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Report to the Chairman, U.S. Securities and Exchange Commission: 

May 2005: 

Financial Audit: 

Securities and Exchange Commission's Financial Statements for Fiscal 
Year 2004: 

GAO-05-244: 

GAO Highlights: 

Highlights of GAO-05-244, a report to the Chairman of the Securities 
and Exchange Commission: 

Why GAO Did This Study: 

Established in 1934 to enforce the securities laws and protect 
investors, the Securities and Exchange Commission (SEC) plays an 
important role in maintaining the integrity of the U.S. securities 
markets. 

Pursuant to the Accountability for Tax Dollars Act of 2002, the SEC is 
required to prepare and submit to Congress and the Office of Management 
and Budget audited financial statements. GAO agreed, under its audit 
authority, to perform the initial audit of SECís financial statements. 
GAOís audit was done to determine whether, in all material respects, 
(1) SECís fiscal year 2004 financial statements were reliable, (2) 
SECís management maintained effective internal control over financial 
reporting and compliance with laws and regulations, and (3) SECís 
management complied with applicable laws and regulations. 

What GAO Found: 

In GAOís opinion, SECís fiscal year 2004 financial statements were 
fairly presented in all material respects. However, because of material 
internal control weaknesses in the areas of recording and reporting 
disgorgements and penalties, preparing financial statements and related 
disclosures, and information security, in GAOís opinion, SEC did not 
maintain effective internal control over financial reporting as of 
September 30, 2004. SEC did maintain in all material respects effective 
internal control over compliance with laws and regulations material in 
relation to the financial statements as of September 30, 2004. In 
addition, GAO did not find reportable instances of noncompliance with 
laws and regulations it tested. 

SEC prepared its first complete set of financial statements for fiscal 
year 2004 and made significant progress during the year in building a 
financial reporting structure for preparing financial statements for 
audit. However, GAO identified inadequate controls over SECís 
disgorgements and civil penalties activities, increasing the risk that 
such activities will not be completely, accurately, and properly 
recorded and reported for managementís use in its decision making. In 
addition, GAO identified inadequate controls over SECís financial 
statement preparation process including a lack of sufficient documented 
policies and procedures, support, and quality assurance reviews, 
increasing the risk that SEC management will not have reasonable 
assurance that the balances presented in the financial statements and 
related disclosures are supported by SECís underlying accounting 
records. 

GAO also found that SEC has not effectively implemented information 
system controls to protect the integrity, confidentiality, and 
availability of its financial and sensitive data, increasing the risk 
of unauthorized disclosure, modification, or loss of the data, possibly 
without detection. The risks created by these information security 
weaknesses are compounded because the SEC does not have a comprehensive 
monitoring program to identify unusual or suspicious access activities. 

SEC is currently working to improve controls in all these areas. 

www.gao.gov/cgi-bin/getrpt?GAO-05-244. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Jeanette M. Franzel at 
(202) 512-9406 or franzelj@gao.gov. 

[End of section]

Contents: 

Letter: 

Auditor's Report: 

Opinion on Financial Statements: 

Opinion on Internal Control: 

Material Weaknesses: 

Compliance with Laws and Regulations: 

Consistency of Other Information: 

Objectives, Scope, and Methodology: 

SEC Comments and Our Evaluation: 

Management's Discussion and Analysis: 

Financial Statements: 

Balance Sheet: 

Statement of Net Cost: 

Statement of Changes in Net Position: 

Statement of Budgetary Resources: 

Statement of Financing: 

Statement of Custodial Activity: 

Notes to the Financial Statements: 

Required Supplemental Information: 

Appendix: 

Appendix I: Comments from the Securities and Exchange Commission: 

Letter May 26, 2005: 

The Honorable William H. Donaldson: 
Chairman: 
U.S. Securities and Exchange Commission: 

Dear Mr. Donaldson: 

This report presents our opinion on whether the financial statements of 
the Securities and Exchange Commission (SEC) are presented fairly for 
the fiscal year ended September 30, 2004. This report also presents (1) 
our opinion on the effectiveness of SEC's internal control over 
financial reporting and compliance as of September 30, 2004, (2) our 
evaluation of SEC's compliance with selected laws and regulations 
during 2004, and (3) weaknesses in financial reporting controls 
detected during our 2004 audit. 

The Accountability of Tax Dollars Act of 2002 requires that SEC prepare 
and submit to Congress and the Office of Management and Budget (OMB) 
audited financial statements. Fiscal year 2004 was the first year SEC 
prepared its first complete set of financial statements. GAO agreed, 
under its audit authority, to perform the initial audit of SEC's 
financial statements. GAO conducted this audit in accordance with U.S. 
generally accepted government auditing standards and OMB audit 
guidance. The accomplishment of the first-ever audit of SEC's financial 
statements was made possible by the tremendous dedication of time and 
effort from both SEC management and staff. 

We are sending copies of this report to the Chairman and Ranking 
Minority Members of the Senate Committee on Banking, Housing, and Urban 
Affairs; the Senate Committee on Homeland Security and Governmental 
Affairs; the House Committee on Financial Services; and the House 
Committee on Government Reform. We are also sending copies to the 
Secretary of the Treasury, the Director of the Office of Management and 
Budget, and other interested parties. In addition, this report will be 
available at no charge on the GAO Web site at [Hyperlink, 
http://www.gao.gov]. 

This report was prepared under the direction of Jeanette M. Franzel, 
Director, Financial Management and Assurance, who can be reached at 
(202) 512-9406 or [Hyperlink, franzelj@gao.gov]. If I can be of further 
assistance, please call me at (202) 512-5500. 

Sincerely yours,

Signed by: 

David M. Walker: 
Comptroller General of the United States: 

[End of section]

Auditor's Report To the Chairman of the U.S. Securities and Exchange 
Commission: 

In our audit of the U.S. Securities and Exchange Commission (SEC) for 
fiscal year 2004, we found: 

* the financial statements as of and for the fiscal year ended 
September 30, 2004, including the accompanying notes, are presented 
fairly, in all material respects, in conformity with U.S. generally 
accepted accounting principles;

* SEC did not have effective internal control over financial reporting 
(including safeguarding of assets), but had effective control over 
compliance with laws and regulations that could have a material effect 
on the financial statements as of September 30, 2004; and: 

* no reportable noncompliance with laws and regulations we tested. 

The following sections discuss in more detail (1) these conclusions as 
well as our conclusions on Management's Discussion and Analysis and 
other supplementary information and (2) the objectives, scope, and 
methodology of our audit. 

Opinion on Financial Statements: 

The SEC's balance sheet as of September 30, 2004, and its related 
statements of net cost, changes in net position, budgetary resources, 
financing, and custodial activity, with accompanying notes for the 
fiscal year then ended, are presented fairly, in all material respects, 
in conformity with U.S. generally accepted accounting principles. 

However, misstatements may nevertheless occur in other financial 
information reported by SEC as a result of the internal control 
weaknesses described in this report. 

Opinion on Internal Control: 

SEC prepared its first complete set of financial statements for fiscal 
year 2004 and made significant progress during the year in building a 
financial reporting structure for preparing financial statements for 
audit. However, because of the material weaknesses in internal control 
discussed below, in our opinion, SEC did not maintain effective 
internal control over financial reporting (including safeguarding of 
assets) as of September 30, 2004. Consequently, SEC's internal control 
did not reduce to a relatively low level the risk that misstatements 
material to the financial statements may occur and not be detected on a 
timely basis by employees in the normal course of performing their 
assigned functions. We did find that SEC maintained in all material 
respects effective internal control over compliance with laws and 
regulations that could have a direct and material effect on the 
financial statements as of September 30, 2004.[Footnote 1] The material 
weaknesses in internal control noted above may adversely affect 
unaudited information used by SEC for decision making. 

Despite the specific issues with internal control, SEC was able to 
prepare, in part through tremendous dedication of time and effort from 
SEC staff, financial statements that were fairly stated in all material 
respects for fiscal year 2004. 

Material Weaknesses: 

The material weaknesses we have identified and discuss in this report 
relate to SEC's internal control over (1) recording and reporting of 
disgorgements and penalties, (2) information security, and (3) 
preparing financial statements and the related disclosures. These 
material weaknesses were considered in determining the nature, timing, 
and extent of audit tests applied in our audit of SEC's fiscal year 
2004 financial statements, and our opinion on internal control does not 
affect our opinion dated February 11, 2005, on these financial 
statements. The details surrounding these weaknesses are being reported 
separately to SEC management, along with recommendations for corrective 
actions. Less significant matters involving SEC's system of internal 
controls and its operations will also be reported to SEC separately. 

Disgorgements and Penalties: 

As part of its enforcement responsibilities, SEC issues and administers 
judgments ordering, among other things, disgorgements, civil monetary 
penalties, and interest against violators of federal securities laws. 
These transactions involve material amounts of collections and reported 
fiduciary and custodial liability balances on the financial statements. 
Since fiscal year 2003, SEC has made significant progress towards 
documenting financial information concerning moneys owed and paid in 
connection with disgorgement and penalty enforcement actions.[Footnote 
2] SEC's work in this area, which continued during fiscal year 2004, 
includes a process of upgrading its disgorgements and penalties 
database to allow for accurate, timely, and proper reporting of 
disgorgements and penalties data, and entering financial data on over 
12,000 parties in SEC enforcement issues. SEC's progress in addressing 
data reliability concerns over disgorgements and penalties data is 
encouraging, and it should continue to work to assure that data are 
accurate, timely, and properly reported. 

In August 2004, SEC's Office of Financial Management assumed 
responsibility for entering and maintaining financial data on 
disgorgements and penalties, and making the necessary calculations and 
adjustments for the preparation of its financial statements. To 
compensate for limitations in the disgorgements and penalties database, 
SEC staff performed extensive manual procedures to compile quarterly 
subsidiary ledgers to update the accounting system for disgorgement-and 
penalty-related balances and activity. While SEC had a draft policy 
covering certain aspects of accounting for disgorgements and penalties, 
the policy was not comprehensive and did not include the process and 
controls for determining the amounts to be recorded and for reviewing 
the disgorgement and penalty financial information and related 
accounting entries. Not having comprehensive policies and controls 
increases the risk that disgorgement and penalty transactions will not 
be completely, accurately, and consistently recorded and reported. 

Although we were able to obtain sufficient audit support for the 
estimated net amounts receivable from disgorgements and penalties, we 
found errors in the recorded balances for the related gross accounts 
receivable and allowance for loss. Specifically, we noted errors and 
inconsistent treatment in recording judgment and interest amounts, 
terminated debts, and collection fees imposed by Treasury. In most 
cases, these errors and inconsistencies were offsetting; however, such 
errors raise concern about the controls over the reliability of the 
gross accounts receivable and related allowance amounts reported in 
footnote 3 to the financial statements. 

Establishing controls over the recording of disgorgement and penalty 
activity, if properly designed and implemented, should provide 
reasonable assurance that disgorgement and penalty transactions are 
recorded in a complete, accurate, and timely manner for management's 
use in decision making and tracking of operations, and to facilitate 
the preparation of financial statements and related disclosures. The 
process should also include maintaining supporting documentation that, 
in reasonable detail, accurately reflects the transactions that are 
recorded, and evidences supervisory review. 

Information Security: 

SEC relies extensively on computerized information systems to process, 
account for, and report on its financial activities. GAO's Standards 
for Internal Control in the Federal Government[Footnote 3] provide an 
overall framework for establishing and maintaining internal control, 
including a discussion of general control activities that apply to 
information systems. As part of the financial statement audit, we 
assessed the effectiveness of SEC's information system general 
controls. Effective information system general controls are essential 
to providing reasonable assurance that financial information is 
adequately protected from inadvertent or deliberate misuse, fraudulent 
use, improper disclosure, or destruction. These controls include 
entitywide computer security management, access controls, system 
software, application development and change control, segregation of 
duties, and service continuity controls. 

During fiscal year 2004, numerous information security control 
weaknesses existed at SEC.[Footnote 4] Specifically, SEC had not 
consistently implemented effective electronic access controls, 
including user accounts and passwords, access rights and permissions, 
network security, or audit and monitoring of security-relevant events 
to limit and detect access to its critical financial and sensitive 
systems. In addition, weaknesses in other information security 
controls, including physical security, segregation of computer 
functions, application change controls, and service continuity, further 
increase the risk to SEC's information systems. As a result, sensitive 
data--including payroll and financial transactions, personnel data, 
regulatory, and other mission critical information--were at increased 
risk of unauthorized disclosure, modification, or loss, possibly 
without being detected. Thus, SEC did not have adequate assurance that 
users only had access needed to perform their assigned duties and its 
network was sufficiently protected from unauthorized users. The risks 
created by these weaknesses are compounded because SEC does not have a 
comprehensive monitoring program to identify unusual or suspicious 
access activities. The details surrounding these weaknesses were 
reported separately to SEC management, along with recommendations for 
corrective actions.[Footnote 5]

A key reason for SEC's information security control weaknesses is that 
SEC has not fully developed and implemented a comprehensive security 
management program to provide reasonable assurance that effective 
controls are established and maintained and that information security 
receives significant management attention. An effective program would 
include issuing guidance and implementing procedures for assessing 
risks, establishing policies and related controls, raising awareness of 
prevailing risks and mitigating controls, evaluating the effectiveness 
of established controls, and using the results of management's 
evaluation to continuously improve controls. While SEC has taken some 
actions to improve security management, including establishing a 
central security management function and appointing a senior 
information security officer to manage the overall security management 
program, it still needs to take additional steps to address all key 
elements of an information security management program. Such a program 
is critical to provide SEC with a solid foundation for resolving 
existing information security problems and continuously managing 
information security risks. 

Financial Statement Preparation Process: 

For fiscal year 2004, SEC did not have documentation showing the 
procedures, systems, analysis of accounts, and personnel involved in 
developing key balances and preparing the financial statements and 
related disclosures, or the related quality control and review 
procedures. SEC's opening balances for its fiscal year 2004 financial 
statements contained material misstatements, some of which also 
affected the fiscal year 2004 reported operating results. SEC posted 
the necessary audit adjustments and produced financial statements for 
fiscal year 2004 that were fairly presented in all material respects. 
However, summarized documentation supporting the financial statement 
preparation process and the development of related balances is needed 
to provide structure and discipline to the process and the related 
quality control procedures. In addition, SEC's process for preparing 
its fiscal year 2004 financial statements was manually intensive, time 
consuming, and did not include documentation of quality control 
procedures. For certain financial statement line items and disclosures, 
the detailed support for the balances and underlying transactions was 
not readily available and was difficult to retrieve. Finally, 
comprehensive accounting policies and procedures for several major 
areas were still in draft or needed to be developed. 

Controls over the financial statement preparation process should be 
designed to provide reasonable assurance regarding the reliability of 
the balances and disclosures reported in the financial statements and 
related notes in conformity with generally accepted accounting 
principles, including the maintenance of detailed support that 
accurately and fairly reflects the transactions making up the balances 
in the financial statements and disclosures. GAO's Standards for 
Internal Control in the Federal Government[Footnote 6] provide an 
overall framework for establishing and maintaining internal control, 
including a discussion of control activities, management review, and 
documentation of processes and transactions. A financial statement 
preparation process with documented policies and procedures, support, 
and quality assurance reviews, if properly designed and implemented, 
should provide SEC management with reasonable assurance that the 
balances presented in the financial statements and related disclosures 
are supported by SEC's underlying accounting records. We believe SEC 
can use the lessons learned from the fiscal year 2004 financial 
reporting and audit processes to formalize and further improve its 
process for developing and reviewing the figures needed to compile and 
prepare its year-end and quarterly financial statements. 

Compliance with Laws and Regulations: 

Our tests of compliance with selected provisions of laws and 
regulations related to financial reporting disclosed no instances of 
noncompliance that are reportable under U.S. generally accepted 
government auditing standards or OMB audit guidance. However, our 
objective was not to provide an opinion on compliance with laws and 
regulations. Accordingly, we do not express such an opinion. 

Consistency of Other Information: 

SEC's Management's Discussion and Analysis, required supplementary 
information, and other accompanying information contain a wide range of 
data, some of which are not directly related to the financial 
statements. We did not audit and do not express an opinion on this 
information. However, we compared this information for consistency with 
the financial statements and discussed the methods of measurement and 
presentation with SEC officials. Based on this limited work, we found 
no material inconsistencies with the financial statements or 
nonconformance with OMB guidance. 

Objectives, Scope, and Methodology: 

SEC management is responsible for (1) preparing the financial 
statements in conformity with U.S. generally accepted accounting 
principles; (2) establishing, maintaining, and assessing internal 
control to provide reasonable assurance that the broad control 
objectives of the Federal Managers' Financial Integrity Act (FMFIA) are 
met; and (3) complying with applicable laws and regulations. 

