[Senate Hearing 105-266]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 105-266
 
     FRAUD IN THE MICRO-CAPITAL MARKETS INCLUDING PENNY STOCK FRAUD

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

                                HEARING

                               before the

                               PERMANENT
                     SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                       ONE HUNDRED FIFTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 22, 1997

                               __________

      Printed for the use of the Committee on Governmental Affairs


                     U.S. GOVERNMENT PRINTING OFFICE
44-227 cc                    WASHINGTON : 1997

_______________________________________________________________________
For sale by the Superintendent of Documents, Congressional Sales Office
         U.S. Government Printing Office, Washington, DC 20402




                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   FRED THOMPSON, Tennessee, Chairman
SUSAN M. COLLINS, Maine              JOHN GLENN, Ohio
SAM BROWNBACK, Kansas                CARL LEVIN, Michigan
PETE V. DOMENICI, New Mexico         JOSEPH I. LIEBERMAN, Connecticut
THAD COCHRAN, Mississippi            DANIEL K. AKAKA, Hawaii
DON NICKLES, Oklahoma                RICHARD J. DURBIN, Illinois
ARLEN SPECTER, Pennsylvania          ROBERT G. TORRICELLI,
BOB SMITH, New Hampshire               New Jersey
ROBERT F. BENNETT, Utah              MAX CLELAND, Georgia
             Hannah S. Sistare, Staff Director and Counsel
                 Leonard Weiss, Minority Staff Director
                    Michal Sue Prosser, Chief Clerk

                                 ------                                

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     SUSAN M. COLLINS, Maine, Chair
SAM BROWNBACK, Kansas                JOHN GLENN, Ohio
PETE V. DOMENICI, New Mexico         CARL LEVIN, Michigan
THAD COCHRAN, Mississippi            JOSEPH I. LIEBERMAN, Connecticut
DON NICKLES, Oklahoma                DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
BOB SMITH, New Hampshire             ROBERT G. TORRICELLI, New Jersey
ROBERT F. BENNETT, Utah              MAX CLELAND, Georgia
           Timothy J. Shea, Chief Counsel and Staff Director
           Jeffrey S. Robbins, Chief Counsel to the Minority
                     Mary D. Robertson, Chief Clerk




                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Collins..............................................     1
    Senator Cleland..............................................     4
Prepared statement:
    Senator Collins..............................................    55
    Senator Cleland with additional copy.........................    58
    Senator Glenn................................................   107

                               WITNESSES
                       Monday, September 22, 1997

Arthur Levitt, Jr., Chairman, U.S. Securities and Exchange 
  Commission.....................................................     9
Emile O. Murnan, St. Louis, Missouri.............................    21
Helen Sprecher, Philadelphia, Pennsylvania; accompanied by Henry 
  Ian Pass. Esq..................................................    23
Louis Poggi, Pembroke, New Hampshire.............................    27
Joseph P. Borg, Director, Alabama Securities Commission, and 
  Member, North American Securities Administrators Association, 
  Inc. (NASAA)...................................................    39
Barry R. Goldsmith, Executive Vice President, NASD Regulation, 
  Inc............................................................    43

                     Alphabetical List of Witnesses

Borg, Joseph P.:
    Testimony....................................................    39
    Prepared Statement with attachments..........................   158
Goldsmith, Barry R.:
    Testimony....................................................    43
    Prepared Statement...........................................   252
Levitt, Arthur, Jr.:
    Testimony....................................................     9
    Prepared Statement...........................................   112
Murnan, Emile O.:
    Testimony....................................................    21
    Prepared Statement...........................................   145
Poggi, Louis:
    Testimony....................................................    27
    Prepared Statement...........................................   154
Sprecher, Helen:
    Testimony....................................................    23
    Prepared Statement...........................................   147

                                APPENDIX
                              Exhibit List

* May Be Found In The Files of the Subcommittee

                                                                   Page

 1. GCold Calling Alert, a brochure prepared by the North 
  American Securities Administrator Association, Inc. (NASAA) and 
  the Securities and Exchange Commission (SEC)...................   269

 2. GMemorandum prepared by Ian Simmons, Counsel, Permanent 
  Subcommittee on Investigations, dated September 17, 1997, to 
  Permanent Subcommittee on Investigations' Membership Liaisons 
  regarding micro-cap fraud hearing..............................   279

 3. GGAO Report, Penny Stocks: Regulatory Actions to Reduce 
  Potential for Fraud and Abuse, February 1993, GAO/GGD-93-59....     *

 4. GGAO Report, Securities Markets: Actions Needed to Better 
  Protect Investors Against Unscrupulous Brokers, September 1994, 
  GAO/GGD-93-208.................................................   297

 5. GWall Street Journal, September 4, 1997, ``Despite Reforms, 
  Penny-Stock Fraud Is Roaring Back''............................   345

 6. GMaterials and news articles submitted to the Permanent 
  Subcommittee on Investigations by the North American Securities 
  Administrator Association, Inc. (NASAA) regarding May 1997 
  State enforcement actions to address the problem of fraudulent 
  sales practices in the micro-cap marketplace                      347

 7. GWall Street Journal, November 19, 1997, ``Departure of Many 
  Lawyers at SEC Stretches Its Resources, Delays Cases''.........     *

 8. GBond Buyer, November 10, 1997, ``Merrill Official Calls for 
  Securities Firms To Take Tough Stand on Compliance''...........     *

 9. GNew York Times, October 30, 1997, ``S.E.C. Schedules A 
  Meeting As Small-Stock Fraud Soars''...........................     *

10. GWall Street Journal, September 26, 1997, ``Bear Stearns 
  Takes Stand on Clearing-Firm Says Regulation Could Hurt 
  Industry'' and additional news articles regarding Bear Stearns.     *

11. GWall Street Journal, September 22, 1997, ``SEC Plan Assault 
  on Small-Stock Fraud'' and additional news articles on 
  Permanent Subcommittee on Investigations' September 22, 1997 
  hearing........................................................     *

12. GBarrons, September 15, 1997, and Kiplinger's Personal 
  Finance Magazine, July 1996, regarding the CRD System..........   422

13. GWall Street Journal, September 8, 1997, ``Big Board Tightens 
  Clearing-Firm Rules''..........................................     *

14. GWall Street Journal, June 2, 1997, ``Securities Regulators 
  Cracking Down On Sales Fraud at Brokerage Firms''..............     *

15. GCorrespondence to Chairman Susan M. Collins, Permanent 
  Subcommittee on Investigations, September 24, 1997, from Barry 
  R. Goldsmith, Executive Vice President, NASD-Regulation, Inc., 
  forwarding supplemental materials for the hearing record 
  regarding NASD-R's public disclosure program and NASD's 
  strengthening of examination requirements for registered 
  representatives. (Supplemental materials not reprinted--may be 
  found in the files of the Subcommittee)........................   430

16. GSupplemental Questions and Answers for the Record of The 
  Honorable Arthur Levitt, Jr., Chairman, U.S. Securities and 
  Exchange Commission............................................   432

17. GSupplemental Questions and Answers for the Record of Joseph 
  Borg, Director, Alabama Securities Commission, and Member, 
  North American Securities Administrator Association, Inc. 
  (NASAA)........................................................   466

18. GSupplemental Questions and Answers for the Record of Barry 
  R. Goldsmith, Executive Vice President, NASD Regulation, Inc. 
  (Attachments to supplemental questions not reprinted--may be 
  found in the files of the Subcommittee)........................   475

19. GWall Street Journal, December 9, 1997, ``Nasdaq, in Newest 
  Clean-Up Plan, Might Remove 3,400 OTC Stocks'' and Baltimore 
  Sun, December 10, 1997, ``Nasdaq looks to pull 3,400 small 
  stocks''.......................................................   553


    FRAUD IN THE MICRO-CAPITAL MARKETS, INCLUDING PENNY STOCK FRAUD

                              ----------                              


                       MONDAY, SEPTEMBER 22, 1997

                                       U.S. Senate,
                Permanent Subcommittee on Investigations,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 1:35 p.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Susan M. 
Collins, Chairman of the Subcommittee, presiding.
    Present: Senators Collins and Cleland.
    Staff Present: Timothy J. Shea, Chief Counsel/Staff 
Director; Mary D. Robertson, Chief Clerk; Ian Simmons, Counsel; 
Dennis McCarthy, Investigator; Kirk Walder, Investigator; 
Lindsey Ledwin, Staff Assistant; Jeffrey S. Robbins, Minority 
Chief Counsel; Bob Roach, Counsel to the Minority; Rachel 
Sullivan (Senator Glenn); Jonathan Frenkel (Senator Glenn); 
Barbara Olson (Senator Nickles); Steve Diamond (Senator 
Collins), Bill Greenwalt (Senator Thompson), Ann Rehfuss 
(Senator Cochran); Michael Loesch (Senator Cochran); Kevin 
Franks (Senator Cleland); Wayne Howell (Senator Cleland); and 
Barbara Perkins (Senator Levin).

            OPENING STATEMENT OF SENATOR COLLINS \1\

    Senator Collins. The Subcommittee will please come to 
order. We expect Senator Cleland to be with us very shortly, 
but in the interest of time, I am going to begin.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Collins appears in the 
Appendix on page 55.
---------------------------------------------------------------------------
    Today, the Subcommittee will launch an investigation of 
securities fraud into what is known as the micro-capital 
markets. For those unfamiliar with the arcane terminology of 
Wall Street, the micro-cap segment of the market includes small 
companies with relatively low market values. It includes but is 
not limited to penny stocks.
    These hearings are both the continuation of a tradition and 
a look to the future. They are a continuation a tradition 
because of our Subcommittee's long history of investigating 
security scams aimed at small investors. They are a look to the 
future because we will be examining new and growing abuses in 
our capital markets.
    These hearings are also timely. Last fall, Federal 
prosecutors charged 46 individuals with stock fraud in New 
York. In May of this year, a 20-State task force acted to shut 
down some of the worst of the firms engaged in stock 
manipulation. And less than 3 weeks ago, on September 4, the 
Wall Street Journal published a lengthy story entitled, 
``Despite Reforms, Penny Stock Fraud is Roaring Back.'' \1\ 
That story noted the very disturbing fact that investors may 
lose as much as $6 billion annually due to penny stock fraud, 
more than triple the 1980's peak.
---------------------------------------------------------------------------
    \1\ Exhibit 5 appears in the Appendix on page 345.
---------------------------------------------------------------------------
    We conduct these hearings against the backdrop of a booming 
stock market and a new generation of unseasoned investors. 
Hidden beneath the rising tide of the market, micro-cap fraud 
represents a pernicious undercurrent that potentially affects 
thousands of American families. Many of these families are, for 
the first time, investing their hard-earned money to save for 
skyrocketing tuition costs, unforseen medical expenses, and 
lengthier retirements. While we have the safest and the most 
successful capital markets in the world, the irony is that 
public confidence in our markets actually creates opportunities 
for con artists to exploit the unwary.
    Micro-cap fraud not only harms the small investor, it also 
has the potential to harm small companies. As this type of 
fraud increases, the willingness to invest in emerging 
enterprises decreases and legitimate companies are denied the 
capital which is the life blood of our free market system.
    How exactly do these scams work? Unscrupulous brokerage 
firms, often operating through intermediaries, purchase large 
amounts of stock in a small company. The stock is virtually 
worthless or of very limited value, but the brokers act to 
drive its price higher by aggressively cold-calling thousands 
of unsuspecting individuals, many of whom have little or no 
prior investment experience.
    In repeated cold calls, the scam artists hammer away at the 
investor on the telephone, promising glowing returns and 
emphasizing the need for immediate action. The inevitable 
result of these aggressive sales tactics is to push the stock 
price higher, at which point the brokerage firms' insiders dump 
their shares, leaving the public with worthless securities and 
the brokers with millions in ill-gotten gains.
    Scratch the surface of a stock manipulation scheme and you 
will inevitably find false or exaggerated information. If you 
doubt the potentially tremendous impact of false information, 
consider the $6 billion Bre-X scam. In that instance, phony 
reports about the gold content of the company's mines drove the 
price of the stock from a few pennies to $240 per share, until 
the fraud was exposed and the stock fell back down to earth. As 
you can imagine, the so-called unsophisticated investors who 
rode the stock down hit the ground with a thud.
    Coercive cold-calling and spreading false information are 
not the only tactics used by boiler rooms engaged in stock 
manipulation. Other practices which I expect we will hear 
testimony on today include making unauthorized purchases in 
consumers' accounts, refusing to execute sell orders in order 
to maintain a stock's upward momentum, using unlicensed persons 
who are paid under the table for making sales, and bribing 
brokers to recommend the stock being manipulated to their 
unsuspecting consumers.
    One particularly troubling problem that we will hear about 
today is the difficulty that regulators have in driving 
unethical brokers out of the industry. When a boiler room 
operation is closed down, often after lengthy proceedings, it 
is unfortunately common for the employees to show up in a host 
of new firms. Not unlike a grade-B science fiction movie, 
killing one of these monsters only seems to create a new army 
of them. Our regulatory system must ensure that when a broker 
participates in this type of fraud, he or she is not allowed to 
remain in the industry and once again pick the pockets of 
unwitting investors.
    There are a number of other regulatory questions that we 
must consider. For example, should the large Wall Street 
clearing houses that process transactions for penny stock 
brokerage firms have more of a role and responsibility in 
stopping fraud and manipulation in the micro-cap markets? How 
effective has the 1990 penny stock legislation been in limiting 
abusive practices? More specifically, since that legislation 
applies only to stocks selling for $5 or less, has the 
fraudulent activity simply moved to somewhat higher price 
stocks, also traded in the micro-cap market? What more should 
be done to police the bulletin board markets?
    While we are confronted with many complex issues, we are 
indeed fortunate to have an outstanding set of witnesses who 
are well-qualified to address those issues. We will first hear 
today from the Hon. Arthur Levitt, Jr., the distinguished 
Chairman of the United States Securities and Exchange 
Commission.
    We will then hear from three individual investors who were 
victimized by fraudulent practices and who have kindly agreed 
to share their experiences with us.
    Finally, we will hear from two other regulators, Mr. Barry 
Goldsmith, the Executive Vice President for Enforcement of NASD 
Regulation, the regulatory arm of the Nasdaq market, and Mr. 
Joseph Borg, the Director of the Alabama Securities Commission, 
who will present the very important perspective of the States.
    As we proceed with today's hearings, as well as with future 
sessions on securities fraud, we should remember that this 
Subcommittee has a dual role. Mindful of Justice Brandeis's 
observation that sunlight is the best disinfectant, we have a 
responsibility to expose abusive practices so that the American 
people can be on guard against them.
    We also have the obligation to determine whether our 
current regulatory scheme affords adequate protection to an 
ever-growing investing public. As I noted earlier, this 
Subcommittee has a proud tradition of looking out for the 
interests of small investors and I am determined, as the new 
Chair of this Subcommittee, to continue that tradition.
    In carrying out our responsibilities, we are indeed very 
fortunate to have the participation of my colleague from 
Georgia, Senator Cleland. As Secretary of State, Senator 
Cleland oversaw securities regulation in Georgia, a State that 
has been in the forefront of the battle against penny stock 
fraud. His experience and his leadership and commitment in this 
area will be an invaluable asset to the Subcommittee.
    I would now like to turn to the Senator for any comments 
that he might have.

