[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





                    H.R. 2179--THE SECURITIES FRAUD
                  DETERRENCE AND INVESTOR RESTITUTION
                              ACT OF 2003

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                    CAPITAL MARKETS, INSURANCE, AND 
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                              COMMITTEE ON
                           FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                              JUNE 5, 2003

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-34




89-810              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice         JULIA CARSON, Indiana
    Chairman                         BRAD SHERMAN, California
RON PAUL, Texas                      GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio                BARBARA LEE, California
JIM RYUN, Kansas                     JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
    Carolina                         HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California                 RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
MARK GREEN, Wisconsin                JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut       STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona             MIKE ROSS, Arkansas
VITO FOSELLA, New York               CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MELISSA A. HART, Pennsylvania        JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia  STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio              BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota           RAHM EMANUEL, Illinois
TOM FEENEY, Florida                  DAVID SCOTT, Georgia
JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey             
TIM MURPHY, Pennsylvania             BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona

                 Robert U. Foster, III, Staff Director
            Subcommittee on Capital Markets, Insurance, and 
                    Government Sponsored Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

DOUG OSE, California, Vice Chairman  PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              JAY INSLEE, Washington
FRANK D. LUCAS, Oklahoma             DENNIS MOORE, Kansas
EDWARD R. ROYCE, California          CHARLES A. GONZALEZ, Texas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
SUE W. KELLY, New York               HAROLD E. FORD, Jr., Tennessee
ROBERT W. NEY, Ohio                  RUBEN HINOJOSA, Texas
JOHN B. SHADEGG, Arizona             KEN LUCAS, Kentucky
JIM RYUN, Kansas                     JOSEPH CROWLEY, New York
VITO FOSSELLA, New York              STEVE ISRAEL, New York
JUDY BIGGERT, Illinois               MIKE ROSS, Arkansas
MARK GREEN, Wisconsin                WM. LACY CLAY, Missouri
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TOOMEY, Pennsylvania      JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia  JIM MATHESON, Utah
MELISSA A. HART, Pennsylvania        STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota           BRAD MILLER, North Carolina
PATRICK J. TIBERI, Ohio              RAHM EMANUEL, Illinois
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
KATHERINE HARRIS, Florida
RICK RENZI, Arizona


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    June 5, 2003.................................................     1
Appendix:
    June 5, 2003.................................................    41

                               WITNESSES
                         Thursday, June 5, 2003

Bruenn, Christine A., President, North American Securities 
  Administrators Association, Inc................................    33
Cutler, Stephen M., Director, Division of Enforcement, U.S. 
  Securities and Exchange Commission.............................     7
Schapiro, Mary L., Vice Chairman an President, Regulatory Policy 
  and Oversight, NASD............................................    10

                                APPENDIX

Prepared Statements:
    Oxley, Hon. Michael G........................................    42
    Clay, Hon. Wm. Lacy..........................................    44
    Gillmor, Hon. Paul E.........................................    45
    Israel, Hon. Steve...........................................    46
    Kanjorski, Hon. Paul E.......................................    48
    Kelly, Sue W.................................................    50
    Royce, Hon. Edward R.........................................    51
    Bruenn, Christine A..........................................    52
    Cutler, Stephen M............................................    60
    Schapiro, Mary L.............................................    80

              Additional Material Submitted for the Record

Bruenn, Christine A.:
    Written response to questions from Hon. Paul E. Kanjorski....    86

 
                    H.R. 2179--THE SECURITIES FRAUD
                  DETERRENCE AND INVESTOR RESTITUTION
                              ACT OF 2003

                              ----------                              


                         Thursday, June 5, 2003

             U.S. House of Representatives,
     Subcommittee on Capital Markets, Insurance and
                   Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 10:08 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Ose, Castle, Manzullo, 
Kelly, Biggert, Capito, Kennedy, Tiberi, Brown-Waite, Harris, 
Renzi, Kanjorski, Meeks, Hinojosa, Lucas of Kentucky, Crowley, 
Israel, Clay, McCarthy, Baca, Lynch, Emanuel, and Scott.
    Chairman Baker. [Presiding.] I would like to call this 
meeting of the Capital Markets Subcommittee to order.
    This morning, we are here to conduct a review of the 
provisions of H.R. 2179, the Securities Fraud Deterrence and 
Investor Restitution Act of 2003. We come to this point after 
an unfortunate period of corporate governance history in which 
it is apparent that certain managerial officers misused their 
privileged positions to enhance their personal well-being at 
the expense of investors and their own corporations.
    This is an unfortunate period of corporate performance and 
required the Congress to act in a forthright manner. To that 
end, the Congress adopted in rather record-setting time the 
Sarbanes-Oxley Act which set significant new standards for 
corporate performance. Contained within that Act was a proposal 
called the FAIR fund which established for the first time a 
formal mechanism by which fines and disgorgements proceedings 
would be returned to the people from whom the assets were 
taken. Although a new concept, it is not a new method of 
compensation to defrauded investors. Federal agencies over 
decades have pursued wrongdoers and utilized mechanisms to 
provide for investor restitution. This legislation would only 
provide for an enhanced ability to assist in this important 
task.
    To that end, I want to express appreciation to the NASD 
having read their testimony, not only for their comments in 
support of the bill, but in reviewing the performance history 
of the enterprise. Over history, there have been thousands of 
times and multi-millions of dollars returned to investors, even 
without the advent of the FAIR fund, demonstrating not only 
that it can be done, but that it has been done successfully.
    Even NASAA, who has expressed concerns about the 
legislation in their testimony, has indicated that investor 
restitution is a laudable goal, despite the attractiveness, I 
would suspect, of keeping investor dollars for the construction 
of executive parking lots and DMV offices. Investor restitution 
is at least a goal we should try to achieve if we can muster 
the will to accomplish it.
    Some have suggested that even if we are to enact 
appropriate authorities, there may be two significant resource 
limitations to enable Federal agencies to take on this task. I 
will propose and be interested to hear the response to the 
concept of providing that some portion of the fines, penalties 
and other assets that are acquired be set aside. After investor 
restitution, after investor education, after any other 
appropriate action that might be pursued, that the residual 
funds be placed into the hands of enforcement agencies for the 
support of these enforcement actions. I cannot understand why 
that would not be an attractive utilization of these resources.
    But as to the other provisions of the legislation which 
constitute the bulk of the proposal, it will enable the 
authorities to pursue in a much less fettered way, wrongdoers. 
If we were to take the cases of Scott Sullivan, Bernie Ebbers, 
and Tyco's Kozlowski, with the passage of this act, authorities 
would have unfettered ability to pursue wrongdoers, to retrieve 
all ill-gotten gains. As to Mr. Sullivan's $20 million-plus 
mansion, it will have a new for sale sign on it. It says ``for 
sale by owner, the U.S. government.'' As to Mr. Ebbers's 
reported estate in Canada, equal in size to the State of Rhode 
Island, it is going to come back home. With regard to the 
Kozlowski art and yachts, all gone. Passage of this Act will 
make sure the art, the yacht, the mansions and even the State 
of Rhode Island will be returned to its rightful owner.
    Let me make it clear: This Act enhances, it does not 
inhibit, the authorities's ability to act. It does not preclude 
any State or local regulator from pursuing wrongdoers wherever 
they may engage in inappropriate conduct. It does provide that 
the money that is recouped will be given back to the people 
from whom it was taken.
    I also want to express my appreciation this morning to the 
Consumer Federation. Over the past weeks, we have been in 
constant communication and negotiation with regard to the 
provisions of the Act. They have expressed their endorsement of 
the proposal and have suggested technical modifications on 
which we have not yet reached resolution, but I am confident 
that in the coming days we will. We can look forward to a 
wholesale endorsement without reservation of this important 
proposal.
    In summary, this legislation is essential to assist in the 
restoration of investor confidence. We give the United States 
government the authority necessary to pursue wrongdoers, and 
assure investors we will not stand idly by while fraudulent 
acts are perpetrated on innocent victims. When the government 
is successful in achieving conviction and recoupment, we will 
give it back to the people from whom it was taken. What is more 
fair than that?
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet today to examine H.R. 2179, the Securities Fraud 
Deterrence and Investor Restitution Act which you recently 
introduced. As you know, I believe that we have an obligation 
to ensure the American investors are appropriately safeguarded 
against cases of securities fraud. I also share your concerns 
that to the extent possible we should prioritize efforts to 
compensate investors for losses resulting from securities 
wrongdoing.
    In testimony before our committee earlier this year, the 
Securities and Exchange Commission suggested a number of 
legislative reforms needed to enhance its ability to 
investigate wrongdoing, deter fraud and compensate deceived 
investors. H.R. 2179 would adopt these meritorious 
recommendations by permitting the commission to return more of 
the penalties that it collects to defrauded individuals. It 
would also increase the commission's power to collect fines, 
penalties and disgorgements that it orders. Additionally, the 
bill's provisions to increase access to information and raise 
fine levels would enhance the ability of the commission to 
conduct its investigations and deter fraud.
    While H.R. 2179 contains all the recommendations proposed 
by the commission earlier this year, it also contains other 
additions. I have serious reservations about one of these 
reforms, Section 8(b). This provision would require State 
security regulators to remit to the Federal government any 
penalties or disgorgements obtained from a broker-dealer under 
certain circumstances. As currently drafted, Section 8(b) poses 
a number of problems.
    Although it may be an unintended consequence, this 
provision would force a State that has already imposed and 
collected a restitution obligation to forward any additional 
penalty that it obtains to the Federal government. In effect, 
the commission would receive the State's penalty, even though 
the State arranged for the wrongdoer to provide full 
restitution to the victims. State regulators have also raised 
concerns that this provision would significantly limit their 
ability to craft appropriate remedies like mandating corrective 
actions in securities enforcement cases.
    Moreover, by allowing the Securities and Exchange 
Commission to take funds from a State, Section 8(b) raises 
constitutional concerns. I am presently unaware of any other 
provision in Federal law that allows the Federal government to 
obtain the money collected by a State in an enforcement action 
without the State's acquiescence. Because it takes money away, 
one could also construe this provision as an unfunded mandate 
on State governments. Historically, our dual securities 
regulatory system in which Federal and State agencies perform 
specific investor protection functions has served us well. In 
recent cases like the online and day-trading scams, penny stock 
fraud, and investment banking problems with Analyst Research, 
initial action by the States eventually led to a more 
comprehensive response by the Federal government.
    We should not upset this symbiotic relationship by 
undermining the incentives or placing fiscal constraints on the 
ability of States to vigorously pursue wrongdoing in the 
securities industry. It is therefore my hope that we will 
remove this provision or significantly revise it when 
considering this legislation in the future.
    While this bill will help to ensure that some investors 
will receive at least partial compensation for the losses that 
the incur as a result of securities fraud, I continue to 
believe that the most meaningful route for investors to receive 
full restitution for their losses is through private 
litigation. We therefore need to ensure that investors harmed 
by corporate wrongdoers can seek legal redress in our nation's 
courts. As the commission notes in its recent report to 
Congress, investor lawsuits complement government enforcement 
action by providing for a mechanism to compensate investors 
through the award of damages.
    While the Securities and Exchange Commission's enforcement 
actions often have several aims, the objective of private 
litigation is exclusively to compensate injured investors. 
Because the ability of investors to fully recover their losses 
often largely depends on the use of private actions, we need to 
work to restore the rights of individuals to bring actions 
against the perpetrators of securities fraud. Amending H.R. 
2179 to provide investors with greater access to the courts in 
cases of securities wrongdoing would achieve this worthwhile 
objective.
    In closing, Mr. Chairman, I look forward to hearing from 
our distinguished witnesses on this important legislation. I 
also hope that we will not rush into a markup on H.R. 2179 
before we can work together to address issues like improving 
the access of defrauded investors to the courts and protecting 
the ability of the States to robustly enforce their securities 
laws.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 48 in the appendix.]
    Chairman Baker. I thank the gentleman.
    Ms. Kelly?
    Mrs. Kelly. Thank you, Mr. Chairman.
    I appreciate your holding this hearing on this important 
legislation. I think it will send a clear message to all 
Americans that securities fraud offenders are going to be 
caught quickly, punished severely, and their ill-gotten gains 
will be taken away and returned to the injured investors.
    Over the past two years, our country has experienced 
monumental and extraordinary events that have changed the 
nature of our work here in Washington and shaped our agenda on 
this committee. No one could have predicted the terror attacks 
on September 11 or the collapse of several major corporations. 
With the passage of unprecedented legislation addressing 
terrorism, reinsurance, anti-money laundering and corporate 
responsibility, I am pleased to say that this committee stepped 
up to these challenges. But as the country faces a faltering 
economy and a war to rid the world of terror, it is even more 
important that Congress take action to rebuild our economy and 
address the eroding investor confidence.
    We have to continue to ensure that the U.S. investors, now 
over half of all American families, have the backing and 
Oversight they need to return the securities market to full-
faith and hope for prosperous futures. That is why I feel very 
strongly about this Securities Fraud Deterrence and Investor 
Restitution Act, and I am very delighted that we are having 
this hearing and I look forward to hearing from our witnesses.
    Chairman Baker. Thank you, Ms. Kelly.
    [The prepared statement of Hon. Sue W. Kelly can be found 
on page 50 in the appendix.]
    Chairman Baker. Mr. Emanuel?
    Mr. Emanuel. Thank you, Mr. Chairman.
    The only thing I can add is that obviously I look forward 
to hearing what they have to say on the priority we all put on 
the restitution in security fraud as it relates to what is 
going on. So I look forward to the testimony and the ability to 
ask questions afterwards.
    Thank you.
    Chairman Baker. Thank you, sir.
    Mr. Kennedy? No statement?
    Mr. Ose?
    Ms. McCarthy?
    Mrs. McCarthy of New York. Thank you, Mr. Chairman.
    Again, I will listen to the testimony and then follow 
through with questions.
    Chairman Baker. Certainly.
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Mr. Chairman.
    I wish to welcome the panelists, and I commend you for 
calling this worthy hearing. I commend you and Ranking Member 
Kanjorski.
    Over the last two years, we have learned of the many 
dangers that can plague an unregulated marketplace. We have 
witnessed the disastrous effects of fraud, corruption and 
cooked books. Individually, American families lost college 
savings, retirement funds, and hopes for the future. 
Collectively, our markets lost the lifeblood of a thriving 
economy, and that is public trust. In response to these 
corporate injustices, Congress collectively and on a bipartisan 
basis passed aggressive legislative reforms to ensure that this 
devious behavior would not be duplicated.
    I believe that H.R. 2179 is a good addition to the 
Sarbanes-Oxley Act passed last year. I am confident that it 
will help fully restore our nation's trust in the American 
marketplace. H.R. 2179 will greatly increase the Securities and 
Exchange Commission's ability to investigate and deter fraud, 
levy and collect fines and disgorgement funds, and provide for 
injured investors. H.R. 2179 will also give the SEC the 
authority to accept privileged information. This will enhance 
the commission's ability to access significant and otherwise 
unobtainable information by allowing private parties to produce 
privileged or work product-protected documents to the 
commission without waiving the privilege or protection as 
against any other party.
    For this, I commend you, Chairman Baker and Chairman Oxley. 
However, I do want to point out a concern that I have. That is 
the impact with Section 8(b) of this legislation and what it 
will have on individual States and their ability to combat 
corporate fraud on a State level. I look forward to working 
with you on this issue.
    Again, thank you, Mr. Chairman. I look forward to hearing 
the panelists and I yield back my time.
    Chairman Baker. I thank the gentleman.
    Mr. Scott?
    Mr. Scott. Yes, thank you very much, Chairman Baker and 
Ranking Member Kanjorski. I want to thank you for holding this 
very important hearing today regarding securities fraud 
deterrence and investor restitution. To you, Chairman Baker, I 
applaud you for your hard work on this legislation and on this 
very timely and important subject.
    I also want to thank the distinguished panel of witnesses 
that will appear before us today, for your testimony on this 
subject.
    Given that President Bush has just signed legislation that 
would cut taxes on dividends and capital gains, I think that it 
is very timely for this committee to consider additional 
investor protections. If the individual investor is not 
confident that anti-fraud actions have any teeth, they may 
still have some hesitation to reenter the market at a time when 
our economy desperately needs that boost. What good is a 
dividend tax cut if investors are being ripped off?
    I believe that H.R. 2179 has many good provisions that will 
help the SEC investigate and deter fraud and return money to 
wronged investors. I must admit I do join with some of my other 
colleagues in having some concerns about Section 8(b). I think 
that this committee will, after hearing and the questions, will 
certainly find an appropriate response to the Section 8(b) 
concerns that I have.
    I would also like to focus on one small component of H.R. 
2179 that would allow portions of the disgorgement funds 
established under Sarbanes-Oxley to be used for investor 
education. While I am a strong believer in preventive medicine 
and education, as I have worked very hard with this committee 
and with homebuyer education to prevent predatory lending, and 
I think the education component for investor education could 
likewise be beneficial, I would like to ensure that investor 
education programs are targeted in ways that reach intended 
audiences and have a maximum impact.
    Many Federal agencies, nonprofit groups and private sector 
firms have public investor education plans. However, I believe 
that we can improve the delivery vehicle for many of these 
worthy programs. I would like for the committee to continue to 
review the standards of investor education curriculum and 
discuss the ways to help match investors with these programs.
    Again, I look forward to hearing the testimony from today's 
panel, and thank you, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Scott.
    Mr. Crowley?
    Mr. Lucas?
    With that, I would like to welcome our first panel to come 
forward please. This morning we will have joining us Mr. 
Stephen Cutler, the Director of the Division of Enforcement for 
the SEC, as well as Ms. Mary Schapiro, Vice Chairman and 
President, Regulatory Policy and Oversight, of the NASD.
    Your full testimony will certainly be made part of the 
record. Feel free to summarize your remarks in 5 minutes.
    Welcome, Mr. Cutler.