We are responsible for obtaining reasonable assurance about whether (1) 
the financial statements are presented fairly, in all material 
respects, in conformity with U.S. generally accepted accounting 
principles; and (2) management maintained effective internal control 
that provides reasonable, but not absolute, assurance the following 
objectives are met: 

* Financial reporting: Transactions are properly recorded, processed, 
and summarized to permit the timely and reliable preparation of 
financial statements in conformity with U.S. generally accepted 
accounting principles, and assets are safeguarded against loss from 
unauthorized acquisition, use, or disposition. 

* Compliance with applicable laws and regulations: Transactions are 
executed in accordance with (1) laws governing the use of budgetary 
authority, (2) other laws and regulations that could have a direct and 
material effect on the financial statements, and (3) any other laws, 
regulations, or governmentwide policies identified by OMB audit 
guidance. 

We are also responsible for (1) testing compliance with selected 
provisions of laws and regulations that could have a direct and 
material effect on the financial statements and for which OMB audit 
guidance requires testing, and (2) performing limited procedures with 
respect to certain other information appearing in SEC's Performance and 
Accountability Report. In order to fulfill these responsibilities, we: 

* examined, on a test basis, evidence supporting the amounts and 
disclosures in the financial statements;

* assessed the accounting principles used and significant estimates 
made by SEC management;

* evaluated the overall presentation of the financial statements;

* obtained an understanding of internal control related to financial 
reporting (including safeguarding of assets) and compliance with laws 
and regulations (including execution of transactions in accordance with 
budget authority);

* obtained an understanding of the recording, processing, and 
summarizing of performance measures as reported in Management's 
Discussion and Analysis;

* tested relevant internal controls over financial reporting and 
compliance with applicable laws and regulations, and evaluated the 
design and operating effectiveness of internal control;

* considered SEC's process for evaluating and reporting on internal 
control and financial management systems under the FMFIA; and: 

* tested compliance, and related internal controls over compliance, 
with selected provisions of the following laws and their related 
regulations: 

* the Securities Exchange Act of 1934, as amended;

* the Securities Act of 1933, as amended;

* the Antideficiency Act;

* laws governing the pay and allowance system for SEC employees; and: 

* the Prompt Payment Act. 

We did not evaluate all internal controls relevant to operating 
objectives as broadly defined by the FMFIA, such as those controls 
relevant to preparing statistical reports and ensuring efficient 
operations. We limited our internal control testing to controls over 
financial reporting and compliance. Because of inherent limitations in 
internal control, misstatements due to error or fraud, losses, or 
noncompliance may nevertheless occur and not be detected. We also 
caution that projecting our evaluation to future periods is subject to 
the risk that controls may become inadequate because of changes in 
conditions or that the degree of compliance with controls may 
deteriorate. 

We did not test compliance with all laws and regulations applicable to 
SEC. We limited our tests of compliance to those required by OMB audit 
guidance and other laws and regulations that had a direct and material 
effect on, or that we deemed applicable to, SEC's financial statements 
for the fiscal year ended September 30, 2004. We caution that 
noncompliance may occur and not be detected by these tests and that 
such testing may not be sufficient for other purposes. 

We performed our work in accordance with U.S. generally accepted 
government auditing standards and OMB audit guidance. 

SEC Comments and Our Evaluation: 

In commenting on a draft of this report, SEC was pleased to receive an 
unqualified opinion on SEC's first-ever financial statements. SEC also 
acknowledged the material weaknesses in internal control and stated it 
is moving aggressively to address and resolve the weaknesses. SEC 
indicated that by June 2006, it will implement corrective actions for 
information technology security weaknesses and that weaknesses related 
to disgorgements and penalties should also be resolved by fiscal year 
2006. To address the material weakness pertaining to preparation of 
financial statements, SEC plans to hire additional staff, formalize 
policies and procedures for preparing and reviewing financial 
statements, and establish a formal audit committee to engage in 
financial reporting issues. 

The complete text of SEC's response is included in appendix I. 

Signed by: 

David M. Walker: 
Comptroller General of the United States: 

February 11, 2005: 

[End of section]

Management's Discussion and Analysis: 

Section 1: Management's Discussion And Analysis: 

The Securities and Exchange Commission is the federal agency that 
administers the federal laws governing the U.S. securities markets. As 
such, the SEC plays a fundamental role in maintaining the integrity and 
vitality of Americas ownership society. The following section outlines 
the agency's vision, mission, values, and set of goals to achieve its 
desired outcomes, as presented in the SEC's five-year strategic plan. 
In addition, the section highlights the SEC's major accomplishments 
during fiscal year 2004, its upcoming challenges, and the results of 
some of its primary performance measures. The section concludes with a 
discussion of the SEC's financial highlights. 

Vision: 

The Securities and Exchange Commission aims to be the standard against 
which federal agencies are measured. The SEC will strengthen the 
integrity and soundness of U.S. securities markets for the benefit of 
investors and other market participants, and conduct its work in a 
manner that is as sophisticated, flexible, and dynamic as the 
securities markets it regulates. 

Mission: 

The mission of the SEC is to protect investors; maintain fair, orderly, 
and efficient markets; and facilitate capital formation. 

Values: 

* Integrity; 
* Fairness; 
* Accountability; 
* Resourcefulness; 
* Teamwork; 
* Commitment to Excellence: 

GOALS: 

[The SEC updated its four agency-wide goals to achieve desired 
outcomes, along with its vision, mission, and values, as part of its 
new strategic plan for FY2004 through FY2009.]

To enforce compliance with federal securities laws. The Commission 
seeks to detect potential problems or issues in the securities markets 
early and prevent violations of federal securities laws. If violations 
occur, the SEC alerts investors to possible wrongdoing and takes prompt 
action to halt and sanction the misconduct. 

To sustain an effective and flexible regulatory environment. Federal 
securities laws seek to promote fair, orderly, and competitive markets 
that protect investors from undisclosed risk while fostering innovation 
and market access. The Commission's role is to establish a regulatory 
environment that both protects investors and permits competition to 
flourish. 

To encourage and promote informed investment decisionmaking. An 
educated investor ultimately provides the best defense against fraud 
and costly mistakes. The SEC works to promote informed investment 
decisions through two main approaches reviewing disclosures to help 
ensure clear, complete, and truthful information is provided to the 
investing public, and implementing a variety of investor education 
initiatives. 

To maximize the use of SEC resources. An efficient, well-managed, 
proactive SEC is critical for protecting investors and the markets. As 
such, the Commission concentrates on enhancing organizational 
effectiveness, investing in its human capital, as well as new 
technologies, and strengthening internal controls. 

ORGANIZATIONAL STRUCTURE OVERVIEW: 

The SEC is an independent federal agency that is headed by a bipartisan 
five-member commission, comprised of the Chairman and four 
Commissioners who are appointed by the President and confirmed by the 
U.S. Senate. The SEC operates under the authority of federal laws, 
including the Securities Act of 1933, the Securities Exchange Act of 
1934, the Investment Company Act of 1940, the Investment Advisers Act 
of 1940, and the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), among 
others. 

At the end of FY 2004, the SEC had more than 4,000 permanent and more 
than 70 temporary staff positions. The SEC is organized into four 
divisions and 21 offices, with its headquarters in Washington, D.C. In 
addition, the Commission maintains 11 regional and district offices 
throughout the country. The SEC's organization chart is presented in 
Figure 1.1. 

Figure 1.1 SEC Organization Chart: 

[See PDF for image]

[End of figure]

RESOURCES: 

Since 2001, Congress and the President have significantly increased the 
SEC's available funding and staff resources. For FY 2004, the SEC 
received the authority to spend $811.5 million and maintain 3,550 full- 
time equivalents (FTEs) and 4,090 positions. These figures represent an 
83 percent increase in dollars and a 21 percent increase in FTEs from 
FY 2001 levels. Of the $811.5 million authorized, Figure 1.2 displays 
the SEC's actual FY 2004 budget obligations of $755 million, as 
allocated to each of the four strategic goals outlined on page 9. 

Figure 1.2 SEC FY 2004 Obligations by Strategic Goal: 

[See PDF for image]

[End of figure]

MAJOR ACCOMPLISHMENTS: 

Under Chairman Donaldson's leadership, in FY2004 the SEC achieved a 
great deal on a variety of fronts. These accomplishments can be grouped 
into five major themes, which are discussed below. The SEC's major 
performance indicators also are displayed where appropriate. Because 
many of the measures are new, prior year data may be limited or 
unavailable. 

Implemented the Sarbanes-Oxley Act and Improved Disclosures to 
Investors: 

This year marked the second anniversary of the Sarbanes-Oxley Act and 
was the opening season for filings reflecting major aspects of the 
Sarbanes-Oxley Act. The Commission completed on schedule the last of 
the ten rulemaking projects that the Sarbanes-Oxley Act required. The 
Commission also fulfilled its ongoing responsibilities to supervise the 
Public Company Accounting Oversight Board (PCAOB) and its regulation of 
auditors of public companies. 

In FY 2004, the Commission approved the PCAOB's code of ethics, process 
for setting auditing standards, and annual budget. As required under 
the Sarbanes-Oxley Act, the Commission conducted independent rulemaking 
before approving the PCAOB's auditing standards, including Standard No. 
2, which outlines requirements for audits of companies' internal 
controls over financial reporting. 

The Commission also launched several regulatory initiatives to improve 
disclosures to investors so they can make better-informed investment 
decisions (see Figure 1.4 on page 17). Highlights of this rulemaking 
agenda included the following: 

"Tagged Data." The Commission solicited comment on a rule allowing 
voluntary supplemental filings of financial data using eXtensible 
Business Reporting Language (XBRL), beginning with the 2004 calendar 
year-end reporting season. This proposal is part of a broad, multi-year 
initiative to assess the benefits of tagged data, which could 
dramatically improve the ability of investors and SEC staff to analyze 
issuers' financial data. 

Asset-Backed Securities. In FY 2004, the Commission released a package 
of proposals updating the registration, reporting, and disclosure 
requirements for asset-backed securities (ABS). In less than 25 years, 
SEC-registered ABS have become an important segment of the fixed-income 
capital markets, with annual public issuance of up to $800 billion. 
These proposals set new disclosure requirements that are more relevant 
for ABS transactions, as the current requirements are designed 
primarily for corporate issuers and therefore do not always provide 
information that is material to the ABS market. 

Deterring Fraud and Abuse by Shell Companies. The Commission proposed 
rules to prohibit the use of Form S-8 by shell companies for capital- 
raising transactions. Also, the proposal would provide more appropriate 
and timely information for "reverse mergers" and "back door 
registrations."

ProxyAccess. The Commission proposed a new rule that would require the 
inclusion of shareholder nominees in the company's proxy materials 
under limited circumstances. Overly compliant boards of directors at 
times have allowed management unfettered control over the proxy process 
and other critical governance issues. This proposal attempts to find a 
middle ground between forcing shareholders to give up their long-term 
interest in the company and sell their stock, on the one hand, and 
forcing them to wage a wasteful proxy fight on the other. 

During FY 2004, the Commission continued to improve its disclosure 
review program. Under the Sarbanes-Oxley Act, the SEC is required to 
review each reporting company and each investment company issuer at 
least once every three years. While the SEC was unable to review as 
many reporting companies during the first two years of this three-year 
cycle as anticipated due to its inability to quickly hire and train 
additional staff, it did strengthen its review processes by adopting 
new approaches to selecting filings for review and focusing its 
resources on material issues in filings. The Division of Corporation 
Finance also continued its review focus for the second year on the 
largest public companies, which required the most substantial 
resources. 

With these enhancements, the Division of Corporation Finance is working 
diligently to meet this Sarbanes-Oxley Act requirement. In addition, 
during FY 2004, the SEC reviewed disclosures for 54 percent of all 
investment companies and is on track to review 100 percent by the end 
of the first three-year cycle (see Figure 1.3 on page 15). 

[Performance Measure Description: The Sarbanes-Oxley Act requires that 
the SEC review the disclosures of all corporations and investment 
companies at least once every three years. These reviews help improve 
the disclosure information available to investors and can uncover 
serious violations of the federal securities laws. This performance 
measure identifies the percentage of corporations and investment 
companies reviewed each year during the first three-year cycle under 
the Sarbanes-Oxley Act.]

Figure 1.3 New Performance Measure: Percentage of Corporations and 
Investment Companies with Disclosures Reviewed by the SEC: 

[See PDF for image]

* Some corporations were reviewed in both FY 2003 and 2004, and have 
been counted in both years. 

Analysis of Results: The Division of Investment Management reviewed 
more than half of investment companies in FY 2004 alone and is on track 
to review 100 percent by the end of the first three-year cycle. The 
Division of Corporation Finance continued its review focus on the 
largest public companies, and has not reviewed as many issuers as 
anticipated during the first two years of this three-year cycle. In the 
past two years, the Division of Corporation Finance experienced 
difficulties hiring the 175 additional staff, particularly accountants, 
needed to conduct the necessary reviews. With the assistance of the 
excepted service hiring authority that the SEC received in July 2003 
and the enlistment of two nationally recognized executive recruiting 
firms, the Division of Corporation Finance was nearly finished with its 
hiring at the end of FY 2004, and is working diligently to review 100 
percent of corporations by the end of this three-year cycle. 

[End of figure]

During FY 2004, the SEC oversaw the accounting standard-setting process 
as the Financial Accounting Standards Board made progress on several 
major projects, such as the consolidation of variable-interest 
entities, accounting for stock compensation arrangements, and 
accounting for business combinations. In FY 2004, the SEC expanded its 
efforts to monitor standards development by the International 
Accounting Standards Board to promote the convergence of U.S. and 
foreign accounting standards and facilitate cross-border securities 
offerings. 

The SEC also created an Office of Global Security Risk within the 
Division of Corporation Finance to identify companies engaging in 
activities that raise global security and humanitarian concerns that 
are material to investors. 

Improved Market Structure, Governance, and Transparency: 

In FY 2004, the Commission pursued an extensive and ambitious agenda to 
improve the structure and governance of the U.S. securities markets 
(see Figure 1.4 on page 17). For example, after the SEC asked each of 
the self-regulatory organizations (SROs) to review the adequacy of 
their governance practices the New York Stock Exchange (NYSE) issued a 
series of proposals to enhance its governance. These proposals, 
approved by the Commission in December 2003, included the creation of 
the following: a smaller, independent board of directors; four key 
board committees overseeing certain critical functions; and an 
autonomous regulatory office headed by a Chief Regulatory Officer. The 
Commission is carefully considering proposals to tighten SRO governance 
further and ensure that SROs are performing their regulatory 
obligations. 

Over the last few decades, the facilities and rules that link our 
securities markets have been tested severely by new technologies and 
trading patterns. In February 2004, the Commission published for public 
comment Regulation National Market System (NMS), a far-reaching set of 
proposals designed to improve and modernize the regulatory structure of 
the U.S. equity markets. Regulation NMS covers four substantive areas: 
trade-throughs, market access, sub-penny quoting, and market data. The 
SEC is currently reviewing more than 700 comment letters received to 
date on proposed Regulation NMS and intends to take final action on the 
rules in FY 2005. 

The Commission moved to reform short sale regulations and to address 
abusive "naked short selling." These rules imposed a requirement that 
broker-dealers, prior to effecting a short sale of any equity security, 
must "locate" securities available for borrowing so that the security 
can be delivered on the settlement date. The Commission approved 
additional delivery requirements for certain equity securities with 
substantial delivery failures. Also included in the new rule was a one- 
year pilot program for specified securities that temporarily suspends 
the operation of the "tick test" and other short sale price tests. The 
pilot will assist the Commission in examining the current price test 
structure and considering alternatives for future short sale 
regulation. 

Performance Measure Description: For FY 2004, the Commission and staff 
set ambitious goals to propose or adopt several major rulemaking 
activities covering a wide range of topics. This agenda included 
proposals to enhance significantly the regulations governing the mutual 
fund industry, modernize the structure of the U.S. securities markets, 
and register hedge fund advisers. This performance measure gauges 
whether the SEC successfully implemented its major regulatory goals 
during FY 2004. 

Figure 1.4 New Performance Measure: Milestones Achieved for High-
Priority Rulemakings: 

[See PDF for image] 

Analysis of Results: The Commission and its staff implemented all of 
the planned actions related to major rulemaking proposals. Among other 
goals, these rules were designed to combat mutual fund market timing 
and late trading practices, improve the compliance culture of 
investment companies and advisers, modernize the regulatory structure 
of the U.S. equity markets, and provide a comprehensive registration 
and disclosure regime for ABS. As a result, these rules address many of 
the most important challenges facing the securities markets and will 
have significant effects for years to come. As the SEC finishes this 
major wave of rulemaking activities, the SEC will work to devise ways 
to measure these effects over time. 

