[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
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
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
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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
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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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