[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                          ONE BROKER GONE BAD:


                        PUNISHING THE CRIMINAL,


                          MAKING VICTIMS WHOLE
=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 23, 2002

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-71






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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Texas                 JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director
                                 ------                                

              Subcommittee on Oversight and Investigations

                     SUE W. KELLY, New York, Chair

RON PAUL, Ohio, Vice Chairman        LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              KEN BENTSEN, Texas
ROBERT W. NEY, Texas                 JAY INSLEE, Washington
CHRISTOPHER COX, California          JANICE D. SCHAKOWSKY, Illinois
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      MICHAEL CAPUANO, Massachusetts
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
ERIC CANTOR, Virginia                WILLIAM LACY CLAY, Missouri
PATRICK J. TIBERI, Ohio








                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 23, 2002.................................................     1
Appendix:
    May 23, 2002.................................................    63

                               WITNESSES
                         Thursday, May 23, 2002

Doherty, David, Executive Vice President for Enforcement, New 
  York Stock Exchange............................................    12
Fazio, Carl, Defrauded Investor, Aurora, Ohio....................     8
Hommel, Thomas, Managing Director and Co-Head of Global 
  Litigation, Lehman Brothers....................................    37
Kaplan, Mark E., Managing Director and General Counsel, SG Cowen 
  Securities.....................................................    35
Lackritz, Marc E., President, Securities Industry Association....    43
Richards, Lori, Director, Office of Compliance, Inspections, and 
  Examinations, Securities and Exchange Commission...............    11
Sibears, Daniel M., Senior Vice President and Deputy for Member 
  Regulation, National Association of Securities Dealers.........    39
Skolnik, Bradley W., Indiana Securities Commissioner and 
  Chairman, Enforcement Section, North American Securities 
  Administrators Association.....................................    41
Stout, Golda Lewis, Defrauded Investor, Elgin, Illinois..........    10

                                APPENDIX

Prepared statements:
    Kelly, Hon. Sue W............................................    64
    Oxley, Hon. Michael G........................................    65
    Jones, Hon. Stephanie Tubbs..................................    67
    LaTourette, Hon. Steve C.....................................    68
    Doherty, David...............................................    79
    Fazio, Carl..................................................   126
    Hommel, Thomas...............................................   104
    Kaplan, Mark E.,.............................................    96
    Lackritz, Marc E.,...........................................   122
    Richards, Lori...............................................    69
    Sibears, Daniel M.,..........................................   109
    Skolnik, Bradley W.,.........................................   116
    Stout, Golda Lewis...........................................   129

              Additional Material Submitted for the Record

Kelly, Hon. Sue W.:
    Frank Gruttadauria letter to the Securities and Exchange 
      Commission and the Federal Bureau of Investigation.........   166
Jones, Hon. Stephanie Tubbs:
    Arbitration Agreements between Richard Lopardo v. Frank 
      Gruttadauria...............................................   167
    Duvin, Cahn & Hutton letter regarding Mr. Samuel Glazer, May 
      21, 2002...................................................   154
    Gruttadauria Lawsuits Threaten Lehman Profits, Cleveland 
      Plain Dealer, April 17, 2002...............................   152
    NYSE Investigating Gruttadauria ex-aide, Cleveland Plain 
      Dealer, April 27, 2002.....................................   150
    New York Stock Exchange Hearing Panel Decision, July 10, 1998   135
LaTourette, Hon. Steve C.:
    Account of Carl Fazio........................................   157
    Account of Dominic A. Visconsi, Sr.,.........................   158
Hommel, Thomas:
    Written response to questions from Hon. Stephanie Tubbs Jones   186
Kaplan, Mark E.:
    Written response to questions from Hon. Stephanie Tubbs Jones   190
Richards, Lori:
    SEC's Examination Report on Frank Guttadauria, November 1993.   133
Sarantakis, Georgia C., Defrauded Investor, prepared statement...   159
Yale, Judy Meyerhoff, Defrauded Investor, prepared statement.....   163


                          ONE BROKER GONE BAD:



                        PUNISHING THE CRIMINAL,



                          MAKING VICTIMS WHOLE

                              ----------                              


                         Thursday, May 23, 2002

              U.S. House of Representatives
       Subcommittee on Oversight and Investigations
                            Committee on Financial Services
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 9:30 a.m., in 
Room 2128 House Office Building, Hon. Sue W. Kelly [chairwoman 
of the subcommittee] presiding.
    Present: Representatives Kelly, Ney, Cantor, Tiberi, 
Inslee, Jones of Ohio, Clay, and Oxley (ex officio).
    Also Present: Representatives Hastert and LaTourette.
    Chairman Kelly. Good morning, ladies and gentlemen. This 
hearing of the Oversight and Investigations Subcommittee of the 
House Committee on Financial Services will come to order.
    I want to thank all members of Congress who are present 
today. Without objection, all members present will participate 
fully in the hearing, and their opening statements and their 
questions will be made part of the official hearing record.
    On January 11, 2002, Frank Gruttadauria, a Cleveland branch 
manager and broker, mailed a letter to the FBI admitting to 15 
years of wilful fraud and theft of his clients' savings, and he 
disappeared. In the aftermath of this revelation, law 
enforcement, the regulators, the successive owners of that 
branch, and Gruttadauria's clients, began to uncover the extent 
of this one broker's deceitfulness and the intricate web of 
lies that he employed to perpetrate his fraud.
    We do know that Mr. Gruttadauria is accused of at least--
stealing at least $40 million of his client's savings, while 
sending his clients fake statements stating that their savings 
had grown to an estimated combined total of $260 million. 
Today, Mr. Gruttadauria is in federal custody after less than a 
month of being on the run.
    It appears that his efforts to evade detection by the firms 
and regulators were much better than his ability to evade the 
law. One issue is clear: Mr. Gruttadauria and any who assisted 
him will be punished for their crimes. From my initial review 
of this case, Mr. Gruttadauria had the ability to perpetrate 
this fraud because of his position in the Cleveland branch as 
both manager and a broker. This put him in the position of 
supervising himself, which is a key point in this case.
    Another key point is the lack of complaints in regard to 
Mr. Gruttadauria's actions. The majority of investigations 
against problem brokers appear to be triggered by five or more 
complaints. Since Mr. Gruttadauria was able to send false 
statements to his clients and forged any authorization he 
needed, he appears to have avoided scrutiny, including anything 
that occurred through traditional warning signs.
    The purpose of this hearing is to examine this case in an 
effort to determine what steps are warranted to ensure that 
similar fraud and theft is prevented. Our responsibility is to 
ensure that scams such as this will not go undetected again. In 
order to do this, we must take a step back from the particulars 
of this case and examine the systems that firms and regulators 
have in place to detect such fraud by managers' brokers.
    We know that the securities industry is very full of 
intelligent people. If they put their mind to it, they could 
potentially inflict a great deal of harm on the savings of many 
families and investors. To preserve and bolster investor 
confidence, we must gain an understanding of how the current 
systems were defeated so consistently over the course of 
approximately 15 years by Mr. Gruttadauria.
    I want to thank all of our distinguished witnesses for 
taking the time out of their busy schedules to join us here 
today. The committee understands the constraints that some of 
our witnesses are under and their inability to discuss some of 
the specifics of the case due to the ongoing nature of the 
Gruttadauria investigation. The last thing we want to do is to 
inadvertently harm the prosecution of Mr. Gruttadauria or any 
of his accomplices.
    We appreciate your willingness to come here today to 
discuss the issues to the best of your ability. I also want to 
make it clear to the members of this committee, and to our 
witnesses, it is my intention to enforce the five-minute rule, 
which limits statements and questions to a five-minute period. 
This will ensure that everyone has an equal chance to state 
their views, and I thank you all in advance for this effort.
    I want to now recognize the Speaker of the U.S. House of 
Representatives, our Speaker, Mr. Dennis Hastert, for an 
introduction.
    Mr. Hastert, we welcome you here today. Your presence lends 
a great deal to this hearing. Thank you. Mr. Speaker, your mike 
needs to be turned on.
    [The prepared statement of Hon. Sue Kelly can be found on 
page 64 in the appendix.]
    The. Speaker. I haven't done this for a while. No.
    [Laughter.]
    Chairman Kelly, thank you very much for holding this 
hearing today. I also want to thank Mr. LaTourette, because he 
worked to bring this about, and also the Chairman of the full 
committee for making this happen.
    You know, one of our bases of wealth in this country is the 
people having confidence in securities and 401Ks and money 
markets and mutual funds that they can invest their money, the 
money that they worked hard or inherited or saved or scrimped, 
or however they accumulated it, and to see that money grow, so 
that they can have something to live their life with and to 
pass on to their children and their grandchildren. And we have 
seen that wealth grow in this country over the last few years.
    But I have a constituent here today, Mrs. Golda Stout, from 
Elgin, Illinois, who invested over $600,000, or her life 
savings, everything she had, with a broker, the same broker 
that you had mentioned in your opening statement. She lost that 
money, not because of fault of her own, in good faith, under 
the confidence that she was investing with a brokerage house 
that had a good name, a good reputation, and all of a sudden 
that fortune, that savings, that lifetime investment that she 
had, was gone.
    We need to make sure that, first of all, those people who 
perpetrated those deeds are punished. But that certainly 
doesn't make whole those people who were the investors. We also 
need in this Congress, the body that makes the laws for this 
country, to make sure that we have a system in place that 
people have confidence that they can invest in the markets, 
invest in the security systems that we have today, that they 
have confidence that if a brokerage house is there and has a 
good name, it is something that they can have confidence in, 
and that there is a system, that we have checks and balances, 
that this type of thing doesn't happen again.
    So, Madam Chairman, thank you for having this hearing 
today. Again, I want to thank Mr. LaTourette for bringing this 
forward, and for the Chairman of the full committee for 
allowing this hearing. But most important, I also want to thank 
those people who are here today to bring this issue forward, to 
lay out what the problem is, and try to help us to start to 
find the solutions to this problem.
    I also, again, want to thank my constituent, Mrs. Golda 
Stout, for being here today and testifying.
    So thank you very much, Madam Chairman.
    Chairman Kelly. Thank you very much, Mr. Speaker.
    We go now to the Chairman of the full committee, Mr. Oxley, 
for an opening statement.
    Mr. Oxley.
    Mr. Oxley. Thank you, Madam Chairwoman.
    And, Mr. Speaker, thank you for your appearance before the 
committee today. We welcome you back anytime.
    I want to take this opportunity to thank you, Mrs. Kelly, 
for this important hearing. The subject of today's hearing, Mr. 
Gruttadauria, who had as many as 470 clients during the height 
of his success, earning more than $6 million in commissions in 
a good year, for some unknown reason that was apparently not 
enough. It appears that over 15 years he sent false statements 
to two dozen or more of his clients.
    It is further alleged that over the same 15-year period he 
misappropriated possibly hundreds of millions of dollars, 
somewhere between $125- and $700 million from those clients, 
several of whom treated him as warmly as they would members of 
their own families. One client even made him the executor of 
his estate.
    He was never caught. Apparently, feeling that he was on the 
verge of being found out, he called his activities to the 
attention of the FBI, fleeing to Colorado where he eventually 
surrendered to authorities. State and federal authorities, as 
well as the brokerage firms which employed him, are continuing 
their months-long effort to uncover the extent of his 
activities. We can only hope that those efforts will bring a 
sense of closure to his many victims and their families.
    It is my sincere hope that our efforts today will be of 
help in this ongoing investigation. We will have the 
opportunity to hear directly from several of Mr. Gruttadauria's 
victims, and we will learn first hand from them how he 
concocted a scheme whereby he misdirected their brokerage 
account statements to post office boxes which he rented and 
personally controlled. He then created false statements in 
order to mislead his clients about the real value of their 
investments.
    Although some may feel that outages of the sort that were 
inflicted by Mr. Gruttadauria upon his trusting clients are 
systemic, the efforts being undertaken by the law enforcement 
prosecutors, SEC, and New York Stock Exchange, Lehman Brothers, 
and S.G. Cowen Securities would certainly indicate that this is 
certainly not the case. Hindsight is always perfect, yet our 
examination revealed that there were missed opportunities for 
the various authorities to stop his criminal activity.
    The presence of representatives today from the SEC, New 
York Stock Exchange, the SIA, National Association of 
Securities Dealers, and North American Securities 
Administrators, underscores their commitment to ensure that 
violations of securities law such as this particularly 
egregious case do not occur in the future, and I look forward 
to hearing from them today about their efforts.
    Let me also note that this committee was pleased to work 
with the SEC in order to provide it with a significant increase 
in its budget to allow for a much needed escalation of its 
enforcement capabilities. As a matter of fact, we provided in 
the reauthorization bill that passed this committee unanimously 
a 50 percent increase in the budget in the Enforcement Division 
of the SEC.
    Apparently, the SEC also had some information years ago on 
Mr. Gruttadauria, and I also look forward to hearing from the 
SEC about how it will improve its processes.
    Before I close, Madam Chairwoman, I want to particularly 
pay tribute to our good friend, Steve LaTourette, for his 
doggedness and his determination on this case. Steve was a 
renowned prosecutor before he came to Congress, and he has 
taken those skills with him on this committee. We are pleased 
to have him on the committee as a very aggressive and active 
member, and this hearing, in many ways, is a tribute to his 
steadfastness on this issue.
    And I am pleased to yield back the balance of my time.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 65 in the appendix.]
    Chairman Kelly. Thank you very much, Mr. Chairman.
    We now go to Ms. Tubbs Jones.
    Mrs. Jones of Ohio. Thank you, Madam Chairwoman.
    To our Chairman of the committee and my colleagues, I find 
myself this morning in a sad situation. I look out in the 
audience, and I see people from the 11th Congressional 
District, who I have known for many, many years, in a position 
where their life savings have been denigrated as a result of 
the conduct of Frank Gruttadauria.
    When I look out in the audience, I see former Council 
President Jim Stanton from the great city of Cleveland; Mary 
Boyle, a County Commissioner from Cuyahoga County; Mr. Carl 
Fazio--and we have a great relationship because his grandson 
Anthony and my son Mervin attended school together.
    It is, in my opinion, a shame that we would be here this 
morning where we have someone who has literally deprived 
hardworking people, who have worked all of their lives, of 
their life savings, of that blanket to cover them in a time of 
most need.
    As we come today before this subcommittee, there are 
several questions that we will all want to have answered, but 
particularly of interest to me will be what, in fact, the SEC, 
in 1993, knew about Frank Gruttadauria and did not do enough to 
keep him from being engaged in a conduct subsequently.
    I do want to have admitted to the record at some point, 
Madam Chairwoman, a finding by the New York Stock Exchange from 
1998 of conduct of Frank Gruttadauria and S.G. Cowen's failure 
to supervise producing branch manage officers acting in the 
capacity of registered representatives. In this instance, we 
have Frank Gruttadauria acting as a branch manager/officer, 
who--and the compliance officer within that company was the 
person who reported directly to Frank Gruttadauria. If that is 
not a signal that something is going wrong, I don't know what 
is.
    [The following information was subsequently furnished by 
Hon. Stephanie Tubbs Jones for the hearing record.]
    Chairman Kelly. Without objection.
    Mrs. Jones of Ohio. Thank you.
    It is our job as members of Congress to sit and listen 
intently, constantly try to keep our sympathies for the victims 
of these crimes from clouding our objectivity that we must 
maintain. However, it is a tough piece to try and keep that 
sympathy from clouding part of our judgment in this instance.
    But be that as it may, Frank Gruttadauria, who--frankly, 
whose conduct is shocking--is alleged to have stolen tens of 
millions of dollars, and I won't repeat that because everyone 
said that. But for the record, everyone knows the amount of 
dollars and the people involved. But how was he able to gain 
the trust of so many people? How was he able, for 15 years, to 
engage in this conduct and go undetected? How is it that there 
were prior violations by--noted by the New York Stock Exchange 
and the SEC where he was able to continue in his conduct?
    And by the end of this hearing this morning, it is my hope 
that we will have information sufficient to assist these 
victims in the process of attempting to collect their dollars 
back from either Frank Gruttadauria or his supervisors, or the 
investment companies that are involved.
    But even more so, that we will have information and 
opportunity to see that we put in place rules and regulations 
that will not allow other people to be victimized as a result 
of such conduct, and that we will be able to look past and 
maybe even foreshadow some of the other conduct that investors 
are engaged in in this instance.
    I yield the balance of my time, Madam Chairwoman. I want to 
compliment you and my colleague from northeast Ohio, Steve 
LaTourette, for giving us the opportunity to have this hearing 
this morning.
    Thank you very much.
    [The prepared statement of Hon. Stephanie Tubbs Jones can 
be found on page 67 in the appendix.]
    Chairman Kelly. Thank you very much, Mrs. Tubbs Jones.
    We turn now to Mr. Tiberi.
    Mr. Tiberi, do you have an opening statement?
    Mr. Tiberi. I do not have an opening statement, Madam 
Chairwoman.
    Chairman Kelly. Thank you.
    We turn to Mr. LaTourette. Mr. LaTourette, we are pleased 
to have you join us this morning.
    Mr. LaTourette. Thank you very much, Madam Chairwoman, and 
I want to thank you, and also the Chairman of the full 
committee, Mr. Oxley, for convening this hearing today.
    I also want to compliment your staff, Madam Chairwoman, for 
the outstanding investigatory work that they have done in 
getting us ready for this hearing. And there is a number of 
people we could talk about, but Andy Cochran, who is seated to 
your left, has really done an outstanding job, and he deserves 
our thanks for getting us to where we are today.
    Madam Chairwoman, many of us in the greater Cleveland area 
were startled, shocked, and dazed when we found out that a 
number of our friends and neighbors had been victimized by a 
broker who worked for Lehman Brothers, Frank Gruttadauria. We 
discovered that he had fled town, leaving a note and a computer 
disk for the FBI, after bilking the firm's clients out of money 
that has ranged from $40 million, it has been complained of, 
to, as the Chairman of the full committee indicates, up to $700 
million.
    I know we have Mr. Fazio here today, who will talk about 
$26 million that he and he alone lost. His victims ranged from 
some very wealthy people to moderate income people, who were 
investing for their retirement years.
    By maintaining a desktop computer, in violation of his 
firm's rules, by setting up a phony post office box, by mailing 
fraudulent statements and juggling funds, it appears that Mr. 
Gruttadauria was able to craft a Ponzi scheme that lasted for 
15 years, and only collapsed, despite what I read in The Wall 
Street Journal today, only collapsed because there was a cash 
call on a divorce case of a rather wealthy client, and also 
because of the persistence of Mrs. Golda Stout. And I think 
that perhaps the SEC and some of the regulators should hire 
Mrs. Stout to supervise and watch things. It is my 
understanding that she initially indicated she wanted to view 
her investments online, was told that, ``Oh, we don't offer 
that service,'' and it is only because she kept pushing and 
pushing and pushing that eventually Mr. Gruttadauria, among 
other reasons, left town.
    Some will come before this subcommittee today and say that 
this is just one very crooked broker gone bad, we are really 
sorry, but it happens, but that there are no systemic 
difficulties or problems that require the attention of this 
committee or any other committee in the Congress. That might be 
the case were there not some historical context not only for 
the Book of Business while it was maintained by S.G. Cowen, but 
also after it was purchased by Lehman Brothers.
    Mrs. Tubbs Jones and others have mentioned the 1993 
complaint, and in that complaint the SEC discovered that Mr. 
Gruttadauria was in charge of an account that had an equity of 
$96,000. It had losses of $86- to $88,000, and commissions 
charged of $39,000 in a six-month period. It is my 
understanding--and we are looking forward to hearing from the 
SEC today--but they neglected to talk to the account holder and 
only talked to Mr. Gruttadauria.
    Someone who will not show up today as a witness is a friend 
of mine from Cleveland, Dominic Visconsi, Sr. His accounts will 
enter into evidence later, returned over a four-year period 54 
percent, 99 percent, 19 percent, 100 percent, and 43 percent.
    Also, Ms. Tubbs Jones mentioned the fine levied by the New 
York Stock Exchange for failure to supervise in 1998. And at 
the same time, Madam Chairwoman, Lehman Brothers was involved 
in litigation by another broker by the name of Ahmed Dahouk, 
who maintained a desktop computer, set up phony post office 
boxes, mailed fraudulent statements, juggled funds, and 
apparently in doing the due diligence when they purchased the 
Cowen business this did not seem to raise any red flags.
    Lastly, Madam Chair, it is my understanding that the 
supervising partner at Lehman Brothers, who supervised Mr. 
Gruttadauria for the year that he had the business, earned a 
base salary of $450,000, received bonuses of $8 million, and 
stock options of $29 million. And the question that I think 
needs to be raised is: why should he be worried about what 
happened with Mr. Gruttadauria and his clients?
    Thank you. I yield back.
    [The following information was subsequently furnished by 
Hon. Steve C. LaTourette for the hearing record.]
    Chairman Kelly. Thank you, Mr. LaTourette. And without 
objection, we will accept that in the record.
    Also, without objection, I would like to enter into the 
record a copy of the letter that Mr. Gruttadauria sent to the 
Cowen & Company and to Chase Manhattan and to the FBI. He sent 
copies of it to a number of people, not just those two listed. 
And without objection, that letter will also be included in the 
record.
    With that, if there are no further opening statements, I am 
going to introduce the first panel. We sincerely appreciate the 
effort it took for all of you to prepare your testimony, and 
the two of you who have traveled here some distance to be here 
today with us.
    Our panel includes Mr. Carl Fazio of Aurora, Ohio; and Mrs. 
Golda Lewis Stout of Elgin, Illinois; both of whose finances 
were devastated by Mr. Gruttadauria's fraud. Lori Richards, the 
Director of Office of Compliance, Inspections, and Examinations 
at the Securities and Exchange Commission. We welcome you, Ms. 
Richards. And Mr. David Doherty, Executive Vice President for 
Enforcement at the New York Stock Exchange.
    I want to thank each of you for agreeing to testify before 
us today, and I welcome you on behalf of the committee.
    Without objection, your written statements and any 
attachments will be made a part of the record. You will each 
now be recognized for a five-minute summary of your testimony. 
There are lights in front of you that will indicate how much 
time you have. You see the boxes there on the table.
    The green light signifies that you are in the first four 
minutes of your summary. The yellow light will turn on when you 
have a minute remaining. And the red light will turn on when 
your time has expired.
    And we will begin now with you, Mr. Fazio. Thank you for 
being here.