     STATEMENT OF STEPHEN M. CUTLER, DIRECTOR, DIVISION OF 
      ENFORCEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Cutler. Thank you, Mr. Chairman.
    Chairman Baker, Ranking Member Kanjorski and distinguished 
members of this subcommittee, good morning.
    I am pleased to be here today to testify on behalf of the 
Securities and Exchange Commission concerning the Securities 
Fraud Deterrence and Investor Restitution Act, H.R. 2179. I 
commend Chairmen Oxley and Baker and the other sponsors of this 
legislation for their initiative and commitment in introducing 
this very far-reaching, useful bill. I also thank the 
subcommittee for holding such a prompt hearing on this 
significant proposal.
    As you know, I testified before the subcommittee this past 
February concerning the findings and legislative 
recommendations contained in a number of reports the commission 
submitted to Congress pursuant to the Sarbanes-Oxley Act. H.R. 
2179 incorporates a number of the proposals from the 
commission's reports which, if adopted, would strengthen the 
commission's enforcement capabilities and assist defrauded 
investors.
    These provisions would greatly enhance the effectiveness of 
the commission's enforcement investigations and significantly 
improve the commission's ability to prosecute securities law 
violations, collect money from wrongdoers, and return the money 
to injured investors. I can report that for these reasons, news 
of this bill has garnered a very enthusiastic response from the 
staff of the commission's Enforcement Division, who will be 
eagerly watching its progress.
    Although all the provisions of H.R. 2179 are important, I 
would like to use the remainder of my time to touch briefly on 
just a few. Section 2 of the bill would improve the 
commission's collection efforts by eliminating State laws that 
enable defendants to shield their assets from commission 
judgments or orders in their homesteads, the so-called 
homestead exemption.
    The exemption arises in commission litigation when a 
defendant fails to pay quarterly disgorgement and the 
commission asks the court to hold the defendant in contempt. In 
contempt actions, defendants often assert that they cannot pay 
some or all of the owed disgorgement because they lack 
sufficient assets. As a result, during the contempt proceeding 
the court must determine which of a defendant's assets are 
available to pay disgorgement. The court has considerable 
discretion in determining whether or not exempted assets, such 
as a homestead, must be used to pay disgorgement.
    Currently when trying to collect disgorgement, the 
commission's staff, at best, must engage in protracted 
litigation to overcome State law exemptions and, at worst, may 
be precluded from reaching assets that should be returned to 
the victims of securities fraud. By overriding State homestead 
laws, Section 2 of H.R. 2179 would make more assets available 
for recovery by the commission and for return to defrauded 
investors, and increase the deterrent value of commission 
enforcement actions against wrongdoers by depriving them of 
more assets.
    Section 3 of the bill contains several important provisions 
to strengthen the commission's enforcement program. Section 
3(a) would enhance the effectiveness of the commission's cease 
and desist proceeding by authorizing the commission to impose 
money penalties in these proceedings. Currently, we have two 
primary means of seeking civil penalties: administrative 
proceedings against entities and persons directly regulated by 
the commission, such as broker-dealers or investment advisers, 
and in Federal court actions against any entity or person.
    By granting the commission additional authority to seek 
penalties in cease and desist proceedings, Section 3(a) would 
eliminate inefficiency, give us added flexibility to proceed 
administratively, and strengthen our ability to hold those who 
assist in violating the securities laws financially accountable 
for their actions. The provision also would provide appropriate 
due process protections for subjects of these proceedings by 
making imposition of a civil penalty in an administrative cease 
and desist proceeding appealable to the Federal Court of 
Appeals.
    Section 3(b) would significantly increase the amount of 
penalties that the commission may seek for violations of the 
Federal securities laws in many types of actions. Increasing 
the size of penalties is an important step in achieving the 
desired deterrent effect under the securities laws. In 
addition, by using the FAIR fund provision in Section 308(a) of 
Sarbanes-Oxley, the commission may more fully compensate 
injured investors if larger penalties are paid.
    Section 4 would allow a person to provide privileged 
information to the commission without waiving that privilege as 
to other persons. If adopted, this provision would help the 
commission gather evidence in a more efficient manner by 
encouraging parties under investigation to voluntarily produce 
to the commission important information that otherwise could be 
withheld. Section 4 would help us conduct more expeditious 
investigations and contribute to quicker enforcement actions 
with a greater likelihood of recovery of assets for investors.
    Section 5 of the bill would enhance the commission's access 
to grand jury information. Specifically, it would authorize the 
Department of Justice subject to judicial approval in each case 
to share grand jury information with the commission staff in 
more circumstances and at an earlier stage than is currently 
permissible. The judicial approval would be based on a finding 
of the commission's ``substantial need to be informed.'' 
Federal and State financial institution regulators already have 
the kind of access to grand jury information that Section 5 
would provide to the SEC. Enacting Section 5 would make it 
possible for us to efficiently and effectively receive timely 
information required to complete our investigations and 
prosecutions, and avoid unnecessary duplication of government 
efforts.
    Now let me skip to Section 8 of H.R. 2179. It contains 
substantive amendments to the FAIR fund provisions. Section 
8(a) would amend the provision by allowing the commission to 
use any penalties paid as a result of commission actions to 
compensate investors injured by defendants in such actions. The 
FAIR fund provision was a groundbreaking measure to help the 
commission return more funds to defrauded investors. It did so 
by changing the law to permit penalty amounts collected to be 
added to disgorgement funds in certain circumstances.
    The commission has begun to make ample use of this new 
authority. To date, we have sought creation of 27 FAIR funds 
for investors and the disgorgement, and penalty amounts covered 
by these 27 actions total almost $990 million. I am confident 
that we will continue to regularly use this provision in the 
future for the benefit of investors.
    Section 8(a) would expand the application of the original 
FAIR fund provisions so that even more penalty dollars may be 
made available to harmed investors. As enacted, the provision 
only permits the commission to add penalty amounts to 
disgorgement funds when a penalty is collected from the same 
defendant that has been ordered to pay disgorgement. Section 
8(a) eliminates this restriction so that all penalties may be 
used to create a FAIR fund, whether or not disgorgement also is 
ordered.
    Section 8(b) provides that if a State establishes by 
agreement or judgment a requirement for brokers or dealers that 
is different from the requirements of the Federal securities 
laws, then penalties or disgorgement paid as a result of the 
agreement or judgment shall be remitted to the commission for 
distribution to injured investors pursuant to the FAIR fund 
provision.
    Congress long ago created a dual securities regulatory 
system in which both Federal and State agencies serve specific 
valuable functions in protecting investors. At the same time, 
there is little question in my mind that the imperative to 
achieve consistent regulation of the U.S. securities markets 
dictates the need for a single dominant national regulator. 
This is not meant to suggest that the States should be 
relegated to the backseat of our regulatory system. State 
securities agencies have played and should continue to play a 
significant role in making our securities markets the most 
respected and trusted in the world. The more resources, both 
Federal and State, we can bring to the cause of maintaining 
this status, the better off investors are.
    During the past year, the overlapping responsibilities of 
Federal and State agencies have been vividly illustrated by the 
joint investigations of research analyst practices undertaken 
by the commission, the self-regulatory organizations, and the 
States. The commission believes it is important to return funds 
collected through enforcement actions to harmed investors 
whenever possible and at all levels of government, Federal, 
State and local. For this reason, the commission and other 
Federal regulators determined to use their portion of the 
monies obtained in the Global Research Analyst settlement to 
recompense investors.
    Moreover, we invited the States participating in the 
settlement to contribute their portions of the settlement 
payments to the Federal distribution fund as well. Thus far, 
one State, the State of Missouri, has responded affirmatively 
to our invitation and has expressed an interest in working with 
us to distribute disgorgement and penalty amounts to investors. 
The policy question of whether Section 8(b) strikes the 
appropriate balance between State and Federal securities 
enforcement power is appropriately Congress's and not the SEC's 
to resolve. Nevertheless, the commission strongly supports the 
concept of investor restitution and we are eager to work with 
the subcommittee to facilitate reimbursement of harmed 
investors from the broadest possible array of sources.
    In conclusion, the commission strongly supports 
congressional action to improve the commission's enforcement 
capabilities. The proposed Securities Fraud Deterrence and 
Investor Restitution Act would greatly assist the commission in 
fulfilling its enforcement mission to prevent, detect and 
prosecute securities law violations and to provide recompense 
to injured investors. We look forward to working with this 
subcommittee in the future to further these important goals.
    I would be pleased to answer any questions the subcommittee 
has.
    [The prepared statement of Stephen M. Cutler can be found 
on page 60 in the appendix.]
    Chairman Baker. Thank you, Mr. Cutler. We appreciate your 
appearance here today.
    Our next witness is Ms. Mary Schapiro, Vice Chairman and 
President, Regulatory Policy and Oversight from the NASD. 
Welcome.