            OPENING STATEMENT OF SENATOR CLELAND \1\

    Senator Cleland. Thank you very much, Madam Chairman. Mr. 
Levitt, it is nice to see you.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Cleland with attachments 
appears in the Appendix on page 58.
---------------------------------------------------------------------------
    Ladies and gentlemen, one of the wonderful pleasures of 
serving in the Senate is to serve with great talented people 
like Senator Collins, who has a flair for quotes. I often find 
myself quoting her. We are cosponsors of the McCain-Feingold 
bill, which has found a new life based on the full Governmental 
Affairs Committee. She had a great quote on the floor of the 
Senate the other day about the $50 billion tax handout to the 
tobacco companies, a quote from Harriet Beecher Stowe, that 
``like Topsy, she was not born, she just was.'' I thought that 
was pretty good. I love your Brandeis quote now about sunlight 
is the best disinfectant. I think that is probably a great 
prelude to these hearings.
    Senator Glenn would like to be here. He has a strong 
interest in the matters we will be discussing, but he asked me 
to be the ranking member here on our side.\2\
---------------------------------------------------------------------------
    \2\ The prepared statement of Senator Glenn appears in the Appendix 
on page 107.
---------------------------------------------------------------------------
    Madam Chairman and Members of the Subcommittee, it is a 
pleasure for me to be here today seeking information and, 
hopefully, some solutions to a major problem that has faced our 
country for years. I did serve as Georgia's Secretary of State 
and Commissioner of Securities for many years. I was 
responsible for administering Georgia's security laws and 
providing investor protection for our residents.
    The securities markets are an integral part of our Nation's 
economy and we have experienced tremendous growth, as has been 
observed, in these markets. In fact, this year alone, the 
markets have reached an all-time record. Unfortunately, these 
successes have led to a tremendous increase in fraud and abuse.
    In 1990, for example, only about 18 percent of all 
Americans were investing in equities. Today, I understand that 
some 31 percent of all Americans are now investing in equities 
and that one in three households now own securities. Just as 
recently as 1992, the daily share volume for the New York Stock 
Exchange and Nasdaq was only about 200 million shares a day. 
Today, the New York Stock Exchange and the Nasdaq market 
consistently trade in excess of 500 million shares. At the end 
of 1996, the market capitalization of Nasdaq was over $1.5 
trillion, more than a three-fold increase from $508 billion at 
the end of 1991.
    The securities markets would not exist without public 
confidence in the integrity of the professionals who work in 
and manage these markets. I salute these professionals and 
commend them for their efforts in promoting and encouraging a 
strong securities market that provides the capital to make our 
country grow and provide economic security for our citizens.
    While there are justifiable criticisms of the markets, the 
purpose of these hearings is to deal with a few bad apples, not 
to force regulatory changes that would be burdensome and a 
hindrance to legitimate capital formation.
    The success of our markets is shown by the billions of 
dollars that change hands each day, either from a telephone 
call, a head nod, or a handshake, which clearly reflect the 
trust and confidence we have placed in their integrity. Should 
this integrity be replaced with mistrust, our confidence would 
erode in the markets, as well as the American economy would 
ultimately suffer.
    We now have, beyond any doubt, the best securities markets 
in the world and it is very important we strive to keep these 
markets strong and the playing field level in order to give all 
of our investors an opportunity to be successful in the market. 
The confidence in our securities markets results, in part, 
because of the excellent cooperation that has existed between 
State and Federal Government regulators and self-regulatory 
organizations. This regulatory partnership has proven to be one 
of the most efficient and effective regulatory collaborations 
in the country.
    Substantive securities regulation in this country began at 
the State level, as a matter of fact. It was in 1911, the State 
of Kansas enacted the Nation's first blue sky law. Other States 
quickly adopted their own version of such legislation. In 1929, 
as a result of the stock market crash, Congress began a series 
of legislative efforts that encompass the body of law known 
today as the Federal securities laws.
    In the 1970's, a major cooperative effort was initiated 
between the States, the SEC, and the NASD and the stock 
exchanges. The results of this effort include a uniform 
competency exam that allow an individual to take one 
examination accepted in all the States, uniform registration 
forms that allow a firm or an individual to use the same forms 
for the States, the SEC, and the self-regulatory organizations, 
and a Central Registration Depository, CRD, that allows for an 
automated one-stop registration filing system.
    Georgia was one of the initial supporters of the CRD. This 
registration and licensing process provides an efficient and 
uniform process that compliments the fundamental purpose of 
State and Federal securities laws to provide investor 
protection and foster the confidence that will encourage the 
investments necessary for capital formation, economic growth, 
and job creation.
    For a regulatory program to be successful, you must have 
vigorous enforcement. When the securities laws were framed in 
the 1930's and 1940's, Congress wisely realized that there 
would never be enough ``cops on the beat'' in the form of 
government-paid securities regulators but that it would be 
necessary for the private bar to enforce the law on behalf of 
defrauded citizens. It is these attorneys who, in the words of 
SEC Chairman Levitt, ``serve a crucial role as a deterrent and 
are a vital supplement to the Committee's enforcement 
resources.''
    In testimony before Congress and in court documents, the 
SEC has repeatedly emphasized the critical role of the private 
lawsuit. However, despite the best efforts of the SEC, the 50 
State securities agencies, and the SROs, there continues to be 
an unacceptably high level of fraud and abuse in today's 
capital markets. Recently, top securities watchdogs in the 
United States have warned investors that the explosion in the 
stock market has brought a sharp rise in securities sales fraud 
and stock price manipulation.
    At a town meeting in Los Angeles, Mr. Levitt cautioned that 
investors are ``more vulnerable than ever to fraud.'' This 
concern has been echoed by others who point to a disturbing 
rise in the level of securities fraud and allege that organized 
crime is seeking a foothold in certain sectors of the 
marketplace.
    What is unusual about the increasing evidence of wrongdoing 
in the stock market is that shady practices tend to go 
unnoticed in the days of a strong bull market. Usually, the 
misconduct is uncovered only after a sharp sustained market 
drop similar to that of 1987. This has the regulatory community 
wary about what it would face should the stock market collapse.
    In the past 5 years, the number of stockbrokers doing 
business in the United States has grown by 50 percent, to some 
650,000. However, during the same time period, the regulatory 
staffs of the Securities and Exchange Commission and the 
National Association of Securities Dealers grew just 18 
percent.
    Let us all understand who suffers in cases of security 
fraud. It is retirees living on fixed incomes, young families 
struggling to make ends meet and save for their children's 
education, teachers, factory workers, and bankers. Each day, 
devastating cases are brought to the attention of securities 
regulators, law enforcement officers, and the private bar. 
Indeed, I am convinced that financial fraud is a serious and 
growing problem.
    Today's hearing will focus on micro-cap fraud, as Senator 
Collins has mentioned. This is a new and modern term we are 
famous for here in Washington for what we have known for years 
as penny stock fraud. In Georgia talk, we call it cheating and 
stealing.
    In the late 1980's, as Secretary of State, I directed a 
series of public hearings to focus on the penny stock fraud 
taking place in Georgia. We heard substantial evidence about 
serious securities violations involving misrepresentations, 
omissions to State material . . . enough about illegalities. 
What they were doing was lying, cheating, and stealing and 
swilling our citizens out of their hard-earned money.
    In the Governmental Affairs Committee, we have been looking 
at the campaign finance fraud and the terms hard money and soft 
money are used. Here, we are talking about hard money, the 
hard-earned money of our citizens and investors. Of course, 
this hard-earned money comes from them to provide capital for 
economic growth, not only that, but unfortunately, a lot of 
that money goes off to those who would line their own pockets 
for ill-gotten gain.
    This led me, when I was Secretary of State, to recommend a 
series of changes to strengthen Georgia's securities laws. 
These recommendations were unanimously enacted as amendments to 
the Georgia Securities Act and gave my staff more tools to 
effectively deal with penny stock fraud.
    In 1990, the SEC recommended and Congress enacted penny 
stock reform. The resulting reforms, both State and Federal, 
were effective for a few years. However, these crooks are 
clever. They accumulate their wealth by stealing, not with a 
gun but with a telephone and a fast line and often through 
threats and intimidations. It did not take long for them to 
figure out how to avoid the reform requirements.
    Now we see the micro-cap fraud being perpetrated by rogue 
brokers making cold calls all over the country, promising 
people that they can get rich quick in today's growing market. 
They use the success of the legitimate market to demonstrate 
the misrepresented potential for trade in their presentations. 
They say whatever it takes to close the sale. They take 
advantage of honest, hard-working people trying to live the 
American dream who make honest money in the market.
    I recognize the right of investors to seek legal remedies 
against those persons selling fraudulent securities. I have 
supported an investor's right to seek redress through 
mediation, arbitration, and civil litigation. While I worked to 
streamline the regulatory process in Georgia, I opposed 
amendments to Federal regulations that would have impaired the 
ability of a State to protect its investors. However, in 1995, 
as Secretary of State and Commissioner of Securities in 
Georgia, I opposed S. 240, the Private Securities Litigation 
Reform Act.
    It appears that we are now seeing a move to preempt 
existing State securities laws by extending the Private 
Securities Litigation Reform Act of 1995 to the States. It is 
not yet clear whether this Act will provide sufficient 
protection to defrauded investors. The main concern here is if 
the courts ultimately interpret it in a way that makes 
recoveries under the Federal law impossible, State remedies 
will be the only means for defrauded investors to redress their 
injuries.
    In the 19 months since its passage, the new Act has barely 
been tested, with no trials, no appellate decisions on 
substantive provisions, no summary judgments, and few decisions 
on any of its provisions. It will take more time to adequately 
assess this law's impact as the courts struggle to interpret 
its provisions.
    The Congress did an excellent job of balancing competing 
interests in the adoption of the National Securities Market 
Reform Act of 1996. I have always favored improvements in the 
regulatory system that do not curtail enforcement efforts to 
protect investors. The current efforts by some industry 
segments to preempt a State's role in the registration and 
licensing of broker-dealers and sales representatives would 
seriously impede the authority of the States to protect their 
residents from unscrupulous firms and brokers.
    I am confident that the SEC will find in its report that 
the States are an integral part of the regulatory process and 
that it would be a mistake to hamper our State regulators by 
removing their jurisdictional authority over broker-dealers. I 
have several suggestions as to where to go from here.
    Investor education--I am interested in new and innovative 
ways to educate the public about the securities markets and the 
risks associated with investment opportunities. A program of 
this type must be fully supported by the regulators and the 
industry.
    The CRD system--modernization of the Central Registration 
Depository should be one of the highest priorities of the 
regulators. Quality information made promptly available to 
regulators is often the key to a successful investigation and 
prosecution of violations. The CRD must be able to deliver both 
data and analytical reports in order for it to be successful as 
a regulatory tool. I encourage regulators to continue support 
for a viable customer complaint database that will provide 
information that could be useful in multi-State investigations.
    Another point is the administrative process. The 
administrative process provides regulators with the most 
effective tools to investigate misconduct and to discipline 
those firms and individuals who commit violations. However, 
regulators must not misuse or abuse the administrative process 
and the process must not be viewed as the ultimate weapon to 
deter fraud in the securities business.
    Civil actions--the filing of civil actions against firms 
and individuals who commit violations appears to have been the 
remedy of choice for the SEC. I think it is time to study the 
effectiveness of the civil process in dealing with serious 
fraudulent conduct by such firms and individuals.
    Criminal prosecution--the filing of criminal complaints and 
the seeking of indictments against rogue brokers and con 
artists will be the most effective tool to deter this type of 
criminal activity. I strongly encourage regulators to work with 
local, State, and Federal prosecutors in developing coordinated 
investigations and prosecutions. Also, State and Federal task 
forces could also provide a opportunity in demonstrating to 
criminals that justice will prevail.
    The taping of sales presentations--I commend NASD for its 
recent recommendation to require certain firms to tape sales 
presentations by certain brokers. The taping of these potential 
problem brokers is a positive step toward better investor 
protection.
    Cold call practices--this is not campaign finance here, 
this is stock brokering here. I also commend the regulators for 
their efforts to place some limitations and restrictions on 
cold calls. I encourage further monitoring and study regarding 
the control of cold calls.
    Clearing firms--I question how many investors have been 
improperly influenced to purchase high-risk and speculative 
securities by using the name of a prominent firm that is merely 
acting as a clearing agent.
    Disclosure--disclosure has always been, as Senator Collins, 
Madam Chairman, quoted Justice Brandeis, disclosure has always 
been the foundation for investors in making investment 
decisions. Regulators have done a good job requiring proper 
disclosure of material facts in registered offerings. In fact, 
some might say that the quantity of disclosure today may be a 
deterrent to real meaningful disclosure. Disclosure in the 
secondary markets, even by market makers, has not been 
effective. I realize that the use of the telephone and market 
volatility require prompt decisions. However, we must be sure 
to find a way for regulators to require that investors in the 
public markets be provided with sufficient information prior to 
making their investment decision.
    The Internet--it is imperative that our regulators have 
access to modern technology and provide programs to monitor 
investment activities on the Internet. Cyberspace fraud will be 
the wave of the future.
    The future of State regulation of securities--I support 
strong enforcement of our securities laws and I am confident 
the States must play a major role in these enforcement efforts. 
I want to encourage the States to be more flexible in licensing 
and registration procedures. I believe in using registration as 
an enforcement tool, but I do not think that States should 
place unreasonable burdens on firms and individuals attempting 
in good faith to become registered in their jurisdictions. I 
have been informed of many such unreasonable and inappropriate 
tactics. In Georgia, I always insisted that my staff be fair 
and reasonable in registration and licensing matters and tough 
on fraud enforcement matters. In other words, reasonable 
regulation and tough enforcement.
    Madam Chairman, thank you for enduring my remarks. This is 
the home of the filibuster. I am looking forward to hearing 
from Mr. Levitt and others on the ways we can improve our 
protection of our investors. Thank you very much.
    Senator Collins. Thank you very much, Senator.
    [The prepared statement of Senator Cleland follows:]
    Senator Collins. Our first witness this afternoon will be 
the Hon. Arthur Levitt, the distinguished Chairman of the 
Securities and Exchange Commission. Prior to becoming Chairman 
of the SEC in July of 1993, Mr. Levitt served as the Chairman 
of the New York City Economic Development Corporation from 1989 
to 1993 and the Chairman of the American Stock Exchange from 
1978 to 1989. Prior to that, Chairman Levitt worked on Wall 
Street for 18 years. I would also note that Chairman Levitt was 
once the owner of a publication very well known here on Capitol 
Hill, the newspaper Roll Call: so he is truly a man of diverse 
talents.
    We are truly fortunate that the Chairman could join us this 
afternoon and I look forward to his testimony. Because of time 
constraints, I am going to ask Mr. Levitt to limit his oral 
testimony to no more than 15 minutes. We will have lights to 
give you a sign of when you are getting low on time. In any 
case, your prepared testimony will be made part of the record.
    Pursuant to Rule 6 of the Subcommittee, all witnesses who 
testify are required to be sworn, so at this time, I am going 
to ask Mr. Levitt to please stand and raise your right hand.
    Do you swear that the testimony that you will give before 
the Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Mr. Levitt. I do.
    Senator Collins. Thank you. Mr. Levitt, you may proceed.

