time-consuming?
    Mr. Cherry-Seto. Yes.
    Mr. Hurt. Do you take it seriously?
    Mr. Cherry-Seto. At all levels of the organization.
    Mr. Hurt. Do you think that the SEC's responsibility for 
investor protection is important?
    Mr. Cherry-Seto. Absolutely.
    Mr. Hurt. And do you all take that seriously?
    Mr. Cherry-Seto. Absolutely.
    Mr. Hurt. I guess my question really deals with a couple of 
things that Professor Taub said. You touched, in your testimony 
about the advertising rule and the necessary change that this 
bill would bring to that rule.
    But I was wondering if you could talk a little bit about 
the custody rule and the recordkeeping and the Form PF? And A, 
do these changes, these proposed changes, in any way jeopardize 
investor protection? And B, if they do not, how do they help 
your company or your firm and the employees that they hire?
    Mr. Cherry-Seto. Let me try to take a stab at the books and 
records piece of this legislation. Part of the issue here is 
that engagement with the industry is important so that we can 
figure out how to come up with regulations that are common 
sense with the way that the industry operates.
    In the case of books and records, I think the intent of 
that section is really talking about keeping records of 
investment advice. When the laws were made, it was very clear 
what you meant by investment advice.
    If you engage a broker and that broker comes to you and 
says, ``I think you should buy this stock,'' they have made an 
investment recommendation to you. And then the SEC could say, 
well, let me look behind and see what the research was for them 
making that recommendation.
    In the private funds space, you have engaged a private fund 
manager like Blue Wolf to work on your behalf to make 
investments. In this case, we are not coming back to the 
investors every time we are looking to invest in a company.
    We are doing that in our own governance structures where 
there may be an advisory committee of L.P.s that help look 
over. But on a day by day basis, we are making recommendations 
to our investment committee, which is within the firm, on 
investments that should be made.
    I think what this legislation is trying to address is that 
in the course of doing work, we look at all sorts of 
investments, many of which don't get consummated. Those 
investments that don't get consummated are most of the 
recordkeeping that we are talking about. And where is the 
investment advice in a prospective investment that never 
happened?
    Mr. Hurt. And what does that have to do with investor 
protection?
    Mr. Cherry-Seto. Well, if the investment is not made, I 
don't think it is really doing much to protect investors. If an 
investment is made in a portfolio company, we do have an 
obligation to keep the investment committee minutes, the 
information around the investment committee, the investment 
committee memos that are put together to support an investment. 
But there are many, many more investments that never make it 
that far.
    Mr. Hurt. Okay.
    Mr. Gallagher, from your time at the SEC, I would imagine 
that you have--and I know that you have struggled with a lot of 
the things that these firms have to go through now that they 
have to register.
    I guess my question is, Ms. Taub couches this as an either/
or thing and investment protection is at odds necessary with 
capital formation. And I guess my question is is does it have 
to be that way? Aren't there ways to promote capital formation 
and at the very same time maintain investor protection?
    Mr. Gallagher. Absolutely, Congressman. In fact, you know, 
one might look at it and say, as I used to when I was on the 
commission, promoting capital formation is increasing investor 
opportunity and and the ability to choose service providers, 
the ability to choose products that otherwise wouldn't exist, 
which is good for the overall economy.
    But really good for investors and creates more competitive 
market in which, you know, the malfeasors might not succeed. 
Because there is real competition.
    And so there is a natural regulatory inclination to reduce 
opportunity to protect, a very nanny state-like instinct, in 
the regulatory agencies these days to reduce opportunity. And I 
think that is the actual detriment and a loss of protection for 
investors.
    Mr. Hurt. Thank you. I yield back.
    Chairman Garrett. The gentleman yields back.
    Mr. Scott, you are recognized for 5 minutes.
    Mr. Scott. All right. Thank you, Mr. Chairman. Very good 
hearing. It seems to me that these bills are sort of put 
forward to maybe spur a greater concern with the SEC to move 
faster in doing its job. However, I have a couple of pertinent 
questions that go to this point.
    Back in 2010, for example, there was a staff report from 
the Federal Reserve Board of New York that argued, and I quote: 
``Along the chain of intermediaries in the shadow banking 
system, the weakest link in that chain is the pinch point that 
can destabilize the entire chain.''
    Now when that staff report was released in 2010, we were on 
this committee, finishing up passing Dodd-Frank. And one of 
Dodd-Frank's main objectives was to fill the regulatory gap 
that was created by this shadow banking system thereby making 
our chain stronger.
    And to that end--and I was a co-sponsor of the Dodd-Frank 
bill. We were working on the bill. And at that point, we made 
sure that Dodd-Frank brought private fund advisers with more 
than $150 million in assets under management out from the 
shadows and into the bright light of the oversight of the 
Securities and Exchange Commission.
    So my question is, given all that we have done, what 
evidence do we have today to suggest that now is the right time 
to loosen the SEC's grip? Any one of you.
    Ms. Taub. I would be happy to respond to that. And I have 
read that report. But first, I do want to respond to something 
that Mr. Hurt said, suggesting that in my testimony I stated 
that investor protection was at odds with capital formation. In 
fact, I have always stated the opposite.
    And my written testimony indicates that they actually are 
perfectly aligned. And that it is trust in our financial 
markets that encourages people to invest and actually can 
decrease the cost of capital because there can be a premium on 
capital if you think someone is going to cheat you.
    But back to the question about shadow banking and Dodd-
Frank and how this bill could affect that. In particular, the 
provision in the bill that would allow private equity firms and 
some hedge funds to no longer complete Form PF, I think it is 
very important.
    The Form PF, as you know, is provided to the SEC 
confidentially and access is given to the Financial Stability 
Oversight Council. And these data have only started, has only 
been collected since 2011. And getting a picture of the 
behaviors in broader market is really important.
    And the part of the form we are talking about is Section 
Four, for the private equity firms. And it provides important 
information related to leverage and counterparty risk and also 
geographic and industry breakdown. And the importance of 
knowing about, obviously, leverage is a key factor in the 
financial crisis, but counterparty risk is important because of 
the links that you are talking about.
    The second thing, though, that goes really to the heart of 
shadow banking is Section 1(c). This is a part that is only 
filled out by hedge funds. If this bill were to pass, hedge 
fund advisers with between $150 million and $1.5 billion assets 
under management wouldn't--
    Mr. Scott. I have only--
    Ms. Taub. Yes.
    Mr. Scott. Sorry to interrupt you, but I have--
    Ms. Taub. It is okay.
    Mr. Scott. Appreciate that response, but I did have one 
other question I wanted to get in concerning Mr. Garrett's bill 
because I have a belief and support a cost-benefit analysis. 
But I do what to raise the issue because back in, I think, 
around 2013, SEC Chair Mary Jo White said that she was 
conducting economic analysis.
    And I would just like to clarify your statement, Mr. 
Gallagher, because it goes to the point that the chairwoman of 
the SEC made that perhaps Mr. Garrett's legislation would 
hamper the SEC's ability to do rulemaking in a timely manner. I 
wanted to get you on the record to please explain that. At 
least give some response to the chairlady's concerns of the 
SEC.
    Mr. Gallagher. Sure. Thank you for the question, 
Congressman Scott. I am an end user of economic analysis. I 
have gone through many rule-makings, mostly Dodd-Frank related, 
over the last several years. Economic analysis has never once 
slowed down the process.
    In fact, my experience is that it speeds up the process 
because it provides decision points and optionality for 
policymakers like myself who need to vote on these rules where 
you otherwise wouldn't have it. Where it would be one size fits 
all.
    It lends itself to negotiation. There were several Title 
VII rules on derivatives. My first year in 2012, that but for 
the economic analysis, we would have had split votes of the 
commission. Instead, we got 5-0 votes. And we got them in a 
timely manner.
    So I think this bill is actually, to Chairman Garrett's 
original point, only incremental in its burden on the agency 
over what the agency's committed to in 2012. What it does is, 
it clarifies and codifies, which is incredibly important, in a 
standalone way, these obligations that the agency has mostly 
already committed to. So I think it is a very positive step.
    Chairman Garrett. The gentleman's time--
    Mr. Scott. You do understand Chairwoman White's concerns 
are legitimate? I just want a yes or no on that.
    Mr. Gallagher. When you run the agency, you are always 
worried about pressure to get things done, running the agency. 
The chairman has so many other duties than the other 
commissioners so any other imposition, any other mandate coming 
from Congress right now, if you are trying to run the SEC, I 
can see it would be a burden in her eyes. But I don't think 
this is a real material one at all.
    Mr. Scott. Okay. Thank you, Mr. Chairman.
    Chairman Garrett. Thank you both.
    The gentleman from Texas is now recognized.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Mr. Cherry-Seto, do you believe that private equity funds 
represent a systemic risk?
    Mr. Cherry-Seto. Do I personally feel that they are--
    Mr. Neugebauer. Yes.
    Mr. Cherry-Seto. I wouldn't say that I was an expert on the 
matter, but there have been a number of folks that I think are 
better messengers than me have said that that is not the case.
    Mr. Neugebauer. Do you think that private equity firms had 
any cause to the financial crisis that we had in 2008?
    Mr. Cherry-Seto. I don't think I am an expert to speak on 
that. But I would say that a lot of private equity firms, 
especially small ones, look much smaller than any holding 
company. You have the holding company that happens to not be 
run by a private equity firm, is either privately held or 
public, that are much larger than our firm.