[End of table]

The Commission established a new regime for overseeing the capital 
requirements of the largest international financial conglomerates. In 
April 2004, the Commission adopted a new program that established a 
voluntary, alternative method of computing deductions to net capital 
for certain broker-dealers. As a condition of a broker-dealer's use of 
this alternative method, the broker-dealer and its holding company and 
affiliates, collectively referred to as a consolidated supervised 
entity, must consent to group-wide Commission supervision, including 
record-keeping and reporting requirements. 

In January 2004, the Commission proposed two new rules to provide point-
of-sale disclosure and improve confirmation disclosure related to sales 
fees and conflicts of interest arising from the distribution of mutual 
funds, 529 plans, and related securities. The SEC received over 1,000 
comments on these proposals, underscoring the intense level of interest 
in this area from investors and the securities industry. The SEC is 
carefully examining those comments and intends to develop final rules 
that will provide investors with timely, practical, and cost- effective 
information about distribution costs and conflicts of interest. 

Vigorously Addressed Challenges in the Mutual Fund and Hedge Fund 
Industries: 

In FY 2004, the SEC led a prompt and multi-pronged response to 
identified abuses in the mutual fund industry. In addition to 
aggressive enforcement activity and broad-based, risk-targeted 
examinations (which are discussed below), the SEC strengthened the 
mutual fund oversight and regulatory framework to minimize the 
possibility of potential abuse in the future. These actions helped 
restore investor confidence in the industry. 

Among the many major regulatory initiatives related to the mutual fund 
industry in FY 2004 (see Figure 1.4 on page 17), the Commission 
accomplished the following: 

* Adopted a comprehensive package of fund governance rules that will 
require, among other things, an independent board chairman and a board 
comprised of 75 percent independent directors. These rules are designed 
to bolster the effectiveness of independent directors and solidify the 
role of the fund board as the primary advocate for fund shareholders. 

* Adopted rules to require that all registered investment advisers 
adopt codes of ethics and that funds and their advisers have 
comprehensive compliance policies and procedures in place, including 
the appointment of a designated Chief Compliance Officer. These rules 
are designed to reinforce the fundamental importance of integrity and 
compliance with the federal securities laws in the investment 
management industry. 

* Enhanced mutual fund disclosure by requiring more frequent disclosure 
of portfolio holdings, requiring that shareholder reports include 
dollar-based expense information, improving disclosure regarding a 
portfolio manager's potential conflicts of interest with the fund, 
requiring improved disclosure of breakpoint discounts, and proposing 
significant amendments to the information that a broker-dealer provides 
its customers in connection with mutual fund transactions. 

* Adopted an amendment to rule 12b-1 to prohibit the use of brokerage 
commissions to compensate broker-dealers for the distribution of a 
fund's shares. This step will eliminate a practice that potentially 
compromises the best execution of a fund's portfolio trades, increases 
portfolio turnover, and biases broker-dealers' recommendations to their 
customers. 

* Proposed to address late trading abuses by permitting same-day 
pricing for fund orders only if they are received by the fund, its 
designated transfer agent, or a registered clearing agency before the 
fund's designated pricing time. 

* Put forth a series of initiatives to address market timing, 
especially so-called "arbitrage" market timing. The initiatives include 
improved fair value pricing disclosure, enhanced disclosure regarding a 
fund's anti-market timing policies and practices, and a proposal that 
funds impose a mandatory two percent redemption fee when investors 
redeem their shares within five days of purchase. 

In July 2004, the Commission voted to propose registering hedge fund 
advisers. Hedge fund managers are, directly and indirectly, providing 
advisory services for many U.S. investors with significant impact not 
only on the investors but also on the operation of the U.S. securities 
markets. In addition, intermediaries are purchasing hedge funds on 
behalf of millions of smaller investor beneficiaries, such as retirees, 
pensioners, and others not generally thought of as the traditional 
hedge fund investor. The increased use of hedge funds in pension plans 
and other funds makes it critical that the Commission has basic 
information about the activities of hedge fund managers. In October 
2004, the Commission voted to adopt this proposal. 

Strengthened the SEC's Examination and Enforcement Programs: 

As a result of recent increases in staff and resources, the SEC 
significantly improved its efforts to enforce compliance with the 
federal securities laws. These efforts have two main components: 
inspecting regulated entities to promote compliance and uncover 
violations, and investigating and litigating violations of law. 

In FY 2004 the SEC's examination program launched a variety of 
initiatives to significantly enhance its oversight of the investment 
management industry, broker-dealers, and SROs. As part of the 
Chairman's risk assessment initiative, the Office of Compliance 
Inspections and Examinations enlisted front-line examiners across the 
country to identify major and emerging risks throughout the industry. 
The Office of Compliance Inspections and Examinations then addressed 
these risk areas in part through dozens of special examinations 
targeted at those risks, called risk-targeted sweeps. Topics included 
mutual fund market timing and late trading, use of fair value pricing 
by international funds, fixed-income mark-ups, and the misuse of non- 
public information from Private Investment in Public Equity structures 
and loan syndicates. As a result of these risk-targeted sweeps, the 
number of significant deficiencies detected by the Office of Compliance 
Inspections and Examinations increased, and needed regulatory 
improvements were recommended (see Figure 1.5 on page 22). 

In FY 2004, significant compliance problems found by the examination 
program included the following: 

"Directed Brokerage and Revenue Sharing." Examinations revealed that 
fund assets increasingly were being used for sales and marketing 
payments to broker-dealers outside of rule 12b-1 distribution 
agreements. These findings resulted in SEC enforcement actions, a new 
Commission rule barring funds from using brokerage commissions to pay 
marketing incentives to broker-dealers, and an SEC rule proposal that 
would require greater point-of-sale disclosure to customers about the 
incentives received by broker-dealers to sell a particular fund. 

Violations by Specialists. Examinations revealed that NYSE specialists 
were "trading ahead" of their customers' orders. This finding resulted 
in SEC and NYSE enforcement actions against NYSE specialist firms. 

Performance Measure Description: The SEC's Division of Enforcement 
receives referrals that come from a variety of sources including SEC 
staff referrals. Both the Division of Corporation Finance and the 
Office of Compliance Inspections and Examinations strive to uncover 
serious potential deficiencies and violations of the federal securities 
laws through the SEC's disclosure review and examination programs. When 
possible deficiencies or violations are found, they may be referred to 
the SEC's Division of Enforcement for further investigation. This 
performance measure tracks the number of enforcement referrals arising 
from significant deficiencies detected by examination staff and the 
Division of Corporation Finance's disclosure review program by fiscal 
year. During FY 2004, the Office of Compliance Inspections and 
Examinations used enforcement referrals as a proxy for significant 
deficiencies detected. In FY 2005, data on the number of significant 
deficiencies detected will be collected and reported. 

Figure 1.5 New Performance Measure: Significant Deficiencies Detected 
and Referrals to the Division of Enforcement from Examination Staff or 
the Division of Corporation Finance: 

[See PDF for image] 

Analysis of Results: Increases in the number of significant 
deficiencies detected by the examination staff can be attributed in 
part to the shift in the examination program's emphasis from routine 
inspection cycles to a more risk-based approach. In FY 2004, 
examination staff identified hundreds of possible risks to investors 
and then conducted risk-targeted sweeps directed at the most salient 
risks to investors, an approach that uncovered many more potentially 
serious violations than in previous years. With respect to the Division 
of Corporation Finance, enforcement referrals rose in part due to the 
delinquent filer program, in which dozens of issuers who failed to make 
disclosure filings as required under federal law were identified. 

[End of figure]

Disclosure and suitability problems in the sale of variable annuities. 
Examinations revealed that many broker-dealers were selling variable 
annuities without adequately disclosing their features, to individuals 
for whom these products were unsuitable, and with poor supervision and 
training. These findings led to the issuance of a public report by the 
SEC and the National Association of Securities Dealers (NASD), 
describing poor and best practices for broker-dealers in this area, and 
an NASD rule proposal designed to ensure better disclosure and sales 
practices. 

Broker-dealers' failure to provide "breakpoint" discounts. An 
examination sweep by the SEC, NASD, and NYSE found widespread failures 
to provide "breakpoint" discounts to customers. The sweep resulted in 
the creation of an industry task force that identified systemic 
solutions, a new SEC rule to better disclose available "breakpoint" 
discounts, and SEC and NASD enforcement actions. 

The extent of "market timing" and late trading in the mutual fund 
industry. After initial indications that mutual funds had collusive 
market timing arrangements with certain hedge funds and other traders, 
SEC examiners conducted a large-scale examination sweep of hundreds of 
firms to identify the scope of the problem. As a result of the risk- 
targeted sweeps, enforcement actions have been brought against ten 
mutual fund complexes to date, and others are still under 
investigation. 

Lack of strong internal controls in the sale of certain structured 
finance products. After Enron and other financial fraud, examiners 
worked together with federal banking regulators to inspect broker- 
dealers and banks involved in the structuring and sale of these 
products. Together, the SEC and the federal banking regulators proposed 
for public comment various internal controls that firms should adopt. 

The enforcement program, including its regional offices, increased its 
staffing by approximately 29 percent between FY 2003 and 2004 as a 
result of increased funding authorized by the Sarbanes-Oxley Act. With 
these new employees, the SEC's enforcement staff opened approximately 
950 investigations, particularly with respect to mutual funds, 
investment advisers, and the mutual fund sales practices of broker- 
dealers. The following is a sampling of the year's significant 
enforcement actions: 

Mutual fund market timing, late trading, and selective disclosure 
actions. The Commission brought 29 actions against participants in the 
mutual fund industry, including Pilgrim Baxter & Associates, Putnam 
Investment Management, Alliance Capital Management, Massachusetts 
Financial Services, and Strong Capital Management. For such cases, the 
Commission ordered a total of $552 million in disgorgement and $480 
million in penalties, which will be distributed to injured investors 
through the "Fair Funds" provision of the Sarbanes-Oxley Act. 

The specialists cases. The Commission and the NYSE found that five 
specialist firms executed orders for their dealer accounts ahead of 
executable public customer or "agency" orders. In settling, the firms 
agreed to pay a total of $247 million in penalties and disgorgement and 
improve compliance procedures. 

SEC v. Lucent Technologies Inc., et al. The Commission charged Lucent 
Technologies and certain current and former Lucent officers, 
executives, and employees, and alleged that the company fraudulently 
and improperly recognized about $1.1 billion of revenue and $470 
million in pre-tax income during FY 2000. Lucent and three of its 
former employees agreed to settle the case. The company agreed to pay a 
$25 million penalty for its lack of cooperation. 

SEC v. Computer Associates International Inc; SEC v. Saujay Kumar and 
Stephen Richards, and SEC v. Steven Woghin. The Commission filed seven 
separate actions against Computer Associates and seven former top 
executives alleging that Computer Associates, one of the world's 
largest software companies, prematurely recognized revenue totaling 
over $3 billion, and that the former executives obstructed the 
Commission's investigation. In addition to other relief, over $225 
million was ordered to be returned to shareholders. 

SEC v. Royal Dutch Petroleum Company and The "Shell" Transport and 
Trading Co., PLC; In the Matter of Royal Dutch Petroleum Company and 
The "Shell" Transport and Trading Co., PLC. The Commission filed 
enforcement proceedings against two foreign-based oil companies in 
connection with their overstatement of 4.47 billion barrels of 
previously reported proved hydrocarbon reserves. In settlement of these 
actions, the defendants consented to a cease and desist order and to, 
among other things, payment of $120 million in penalties. 

In total, the staff instituted about 375 administrative proceedings and 
264 civil proceedings, prevailing in the great majority of the 
enforcement actions decided by district courts or administrative law 
judges (see Figure 1.6). In FY 2004, more than $3 billion, a record 
amount in penalties and disgorgement, was ordered in cases brought by 
the SEC. Criminal proceedings were brought against 302 entities and 
individuals in matters relating to SEC cases in FY 2004. 

Performance Measure Description: Once the SEC determines through an 
enforcement investigation that a person or company has violated the law 
and should be charged, the SEC works to secure a judgment against the 
violator and appropriate sanctions. These cases are filed either in 
U.S. District Court or before an administrative law judge. Successfully 
resolved is defined as those parties against whom the SEC successfully 
obtained an administrative order or a judgment by consent, by default, 
through summary judgment, or following a bench or jury trial. This 
performance measure identifies the percentage successfully resolved in 
FY 2004 of all parties against whom a judgment was entered that year. 

Figure 1.6 New Performance Measure: Enforcement Cases Successfully 
Resolved: 

[See PDF for image] --graphic text: 

FY 2003: Data not available. 

FY 2004: 98%. 

Analysis of Results: In FY 2004, the SEC successfully resolved the 
cases against the vast majority of the defendants or respondents it 
charged. In general, the SEC strives to bring cases that are as strong 
as possible but, at the same time, aims to file large, difficult, or 
precedent-setting cases when appropriate, even if success is not 
assured. 

[End of figure]

Improved the SEC's Operational Effectiveness: 

Since Chairman Donaldson was appointed, he has focused on improving the 
SEC's ability to anticipate potential problems across the securities 
industry by "looking over the hills and around the corners" for the 
next emerging abuse of securities laws. The Chairman initiated a 
thorough internal review of how the SEC identifies current problems 
and, equally important, future risks. As a result of this review, the 
SEC launched a new risk assessment program and created an Office of 
Risk Assessment, the first of its kind at the Commission. 

The goal of the SEC's risk assessment program is twofold: to become 
better equipped to anticipate potential problems; and then to prevent 
these problems from affecting the markets. Toward these ends, the SEC 
first launched risk assessment activities within its various divisions 
and offices, creating internal risk teams that employed a "bottom-up" 
approach to mapping risk within each program. For those areas of 
greatest concern, the SEC proactively initiated risk-targeted 
examination sweeps, enforcement investigations, and disclosure reviews. 
Such efforts have helped focus the SEC's operations on those areas that 
present the biggest risks to investors. In addition, the recently hired 
Director of the Office of Risk Assessment will coordinate internal risk 
teams and help the entire Commission anticipate new or resurgent forms 
of fraud and questionable activities. 

The SEC completed comprehensive workforce and workflow reviews of all 
SEC divisions and offices, leading to more efficient organizational 
structures and an improved alignment of the SEC's resources, needs, and 
mission priorities. These reviews helped ensure that all resources were 
allocated efficiently on the basis of well-defined program objectives 
so that the Commission has "the right people in the right place at the 
right time."

Chairman Donaldson also launched the "dashboards" initiative to 
regularly track divisions' and offices' progress in achieving 
programmatic, operational, staffing, and budgetary objectives. These 
management reports help the Chairman and senior managers gauge 
performance and adjust operations and resources, as necessary. 

The Commission received authority from Congress to hire more than 840 
new staff in February 2003, and in July 2003 the SEC was allowed to 
expedite the hiring of accountants, economists, and examiners. These 
two actions set the stage for a tremendous hiring wave in FY 2004. With 
the help of a significantly enhanced recruitment and orientation 
program, and without compromising quality, the SEC hired more than 
1,000 new employees between FY 2002 and FY 2004, reducing its vacancy 
rate substantially (see Figure 1.7 on page 28). As the Commission 
continues to fill normally occurring vacancies, it will continue to 
explore innovative ways to attract top talent from diverse backgrounds, 
particularly accountants. 

26 The SEC also continued to develop several important programs to 
retain employees with valuable skills. For example, the SEC continued 
its compensation program that rewards superior performance through a 
new pay for-performance system. The Commission also offered an expanded 
benefits package that includes a number of programs, including: the 
student loan repayment program, which in FY 2004 covered about ten 
percent of the SEC's workforce; offering dental and vision benefits; 
maintaining life cycle accounts to help employees address work-life 
issues; and continuing its childcare subsidy program. The Commission 
also continued its commitment to staff training through the creation of 
the SEC University (SEC-U). These efforts have already begun to yield 
results. The GAO surveyed SEC staff and found them "significantly more 
satisfied with their pay and their ability to use flexitime and 
flexiplace." In addition, the SEC's turnover rate has remained at 
historically low levels, although it has increased slightly in the past 
two fiscal years (see Figure 1.7 on page 28). 

Performance Measure Description: Most of the functions performed by the 
SEC require highly trained staff to perform duties such as 
investigating violations of the federal securities laws, reviewing the 
activities or disclosures of securities market participants, or 
drafting new securities regulations. Therefore, the SEC has focused its 
energies on retaining high-performing staff and closely tracked its 
turnover rate to gauge the success of these efforts. Also, in FY 2003 
Congress increased the SEC's size by more than 840 new staff positions. 
Therefore, a major goal for the SEC in FY 2004 was to fill these new 
positions and reduce the vacancy rate back to previous levels. 