 TESTIMONY OF ARTHUR LEVITT, JR.,\1\ CHAIRMAN, U.S. SECURITIES 
                    AND EXCHANGE COMMISSION

    Mr. Levitt. Chairman Collins, Senator Cleland, thank you 
for this opportunity to appear on behalf of the Securities and 
Exchange Commission before the Permanent Subcommittee on 
Investigations. The foremost mission of the SEC is to protect 
investors, and so we are especially grateful for the spotlight 
you have brought to bear on this important issue.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Levitt appears in the Appendix on 
page 112.
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    It is an unfortunate irony of history that the best markets 
bring out the worst elements. The higher the market, the 
greater investor optimism, the more opportunities for outright 
and outrageous fraud. The Chicago Tribune wrote that an aging 
bull market always brings the sleazier elements out of Wall 
Street's woodwork, and that was a year ago. As the market 
continues to soar to new levels, each day brings us new 
challenges in fighting fraud, especially in the micro-cap and 
penny stock market.
    These hearings are focusing on a matter of paramount 
importance to the investing public, and they could not come at 
a more opportune time. I commend you for bringing to these 
hearings the defrauded investors who sit with us today, because 
there is nothing worse for the integrity of our markets, there 
is nothing worse for the process of capital formation, which 
depends so extensively on trust and confidence in those 
markets, than the dishonesty, the distortions created by greed.
    I think that even in the days since the printed version of 
my testimony was completed and submitted to the Subcommittee, 
our Commission's law enforcement efforts have pursued some of 
the most audacious frauds conceivable. I would like to give you 
a few quick examples.
    Just last Tuesday, September 16, the Commission obtained 
emergency judicial relief from a Federal judge in California in 
the form of a temporary restraining order and an asset freeze 
against the Geneva Group and Nicholas Garcia. We charged the 
defendants with a classic pattern of micro-cap fraud, where a 
shell company with no apparent business operations was being 
sold to investors through high-pressure sales practices, 
pretending it was a legitimate company with wide-ranging 
business operations.
    The following day, September 17, the Commission filed a 
securities fraud action in Federal court in California against 
five defendants, charging them with involvement in a fraudulent 
stock leasing scheme. The complaint alleges that the defendants 
acquired large blocks of restricted stock of 18 public 
companies, promising the companies that they would pay large 
monthly rental fees. After holding the stock for 1 year, the 
defendants promised to return the stock to the companies. The 
defendants then tried to sell the stock for property, money, or 
credit. The purchasers of the stock have suffered losses of at 
least $9.5 million.
    Finally, just last Thursday, in a tale frighteningly 
similar to a Hollywood movie script, the U.S. Attorney for the 
District of Nevada filed a detention motion against a penny 
stock promoter who is the target of an ongoing securities and 
bank fraud and money laundering investigation. This individual 
was arrested after recorded telephone conversations revealed a 
plot to arrange an accident for an accountant who was slated to 
testify against him at an upcoming trial.
    Allegations of this nature, once relegated to what we used 
to call ``street crime,'' send a shiver through our markets. 
This is not behavior that investors expect from market 
professionals, from corporate executives. It is not behavior 
that this Commission will tolerate.
    I cite these recent cases because they are an indication of 
some of the problems facing both civil and criminal law 
enforcement agencies every single day, not to mention 
investors. The remarkable efficiency, credibility, and success 
of our capital markets today has attracted more and more con 
men and criminals. Our securities markets are still the most 
efficient and fairest markets in the world, and while we must 
be careful not to be unduly alarmist, the actions that we have 
already taken, coupled with the program I will outline today, 
demonstrate the Commission's resolve to step up our regulatory 
and enforcement efforts in this area.
    As these cases suggest, fraud among low-capitalization 
stocks frequently involves two different but related problems. 
The first is aggressive and often fraudulent sales practices, 
such as lying to customers or unauthorized trading in their 
accounts.
    The second problem involves manipulation of micro-cap 
stocks by brokers, issuers, or promoters. These stocks are 
often traded in markets where there are no listing standards; 
and, in fact, often the issuer does not file financial reports 
with the Commission because it is so small.
    The Commission is responding to fraud in the micro-cap 
market with a wide-ranging campaign focused on three 
strategies: prevention, enforcement, and regulatory 
initiatives. I will discuss each briefly in turn.
    In terms of prevention, the Commission believes it is 
better to prevent fraud before the life savings of investors 
are destroyed than to simply punish the perpetrators after they 
have done their damage. To achieve this, we have conducted 
aggressive broker-dealer inspections as well as market and 
Internet surveillance.
    It is not enough, however, for regulators alone to protect 
investors. We also have to give investors the tools to protect 
themselves. The best tool, in my judgment, is investor 
education, and that is why in recent years the Commission has 
developed an incredibly aggressive investor education program. 
We have created a Web site that offers SEC press releases, 
investor alerts, litigation releases, tips on avoiding fraud, 
and our huge EDGAR database of corporate information.
    We have held 20 town meetings in cities all over America 
where thousands of investors come out and for 2 hours sit there 
and ask questions about their investments. We had nearly 6,000 
investors in Los Angeles. We have had 2,000 investors near 
Hamden, Connecticut. All over the country, to see investors 
come and ask questions that they were embarrassed or ashamed to 
ask their brokers, truly tells you what is going on out there.
    We have created a toll-free SEC hotline. We have developed 
a series of investor education brochures, and I am pleased to 
announce to you today the release of the latest such brochure, 
entitled ``Cold Calling:'' \1\ It is going to be distributed to 
investors nationwide by the SEC and the North American 
Securities Administrators Association. We also have brochures 
on how to buy municipal bonds, how to buy a mutual fund, and 
how to pick a broker.
---------------------------------------------------------------------------
    \1\ Exhibit 1 appears in the Appendix on page 269.
---------------------------------------------------------------------------
    One other vital defensive tool for investors is the broker 
disciplinary database known as the CRD. We are going to do 
everything we can to help NASDR head Mary Shapiro fulfill her 
pledge to improve the CRD and make it available through the 
Internet.
    We have stepped up both our civil and our criminal 
enforcement efforts. We are working with criminal authorities 
as never before, not merely to kick brokers who steal from 
innocent investors out of the business temporarily or 
permanently but to put them behind bars where they belong. We 
are sharing intelligence, pooling resources, and coordinating 
cases with our fellow law enforcement agencies.
    In the last year alone, for example, we charged or 
prosecuted more than 80 individuals in a coordinated effort 
with the Department of Justice. We have also worked closely 
with the self-regulatory organizations, or SROs, State 
regulators, local prosecutors, and our foreign counterparts to 
maximize our resources and stop micro-cap fraud at its earliest 
stages.
    Finally, we have undertaken a series of regulatory 
initiatives. Over the last several months, the Commission staff 
has worked with the New York Stock Exchange and the NASD to 
develop rules that address problems in this sector of the 
market. For example, we think that clearing firms should be 
more responsive to customer complaints and should provide more 
information about the conduct of firms whose trades they 
process. We are now considering a New York Stock Exchange rule 
that will address these concerns.
    We are going to ask market makers trading and broker-
dealers selling securities on the NASD's over-the-counter 
bulletin board and the National Quotation Bureau's pink sheets 
to obtain more up-to-date information about the issuer before 
they are allowed to quote or recommend a stock. We will also be 
asking the NASD to evaluate once again standards for securities 
of companies quoted on the Bulletin Board.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit 19 describing subsequent NASD action taken on the 
Bulletin Board which appears in the Appendix on page 553.
---------------------------------------------------------------------------
    The SEC itself is taking a series of dramatic steps to 
combat micro-cap fraud and rogue brokers. We are putting the 
rules governing the micro-cap market under a magnifying glass 
to examine how well they have worked, how to plug the 
loopholes, and how to make them work even better. We are 
focusing greater attention not only on rogue brokers but on 
rogue firms, because boiler rooms belong in power plants, not 
in professional brokerage firms.
    The keystone of this initiative is the creation of a 
special Commission-wide working group which will bring together 
SEC divisions and offices to find better ways to attack these 
frauds early on, before they have taken their toll on 
investors. If our Office of Compliance Inspections and 
Examinations finds a pattern of abuse of one of our small 
business exemptions, for example, they will immediately work 
with their counterpart from our Office of Small Business Policy 
to determine whether we should change that rule.
    The SEC can do a lot, but, especially in this market, we 
cannot do it alone. That is why this morning I met with Dick 
Grasso, the head of the New York Stock Exchange, Frank Zarb of 
the NASD, and the head of the NASAA to ask for their support, 
as well. In meeting with them today, they each pledged their 
commitment to minimize abuses in the micro-cap market through 
joint initiatives with the Commission, the industry, and the 
States.
    There is one other critical challenge presented by micro-
cap stock fraud. We need to control the fraud without damaging 
the market for securities of legitimate small businesses. I 
have always been a fierce advocate of the interests of small 
business. I want to assure Senator Collins and the Subcommittee 
that I am not about to stop now. We are going to weigh the 
needs of small businesses very carefully as we attempt to close 
some of the loopholes that have created these problems.
    Madam Chairman, as I noted earlier, in a market like this, 
parasites crowd in to feast on the bull's success. While we are 
aware of the problem and actively addressing it, we are deeply, 
deeply grateful for your interest in focusing public attention 
on an issue so important. You have truly shown great 
leadership.
    I look forward to working with you, not just today but in 
the future, and with your colleagues, to eliminate any of the 
abuses that you and Senator Cleland have mentioned and others 
that exist in the market today. Thank you for this opportunity.
    Senator Collins. Thank you very much, Chairman Levitt.
    In reading your written testimony and listening to your 
comments, it struck me that many of the practices that you 
describe, whether it is market manipulation or the high-
pressure cold calls or unauthorized transactions or no net 
sales policies, sound very much like the practices of a decade 
ago when I was a cabinet official in the State of Maine with 
responsibility for a department that included securities 
regulation. Indeed, to give my friend from Georgia yet another 
quote, it does remind me of that old Yogi Berra line that it 
sounds like deja vu all over again.
    This leads me to wonder whether the remedies that we have 
tried--whether it be greater disclosure requirements or 
electronic monitoring of trades--can only take us so far, since 
the business comes down essentially to how brokers treat their 
customers. So is it almost impossible to get control of these 
problems unless we raise the minimum competency levels and the 
ethical standards of the brokerage community.
    I want to emphasize that the vast majority of individuals 
working in this field are ethical and are looking out for their 
investors' best interests; but we have had a continuing problem 
that does not seem to go away no matter how much we enact new 
administrative or regulatory or legal reforms.
    So starting first with the competency issue, we have no 
minimum educational requirements and it has been suggested to 
me that passing the entry-level NASD exams can largely be a 
matter of just cramming and taking the test often enough. 
Indeed, when I harken back to my regulatory days at the State 
level, it truly was more difficult in the State of Maine to get 
a license as a cosmetologist than as a broker, even though one 
could argue that recovering from a bad hairdo is far easier 
than recovering from bad investment advice.
    But in all seriousness, with brokers engaged in the 
business of advising people on what to do, in many cases with 
their life savings, where mistakes can have just absolutely 
devastating consequences, as we are going to hear from some of 
our witnesses later today, do you believe that competency 
requirements for brokers are sufficiently demanding?
    Mr. Levitt. Senator, you know, I was a stockbroker for a 
number of years, and I ran a branch office, and I managed 
thousands of brokers, and I have enormous respect for the 
profession. I think they have done remarkably well, and the 
vast, vast majority of the brokers in America today are 
extremely competent and the most professional in the world. 
They account for the low cost structure in our process of 
capital formation.
    I would say that today's brokers are better trained and 
better equipped than they have been at any other time in 
history. They not only have to take the qualifying examination 
to begin with, but through an initiative that was embarked upon 
jointly among the Commission, the Securities Industry 
Association, and the SROs, we imposed additional requirements 
for training and retraining in products that brokers sell--
because today, it is not just stocks and bonds. It is options 
and derivative instruments and real estate and insurance and a 
host of other products, and those brokers have to be trained on 
a regular basis in both products and regulations.
    I do not believe that the problem is a lack of training. I 
think there is some problem in terms of incentives that the 
firms give to brokers, which have up to now been largely 
quantitative, that is, the more the broker trades, the more he 
gets paid. That issue, too, has been addressed by the industry 
through the recommendations of the Tully Committee to create 
other kinds of incentives and to do away with some of the clear 
conflicts of interest, such as product-specific contests at 
various firms where a broker gets sent to Honolulu by selling 
more of a particular underwriting. They rarely exist any longer 
today. Very few brokerage firms offer incentives to brokers to 
sell the home-grown product any longer. But I think more work 
has to be done in this area. The Commission does not intend to 
legislate compensation, but we certainly intend to focus public 
attention upon it.
    I do not think that the competency levels have to be 
raised. I think that the problem is not with the bulk of the 
brokers. The problem is with the really bad actors, that no 
matter what the competency levels were, these are dishonest, 
crooked people. We have got to kick them out of the industry 
and keep them out. We have to send them to jail. We have to 
work with the Justice Department, and this Commission for the 
first time has conducted joint efforts, and is presently 
conducting a joint and public effort with the Justice 
Department, to take brokers who have stolen vast amounts of 
money from their customers, and not merely to push them out of 
the industry but to have them wearing striped suits. That is 
where the effort has to be made, in my judgment.
    Senator Collins. I really applaud the efforts that you are 
making to work with the Department of Justice and the State 
Attorneys General to bring more criminal prosecutions. But let 
me follow up on what you just said and ask your opinion on the 
whole issue of ethical standards.
    It seems to me that as long as we tolerate a sales as 
opposed to a ``fiduciary'' mentality in segments of this 
industry, we are going to have problems. In addition, high 
ethical standards tend to result as much from tradition as from 
rules and that is difficult to change overnight.
    But I do have one specific approach that I want to get your 
reaction to. Why not take a page out of the book of one of your 
fellow New Yorkers and institute a zero tolerance policy, 
making it known that one serious breach of the rules and you 
are out of the industry? As the Chairman of the SEC, you could 
send out the word that if you turn an account, you are out of 
the industry. If you knowingly execute an unauthorized 
transaction, you are gone for at least, say, 2 years.
    If we are going to allow aggressive selling, the 
consequences of exceeding the limits should be severe and known 
to all in the industry. So why not announce a zero tolerance 
policy and then follow through with it? It strikes me that what 
has worked on the streets of New York might well work in its 
offices.
    Mr. Levitt. Well, I applaud the concern and interest that 
underlies that thought. This particular Commission has included 
among the foremost initiatives that we have pursued over the 
last 4 years, our efforts to drive rogue brokers out of the 
industry and to raise the standards of professionalism that are 
part of the industry.
    I believe that a broker's impact on a person's life is 
every bit as great as a lawyer's, as his accountant's, and 
maybe in some instances as his physician's, so that I regard 
this with the same seriousness as you do.
    The Commission has been approaching this in a number of new 
ways. We have made a major issue of supervision. Every broker 
who gets kicked out of the industry or gets suspended and who 
then comes back into the industry, represents a responsibility 
for a supervisor. If that broker becomes a recidivist and gets 
kicked out again, this Commission wants to hold his supervisor 
responsible. We have brought more supervisory actions than any 
Commission in history.
    Now, the way we get at this issue is through a cooperative 
effort. Because of our limited resources, we can't do it by 
ourselves. Nor should we. Because we are talking about a 
culture, and that culture can be approached best, in my 
judgment, with a consensus approach with State regulators, who 
are the cops on the beat in the localities, which is terribly, 
terribly important, and with the SROs in the form of the NASD 
and the New York and the American Stock Exchanges. And they 
know that this Commission cares enormously about their level of 
tolerance of bad practices.
    The committee that I have formed today is going to meet 
within the next 2 weeks to talk about tightening up on the 
practices. I do not know that it will decide to go to zero 
tolerance because I am not certain as to which offense or 