    I mean, our firm is fairly typical for the middle market. 
There are thousands of firms of our size, manage under a half 
billion of capital. We have majority interest in 10 or 12 
companies.
    Mr. Neugebauer. So I think one of the things I want you to 
do is maybe explain who is a typical client of a private equity 
company?
    Mr. Cherry-Seto. Here often pension funds are big investors 
in private equity assets.
    Mr. Neugebauer. So they are sophisticated investors. Is 
that right?
    Mr. Cherry-Seto. They are definitely investors that have 
access to legal support. Most of them have advisers, that this 
is the only business they advise on, not only for investments, 
but specifically on alternatives in the private equity market, 
very sophisticated advisers.
    Mr. Neugebauer. Mr. Gallagher, would you concur that--what 
is your position? Do you think that private equity companies 
are a systemic risk?
    Mr. Gallagher. Absolutely not.
    Mr. Neugebauer. And you don't think they had anything to do 
with causing the crisis?
    Mr. Gallagher. Absolutely not. I think they got swept up 
into Title IV. Lord knows why. I wasn't here for that process, 
and I don't think the regime fits the business model.
    Mr. Neugebauer. And the President signed an executive 
order, 13579, which requires an independent regulatory agency 
to perform an analysis of rules that are ``ineffective, 
insufficient, excessively burdensome, and to modify, streamline 
and repeal them in accordance to what they have learned.''
    While you were commissioner at the SEC, were you aware 
whether the SEC took part of any kind of analysis like that to 
comply with Executive Order 13579?
    Mr. Gallagher. No. Unfortunately, Congressman, it never 
happened. There was a lot of talk about it, but it never 
happened.
    Mr. Neugebauer. Why do you think that was?
    Mr. Gallagher. Well, it was a very regulatory time during 
my tenure on the commission, and the emphasis was on 
promulgating rules, not reviewing them, not writing them off 
the rulebooks.
    Mr. Neugebauer. In your testimony I think you said that SEC 
was ``constantly bombarded with pressure from special interest 
priorities.'' Could you describe some of the examples of what 
you see as SEC's missteps in terms of setting its own 
priorities?
    Mr. Gallagher. Look, it is since 2010, since Dodd-Frank 
when the SEC was mandated by Congress to conduct roughly 100 
rulemakings, studies and the like, the agenda has effectively 
gotten away from the agency. As you well know, a lot of those 
mandates had 2-year timeframes.
    Here we are. It will be 6 years I believe here in July 
since the enactment of Dodd-Frank and the agency still has 
roughly 35, 40 percent of the final rulemakings to do.
    So that the rulemaking agenda has been dominated by Dodd-
Frank and, you know, I think within the Dodd-Frank mandates is 
where I often squabbled with my colleagues on the commission. 
Prioritizing those mandates I thought were askew.
    The best evidence of which is that my first 10 months on 
the commission a quarter of my time was spent on Sections 1502 
and 1504 of Dodd-Frank, conflict mineral disclosure and 
extractive resource disclosure when here we sit today and the 
Title VII, derivatives rulemakings, remain unfinished.
    Mr. Neugebauer. But you talk about the external, I guess, 
special interest priorities. Do you think that was influencing 
more of the agenda or are they trying to knock out some of the 
Dodd-Frank?
    Mr. Gallagher. Congressman, I think the squeaky wheels got 
a lot of the grease. So, you know, the 1502 rulemaking here, 
again, is instructive. That was why did I spend 20, 25 percent 
of my first 10 months on it? Because it was a steady parade of 
special interest groups on all sides of the aisle, pro, for, 
you know, and against the rule coming in to meet with us and 
push this to the front of the agenda.
    The 1502, you know, accept the wisdom of Congress. This was 
something that had to be done. It is the law of the land. 
Someone needed to realize that it was not going to happen. You 
know, that these 100 mandates were not going to be completed 
within 2, 3 years, and 1502 should have been at the end of the 
pile not at the beginning.
    Mr. Neugebauer. I thank the gentleman.
    I yield back.
    Chairman Garrett. The gentleman from Connecticut is 
recognized for 5 minutes.
    Mr. Himes. Thank you, Mr. Chairman.
    I would love to just direct a few questions to Professor 
Taub and by way of background, I worked with Mr. Hurt on a bill 
a number of years ago that would have provided exemptions from 
registration to larger and more leveraged private funds.
    And at the time the theory was that they are not 
systemically dangerous, which I happen to continue to believe. 
And that limited partners in these funds as sophisticated 
investors don't require quite the same oversight and assistance 
that retail investors do.
    I look back on that with some ambivalence because I still 
think that those two things are true, but obviously the SEC 
used the filing of Form PF to identify a not inconsequential 
amount of skullduggery with respect to fees, conflicts of 
interests.
    And many of their exams resulted in some disclosures that 
were really pretty uncomfortable for the way limited partners 
in these funds were treated. So I approach these questions with 
ambivalence.
    I continue to believe, Professor Taub, that a private fund 
is not the same as a mutual fund. They tend to hold private 
securities as opposed to public securities. They tend to deal 
with sophisticated investors.
    So I am wondering if we can drill in, and as you look at 
the elements of the proposed Hurt legislation here, I am really 
interested in your opinion because I think your critique was 
pretty good. But is everything in here a bad idea?
    I mean, let me just rattle off a couple to get your 
hopefully quick opinion on. You know, the delivery of brochures 
to clients, that exemption would apply only if a prospectus had 
been delivered. So I am wondering should I be concerned about 
that?
    The exemption from annual independent audits and surprise 
examinations is only in the case of limited partners that are 
insiders, family members, family offices. You are shaking your 
head. I will give you a chance because I am asking this 
honestly. I am not making a rhetorical point here.
    And, you know, on the client notification on consent to 
ownership changes, that strikes me as sort of administrative in 
nature. So I do, Professor Taub, want to give you the 
opportunity. Is everything in this bill a bad idea or is it 
possible that some of these things, including what I have just 
listed is in fact a tailoring of legislation to the fact that 
private funds are not in fact mutual funds?
    Ms. Taub. Thanks so much, Congressman. I appreciate those 
questions. I want to answer it but you also made a comment 
which I thought was interesting about sophisticated investors. 
And I did write a paper entitled, ``The Sophisticated Investor 
in the Global Financial Crisis.''
    And what is interesting is, I am sorry to bring up Bernard 
Madoff again, but if you think about a lot of his money came 
through feeder funds. And the feeder funds were giant, 
sophisticated investors, so themselves.
    These were a fund-to-fund structure. So if a sophisticated 
investor is being lied to and provided false information I am 
not exactly sure how that benefits capital formation. But 
seriously, I think--
    Mr. Himes. I don't want to cut you off. Look, I don't think 
we can build an entire regulatory structure around a Madoff 
possibility. Obviously Madoff undertook a lot of very illegal 
activity, but I really am interested in--
    Ms. Taub. Yes.
    Mr. Himes. --whether your opinion is in particular those 
three areas that I highlighted. Is this a collection of totally 
bad ideas? Or am I right that some of these things actually may 
be fairly reasonable tweaks to the regulations?
    Ms. Taub. Well, quickly since you mentioned the brochure, 
the brochure is basically part two of this Form ADV that has to 
be filed. And the reason why it is still important even if a 
prospectus has been given, is that it is written in plain 
language. It has to be updated. And in this brochure the 
advisor has to disclose if there has ever been any disciplinary 
actions.
    Listen, there are so many good--
    Mr. Himes. Does that not have to be disclosed in a 
prospectus though?
    Ms. Taub. It would have to--no, because if a disciplinary 
action happened after the--not the prospectus, but the offering 
document, that it would not have appeared. So if they get in 
trouble I think--like I said, there are so many good advisors. 
Why shouldn't there be a fair playing field and those that do 
have disciplinary actions disclose that?
    The thing with custody is it is not just for firms that 
only have the limited partners. It is family members. It is 
anyone who has a relationship. And the term ``relationship'' 
can--it is is not defined. So that is of concern.
    So I, you know, if you wanted to go line by line I would be 
happy to define, you know, something in here that I didn't find 
troubling. I only highlighted the things that struck me as 
problematic. Thanks.
    Mr. Himes. Okay. Thank you. Let me ask one last question in 
my limited time. It does seem that Form PF did, and I will look 
at the whole panel on this, give the SEC some information that 
it used to find some troublesome behavior with respect to fees 
in particular and conflicts of interest.
    Professor Taub cites in her testimony the work of a 
Professor Coll who--
    Chairman Garrett. Do you have a question before your time?
    Mr. Himes. --had a $10,000 cost associated with Form PF. 
Does the panel disagree that Form PF in and of itself is not 
outrageously burdensome?
    Mr. Gallagher. I don't think that these fee issues were 
discovered through PF if that is my recollection. It was a 
regular way examination by SEC examiners of the books and 
records of the advisor. PF is wholly separate information to be 
provided for systemic--
    Mr. Himes. So we are back to the independent audits and 
surprise audits. Is that what--
    Chairman Garrett. The gentleman's time has--
    Mr. Gallagher. It is regular audits. PF doesn't make any 
sense for private equity.
    Mr. Himes. Okay.
    Chairman Garrett. The time has expired.
    Mr. Himes. Thank you, Mr. Chairman.
    Chairman Garrett. Yes.
    Mrs. Wagner?