             STATEMENT OF CARL FAZIO, AURORA, OHIO

    Mr. Fazio. Thank you, Chairman Kelly, Members of the House 
Financial Services and Oversight and Investigations 
Subcommittee. Thank you for inviting me to be with you today. I 
will share with you my family's story of betrayal by four of 
America's great institutions--Lehman Brothers, Cowen & Company, 
S.G. Cowen, and Hambrecht & Quist.
    Caution shown by today's investors not only reflects the 
lack of confidence the public has in corporate accounting; it 
demonstrates that the public also understands that major 
investment banking firms only say the right thing. They do not 
do it, and, more importantly, they apparently turn a blind eye 
when investors are hurt.
    I am Carl Fazio. I came to this country at the age of 
three. Through great effort and energy, my family was able to 
build one fruit stand into Fisher-Fazio's, a major chain of 
supermarkets which ultimately became a New York Stock Exchange 
company. At the time of its sale, I was its chairman, and we 
employed approximately 20,000 people.
    Today, as I stand before you, although I earned and 
invested a handsome amount of money, I have a few liquid 
assets. I am unable, at the age of 85, to pay my bills as they 
become due, and I am forced to sell my home, all because of the 
greed of Lehman Brothers, Cowen & Company, S.G. Cowen, and, 
possibly, Hambrecht & Quist.
    While focusing on generating fees, they failed to police 
their own brokers and employees. We have only recently learned 
that the New York Stock Exchange, in a disciplinary proceeding 
against Cowen & Company dealing with 1994 and 1995, criticized 
it for having compliance people subordinate to branch office 
managers. Even though the Stock Exchange found this deficiency, 
it was never corrected.
    In Cleveland, Robert Semanek, the firm's compliance person, 
reported to Frank Gruttadauria. This is wrong. Neither Cowen & 
Company, S.G. Cowen, nor Lehman Brothers changed their 
procedures. That is a key reason why Frank Gruttadauria could 
generate fraudulent statements on his personal computer which 
he had in his office.
    He had the computer even though, according to some 
newspaper reports, it was against company policy. My assets 
have been stolen from me, not just by Frank Gruttadauria, but 
by the collective efforts of the brokerage firms that lent them 
their credibility and resources and turned their backs on 
protecting me.
    After the sale of my company, at the request of my first 
wife, through her close friend, I entrusted some of my funds to 
Frank Gruttadauria and his firm. Over the years, he became as 
close to me as one of my own sons. I viewed him as a member of 
my family and proudly watched him receive accolades in the 
investment community and rise up the ladder to becoming a 
senior director of S.G. Cowen and the branch office manager for 
Lehman Brothers.
    His positions in the companies gave me confidence. Little 
did I know that at some time, from the little records that I 
have been able to get since Frank Gruttadauria admitted his 
frauds and ran away, maybe as early as the 1990s, he took my 
money and misappropriated it in order to grow his commission 
income, all the while sending me false statements which 
reflected the trades I sought in the market.
    He did this while encouraging me to deposit more and more 
money. Ultimately, all of my liquid assets were put under the 
control of Frank Gruttadauria, who stole them.
    I believe I am a very knowledgeable investor. I told Mr. 
Gruttadauria what I wanted to buy and what I wanted to sell. I 
made my own trades. I was in constant contact with him and his 
office, and I reviewed what I believed to be confirmations and 
my statements. Little did I know that I was dealing with smoke 
and mirrors.
    Now their greed has devastated me. And if the brokerage 
firm's actions are not bad enough, S.G. Cowen, a brokerage firm 
I sued, is now attempting to manipulate the court system by 
removing my claim to arbitration. As they said in their motion, 
and I quote, ``Plaintiffs must pursue their claims in 
arbitration before a panel of--an appropriate self-regulatory 
organization.''
    I am 85 years old. I need this money to live on now. On 
January 28, I met with Lehman Brothers and told them of my 
urgent need for money.
    And I would like to close by reading you a portion of 
Lehman's mission statement. I quote, ``We are one firm, defined 
by our unwavering commitment to our clients.'' In my situation, 
they not only wavered, they punted, and now they just don't 
care.
    Thank you for your time.
    [The prepared statement of Mr. Carl Fazio can be found on 
page 126 in the appendix.]
    Chairman Kelly. Mr. Fazio, we thank you for your statement. 
That is certainly a very, very moving statement.
    I want to explain to the people here, and to our panel, 
that the business on the floor today is such that we may be 
moving back and forth to vote. We have a vote that has just 
been called.
    So what I am going to try to do in order--because I know 
some of you have planes that you need to meet, and so forth, I 
am going to be trading off the Chair with people, so that we 
are going to have a rotating group of people moving back and 
forth, so that we can keep this hearing open and keep it going.
    So with that being said, I hope you will indulge us in 
changing people sitting in this char. I am still running the 
hearing, and I will be back. I am going to be going back and 
forth to vote now and then.
    With that, I want to go to you, Mrs. Stout.

        STATEMENT OF GOLDA LEWIS STOUT, ELGIN, ILLINOIS

    Mrs. Stout. I, too, want to thank the members of the 
Financial Service Committee and the subcommittee for inviting 
me to testify. Over the past months, I have watched others 
testify. I am impressed with their apparent confidence and calm 
demeanor. I assure you that this is not my state at this 
moment.
    As my opening statement, I want to share with you an edited 
version of a letter sent to my Congressman for my district, 
Dennis Hastert. I met Dennis Hastert in Elgin many, many years 
ago when he was campaigning for his first term of the House of 
Representatives. We were both much younger at that time.
    I was born in 1915 on a small farm in central Iowa. I 
suffered, along with millions of other American citizens, the 
ravages of depression. I made a commitment to work hard and 
save. My life has been productive, and I am very proud of my 
accomplishments. I have a family which I truly love, and they 
have the same feeling for me.
    As a result of my savings and investing, I felt secure in 
knowing that my remaining years of life would be without 
financial worry, but all that was changed in January of 2002 
with the news of the fraud perpetrated on many others and on me 
by the managing director of the Cleveland office of Lehman 
Brothers, Frank Dominic Gruttadauria, who formerly worked for 
S.G. Cowen, Cowen & Company.
    The complete story of Mr. Gruttadauria will not be known, 
if ever, for years to come. However, by his own witness 
statements to the FBI, he has defrauded his clients for over 15 
years. Given some of the most recent articles, it appears to me 
that the process of recovering my lost investments may be long 
and expensive.
    While I trusted my broker as many investment companies are 
stressing in their television advertising, I was not passive 
with the respect to monitoring the stockmarket and investment 
portfolio. I tracked the markets daily and have records going 
back to 1992. And I also verified my portfolio balance with 
each monthly report.
    However, I did not receive the true reports. They were sent 
elsewhere by the brokerage firm as a result of Mr. 
Gruttadauria's actions. Instead, I received a very authentic-
looking account statement, which agreed with my own personal 
records. I also received yearly the 1099s, which my accountant 
used to prepare for the individual tax returns. And over the 
years, Mr. Gruttadauria was privately looting my account. All 
of this occurred without detection by myself.
    This brings me to the main point. Stockbrokers' misdeeds 
must be prevented from occurring again to any person who uses a 
brokerage account as an investment vehicle. As we all know, 
Social Security should not be the foundation of any retirement 
plan. IRAs, 401Ks, and other investment activities are the real 
foundation for retirement. In almost all cases, these 
activities will involve investments using a brokerage firm.
    As pointed out in the article in The Wall Street Journal, 
the Plain Dealer of Cleveland, active compliance monitoring and 
reporting is critical. My hope is that you and your colleagues 
in the Congress can address, to the greatest extent possible, 
the need to prevent stockbroker fraud and to require the 
brokerage firms to monitor and enforce compliance by their 
officers and employees.
    Thank you.
    [The prepared statement of Ms. Golda Lewis Stout can be 
found on page 129 in the appendix.]
    Chairman Kelly. We thank you, Mrs. Stout.
    We will go next to you, Ms. Richards.

  STATEMENT OF LORI RICHARDS, DIRECTOR, OFFICE OF COMPLIANCE, 
    INSPECTIONS, AND EXAMINATIONS, SECURITIES AND EXCHANGE 
                           COMMISSON

    Ms. Richards. Chairwoman Kelly, Chairman Oxley, members of 
the subcommittee, I appreciate the opportunity to appear before 
the subcommittee today on behalf of the Securities and Exchange 
Commission to discuss the Frank Gruttadauria matter and 
potential measures to prevent theft by registered 
representatives of stockbrokers.
    As I think you know, the SEC filed an enforcement action 
against Mr. Gruttadauria alleging that he misappropriated 
customer funds for his own purposes, directing those funds to 
other customers' accounts, either as purported returns or to 
satisfy their withdrawal requests. In essence, this was a Ponzi 
scheme, pure and simple, taking money from some clients to 
cover the withdrawal requests that were made by other clients.
    The SEC alleges that Mr. Gruttadauria forged client 
signatures on withdrawals, made unauthorized transfers of 
funds, and took customer funds purportedly to open accounts, 
but never actually opened accounts. Then, to conceal the fraud 
from his customers, he created and sent false account 
statements to customers that greatly overstated the values of 
their accounts, and caused the clients' actual account 
statements to be sent to post office boxes under his own 
control.
    I want to say, listening to the victims, Mrs. Stout and Mr. 
Fazio, how much I empathize with them.
    I know that the subcommittee is most interested in what can 
be done to prevent future conduct like Mr. Gruttadauria's. At 
the most basic level, firms are responsible for establishing 
systems of supervision and internal controls that are 
reasonably designed to ensure that their employees are in 
compliance with the law. Broker-dealers are required, under 
current law, to have adequate procedures and controls to 
identify the kind of sales practices that Mr. Gruttadauria 
engaged in, and to conduct regular reviews of their employees' 
activities.
    I am pleased to tell you that many firms have in place 
procedures to help them prevent and detect fraud by brokers. My 
written testimony that I submitted sets out, in some detail, 
some of the procedures that firms can use, including things 
like verifying changes of address directly with the customer, 
confirming customer authorizations to transfer funds out of 
their account, paying special attention to post office boxes 
and other addresses that are not the customer's home address, 
exercising control over account statements, supervising 
employees' use of personal electronic devices, and providing 
independent supervision and review of activity by producing 
managers. These are, I think, very important.
    I would like to switch gears for just a minute and briefly 
address the SEC's examination efforts. In one of our 
examinations in 1993, as has been raised today, we came very 
close to Mr. Gruttadauria. We conducted a cause examination of 
the Chicago, Illinois, office of Cowen where Mr. Gruttadauria 
serviced some of his accounts, after receiving an anonymous tip 
that alleged churning (or excessive trading) in one of his 
accounts.
    While there were some flags that prompted the SEC examiner 
to conduct a detailed review of that particular account and 
other Gruttadauria accounts in the Chicago office, the 
examination was unable to establish sales practice abuse in 
that account sufficient to warrant further action. Now, I will 
say that knowing what we know now, I wish I could say that we 
had detected the fraud in 1993.
    Well, what has the SEC done in response to this event? As 
you would expect, we have worked closely with the New York 
Stock Exchange and the NASDR to understand the alleged fraud in 
this case, and we intend to continue to vigorously prosecute 
Mr. Gruttadauria. Together with the SROs, we are focusing 
particular attention on examining firm procedures and systems 
to prevent fraud of this type in the future.
    We have reminded securities firms of the importance of 
these procedures, and we will also be conducting a series of 
examinations focused solely on firm procedures designed to 
prevent theft by registered representatives.
    We intend to ensure that the best practices that I have 
described in my testimony become the universal practices in the 
securities industry.
    I am pleased to answer any questions that the subcommittee 
may have.
    [The prepared statement of Ms. Lori Richards can be found 
on page 69 in the appendix.]
    Mr. LaTourette. [presiding] Thank you very much, Ms. 
Richards.
    And before I yield to Mr. Doherty, for those of you from 
Cleveland or Illinois that don't come here on a regular basis, 
there is a 15-minute vote on the floor, and so I ran as quickly 
as I could to get to the Capitol and come back so we can keep 
the testimony going. And our colleagues will come back and join 
us for the question and answer period.
    So I apologize that we are conducting legislative business 
at the same time we are doing this, but we wanted to not 
inconvenience anybody.
    Mr. Doherty, welcome, and we are looking forward to hearing 
your testimony.

