Hearing on Saving Investors Money and Strengthening the SEC

Chairman Gramm, Members of the Committee, thank you for the invitation to testify before you today on the subject of Securities and Exchange Commission (SEC) transaction fees. I appreciate this opportunity to present the views of the Security Traders Association (STA), and I applaud you for scheduling a hearing on this important issue in the first weeks of the 107^th Congress.

I also want to thank you Mr. Chairman for your efforts to enact legislation to provide meaningful and equitable fee relief. STA supported S. 2107, the Competitive Market Supervision Act, last year, and was heartened to see you and Senator Schumer reintroduce this legislation as S. 143 last month. S. 143 is a balanced and workable proposal, which I will discuss later in my testimony.

I am Lee Korins, President and CEO of the Security Traders Association - the STA is composed of 30 regional affiliates and over 7,000 individual members throughout North America and Europe. It is the largest group of its kind in the world. Our membership represents all facets of the securities industry. While many members are traders for securities firms and institutions, others are partners, specialists, floor traders, proprietors or registered representatives - all of whom are charged with the responsibility of executing orders at the fairest prevailing prices. The fact is that no one speaks for individual professionals in the securities industry with more credibility than STA.

Today, I want to briefly discuss:

• the history and evolution of SEC fees;

In 1996, Congress enacted the National Securities Markets Improvement Act (NSMIA) reforming regulation of the securities and mutual fund markets. NSMIA also modified the SEC fee structure – including extension to NASDAQ trades of the transaction fees imposed by Section 31 of the Securities Exchange Act of 1934. The SEC reauthorization was the result of a complex deal worked out between House and Senate authorizers and appropriators, the Office of Management and Budget (OMB), and the SEC, following years of Congressional wrangling over a new SEC funding mechanism. Unfortunately, however, the 1996 legislation has not functioned as intended.

Since the 1930s the federal government has levied SEC fees on the regulated community, including registration fees authorized by Section 6(b) of the Securities Act of 1933, and transaction fees authorized by Section 31 of the Securities Exchange Act of 1934. These fees were deposited in the Treasury's General Fund as general revenues. The SEC received no credit for collected fees and could not directly use the funds, but rather was funded through an annual appropriation. Since 1983, the SEC has been a net contributor to the Treasury, collecting far more fees than necessary to cover its budget.

In 1990, the budget rules were significantly changed. Specifically, the 1990 Budget Enforcement Act set limitations on specific spending categories and created "pay-as-you-go" procedures to require offsets for decreases in revenue or increases in entitlement spending. These rules put severe restraints on discretionary spending, forcing appropriators to choose among competing programs. The SEC was thus forced to compete for discretionary funding with the Departments of Commerce, Justice and State, which are funded in the same annual appropriations legislation as the SEC.

Beginning in 1990, the appropriators decided to respond to the problem of insufficient resources to fund competing programs by imposing annual rate increases in the Section 6(b) registration fee in each year’s Commerce, Justice, and State Appropriations Bill. The amounts attributable to such increases were credited against the agency's appropriation account as an offsetting collection. Offsetting collections are deposited in special appropriations accounts, as opposed to the General Fund, and are available to appropriators to finance agency activities. This funding mechanism increased the overall funds available to the Appropriations Committees. This practice eventually led to objections by various Members of Congress on both jurisdictional and policy grounds. Since the agency was collecting far more in fees than its budget required, opponents argued that the annual SEC fee increases contained in appropriations bills constituted a tax. Members began to call for a new SEC funding structure that allowed the government to cover the costs of the SEC's regulatory activities without artificially inflating the cost of raising capital in the markets. In 1993, the House Energy and Commerce Committee, under the leadership of then-Chairman Dingell and Representative Bliley, crafted a bill which would have established a mechanism by which the SEC would set and collect fees solely to recover the costs of its regulatory activities. The House unanimously passed this bill.

During that same year, the House and Senate again passed an SEC appropriations measure which raised registration fees and credited the amount as an offsetting collection. Both House Ways and Means and House Energy and Commerce Committee members lodged complaints, and language was included in the conference report on the Commerce, Justice, and State Appropriations Bill indicating that the practice would be ended.

When the Commerce, Justice, and State Appropriations Bill for FY 1995 came to the floor of the House on June 28, 1994, the bill again contained a provision that would have imposed additional registration fees as offsetting collections. House Members succeeded in striking the provision from the House bill on procedural grounds, and subsequently prevailed in an effort to keep the provision out of the conference agreement. This move left the SEC with an appropriation of $60 million, significantly below the $297 million originally provided by appropriators. The agency indicated that it would have to severely restrict its operations beginning in October 1994 absent congressional action.

This funding crisis prompted Congress, to pass a stop-gap measure (P.L. 103-352), authorizing a registration fee increase for another year, in order to fund the Commission through 1995. House Report 103-739 indicated that this was done as a one-time fix to avert an SEC shutdown, and contemplated passage in the next Congress of an SEC reauthorization that would "eliminate the need for one-year-at-a-time increases in registration fees." The stage was thus set for an SEC reauthorization that would establish a predictable and adequate fee structure to recover funds solely to offset the cost of the Commission's regulatory activities.