    Mrs. Wagner. Thank you, Mr. Chairman, and thank you all for 
joining us today for this important hearing and discussion on 
reforms we can introduce at the SEC in order to make sure that 
capital is allocated as efficiently as possible and that 
shareholder value is prioritized.
    Increasingly we have seen government get in the way of our 
capital markets and the ability of public companies to grow and 
expand their business on behalf of their employees and 
shareholders. For small companies that are continuing to expand 
and grow, this often results in them staying private longer 
than deal with extraneous issues of being a public company, 
especially when the cost of going public is estimated to be 
$2.5 million at first with continuing annual costs of $1.5 
million.
    Mr. Quaadman, welcome back. Good to see you. In your 
testimony you note that, and I quote: ``For 19 of the last 20 
years we have seen a number of public companies decline. We now 
have fewer than half of the public companies than we did in 
1996.'' Could you please explain why you think that this has 
occurred?
    Mr. Quaadman. I think you put your finger on one of the 
reasons in terms of the IPOs and difficulty there. The other, 
quite frankly, is what is called the Michael Bell problem, 
where you have an entity that is a public company that is faced 
with a lot of these costs, burdens, and the annual fights that 
they have to go through in terms of shareholder proposal and 
director elections.
    And that takes up so much time and effort that--
    Mrs. Wagner. Mm-hmm.
    Mr. Quaadman. --management actually begins to move away 
from managing the corporation for the long term. So there you 
actually had a company that decided to go from public to 
private, and Michael Bell said he would never operate a public 
company again because he would rather manage the company than 
having to deal with these fights.
    So I think if we had, you know, as an example with the 
proxy advisory firms, if we had more oversight there and we had 
openness and transparency that we expect in other areas, that 
might alleviate things. But we do not have a hospitable 
environment either to create or remain a public company in the 
United States.
    Mrs. Wagner. Well, moving off of that and expanding a 
little bit there, for small companies that are looking to go 
public, they have to see all of these pressures that you have 
talked a little bit about here briefly that they will encounter 
from activists and battles on proxy votes that promote 
priorities.
    And this is my biggest concern. They promote priorities 
that have nothing to do with long-term--
    Mr. Quaadman. Yes.
    Mrs. Wagner. --shareholder value. How much of a 
disincentive does this make for those small businesses that are 
looking at going public and how can we improve, outside of what 
you mentioned vis-a-vis oversight, this corporate governance 
climate, so to speak?
    Mr. Quaadman. Yes. I think we can spend a whole day 
answering that one question. Number one, I think just creating 
the small business advocate, which this subcommittee has been 
in the lead on, is really important to get a voice for capital 
formation and competition in the SEC, one.
    Two, I think it is really important, not only that we get 
more oversight, but that we have more emphasis on what we need 
to do in terms of capital formation. So, if we take a look at 
it and we have a very diverse capital system, we need to have 
private equity but we also need to have public companies.
    So in order to deal with, let us say, proxy advisory 
issues, that is a very important thing to deal with because 
companies just will not decide to go public because of issues 
like that. In fact, if you go to Silicon Valley, the two 
reasons why they will tell you they will not go public, one, 
are proxy advisory firms.
    Mrs. Wagner. Right.
    Mr. Quaadman. Two is the internal control costs placed on 
them by the PCAOB.
    Mrs. Wagner. Okay. Okay. Let me move on. Mr. Quaadman, 
thank you very, very much.
    Mr. Gallagher, good to see you again. I am increasingly 
concerned that shareholders' interests are not truly being 
represented by this proxy system. How has the current 
complexity of the proxy system contributed to inaccuracies in 
the processing and reporting of proxy votes?
    Mr. Gallagher. Congresswoman, I have heard over the years 
anecdotally so many stories of failings on the part of the 
proxy advisory firms, whether they be bad recommendations or, 
you know, mechanical issues and the like. And that is one of 
the reasons I got so inspired to pay attention to the issue.
    As a commissioner you often act as an ombudsman for 
complaints and the like. And so--
    Mrs. Wagner. In my limited time, Mr. Gallagher, is there 
any way we can simplify the system to make it more beneficial 
for the owners and I should say on behalf of the owners for the 
intermediaries? When was the last time that we did something 
like this?
    Mr. Gallagher. You know, I think it is about time that 
Congress take a look at what I had called as a commissioner of 
the Federalization of corporate governance.
    Mrs. Wagner. Right.
    Mr. Gallagher. Find the touch points where the Federal 
Government has been inserted to which otherwise is a state law 
system dominated by Delaware in particular, and decide does it 
make sense? 14(a)(8) shareholder proposal rule is out of 
control and needs to be revisited. If not the SEC then it 
should be this Congress. You know--
    Mrs. Wagner. It is past time that we update the process.
    Mr. Gallagher. It is past time and there are these touch 
points. And I do favor--
    Mrs. Wagner. All right. Thank you very much. I am out of 
time. I yield back, Mr. Chairman.
    Chairman Garrett. The gentlelady yields back.
    The gentleman from California is recognized.
    Mr. Sherman. Okay. A couple comments on proxy advice. I 
think it is an attack on capitalism to tell investors that it 
is virtually illegal for them to consider anything other than 
earnings per share in making their investments. That they are 
silly or that they are not to be given the information they 
want.
    And if investors want to prevent companies from investing 
in Iran, if they want to be interested in the political 
contributions that are made with their money, if they want to 
avoid their companies or at least know how their companies are 
engaged in blood diamonds and conflict minerals, that investors 
have a right to that information. And they have a right to even 
vote on whether the company should engage in those activities 
or not.
    And to say that investors must only consider earnings per 
share is to say that the investor doesn't own their own money; 
cannot make decisions that reflect their own values.
    So I would say I believe in openness and transparency with 
proxy advisory firms, but not if the purpose is to prevent 
openness and transparency by the operating companies which 
solicit those proxies. And likewise openness and transparency 
includes a real audit that we can rely upon that includes many 
times internal controls.
    Commissioner or Former Commissioner Gallagher, I want to 
direct your attention to the bill to deal with the NMS. We have 
that playing an important role in SEC regulation of the 
exchanges. The exchanges on the one hand are a regulator.
    On the other hand they are market participants. They are 
for-profit companies who derive most of their money to making 
sure that some investors know about what is going on a 
microsecond before other investors know what is going on. So 
they are profit-driven and they are in favor of transparency 
but some are more entitled to transparency a millisecond before 
others.
    The NMS includes the exchanges but doesn't include other 
industry participants such as the consumers of the exchange 
service, namely the brokers, and also the asset managers, those 
on the buy side. Does it make sense from the NMS plan to 
include folks other than the exchanges themselves?
    Mr. Gallagher. Well, thank you for the question, 
Congressman. As a commissioner I heard lots of complaints on 
both sides of this debate. You had the brokers come in in 
particular complaining that they didn't have a real voice or 
ability to impact the direction of NMS plan participants. I 
heard from the exchanges making the exact counterpoint.
    Without sitting in these rooms, you know, during the plan 
debates it was hard for me to actually decide where the truth 
lied. And I know that this committee and, you know, others in 
Congress are interested in this issue.
    If there is legislation I think it is appropriate actually 
for Congress to weigh in. This all derives, of course from the 
1975 Act amendments.
    Mr. Sherman. I would point out that certainly if you are 
going to have an advisory board to a public utilities 
commission you include people who represent the consumers 
including the very large consumers of the utility services, not 
just the utilities themselves.
    Mr. Cherry-Seto, there is the bill to change the Form PF to 
provide some information on the companies. Mr. Himes points out 
that Form PFs have disclosed certain things about fees. I will 
point out, though, when it comes to Madoff everything was filed 
with the SEC and they didn't do anything with it.
    Mr. Cherry-Seto. Right.
    Mr. Sherman. So does it make sense--our purpose here is to 
focus--I mean, the reason we passed this was to deal with 
systemic effects, not to protect, although we always want to 
protect individual investors and we should have a comprehensive 
scheme for doing that.
    Do the prudential regulators need all the information on 
that form? And is private equity, dealing with private equity 
part of dealing with systemic risk?
    Mr. Cherry-Seto. I think in the case of Form PF there is 
definitely additional information in there. Its primary purpose 
is to look at systematic risk and that is the lens that one 
should use to look at the information there.
    But I would like to point out this legislation is not 
looking to exempt anyone from today reporting Form PF. If this 
was passed, no advisors would have an exemption from reporting 
Form PF. This is looking at information like you mentioned that 
is maybe trying to get at the question of systematic risk, and 
it doesn't serve a purpose for investors.
    You look at the private market, I mean, I would also go 
back to, like, the custody rule. Like when we talked about 
delivering the brochure to our clients, keep in mind that a 
client in this context is not what was originally meant when 
they look at delivering to clients. The client is the fund 
itself.
    So technically the bill is saying you need to deliver the 
brochure to your fund. And when people want to do that, 
technically follow that rule they save it on their network 
because they delivered it to themselves.
    Mr. Sherman. Hmm.
    Mr. Cherry-Seto. That is what they are talking about 
delivering a brochure. And the brochure is extremely important 
in this case and here we are just saying that it should only be 
updated when there is a material change. If there are material 
changes you still need to update your brochure.
    Mr. Sherman. Thank you.
    Chairman Garrett. Thank you.
    Mr. Hill is recognized for 5 minutes.
    Mr. Hill. Thank you, Mr. Chairman. I appreciate you and the 
ranking member holding this important hearing on these issues.