   STATEMENT OF MARY SCHAPIRO, VICE CHAIRMAN AND PRESIDENT, 
             REGULATORY POLICY AND OVERSIGHT, NASD

    Ms. Schapiro. Thank you, Chairman Baker, Ranking Member 
Kanjorski and members of the committee. I appreciate having the 
opportunity to testify today on this very important 
legislation.
    NASD believes this bill will strengthen the enforcement 
hand of the Securities and Exchange Commission at a time when 
more than 85 million American investors are looking to 
regulators, legislators and industry leaders to meet our 
collective responsibilities to protect investors and strengthen 
market integrity. Toward that end, we endorse the bill's twin 
goals, for we believe it will both maximize the amount of 
restitution that is returned to investors and strengthen our 
nation's system of securities regulation.
    I believe this bill can have a third important affect on 
investor confidence and the culture of corporate America. That 
is to change significantly the calculus by some companies and 
executives who seem to believe that paying SEC penalties is not 
a sign that they have abused investor trust, but rather just 
another cost of doing business.
    As you know, NASD is the world's largest securities self-
regulatory organization. Virtually every brokerage firm in the 
country that does business with the U.S. public must, by law, 
be a member of NASD. With a staff of 2,100, more than a dozen 
district offices throughout our country, and an annual budget 
of $400 million, we touch nearly every aspect of the securities 
business. By providing a layer of private sector regulation 
between the SEC and the brokerage industry, NASD is not only a 
guardian for investors, but also a bargain for taxpayers.
    I am particularly pleased to be testifying with my 
colleagues from the SEC and NASAA. In the U.S. system of 
securities regulation, each of us plays a vital role. The SEC 
has overall responsibility for setting the national structure 
of securities markets and regulation. The SROs, including NASD, 
set and enforce rules for the day to day operations of the 
markets and the brokerage industry. The State Securities 
Regulators are our invaluable partners in licensing and 
enforcement, adding more cops on the beat at the local level.
    All three sets of actors, SEC, NASD and its sister SROs and 
the States, need the proper mandates and tools to do their work 
effectively. All three, for example, were critical to achieving 
the recent $1.4 billion Global settlement with the large Wall 
Street investment houses. In developing and finalizing that 
settlement, we sought to underscore four basic principles: one, 
to change the way Wall Street does business; two, to get 
maximum recovery to investors using the FAIR fund; three, to 
fund investor education in effective and innovative ways; and 
last but not least, to make certain that the evidence we 
uncovered would be made available to harmed investors so they 
would be able to seek recovery of their losses through 
meritorious arbitrations and court proceedings.
    At NASD, we believe that an important part of restoring 
investor trust is to ensure and demonstrate very publicly that 
where wrongdoing is uncovered and proven, significant fines 
will be collected and channeled to greater enforcement efforts, 
enhanced regulation and through restitution to investors. H.R. 
2179 furthers the goals of maximizing restitution to investors 
and arming the SEC with additional tools to quickly and 
effectively combat securities fraud.
    In this same vein, NASD also welcomes the provisions of 
H.R. 2179 that will strengthen the SEC's ability to pursue 
violators and increase opportunities for investors to recoup 
losses due to fraud. In particular, I would note the 
elimination of the homestead exemption that will be helpful to 
investors as they attempt to collect from those who have 
defrauded them. This will stop illicit profits from winding up 
in the pockets of wrongdoers, while investors' pockets remain 
empty. This is an important provision for solving the corrosive 
and perennial problem of crooks building massive homes to 
shelter ill-gotten gains from injured investors.
    Mr. Chairman, NASD is pleased to testify in support of this 
legislation. We remain committed to working with your committee 
and with our valued partners in securities regulation to bring 
integrity to the markets and confidence to investors.
    Thank you again for this opportunity and I would also be 
happy to answer any questions you or your colleagues have.
    [The prepared statement of Mary L. Schapiro can be found on 
page 80 in the appendix.]
    Chairman Baker. Thank you very much.
    Mr. Cutler, the SEC prior to Sarbanes-Oxley obviously had 
been involved in investor restitution and recoupment of ill-
gotten gains for decades. With the passage of Sarbanes-Oxley in 
the course of the year in which the FAIR fund has been created, 
you have indicated there are 27 funds now created, with the 
potential of $990 million of restitution potentially made 
available. Is that correct?
    Mr. Cutler. I believe that we have made motions in 27 
different actions. I do not believe we have yet gotten court 
approval in all those actions. Indeed, I can tell you that one 
of the very significant actions where we are seeking court 
approval is in the WorldCom matter, which involves $500 million 
of the $990 million that I referred to before. But it is 
absolutely right that we are seeking to use this provision 
wherever we can to get money back to investors. We think it is 
very significant and a terrific thing that you and this 
subcommittee and Congress have done for investors.
    Chairman Baker. Subject to court permission, then, you do 
not view mechanically a problem in providing for the 
distribution of those funds, subject to court approval to do 
so?
    Mr. Cutler. Not at all. Again, you are absolutely right. It 
is what we have always done, always sought to get disgorgement 
payments back to investors. What this legislation allowed us to 
do was to try to enhance the amount of money that was returned 
to investors by allowing us to combine disgorgement payments 
with penalties.
    Chairman Baker. With regard to the comments referencing 
8(b), getting to the heart of the matter, if a State regulator 
were to pursue a wrongdoer and find that wrongdoer, and not as 
a consequence change market structure, that fine would be 
retained by the State. Would it not?
    Mr. Cutler. Under the proposal as I understand it, yes, 
sir.
    Chairman Baker. So that it would only be in a tandem action 
where the regulator would affect Federal securities law 
governance, and a fine being imposed, that the funds would be 
forwarded from the State regulator to the SEC to be disposed of 
through the FAIR fund. Is that correct?
    Mr. Cutler. Yes, although as I understand the proposal, it 
is not always the case that actions that States bring are in 
tandem with those of the Federal regulators.
    Chairman Baker. My point is not in tandem with the Federal 
regulator. It could be a unilateral action by a State 
regulator, but as long as the action does not affect Federal 
market structure, then the fine collected is retained by the 
State. It only is applicable with regard to Federal statutory 
market function and fine. A State regulator could enter into a 
voluntary agreement with a wrongdoer that does affect market 
structure, as long as they were not fined. What is it, then, 
that inhibits a State regulator from taking action if this bill 
were to become law?
    Mr. Cutler. I don't know, and it may be nothing. Probably 
Ms. Bruenn is in a better position to answer this than am I. I 
know that one of the technical concerns that the States have in 
connection with this proposal is whether the monies could be 
returned if some sort of FAIR fund were set up for investors of 
those States.
    Chairman Baker. Correct, but my point being, let's go to 
the Merrill settlement, for example; $50 million went to New 
York. There has never been anything represented to us that half 
of these defrauded investors resided in New York. If we are 
trying to get to a national policy that provides recompense in 
relation to the people who were wronged, the idea is that if 
you are going to change market structure and fine, then let's 
distribute the resources where the people are, as opposed to an 
objection to having the compensation kept by the State that 
initiates the action, not with regard to where the investors 
are domiciled.
    If I had anybody explain to me how the $100 million 
distribution was made that was relative to some formula or 
study of participation by investors, it possibly might make 
sense. The NASSA, for example, received $2 million of that 
settlement. I would be interested to find out on what basis 
that allocation was made. It is not even a State, I don't 
think.
    My point being that the current methodology for 
distribution of compensation does not have a rational nexus to 
the act itself. If we do not preclude States from pursuing 
wrongdoers; you can keep the money if you do not change market 
structure; you can change market structure and not levy a fine; 
you can do both and provide that the money go back to the 
people from whom it was taken.
    Ms. Schapiro, NASD has done this as well. Do you have 
observations of any technical inhibitions to your ability to 
provide compensation to wronged investors in actions of the 
NASD in prior years?
    Ms. Schapiro. No. We have made returning funds to investors 
a high priority in our enforcement program. To date this year, 
there have been 33 cases in which restitution has been ordered 
by the NASD to firms to grant to investors. We share the goals, 
I believe, of this entire committee that we maximize on return 
to investors through restitution.
    Chairman Baker. And NASD has done this for many years, I 
presume?
    Ms. Schapiro. Yes, we have done it for many years and it 
will continue to be a priority whenever we do an enforcement 
action to look to identify victims of the wrongdoing and 
maximize return to those victims. It is not always possible, 
but that is our goal. Where it is not possible, fine money is 
devoted and dedicated to expanding enforcement capability and 
our regulatory abilities.
    Chairman Baker. Thank you. I did not realize I had long 
exhausted my time. I want to come back.
    Mr. Kanjorski?
    Mr. Kanjorski. Mr. Chairman, I am certainly willing to wait 
for any further questions you have.
    Chairman Baker. Maybe I can get somebody to yield time. 
That is all right.
    Thank you, Mr. Kanjorski.
    Mr. Kanjorski. Mr. Cutler, you obviously have not been the 
proposer of Section 8(b), but you seem to agree with the 
chairman's and probably even my desire that there be some 
national standard and fairness in distribution. But have you 
considered some of the unintended consequences of 8(b)? For 
instance, suppose that the SEC at some future date is not 
aggressive. What is the incentive for States to proceed in the 
absence of an aggressive SEC when they would have to bear the 
expense of the pursuit of these fines and disgorgement and 
would not even be compensated for their expense?
    What I relate to is in the Federal government between the 
various departments we have this problem. I will give you an 
example I worked on several years ago that still happens to be 
constant today. Nothing has been done. In the Department of 
Energy there is about $50 billion worth of surplus equipment 
and property. Under existing law, if the department proceeds to 
sell or handle or dispose of that property, they have to spend 
it out of their departmental budget.
    On the other hand, when they sell that property or dispose 
of that property, it does not come to the Department of Energy, 
but goes into Treasury directly. As a result, there is a 
disincentive for them to get involved in disposing those 
surplus and excess properties. I am just analogizing that 
situation as a disincentive.
    Why would an Attorney General of a State or a securities 
exchange commission on a State level expend their budget and 
assets to pursue a wrongdoer when in fact they will receive 
none of the benefits from their success, but get all of the 
detriment and expense of pursuing it, not only the expense of 
that individual case where they are successful, but will be 
short-changed in pursuing other cases that they may not be 
successful in, and therefore further erode their budgetary 
considerations in the commission itself or in the Attorneys 
general office of the various States? How do we resolve that 
problem?
    Mr. Cutler. First, I want to take issue with the predicate 
for your question. It is hard for me to imagine that we will 
not be aggressive, so let me start there because that is where 
you started.
    Mr. Kanjorski. We have to assume that, not this SEC, but 
some future SEC just sits on its hands. It is always possible 
in government.
    Mr. Cutler. I did not think you were talking about this 
SEC.
    Mr. Kanjorski. Right.
    [LAUGHTER]
    Mr. Cutler. So let me take the rest of your question. Why 
would a State continue to proceed, push forward to prosecute a 
violation if the money that they extracted was not coming into 
their coffers? Actually, the analogy that I thought of was 
actually the SEC. None of the money that we have ever collected 
in fines or disgorgement has been tied to our budget. Indeed, I 
think in some ways that has been very healthy because it means 
that we are pursuing wrongdoers not because somehow it would 
enhance our coffers, but because it is the right thing to do 
and that is our mission.
    In no way has the lack of any nexus between what we have 
collected and what we are budgeted at deterred us or precluded 
us or discouraged us from seeking to go after wrongdoers. It is 
hard for me to imagine that any State securities regulator or 
any State prosecutor would be deterred or precluded or 
discouraged from going after wrongdoing because the money was 
not going into that regulator's back pocket. I think our State 
regulators are too professional to think that way.
    Mr. Kanjorski. You just do not believe that there would be 
any budgetary considerations, and therefore the analogy I gave 
of the Department of Energy, they are unique, in fact, that 
they are not pursuing a good public policy to recoup $50 
billion of property that they have no use for because it would 
take directly from their budget? That is a unique department of 
government, do you think?
    Mr. Cutler. All I can speak to is the experience that we 
have had at the SEC as prosecutors, and that consideration does 
not enter into our calculations.
    Mr. Kanjorski. I understand that, and of course you had a 
lenient Congress to be willing to appropriate and double the 
appropriations for the Securities and Exchange Commission, but 
that may not be true on a State level. I do not imagine that 
the budgets of State Securities Exchange Commissions are as 
robust as the Federal budget. Secondly, there very often may be 
a difference of political affiliation between the Chief 
Executive of a State and the Attorney General.
    What he expends his budget on may be very important in 
terms of not expending it on a situation where the recovery 
would not justify his expense to his own budget in continuing 
prosecution, and in fact would only be working for the benefit 
of the Federal government or the national Securities and 
Exchange Commission. He may have a very hard time justifying in 
a small State why he is spending one-third of his budget in the 
pursuit of securities actions and therefore having to ignore 
other prosecutions when none of that money will be recouped.
    Now, in the ideal world, I think you are probably right. 
All prosecutors do not consider budgetary considerations, but 
maybe I have had a terrible experience sometimes with district 
Attorneys and Attorneys general at the State level that that 
does become significant, as it is in the Department of Energy, 
I mean, with a huge problem. We have just not been able to 
force them to get rid of their excess property and allow the 
government to use it generally because we have not incentivised 
them; we have actually penalized them. You do not see that 
potential as an unintended consequence of Section 8(b)?
    Mr. Cutler. I understand the concern. I take the chairman's 
point that we are only talking about in this proposal a very 
narrow slice of what it is that States do in securities 
enforcement actions. That is, you could probably count on a 
couple of hands actions that are brought where both restitution 
or penalties are sought, and relief is imposed that would 
require a broker-dealer firm to establish policies that go 
beyond the Federal securities laws.
    So I do not know if I have the concern as acutely as you 
do, Mr. Kanjorski, but I do understand the concern. I think 
there are complicated policy questions here, and it is probably 
not my purview to say what it is that would happen as a result 
of the State budgeting process. I can imagine that to the 
extent that States were returning money to investors in their 
States, that might actually put them in a position to achieve a 
greater budgetary allowance for the securities enforcement 
mission.
    Mr. Kanjorski. Obviously, it is a concern of mine and I 
have heard it expressed in several of the opening statements, 
particularly Section 8(b). Could we extract from you an 
agreement to work with the State regulators to refine Section 
8(b) in the immediate future so that if it is worthwhile, and 
it may be, it can be acceptable to some of us that have 
concerns, and particularly with the State regulators? Maybe 
something can be definitively worked out from the Federal SEC 
with the State regulators.
    Mr. Cutler. I cannot speak for the commission, sitting 
here, but I think it is a terrific idea that we work with this 
subcommittee, as well as the SROs and the States, to figure out 
the parameters to the extent that there are technical issues 