offenses should trigger that. While I think that churning is a 
heinous offense, I think there are others that are even worse.
    But I assure you that the industry, working collectively 
and in the best fashion to change a culture, will bring about 
stronger penalties, stronger methods for getting at this 
problem. And the Commission will be absolutely relentless in 
terms of pressuring the industry to raise the standards to see 
to it that bad brokers do not enter, and no less can stay, in 
the industry. And we will move in the direction of zero 
tolerance. Whether we arrive there in one fell swoop is a 
different question.
    Senator Collins. I really believe that is key, because 
every time we try to tighten up on the regulatory scheme 
through increased information or more monitoring, we are not 
really getting at the underlying problem. It seems to me that 
the SEC more than anyone, perhaps, has the ability to force the 
change in culture that you have just described, and I applaud 
you for your willingness to send that message very clearly.
    In a recent speech, or perhaps it was a newspaper, when you 
were talking about the role of the SEC and State regulators, 
you made what I thought was a very good point. You said that 
investors would be better protected if our response were 
triggered by complaints and not by job changes. Do we not need 
a system that will trigger action at the time that a 
disciplinary action is taken against a broker rather than when 
the broker changes jobs? For example, you could have an 
unethical broker stay with the same firm for a very long time. 
Then he or she is unlikely to come to the attention of 
regulators. The scrutiny comes when there is the job change and 
the relicensing process takes place.
    I know that the CRD improvements offer some hope in this 
area, but could you elaborate on that?
    Mr. Levitt. Sure. The CRD is the Central Registration 
Depository. I am going to sound a little bit like a Ross Perot 
imitation here because I think it is important to get this out 
to investors. The telephone number for the CRD is 800-289-9999. 
This is a crucial part of our investor education effort.
    Mary Shapiro, the head of the NASDR and a former 
Commissioner, made a courageous decision to discard the old 
system and design a new one. We are going to have full Internet 
access in 1998, and I want the entire project done by the end 
of 1999. By that time, I want 100,000 calls that we now get 
each year to increase to over a million. I want this to be one 
of the best-known 800 numbers and Web sites in America, 1-800-
289-9999.
    Senator Collins. Let me follow up on that point. When I was 
meeting with the investors, the victimized investors who will 
testify next, it occurred to me that one way we could help 
people who believe they are being ripped off or encountering 
problems is to require the account statements that are sent out 
to have a telephone number such as the one you have just 
described or perhaps the name, address, and phone number of one 
of the regulators or the NASD so investors know where to turn 
for help. Is that something that you would consider?
    Mr. Levitt. Yes. I think that is a good idea, and that is 
one of the notions that we talked about with the self-
regulating organizations. How can we get information out to the 
public that tells them that you have got to be careful of this 
firm, that you have got to watch this broker, or here is the 
number that you should call, and please call it before you do 
business with a new broker that you have never met.
    Now, I urge in every way, in every forum I get, that an 
investor who does business with a broker over the telephone 
that he or she has never met before is just making a terrible 
mistake. I encourage that linkage between a customer and a 
broker. Know your broker. Call up and find out whether he or 
she has had a regulatory problem, and do you really want to 
entrust your life's savings to someone who has been kicked out 
of the industry or disciplined or has been the object of 
hundreds of investor complaints?
    That is what we have got to get investors to begin to do. 
The information is there. We are committed to making that 
information more visible, more available, more usable, and the 
form that you suggest, I think, is a good one; and we are going 
to consider it. Whether the confirmation slip is already too 
jumbled to be meaningful, whether we are talking about a 
mailing that would go with the confirmation, I am not sure, but 
it is that concept of revealing to investors brokers who have a 
problem, is one that is high on our list of priorities.
    Senator Collins. Let me ask you just one more question 
before turning to my colleague, Senator Cleland. Your new 
brochure is excellent. I was leafing through it as you were 
describing it, and I think it would, in fact, help investors to 
be very cautious. But I wonder how many investors are actually 
going to see this brochure. Would there be merit in requiring a 
broker or a brokerage firm which is doing a great deal of cold 
calling to be required to send this information out to people 
who are opening new accounts?
    I am trying to think of a way to make sure that it gets to 
the people who need to read it. It is very good. It would 
certainly warn people of the dangers of responding to a cold 
call pitch. But if investors do not get it, if it does not 
reach them, then it is of little value. So what would you think 
of actually requiring investor education materials to be 
included with account statements or in some way distributed by 
firms that do a great deal of cold calling?
    Mr. Levitt. I think a phone in the hand of these cold 
callers is as dangerous to the public as a car in the hands of 
drunk drivers. Just the other day, a friend of mine told me of 
a cold call that he got at 7:15 in the morning, and he said, 
``How dare you wake me up at this hour.'' The broker said, ``It 
is the early bird that gets the worm.'' It is that kind of 
cavalier approach that, I think, bears on a culture that has 
got to be discouraged.
    We certainly are going to encourage wide distribution of 
that cold calling brochure. We are going to encourage it 
without forcing it. I think, again, the strategy of the 
Commission has been to mobilize the best instincts of the 
industry, which is mindful of these perceptual problems. The 
bulk of the firms in America today would have nothing to do 
with brokers who abuse the cold calling privilege, in effect, 
and it is only firms that are really outlaw firms that cast a 
reputational stigma upon the industry.
    I think we have got to bring and encourage the NASD and the 
New York Stock Exchange to bring cases against violators of the 
cold calling culture. Cold calling is a function of American 
business, and I would not dare say no calling should take 
place. It should. It has an appropriate place.
    Now, I think it is wrong, however, to have a battery of 
cold callers who may be kids in high school or in college who 
are not trained, who do not have to pass any of the tests that 
a broker has to pass, out there cold calling and turning the 
account over to a broker they work for or, indeed, illegally 
making the sale themselves. That we are going to nip in the 
bud. We are going to encourage cold callers to follow 
standards. A cold caller must be experienced, must know what 
kinds of clients qualify for a call and what kinds of 
representations to make.
    So my long-winded answer to your question is, you bet we 
are going to encourage the broadest distribution by the firms 
and others of this kind of information. We are not going to 
regulate it, but we are going to encourage it in the strongest 
way we possibly can. We are going to use our town meetings to 
do it. We are going to use our Web site to do it.
    We are going to talk about it continually, because the one 
question that I ask in town meetings which gets the greatest 
response is when I ask for a show of hands: ``How many of you 
have been awakened in the morning or late at night by an 
abusive caller who does not seem to know the word no?'' I would 
say 75 percent of the hands shoot up. That tells us something. 
So you are clearly onto something, and we intend to follow up 
on it.
    Senator Collins. Thank you, Chairman Levitt.
    Senator Cleland.
    Senator Cleland. Thank you, Madam Chairman.
    Mr. Chairman, thank you for being with us today. When you 
mentioned putting the con artists in the striped suits, you 
meant broad stripes, right, not small stripes?
    Mr. Levitt. Right.
    Senator Cleland. I am wearing a striped suit today. I just 
wanted to make sure. [Laughter.]
    Senator Cleland. Thanks for being with us. I understand the 
importance of injunctions and consent decrees and receivers and 
trustees and other types of administrative and civil sanctions 
that can be applied against violators. The media is full of 
stories about the major frauds perpetrated on our citizens. It 
is my opinion that the only sanction, quite frankly, as you 
have indicated by your comment, that most of the serious 
violators will understand as a successful deterrence is jail 
time and the completion of a successful criminal prosecution. 
Do you have any idea why more of the major fraud cases do not 
end up in the criminal courts?
    Mr. Levitt. Well, I think it is a question of calendars 
that are so full and commitments that are so great, and these 
are cases that are difficult cases to bring and to prove. It is 
only in the most egregious instances that we get to criminal 
actions. We find that there are very few districts of our 
Federal courts that are experienced at bringing securities 
cases. Some of them, such as New York and California and some 
large areas, do have that experience and recognize it as a 
major area for their involvement. Others simply would rather go 
after bank robbers than they would going through the difficult 
process of trying to prove what a securities fraud is.
    Senator Cleland. Thank you. How about your enforcement 
staff? Do you have enough people to do your job well?
    Mr. Levitt. Probably not. With our markets exploding, with 
many times more investors in the market today than ever before 
in history, with mutual funds taking up more investors' 
resources than all the combined deposits in our banks in 
America today, our resources are severely strained, 
particularly in the enforcement area. We, like every other 
agency in government, are mindful of restrictions on 
government; and, for the past 3 years, we have operated pretty 
much on a flat budget.
    I am under no illusion that we can ever wipe out totally 
all fraud in America. And I would emphasize again that, while 
the number of scamsters out there is probably greater today 
than any time before, relative to the number of investors in 
the market and the dollar volume of new issues coming on the 
market, we are no worse than we have been for years.
    Nevertheless, my answer to your question is we are 
straining, and we have to leverage our resources by working 
more closely with State regulators, by getting our self-
regulating organizations to assume more of the burden of 
responsibility.
    Senator Cleland. I would like to just follow up on that. 
Where do you see the role of the States here, particularly in 
terms of enforcement?
    Mr. Levitt. I think it is critically important that the 
States maintain their licensing abilities. States really need 
to understand who is applying for a license and what is going 
on. Senator Collins mentioned before the fact that, if a broker 
stays at the same firm for a number of years, the focus of the 
State tends to be on other things and does not come down until 
a broker transfers from one State to another.
    I think that has got to change. I think the State 
regulators have to take cognizance of the fact that the States 
are a vital linkage here, particularly since the passage of a 
law last year which mandates the States to take on the 
responsibilities for small investment advisers. That is a 
critical problem.
    I think it is essential that the SEC work closely with 
State regulators. We may not see things exactly the same way, 
because, from the standpoint of the firms and the standpoint of 
the system, 50 different State regulators with different kinds 
of regulation within the States can create redundancies and 
costs that really make the system unworkable.
    So we have tried very hard to persuade the States to try to 
standardize their practices in a way which enables us to deal 
with one system rather than 50 systems; and, until that 
happens, we can never harmonize the role between the Federal 
Government and the States. But I believe the States are moving 
in that direction and they have taken recent actions. They 
recognize the greatest danger that they face is moving into too 
many different directions. They will earn the animus of the 
brokerage firms, of the industry, of the self-regulators, and 
the Commission by doing that, but, by harmonizing and working 
together, I think we create a strong regulatory presence that 
is the best way to get at fraud.
    Senator Cleland. When I was Secretary of State in Georgia 
and responsible for securities regulation, we worked closely 
with the SEC just to do that very thing. One of the things that 
has surprised me is the incredible dollar value now of the 
whole penny stock market and its impact on illegal impact on 
the economy, siphoning off legitimate investment to very, very 
high-risk investment.
    I notice that the Wall Street Journal recently estimated 
that investor losses resulting from penny stock fraud has risen 
from, say, $2 billion a year in the late 1980's to an 
incredible some $6 billion today. Does that sound about right 
to you?
    Mr. Levitt. It is difficult to tell. I think that that 
estimate was probably based upon a study done by the State 
regulators some years ago and factored into that the growth of 
the market, and assumed that the growth of fraud ran along 
parallel lines. I am not sure whether that is so or not. I have 
not seen a study which I would call reliable. But my anecdotal 
experience tells me, as markets rise, as numbers of investors 
proliferate, as numbers of brokers proliferate, as numbers of 
new issues proliferate, there is no question but that fraud 
will go right along with it.
    Willie Sutton used to say that he robbed banks because that 
is where the money is. Well, I think the scamsters and the 
brokerage industry probably do the same thing. Again, the 
percentage is small, but the scamsters that are out there do 
incalculable harm to the system. To have these three investors 
up here on national television testifying to how they were 
violated does more to hurt our process of capital formation 
than anything else I can imagine. I think it is an unfortunate 
consequence which, I think, all of us have to resolve to give 
the maximum exposure to and to try to make the penalties so 
onerous that this will not be necessary in the future.
    Senator Cleland. I appreciate that point of view. I am 
concerned that Congress seems determined to continue on a 
course of chipping away at investor protections and remedies as 
a means of encouraging economic expansion. I am certainly 
interested in a robust economy, but experience is our best 
teacher here. We know that if we tip the scales too far in the 
direction of promoting capital formation, fraud flourishes. Our 
challenge, it seems to me, is in keeping the scales of capital 
formation and investor protection in balance. Would you like to 
comment on that?
    Mr. Levitt. I think you are absolutely right, that while 
the Commission has two initiatives: capital formation, 
nurturing it, encouraging it, and investor protection--as far 
as I am concerned, the primary initiative of this Commission or 
any Commission must be protection of investors. There can be no 
capital formation in a system that cannot be trusted.
    The numbers that investors depend upon must be reliable. 
You have read about a great deal of controversy involving the 
FASB, the independent mechanism for establishing accounting 
standards and their efforts to call for the accounting for 
derivatives, which take up billions of dollars in our 
marketplace today. We oversee the FASB, and I believe that the 
business community and the regulatory community must support 
efforts to see to it that the numbers that investors rely upon 
are accurate. So I believe that public confidence comes first 
in our scheme of things. There can be no markets, none, without 
public confidence in the reliability of those markets and the 
people who run them.
    Senator Cleland. I could not agree more.
    Madam Chairman, just to maybe wind up with a Yogi Berra 
quote that I heard the other day for the first time, that 90 
percent of baseball is mental and the other 50 percent is 
physical---- [Laughter.]
    Senator Cleland [continuing]. I think your point has been 
well taken, Mr. Chairman, that 90 percent of this securities 
investment game is confidence in those who play the game and 
the other 50 percent is financial.
    Thank you very much, Madam Chairman. Let me just recognize 
Jeff Robbins, our Minority Chief Counsel who has done a lot of 
work with our team today. Thank you very much.
    Senator Collins. Thank you, Mr. Chairman. I know that all 
of us have additional questions that we will submit for the 
record.\1\
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    \1\ Exhibit 16 appears in the Appendix on page 432.
---------------------------------------------------------------------------
    I would ask that you give careful consideration to my 
suggestion for the zero tolerance policy and work with us to 
see if we can come up with something that would assure due 
process, if limited to serious breeches, but nonetheless sends 
the message of zero tolerance.
    Mr. Levitt. I promise you that I will. Thank you.
    Senator Collins. Thank you.
    The next panel of witnesses will please come forward. The 
second panel includes Emile Murnan, Helen Sprecher, and Louis 
Poggi. These are three investors who will tell the Subcommittee 
about their recent experiences investing in the micro-capital 
markets.
    We are going to first hear from Mr. Murnan, who is a 
resident of St. Louis, Missouri, who retired several years ago 
as a salesman of industrial woodworking machinery.
    We then will hear from Mrs. Helen Sprecher, a longtime 
resident of Philadelphia. Mrs. Sprecher and her husband owned a 
grocery store, I think for some 30 years----
    Mrs. Sprecher. Thirty-seven years.
    Senator Collins. Thirty-seven years. Mrs. Sprecher is 
accompanied by her attorney, Mr. Henry Pass.
    Finally, we are going to hear from Mr. Louis Poggi, a 
resident of Pembroke, New Hampshire. He is a father of five 
children and is employed by Federal Express.
    We are looking forward to hearing from you and I want to 
give each of you a special thank you for being willing to come 
before the panel today and share your experience. What you are 
doing is going to help others be better informed investors, and 
I really thank you because I know this is difficult, to come 
forward and talk about your own experiences.
    I am going to ask each of you to limit your comments to 10 
minutes. This green light will go on at the beginning. The 
yellow will come on when you have 2 minutes left so that it 
will allow you to wrap up. We will make any prepared testimony 
that you have part of the record.
    As I mentioned previously, pursuant to Subcommittee Rule 6, 
all witnesses are required to be sworn in, so I am going to ask 
you all to stand and raise your right hand.
    Do you swear that the testimony that you are about to give 
to the Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Mr. Murnan. I do.
    Mrs. Sprecher. I do.
    Mr. Poggi. I do.
    Senator Collins. Thank you very much.
    Mr. Murnan, we are going to start with you, please.

