[Senate Hearing 108-884]
[From the U.S. Government Publishing Office]
S. Hrg. 108-884
THE ROLE OF STATE SECURITIES
REGULATORS IN PROTECTING INVESTORS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
ON
EFFORTS TO ENFORCE SECURITIES LAWS, INVESTMENT ADVISER REGISTRATION AND
LICENSING, STATE INVESTIGATIONS INTO MUTUAL FUND INDUSTRY ABUSES, AND
INVESTOR EDUCATION PROGRAMS
__________
JUNE 2, 2004
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
______
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho ZELL MILLER, Georgia
JOHN E. SUNUNU, New Hampshire THOMAS R. CARPER, Delaware
ELIZABETH DOLE, North Carolina DEBBIE STABENOW, Michigan
LINCOLN D. CHAFEE, Rhode Island JON S. CORZINE, New Jersey
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Bryan N. Corbett, Counsel
Dean V. Shahinian, Democratic Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
?
C O N T E N T S
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WEDNESDAY, JUNE 2, 2004
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Sarbanes............................................. 2
Senator Corzine.............................................. 4
Senator Dodd................................................. 20
WITNESSES
Peter C. Harvey, Attorney General, State of New Jersey........... 5
Prepared statement........................................... 31
Ralph A. Lambiase, President, North American Securities
Administrators Association, Inc. and Director, Division of
Securities, Connecticut Department of Banking.................. 8
Prepared statement........................................... 33
Response to a written question of Senator Miller............. 51
Joseph P. Borg, Director, Alabama Securities Commission and
Chairman, Enforcement Section, North American Securities
Administrators Association, Inc................................ 10
Prepared statement........................................... 38
Response to a written question of Senator Miller............. 52
Charles Leven, Vice President, Board Governace and Chair, Board
of Directors, AARP............................................. 12
Prepared statement........................................... 48
Juanita Periman, of Butte, Montana............................... 14
(iii)
THE ROLE OF STATE SECURITIES REGULATORS IN PROTECTING INVESTORS
----------
WEDNESDAY, JUNE 2, 2004
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:10 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Richard C. Shelby (Chairman of
the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The hearing shall come to order.
During this past year, this Committee has examined a range
of issues confronting the securities industry. Much of the
Committee's attention has been focused on the so-called Global
Settlement of Wall Street analysts' conflicts of interest and
the revelations of wrongdoing in the mutual fund industry.
These scandals had much in common: They both involved egregious
conflicts of interest, widespread misconduct, and inadequate
disclosure to investors.
There was another common theme underlying these scandals:
State securities regulators initiated both investigations.
Although the SEC is the primary securities market regulator,
time and again we have seen the need for vigorous State
regulators to pursue investigations and enforcement actions.
Much of the misconduct at the root of the Global Settlement
and mutual fund scandal was long-standing industry practice--
``open secrets'' on Wall Street but unknown to ordinary
investors. State regulators were the first to initiate
enforcement actions against these ingrained and questionable
industry practices. State regulators are the local cops on the
beat, and their proximity to investors enables them to serve as
an early detection system for growing frauds and scams.
Recent enforcement cases demonstrate the benefits of a dual
regulatory structure in which both State and Federal regulators
protect investors' interests. Although Federal and State
regulators have distinct roles to play in our securities
markets, they share the same goal of stopping misconduct and
assuring a fair deal for the ordinary investor. Successful
State and Federal collaboration is essential to ensure vigilant
protection of our securities markets.
State regulators have a mandate to protect investors that
extends beyond enforcement actions and coordination with
Federal regulators. Many States have proactively launched
initiatives designed to preempt future frauds by educating
investors as to how they can protect their assets and to
identify signs of wrongdoing. An educated investor is a better
investor and the first line of defense against securities
fraud.
I look forward to hearing more about State-sponsored
investor education programs and the centralized broker-dealer
and investment adviser registration systems that States have
created. This morning, the Committee will hear from several
regulators who are at the forefront of investor protection.
First, we have Peter Harvey, the Attorney General of the
State of New Jersey. We welcome you, sir.
Mr. Harvey. Thank you, Mr. Chairman.
Chairman Shelby. Mr. Ralph Lambiase is the Director of the
Securities and Business Investment Division at the Connecticut
Department of Banking and President of the North American
Securities Administrators Association. We welcome you, too.
Mr. Lambiase. Thank you, sir.
Chairman Shelby. Mr. Joseph Borg is the Director of the
Alabama Securities Commission and Chairman of the Enforcement
Section Committee of the North American Securities
Administrators Association. Mr. Borg, we welcome you, too.
Mr. Borg. Thank you, Mr. Chairman.
Chairman Shelby. I look forward to hearing the regulators
discuss current enforcement actions, Federal and State
coordination, and other initiatives designed to protect
investors. This morning, we will also hear from two witnesses
who can address the day-to-day activities of State regulators
that are critical to ensure investor confidence and integrity
in our markets.
Mr. Charles Leven is the Chairman of the Board of Directors
of the American Association of Retired People and Vice
President for Board Governance. Older Americans have long been
targets of securities fraud, and Mr. Leven will address how the
AARP works with State regulators to educate investors and to
reduce their risk of being a victim of fraud.
Finally, the Committee will hear from Ms. Juanita Periman.
Ms. Periman is a resident of Montana and has traveled a long
way to be with us today. Several years ago, Ms. Periman was
victimized by a securities fraud in which her broker made
unauthorized trades and liquidations in her accounts. Ms.
Periman contacted the Montana Securities Department and has
worked with the regulators to pursue the wrongdoer and to
obtain restitution. I thank Ms. Periman for traveling to
Washington in order to share her story with us and the rest of
the Senate.
I thank each of you for coming, and we look forward to
hearing your testimony.
Senator Sarbanes.
STATEMENT OF SENATOR PAUL S. SARBANES
Senator Sarbanes. Thank you very much, Chairman Shelby, and
I want to commend you for holding today's hearing.
The protection of securities investors has always been a
high priority for this Committee and an issue on which I have
placed a great deal of emphasis. It is my own view that State
securities regulators perform an essential role in promoting
the goal of investor protection. Their work is particularly
important for protecting retail investors from those brokers
and financial advisers that engage in improper or fraudulent
practices. And through registration, examination, and
enforcement, and by various programs to educate the public, I
think they render a very important service.
We regularly see instances of how important their work is.
Let me give just a couple of examples, some of which will echo
what the Chairman had to say.
In April 2002, New York State officials--the Attorney
General, the Securities Bureau Chief, and others--led a
settlement with major brokerage firms regarding misleading
stock research recommendations. This led to a major enforcement
effort in which State regulators joined forces with Federal
regulators to negotiate a Global Settlement with 10 major
securities firms.
In September 2003, the Massachusetts Secretary of the
Commonwealth and Deputy Secretary for Securities found
instances of late trading and improper market timing of mutual
funds. This led to a comprehensive investigation of the mutual
fund industry by Federal and State authorities, which is
resulting in enhanced oversight and enforcement as well as in
regulatory reforms.
In my own State of Maryland, Melanie Lubin, the Securities
Commissioner, has been active in enforcing securities laws to
protect citizens, as well as in promoting financial education
to reduce the potential for investor abuse, working closely
with the Maryland Coalition for Financial Literacy. Ms. Lubin
has served as Securities Commissioner for 6 years, has worked
with Maryland's Attorney General Joseph Curran for 18 years,
and is doing a very good job.
Mr. Chairman, I think the State regulators have particular
strengths that enable them to be effective and, as has often
been said, ``to be the first line of defense against investor
fraud.'' They are geographically close to investors, have
offices located in many instances throughout their States. Many
investors find State regulators easily accessible and call them
first about a securities problem. They are familiar with the
securities activities taking place in their local areas and
with the local brokers and dealers. And they can act quickly in
response to phone calls or letters.
Recently, some have advanced the view that the authority of
the States should be curtailed because of the presence of
Federal securities regulation. It is my view that such
preemption of State authority would not serve the public
interest. Recent history, some of which I have just recounted,
provides ample evidence of the value of State securities
regulators in protecting the investing public.
Furthermore, State securities regulators have been in the
forefront of investor education. A decade ago, they had the
foresight to establish the Investor Protection Trust, which is
designed to fund projects that educate investors. So, I look
forward to hearing the testimony of the witnesses here this
morning and hearing Ms. Periman, who will underscore exactly
what they are trying to address. And as we continue to work
with the States to protect securities investors, I am
interested in any new initiatives they have undertaken, current
trends in securities misconduct, the extent of cooperation with
the SEC, the extent to which we are all working together for a
common purpose.
Thank you very much, Mr. Chairman.
Chairman Shelby. Senator Corzine.
STATEMENT OF SENATOR JON S. CORZINE
Senator Corzine. Thank you, Mr. Chairman, and I appreciate
very much your holding this hearing. Investor protection is
something that all of us find at the top of our agenda with
regard to oversight of the securities markets, and I no doubt
believe that the cooperation that we need to see between State
and Federal regulators is absolutely essential. So making sure
that we have effectively functioning national markets with good
checks and balances from both Federal regulators, obviously,
but the underpinning role that our State regulators play is
extraordinarily important, and finding the right balance there
is what I hope that this hearing and other discussions about
this will take us. The whole effort of registration,
examination, enforcement, and education are things that I truly
believe the State regulators have a role to play in, but making
sure that we have deep and broad markets is also something that
is important to encourage. And so some synergy across the
national markets I think is absolutely essential.
I am also here because I have a very good friend and
someone who I trust his judgment as much as anyone both in the
legal world but in politics and public service, and that is New
Jersey's State Attorney General Peter Harvey, who, by the way,
was born and raised in Tuskegee, Alabama, so he has plenty of
positive ingredients that you might identify with.
Chairman Shelby. I knew you had a lot of redeeming features
before you came today.
[Laughter.]
Senator Sarbanes. And went to college at Morgan State
University in Baltimore, Maryland.
[Laughter.]
Senator Corzine. Good Lord, you wouldn't even let me get it
out.
[Laughter.]
I thought I was really going to butter up to both the
Ranking Member and the Chairman here quite effectively.
Let me just tell you that there is not a finer lawyer,
there is not a finer public servant in New Jersey than Peter
Harvey. He has had all kinds of accolades, just named Lawyer of
the Year by the New Jersey Law Journal and was very active
before he came into public service in all kinds of supporting
roles. And I am really pleased to introduce him.
I also would just say that he has very practically just
been involved in the PIMCO affiliate settlement that has been
very much in the press, I think dealing with the kinds of
trading abuses and investment protection issues that we are so
interested in. I welcome him and all of the other witnesses and
look forward to hearing your comments.
Chairman Shelby. Thank you.
All of your written testimony has been made part of the
record. We have that, if you will briefly sum up your best
points that you want to make.
Mr. Harvey, we will start with you.
STATEMENT OF PETER C. HARVEY
ATTORNEY GENERAL, STATE OF NEW JERSEY
Mr. Harvey. Thank you. Chairman Shelby, Ranking Member
Sarbanes, and Members of the Committee, I am Peter Harvey,
Attorney General of the State of New Jersey, and thank you for
inviting me here to testify today on the issue of State
regulation and enforcement of securities laws.
As you know, the States play a critical role in regulating
securities. By highlighting what we are doing in New Jersey, I
hope to illustrate clearly why the States are a crucial
component of investor protection in this Nation. I want to
acknowledge and thank Senator Jon Corzine, who has been a wise
and experienced leader in the investment industry and community
and now devotes his wisdom and leadership in service of the
Nation and New Jersey. I want to thank him particularly for
being a strong advocate of investor education and protections.
Let me just give you some idea of State regulatory
oversight in New Jersey. Many middle-class Americans seek to
build their assets for retirement, as well as their children's
college education by investing in stocks and bonds. These days,
most of the money that Americans invest is not in banks. It is
invested in securities, predominantly through pension plans,
private retirement plans, including 401(k), Keough, IRA plans,
and major mutual funds, and also through broker-dealers. Thirty
years ago, only a small fraction of U.S. citizens ventured into
the securities market. We now have nearly 100 million
investors. That is certainly a lot of people and a lot of
money.
Unfortunately, there are plenty of modern-day Willie
Suttons--armed with a sales pitch instead of a gun--who know
where the money is and have learned that many investors are
easy marks for a scam. Those investors are spread over 50
States, which is really too much territory to cover without
State securities regulators.
In New Jersey, the Bureau of Securities acts on behalf of
the Attorney General. New Jersey is one of only five States to
place such an agency directly under the control of the Attorney
General. As Attorney General, I have both criminal and civil
authority to prosecute securities fraud.
The bureau has a staff of about 60 people to enforce New
Jersey's Uniform Securities Law. The bureau is funded through
fees paid by the regulated community, as well as fines and
other sums collected in enforcement actions. The bureau
regulates the sale or offer of any security sold into or from
New Jersey, as well as firms and persons engaged in the
securities business in our State. The primary mechanisms for
regulation are: One, registration of securities, firms, and
agents; and, two, enforcement actions against those who fail to
comply with registration or engage in fraud.