Figure 1.7 Performance Measure: SEC Turnover and Vacancy Rates: 

Analysis of Results: In the late 1990s and early 2000s, the SEC 
experienced high turnover rates, mainly due to the availability of 
higher pay and benefits at other federal financial regulators and in 
the private sector. In FY 2001, the SEC gained the authority to set pay 
and benefits commensurate with other financial regulators within the 
federal government. Since that time, the Commission has implemented a 
pay-for-performance system, enhanced benefits, invested in new work- 
life programs, and bolstered its training programs through the SEC-U in 
an effort to reduce turnover. These efforts contributed to 
substantially lower turnover rates in the past few years. With respect 
to vacancies, the chart shows that the SEC had a high vacancy rate at 
the end of FY 2003, largely because it had not yet filled many of the 
more than 840 new positions that Congress approved for the SEC that 
year. The SEC has since launched a variety of new recruiting 
initiatives, significantly expanding its outreach, hiring two executive 
recruiting firms, and creating a new recruiting video. The SEC has 
lowered its vacancy rates substantially and also has about 100 
additional staff hired and set to come on board early in FY 2005, which 
will reduce vacancies further. 

[End of figure]

Separately, in addition to hiring a Director of Risk Assessment, the 
Chairman also rounded out the SEC's senior management team by hiring a 
new Chief Accountant, Chief Economist, and Chief Information Officer 
(CIO). 

The SEC also executed an aggressive 20-month effort to prepare its 
first audited financial statements and Performance and Accountability 
Report (PAR). The SEC began reporting quarterly financial results in FY 
2004 and worked diligently to strengthen its financial and internal 
controls. 

Finally, the Office of Information Technology implemented an aggressive 
agenda under the SEC's new CIO (see Figure 1.8 on page 30). A few 
highlights of the many initiatives launched in FY 2004 are listed 
below: 

* As part of its "data tagging" initiative, the SEC automated Forms 3, 
4, and 5 using eXtensible Markup Language (XML) tagging formats, which 
permit filings over the web and enable SEC and public users to obtain 
data in a format useful for analysis. 

* The Office of Information Technology continued to implement a 
document imaging and management system for the SEC. The initial stages 
of the effort focused on imaging the Division of Enforcement's large 
backlog of paper-based discovery documents. Concurrently, the Office of 
Information Technology upgraded many elements of the SEC's information 
technology (IT) infrastructure enabling it to handle the large-scale 
storage and retrieval of image files. This system will save staff time 
spent searching and analyzing millions of pages of documents, and 
protect this information in the event of an emergency that would damage 
paper documents. 

* The point-to-point network redesign initiated in FY 2003 was made 
fully operational by the middle of FY 2004, providing continuous 
communications between SEC sites in the event that a disaster forces 
headquarters or the operations center to close. 

* In FY 2004, the Office of Information Technology implemented the 
initial stages of a comprehensive redesign of its capital planning and 
investment control (CPIC) processes. The initial changes focused on new 
operating budget approvals and investment approval thresholds, which 
went into effect in early FY 2005. 

* The SEC's enterprise architecture (EA) planning improved 
substantially in FY 2004, with the finalization of the EA repository 
and an internal website to provide EA information to all SEC staff. As 
a result, all project sponsors and managers are able to access the 
SEC's business reference model, information resource catalog, and other 
core elements of the SEC's EA in planning their projects. 

Performance Measure Description: The SEC focused its IT investments on 
five primary areas to enhance program effectiveness and operational 
efficiencies. A variety of projects have been implemented in these 
areas, ranging in complexity and duration (e.g., some may be completed 
in a single fiscal year while others span multiple fiscal years). This 
performance measure identifies some of the SEC's major IT initiatives 
and whether the SEC successfully achieved major project milestones. 

Figure 1.8: New Performance Measure: Milestones Achieved for High-
Priority IT Projects: 

[See PDF for image]

Analysis of Results: The SEC made significant progress in each of the 
major areas identified above. In particular, efforts such as the 
introduction of "tagged data" into EDGAR, document imaging, the 
implementation of the point-to-point system design, and progress on 
developing the Commission's EA will have major impacts on the 
efficiency and effectiveness of the SEC's programs. The SEC has 
formulated plans to build on these initiatives in FY 2005 through 
efforts such as developing the Commission's data mining and forensics 
applications, electronic media capture and search capabilities, and 
disclosure-related systems. 

[End of table]

CHALLENGES: 

Although the SEC successfully implemented an ambitious agenda in FY 
2004, many challenges remain. Over the next year, the SEC anticipates 
taking action to address these challenges, through initiatives outlined 
in its five-year strategic plan. These initiatives will provide 
important protections for investors, improve the markets' structure, 
and enhance the SEC's operational effectiveness. The following are some 
of the SEC's key challenges, and the ways, both past and future, that 
the Commission has worked to address them. 

Uncovering Emerging Threats to Investors. The SEC faces the continuing 
challenge of addressing new or resurgent forms of fraud and 
questionable activities before they pose a serious threat to investors. 
In FY 2004, the Commission began implementing an aggressive strategy to 
uncover emerging risks in their early stages through the risk 
assessment initiative launched by Chairman Donaldson. The SEC will 
expand upon this effort in FY 2005, hiring additional staff dedicated 
to risk management and developing new techniques to detect, gauge, and 
manage sources of potential risk, whether in disclosure filings, market 
data, evidentiary or examination documents, or elsewhere. New 
technologies may include diagnostic and data mining systems, 
collaborative software, or access to new databases. For example, within 
the examination program, the SEC will launch a surveillance system for 
funds and advisers. The system will provide current information about 
funds and their advisers, so that the Office of Compliance Inspections 
and Examinations can identify trends and patterns that require follow- 
up by examiners or other staff. The Office of Compliance Inspections 
and Examinations also will begin implementing a new initiative to 
deploy monitoring teams for the largest investment advisory 
organizations, which will serve as the SEC's "eyes and ears" for this 
critical industry. 

Analyzing Unprecedented Amounts of Data from Investigations and 
Examinations. The increasing complexity and technological 
sophistication of the securities markets has deeply affected the SEC's 
enforcement and examination programs, as the volume of data that might 
be relevant to an SEC investigation or inspection has grown 
exponentially. The SEC must adapt accordingly, with new systems and 
processes that can help staff review huge amounts of information 
quickly and thoroughly. In FY 2005, the SEC plans to upgrade the 
enforcement program's IT forensics capabilities, allowing staff to 
obtain and analyze data more quickly in the course of enforcement 
investigations. The SEC also will deploy new tools to analyze e-mail 
and other electronic media received through investigations and 
examinations for any contextual relationships. The imaging project 
initiated in FY 2004 will continue, completing the remainder of the 
enforcement program's paper document backlog and ensuring that the vast 
majority of enforcement document reviews can leverage automated search 
and browsing tools. 

Enhancing Disclosures to Investors. Technological advancements have 
given the SEC an unprecedented opportunity to make disclosures more 
easily accessible and usable by the investor community. To meet this 
challenge, the SEC will move forward with its initiative to deploy 
"data tagging" to make financial data easier to analyze across 
industries or funds. The Commission also will explore converting 
additional disclosure forms into "tagged" format, redesign the Internet 
portal for the EDGAR system, and rebid the EDGAR contract with an eye 
toward substantially improving the effectiveness and flexibility of the 
system. 

Attracting and Retaining Quality Staff. The SEC has worked hard to 
bring its attrition rate down to the historic lows of the past few 
years. However, as shown above, with the recent economic recovery, the 
SEC's attrition rate is inching up again. Over the next fiscal year, 
the SEC must take a variety of additional steps to ensure that it 
becomes the "employer of choice" within the federal government, 
attracting and retaining a highly talented and diverse workforce. The 
SEC will continue to refine its compensation and benefits packages to 
ensure that they are competitive with those of other federal financial 
regulators. The Commission will enhance its training program through 
the SEC-U, offering courses covering areas such as continuing education 
for attorneys and accountants, securities industry training, and 
employee development and management. The SEC will work to create high- 
quality facilities that will improve staff morale and improve 
productivity. The SEC's facilities in Washington, D.C., New York, and 
Boston will implement such enhancements in FY 2005. Another priority is 
for the SEC to create a "virtual workforce" and expand the use of 
telework to permit staff to work from home and maintain work-life 
balance. 

Financial Management System Controls. The SEC is committed to the 
effective and efficient management of the resources that have been 
entrusted to the Commission. The Commission has already taken a series 
of steps toward this goal and will continue to tighten internal 
controls in FY 2005, including the following: 

* The SEC worked to enhance its internal controls in the area of 
property management and accountability. New procedures were implemented 
to identify, track, and report in-house software development costs, but 
they have not yet been formally documented. 

* In FY 2003 the SEC met its goal of replacing the disgorgement 
tracking system with an upgrade to its Case Activity Tracking System, 
for which the financial components of the system were added in FY 2003 
and populated in FY 2003 and FY 2004. Also in FY 2004, the SEC 
continued to work on procedures to ensure that all enforcement 
activities resulting in an assessment of penalties and disgorgement are 
properly documented and reported in a timely manner. In FY 2005, the 
enforcement and accounting staff will continue to work to ensure that 
the data meets the Commission's financial reporting needs. 

Information Resources Management. The SEC is working continually to 
strengthen its information resources management program, which has been 
identified by the Inspector General as one of the agency's ongoing 
challenges. In FY 2004, the Commission's new CIO significantly 
restructured the Office of Information Technology by establishing EA 
and project management offices. In addition, the initial stages of a 
comprehensive redesign of its CPIC processes were implemented, an EA 
repository was finalized, and an internal website to provide ready 
access to the SEC's business reference model and information resources 
catalog was made available. Finally, the Commission produced an IT 
policy framework to align the Office of Information Technology's 
operational controls and policies with the Clinger-Cohen Act and the 
Office of Management and Budget (OMB) guidance. These efforts will 
continue in FY 2005, as the SEC continues to redesign its CPIC 
processes, implements new tools for tracking IT projects, and completes 
its EA plan. 

The SEC continues to make progress in developing and implementing a 
mature information security program. In FY 2004, the Office of 
Information Technology certified eight major IT systems and began 
working on completing the accreditation documentation. Further, the SEC 
initiated development of plans to improve its incident response 
capability, provided IT security training to 4,200 SEC employees and 
contractors, and continued its specialized training program for 
technical staff. In FY 2005, the certification and accreditation of the 
SEC's IT systems will continue, and the Office of Information 
Technology will conduct a comprehensive review of its security 
policies, procedures, and technical architecture to ensure compliance 
with the best practices in information security. Also, the Office of 
Information Technology will deploy a new generation of intrusion 
detection and monitoring tools for its IT systems and network. 

MANAGEMENT CONTROLS AND COMPLIANCE WITH LAWS AND REGULATIONS: 

SEC management is responsible for the fair presentation of the 
principal financial statements in conformity with GAAP and the 
requirements of OMB Bulletin Number 01-09. Management is also 
responsible for the fair presentation of the SEC's performance measures 
in accordance with OMB requirements. The quality of the SEC's internal 
control rests with management, as does the responsibility for 
identifying and complying with pertinent laws and regulations. 

Federal Managers' Financial Integrity Act: 

The Federal Managers' Financial Integrity Act of 1982 (FMFIA) requires 
agencies to annually evaluate their system of internal control and 
report to the President and Congress on whether it complies with the 
standards and objectives set forth in the Act. If noncompliant, an 
agency's report must identify the material weaknesses and the plans for 
correcting those weaknesses. FMFIA also requires a statement indicating 
whether the agency's accounting system conforms to the principles and 
standards of the Comptroller General of the United States. 

On December 22, 2004, the Chairman provided qualified assurance that, 
taken as a whole, the SEC's system of controls for the fiscal year 
ended September 30, 2004, was adequate and effective and had achieved 
the intended objectives under Section 2 of FMFIA. This qualified 
assurance considered two material weaknesses, which are discussed 
below. 

The Chairman also reported that the financial management systems were 
generally in conformance with the principles and standards developed by 
the Comptroller General and implemented through OMB Circular A-127. One 
instance of material nonconformance was identified and is described 
below. 

While the SEC acknowledged weaknesses in its internal controls and 
financial management systems, it also emphasized its commitment to be 
effective and efficient in the management of the resources entrusted to 
the Commission. A discussion of the corrective actions taken and 
planned by the SEC to address these matters is also described in the 
following pages. 

FMFIA Management Control Program and Review Process: 

In accordance with guidance issued by the Commission's Executive 
Director, 26 management control components conducted informal reviews 
of their financial, administrative, and program management controls. In 
addition, the SEC's Office of Inspector General completed 23 
alternative reviews during FY 2004. Most components were reviewed, with 
some undergoing multiple reviews. 

Further, the SEC's Executive Review Board, which is responsible for 
overseeing the use of the Commission's human resources, conducted a 
thorough assessment of the management responsibilities of all 
supervisors, managers, and senior officers. The review involved 
developing a framework that would ensure adequate supervision of staff 
and equitable distribution of responsibility and workload among 
supervisors and managers. 

Finally, GAO conducted an audit of the SEC's financial statements. 
GAO's procedures included audits of the financial statements, the 
management controls over the financial systems and operating procedures 
affecting the statements, and the SEC's compliance with selected 
provisions of laws and regulations applicable to the management of 
financial resources. 

Status of Management Controls: 

In December the SEC reported two material weaknesses under Section 2 of 
the FMFIA and one material nonconformance under Section 4. During the 
audit of SEC's financial statements, a third material weakness was 
identified related to the SEC's preparation of financial statements. 
The three material weaknesses and the material matter of nonconformance 
are outlined below. 

The internal control standards for Federal agencies established by the 
GAO defines a material weakness as a significant deficiency or 
deficiencies in the design or operation of one or more internal control 
components that fail to reduce to a relatively low level the risk that 
misstatements caused by error or fraud in amounts that would be 
material in relation to the financial statements would occur and not be 
detected within a timely period by employees in the normal course of 
performing their assigned functions. OMB guidance defines 
nonconformance as "instances in which financial management systems do 
not substantially conform to financial systems requirements. 

1. Penalties and Disgorgement: 

Description: The SEC has a material weakness related to its collection 
and management of financial information on penalties and disgorgement 
ordered as a result of SEC enforcement actions and one nonconformance 
related to federal financial management system requirements. These 
issues arise because the agency did not have a management information 
system in place to collect accurate data on penalties and disgorgement 
when the requirement for audited financial statements was set. The SEC 
needs to finish the development of comprehensive policies and implement 
internal controls for the system developed in the past two years to 
collect the needed financial data. To compensate for the system 
limitations, the SEC staff performed extensive manual procedures to 
compile necessary information and update the accounting system which 
the GAO then tested to obtain support for the estimated net amounts 
receivable. However, errors and inconsistent reporting were noted that 
confirmed a need for improved controls. 

Corrective Actions Taken: Since the beginning of calendar year 2003, 
SEC staff identified data needed for financial reporting, designed and 
implemented a system to record and report on data collected, designated 
and trained reporting and reviewing staff, developed manuals and 
procedures, and entered data on over 12,000 parties to SEC enforcement 
actions. In the Chairman's December 2004 FMFIA report, management 
recognized the need to reexamine and change certain documentation and 
data entry procedures and to strengthen coordination and communication 
among offices. In addition, the report indicated that the new system 
for tracking and recording penalties and disgorgement requires further 
adaptations to strengthen data integrity support, and to assure 
effective internal controls exist to provide for accurate financial 
reporting on complex aspects of judicial and administrative orders. 

Corrective Actions Planned. During FY 2005 the staff will complete a 
comprehensive review of files and data and review and strengthen 
policies and procedures. The enhanced procedures will strengthen 
internal control over the existing management information system. It is 
anticipated that consistent application of the internal controls and 
limited system redesign, to improve recording and reporting 
capabilities, will be adequate to resolve the material weakness in FY 
2006. However, replacement of the current system will provide more 
effective assurance that internal controls are consistently applied. To 
that end, in FY 2005 the SEC also will begin a multi-year project to 
replace the existing system. A requirements analysis will be completed 
in FY 2006. 

2. Information Systems and Security Controls: 

Description: Effective information system controls are required to 
provide assurance that financial information is adequately protected 
from misuse, fraud, improper disclosure, or destruction. These controls 
take the form of technical safeguards such as firewalls and application 
design, as well as procedural controls such as access management and 
segregation of duties. The SEC has previously reported a material 
weakness related to its information systems and security controls. 
These issues stem from the historical lack of a comprehensive agency 
program to manage information security; specifically, weaknesses have 
been identified in access control management, network security, audit 
and monitoring functions, user awareness, and other areas. Compliance 
with the requirements of OMB Circular A-130, Appendix III, regarding 
accreditation of applications and the Federal Information Security 
Management Act also requires strengthening. 