      TESTIMONY OF EMILE O. MURNAN,\2\ ST. LOUIS, MISSOURI

    Mr. Murnan. Madam Chairman and Members of the Subcommittee, 
my name is Emile Murnan and I am pleased to be here today to 
testify before you about my recent experience as a victim of 
fraud by a securities brokerage firm.
---------------------------------------------------------------------------
    \2\ The prepared statement of Mr. Murnan appears in the Appendix on 
page 145.
---------------------------------------------------------------------------
    I am 78 years old and retired several years ago from a 
sales career. My home is in Ballwin, which is one of the many, 
many suburbs of St. Louis, Missouri, famous for the Gateway 
Arch and gullible people. [Laughter.]
    Mr. Murnan. I do not receive a pension and, therefore, I 
try to be careful in management of my funds. It is apparent to 
me that control is needed to protect others from becoming 
unwitting victims of fraud by an industry entrusted by so many 
to conduct transactions which are critical to their financial 
security.
    My story begins on January 16, 1997, when I received a 
telephone call from a Mr. Marlon Tropeano. He is with the L.T. 
Lawrence and Company in New York City. I had never done any 
business with him or his firm and I am not really sure how he 
came about having information on me. It seems that when you 
purchase a stock from a broker, especially in New York, they 
must put your name on a list and sell it to all the other 
brokers in town because I have had numerous telephone calls 
from different brokerages, all in New York, and they are all 
with this same type of thing, trying to get you to buy 
something you never heard of.
    However, in my case, he wanted me to buy shares in Callaway 
Golf Company, and I was familiar with Callaway. I know it is a 
good company on the New York Exchange and so forth, and at this 
particular time, I had a few bucks to spend because a bond I 
had had matured. So I bought 200 shares of the Callaway Golf 
stock. I regarded this as a long-term investment, and on 
January 18, I paid for it in the amount of $6,040.
    The trouble began about 6 days later--exactly 6 days later, 
after the date of purchase, when he sold Callaway Golf for a 
total of $6,308. That is a slight gain, but I did not know he 
had done it even. The same day that he sold that, he bought 
1,000 shares of Medaphis Corporation stock for a total price of 
$13,840. He has now established a margin account, without my 
permission, of $7,530.
    This thing gets worse. Six days after that, on January 28, 
he purchased 4,700 shares of QPQ stock for a total of $12,940. 
This means he had now established a margin account of $20,000. 
One thing I might add that I had some thoughts on is how 
ethical is it for a brokerage company to allow a firm to 
establish a $20,000 margin account on an investment of $6,000? 
It just does not seem to make any sense to me.
    Anyway, on February 5, without my permission, he sold the 
1,000 shares of Medaphis for $13,109. This is a small loss of 
$730, but it gets worse. On the same day, he sold 1,600 shares 
of QPQ, and on February 12, he sold 1,900 shares of QPQ, and 
finally on April 10, the account was closed and I received a 
check of $292, for a loss of $5,748 out of my original 
investment of $6,040. It is only about a 94 percent loss.
    On February 13, I returned from a trip to Florida and when 
I opened my mail, here were all these confirmations of buys and 
sells, which I just could not believe. I could not believe he 
had sold the Callaway Golf stock and bought two other stocks 
without my permission at a substantial loss, because now I have 
the buys and the sells all in the same mail.
    On February 21, I sent a letter to the Compliance 
Department of L.T. Lawrence and Company disputing these 
unauthorized trades and the loss of my money. On March 11, I 
was contacted by telephone by Mr. Andrew Basile, who stated he 
was Senior Vice President and head of the Compliance 
Department. He assured me that he would investigate my 
complaint, but nothing was ever done to resolve the issue of 
this lost money. I talked to him several times, plus others 
under him. Their attitude is, yes, so what? We lost your money. 
We are not going to do anything about it and we do not 
apologize. It is just tough luck.
    So since I could not get anywhere with them, I took matters 
into my own hands and I wrote the NASD in New York City, the 
Securities and Exchange Commission in Chicago, and North 
American Securities Administration Association in Washington, 
D.C., as well as the Commissioner of Securities of the State of 
Missouri in Jefferson City, plus I retained the services of an 
attorney.
    An examiner for the Missouri Securities Division later 
determined that L.T. Lawrence and Company had 15 customer 
complaints filed against Mr. Tropeano, 11 of these complaints 
prior to his solicitation to me.
    Finally, on July 12, a settlement was reached and the 
losses were reimbursed through my attorney, minus his fee. This 
whole affair has been an extremely troublesome experience for 
me and has caused me considerable expense and made me very 
unhappy. It seems that in this age of technology, these 
renegade fraudulent activities should no longer be possible by 
companies who are entrusted with the key elements of our 
financial security.
    This concludes my statement, Madam Chairman, and I would be 
pleased to answer any questions.
    Senator Collins. Thank you very much, Mr. Murnan. I 
appreciate so much your sharing your experience with us. We are 
going to hear from the other two witnesses first and then we 
will be asking you questions.
    Mrs. Sprecher.

  TESTIMONY OF HELEN SPRECHER,\1\ PHILADELPHIA, PENNSYLVANIA; 
              ACCOMPANIED BY HENRY IAN PASS, ESQ.

    Mrs. Sprecher. It is hardly necessary for me to say I 
consider it a great honor to be here today. My name is Mrs. 
Helen Sprecher and I reside in Philadelphia, Pennsylvania. My 
husband, Harry Sprecher, is unable to attend this hearing due 
to his declining health.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mrs. Sprecher appears in the Appendix 
on page 147.
---------------------------------------------------------------------------
    My husband and I are both 85 years old. Before our 
retirement in 1988, we owned a small neighborhood grocery 
store. We worked very hard, 7 days a week for 31 years, and we 
were able to save about $100,000 for our retirement. But as a 
result of the devious and deceptive practices of unscrupulous 
stockbrokers and their firms, nearly every penny was lost.
    I am appearing before you today and making this statement 
in the hope that what happened to my husband and me can be 
prevented in the future. I am telling my story so that other 
elderly and other vulnerable citizens might be spared the 
suffering, the financial loss, and the emotional trauma that we 
have had to endure.
    Our problems with stock brokerage firms began in the fall 
of 1990, when we were contacted by a stockbroker named John 
Baratta. At that time, we were led to believe that Mr. Baratta 
was affiliated with the prestigious Wall Street brokerage firm 
of Morgan Stanley. Mr. Baratta persuaded us to open a brokerage 
account with him and he started to purchase stock for us 
shortly after the account was opened.
    While Mr. Baratta was our stockbroker, we periodically 
received account statements from Morgan Stanley showing the 
status of our account. The account statements indicated that 
Morgan Stanley had been introduced to us through a company 
called Manchester Rhone Securities. However, I do not recall 
Mr. Baratta ever telling us that he worked for Manchester Rhone 
Securities. During this time, we always thought that we were 
dealing with the firm of Morgan Stanley.
    It was not until I recently consulted with attorney Henry 
Pass that I found out that Mr. Baratta actually worked for 
Manchester Rhone Securities, a very small brokerage firm that 
has since gone out of business. Had we known Mr. Baratta was 
not affiliated with Morgan Stanley, we would probably not have 
done business with him.
    During that time, Mr. Baratta said that Morgan Stanley was 
looking at a company called Wave Tech, a waste disposal firm in 
Canada. Morgan Stanley took Mr. Baratta and some other brokers 
to look over the operation. He was so impressed, he purchased 
20,500 shares at $1.25 a share for our account. Sometime during 
the fall of 1991, Mr. Baratta informed me that he had switched 
brokerage firms and was now working for S.D. Cohn, a company on 
Wall Street in New York City. At that time, he also told me 
that Morgan Stanley was no longer doing business with small 
investors such as me and my husband. We then agreed to have the 
stock in our Morgan Stanley account transferred to a new 
account at S.D. Cohn by Mr. Baratta. When we switched brokerage 
firms, our account was worth approximately $98,000.
    Mr. Baratta continued to be our stockbroker until February 
or March of 1993. Around that time, we learned that Mr. Baratta 
was no longer affiliated with S.D. Cohn and that a stockbroker 
named Donald Lou Spitzer had taken over our account. Although I 
had never met Mr. Spitzer, he seemed nice on the telephone and 
persuaded us to let him handle our account in the future. He 
said his mother was 92 years old and he took care of her 
accounts and he would be very careful with my portfolio.
    Both my husband and I were having health problems. My 
husband had three very serious operations, a double bypass, an 
operation on the esophagus, and one on the colon. I was also 
having health problems, so I was in no condition to make any 
decisions. Mr. Spitzer was well aware of my condition. He 
promised to make good on my losses.
    He purchased 25,000 warrants in American Track System, 
expecting the shares to come on the market at $5 or $6 a share. 
Mr. Spitzer sent me a beautiful brochure of the company and its 
prospects. I felt I could not leave Mr. Spitzer or the company 
he was with because his promise of restitution, it would just 
be dropped.
    In August of 1994, Mr. Spitzer sold Wave Tech at 3/32, 
which is a little more than a dime. The following week or so, 
the company was taken over by someone else for a little over $1 
a share, so that was a loss of over $20,000 right there.
    Around September of 1994, Mr. Spitzer informed me by 
telephone that he had left the S.D. Cohn brokerage firm and had 
joined a new firm called Investors Associates. We allowed Mr. 
Spitzer to transfer our account to Investors Associates. We 
continued to deal with him until June of 1995.
    Around that time, a gentleman named Keith Bleich telephoned 
me and identified himself as a broker for Investors Associates. 
He said that he was calling to inform me that Donald Spitzer 
had been discharged from Investors Associates because of 
unethical practices. Mr. Bleich then told me that our account 
had been transferred to him and that he intended to give our 
account his personal attention. He also assured me that because 
of our age, he would make sure that we would never lose any 
money. Unfortunately, I believed him. He said he was going to 
be a father for the first time and was very considerate and 
worried and sort of got me into that event, worrying about he 
and his new baby coming on. He talked about that endlessly.
    About a month later, Mr. Bleich called again and asked if I 
had any other securities that were not in our account with 
Investors Associates. At the time, I had in my personal 
possession 440 shares of RJR Nabisco stock. Mr. Bleich said it 
would be to our advantage to have everything in one place. I 
suppose if I was deceased, my heirs, it would be nice for them 
to have everything in one place. He told me he would send 
Federal Express to pick up my stock certificates for delivery 
to his office, which should have been some kind of a clue. He 
was so glib and persuasive that I agreed to send him my stock.
    Because the RJR Nabisco stock paid a nice dividend which 
supplemented our Social Security benefits, I told Mr. Bleich 
that the stock was not to be sold and he promised not to do so. 
Over the next several days, he called me three or four times a 
day, trying to convince me to buy stock in a company called 
Electronics Communications. He told me that the company was new 
and that the stock was about to skyrocket. I had never heard of 
the company, so I would not commit myself. I told him it was a 
very difficult time for me, since I was recuperating from 
surgery for the aneurism of the aorta which had left me very 
weak and unable to think straight and he was putting a lot of 
pressure on me.
    Sometime in August of 1995, a statement arrived from 
Investors Associates. To my utter shock and surprise, most of 
the stock in our portfolio had been sold without my permission, 
including the RJR Nabisco stock from which we had been relying 
on. The statement also indicated that we now owned 3,000 shares 
of Electronic Communications and 1,500 shares of Air Methods, 
Incorporated. Both of these stocks were purchased by Mr. Bleich 
without my permission. I later learned that Investors 
Associates was an active market maker in these securities.
    Shortly thereafter, the value of both stocks started to 
plummet and our margin obligation went from $950 to almost 
$5,000. Margin calls were coming in two or three times a week, 
so I frantically called Mr. Bleich. He insisted that the stocks 
were going to make a lot of money. Margin calls continued to 
come in two or three times a week, calls that I could not meet.
    Although I continued to call Mr. Bleich, it became obvious 
to me that my calls to him were seen as a nuisance. Whenever I 
would call, I would always be told that he was in a meeting or 
out of the office. Eventually, the 1,500 shares of Electronic 
Communications had to be sold off to partially satisfy the 
margin calls and we sent him $3,000 to satisfy some of the 
calls.
    In July of 1996, I informed NASD about my problems with 
Investors Associates and Mr. Bleich. When Mr. Bleich heard 
about this, he called to tell me that everything that had been 
in our portfolio when he took over the account had been put 
back and that we no longer owned any of the stock that he had 
purchased without my permission. I later learned that this was 
not true because the statements I continued to receive from 
Investors Associates did not show the changes in our account 
that Mr. Bleich had assured me had taken place.
    In the meantime, margin calls against our account were 
still coming in. When I phoned Mr. Bleich, he insisted the 
changes had, in fact, been made and everything would be fine. 
During one of my last telephone conversations with Mr. Bleich, 
he brought another gentleman on the line who claimed to be an 
attorney for Investors Associates, a David Sayed. David Sayed, 
or whoever answered the telephone, verified that the changes in 
our account had been made. However, I continued getting margin 
calls and our account statements from Investors Associates 
indicated that they were still charging me interest on stocks 
that I was not supposed to own in the first place.
    In February of this year, I consulted an attorney, Mr. 
Henry Pass, to see what legal recourse we had as a result of 
the unscrupulous handling of our stock brokerage account. After 
Mr. Pass reviewed our records, I learned about the losses my 
husband and I had incurred since the time we first opened our 
account through Morgan Stanley in 1990 until the time that we 
closed the account with Investors Associates in April of this 
year.
    Due to the declining health of my husband and myself, I had 
not been able to keep track of all the activity in the account. 
During this period, I had been recuperating from the surgery 
related to the aortic aneurism. My husband had also undergone 
surgery, as well as chemotherapy for cancer of the colon and 
the esophagus and a lot of my time was spent caring for him. I, 
therefore, was not aware of all the churning and other 
improprieties that occurred during this time.
    In December of 1990--I am sorry.
    Senator Collins. You can conclude your statement. Take a 
little bit longer.
    Mrs. Sprecher. When we entrusted our retirement savings 
with John Baratta through Manchester Rhone Securities and 
Morgan Stanley, our account was worth approximately $96,000 
[sic]. However, when we closed our account with Investors 
Associates in March of this year, our account was worth $2,300. 
The stress of the situation has greatly affected my health, 
both physically and emotionally. I have been experiencing 
anxiety attacks, nausea, loss of appetite, and inability to 
sleep. The distress and anguish are sometimes unbearable and 
have caused me to lose over 15 pounds.
    Shall I stop?
    Senator Collins. If you have more you want to say to us----
    Mrs. Sprecher. There is another page.
    Senator Collins. Please continue.
    Mrs. Sprecher. Until I was referred to attorney Henry Pass, 
I did not know that there are laws on both the State and 
Federal levels that are supposed to protect my husband and me 
from the unscrupulous and illegal practices that we 
experienced. Unfortunately for us and for so many others, these 
laws did not prevent the firms and stockbrokers with which we 
dealt from engaging in the practices that caused us to lose so 
much money and to experience so much grief and misery.
    Mr. Pass has instituted lawsuits against the companies and 
individuals involved and I am hopeful that my husband and I 
will be able to recover at least some of the money that we have 
lost over the years. I only hope that something can be done by 
the government to prevent retirees, such as myself, from 
becoming victims of the unsavory, unethical practices of 
investment firms and stockbrokers that seek us out. Something 
must be done to protect all of us from the kind of people who 
preyed on my husband and me, caused me to lose most of our 
retirement savings, inflicted on us such terrible anguish and 
distress in our twilight years.
    Thank you for inviting me to share my story with you.
    Senator Collins. Thank you very much, Mrs. Sprecher. Your 
story is the reason we are here today. What happened to you is 
absolutely outrageous, and it is our commitment to try to 
change the system in a way to prevent that.
    Mrs. Sprecher. Yes, so I heard from Mr. Levitt.
    Senator Collins. Exactly.
    Mr. Poggi.