Since becoming Attorney General last year, I have dedicated
increased staff and resources to the Bureau of Securities in
order to handle the enormous workload. I will highlight a few
facts and cases that illustrate the scope of the securities
fraud problem we face in New Jersey alone.
New Jersey has a large amount of investment activity. It
ranks fourth in the United States in total firms and agents
registered, behind only California, New York, and Florida. The
Bureau of securities registers approximately 2,700 broker-
dealer firms, 155,000 agents, more than 2,000 investment
advisers, and 12,200 investment adviser representatives.
Registration is important to States as it permits State
regulators to weed out bad actors and fraudulent or suspect
securities offerings.
Another critical component of the bureau's work is investor
education. Bureau representatives regularly conduct seminars
for senior citizens, a particularly vulnerable group, and
community groups on avoiding securities fraud. State Attorneys
General and securities regulators would welcome Federal
assistance in the investor education area, whether in the form
of national ad campaigns or grants for State programs.
Let me turn now to discuss briefly our enforcement efforts.
New Jersey has about 200 enforcement cases in the
investigative stage at any given time and more than 40 in
active litigation. New Jersey is no stranger to major
securities fraud cases. A good example is Robert Brennan, the
penny stock king who defrauded investors of millions of
dollars. The high-profile bankruptcy fraud trial which led to
Brennan's imprisonment in 2001 was a result of a cooperative
effort involving the Bureau of Securities in New Jersey, the
Securities and Exchange Commission, the FBI, and the U.S.
Attorney's Office for the District of New Jersey. It was a
direct outgrowth of two separate civil matters brought by the
Bureau of Securities and the SEC. We have secured a $55 million
claim in bankruptcy court against Mr. Brennan and a $45 million
judgment, yet to be collected, but we are still working on it.
I want to focus, however, on more recent activities.
New Jersey played a major role in the landmark multi-State
settlement announced last year between securities regulators
and 10 top Wall Street firms regarding stock analyst practices.
New Jersey also was lead State for the investigation of Bear,
Stearns, & Company. The case, as you know, brought major
reforms to the industry to ensure that stock analysts are not
subjected to pressure to report favorably on stocks and bonds
of investment banking clients of their firms.
Just yesterday, I announced another major settlement with
significant implications for the industry. New Jersey reached
an $18 million settlement with Allianz Dresdner Asset
Management and two affiliated companies regarding allegations
of a fraudulent arrangement that permitted a large investor to
market-time more than $4 billion in transactions in their
mutual funds, in violation of fund policies and to the
detriment of long-term investors. The settlement requires the
defendants to implement corporate governance changes to ensure
that portfolio managers for their mutual funds function
independently of business managers and that the funds comply
with their own policies barring market timing.
In between these milestones, New Jersey has filed eight
major securities fraud cases involving, in the aggregate, more
than 1,000 investors and more than $160 million in investments.
In February 2004, we filed suit against three men and their
companies, including Clover Management Group, Inc., of Fort
Lee, New Jersey, that engaged in an elaborate scheme to swindle
investors in the United Kingdom out of more than $55 million.
The defendants falsely claimed to offer investments in the
defense industry that would provide strong returns while
supporting the British and United States war effort in Iraq and
the worldwide war on terrorism. New Jersey has seized the
assets of the defendants, including a $2 million yacht, bank
accounts, luxury cars, and a painting by renowned artist
Eduardo Arranz-Bravo. The seizures followed cooperative
investigations by our Bureau of Securities, Federal
authorities, and New Scotland Yard. The defendants duped
sophisticated investors out of huge sums through slick
marketing, which included touring investors around a defense
industry plant and claiming to be advised by renowned military
leaders and financiers.
As mentioned above, as Attorney General I also have the
authority to criminally prosecute securities fraud. In June
2003, we simultaneously filed criminal and civil actions
against more than a dozen New Jersey companies and their
principles for allegedly stealing more than $80 million from
investors. The scheme's principle architect was Thomas
Giacomaro, who pleaded guilty to money laundering charges
brought by the Division of Criminal Justice in the Attorney
General's Office and Federal charges of mail fraud and tax
evasion. Among the parties who lost money in this scheme was
best-selling novelist Mary Higgins Clark.
Many of these cases have involved cooperation between State
and Federal authorities, including the Brennan case, the Wall
Street stock analyst settlement, the Clover case, and the
Giacomaro case. State securities regulators and the SEC can
accomplish a lot by working together, as our representatives in
the North American Securities Administrators Association have
been emphasizing in their ongoing discussions with the SEC and
their cooperative initiatives. However, another point should
not be lost. States also can be extremely effective on their
own, as we have demonstrated in the Allianz Dresdner case. In a
4-month period, we filed and settled a case that addressed a
serious industry problem and led to reimbursement of the
affected funds. We secured needed reforms, but resolved the
case quickly to avoid a lingering cloud that might harm the
funds. Several other States have also shown their effectiveness
on this front.
Although I have discussed high-profile cases that in some
instances did catch the attention of Federal authorities, many
of our securities fraud cases--both civil and criminal--would
not be pursued by Federal regulators, leaving investors without
recourse. There are simply too many cases out there, and
sometimes the dollar amount of the fraud is not large enough to
interest Federal securities regulators given their limited
resources.
The bottom line is the task of protecting investors is too
large to be handled by a single Federal agency, the SEC.
Investors need the protection of State securities bureaus. We
hope you will maintain, if not enhance, the authority of State
securities regulators.
Thank you again for the opportunity to testify. I share
your concern about this vital issue and stand ready to work
with you to examine what areas need to be addressed in the
future, and I look forward to working with you and other
Members of the Committee with respect to this task.
Chairman Shelby. Thank you, Mr. Harvey.
Mr. Lambiase.
STATEMENT OF RALPH A. LAMBIASE
PRESIDENT, NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC., AND
DIRECTOR, DIVISION OF SECURITIES,
CONNECTICUT DEPARTMENT OF BANKING
Mr. Lambiase. Thank you. Chairman Shelby, Ranking Member
Sarbanes, and Members of the Committee, I am Ralph Lambiase,
Connecticut Securities Director and President of the North
American Securities Administrators Association, referred to as
NASAA. I would like to thank you for this opportunity to
present an overview on the many ways that State securities
regulators serve and protect more than 100 million investors in
North America. I also want to take this occasion to thank
Connecticut's senior Senator, Christopher Dodd, for continuing
to serve as a strong advocate for investor protection and
listening to the concerns of the Connecticut Department of
Banking, which includes the Securities Division.
Our securities markets may operate on Wall Street, but
stocks, bonds, and securities are sold on Main Street, in our
neighborhoods and even over our kitchen tables, from nearly
96,000 branch offices nationally. States have protected its
residents from fraud for nearly a 100 years. We bring civil and
administrative actions to penalize or to seek restitution from
those who have violated our laws. We work with criminal
authorities to prosecute those who would commit securities
fraud. Ten of my colleagues are appointed by the Secretaries of
State; five come under the jurisdiction of their States'
Attorneys General; and some, like me, fall within their States'
banking, commerce, and similar departments or commissions. No
matter where we are located within our governmental structure,
State securities administrators share a common passion for
protecting their citizens from investment fraud and abuse.
While some of our high-profile enforcement actions make
national headlines, I would like to focus today on our other
equally important regulatory responsibilities. In addition to
enforcing our securities laws, we license stockbrokers and
investment firms; we investigate complaints and allegations of
investment fraud; we examine broker-dealers and investment
advisers to ensure compliance with securities laws and the
maintenance of accurate records of client accounts; we assist
small businesses in raising capital, and we review certain
local offerings not covered by Federal law; we educate
investors by providing tools and the knowledge they need to
make informed investment decisions; and we advocate the passage
of strong but sensible and consistent State securities laws and
regulations.
State regulators are generally recognized as investors'
first line of defense, and States have long been acknowledged
as laboratories of innovation. Both of these characterizations
are on point. As grass-roots regulators, we are accessible and
accountable. Our ability to adapt successful programs initiated
in one State and expanded to others benefits both the public
and the industry.
States have a long tradition of protecting investors by
helping them build financial knowledge and security through
education. Our financial education professionals work in
classrooms, the workplace, and senior centers, delivering
financial education to constituents of all ages.
Last year, through NASAA, we launched a multifaceted
education campaign to assist senior investors. We focused
particular attention to the problem of Internet investment
fraud directed at seniors.
To improve the level of youth financial literacy, we have
developed a system for delivering training events that offer K-
12 teachers the knowledge, resources, and tools that they will
need to bring effective personal finance education into their
curriculums.
I would also like to highlight a few other key points. The
first is our sincere interest in working with our counterparts
at the SEC and the SRO's, as well as regulators abroad, to
collectively use our limited resources to protect investors. As
the number of Americans who rely on the securities markets has
grown, so, too, has the number of firms and individuals serving
as investment professionals. Today, more than 5,200 firms offer
and sell securities. Some 90 percent of these firms have fewer
than 100 employees. Investing is clearly a local business.
While we hear a lot about the globalization of our markets,
virtually all of the Nation's 650,000 securities agents sell in
our neighborhoods. Protecting investors is a significant
challenge, and no single regulatory agency can go it alone.
We look forward to the continued progress of our
discussions with the SEC to improve coordination and
communication as part of a joint initiative launched last
September. The research analyst cases of 2002 and 2003 and the
more recent investigations of the mutual fund industry are good
examples of the importance of our complementary State and
Federal regulatory system. Now, as the SEC and the SRO's move
forward in their rulemaking process, we stand ready to provide
insight from our unique grass-roots perspective. These
collaborative efforts have and continue to restore investor
confidence in our financial markets.
Earlier this year, Congress removed Federal preemptive
provisions from H.R. 2179, the Securities Fraud Deterrence and
Investor Restitution Act of 2004. It is vitally important that
Congress reject attempts to weaken State regulatory authority.
When investors have confidence in the markets, issuers have
access to needed capital, and our economy prospers. Greed and
wrongdoing that goes unchecked undermines investor confidence.
When it comes to investigation and enforcement of securities
wrongdoing, investors are demanding more cops, not fewer.
Protecting investors against fraud and punishing those who
would commit fraud are fundamental roles of Government, be it
Federal or State, or provincial in the case of our neighbors to
the north. We at home are deeply grateful to those Members of
Congress who have been champions of investor protection.
Congressional commitment to the integrity of our financial
markets, accountability in corporate governance, and full and
fair disclosure has helped make our Nation's markets the best
in the world.
I pledge to you the continued support of the NASAA
membership to work with the Committee to provide any additional
assistance the panel may need. And I would like to thank you
for the opportunity to testify here on the role of State
securities regulators.
Chairman Shelby. Thank you very much.
Mr. Borg, I just want to say again we are happy to have you
here. Of course, Mr. Borg is the Director of the Alabama
Securities Commission and he is Chairman of the Enforcement
Section Committee, the North American Securities Administrators
Association.
STATEMENT OF JOSEPH P. BORG
DIRECTOR, ALABAMA SECURITIES COMMISSION AND
CHAIRMAN, ENFORCEMENT SECTION, NORTH AMERICAN
SECURITIES ADMINISTRATORS ASSOCIATION, INC.
Mr. Borg. Thank you again, Mr. Chairman. Chairman Shelby,
Ranking Member Sarbanes, Senator Corzine, I am Joe Borg,
Director of the Alabama Securities Commission and Chairman of
the Enforcement Section for NASAA.
It is a particular honor for me to be here and have the
opportunity to publicly thank my Senator, Richard Shelby, for
his thorough and thoughtful approach to restoring investor
confidence in our markets.
Today, I am delighted to have the chance to share with you
some of the highlights from States' enforcement activity.
Certainly, two of the most high profile enforcement matters to
date have been the research analyst cases and the mutual fund
cases. This Committee is familiar with the analyst conflict of
interest global settlement. All 50 States, the District of
Columbia, and Puerto Rico, in conjunction with the SEC, the New
York Stock Exchange, and the NASD agreed to settle with the 10
firms involved. The level of State, Federal, and SRO
cooperation was unparalleled, but I would like to stress, not
unprecedented.
Those settlements achieved a number of very important
objectives and resulted in much-needed change in the way the
firms conduct their business. A rigorous separation between
research and banking was affected by the settlement.
Independent research will provide investors at the 10 firms
with research procured by independent consultants and a total
of $80 million will be directed for investor education purposes
over a 5-year period.
With respect to the mutual fund scandals I would like to
commend this Committee for its complete and deliberative
examination of the trading abuses in the industry, and I can
assure you that the States will continue to actively pursue
inquiries into mutual fund improprieties, and we are committed
to aggressively addressing mutual fund complaints raised by
investors in our jurisdictions. But these high profile national
cases are rare, and they should not obscure the more routine
caseload that represents the bulk of States' enforcement work.
State securities regulators are vigorously pursuing sales
practice abuses and a variety of scams and frauds against
unsuspecting investors. We often initiate investigations as a
result of complaints from investors in your States who feel
they have been wronged by a broker/dealer, securities
professional, or those claiming to be securities or investment
professionals.