with respect to this approach, that we figure out a way to work 
them out. I think that is a terrific idea.
    Mr. Kanjorski. I appreciate that, Mr. Cutler.
    Chairman Baker. Thank you, Mr. Kanjorski.
    Ms. Kelly?
    Mrs. Kelly. Thank you, Mr. Chairman.
    Mr. Cutler, I am a little confused about some of your 
comments. I have some prior testimony that was submitted, and 
then I have some testimony that I picked up this morning. This 
is in relation to Section 8(c). You say in both pieces of 
testimony, it is important to determine how it would affect 
incentives to and fiscal constraints on a State's ability to 
pursue securities related misconduct aggressively and 
vigorously. And then you speak of technical drafting issues. I 
am interested in your prior testimony because you outlined a 
couple of technical drafting problems.
    I am also concerned, as Mr. Kanjorski is, about the 
effective regulation with regard to this, and the dialogue 
between the States and the SEC. Do you want to elaborate on 
that a little bit? Then I have one more question I would like 
to ask.
    Mr. Cutler. Sure. I think we share the twin goals of 
Section 8(b). We had referred to it as Section 8(c). The twin 
goals are getting as much money back to harmed investors as 
possible. I think that is probably a goal we share with the 
States. Also to the extent that the provision speaks to this, 
the need for a single dominant national regulator when it comes 
to issues of our national market system.
    Indeed, I was on a panel yesterday with Mr. Spitzer from 
New York, not a panel before Congress, but speaking session, 
and he agreed that when it comes to reforms that change how the 
national market system works, it is incumbent upon the States 
to work with the Federal government to ensure that we do not 
have balkanized markets. It seems to me and it seems to the 
commission that those are the twin goals of Section 8(b). To 
that extent, we are very supportive of Section 8(b).
    Yes, there are some technical issues; and yes, there are 
issues about what kinds of incentives this creates or 
disincentives it may create that Mr. Kanjorski pointed out. 
That is why I think it is important that we work with the 
States and with this subcommittee, and with the SROs, to come 
up with an appropriate and effective way to implement the twin 
goals of Section 8(b).
    Mrs. Kelly. In your testimony, you spoke of the commission 
inviting States to participate in the Global settlement, that 
they would contribute their portions of the settlement payments 
to the Federal distribution fund. And just now, speaking to Mr. 
Kanjorski, you gave a rather ringing endorsement of State 
regulators. Yet, you are also experiencing, I believe, some 
reluctance from the States to work with the SEC and with the 
Federal distribution fund, I believe. Is that not true?
    Mr. Cutler. It is true. We extended an invitation to all of 
the States and we have to date heard from a single State that 
is prepared to work with us on distributing money back to 
investors.
    Mrs. Kelly. Why do you think that reluctance exists?
    Mr. Cutler. In some cases, as I understand it, the State 
statutes themselves do not provide for State restitution when 
it comes to penalties. So one of the things that is very 
helpful in connection with Section 8(b) and the approach that 
Section 8(b) takes is a way to overcome those hurdles.
    Mrs. Kelly. Do you feel that because we have set up the 
Federal distribution fund, do you feel that the States are 
reluctant because they need the float currently? Do you think 
that situation might change?
    Mr. Cutler. I just do not know. I have heard about the 
statutory hurdle. I know that one concern of States, and I 
appreciate this concern, is any money that they have collected 
be returned to citizens of their State. That is something we 
told the State of Missouri that we would work with them on, but 
I cannot speak to other potential concerns because I have not 
heard any.
    Mrs. Kelly. Do you feel the SEC is prepared to work with 
all 50 States and would return that money to the individual 
States's investors, because administratively, that could be 
quite a bit for you.
    Mr. Cutler. Again, that is something that we are going to 
work on with the States. It is administratively difficult. But 
to the extent that it is practicable, we understand the issue 
and we respect the issue and would like to try to accommodate 
the States in connection with that concern.
    Mrs. Kelly. Certainly, my personal feeling is that any way 
that we can possibly rapidly get the money back to the 
investors that they are owed because of decisions, that needs 
to be done. We need to grease those skids. My concern with 
regard to what you are saying is that I would like to have the 
SEC take a look at which way is actually going to be the 
fastest, whether it is State redistribution of the funds or 
Federal. But I think that what we need to focus on is the speed 
with which those people can get their money back once these 
adjudications are made. I hope you will look at that.
    Mr. Cutler. I share your concern, Representative Kelly. I 
think it is important to do this as quickly as possible.
    Mrs. Kelly. I do not think investor confidence is going to 
be improved until and unless we have some mechanism quickly in 
place to return the money. People need to have faith that if 
they are caught in a situation, as some of these people have 
been, with basically malfeasance on the part of some of these 
people, the investors need to know they can be made whole and 
swiftly.
    Thank you very much, Mr. Chairman.
    Chairman Baker. The gentlelady's time has expired.
    Mr. Scott?
    Mr. Scott. Thank you very much, Mr. Chairman.
    I wanted to ask about the role of the States. To what 
extent have States failed to return money to the investors, and 
have instead used the money for their general fund? I am a 
former State senator and rules chairman. I have worked with 
budget committees and I know that in the State when these funds 
are undedicated, they see that as free money. I was wondering 
to what extent have they failed to return the money to 
investors. That is the first part of the question.
    Mr. Cutler. I do not want to overstate the problem, 
Representative Scott. Indeed, I believe the States typically 
are very concerned about getting restitution payments to 
investors. When it comes to the penalty portions of what they 
collect, I think the story may be slightly different. Again, I 
should let Ms. Bruenn speak to this when she follows with her 
testimony.
    I do know that in the Global Research Analyst settlement, 
again to repeat what I said earlier, we have only heard from 
one State that is interested in returning its portion of the 
penalty and disgorgement payments to investors. I just do not 
know if that is indicative of the approach that the States take 
in other matters.
    Chairman Baker. Would the gentleman yield in response to 
his question?
    Mr. Scott. Sure.
    Chairman Baker. I just happen to have a sheet relative to 
the Global settlement distribution. New York, Texas, Kansas, 
Massachusetts, Maine, Colorado, Arizona and New Hampshire did 
an unqualified allocation to the general fund. Utah did an 
education fund first, but any funds remaining over $100,000 at 
the end of the year went to the general fund. Washington State 
puts most of it in the State treasury, but a portion is going 
to go to the Securities Enforcement Division at the State 
level. Missouri is joined with the SEC in a restitution effort 
at the national level. Virginia is doing a DMV construction and 
loans for school construction. And Nebraska is going to endow a 
chair in its State university. So generally speaking, and I 
appreciate the gentleman yielding, it has not gone to 
restitution for any number of reasons.
    I thank the gentleman for yielding.
    Mr. Scott. Thank you.
    Chairman Baker. Does the gentleman yield back, or do you 
wish to continue? I am sorry. Thank you, sir.
    Mr. Manzullo?
    Mr. Manzullo. Thank you very much.
    I have some questions with regard to what could be some 
extraordinary remedies the SEC is seeking and perhaps you can 
help me on this. If the IRS obtains a judgment against an 
individual, does the law say the IRS lien will override a 
homestead exemption?
    Mr. Cutler. I do not know the answer, Representative 
Manzullo.
    Mr. Manzullo. Do you know of any laws that preempt the 
homestead exemption?
    Mr. Cutler. With respect to other areas of the law, I just 
do not know, Mr. Representative.
    Mr. Manzullo. I think this is extraordinary. I think that 
is something you ought to check on. The State of Illinois, when 
I practiced law, I have been here for 10 years, the homestead 
exemption was only $7,500 for an individual. Did somebody give 
you the answer on that on the IRS lien?
    Mr. Cutler. I am sorry?
    Mr. Manzullo. I am sorry. I thought somebody behind you 
whispered the answer on that.
    The remedies you are seeking only apply to a judgment that 
is obtained at a District Court. Is that correct? Or are you 
trying to give an order of the SEC the same efficacy as a court 
judgment?
    Mr. Cutler. I would have to look back at the legislation. I 
know it applies to Federal court judgments. I just do not know 
whether it applies to administrative proceedings as well.
    Chairman Baker. Would the gentleman yield on his question 
for a moment?
    Mr. Manzullo. Yes.
    Chairman Baker. The way in which Sarbanes-Oxley passed, it 
did in fact affect the homestead exemption at the State level, 
based on the presumption that securities fraud ill-gotten gains 
were dumped into houses pursuant to a State's homestead 
exemption protection. However, there is an intervening step 
which may be taken by filing bankruptcy which precludes, then, 
your ability to go after the home once you are under the 
protection of the bankruptcy. What this provision would enable 
us to do is to go after the asset regardless of a homestead 
provision or a bankruptcy proceeding.
    So the gentleman is correct that this is an extraordinary 
remedy, but there has been a case in the past where the 
Congress has acted to lower the protections of the homestead 
exemption.
    Mr. Manzullo. I think this needs to be taken a second look 
at, because number one, it is preempting all State laws. 
Traditionally, the common law exempted a horse, which has been 
interpreted by the State of Wisconsin to mean an automobile, a 
means of conveyance. It has exempted personal effects, wedding 
rings in the State of Illinois, and a homestead with a very 
modest amount. What you are saying is that your judgment is 
more important than judgments for back child support, for 
unpaid alimony, for families of people who are killed by drunk 
drivers, and places this ahead of every other judgment that is 
out there, and really does violence to the whole purpose of the 
homestead exemption.
    I think that is very roughshod. My suggestion would be 
maybe allowing a constructive trust to be placed on a 
homestead. In other words, if you can trace that the defrauded 
money was used to buy the residence or to pay down a mortgage, 
then to the extent that you could trace it, that would allow 
you to actually go after at least that portion of the 
homestead.
    One of the examples you used here also would wipe out an 
innocent spouse's right to keep the homestead. If I am reading 
the example that you set forth on page five, citing this SEC v. 
Great White Marine case, where apparently you were upset with 
the fact that the innocent spouse was allowed to keep one-half 
of the equity in the homestead. This Congress about three years 
ago passed a provision insulating innocent spouses from the IRS 
lien whenever the spouse who had actually defaulted on his or 
her taxes ended up with a judgment. Do you recall that Chairman 
Baker? It was the Taxpayers Bill of Rights, I think, that we 
called it.
    Are you saying that the innocent spouse would lose his or 
her homestead right in the property?
    Mr. Cutler. No. As I understand it, that is not the purpose 
of the legislation. Really, what we are talking about is the 
right of someone who has committed fraud to step in ahead of 
victims and keep the money, keep it sheltered in a mansion, as 
opposed to disgorging it and giving it back to harmed 
investors.
    Mr. Manzullo. Okay. I can understand, but I would suggest 
there is a better way than simply saying SEC judgments will 
override homestead laws, and allow the court to set up a 
constructive trust. You know what that is, where you follow the 
trail of the money. Because at that point, you are still 
protecting the homestead right, while following the money, if 
somebody stole $1 million and took that $1 million and put it 
into a homestead. Do the courts, in your understanding, have 
the ability to set aside that homestead now to the extent that 
the defrauded money was put into the homestead? Or is that the 
remedy that you are seeking?
    Mr. Cutler. That is the remedy that we are seeking. With 
respect to penalties, we do not have any ability to break 
through the homestead exemption, and with respect to 
disgorgement, it is very limited and requires substantial 
litigation.
    Mr. Manzullo. But does the legislation specifically require 
the tracing of the defaulted money to the particular property?
    Mr. Cutler. It does not, and I think for a very good 
reason. The very good reason is that money is fungible. Yes, 
would it be helpful to get the power to break through the 
homestead exemption when you can trace the money? Sure, that is 
more than we have now. But I would submit to you that it is not 
enough, Mr. Manzullo. The reason is because it is very easy for 
someone to put the money somewhere else and then go buy the big 
mansion. Because money is fungible, I do not think a provision 
that is limited to a tracing provision would be as effective as 
this subcommittee would like and we would like.
    Mr. Manzullo. I do not know if the subcommittee is 
satisfied. I have very deep serious questions over simply 
coming in and saying the SEC order or final judgment is more 
important than an order for back child support, orders for 
victims of drunken driving cases, or orders for other common 
law or statutory frauds that are taking place. I mean, this is 
extremely serious when you are going to preempt those homestead 
laws.
    We went through that in the bankruptcy reform. If I recall, 
I am not sure if there was a provision allowed in there as to a 
monetary amount or as to the State, but what you are saying is 
that you would come ahead of all other classes of creditors 
involved, for example, in a bankruptcy in going after to try to 
find the homestead.
    I would think you might be better off working on the 
provision to allow that constructive trust. I do not think it 
is that difficult. If somebody stole millions of dollars and 
then after the fraud has taken place, they have gone out and 
bought a brand new home, what is so hard about that, to say 
that the home was purchased after the money was stolen?
    Chairman Baker. I am sorry. I am just waiting for the 
gentleman to conclude. The gentleman's time has expired.
    Mr. Manzullo. Thank you.
    Chairman Baker. Mr. Emanuel?
    Mr. Emanuel. Let me ask you, on this homestead exemption, 
do you have a dollar figure? What is the revenue size here? 
What is the cost that we are looking at?
    Mr. Cutler. I do not have that information available.
    Mr. Emanuel. Is there any guesstimate out there besides 
from you that you could call, say a reputable organization?
    Mr. Cutler. We can try to get that information.
    Mr. Emanuel. One of the things that would be helpful here 
is to bring this down to some brass tacks, so that we 
understand what the size is that we are dealing with here. Not 
that this is not a relevant discussion; sometimes those 
irrelevant discussions are up in the air. But what in fact is 
the dollar figure that is at stake here? What is the cost here 
that we are dealing with? Nobody has ever put a guesstimate 
together, to your knowledge?
    Mr. Cutler. Not to my knowledge, but why don't we try to do 
that, Mr. Representative.
    Mr. Emanuel. Okay. That would be helpful.
    Question whether requiring remission of penalties obtained 
by a State where remedial actions are ordered, will it weaken 
State security law enforcement efforts? Do you know that?
    Mr. Cutler. Excuse me, I did not hear.
    Mr. Emanuel. Whether requiring remission of penalties 
obtained by a State where remedial actions are ordered will 
weaken State securities law enforcement efforts. What is your 
view?
    Mr. Cutler. Again, in my view, no responsible State 
prosecutor, no responsible prosecutor at any level would make 
decisions about whether to go after misconduct on the basis of 
whether the money was coming back to the coffers of the State 
or not. Having said that, I understand that there may be some 
complicated budgetary issues that I know Ms. Bruenn will speak 
to as well, and this subcommittee will consider. For the most 
part, they are beyond my area of expertise.
    Mr. Emanuel. Thank you. No further questions.
    Chairman Baker. Thank you, Mr. Emanuel.
    Ms. Harris?
    Ms. Harris. Thank you, Mr. Chairman.
    I don't think anyone can argue with the concept of 
homestead preemption clause that has been included in this 
legislation to make sure that fraudulent funds are not harbored 
in multimillion dollar mansions. But I have grave concerns as 
you attack the homestead exemptions. In the State of Florida 
and many other southern States, these were originally conceived 
to protect mama at home with the children. I really want to 
associate myself with the gentleman from Illinois's comments 
because it just strikes me as such a big government oppressive 
approach.
    Certainly, the tracing provision may not get you as close 
to it as you need, but to go in when there is an innocent 