      TESTIMONY OF LOUIS POGGI,\1\ PEMBROKE, NEW HAMPSHIRE

    Mr. Poggi. Madam Chairman and Members of the Subcommittee, 
my name is Louis Poggi and it is a pleasure for me to be here 
today to tell you my personal story of being defrauded by a 
stock brokerage firm.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Poggi appears in the Appendix on 
page 154.
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    I am employed as a truck driver by Federal Express. I live 
in Pembroke, New Hampshire, and am the father of five children. 
My life is hectic, to say the least, and the story I am about 
to tell you was a devastating experience for me and my family. 
I sincerely hope that this hearing will lead to new regulations 
of the securities industry which will prevent others from such 
unnecessary suffering.
    My experience with this scam started in June 1995, when I 
received a telephone call out of the blue from Pat Boyce. Mr. 
Boyce identified himself as a broker for Investors Associates, 
Inc., of Melville, New York. I am not sure how Mr. Boyce 
obtained my telephone number or identified me as a potential 
customer.
    During this initial conversation, Pat Boyce solicited me to 
purchase stock in Cheyenne Software, Inc. His sales pitch was 
overwhelming and he tried very hard to convince me that the 
price of this stock was going to rise very quickly, which would 
result in a huge profit for me. I became tired of Mr. Boyce's 
relentless solicitation and told him, sure, go ahead, buy the 
stocks. It did not mean a thing to me. He was just a guy on the 
phone from New York.
    I told him, sure, go ahead and buy the stock, but I thought 
it was a joke. I did not realize what I was doing because Mr. 
Boyce told me at a later date that I had actually bought stock 
in Cheyenne Software. As a result of this initial conversation, 
I learned later that the trade date of this purchase was June 
30, 1995, for 1,000 shares of Cheyenne Software at a total cost 
of $18,216.75.
    Mr. Boyce called me a few weeks after our initial phone 
conversation. He informed me that the price of Cheyenne 
Software stock was rising and that I had already made a profit 
of $3,000. I was astounded to have gained such a profit on an 
investment that I had not really made, or I thought I made. A 
sudden profit of $3,000 was like a major windfall to me.
    I told Mr. Boyce that I now wanted to sell my shares in 
Cheyenne Software in order to receive my $3,000 profit. My 
Boyce told me that I must send Investors Associates $18,216.75 
to cover the purchase price of the stock. I replied that I was 
not able to do that, but if I owned the stock, why could I not 
just sell it and you send me the profit of $3,000. Please note 
that at this point, I had not submitted any money to Investors 
Associates.
    Mr. Boyce stated that I must send him a check for the 
initial purchase and then I would own the stock, so I could 
then turn it in to sell it. I did not understand the stock 
market business and this situation was confusing to me, but I 
was intent upon getting my $3,000. That was quite a bit of 
money to me. I was going to make that profit, even if it meant 
coming up with the $18,216.75.
    It happens that my father lives about 20 minutes from 
Investors Associates office in New York. I routinely visit my 
parents, so I decided to make a trip there to check out the 
Investors Associates office. I wanted to see if it was a real 
company or just some guy calling me from his kitchen. I went to 
Investors Associates office and it appeared to be a legitimate 
company in a normal office building, actually, a luxurious 
office building.
    This visit gave me confidence in Investors Associates, so I 
told them I would purchase the Cheyenne Software stock with my 
credit card. They told me that I could not do that. At this 
point, I felt that all I had to do to get the $3,000 profit was 
to obtain $1,216.75 which would be quickly returned to me 
because I intended to sell the stock as soon as the purchase 
was confirmed. In fact, I was led to believe that I could 
quickly sell the stock to make back the $18,216.75 plus the 
additional $3,000 gain.
    That same day, on or about June 30, 1995, I obtained cash 
advances from my credit cards and purchased the 1,000 shares of 
Cheyenne Software. I told Investors Associates that I wanted to 
sell my 1,000 shares of Cheyenne Software as soon as possible 
in order to receive my $3,000 profit and get my initial 
investment back to pay off the credit card debt, and they did 
say ``fine''.
    It was my understanding that the stock would be sold and my 
money from the sale would be placed in an account with 
Investors Associates. I waited approximately 10 days and still 
did not receive the money or any confirmation of the trade. I 
called Pat Boyce, who told me he had made money for me once and 
that now he knew of another stock, Universal Self Care, and 
that I should buy it. I told Pat Boyce that I wanted to close 
out my account because I needed the money to pay back the cash 
advances on my credit cards.
    Pat Boyce gave me a strong sales pitch about Universal Self 
Care stock. I told him that I did not want to purchase 
Universal Self Care and he became very upset with me. Boyce 
said that he had made money for me on the Cheyenne Software 
stock and he could not understand why I would want to close out 
my account.
    Boyce told me the Universal Self Care stock was guaranteed 
to rise in price because Investors Associates is on the board 
of directors and they would be able to control the stock. I 
told Boyce that the profit in Cheyenne Software was just a 
fluke and that I really did not know anything about Universal 
Self Care. I informed Boyce that I would not buy this stock 
over the phone, that I needed time to research it. Boyce did 
not seem to hear me, because he said, ``Mr. Poggi, do you want 
me to put that order in now?''
    The conversation ended with the agreement that we would 
watch Universal Self Care stock until the end of the day but no 
purchase would be made without my authorization. It seemed to 
me that Pat Boyce was reading from some type of script during 
this conversation because he would not take no for an answer.
    I immediately called Waterhouse Securities, who I have done 
business with previously, to determine the price of Universal 
Self Care stock. The stock was quoted as selling at $.25 less a 
share than the quote from Pat Boyce. I was outraged, so I 
called Pat Boyce back and told him that he is charging me $.25 
more per share than Waterhouse Securities, which is outrageous. 
I would like to note here that that came out to an $800 profit 
commission to him out of this transaction, which was very 
generous on his part, to pay himself $800, I would say.
    I informed him that I did not want anything to do with 
Universal Self Care stock. Boyce told me it was too late 
because he had already bought 5,000 shares of Universal Self 
Care with the money in my account from the Cheyenne Software 
trade. He said that the $.25 extra per share was his 
commission. He told me that he had to make a living, too, and 
that is why he did charge me an extra $.25 per share.
     The first trade on Cheyenne Software was a $35 commission 
charge, so I would say there was something unbalanced there, to 
say the least.
    I told Boyce that I did not authorize his purchase and just 
wanted my money back. I was, to say the least, extremely upset. 
I now owned a stock that I knew nothing about which was 
purchased with money from my credit card cash advances. I 
called Boyce again that day and told him to immediately sell 
the stock in Universal Self Care. He told me that he was not in 
a position to sell the stock.
    I called Boyce back again a few days later, which he told 
me that I have no worries because the price of Universal Self 
Care is going to be pushed up and he will sell it. I continued 
to insist that Boyce sell my shares in Universal Self Care, 
even though he had almost convinced me that the stock was going 
to be profitable. Boyce then transferred my call to Vince 
Grecco, who told me that he was the owner of Investors 
Associates. Grecco said that he would sell the stock in 
Universal Self Care, but he snidely told me to enjoy retiring 
on Social Security. He said that his company could have made me 
a fortune. I told him just to sell the stock and send me the 
money.
    A few days later, I received a notice that I had bought 
5,000 shares of Universal Self Care at a net cost of 
$17,360.50. I thought this was just a mistake and that I would 
be receiving my funds in the near future from Investors 
Associates, basically taking him on his word that he was 
sending me the money.
    About 10 more days passed and I called Pat Boyce, who told 
me that Universal Self Care stock was not sold from my account. 
I told Boyce that Grecco had ensured me that the stock would be 
sold. Boyce stated that my account had been closed and the 
stock certificates were being forwarded to me. He said I should 
receive the stock certificates in 6 to 10 weeks, at which point 
I could then have the shares sold by a brokerage of my choice.
    I broke down at this point in the conversation and became 
very emotional. I was hysterical and Boyce hung up on me. I 
composed myself and called Investors Associates a short time 
later. This time, my call was transferred to Vince Grecco. He 
told me that I had instructed him to close my account and that 
it is standard procedure with this company to send investors 
the stock certificates of their shares when they close an 
account. I told Grecco that I wanted the shares in Universal 
Self Care to be sold. I did not want the stock certificates. 
Grecco told me that it was too late to sell because the account 
had been closed and the stock certificates were in the system.
    Shortly after this conversation with Grecco, I went on 
vacation with my family, but I called Grecco every day trying 
to resolve this matter. Grecco told me that there was nothing 
he could do and that he was sorry I did not understand the 
jargon of the industry. Grecco repeatedly told me that he just 
was following my orders to close the account.
    The clearinghouse for Investors Associates on my account 
was Prudential Securities. I finally decided to call the local 
office of Prudential Securities to try to determine the status 
of my stock certificates. I do not remember the name of the 
person I spoke with at Prudential, but he assured me that the 
stock certificates would be forwarded to me as soon as 
possible. The stock certificates for Universal Self Care were 
subsequently received on or about August 22, 1995, in the mail 
by my sister on Long Island. I instructed her to take the 
certificates to the local Waterhouse Securities office and have 
them sold. The 5,000 shares in Universal Self Care were sold on 
or about August 25, 1995, for $14,437.50.
    Subsequently, I filed a complaint with the National 
Association of Securities Dealers, NASD, in New York. A couple 
of months passed before the NASD conveyed to me that I should 
pass on my complaint to New Hampshire authorities. I then filed 
a complaint with the State of New Hampshire Bureau of 
Securities Regulation. This complaint was finally settled on 
April 23, 1997, with Pat Boyce being ordered to make 
restitution to me in the amount of $2,925 and Investors 
Associates assessed a penalty of $25,000.
    This concludes my story, which obviously has been a 
terrible experience that will affect me in many ways for the 
rest of my life. I thank you for allowing me to share this 
information with you and I would be pleased to answer any 
questions.
    Senator Collins. I want to thank you, Mr. Poggi, for 
sharing your story with us.
    I want to thank all three witnesses again before we go to 
questions. What you have done today is put the human face on 
what happens when an individual is ripped off by an 
unscrupulous broker. We hear all the statistics and the amount 
of money that is lost, but your testimony does more than 
anything else to make people understand the human consequences 
when this kind of unethical and illegal behavior occurs, and in 
that sense, you have provided an invaluable service not only to 
this Committee but to the public, as well. So I thank you for 
coming forward.
    I do want to ask you just a few questions. When each of you 
ran into trouble, did you know to whom to turn for help? Was it 
difficult to figure out where to go, whether to contact Federal 
officials or State officials or the firm itself? Mr. Poggi, we 
will start with you and go right across the panel.
    Mr. Poggi. Well, to say the least, I was confused and I 
immediately did not know where to turn. But just a little bit 
of research, I figured out the NASD was based in New York City 
and I called them and they told me to just handwrite something 
and get the ball rolling. I did not realize about the 
Securities and Exchange Department in New Hampshire or I 
probably would have went right to them, because that is where I 
got my best results. I just want to make a note----
    Senator Collins. At the State level?
    Mr. Poggi. Yes, at the State level, New Hampshire. As soon 
as this happened, it probably was within days that I went on 
vacation, and here I am spending quality time that I should be 
enjoying my children, I am ready to have a nervous breakdown, 
because as you know, all my money was tied up in cash advances 
on my credit card, so it was not a fun vacation and how do you 
put a dollar value on that? I should be enjoying my children. 
As a matter of fact, I was vacationing in Maine.
    Senator Collins. Good judgment. [Laughter.]
    Mr. Poggi. Right, on the coast of Maine, which is a very 
gorgeous place. I recommend everybody go there.
    Senator Collins. I tell Senator Gregg that all the time.
    Mr. Poggi. Oh, yes. It is beautiful. Here I am, instead of 
enjoying the scenery and my children, I am writing letters and 
talking to Vince Grecco on the phone. It was a nightmare.
    Senator Collins. Mr. Murnan, was it obvious to you where 
you could go for help or was that a difficult thing to figure 
out?
    Mr. Murnan. It was not obvious, but it was not really too 
difficult. I know a couple brokers in St. Louis and I called 
them and told them what had happened and they gave me names and 
addresses. Then some of the agencies, when they sent me 
information, they would also suggest that I contact this agency 
or that agency, which I did. So eventually, I had, I think, 
just about all the agencies alerted and on the case.
    The first thing after I made my initial contact with the 
NASD, I received a call from the L.T. Lawrence and Company 
complaining that I had gone and alerted the authorities of 
their actions. They put this broker on the phone and he started 
screaming at me and he says, you are affecting my ability to 
make a living by doing this, and I said, well, you have 
affected mine, too, by losing all my money. I had conversation 
after conversation with him and I saw it was never going to get 
anywhere, so finally I enlisted the services of all the other 
agencies that I mentioned plus my attorney. The NASAA and the 
State agency were most helpful.
    Senator Collins. Mrs. Sprecher, before you hired a private 
attorney to help you sort through this maze that you were going 
through, did you know where to turn for help?
    Mrs. Sprecher. I did not know I had any other recourse. I 
sent for a book that was advertised. It was called ``Legal 
Problem Solver'' and I was thumbing through this book and I 
came across stocks, and lo and behold, I read about the 
Pennsylvania Security Commission and the NASAA, so I wrote to 
the Pennsylvania Security Commission and they responded right 
away. They also said I should contact the others, like the 
NASAA, so I also wrote them.
    Senator Collins. One of my suggestions which I am going to 
be pursuing is it seems to me that the account statements 
received by investors, should include the name, address and the 
phone number of a regulator who could help an investor. 
Investors would then not have to research, would not have to 
wonder where to go. Do you think that would be helpful, if I 
could just get pretty brief responses?
    Mrs. Sprecher. If I was aware of what a regulator was. At 
that time, I probably would have seen ``regulator'' and 
thought, well, that is just something to do with the stock. I 
would not have known to call that number or anything.
    Senator Collins. So it is going to be----
    Mrs. Sprecher. It has to be in plainer language than just 
``regulator''.
    Senator Collins. Right. What I am suggesting is, for 
example, if it said on the bottom of the account statement, if 
you are having difficulties----
    Mrs. Sprecher. That would be better.
    Senator Collins. OK. Mr. Murnan, would that kind of change 
be helpful, if on the account statement it had the name, 
address and the phone number of someone you could call if you 
ran into the kind of trouble----
    Mr. Murnan. That would be most helpful, and also, I believe 
this would be a deterrent to these people doing it in the first 
place, because now you easily know what to do. I think the way 
they operate----
    Mrs. Sprecher. Yes. I think that would be good.
    Mr. Murnan [continuing]. They feel that the average 
individual is not going to know what to do and a lawyer will 
not take it because it is too small, perhaps, so they wind up, 
a lot of them just do nothing and accept the loss. I was so 
incensed when this happened to me, I was mad. I felt like I had 
been robbed. He could not done it much worse with a gun. I just 
was not going to put up with it. I was going to try to get some 
results from it, which, finally, I did, but I was still out 
half----
    Senator Collins. Still at a loss, though. Mr. Poggi, would 
that have been helpful in your case?
    Mr. Poggi. Madam Chairman, I think that would have been 
most helpful.
    Senator Collins. Thank you. I have just a couple of 
specific questions. Mr. Murnan, did Mr. Tropeano, is that how 
you say it?
    Mr. Murnan. Tropeano.
    Senator Collins [continuing]. Tropeano ever discuss with 
you Medaphis Corporation or QPQ Corporation prior to the 
trading of the stock? Did you ever get a prospectus?
    Mr. Murnan. He did not, and for months, I did not know what 
they were, even. A broker in St. Louis, I told him about it and 
he said he would do some research, which he did, and he sent me 
information.
    Senator Collins. What did you find out about QPQ?
    Mr. Murnan. He sent me some data that they had. You know, 
they have data on all companies. He sent me this data and it 
showed that the all-time high for QPQ was $2.25 per share. He 
charged me $2.75 a share, $4,700, which right away is a loss of 
$2,350. It was not too much longer after that that he 
apparently started selling it. This all happened within less 
than 2 months, the buying and all the selling and all the loss.
    Senator Collins. Was that the company that owns pizza 
parlors in Poland?
    Mr. Murnan. Yes. That is what I learned. The company had 
two pizza parlors----
    Senator Collins. And you found that out through your own 
research?
    Mr. Murnan. They are doing millions of dollars worth of 
stock. This data I received also said that there was much, much 
insider trading, buying and selling of this stock before they 
hooked me with it.
    Senator Collins. Thank you. Mr. Poggi, did your broker ever 
discuss with you the risks of investing in Cheyenne Software or 
ever provide you with a prospectus or other written information 
about the company?
    Mr. Poggi. No. There was no written information about any 
company or any prospectus. The only thing he ever said was that 
the stocks were going to go up and there was no discussion of 
any risk whatsoever.
    Senator Collins. My final question is for Mrs. Sprecher. 
Mrs. Sprecher, it sounds like you were under the impression 
that you were doing business with Morgan Stanley, a well-known, 
reputable firm.
    Mrs. Sprecher. That is right.
    Senator Collins. Is that correct?
    Mrs. Sprecher. That is correct.
    Senator Collins. If you had known that----
    Mrs. Sprecher. No, I would not have ever accepted a company 
that was that weak. Before that, I had been dealing with Bache 
and Company, another great big company.
    Senator Collins. So if you had realized that you were not 
doing business with Morgan Stanley but rather with Manchester 
Rhone----
    Mrs. Sprecher. This was taken over by Prudential, another 
very well-known company. I would not have ever dealt with those 
other companies.
    Senator Collins. So you feel that you were misled not only 
because of the unauthorized trades, but you were not even doing 
business with whom you thought you were doing business, is that 
correct?
    Mrs. Sprecher. That is right. And when Mr. Baratta told me 
that Morgan Stanley was actually taking them by helicopter to 
look at something they were interested in in Canada, I was sure 
I was dealing with Morgan Stanley.
    Senator Collins. I want to again thank all three of you. I 
feel bad for the experience you have. Senator Cleland has some 
questions, but Mr. Poggi, did you have something you wanted to 
add?
    Mr. Poggi. I did not know if we were wrapping it up, but I 
was thinking, when we have something this outrageous, I mean, 
why cannot these young kids which a lot of these brokerage 
houses hire to make these cold calls, to get swifter results in 
investigating, why can they not be suspended upon investigation 
and get them right out of that, get them away from that phone 
and computer and let them sit home wondering if they are going 
to collect unemployment or where their next move is going to 
be, especially if they know they have ripped people like us 
off?
    Senator Collins. I think you raise a very good issue. I 
know that the NASD is here and the State regulators are here, 
but I am going to make sure that Chairman Levitt also gets a 
copy of your testimony, all three statements. I know he will be 
interested, because that is what I am pushing toward, is to 
have quicker, firmer, more severe penalties for brokers who 
engage in unethical behavior.
    The problem we have now is it is relatively easy to get 
into the brokerage business, to get into the industry. There 
are no educational requirements, as we discussed earlier. There 
is an exam, but if you study enough and cram and take it enough 
times, you are probably going to pass. So really, the broker 
does not have much of an investment in this case. He can just, 
even if he gets out of the business, he has made the profit and 
that is why I think we need a much more severe approach in the 
zero-tolerance policy about which I talked with Chairman 
Levitt.
    Senator Cleland.
    Senator Cleland. Thank you, Madam Chairman.
    We are just all delighted that you had the courage to come 
and visit with us today. Maybe it will do some good for 
thousands of people out there like you who are, indeed, ripped 
off, unfortunately, just like you, with these shameful, 
dishonest people.
    Let me just say, I would like to hear again how much each 
of you lost, starting with Mr. Poggi.
    Mr. Poggi. Well, I gained $3,000 and then I lost that 
$3,000 on the unauthorized trade and probably about another 
$3,500 of my money from my cash advances on the credit cards.
    Senator Cleland. So you lost a total of, what, about 
$3,500?
    Mr. Poggi. Right, out of my own pocket, but that $3,000, as 
far as I was concerned, I earned that and that was mine, too.
    Senator Cleland. You certainly have gone through enough 
pain. You sure have.
    Mr. Murnan, how much money did you lose?
    Mr. Murnan. My investment was $6,040 and I lost $5,748 of 
that, so all but $292, I lost.
    Senator Cleland. Not to count the suffering and the 
emotional turmoil that you went through.
    Mr. Murnan. Yes, that is for sure, the phone calls and 
letter writing and so forth.
    Senator Cleland. Mrs. Sprecher.
    Mrs. Sprecher. About $96,000.
    Senator Cleland. About $96,000?
    Mrs. Sprecher. Yes. I would like to know if the broker 
houses would not have to send--say if you were going to buy a 
stock, they would have to send you like a buy permit that you 
would have to sign and send back to them, especially for the 
elderly people. Say they have to return it within 5 days. That 
would give them 5 days to think about it, whatever somebody 
wanted to sell them.
    If a broker would ask a person's age and they were of 
retirement age--I do not mean anybody as old as I am, anybody, 
say, 70 or older, they want to buy a stock, unless they are 
very influential and they have dealt and they have made money 
with the company. If you are dealing with another company, a 
small company, if they want to sell you a stock, they could get 
someone on the telephone who would not even be aware of what 
they were selling them and maybe buy it. If they had time to 
send it to them and look at it, maybe a prospectus, maybe tell 
them what the company did and what the earnings were in the 
last few years, if the person still wanted to buy it, they 
would have to sign a buy certificate and send it back. That 
would give the person, say, 5 days' time to think about it and 
also send them a check for it or whatever way they deal with 
it.
    Senator Cleland. Mr. Murnan, you had a comment?
    Mr. Murnan. I had a question. It would be interesting to 
know how these brokerage houses get your name, your phone 
number, your address, and maybe a Social Security number before 
they ever call you. This practice should be checked into, I 
think.
    Mrs. Sprecher. Everybody sells names.
    Senator Cleland. One of the things that I have learned in 
dealing with securities fraud is, first of all, just deal with 
somebody you know.
    Secondly, unfortunately, Mrs. Sprecher and Mr. Murnan, the 
people who want to rip people off do focus on those most 
vulnerable----
    Mrs. Sprecher. I know. I found that out.
    Senator Cleland [continuing]. And unfortunately, they are 
the elderly and the retired who do have some small amount of 
disposable income and then are able to, unfortunately, answer 
the phone. Then many people are gullible to go ahead and send 
people money that they do not know. That is part of the 
problem.
    What are some of the steps that you might suggest in terms 
of, say, public education, maybe that the SEC ought to think 
about or the State regulators ought to think about? Mr. Murnan.
    Mrs. Sprecher. I did write it down. Now I do not know what 
I did with it.
    Mr. Murnan. I forgot what I was going to say.
    Mrs. Sprecher. I think I just said what I thought they 
should do.
    Mr. Murnan. I have been asked, well, why would you buy a 
stock from somebody that you do not know, and my answer was, 
well, he was good enough to call me at the right time. He came 
up with a good stock that I knew about, felt was a good 
investment. I figured that this business is so well regulated--
in fact, I never had thought about it, getting ripped off. This 
is so well regulated that it does not matter where you buy it. 
Callaway Golf stock is Callaway Golf stock, if you buy it in 
New York or Chicago, but that proved not to be the case.
    Senator Cleland. Because, unfortunately, there are 
unprincipled people out there----
    Mr. Murnan. I know that.
    Senator Cleland [continuing]. Who are determined to rip 
people off.
    Mr. Poggi, what do you think might have prevented your 
experience in terms of, say, investor information or regulatory 
authority that might have helped?
    Mr. Murnan. Do not answer the phone.
    Mr. Poggi. Well, I feel that I should have done a little 
bit more investigating than just going down to their office. 
They had a nice front, and I was going to get in and out real 
fast and make my $3,000. But had I probably sent in or made a 
phone call to the NASD and found out what kind of blemishes 
they did have on their company, that might have been enough 
right there, and really, that is all you have to do, is it is 
all public knowledge, any broker or any company, and it really 
is up to us to do our homework and find out who we are dealing 
with. It is available. All we have to do is call the NASD.
    So if we have the phone number on a bill or something, or 
like they said before, maybe send them--I think you said 
before, before they cold call, send you a piece of literature 
with phone numbers and who you are and everything and that 
ought to eliminate a lot of riff-raff. Then you have those 
numbers. It is like, hey, here is a number. Check me out. Call 
the NASD and find out who I am, or whatever. If they do not, 
then that red flag goes up and watch out. But it is available.
    Senator Cleland. In terms of my experience in Georgia, we 
always advised people to just ask the first question, that was, 
are you licensed by the Secretary of State in Georgia? That 
usually ended the conversation on these kind of matters.
    Secondly, Madam Chairman, did not the Chairman of the SEC 
put forward a 1-800 number of some kind that he wanted to get 
out?
    Senator Collins. He did, indeed.
    Senator Cleland. He wanted to receive more and more calls 
there from investors that might have a problem or might want 
some information about investing.
    Correct me if I am wrong. Did I hear that all three of you 
were positive, basically, in terms of your dealing with State 
regulators? You got either a phone call returned or quick 
response or some help or something? Is that right, Mr. Poggi?
    Mr. Poggi. Yes, that is correct. When I contacted the NASD 
right after Pat Boyce had purchased my stock, or the stock that 
I did not authorize, I got right on the phone and I was 
handwriting a letter. I mean, literally, you just have to 
document something. But I figured, now my stock certificates 
were going to be sent to me and Vince Grecco said that that was 
going to be up to 10 weeks. It actually was about 4 to 5 weeks, 
and NASD did not do anything. I think they are inundated with 
all kinds of problems. I was pretty much on a list.
    So it was not until after I had received my stock 
certificates and sold them that I went to the New Hampshire 
Securities and Exchange and then we really began the fight to 
get my money back and try and get these guys thrown out of 
business.
    Senator Cleland. Mr. Murnan, what was your experience with 
State regulators?
    Mr. Murnan. Mine?
    Senator Cleland. Yes, sir.
    Mr. Murnan. They were most helpful. In fact, they were 
instrumental in me going to New York, where the District 
Attorney had a similar program to this and the news media was 
there. In fact, they went into this L.T. Lawrence and Company 
and went through the records and found they had had about 300 
complaints, and on this particular Tropeano man, they had 15 
complaints on him. Those were not all in Missouri, I guess, but 
none of them were reported. They just all went unknown.
    Senator Cleland. Mrs. Sprecher, what was your experience 
with State regulators?
    Mrs. Sprecher. With who?
    Senator Cleland. State regulators, your State?
    Mrs. Sprecher. Positive. I thought they had sent letters to 
Investors Associates and really pushed them. They are out of 
business now.
    Senator Cleland. OK.
    Mrs. Sprecher. But they just changed their name, as far as 
I know, and they are back in business.
    Senator Cleland. Madam Chairman, I will just wrap up my 
part of the program here by just saying that when I was growing 
up in Georgia as a young boy, I used to watch something called 
the ``Ted Mack Original Amateur Hour'' and they used to say, 
``The number in New York to call is . . . '' In this case, we 
have the Chairman of the SEC giving us a 1-800 number for 
investor protection, anybody interested in calling it, 1-800-
289-9999. We are not dealing with amateurs here. These are 
professional rip-off people. Thank you very much.
    Senator Collins. Thank you, Senator.
    I want to echo the Senator's comments that I think it is 
highly significant that each of these consumers found that when 
they called State officials, that they got some help. You and I 
both have experience in that area and know what important roles 
State regulators play, as well.
    I want to thank you so much for sharing your experiences 
with us today. I know that they have been very painful 
experiences and I really feel bad that you have had to go 
through this. But through your bad experience, I believe we can 
bring about some improvements in the system, so thank you very 
much and good luck to all of you.
    Mr. Murnan.
    Mr. Murnan. Could I just tell you one more little thing?
    Senator Collins. Sure.
    Mr. Murnan. To add irony to the end of this, if he had not 
sold my Callaway Golf stock, it would now be a paper profit of 
$1,000.
    Senator Collins. Is that not awful. Thank you very much.
    Senator Cleland. Thank you all.
    Senator Collins. Our final panel of witnesses this 
afternoon includes Joseph Borg, the Director of the Alabama 
Securities Commission and member of the North American 
Securities Administrators Association, and Barry R. Goldsmith, 
the Executive Vice President of NASD Regulation. We are very 
fortunate to have this panel with us today. They represent the 
States and, obviously, NASD and will be able to provide the 
Subcommittee with an overview of their respective enforcement 
missions.
    As the witnesses are getting settled, I will continue the 
introductions. The first witness is going to be Joseph Borg. He 
is, as I mentioned, Director of the Alabama Securities 
Commission. He is responsible for the direction and supervision 
of the Statewide agency involving the registration of 
securities dealers, agents, investment advisors, and investment 
advisor representatives, as well as the enforcement of civil 
and criminal statutes under the Alabama Securities Commission. 
He has considerable investigative and litigation experience and 
played a leading role in putting out of business one infamous 
firm, Stratton Oakmont.
    We will also be hearing today from Barry Goldsmith, the 
Executive Vice President of NASD Regulation. In that capacity, 
Mr. Goldsmith is responsible for formulating the enforcement 
policy of the NASD and its over 500,000 individual registered 
representatives. The creation of this new subsidiary was one of 
the several major new recommendations made by the Select 
Committee on Structure and Governance, headed by former New 
Hampshire Senator Warren Rudman.
    As I mentioned, all of our witnesses are sworn, pursuant to 
Rule 6 of the Subcommittee, so if you would please stand as I 
administer the oath.
    Do you swear that the testimony you are about to give 
before the Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Mr. Borg. I do.
    Mr. Goldsmith. I do.
    Senator Collins. Thank you.
    Mr. Borg, we will start with you, now that we have had all 
these accolades to State regulation.

 TESTIMONY OF JOSEPH P. BORG,\1\ DIRECTOR, ALABAMA SECURITIES 
       COMMISSION, AND MEMBER, NORTH AMERICAN SECURITIES 
            ADMINISTRATORS ASSOCIATION, INC. (NASAA)