Many investors understandably feel that the logical place
to start with a grievance is their local State securities
regulator, and as Chairman Shelby noted earlier, we are the
local cop on the securities beat. Our offices are close to the
investing public. We are responsive, and we can take immediate
action without the time needed to obtain formal agency orders.
Now, this is evident from the States' impressive record in
bringing enforcement cases, including criminal prosecutions.
The chart before you illustrates State enforcement statistics
for the reporting period 2002 to 2003 with over 70 percent of
the 52 jurisdictions responding. The States filed almost 3,000
administrative, civil, and criminal enforcement actions,
assessed over $822 million of monetary fines and penalties, and
procured more than $660 million in restitution, rescission, and
disgorgement, and sentenced criminals to over 717 years of
incarceration. NASAA sent out a recent survey to obtain this
latest data, and I will be pleased to follow up with the
Committee in a few weeks with more complete information.
For the past several years, NASAA has released its list of
top 10 investment scams, schemes, and scandals to alert
investors to increasingly complex and confusing investment
frauds. The problem areas that we are pursuing with enforcement
cases include unlicensed securities sellers who are pitching
securities that are unregistered. Scam artist use high
commissions to entice some insurance agents, investment
advisers, and even accountants and lawyers into selling
investments that they may know little about, such as bogus
limited partnerships or promissory notes, all offering supposed
high returns with little or no risk.
Prime bank schemes are a perennial favorite of con artists
who promise investors access to secret high-yield instruments
made through trades among the world's top or what they call
``prime banks.'' Promoters falsely claim the investment is
guaranteed or secured by some kind of collateral or insurance.
The investors ultimately find out that prime banks simply do
not exist.
Sales of variable annuities have increased dramatically
over the last decade, and as sales have risen, so too have
complaints from investors. We are concerned that investors are
not being told about high surrender charges and the steep sales
commissions agents often earn when they move investors into
variable annuities. Often pitched to seniors through investment
seminars, these products are unsuitable for many retirees.
Risky viatical settlement contracts, now expanded to life
settlement contracts, are products that have been on our radar
screens and subject to State securities enforcement actions for
the past several years. In a typical transaction, the person
who is terminally ill sells his policy to a third-party broker
in return for a portion of the death benefit. State regulators
are seeing deceptive marketing practices, numerous instances of
fraud, and claims that viaticals offer safe, guaranteed returns
like bank certificates of deposit.
Just last month the SEC and State regulators stepped in to
shut down and revoke the license of Mutual Benefits
Corporation. In addition, Florida regulators charged the
company with racketeering and 15 counts of investor fraud,
saying that the company lured tens of thousands of investors
into an elaborate Ponzi scheme that raised more than one
billion dollars.
In affinity fraud cases, scammers often use their victims'
religious, social, or ethnic identity to gain their trust and
then steal their life savings. So, many fall prey to affinity
group fraud in which a con artist is or seems to be a member of
the same ethnic, religious, career, or community-based group.
For example, my office recently completed a criminal
investigation into a religious affinity fraud case that
resulted in six defendants being convicted. The case involved
nonexistent church bonds, money laundering, and securities
fraud that absolutely destroyed the Daystar Assembly of God
Church located in Prattville, Alabama. Losses exceeded $3
million, and as a result, the congregation lost its church.
Almost all those convicted were church members, and the ring
leader received a 31-year prison sentence.
Even with the funding increase that Congress has allocated
for the SEC, the Commission just cannot go it alone. There must
be greater cooperation and division of labor among State,
industry, and Federal regulators. To that end, as Mr. Lambiase
mentioned earlier, representatives of NASAA and the SEC have
been meeting on a regular basis as part of a joint initiative
to study ways to improve Federal and State cooperation. I am a
member of this working group, and I can assure you that
discussions have been educational, thorough, and constructive.
In addition, along this line, we have formed a NASAA/NAIC
enforcement subgroup to improve coordination and focus on the
persistent problem of insurance agents engaged in the unlawful
sale of various securities investments.
Mr. Chairman, State securities regulators are dedicated to
pursuing those who have violated the trust of our citizens. We
will fight to ensure that State securities regulators maintain
the authority to regulate, at the local level, and bring
enforcement actions with appropriate remedies against those
firms and individuals who violate securities laws in our
jurisdictions. State securities regulators wish to work with
you and your Committee to provide you with any additional
information or assistance you may need.
Thank you again for inviting me to speak on behalf of the
States to discuss our efforts in protecting the investing
public, and I will be happy to answer questions at the
appropriate time.
Chairman Shelby. Thank you, Mr. Borg.
Mr. Leven.
STATEMENT OF CHARLES LEVEN
VICE PRESIDENT, BOARD GOVERNANCE AND
CHAIR, BOARD OF DIRECTORS, AARP
Mr. Leven. Good morning, Chairman Shelby, Ranking Member
Sarbanes, and Members of the Committee. My name is Charles
Leven. I am AARP Vice President for Board Governance and Chair
of the Board of Directors.
I appreciate this opportunity to testify on a matter of
keen interest to us, investor protection. My testimony today
focuses on the role that State securities regulation and
regulators play in securing essential marketplace conditions on
fair play and practice.
The rapid growth in investment activity over the past
decade has severely taxed the resources of Federal and State
securities commissions. According to the North American
Securities Administrators Association, there are at least
20,000 investment adviser firms in the United States,
approximately only 8,000 of whom are large firms that register
with the Securities and Exchange Commission. The remaining
smaller firms are registered with the States.
NASAA also estimates that 150,000 to 175,000 individuals
hold State licenses to act as investment adviser
representatives. The need for complementary Federal and State
investor protection efforts has never been more evident.
According to the 2001 Federal Reserve Survey of Consumer
Finances, the percentage of households that own stocks, either
directly or indirectly, increased from 32 percent in 1989 to 52
percent in 2001. This growth in investment has occurred even
though in recent years the stock markets have weathered a
sluggish economy, experienced steep market declines, trade
deficits, and reports of numerous scandals ranging from illegal
corporate accounting practices to insider trading. These shocks
to the securities marketplace have resulted in serious
consequences for ordinary saver/investors.
A 2004 survey of investors by AARP confirms a reduced
confidence in financial service professionals, continuing
concerns about the fairness of stock market conditions, and the
desire for stronger regulation of the securities industry. We
are reminded by recent market history just how vital the State
securities commissions are in our dual system of market
regulation and investor protection.
For AARP, the goal of providing American investors with
market conditions of fair play and practice is advanced by
promoting harmonization within our concurrent Federal/State
system of securities regulation. Surely State securities
regulatory commissions must and are playing an essential role.
State securities regulators are responsible for the licensing
of firms and investment professionals, registration of some
securities offerings, branch office sales practice audits,
investor education, and most importantly, the enforcement of
State securities laws.
One of the principal virtues of our concurrent system of
securities regulation is State authority to investigate and
bring enforcement action with respect to fraud or deceit or
unlawful conduct in connection with securities transactions.
State securities administrators are frequently the first point
of contact when an investor has a securities transaction-
related complaint. State regulators often work very closely
with criminal prosecutors at the Federal, State, and local
levels to punish those who violate our securities law.
The New York State criminal case against research analysts,
settled in 2003, is a useful illustration of the significant
role that State securities regulators can play. Precisely
because the States also had investigatory and enforcement
powers, one State was able to take the initiative in what
became a $1.4 billion settlement with 10 leading broker-dealer
firms with funds set aside for investor education programs.
Ultimately, NASAA, the State of New York, and Federal
regulators worked cooperatively on the global research analyst
settlement.
Also, in 2003, the regulators in Massachusetts began what
would become a series of investigations by other State and
Federal regulators into the Nation's $7.6 trillion mutual fund
industry. Clearly, these examples serve to validate the
rationale for maintaining a well-balanced and concurrent
securities regulation system.
Further, State regulators have been active in coordinating
reviews of filings, developing uniform registration statement
for offerings that are exempt at the Federal level, and in
crafting policy statements on the number of review issues that
strengthen uniformity of review in the States.
For example, in 2002, a new version of the Uniform
Securities Act was adopted by the National Conference of
Commissioners on Uniform State Laws. The Uniform Securities Act
has been the model for nearly 40 States' securities laws.
AARP has been impressed by State efforts in the area of
investor education. For example, the Investor Protection Trust,
whose trustees are chosen from among State regulators, is
chartered to provide objective, noncommercial investor
information. The IPT uses funds collected in settlements
against investment companies that have been charged with
violating securities laws. Last year, complementing its
existing investor education section, NASAA initiated a major
investor education campaign aimed at older investors by
launching an online senior investor research center.
In closing, we believe there are demonstrated benefits to
the dual system of securities regulation and to the role and
value that State securities regulators play in that system. I
will be happy to answer any questions when appropriate.
Chairman Shelby. Thank you, Mr. Leven.
Ms. Periman.
STATEMENT OF JUANITA PERIMAN
OF BUTTE, MONTANA
Ms. Periman. Good morning. My name is Juanita Periman of
Butte, Montana. I want you to know what an honor and privilege
it is for me to appear before you this morning.
I am here to tell you how much I appreciate the help I got
from my State's securities regulators. I am not alone. I was
among over 30 people, including 7 widows, 21 retired
individuals or couples, and 3 in assisted living facilities,
who fell victim to what turned out to be one of the State of
Montana's largest securities cases.
My story began following the death of my husband in 1998,
when I opened an IRA through a broker named Tom O'Neill at the
local office of Piper Jaffrey in Butte. I also transferred the
proceeds of my husband's IRA and other retirement savings to my
new IRA. I had no previous investment experience, and my only
investment objectives were income, safety, and growth. I was at
a vulnerable point in my life, and Tom was a long-time family
friend and former business associate of my husband.
To cope with the loss of my husband I traveled a lot with
the Christian Youth Ministries and also visited family. After
returning home from one of these extended trips I found my
mailbox filled with letters from my broker's office.
Regrettably, I did not pay much attention to these letters.
When I finally opened them I saw that they were
confirmation notices of trade in my account. I knew something
was not right because I had not authorized these trades.
At first, I questioned my broker, but he told me not to
worry. He even made me feel stupid and guilty for questioning
him.
The more I thought about it, the more I realized I was in
trouble. At least half of my account has been wiped out and I
really did not know where to turn for help. My sister suggested
I contact the Montana Securities Department, and I did that in
December 2000. I explained my situation. They listened and told
me to immediately close my account.
The Securities Department investigated my complaint and
found that it appeared that my broker was illegally trading in
my account. As they dug deeper into my case, the Department
found 38 other people that might also be victims. Montana
securities regulators suspended the broker in March 2001,
putting a halt to any further illegal activity, and they also
took action against his firm.
Through a negotiated settlement we got our money back and
the stockbroker was banned from the securities industry for
life. The State also negotiated for changed business practices
on the part of the firm so that other people will never have to
be victimized in that way.
My case demonstrates the quick response and effectiveness
of State securities regulators in protecting investors. Five
weeks after I first contacted my State securities regulators,
the State had concluded its investigation.
I really believe that being close to the investing public
is an advantage for State regulators. The person I first spoke
to was the same person that conducted the investigation.
Calling someone who could immediately investigate the case and
who could come to Butte and talk to me was really important.
They are the first responders, and I felt a real connection to
the State staffers who were available to help me throughout the
entire case.
It is really scary being a victim of fraud, but the staff
in Montana helped me to understand it was not my fault and that
I did the right thing when I called them for help. These are
local people helping their neighbors. They are local heroes. I
am glad my State had the authority and the regulatory tools to
pursue my case to a successful conclusion.
If I do nothing else this morning, I want to get the
message across that no one has to be a victim of investment
fraud, especially seniors.
Common sense tells you that if something sounds too good to
be true, it almost always is. But you do not have to rely on
common sense alone. If you have the slightest suspicion of what
is going on, contact your State securities regulator. They will
know when something is not right. They can tell you whether the
investment product is licensed for sale in your State, and
whether the salesperson has a history of wrongdoing.
I am very grateful that my State securities regulators
responded so quickly and successfully to my call. I only wish
that I had contacted them sooner.
Thank you again for the opportunity to tell my story.
Chairman Shelby. Ms. Periman, I want to thank you for
coming all the way from Montana here today. You have a great
story and I think it reinforces the roles of the State
regulators. So we thank you very much.
Ms. Periman. Thank you, Mr. Chairman.
Chairman Shelby. Much of the focus on State securities
regulation is centered on the headline grabbing investigations
such as mutual fund investigations and the Global Settlement.
We will start with Mr. Harvey. Would you describe the day-to-
day investigations and enforcement actions generally that
comprise the bulk of your enforcement cases, and how do you
determine when a routine State enforcement action should be
shared with the Federal regulators?
Mr. Harvey. I think Ms. Periman's case----
Chairman Shelby. It is a good illustration, is it not?