    Mr. Quaadman, as you know, last October the Department of 
Labor released an interpretive bulletin for economically 
targeted investments and investment strategies environmental, 
social and governance factors, which now allows these factors 
and collateral benefits to be considered when selecting an 
investment in an ERISA plan.
    Now, it is been kind of 3 decades in the study of and the 
participation in the asset management industry, and I have read 
the document and it is very, very carefully worded. But I still 
am concerned that this guidance undermines ERISA's mandate that 
plan assets are invested solely in the interest of plan 
participants and that these factors, other factors might take 
precedent an deviate from maximizing returns for beneficiaries.
    In passing ERISA, Congress chose specifically not to 
include any provision that would allow plan assets to be used 
to pursue any societal purpose other than protecting plan 
assets. To the contrary, Congress included Section 404(a) which 
says, ``In order to make a law of trust applicable to the plans 
and eliminate such abuses as self-dealing, imprudent investing 
and misappropriation of plan funds.''
    Recently, both of the main proxy advisory firms have 
partnered with ESG research firms. Glass Lewis announced their 
partnership with Sustainalytics to integrate Sustainalytics' 
ESG research and ratings into Glass Lewis proxy research and 
vote management platforms.
    This is an issue that I don't think has received very much 
attention. And I would be interested in your thoughts on the 
bulletin, any thoughts and concerns you might have first. And 
then secondarily, any ties to proxy advisors and their advisors 
that we are discussing today?
    Mr. Quaadman. Yes. Thank you very much, Congressman Hill. 
Let me address that in two separate points. We are very 
concerned about that bulletin. We had written to Secretary 
Perez before the bulletin was released where we asked for 
empirical evidence as to why they were considering some of the 
changes they were.
    Unfortunately with the bulletin today, environmental, 
social and governance concerns now rank on par with investment 
return for ERISA pension funds, and that is now migrating out 
to other areas.
    So as an example, the New York State Common Fund, which has 
an ERISA-type fiduciary duty, issued 75 shareholder proposals 
last year on proxy access. But they were very open about the 
fact they were not going for good corporate governance issues.
    They are actually looking to put a pressure point on 
companies regarding climate change proposals. So rather than 
having that open debate there it was wrapped up in a corporate 
governance debate.
    You know, the second point to it is when you take a look at 
the proxy advisory firms, and this is what the 2014 SEC 
guidance did and where the Duffy bill goes even further, is 
that the proxy advisory firm guidance or recommendations need 
to be correlated to the fiduciary duty of their clients, just 
as the institutional investor that they are providing 
recommendations to.
    So that if we are now beginning to muddy those waters, all 
the debates that we are having today about enhancing long-term 
shareholder value are going to go out the water. And we are 
going to have situations like the Illinois Pension Funds where 
you have a very active pension fund on things other than good 
return now suddenly going underwater, and unfortunately it is 
going to be the taxpayers that are going to foot the bill.
    Mr. Hill. Well, this is concerning to I think taxpayers 
because public pension funds are severely underfunded in this 
country. And also use, in my judgment, hypothetical actuarial 
return statements that are far too high to today's market 
conditions. So I do have a lot of concerns about it.
    Commissioner Gallagher, your thoughts on that subject?
    Mr. Gallagher. Thank you for the question, Congressman. I 
saw the circular, too, last October. For me, you know, similar 
reaction to what Mr. Quaadman said. More though it for the 
first time caused me to think about what I see is a trend or a 
push for the Federalization of the retirement system, you know, 
more generally where there seems to be interest with ERISA 
waivers coming out of DOL.
    This policy statement and elsewhere, a move towards, as we 
have seen very publicly, state-sponsored private sector 
retirement plans, which, you know, if they add an option if 
they are in a competitive market you might think that is a good 
thing. But I am not sure that is the case.
    So I do think this is something for the Congress to watch 
and watch very carefully. That, you know, the track record of, 
you know, government oversight of retirement plans has been 
checkered in some ways and expanding it might not be the best 
thing.
    Mr. Hill. Thanks, Commissioner.
    Chairman Garrett. The gentleman's time?
    Mr. Hill. Thanks, Mr. Chairman. I yield back.
    Chairman Garrett. All right.
    Mr. Carney is recognized for 5 minutes.
    Mr. Carney. Thank you, Mr. Chairman. Thank you for holding 
this hearing today, and thank the panelists for coming and for 
sharing your expertise.
    I represent the whole state of Delaware. We have a lot of 
people at my state with considerable interest in and expertise 
in corporate governance, corporate law and providing corporate 
services to three-quarters of the Fortune 500.
    And I have been involved as a result of that, that we have 
a lot of expertise both in the State Division of Corporation 
within the corporate bar in the state of Delaware, as well as 
in the provision of corporate services.
    And so I pay attention to some of these issues and advice 
that I receive from folks back home I meet to--my involvement 
with when we saw the downturn a few years ago and the decline 
in IPOs, companies doing initial public offering, which led to 
my involvement with Mr. Fincher and the IPO onramp. We are 
working on beneficial ownership issues today as we speak.
    And it has also led me to my involvement with Mr. Duffy 
when he came to me to talk about this bill, this draft bill 
that we have here on proxy advisory firms. And so I would just 
like to--got to get on the record some of what I think you said 
earlier, Commissioner Gallagher, about the need for the bill as 
you see it, in summary please?
    Mr. Gallagher. First of all, Congressman, I wanted to thank 
you for your collegiality during my tenure as a commissioner. 
You know, your positive approach to these capital formation 
issues and it was always great to work with you, even bothering 
you on the Amtrak train on your commute home.
    Look, I pushed for years as a commissioner to get some 
movement, some reform of the proxy advisory oversight system to 
the extent there was one. The culmination of that was SLB 20 in 
2014. I think it was a positive step forward.
    What I have heard since then, though, it was just simply 
not enough. And if you look at the legislation that is being 
debated by this committee, I think it is very incremental in 
its nature. I think--
    Mr. Carney. It is pretty straightforward. I mean, not 
that--
    Mr. Gallagher. It is very straightforward. It gives us 
the--if I am the SEC, again, it gives the SEC the look into 
this industry into the conflicts and into the business 
practices that this Congress 10 years ago gave the SEC with 
respect to credit rating agencies.
    And now unfortunately that was a little too late in time to 
stop some of the things we saw in 2005, 2006, 2007 with credit 
ratings, but I think that sort of incremental step, that 
transparency is hard to argue against.
    And so I do think based on everything I hear, there are 
academic studies that will tell you one thing on the left and 
one thing on the right, you know, you look--
    Mr. Carney. Is there something in the bill that you 
wouldn't do or something that is not in the bill that you think 
we ought to think about?
    Mr. Gallagher. Look, I actually pause and I have said this 
to Gary Retelny at ISS and others. I don't have, you know, 
anything against the industry. If they provide a service and it 
is done in good faith then it is a good quality product, then 
they should be there in the market.
    Where they get the imprimatur of Federal regulation, where 
the no action letters and the rule interpretations basically 
give them a monopoly, that is something that you shouldn't 
abide.
    And so I don't see anything in this legislation because, 
again, I think you could have gone further. I think it is very 
incremental in its transparency focus.
    Mr. Carney. Maybe we could talk about those.
    Mr. Quaadman, do you have any more to add to that?
    Mr. Quaadman. Yes. Let me just add, one, you know, we did a 
survey with NASDAQ and public companies last summer where we 
wanted to see how public companies were dealing with the SEC 
guidance. What we found was when companies were looking for a 
conflict of interest with a proxy advisory firm, they were 
finding it 45 percent of the time. That is a pretty high and 
dramatic number.
    And I also have an email. I know Mr. Bartl had mentioned an 
email, but I have an email here from ISS offering services to a 
company that was issued after the 2014 guidance was issued. And 
I would like to submit this for the record.
    I think there are still significant problems that exist. I 
do agree with Commissioner Gallagher. SLB 20 was an important 
step forward. I think the Duffy-Carney legislation is a very 
balanced way to push the ball forward, to have more oversight, 
to make sure we have a balanced system that benefits investors 
and companies, and allows the SEC to do its job.
    Mr. Carney. Thank you.
    Anyone on the panel have something in the bill that they 
don't like or something that they would like to see us think 
about in the bill?
    Mr. Bartl. Well, Congressman Carney, I was just going to 
say that I think that the one aspect of this bill that can't be 
emphasized enough is that where there has been this specific 
oversight, and I go back to the peer group episode in 2012 
which got SEC attention. It got press attention that caused a 
change and this ongoing, regular oversight will be effective.
    Mr. Carney. Thank you, sir.
    Mr. Bartl. So I think that is the positive side of the 
bill. I don't have anything that I would change at this point.
    Mr. Carney. Thank you.
    Ms. Taub. Hi. Yes. I don't like this bill and I am 
surprised at, you know, this is the free enterprise system that 
we have sophisticated investors that we spoke about before 
entering freely into contracts, not required to with these 
enterprises that provide an important service for them.
    And we have regulators who have the tools that they need to 
deal with those conflicts of interest at advisory firms as well 
as fiduciary duty at the institutional investor firms.
    And reportedly we are doing this because the regulators 
can't deal with those issues and somehow there is a monopoly if 
you create this giant complex regime it is going to create 
barriers to entry.
    And secondly, one of the biggest concerns I have with this 
bill is the private right of action that it gives to issuers if 
they are not satisfied with the resolution of their complaint 
when they are given a copy in this very tight, you know, 6-week 
window to look at the recommendation.