The GAO audit confirmed many of the findings reported in prior years 
through the FMFIA and audit programs related to general controls over 
information technology security. While the auditors did not note any 
instances of security breaches that would affect the financial systems 
or records, they concluded that these information security control 
weaknesses put sensitive data-including payroll and financial 
transactions, personnel data, and other program-related information-at 
increased risk of unauthorized disclosure or modification. In addition, 
the SEC was found to lack a comprehensive monitoring program to 
identify unusual or suspicious activity. However, their review of 
existing controls and agency remediation plans provided adequate 
assurance that financial data and systems were auditable. 

Corrective Actions Taken: The SEC has launched a series of initiatives 
to reorganize its information security program, and reorient it towards 
resolving the control issues outlined above. The Commission began its 
certification and accreditation efforts in FY 2003 to ensure that all 
major information systems are designed and operated with acceptable 
levels of security risk; this effort is ongoing. In FY 2004 the SEC 
hired a Chief Information Security Officer to centrally manage and 
implement the various components of its information security program. 
SEC staff also began revising information security control documents 
and all policies, procedures and guidelines to reflect National 
Institute of Standards and Technology guidelines as mandated by FISMA. 
The SEC continued to promulgate security awareness training internally- 
4,200 employees and contractors were trained in FY 2004-and implemented 
a specialized security training program for technical staff. 

Corrective Actions Planned. Both SEC general support systems and 
financial applications will be certified and accredited by the end of 
calendar year 2005. Corrective actions for the specific control 
weaknesses identified in the GAO review are being implemented according 
to a quarter-by-quarter timeline, and will be complete by June 2006. 
Meanwhile, the agency will continue to redesign and enhance its overall 
information security program by: (1) clarifying roles and 
responsibilities for enterprise information security, (2) developing 
and revising security risk assessment processes, (3) implementing a 
comprehensive set of information security policies and procedures, (4) 
providing security awareness training to employees and contractors, and 
(5) systematically testing policies and procedures for their 
appropriateness and effectiveness. 

3. Preparation of Financial Statements: 

Description: The SEC produced its first complete set of financial 
statements in 2004. In preparing the financial statements, material 
errors were noted in the opening balances and procedures did not exist 
to support the process to accumulate the necessary data to complete the 
financial statements. As a result, the process to prepare the FY 2004 
financial statements was manually intensive, consumed significant staff 
resources, and did not include documentation of quality control 
procedures. Additionally, comprehensive accounting policies and 
procedures for several major areas were still in draft or still needed 
to be developed. 

Corrective Actions Taken: The SEC assigned financial reporting staff 
and developed procedures to compile and issue FY 2004 annual financial 
statements. The staff drafted and applied the accounting policies 
necessary to prepare the complete set of financial statements. The SEC 
has made all necessary accounting adjustments to correct the errors in 
the opening balances and, as a result of implementation of the new 
policies, does not expect errors of this nature to recur. The SEC is 
now developing a plan to review, update and document the preliminary 
accounting procedures established during FY 2004. 

Corrective Actions Planned. During FY 2005, the SEC will increase its 
financial reporting staff and formalize policies and procedures used in 
the first year of financial reporting. The SEC will develop policies 
and procedures where they did not exist and preliminary accounting 
procedures still in draft will be finalized. Consistent application of 
the enhanced procedures for recording penalties and disgorgement also 
will increase assurance that significant balances are reported 
accurately. 

Efforts to solicit advice from staff experts within SEC will continue. 
In addition, this spring the SEC will establish a formal audit 
committee to provide regular review by key management officials of SEC 
financial reports and to provide advice to strengthen operations, 
policies and controls. 

The Office of Management and Budget recently issued a revised Circular 
A-123 on Management's Responsibility for Internal Control. By the end 
of FY 2005 SEC will develop a plan for implementation, as the revisions 
will become effective for FY 2006. 

Financial Management Systems: 

Although the SEC is not required to report under the Federal Financial 
Management Improvement Act, the Commission believes it is in 
substantial compliance with federal financial management system 
requirements, federal accounting standards, and the U.S. Government 
Standard General Ledger, except for the forgoing discussion on 
reporting under Section 4 of FMFIA. 

Federal Information Security Management Act: 

FISMA requires federal agencies to conduct an annual self-assessment 
review of their IT security program, to develop and implement 
remediation efforts for identified security weaknesses and 
vulnerabilities, and to report compliance to OMB. SEC's Office of 
Inspector General performed an independent review of SEC's compliance 
with FISMA requirements. The report confirmed the SEC had successfully 
eliminated a previously identified significant deficiency, however, 
during this review four additional significant deficiencies were noted. 
The SEC submitted its annual FISMA report to OMB in November 2004. 

Prompt Payment Act: 

The Prompt Payment Act requires federal agencies to report on their 
efforts to make timely payments to vendors, including interest 
penalties for late payments. In FY 2004, the SEC did not pay interest 
penalties on 95.4 percent of the 13,487 vendor invoices processed, 
representing payments of approximately $138.8 million. Of the invoices 
that were not processed in a timely manner, the SEC was required to pay 
interest penalties on 623 invoices, and was not required to pay 
interest penalties on 983 invoices, where the interest was calculated 
at less than $1. In FY 2004, the SEC paid over $90,000 in interest 
penalties, or $649 in interest penalties for every million dollars of 
vendor payments. 

Improper Payments Information Act: 

The Improper Payments Information Act requires federal agencies to 
annually review all programs and activities they administer, identify 
those which may be susceptible to significant erroneous payments and 
the extent of the erroneous payments in its programs, and report the 
actions it is taking to reduce erroneous payments. During FY 2004, the 
SEC had controls in place to identify and correct erroneous payments 
that, in total, did not exceed the $10 million threshold. 

Debt Collection Improvement Act: 

The Debt Collection Improvement Act prescribes standards for the 
administration, collection, compromise, suspension, and termination of 
federal agency collection actions and referral to the proper agency for 
litigation. In FY 2004, the SEC referred $271.1 million to Treasury for 
collection. Collections of delinquent debt by Treasury for the same 
period was $178,700. 

PERFORMANCE MEASURES SUMMARY: 

The SEC's performance measurement systems have been significantly 
enhanced by two major efforts in FY 2004. First, the Commission 
approved a new five-year strategic plan that sets the direction for the 
SEC with a new vision, mission, values, and goals. The SEC also 
launched the "dashboards" initiative to enhance its performance 
measures and provide senior managers with regular snapshots of the 
agency's progress toward its goals. As a result of these efforts, many 
of the measures listed below are new, and some do not yet show data for 
FY 2004 or previous years. 

These performance measures gauge how much activity the Commission 
conducts in a given fiscal year, how quickly it accomplishes its tasks, 
and what effects these activities have on the markets and for 
investors. However, for the SEC, measuring outcomes is the most 
challenging area of the three, as is the case with many regulatory and 
law enforcement agencies. In many instances, the Commission's impact 
can only be assessed indirectly. The SEC has devised a number of proxy 
measures that, when taken as a whole, provide a reasonable picture of 
its effectiveness in fulfilling its mission. As the Commission learns 
from its experience in this area, it will continue to refine these 
measures, both in the "dashboards" and in future performance reports. A 
summary of the SEC's major performance measures, organized by goal, is 
presented in Figure 1.9 on page 43. 

A discussion of the SEC's implementation of the President's Management 
Agenda is located in Section 2: Performance Section. 

Figure 1.9 Performance Results Summary: 

[See PDF for image]

[End of table]

FINANCIAL HIGHLIGHTS: 

The SEC's financial statements summarize its financial activity and 
financial position. The SEC prepared audited financial statements for 
the first time in FY 2004 pursuant to the mandate of the Accountability 
of Tax Dollars Act of 2002. The statements were audited by the GAO and 
received an unqualified opinion. The audit also addressed the SEC's 
internal controls and compliance with federal laws and regulations that 
have a direct effect on the financial statements. The auditors' 
findings on those subjects are addressed in Section 3: Financial 
Section. 

The financial statements and footnotes, and the balance of the required 
supplementary information, appear in Section 3: Financial Section. As 
these are the SEC's first audited financial statements, they reflect 
only FY 2004 results. In future years, the statements will be presented 
on a comparative basis. 

Net Position: 

The major components of the SEC's financial activities consist of Fund 
Balance With Treasury (FBWT), Accounts Receivable, Property and 
Equipment, Liabilities, and Revenues and Costs. A brief discussion of 
each of these components is presented on pages 45 to 51. 

Figure 1.10 Composition of SEC's Assets, Liabilities, and Net Position 
as of September 30, 2004 (Dollars in Thousands): 

[See PDF for image]

[End of table]

Fund Balance With Treasury: 

As of September 30, 2004, the SEC's FBWT of $4,202.6 million represents 
91.80 percent of assets totaling $4,578.3 million. As summarized in the 
chart below, FBWT includes (1) restricted entity funds that represent 
funds not available for use by the SEC and can only be made available 
by the U.S. Congress; (2) unrestricted fiduciary assets, which include 
the collection of civil monetary penalties, interest, and disgorged ill-
gotten gains that may be paid out to harmed investors pursuant to 
authorized distribution plans; (3) unrestricted entity funds that are 
obligated and unobligated balances available to finance expenditures; 
and (4) unrestricted customer deposit accounts for customers who 
maintain a deposit account at the SEC to facilitate filing processes. 

Figure 1.11 Fund Balance With Treasury as of September 30, 2004 
(Dollars in Thousands): 

[See PDF for image] --graphic text: 

Pie chart with four items. 

Unrestricted Customer Deposit Accounts: $62,284; 
Unrestricted Entity Funds: $382,807; 
Unrestricted Fiduciary Assets: $863,167; 
Restricted Entity Funds: $2,894,382. 

[End of figure]

Restricted funds are the bulk of the SEC's FBWT and are primarily an 
accumulation of fees and assessments paid to the Commission since 1991 
pursuant to Section 6(b) of the Securities Act of 1933 and Sections 
13(e), 14 (g), and 31 of the Securities Exchange Act of 1934 in excess 
of amounts that the SEC was authorized to use in its annual operations 
through the Congressional appropriations process. The SEC does not have 
authority to spend these funds unless it obtains permission through 
legislation from Congress. 

Given the restricted nature of these fees, SEC management has begun 
exploring ways for a permanent resolution that would allow the SEC to 
exclude these funds from its assets. SEC management is also undertaking 
a multi-year legislative effort to bring the amount of fees generated 
by the SEC in line with its annual operating budget and eliminate 
surplus fees. 

Accounts Receivable: 

The SEC's net accounts receivable as of September 30, 2004, of $326.5 
million consists of gross accounts receivable and an estimated 
allowance for uncollectible amounts of $1,720.3 million and $1,393.8 
million, respectively (see Figure 1.12). 

Figure 1.12 Accounts Receivable as of September 30, 2004 (Dollars in 
Thousands): 

[See PDF for image]

[End of figure]

Civil monetary penalties levied against violators of federal securities 
laws constitute most of the SEC's accounts receivable activity. The SEC 
has a fiduciary responsibility to collect, manage, and distribute civil 
monetary penalties and disgorgement to non-federal individuals or 
entities pursuant to plans approved by the court or Commission. These 
fiduciary receipts constitute the SEC's collection, management, and 
disposition of cash or other assets in which non-federal individuals or 
entities have an ownership interest that the SEC must uphold. When 
collected, fiduciary receipts are included in FBWT, and an equal and 
offsetting liability for assets held by the SEC at or outside of the 
U.S. Department of the Treasury (Treasury) is reported in the name of 
the SEC as a non-entity liability in the Balance Sheet. The SEC has a 
custodial responsibility over non-entity accounts receivable, which are 
established when the SEC has been designated in administrative 
proceedings or court-ordered judgments to collect, manage, or 
distribute the assessed disgorgement, penalties, and interest. When 
collected, these funds are returned to the General Fund of the 
Treasury. The SEC is not authorized to use the funds. 

The SEC's allowance for doubtful accounts is an estimate of how much of 
the gross accounts receivable are uncollectible. The overall allowance 
of 81.02 percent is based on an analysis of certain large individual 
accounts and historical collection activity. 

Property and Equipment: 

The SEC's property and equipment consists of software and general 
purpose equipment, capital improvements made to buildings that the SEC 
leases for office space, and internal-use software development costs 
for projects in development. The cost of the SEC's property and 
equipment as of September 30, 2004, is summarized in Figure 1.13. 

Figure 1.13 Cost of Property and Equipment as of September 30, 2004 
(Dollars in Thousands): 

[See PDF for image]

[End of table]

Liabilities: 

A summary of the SEC's liabilities as of September 30, 2004, is 
presented in Figure 1.14. 

Figure 1.14 Liabilities as of September 30, 2004 (Dollars in 
Thousands): 

[See PDF for image]

[End of table]

Most of the SEC's liabilities are the result of its fiduciary and 
custodial liabilities. Fiduciary activities consist of the receipt, 
management, accounting, and disposition by the SEC of cash or other 
assets in which non-federal individuals or entities may have an 
interest that the SEC or federal government must uphold. The SEC's 
fiduciary liabilities arise out of cases brought by the SEC against 
respondents. This monetary relief can take the form of civil monetary 
penalties or disgorged ill-gotten gains. In administrative proceedings, 
assessed civil monetary penalties may be added to disgorged illegal 
gains and become part of the disgorgement fund that the SEC maintains 
for distribution to the victims of the violations. The fund balances 
result from fiduciary activities undertaken pursuant to the SEC's 
statutory direction and authority. 

The SEC's custodial liability as reported on the Statement of Custodial 
Activity (see Section 3: Financial Section) consists primarily of 
disgorgement, penalties, and interest paid by violators of federal 
securities laws into the General Fund of the Treasury. Non-federal 
individuals or entities do not have an ownership interest in these 
moneys, and the SEC is not authorized by law to use the funds. 

Revenues and Costs: 

The SEC's $575.8 million net income from operations is a result of 
gross revenues and cost of operations in the amounts of $1,301.9 
million and $726.1 million, respectively. The SEC's revenues represent 
fees and assessments paid pursuant to Section 6(b) of the Securities 
Act of 1933 and Sections 13(e), 14 (g), and 31 of the Securities 
Exchange Act of 1934, which are summarized in Figure 1.15. 

Figure 1.15 Revenue Summary for the Year Ended September 30, 2004 
(Dollars in Thousands): 

[See PDF for image] --graphic text: 

Pie chart with three items. 

Intragovernmental Reimbursable Revenue: $609; 
Sections 6(b), 13(e), and 14(g) Filing Fee Revenue: $389,904; 
Section 31 Fees and Assessments: $911,432. 

[End of figure]

These fees and assessments support the SEC's six major program areas, 
including Full Disclosure, Prevention and Suppression of Fraud, 
Supervision and Regulation of Securities Markets, Investment Management 
Regulation, Legal and Economic Services, and Program Direction. The 
gross cost of operations for these six program areas is presented in 
Figure 1.16 SEC management plans to explore reorganizing the structure 
of its programs in FY 2005. 

Figure 1.16 Gross Cost of Operations for the Year Ended September 30, 
2004 (Dollars in Thousands): 

[See PDF for image] --graphic text: 

Pie chart with six items. 

Full Disclosure: $90,307; 
Program Direction: $166,280; 
Legal and Economic Services: $27,850; 
Investment Management Regulation: $90,359; 
Supervision and Regulation of Securities Markets: $119,602; 
Prevention and Suppression of Fraud: $231,658. 

[End of figure]

Limitations: 

The SEC has prepared its FY 2004 financial statements in accordance 
with the requirements of OMB Bulletin Number 01-09, Form and Content of 
Agency Financial Statements. OMB Bulletin Number 01-09 incorporates the 
concepts and standards contained in the Statements of Federal Financial 
Accounting Concepts and the Statements of Federal Financial Accounting 
Standards (SFFAS) issued by the Federal Accounting Standards Advisory 
Board (FASAB). 

On October 19, 1999, the American Institute of Certified Public 
Accountants Council designated the FASAB as the accounting standards- 
setting body for federal government entities. Therefore, the SFFAS 
constitute the generally accepted accounting principles (GAAP) for the 
federal government. The FASAB established these concepts and standards 
to help federal agencies comply with the requirements of the Chief 
Financial Officers Act of 1990 and the Government Management Reform Act 
of 1994. These two acts demand financial accountability from federal 
agencies and require integrated accounting, financial management, and 
cost accounting systems. 