   STATEMENT OF DAVID DOHERTY, EXECUTIVE VICE PRESIDENT FOR 
              ENFORCEMENT, NEW YORK STOCK EXCHANGE

    Mr. Doherty. Thank you. Good morning, Chairwoman Kelly, and 
members of the committee. I appreciate the opportunity to talk 
with you this morning about how the New York Stock Exchange 
regulates our member firms, and to provide some information 
about actions we have taken concerning Cleveland broker Frank 
Gruttadauria and others associated with him.
    Regulation of the securities industry in the United States 
depends upon self-regulation and begins with the broker-dealer 
itself. The Exchange plays a critical role by maintaining an 
extensive system for monitoring and regulating the activities 
of its membership with SEC oversight. The regulatory group of 
the Exchange currently employs approximately 560 people 
representing over one-third of the entire Exchange's staff, 
with an operating budget of $142 million.
    The Division of Member Firm Regulation, with a staff of 
265, oversees 260 member organizations that employee nearly 
160,000 registered persons and service nearly 93 million 
customer accounts. That is more than 85 percent of the public 
customer accounts carried by broker-dealers in the United 
States.
    Our staff conducts annual on-site examinations of every one 
of these firms. We visit the main office and approximately 200 
branch offices each year, which are selected using a risk-based 
analysis. Our criteria and methodology for selecting branch 
offices for review is constantly being upgraded and refined 
based on experience and new technology. A more complete 
description of our exam program is included in my written 
testimony.
    Serious or repeated violations found by our examiners are 
referred to the Exchange's Enforcement Division. The 
Enforcement Division, which has a staff of about 136, carries 
an inventory of approximately 700 cases and initiates over 200 
enforcement actions a year. Enforcement staff conduct 
investigations often in cooperation with the SEC and decide 
whether to institute formal enforcement proceedings. Possible 
sanctions or penalties include censures, fines, suspensions, or 
permanent bars from our membership.
    The short-term objective of an effective enforcement 
program is to catch and punish the people who break the rules. 
The long-term objective is to deter other violative activity, 
induce compliance, and ultimately enhance investor confidence 
in the integrity of the market.
    I would like to address the matter involving Mr. Frank 
Gruttadauria, the former broker for Lehman Brothers and S.G. 
Cowen. The Exchange learned of the Gruttadauria matter on 
January 22 of this year when we were contacted by officials 
from Lehman Brothers. We responded immediately by putting 
together a team of enforcement attorneys and examiners, meeting 
with the compliance officials at Lehman, discussing the case 
with the SEC, and beginning an investigation.
    That investigation, which is ongoing, focuses on the manner 
in which Gruttadauria conducted his activities, the supervisory 
structure and procedures in the Cleveland office, and the 
overall supervisory structure of both Lehman and S.G. Cowen. 
The Exchange is working cooperatively with the SEC's 
Enforcement Division in this investigation.
    The Exchange has taken the following actions so far 
regarding the Gruttadauria matter. On February 5, two weeks 
after first being notified of this matter, we issued charges 
against Gruttadauria for misappropriation of customer funds and 
failure to cooperate with Exchange investigation. A hearing was 
held, findings were made that he was guilty as charged, and on 
March 19 he was censured and permanently barred from 
association with any New York Stock Exchange member firm.
    Also, in February and April, we issued charges against two 
of Gruttadauria's assistants based on their refusal to provide 
required information to us. It is worth noting that in 1998 the 
Exchange brought formal enforcement proceedings against Cowen 
for a number of violations. A major focus of the case was 
improper order ticket procedures, failure to comply with margin 
requirements, but other violations included failure to 
reasonably supervise producing branch office managers and 
failure to comply with rules governing discretionary accounts, 
among others.
    This resulted in a decision by consent in which Cowen 
received a censure, a fine of $380,000, and a requirement was 
imposed that Cowen correct procedural and supervisory 
deficiencies. Cowen's compliance with the 1998 decision is one 
of the matters that is under review in our current 
investigation.
    Since the beginning of this year, the Exchange has 
undertaken a number of initiatives focusing on compliance 
systems and procedures at retail firms. These initiatives were 
partly in response to the Gruttadauria matter, but they also 
reflect our commitment to continually review, expand, and 
improve our regulatory program to adapt to new information and 
technological advances.
    So, we have already permanently barred Frank Gruttadauria. 
We are investigating the supervisory structures at the firms 
where he worked. We have enhanced our examination procedure, 
and we have under consideration adoption of new rules to 
strengthen investor protection in this area.
    Let me assure you of the Exchange's continuing commitment 
to our strong regulatory program. Thank you again for the 
opportunity to testify today.
    [The prepared statement of Mr. David Doherty can be found 
on page 79 in the appendix.]
    Mr. LaTourette. Mr. Doherty, we thank you very much for 
your testimony.
    The schedule indicates that other members of the panel, 
including the Chairman, will be back shortly. And so in light 
of the fact that there is great interest in asking questions of 
everyone who has testified so far, I think it is the Chair's 
predisposition to take a short recess. If you could not wander 
too far, so that when Mrs. Kelly comes back we don't have to 
gather people from the far reaches of the building, I would 
appreciate that.
    And the subcommittee will stand in recess, subject to the 
call of the Chair.
    [Recess.]
    Chairman Kelly. [presiding] Is Mr. Doherty in the room? 
Absent Mr. Doherty, I think we will go ahead with some--with 
the questions. I would like to ask some questions of you, Ms. 
Richards.
    Ms. Richards, on page 5 of your testimony, you refer to 
firm practices to prevent and detect fraud. One of these 
policies is, and I quote, ``special attention to P.O. boxes.'' 
Now, we are aware that this was a key way in which Mr. 
Gruttadauria was able to perpetuate his scam. Is this policy a 
requirement of the SEC or just a suggestion?
    Ms. Richards. I guess I think that under a broker-dealer's 
existing duty to supervise, they have an obligation under 
existing rules and regulations to make sure that their 
supervision is adequate. And use of P.O. boxes has been found 
not only in this case, but also in other cases, to facilitate 
fraud by registered representatives. This is not the first time 
that this P.O. box trick has been used.
    So in light of that, I think that broker-dealers must, 
under existing obligations to supervise, pay special attention 
to the use of P.O. boxes. And there is nothing inherently wrong 
with the customer using a P.O. box. Many customers in rural 
areas, for example, use a post office box. But when a firm sees 
that a customer has a post office box, they ought to pay 
special attention to ensuring that the customer has truly 
authorized the firm to use the P.O. box.
    Chairman Kelly. Perhaps, Ms. Richards, it might be a good 
idea if the SEC took another look at some kind of oversight on 
the use of P.O. boxes. Would you agree?
    Ms. Richards. Absolutely. And that is exactly what we are 
doing now. Immediately after the Gruttadauria case broke, we 
met with the New York Stock Exchange and the NASD and decided 
to pay collectively, as securities regulators, special 
attention on these what I think are very basic compliance 
procedures designed to prevent theft.
    So in all of our examinations going forward, we intend to 
focus on firm procedures, not only in this area but in the 
other areas that I have identified in my testimony. If through 
that process we determine that additional rules or regulations 
are appropriate, we intend to alert the Commission to that 
early, and to work closely with the self-regulatory 
organizations in determining whether or not additional 
rulemaking is appropriate.
    Chairman Kelly. So, once again, though, you are looking at 
allowing the firms themselves to govern what is happening with 
regard to the relationship of the post offices boxes with 
regard to their clients and the delivery of the statements for 
the accounts. Is that correct?
    Ms. Richards. Firms have an existing duty to supervise, and 
this is an area where they have got to pay, in my view, 
enhanced attention--compliance attention--to. They have got to 
scrutinize use of post office boxes carefully. I don't think it 
would be appropriate for regulators to prohibit the use of post 
office boxes, as I said, because many customers in rural areas 
in particular need to use post office boxes.
    But when the firm sees that a customer has a P.O. box, or 
an``in care of'' address, or any address other than their home 
address, they need to pay particular attention to that.
    Chairman Kelly. Well, let us go to an exam that was 
conducted by your examiner in 1993. You mentioned it on pages 4 
and 5 of your testimony. That they did not contact the customer 
that was involved. Is it a normal practice to contact the 
customer when the account is being examined?
    Ms. Richards. It is a judgment call that is made by the 
examiner, based on the facts that are developed during the 
examination. If I could, I would like to describe to you in a 
little bit more detail what happened in the 1993 exam.
    Chairman Kelly. Prior to your description, I would like to 
simply say that I understand this was done in December of 1993, 
that it was signed off by five supervisors, there is five 
signatures on that. I also would like you to submit that for 
the record within the next 24 hours. Will you please comply 
with that request?
    Ms. Richards. We have made the entire examination report 
available.
    Chairman Kelly. No, ma'am. I want it submitted for record.
    Ms. Richards. I would have to go back to our Commission and 
ask for authority to do that.
    Chairman Kelly. Will you please do that?
    Ms. Richards. Yes, I will.
    Chairman Kelly. Proceed with what your explanation was.
    [The following information was subsequently furnished by 
Ms. Lori Richards for the hearing record.]
    Ms. Richards. In 1993, the Commission received an anonymous 
complaint about a customer's account that was maintained by Mr. 
Gruttadauria. The anonymous complaint alleged that there was 
churning in the account, and churning is simply excessive 
trading, trading that is not appropriate for the particular 
customer. It is designed to provide the registered 
representative with commissions, but involves trading that is 
not appropriate for the customer.
    Based on that anonymous complaint, the Commission went in--
examiners in Chicago went in to Cowen's Chicago office and 
conducted an examination focused primarily on that particular 
account. They examined the account statements that were 
provided not by Mr. Gruttadauria but by the firm itself, and 
the examiner noted that the trading was very significant. There 
was a lot of trading in the account during a six-month period 
three years before the examination.
    The fact that there was frequent trading, in and of itself, 
while it is a red flag, it is not in and of itself violative, 
because many customers engage in frequent trading. So what the 
Commission then does, after it noted that there was such 
frequent trading, in fact, the examiner computed a turnover 
rate in the account of 18 times. That is very significant. That 
is a lot of trading.
    So with that information, the examiner then looked at 
whether or not the trading was indicative of a violation of the 
law. And the elements of a churning violation are really just 
two. First, is the trading excessive for that particular 
customer? And then, second, does the registered representative 
have control over that particular account? So the turnover 
ratio is just one part of the analysis.
    The next step was to review the background of this 
particular investor. The account documents that were provided 
by the firm, not by Mr. Gruttadauria but by the firm, indicated 
that this was an experienced investor. This was someone with a 
very significant net worth of about $5 million and with 10 
years or so of trading experience in equities and options. 
Based on that, it appeared to the examiner that this was an 
experienced trader, an experienced investor.
    The next step was to review who was directing the trades, 
because this is an element in a churning charge--the trades 
must have been directed by the registered rep. Based on the 
registrant and Mr. Gruttadauria, the examiner was told that the 
trades were unsolicited. That is, that the investor herself was 
directing the trades.
    The Commission's examination procedures at that time would 
require the examiner to confirm that statement by looking at 
the order tickets.
    The next step was to review other customers' accounts, 
because what we often find is that when a registered rep is 
engaged in churning one account, they will churn other 
customers' accounts. So we looked at a sample of Mr. 
Gruttadauria's other accounts in the Chicago office and found 
no indications of churning. We also--
    Chairman Kelly. May I--I am sorry to interrupt you, but the 
account information that Mr. LaTourette has submitted for 
record today indicates that there was at least one account, if 
I am looking at it correctly, that was churned, in 1993, had a 
turnover ratio of 34 percent. He made a 99 percent commission 
rate on that.
    In 1995, which was post this examination, there were some 
other really egregious types of churning here that should 
certainly but the ratio of 34 certainly ought to have had a red 
flag in 1993. I am going to interrupt your testimony here, but 
just because I have a question. I am going to run out of time, 
and I need to talk to Mr. Doherty. I am going to go--I would 
like to go back to you. I will go back to you. So stop yourself 
where you are, and we will come back.
    I want the rest of the--I would like you to read into the 
record, or state for the record, exactly what happened in the 
1993 exam. But I also want to caution you that the committee 
would expect a response from your organization within the next 
24 hours regarding that report.
    Mr. Doherty, I wanted to ask you just one question, and I 
will come back to you. On page 13 of your testimony, you 
mention your 1998 enforcement action against Cowen for, among 
other things, and I am quoting-- ``the failure to reasonably 
supervise branch office managers acting in the capacity of 
registered representatives.''
    And then you also mention on page 14 of your testimony--
and, again, I am quoting--``in 1999, outside counsel concluded 
in its report to the Exchange that Cowen had satisfied its 
undertaking in all material respects and made significant 
efforts in addressing areas of deficiency.''
    I would like you to try to discuss what steps were taken to 
improve the supervision of branch office managers at that 
point, and any reasons that you are aware of that this improved 
supervision didn't detect Mr. Gruttadauria's actions. These 
people were defrauded. These people have lost their life 
savings.
    Mr. Doherty. They certainly have. The enforcement 
proceeding that we brought in 1998 we considered to be a very 
significant one. There were a number of violations involved. A 
small part of it related to failure to supervise producing 
branch office managers in the 1995 exam in one of the New York 
offices.
    We were sufficiently concerned with the supervisory 
deficiencies in that case that we not only imposed a 
significant fine, but we required, as a part of the settlement 
that Cowen entered into that a consultant be appointed who 
would come in and look at the systems and procedures that Cowen 
was putting in place and make an evaluation as to whether those 
systems and procedures, as enhanced, were adequate.
    And the consultant--it was an outside law firm--did that 
and filed a report and represented that they had confirmed that 
a number of enhancements had been made, such as the firm had 
appointed a senior person full-time whose job was to supervise 
producing branch office managers.
    There was an indication and confirmation that the firm had 
developed a process where a detailed questionnaire would be 
sent out to branches required to be answered by the firms, and 
it got into areas that are involved here dealing with LOAs and 
post office boxes. That was supposed to be, under the 
procedures, followed up twice a year by branch office visits 
from this new supervisory structure that was put in place.
    There was also a representation that the branch office 
manager's correspondence would be put in a separate file that 
would be reviewed monthly. And there was a general 
representation that all of the procedures put in place now had 
adequately enhanced supervision. There was a representation 
that the Compliance Department had enhanced supervision 
generally by, among other things, adding resources.
    So one of the things that we are looking at carefully in 
our investigation now is whether these procedures were number 
one, actually put in place; number two, if put in place, 
maintained; and, number three, even if the procedures were put 
in place, were they adequately implemented? Sometimes we see 
procedures, and they are a great looking set of procedures, but 
implementation is not carried out.
    So this is what we are looking at now in the course of our 
investigation. We required this enhanced review as a part of 
that enforcement proceeding, and we received assurances not 
only from the outside law firm, but the report was filed and it 
was certified by both the Board of Directors and the CEO that 
these procedures had been put in place.
    Chairman Kelly. Thank you, Mr. Doherty.
    Mr. Doherty. Now, we are concerned that in light of this, 
the Gruttadauria activities were continued, and that is very 
much the focus of our investigation.
    Chairman Kelly. Thank you, Mr. Doherty. One of the things 
that really concerns me about this case is it hasn't been just 
Mr. Gruttadauria. There have been other cases. We need to do as 
much as we can to have you do what you need to do to put the 
public's trust back into the system.
    So with that being said, I am going to turn to my 
colleague, Ms. Tubbs Jones.
    Mrs. Jones of Ohio. Thank you, Madam Chairwoman.
    Mr. Fazio, unfortunately, we only have five minutes to 
question. But it would be a shame that you wouldn't have a 
couple--another opportunity to be heard, at least briefly. Can 
you tell me, looking back, sir, what was it that engendered Mr. 
Gruttadauria to you? If we were going to talk to other senior 
citizens like you and Mrs. Stout, what would you tell them to 
look out for?
    Mr. Fazio. Do you mean now that--
    Mrs. Jones of Ohio. Yes, sir.
    Mr. Fazio. --this happened?
    Mrs. Jones of Ohio. Looking back, in hindsight, sir.
    Mr. Fazio. Well, I would say that you need to talk to 
somebody above the branch manager in New York and check if, in 
fact, any brokerage company person ever called any investor 
when there was an address change to check it out, and to be 
careful because things can be done with these phony statements 
that we are learning and we know now.
    And did any person ever call any customer? I never got a 
call from anyone else. I never did. And these numbers were 
changed, and my signature was forged, and so forth, to change 
them. Never got a call from anyone, and I didn't know what was 
going on. I really didn't. I didn't know that these box numbers 
even existed until now, until all of this--everything came up.
    Mrs. Jones of Ohio. But there was something about Mr. 
Gruttadauria that caused you to place some trust in him. But 
what I am asking you is: with regard to personality, or 
whatever, what would you say to another senior citizen who 
might have been--might be contacted by a broker?
    Mr. Fazio. Well, I would say that sometimes you have got to 
watch your closest friends. He was a very close friend. I told 
you I treated him like he was my son. That is how close we 
were.
    Mrs. Jones of Ohio. Okay.
    Mr. Fazio. And you have got to be careful, and that is all 
you can do.
    Mrs. Jones of Ohio. Okay.
    Mr. Fazio. But mainly is that companies themselves have to 
check out their people. You know, you can't do it with the 
compliance officer, as I pointed out, in the same office 
reporting to the manager. You have got to do it where the 
compliance officer reports to somebody else above the manager, 
somebody in New York to check all these things out.
    Mrs. Jones of Ohio. Thank you.
    Mrs. Stout, a short answer if I could get one from you as 
well. Go ahead.
    Mrs. Stout. Well, I wish that I had been smart enough to 
analyze why did I have checks with DeGrandis for the signature. 
Now, it should have been Lehman or Cowen. Instead, it was 
someone else. I had my own tax person. Why would I be having 
that firm as a tax representative?
    Mrs. Jones of Ohio. For the record, tell people who 
DeGrandis is, Mrs. Stout.
    Mrs. Stout. Well, I think that they are a tax firm working 
in Ohio.
    Mrs. Jones of Ohio. Well, this was someone that Mr. 
Gruttadauria represented or expected that you might use for 
your tax purposes, an attorney in Cleveland, right?
    Mrs. Stout. He might have, but I was--never even hinted to 
say I would like to have or needed--
    Mrs. Jones of Ohio. Okay. Anything else you would say to 
other seniors who might be considering doing some investment, 
what they should look out for from your own perspective?
    Mrs. Stout. Well, when they start saying--I wanted to have 
online for my--so I could watch each day. When I called to ask, 
he said, ``Oh, no, we do not do that. I will not be harassed.'' 
When you start having--saying, ``I won't do this. I won't do 
that,'' that is a red flag. Watch. And in the future, don't 
have that person--he said, ``If this is the way that you feel 
so strongly, then I will get you another broker.'' I was--
    Mrs. Jones of Ohio. And you should have said, ``Then, get 
me another one,'' right?
    Mrs. Stout. Well, and so what I should have done--you know, 
I kind of hemmed and hawed there for a minute, and he said, ``I 
will tell you what I will do. I will send you the symbols, but 
this is against my principles.''
    Mrs. Jones of Ohio. Okay.
    Mrs. Stout. You know what? It isn't his principles, it is 
mine, that I should be thinking about. And that was a mistake. 
You know what? You should come back on your own intuition. I 
did not. I was--I am like Carl. I thought he was like my son, 
and I trusted the firm. After all, it is a good firm. I thought 
he was in Chicago. I never knew that he was in Ohio. Had no 
idea.
    He visited me, told me about--took me out for dinner, told 
me about the one daughter that was a candy striper at--
    Mrs. Jones of Ohio. He drew you in, in other words. He drew 
you in to his confidence.
    Mrs. Stout. Oh, honey, he was right there.
    [Laughter.]
    Mrs. Jones of Ohio. Thank you, Mrs. Stout.
    Let me go to Mr. Doherty from the New York Stock Exchange. 
Can you tell us how often brokerage firms incur charges like 
the one that was brought against Cowen & Company in 1998 with 
regard to failure to supervise branch manager officers, 
etcetera?
    Mr. Doherty. Well, let me answer more broadly.
    Mrs. Jones of Ohio. Okay.
    Mr. Doherty. In a typical year, our enforcement program 
will bring about 200 formal enforcement proceedings. The large 
majority of those charged are individuals. But in a typical 
year, I would estimate 20 or 25 member firms themselves are 
charged as Cowen was in the example we have heard about.
    Mrs. Jones of Ohio. And of the--go ahead. I am sorry.
    Mr. Doherty. Well, those charges range all the way from 
purely financial and operational kinds of things, a net capital 
violation, for instance, to, in some cases, inadequate 
supervisory procedures. And then some of the inadequate 
supervisory procedures cases relate to sales practice issues.
    Mrs. Jones of Ohio. Well, a firm signs up to be part of the 
New York Stock Exchange, what commitments do they make?
    Mr. Doherty. Well, they make a commitment to not only abide 
by the federal securities laws, but they make a commitment to 
abide by the New York Stock Exchange's rules, which really 
impose on the firms not only a variety of particular rules but, 
importantly, our rules require that our firms operate 
consistent with ethical standards. So that it is a level of 
conduct which could be violated that doesn't reach a violation 
of the federal securities laws.
    So our rules require such things as--or preclude conduct 
inconsistent with just and equitable principles of trade, and 
the like, ethical standards.
    Mrs. Jones of Ohio. Do you have subpoena power as the New 
York Stock Exchange?
    Mr. Doherty. We don't--
    Mrs. Jones of Ohio. To your members.
    Mr. Doherty. We don't have subpoena power, but--and our 
jurisdiction is limited to our members and employees, people 
associated. But we--
    Mrs. Jones of Ohio. So if I fail to agree to provide you 
information or cooperate, what do you do to me?
    Mr. Doherty. Well, with respect to the people we have 
jurisdiction over, we have something better than--
    Mrs. Jones of Ohio. That is what I meant, if I were a 
member. Okay.
    Mr. Doherty. And that is we have a rule that requires that 
our members and people associated comply with our reasonable 
requests for information in our investigations and that is the 
provision which we have used to charge three people in this 
particular investigation. We use it often, and the usual 
consequence is that people are barred from the industry until 
they comply or perhaps barred after a certain period of time if 
they don't. So there are significant consequences.
    Mrs. Jones of Ohio. Two shorter questions with hopefully 
shorter answers. You have heard Mr. Fazio, Mrs. Stout, and 
others say that the reason they invested with these companies 
was because of their reputation long term. Do you, as the Stock 
Exchange, treat people who have been long-term members any 
differently than you treat newer members to the Stock Exchange?
    Mr. Doherty. No. We apply the same standards to everyone. 
We sue the big firms and the small firms equally.
    Mrs. Jones of Ohio. Do you treat sanctioned firms any 
differently than you treat non-sanctioned firms?
    Mr. Doherty. The fact that a person or a firm had engaged 
in violative activity previously would be considered in the 
size of the sanction or punishment that would be imposed if 
there was another violation.
    Mrs. Jones of Ohio. For example, in '98, when you 
sanctioned Cowen & Company, what was the follow up after that 
sanction?
    Mr. Doherty. Well, we haven't--that is the last enforcement 
proceeding--
    Mrs. Jones of Ohio. Okay.
    Mr. Doherty. --that we initiated against Cowen to my 
knowledge.
    Mrs. Jones of Ohio. But who, then, is responsible for 
overseeing whether or not they have complied with the sanction 
that you impose?
    Mr. Doherty. Well, in the first instance, the firm has a 
continuing responsibility to, under our rules, and as Ms. 
Richards said, to run their business operation in a way that 
complies with the rules. Secondly, our examiners will typically 
go back into a member firm in the follow-on years where they 
have found problems to do a review to ensure that the problems 
have been corrected.
    Mrs. Jones of Ohio. Did you go back to Cowen after '98?
    Mr. Doherty. Yes. We went--
    Mrs. Jones of Ohio. And who went back? And what did you 
find?
    Mr. Doherty. Our examiners went back in and reviewed for 
compliance with many of the exceptions that were found, and 
they found no deficiencies that they felt were worthy of 
referring to the enforcement program.
    Mrs. Jones of Ohio. I am out of time, but I--we are going 
to have another round. Is that correct?
    Chairman Kelly. We will see if that is possible.
    Mrs. Jones of Ohio. Because I have a lot of questions for 
Ms. Richards, but thank you, Madam Chairwoman.
    Chairman Kelly. Ms. Tubbs Jones, I am going to hold the 
record open for 30 days for questions and submitted answers for 
all members of the committee, because some of the members can't 
be here today. So by all means, if you have further questions 
of this panel, you may submit them, and we can expect their 
responses within 30 days. So feel free to do that, if we are 
not able to do a second round here.
    We turn now to my colleague, Mr. Ney. Mr. Ney, are you 
ready?
    Mr. Ney. Thank you, Madam Chairwoman.
    I had a question, Mr. Doherty. A securities attorney quoted 
in the Cleveland Plain Dealer story said that a turnover rate 
of six times a year should raise a red flag, and that was 
reported in the PD. In your opinion, if the SEC could have told 
you the level of commissions and a turnover rate of 18 times in 
six months, do you think the Exchange might have wanted to take 
a more closer look at Gruttadauria's accounts?
    Mr. Doherty. I think that we would have--it would have been 
a red flag, and it would have been something that we would have 
looked at carefully. I can't tell you that we would have done 
it any differently from what the SEC did. In hearing Ms. 
Richards' testimony, it sounds as though they brought to bear 
the same kind of analysis that we would have.
    Mr. Ney. Another question I had would be for Ms. Richards 
and Mr. Doherty. Mr. Gruttadauria apparently created these 
phony account statements on his own computer outside of the 
office system. How can that be prevented in the future, that 
they could be--or can it? Just some thoughts from both of you 
on that.
    Ms. Richards. One of the things that we recommend in our 
testimony is that broker-dealer firms maintain very tight 
control over blank account statements and other account 
documents of the firm, so that registered representatives and 
other unauthorized employees can't get hold of them, doctor 
them up, and send them out.
    Another thing that many firms are doing now is creating 
account statements that are very difficult to duplicate. They 
have holograms or watermarks or special indicia on the 
original, so that it makes it easier to detect a forgery. So I 
think control over the actual sending of the account statements 
by brokerage firms is terribly important.
    Mr. Doherty. If I could add that in 1999 we added an 
element to our exam program that required our examiners to do a 
careful review of this very area, to look to see whether there 
were any personal computers being used by any salesmen in the 
office, and to do an examination of what procedures the firms 
had in place to supervise the use of those personal computers.
    And that is an area we are very much concerned about with 
electronic communications and use of the internet by registered 
reps, and we have brought a bunch of enforcement cases against 
registered reps in that area. This is something that we did at 
least two or three years ago in terms of extending our exam 
program.
    Mr. Ney. The other question I wanted to ask someone I 
guess--if people are receiving false statements for a number of 
years, and they have prepared their taxes, wouldn't Lehman 
Brothers have to send notification of earnings, and, therefore, 
the people overpaid their taxes that are sitting here? I don't 
know who wants to reflect on that, but--
    Mrs. Stout. I don't really see how it could be. I received 
the 1099s, my monthly statements--
    Chairman Kelly. Ma'am, please turn on your microphone. 
Somehow it has gotten turned off. Pull it closer to your mouth, 
and then we can all hear what you say.
    Mrs. Stout. All right.
    Chairman Kelly. Thank you.
    Mrs. Stout. I did receive the 1099s, my monthly statements. 
There was no other way that I figure that I could have been 
alerted.
    Mr. Ney. Well, I guess my question--and probably maybe the 
other panel can answer it--my question is geared towards if 
you're--you know, you're receiving these false statements. 
Lehman Brothers, I assume, had to be responsible for 
notification to IRS of, you know, the real account. So, 
therefore, you know, I guess there was no IRS catching the 
difference, which would have alerted you early. I guess there 
is no mechanism.
    But, obviously, Lehman Brothers had to have sent those in. 
Isn't that correct? Isn't that the way it works? So it would 
have showed to the IRS, you have Mrs. Stout, here is how much 
she made, but she shows she made--and over a period of 10 years 
or nine, surely that should have gotten caught somewhere, I 
would assume, by IRS.
    Mrs. Stout. Well--
    Mr. Ney. Although maybe I shouldn't--
    Mrs. Stout. --maybe I could come back and say now I had 
Microsoft, I had Cisco. That was--it would grow. I had--I 
started out with 750 shares. When I got my last statement, I 
had 12,000 of one and 27,000 of another, which showed that I 
had all of that, but it wouldn't show on my income tax, because 
it was still in the firm, and not--
    Mr. Ney. I have gone past my time. Maybe later on somebody 
can clarify, was he sending false statements to Lehman 
Brothers, to the IRS? No. Right? Yes? No.
    Chairman Kelly. Go ahead and ask that question. I will give 
you--
    Mr. Ney. Thank you. If you could--
    Chairman Kelly. --a little more time. Ms. Richards, if you 
could answer that.
    Ms. Richards. I was just going to say our investigation is 
ongoing. I think if the firm was sending accurate 1099s to the 
addresses on file, for many of these customers those were post 
office boxes. So they would not be getting the accurate 1099s.
    Mr. Ney. But they went to the IRS.
    Ms. Richards. Yes.
    Mr. Ney. Right?
    Ms. Richards. Yes. I would think that--yes.
    Mr. Ney. So it should show different what Mrs. Stout was 
reporting from the false--and then what the IRS was getting 
from Lehman Brothers. It should show a difference, I think.
    Ms. Richards. There would be a discrepancy. I just don't--I 
don't know what the IRS--