spouse with children and home, and basically take that 
homestead, which is really considered sacred in the States of 
Florida and Texas and some 15 other States. Many States do not 
have that provision and so it does not cause the angst, but 
this is something incredibly important.
    There has already been a crack in that homestead exemption, 
Mr. Chairman, in the bankruptcy bill where they have already 
attached a provision concerning homestead, cracking that 
initial issue. I am just extremely concerned that we move 
forward with this. I think it requires a lot more interest and 
effort, I can tell you, from the States that really consider 
homesteads that sacred issue.
    You do have vendors's liens. You do have a mechanic's lien. 
But just in terms of the mortgage laws, in order to get a 
mortgage, all of these kinds of things in some of these States, 
you are going to change the course of financing across-the-
board when you are setting the SEC first in terms of being able 
to collect these funds in going after homesteads. So I have 
grave concerns about the homestead clause in this bill.
    Chairman Baker. Does the gentlelady yield back?
    Ms. Harris. Yes, Mr. Chairman.
    Chairman Baker. Ms. McCarthy?
    Mrs. McCarthy of New York. Thank you, Mr. Chairman.
    I think with the questions that we are seeing, I mean, that 
is the whole idea of having a subcommittee hearing, so that we 
can hopefully work these things out. I think overall, the goal 
of the bill has its very good merits. Obviously, you have heard 
a number of us talking about our concern about the States.
    In your testimony, you indicated that with respect to 
Section 8(b) of the bill, that Congress created a dual 
securities regulatory system in which both State and Federal 
agencies serve specific valuable roles. You testified that the 
question of whether this section strikes the appropriate 
balance between the State and Federal securities enforcement 
power is Congress's to resolve.
    You also recommend that this issue may require further 
study, given that the FAIR fund provision has been in effect 
for less than one year, and that distribution of funds under 
the Global settlement, as you testified, may yield important 
lessons.
    I guess my question is, and we talked about this earlier 
when you answered a question, how long would such a study last 
and who would conduct the study? Can you give me some specifics 
on the suggested study of what you would even be looking for?
    Mr. Cutler. The only thing I think we were trying to 
suggest is that we have only had I think it is about 10 months 
worth of experience with the FAIR fund provision. You are 
probably in a better position to make the judgment as to how 
much experience we need with that provision. Again, I thought 
Mr. Kanjorski's suggestion that we work together with the 
States and the subcommittee to see if we can come up with 
something workable was an excellent one.
    Mrs. McCarthy of New York. The other thing, and again I 
know an awful lot of my State Attorneys or Attorneys general 
that certainly will continue to work, but obviously with the 
economic climate that is out there, my fear is would they back 
off on certain types of prosecutions through SEC if they do not 
have the money. I mean, their funds are going to be cut like 
everybody else's because most States are mandatory. They have 
to meet their budget. It is not like here where we can just 
raise the budget ceiling. So I have a concern about that and I 
think that we have to, before this bill goes forward, try and 
work out something that we can guarantee that the States and 
the Federal government will work together.
    Thank you.
    Chairman Baker. The gentlelady yields back.
    Mr. Tiberi?
    Mr. Tiberi. Mr. Chairman, I will yield my 5 minutes to the 
chairman.
    Chairman Baker. I thank the gentleman for his insightful 
judgment.
    [LAUGHTER]
    I want to return to the issue just raised by the gentlelady 
and others with regard to the ability of a State Enforcement 
Authority to pursue wrongdoers and the disposition of the 
fines, penalties or disgorgements generated. As Section 8(b) is 
constructed, I am the Attorney General of Louisiana, and I am 
pursuing Corporation X and I get them. We collect $100 million. 
Those are the terms of the deal. We do not affect market 
structure at all. Give me the money; I get to keep it; the 
State gets to keep it; and I can go out and build all the 
parking lots I want.
    Is that your understanding of how the current Section 8(b) 
would function, Mr. Cutler?
    Mr. Cutler. Yes. It is a very narrowly crafted provision. 
It only applies when the State both seeks money and a remedy 
that would require a broker-dealer firm to go beyond the 
current requirements.
    Chairman Baker. The current Federal regulatory structure.
    Mr. Cutler. That is right.
    Chairman Baker. Now, the reason for that being constructed 
in that fashion is to retain the SEC's primacy in Federal 
regulation of securities transactions. That means if the State 
regulator chooses to pursue someone and simply wants to change 
market structure, whatever that might be, however they choose 
to do, separating investment banking from something else that 
might be problematic, they can do that, but they cannot also 
levy a fine without distributing those proceeds back through 
the FAIR fund to the defrauded investor. Is that your 
understanding?
    Mr. Cutler. It is, although I hope that if they do pursue 
market structure reforms, they will also come and talk to us. I 
think over the past year, we have developed a good enough 
relationship where I hope and am optimistic that that would 
happen.
    Chairman Baker. Good luck. My point is that there is 
nothing that precludes a local Enforcement Authority from going 
after a wrongdoer and securing a fine and using it for whatever 
purpose they choose, even if Section 8(b) were operative law.
    Ms. Schapiro, do you have any different view?
    Ms. Schapiro. No, I do not.
    Mr. Manzullo. Will you yield, Mr. Chairman?
    Chairman Baker. Sure. I would be happy to yield to the 
gentleman.
    Mr. Manzullo. Let me construct something.
    Chairman Baker. This is Mr. Tiberi's time. He is yielding 
to you.
    Mr. Manzullo. All right. The example the chairman gave, 
they go after Corporation X; they recover $100 million, but 
that $100 million was ill-gotten gains by that particular 
broker or corporation as a result of setting up fraudulent 
operations against senior citizens.
    Rather than totally removing the brokering operation or the 
corporation from doing business in the future, the Attorney 
General secures as part of the settlement the agreement of on-
spot monitoring of everyone dealing with that corporation or 
broker over the age of 65 because it is making the assumption 
is was some sort of fraud on senior citizens. That would change 
the structure. That would be outside the normal penalty that 
the Federal government SEC could lay in. That would trigger the 
funds under section 8(b) going to the Federal government, as 
opposed to coming to the State.
    So the question that comes to my mind, is the Attorney 
General that was pursuing that, would he probably study the 
structure of the settlement so as not to change the structure 
of security laws, so that the receipts would come back to the 
State, even though the proper methodology if you are handling 
that was perhaps setting up a monitoring device to protect 65-
year-olds or older who were being particularly defrauded by 
this scheme?
    Chairman Baker. Reclaiming Mr. Tiberi's time, the structure 
the gentleman suggests would not change Federal market 
structure. It would have to be something inconsistent with 
current Federal regulatory oversight that would trigger this 
provision. So I appreciate the gentleman's point, but it is a 
very narrow field of applicability that triggers this response.
    Mr. Cutler may want to respond or may not. Mr. Cutler?
    Mr. Cutler. Again, to the extent that it does not change 
the national market regulations that we have in place, it 
obviously would not trigger the provision.
    Chairman Baker. Define that. It would be helpful to us to 
define ``Federal market regulations in place.'' What does that 
reference?
    Mr. Cutler. As I understand it from the legislation, it is 
rules and requirements at the SEC level, as well as the SRO 
level, that are currently in effect.
    Chairman Baker. So in effect, the State could not change 
SEC rules and regulations unilaterally, or if they did and 
fined, then the money would come to us.
    Mr. Cutler. That is my understanding.
    Mr. Kanjorski. May I add to that question, though? Under 
current SEC regulations, do you have the authority to establish 
monitoring of a particular category of brokers or corporations 
in dealing with 65-year-olds? Do you have that? I am not aware 
that you would have the ability to do that.
    Ms. Schapiro. If I might jump in, I believe under SRO rules 
it would not be violating an SRO rule or an SEC rule or do any 
injustice here to say that as a result of a heightened 
supervision that is required under our rules with respect to 
particular conduct that takes place within a broker-dealer 
firm, that a firm must do anything necessary to guard against 
that conduct in the future, and could certainly, because the 
rules are written rather broadly, encompass something like 
maintaining separate records of how senior citizens are dealt 
with.
    Mr. Kanjorski. Ms. Schapiro, using that argument, there is 
practically nothing that could be required in a settlement that 
would trigger the funds under Section 8(b) to come to the 
Federal government.
    Ms. Schapiro. No, what I am suggesting is that in the 
example you posit, there is nothing that is contrary to self-
regulatory organization rules that would in fact trigger this 
provision.
    Mr. Kanjorski. Okay. That is for your rules. How about the 
SEC?
    Ms. Schapiro. It is either rules, as I understand it.
    Mr. Kanjorski. Well, is there anything in the settlement, 
then, that could trigger and would be in violation of those 
rules? I am not sure. I mean, you are seeming to say that a 
settlement could call for any structure and that would not be 
in violation of your rules or the SEC rules. If that is the 
case, then there will be no triggering mechanism for Section 
8(b) to apply where the funds would come to the Federal 
government.
    Ms. Schapiro. No, I do not believe that is the case. I 
think if you look at, for example, the Global settlement, which 
required fundamental structural changes in an investment bank, 
that that is the kind of thing that would probably trigger this 
requirement. I do believe there will be some interpretive 
issues around exactly what falls under this provision and what 
does not, and what is contrary to an existing SEC or SRO rule.
    Mr. Kanjorski. Who is the final determiner of whether they 
make a structural change like that? The Federal SEC? The 
Attorney General of the State? The Justice Department of the 
United States? Who makes that determination?
    Ms. Schapiro. I think that is one of the issues that 
probably needs some further discussion.
    Chairman Baker. Mr. Kanjorski, you have exhausted Mr. 
Tiberi's time.
    Mr. Tiberi. Mr. Chairman, that is the most time I have ever 
had.
    [LAUGHTER]
    Chairman Baker. And it is the most effective use you have 
ever made.
    [LAUGHTER]
    Mr. Hinojosa?
    Mr. Hinojosa. Thank you, Mr. Chairman.
    I wish to address my first question to Ms. Schapiro. How do 
you think Section 8(b) of this legislation will affect a 
State's ability to robustly combat corporate fraud?
    Ms. Schapiro. Thank you. I really would associate myself 
with Mr. Cutler's remarks. I think that there should not be any 
disincentive to rigorous State enforcement of the laws. My 
experience in working with State regulators over many, many 
years as an SEC commissioner, a chairman of another Federal 
agency, and at the NASD has been that they are as committed and 
dedicated to investor protection, regardless of where fine 
money or other remedy funds go. I think that they will maintain 
that commitment regardless.
    I also think that this really is a fairly circumscribed 
provision that does not hurt their ability to get fines so long 
as there is not prescriptive relief that changes either SRO or 
SEC rules. Of course, where they believe that that is the right 
remedy to change SRO or SEC rules in how a broker-dealer 
operates, then there would not be fine money, but one would 
hope that the Federal regulators would also step in there and 
more broadly look at that conduct.
    I think over time, we have to look at the impact of any 
legislation to see if any kinds of disincentives are created. 
But I think the combination of the professionalism of State 
Securities Administrators and their commitment to investor 
protection, and the narrowness of this bill, really should not 
create any disincentive.
    Mr. Hinojosa. Mr. Cutler, some time ago SEC gave our 
committee some suggestions on how to improve investor 
protection in our marketplace. Why did you not see a need for 
these reforms back in February?
    Mr. Cutler. Mr. Hinojosa, are you talking about Section 
8(b) in particular?
    Mr. Hinojosa. Well, the new amendments that are being 
proposed now to strengthen the law that we have is one that I 
think you should have brought to us back when you came and 
spoke in February, I believe, and that is specifically Section 
8(b) that we are discussing today.
    Mr. Cutler. Right. I think what has spotlighted, if you 
will, the Section 8(b) concern is the Global Research Analyst 
settlement which we had not yet consummated back in February. I 
think what has given rise to the concern about the use of 
penalty monies is the way that we are dealing with the Global 
Research Analyst settlement and the proposed distribution of 
monies in that settlement. That has only happened recently.
    Mr. Hinojosa. With that, Mr. Chairman, I yield back my 
time.
    Excuse me, I would like to give my time, then, to Mr. 
Emanuel.
    Mr. Emanuel. Could you expound? Earlier you had said 
something about monies being fungible as we were dealing with 
the homestead, to go back to that. I think you were onto 
something and then you kind of veered off or got cut off. So 
can you expound on what you were talking about as it related to 
money being fungible and its relationship to the homestead 
issue?
    Mr. Cutler. Sure. The concern is that if illicit monies, 
monies wrongfully obtained are, let's say, put in the bank, and 
then monies from the liquidation of stock were used to buy a 
house, under a provision which limited our ability to go after 
a homestead to where we could actually trace the money to the 
homestead, the homestead in that example might be protected 
because the monies were literally used for something other than 
the purchase of the house.
    Mr. Emanuel. Do you have a particular example or cases 
where in fact exactly what you were trying to get at, because 
what I am trying to do is find a way to address some of the 
questions my colleagues have asked, both from Illinois and 
Florida, in the sense that one does not want to see the SEC 
stopped, but on the other hand where somebody is clearly using 
cracks within the law, fissures in the law to hide monies and 
dollars, that I want to address. So if there is a way that we 
can kind of lock these two together in some area. Do you have 
specific cases that come to mind or are there cases that exist 
where people clearly were buying a house for that purpose of 
sheltering dollars that would normally go back to those who 
have been defrauded?
    Mr. Cutler. I cannot summon any right here. We will go back 
and look at it. The concern I would have, Mr. Emanuel, is that 
because of the way current law operates, there may be no need 
for a criminal or wrongdoer under the civil securities laws to 
go ahead and engage in that kind of mechanism. That is, that 
there would be no need to do anything other than plop the money 
right into the house. But we will go back and look, and I think 
your inclination is exactly right and you are a terrific 
diplomat.
    Mr. Emanuel. That also has never been used to describe me.
    [LAUGHTER]
    Chairman Baker. And the gentleman's time has expired as 
well.
    Mr. Emanuel. Thank you. I have made the most use of my time 
today. Thank you.
    Chairman Baker. Very helpful, sir.
    I need to correct the record. In response to Mr. Manzullo's 
question relative to homestead exemption in bankruptcy 
proceedings, I had indicated my recollection of Sarbanes-Oxley 
was that there was bankruptcy court protection against a 
securities fraud penalty being assessed. Section 803, staff has 
informed me, which was in the final adopted version of 
Sarbanes-Oxley, disallows, and this is significant, discharge 
under bankruptcy of any debt arising under a securities law 
claim, meaning if the person has engaged in wrongful conduct 
and has been fined by the SEC, that is not protected in 
bankruptcy proceedings. So the concerns raised by Mr. Manzullo 
should have been raised with regard to Sarbanes-Oxley as well, 
because you now have a privileged position as a result of the 
passage of that Act. So we may talk about both issues in the 
same context.
    Ms. Biggert?
    Mr. Crowley?
    Mr. Crowley. Thank you, Mr. Chairman.
    I find myself as a member from the New York delegation in 
an interesting position here, because I do not necessarily 
disagree with where you are going, but I am at the same time 
somewhat defending my Attorney General for what was really some 
outstanding work in the settlement in my State. Let me first 
say that in New York, we know that the industry in which Mr. 
Spitzer was engaged in investigating is an important one for 
New York State and for New York City. It is critical. It is 
crucial. I do know it goes beyond New York. The market and the 