Mr. Harvey. Very much so, and it is quite appropriate for
this Committee's consideration. This is the kind of complaint
that State regulators get all the time and we certainly get in
New Jersey. I have often said--and I continue to believe--that
the investor about whom I am most concerned and about whom I am
most fearful, is the senior citizen because broker-dealers will
frighten senior citizens into believing that they are going to
run out of money, that there is a race against time between
their death and their assets. They prey upon their fear to get
them to invest in all kinds of ridiculous schemes.
Some of them have been outlined for you by Mr. Borg, these
promissory note schemes, investments in nonexistent
partnerships. These are the kinds of complaints we get on an
ordinary basis. We investigate them and find out that these
broker-dealers are engaging in transactions that are not
authorized, contrary to their own printed material, that they
are selling unregistered, unlicensed securities. In some
instance the brokers themselves are unlicensed. They are
essentially nothing short of swindlers.
What happens to a senior citizen is their entire life
savings are wiped out for good. They are embarrassed to go and
tell their children that this has happened to them, and they
are very fearful that they are going to become destitute, and
worst of all, be put in a nursing home and left to die.
So these are the types of cases that we encounter on a
daily basis, and we investigate them. They are much too great
in number for any one agency to investigate. Many times they
spread across multiple States. We have found that the same
investment scheme that we have investigated in New Jersey, New
York may be investigating it, Connecticut may be investigating
it, Florida may be investigating it, because the same conduct
is occurring.
With respect to cooperation, I think that there has been
better cooperation between the Securities and Exchange
Commission and the States, and we are still looking for ways
that we can collaborate more efficiently and effectively. I am
optimistic about it. I think that Federal authorities sometimes
can be of great value to State regulators, but I do not think
that by any stretch of the imagination they should supplant
State regulators.
Chairman Shelby. Mr. Lambiase, could you briefly give us
your view on why the Global Settlement was seemingly such a
success?
Mr. Lambiase. I think it was a success, because it took a
limited number of resources and it took the expertise of both
the States and at the Federal level and the SRO's, and was
divided up in such a manner as to be able to address all
issues. Each party to the settlement brought a particular
expertise. The rulemaking, as you know, was looked at by the
SRO's and the SEC. The States focused on enforcement and a lot
of the conduct that was going on at the local level.
I would like to point out another issue about State
regulation and our ability to look at issues which really stems
from customer complaints we receive, the Ms. Perimans that call
us, written complaints and sales practice activity we uncover
during our branch examination procedures. This is what will
ultimately trigger States to pursue further inquiry, and I
would like to point that up.
Chairman Shelby. Mr. Borg, would you just touch for a few
minutes on why it is important not to have Federal preemption
here? I think it is obvious, but I would like for you----
Mr. Borg. Mr. Chairman, I could go on all day on that
issue. But let me point out----
Chairman Shelby. That is an important issue here.
Mr. Borg. It certainly is. The scams that we see on a local
level vary. I could give you examples of catfish farm
investments in Tuskegee. I can give you foreign currency with
Swiss bank accounts out of Montgomery, Alabama. I can give you
examples of local cases that do not involve publicly traded
companies or registered broker-dealers, which generally is not
the purview of the SEC. These are local frauds, regional
frauds, unlicensed, unregistered, that go into the billions of
dollars. The type of cases we see will be phony gold mines,
oil, and gas scams.
During the anthrax scare we were seeing things along the
Internet that said, ``We have the cure for anthrax.'' These are
things that happen maybe in a small community. I can think of
one case which you are familiar with in Phoenix City, where
here a little operator, in 90 days, got 33,000 participants in
a program and never took out a single ad, all through the
Internet. That is the purview of the State securities
regulators. We are on the spot. We are there quickly.
Chairman Shelby. That is why we do not need preemption, is
it not?
Mr. Borg. That is exactly so.
Chairman Shelby. Thank you.
Mr. Leven, you are here on behalf of, I guess, everybody
but a lot of us that are older Americans.
Mr. Leven. Well, some of us a bit older than others.
[Laughter.]
Chairman Shelby. Absolutely. But we all know that older
Americans have been, for a long time, targets of fraud, but it
seems today even maybe more so, especially in the securities
field. Elaborate, if you would for a minute, on how the State
regulators coordinate with your group, AARP, to better protect
and educate the older Americans as far as investments.
Mr. Leven. We have a very close relationship with them and
a great deal of respect for them. They are primarily very
active for us, both as a first line of defense for our people
50 and older--remember, the people 50 and older is where the
disposable income is, and so, the sharks move into that
direction as quickly as they can. And these people are our
first line of defense, both in terms of helping us in
prosecuting and getting recoveries and probably even more
important, educating the investor, which is a very important
part of what they do, and we certainly appreciate that.
Chairman Shelby. Thank you.
Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman.
Ms. Periman, I want to thank you for your testimony. I know
it is sometimes difficult to tell that story, but I hope you
appreciate how important it is for us to have on the record
specific cases that actually occurred. It is enormously helpful
in setting out what the problem is.
I am interested in increasing the resources, if at all
possible, and then maximizing them to try to deal with these
various securities frauds. I want to ask some questions in that
regard to the administrators.
I am interested in the extent of the Federal and State
cooperation amongst the regulators. For example, when a State
securities regulator pursues an enforcement case, does the
regulator inform the SEC? When the SEC is pursuing an
enforcement case in a State, does the State regulator receive
information about this from the SEC? That is just one example.
You may have others in mind. What is your take on the state of
interplay between the State regulators and the Federal
regulators?
Mr. Harvey. Senator, here is one of the enduring tensions
with regulators, and it does not matter whether they have
enforcement authority or not. Everybody wants to look good at a
certain point.
Senator Sarbanes. Yes, politicians suffer from the same
thing.
[Laughter.]
Mr. Harvey. So you have occasions where we are not
communicating as well as we should be, so investigations may be
commenced in a State and States are not advised of them. There
are times that States will undertake their own investigations
and not advise the SEC. We are working to improve that
communication.
I think we need better coordination because it avoids
duplication of effort, and there are some cases that are better
handled through a multi-State effort, the brokerage cases that
we have all discussed earlier today.
Where I think that we need additional resources is not
necessarily in enforcement--that helps--but in investor
education. Part of what is happening to our senior citizens and
to ordinary Americans is that they are getting pieces of data
about the stock market and the growth of the equity markets and
why their investments are better put there than in certificates
of deposit. All that is true. But unless you are a significant
investor with a mutual fund company, you do not go to
investment seminars. And we have to find a way to take that
message to senior citizen centers, to planned retirement
communities where we can go into these communities and explain
to seniors what the scams are and how to go about the business
of determining whether someone is legitimate or not.
I think if we can find Federal resources to supplement what
the States are doing as well as perhaps on the Federal level,
that would be one of the most important things that I think
this Committee and this Congress could do for ordinary
Americans.
Senator Sarbanes. Does anyone want to add to that?
Mr. Lambiase. I would like to make an observation. The
level of cooperation between the States and Federal is somewhat
looked at within a regional context. Different regions within
the country--the Northeast region has a different relationship
with the SEC and the SRO's than you might see in another area.
But I do think that the model that should be followed on
cooperation is that which we have amongst our own States. There
is a complete trust and cooperation among State regulators. We
will share information. We will share resources together. We
will work jointly. We have a complete trust and respect for
each other. And it is that trust and respect for each other
that allows us to work effectively as well as we do. I would
like to see that model a little bit more extended to the
Federal and State side.
Mr. Borg. Senator Sarbanes, if I may, certainly Mr.
Lambiase is correct. There are some regional differences, and I
would like to speak strictly to the Southeastern region. We
have a very good effort of cooperative participation with the
SEC. For example, just last month, not only did we bring a case
together, but we also do joint press releases together. This
was on the Heyman International case. The SEC, when we met with
them, realized we were looking at the same case from both ends.
They took care of the asset freeze and the filing--we went to
court with them--while we took care of the local agents with a
cease and desist order. So we were able to cooperate and
coordinate.
This is the type of thing that will come out, I think, of
the joint initiative between the SEC and NASAA over time. But
there is an educational curve. We have to learn a little bit
more about their procedures and their methodology. They have to
learn a little bit more about our abilities and what we can do
on a quick regional or State-level basis.
This is not unusual. Most of the past work has been on an
informal basis, and I can think of even public company cases in
1995 that we brought with the SEC against the Comptronics
Company, where they took a parallel track. They did the
Federal; we did the State. We combined them at the proper
moment. Everyone pled guilty.
Chairman Shelby. How big a fraud was that, Mr. Borg?
Mr. Borg. The stock losses to investors was $378 million,
if my memory serves correct. As you may recall, it was the
largest employer in the Guntersville area of north Alabama at
the time. But that would be an example.
I think as we continue doing regional meetings with the
SEC, we are doing a lot more joint conferences and exchanging
information and ideas, and I think the initiative will help
bring about a more efficient method as opposed to starting it,
because we have done cooperative efforts with the SEC for a
long time.
Senator Sarbanes. When we passed the Fair Credit Reporting
Act at the end of last year, we included in it a title on
financial literacy and it was strongly supported by Chairman
Shelby, and strongly supported, actually, by all Members of
this Committee in a very strong bipartisan effort. That,
amongst other things, established a Federal coordinating
committee to coordinate the efforts directed toward financial
literacy on the part of the Federal departments and agencies.
Many of them have various programs of one type or another
directed toward financial literacy, but they have never tried
to bring them all together and develop a concerted strategy.
Part of the charge given to that coordinating commission,
which is under the chairmanship of the Secretary of the
Treasury, is to coordinate and work with State officials on
financial literacy, which, of course, you all are very much
engaged in.
Have they reached out to you yet in order to try to
establish such working relationships? We very much want them to
do that, and I am just interested whether that has occurred or
is in the process of occurring. Because if it is not, why, we
need to prod and push the coordinating committee.
Mr. Lambiase. I have some information on that. Karen Tyler,
North Dakota Securities Commissioner and Chairman of the
Investor Education Section for NASAA, made a public
presentation at the most recent meeting of the Financial
Literacy and Education Commission on behalf of NASAA. So we
appreciate the follow-up on that, sir.
Senator Sarbanes. Good. Well, I think you should keep an
eye on that because it really could be quite productive if it
is really done the way it is supposed to be done. And I think
if you all keep pushing it and getting in there into that
venue, it would be very helpful to your efforts and to an
overall coordinated effort.
Thank you, Mr. Chairman. I see my time has expired.
Chairman Shelby. Senator Dodd.
STATEMENT OF SENATOR CHRISTOPHER J. DODD
Senator Dodd. Thank you, Mr. Chairman, and our witnesses.
I will begin just by thanking you and Senator Sarbanes, Mr.
Chairman, for doing this. This is--I do not know--maybe the
fourth or fifth subject matter on which this Committee has held
very worthwhile oversight hearings. This was not occurring with
great frequency up here in the last number of years by
Committees doing good oversight. There have been some stories
written recently about the absence of good oversight, and that
complaint I think has a great deal of legitimacy with regard to
an awful lot of Committees. It is not true about this
Committee, and it is a great tribute to the Chairman and the
Ranking Member that we have just had a series of hearings on
going back and reviewing legislation which this Committee has
adopted or passed and determining whether or not it is working
as well as we would like. I want to begin my brief comments by
thanking both of you. It has been tremendously worthwhile, and
I thank our witnesses.
Ralph, it is wonderful to see you.
Mr. Lambiase. Thank you, sir.
Senator Dodd. I was not here to hear you say nice things
about me, so I appreciate it on the record.
[Laughter.]
You have done a tremendous job. I do not know if the
Committee Members are aware of this, but a long and
distinguished record of service in Connecticut, and now as the
national President of NASAA. So we are very proud of you. You
have done a great job in our State, and it is an honor to have
you before the Committee.
Mr. Lambiase. Thank you, sir. It is an honor to be here.
Senator Dodd. Just a couple of questions. Some of this you
have already addressed, but picking up on the point that
Senator Sarbanes was addressing, and that is the educational
efforts. Under the Global Settlement, part of that $1.4 billion
was to go back to State regulators for this education effort. I
do not know how much of that $1.4 billion actually comes back
to you. I do not know if you have an exact number. But I wonder
if you could pick up on it.
And then this subject was raised by the Chairman as well,
and that is regarding the elderly, Mr. Leven, the perfect storm
has occurred. You list your top 10 scams and schemes and
scandals list, NASAA does each year. And this year it includes
a new listing. It is called senior investment fraud, and it
states--and I think this is very well put. It says, ``Volatile
stock markets, low interest rates, rising health care costs,
and increasing life expectancy combine to create a perfect
storm for investment fraud against senior investors.'' And I
think that says it well.
I wonder if you might just pick up on the two questions;
that is, the amount of money you are getting back for investor
education, and then speak to me a bit about what is going on.
What schemes are you seeing? You have addressed this a little
bit already, Mr. Borg, and you did, Ralph, but give us a range
of the kind of scams we are looking at that seniors should
really be aware of. This is a hearing which is being covered, I
think, by C-SPAN, and if it is, people watch these programs and
we say to them all the time check with people, you know, when
you are alone and you do not get many phone calls, you do not
get a lot of mail, you are just ripe for being abused by people
who take advantage of you.