    Mr. Ney. I mean, it is important to know whether that--I 
mean, I feel sorry for these people that have been burned. I am 
just wondering what system should have caught that.
    Thanks very letting me exceed my time.
    Chairman Kelly. Perfectly all right. It is a legitimate 
question. It needs answering. It raises a lot of issues, and it 
is probably part of the ongoing judicial investigation.
    Now we go to Mr. LaTourette.
    Mr. LaTourette. You caught me by surprise, Madam Chairman. 
I thought Mr. Cantor was still here.
    Mrs. Stout, since this story broke, has anyone other than 
Mr. Gruttadauria from Lehman Brothers come to visit you in 
Elgin, Illinois?
    Mrs. Stout. Yes. I had representatives of Lehman.
    Mr. LaTourette. Right. Can you tell us about that exchange 
or what happened when they came to see you?
    Mrs. Stout. I beg your pardon?
    Mr. LaTourette. What was the purpose for which they came to 
visit you, and what happened?
    Mrs. Stout. Well, I had called the office and wanted to 
have an explanation, and they, I assume, decided they wanted to 
come I think maybe to check to see if I was going to be an easy 
customer, if they would be able to hoodwink me, and I--and they 
left. I had no information from them.
    Mr. LaTourette. Did you ask them about your money? I mean, 
what--
    Mrs. Stout. Oh, yes, I did. And I asked if there was a 
chance that I would be getting it back.
    Mr. LaTourette. And what did they tell you?
    Mrs. Stout. No answer.
    Mr. LaTourette. Okay. When Mr. Fazio comes back, I have a 
couple of questions for him.
    But, Ms. Richards, I am going to ask my legislative 
assistant to hand you a document that the Chairwoman was 
talking to, and this is--when you were indicating before the--
and, Mrs. Stout, just back to you, Mrs. Cuneo is your sister, 
right?
    Mrs. Stout. Yes.
    Mr. LaTourette. Your sister.
    Mrs. Stout. Yes.
    Mr. LaTourette. And that was--Mrs. Cuneo's account was the 
subject of the 1993 complaint, Ms. Richards, is that the 
anonymous complaint, the--
    Mrs. Stout. I am not sure, but it could be.
    Mr. LaTourette. I am asking Ms. Richards. Cuneo was the 
investor involved in the 1993 anonymous complaint?
    Ms. Richards. The identity of the accounts that we examine 
are typically not public.
    Mr. LaTourette. Right. But they will be when you comply 
with Mrs. Kelly's request. And I think it is Mrs. Stout's 
sister that was ripped off in 1993, and we will determine that.
    I have put in front of you a document that is an account 
belonging to a fellow by the name of Dominic A. Visconsi, Sr., 
and it goes from '92 to '96. And at the bottom--I think Mr. Ney 
asked you--it is my understanding under federal law, and also 
S.G. Cowen's own internal manual, that a turnover ratio of six 
gives rise to a conclusive presumption of excessive trading or 
churning. Is that your understanding, or am I mistaken?
    Ms. Richards. We would actually look very hard at any 
account that had a turnover ratio of less than six. We would 
look at an account that had a turnover--an annualized turnover 
ratio of two to three. We would then focus hard on those 
accounts.
    Mr. LaTourette. What about the ones that are turned over 
more than six times?
    Ms. Richards. Well, certainly, those would trigger our 
attention.
    Mr. LaTourette. Well, in the document I have put in front 
of you, in 1992, Mr. Visconsi's account, with an average equity 
of $416,000, was charged commissions of $113,000, and turned 
over 18 times. Would you consider that to be unusual activity 
worthy of your examination, had you known about it?
    Ms. Richards. Absolutely.
    Mr. LaTourette. And, likewise, in 1993, average equity of 
$447,000, commissions of $221,000, and a turnover ratio of 34 
times. I would imagine that would grab your attention as well, 
had you known about it.
    Ms. Richards. Yes.
    Mr. LaTourette. And, Mr. Fazio, I have had a chart made of 
an account that your lawyer was kind enough to give me last 
night. If we could put the chart up on the easel. It is your 
account 00-00068. And the year that we have highlighted is 
1990, and I would just like you to take a look at it. And, one, 
does that look familiar to you? Do I read it right that, in 
1990, your account had an average equity of $103,000 roughly, 
that the commissions charged on it were $67,471.70, and the 
turnover ratio was a little over 15 times, is that a correct 
reading?
    Mr. Fazio. That is correct.
    Chairman Kelly. Excuse me. I want to know if you would like 
to have that entered into the record.
    Mr. LaTourette. Yes, please.
    Chairman Kelly. So moved.
    [The following information was subsequently furnished by 
Mr. Carl Fazio witness] for the hearing record.]
    Mr. LaTourette. And, Ms. Richards, likewise, with the 
Visconsi account, and we are, again, in the same time period as 
your investigation in 1993 of the account we believe was owned 
by Mrs. Stout's sister, would you find the information that is 
on that board to be worthy of your attention and examination?
    Mrs. Stout. I am sorry. I did not--
    Mr. LaTourette. No, no, I was talking to Ms. Richards. I am 
sorry, Ms. Stout.
    Ms. Richards. We would definitely scrutinize an account 
with that kind of turnover ratio. I think it is important to 
note that we focus on firms' exception reports, which would 
typically flag accounts with turnover ratios of certainly that 
high. And then we would drill down and focus specifically on 
those accounts.
    So if the firm's exception reports were accurately 
identifying accounts with those kinds of turnover ratios, we 
would drill down very hard and focus on them.
    Mr. LaTourette. And, lastly, let me ask you, it is my 
understanding, in response to the questions by the Chairwoman, 
that your investigators made a judgment call not to talk to the 
investor in 1993 in that investigation. And basically--and, 
Mrs. Stout, let me come back to you, who was the executor of 
your sister's estate? Do you recall?
    Mrs. Stout. Frank.
    Mr. LaTourette. Frank Gruttadauria. Doesn't that create 
sort of, Ms. Richards, a closed loop? If you go and you talk to 
Mr. Gruttadauria, who apparently is trusted by people like Mr. 
Fazio and Mrs. Stout, and apparently her sister, and you have 
an account that has been turned over 18 times in six months, 
charged commissions of $39,000 on an equity of $96,000, does 
due diligence or an appropriate investigation stop with a guy 
like Frank Gruttadauria? I mean, don't we have an obligation to 
go out and talk to somebody else besides the thief?
    Ms. Richards. Well, again, focusing on the information that 
the examiner had before him at the time, it was a judgment 
call. And one of the critical factors that the examiner relied 
on was whether or not the investor that owned the account had 
complained. And, in fact, this investor had never complained 
about the trading in her account.
    Looking back on it now, with all that we know about what 
Mr. Gruttadauria did and what he was capable of, yes, I 
certainly wish we would have talked to the customer. But, I 
mean, now, looking back, I don't know what the customer would 
have said.
    Mr. LaTourette. Of course not.
    Ms. Richards. Truly, I don't know if, looking back on it 
now, if the customer wished to engage in frequent trading and 
herself directed the trading, as we were told by the firm.
    Mr. LaTourette. But I think if you put the '93 account 
together with the Visconsi account together with the Fazio 
account, I mean, something smells pretty bad here, and perhaps 
we should have talked to additional people. And I had a 
question and now it is out of my head.
    Mrs. Stout, back to you, let me--when Lehman Brothers 
visited you, did you have the impression that it was an attempt 
to get you to settle any claim you might have against them?
    Mrs. Stout. No.
    Mr. LaTourette. Okay. Did they inquire as to whether or not 
you were represented to counsel, whether you had a lawyer?
    Mrs. Stout. I had not had a chance to get counsel.
    Mr. LaTourette. Okay. And lastly, Ms. Richards--and I 
appreciate the Chair's indulgence--was the investigation 
conducted in 1993 shared with S.G. Cowen?
    Ms. Richards. S.G. Cowen compliance personnel were in the 
room when we interviewed Mr. Gruttadauria, and when we asked 
questions about the accounts and the exception reports. So they 
were very well aware of what we were focused on.
    Mr. LaTourette. Would your investigative file have been 
available to Lehman Brothers when they were conducting their 
due diligence when they purchased the retail business of S.G. 
Cowen in the year 2000?
    Ms. Richards. No, because the examination didn't result in 
conclusive findings of violations. There was no deficiency 
letter sent to the firm.
    Mr. LaTourette. Would your investigative file have been 
shared with Mr. Doherty in the Enforcement Division of the New 
York Stock Exchange?
    Ms. Richards. We share examination reports with the SROs 
whenever it's relevant for either party. But in this case, it 
wasn't.
    Mr. LaTourette. And I was going to ask Mr. Doherty, before 
reading it in the newspaper, being advised during the course of 
these proceedings, any idea that Mr. Gruttadauria had been the 
subject of this anonymous complaint in 1993?
    Was there any idea by you, Mr. Doherty, that Mr. 
Gruttadauria had been the subject of this 1993 complaint?
    Mr. Doherty. Not to my knowledge, no.
    Mr. LaTourette. Thank you very much, Madame Chairman.
    Chairman Kelly. Thank you. Mr. Inslee, do you have 
questions?
    Mr. Inslee. If I may, Madame Chair, I'd like to yield to my 
colleague from Ohio my time in this regard. She's been doing 
excellent work on it.
    Chairman Kelly. Thank you.
    Ms. Jones. Thank you, Mr. Inslee. I want to start and 
continue the line of questioning from Mr. LaTourette, Ms. 
Richards.
    In 1993, you got an anonymous complaint. You went and 
reviewed the record. Under all anonymous complaints, is it that 
you never talked to the customer?
    Ms. Richards. No, that certainly is not the policy. I think 
our policy currently--
    Ms. Jones. Take me back to 1993, not currently.
    Ms. Richards. In 1993, our policy would have been to 
contact a customer if there were any loose ends, if there was 
any indication.
    Ms. Jones. But who better than the customer than to tell 
you or to signal to you of some difficulty?
    Ms. Richards. Well, in fact, the examiner made the decision 
not to contact the customer because he was focused on the fact 
that the customer had never complained to the firm, the fact 
that the trades appeared to be directed by the customer and the 
fact that this customer appeared to be an experienced trader.
    Ms. Jones. Appearances are deceptive. Would you agree with 
me on that, Ms. Richards?
    Ms. Richards. This was according to the new account form 
that the customer would have filled out with the brokerage 
firm. The customer would have indicated to the brokerage firm 
his or her net worth, his or her investment experience, his or 
her investment--
    Ms. Jones. Back up a minute. You said it appeared that the 
customer signed the form. What I'm trying to get to is 
appearances are deceptive. We're sitting here with people like 
Mr. Fazio, Mrs. Stout, Mr. Glazier. Under the appearances 
invested with Mr. Gruttadauria, you were the examination folk. 
It's incredible to me that--I'm a former prosecutor, you're an 
examiner. You go after the witnesses. The best witness would be 
the customer that you would talk with them to find out in any 
instance, would it not be?
    Ms. Richards. Sitting here now, I wish we would have called 
the customer, absolutely. I don't know what the customer would 
have said.
    Ms. Jones. We never know what anybody is going to say.
    Ms. Richards. But sitting here now, I certainly wish we 
would have talked to the customer, yes.
    Ms. Jones. So now the rules, seeing as we're now trying to 
get so instances like this don't happen again, you talk to the 
customer now?
    Ms. Richards. Yes, we have a much more liberal policy on 
when the government contacts the customer about a particular 
account, absolutely.
    There's another change, if I could--
    Ms. Jones. Please.
    Ms. Richards. There's another change in the law that I 
think will be helpful in preventing similar situations like 
this. Under new rules that were adopted by the Commission a 
couple of months ago. The information that I described on a new 
account form about the customers' name, address, investment 
objectives, net worth, that information now will have to be 
sent to the customer for verification, so that will prohibit a 
registered representative from falsifying information on the 
new account form and I think that's a terribly important--
    Ms. Jones. It won't prohibit falsification.
    Ms. Richards. Well, the registered representative will be 
out of the picture. The firm will send that statement to the 
customer and the customer can look at it and say--
    Ms. Jones. Where does the firm get the customer's address?
    Ms. Richards. The firm would get the customer's address 
from the customer.
    Ms. Jones. So you're saying that every firm now will have a 
direct contact with a customer even though there is another 
representative involved in the process?
    Ms. Richards. Yes, the firm itself will communicate 
directly with the customer and the customer will then be able 
to verify yes, that's my name, that's my address or no, it's 
not or that's not my investment objective, that's not my net 
worth. It will make it much more difficult for registered reps 
to lie about those things--
    Ms. Jones. And what caused you to make this rule change in 
the last two months?
    Ms. Richards. It had been in the works for some period of 
time. We worked very closely with the state securities 
regulators who suggested to us that this was a change that 
needed to be made to prevent theft by brokers. The Commission 
agreed with it and made the change a couple of months ago.
    Ms. Jones. What other changes have you made to assure an 
investing public that you are going to do your job?
    Ms. Richards. Well, there's another change imposed in the 
same books and records rule that I think Mr. Fazio alluded to 
and that is the protection against registered representatives 
opening post office boxes in their control. The new rule would 
require that brokerage firms send a change of address 
confirmation to the old address and the new address. That, I 
think, will go a long way towards preventing registered 
representatives from creating these fictitious post office 
boxes, because the customer will get a notice from the firm 
that says have you or have you not changed your address to a 
post office box? I think that's an important protection.
    Ms. Jones. Did you see all of these events that are 
occurring and I look at them, oh wow, okay--I can finish that 
question or not? No, okay, I won't. I'll go back.
    Chairman Kelly. Mr. Tiberi. We'll let you hold that thought 
and come back.
    Mr. Tiberi.
    Mr. Tiberi. Thank you. Thank you, Madame Chairwoman. Just a 
couple of questions. Ms. Richards, of your total investigative 
force meaning like attorneys, investigators, supervisor 
attorneys, senior trial counsels, how many are employed in the 
Northeast Region in New York?
    Ms. Richards. The Northeast Region is comprised of both 
enforcement attorneys as well as examiners and accountants who 
conduct examinations of broker dealers, investment advisers, 
and investment companies. I don't know offhand the total number 
of staff in the New York office, but I'm happy to provide that 
to you.
    Mr. Tiberi. That would be great. My understanding is is 
that the bulk of the employees who do criminal investigations, 
the staff attorneys are located here in Washington, D.C. and 
they're sent out rather than having a stronger presence 
throughout the United States. And it would seem to me that 
maybe that has created a problem.
    Ms. Richards. We have 11 regions and districts in major 
metropolitan centers which are staffed by not only enforcement 
attorneys who bring enforcement cases, but also in my office, 
by examiners and accountants who conduct examinations of 
registered firms in their regions and districts.
    Here in Washington in the examination program, we have a 
staff of about 100 accountants, examiners and attorneys who 
also conduct examinations and assist in the examinations 
conducted by the field offices.
    Mr. Tiberi. You'll provide that information to us?
    Ms. Richards. Sure.
    Mr. Tiberi. Thank you. Ms. Stout, you mentioned in your 
testimony that with respect to on-line services that Mr. 
Gruttadauria was dissuading you from, in your own words, 
accessing your on-line account. How did he do that? How did he 
dissuade you from doing that?
    Ms. Stout. He really had not persuaded me not to. I was 
still insistent on doing it, but when I called--he told me that 
he had made up his mind when he went into business that he 
would never have any on-line. He would not be harassed by his 
clients and I said I have never harassed you, Frank. I would 
like to do it. It's a joy for me to learn new things and he 
said if you feel so strongly I will have to get you another 
broker. And I thought, well, I don't know. And I kind of led 
him on and he said I'll tell you what, Golda, I've know you for 
all these years. I will send you the symbols and I thought all 
right. But I didn't get the symbols. And then I was going to 
call and say forget it.
    Mr. Tiberi. Over the years you received monthly statements, 
Ms. Stout?
    Ms. Stout. Yes.
    Mr. Tiberi. I assumed you paid taxes on those statements?
    Ms. Stout. Oh, yes, I did.
    Mr. Tiberi. How much tax do you believe you paid in the end 
on money that you didn't earn?
    Ms. Stout. Well, two years ago I almost went into 
hysterics. I ended up paying $32,000 to the government. I paid 
quite a little bit to the state, plus I had been paying 
quarterly for the estimated. Now that will give you an idea of 
what I did do.
    Mr. Tiberi. Ms. Stout, did either Cowen or Lehman offer to 
take responsibility?
    Ms. Stout. No.
    Mr. Tiberi. Okay. Has either company offered to make up the 
losses incurred?
    Ms. Stout. No.
    Mr. Tiberi. Mr. Fazio, has either company offered to make 
up losses that you incurred?
    Mr. Fazio. No. They have not offered anything.
    Mr. Tiberi. And neither Cowen or Lehman will take 
responsibility, Mr. Fazio?
    Mr. Fazio. No, they have not. I asked for some substance of 
some kind until we settle it. They didn't offer a dime, 
nothing.
    Mr. Tiberi. Madam Chair, I'd like to yield the balance of 
my time to Mr. LaTourette.
    Mr. LaTourette. Thank you very much, Mr. Tiberi, for the 
courtesy on the little less than a minute that you have 
remaining.
    Mr. Fazio, I wanted to reference before we go into other 
matters, there was a rather obnoxious column in the Cleveland 
Plain Dealer a couple of months ago and it's unusual for the 
Cleveland Plain Dealer, it's a fine newspaper, but it suggested 
that those of you who lost money were either sloppy, greedy or 
inattentive and that perhaps participated in your own demise. 
And I would just like you, sir, to indicate for the purposes of 
the record, were you a sloppy, inattentive or a greedy 
investor?
    Mr. Fazio. Absolutely not. I kept track of everything I did 
and checked it against the statements and everything balanced. 
If it didn't, he would correct it. I was not a sloppy investor 
and this person, I was so mad when I read that article I wanted 
to cancel the Plain Dealer.
    Mr. LaTourette. The statements that you received from Mr. 
Gruttadauria, did they mirror the notes and notations that 
you--
    Mr. Fazio. Yes, they mirrored my investments as I kept 
track in several notebooks of my trades. They did. I want to 
add one other thing, that in answer to another question, the 
customer did not sign the form. When Lehman took over, I'm the 
client, it was forged. My name was forged. Customers had no way 
of knowing about the trades, the excessive trades or anything 
else. Signatures were forged.
    Mr. LaTourette. Thank you very much and thank you again, 
Mr. Tiberi, for your courtesy.
    Chairman Kelly. Thank you, Mr. LaTourette. Mr. Clay, have 
you questions?
    Mr. Clay. Thank you, Madame Chair. Let me thank you for 
conducting this hearing as well as I'd like to ask unanimous 
consent to submit my statement in the record.
    Chairman Kelly. So moved.
    Mr. Clay. And yield the balance of my time to Ms. Jones.
    Ms. Jones. Thank you, Mr. Clay. Ladies and gentlemen, I've 
been able to twist all of my colleagues' arms to tell them this 
is my jurisdiction, give me your time and I thank each of them 
for being willing to do so.
    For the record, Madame Chairwoman, we had asked Mr. Samuel 
Glazier to come and testify and under advice of his counsel, he 
chose not to, but he is seated here in the room today and we do 
have a letter from Mr. Glazier's attorney that I'd like to 
submit for the record, so that everybody will understand why it 
was he chose not to testify.
    [The following information was subsequently furnished by 
Hon. Stephanie Tubbs Jones for the hearing record.]
    Chairman Kelly. So moved.
    Ms. Jones. Great. Thank you. Let me see, where did I leave 
off.
    Let me go back to you, Ms. Richards. Tell us how you 
perceive and Mr. Doherty, you can answer this question, that 
you, the Stock Exchange, and you the SEC, are going to 
collaborate to see that Mr. Glazier and Mr. Fazio and Ms. Stout 
and Mr. Stanton and others may be able to get some relief?
    Ms. Richards. Well, in our enforcement action that we filed 
against Mr. Gruttadauria, we asked for disgorgement of any and 
all ill-gotten gains. Any ill-gotten--
    Ms. Jones. Just for the record, why don't you tell us what 
disgorgement is, okay?
    Ms. Richards. That's a request to the Court that Mr. 
Gruttadauria be ordered by the Court to turn over any monies or 
property that he may have obtained unlawfully.
    Ms. Jones. And so has he been enjoined from disposing of 
those assets, have you corralled those assets for purposes of 
the possible victims?
    Ms. Richards. We asked for, at the time we filed the 
complaint, an asset freeze, a freeze of all of his accounts and 
the Court entered that order.
    Ms. Jones. So who is it, if you can answer this question, 
responsible for corralling--you know, we generally set up 
someone who has oversight over such assets. Has someone been 
assigned to do that and are you able to tell us for the record 
what the value of those assets may be at this time?
    Ms. Richards. As far as the value of the assets, I think 
it's too early to know. The Commission's enforcement staff is 
still in the midst of taking discovery and very actively 
investigating this matter, not only as to Mr. Gruttadauria, but 
also as to other individuals who may have assisted or 
participated in the fraud along with him.
    Ms. Jones. In light of the fact that Mr. Gruttadauria was 
employed by Lehman Brothers had you corralled any of Lehman's 
assets in order to be able to satisfy the possible losses of 
these victims?
    Ms. Richards. Under the securities laws' framework, there 
is a remedy of arbitration. Each customer can arbitrate his or 
her dispute with a brokerage firm. In addition, I know that a 
number of customers are considering taking action in Federal 
Court and State Court.
    Ms. Jones. Let me ask my question again, in light of the 
fact that Mr. Gruttadauria was employed by Lehman Brothers, 
have you corralled any of the assets of the Lehman Brothers or 
SG Cowen in order to satisfy the losses of the victims of this 
particular incident?
    Ms. Richards. The Commission doesn't have authority to 
obtain monies directly on behalf of investors. Typically, when 
we obtain disgorgement of ill-gotten gains, we would then seek 
the Court's approval to disperse those moneys back to investors 
who were defrauded.
    Ms. Jones. Isn't it conceivable, Ms. Richards, that Mr. 
Gruttadauria had ill-gotten gains, Lehman Brothers also had 
ill-gotten gains, so in fact, their assets ought to be 
corralled? Let me cut if off. It's conceivable that if 
Gruttadauria got ill-gotten gains, so did Lehman Brothers, 
because it's based on a commission. Is that true?
    Ms. Richards. The Commission is continuing to investigate 
the conduct by the two brokerage firms that employed him.
    Ms. Jones. So you're saying the SEC has no authority to 
deal with Lehman Brothers as they're dealing with Gruttadauria 
in term of assets?
    Ms. Richards. The Commission has the authority to bring 
enforcement actions against both of those firms and we are very 
actively investigating them. Both of these firms are still in 
business. Both of these firms are healthy. They have adequate 
net capital. They have adequate reserves. This is not a 
situation--
    Ms. Jones. How long does it take to declare bankruptcy, Ms. 
Richards?
    Ms. Richards. I don't know. These firms have adequate 
capital to continue to do business.
    Ms. Jones. I'm trying to get my staffer to find me a 
newspaper article where Lehman is, in fact, claiming the 
possibility that so many suits to cause them to be placed in 
financial difficulty. Have you seen that article?
    Ms. Richards. I saw an article where they disclosed that 
the firm was taking a reserve against the potential for 
lawsuits.
    Ms. Jones. So what does that tell you?
    Ms. Richards. It tells me they're starting to set aside 
money for the possibility that they'll have to make some of the 
victims whole.
    Ms. Jones. So you're saying to the world on behalf of the 
SEC that Lehman Brothers is going to be in a position to settle 
or pay up all these folks who have lost money. Help her out, 
come on.
    Mr. Doherty. Could I add something? Since we're 
investigating this matter right now, I'd rather not comment on 
what we have in mind here. But I can tell you that when we get 
involved in an investigation and we see customers who have been 
damaged and have had money stolen, very much a high priority of 
our concern before we resolve that enforcement action is that 
those customers get taken care of and dealt with fairly by our 
member firms.
    Ms. Jones. So are you saying that the stock exchange is 
going to have the back of Lehman Brothers for satisfying the 
claims of all these folks?
    Mr. Doherty. What I'm saying is that since I can't comment 
on what we're going to do in this case, I'll tell you what 
we've always done and what has been our consistent practice 
where investors have had their money stolen by an employee of a 
member firm. We have made it very clear to our member firms 
that we expect them to deal fairly with their customers and 
reimburse their customers. They understand that and I cannot 
think of a case in the last 10 years where an employee of one 
of our member firms has stolen money and that that customer has 
not been taken care of by the member firm.
    Ms. Jones. Thank you, Madame Chairwoman. I appreciate the 
time.
    Chairman Kelly. Thank you. Ms. Richards and Mr. Doherty, 
I'd like an answer to this question. Do either of your 
institutions have any rules about the appropriateness of branch 
managers or brokers who supervise their compliance officers? Do 
either of you have any rule in existence now and did you back a 
couple of years ago? How long has this rule been in place?
    Ms. Richards, do you want to answer that first and then 
we'll go to Mr Doherty?
    Ms. Richards. Yes, as I said, broker-dealers have a duty to 
reasonably supervise. We would not consider a reasonable 
supervisory system a structure in which supervision was had by 
a subordinate. That to us would not reflect a reasonable system 
of supervision. Supervision must be independent to be 
effective, so we would look to someone outside of the branch 
manager's chain of command to supervise that branch manager's 
activities.
    I would note that that's something that was specifically 
set forth in my testimony as one of the practices that we 
intend to focus on very hard in our examinations.
    Mr. LaTourette. Will you yield to me just for that, on that 
point?
    Chairman Kelly. Of course.
    Mr. LaTourette. In this situation where Mr. Semanek is the 
compliance officer on behalf of Lehman Brothers and he's a 
subordinate of Mr. Gruttadauria, are you indicating that that 
is a nonsatisfactory arrangement?
    Ms. Richards. I can't comment on the facts of this 
particular case because that very situation is under 
investigation by our enforcement staff, but a situation in 
which a subordinate of a branch manager is supervising that 
branch manager's activity, in my view, doesn't reflect a 
reasonable system of independence.
    Mr. LaTourette. With the Chairwoman's indulgence because I 
don't want to parse words or have anybody leave here and be 
confused, so you're not going to comment about Mr. Semanek and 
Mr. Gruttadauria, but if, for the purposes of a hypothetical 
there was a guy in Cleveland who was the branch manager and his 
compliance officer was his subordinate, would you find that to 
be an inappropriate supervisory structure?
    Ms. Richards. In Cleveland or wherever--
    Mr. LaTourette. Anywhere in the world.
    Ms. Richards. Yes, we would be very critical of that.
    Mr. LaTourette. Thank you.
    Mr. Doherty. Could I add that in our view a producing 
branch office manager needs to be supervised with respect to 
his own production like any other salesman and so that I would 
completely agree with Ms. Richards that supervision by a 
subordinate, if that's the sole aspect of the supervision, 
would not be, in our view, reasonable and we have brought 
enforcement cases against firms and others where we felt that 
was a deficiency.
    Chairman Kelly. Ms. Richards, it's my understanding that 
you put this oversight in place about 1998. Is that correct?
    Ms. Richards. Oversight?
    Chairman Kelly. The oversight of the decision being that it 
was inappropriate for a branch manager or a broker to supervise 
their own compliance officer. Wasn't that in place in 1998?
    Ms. Richards. The duty to supervise has certainly been in 
place and is the framework, the linchpin of the federal 
securities laws--
    Chairman Kelly. So it was not enough to stop Mr. 
Gruttadauria, is that correct? Must have been. Is that correct?
    Ms. Richards. Existing duties to supervise apparently 
failed with respect to Mr. Gruttadauria.
    Chairman Kelly. Thank you very much. Does either the SEC or 
the New York Stock Exchange believe that they require greater 
authority to detect fraud similar to Mr. Gruttadauria's? Is 
there something here that we need to look at at the federal 
level that will not impinge on the trading that's occurring, 
will not impinge on the markets and yet do you need another 
tool in your toolbox?
    Ms. Richards. I would say that, on behalf of the 
Commission, that we have 250 examiners for a population of 
8,000 registered broker dealers, some 90,000 branch offices and 
678,000 registered representatives that we police, with the 
SROs, with 250 examiners. The Commission is now engaged in a 
top-to-bottom review of its resources to determine whether or 
not we need more--just simply need more people to do the job 
that we need to do. Chairman Pitt has spearheaded that effort 
and we're working closely with him to make those kinds of 
determinations.
    Chairman Kelly. What about you, Mr. Doherty?
    Mr. Doherty. My reaction is I don't think we need 
additional authority. I think we need to continue to gather 
information and adapt our program. We have under consideration 
some rules that would impose more specific requirements in this 
area that would hopefully go a long way toward enhancing 
investor protection in this area.
    In the final analysis, however, responsibility has to be on 
the member firms to put in place the kind of procedures that 
the rules require and run their business in a way that's 
compliant with the rules. We oversight that. The SEC oversights 
that.
    Overall, this system, has given us the best markets in the 
world, but that doesn't mean that we can't improve things and 
that's what we're trying to do.
    Chairman Kelly. Well, I thank you all for your testimony. I 
want to note that some Members may have additional questions. 
I'm sure they do have additional questions for this panel and 
they may wish to submit them in writing. So without objection, 
the hearing record will remain open, as I had stated earlier, 
for 30 days for Members to submit written questions to these 
witnesses and to put their responses in the record.
    I'd like to thank the first panel very much for appearing 
here. We appreciate your testimony and I want to especially say 
to you, Mr. Fazio, and Ms. Stout, you are excellent 
spokespeople for those people who were damaged by Mr. 
Gruttadauria's actions and we thank you for traveling so far to 
be with us today.
    With that, I'm going to excuse this first panel with our 
great appreciation. Thank you so much.
    Ms. Jones. Madame Chairwoman, just for the record, I found 
that newspaper article that I was talking about with Lehman 
Brothers with the reserves and not having enough money to help 
out these folks and I would just like to submit it for the 
record.
    Chairman Kelly. With unanimous consent, so ordered.
    Ms. Jones. Thank you.
    Chairman Kelly. This panel is excused. I'd like to have the 
second panel start taking their seats.
    For our second panel we welcome Mark Kaplan, Managing 
Director and General Counsel, SG Cowen Securities; Mr. Thomas 
Hommel, Managing Director and Co-Head of Global Litigation for 
Lehman Brothers; Daniel Sibears, did I pronounce that correct? 
Mr. Sibears, did I pronounce that correctly?
    Mr. Sibears. It's pronounced Sibears.
    Chairman Kelly. Sibears, thank you very much. Mr. Sibears, 
Senior Vice President and Deputy for Member Regulation for the 
National Association of Securities Dealers; Mr. Bradley 
Skolnik, Indiana Securities Commissioner and Chairman of the 
Enforcement Section of the North American Securities 
Administrators Association; and Marc Lackritz, President of the 
Securities Industry Association. And we thank all of you for 
being here. I appreciate your testimony before us today and I 
welcome you on behalf of the full committee. Without objection, 
your full written statements and any attachments that you have 
will be made part of the record and you'll each now be 
recognized for a 5-minute summary of your testimony.
    I'd like to begin with you, Mr. Kaplan.