In 1995, control of Congress shifted to the Republican Party and the legislative agenda was crowded, leaving unaddressed the SEC fee issue. However, in light of the prior year's funding crisis, the Administration's FY 1996 budget proposal stressed the need for a sound, stable and long-term funding structure for the SEC. The FY 1996 Commerce, Justice, and State Appropriations Bill (H.R. 2076), was vetoed by the President due to unrelated policy disputes, and the SEC's FY 1996 budget was funded by a series of continuing resolutions. Ultimately, Congress and the President agreed to an omnibus spending bill (H.R. 3019) that funded the SEC for the remainder of the year.

In 1996, then-House Commerce Committee Chairman Bliley (R-VA) introduced H.R. 2972, the SEC Reauthorization Act. The bill was designed to end the appropriators' practice of funding SEC activities through the yearly ritual of raising registration fees as offsetting collections. The proposal would have: reduced Section 6(b) registration fees over a 6-year period; incrementally extended the Section 31 transaction fees to NASDAQ trades; and reduced the rate for all transaction fees beginning in 2002. In total, the package was projected to reduce fee collections by $751 million by 2002. Initially, a portion of the fees was to be deposited as offsetting collections. Beginning in 2002, all fees would be deposited in the General Fund and no fees would be allotted as offsetting collections.

Mr. Chairman, in 1996 you introduced S. 1855, a bill that would have also reduced SEC fees. However, in response to concerns by the Clinton Administration you and then-Senate Banking Committee Chairman D'Amato (R-NY) agreed to postpone consideration of the legislation. The Administration expressed concern that ending the offsetting collections funding practice would require appropriators to fund the SEC's full budget out of the General Fund, subject to the discretionary spending caps, forcing reductions in other programs.

The House passed H.R. 3005, the Securities Amendments of 1996, on June 19, 1996, but not before adding the SEC reauthorization provisions originally embodied in H.R. 2972. The Senate amended and passed H.R. 3005 without the fee provisions on June 27, 1996, setting up a conference in which the SEC fee issue would have to be resolved. The fee issue was highly controversial in conference. Negotiations among House and Senate authorizers and appropriators, the OMB, and the SEC held up the bill for weeks and threatened to entirely derail the legislation. An agreement was finally reached on the fee issue and the bill was passed in the closing days of the 104th Congress. H.R. 3005 became P.L. 104-290 – the National Securities Markets Improvement Act when the President signed the bill on October 11, 1996.

Under the complex deal worked out in conference, transaction fee rates were fixed until FY 2007, and decreased thereafter. NSMIA specified that a portion of the registration fee is deposited as General Fund revenue, and a portion is made available to appropriators as offsetting collections. Transaction fees remain at 1/300^th of 1% until FY 2007, when they are reduced to 1/800^th of 1%. Beginning in 1997, NASDAQ trades became subject to the full transaction fee rate. While the exchange transaction fees are collected as General Fund revenue, the NASDAQ transaction fees are deposited as offsetting collections. (However, this will change when the NASDAQ converts to an exchange later this year and those transaction fees will be deposited in the General Fund, and therefore be unavailable to the appropriators.) By pushing general revenue losses into the out-years, the new fee structure minimized budget-scoring concerns.

Unfortunately, actual fee collections have significantly outpaced the Congressional Budget Office’s (CBO) and OMB's conservative estimates of market growth relied on by this Committee and Congress in enacting NSMIA. In FY 2000, actual collections from all sources (including Section 31, Section 6(b) and merger and tender fees) grew to $2.27 billion dollars - over six times the SEC's budget of $377 million. The latest CBO estimates show runaway growth in the fees from $2.478 billion in FY 2001 to $3.769 billion in FY 2005. In other words, total SEC fees are projected to raise $15.2 billion over the next five years ostensibly to finance an agency that will require only a fraction of that amount over the same period. These excessive and growing fee collections will remain a tax on savings and investment unless Congress takes action.

Today’s fee collection surplus was not anticipated because the government’s budget projections used overly conservative estimates of the dollar volume growth in the markets. The markets have experienced remarkable dollar volume growth over the last few years. For example, total volume on the NASDAQ increased from 272.6 billion shares in 1999, to 439.6 billion in 2000. This 60% increase in NASDAQ trading volume occurred even as the value of the NASDAQ index plummeted by 50%.

With volume growth driving fee receipt growth, it is not surprising that budget estimates routinely fall short of actual fee collections and must be continually revised upward. A set of fee projections for FY 2001–2007 illustrates this trend, and the constantly expanding fee surplus:

Looking at FY 2001, the 1999 estimate for fees for that year were two and a half times greater than estimated in NSMIA just three years earlier. Now the latest CBO estimate for FY 2001 shows that fee receipts will be about 25% higher than estimated in 1999 and three times greater than the 1996 NSMIA estimate.