marketplace is something that this nation and the world is 
concerned about.
    But I think besides our Federal banking laws, there are 
probably only two other banking laws in the world that really 
matter. One is Switzerland's and the other is New York State's 
banking laws. The Martin Act is the State law which Attorney 
General Spitzer used to conduct his investigation.
    Also, I consider all the money from the people who pay 
taxes in New York were spent on the investigation. So it is not 
really unreasonable for me to see at the end when there is a 
settlement that New York State would look to recoup some of the 
monies that were spent in that investigation, and one that was 
brought to a conclusion that amounts to some $1.5 billion. So 
just for the record, I want to state that.
    One side says yes, well, there should be uniformity, and I 
think you are saying that Mr. Spitzer agrees with you, Mr. 
Cutler, that there should be some form of uniformity. I am one 
who generally supports preemption on many of these issues from 
the Federal end. But here is an example where New York State 
took the bull by the horns, that may not be the right animal to 
describe here, but he certainly did in this case, and I think 
deserves a great deal of credit for the settlement that took 
place.
    I also think it is hard to separate whether or not that 
would not have an impact upon Mr. Spitzer or whoever he or she 
may be, the Attorney General of New York State or any State. It 
is really difficult for me to believe that that is not going to 
have an impact on their ability to conduct those 
investigations. I do not know what the cost of the 
investigation was. It probably was not $50 million. I do not 
know what it was, but it was a considerable amount of money. I 
just wanted to lay that out there.
    I have a question, though, in regards to some of the 
discussion that I have heard trickle down to my office from 
Wall Street and their lawyers is that it is believed by many 
that a considerable portion of the penalties that some of these 
firms have been hit with, they believe can be paid by insurance 
companies that they have contracted out with. What is your 
feeling on that? Do you think that that is fair if that is the 
case? And is that true and is that fair? It is almost like the 
analogy of if I got a ticket for speeding on the New York State 
Thruway, I would ask my insurance company to pay for it. 
Innately, that does not seem very fair to me. Can you comment 
on that?
    Mr. Cutler. Sure. I agree with you. What we did in the 
Research Analyst settlement is something we had never done 
before, which was to include a provision which expressly 
prohibits any of the firms from seeking insurance coverage or 
indemnification for the penalty portion of their payments.
    Mr. Crowley. So it is covered in that? You have come to an 
agreement that is solid on this, right?
    Mr. Cutler. Yes.
    Mr. Crowley. Okay. I appreciate it, and thank you very 
much.
    I yield back the balance of my time.
    Chairman Baker. Thank you, Mr. Crowley.
    Mr. Baca?
    Mr. Baca. Thank you very much, Mr. Chairman.
    Mr. Cutler and Ms. Schapiro, thank you very much for 
appearing here today. I believe that the legislation does have 
merits and I have a couple of questions that I would like to 
ask.
    My first question deals with Section 8(d) of the bill. This 
section provides that SEC may use undistributed amounts of fund 
from disgorgement funds or FAIR funds to educate investors. 
Such educational programs would be administered by an 
established not-for-profit or governmental organization. I 
commend these efforts. I agree that financial literacy is 
crucial for participation in capital markets. Financial 
literacy is the first line of defense against fraud.
    Could you tell me what kind of programs you have in mind? 
That is question number one. Number two: What kind of 
organizations would administer these programs? That is question 
number two. And are you making efforts to target Hispanics and 
other minorities?
    Ms. Schapiro. Under the legislation, any undistributed 
funds could be used for investor education. That would include 
funds where it was just infeasible to distribute the money or 
where there was more money than was appropriate to distribute. 
The money could be administered for investor education purposes 
by a not-for-profit foundation and so forth, or a governmental 
entity. It will obviously be the SEC's choice ultimately about 
what to do in that regard.
    I will say that there is an enormous amount of money as 
well available under the Global settlement for investor 
education purposes that will be administered through a court-
approved plan to broadly educate investors about how to make 
better decisions with respect to the stock market and other 
investing. As part of that, I would hope and we have encouraged 
the SEC to do a survey of what works and what doesn't work in 
the investor education arena.
    There are hundreds of organizations engaged in investor 
education. There are wonderful programs that develop high 
school curricula, that target the Hispanic community, senior 
citizens, the African American community. All of those are 
areas where we need to put a renewed emphasis on investor 
education. It is part of what NASD is doing.
    Now, I would turn it over to Steve for the specifics.
    Mr. Cutler. Mr. Baca, I think it is critical that any 
investor outreach and education efforts embrace all sectors of 
society. We ought to, and I think it is incumbent upon the 
government to embrace the concept of diversity when it comes to 
investor education dollars. I agree with my colleague in that 
regard.
    Mr. Baca. Thank you very much. That is why I hope that we 
look at the kind of programs that we develop to target not only 
the Hispanic population, but other minorities as well. But what 
kind of programs would administer these? I don't know. Do you 
have a list or something that would be available for us that 
would administer these kinds of programs?
    Mr. Cutler. We can certainly get to you a list of current 
investor education programs and entities. I know that in 
connection with the Global Research Analyst settlement, it is 
something that we are looking at very hard because we have 
available in connection with that settlement on the Federal 
side on the order of $50 million over a five-year period to 
expend on investor education efforts. Our investor education 
office is gathering a list, I assume they actually already have 
it, and we will provide it to you, of investor education 
programs that currently exist.
    Mr. Baca. Okay. Thank you.
    My second question is in regard to Section 7 of the bill. 
Section 7 authorizes SEC to retain private legal counsel to 
collect debt owed as a result of SEC judgments or orders and to 
negotiate appropriate fees to pay for such private legal 
counsel. As I understand it, this provision would enhance the 
SEC's ability to recover more of the money owed by securities 
law violators.
    How does this program compare to efforts by other agencies 
to hire private sector debt collection contractors? That is 
question number one. And then question number two, is this 
different than the program run by the IRS in which contractors 
violate the Fair Debt Collection Practice Act, which is 
question two. And three is, are these just apples and oranges, 
is there some level of commonality that should concern me?
    Mr. Cutler. We do think this provision would be very 
helpful. It is a power that I believe the Department of Justice 
already has available to it, to contract directly with private 
Attorneys. We have not had that power. It has created a number 
of inefficiencies in how we go about collecting on judgments.
    We also think it would allow us to leverage our resources 
much more effectively because the collection of judgments 
invariably turns on interpretations of State law. It is a lot 
more efficient to be able to rely on local counsel in the 
relevant jurisdiction than to have a Federal regulator learn 
the collection procedures and laws of each jurisdiction around 
the country.
    What makes some of our judgments different than other 
judgments is that they tend to be big, and they also tend to 
have been collected from scofflaws or entered against 
scofflaws, and that differs from other sorts of judgments that 
other government agencies would ordinarily try to collect.
    I understand your concern about violations of the Federal 
Debt Collection Act, and I think it would be incumbent upon us 
in the contracting process with private law firms to ensure 
that we have protections in place so that those violations do 
not occur.
    Mr. Baca. Could there be a possibility of double-dipping in 
collecting by one agency versus another?
    Chairman Baker. That will be the gentleman's last question. 
Your time has expired, but please respond.
    Mr. Cutler. That does not strike me as a particular 
problem, and I think we could work that out.
    Chairman Baker. Thank you, Mr. Baca.
    Mr. Meeks?
    Mr. Meeks. Thank you, Mr. Chairman.
    I think I caught the tail end of Joe Crowley, the gentleman 
from New York's statement. I am also from New York and have a 
background somewhat. I used to be an investigator for the New 
York State Investigation Commission. On the whole question 
about restitution, no one wants to say they are against 
restitution to individuals who have been defrauded.
    However, on the question of how much money we are talking 
about and how many people are in the class, so how much really 
do they get back, I think that is a real question, as opposed 
to the costs to undergo the investigation, et cetera, as the 
States have done. That is a real consideration and something 
that I think we have to look at and make a determination on 
because we do not want to dissuade the States's Attorneys 
general, whether it is New York's or anyone else, from engaging 
in investigations because they know the cost of it and they 
cannot recoup any of those costs. So that is a real concern.
    Let me ask this to you, Mr. Cutler. I really want to ask 
you a question that is more related to a hearing that we 
conducted Tuesday regarding employee stock options. I 
understand that the offer of employee stock options helps small 
cash-strapped companies attract top-rate employees in place of 
a salary. Actually, I support that.
    On the other hand, I am tremendously concerned when I look 
at companies like WorldCom, whose executives manipulated their 
own stocks and statements to boost the stock price, and turned 
the benefit of their own stock to their benefit. And then I 
know that we go after individuals, and I am not talking about 
anything but the merit of the case, et cetera, when you are 
talking about what is happening with Martha Stewart, but when 
we look at what is being done with the settlement now of $1.5 
billion, which WorldCom was going to have to pay, I guess the 
agreement is now $500 million.
    The question that I have is, with all of this, and I do not 
see anybody from any of the executives being indicted right now 
from WorldCom. Let me ask you the question I asked on Tuesday. 
How do we maintain stock options as an incentive for hard work, 
while not providing an incentive for executive management to 
manipulate their own compensation? Do you have any opinion on 
that?
    Mr. Cutler. Discretion suggests to me that I do not. I am 
just the enforcement thug who when they tell me what the law 
is, I go out and prosecute violations of it. I think probably 
the policy questions here are better left to others. I know 
certainly it has been a problem in the past, executive 
compensation and whether that creates the right incentives. But 
I cannot give you advice on how to get out of that box. I know 
that the expensing of options is now an issue before FASB.
    Mr. Meeks. Ms. Schapiro?
    Ms. Schapiro. I guess I should exercise the same discretion 
as Mr. Cutler and not answer. But I will say that I think 
options have served an important purpose for many companies 
over the past 10 or so years in this country. I think the 
problem is abuses, grants of stock options.
    I think much has happened under Sarbanes-Oxley and other 
events in the last year that really have given management 
compensation committees of boards of directors a higher sense 
of what their obligation is to shareholders when they are 
granting stock options. I believe that we are starting to see a 
chilling effect of some of the events in the last year on abuse 
of grants of stock options.
    The other terribly important thing here is the appropriate 
accounting treatment for stock options. That will do more, I 
think, than any other thing to cut down on abuse of grants of 
stock options, if they are accounted for correctly.
    Mr. Meeks. Thank you.
    Mr. Crowley. Will the gentleman yield?
    Mr. Meeks. I yield.
    Mr. Crowley. Thank you. I thank my colleague for yielding.
    I just wanted to go back real quickly. I had my staff just 
check something out before I brought it up. I understand that 
in the settlement that took place, that all the companies 
involved admitted to no wrongdoing and that was part of the 
settlement. I am not suggesting anything beyond that.
    I just wanted to go to another set of laws and rules, the 
RICO laws. I am not suggesting, again, that these companies 
were involved in any type of action that could be undertaken by 
RICO. But under those set of laws, isn't it true that local law 
enforcement is able to retain a portion of the ill-gotten gains 
and possibly sell them off and use the proceeds to fight crime 
in their jurisdictions? If that is the case, aren't we setting 
up a separate protocol in the future for illegal-gotten gains 
within the financial services and the capital markets sector 
specifically?
    Mr. Cutler. I cannot tell you because I am not an expert on 
RICO. I can tell you, Mr. Crowley, that I do not think the 
issue of recouping expenses was the turning point, if you will, 
for the fulcrum of the decision by the New York Attorney 
General and others about where the money should go. Indeed, 
back in December when we announced the settlement in principle, 
I know that Mr. Spitzer said at that time that to the extent 
practicable, any monies that the State of New York collected 
would be returned to investors.
    Now, at the end of the day for statutory and other reasons, 
the New York Attorney General determined that it was not 
practicable, but it was not an issue, and he can speak to this, 
and I think Ms. Bruenn can speak to this as well, it was not an 
issue about whether to recoup expenses or not.
    Mr. Crowley. I agree with you. I don't mean to say that 
that was the sole purpose. That wasn't. At the same time, New 
York is not asking for one-third of the money that was recouped 
either, and putting that into the New York State coffers as 
well. So I mean, all things said and done, $50 million is a 
very small amount in the overall picture of the $1.5 billion.
    I thank you for your time and I thank the chairman for the 
time.
    Chairman Baker. Thank you, Mr. Crowley.
    I would just observe that much of what is contained in 
Section 8(b) is responsive to comments by many States's 
Attorneys general who said, one, we may not have the authority, 
but two, we clearly do not have the resources, although we 
agree that restitution should be a principal goal. I think we 
are very close to having resolution to the matter that the 
committee would find favorable.
    Certainly, we can address expenses of litigation as an 
appropriate cost item to be shared by the State, but one 
overriding element that we cannot take our eye off of, the 
money came from somebody's pocket. It is no different from 
walking down the street and seeing someone drop a $20 bill and 
making the effort to pick it up and give it back to them. I 
think that is an extremely important role for the government to 
pursue, and I think we can achieve that goal ultimately.
    I am going to suggest a recess, given the pending vote on 
the floor, unless any member has any further statement or 
question of this panel.
    Mr. Crowley. If the gentleman could just yield for a 
moment.
    I don't disagree with your premise either. I think it is 
difficult for those people who have been wronged to have the 
advocacy outside the SEC, and the SEC does a wonderful job and 
are not paid enough to do the job that they do. Having said 
that, in New York State, for instance, the Attorney General's 
office, he is acting on behalf of his constituency, which is 
within New York State, many of whom have been wronged. So I do 
understand that. I do not necessarily disagree with the premise 
of our panelists either, that there should be some uniformity 
and conformity, and I am happy to hear that you are open to 
discussing how that can be divided in the future.
    Chairman Baker. Sure. No, I laud him for grabbing the horns 
of the bull. The only question I have is where he sent the 
filets. That is all I am talking about.
    [LAUGHTER]
    Let me express my appreciation to the panel for their 
helpful testimony this morning. We are going to stand in recess 
for a few minutes. We have more than one vote. We will return 
as soon as possible to reconvene for our second panel.
    Thank you.
    Mr. Cutler. Thank you.
    [RECESS]
    Chairman Baker. We are going to go ahead and proceed. It 
would be inappropriate to keep you waiting without presenting 
your testimony. In fairness to the hearing record, what I would 
then do is probably submit my questions in writing, since there 
is no member from the other side to have equal time. That is 
acceptable to me, and I think to the folks representing both 
interests.
    So at this time, Ms. Christine Bruenn, President, North 
American Securities Administrators Association. Welcome. Your 
full testimony will certainly be made part of the record. In 
the meantime if we get a second member, we will stay around for 
a bit.
    Please proceed.