  STATEMENT OF MARK E. KAPLAN, MANAGING DIRECTOR AND GENERAL 
                  COUNSEL, SG COWEN SECURITIES

    Mr. Kaplan. Thank you. Madame Chair, Members of the 
Subcommittee, I thank you for the opportunity to come before 
this Panel for this important hearing. On behalf of SG Cowen, I 
pledge our company's full support for your efforts. We applaud 
the Subcommittee for its leadership in working to protect 
investors from fraud and other abuses.
    SG Cowen is committed to doing everything possible to get 
to the bottom of this scheme and to do what's right for our 
former clients by making every effort to reach a fair and 
equitable resolution of their claims.
    I want to begin by briefly reviewing SG Cowen's short 
involvement in the retail brokerage business and where Frank 
Gruttadauria fit into that business. In July 1998, SG 
Securities purchased most of the assets of Cowen & Company, a 
wholly unrelated firm. Frank Gruttadauria had worked for Cowen 
& Company for over eight years.
    SG Securities did not have a retail brokerage business 
until this acquisition. With the purchase, SG Cowen was formed 
as a full-service investment banking and retail brokerage firm 
in the United States.
    In October 2000, a little over two years later, SG Cowen's 
retail brokerage business, including Frank Gruttadauria and his 
accounts, were sold to Lehman Brothers. Our firm has been out 
of the retail brokerage business since that time.
    Because we sold that business, we are faced with a unique 
and significant challenge in piecing together what happened in 
the Gruttadauria scheme. First, practically everyone involved 
in SG Cowen's retail brokerage business no longer works at the 
firm. As a result, we lack the institutional memory that would 
help us resurrect and reconstruct what happened during the time 
that Mr. Gruttadauria worked at the firm.
    Second, the files that we are researching are stored on 
vast amounts of paper and microfiche, not electronically. That 
requires us to manually review more than 11,000 boxes of 
documents relating to hundreds of thousands of transactions 
and, to unravel this scheme, we must analyze every transaction 
in every account.
    Lastly, we are attempting to unravel a scheme that escaped 
detection, notwithstanding the due diligence, compliance 
procedures and independent reviews of several distinct 
companies and outside entities--which points to the 
sophistication and the complexity of this scheme. Even so, 
speaking for SG Cowen, we wish our efforts had uncovered it 
sooner and we're doing everything we can to ferret out what 
really happened.
    To do that, and from the very first day we learned of this 
problem, SG Cowen has dedicated substantial company resources 
to the complex task of reconstructing client records. This 
includes well over 100 people working on a nearly around-the-
clock basis. We estimate that more than 30,000 person-hours 
have been expended in this effort and we are far from finished.
    While this is very much a work in progress, we have learned 
some things that I would like to share with the panel. However, 
and as I am sure you understand, we simply cannot comment on 
matters that bear on the on-going investigations of the SEC and 
the New York Stock Exchange and that are the subject of private 
litigation.
    What I can say is that some clients did receive false 
statements with inflated account balances from Mr. 
Gruttadauria. When they sought to withdraw funds, based on 
these artificially high levels, Mr. Gruttadauria had to get the 
money from somewhere else and that turned out to be the 
accounts of other clients. That appeared to require him in turn 
to provide false statements to those other clients and so the 
scheme grew. Thus, at its root, this was a scheme in which 
Frank Gruttadauria appears to have been robbing Peter to pay 
Paul. Many questions still remain. Did some people lose 
substantial sums? Did some people wind up with substantially 
more money than their investments would have earned? Were the 
compliance procedures and supervision at the various firms 
inadequate? Or was Frank Gruttadauria's scheme unusually 
sophisticated in evading detection?
    Because of the nature of this scheme, we need to understand 
what happened with all transactions and all affected accounts 
before we can determine how to address any individual client's 
claim. Again, we are pursuing this task with great urgency, but 
it will take time.
    Members of the Subcommittee, we offer our sincere apology 
to the former clients of SG Cowen for the harm that Frank 
Gruttadauria's conduct has caused them. His conduct is anathema 
to us. That is not the way we do business and that is not who 
we are. We are proud of our hard-earned reputation for 
integrity in the marketplace and for what we do for our 
clients. That is why SG Cowen will continue to work tirelessly 
to determine exactly what happened and to make every effort to 
reach a fair and equitable resolution of our former clients' 
claims. We know that that can't happen fast enough for them and 
they are absolutely right.
    With that, I thank you very much for the opportunity and 
welcome the chance to answer any questions you may have.
    [The prepared statement of Mr. Mark Kaplan can be found on 
page 96 in the appendix.]
    Chairman Kelly. Thank you very much, Mr. Kaplan.
    Mr. Hommel.

STATEMENT OF THOMAS E. HOMMEL MANAGING DIRECTOR AND CO-HEAD OF 
               GLOBAL LITIGATION, LEHMAN BROTHERS

    Mr. Hommel. Thank you, Madame Chairwoman. My name is Thomas 
Hommel. I'm a Managing Director with Lehman Brothers in New 
York. I have a few remarks that I'd like to read into the 
record, after which I'd be happy to answer any questions that 
the Committee may have for me.
    In January of this year, Frank Gruttadauria reportedly sent 
a letter to the FBI admitting that he had defrauded his clients 
for a period of 15 years. Mr. Gruttadauria worked for Lehman 
Brothers for only 15 months at the very end of this 15-year 
period. His employment resulted solely from Lehman's 
acquisition of certain retail customer accounts and branch 
offices from SG Cowen & Company in October of 2000. Prior to 
Lehman's acquisition of the Cowen branches, we performed due 
diligence with respect to Cowen's personnel and operations. Our 
due diligence disclosed that Mr. Gruttadauria had a spotless 
compliance record with not even a single customer complaint 
against him, nor were there any significant number of customer 
complaints in the entire Cleveland Office.
    Lehman acquired over 60,000 accounts from Cowen, including 
4,900 in the Cleveland Branch Office. Approximately 470 of 
those accounts were handled by Frank Gruttadauria. It now 
appears that Mr. Gruttadauria was indeed deceiving a relatively 
small number of those clients, as well as his employers. He did 
so by diverting account statements generated by the brokerage 
firms for which he worked and preparing and sending to these 
clients false statements reflecting nonexistent trades and 
false account balances. These activities took place for a 15-
month period at Lehman Brothers for two basic reasons. First, 
the addresses received by Lehman for 40 of Mr. Gruttadauria's 
470 accounts were incorrect. These were the diverted 
statements. Second, the assets delivered over to Lehman from 
Cowen in those accounts were relatively small and the account 
activity, both trading activity and transfers of funds, was 
virtually nonexistent outside of a handful of accounts. Since a 
brokerage firm is charged with safeguarding a client's 
securities and funds, compliance systems are designed to do 
just that and a lack of activity in these accounts at Lehman 
meant that they were not singled out for scrutiny.
    At the cornerstone of supervisory procedures for every 
broker-dealer is the ability independently to send to all of 
its customers confirmations and monthly statements reflecting 
all activity in their accounts. In the tape to tape or computer 
transfer of account information from Cowen to Lehman in October 
of 2000, the incorrect addresses that Mr. Gruttadauria had put 
in place at Cowen were transferred to Lehman. Thus, a 
fundamental supervisory tool had been taken away from Lehman 
without its knowledge as a result of purchasing accounts that 
had defective addresses.
    Moreover, nothing about the addresses that were on these 
accounts appeared suspicious in any way. In virtually all 
instances, the addresses appeared to be accounting firms or law 
firms which presumably had been employed by the high net worth 
client, or otherwise contained street addresses. Indeed, there 
is nothing extraordinary about a high net worth client 
directing his broker to send account statements to his 
accountant or to a lawyer. One of the accounting firms listed 
had a post office box included in the address, while another 
was, in fact, an actual accounting firm with its actual street 
address listed. Thirty of the 40 accounts transferred from 
Cowen to Lehman that had incorrect addresses were directed to 
one or the other of these accounting firms. The 40 accounts 
that were transferred to Lehman that had bad addresses 
contained assets of less than $5 millon. The false account 
statements for those same accounts reflected equity of over 
$250 million. From these hard facts, it is clear that to the 
extent that the assets reflected in the false account 
statements ever existed, they had been dissipated long before 
they reached Lehman Brothers. Because there were relatively 
modest amounts in the Lehman accounts, there was little or no 
trading in these accounts. There were few transfers of funds as 
well, again, putting aside a small handful of accounts.
    On January 17, 2002, the very same day Lehman learned about 
the alleged misappropriation, it sent a new management team to 
Cleveland, as well as various other personnel to immediately 
meet with clients. Lehman also immediately notified its 
regulators and has fully cooperated with the numerous inquiries 
it has received from those regulators and other governmental 
entities. The complete former management team of the office was 
replaced. All of Mr. Gruttadauria's clients were immediately 
contacted to ensure that they knew precisely what was in their 
accounts and meetings were conducted with the affected 
customers to fully share with them what information the firm 
had regarding their accounts. Indeed, within 3 weeks of Mr. 
Gruttadauria's disappearance, Lehman Brothers had contacted 
substantially all of Mr. Gruttadauria's 470 clients and we 
personally have met with representatives, either family members 
or counsel, of 24 of the families involved in Mr. 
Gruttadauria's scheme, accounting for all but a few of the 60 
accounts, which includes the fictitious accounts, for which 
false statements were prepared.
    Moreover, Lehman has already paid substantial sums to 
certain customers, including the customers whose accounts 
served as the bank for Mr. Gruttadauria's scheme at Lehman 
Brothers, to reimburse them for funds misappropriated from 
their accounts while at Lehman, without requiring those people 
to sign releases. Lehman believes that the amounts already paid 
represent a substantial portion of any funds that may have been 
misappropriated while Mr. Gruttadauria was employed by Lehman, 
and is continuing its efforts to identify and reimburse any 
remaining customers for any such misappropriation that may have 
occurred at Lehman. Lehman Brothers, unfortunately, was in the 
unenviable position of having to tell these customers that they 
were not worth what they thought they were. However, 
substantially all of the alleged inflation in the account value 
and substantially all of the alleged misappropriation took 
place prior to these people ever become customers of Lehman 
Brothers. Lehman Brothers, as part of its 150 year tradition, 
places an enormous premium on earning the trust and confidence 
of its clients. We regret deeply that these events took place, 
but also firmly believe that our systems of supervisory 
procedures are more than reasonably designed to prevent and/or 
detect this type of activity.
    Indeed, Lehman's compliance record since 1994, when the new 
Lehman Brothers re-emerged, is an enviable one, with not a 
single regulatory sanction associated with our private client 
services business. We will continue to work with the affected 
clients, with their counsel, with the regulators and the 
Courts, to resolve the claims that have been raised in the most 
fair and efficient manner possible.
    Thank you.
    [The prepared statement of Mr. Thomas E. Hommel can be 
found on page 104 in the appendix.]
    Chairman Kelly. We thank you.
    We next go to Mr. Sibears.