    And why wouldn't an issuer be unsatisfied if there wasn't a 
vote the way we want to recommendation? And so I am deeply 
confused why this committee in particular would be either 
trying to entrench a monopoly or try to shut down a successful 
business.
    Mr. Carney. Thank you. Well, we disagree but thank you and 
I yield back.
    Chairman Garrett. You disagree? Okay.
    The gentleman from Vermont--oh, no, from Maine.
    Mr. Poliquin. There were some people--
    Chairman Garrett. Thought we had a fellow put down. That 
is--
    Mr. Poliquin. Mr. Chairman, there are some people who are 
envious of not coming from Maine, and I do recognize for the 
record that you are from New Jersey.
    [laughter]
    And I appreciate very much, Mr. Chairman, this terrific 
hearing today. I thank all of the witnesses today.
    When I was a boy growing up in Maine, our State was dotted 
with dozens of paper mills, textile mills, shoe factories. And 
our families could take care of themselves and they had the 
option of going right from high school directly into working at 
these mills with good jobs, with benefits that they could keep 
and take care of their families.
    You know, over the past 30 years, a lot of these mills have 
closed. I don't know if you folks have ever experienced it. I 
have. When a small town loses a mill it devastates that 
community, absolutely devastates it. Schools get smaller, some 
of them close. The collection baskets at church dwindle. 
Hospitals struggle and a lot of families leave and go down 
state to New Jersey.
    That being said, there are a lot of issues that cause these 
mills to close. Taxes are too high, regulations are too tough, 
a lot of which are brought on by us or by the people that set 
the rules in government.
    Now, sometimes you can't control it, like foreign 
competition or different products that are being offered that 
are no longer used, like newsprint or catalogs. Now, one of our 
great paper mills in the state of Maine, which is healthy, is 
Twin Rivers Paper Madawaska.
    Mr. Cherry-Seto, you are from Blue Wolf Capital, invested 
in our mill, in that mill. Now, this is in northern Maine right 
against the Canadian border, 600 jobs in the St. John Valley, 
600 paychecks, 600 mortgage payments. Thank you sir, very much 
for that investment in our state.
    Now, that mill does not make some of the products that it 
did, I am sure, a number of years ago. They make paper bags for 
McDonald's French fries. I love it. Every time I am on the road 
in that district I go to McDonald's and I buy two bags of 
fries.
    [laughter]
    And they make that thin paper that we print medication 
instructions on. Now, I take pills like everybody else--not 
that pill--and we should continue to print that paper like you 
do up there, and also the thin paper that our mutual fund 
reports are printed on.
    Mr. Cherry-Seto, as you know, I would like to ask you a 
question. You invested in that mill. That mill was in 
bankruptcy in 2010. You folks invested in it in 2013. Tell me 
why you invested in that mill, sir, and tell me what changed at 
the mill that made it so successful. It continues to be a 
thriving employer in that part of our state.
    And tell me about the Investment Advisers Modernization Act 
that Mr. Hurt and Mr. Vargas are putting forward today. Tell me 
how that can help you and companies like yours invest in paper 
mills like this and keep those jobs and those communities 
going?
    Mr. Cherry-Seto. Thank you, Congressman. I think Twin 
Rivers is a good example of where there is a company that has a 
strong reason to exist, but there are challenges that they face 
that make it difficult to invest. As you had mentioned, they 
came out of bankruptcy in 2010. There were cuts to the pensions 
coming out of bankruptcy.
    There was a lot of animosity and mistrust. People didn't 
know what the future was going to hold. Coming out of 
bankruptcy you find situations where there are liabilities left 
on the companies that nobody knows with certainty of the 
company surviving.
    And I think firms like Blue Wolf and other private equity 
funds in different parts of the market, they come with a 
certain expertise. And we felt that we could understand the 
risks of investing in a business and be a partner to help.
    You know, as you mentioned, it is on the border of Maine 
and New Brunswick. Part of the company is over on the Canadian 
side of the border.
    Mr. Poliquin. Right.
    Mr. Cherry-Seto. And you can imagine what the complexities 
are of coming out of bankruptcy and having both the Maine 
government and the New Brunswick government involved.
    Mr. Poliquin. Thank you, Mr. Cherry-Seto. And tell me 
specifically, tell us specifically how if the Investment 
Advisers Modernization Act of 2016 offered by this committee 
would help private equity firms like yours invest in mills like 
this so we can show compassion for the people that work there 
and we can grow these businesses and create more jobs?
    Mr. Cherry-Seto. Sure, Congressman. I think the issue is on 
focus, right? Investors invest their money with us because they 
believe that we can find good investments like that, create 
good jobs like that. And so that is what we do best.
    I think in some sense it would be analogous to looking at 
Members of Congress and the unfortunate situation where you are 
asked to spend a lot of time on fundraising. And if you could 
free up some more time from fundraising, you would be able to 
spend more time on what you really want to do here, which is 
govern and pass legislation.
    We look at it somewhat the same way for us. All right. Here 
we are. Compliance is important. Fundraising is important. It 
is part of who we are. That is not going to go away.
    But we are successful by focusing on investing money. And 
so I think in this case having the legislation be more rational 
would help us to focus more time on looking for companies and 
building jobs.
    Mr. Poliquin. Thank you very much, Mr. Cherry-Seto, again, 
for your company, your investment in our great state.
    Mr. Chairman, since you picked on my state, I have one more 
question, and with all due respect--
    Chairman Garrett. Well, we are going to actually do a 
second round I think here.
    Mr. Poliquin. My schedule is such that I cannot, but if you 
can award me another minute or two because of the way you 
picked on our state, then I would consider it an even fight.
    [laughter]
    And I would consider it we are even, sir--with all due 
respect.
    Chairman Garrett. I will look to Mr. Hultgren whether he 
can hold off and without objection the gentleman is recognized 
for--
    Mr. Hultgren. Just because Maine is so beautiful.
    Mr. Poliquin. Thank you. Thank you, Mr. Hultgren. I 
appreciate it.
    Thank you, Mr. Chairman, very much.
    Chairman Garrett. And be forewarned if you say anything 
against it.
    Mr. Poliquin. Yes, sir. I will talk quickly.
    Chairman Garrett. The gentleman is recognized for 1 
minute--
    Mr. Poliquin. Thank you.
    Chairman Garrett. --without objection.
    Mr. Poliquin. Thank you, sir.
    Mr. Gallagher, Professor Taub in her written testimony 
notes that the SEC has the authority to inspect and discipline 
institutional investors who ``mindlessly follow advice without 
considering their fiduciary duty.'' She further states in her 
testimony that ``the status quo is far better than any changes 
offered by Mr. Duffy.''
    Now, you spent some time at the SEC. Do you agree with her?
    Mr. Gallagher. Thank you, Congressman, and I love Maine. 
The professor is correct. The SEC does have that authority to 
discipline the institutional investors through the anti-fraud 
provisions. Finding that activity though is the real key.
    There are 11,400 registered investment advisors with the 
SEC, a couple hundred examiners, so to find evidence of voting 
abuse that would implicate the proxy advisory firms, you are 
going to have to send those couple hundred off into the several 
thousand as opposed to registering and examining basically two 
firms that control 97 percent. So it seems pretty logical that 
you would take the latter route.
    Mr. Poliquin. Therefore I can conclude that you agree that 
Mr. Duffy's bill has merit?
    Mr. Gallagher. Beyond that, yes.
    Mr. Poliquin. Thank you, sir.
    Thank you, Mr. Chair, very much for the additional time.
    Thank you, Mr. Hultgren, very much.
    Chairman Garrett. Thank you. And I think we all can agree 
that we all like the teddy bears that come from--oh, wait. That 
is the other state, too.
    [lLaughter]
    So Mr. Hultgren is recognized?
    Mr. Hultgren. Thank you, Mr. Chairman.
    Thank you all for being here.
    Mr. Bartl, I am going to address my questions to you at 
first, if that is all right? You note in your testimony that 
the Center on Executive Compensation is, and I quote you, ``is 
concerned that the lack of sufficient resources on the part of 
the proxy advisors leads to a check the box mentality.'' You 
also note that ``the ability to understand and summarize pay 
programs, for example, requires time, resources and 
diligence.''
    You testify, however, that the, and I again quote you, 
``The irony is that issuers are responsible for ensuring the 
accuracy of proxy advisory firms' reports, even though proxy 
advisory firms are supposed to be the experts providing the 
information that investors rely on to execute a fiduciary 
duty.''
    I wonder if you could please explain this ``irony,'' as you 
said, and how can an issuer be tasked with reviewing the 
accuracy of a proxy advisory vote recommendations?
    Mr. Bartl. Well, thank you for the question, Congressman 
Hultgren, and I think the issue is really currently only one 
firm gives companies that opportunity. And that is in the S&P 
500. They often have a very narrow window, between 24 and 48 
hours, and that is assuming that the draft report goes to the 
right person at the company, because sometimes it does get 
lost.
    For the rest of, you know, publicly held companies, they 
are, you know, at the mercy of somebody getting a hold of that 
and then going back and, you know, either dealing with the 
proxy advisory firm, whether that be ISS or Glass Lewis or more 
likely going directly to investors.
    And if you are a small company, the resources you have to 
be able to change that within the time you have, because, you 
know, those reports are typically issued within about 3 weeks 
of the annual meeting, the barriers are extremely high.
    So the opportunity is fairly small for those, you know, 
investors or those companies, rather.