  STATEMENT OF CHRISTINE A. BRUENN, PRESIDENT, NORTH AMERICAN 
          SECURITIES ADMINISTRATORS ASSOCIATION, INC.

    Ms. Bruenn. Thank you, Chairman Baker.
    I am Christine Bruenn, Maine Securities Administrator and 
President of the North American Securities Administrators 
Association. I commend you for holding this hearing and thank 
you for the opportunity to appear before your committee to 
present the States' views on the Securities Fraud Deterrence 
and Investor Restitution Act of 2003.
    The Securities Administrators in your States are 
responsible for the licensing of firms and investment 
professionals, the registration of some securities offerings, 
branch officer, sales practice audits, investor education, and 
most importantly the enforcement of State securities laws.
    Some securities commissioners are appointed by their 
Governors or Secretaries of State. Others are career State 
government employees. Notably, only five report to or are under 
the jurisdiction of their Attorneys general. We have been 
called the local cops on the securities beat, and I believe 
that is an accurate characterization. Because of our proximity 
to the local investor, the States are an indispensable early 
warning system for fraud. The State Securities Regulators work 
with national regulators on market-wide solutions.
    That was the pattern followed with penny stock fraud, 
micro-cap fraud, day trading, and other areas. It bears 
repeating: The States investigate and bring enforcement 
actions; they do not engage in rulemaking for the national 
markets. That is rightly the purview of the SEC and the SROs.
    We appreciate the subcommittee's leadership in identifying 
some of the practices that resulted in the analyst conflicts of 
interest inquiry, as well as the continuation of the work you 
started during the last Congress that culminated in the 
Sarbanes-Oxley Act. NASAA applauds the subcommittee for many of 
the provisions in H.R. 2179. We appreciate your commitment to 
strengthening securities regulation and we want to work with 
you to reach our shared goals of enhanced investor protection 
and stiffer penalties for those who commit securities fraud. 
Given what has happened in the past few years on Wall Street 
and in boardrooms across the country, now is the time to 
strengthen, not weaken, investor protection.
    Although NASAA supports the vast majority of the provisions 
in H.R. 2179, I must express our deep concerns regarding 
Section 8(b). First let me say that we share your goal of 
returning more funds to defrauded investors. We agree that 
restitution should be a priority for all regulators. In fact, a 
primary and routine objective of State Securities Regulators is 
to obtain restitution for investors as part of enforcement 
actions. For example, in the 2002 reporting period, State 
Securities Regulators collectively obtained orders of over $309 
million in restitution. During the same period, roughly only 
$71 million was ordered in fines and penalties.
    To make the point that restitution is a priority, let me 
illustrate with some statistics. In my home State of Maine for 
fiscal year 2003 to date, my agency participated in the return 
of over $2.8 million to investor victims, while collecting, 
apart from the Merrill Lynch settlement, only $16,000 in 
penalties to the general fund. Data for Pennsylvania reflects 
the same priorities. For fiscal year 2003 to date, the 
Pennsylvania Securities Commission oversaw the payment of $8.2 
million in restitution and disgorgement and the collection of 
just $130,057 in civil penalties.
    While we agree on the priority of restitution, there are 
provisions of H.R. 2179 that raise practical and public policy 
issues, as well as the specter of unintended consequences that 
could actually harm investors. We believe it would be bad 
public policy to attempt to direct a State authority to remit a 
civil penalty or disgorgement ordered in a State case to a 
Federal governmental body for distribution. These funds 
rightfully belong to the citizens or investors in the State. 
Decisions regarding the use of penalties are best made by the 
State legislatures and regulators so they can be tailored to 
the unique circumstances of each jurisdiction.
    State Securities Regulators apply a variety of sanctions 
when taking enforcement actions against broker-dealers, 
depending upon the specific facts of each case. Remedial 
sanctions are very important enforcement tools in addition to 
restitution and monetary penalties. Where State Securities 
Regulators investigate and resolve enforcement cases using 
these remedies, their judgment regarding appropriate outcomes 
should be respected and supported. We impose remedies to suit 
the particular enforcement case and use our discretion to 
address unique situations.
    There are a wide variety of remedies we may choose to 
impose. In the case of selling unsuitable investments, for 
instance, we may have the branch manager review trades and 
compare them with a customer's investment objectives, or ask a 
broker-dealer, for a fixed period of time, to keep a separate 
file on transactions with senior citizens. In other cases, 
closer supervision of a broker, expansion of the compliance 
department, or enhancement of internal controls might be 
necessary.
    Finally, the legislation leaves open some questions. It is 
unclear if it would apply if a State imposed the same remedial 
sanctions that were imposed in a parallel Federal proceeding, 
where both the State and Federal orders went beyond the 
requirements of Federal law. The uncertainty in the mechanics 
of the bill points to another problem. When the State, the SEC 
and the industry respondent in a given case disagree on whether 
the provisions of Section 8(b) are triggered, how is that 
impasse to be resolved? This question suggests increased 
conflict between all three players and resources being wasted 
in resolving such disputes.
    In contrast with this scenario is the very positive 
experience in the recent Global settlement with the leading 
Wall Street firms. In my view, the Global investigation and 
agreement was a model for State-Federal cooperation that will 
serve the best interests of investors nationwide. We must be 
able to leverage our resources and continue to work together on 
these cases. With 85 million investors relying on our 
securities markets to meet their financial goals, and on 
regulators to keep their markets well-policed, we cannot afford 
to undermine our complementary regulatory system.
    To sum up our concerns, while we wholeheartedly support the 
provisions in H.R. 2179 to strengthen the SEC's Enforcement 
Authority, it appears to be inconsistent to enhance the SEC's 
enforcement power while at the same time inhibiting the 
States's options in enforcement actions.
    Mr. Chairman and members of the subcommittee, in closing I 
want to repeat our support of the goals of this legislation. 
The SEC needs more authority and resources, and those who break 
our securities laws should pay a higher price than they do 
today. But we are deeply troubled that this legislation, while 
strengthening the SEC, could weaken and limit the efforts of 
State Securities Regulators to protect investors in your 
States. Eighty-five million investors, many of them wary and 
cynical, expect us to remain vigilant, to work together, to 
stay the course, and to make sure that Wall Street puts 
investors first.
    I pledge the support of the NASAA membership to work with 
you and your subcommittee. We would be willing to work with the 
SEC and others to come to an agreement on Section 8(b) and to 
provide you with any additional information and any assistance 
you may need.
    Thank you for this opportunity to testify.
    [The prepared statement of Christine A. Bruenn can be found 
on page 52 in the appendix.]
    Chairman Baker. Thank you, Ms. Bruenn.
    I noted on page four of your testimony when you were 
referencing the actions in Maine, Pennsylvania and Arizona, and 
the collections made in reference to the penalties assessed. To 
your knowledge, particularly in the State of Maine where I am 
certain you do know, were those penalties or recoupments in 
relation to events or activities that were within your State 
and affected principally residents of the State of Maine?
    Ms. Bruenn. The way I would respond to that is to say that 
those investigations primarily affected Maine investors. There 
are occasions when our cases go into New Hampshire or 
Massachusetts, or we collectively join with other regulators in 
either New England or nationwide on a particular broker-dealer 
or a particular issue.
    I think the important point here is that I have made it a 
priority to take penalties generally unless I have made 
restitution first. I absolutely agree that restitution should 
be the priority in every example. I think we have had a 
difference on one case, the Analyst case, about what the right 
answer is, but I totally agree with you that restitution should 
always be a priority.
    Chairman Baker. Thank you for that. The point of my 
question was that generally speaking the actions taken in the 
three States that generated the restitution cited in relation 
to the small amount of penalty were more often than not local 
aberrations within the State over which you have jurisdiction. 
You would not, for example, tell the people of Pennsylvania 
with your actions what remedy they should seek with regard to 
misconduct in securities markets.
    Ms. Bruenn. I can speak for Maine. Our penalties are 
generally for brokerage firms who have violated a specific 
statute in Maine, with Maine investors.
    Chairman Baker. That being the point, there are a couple of 
observations. One, generally speaking these were local in 
nature in violation of a particular statute or regulation of 
the agency. Secondly, it is responsive to the point made 
earlier, if you do not get to keep the money, would you take 
the action?
    You have three States where you have had significant 
recoupment and very small penalties in relation to that action, 
only $16,000 in monies to the general fund, and giving $2.8 
million in compensation to Maine residents. That is a pretty 
good deal. I think it supports the view by Mr. Cutler earlier 
in the day that professional regulatory agents are going to act 
in the best interest of their constituents, money 
notwithstanding.
    Secondly, under Section 8(b) as constructed, if you took 
the actions cited in these three States and laid them aside the 
requirements of Section 8(b), and it may not be appropriate to 
do it today, but I would like to get back from you the case, 
just take Maine, we will keep it narrow, and present to us the 
prohibitions that the resolutions reached would not have been 
permissible under Section 8(b). That would be very helpful to 
us.
    It is not the intent to preclude State regulators from 
acting, but it is the intent to make sure that where your 
actions go beyond State boundaries, where there are people who 
have been wronged, and where you take the money and bring it 
into your State general fund, and it is not distributed to 
those non-resident victims, there ought to be a way to work 
this out.
    If you can give us case-specific points that show how the 
proposed rule is not consistent with the remedy you have sought 
in those $2.8 million worth of recoupment in Maine, that would 
be very instructive, because we have limited the taking of the 
dollars to a twofold step. You have got to change market 
structure and you have got to seek a penalty.
    Now, I would be happy to look at even stipulating further, 
as we have had these discussions with the Consumer Federation, 
where it clearly is an action relating, for example, to a 
broker-dealer in a city who has run false advertisements and 
you find him, there is no question about that. That stays with 
a State. There ought to be a way to have an illustrative list 
and then figure out how we describe it.
    Let me put it this way. Do you have a theoretical problem, 
forgetting Section 8(b), with giving money back to people who 
have been defrauded, when your actions within your State make 
resources available, and the preponderance of investors who 
would benefit from your action are not within your State?
    Ms. Bruenn. Mr. Chairman, I think you have identified the 
key issue here, which is the triggering mechanism. I think the 
way we were reading Section 8(b), the trigger seemed much 
broader than the way it has been described here today. I 
believe that we could probably work together on coming up with 
something that made us all comfortable. I need to be free to do 
my routine investigations that affect one broker or eight 
brokers and 25 or 50 or 150 investors in Maine, where I can 
impose a remedy that seems to address a particular broker-
dealer or branch office's problem in that case.
    My jurisdiction is very narrow. It is for offers and sales 