So share with us a bit more information about these scams
that are out there.
Mr. Lambiase. Yes, I would like to address the first
question about the amount of funds which States will ultimately
receive for purposes of investor education. I think that
approximates $27 million in the aggregate of all the States
which will be dedicated toward furthering investor education.
The second question really is a question of time and what
is going on in the marketplace. Nowadays, with interest rates
being historically low in terms of the return that an investor
would get, the scams that you see really are focused toward the
elderly with the returns. You get a very minimal, a meager
return from putting money in a savings account or in some kind
of certificate of deposit, and, hence, you get into the prime
bank notes, which my colleague Joe mentioned, offering greater
returns.
What people prey upon now is the elderly's inability to
collect at this time an income stream which is sufficient to
carry them through, so they look for greater returns. The best
frauds are really the ones which say, well, we will give you or
we will guarantee a 10-percent-a-month return or some kind of
21-percent annual return, something which is outlandish to us
but certainly would be something that a person on a limited or
fixed income would need right now to survive.
Senator Dodd. Those are like magic words, if you are out
there, people start guaranteeing you a return on investment.
The bells should start ringing.
Mr. Lambiase. Absolutely.
Mr. Borg. Absolutely, Senator. I might also add, when it
comes to seniors, in the 1990's or before the market crash, it
was a matter of preying on, ``Don't you want to make things
better for your grandkids? Let's go ahead and find these great
investments with these tremendous returns.''
Now it is a fear factor. ``You are going to run out of
money. You do not have enough money coming in from your bank
CD's. You have to move out of them. You cannot trust the
market. You have to go with me. I am the guy that is going to
give you that 30-percent return, that 8-percent guaranteed
because it is collateralized, it is insured by some insurance
company. And look at this. We are going to put the money in a
prime bank in Europe''--which doesn't exist, as I mentioned
earlier. So now they are preying on the fears of seniors
running out of money.
The best frauds are ripped right out of the headlines. Gas
prices are going up. ``Look, I can get you into this oil and
gas venture where you are going to make a lot of money. How can
you lose? Look at gas prices.''
Technology. ``Well, you know, gee, we are at war. We have
these new technology devices. The Government is going to buy
them all. Here is where you should invest your money. It is a
guaranteed return.''
That is the type of tactic that is being used.
Added to that, when it comes to seniors--and I am sure Mr.
Leven will back me up on this--the slick operators talk to
their customers, talk to their victims. They will make them
comfortable. They will get to know them. They won't pressure
them on the first call. They will make them feel like they are
part of the family. And those seniors--my parents are very
cordial. They would not think of hanging up on a person. And
they will use that courtesy to sucker them into these
investments.
That is what we are fighting, and we have to get seniors to
understand that if they are taken, it is not their fault. They
have been conned.
Senator Dodd. Does anyone else want to add anything? Mr.
Harvey or Mr. Leven, do you want to add anything?
Mr. Lambiase. I just would like to point out from the
seniors' point of view, you know, we are in a very interesting
position. We are on fixed incomes. We have low returns on
pretty much any investment you would care to name. Taxes are
going up consistently and constantly, at local levels,
certainly, education, county taxes, whatever, you name it. And
we are getting a constant drain on whether we can keep our
homes.
So when someone comes along and offers anything that is a
little bit tantalizing or creates an opportunity, you can well
understand the state of mind that would lead you to
participate. And so we need help, and these people are, again,
as I said before, the first line of giving us help. But it is
education more than anything else. We need more and more
financial education.
Senator Dodd. Absolutely.
Mr. Harvey, do you want to comment?
Mr. Harvey. Yes. I would urge seniors to ask essentially
three questions.
One is: Is this particular broker-dealer or offeror
licensed with a State securities entity? And ask for permission
to get the license number and call the State Bureau of
Securities. They should give you the number if they are
legitimate.
Second, are the securities registered with a State Bureau
of Securities?
Then, third, I would ask: Do I have to decide this today?
Any dealer or purported dealer who says you have to get into
this today or this week or you are going to lose it forever,
you know it is phony. There is no such investment that you must
invest in today or it will forever be lost in time. You have to
assume that he gave that pitch 30 days ago and that he is going
to give it 30 days in the future.
So these are the kinds of questions. Slow it down.
Remember, seniors have to keep in mind, this is your money and
you do not have to give it to him if you do not wish to. Take
your time, slow it down, and ask more questions. Because if you
lose it, it is gone forever. Many of these individuals are
judgment-proof. Even with the multimillionaire and, some
argued, billionaire Robert Brennan, he had a lot of money. It
is true that we signed a $45 million judgment and obtained a
second $55 million judgment in bankruptcy. We have been chasing
the money for the past several years because it has been hidden
in Europe and elsewhere.
Senator Dodd. Mr. Chairman, could I ask one more question?
Chairman Shelby. You go right ahead.
Senator Dodd. I appreciate this. Ms. Periman, thank you.
Let me echo Senator Sarbanes' comments and the Chairman's
comments.
Ms. Periman. Thank you very much.
Senator Dodd. Very special to have you here. It is a long
way to come, and it is always painful to have to tell a story
that sounds embarrassing because somehow--even in your voice,
you almost said you did something--you did nothing wrong at
all. You did everything right. There are an awful lot of people
who would have done nothing and just taken this broker's
admonitions that somehow you were at fault in all of this. But
you did exactly the right thing, and the people out there
watching, listening, or reading about this, we need more people
like you because without you, it is hard for these people to do
the job. You provide the evidence and the facts that make it
possible for them to go after these people.
Ms. Periman. Thank you for the opportunity. Unfortunately,
in my instance, this was not a total stranger. This is someone
that I had known for more than 20 years.
Senator Dodd. I want to ask about the mutual fund issue, if
I could just briefly, Mr. Chairman. In the past year, due to
the hard work of State securities administrators and
regulators, numerous mutual fund abuses have been brought to
light. And, obviously, your colleague in New York, Attorney
General Spitzer, has been very involved. My Attorney General,
Dick Blumenthal, in Connecticut has been very involved, as
Ralph knows.
I wonder if you can describe the current feeling among
investors toward mutual funds. And has the work of yourselves
and the SEC helped to restore any confidence? What is your read
out there on how investors are feeling about mutual funds
today?
Mr. Borg. My read, Senator, is that the mutual fund
industry, although it has taken some hits because of these
abuses that are out there, most Americans, I think, are sitting
still. They are going to wait and see what happens.
The difference between the mutual fund issues and, say, the
research analysts or the theft cases is that there is not an
immediate significant drop in the value of the underlying
securities, because the losses to the investor on a per account
basis are slight in reference to someone who steals your
retirement savings account. So, I think there is a perception
that things are being done to correct the abuses. Also, mutual
funds have been the bulwark of middle-class America for a long
time. They understand that there was risk in technology stocks
and some things here, and maybe the analysts should have told
the truth. But be that as it may, mutual funds still are the
mainstream investment vehicle of choice. And I think there is
some skittishness. There is some concern. But I do not believe
there is panic. And that is an important factor. And the
quicker the mutual fund issues are resolved and what Americans
want is they want to know that it has been disclosed and
cleaned up and things are in place. I do not think there has
been a big panic in the mutual fund industry.
Senator Dodd. Ralph.
Mr. Lambiase. Yes, I would like to make a statement on
that. I really think the public sees the role of this Committee
and its oversight, and I think that has had a tremendous
support structure for the public. Once they know that the
Senate is looking at this--and, indeed, there were at least
four different bills that were sponsored, even you yourself,
sir, with the transparency on the mutual funds, the disclosure,
the fees. I think once you get that visibility, the comfort
level of the public is what was--I do not think it was simply
us, but clearly, it was not the SEC alone. I think a tremendous
amount is the guidance that this Committee does through its
proposals and the guidance that it gives out to the rest of us
on the industry side and the public.
Senator Dodd. Anyone else? Well, any points here and
comments on the legislation, you may want to submit, Mr.
Chairman, some comments on these bills. You would have a pretty
good idea. Are we going overboard? Obviously, as you point out,
Mr. Borg, this has been a great wealth creator. Mutual funds
have been a tremendous success, and I think we want to be
careful I how we react to it. The Chairman, I think, has acted
very responsibly, along with Senator Sarbanes. We have not
pushed this overly aggressively, but at some point I would be
very interested in whether or not you think we need to act or
whether or not you think the SEC is acting sufficiently enough
on its own through the regulatory process that our actions may
not be necessary. But I would be very interested in how you
would react to the current response to it and whether or not we
should step up to the plate.
Mr. Lambiase. To be honest with you, I think the
introduction of the bills, the topic areas that were brought up
and the subject matter, to see how the SEC or the Federal
regulators will react is one thing, but I think clearly the
message was sent to regulators that deal with this and Congress
will not have to deal with this. But, clearly, you gave them
adequate direction by identifying within the bills what the
problems are, and I do think that waiting to see what rules
come out that are necessary, but I think also in addition to
rules, you also need aggressive enforcement of the current
laws. And I think that is very important.
I think the Committee has actually moved in a very
deliberate and thoughtful process, and I truly compliment the
Committee for this.
Senator Dodd. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Thank you. We appreciate your remarks. I
think the message was to the SEC we are going to give you an
opportunity to do your job, and I believe they are on the right
track. But if you do not do your job, we are going to be here.
We are going to be watching. Our oversight is important.
Mr. Harvey and Mr. Borg, would you briefly address any
investment schemes or products where you would expect to see
increased enforcement activity? Are State regulators conducting
any investigations of 529 plans or hedge funds?
Mr. Harvey. I cannot tell you that we have any
investigations going on of 529 funds. We are beginning to study
them to determine whether or not there is inappropriate
activity occurring. With hedge funds, we have been examining
those funds for some time, and we intend to continue to do so.
A lot of what is new is still old. A lot of the schemes
that we see are packaged differently, but they are the same old
schemes. And Mr. Borg has outlined them quite thoroughly and in
detail. But with respect to the two areas that you have asked
about, one we are going to begin to examine very carefully and
the other we are examining on a regular basis.
Chairman Shelby. What about payments to insurance brokers,
illegal trading in variable annuities products, stuff like
that? Are you all involved in some of that?
Mr. Harvey. We are beginning to look at that activity. It
is curious. We share responsibility for that as well with the
Department of Banking and Insurance in the State of New Jersey,
so we are going to take a closer look at it going forward.
Chairman Shelby. Mr. Borg.
Mr. Borg. Senator, with regard to the 529 plans, as you
know, they are designed by States to provide a tax-advantaged
means of saving for college. Because they are of that type,
they fall into a type of municipal fund securities that is
generally regulated by the MSRB. They are a unique class, this
529, which is named after the Internal Revenue Code provision,
of course. They are not subject to most Federal securities laws
that, say, would be applicable to mutual funds. And that is
because they are issued by State or local authorities.
There is usually a component in the Uniform Securities Act,
which means it applies to most States, where local or State-
sponsored funds, issued funds, are also exempt from
registration and licensing. So there is a question about where
the authority lies, if you will.
One thing I am fairly convinced of is they are not exempt
from antifraud authority, such as the 10(b)-5 used against, you
know, artifice to defraud. But I think what States are starting
to look at for the issues, if you will, in the 529's are that
the disclosures are not sufficient or uniform; that the costs
may vary from State to State on the various 529 plans. And I
know there is concern, although I have not seen it, that high
fees could actually overshadow the tax benefits.
We have seen a push to sell more of these things, and I
think they are doing that. There may be some evidence that
there are higher fees being paid. So, I think the tax treatment
may differ. An Alabama resident buys a 529 in Rhode Island
there may be some differentials.
I think there is a lot of confusion in this area right now.
There is possibly a limit to what State securities regulators
can do. We are studying the issue. We do have a group that is
looking at it, and I understand there are other hearings going
on, maybe concurrently, regarding 529 plans.
Chairman Shelby. Thank you.
Could you elaborate just briefly on the centralized
registration databases for broker-dealers?
Mr. Lambiase. Yes, sir.
Chairman Shelby. How is it working?
Mr. Lambiase. The Central Registration Depository system
was created in 1981 with the NASD and the States, and really
what it did was it took a system of manually filing an
application in every State and established a central filing
system, and ultimately you eliminated the State filings being
made in every jurisdiction where someone wanted to conduct
business.
That system of CRD was ultimately emulated recently with
the IARD, as Senator Sarbanes asked about. That is the
Investment Adviser Registration Depository. It is modeled after
the CRD, and that is the system where you have 11,000--that is
done in conjunction with the SEC. They are paperless filings to
people. You mark the license where you want to maintain it, in
Connecticut and, say, multiple jurisdictions. You send one
check in. It is reviewed on a screen. It provides to the public
a tremendous database of information regarding disciplinary
events and histories of individuals. It maintains that record.