    Mr. Hultgren. Okay. Following up, Mr. Bartl, Professor Taub 
references in her written testimony that an article by 
Professors Choi, Fisch, Kahan, entitled, ``The Power of Proxy 
Advisors, Myth or Reality?'' in 2010, that found a substantial 
degree of divergence, and ``a substantial degree of divergence 
from ISS recommendations, refuting the claim that most firms 
follow ISS blindly.''
    However, you note in your testimony that several research 
reports and economic studies have catalogued the influence of 
proxy advisory firm recommendations on votes on shareholder 
proposals. I wonder if you could please explain your 
understanding and the claim that proxy advisory firms are 
capable of influencing shareholder proposal votes?
    Mr. Bartl. Yes. I think some explanation of this happened 
earlier, too, Congressman Hultgren, but I think that if you 
look at that study, if I recall correctly, the Choi study dealt 
with the, you know, non-contested director elections, you know, 
previous to Dodd-Frank. So one, you were dealing with a 
different subset of votes.
    Secondly, she was looking at mutual funds with large 
governance research arms. The research that is out there, both 
pre Dodd-Frank and after Dodd-Frank, Bethel-Gillan, for 
example, talked about I think a 20 percent influence of ISS on 
director elections.
    The Larcker research that talks about significant influence 
on say on pay votes post-Dodd-Frank. There is a lot of research 
out there. And then, you know, anecdotal research just from the 
say on pay votes that shows an influence, definitely an issue.
    The other thing to keep in mind is influence is different 
for different investors. The large investors are going to use 
this information as a bit of a prioritization. When you get a 
negative recommendation their research departments are going to 
pay more attention typically. That is our experience.
    For the middle tier they are going to take the 
recommendation significantly and those that, at least for ISS, 
have ISS vote on their behalf, will take it absolutely 
directly. So I mean, you are talking about a wide band of 
investors that are using this for various forms that are 
influential.
    Mr. Hultgren. Okay. Thanks.
    Mr. Gallagher, if I can ask a quick question to you? You 
note in your testimony that recommendations provided by proxy 
advisory firms may be tainted by conflicts of interest. I 
wonder if you could provide a scenario where a proxy advisor 
has a conflict of interest that prevents it from providing 
independent, objective advice? I wonder if there are any 
specific examples you might be able to provide?
    Mr. Gallagher. Thanks for the question, Congressman 
Hultgren. You know, there are two that really come to my mind. 
One is the more obvious in which a proxy advisory firm also 
provides consulting services to an issuer that it is providing 
recommendations about. And that is one that is, again, obvious 
and one that was addressed in SLB 20, which would need to be 
disclosed, an obvious conflict.
    The other one that we talked about in the SEC Roundtable 
December 2013 is less obvious and may be one that is more 
pernicious, which is the control of its certain advisory 
clients over the substance of the recommendations coming from 
the proxy advisory firms.
    How do you find that? Where is it in the books and records? 
How do you prove it? That is, you know, a much less obvious 
question. But it is one that anecdotally I hear exists.
    Mr. Hultgren. Okay. Thank you. My time has expired. Thank 
you all for being here.
    Since the chairman has been very kind to the state of 
Illinois, I will yield back without asking any further 
questions.
    [laughter]
    Chairman Garrett. There you go. Thank you. The gentleman 
yields back.
    So without objection I am going to suggest we go around for 
a second round if the panels up to it. Obviously there are not 
that many here and they all may not use their 5 minutes. And 
with that, no objection, so ordered.
    So just a couple, and it is getting even less people 
apparently.
    [laughter]
    Just a couple of quick questions on the proxy advisors. I 
will go to Mr. Bartl, two or three questions real quick. In 
your testimony that the Center on Executive Compensation 
conducted a survey that found inaccuracies in the data and 
facts that the two predominant firms relied upon with the 
recommendations. Can you just briefly explain the findings of 
the survey again?
    Mr. Bartl. Yes. So the survey, first of all, found that, 
you know, about 55 percent of respondents found that they had 
an error or an inaccuracy, and about 70 percent talked about 
actually, you know, changing a recommendation in advance of a 
recommendation because of a proxy advisory firm policy or 
practice in the prior 3 years.
    So in terms of, you know, the errors and inaccuracies, you 
have companies that are taking advantage of the research 
because of this belief, and our study did deal with that as 
well, because of the belief that there is some influence from 
the consulting side over to the research side. So you get that 
fairly regularly.
    Chairman Garrett. Okay. So I got that. So these issues have 
not been just for a short period of time. We have looked at the 
issue or the SEC has looked at investment advisors to some 
extent and knew that they were out there advising for some 
period of time. And the SEC took some steps, right? They issued 
guidance 2 years ago, 2014.
    Mr. Bartl. That is right. That is right.
    Chairman Garrett. So I guess I will start with Mr. Bartl. 
So that guidance comes out and that is supposed to be dealing 
with the problem. I guess a short question very blunt is has 
that guidance been sufficient? Have you seen changes in the 
operations of the firms?
    Mr. Bartl. Yes. We haven't seen changes, Mr. Chairman.
    Chairman Garrett. Have or have not?
    Mr. Bartl. We have not seen changes, Mr. Chairman, and I 
think the issue is that, you know, the guidance reiterated 
what, you know, investors needed to do to monitor proxy 
advisory firms. It then also said that for investors that are 
using the proxy advisory firms as a direct--you know, 
incorporating the recommendations and having them vote the 
proxies on their behalf, there is a higher level, a higher 
standard that the proxy advisory firms issue.
    But when you look at that middle tier that I was talking 
about or even the lower tier, the SLB does not impact those. 
And that is where I think where we talked about this impact of 
ongoing oversight as we saw with, again, I mentioned the peer 
group issue back in 2012.
    And we saw it again when, you know, the SLB was issued and 
the roundtable happened. There is a lot more attention paid to 
the processes that the advisory firms use because of that 
attention. And this would elevate that ongoing attention for 
what Commissioner Gallagher talked about a minute ago.
    Chairman Garrett. I got that. So, you know, the professor 
used a word that what we don't want to do anything, you said, 
that would reinforce the monopoly. And I guess actually the 
correct term--or duopolies. I think of it as a monopoly, which 
is your words. That came about. So we do have a monopoly.
    So you are saying we have a monopoly, and that is, to me in 
any framework is a problem when there is no--if you are going 
to have a monopoly maybe there should be some involvement there 
for the government to make sure that things are actually 
running correctly.
    The monopoly came about not just because of the nature of 
the marketplace. My understanding the monopoly came about--
somebody said this, maybe Dan Gallagher said this, as far as 
the no action--I am sorry, Commissioner Gallagher--came about 
due to what the no action letter, right? You do the no action 
letter. That basically gives carte blanche to the firms out 
there to say, ``I guess we don't have to do anything.''
    This is my simple way of looking at this. We really don't 
have that responsibility anymore. No one is going to come back 
at us. We can just abdicate this responsibility out there. And 
there are two firms out there. It coalesces around them. And is 
that in a nutshell, Mr. Bartl?
    Mr. Bartl. Yes. Mr. Chairman--
    Chairman Garrett. How that came about?
    Mr. Bartl. --I think the issue here is that, you know, all 
of us on the panel I think at one point or another has said you 
have to be careful about entrenching the current players.
    Chairman Garrett. Right.
    Mr. Bartl. But as a practical matter the current players 
haven't changed over the course of the last, you know, 6 or 7 
years. And therefore, you know, we view this as a preferable 
alternative to the status quo because it has the ongoing 
approach. The market for proxy advisory firms globally has been 
condensing not expanding.
    Chairman Garrett. And I am going to throw one last one back 
on my bill, professor, to--
    Mr. Bartl. Yes.
    Chairman Garrett. You are a professor so you have your 
students. And I will just throw out this question to you. Don't 
you advise your students when they are looking and trying to 
make any of the decisions they have to make that they should do 
what? Look at the pros and the cons of that decision.
    And when you make them look at the pros and cons, basically 
it is the costs and the benefits of the decisions that they 
have to make in life or in business. And isn't that simply 
really what we are trying to do?
    Ms. Taub. I am so glad you said that, because I mean to be 
clear--
    Chairman Garrett. Uh-oh.
    Ms. Taub. --we are not talking about dispensing with cost-
benefit analysis.
    Chairman Garrett. Okay.
    Ms. Taub. What I was talking about is what type of cost-
benefit analysis--
    Chairman Garrett. Okay.
    Ms. Taub. --should be used, right?
    Chairman Garrett. Yes.
    Ms. Taub. And secondly, whether it should be subject to 
judicial review by unelected judges who are not experts in the 
area. So for example, cost-benefit analysis, should I buy this 
car or that car, is largely going to be economic concerns and 
some preferences. Cost-benefit analysis, should I marry my 
husband, isn't going to be, at least for me, an economic 
question. It is going to have other factors.
    And so what we have learned, especially with the D.C. 
Circuit when we looked at--sorry, the D.C. District Court 
decision in National Association of Manufacturers, they said 
you can't compare apples to bricks.
    So I do think that agencies including the SEC should engage 
in a cost-benefit analysis process. And I think it should be of 
their choosing. It can be conceptual.
    My problem is the illusion of precision because it is a 
Catch-22. If you say reduce this to a number we all know it 
can't be done. Years later then they can be questioned and 
mocked--
    Chairman Garrett. Well, thank you, but I think--
    Ms. Taub. --for are not coming up with the right number.