   STATEMENT OF DANIEL M. SIBEARS, SENIOR VICE PRESIDENT AND 
     DEPUTY FOR MEMBER REGULATION, NATIONAL ASSOCIATION OF 
                       SECURITIES DEALERS

    Mr. Sibears. Chairman Kelly, Members of the Committee, 
thank you for the opportunity to testify on behalf of the NASD. 
First, let me briefly describe the NASD. The National 
Association of Securities Dealers is the world's largest self-
regulatory organization or SRO. Under federal law, the roughly 
5500 brokerage firms and almost 700,000 registered 
representatives in the U.S. securities industry, comes under 
our jurisdiction. Employing industry expertise and resources, 
we license industry participants, write rules to govern the 
conduct of brokerage firms, educate our members on legal and 
ethical standards, examine them for compliance with NASD and 
federal rules, investigate infractions and discipline those who 
fail to comply. We have a staff of 2,000 with headquarters in 
Washington, D.C. and 15 district offices throughout the 
country. We are governed by an independent Board of Governors, 
at least half of whom are unaffiliated with the securities 
industry.
    I'm the Senior Vice President and Deputy for the Member 
Regulation Department which has over 800 dedicated employees. 
My testimony today will focus on the exam program which is the 
largest function carried out by member regulation. I recognize 
that the Committee has a significant interest in the 
Gruttadauria case. For the reasons set forth in my written 
statement, however, I am not in the position to comment 
specifically on that matter which is under investigation by the 
New York Stock Exchange and the Securities and Exchange 
Commission.
    On an annual basis, the NASD examines approximately 2600 
brokerage firms' headquarters and over 200 branch offices. The 
yearly schedule of exams is prepared in conjunction with other 
SROs, including the New York Stock Exchange, pursuant to an 
agreement to maximize cooperation and to minimize duplication 
among regulators.
    The exam process has advanced with technology. In the mid-
1990s, the NASD developed automated exam modules, essentially 
taking the paper modules procedures and schedules of the past 
and placing them on a computer. With the NASD's recent 
development of INSITE which stands for Integrated National 
Surveillance and Information Technology Enhancements, we use 
sophisticated data mining techniques to detect signals of 
change in member firm activities. This includes statistical 
analysis of customer complaints, transactional and trading 
information, registration information and financial 
information.
    All this technology is helpful in identifying problems, but 
our goal is to have the systems that encourage firms to 
identify and stop problems before they happen. We use all the 
tools at our disposal, automated, manual and intellectual, to 
anticipate problems. The tools used to conduct the exams have 
changed and although the scope has grown, what we examine for 
has not changed radically. During our on-site visits to the 
firm's office, the examiners review the firm's books and 
records such as financial computation work papers and 
subsidiary ledgers, order tickets and confirmations, complaint 
and correspondence file and many other records. Examiners check 
that the firm's records support the regulatory filings that the 
firm has made to the NASD in the case of trade reporting, 
financial filings, complaint filings and advertising filings, 
for instance. Examiners prepare independent financial 
calculations to determine the financial condition of the firm, 
including such measures as net capital and customer reserve. 
Examiners also interview the firm's compliance officers and 
management to learn about its supervision in operational 
practices. The front line of our system of preventive 
compliance is at the securities firm itself. All securities 
firms are required to have supervisory systems and internal 
controls. NASD takes our members' supervisory obligations very 
seriously. Effective evolving supervisory systems form the 
foundation of a firm's ability to ensure that its associated 
persons are appropriately dealing with customers and the 
customers are protected. Appropriate supervision safeguards the 
firm and increases investor confidence, thereby ultimately 
ensuring the fair and efficient functioning of our markets.
    However, ordinary supervisory procedures may be 
insufficient to ensure compliance in certain circumstances, 
circumstances that may warrant heightened supervisory controls 
include registered representatives who have been the subject of 
numerous customer complaints, disciplinary actions or 
arbitrations, registered representatives terminated from 
association with prior firms for regulatory reasons or 
concerns, registered representatives who have frequently 
changed their employment and registered representatives whose 
trading practices or customers appear on certain exception 
reports generated by the firm to monitor customer accounts.
    Firms that ignore such signals or red flags of sales 
practice violations or that never put in heightened supervision 
of problem brokers may themselves be the subjects of 
disciplinary action for failure to supervise the brokers. While 
today's hearing is focused on one bad actor, the overwhelming 
majority of NASD members materially comply with the letter and 
the spirit of the rules and the law. They view their own 
reputation for fair dealing and high standards as a competitive 
asset in a competitive industry.
    The NASD's job is to protect investors by setting high 
standards of conduct and by disciplining those that fail to 
live up to those standards, sometimes by barring them from the 
industry for life.
    I'd be pleased to take any questions that you may have.
    [The prepared statement of Mr. Daniel Sibears can be found 
on page 109 in the appendix.]
    Chairman Kelly. Next we go to Mr. Skolnik.

      STATEMENT OF BRADLEY W. SKOLNIK, INDIANA SECURITIES 
COMMISSIONER AND CHAIRMAN, ENFORCEMENT SECTION, NORTH AMERICAN 
             SECURITIES ADMINISTRATORS ASSOCIATION

    Mr. Skolnik. Chairwoman Kelly and Members of the 
Subcommittee, I'm Brad Skolnik, Indiana Securities Commissioner 
and Chairman of the Enforcement Section of the North American 
Securities Administrators' Association. I commend you for 
holding this hearing and thank you for the opportunity to 
appear today.
    The Securities Administrator in your state is responsible 
for the licensing of investment professionals and securities 
offerings, investor education and most importantly the 
enforcement of state securities laws. We've been called the 
local cops on the beat and I believe that is an accurate 
characterization.
    Today, our focus is on the case of Frank Gruttadauria. My 
testimony will focus on two questions. What should be done to 
prevent another Gruttadauria from cheating investors out of 
their money and what steps can investors take to better protect 
themselves from these criminals?
    I believe our securities laws and regulations are 
fundamentally sound. One lesson from this case might be that 
compliance departments need to toughen their enforcement of the 
rules already on the books. Compliance departments must have 
reasonably designed standards and systems in place to prevent 
and detect fraud. For example, it's important that firms 
implement an effective, centralized compliance system to 
approve the opening of accounts and to monitor associated name 
and address changes.
    In addition, I encourage brokerage firms of a reasonable 
size to provide on-line access to their customers' account 
statements. Investors will then be able to check their mailed 
account statements against the information provided directly by 
the firm's website which is not subject to manipulation by a 
crooked broker.
    Another useful tool would be more resources for regulators. 
I applaud recent House action to raise the SEC budget. We need 
to make sure that both state and federal regulators have the 
resources they need to do their jobs. There's also another way 
to fight these criminal fraudsters. Securities regulators must 
work with prosecutors to obtain more criminal convictions. The 
prospect of serious jail time is the only way to deter these 
calculating cold-blooded recidivist criminals. Anything less is 
viewed as just the cost of doing business.
    Think about it. Someone steals your car, they go to prison. 
A con artist steals the money your parents saved for retirement 
and all too often, only gets fined. That's just not right.
    Make no mistake about it. Frank Gruttadauria stands accused 
of being an unscrupulous scam artist and his alleged criminal 
activities will be addressed in a court of law. However, as a 
State Securities Commissioner, I've encountered too many 
fraudsters who have swindled hard-working Americans out of 
their life savings.
    Indeed, over the past few years, in my home state of 
Indiana, we've encountered at least two high profile incidents 
where stock brokers employed some of the same tactics such as 
the issuance of fictitious account statements to plunder their 
clients.
    The question is how can we better protect investors from 
being victimized by the next Gruttadauria? We need to realize 
that no matter what we do, there will be always be diabolical 
con artists. That's why stiff penalties and long prison 
sentences are so important.
    In addition, NASAA has some tips for how investors might 
better protect themselves from these sophisticated scams. 
First, periodically check mailed account statements against on-
line information from the firm's website or by calling the 
firm's headquarters. Secondly, we've all heard the saying, 
don't put all your eggs in one basket. Investors should 
consider spreading their investments possibly among two or 
three firms. Third, contact your State Securities Regulator to 
check out a broker before doing business with them. We can tell 
you if the company or individuals offering investment advice 
are licensed or if they have any disciplinary history. Fourth, 
use common sense. If written account statements show you're 
making lots of money at a time when the stock market is in 
decline, maybe you should double check your accounts with the 
firm's compliance office. Fifth, with the advent of desktop 
publishing and technology, it's not difficult to create bogus 
account statements. I encourage investors to carefully check 
for typographical errors that sometimes appear on falsified 
statements. Sixth, many investment professionals use either 
custodians or clearing brokers to hold their clients' funds and 
securities. Investors should periodically compare statements 
received from their broker with these independent third parties 
for confirmation and accuracy. And finally, investors should 
make sure their account statements are issued by the brokerage 
firm or mutual fund complex and not from some other assumed 
business name used by the investment professional.
    I applaud you for holding these hearings in an effort to 
shed light on the criminal abuses in the securities markets. 
The problems in this area are serious, but can be successfully 
addressed if securities regulators and policy makers work 
together on solutions and if investors are properly educated so 
they can protect themselves. Thank you very much.
    [The prepared statement of Mr. Bradley Skolnik can be found 
on page 116 in the appendix.]
    Chairman Kelly. Thank you very much, Mr. Skolnik. I hope 
that anyone who receives a transcript or has any indication of 
what you've just said who is an investor will listen and act 
upon those seven suggestions. Thank you for putting them into 
the record.
    We go now to Mr. Lackritz.

 STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY 
                          ASSOCIATION