    Mr. Borg. Thank you, Madam Chairman and Senator Cleland. I 
am Joe Borg, Director of the Alabama Securities Commission, and 
I do, on behalf of NASAA, welcome the opportunity to 
participate in your oversight hearings on the growing problem 
of fraud in the sale of small company stocks.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Borg appears in the Appendix on 
page 158.
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    I am representing NASAA, which has led numerous enforcement 
efforts in this area, and I commend you for the timeliness in 
holding a hearing on this important subject. As mentioned by 
Chairman Levitt and Senator Cleland earlier, I believe, over 
one in three households now are investing in the capital 
markets, up from 1 in 17 in 1980. Securities fraud has a 
profound impact on a great number of working families. That has 
been demonstrated here just a few moments ago.
    I have been involved in the securities markets for about 15 
years as a partner in a law firm, as a State securities 
regulator, and as an actual investor. I am here today to 
discuss the very serious and growing problem of fraud in what 
has been termed the micro-cap market. Daily, it threatens 
investors across the United States with losses of millions of 
dollars.
    Moreover, in my opinion, this threat casts a shadow on 
every financial institution in our markets today. One of the 
unreported costs of this problem is the millions of dollars 
intended to seed new businesses that end up in the pockets of 
swindlers rather than creating new jobs, and its consequences 
are also increased distrust of the markets by the grassroots 
Americans that support the entire market.
    I am actually speaking about the efforts of small 
unscrupulous firms who use sophisticated scripts and an army of 
cold calling solicitors and brokers to sell micro-cap stocks to 
investors by any means, including false and fraudulent 
misrepresentations, dishonest and unethical sales practices, 
and I would agree with Senator Cleland, as the neighboring 
State, we call it like you call it. It is lying, cheating, and 
stealing.
    On May 29, 1997, at a news conference with the New York and 
New Jersey Attorneys General, NASAA announced that 20 State 
securities agencies had filed 37 actions against 14 of these 
firms. That announcement was phase one of what is going to be 
and will continue to be the biggest nationwide crackdown ever 
by the States aimed at brokers fraudulent selling stocks over 
the phone.
    That announcement resulted from a directive from the NASAA 
office that created a strike force represented by 12 States. In 
February, audit teams comprised of examiners from these States 
struck five preselected firms in the New York metropolitan 
area. Concurrently, other States conducted similar 
investigations, and ultimately, 20 States participated in the 
actions, with NASAA serving as the coordinating council for 
this nationwide crackdown.
    One of the targets, the brokerage firm of Investors 
Associates, was subject to 15 State actions. To date, Alabama, 
California, Indiana, Massachusetts, New Hampshire, Oklahoma, 
South Carolina, and Texas have revoked the license of Investors 
Associates and Ohio recently denied its application for a 
license.
    State securities examiners confirmed that employees of the 
targeted firms pressure their victims into buying stock in 
unknown companies by reading from scripts. The brokers and cold 
callers know little or nothing about the companies they are 
paid to hype. I would like to add at this point that these cold 
callers are unregulated, unlicensed.
    Here is an excerpt from one of the scripts taken from a 
trash can at a brokerage house on Long Island. It is the sale 
of micro-caps that is a planned and choreographed production. 
In fact, the script begins with the stage instruction to 
``speak slowly and nonchalantly''. Here is what they say.
    ``Two or three times a year, we at Investors Associates get 
our preferred clients involved with a niche area of the market 
where we can potentially turn a 6, 7-figure profit within the 
course of a few trading hours, more specifically, what we call 
initial public offerings.'' Now, after providing a little 
detail about a particular stock, which is generally hype, the 
script goes on to say, ``In other words, a return of 100 
percent in 20 minutes perhaps sounds a bit unrealistic, but 
that is exactly how our IPOs work. We did three deals last 
year, yielding collectively 34 points within the first 10 days 
of trading and that is a fact.'' That is out of the script.
    Of course, once enough shares are sold and the price is 
driven high enough, insiders sell the stock, creating a price 
slide, making fortunes for themselves and wiping out the 
savings of innocent investors. In the vernacular of the 
industry, this is called the pump and dump. Although the 
unknown companies being peddled are small, it is not their size 
that is dangerous but the dishonest way that their stock is 
represented and sold.
    In the course of NASAA's sweep, State examiners discovered 
four systemic abuses by the targeted firms. These include, 
first, trading abuses, and you have heard this today. Our 
examiners found an army of unlicensed solicitors who are 
accused of falsifying records, conducting unauthorized trades, 
and failing to complete trades. These are the tools of stock 
manipulation and securities fraud.
    Second, failure to report investor complaints. State 
examiners found hundreds of unreported investor complaints. 
Most of the offices audited failed to have centralized 
procedures for handling and reporting customer complaints, as 
required by regulation. The consumer complaints were just 
gathering dust in some corner or on some shelf, totally 
ignored.
    Third, evasion of broker-dealer registration requirements 
through the use of third-party franchise agreements. Rather 
than acting as a legitimate branch of a broker-dealer, these 
franchises operate independently with no central compliance, no 
supervisory procedures, no oversight, as is generally the 
industry practice. While they operate independently, they do 
not have independent capital nor independent bonding upon which 
the investing public can rely. When a broker-dealer or its 
satellite offices are not properly registered, that is a sure 
sign that something is terribly wrong.
    Fourth, abusive cold calling practices. Most of the firms 
and branches relied on high-pressure scripted telephone cold 
calling techniques that include falsifying experience and 
performance as well as other outright lies. This is the key to 
the scheme. Without the high-pressure cold calling, the rest of 
the illegal scheme would never succeed.
    Again, we are talking about a small segment, a very small 
segment, of the broker-dealer industry. However, the dollars 
are phenomenal.
    Unquestionably, as you heard from one of the witnesses 
earlier, the use by unscrupulous broker-dealers and their 
agents of a prestigious type New York, Wall Street-type name 
and address still tends to create an air of legitimacy and the 
promise of a golden opportunity, not only for the unwary or 
inexperienced investor but, in my experience, in many cases 
also for more well-educated and more sophisticated investors. 
This is especially true when the lesser-known brokerage firm 
markets a recognizable clearing firm name as a way to impress 
investors and gain their confidence. This is a confidence game.
    I am confident, Madam Chairman, that these hearings will 
uncover numerous examples of high-pressure boiler room sales 
practices, misrepresentations, unsuitable sales, failure to 
execute trades, trading in accounts without authorization, and 
in a number of cases, out and out threats.
    But I do not want to focus on more problems of the victims 
and what type of problems they incur, but I would like to take 
a moment to go through a specific detailed study to show how 
the manipulation occurs and also to present for your 
consideration indications of generational networking among 
these firms. We are going to talk a little about a history and 
progression of networking that continues unchecked today.
    Looking at the Steve Madden chart--now, Steve Madden is the 
name of a shoe company that was brought public by IPO--there 
was a big group of States, including a major player from 
Senator Cleland's State of Georgia, that worked on this 
project. Looking at this chart, you will notice, for example, 
that the time line shows the creation of 10 million shares of 
stock from 200. Now, this is all prior to public offering and 
before the public gets involved, 10 million shares from 200. At 
the same time, a $100,000 bridge loan was made by three 
individuals who are the principals of Stratton Oakmont, or were 
the principals.
    As we go through the chart, a plan and scheme of bridge 
loans and transitional shares, inside purchasers--the first 
initial shares were sold to 16 purchasers, 12 of whom were 
Stratton Oakmont insiders. The bottom line is, the stock went 
from less than $.50 a share to an offering price over $5 to the 
public, with the insiders making a profit. What is not shown at 
the IPO level, when it goes out to the public, there was $5.1 
million of promissory notes still owed to the principals of 
Stratton Oakmont.
    What came to my attention this morning is that those 
principals are now trying to collect on that $5.1 million. I am 
not sure what effect that will have. I did notice that last 
Thursday, there was a filing with the SEC for Mr. Jordan 
Belfort, the former principal of Stratton Oakmont who has now 
been barred from the industry, to acquire almost 900,000 shares 
more. The cost or source of funds was undisclosed. I do suspect 
it is those promissory notes that are now showing up at this 
late date.
    If we could change the chart, I would like to point out 
that of the Steve Madden initial public offering of 
$12,500,000, 52.3 percent went to insiders and friends of the 
insiders. I suspect that most investors, if they knew that 
almost $.52 of their dollar was going to the pockets of 
investors, would have a second thought about investing in that 
company.
    What that first chart does not indicate is the effect of 
that $5.1 million, that if it gets collected, if it has to be 
paid from Steve Madden assets, the proceeds to the company will 
decrease from 52.3 to 11.3 percent. We are talking, out of $12 
million, only $1.5 million getting to the company, supposedly 
to increase the company's earning capacity and make a return 
for the investors.
    If we can go to the next chart, I would like to point out 
this chart here is a generational networking analysis. Under 
Stratton Oakmont, I have three individuals, the first of which 
is Jordan Belfort. Mr. Belfort came from Investors Center. The 
idea behind this chart is, if you track agents, starting at 
First Jersey and working all the way down, First Jersey being 
the Robert Brennan notorious penny stock promoter, and going 
all the way down, agents become principals, get barred from the 
industry after making, in Mr. Jordan Belfort's case, about $84 
million, and move on to their agents, who become sales 
professionals and then form their own companies, and it 
continues on and on and on.
    The conclusions are obvious and inescapable. You cannot 
ignore them. The abuse in this area continues to grow. As 
regulators pursue and shut down one firm, another or even 
several emerge to take its place. The lying, cheating, and 
stealing, as Senator Cleland stated earlier, continues 
unabated.
    Thankfully, Stratton is gone. Belfort is out of business, 
and so is the other principal, Danny Porush. However, this does 
not solve the problem, and it is said that those who do not 
learn from history tend to repeat it. I think we have been 
repeating history.
    These losses are unacceptable, and unless regulators are 
given necessary enforcement tools and resources to strike at 
the individual agents with both civil and criminal sanctions, 
the infestation in our markets will continue. We must 
discourage rogue broker entrepreneurs by bringing criminal 
cases. Prosecute the trainer. Let it be known that the cost of 
business just went up.
    Rogue brokers of firms will agree to pay a civil fine of 
$100,000 or even $1 million as the cost of doing business as 
long as they can continue to bilk the investors of tens of 
millions of dollars. Again, this is just unacceptable.
    We have heard that $6 billion is lost through these 
fraudulent practices. Whether that is high or low is 
immaterial. Those kind of losses of any type of amount is 
unacceptable.
    We would recommend three phases. Front-end protections, for 
example, would be important. We recommend that the SEC consider 
adopting the use of State enforcement actions to disqualify 
persons based on those State orders by interpreting the 
language in Section 3(a)(39), which States basically that the 
Commission can utilize ``other appropriate regulatory agency 
information''. That could mean State security agencies. If the 
State has issued an order against a broker-dealer or a broker-
dealer-agent, I see no reason why that cannot be used by 
Federal prosecutors or Federal agencies or the NASD as a 
disqualifier.
    The continuation of State licensing procedures is 
absolutely important. It is the first barrier against entry of 
fraudulent brokers and broker-dealer-agents into the market. 
This is absolutely critical, I think, and I commend Chairman 
Levitt for recognizing the importance of State licensing 
authority.
    Ongoing protections, we would recommend that the role of 
the clearing firms be examined. It is important that clearing 
firms have some responsibility to the industry and the 
investors for whom they clear. Also, a disturbing trend has 
been in the area of omnibus clearing arrangements, which are so 
generalized as even the clearing arrangements do not know who 
they are clearing for. We are very seriously concerned about 
this trend.
    Also, books and records. There is a proposed rule for books 
and records requirements for broker-dealers under the 
Securities Exchange Act of 1934, which was originally released 
October 22, 1996. The SEC, in my opinion, has recognized the 
importance of books and records for use by the States in 
regulatory and enforcement actions. We believe the time is ripe 
for SEC adoption of a meaningful and agreeable Federal books 
and records rule that closely tracks the October 1996 release.
    Lastly, after the fact. SIPC is 27 years old. It is time 
for a review. This Act has not been amended since 1970 and the 
question is, is the protection still sufficient coverage for 
the investors? Should consideration be given to raising the 
payment levels, and should actions other than a firm's 
financial failure be the cause to trigger coverage?
    Lastly, I am pleased by Chairman Levitt's comments 
recognizing the value of State licensing powers, which 
authority is on the forefront of protecting our markets and 
investors, and I am ecstatic that the Chairman today announced 
a new drive to combat this insidious problem. I can assure 
Chairman Levitt and this Committee of my and my colleagues at 
NASAA's commitment to assist in the war to protect the markets 
and the investors because these markets and these investors 
have served our great country so well. Thank you.
    Senator Collins. Thank you, Mr. Borg.
    Mr. Goldsmith.

 TESTIMONY OF BARRY R. GOLDSMITH,\1\ EXECUTIVE VICE PRESIDENT, 
                     NASD REGULATION, INC.