Clearly, this is not the scenario this Committee intended when it fought to redesign the SEC funding structure in 1996 to reduce the amount of the fee surplus. I want to emphasize that the issue here is not SEC funding. Indeed Mr. Chairman, the legislation you have sponsored with Senator Schumer protects SEC funding. Section 5 of S. 143 safeguards against overcollections or undercollections of the fees. This provision is one of the most important in the proposed legislation to avoid repeating the mistakes of prior fee restructuring efforts – it eliminates the need to have absolutely accurate long-term projections of market activities – something that simply cannot be done. Section 5 ensures that the restructured fees will fund the SEC without turning the fees into a general revenue tax – regardless of the accuracy of budget projections.

For the record, I will state unequivocally that the industry and all investors consider it their duty to pay for continued self-funding for the SEC. That has never been in question, the discussion focuses only on the level of collections.

Section 31 transaction fees operate as a tax on the gross trading revenue of securities professionals. One STA member firm which makes markets in about 100 NASDAQ stocks estimated that its Section 31 fee payments amounted to 40% of its net OTC trading profits before the allocation of overhead. Another firm found that its Section 31 fee payments were twice the amount of its rental payments for the building housing its trading activities. Section 31 fees operate as a gross receipts tax, with traders reporting rates of 3.5%, and as high as 6% of gross revenues. As a gross receipts tax, the fees are paid before federal and state taxes, before salary, and before allocations for overhead. Because of this, market makers and specialists face potential losses in a down market as margins get further squeezed even as their trading volumes and transaction fees can continue to increase. This is a perverse scenario and onerous burden on the very traders who provide liquidity in the markets for hundreds of stocks.

Excessive fees also reduce liquidity in the market. The major impact falls on the thinly traded stocks of small start-up companies. Therefore, the fees deter capital from flowing to the entrepreneurial, high technology companies that have driven the new economy and given us the longest expansion in U.S. history.

But ultimately, the investing public shoulders this burden. Section 31 fees are a tax on personal savings and investment in the form of lower returns. And as more Americans invest, more people pay this tax. Indeed, recent Federal Reserve data show that the percentage of households owning equities has increased from around 32% in 1989 to 41% in 1995 and to over 50% in 2000. It is important to note that Americans of all income levels are increasing their savings through equity ownership. According to some of the most recent statistics, 29% of households with incomes between $15,000 and $25,000 own stock.

What is the impact of these fees on people saving through mutual funds? Take for example two widely held mutual funds, the Vanguard Windsor II Fund and the Vanguard Growth Fund. Each pays close to one quarter of a million dollars annually in these fees – fees paid by investors through reduced earnings. And just as more Americans are owning equities, more people are also saving through mutual funds. 49% of U.S. households, or approximately 50 million households own mutual funds. 17% of U.S. households with incomes below $25,000 owned mutual funds in 2000. This is up from 13% of households in that income bracket just two years earlier. So this is not a tax on the wealthy. It is paid by the smallest as well as the largest market participants in the country.

Section 31 fees are not only a drag on savings through equities and mutual funds, they also hurt those who participate in pension plans, including public pension plans. For example, over a five-year period the following states’ public pension plans will pay millions of dollars of Section 31 fees:

• New York – over $13 million;

• California – nearly $18 million;

• New Jersey – over $2.5 million;

• Michigan – nearly $5 million;

• Pennsylvania – approximately $6.5 million; and

• Connecticut – over $1 million.

Finally, SEC Chairman Arthur Levitt’s testimony last year noted that individual investors pay 87% of the fees levied on NYSE trades. This clearly illustrates where the burden of these fees falls.

At a time when the government is encouraging savings and planning for the future, it is inconsistent for it to levy this pernicious tax on investment.

STA strongly supports S. 143. This legislation provides meaningful fee relief, while ensuring that the SEC continues to have the resources necessary to supervise and regulate the securities markets. Indeed, the fee levels set in S. 143 will accommodate the recent significant increases in the SEC’s budget and the "pay parity" provision that is also a part of this legislation. Furthermore, S. 143 addresses concerns raised by Members of the Appropriations Committees by ensuring that they will continue to receive the same level of fees designated as offsetting collections as included in the most recent budget baseline. Indeed, as mentioned earlier in my testimony, without a change in current law, the conversion of the Nasdaq to an exchange will automatically deprive the appropriators of nearly all the offsetting collections they now receive.

As I also mentioned earlier, we applaud the inclusion of a fee cap and floor concept that insures against the unintended overcollection of fees while protecting the SEC from any possible shortfall. Given the recent track record of budget projections, this is a prudent safeguard to ensure that the legislation fulfills its intent. In sum, S. 143 would move the fee collection system towards its original purpose: providing a stable source of funding for the SEC, derived from a constituency that benefits from its oversight and regulation.

In closing, Mr. Chairman, STA applauds you for scheduling this prompt hearing on an issue of great importance to our members across the United States. Thank you, and I will be happy to answer any questions.

Home | Menu | Links | Info | Chairman's Page