There are currently 660,000 people that are on the CRD
database and 172,000, I believe, on the IARD database. And that
is only the ones currently licensed, not including information
on individuals that previously were licensed. And that is what
has made this industry very effective in terms of licensing,
uniformity, paperless environment.
Chairman Shelby. Ms. Periman what would be your single,
strongest message to deliver to other senior investors that are
thinking about investing?
Ms. Periman. If you have any questions at all, go to your
State securities regulators.
Chairman Shelby. Promptly.
Ms. Periman. Promptly.
Chairman Shelby. As you did. Thank you.
Senator Sarbanes.
Senator Sarbanes. Thank you very much, Mr. Chairman. First
of all, let me say I think this has been an enormously helpful
panel, and it only reinforces my view that there is a very
critical and essential role to be played by the State
securities regulators in terms of protecting the investors.
That role need not be in conflict or inconsistent with the SEC
role of setting national standards that apply in the securities
industry or carrying out its responsibilities as well. In fact,
the two working together can provide a strong protective
environment for the investor.
Let me ask you this question. I am interested in this. How
much cooperation do you receive from the industry, from the
broker-dealers and so forth? After all, their reputation, the
reputation of the good people, and there are many good people
in the industry, is tarnished and affected by the activity of
these sharp operators. When you talk to the good people in the
industry, they condemn these activities, but I am not clear how
much they do or how forthcoming they are in trying to check
this activity from happening, somehow excising these people out
of their industry. Of course, they have their own self-
regulatory organizations, but what is your perception of the
amount of support and cooperation you receive generally from
those who are playing by the rules with respect to those that
are playing outside the rules and causing the kinds of cases
that we heard from Ms. Periman this morning?
Mr. Harvey. Let me categorize cooperation in two forms. One
is the firm that is not the subject of an investigation versus
the firm that is the subject of an investigation. In the latter
case we get a lot of cooperation for obvious reasons.
With respect to firms that are not engaged by a securities
enforcer, I think they would just as soon be left alone.
Generally, you will find former employees who may come forward
and give you information that leads to an investigation, but by
and large, while we have conversations with a number of broker-
dealers in informational forums, it sometimes may lead to an
investigation, sometimes not.
In the latter case again, where you have a firm engaged in
an investigation, we generally find that they have been very
cooperative. And we in New Jersey almost insist upon a
continuing cooperation provision in any settlement that we
reach with the firm, because we have discovered that while we
may have discovered one type of conduct with the firm, there
may be other types of conduct that are going on, or there may
be other parties about whom the firm has knowledge that they
can share with you if you ask them. So when we resolve our
differences with a firm, we almost always insist upon
continuing cooperation.
But in terms of a firm out of the blue volunteering
cooperation to tell you about the ills of the industry, that is
not a common occurrence.
Senator Sarbanes. We have these self-regulatory
organizations. What is your perception of how effective they
are? What gaps do you see in terms of what they do, and how
much help do you receive from the self-regulatory
organizations?
Mr. Lambiase. The self-regulatory organizations are not
governmental bodies, so when we look at it, we look at it as
individuals. It is a professional standard that they try to
set, but they are also guided very much by what the standard
practice is within the industry. When we look at cooperation,
to go back to the Attorney General's comments on cooperation,
we look at cooperation from the grass roots side with the local
investor that has a problem. You can get more cooperation. When
you start moving up into the cultural environment of the firm,
what we call the compliance culture of a firm, that is really
looked at more by the SRO and the overall SEC.
And generally, you do not get cooperation because what you
get is a statement that we are acting no differently than
everyone else would in the industry and that is the standard
that we all go by. So really we are not going to change our
procedures, our way of doing business unless you get this broad
range of reform that we see at your level. So, I think the
SRO's serve an important role, but I do keep in mind that they
are not governmental bodies, and I think that their focus is
the member and the operational standards of their members, the
financial capability. Ours is solely investor protection.
Senator Sarbanes. Mr. Chairman, could I ask one final
question?
Chairman Shelby. Go ahead.
Senator Sarbanes. I am curious, and it may be a little
awkward, but I want to hear from the security administrators
about this. If you had a ranking 1 to 10 of the effectiveness
of the State securities administrator State-by-State, what
would the profile of the State securities administrators look
like? I do not want you to identify the States, but assuming
that 9 or 10 is the best, and I would concede that to the
people at the table just for the sake of this question. How
effective are the State securities administrators across the
country?
Mr. Lambiase. At the grass roots level, sir, they are the
best there is. We are not setting national policy. That is
being handled by the SEC or the SRO's under the SEC oversight.
I do not think that there is a finer group of people dedicated
to protecting the citizens at home than State securities
regulators, as you have heard from Mrs. Periman. But you can go
across every State. They are all committed to protecting their
constituents.
Senator Sarbanes. How professional do you think the offices
are? How well-trained and educated and how well-resourced are
the State securities administrators State-by-State?
Mr. Borg. Certainly with regard to resources that is an
individual State decision.
Senator Sarbanes. Mr. Leven, I think in your testimony you
said not enough resources were being committed at the State
level, as I understand it.
Mr. Leven. I think that was related as much to the growing
number of investors in the pool and the growing number of
obvious things that are happening, so no matter how much these
fellows strive, there is a limit on how much they can do with
the monies they have today and the staffs they have today. I do
not think we are recognizing the future here to that degree.
Senator Sarbanes. What about the professionalism and the
training, and how equipped are the State securities
administrators?
Mr. Borg. Through the NASAA organization, not only do we
run conferences, but we also run regular training programs for
each section, broker/dealer, enforcement, etc. There are
coordinating conferences that NASAA itself funds for the States
so that the States do not have to pick up the tab. At any given
time, you have over 300 volunteers working from the State
securities regulators with the NASAA committees and project
groups, whether it is international, multi-State, investor
education, broker/dealer, or CRD. Therefore, through the NASAA
organization, we have been able to arrange training that does
not tax the resources of the State securities regulators.
Now, that being said, there is always room for improvement.
We are always looking for opportunities. We are, as I mentioned
earlier, now working with the NAIC on some joint training
programs. We are trying to understand what they look at and how
they examine. They are going to look at what we look at and
examine it to help further coordinate. There is always room for
improvement and we can always use more resources. Do I have
enough resources? No, I do not.
Senator Sarbanes. Is there pretty good continuity of
personnel so you have really seasoned experienced people in
these offices or is it constant turnover and a difficulty of
holding on to good experienced people?
Mr. Borg. On the staff level, I suffer more from
retirements than I do from turnover. That being said, you have
to remember that a number of State securities regulators are
subject to appointment by governors or other elected officials,
and they may change as the administration moves on. That is not
the case in my State and a number of other States. I would say
after the top level, the staff members generally do not change.
You will have the usual turnover for other jobs, but I think
you will find less of a turnover, and this is my opinion, less
of a turnover in State securities regulators than you will find
in most other areas.
Mr. Lambiase. I would like to echo those comments, sir, and
I would also like to point up that NASAA sponsors over 12
training programs a year, everything from conducting
examinations at broker-dealers, it does training on investment
advisers, corporate finance issues, enforcement, how to
prosecute cases. This year, we did the first joint training
with the NAIC, National Association of Insurance Commissioners
and State securities regulators, looking at common areas. And
as Joe pointed out, there are over 250 volunteers right now
that we have simply assigned to committees. We have a greater
number that will volunteer with us. I think it is what is
devoted at the local level that matters. NASAA will do
everything it can to help support the States' roles in its
protection.
Senator Sarbanes. Thank you very much, and continue on in
your good work.
Chairman Shelby. Senator Dodd.
Senator Dodd. Just one. I cannot resist, Ralph, since you
are here. Anything unique? What are you looking at in
Connecticut right now, for instance?
Mr. Lambiase. Our particular issue in Connecticut right now
really would focus a lot on what we have seen with mutual funds
and variable annuities. Variable annuities are regulated by
insurance regulators and not securities in Connecticut, but
yet, you look at the annuity being wrapped, wrapping a mutual
fund in it, and securities division does not really have
jurisdiction, but you look at what is happening. And it is very
gratifying in some respects to look at some of the
institutions, the mutual funds that we are seeing, that
actually stopped market timing, that we call had their own
market timing police. I mean what is grabbing the headlines
today are the examples where there were breakdowns, but yet
there are many firms that actually prohibited, caught, and
stopped market timing, and I am pleased to say that we have
seen that in many instances within our own Connecticut-based
firms.
Senator Dodd. Good. Thank you again, Mr. Chairman.
Chairman Shelby. No other questions.
I want to thank first, Ms. Periman. Thank you as a citizen
for your story, and I hope things work out for you. I really
do.
Ms. Periman. Thank you very much.
Chairman Shelby. I want to thank the others for your
contribution too here today. You do play an important role. And
Senator Sarbanes and a lot of us on the Committee, we
understand it and we are concerned when people try to talk
about preemption. Thank you so much.
The hearing is adjourned.
[Whereupon, at 11:50 a.m., the hearing was adjourned.]
[Prepared statements and responses to written quesdtions
supplied for the record follow:]
PREPARED STATEMENT OF PETER C. HARVEY
Attorney General, State of New Jersey
June 2, 2004
Chairman Shelby, Ranking Member Sarbanes and Members of the
Committee. I am Peter Harvey, Attorney General for the State of New
Jersey. Thank you for inviting me to testify today on the issue of
State regulation and enforcement of securities laws.
The States play a critical role in regulating securities. By
highlighting what we are doing in New Jersey, I hope to illustrate
clearly why the States are a crucial component of investor protection
in this Nation. I want to acknowledge and thank Senator Jon Corzine,
who was a wise and experienced leader in the investment industry and
now devotes his wisdom and leadership in service of the Nation and New
Jersey. I want to thank him particularly for being a strong advocate
for investor education and protection.
State Regulatory Oversight
The securities markets have attracted investors large and small.
Many middle-class Americans seek to build their assets for their
children's college education and retirement by investing in stocks and
bonds. These days, most of the money is not in banks. It is invested in
securities, predominantly through pension plans, private retirement
plans (401(k), Keogh, IRA) and major mutual funds, but also through
private broker-dealers. Thirty years ago, only a small fraction of U.S.
citizens ventured into the securities markets. Now, we have nearly 100
million investors. That is a lot of people and a lot of money.
Unfortunately, there are plenty of modern-day Willie Suttons--armed
with a sales pitch instead of a gun--who know where the money is and
have learned that many investors are easy marks for a scam. Those
investors are spread over 50 States--too much territory to cover
without State securities regulators.
In New Jersey, the Bureau of Securities acts on behalf of the
Attorney General. New Jersey is one of only five States to place such
an agency directly under the control of the Attorney General. As
Attorney General, I have both criminal and civil authority to prosecute
securities fraud.
The Bureau has a staff of about 60 people to enforce the New Jersey
Uniform Securities Law. The Bureau is funded through fees paid by the
regulated community as well as fines and other sums collected in
enforcement actions. The Bureau regulates the sale or offer of any
security sold into or from New Jersey, as well as firms and persons
engaged in the securities business in our State. The primary mechanisms
for regulation are (1) registration of securities, firms, and agents,
and (2) enforcement actions against those who fail to comply with
registration or engage in fraud.
Since becoming Attorney General last year, I have dedicated
increased staff and resources to the Bureau of Securities in order to
handle the workload. I will highlight a few facts and cases that
illustrate the scope of the securities fraud problem we face merely in
the State of New Jersey.
New Jersey has a large amount of investment activity. It ranks
fourth in the United States in total firms and agents registered,
behind only California, New York, and Florida. The Bureau of Securities
registers approximately 2,700 broker-dealer firms, 155,000 agents, more
than 2,000 investment advisers, and 12,200 investment adviser
representatives. In addition to the large industry presence, New Jersey
has the second-highest per capita income in the country, with many
people seeking to invest their money to protect and increase it. New
Jersey also has an aging population, and many of the elderly are
particularly vulnerable to those engaged in securities fraud.
Registration is important to States as it permits State regulators
to weed out bad actors and fraudulent or suspect securities offerings.
Our Bureau of Securities has the power to deny, suspend, or revoke the
registration--and consequently the ability to do business in or from
New Jersey--of any broker-dealer, agent or investment adviser and to
issue a stop order against any securities offering sold in or from the
State. In addition, the Bureau Chief has broad investigative powers and
the power to subpoena records and compel testimony or other statements
under oath. The Bureau conducts examinations of books and records of
broker-dealer and investment adviser firms to determine if they are in
compliance with New Jersey's Uniform Securities Law.
Another critical component of the Bureau's work is investor
education. Bureau representatives regularly conduct seminars for senior
citizens and community groups on avoiding securities fraud. In this
area, an ounce of prevention truly is worth a pound of cure. There are
many people entering the market who do not know what to invest in, how
to choose a broker, or how to recognize a swindle. We teach basic
precautions, such as checking whether brokers and investments are
registered, and realizing that if a deal sounds too good to be true, it
is not true in most instances. State attorneys general and securities
regulators would welcome Federal assistance in the investor education
area, whether in the form of national ad campaigns or grants for State
programs.