The financial data in this report and the financial statements that 
follow have been prepared from the SEC's accounting records in 
conformity with GAAP The SEC's financial statements consist of the 
Balance Sheet, the Statement of Net Cost, the Statement of Changes in 
Net Position, the Statement of Budgetary Resources, the Statement of 
Financing, and the Statement of Custodial Activity. The financial 
statements were prepared pursuant to the requirements of 31 United 
States Code 3515 (b). The following limitations apply to the 
preparation of the financial statements: 

While the statements are prepared from books and records in accordance 
with the formats prescribed by the OMB, the statements are in addition 
to the financial reports used to monitor and control budgetary 
resources, which are prepared from the same books and records. 

The statements should be read with the understanding that the SEC is a 
component of the U.S. Government, a sovereign entity. One implication 
is that unfunded liabilities cannot be liquidated without legislation 
that provides the resources to do so. 

In addition, certain information contained in this report may be deemed 
forward-looking statements about events and financial trends that may 
affect future operating results and financial position. Such statements 
may be identified by words such as "estimate," "project," "plan," 
"intend," "believe," "expect," "anticipate," or variations or negatives 
thereof or by similar or comparable words or phrases. Prospective 
statements are subject to risks and uncertainties that could cause 
actual results to differ materially from those expressed in the 
statements. Such risks and uncertainties include, but are not limited 
to, the following: changes in U.S. or global economic conditions; the 
availability, hiring, and retention of qualified staff employees; 
government regulations; disputes with labor organizations; and 
deployment of new technologies. The SEC undertakes no obligation to 
publicly update its financial statements to reflect events or 
circumstances after the date hereof, or to reflect the occurrence of 
unanticipated events. 

[End of section] 

Financial Statements: 

SECTION 3: FINANCIAL SECTION: 

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Balance Sheet As of September 30, 2004: 

(Dollars In Thousands): 

ASSETS: 

Intragovernmental: Fund Balance With Treasury (Notes 1-J and 2): 
$4,202,640; 
Intragovernmental: Accounts Receivable (Notes 1-K and 3): $219; 
Total Intragovernmental: $4,202,859; 
Cash (Note 1-M): $11; 
Accounts Receivable, Net (Notes 1-K, 3, and 5): $326,283; 
Advances and Prepayments (Note 1-L): $11; 
Property and Equipment, Net (Notes 1-N and 4): $49,103; 
Total Assets: $4,578,267. 

LIABILITIES: 

Intragovernmental: Accounts Payable (Notes 1-P and 6): $8,055; 
Intragovernmental: Unfunded FECA Liability (Notes 1-Q and 7): $1,120; 
Total Intragovernmental: $9,175; 
Accounts Payable (Notes 1-P and 6): $16,456; 
Accrued Payroll and Benefits (Notes 1-P and 6): $17,369; 
Accrued Leave (Note 1-R): $28,705; 
Customer Deposit Accounts (Notes 5 and 6): $62,284; 
Actuarial Liability (Notes 1-S and 7): $5,140; 
Fiduciary Liability (Notes 1-V, 5, and 15): $863,167; 
Custodial Liability (Notes 1-U and 14): $279,054; 
Commitments and Contingencies (Note 16): $500; 
Other Accrued Liabilities: $5,816; 
Total Liabilities (Notes 1-P and 6): $1,287,666. 

NET POSITION: 

Unexpended Appropriations: $313; 
Cumulative Results of Operations: $3,290,288; 
Total Net Position: $3,290,601; 
Total Liabilities and Net Position: $4,578,267. 

The accompanying notes are an integral part of these financial 
statements. 

[End of table]

Statement of Net Cost For the year ended September 30, 2004: 

(Dollars In Thousands): 

NET COST OF OPERATIONS (Notes 10 and 11): 

Full Disclosure: Intragovernmental Gross Cost: $5,032; 
Full Disclosure: Gross Cost with the Public: $85,275; 
Full Disclosure: Total Gross Cost: $90,307; 

Prevention and Suppression of Fraud: Intragovernmental Gross Cost: 
$17,349; 
Prevention and Suppression of Fraud: Gross Cost with the Public: 
$214,309; 
Prevention and Suppression of Fraud: Total Gross Cost: $231,658; 

Supervision and Regulation of Securities Markets: Intragovernmental 
Gross Cost: $6,560; 
Supervision and Regulation of Securities Markets: Gross Cost with the 
Public: $113,042; 
Supervision and Regulation of Securities Markets: Total Gross Cost: 
$119,602; 

Investment Management Regulation: Intragovernmental Gross Cost: $4,926; 
Investment Management Regulation: Gross Cost with the Public: $85,433; 
Investment Management Regulation: Total Gross Cost: $90,359; 

Legal and Economic Services: Intragovernmental Gross Cost: $1,613; 
Legal and Economic Services: Gross Cost with the Public: $26,237; 
Legal and Economic Services: Total Gross Cost: $27,850; 

Program Direction: Intragovernmental Gross Cost: $56,772; 
Program Direction: Gross Cost with the Public: $109,508; 
Program Direction: Total Gross Cost: $166,280; 
Total Entity: Total Gross Cost: $726,056; 
Total Entity: Less Earned Revenue: $(1,301,945); 
Total Entity: Net (Income)/Cost from Operations: $(575,889). 

The accompanying notes are an integral part of these financial 
statements. 

[End of table]

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Statement of Changes in Net Position For the year ended September 30, 
2004: 

[See PDF for image]

[End of table]

The accompanying notes are an integral part of these financial 
statements. 

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Statement of Budgetary Resources For the year ended September 30, 2004: 

(Dollars in Thousands): 

BUDGETARY RESOURCES: 

Budget Authority: Net Transfers (Note 12): $-. 

Unobligated Balance: Beginning of Period: $2,409,706; 
Unobligated Balance: Net Transfers, Actual (Note 12): -; 

Spending Authority from Offsetting Collections: Earned: Collected: 
$1,392,878; 
Spending Authority from Offsetting Collections: Earned: Customer 
Receivables and Refund Payables: $39; 

Change in Unfilled Customer Orders: Without Advance Received: $182; 
Subtotal: $1,393,099; 

Actual Recoveries of Prior Year Obligations: $75,327; 
Permanently Not Available: $(994); 

Total Budgetary Resources: $3,877,138; 

STATUS OF BUDGETARY RESOURCES: 

Obligations Incurred (Note 13): Direct: $827,619; 

Unobligated Balance Available: Realized and Apportioned for Current 
Period: $56,020; 
Unobligated Balance Available: Exempt from Apportionment: $600; 
Unobligated Balance Not Available: Restricted and Expired Funds: 
$2,992,899; 
Total Status of Budgetary Resources: $3,877,138. 

RELATIONSHIP OF OBLIGATIONS TO OUTLAYS: 

Obligated Balance, Net, Beginning of Period: $183,787; 
Accounts Receivable: $(219); 
Unfilled Customer Orders from Federal Sources: $(182); 
Undelivered Orders: $179,886; 
Accounts Payable: $48,795; 
Obligated Balance, Net, End of Period: $228,280; 
Outlays: Disbursements: $707,578; 
Outlays: Collections: $(1,392,878); 
Net Outlays: $(685,300). 

The accompanying notes are an integral part of these financial 
statements. 

[End of table]

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Statement of Financing: 

For the year ended September 30, 2004: 

(Dollars in Thousands): 

RESOURCES PROVIDED TO FINANCE ACTIVITIES: 

Budgetary Resources Obligated (Note 13): Obligations Incurred: 
$827,619; 
Budgetary Resources Obligated (Note 13): Obligations Incurred: Less: 
Spending Authority from Offsetting Collections and Recoveries: 
$(1,468,426); 
Net obligations: $(640,807); 
Other Resources: Imputed Financing from Cost Absorbed by Others: 
$30,444; 
Other Resources: Total Resources Provided to Finance Activities: 
$(610,363). 

RESOURCES USED TO FINANCE ITEMS NOT PART OF THE NET COST OF OPERATIONS: 

Change in Budgetary Resources Obligated for Goods, Services, and 
Benefits Ordered but Not Yet Provided: $(48,328); 
Resources That Finance the Acquisition of Assets Capitalized on the 
Balance Sheet: $(30,816); 
Net Decrease in Revenue Receivables Not Generating Resources until 
Collected: $90,876; 
Total Resources Used to Finance Items Not Part of the Net Cost of 
Operations: $11,732. 

COMPONENTS OF NET COST OF OPERATIONS THAT WILL NOT REQUIRE OR GENERATE 
RESOURCES IN THE CURRENT PERIOD: 

Components Requiring or Generating Resources in Future Periods: Costs 
That Will Be Funded by Resources in Future Periods: $5,729; 
Components Requiring or Generating Resources in Future Periods: Other: 
$89; 
Components Requiring or Generating Resources in Future Periods: Total 
Components of Net Cost of Operations That Will Require or Generate 
Resources in Future Periods: $5,818; 

Components Not Requiring or Generating Resources: Depreciation and 
Amortization: $14,050; 
Components Not Requiring or Generating Resources: Revaluation of Assets 
or Liabilities: $2,624; 
Components Not Requiring or Generating Resources: Other Costs That Will 
Not Require Resources: $250; 

Total Components of Net Cost of Operations: That Will Not Require or 
Generate Resources: $16,924; 
Total Components of Net Cost of Operations: That Will Not Require or 
Generate Resources in the Current Period: $22,742; 
Net (Income)/Cost from Operations: $(575,889). 

The accompanying notes are an integral part of these financial 
statements. 

[End of table]

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Statement of Custodial Activity: 

For the year ended September 30, 2004: 

(Dollars in Thousands): 

REVENUE ACTIVITY: 

Sources of Cash Collections: Penalties and Disgorgement: $216,255; 
Sources of Cash Collections: Other: $98; 
Total Cash Collections: $216,353; 
Accrual Adjustments: $213,164; 
Total Custodial Revenue (Notes 1-U and 14): $429,517. 

DISPOSITION OF COLLECTIONS: 

Amounts Transferred to the Treasury General Fund: $216,353. 

Total Disbursements: $216,353; 
Change in Liability Accounts: $213,164; 
Total Disposition of Collections: $429,517. 

NET CUSTODIAL ACTIVITY: 

The accompanying notes are an integral part of these financial 
statements. 

[End of table]

NOTES TO FINANCIAL STATEMENTS: 
As of and for the fiscal year ended September 30, 2004: 

Note 1. Summary of Significant Accounting Policies: 

A. Reporting Entity: 

The United States Securities and Exchange Commission (SEC) is an 
independent agency of the United States established pursuant to the 
Securities Exchange Act of 1934. The SEC's mission is to protect 
investors: maintain fair, honest, and efficient securities markets; and 
facilitate capital formation. With this mission in mind, the SEC works 
with the United States Congress, self-regulatory organizations (e.g., 
stock exchanges and the National Association of Securities Dealers), 
state securities regulators, and many other organizations in support of 
the agency's mission. 

These financial statements report on the SEC's six major program areas: 
Full Disclosure; Prevention and Suppression of Fraud; Supervision and 
Regulation of Securities Markets; Investment Management Regulation; 
Legal and Economic Services; and Program Direction. These programs are 
intended to promote the public interest by protecting investors and 
preserving the integrity and efficiency of the securities markets; 
encouraging international regulatory and enforcement cooperation; 
educating and assisting investors; overseeing the operations of the 
nation's securities markets and participants; regulating investment 
companies; and ensuring compliance through inspection, examination, and 
full disclosure. 

B. Fund Accounting Structure: 

These financial statements present the SEC's individual funds and 
accounts. The SEC is classified in the Other Independent Agencies 
section of the federal budget. The SEC's financial activities are 
accounted for by the Treasury account fund symbol, summarized as 
follows: 

Salaries and expenses (5040100) include the appropriated general funds 
used to carry out the SEC's missions and functions for the fiscal year. 

Special fund receipts (50X0100) include revenues collected by the SEC 
in excess of appropriated funds (see Note 2. Fund Balance With 
Treasury). 

Deposit funds (50F3875 and 50F3880) account for customer moneys held 
temporarily until earned by the SEC, civil monetary penalties and 
disgorged ill-gotten gains collected and held on behalf of harmed 
investors, and to hold collections awaiting disposition or 
reclassification. 

Miscellaneous receipt accounts (501099 and 503220) hold non-entity 
receipts and accounts receivable from SEC custodial activities that 
cannot be deposited into funds under SEC control. 

The SEC does not have lending or borrowing authority, except as 
discussed in Note 16. Commitments and Contingencies. The SEC does have 
custodial and fiduciary responsibilities, as described in Note 14 
Custodial Revenues and Liabilities and Note IS Fiduciary Liabilities, 
and as described below. 

Custodial revenues are the collection of non-exchange revenues for the 
General Fund of the Treasury, a trust fund, or other federal recipient 
entities. These revenues arise when the SEC exercises its powers to 
demand payments from the public and has a specifically identifiable, 
legally enforceable claim to cash or other assets, and collection is 
probable and the amounts are measurable. Fiduciary liabilities arise 
from the receipt, management, accounting, and disposition by the SEC of 
cash or other assets which non-federal individuals or entities have an 
ownership interest that must be upheld. 

C. Intra-and Inter-Agency Relationships: 

The SEC does not transact business among its own operating units, and 
therefore, intra-entity eliminations are not necessary. The SEC does 
have certain oversight responsibilities with respect to the Financial 
Accounting Standards Board (FASB); Securities Investor Protection 
Corporation (see Note 16. Commitments and Contingencies); and the 
Public Company Accounting Oversight Board. These entities have been 
excluded from the SEC reporting unit and the accompanying financial 
statements. 

D. Basis of Presentation: 

The accompanying financial statements present the financial position, 
net cost of operations, changes in net position, budgetary resources, 
financing, and custodial and fiduciary activities of the SEC's core 
business activities in conformity with accounting principles generally 
accepted in the United States for the federal government and Office of 
Management and Budget (OMB) Bulletin 01-09, Form and Content of Agency 
Financial Statements. Therefore, they may differ from other financial 
reports submitted pursuant to OMB directives for the purpose of 
monitoring and controlling the use of SEC budgetary resources. The 
SEC's books and records serve as the source of the information 
presented in the accompanying financial statements. Assets, 
liabilities, revenues, and costs have been classified in these 
financial statements according to the type of entity associated with 
the transactions. Intragovernmental assets and liabilities are those 
from or to other federal entities. Intragovernmental earned revenues 
are collections or accruals of revenue from other federal entities, and 
intragovernmental costs are payments or accruals to other federal 
entities. 

E. Basis of Accounting: 

Transactions are recorded on the accrual and budgetary bases of 
accounting. Accrual accounting allows for revenue to be recognized when 
earned and expenses to be recognized when goods or services are 
received without regard to the receipt or payment of cash. Budgetary 
accounting facilitates compliance with the requirements for and 
controls over the use of federal funds. 

The accompanying financial statements are presented on the accrual 
basis of accounting. The accounting principles and standards applied in 
preparing these financial statements are in accordance with the 
accounting policies and practices summarized in this note and the 
following hierarchy of accounting principles: 

Federal Accounting Standards Advisory Board (FASAB) Statements and 
Interpretations plus American Institution of Certified Public 
Accountants (AICPA) and FASB pronouncements if made applicable to 
federal governmental entities by a FASAB Statement or Interpretation;

FASAB Technical Bulletins and the following pronouncements if 
specifically made applicable to federal government entities by the 
AICPA and cleared by the FASAB: AICPA Industry Audit and Accounting 
Guides and AICPA Statements of Position;

AICPA Accounting Standards Executive Committee Practice Bulletins if 
specifically made applicable to federal governmental entities and 
cleared by the FASAB and Technical Releases of the Accounting and 
Auditing Policy Committee of the FASAB;

Implementation guides published by the FASAB staff and practices that 
are widely recognized and prevalent in the federal government; and: 

Other accounting literature published by authoritative standard- 
setting bodies and other authoritative sources (a) in the absence of 
other guidance in the first four parts of this hierarchy, and (b) if 
the use of such accounting principles improves the meaningfulness of 
the financial statements. 

E Budgets and Budgetary Accounting: 

The Securities Exchange Act of 1933 and the Securities Exchange Act of 
1934 established the securities registration, securities transaction, 
tender offer, merger, and other fees and charges collected by the SEC 
to offset its appropriated funds. Until passage of the National 
Securities Market Improvement Act in 1996, the United States Congress 
continued to increase fee rates to offset partially the cost of funding 
the agency. The National Securities Market Improvement Act in 1996 
reduced fee rates and provided future annual reductions in fee rates. 
In 2002, the Investor and Capital Markets Fee Relief Act was signed 
into law. This legislation set fee rates for FY 2002 and requires the 
SEC to adjust the fee rates for FY 2003 through FY 2011, and make a 
final adjustment to fix the fee rates for FY 2012 and beyond. 