of securities in Maine. I do not have the authority to tell any 
broker-dealer how to do their business outside my boundaries. 
So I feel very comfortable saying to you that I think that 
there is an answer here.
    Chairman Baker. Let me return to the question, because I 
want to make sure we get on the record a specific answer, and 
we can take the Global settlement as the nexus to come together 
here. There is no evidence that 50 percent of the harmed 
investors as a result of the Merrill Lynch settlement resided 
in New York, yet half the money went to New York. That was the 
problematic aspect of the settlement from my perspective.
    Secondly, only a very small portion of the Global 
settlement, again from my perspective, went to investor 
restitution. From Maine looking into the Global settlement, if 
20 percent of the investors lived in Maine, I would have no 
difficulty in supporting an effort to give Maine 20 percent of 
the settlement. Would you object to that?
    Ms. Bruenn. No, sir. And we tried to address exactly the 
concern you raise. I think, one, the Merrill Lynch settlement 
was a unique circumstance where the State of New York's 
Attorney General had already done most of the work, and was 
trying to make sure that the procedure ended with all of the 
States coming together. I think it was a very unique situation, 
and I would hate for all of State securities regulation and our 
approach to restitution to be judged by that one case.
    Chairman Baker. No, we are together. All I am suggesting is 
if you take an action that results in harmed investors outside 
your State not having the opportunity for restitution, but it 
is your prompt corrective action that brought this person to 
justice, you would not object to a mechanism to provide for 
distribution of compensation to people outside the State, as 
long as you do not have to do it yourself. You do not have to 
pay for it and you do not have to sort out who gets what.
    That is the reason for the SEC distribution mechanism, 
because every State Attorney General who has come to us 
expressing concern said, ``We don't have the ability to do 
this.'' I said, well, would you object to the SEC doing it? 
``Well, no, as long as we got fair treatment.''
    Ms. Bruenn. I guess the problem I have is that with that 
particular Merrill Lynch settlement, for instance, Maine got 1 
percent of the penalty money. So putting aside what New York 
got and whether that was the right way to do it or not, the 
rest of the States divided up the money based on population, 
trying to address the fact that in a small State I am going to 
have fewer victims than they are going to have in a much larger 
State. I think we tried to do that. I think my problem with the 
legislation is it takes away my discretion.
    Chairman Baker. Let me jump on that small State issue.
    Ms. Bruenn. Okay.
    Chairman Baker. If Connecticut, a high-income State, 
sophisticated people, contrast that with Louisiana. I will 
guarantee you, there are five times as many investors harmed by 
the Merrill Lynch action as there were in Louisiana. Now, why 
should we get more money than Connecticut because we have a 
bigger population?
    The equity of it is what I am driving at. That is the whole 
issue behind the proposal, is if we are going to collect vast 
sums of money, we ought to make sure we make our best effort, 
and if there are legitimate reasons why we cannot, let's 
explain it. But let's make our best effort to give the money 
back to the people from whom it was taken.
    I am going to yield to Mr. Kanjorski.
    Mr. Kanjorski. Mr. Cutler does not believe that there would 
be any budgetary considerations by State regulators or 
Attorneys general in expending money for lawsuits where there 
would be a small recovery. Do you feel that, at least in some 
way, the States that get heavily involved in these transactions 
and expend a larger portion of their budget or allocation for 
that particular litigation, should be compensated for that, as 
opposed to just splitting it in some formula without taking 
that into consideration? If you don't take that into 
consideration, will that tend to cause the justice departments 
of the various States or the SECs of the various States not to 
be as aggressive?
    Ms. Bruenn. Representative Kanjorski, I believe we are all 
committed public servants and we are going to go do the right 
thing whether the funding comes our way or not. However, we are 
also human, and we run agencies where we are expected to 
produce results. If the results are that money gets sent to 
Washington, with all due respect, I have to say that that will 
undermine my ability to get funding for my agency.
    Mr. Kanjorski. Do any of these actions constitute something 
similar, or are they constructed in the class action type of 
situation where the decision process would eliminate any 
further liability if other actions are brought by other 
individuals?
    Ms. Bruenn. Under the State laws, investors in our States 
are not only served by the actions that I bring as a regulator 
and my colleagues bring as regulators, but they have their own 
private cause of action that can be pursued either in a class 
action lawsuit or in arbitration. We had three goals in the 
Analyst conflicts of interest settlement. One of them was to 
make sure that we provided information for investors. We intend 
to help them with that arbitration process.
    Mr. Kanjorski. So the courts do not consolidate the actions 
into one class action? They preserve the rights of private 
class actions or private investor lawsuits? Is that correct?
    Ms. Bruenn. I am not an expert on class action law, but I 
would point out that most of these actions will be brought in 
arbitrations which are not consolidated. Each investor gets the 
opportunity to have a hearing based on their own personal 
situation.
    Mr. Kanjorski. That is in making restitution claims from 
the State of Maine. I am talking about in the recovery from the 
party who has wronged them. What I am trying to get at, is 
there any time, as in class actions, that a settlement 
constitutes a universal global settlement, and that forestalls 
any other State or any other class from bringing any action 
against that particular defendant, and the potentiality of that 
being abused?
    I do not want to suggest it, but in corporation law, we 
have seen that Delaware has created a mechanism to become the 
land of corporations. You theoretically could have another 
State, Louisiana, become the land of securities transactions in 
order to allow a final settlement to be arrived at to bar any 
further recovery from other States that probably suffered a 
great deal more. I don't want to suggest that they would act as 
a straw man or a shill for the defendants, but in fact they 
could do that.
    Ms. Bruenn. To the best of my knowledge, there is no State 
jurisdiction that would preclude any other regulator from also 
bringing an action, or any individual from pursuing their 
private right of action. No settlement would preclude another 
action.
    Mr. Kanjorski. So what happens is they insist before they 
arrive at a settlement that all 50 States's Securities 
Regulators enter into the agreement and are satisfied with the 
disposition of the funds?
    Ms. Bruenn. That happens in these very large cases with 
national impact. The defendants want to make sure that the 
States will have buy-in, and that is where we have used the 
mechanism of NASAA, the membership organization that I am 
serving as President, to bring the States together and to try 
and speak with one voice and come up with one resolution.
    Mr. Kanjorski. Do you think the bill as presently 
structured fails to put in place a mechanism to decide how the 
disposition should be made or whether there is a change in the 
structural laws or regulations of securities so that it would 
trigger the mechanism to go to the Federal government? Do we 
have to find some arbiter, rather than retreating to a full 
class and Supreme Court decision between the SEC and the 
various States, which could be very expensive and probably 
smaller States would not be able to be parties to it just 
because of the expense involved?
    Do you see a need for some final decision making body that 
is representative of the interests of both the States and the 
Federal government, a board of arbitration or something that 
would be set up and properly appointed to have a balanced 
representation to make some of these jurisdictional decisions 
as to whether or not the fines and disgorgements or other 
restitution would flow to the Federal government or the 
individual States?
    Ms. Bruenn. I think we need a bill that is clear about the 
triggering mechanism. I would hope that we would have something 
that would be clear enough. I do not think it would be a good 
use of resources for me to be litigating with the SEC or with 
an industry member about what this bill means and whether I 
have overstepped my jurisdiction. I would like it to be as 
clear as possible.
    We have had a very good relationship with the SEC. I think 
of us as being partners in working on the same issues, just 
from different perspectives. I think our relationship with them 
would be undermined if they became the big brother who got to 
go behind our cases.
    I think the trigger here was the analyst cases. The New 
York Attorney General got out in front. I do not think you want 
to really preclude States from playing that role of being the 
early warning system on issues. I think what you want is a 
mechanism that says once that happens, let's all get together 
and resolve this together, with the SEC providing the national 
leadership.
    Mr. Kanjorski. From your statements just now, I suppose you 
don't mean to make the SEC, then, the final arbiter. We should 
have some independent entity to make that decision because 
there may be a time in the future that an SEC just asserts its 
jurisdiction all the time and makes the decision in favor of 
itself all the time. That would basically either give you the 
choice of going toward regular litigation or surrendering your 
rights eventually, and becoming cowed to the Federal SEC.
    Ms. Bruenn. I would suggest that you are right; that if the 
SEC becomes the arbiter, our ability to be unique or initiate 
things that the SEC has not blessed would be hobbled.
    Mr. Kanjorski. Okay. You offered to participate with trying 
to work with the SEC and with the committee, to see if this can 
be crafted. Do you feel that Section 8(b) is something, and we 
know it all has merit, I mean, what the intentions are. I don't 
think anybody argues with the merit of the final result that we 
are trying to get at. But do you think we can craft something 
that is agreeable both to state regulators, to the SEC, and 
basically to the Congress to get the ideal accomplished?
    Ms. Bruenn. I would hope so, and I am committed to trying.
    Mr. Kanjorski. Very good.
    Thank you very much, Mr. Chairman.
    Chairman Baker. Thank you, Mr. Kanjorski.
    I have a series of questions, and at this point I don't 
want to enter into and start a whole new series of questions. 
What I will do, just to give you notice, we will get a letter 
out to you probably tomorrow that will have a series of issues, 
for example, for illustrative purposes. I would like to see 
from your perspective what each State did allocate their 
settlement proceeds from the Global settlement to have on the 
record. So members who ask what happened to the money, and 
whether it is used for enforcement, for education, or for 
general fund purposes, can make that judgment. I know they will 
rely on your representations of what did take place as being 
the accurate indicator of how those funds were used.
    I have other questions even with regard to NASAA's receipt 
of the $2 million allocation of the settlement and how that is 
utilized. So I will get that out.
    I do appreciate the time you spent here today to testify 
before the committee, and I appreciate your good-faith 
representations to work with the committee to come to 
resolution. At least I think we are generally in accord, that 
getting money back to the people from whom it was taken is a 
good thing.
    Mr. Kanjorski. Mr. Chairman, may I call your attention to 
the fact that this administrator works for a great Governor, 
that was a former colleague of ours?
    Chairman Baker. Absolutely. I look forward to having 
further continued excellent cooperation as we move forward 
toward a legislative remedy to what we all agree is an 
appropriate step, and that is to give the money back to the 
people from whose pocket it was taken.
    I thank you for your appearance here today.
    Ms. Bruenn. Thank you for inviting me.
    [Whereupon, at 12:42 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



                              June 5, 2003

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