Finally, the Bureau has a full-time staff devoted to fielding
complaints from investors. The Bureau receives thousands of complaints
and inquiries each year. Customer complaints are frequently resolved
with the Bureau acting as a middleman between the investor and the
broker-dealer firms. Those kind of complaints often involve problems
with accounts or account statements or with a nonresponsive broker.
Other complaints are more serious and lead directly to full-scale
investigations.
New Jersey's Enforcement Efforts
New Jersey has about 200 enforcement cases in the investigative
stage at any given time and more than 40 in active litigation. New
Jersey is no stranger to major securities fraud cases. A good example
is Robert Brennan, the penny stock king who defrauded investors of
millions. The high-profile bankruptcy fraud trial which led to
Brennan's imprisonment in 2001 was a result of a cooperative effort
involving our Bureau of Securities, the SEC, the FBI, and the U.S.
Attorney's Office. It was a direct outgrowth of two separate civil
matters brought by the Bureau of Securities and the SEC. We secured a
$55 million claim in bankruptcy court against Brennan and a $45 million
judgment, which we are working to collect. I want to focus, however, on
our more recent efforts.
New Jersey played a major role in the landmark settlement announced
last year between securities regulators and 10 top Wall Street firms
regarding stock analyst practices. New Jersey was co-chair, with
California and New York, of the steering committee for the multistate
task force organized by the North American Securities Administrators
Association that investigated the firms. New Jersey also was lead State
for the investigation of Bear, Stearns & Co. The case, as you know,
brought major reforms to the industry to ensure that stock analysts are
not subjected to pressure to report favorably on stocks and bonds of
investment banking clients of their firms.
Just yesterday, I announced another major settlement with
significant implications for the industry. New Jersey reached an $18
million settlement with Allianz Dresdner Asset Management and two
affiliated companies regarding allegations of a fraudulent arrangement
that permitted a large investor to market time more than $4 billion in
transactions in their mutual funds in violation of fund policies and to
the detriment of long-term investors. The settlement requires the
defendants to implement corporate governance changes to ensure that
portfolio managers for their mutual funds function independently of
business managers, and that the funds comply with their own policies
barring market timing.
In between those milestones, New Jersey has filed eight major
securities fraud cases involving, in the aggregate, more than one
thousand investors and more than $160 million in investments.
While some con artists target small, inexperienced investors, the
reality is that wealth and sophistication are no guarantee that an
investor will not be defrauded. In February 2004, we filed suit against
three men and their companies, including Clover Management Group Inc.
of Fort Lee, N.J., that engaged in an elaborate scheme to swindle
investors in the United Kingdom out of more than $55 million. The
defendants falsely claimed to offer investments in the defense industry
that would provide strong returns while supporting the British and
United States war effort in Iraq and the worldwide war on terrorism.
New Jersey has seized the assets of the defendants, including a $2
million yacht, bank accounts, luxury cars, and a painting by renowned
artist Eduardo Arranz-Bravo. The seizures followed cooperative
investigations by our Bureau of Securities, Federal authorities, and
New Scotland Yard. The defendants duped sophisticated investors out of
huge sums through slick marketing, which included touring investors
around a defense industry plant and claiming to be advised by renowned
military leaders and financiers.
Elaborate marketing also was involved in the case of Michael R.
Casey. We filed suit in December to seek restitution for at least 195
investors who we allege were defrauded of up to $15 million in a real
estate investment scheme run by Casey. We allege Casey set up a complex
network of business entities to front his scheme and recruited
investors through his tax preparation business and a series of
investment workshops held under the name Midas Financial Planning
Services Group.
As mentioned above, as Attorney General, I also have the authority
to criminally prosecute securities fraud. In June 2003, we
simultaneously filed criminal and civil actions against more than a
dozen New Jersey companies and their principals for allegedly stealing
more than $80 million from investors. The scheme's principal architect
was Thomas Giacomaro, who pleaded guilty to money-laundering charges
brought by the Division of Criminal Justice in the Attorney General's
Office and Federal charges of mail fraud and tax evasion. Among the
parties who lost money in the scheme was best-selling novelist Mary
Higgins Clark.
A common theme in each of these cases is that the securities sold
by the defendants were not registered with the New Jersey Bureau of
Securities, as required by law. If the victims had called the Bureau
before investing, as we urge all investors to do, they could have
avoided their losses. Again, the need for investor education is
highlighted.
Another frequent theme in these cases is cooperation between State
and Federal authorities. That theme can be seen in the Brennan case,
the Wall Street stock analyst settlement, the Clover case and the
Giacomaro case. State securities regulators and the SEC can accomplish
a lot by working together, as our representatives in the North American
Securities Administrators Association have been emphasizing in their
ongoing discussions with the SEC and their cooperative initiatives.
However, another point should not be lost. States also can be extremely
effective on their own, as we demonstrated in the Allianz Dresdner
case. In a 4-month period, we filed and settled a case that addressed a
serious industry problem and led to reimbursement of the affected
funds. We secured needed reforms, but resolved the case quickly to
avoid a lingering cloud that might harm the funds. Several other States
also have shown their effectiveness on this front.
Although I have discussed high-profile cases that in some instances
did catch the attention of Federal authorities, many of our securities
fraud cases--both civil and criminal--would not be pursued by Federal
regulators, leaving investors without recourse. There are simply too
many cases out there, and sometimes the dollar amount of the fraud is
not large enough to interest Federal securities regulators given their
limited resources. The States serve as valuable partners in securities
regulation and in recent years have provided early warnings about
dangers in the marketplace, sounding the alarm on day trading, penny
stocks, microcap funds, and analyst conflicts.
The bottom line is that the task of protecting investors is too
large to be handled by a single Federal agency, the SEC. Investors need
the protection of State securities bureaus. The task of protecting
investors is only going to grow as trends push individuals to deal
directly with their retirement costs and as discussions proceed at the
Federal and State levels about giving people increased control over
investment of their Social Security and other retirement funds, beyond
401(k), Keogh, and IRA plans.
We hope that you will maintain if not enhance the authority of
State securities regulators. Further, any additional resources you can
provide to us will, I can assure you, be money well spent. Investor
protection is the key to investor confidence, and investor confidence
is the key to raising the capital that fuels this Nation's economic
engine. We can make the Nation stronger by working together.
Thank you again for the opportunity to testify. I share your
concern about this vital issue and stand ready to work with you as you
examine and address it in the future. I look forward to answering any
questions that you might have for me today.
----------
PREPARED STATEMENT OF RALPH A. LAMBIASE
Director, Division of Securities
Connecticut Department of Banking and
President, North American Securities
Administrators Association, Inc.
June 2, 2004
Introduction
Chairman Shelby, Ranking Member Sarbanes and Members of the
Committee, I am Ralph Lambiase, Connecticut Securities Director and
President of the North American Securities Administrators Association,
Inc. (NASAA).\1\ I would like to thank you for inviting me to appear
before the Committee today to present an overview on the many ways
State securities regulators serve and protect the more than 100 million
investors in North America. I also want to thank Connecticut's senior
Senator, Chris Dodd, for continuing to serve as a strong advocate for
investor protection and for listening to the concerns of the
Connecticut Department of Banking, which includes the Securities
Division.
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\1\ The oldest international organization devoted to investor
protection, the North American Securities Administrators Association,
Inc. was founded in 1919. Its membership consists of the securities
administrators in the 50 States, the District of Columbia, Canada,
Mexico, and Puerto Rico. NASAA is the voice of securities agencies
responsible for grassroots investor protection and efficient capital
formation.
---------------------------------------------------------------------------
States Have Protected Main Street Investors for Nearly 100 Years
Let me begin with a brief overview of State securities regulation,
which actually predates the creation of the Securities and Exchange
Commission and the NASD by almost two decades. States have protected
Main Street investors from fraud for nearly 100 years.
The role of State securities regulators has become increasingly
important as growing numbers of Americans rely on the securities
markets to prepare for their financial futures, such as a secure and
dignified retirement or sending their children to college. Securities
markets are global but securities are sold locally by professionals who
are licensed in States where they conduct business.
As the securities director for the State of Connecticut, I interact
directly with investors who approach me at investor education seminars
or call my office with
concerns or complaints. Our agency works with criminal authorities to
prosecute companies and individuals who commit crimes against
investors, and brings civil actions for injunctions, restitution, and
penalties against companies and individuals who commit securities
fraud.
Similar to the securities administrators in your States, our agency
is also responsible for licensing firms and investment professionals,
registering some securities offerings, examining broker-dealers and
investment advisers, providing investor
education, and most importantly, enforcing our State's securities laws.
Eleven of my colleagues are appointed by their Secretaries of State,
others by their governors; five come under the jurisdiction of their
States' Attorney General; and some, like me, fall within their State's
banking, financial institutions, or commerce departments. No matter
where we are located in our State structure, each State securities
administrator shares a common passion for protecting the citizens in
our States from investment fraud and abuse.
How State Securities Regulators Serve and Protect Investors
We have been called the ``local cops on the securities beat,'' and
I believe that is an accurate characterization. We are here to serve
and protect investors. State securities regulators respond to investors
who typically call us first with complaints, or request information
about securities firms or individuals. State officials are directly
accountable to the electorate.
While some of our high profile enforcement actions make national
headlines, I realize that not everyone fully understands the value
added by State or provincial securities regulators. I would like to
focus my remarks this morning on the many other ways State securities
regulators serve investors. In addition to enforcing your State's
securities laws, we work within your State government to protect
investors and help maintain the integrity of the securities industry
by:
Licensing stockbrokers, investment adviser firms (those
managing less than $25 million in assets), and securities firms
that conduct business in the State;
Investigating investor complaints and potential cases of
investment fraud;
Examining broker-dealer and investment adviser firms to ensure
compliance with securities laws and maintenance of accurate records
of client accounts;
Assisting small businesses to raise capital and reviewing
certain local offerings not covered by Federal law.
Educating investors about their rights and providing the tools
and knowledge they need to make informed financial decisions, and;
Advocating passage of strong, sensible, and consistent State
securities laws and regulations.
Specifically, I would like to outline significant accomplishments
of State securities regulators in four areas: Investor education;
licensing broker-dealers, and investment advisers; helping small
businesses raise capital; and our efforts to build bridges with
regulators and prosecutors here and abroad.
Adding Value by Building Financial Knowledge and Security Through
Education
State and provincial securities regulators have a long tradition of
protecting investors through financial education. We appreciate the
Committee's long-standing advocacy of investor education programs to
give Americans of all ages the ability to
recognize and avoid investment exploitation and build good money
management habits. I would also like to commend Members of this
Committee for championing the need for the coordination and
implementation of economic and financial literacy programs in the
United States.
Recognizing the value and the impact of financial education,
NASAA's Board of Directors elevated investor education to Section
status in 1997 to help support the ongoing financial education efforts
of State and provincial securities regulators. The Investor Education
Section, along with a network of professionals from across the NASAA
membership, develops, coordinates, delivers, and supports financial
education initiatives used by securities regulators in their ongoing
efforts to improve the level of financial literacy in their
jurisdictions.
Most State and provincial securities regulators have established
investor
education programs within their agencies. The result is an effective
network of dedicated professionals delivering financial education at
the grassroots level. Our financial education professionals can be
found at work in classrooms, the workplace, and senior centers. They
partner with teachers, employers, and peer-based volunteer groups to
deliver financial education to our constituents of all ages.
For example, under the guidance of the Investor Education Section's
Senior Outreach Project Group, NASAA initiated a major education
campaign last fall aimed at senior investors. As part of the
initiative, we launched an online Senior Investor Resource Center on
the NASAA website to give senior investors the tools they need to
reduce their risk of being a victim of fraud. And as part of a
continuing effort to improve the level of youth financial literacy in
our jurisdictions, the Investor Education Section's Youth Outreach
Project Group recently developed a Teacher Training Event blueprint to
provide a comprehensive, step-by-step system for developing and
delivering a teacher training event that offers K-through-12 teachers
the knowledge, resources, and tools they need to efficiently and
effectively integrate personal finance education into their classroom
curriculums.
State regulators, through NASAA, also have developed a series of
investor awareness brochures to provide financial education to our
residents. The brochures cover a variety of topics ranging from how to
protect yourself from cold-calling investment sales pitches to how to
select a financial planner.
State securities regulators also look for opportunities to join
forces with other members of the financial education community. For
example, we support and participate in a variety of national financial
education programs to increase financial literacy, such as the American
Savings and Education Council, the Investor Protection Trust, Jump$tart
Coalition for Financial Literacy, and Financial Literacy 2010. Through
NASAA, State securities regulators have collaborated with the
Securities Industry Association to produce resources to help investors
understand brokerage account statements; and with the Investment
Company Institute and the College Savings Plan Network to produce the
brochure, ``A Guide to Understanding 529 Plans.'' Last year, we
published a Fraud Awareness Quiz that the AARP will include in newly
created speakers guides for their local offices. And, we recently
entered into an agreement with the Department of Defense through which
our members will work to deliver financial education to members of the
military.