    Mr. Lackritz. Thank you, Madame Chairwoman, and Members of 
the Subcommittee. Thank you very much for the opportunity to 
testify today to describe the regulatory structure of the 
securities industry which I know you've already heard a little 
bit about, the efforts that we're making to continually improve 
compliance and prevent fraud, and a new investor education and 
information efforts underway to help empower investors and 
prevent this kind of incident.
    The securities industry is profoundly concerned whenever an 
investor loses money through fraud and we share your 
Subcommittee's outrage over this particular incident. Indeed, 
we're embarrassed that this type of fraud has even occurred 
because although it happens only rarely, it simply should not 
occur at all. Our industry prides itself on our dedication to 
ensuring the highest ethical standards among our professionals 
and our deep commitment to earn the public's trust and 
confidence that the markets operate fairly with complete 
integrity. When that trust and confidence are undermined in any 
way, our reputations are diminished and investors become more 
reluctant to provide the capital that companies need to grow 
and flourish, employ more workers and provide financial returns 
that boost our nation's prosperity. That's why we have no 
tolerance for those who have broken the law and we believe that 
bad actors should be prosecuted to the full extent of the law.
    Although this, episode of fraud is egregious and 
unacceptable, it is important to note how rare these incidents 
are. More than 99.99 percent of all transactions result in no 
complaints, a record that other industries and professions 
envy. Since 1995 the increases in dollar volume in securities 
transactions dwarf the increase in complaints. Every single day 
nearly $700 billion in transactions clear and settle on the 
stock and debt markets based on a handshake, a nod, a hand 
signal, a keystroke or a phone call. This would not be possible 
without strong, fair regulatory scheme that protects investors 
and ensures the integrity of the markets.
    The securities industry multi-tiered regulatory structure 
makes them amongst the most highly regulated industries. The 
first layer of investor protection occurs within the brokerage 
firm itself. Broker dealers are responsible for complying with 
every law and regulation pertaining to their business, 
including the strict supervision of all personnel. They must 
also comply with mandatory continuing education programs.
    SROs, the second tier of regulation, verify that brokerage 
firms have systems and procedures in place to manage themselves 
properly and to comply with securities regulations, review 
firm's books and records, and administer tests and supervise 
the industry's mandatory continuing education requirements. 
They also create a compliance system by which individuals and 
securities firms can police their own activities. For example, 
the NASD regulation maintains a public disclosure program on 
its website. I've give you that address in my written 
testimony, as well as a toll-free telephone number that 
provides disciplinary information on all licensed securities 
brokers. This resource which we believe is unique in any 
profession, enables investors to know instantly whether a 
broker with whom they are considering doing business has ever 
had disciplinary action taken against him or her.
    As you know the SEC is charged with preserving the 
integrity, efficiency and fairness of the securities markets by 
administering and enforcing the federal securities laws. And it 
also oversees the SROs. They have a long and successful history 
of detecting fraud and punishing wrongdoers. This year already, 
the SEC brought more enforcement actions in the first quarter, 
61 cases, than it did during the same period last year and in 
taking the helm of the SEC, Chairman Harvey Pitt is refocusing 
the agency's role on catching problems early rather than 
spending years developing a case and then imposing penalties. 
We support this effort and Chairman Pitt's request for more 
resources to expand the commission's legal and enforcement 
staff and we appreciate this Subcommittee's and Committee's 
full support of greater resources for the SEC because a fully-
funded SEC is critical for both the securities industry and our 
customers.
    As you know, Congress is the ultimate overseer and ensures 
that the SEC is fulfilling its responsibility to regulate the 
markets.
    This regulatory structure has been extremely successful by 
fostering the broadest, deepest, most transparent markets in 
the world and now countries across the globe are trying to 
emulate our system. I think we've established a record the 
entire industry can be proud of, the public can rely on and 
other industries can only envy. Yet, once in a while a bad 
actor slips through the structure and defrauds our customers. 
When this happens, the industry works very, very hard to make 
customers whole and to improve our system by detecting and 
stopping fraud. Broker-dealers use sophisticated technology to 
detect abuses. For example, computers compare clients' 
electronically-stored profile against the trades he or she is 
trying to undertake. If the two don't match, the broker-
dealers' compliance officers will scrutinize the activity 
immediately. Market regulators also use advanced state-of-the-
art software and computerized surveillance systems to detect 
and investigator signs of foul play.
    In addition to our efforts to stop fraud before it happens, 
the broker-dealers in the industry are redoubling our investor 
education efforts so that investors will have the necessary 
tools and skills to invest responsibly and avoid being 
defrauded. We have published literally dozens of educational 
brochures and participated in investor town meetings across the 
country organized by the SEC. In addition, we fully support the 
Treasury Department's new campaign for financial literacy, a 
goal our industry has been committed to achieving for more than 
25 years through our stock market gain. More than 600,000 
students in fourth through twelfth grade participate in this 
10-week program that combines basic economic education with an 
investment simulation exercise.
    We also recently launched a new website, 
www.siainvestor.org which provides interactive on-line learning 
tools that addresses investors' different needs and it's free 
to anyone that accesses it.
    The securities industry works in concernt with government, 
regulators and self-regulatory organizations to promote a 
culture of trust and confidence which are our most important 
assets. In such an environment, innovation soars, competition 
thrives and investor confidence flourishes. We will continue to 
work together to eliminate any and all incidents of wrong-doing 
through effective leadership, compliance, self-regulation and 
more investor education. These actions will help maintain and 
enhance the public's trust and confidence which is good for 
investors, good for our industry and good for our country.
    Thank you very much.
    [The prepared statement of Mr. Marc Lackritz can be found 
on page 122 in the appendix.]
    Chairman Kelly. We thank you. I'd like to open the 
questioning with a question to Mr. Kaplan and Mr. Hommel. Have 
you contacted Mr. Fazio and Ms. Stout with regard to their 
accounts because they said here, today that you have not?
    Mr. Kaplan. I can begin. I did hear their testimony. I have 
not personally spoken to them. I have personally spoken to many 
of Mr. Gruttadauria's clients. The only thing that I can say, 
Chairperson Kelly, is that we are committed to reaching a 
resolution, a fair resolution with each of these clients. It is 
very difficult, we understand, for these clients to have gone 
through this. We are committed to that process. We understand 
that it has been a long one, but this is one that we are 
committed to and one we have devoted a tremendous amount of 
resources to.
    Chairman Kelly. Mr. Kaplan, if I understand the testimony 
here this morning, Mr. Gruttadauria had less than 500 clients, 
is that correct?
    Mr. Kaplan. I believe that may be generally accurate, 
correct.
    Chairman Kelly. And Mr. Kaplan, all of this happened, the 
problem became apparent as I understand it, in January. How 
long do these people have to wait before they get some kind of 
contact from your company?
    Mr. Kaplan. I agree with the Chairperson that this process 
has not moved as quickly as we would like and I know the 
clients would like. As I indicated in our oral statement, the 
process for us of unraveling this scheme has been a very 
complex one and one that has required a lot of time and a lot 
of resources.
    As I indicated, this for us, has not just meant reviewing 
the two years that he worked at SG Cowen, but we have gone back 
to look at all of the records while he worked at Cowen and 
Company and this has required us to piece together each of the 
individual transactions in each of the accounts which, because 
of the way records were kept, has required a manual review of 
all of those records. We have devoted at this time about $4 to 
$5 million to try to recreate these accounts. This has meant 
scores of lawyers, scores of accountants. We recognize the 
urgency. We appreciate your efforts and you have our pledge 
that we will work as quickly as possible to try and reach a 
fair and equitable resolution with those clients.
    Chairman Kelly. Mr. Hommel, you have not answered these 
questions. Will you, please?
    Mr. Hommel. Madame Chairwoman, within 30 days after Mr. 
Gruttadauria's disappearance, I personally met with Ms. Stout 
in her home in Elgin, Illinois, as well as with Mr. Fazio and 
his counsel, Mr. Kranz, in Mr. Kranz' office in Cleveland. We 
also met with representatives or the clients of 24 of the other 
families who were involved in Mr. Gruttadauria's scam. The 
purpose of the meeting was to make sure that these folks had 
the information that we had so that we were all dealing with 
the same set of facts, and in fact, many of the folks did not 
have their actual account statements. We brought them with us 
and gave them to them. We asked them to show us the false 
account statements that they were receiving so that we knew 
what they were receiving and from that point forward, we've 
engaged them, in some instances with greater success than in 
others, in discussions that are designed to ultimately lead to 
a resolution of this situation.
    Chairman Kelly. Mr. Kaplan, you're aware, I know, of the 
New York Stock Exchange 1998 enforcement action against Cowen. 
Can you discuss with us the changes, if any, that the firm made 
to address the failure to reasonably supervise branch office 
managers acting in the capacity of registered representatives, 
that that terminology was in that report. Can you address that?
    Mr. Kaplan. Yes. Shortly before SG Securities acquired 
Cowen and Company, Cowen and Company did enter into a consent 
order with the New York Stock Exchange that related to a number 
of different issues. As a result of that consent order, SG 
Cowen implemented a number of changes. It hired a number of 
additional personnel in the compliance department, including a 
new director of branch examination whose role was to go out and 
conduct audits of each of the branches. There was a compliance 
committee formed at the very top of the company to review both 
the progress with this order and to review generally the 
compliance procedures. There were personnel changes in the 
margin department and there were supervisory changes within the 
firm. I do know from looking back at this material that six 
months later, an outside independent law firm came and reviewed 
the changes that were made. That law firm certified to the 
Exchange and certified to the executives at SG Cowen that 
changes, in fact, were made. The issue that you raise is an 
important one, which is whether those changes could have 
prevented this fraud from happening. That is an issue that we 
are looking at as well. That is an issue that we are 
cooperating on with the New York Stock Exchange.
    Chairman Kelly. Thank you. I'm out of time and I'm going to 
go now to Ms. Jones.
    Ms. Jones. Thank you, Chairwoman Kelly. Let me say at the 
outset to all the panelists I have 5 minutes. I'm going to ask 
short questions. I'd like short answers, if you could 
facilitate me, please.
    Mr. Kaplan, during the period of time that Mr. Gruttadauria 
was employed with SG Cowen, how much money did you make from 
his trades?
    Mr. Kaplan. I am not sure.
    Ms. Jones. Could you get an answer for me, sir?
    Mr. Kaplan. Yes, I will.
    Ms. Jones. It was more than $2 million, $3 million, $4 or 
$5 million that you could say that, could you not, sir?
    Mr. Kaplan. I can't speculate, but I will provide you with 
that exact information.
    Ms. Jones. How much money did SG Cowen make in 1995?
    Mr. Kaplan. We did not acquire Cowen and Company and Mr. 
Gruttadauria until 1998.
    Ms. Jones. How much did you make in 1998?
    Mr. Kaplan. Again, I apologize that I do not have those 
specific figures.
    Ms. Jones. You understand why I'm asking these questions, 
do you not, Mr. Cowen
    Mr. Kaplan. You are right to focus on those issues. I 
apologize that I don't have the answers for you right now.
    Ms. Jones. In fact, the people who lost dollars as a result 
of his conduct--strike that. You do understand that you are 
responsible for the conduct of Mr. Gruttadauria, do you not, 
sir?
    Mr. Kaplan. We understand our responsibility here.
    Ms. Jones. That wasn't my question. My question is that you 
do understand that you are responsible for the conduct of 
Gruttadauria?
    Mr. Kaplan. We do understand that and, as I indicated, we 
are committed to reaching a fair and equitable resolution with 
his clients.
    Ms. Jones. There may be a little question as to what is 
fair and equitable in light of the fact that Mr. Gruttadauria 
represented to these people and they relied upon his 
representation that they have a certain amount of money when 
you may now come and say well, the real thing you have was X, 
but I have a piece of paper that said I had 10 times that?
    Mr. Kaplan. Well, I think that is one of the issues that 
will go into the decision or the discussion as to what is a 
fair and equitable resolution. There are clients--
    Ms. Jones. Thank you very much. I hate to cut you off. Let 
me go on now to Mr. Hommel. Pronounce it for me, sir?
    Mr. Hommel. Hommel.
    Ms. Jones. Hommel. How much did you make even though you 
only had Mr. Gruttadauria, at least that's your statement work 
for you for only 18 months, how much money did you make from 
his trading?
    Mr. Hommel. I also do not have precise figures for you, but 
I would note that the trading activity during Mr. 
Gruttadauria's tenure at Lehman Brothers was very, very low.
    Ms. Jones. That wasn't the question I asked you.
    Mr. Hommel. I don't know, ma'am.
    Ms. Jones. You can get that information for me, can you 
not, sir?
    Mr. Hommel. I will.
    [The following information was subsequently furnished by 
Mr. Thomas E. Hommel for the hearing record.]
        [During the period of time Mr. Gruttadauria was 
        employed by Lehman Brothers Inc. the gross revenue 
        generated by transactions in the accounts serviced by 
        him was $3,122,515. Mr. Gruttadauria's total 
        compensation for salary and sales credit for that same 
        time frame was approximately $1,007,000.]
    Ms. Jones. Can you tell me who Mr. Steve Lessing is?
    Mr. Hommel. Mr. lessing is the head of sales for our 
organization.
        [From 1996 through April 2000, Stephen M. Lessing was 
        Head of Global Sales and Research of Lehman Brothers 
        Inc., responsible for the Firms's Fixed Income and 
        Equity Sales and Research organizations, as well as the 
        Private Client Services business. In April 2000, Mr. 
        Lessing became the Senior client Relationship Manager 
        for the Firm and Head of the Private Client Services 
        Group.]
    [The following information was subsequently furnished by 
Mr. Thomas E. Hommel for the hearing record.]
    Ms. Jones. How long has he worked for Lehman Brothers?
    Mr. Hommel. Mr. Lessing has been there for at least as long 
as I have which is 16 years, but I don't quite know the exact--
        [Mr. Lessing has worked for Lehman Brothers for 22 
        years.]
    Ms. Jones. Okay, and what was his supervisory authority, 
sir?
    Mr. Hommel. He is basically the global head of sales.
        [As head of Private Client Services, Mr. Lessing had 
        general executive responsibility for the operation of 
        that business, but was not the day-to-day business 
        head.]
    Ms. Jones. Then he had oversight over Mr. Gruttadauria?
    Mr. Hommel. That would include institutional sales, retail 
sales, sales in many different forms.
        [From October 2000 to January 22, 2002, Mr. 
        Gruttadauria was employed in the Private Client 
        Services business of Lehman Brothers.]
    Ms. Jones. The answer is yes or no, sir.
    Mr. Hommel. Yes ma'am.
    Ms. Jones. Okay, thank you. And what was he paid, sir?
    Mr. Hommel. I don't know, ma'am.
    Ms. Jones. Can you get that information for me?
    Mr. Hommel. I will do so.
        [For the fiscal year 2001, Mr. Lessing was paid a 
        salary of $450,000 and received a cash bonus of 
        $2,050,000. He also received $2.5 million worth of 
        restricted stock units which will vest over a period of 
        five years in accordance with the terms of the plan 
        pursuant to which they were issued. Mr. Lessing also 
        received options for the purchase of 300,000 shares of 
        Lehman Brothers Holdings Inc. stock.]
    Ms. Jones. And you can also get for me the information as 
to how much money you made as a result of the sales by Mr. 
Gruttadauria.
    Mr. Hommel. We will do that.
    Ms. Jones. Let me go on a little bit. There's an article 
dated April 27th that says the SEC accuses Mr. Gruttadauria of 
stealing client money for himself and using some of it to 
shower Ms. English with $600,000 in cash and $100,000 worth of 
gifts. Let me take you to the NASD standards for discipline and 
somewhere it's either there or one of your other people who 
testified said that is a signal for a broker to not be giving 
gifts to other employees in the firm. I'm not quite saying it 
correctly, but you understand what I'm saying to you, don't 
you, sir?
    Mr. Hommel. Yes, we have a policy which prohibits managers 
from making such gifts.
    Ms. Jones. In fact, could you find out for me how much 
money was showered upon Ms. English as a result of the conduct 
of Mr. Gruttadauria and if, in fact, it was in violation of 
your standards, what you did about it?
    Mr. Hommel. We will endeavor to do that. Of course, we may 
not have all the information necessary to get a complete 
picture. Ms. English would be in a better position to do that.
        [We are not in possession of any records or information 
        regarding the value or extent of any gifts allegedly 
        given by Frank Gruttadauria to Laurie English. Lehman 
        Brothers was unaware of any such gifts.]
    Ms. Jones. Let me ask you. What is a Lehman Brothers policy 
with regard to a broker, a branch office manager supervising a 
compliance officer and then who supervises a branch office 
manager? All right, who didn't want me to talk? It's okay. I'm 
going to go anyway. Who supervises the branch office manager in 
his investment and trading?
    Mr. Hommel. In this instance, Mr. Gruttadauria had a direct 
reporting line into the regional management office in Chicago, 
so he was supervised directly by the regional manager in 
Chicago and the regional office in Chicago.
    Ms. Jones. And who was that person?
    Mr. Hommel. The regional manager in Chicago's name is 
Michael Smith.
    Ms. Jones. Was he the regional manager at the time that Mr. 
Gruttadauria was employed by your company?
    Mr. Hommel. He was.
    Ms. Jones. How much money did he make as a result of the 
trading of Mr. Gruttadauria?
    Mr. Hommel. I do not know.
    Ms. Jones. You can get that information for me as well?
    Mr. Hommel. I'd be happy to get that for you.
    Ms. Jones. Thank you very much.
        [There was no direct relationship between revenues 
        generated by Frank Gruttadauria and Michael Smith's 
        compensation.]
    Chairman Kelly. You're out of time.
    Ms. Jones. I'll come back.
    Chairman Kelly. Would you like to have those articles that 
you held entered into the record?
    Ms. Jones. Yes ma'am, thank you very much.
    Chairman Kelly. With unanimous consent, so moved. Mr. 
Tiberi.
    Mr. Tiberi. Thank you, Madame Chair. To Mr. Kaplan and Mr. 
Hommel, did Lehman and Cowen have a policy requiring disclosure 
of a special fiduciary relationship and I'm speaking to the 
issue of Mrs. Cuneo who passed away in 1997 and the fact that 
Mr. Gruttadauria was named executor of her estate.
    Mr. Kaplan. On behalf of SG Cowen, I am not sure what the 
firm's policy was at that time as to individual brokers acting 
as trustees for client accounts.
    Mr. Tiberi. Can you get us that information?
    Mr. Kaplan. I can.
    Mr. Tiberi. And can you get us that information of what--
well, it wouldn't apply to you. Mr. Hommel?
    Mr. Hommel. Yes. I can tell you that if a firm employee 
were to accept responsibilities in that capacity, it would have 
to be disclosed. I will let you know whether or not there was a 
prohibition on that, but I can tell you that if there were an 
acceptance of those responsibilities it would have to be 
disclosed to the compliance department of the firm.
        [S.G. Cowen approved of Mr. Gruttadauria acting as the 
        broker for the Estate of Anne Cuneo with respect to 
        which he acted as the Executor. Since that account was 
        acquired by Lehman, the relationship remained in place. 
        At Lehman, the decision whether to allow a broker to 
        service an account where he or she may be acting in a 
        fiduciary capacity is made on a case-by-case basis.]
    Mr. Tiberi. Do you know, to your knowledge, did anyone 
check those disclosures in Mr. Gruttadauria's case?
    Mr. Hommel. I don't know.
        [There is no record of any inquiry with respect to Mr. 
        Gruttadauria acting as Executor of the Estate of Anne 
        Cuneo.]
    Mr. Tiberi. You can find out?
    Mr. Hommel. We will find out for you.
    Mr. Tiberi. Thank you. Continuing, Mr. Hommel, are the 
press reports accurate that your firm gave Mr. Gruttadauria a 
$5 million bonus to remain in the Cleveland office and run it?
    Mr. Hommel. We paid Mr. Gruttadauria a $5 million retention 
bonus as part of that acquisition, as we paid a retention bonus 
to the other brokers of Cowen who came over to Lehman Brothers. 
We believe that that is commonplace in these types of 
transactions. I personally don't know of any transaction 
involving the sale and purchase of retail assets that did not 
involve retention bonuses for the simple reason that ours is a 
very fluid industry from the employment perspective. Brokers 
are free to go to whomever they'd like to work with.
    Mr. Tiberi. Thank you. With that purchase, did you also 
accept their liabilities and their assets?
    Mr. Hommel. I'm sorry?
    Mr. Tiberi. With that purchase, did you accept their 
liabilities and their assets?
    Mr. Hommel. No, we didn't. We purchased accounts and the 
asset purchase agreement is very clear that we did not accept 
liabilities.
    Mr. Tiberi. During the purchase, were you aware of the 1998 
fine against that office from the New York Stock Exchange?
    Mr. Hommel. Yes, we were.
    Mr. Tiberi. You were. And Mr. Kaplan, just to follow up on 
Ms. Kelly's question earlier, you said you had met with victims 
or met with some of the victims. What efforts have been made by 
Cowen to fully make the victims whole?
    Mr. Kaplan. At this point our efforts have been focused on 
trying to understand what happened in each individual client's 
accounts. As I indicated in my oral testimony, this scheme was 
perpetrated by shifting monies from one account to another 
account. In order to understand what is a fair and equitable 
resolution with each client, we must understand how much a 
client put in and how much a client took out. That process has 
involved a tremendous amount of work and when we complete that 
process, we will meet with each of the clients to reach that 
resolution.
    Mr. Tiberi. What's the time line, Mr. Kaplan, do you have 
any idea?
    Mr. Kaplan. I hope to complete that process within the next 
several months.
    Mr. Tiberi. I yield the balance of my time to Mr. 
LaTourette.
    Mr. LaTourette. Thank you very much, Mr. Tiberi. Mr. 
Kaplan, on October 15 of 1997, the New York Stock Exchange sat 
down with counsel for Cowen, I believe they're Wilke, Farr and 
Gallagher, and during the course of that and that had to do 
with the allegation of violation of New York Stock Exchange 
Rule 342, failure to supervise in accordance with those 
procedures. And then in the response document, do you have your 
response document from that time with you?
    Mr. Kaplan. I do not have it, sir, although I have some 
familiarity with it.
    Mr. LaTourette. Okay, and Madam Chairwoman, I'd ask 
unanimous consent that this response document be made part of 
the record and I'd ask that the document be supplied to Mr. 
Kaplan so that he can refer to it. But the salient points are 
that Cowen promised a sea of changes relative to the 
investigation by the New York Stock Exchange and in pertinent 
part on page 76 indicates Cowen recognizes the concern that 
arises from a situation in which the operations manager is 
placed in a position of supervising to even a limited extent 
the individual to whom he or she reports. Does that comport 
with your response to the New York Stock Exchange's inquiry?
    Mr. Kaplan. Well, again, SG Cowen or SG Securities, when it 
purchased Cowen and Company in 1998, was made aware of this 
consent order and, as I indicated, implemented a number of 
changes in conjunction with the Exchange. In order to address 
these very problems raised by the Exchange, it is clear that 
that is one of the issues that we are looking into as to 
whether those changes could have caught someone like Mr. 
Gruttadauria who perpetrated this scheme.
    Mr. LaTourette. When Mr. Doherty met with me the other day, 
he indicated that the $385,000 fine levied by the New York 
Stock Exchange, only 12 fines have been larger in the history 
of the Exchange. I don't ask you to comment on that, but the 
question is if the statements in that pleading were true, when 
SG Cowen acquired the business in 1998, it's my understanding, 
even though you couldn't answer Ms. Tubbs-Jones' question that 
Mr. Gruttadauria generated for SG Cowen $5 million in 1998 and 
$5 million in 1999 as commission. Now I'll ask you to go back 
and check that out. And my question is, if that's true, and I'm 
going to ask you to assume that that's true, how, by examining 
the accounts that you took possession of in 1998, could there 
ever be a justification for fees or commissions of $5 million 
produced by this man? The amount of equity in the accounts 
versus what the commissions were, if you accept my statement 
that he earned $5 million for your firm, they don't match and 
why didn't that do something to you guys? Why didn't that raise 
a red flag? Why didn't that come to anybody's attention?
    Mr. Kaplan. Mr. Gruttadauria, as we have heard all of this 
morning, put together a very complex and sophisticated scheme. 
You heard how he gained the trust of his clients. He betrayed 
the trust of these clients. One of the things that we're 
looking into is whether this was a matter of someone who put 
together a very complex and sophisticated scheme that evaded 
detection by all of the firms he worked for, firms that 
conducted due diligence, and by their compliance departments 
and their supervisors. That is one of the issues that we know 
we are obligated to address to this panel, his former clients 
and to the Exchange. That is a very important issue. I cannot 
at this point indicate how that took place.
    Mr. LaTourette. Madam Chairwoman, I see Mr. Tiberi's time 
has expired. If I might continue on my own time?
    Chairman Kelly. By all means, proceed.
    Mr. LaTourette. Thank you very much. Mr. Hommel, that 
