Testimony of SEC Chairman Christopher Cox

Tuesday, September 23, 2008; 10:37 AM

Testimony of Christopher Cox, Chairman of the U.S. Securities and Exchange Commission before the Committee on Banking, Housing, and Urban Affairs, United States Senate, September 23, 2008

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, thank you for inviting me here to today to discuss the turmoil in the U.S. credit markets and the efforts of the Securities and Exchange Commission, in concert with the Department of the Treasury, the Federal Reserve, and other regulators to protect investors and our markets. I should say at the outset that my testimony is on my own behalf as Chairman of the SEC, and does not necessarily represent the views of the Commission or individual Commissioners.

Last week, by unanimous decision of the Commission and with the support of the Secretary of the Treasury and the Federal Reserve, the SEC took temporary emergency action to ban short selling in financial securities. We took this action in close coordination with regulators around the world. At the same time, the Commission unanimously approved two additional measures to ease the crisis of confidence in the markets that threatened the viability of all financial firms, and which potentially threatened the ability of our markets to function in a fair and orderly manner. The first makes it easier for issuers to repurchase their own shares on the open market, which provides an important source of liquidity in times of market volatility. The second requires weekly reporting to the SEC by hedge funds and other large investment managers of their daily short positions ¿ just as long positions are currently reported quarterly on Form 13F.

All of these actions relying upon the Commission's Emergency Authority under Section 12(k) of the Securities Exchange Act remain in effect until October 2, and are intended to stabilize the markets until the legislation you are crafting becomes law and takes effect.

The Commission's recent actions followed on the heels of new market-wide SEC rules that more strictly enforce the ban on abusive naked short selling contained in Regulation SHO. These new rules require a hard T+3 close-out; they eliminate the options market maker exception in Regulation SHO; and they have put in place a new anti-fraud rule expressly targeting fraudulent activity in short-selling transactions.

First and foremost, the SEC is a law enforcement agency, and we have devoted an extraordinary level of enforcement resources to hold accountable those whose violations of the law have contributed to the subprime crisis and the loss of confidence in our markets. We have over 50 pending law enforcement investigations in the subprime area. Our Office of Compliance Inspections and Examinations has initiated examinations of the effectiveness of broker-dealers' controls to prevent the spread of false information intended to manipulate securities prices. The Division of Enforcement has undertaken a sweeping investigation into market manipulation of financial institutions, focused on broker-dealers and institutional investors with significant trading activity in financial issuers and with positions in credit default swaps. The reason for this aggressive enforcement investigation is the significant opportunities that exist for manipulation in the $58 trillion CDS market, which is completely lacking in transparency and completely unregulated.

Our subprime enforcement efforts fall primarily into three broad categories: first, subprime lenders; second, investment banks, credit rating agencies, insurers and others involved in the securitization process; and third, banks and broker-dealers who sold mortgage-backed investments to the public.

We are investigating whether mortgage lenders properly accounted for the loans in their portfolios, and whether they established appropriate loan loss reserves. In connection with the sale of mortgage-backed securities and collateralized debt obligations, we are investigating the role of the various parties involved in the securitization process. Among other things, we are focused on whether lenders adequately disclosed the risk profiles of underlying loans, whether they valued their portfolios appropriately, and whether they made adequate risk disclosures to investors. We are also investigating whether investment banks and broker-dealers defrauded retail customers by making false representations, or by putting investors into unsuitable mortgage-backed investments.

Last month, the Enforcement Division, working with state regulators from around the country, entered into agreements that when finalized will be the largest settlements in the history of the SEC, in behalf of investors who bought auction rate securities from Merrill Lynch, Wachovia, UBS and Citigroup. The terms of these agreements would provide complete recovery for individual investors. Our Enforcement Division is continuing to investigate other firms.

Recently the Commission brought enforcement actions against two portfolio managers of Bear Stearns Asset Management, whose hedge funds collapsed in June of last year. We allege that they deceived their investors and institutional counterparties about the financial state of the hedge funds, and in particular the hedge funds' over-exposure to subprime mortgage-backed securities. The collapse of the funds caused investor losses of over $1.8 billion.

The Commission is likewise using our regulatory authority to ensure that the market continues to function in a fair and orderly manner. Last week, the Commission's Office of Chief Accountant provided guidance to clarify the accounting treatment of banks' efforts to support their money market mutual funds. The guidance clarified how banks should treat, for purposes of their balance sheets, the financial support they provide to money market funds within the same financial services complex. This will help assure banks that assistance to money market funds does not automatically trigger adverse accounting results. Clarity on this subject is important to protect investors in money market funds.

In the past week, the SEC, working with the Federal Reserve, oversaw the sale of substantially all of the assets of Lehman Brothers, Inc., to Barclays Capital. This quick result, following the Lehman bankruptcy, has brought immediate and significant benefits to Lehman's brokerage customers and the capital markets. The hundreds of thousands of Lehman's customer accounts can now be transferred, instead of going through a lengthy brokerage liquidation process that could take weeks and impair customer access to cash and securities. The transfer of most retail accounts, which hold over one hundred billion dollars in assets, is expected to be completed within days.

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