The SEC is subject to certain restrictions on statutory fees and 
charges. Revenue collected in excess of appropriated amounts 
constitutes offsetting receipts deposited in a restricted special fund 
receipt account at the United States Department of the Treasury 
(Treasury). The special fund receipt account has no liabilities 
currently, and the entire fund balance remains restricted for use by 
the SEC. The SEC may use funds from this account only as authorized by 
the United States Congress, made available by OMB apportionment, and 
upon issuance of a Treasury warrant. 

Fees other than the restricted excess fees are offsetting collections 
subject to an annual congressional limitation of $812.1 million for the 
budget FY 2004. Funds appropriated but not used in a given fiscal year 
are transferred to the special fund receipt account for use in future 
periods, as appropriated by the United States Congress. 

Each fiscal year, the SEC receives an appropriation of Category A funds 
from the OMB, which apportions budgetary resources by fiscal quarter. 
The SEC also receives a small amount of Category B funds, or those 
funds exempt from quarterly apportionment. 

G. Use of Estimates: 

The preparation of financial statements in conformity with United 
States generally accepted accounting principles for the federal 
government requires management to make estimates and assumptions that 
affect the reported amounts of assets and liabilities and the 
disclosure of contingent assets and liabilities at the date of the 
financial statements and the reported amounts of revenues and expenses 
during the reporting period. Actual results could differ from estimates 
contained in the accompanying financial statements. 

H. Revenue and Other Financing Sources: 

The SEC's revenue and financing sources include exchange revenues, 
which the agency has earned by providing goods and services to other 
federal entities or the public, and non-exchange revenues, which arise 
from the SEC's authority to collect fees or donations from the public. 

The SEC's funding is through primarily the collection of securities 
registration, securities transaction, and tender offer, merger, and 
other fees and charges. The SEC's fee rates are established by law and 
are applied to volumes of activity reported by self-regulatory 
organizations or to filings submitted by registrants. When received, 
these fees are recorded as exchange revenue. The SEC is authorized by 
law to include these amounts in its obligational authority or to offset 
its expenditures and liabilities upon collection. All amounts remitted 
by customers in excess of the fees for specific services are recorded 
as liabilities in deposit accounts until earned by the SEC from 
customer filings or returned to the customer pursuant to SEC policy, 
which calls for the return of customer deposits when an account is 
dormant for six months. 

The SEC is also involved in litigation that results in the assessment 
of civil monetary penalties, interest, and disgorged ill-gotten gains 
by violators of federal securities laws. This activity is recognized as 
non-exchange revenue and presented on the Statement of Custodial 
Activity when the SEC collects this revenue on behalf of the General 
Fund of the Treasury, a trust fund, or another federal government 
entity. This activity may also be classified as fiduciary activities 
when the SEC collects these assessments on behalf of non-federal 
individuals or entities that have an ownership interest. An equal and 
offsetting liability for the assets held by the SEC at or outside the 
Treasury is reported in the Balance Sheet. The SEC does not record 
fiduciary assessments collected and held by another federal entity or a 
non-federal government entity, such as a court registry or receiver. 

In addition, the SEC's share of the cost to the federal government for 
providing pension and other post-retirement benefits to eligible SEC 
employees is recognized as an imputed financing source. The SEC may 
also receive some gifts-in-kind that are used for primarily official 
travel to further the SEC's mission and objectives. 

I. Entity/Non-Entity: 

Assets that an entity is authorized to use in its operations are titled 
entity assets, while assets held by an entity and not available for the 
entity's use are termed non-entity assets. Although constrained by 
statute, most of the SEC's assets are entity assets available to carry 
out its mission, except portions of Fund Balance With Treasury that 
contains special fund receipts or customer deposit accounts, and 
custodial accounts receivable and fiduciary assets that represent the 
amount of uncollected and collected but undisbursed civil monetary 
penalties, interest, and disgorged ill-gotten gains. 

J. Fund Balance With Treasury: 

Fund Balance With Treasury represents obligated and unobligated 
balances available to finance expenditures. It also includes balances 
restricted for use without further authorization by the United States 
Congress and apportioned by the OMB. All SEC banking activity is 
conducted in accordance with directives issued by the Treasury, 
Financial Management Service (FMS). All revenue and receipts are 
deposited in commercial bank accounts maintained by the FMS or wired 
directly to a Federal Reserve Bank. The Treasury processes all 
disbursements made by the SEC. All moneys maintained in commercial bank 
accounts are transferred to the Federal Reserve Bank on the next 
business day following the day of deposit. 

Fund Balance With Treasury also includes funds that the SEC collected 
and holds at or outside the Treasury in the name of the SEC on behalf 
of non-federal individuals or entities that have an ownership interest. 
These funds represent the collection of civil monetary penalties, 
interest, and disgorged ill-gotten gains that will be paid out to 
harmed investors pursuant to authorized distribution plans (see Note 
IS. Fiduciary Liabilities). 

K. Accounts Receivable and Allowance for Uncollectible Accounts Entity 
and non-entity accounts receivable consist of amounts due primarily 
from the public. 

Entity accounts receivable from the public represent a small portion of 
the SEC's business activities because agency fee legislation requires 
payment at the time of filing or registration in the conduct of its 
core business activities, and stock market exchange fees are payable to 
the SEC twice a year-in March for the period September through December 
and in September for the period January through August. Therefore, 
these accounts receivable comprise exchange and filing fees due and 
payable to the SEC primarily for activity during the month of 
September; goods or services provided pursuant to requests made under 
the Freedom of Information Act (FOIA); host reimbursement of SEC 
employee travel; and other employee-related debt. 

Non-entity accounts receivable comprise disgorgement, civil monetary 
penalties, and interest levied against violators of federal securities 
laws. The SEC maintains a custodial responsibility over these non- 
entity accounts receivable that are recognized when the SEC has been 
designated in authorized judgments to collect the assessed civil 
monetary penalties and interest. When collected, these funds are 
returned to the General Fund of the Treasury, as non-federal 
individuals or entities do not have an ownership interest in these 
revenues, and the SEC is not authorized to use the funds, except as 
discussed below. 

In certain cases, orders granting monetary relief to harmed investors 
in the form of civil monetary penalties and disgorged ill-gotten gains 
from federal securities law violators and respondents constitute a 
fiduciary responsibility for the SEC. These fiduciary receipts 
represent the collection or receipt, management, protection, 
accounting, investment, and disposition by the SEC of cash or other 
assets in which non-federal individuals or entities have an ownership 
interest that the SEC must uphold. When collected, fiduciary receipts 
are held in Fund Balance With Treasury, and an equal and offsetting 
liability for assets held by the SEC at or outside the Treasury in the 
name of the SEC is reported as a non-entity liability in the Balance 
Sheet. 

As of September 30, 2004, the SEC recorded a $1,393,608 thousand 
allowance for uncollectible amounts to reduce the gross amount of its 
non-entity accounts receivable to its estimated net realizable value, 
as summarized in Note 3. Accounts Receivable, Net. A provision for 
estimated losses for uncollectible amounts of $466,283 thousand has 
been recorded as a reduction of non-exchange revenue in FY 2004. The 
allowance for uncollectible amounts and the related provision for 
estimated losses for Penalties and Disgorgement and FOIA accounts 
receivable are based on reserving 100 percent of debts over two years 
old, an analysis of the collectibility of individual account balances 
for the largest remaining debts, and on historical collection data to 
determine on a percentage basis the value of gross accounts receivable 
that are likely to be collected by the SEC. This percentage is applied 
to the remaining Penalties and Disgorgement and FOIA accounts 
receivable to reflect the balances at their estimated net realizable 
value. The allowance for uncollectible amounts and the related 
provision for estimated losses for Filing Fees and Other is based on 
historical collection data to determine on a percentage basis the value 
of gross accounts receivable that are likely to be collected by the 
SEC; and no allowance for uncollectible amounts and the related 
provision for estimated losses has been established for Due for 
Reimbursable Agreements and Exchange Fees, as these gross accounts 
receivable are deemed to represent their net realizable value. In 
addition, unless a court or administrative proceeding order specifies 
the amount of pre-and post-judgment interest, the SEC does not 
recognize such interest as accounts receivable. 

L. Advances and Prepayments: 

The SEC may advance funds to its personnel for travel costs and these 
amounts are expensed when the travel takes place. The SEC may also 
prepay amounts in anticipation of receiving future benefits. These 
payments are expensed when the goods have been received or services 
have been performed. 

M. Cash: 

The SEC's cash balance consists of petty cash funds maintained to 
reimburse personnel for minor expenses. 

N. Property and Equipment, Net: 

The SEC's property and equipment consist of software and general 
purpose equipment used by the agency; capital improvements made to 
buildings leased by the SEC for office space; and internal-use software 
development costs for projects in development. Property and equipment 
purchases and additions are stated at cost. Property and equipment 
acquisitions that do not meet the capitalization criteria, normal 
repairs, and maintenance are charged to expense as received or incurred 
by the SEC. 

Property and equipment are depreciated over their estimated useful 
lives using the straight-line method of depreciation. Contractor costs 
for developing custom internal-use software are capitalized when 
incurred for the design, coding, and testing of the software. Software- 
in-progress is not amortized until placed in service. The table below 
summarizes the major classes of depreciable property and the SEC's 
capitalization policies. 

[See PDF for image]

[End of table]

Software-in-progress may be expensed when the project is abandoned 
because the SEC has determined that the project will no longer provide 
value to the agency. 

O. Non-Entity Assets: 

Assets held by and not available to the SEC for obligation are 
considered non-entity assets. These assets consist primarily of 
accounts receivable established for SEC custodial activities for 
transfer to the General Fund of the Treasury, and fiduciary assets held 
by the SEC on behalf of non-federal individuals or entities that have 
an ownership interest, which the SEC must uphold on their behalf. 

P Liabilities: 

The SEC records liabilities for amounts that are likely to be paid as 
the result of events that have occurred as of September 30, 2004. The 
SEC considers liabilities covered by three types of resources: realized 
budgetary resources; unrealized budgetary resources that become 
available without further Congressional action; and cash and Fund 
Balance With Treasury. Realized budgetary resources include obligated 
balances that fund existing liabilities and unobligated balances as of 
September 30, 2004. Unrealized budgetary resources represent fee 
collections in excess of amounts appropriated for current fiscal year 
spending. These resources are used to cover liabilities when 
appropriation language makes these unrealized budgetary resources 
available in the fiscal year without further Congressional action. 

Cash and Fund Balance With Treasury include amounts for liabilities 
that will never require the use of a budgetary resource. These 
liabilities consist of customer deposit accounts, refunds payable to 
customers for filing fee overpayments, and undeposited collections. Due 
to the SEC's funding structure, certain fees that were collected are 
withheld and deposited into a restricted special fund receipt account. 
These funds cannot be considered a budgetary resource until 
appropriated by the United States Congress and made available by OMB 
apportionment and issuance of a Treasury warrant. 

Q Injury and Post-employment Compensation: 

Claims brought by SEC employees for on-the-job injuries fall under the 
Federal Employees' Compensation Act (FECA) administered by the United 
States Department of Labor (DOL). The DOL bills each agency annually as 
its claims are paid, but payment on these bills is deferred for two 
years to allow for funding through the budget process. As of September 
30, 2004, the SEC recorded a $482 thousand liability for claims paid on 
its behalf during the benefit period October 1, 2003, through September 
30, 2004. 

Similarly, SEC employees who lose their jobs through no fault of their 
own may receive unemployment compensation benefits under the 
unemployment insurance program also administered by the DOL. The DOL 
bills each agency quarterly for paid claims. For FY 2004, the SEC paid 
$30 thousand for claims paid by the DOL on behalf of former SEC 
employees. 

R. Annual, Sick, and Other Leave: 

Annual leave and compensatory time are accrued as earned, and the 
accrual is reduced when leave is taken. Each fiscal quarter, an 
adjustment is made to ensure that the balances in the accrued leave 
accounts reflect current leave balances and pay rates. Accrued leave as 
of September 30, 2004, was $28.7 million. No portion of this liability 
has been obligated. Funding will be obtained from future financing 
sources to the extent current or prior year funding is not available to 
pay for leave earned but not taken. Sick leave and other types of non- 
vested leave are expensed as used. 

S. Employee Retirement Systems and Benefits: 

SEC employees participate in either the Civil Service Retirement System 
(CSRS) or the Federal Employees Retirement System (FERS), depending on 
when they were hired by the federal government. The FERS was 
established by enactment of Public Law 99-335. Pursuant to this law, 
the FERS and Social Security automatically cover most employees hired 
after December 31, 1983. Employees who are rehired after a break in 
service of more than one year and who had five years of federal 
civilian service prior to 1987 are placed in the CSRS offset retirement 
system or may elect to join the FERS. 

The SEC's financial statements do not report CSRS or FERS assets or 
accumulated plan benefits that may be applicable to its employees. The 
reporting of such liabilities is the responsibility of the United 
States Office of Personnel Management (OPM). While the SEC reports no 
liability for future payments to employees under these programs, the 
federal government is liable for future payments to employees through 
the various agencies administering these programs. The SEC does not 
fund post-retirement benefits such as the Federal Employees Health 
Benefit Program and the Federal Employees Group Life Insurance Program. 
The SEC is also not required to fully fund the CSRS pension 
liabilities. 

Instead, the financial statements of the SEC recognize an imputed 
financing source and corresponding expense that represent the SEC's 
share of the cost to the federal government of providing pension, post- 
retirement health, and life insurance benefits to all eligible SEC 
employees. For the fiscal year ended September 30, 2004, the SEC made 
contributions based on OPM cost factors equivalent to approximately 
6.81 percent and 10.39 percent of the employee's basic pay for those 
employees covered by CSRS and FERS, respectively. 

All employees are eligible to contribute to a thrift savings plan. For 
those employees participating in the FERS, a thrift savings plan is 
automatically established, and the SEC makes a mandatory 1 percent 
contribution to this plan. In addition, the SEC makes matching 
contributions ranging from 1 to 4 percent for FERS-eligible employees 
who contribute to their thrift savings plans. FERS participating 
employees are also covered under the Federal Insurance Contributions 
Act (FICA), for which the SEC contributes a matching amount to the 
Social Security Administration. No matching contributions are made to 
the thrift savings plans for employees participating in the CSRS. 

For the fiscal year ended September 30, 2004, the SEC's retirement plan 
contributions for CSRS and FERS participants were $36.9 million. The 
SEC also contributed to the Social Security Administration for FICA 
benefits totaling $21.4 million for the fiscal year. 

T. Environmental Cleanup: 

The SEC does not have any liabilities for environmental cleanup. 

U. Custodial Activities: 

The Statement of Custodial Activity presents the sources and 
disposition of SEC custodial activity that consists primarily of the 
assessment of civil monetary penalties and interest against violators 
of federal securities laws. When collected, the funds are returned to 
the General Fund of the Treasury, as non-federal individuals or 
entities do not have an ownership interest in these revenues, and the 
SEC is not authorized by law to use the funds, except as discussed in 
Note 1-K. Accounts Receivable and Allowance for Uncollectible Accounts. 

Fiduciary Activities: 

Fiduciary activities represent the receipt, management, accounting, and 
disposition by the SEC of cash or other assets in which non-federal 
individuals or entities have an ownership interest that the SEC or 
federal government must uphold. These fiduciary activities are 
classified as fiduciary assets held by the SEC at the Treasury in the 
name of the SEC to be disbursed at some later date pursuant to a court- 
or SEC-approved disbursement plan. 

Typically, these claims arise from enforcement action taken against 
federal securities law violators to grant monetary relief. Pursuant to 
a court order or judgment or at the SEC's discretion, assessed civil 
monetary penalties may be added to disgorged illegal gains against 
securities law violators and become part of the disgorgement fund 
maintained by the SEC for distribution to the victims of the 
violations. The SEC does not record fiduciary assessments collected and 
held by another federal entity or a non-federal government entity, such 
as a court registry or receiver. 

Note 2. Fund Balance With Treasury: 

At September 30, 2004, Fund Balance With Treasury consisted of the 
following: 

[See PDF for image]

[End of table]

Unrestricted funds are available to the SEC for obligation and 
expenditure; while restricted funds must be made available by the 
United States Congress before the SEC can obligate and expend these 
funds. No discrepancies exist between the fund balance reflected in the 
general ledger and the balance in the Treasury accounts. Non-entity 
funds consist of amounts held on deposit for the convenience of SEC 
filers and fiduciary assets held at the Treasury in the name of the 
SEC. 