    Chairman Garrett. And Mr. Gallagher's comment was they were 
able to make decisions not entirely on that, but at least to 
have that there as your factor. I see my time went way over.
    I will now recognize, rather, the gentlelady from New York.
    Mrs. Maloney. We are talking about all these bills, cost-
benefit analysis. I would just like to reflect a little bit 
about why did we pass all these regulations? And that was 
because of the worst financial crisis certainly in my lifetime.
    And I would just like to ask Professor Taub, how much did 
this, in terms of analysis, how much did this crisis cost the 
American people? I have heard that everything from 9 million 
jobs to 9 million people losing their homes. What did this 
economic crisis cost the American people? How many billions, 
trillions I guess? Trillions.
    Ms. Taub. You know, the actual dollar figures have been 
estimated in ranges, but in terms of lost economic output I 
have heard in the many trillions. And I can't point to a 
figure. I am not an economist, and there are many different 
studies that are out there, but in the many trillions.
    But the problem is, again, it is not just about things that 
we can quantify. When more than 7 million people, sorry, 7 
million homes are lost to foreclosure or short sales, that has 
impacts beyond economic ones. There are also other economic 
impacts.
    And the, you know, the run up to the crisis, the bubble, 
the gains of that were not felt evenly and neither was the 
crash. And so, you know, the numbers are large. I don't think 
we can even still quantify the impact at this point.
    Mrs. Maloney. Well, would you generally like to express 
your belief on how these bills would affect the SEC's ability 
to oversee and enforce reforms that Congress passed as a result 
of the financial crisis? Some reported that it was $21 trillion 
or $13 trillion, a range from $13 trillion to $21 trillion? It 
is many people haven't recovered.
    Congress put in place reforms to prevent another financial 
crisis and to better protect Americans from losing their homes, 
losing their jobs, another economic downturn. I always get 
reports every now and then that they think the next crisis is 
on the verge, but do you believe that?
    What about these three bills? Do you think that these bills 
would prevent the SEC from really overseeing and enforcing 
reforms that Congress put in place to protect the American 
economy?
    Ms. Taub. So I think what is ironic about some of these 
bills is there are some really good tools that the SEC has and 
information they are given and these bills want to take that 
away.
    But then the third bill, then the proxy advisory bill wants 
to foist onto the SEC without any specific designation of which 
division would handle it and not any earmarked money, a 
structure that I don't know that the agency, or at least I 
don't know the investors have asked for or need, really need.
    Mrs. Maloney. And like you said, it would take away 
protections that the SEC has put in place to protect the 
American economy.
    Ms. Taub. One of the most difficult things is in any cost-
benefit analysis you need inputs and estimations. And you need 
good data, and there isn't yet good data on the incidence of 
fraud within firms. That could be banks or it could be other 
types of firms. And there are not good data on the amount of 
fraud.
    So when you look at a cost-benefit analysis it is not as if 
we are taking precise numbers, putting them into a computer and 
then boom, there is this precise answer. There are lots of 
estimations and incomplete data.
    And also these--but again, I think the SEC should engage in 
economic analysis. All I am saying is I don't think the problem 
with adding this on, creating--you know, it doesn't eliminate a 
private cause of action.
    Even previous iterations of bills might have, but forcing 
them to go through this particularly quantitative cost-benefit 
analysis portending to be able to reduce something to a bottom 
line figure, then becomes evidence in a APA case and so on.
    It may not, as Commissioner Gallagher says, slow the 
commission down at the beginning, but it certainly slows them 
down afterward when they are in court.
    Mrs. Maloney. Well, thank you, and I yield back the balance 
of my time.
    Chairman Garrett. The vice chairman is recognized for 5 
minutes.
    Mr. Hurt. Thank you, Mr. Chairman.
    Mr. Gallagher, Professor Taub in her testimony makes 
reference to a report prepared by Better Markets called, 
``Setting the Record Straight on Cost-Benefit Analysis and 
Financial Reform at the SEC.'' She goes on to state that the 
organization opines that what sounds like a benign cost-benefit 
analysis is actually an industry-only analysis.
    And I was wondering if you could comment on that and 
whether you agree with that characterization that a cost-
benefit analysis is just an industry-only analysis?
    Mr. Gallagher. Well, thanks for the question, Congressman. 
I am not familiar with the Better Markets reports. I don't 
spend time with special interest group reports like that 
because they are typically one-sided on their own. And so, you 
know, I think this all just boils down to, as I mentioned 
earlier, you know, just good government.
    And, you know, we have a disparate body of congressional 
mandates that the D.C. Circuit has interpreted to require the 
SEC to conduct an economic analysis today. I think what you are 
doing, what Chairman Garrett is doing with his bill is tying it 
all together and making it clear, making it followable and 
predictable.
    It doesn't mean--Professor Taub may be absolutely right 
that it changes a posture in a litigation that follows a 
rulemaking, but I don't think it is necessarily for the worst. 
I think it is such a bowl of spaghetti right now that it is 
incumbent upon Congress to clarify it.
    Mr. Hurt. Thank you. And I yield back the balance of my 
time.
    Chairman Garrett. The gentleman yields back.
    And the gentleman from California is recognized.
    Mr. Royce. Well, thank you very much, Mr. Chairman, 
appreciate it.
    And I had a question for Mr. Quaadman. You note in your 
written testimony that rule writing entities, such as the PCAOB 
and Municipals Securities Rulemaking Board are subject to the 
same requirements and enhancements contained in the SEC 
Regulatory Accountability Act. Could you please explain why 
that is beneficial and also should the SEC require FASB conduct 
similar cost-benefit analysis when setting accounting and 
reporting standards?
    Mr. Quaadman. Yes, thank you, Mr. Royce. So first off, we 
propose for any subordinate organization of the SEC that if 
they are involved in rule writing that has a force of 
regulation, there should be a cost-benefit analysis. So that 
would include FASB. I believe FINRA has committed to do that.
    The PCAOB, as an example, their standards have to go 
through the SEC rulemaking process before they go final, so you 
should have a cost-benefit analysis there.
    And as one example, the PCAOB, because they could not get 
standards done over the last several years for a variety of 
different reasons, had a very aggressive inspections program.
    And because they had a very aggressive inspections program 
2 years down the line, companies suddenly started to see that 
their internal control costs were going up by 300 percent.
    So that shows, number one, the dramatic impact the PCAOB 
could have on companies, but more importantly, why you need to 
have actions go through a formal process so you can understand 
what the costs and benefits are rather than through a circular 
route.
    Mr. Royce. So that is one of my concerns.
    Let me go to question Mr. Bartl. I am struck by the 
inherent conflict of interest that you described in your 
testimony when the ISS consulting arm uses its relationship 
with ISS research to sell business. Is this a common 
occurrence, I would ask? And do investment advisors take this 
into account when hiring a proxy advisory firm? And should 
they?
    Mr. Bartl. Thank you, Congressman Royce. I appreciate the 
question. And so I think the answer is we have seen a much more 
aggressive push by the consulting arm of ISS against the 
research side.
    The one email exchange that we included in our testimony is 
just an example. In fact, the irony is that that one was 
actually repeated to another company using the wrong company's 
ticker in rapid fire succession.
    I think what we have seen is that there are certain types 
of investors, pension funds particularly, that have a tendency 
to use Glass Lewis because of the lack of consulting arm there, 
even though there are other conflicts inherent in Glass Lewis, 
as we talked about in our testimony.
    And so I think there is a knowledge. In fact, when Glass 
Lewis came on the scene back in around 2002, that was one of 
the things that led to that occurrence. But both proxy advisors 
suffer from, you know, conflicts of interest that certainly 
deserve greater oversight and scrutiny. And that is, I think, 
one of the redeeming factors, one of the best reasons for 
Congressman Duffy's bill.
    Mr. Royce. And Mr. Gallagher, so you are saying it is that 
added transparency Mr. Bartl was saying or knowing a conflict 
exists as part of the solution here. Your thoughts quickly on 
how Mr. Duffy's bill helps get at that problem?
    Mr. Gallagher. Thank you for the question, Congressman. 
Look, I think it gets right to the heart of the matter with 
transparency and disclosure, the basic tenets of the securities 
laws. If there are conflicts, disclose them. If there are 
conflicts that Congress can't abide you might want to prohibit 
them, and that has happened, too, in other scenarios.
    But just the basic knowledge and disclosure of these 
conflicts can help investors and voters make better decisions. 
And we don't have that.
    Mr. Royce. Maybe, but I think there is more that has to be 
done here because there should be more competition in the proxy 
advisory space. But instead what we have created is a 
government-approved duopoly that is not serving investors.
    Do you go back to Mr. Bartl's testimony where he said we 
now have a check the box mentality with little review of the 
accuracy of proxy advisory firm reports. What could be done to 
change this dynamic to really introduce competition given the 
duopoly?
    Mr. Gallagher. In addition to the legislation that is being 
debated here, I think the SEC could rescind the two no-action 
letters that followed the 2003 rulemaking that basically 
created that duopoly for the two firms.
    And I think after that, I will tell you, Congressman, one 
positive thing is--a lot of this is couched in the negative. 
Since SLB 20 we have seen the adviser community pay more 
attention to these issues.
    We have seen the larger asset managers resource their 
voting function. We see the message trickling down to medium-
and small-size advisors that A, you don't have to vote every 
share every vote, that B, you can do things other than rotely 
relying. But I would take--
    Mr. Royce. Yes.