    Mr. Goldsmith. Thank you, Chairman Collins. I am very 
pleased to be here and thank you and the rest of the 
Subcommittee and Senator Cleland for the opportunity to testify 
about the micro-cap fraud problem in U.S. markets and our 
efforts to address it.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Goldsmith appears in the Appendix 
on page 252.
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    Sitting here today listening to the three investor 
witnesses who preceded me has done more to convince me than 
anything I have heard at this hearing that we, as regulators, 
need to do more. We have to look at fresh approaches at 
addressing this problem.
    I readily acknowledge that there are some dishonest 
individuals and firms in the securities business today. 
However, let me also say that the overwhelming majority of 
securities professionals and individuals in the industry today 
are honest and ethical and treat their obligation to comply 
with the law seriously, and as they should, put the individual 
investor's interest first.
    The problem firms that we have heard about today represent 
a tiny portion of the more than 5,500 securities firms in this 
country and are, for the most part, firms that concentrate 
their activities in the securities of thinly-capitalized micro-
cap companies. While many of these smaller companies offer good 
invesment opportunities for public investors, sales of 
securities of these companies are also susceptible to the 
abusive practices that we have heard so much about today. We 
see too much in the way of misrepresentation, manipulation, 
phony guarantees, phony promises and unauthorized trades. It is 
in this area, of micro-cap thinly-traded securities, that we 
see the greatest growth in fraudulent activity today.
    I would like to spend a moment talking about NASD 
Regulation's enforcement record. As these hearings demonstrate, 
we have to redouble everything we have been doing in the past. 
NASD Regulation has already begun to do so, with major 
investments and new staff and surveillance systems being made 
now and budgeted for in the future. These enhancements have 
increased both the numbers and impact of our enforcement 
actions, as well as the effectiveness of the sanctions we have 
obtained.
    I have described some of our recent enforcement actions in 
my written testimony. We have sanctions guidelines that are now 
under review and are going to be totally revamped. Last year, 
we brought 1,200 disciplinary actions, threw nearly 400 brokers 
out of the business. This year, we are running about 18 percent 
ahead of that in terms of barring individuals from the 
business.
    The priority in every case that we bring against offending 
firms and individuals is to make restitution to injured 
investors. In two recent micro-cap cases that we brought just 
last month, D.H. Blair and GKN Securities, more than 4,300 
investors in 48 States will receive more than $3.8 million in 
restitution and interest.
    Stratton Oakmont, a firm that we heard so much about today, 
was thrown out of the business by NASD Regulation in December. 
This is a prime example of how the States and the SROs and the 
SEC can work together. The NASD decision expelling Stratton 
Oakmont specifically made reference to securities actions 
brought by 19 States, including the State of Alabama. I am 
against regulatory duplication, but in certain cases, a little 
duplication is not a bad thing.
    The Subcommittee has expressed particular interest in how 
we assure that past offenders do not repeat their violations. 
We accomplish this by giving regulators and investors 
information on past violations, punishing repeat violators more 
heavily, closely monitoring the firms that hire past violators, 
and requiring heightened supervision of any brokers with a 
significant disciplinary history.
    Our sanctions guidelines already provide for significant 
escalating sanctions against recidivists. Where we see barred 
brokers reappear on the fringes of our industry as unsavory 
stock promoters and people who are beyond our jurisdiction, we 
refer those cases to the SEC and to criminal law enforcement 
authorities.
    We cannot arrest people. We cannot put people behind bars. 
But the NASD has the manpower and the technical expertise to 
assist criminal prosecutors around the country to do their 
jobs. Recently, we have noticed increased interest by State and 
local criminal prosecutors in tackling these cases. With 
appropriate training and help from the regulators, we believe 
they can do just that and these cases are going to be brought.
    We have made micro-cap a prime focus of our regulatory 
program, but we have to do more. The NASD is actively studying 
this market, particularly the over-the-counter bulletin board, 
where many of the securities that we heard about today are 
traded. We are going to make the changes that are necessary to 
address the problems we see.
    While the bulletin board provides a marketplace with real 
time price and volume information, investors need to have 
access to more accurate and current information about the 
companies whose shares trade there. Too often, the only 
information investors have is the misinformation and hype 
posted on a stock promoter's Web page or the pie-in-the-sky 
promises made by brash cold calling brokers.
    We are going to propose a number of initiatives in that 
area. First, we must take a hard look at whether there should 
be higher threshold standards for including a stock in the 
over-the-counter bulletin board. We will look closely at 
whether a company that is either unwilling or unable to provide 
full and timely disclosure of information to the public and to 
regulators should be given quotation visibility on this 
electronic medium. Such a proposal could limit quotation on the 
OTC bulletin board to companies providing and filing periodic 
reports with the SEC and other financial regulators.
    Second, we are going to work with the SEC to strengthen the 
tools that we have to keep the shares of bogus companies from 
being traded in the over-the-counter market in the first place. 
This can be accomplished by toughening and clarifying the rules 
we have to prevent broker-dealers from initiating or continuing 
to quote an OTC security when they do not have current, 
reliable financial and other information about the issuer.
    Third, we are also considering a rule to prohibit a broker 
from recommending an OTC security unless he or she also has 
first reviewed the issuer's current financial statements and 
believes that they are accurate.
    Fourth, we are considering rule changes that would place 
tough new requirements on brokers, beyond the existing 
suitability requirements, to confirm with their customers that 
purchases of these types of speculative over-the-counter 
securities are suitable, given the customer's age, experience, 
and investment objectives. We are looking at requiring brokers 
to disclose to their customers specific information about these 
types of investments and explain to them the differences 
between the over-the-counter market and the Nasdaq stock 
market. We will determine if there is an increased need for 
regulation on the operation of the bulletin board, such as to 
give the NASD the authority to halt trading or halt quotes of 
securities under certain circumstances.
    Finally, we must be more proactive in educating investors 
on the specific and unique characteristics of the OTC equities 
market. We have already begun a program to educate investors 
about the OTC bulletin board, the pink sheets, and other 
quotation media.
    I would like to talk about some of the new rules that we 
have initiated and those that we are proposing and have under 
consideration. We feel that these rules will have a very strong 
impact on investor protection in this marketplace. First of 
all, with respect to clearing firms, a focus of these hearings, 
and we have heard testimony today about how one of these 
brokers used Morgan Stanley's name in order to attract Mrs. 
Sprecher to invest. The focus of these hearings has been the 
increasing responsibility of clearing firms for notifying 
regulators of problems with introducing firms.
    We are working closely with the SEC and the New York Stock 
Exchange, to impose new reporting responsibilities on brokers 
that clear trades for these smaller firms. These proposals 
would require clearing firms to provide information that will 
allow self-regulators to better monitor the smaller firms for 
which they clear trades--the introducing firms.
    Our boards will soon be considering proposals to require 
clearing firms to report to their designated examining 
authority, either the NASD or the New York Stock Exchange, the 
written complaints that they receive on introducing firms and 
to forward these complaints to the introducing firms, as well. 
This will help get at the problem that Mr. Borg identified of 
complaints that are being deep-sixed and put on shelves that 
nobody sees. This is a double check and additional information 
that we need.
    I would like to talk about taping. Taping has a salutary 
effect. When we succeed in putting a recidivist firm out of 
business, we think that our job is not over. We have heard 
testimony today about principals of firms who we expel turning 
around and forming new firms under a different name, or other 
times the firms move en masse to a branch office of an existing 
firm. When a large number of brokers like these become employed 
at another broker-dealer, this raises a real risk that their 
new firm will have significant sales staff who may not yet have 
forgotten their old bad habits.
    In addition to our other enforcement efforts against repeat 
offenders, the NASD board this month sent to the SEC for its 
review, and hopefully approval, a rule that would require 
brokerage firms to tape all customer sales calls for 2 years if 
a specified percentage of the firm's brokers worked for firms 
that have been expelled for telemarketing fraud or sales 
practice abuse.
    Cold calls, telemarketing, we have heard stories today that 
turn my spine cold about cold calling. These tactics are often 
used to induce investors to purchase stock over the telephone 
from a broker they do not know and probably would not want to 
know if they met him or her. We have adopted telemarketing 
rules, and in a related initiative, we now have out for comment 
to our members a rule that for the first time would require all 
persons who make cold calls to be registered security sales 
representatives.
    Right now, as I speak, there are firms who are using 
unregistered staff, people who do not have to pass NASD 
examinations or undergo the education that is required to make 
calls to investors. The proposed rule will assure that those 
making the cold calls are aware of our rules and subject to our 
regulation and sanctions.
    We are also developing a new Internet search engine that 
will help combat Internet fraud, and obviously we are working 
on new initiatives to give investors more information that they 
want. One of the comments that Chairman Collins made about 
putting phone numbers on brokerage statements is something that 
I definitely want to consider. Right now, we are talking to a 
number of major utilities on the East and West Coasts to use 
envelope stuffers to put this kind of information in the hands 
of the type of audience we must reach. We need to be marketers. 
We need to be effective. Publishing an 800 number that nobody 
remembers is not enough. We need to do more.
    I would be happy to respond to any questions you might 
have.
    Senator Collins. Thank you very much, Mr. Goldsmith.
    I commend you for the steps that the NASD is taking to 
further regulate the bulletin board, to look at that issue, 
since I think a lot of people, given the bulletin board's link 
to Nasdaq, assume that it provides the same kind of stability 
in terms of disclosure and listing requirements as the other 
NASD markets. I also commend you for the other rule changes 
that you have just described to us that are under consideration 
involving among other clearing firms and cold calling.
    But as I said to Chairman Levitt, in the end, I think this 
comes down to an issue of the confidence and the ethics of the 
people in the industry. As I said in my opening comments, the 
vast majority of brokers, and you have underscored that, are 
ethical. We do have, however, a persistent minority that no 
matter what we seem to do from a regulatory or legislative 
perspective just keep popping up and that is why I want to 
pursue with you the questions that I asked Mr. Levitt.
    I am not kidding when I say that in the State of Maine, it 
is easier to get a license to be a stockbroker than it is to 
become a cosmetologist. A cosmetologist has to have a high 
school education, has to have undergone specialized training, 
has to take both a written exam and a practical exam, has 
continuing education requirements every 2 years, and yet, 
obviously, the consequences of someone who is a licensed broker 
for an unwitting, unsophisticated investor who is given bad 
investment advice are so much more severe.
    Do you think that the competency levels for brokers are 
sufficient? Is entry into the industry too easy?
    Mr. Goldsmith. I really do not think that the problem rests 
with how difficult the exam is. In fact, we brought cases, I 
believe, against 52 individuals who felt that it was too 
difficult and they got somebody who they paid to take the exam 
for them. That is something that, hopefully, will not happen 
again.
    But I think what we need to do, I agree with your comment 
about increasing sanctions for the bad apples. We see too many 
cases where firms, as a cost of doing business, will pay $1 
million fines and go on to, in a sense, rob Peter to pay Paul. 
Even in cases where arbitration systems are set up, we 
sometimes find that these firms are paying old investors 10 
cents on the dollar with new investors' money.
    I do not think, though, that toughening the exams will 
necessarily stop that problem. I think you hit it on the head, 
that these are really ethics we are talking about and we have a 
lot of very smart crooks in the business who would be able to 
pass just about any reasonable exam that could be taken.
    So I think we need to concentrate on getting the bad people 
out, educating investors, and looking hard at cases and saying, 
is this a firm or is this an individual that we want to, in a 
sense, live another day with other investors, or are we going 
to draw the line here and try to get them out of the business? 
Sometimes with numbers of cases and burdens, it is something 
you have to look back on and make the decision to bite the 
bullet.
    Senator Collins. I think that is a critical issue. I think 
the NASAA issued a report that was quoted in the House report 
accompanying the 1990 penny stock legislation that said in one 
study, something like 83 percent of the people who were working 
for firms with trouble had a previous history of violations of 
securities laws. That again raises the concern to me of whether 
we are tough enough and whether we should have a zero tolerance 
policy. For example, if there is a serious breach of ethics, 
you are out, or you are at least out of the industry for a 
significant period of time. What is your reaction to that?
    Mr. Goldsmith. I think, as I said, our sanctions guidelines 
are being reviewed from top to bottom. We have a committee made 
up of staff members, industry members, and committee members, 
looking at our guidelines. I think there has been an 
appreciation that we have ratcheted up our sanctions.
    We have also, as part of the joint regulatory sales 
practice sweep that the SEC, NASAA, and the NASD did last year, 
issued a notice to members requiring heightened supervision of 
brokers with disciplinary histories. And one thing we are doing 
that I think has a very beneficial effect, particularly now as 
CRD is going to become more investor-friendly and enable 
investors to get information on brokers, is bringing cases and 
drilling down to low levels in terms of brokers. We are not 
just suing the top two or three people in the firm.
    A.R. Baron is a case that we have heard a lot about. There 
have been indictments by the Manhattan District Attorney's 
office and we have sued 23 brokers there. GKN, a case I 
mentioned, 29 brokers. H.J. Meyers, which I think is right 
there on Mr. Borg's chart, more than 35 brokers. What we want 
to do is tag these brokers, and these may not be brokers who 
have committed capital offenses, but tag them with disciplinary 
histories so when they go from firm to firm, that is known to 
their new firms. When investors get a call and want to check 
out the broker, they will see that this is a broker who has 
been disciplined. That is something, I think, that is going to 
have an effect.
    Senator Collins. Let me follow up on that very point. You 
just mentioned A.R. Baron, and in your testimony you mentioned 
enforcement actions taken against Hibbard Brown. These are 
firms that, it is my understanding, are no longer in business, 
is that correct?
    Mr. Goldsmith. Yes.
    Senator Collins. With respect to each of those firms, do 
you know how many brokers worked for the firm and how many of 
those brokers are still in the industry? You mentioned that you 
are suing further down, but are a lot of the people who worked 
for those two firms still in the business and are they subject 
to any sort of special ongoing scrutiny by either NASD or their 
new firms, if they are still in business?
    Mr. Goldsmith. A firm that we expel, our taping rule, if it 
is approved, will come into effect. And one thing that we do, 
we have an examination program and we had over 2,400 main 
office exams last year and cause exams based on customer 
complaints, 5,200. When our examiners go into firms, we are 
aware of the brokers who are there and we are aware of their 
past affiliations and those are red flags for us, as well.
    So we do keep track of where brokers go. I think you will 
find that in many of these firms, particularly some of the 
younger brokers end up going into the used car business when 
their firms go out of business. Also there are a fair number 
that just scatter. But sometimes we hear that there is a 
nucleus of brokers going to firm XYZ. We will go into that firm 
and we will look around. It is a piece of regulatory 
intelligence that I think is very important and one that we 
use.
    Senator Collins. Mr. Borg, earlier today, and I know you 
were here for the testimony of our consumer witnesses, we heard 
two of the witnesses, Mrs. Sprecher and Mr. Poggi, were the 
victims allegedly of outrageous conduct by a firm called 
Investors Associates. I wondered if you are familiar with the 
firm, whether or not you know what its status is now and 
whether there was a sufficient regulatory response, in your 
judgment.
    Mr. Borg. Investors Associates was suspended, their license 
revoked in Alabama, I believe either December of 1996 or 
January of 1997. It is my understanding that Investors 
Associates still maintains its NASD license. Its license has 
been revoked in at least 10, perhaps 12, States, and some of 
the people of Investors Associates have moved on to other 
firms, including some of the folks that were mentioned today.
    I would point out, as I was listening to the testimony 
today, I recognized a number of these names, these individuals, 
such as Mr. Baratta, who came from Investors Center, which is 
on the chart, and Mr. Bleich, who came from Duke Associates, 
and Mr. Tropeano, who came from Continental Brokers, which is 
on a subsequent chart in the submitted materials. Mr. Grecco is 
well known. He is both from Investors Center and Stratton 
Oakmont. So this, I think, proves the point. Mr. Spitzer was 
also mentioned as one who took over the Sprecher account. He is 
formerly with GKN. So I think this shows the pattern that goes 
on.
    Has there been sufficient response? That is a tough 
question. I do not believe--I would prefer a stronger response, 
and I think, as this program of working together on the micro-
cap attack, as Chairman Levitt mentioned today, including 
joining with the NASD, perhaps the State concerns on the extent 
of the regulatory attack can be increased, especially if there 
are some other indications, such as cold callers who have to be 
registered.
    If they are not registered, they are not on the CRD. If 
they are not on the CRD, I do not know about them and there is 
nothing I can do except bring a criminal action. I cannot 
revoke the registration or suspend it; they are not licensed. 
So I am pleased to hear Mr. Goldsmith today talk about 
enforcing a regulation or proposing a regulation to that 
extent.
    I do think that regulatory actions by the SEC, the NASD, 
and the States--we fall into this category, as well--in the 
past have concentrated on the principals and the firms. I do 
not think that, historically, any of the regulatory agencies 
really recognized the progression, as you will, or the 
generational networking that existed until recently.
    I do believe that there has to be greater response up front 
prior to the time, for example, that Mr. Belfort and Mr. 
Greene, who are on their yachts now, have taken several hundred 
million dollars and are now out of the business. It is a little 
late.
    Senator Collins. It is incredible to me--and your tracing 
the patterns of employment of these individuals just 
underscores the point--it is incredible to me that these rogue 
brokers can just keep popping up over and over again and that 
we are not taking action to bar them from the industry. I am 
just perplexed by that, because you know that they are going to 
go on to victimize other people, similar to the people we have 
heard from today.
    Mr. Borg. And that is why I recommended that if the NASD 
and the SEC could utilize a State order, to the extent that it 
could utilize orders between NASD and SEC, to prevent these 
brokers from continuing in the industry or at least suspend 
their operations until such time as a full review could be 
made, I think that would go a long way to preventing the 
further transfer from place to place.
    Unfortunately, the CRD system does not trigger our notice 
at the State level until there is a firm transfer, and if it is 
a mass transfer, then that means we have to go through one by 
one, and we try to do that, but the States do have limited 
resources.
    That is why it is so important, and I heard Chairman Levitt 
state today that they have all this information, but it is hard 
to prosecute. Well, it is easier for the States to prosecute, 
but I do not have the resources and information he does. It is 
a combination of the SEC and the NASD, with their resources and 
their information and their expertise and our ability to get 
into State court in a quicker manner, perhaps, than the U.S. 
Attorney's Office or the Department of Justice, but a 
combination of all these factors is what it is going to take to 
drive these people out of business.
    Senator Collins. Thank you.
    Senator Cleland.
    Senator Cleland. Mr. Borg, it is good to see you.
    Mr. Borg. Thank you, sir.
    Senator Cleland. Mr. Goldsmith, thank you very much.
    Let me just follow up on that point. I think you really hit 
the nail on the head there. I mean, what we have here is a 
troika with the SEC and then the NASD and then the States, 
three levels, certainly two levels of government and one 
involving the private sector there, all having to work hand-in-
glove to track down and nail and prosecute and put in striped 
suits--broad stripes--bad guys or bad gals. They are pretty 
elusive.
    I can remember being Secretary of State in Georgia. We put 
together a 6-State task force to crack down on some boiler 
rooms out in Orange County, California. You just referred to a 
20-State effort--was it not 20 States?
    Mr. Borg. Yes, sir, the May sweep.
    Senator Cleland. Yes. I think that is quite incredible.
    I just want to come back to the role of the States. 
Obviously, you have some defenders here who think the role of 
the States ought to be a strong one, but you just mentioned 
right there at the end your ability to get into State court 
quickly if you had some help from others, NASD or the SEC in 
terms of information. Is that correct?
    Mr. Borg. Yes, sir, I believe so. My State brings a number 
of actions every year. I think last year, we brought 30 
criminal actions. I have something like 36 or 38 defendants 
awaiting trial right now on charges, not necessarily micro-cap 
but general securities fraud, whether they are non-existent 
stock or investment advisors who have ripped off pension 
accounts.
    But the thing is, on this micro-cap, because of the time 
and effort it takes--you may recall that time line on the Steve 
Madden chart with the creation of the bridge units and the 
selling of the private placements. This is information that is 
the expertise of the NASD. If that could be combined with 
getting the complaints to us quicker, because sometimes they do 
end up at the NASD as opposed to the States, we would like to 
facilitate a greater exchange of that information, and I think 
we are doing it. It has started on a district level.
    Then if the NASD would refer to us those complaints as soon 
as they hit and if we can find sufficient basis in our State 
law, I think the Attorney Generals or the District Attorneys, 
or in our agency case, we prosecute our own cases most times 
with the assistance of the DAs and the AGs, we could get into 
court a lot quicker on a good criminal case.
    In some cases, the determination may be there is not quite 
enough to meet the burden of a criminal case, because as you 
know, it is a much higher burden than revoking a license or 
suspending them from business, and that is a decision that is 
going to have to be made on a case-by-case basis.
    But with the information from the SEC and the NASD, 
combined with the cop on the beat, as Arthur Levitt has 
referred to the States, abilities to get into court, I think 
you would see an increase in criminal prosecution. I think you 
would also see a speeding up of the process of revocations of 
licenses and suspensions, and if the SEC and the NASD would 
honor those suspensions of licenses, I think you would see a 
quicker response.
    Senator Cleland. Do you think criminal prosecution is the 
ultimate deterrent?
    Mr. Borg. Yes, sir. If I can give you a quick example of 
what I think happens, and I was not a personal witness to this, 
but one of the people we interviewed with regard to the 
Stratton case indicated that at one point in time, one of the 
principals in the boiler room, which is a big board room where 
they had 250 to 300 people making cold calls, which, by the 
way, Senator, they made a million calls a month. We took 18 
months of their records----
    Senator Cleland. That is more than I raised in soft money. 
[Laughter.]
    Senator Cleland. Strike that from the record. I am kidding.
    Mr. Borg. But at one point in time, there was a fine levied 
or there was an action brought and one of the principals got up 
on the table to announce that one of the regulators had taken 
this action or had fined them a certain amount and the report 
goes that everyone, ``Awww.'' And then he announced, ``But, in 
the same 30 days, we made $10 million,'' and everybody went, 
``Yay.'' So, no, there is no sufficient response in a civil 
proceeding if they can pay you $1 million and steal $5 million. 
It is a cost of doing business. Therefore, I think the proper 
response would be a criminal action, and you have to get past 
the principals to the agents to deter new agents if they think 
there is a possibility of going to jail.
    Senator Cleland. What do you think about this concept of 
zero tolerance the Chairman mentioned and Mr. Goldsmith is 
interested in and made a comment to the New York Attorney 
General in terms of zero tolerance? Should we be thinking about 
that?
    Mr. Borg. I am very interested in zero tolerance. I would 
like to be able to work with NASD and the SEC on developing 
guidelines toward zero tolerance. I think it is something that 
can be discussed.
    If I might digress just for a second, the idea of putting 
the numbers on the account statements, I think, is an excellent 
idea. However, I would recommend one change to that. In Mr. 
Poggi's case, the number on the account statement would have 
been too late because the account statement he got was after 
the trades had been made, within that 30 days, and the 
statement will not drop, chances are, until sometime at the end 
of the month.
    I would recommend that either at the initial application 
stage, prior to any trade, that that information be delivered, 
either as part of the client form to allow them to do business 
or a separate mailing that gives that information up front, 
because, as I said, in Mr. Poggi's case, I think had it been on 
the account statement, he would not have seen it for 45 days 
and it was too late in his case.
    Senator Cleland. You mentioned about the effectiveness or 
the ability to go into State court quickly. The Private 
Securities Litigation Reform Act placed certain restrictions on 
the ability of defrauded investors to seek redress in class 
action lawsuits. Should the new Act be amended to preclude 
investors from bringing actions in State courts?
    Mr. Borg. I think the issue is different. I am not up on 
the Private Litigation Reform Act, per se. I am sure my general 
counsel at the Commission is. But what I am talking about here 
is the enforcement of the anti-fraud authority and the criminal 
violations under a criminal act. The State is not precluded, as 
I understand it, from bringing any actions under private 
litigation reform, and that is for class action type lawsuits, 
and that would be a civil redress. Therefore, I am not 
qualified to speak to that, Senator.
    But I would say that on the criminal side, that that would 
be a police power to the State and I think the State, if it has 
a violation of its statute or a violation of a Federal statute 
or Federal regulation that they are required to meet at the 
State level, then I think the States can act on that.
    Senator Cleland. Mr. Goldsmith, talk to us a little bit 
about zero tolerance and how you see that in your line of work.
    Mr. Goldsmith. Let me take an easier question first and 
then I will answer that one. I think it is clear, I think we 
all agree that we need to increase the sanctions, and I am not 
talking about by $500 or $1,000. When we are dealing with 
people who should not be dealing with investors, we ought to 
get them out of the industry.
    I think any kind of zero tolerance, just as I think in the 
three strikes and you are out, in any court system, you have to 
recognize that you are dealing with firms with limited 
resources. If you have a zero tolerance that runs from a 
technical violation all the way up, you are going to have 
people litigating and prosecuting and appealing to the SEC and 
the court of appeals.
    Our disciplinary process moves quite quickly at the NASD, 
but people have the right, as they should, to appeal that. It 
then goes to the Commission. It could then go to the court of 
appeals. If you are trying to throw people out of the business 
for violations that may not warrant that, that could be a 
problem and it is going to hurt your enforcement down the road.
    But a carefully articulated policy with guidelines that, 
with respect to certain types of violations of certain 
magnitudes, would warrant expulsion, and we have that and we 
are looking at toughening those, I think is something worth 
looking at. Again, we are revamping our entire sanctions 
guidelines to that end and we are toughening up. We have thrown 
out more firms. We have expelled more individuals, and I think 
we still need some further toughening.
    Senator Cleland. Madam Chairman, that is the end of my 
questioning. I would just like to thank some key people on my 
staff. Wayne Howell, who is the former head of the North 
American Association of Securities Administrators, now my 
Administrative Assistant, has put a lot of work in on this 
hearing and will be helping me on other hearings, as well as 
Kevin Franks on my staff and Jeff Robbins, minority counsel. 
Thank you, Madam Chairman.
    Senator Collins. Thank you, Senator, and I want to thank 
you for your personal leadership in this area. I know we are 
going to continue to work together on it and I look forward to 
that.
    I want to thank our witnesses. The hearing record will 
remain open for 30 days and it is possible that our counsels, 
as well as other Senators on the panel, will have additional 
questions to submit in writing and we hope that you will assist 
us on our ongoing investigations.\1\
---------------------------------------------------------------------------
    \1\ Exhibits 16, 17, and 18 appear in the Appendix on pages 432, 
466, and 475 respectively.
---------------------------------------------------------------------------
    I, too, want to thank my staff people who worked very hard 
on this, Ian Simmons, Tim Shea, Dennis McCarthy, Mary 
Robertson, Lindsey Ledwin. As you can see, when you are in the 
majority, you get more people to thank. [Laughter.]
    I want to acknowledge Jeff Robbins's assistance also as the 
minority counsel, and I particularly want to have a special 
thank you to my legislative counsel who is also a former State 
securities administrator, Steve Diamond.
    Thank you very much for helping us explore this issue and 
the hearing is now adjourned.
    [Whereupon, at 4:46 p.m., the Subcommittee was adjourned.]



                            A P P E N D I X

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