raises a question of you and I'll ask you to assume for the 
purposes of my question that, in fact, Mr. Gruttadauria did 
earn commissions for SG Cowen of $5 million in 1998 and 1999, 
but regardless of what the number is, during the course of the 
due diligence conducted by Lehman, you would be aware of what 
his potential was or what he had generated for Cowen or no?
    Mr. Hommel. We would know what his production statistics 
were, yes.
    Mr. LaTourette. For 1998 and 1999?
    Mr. Hommel. Yes.
    Mr. LaTourette. If I'm correct that for both years it was 
$5 million or there abouts and if you are correct that most of 
the thefts that occurred prior to the transfer of these 
accounts from SG Cowen to Lehman Brothers, does that not raise 
some question in your mind how accounts that you say have a 
diminished value, by the time you receive them, have produced 
$5 million in commissions for SG Cowen in the two previous 
years?
    Mr. Hommel. Certainly in retrospect, as we look at it now. 
As we looked at it then, looking at the New York Stock Exchange 
investigation and the results of it and Mr. Gruttadauria's 
statistics, there was nothing to indicate to us at that point 
that whatever commission level Mr. Gruttadauria earned in 1998 
and 1999, was through the use of anything but trading on a 
legitimate basis with his accounts.
    Mr. LaTourette. And Mr. Kaplan, back to you. We've heard 
talk about the 1993 anonymous complaint filed with the 
Securities and Exchange Commission and how that was resolved. 
Were you aware of that, sir?
    Mr. Kaplan. No. As I indicated, SG Securities did not 
acquire the firm until five years later. We first learned of 
this anonymous complaint as it hit the press yesterday. We have 
checked our records and we have seen no evidence of that in any 
of the due diligence or in his files.
    Mr. LaTourette. And Mr. Hommel, the same question to you. 
Before it was reported in the press, yesterday, did you have 
any indication of this 1993 complaint?
    Mr. Hommel. No, none whatsoever.
    Mr. LaTourette. Mr. Kaplan talked about perhaps this was a 
fellow who was engaged in a rather elaborate scheme, sort of 
indicating a uniqueness to it, but what Mr. Gruttadauria was up 
to was not unique at all. This has happened before, has it not, 
this same pattern of behavior, Mr. Hommel?
    Mr. Hommel. I don't see this as a pattern of behavior that 
we have experienced before.
    Mr. LaTourette. You do not see it?
    Mr. Hommel. No, if you're referring to--
    Mr. LaTourette. Let me get to that. I think that Mr. Daouk 
and when you were in my office, you indicated that Mr. Daouk is 
different because he was a referring broker, as opposed to 
someone who is an employee and I guess that I became surprised 
then when I read the District Court decision from 1998 that 
indicated that Lehman effectively made WIS, Mr. Daouk's company 
its de facto branch office. And as I understand the facts in 
the Daouk case which is currently--is it resolved yet?
    Mr. Hommel. No, it's still pending.
    Mr. LaTourette. Then it was pending at the time that you 
were doing your due diligence in an attempt to purchase SG 
Cowen's retail business, was it not?
    Mr. Hommel. It was.
    Mr. LaTourette. It's my understanding that in the Daouk 
matter, Mr. Daouk had created new signatures for clients to 
allow them to authorize future transactions, that he had 
prepared and distributed forged monthly account statements, 
that he had used a personal off-network computer and that he 
had established post office boxes where he intercepted the 
client information sent from Lehman and that he churned 
accounts in order to generate excess commissions which were 
shared by both he and Lehman Brothers.
    Is it your observation that that pattern of conduct that 
Mr. Daouk is accused of engaging in is significantly different 
from Mr. Gruttadauria's behavior?
    Mr. Hommel. I do.
    Mr. LaTourette. And can you explain to me why you think 
that is so?
    Mr. Hommel. I think that because first, Mr. Daouk was never 
an employee of Lehman Brothers. He was never an employee of 
Shearson Lehman Brothers. He was an employee of E.F. Hutton 
back in the mid-1980s in its Beirut office. E.F. Hutton closed 
its Beirut office in 1986 and the office was taken over by a 
firm called World Investor Services which never had any direct 
affiliation with Shearson Lehman Brothers or Lehman Brothers. I 
think the passage you're referring to is the court's recitation 
of an allegation in the complaint.
    However, the fact is that World Investor Services entered 
into an introducing broker relationship with E.F. Hutton to 
which Shearson Lehman Brothers succeeded when Shearson bought 
Hutton in late 1987 or early 1988. That contractual 
relationship persisted through 1992 when the business left us. 
Mr. Daouk worked for an introducing broker that referred 
accounts to E.F. Hutton and later to Shearson Lehman Brothers. 
They were the primary point of contact with those clients. The 
clients were predominantly Lebanese nationals with some Saudi 
nationals. The accounts were largely opened in the mid-1980s 
when there was a civil war in Lebanon. Mail service was 
sporadic, if existent at all, and post office boxes to my 
understanding, were in wide use. In any event, we never had 
direct contact with these clients. Mr. Daouk, as the referring 
broker, did. He also took discretion on the accounts so that 
Shearson Lehman Brothers and Hutton before them, essentially 
acted as a clearing broker for these trades.
    Mr. LaTourette. The two accountant firms, accountancy firms 
that Mr. Gruttadauria established, I'll find my notes, but 
basically where these statements were going, WJS and DH--
    Mr. Hommel. One is an actual accounting firm.
    Mr. LaTourette. Which one is an actual accounting firm?
    Mr. Hommel. I believe it's DeGrandis and DeGrandis.
    Mr. LaTourette. Okay. And then how many of the fraudulent 
statements were going to--the real statements were going to 
that accounting firm.
    Mr. Hommel. There's a universe of 40 accounts that were 
transferred over. There were 60 accounts for which false 
accounts were created, but a number of them had--they were 
fictitious in their entirety, that is, there was no 
corresponding Lehman Brothers account. For the 40 accounts that 
came over from Cowen for which fictitious account statements 
were created, but for which real accounts did exist, 30 of 
those account statements were diverted to one or the other of 
the accounting firms. Seventeen, I believe, went to JYM 
Accounting. JYM had a post office box. Those 17 were--17 of the 
18 of the accounts that had post office boxes. The other one 
happened to be a legitimate account so that the customer was 
actually getting the fake statement and the real statement with 
the same number at the same address. However, 30 of the 40 went 
to the accounting firms. Seventeen of them went to the post 
office boxes in the name of JYM.
    Mr. LaTourette. Were you in the room when the first panel 
testified?
    Mr. Hommel. I was.
    Mr. LaTourette. You had the opportunity to listen to those 
folks. The exhibits that we put up relative to the activity, 
just based upon your experience and how you guys run your 
firms, the activity of Mr. Fazio's account in 1990 that we had 
on the chart, is there anything that in your experience would 
have triggered perhaps an inquiry by members of your firm had 
you been aware of it?
    Mr. Hommel. I think that those numbers may have triggered 
some type of response from compliance supervisory systems, but 
to say out of context right now what our reaction would have 
been back then had it been us instead of some other firm, I 
don't think that I can speak to that.
    Mr. LaTourette. How about you, Mr. Kaplan?
    Mr. Kaplan. I have the same response. Without knowing Mr. 
Fazio and what his intentions are and investment philosophy, it 
is hard for me to speculate as to what actions would have been 
taken at the time.
    Mr. LaTourette. Do you think, when we were talking to Ms. 
Richards from the SEC, that perhaps it would at least cause you 
to make an inquiry of the investor? Were they sort of this 
hyperactive investor that wanted to turn over their account 18 
times in six months?
    Mr. Kaplan. It is traditional in our industry that our 
compliance officers, when they see an account with an unusual 
activity, that they will make contacts with the client to 
ensure that that trading is consistent with what they want.
    Mr. LaTourette. How about you, Mr. Hommel?
    Mr. Hommel. I would agree with Mr. Kaplan's statement on 
that point.
    Mr. LaTourette. Thank you very much. Thank you, Madam 
Chairman.
    Chairman Kelly. Thank you very much. The questions here, I 
know that they seem difficult, but on the other hand, they're 
very, very important to us in terms of understanding what has 
gone on here and what our need is to respond to this.
    I'd like to address a question to you, Mr. Sibears. Since 
we know that the SEC had a clear indication of churning in 
1993, and the stock exchange performed some review of the 
Gruttadauria accounts in 1994 which might have caught him, I 
have to ask you, did the NASD ever review specific customer 
account statements of Gruttadauria clients?
    Mr. Sibears. Chairman Kelly, we have gone back and done an 
exhaustive review of the records of the exams that we've 
conducted of firms that Mr. Gruttadauria was associated with 
and we've not been able to detect any accounts that we have 
reviewed in the course of examination program that were 
accounts of Mr. Gruttadauria's clients.
    Chairman Kelly. Mr. Sibears, I find that a very interesting 
statement since there was obviously some question here in 1993. 
Again, 1998, there were some flags raised and yet there's no 
record of your looking back at what happened here, is that 
correct?
    Mr. Sibears. Well, we certainly have a record of what 
examinations that we conducted that related to the firms in 
question, but as Mr. Doherty testified to, the New York Stock 
Exchange has a number of firms that are members of the New York 
Stock Exchange. I don't believe, at least his oral testimony, 
mentioned the fact that some of those firms, in fact, virtually 
all of those firms, not everyone, are dual members of the New 
York Stock Exchange and the NASD. And we have a very highly 
cooperative program between the New York Stock Exchange and the 
NASD that is designed to ensure that firms do not receive any 
kind of regulatory overlap or unnecessary duplication.
    So, for example, in a firm like these that we've been 
talking about, when we did our reviews of Cowen and Lehman, our 
focus tended to be not on financial issues or operational 
issues, but on things that were unique to our jurisdiction such 
as municipal underwritings, private securities transactions, 
trading of market making rules that are unique to our authority 
as a regulator so as to avoid the overlap. So in this kind of 
instance, it wouldn't be particularly unusual.
    Chairman Kelly. On page 5 of your testimony, sir, you go 
into great detail about the number of scams that the NASD has 
found that are carried out through the use of bogus post 
offices or bogus addresses. You mentioned that you sent a 
member alert highlighting that concern to your member firms. 
Can you tell me when you sent that member alert?
    Mr. Sibears. Yes. We sent that on January 28th and what we 
did was--
    Chairman Kelly. January 28th of this year?
    Mr. Sibears. 2002 and it was posted to our website which 
we--is our standing operation procedure now, to get the 
broadest attention and audience.
    Chairman Kelly. You also mentioned that you revised your 
examination procedures with this regard. Can you tell me when 
you made those revisions?
    Mr. Sibears. That was earlier in this year and the 
revisions that we talk about in that testimony were directly 
related to the Gruttadauria matter. We did have certainly a 
number of very extensive supervisory procedure examination 
steps, but those procedures in that exam protocol was refined 
as a result of this matter.
    Chairman Kelly. All right, thank you very much. I have one 
question for all of the witnesses and that is do you think that 
the regulators need any new authority to enable them to 
specifically detect this type of fraud, the type of fraud that 
was demonstrated by Mr. Gruttadauria and I'm asking all of you.
    Mr. Lackritz, why don't we start with you?
    Mr. Lackritz. Thank you, Madame Chairwoman. We would 
strongly support increased resources for enforcement of the SEC 
as I mentioned in my testimony. We strongly appreciated and 
supported your Committee's action to increase the authorization 
of the SEC, specifically for enforcement activity and I think 
that's the main area that we would recommend changing.
    Chairman Kelly. Mr. Skolnik, have you a comment?
    Mr. Skolnik. Madame Chairwoman, I believe that the 
securities laws presently in place and the authority that state 
regulators, as well as federal regulators and SROs have is 
adequate. I do concur, I think that regulators at all levels 
probably need more resources to deal with the demands that have 
been created by just the vast increase in the number of 
investors who have entered our capital markets in the last 
couple of decades.
    Chairman Kelly. Mr. Sibears?
    Mr. Sibears. With the caveat, Madame Chairman, that 
hopefully we can supplement the record after we talk about this 
a little bit more back at the NASD because I've been thinking 
of your question since you asked Mr. Doherty and Ms. Richards. 
I think it's an incredibly important question, but it strikes 
me that we have very good and very broad authority and the 
important thing is the ability to both try to be very proactive 
and catch these problems through our processes before they 
occur and have the flexibility to very quickly amend our 
procedures and refocus our examination and enforcement programs 
once something is brought to our attention which, for example, 
in this case, we were able to do. But I would hope to be able 
to possibly even respond to this while the record is open more 
fully.
    Chairman Kelly. Mr. Hommel, Mr. Kaplan, would either one of 
you like to respond?
    Mr. Hommel. We believe that the current regulatory scheme 
is adequate to protect the interest of investors. We firmly 
believe that actually our compliance systems were the reason 
that Mr. Gruttadauria's scheme came to an end.
    Chairman Kelly. Mr. Kaplan?
    Mr. Kaplan. I would agree that increased resources is 
critical for the SEC and its audit function. However, these 
regulators cannot be everywhere. They cannot look at every 
account and I think each member firm, has an obligation to make 
sure that we maintain a review of our clients, a review of our 
employees. That obligation is on us as well.
    Chairman Kelly. Thank you. Thank you very much. Ms. Tubbs-
Jones, do you have any more questions for this panel?
    Ms. Jones. Lots. I only have 5 minutes. Mr. Hommel, did you 
say that you believe it was your compliance system that brought 
to light the conduct of Mr. Gruttadauria?
    Mr. Hommel. We think that our compliance systems 
contributed to the fact that he went underground when he did.
    Ms. Jones. Now there's a difference in contributing and 
bringing to light. You do understand the distinction between 
the words?
    Mr. Hommel. I didn't mean to say anything other than that 
our compliance systems contributed to the fact that he did.
    Ms. Jones. I accept that change in your statement, sir. Did 
you also say that you had an asset agreement that when the--the 
accounts transferred from SG Cowen or whatever the name of the 
company--
    Mr. Hommel. We purchased assets from SG Cowen. The assets 
were the accounts.
    Ms. Jones. And did you say that your agreement, in the 
agreement you did not accept any liabilities?
    Mr. Hommel. No, the agreement we feel is quite clear that 
any liabilities that arise from the operation of that business 
prior to the closing date of the transaction remained with SG 
Cowen.
    Ms. Jones. But any liabilities that result from any conduct 
after the date of that transaction, you are responsible for?
    Mr. Hommel. That's correct.
    Ms. Jones. Is that a fair statement?
    Mr. Hommel. That is a fair statement.
    Ms. Jones. Making that statement then, can you tell me when 
you will respond to all these folks seated in the audience for 
that liability?
    Mr. Hommel. Well, we have responded to some of them, as I 
said in my opening statement. We have reached interim 
resolutions with some of the clients where we've identified 
misappropriated funds. We have credited those clients. If I 
may, with respect to the folks in here and many other folks, 
we're in a difficult position in that the assets that came over 
were pretty much static when they hit Lehman Brothers. That is, 
there was no change in their actual financial situation. That 
is a generalism, but largely true throughout the 40 accounts 
for which false statements were produced.
    Ms. Jones. That's your allegation. According to all these 
people in the room the accounts have changed significantly 
since the time they came from Cowen to Lehman.
    Mr. Hommel. I don't know that that's what they say because 
when they came in, the false account statements carried very 
large balances which over time have not tremendously declined.
    Ms. Jones. So you're saying that most of the people in this 
room were not damaged by the conduct of Mr. Gruttadauria?
    Mr. Hommel. No, I'm not saying that at all.
    Ms. Jones. I don't want to press words with you. Let me 
move on, okay?
    Mr. Lackritz, in your statement, you say that there are 
three levels of regulation or supervision in your industry. The 
first level is investor protection from the brokerage firm. The 
second is the self-regulatory organizations and the third is 
the Securities and Exchange Commission.
    Mr. Lackritz. Yes.
    Ms. Jones. If you were called as an expert witness in the 
lawsuit, all of these good folks against Lehman Brothers, what 
level and I will ask you in your opinion, based on your 
background and experience, sir, at what layer was there a 
breakdown? What layer would that be, 1, 2 or 3? A breakdown in 
the supervision to avoid what we have in place, the losses we 
have in place today, sir.
    Mr. Lackritz. That's a very tough question to answer, 
Congresswoman.
    Ms. Jones. I know I ask tough questions. So give me a tough 
answer, sir.
    Mr. Lackritz. I'll do my best.
    Ms. Jones. Okay.
    Mr. Lackritz. I think that's what the litigation and the 
enforcement actions are in the process of uncovering right now. 
There are facts in each of these circumstances with respect to 
each of these firms. Obviously, there was a breakdown in the 
system and obviously, this was an incident that--I'm 
embarrassed to be here. I'm apologizing on behalf of the 
industry to the victims. In terms of--it was a breakdown 
throughout the process.
    Ms. Jones. So you would assess blame at every level of 
supervision? Or responsibility?
    Mr. Lackritz. Yes, responsibility certainly.
    Ms. Jones. So what would you do to improve, improve every 
level?
    Mr. Lackritz. I think that we have continually place 
emphasis on improving compliance systems and technology in the 
firms which we're doing. We have to continue to increase 
investor education which we're doing and improve compliance 
programs.
    Ms. Jones. Thanks. I've got one last round of questions.
    Mr. Skolnik, let me back up, real quick. Mr. Hommel, did 
you say you didn't learn until very recently about the 1993 
case, sir?
    Mr. Hommel. That's correct.
    Ms. Jones. And Mr. Kaplan, you said the same thing. Is that 
correct?
    Mr. Kaplan. That is correct.
    Ms. Jones. Then Mr. Skolnik, how could every day Joe and 
Stephanie call the NASSA or their state security regulator to 
find out about Frank Gruttadauria if neither of these companies 
who specialize in hiring brokers knew about the 1993 conduct, 
sir?
    Mr. Skolnik. Congresswoman, it's very clear here that these 
investors were vigilant. As we heard today from the testimony 
that I think touched us all, they did carefully scrutinize 
account statements and did ask, I think Mrs. Stout talked about 
how she challenged Mr. Gruttadauria and did ask questions.
    One thing investors can do is to contact their state 
securities regulator to inquire whether the investment 
professional, the stock broker or investment advisor they're 
dealing with is properly licensed to be conducting business and 
to determine if they have any disciplinary history.
    In this case, unfortunately, it would not have necessarily 
have detected any wrongdoing on behalf of Mr. Gruttadauria 
because he did not have a disciplinary record. However, in a 
lot of cases, a lot of enforcement cases and investigations 
that we initiate, we see situations where if investors had 
taken the opportunity to contact a state securities regulator, 
they would have learned that the investment professional they 
are dealing with may have had a disciplinary record or worse 
yet, maybe was not even properly licensed to conduct business.
    Chairman Kelly. Thank you, Ms. Tubbs-Jones.
    Ms. Jones. Thank you, Madame Chairwoman.
    Chairman Kelly. Mr. LaTourette.
    Mr. LaTourette. Thank you, Madame Chairwoman. I'd like to 
throw this open to anyone on the panel because it's a question 
that comes up from time to time. Is there a recognized rule of 
thumb for what the measure of damages should be in the 
situation that we find ourselves in today?
    Mr. Hommel?
    Mr. Hommel. Given the pendency of litigation, I'm a bit 
restrained in what I can talk about. There are several theories 
of recovery that have been advanced by the plaintiffs.
    Mr. LaTourette. I'm not interested in their theories. I 
guess I'm wondering in cases that you've encountered during the 
course of your career is there sort of a rule of thumb that 
this is what this kind of theft is worth?
    Mr. Hommel. I've not encountered a case specifically like 
this in my career, but I would imagine that in approaching the 
situation, what we try to do is define common ground with the 
complaining customers' rooted in the actual cash flows. That 
has been something that has prevented us from moving along in 
the negotiations with some of these folks because, as I said, 
the cash flows at Lehman Brothers simply did not exist in many 
of these accounts.
    Mr. LaTourette. Anyone else have an observation about how 
these things are normally taken care of?
    Mr. Lackritz. I think that in almost all of these 
situations, it's the responsibility of the firm to make their 
clients whole or to treat their clients fairly and in almost 
all of these situations when they occur and it's very rare that 
they occur. I think it's important and I want to stress, the 
system actually works very effectively. Unfortunately, there 
are these rare instances when this kind of behavior occurs and 
when it does, the firms take responsibility to treat their 
customers fairly and make them whole in the circumstance.
    Mr. LaTourette. And I think as I understood Mr. Hommel, we 
can have different definitions of what making them whole means, 
but is there any notion in this type of litigation relative to 
punitive damages as opposed to negligence or not paying 
attention or when someone actually goes out and steals, it's 
under your supervision as appears to be the case here, is there 
any notion of punitive damages in any of the cases that you're 
aware of? If you know. If you don't that's fine. I'm talking to 
you, Mr. Lackritz, I'm sorry.
    Mr. Lackritz. I'm only aware of punitive damages in very 
rare and unusual instances where there's gross and willful 
negligence as opposed to failure to supervise or something like 
that.
    Mr. LaTourette. But in essence, if gross negligence gives 
you punitive, I suppose intentional actions are even higher 
than gross negligence and the other observation I would make is 
that Mr. Hommel has never seen the situation, I guess, I would 
describe this as unique, based upon the breadth of his 
experience.
    Mr. Hommel, let me--you talked about due diligence when 
Lehman bought the business from SG Cowen. Can you describe in a 
little detail for us what that means and specifically does due 
diligence include going into each and every one of Mr. 
Gruttadauria's accounts and physically looking at them or not?
    Mr. Hommel. No, there would be no reason to go into Mr. 
Gruttadauria's accounts at that point. There were almost 100 
brokers who came over with accounts that numbered in excess of 
60,000, so it would require going into 60,000 accounts which is 
fairly impractical. What we did was we reviewed the compliance 
records of every one of the brokers who were coming over and 
for each broker who had one or more entries on his compliance 
record, complaints on his compliance record, we gave them 
special scrutiny. We also did an analysis of the customer 
complaints throughout the Cowen system and we checked all the 
arbitrations and litigations that were pending against any of 
the registered representatives in the system.
    We looked at the Cowen audits going back several years to 
see what was turned up, all of which is, I would submit, 
somewhat standard, but in this instance we also took a look at 
the New York Stock Exchange report and the New York Stock 
Exchange report had several issues that needed to be dealt 
with. As we look back, it appeared that a prominent New York 
law firm had come in, had assisted Cowen, in addressing those 
problems, had made recommendations that were subsequently 
adopted and as we looked at that incident as a whole it 
appeared to us, not as a red flag, but as an indication that 
Cowen had been inspected and corrected.
    Mr. LaTourette. When you say that you looked at any 
complaints filed against the brokers that came over, we know 
today that a complaint was filed against Mr. Gruttadauria in 
1993. Are you saying that the only complaints that you looked 
at were those that resulted in a finding, some sort of adverse 
finding?
    Mr. Hommel. No, we looked at complaints that were on the 
CRD, the Central Registration Depository. There are certain 
requirements that a broker must report, complaints to the CRD, 
so we get the broker's registration file, which is the CRD 
file, and we see any complaints that have been registered 
against that broker. For reasons that were explained before, 
apparently, this 1993 incident did not make it on to Mr. 
Gruttadauria's compliance record.
    Mr. LaTourette. Okay. I thank you. I don't think I have 
anything else.
    Chairman Kelly. Thank you very much. The Chair notes that 
some Members may have additional questions for this Panel and 
they may wish to submit them in writing, so without objection 
the hearing record is going to remain open for 30 days for 
Members to submit written questions and for these witnesses to 
place their responses in the record.
    The Chair also notes that Mr. Fazio and Ms. Stout have 
stayed for this Panel's testimony and let me say that I 
sincerely hope for both of them that this hearing and that 
their testimony will result in better protections for all 
investors. We appreciate the fact that they came such a 
distance and took so much time and I think it's incumbent of 
all of the agencies that have been here, giving testimony today 
that they understand that this is not--it cannot be business as 
it has been in the past. We must have better regulatory 
oversight so this kind of thing and these kinds of people are 
never again damaged. We must have a change. If you need this to 
come from the federal government in the form of a law, then we 
will do it. We need to do whatever we can to help the people of 
this nation feel that they cannot lose their entire savings 
when they put their savings in the trust of someone like Mr. 
Gruttadauria.
    I will excuse the second Panel with our great appreciation 
for your time. I want to briefly thank all of the Members and 
their staffs, but also I want to thank my counsel, Mr. Andy 
Cochran, for his terrific work on this panel and the other 
staff here on this Financial Services Committee. They've worked 
very hard on this hearing and I thank them for their assistance 
in making the hearing possible.
    This hearing is now adjourned.
    [Whereupon, at 1:00 p.m., the hearing was concluded.]
                            A P P E N D I X



                              May 23, 2002
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