Customer deposit accounts are for filers who maintain a deposit account 
at the SEC to facilitate filing processes. These funds are drawn down 
when filers submit filings, and filers can replenish their deposit 
account as desired. 

Account balances with no activity for six months are returned to the 
customer. Funds maintained in customer deposit accounts are not 
available for SEC use until a filing has been submitted to the SEC, and 
then the funds are reclassified to entity funds. 

Fiduciary assets are funds collected and held on behalf of non-federal 
individuals or entities that have an ownership interest, which the SEC 
must uphold and distribute at some later date pursuant to a court-or 
SEC-approved distribution plan. 

Note 3. Accounts Receivable, Net: 

At September 30, 2004, accounts receivable consisted of the following: 

[See PDF for image]

[End of table]

Note 4. Property and Equipment, Net: 

At September 30, 2004, property and equipment consisted of the 
following: 

[See PDF for image]

[End of table]

Leasehold improvements include costs incurred for the SEC's new 
building that is currently under construction. The SEC expects to 
occupy the building in 2005, and therefore, no depreciation expense has 
been recognized as of September 30, 2004. 

Note 5. Non-Entity Assets: 

At September 30, 2004, non-entity assets consisted of the following: 

[See PDF for image]

[End of table]

Note 6. Liabilities: 

At September 30, 2004, liabilities consisted of the following: 

(DOLLARS IN THOUSANDS)

Liabilities Covered by Resources Intragovernmental: Accounts Payable: 
$8,055. 

Total Intragovernmental Liabilities: $8,055.
Total Intragovernmental Liabilities: Accounts Payable: $16,456.
Total Intragovernmental Liabilities: Accrued Payroll and Benefits; 
17,369. 

Total Liabilities Covered by Resources: $41,880. 

Liabilities Not Covered by Resources Intragovernmental; [Empty]. 

Unfunded FECA Liability: $1,120. 

Total Intragovernmental Liabilities: $1,120.
Total Intragovernmental Liabilities: Accrued Leave: $28,705.
Total Intragovernmental Liabilities: Actuarial Liability: $5,140.
Total Intragovernmental Liabilities: Customer Deposit Accounts: $62,284.
Total Intragovernmental Liabilities: Custodial Liability: $279,054.
Total Intragovernmental Liabilities: Fiduciary Liability: $863,167.
Total Intragovernmental Liabilities: Commitments and Contingencies: 
$500.
Total Intragovernmental Liabilities: Other: $5,816. 

Total Liabilities Not Covered by Resources: $1,245,786. 

Total Liabilities: $1,287,666. 

[End of table]

Note 7. Actuarial Liability: 

The FECA provides income and medical cost protection to covered federal 
civilian employees injured on the job and for those who have contracted 
a work-related occupational disease, and dependents of employees whose 
death is attributable to a job-related injury or occupational disease. 
Claims incurred for benefits under the FECA for the SEC's employees are 
administered by the DOL and are paid by the SEC ultimately. 

The SEC's estimate is based on the DOL's model for estimating the FECA 
actuarial liability for federal agencies not specified in the DOL's 
FECA model. The model considers the average amount of benefit payments 
incurred by the SEC for the past three fiscal years, multiplied by the 
medical and compensation: 

liability to benefits paid (LBP) ratio for the whole FECA program, 
estimated at approximately 11 times the annual payments. To capture 
variability, the model estimates the liability using three sets of LBP 
ratios, summarized as follows: 

LBP Category: High; 
Medical: 9.30%; 
13.40%. 

LBP Category: Overall Average; 
Medical: 8.00%; 
Compensation: 11.90%. 

LBP Category: Lowest; 
Medical: 6.90%; 
Compensation: 11.50%. 

[End of table]

For FY 2004, the SEC used the Overall Average LBP rate to calculate the 
$5.1 million FECA actuarial liability. 

Note 8. Leases: 

The SEC has the authority to negotiate long-term leases for office 
space. As of September 30, 2004, the SEC leased office space at 17 
locations under annually renewable operating lease agreements that 
expire between 2005 and 2019. The SEC paid $51,869 thousand for rent 
for the fiscal year ended September 30, 2004. Under existing 
commitments, the minimum lease payments through FY 2009 and thereafter 
are as follows: 

(Dollars In Thousands): 

Fiscal year: 2005; 
Minimum Lease Payments: $59,491. 

Fiscal year: 2006; 
Minimum Lease Payments: $62,139. 

Fiscal year: 2007; 
Minimum Lease Payments: $60,285. 

Fiscal year: 2008; 
Minimum Lease Payments: $56,795. 

Fiscal year: 2009; 
Minimum Lease Payments: $54,557. 

Fiscal year: 2010 and thereafter; 
Minimum Lease Payments: $349,033. 

Total Future Minimum Lease Payments: $642,300. 

[End of table]

Note 9. Imputed Financing: 

The SEC recognizes an imputed financing source and corresponding 
expense to represent its share of the cost to the federal government of 
providing pension and post-retirement health and life insurance 
benefits (Pension/Other Retirements Benefits (ORB)) to all eligible SEC 
employees. For the fiscal year ended September 30, 2004, the components 
of the imputed financing sources and corresponding expenses were as 
follows: 

[See PDF for image]

[End of table]

Note 10. Program Costs: 

Program costs are accumulated by responsibility segment and consist of 
costs related directly to the individual business lines and overall 
support costs allocated to the business lines. All costs incurred 
during the fiscal year ended September 30, 2004, were assigned to 
specific programs. Total program or operating costs for the fiscal year 
ended September 30, 2004, by cost category are summarized below. 

[See PDF for image]

[End of table]

Note 11. Program Cost by Category and Responsibility Segment For the 
fiscal year ended September 30, 2004, program costs by cost category 
and responsibility segment were as follows: 

[See PDF for image]

[End of table]

Note 12. Transfers without Reimbursement: 

For the fiscal year ended September 30, 2004, transfers of budgetary 
authority (from) to other SEC funds consisted of the following: 

[See PDF for image]

[End of table]

Note 13. Status of Budgetary Resources: 

A. Apportionment Categories of Obligations Incurred: 

For the fiscal year ended September 30, 2004, obligations incurred as 
reported on the Statement of Budgetary Resources consisted of the 
following: 

[See PDF for image]

[End of table]

B. Explanation of Differences between the Statement of Budgetary 
Resources and the Budget of the United States Government: 

The distinction between Category A and B funds is that Category A funds 
are subject to apportionment by the OMB, while Category B funds are 
available for use by the agency without being subject to quarterly 
apportionment. As of September 30, 2004, there were no material 
differences between the Statement of Budgetary Resources and the Budget 
of the United States Government. 

Note 14. Custodial Revenues and Liabilities: 

For the fiscal year ended September 30, 2004, custodial revenues 
consisted of the following: 

[See PDF for image]

[End of table]

For the fiscal year ended September 30, 2004, custodial liabilities 
consisted of the following: 

[See PDF for image]

[End of table]

Note 15. Fiduciary Liabilities: 

As a civil law enforcement agency, the SEC has broad regulatory and 
enforcement powers and judicial and administrative remedies available 
to enforce federal securities laws. The principal laws that grant the 
SEC its authority include the: Securities Act of 1933; Securities 
Exchange Act of 1934; Public Utility Holding Company Act of 1935; Trust 
Indenture Act of 1939; Investment Company Act of 1940; Investment 
Advisers Act of 1940; Securities Investor Protection Act of 1970; 
Insider Trading Sanctions Act of 1984; Government Securities Act of 
1986; Insider Trading and Securities Fraud Enforcement Act of 1988; 
Securities Enforcement Remedies and Penny Stock Reform Act of 1990; 
Market Reform Act of 1990; Unlisted Trading Privileges Act of 1994; 
Private Securities Litigation Reform Act of 1995; Philanthropy 
Protection Act of 1995; National Securities Markets Improvement Act of 
1996; International Anti-Bribery and Fair Competition Act of 1998; 
Securities Litigation Uniform Standards Act of 1998; Gramm-Leach-Bliley 
Act; Commodity Futures Modernization Act of 2000; Investor and Capital 
Markets Fee Relief Act of 2001; and Sarbanes-Oxley Act of 2002. 

Among many things, these acts require security issuers to provide 
investors with certain information on new and outstanding securities 
offered for sale to the public; prohibit fraud, manipulation, and 
insider trading in the securities markets; set fines for criminal 
violations of federal securities: 

laws; permit the SEC to seek civil monetary penalties for gains or loss 
avoidance of insider trading transactions; establish the length of 
prison terms for federal securities law violations; permit the SEC to 
enter temporary and permanent cease-and-desist orders; seek court 
orders imposing civil monetary penalties; and enter administrative 
orders requiring respondents to disgorge gains. 

Orders issued by administrative law judges or federal courts granting 
monetary relief to harmed investors in the form of civil monetary 
penalties and disgorged ill-gotten gains from federal securities law 
violators and respondents constitute the SEC's fiduciary activities. 
These fiduciary activities represent the receipt, management, 
accounting, and disposition by the SEC of cash or other assets in which 
non-federal individuals or entities have an ownership interest that the 
SEC or federal government must uphold. Pursuant to a court order or 
judgment or at the SEC's discretion, assessed civil monetary fines and 
penalties may be added to disgorged illegal gains against securities 
law violators and become part of the disgorgement fund maintained by 
the SEC for distribution to the victims of the violations. The balances 
in the funds result from fiduciary activities undertaken pursuant to 
the SEC's statutory direction and authority. At September 30, 2004, the 
assets held by the SEC in a fiduciary capacity and its offsetting 
liability consisted of the following: 

[See PDF for image]

[End of table]

During the fiscal year ended September 30, 2004, the source and 
disposition of the SEC's fiduciary activities consisted of the 
following: 

[See PDF for image]

[End of table]

Note 16. Commitments and Contingencies: 

A. Commitments: 

The Securities Investor Protection Act of 1970, as amended (SIPA) 
created the Securities Investor Protection Corporation (SIPC) to 
provide certain financial protections to customers of insolvent 
registered securities brokers, dealers, firms, and members of national 
securities exchanges for up to $500,000 per customer. The SIPA 
authorizes the SIPC to create a fund to maintain all moneys received 
and disbursed by the SIPC. The SIPA also gives the SIPC the authority 
to borrow funds from the SEC in an amount not to exceed in the 
aggregate $1 billion in the event that the SIPC fund is or may appear 
insufficient for purposes of the SIPA. If necessary, these funds would 
be made available to the SEC through the purchase by the Treasury of 
notes or other obligating instruments issued by the SEC. Such notes or 
other obligating instruments would bear interest at a rate determined 
by the Secretary of the Treasury. As of September 30, 2004, the SEC had 
not loaned any funds to the SIPC, and there are no outstanding notes or 
other obligating instruments issued by the SEC. 

In addition to the future lease commitments discussed in Note 8. 
Leases, the SEC is obligated for the purchase of goods and services 
that have been ordered, but not yet received. Net obligations for all 
of the SEC's activities were $228,280 thousand as of September 30, 
2004, and of this amount $53,390 thousand were delivered and unpaid. 

B. Contingencies: 

The SEC is party to various routine administrative proceedings, legal 
actions, and claims brought by or against it, including threatened or 
pending litigation involving labor relations claims, some of which may 
ultimately result in settlements or decisions against the federal 
government. As of September 30, 2004, SEC management expects that it is 
probable that approximately $500 thousand may be owed for a settlement 
involving an Equal Access to Justice Act application. The SEC is also 
party to a grievance over the agency's implementation of its new pay 
system. Subsequent to September 30, 2004, an arbitrator issued a 
preliminary decision unfavorable to the agency, which the SEC fully 
intends to appeal. The SEC cannot predict the outcome of the appeal, 
and an amount or range of possible loss cannot be accurately estimated 
at this time. 

[End of section]

U.S. SECURITIES AND EXCHANGE COMMISSION: 

Required Supplemental Information As of September 30, 2004: 

[See PDF for image]

[End of table]

The SEC has not deferred to a future period maintenance on the property 
and equipment presented on the Balance Sheet as of September 30, 2004. 

[End of section]

Appendix I: Comments from the Securities and Exchange Commission: 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION: 
WASHINGTON. D.C. 20549: 

May 18, 2005: 

The Honorable David M. Walker: 
Comptroller General of the United States: 
Government Accountability Office:
441 G Street, N.W.: 
Washington, D.C. 20548: 

Dear Mr. Walker: 

Thank you for the opportunity to respond to the Government 
Accountability Office's (GAO) draft report entitled "Financial Audit: 
Securities and Exchange Commission's Financial Statements for Fiscal 
Year 2004". The GAO has completed the audit of the Securities and 
Exchange Commission's first-ever financial statements. We are pleased 
that the audit found that the statements and notes are presented 
fairly, in all material respects, and in conformity with U.S. generally 
accepted accounting principles for Federal agencies. Additionally, the 
audit found no instances of reportable noncompliance with laws and 
regulations tested. The report also presents GAO's opinion on the 
effectiveness of SEC's internal controls over financial reporting 
(including safeguarding of assets). 

The opinion on internal controls identified three material weaknesses 
that the SEC is moving aggressively to address and resolve. In the area 
of general controls over information technology security, the audit 
confirmed many of the findings reported in prior years through the 
SEC's Federal Managers' Financial Integrity Act (FMFIA) and audit 
programs. In our response to GAO's related report, "Information 
Security: Securities and Exchange Commission Needs to Address Weak 
Controls over Financial and Sensitive Data," we indicated that by June 
2006 the SEC will implement corrective actions for the specific control 
weaknesses identified in the audit according to a quarter-by-quarter 
timeline. 

The material weakness identified in the area of documenting and 
reporting on financial data related to disgorgements and penalties 
arising from enforcement actions also confirms findings reported over 
the past three years through the SEC's FMFIA program. As mentioned in 
the report, the SEC has made significant progress in this area and 
continuing efforts to strengthen these operations remain an important 
programmatic and financial management initiative. During FY 2005 the 
staff will complete a comprehensive review of files and data and review 
and strengthen policies and procedures. It is anticipated that 
consistent application of strengthened internal controls and 
potentially some limited redesign of the program's existing management 
information system will be adequate to resolve the material weakness in 
FY 2006. However, replacement of the current system and a more thorough 
reexamination of the relevant business processes will provide more 
effective assurance and in FY 2006 the SEC will complete a requirements 
analysis as the first phase of the multi-year project to replace the 
system. 

The third material weakness, preparation of financial statements, 
reflects the fact that the fiscal 2004 financial statements were the 
SEC's first, and the procedures and management systems used to prepare 
and review the statements have not been fully documented and integrated 
into agency operations. To resolve the weakness, we will increase our 
financial reporting staff this fiscal year and formalize policies and 
procedures. Financial management staff will continue to solicit advice 
from staff experts within the SEC. Senior management reviewed the 2004 
statements and management processes supporting them; certain initial 
policies applied in the first year of financial reporting have been 
confirmed and others have been modified or recommended for further 
review. The agency will establish a formal audit committee to provide 
for continued regular review and advice by key management officials. 

We remain committed to enhancing the financial and operational 
effectiveness of the SEC and appreciate your support of those efforts. 
We look forward to continuing our productive dialogue with the GAO on 
the issues addressed in the FY 2004 audit. 

If you have any questions relating to our response, please contact 
Margaret Carpenter, Chief Financial Officer, at (202) 551-7854. 

Sincerely,

Signed by: 

Margaret J. Carpenter: 
Chief Financial Officer: 

Signed by: 

James M. McConnell: 
Executive Director: 

Signed by: 

Peter Derby:
Managing Executive for Operations: 

cc: Jeanette M. Franzel, Director, Financial Management and Assurance, 
GAO. 

[End of section]

(194387): 

FOOTNOTES

[1] Our opinion on internal control is based on criteria established 
under 31 U.S.C. ß 3512 (c), (d), commonly referred to as the Federal 
Managers' Financial Integrity Act (FMFIA) and the Office of Management 
and Budget (OMB) Circular A-123, revised June 21, 1995, Management 
Accountability and Control. 

[2] Material weaknesses and system nonconformance issues concerning 
data integrity and financial reporting for disgorgements and penalties 
are reported in SEC's FMFIA reports for fiscal years 2002, 2003, and 
2004. 

[3] GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999). 

[4] In its fiscal year 2004 report pursuant to the Federal Information 
Security Management Act (FISMA), SEC's Office of Inspector General 
reported that SEC was not substantially in compliance with FISMA 
requirements that are intended to strengthen information security. 
Also, SEC has reported problems with its information security program 
as a material weakness in its FMFIA report since 2002. 

[5] GAO, Information Security: Securities and Exchange Commission Needs 
to Address Weak Controls Over Financial and Sensitive Data, GAO-05-262 
(Washington, D.C.: March 2005). 

[6] GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999). 

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