    Mr. Gallagher. --Mr. Bartl and Mr. Quaadman's word, you 
know, on its face that this still isn't enough.
    Mr. Royce. Well, in closing I would thank the chairman for 
holding this hearing, and I certainly want to thank my 
colleague for the legislation that he is putting forward here.
    Thank you, Mr. Duffy.
    Mr. Chairman, thank you.
    Chairman Garrett. Thank you.
    And with that, I will now yield 5 minutes to the sponsor of 
the legislation, Mr. Duffy.
    Mr. Duffy. Thank you, Mr. Chairman. I apologize. I had to 
step out for a little bit. Rarely have I been in this committee 
and been advocating for more regulation. This is, I think, a 
first for me, so duly noted.
    Mr. Bartl, just again, I think you have had several 
questions about conflicts of interest in regards to proxy 
advisors. Kind of lay that out for me again. You did it in your 
testimony, but lay out conflicts of interest in regard to proxy 
advisors?
    Mr. Bartl. Sure. I mean, there are really--and I really 
appreciate the bill and the question. There are really three or 
four depending on how you slice it. One is the role of ISS in 
providing consulting to companies, and on the other side 
providing research that is so-called independent and this 
firewall that, you know, so-called firewall that exists.
    Mr. Duffy. It doesn't exist.
    Mr. Bartl. Right. Well, and that is again why oversight is 
necessary. Probably even more importantly is this notion of 
providing consulting on shareholder proposals by investors, 
investor proponents and providing cursory disclosure on the 
fact that they do so because they then provide recommendations 
on those same proposals. And, you know, hopefully that is--
    Mr. Duffy. So in fact you could be giving advice on a 
shareholder proposal and then to other investors how they are 
going to vote on the proposal--
    Mr. Bartl. Right.
    Mr. Duffy. --and to the company in which it is effected?
    Mr. Bartl. That is correct.
    Mr. Duffy. And does this go to the highest bidder? I mean, 
if you pay the most money you win the day?
    Mr. Bartl. And again, we have the separation--
    Mr. Duffy. Right.
    Mr. Bartl. --that is there. But this is, you know, of the 
issues that probably have the most impact that is probably the 
one. And then you have beyond the operational side the 
ownership side, which is on the Glass Lewis front and its 
ownership by the Ontario Teachers' Pension Plan both a private 
equity and the--
    Mr. Duffy. Do they give advice on companies in which they 
invest?
    Mr. Bartl. They disclose the fact that they are giving 
advice on companies in which--
    Mr. Duffy. So they do.
    Mr. Bartl. --OTTP exists, or OTPP there.
    Mr. Duffy. Does the panel all agree that this is a problem? 
That there is a conflict of interest here? Shaking--
    Mr. Quaadman. Yes. Mr. Duffy--
    Mr. Duffy. So we are--
    Mr. Quaadman. --I agree with Mr. Bartl's characterization. 
I would also just add, too, Glass Lewis. They are owned by an 
activist investor fund. And we had actually written twice to 
the SEC in 2011 and 2012 asking them to look into the apparent, 
or at least the appearance of, a conflict of interest with 
activities by the Ontario Teachers' Pension Fund and also Glass 
Lewis recommendations as well.
    Mr. Duffy. So we are looking at a lot of companies and a 
lot of shares. Do these proxy advisory firms have the staff to 
provide adequate advice, Mr. Quaadman?
    Mr. Quaadman. As I had mentioned earlier, you have one firm 
that has 180 analysts looking at tens of thousands of companies 
globally, making recommendations on 250,000 shareholder 
proposals and director elections over a very compressed time 
period. And you would just have to look at that as you can't 
possibly do the due diligence that you need to do.
    The other thing is, as others have mentioned here, there is 
an extremely high error rate. And I have to say Mr. Retelny at 
ISS has made some changes over the last year where they are 
starting to issue new reports where there is an error that has 
been found and fixed.
    But that was not done up until about a year ago.
    Mr. Duffy. So the answer is they don't have the staffs, 
right? I mean, they are not big enough?
    Mr. Quaadman. The other--
    Mr. Duffy. Mr. Gallagher?
    Mr. Quaadman. I would just--
    Mr. Gallagher. Yes.
    Mr. Duffy. Go ahead.
    Mr. Gallagher. That question, anecdotally I hear they do 
not, but again, everything I have heard is just an anecdote. I 
haven't gone to the physical plant. They are not SEC 
registrants other than the registered investment adviser 
subsidiary of ISS.
    Mr. Duffy. So you had a different Chair in the not too 
distant past at the SEC. Is it your opinion that the SEC can 
act without legislation or do you think that we have to have 
legislation here to instruct the SEC to act on this issue?
    Mr. Gallagher. So this is the metaphysical question I have 
been wrestling with for years because I was trying to get the 
SEC to act in a manner that would obviate legislation. I think 
the SLB 20 was a step forward. You know, rescinding the no-
action letters, revisiting the 2003 rulemaking and the 
interpretation thereof would have been other positive steps, 
but they were not taken.
    But to tell you the truth, at the end of the day even if 
all of that had been done you would probably be sitting here 
today debating legislation.
    Mr. Duffy. And do we agree this has a huge impact on 
corporate governance, that you have two firms that control 97 
percent of proxy advice?
    Mr. Gallagher. Absolutely.
    Mr. Duffy. Two firms?
    Mr. Bartl. Yes.
    Mr. Gallagher. Yes.
    Mr. Quaadman. Yes.
    Mr. Duffy. And so it would be incumbent upon us to actually 
take action, instruct the SEC to make rules and let us get this 
taken care of. Anyone disagree with that?
    Mr. Bartl. No.
    Mr. Gallagher. No.
    Ms. Taub. I do.
    Mr. Duffy. Okay. Go ahead.
    Ms. Taub. I am not an anti-trust expert and I don't 
recall--
    Mr. Duffy. My time is up. If I could have 1 minute and let 
her--
    Ms. Taub. Well, so--
    Mr. Duffy. --answer the question--
    Chairman Garrett. If she says she is going to agree--
    [laughter]
    Now--
    Ms. Taub. I don't want to take your time.
    Chairman Garrett. No, no, I am sorry. You have the 
additional minute to respond.
    Mr. Duffy. I am sure the ranking member wouldn't oppose 
either.
    Ms. Taub. Thank you. I mean, I don't recall referring to 
the two companies as a monopoly. I think that is referencing 
something someone else had said. But in terms of this, if you 
are concerned about two firms having a larger share, having the 
majority of, you know, 90 plus percent share of the market, 
then I don't see how creating a more complex regulatory regime 
that would, you know, possibly create barriers to entry solves 
that particular problem.
    Also I am hearing two different things. I am hearing folks 
say we need more people doing this. And then I am also hearing 
it is not possible to be done. But what is the status quo if 
these firms don't exist?
    Large institutional investors are choosing to rely on them 
as one data point. Smaller investors rely on them. What would 
happen to small investment funds?
    Would they have to create, you know, duplicative in-house 
proxy voting staffs that were going to read all of these, you 
know, all these proxies? There is nothing wrong with going to a 
third party and getting investment advice.
    As for the conflicts of interes, let me just say--
    Chairman Garrett. Sure.
    Ms. Taub. --other fields there are conflicts of interest 
and how are they dealt with and whether it is law or finance? 
The first step is disclosure. And if we look not just at the--
    Mr. Duffy. And you agree with disclosure, right?
    Ms. Taub. I agree with disclosure--
    Mr. Duffy. Disclose conflict?
    Ms. Taub. --and I would also agree with the first step is 
best practices. And if you look at what is happening in Europe, 
you look in the U.S., Glass Lewis and others--
    Mr. Duffy. And I want to give Mr. Gallagher--
    Ms. Taub. --are part of--yes.
    Mr. Duffy. --a chance. Are you a lawyer?
    Ms. Taub. Yes, I am.
    Mr. Duffy. As am I. It was pretty tough. I never could 
represent two clients in the same case. It was a conflict of 
interest. Invariably they have competing interests and you 
can't represent both of them aggressively. And that is why we 
say, listen. You have to pick one.
    Mr. Gallagher, want to quickly respond? Do you agree with 
Professor Taub?
    Mr. Gallagher. Yes. I agree on that conflict analysis and 
just want to point out that one of--there are two big things 
that came out of SLB 20. It was clarification from the 
commission to the advisory community that despite what you read 
into the 2003 rulemaking, this wasn't Department of Labor. This 
wasn't the Avon letter.
    You don't have to vote every share every vote. Well, that 
is still not going to be appetizing to most advisors. They are 
going to feel they need to vote.
    The second part was that we said you can predetermine your 
voting. You can tell your clients, your advisory clients, we 
are going to vote with management every time. You can tell them 
we are going to vote with CalPERS every time. It can suit your 
fiduciary duty, as Mr. Bartl said earlier.
    We haven't seen that take up. That would obviate the 
necessary reliance on ISS and Glass Lewis. We haven't seen it 
yet, so--
    Mr. Duffy. As always, great point, Mr. Gallagher. Fantastic 
panel. Thank you for all of your agreement.
    With that I yield back.
    Chairman Garrett. Thank you. The gentleman yields back.
    I will concur, this was a great panel. Thank you for your 
input and your information.
    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 being said, thank you again. And this hearing is 
adjourned.
    [Whereupon, at 5:12 p.m., the hearing was adjourned.]














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