Educating and training our members also is a vital part of NASAA's
mission. This year, NASAA is hosting 12 training seminars including the
first-ever training session with insurance regulators with the goal of
sharing information about laws and enforcement practices that can be
put to practical use in combating securities fraud committed by
insurance agents. Our emphasis on training helps promote uniformity by
ensuring that State examiners, investigators, and prosecutors are
schooled in the current problem areas so that they can more effectively
serve investors.
Adding Value By Streamlining Broker-Dealer, Investment Adviser
Registration and Licensing
Our securities markets may operate on Wall Street, but stocks,
bonds and other securities are sold on Main Street, in our
neighborhoods and even over our kitchen tables from nearly 96,000
branch offices nationwide. Today, roughly half of all U.S. households
rely on the securities markets to plan and prepare for their financial
futures. And the number of firms and individuals holding themselves out
as investment professionals has grown significantly in the past two
decades. In Connecticut, for example, nearly 3,000 investment firms and
more than 110,000 securities professionals are licensed to conduct
business with our citizenry. Nationwide, those numbers grow to more
than 16,000 investment firms and nearly 825,000 securities
professionals.
State securities regulators believe it is critical that information
about these individuals and firms be readily accessible to the
investing public, industry, and regulators. Two of the more notable
success stories in accomplishing this accessibility have been the
Central Registration Depository (CRD) and the Investment Adviser
Registration Depository (IARD) systems. These powerful tools help State
securities regulators weed out any ``bad apples'' seeking licenses to
do business with their State's investors.
Developed by NASAA and NASD and implemented in 1981, CRD
consolidated a multiple, paper-based State licensing and regulatory
process into a single, nationwide computer system. Today, the CRD is
arguably the best licensing system in existence. Its computerized
database contains the licensing and disciplinary histories on more than
650,000 securities professionals and 5,200 securities firms. The IARD,
developed jointly by NASAA and the SEC, is our newest licensing system
and is to investment advisers what the CRD is to broker-dealers. Its
database helps promote uniformity, through use of common forms, and
efficiency through a paperless environment. It helps investors research
the employment and disciplinary histories of more than 11,000
investment adviser firms and 173,000 individual investment advisers.
Adding Value Through Coordinated Review
States are traditionally recognized as laboratories of innovation.
Our ability to adapt successful programs launched in one State to
benefit all has led to regulatory initiatives that have benefited both
the investing public and industry. For example, a simplified program
developed in Washington State to help small businesses raise capital
through a public offering has evolved into a program of coordinated
review now in place in 37 States. Under NASAA's SCOR program, comments
from various State regulators are consolidated into one comment letter
from the ``lead'' State examiner. This allows the company to resolve
all issues regarding multistate filing through that one examiner and
allows other States in which a company wants to sell its securities to
provide comment. Regional SCOR programs have been established in the
mid-Atlantic, New England, Midwestern, Southwestern, and Western
States.
The similar national Coordinated Review-Equity Program (CR-Equity)
for larger offerings provides a uniform State registration procedure
designed to coordinate the blue-sky registration process in all of the
States in which the issuer seeks to sell its equity securities. CR-
Equity generally is intended for initial public offerings. Of the 42
jurisdictions that register equity offerings, all but one currently
participates in this program. A third review program, CR-Fran, is
available to a franchisor filing an initial application to register its
offering in two or more participating States.
Enhancing Cooperation and Coordination
NASAA welcomes the opportunity to continue to work with our
regulatory counterparts at the SEC and the SROs to collectively use our
resources to protect investors. We also look forward to the continued
progress of our ongoing series of constructive discussions with the SEC
as part of the joint initiative launched in September 2003 to explore
ways to improve coordination and communication. We stand ready to
provide insight from our unique perspective to the SEC and SROs as they
move forward in their rulemaking process.
This ongoing initiative with the SEC is not our only opportunity to
discuss issues of common concern between State and Federal securities
regulators. NASAA and the SEC co-sponsor an annual Conference on
Federal-State Securities Regulation in accordance with Section 19(d) of
the Securities Act of 1933. As part of the conference, representatives
from the SEC and NASAA divide into working groups in the areas of
corporation finance, broker-dealer regulation, investment advisers,
investor education, and enforcement. Each group discusses methods to
enhance cooperation in its subject area and to improve the efficiency
and effectiveness of Federal and State securities regulation.
NASAA also is taking steps to reach out to other regulators at both
the State and Federal levels. For example, last month, NASAA
successfully joined forces with the National Association of Insurance
Commissioners to conduct the first-ever joint training program to
benefit State insurance and State securities regulators who want to
work together more effectively to solve the persistent problem of
securities fraud by insurance agents. Earlier this year, NASAA accepted
an invitation from the U.S. Treasury Department to become a member of
the Financial and Banking Information Infrastructure Committee (FBIIC),
which is sponsored by President's Working Group on Financial Markets.
As an active FBIIC member, NASAA helps coordinates public-sector
efforts to improve the reliability and security of the U.S. financial
system. FBIIC also develops procedures and systems to allow Federal and
State regulators to communicate among themselves and with the private
sector during times of crisis. NASAA also serves as a member of the
Federal Reserve's Cross-Sector Group. The group's bi-annual meetings
are hosted by the Federal Reserve and include representatives from the
State and Federal banking, insurance, and securities regulators.
As you know, investment fraud knows no borders. That is why State
and provincial securities agencies, through NASAA, have reached out to
their colleagues in the international arena. NASAA plays an active role
in the International Organization of Securities Commissioners (IOSCO)
and the Council of Securities Regulators of the Americas (COSRA).
A strong need exists to develop cooperative information sharing
programs, policies and laws to move toward greater enforcement and
protection from fraud. NASAA's Board last fall created an International
Project Group to facilitate this effort. We also have taken steps to
work more closely with our Canadian colleagues by adding liaisons to
each of our sections: Broker-dealer, corporation finance, enforcement,
investment adviser, and investor education. And, we are exploring the
feasibility of expanding NASAA's membership to include a number of
other North American jurisdictions.
When considering State, Federal, and industry cooperation, I think
one of the best examples is the Securities Industry Regulatory Council
on Continuing Education. In the months following the market crash of
1987, I recall Senator Dodd raising the issue of the importance to both
industry and investors of knowing how various financial products react
in periods of market volatility. Continuing advocacy from the States
helped prompt the industry in 1995 to create the Council, which is
comprised of representatives of the securities industry, self-
regulatory organizations, the SEC, and NASAA. Our joint efforts have
resulted in a national continuing education program that is accepted by
all regulatory agencies. Each year, more than 175,000
financial professionals participate in the continuing education
program's computer-based training.
Preserving State Regulatory Authority
The initiatives I have outlined clearly demonstrate the value-added
benefits of State securities regulators. We focus on Main Street
investors. We are grassroots regulators. We are the first line of
defense for investors in our States. I would like to emphasize my
belief that in cases where State securities regulators investigate and
resolve enforcement cases, our judgments regarding appropriate outcomes
must be respected and upheld.
Our State-Federal system of regulation is collaborative and
complementary, and above all, we all want what is best for investors.
The research analyst cases, and the recent investigations of the mutual
fund industry, are good examples of the value of our complementary
regulatory system. In these massive undertakings, State regulators
worked on enforcement issues while the SEC and SRO's devoted resources
both to enforcement and, most importantly, rulemaking.
Congress made clear in its passage of National Securities Markets
Improvement Act of 1996 its intent to foster a cooperative rulemaking
process between State and Federal securities regulators. The recently
enacted SEC books and records rule is an example of this cooperative
process. Some, however, continue to portray our State-Federal
regulatory system as duplicative. Our actions have been and will remain
consistent with the intent of Congress. When it comes to investigation
and enforcement of Wall Street wrongdoing--investors need more cops on
the beat, not fewer. There must be continued cooperation and shared
efforts among State, Federal, and industry regulators.
Earlier this year, Congress recognized that State securities
regulators are essential partners to Federal regulators in protecting
investors when it removed Federal preemptive provisions from H.R. 2179,
the ``Securities Fraud Deterrence and Investor Restitution Act of
2004.'' We continue to remain vigilant and prepared to face attempts by
special interests to neutralize State regulators who are aggressively
protecting investors. These interests will continue to complain about
the ``patchwork quilt'' they think they see whenever they look out
across the country. What they are seeing is 50 State agencies working
collaboratively to keep the industry free of wrongdoing and instilling
consumer confidence in the marketplace. It is not regulation that keeps
investors away from the marketplace--it is greed and wrongdoing that
goes unchecked that undermines investor confidence.
We have heard industry make an issue about the cost of regulatory
compliance. I submit to you that despite all of the publicized
problems, 2003 was one of the most profitable years ever for Wall
Street. According to the Securities Industry Association, profits in
the securities industry were $15 billion last year, nearly double those
of 2002 and the third best year ever for Wall Street.
We have heard industry say, ``trust us.'' Just last year, the
president of the mutual fund industry's trade association, praised
industry executives for their ``unshakeable commitment to putting
mutual fund shareholder interests first.'' Three months later, State
regulators launched the first of many investigations into the mutual
fund industry for, in essence, putting its own interests ahead of those
of its shareholders.
We have heard investors say enough is enough. And we agree.
Protecting investors against fraud and punishing those who would
commit fraud are fundamental roles of government, be it Federal, State,
local or in the case of our neighbors to the north, provincial. For
State securities regulators, ``putting investors first'' is more than
just a slogan. It is what we do for our citizens on a daily basis.
Conclusion
Mr. Chairman and Members of this Committee, I would like to offer
you my personal opinion based on more than 30-plus years as a
securities regulator. Protecting investors is a significant challenge
and no single regulatory agency can go it alone. I firmly believe that
now is the time to strengthen, not weaken our unique complementary
regulatory system of State, industry, and Federal regulation.
Collectively, we can all work together--government, self-regulators and
industry--to achieve positive results. More than 100 million North
American investors expect us to remain vigilant, to stay the course,
and to make sure that Wall Street puts investors first. We cannot let
these millions of investors down.
I firmly believe that tough and consistent regulatory oversight is
the key to helping investors maintain their confidence in the market.
Just as strongly, I believe that straight-talking investor education,
coupled with hard-hitting and unfailing enforcement, are the keys to
investor protection. The citizens in my State depend on me to protect
them by enforcing the securities laws on our books. I can speak for all
my North American colleagues in stressing the importance of securities
regulators continuing to protect the citizens in our jurisdictions. Our
job is straightforward--protecting investors and doing right on their
behalf.
It is vitally important that Congress reject attempts to weaken
State enforcement authority. I am deeply grateful to those Members of
Congress who have been champions of the rights and protection of
investors. Congressional commitment to integrity in our financial
markets, accountability in corporate governance, and full and fair
disclosure has helped make our Nation's markets the best in the world.
When investors have confidence in the markets, issuers have access to
needed capital and our economy prospers.
I pledge the continued support of the NASAA membership to work with
the Committee to provide any additional information or assistance the
panel may need. Thank you for the opportunity to testify on the role of
State securities regulators.
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PREPARED STATEMENT OF JOSEPH P. BORG
Director, Alabama Securities Commission and
Chairman of the Enforcement Section of the North
American Securities Administrators Association, Inc.
June 2, 2004
Chairman Shelby, Ranking Member Sarbanes, and Members of the
Committee, I am Joe Borg, Director of the Alabama Securities Commission
and Chairman of the Enforcement Section of the North American
Securities Administrators Association, Inc. (NASAA).\1\ It has been a
privilege for me to serve as Director of the Commission since 1994, and
to have been elected as NASAA's President for during 2001-2002. It is a
particular honor for me to have the opportunity to publicly thank my
Senator, Richard Shelby, for his thorough and thoughtful approach to
restoring investor confidence in our markets. You just heard an
overview of State securities regulation from NASAA's President, Ralph
Lambiase, and I am delighted to have the chance to share with you some
highlights from the States' enforcement activities.
---------------------------------------------------------------------------
\1\ The oldest international organization devoted to investor
protection, the North American Securities Administrators Association,
Inc., was founded in 1919. Its membership consists of the securities
administrators in the 50 States, the District of Columbia, Canada,
Mexico, and Puerto Rico. NASAA is the voice of securities agencies
responsible for grassroots investor protection and efficient capital
formation.
---------------------------------------------------------------------------
Overview
The Enforcement Section assists the NASAA Board and membership in
coordinating enforcement efforts regarding multistate frauds by
facilitating the sharing of information and leveraging the fixed
resources of the States more efficiently. Members of this Section act
as points of contact for other Federal agencies and the self-regulatory
organizations (SRO's), and help identify new fraud trends such as those
involving promissory notes, viatical settlements, and microcap
securities. The Section has eight project groups under its
jurisdiction, with over 40 volunteer members who focus on planning
NASAA's annual enforcement conference, the enforcement portion of the
19(d) conference with the Securities and Exchange Commission (SEC)
mandated by the Securities Act of 1933, maintaining our enforcement
databases, coordinating special projects, and identifying enforcement
trends.
The enforcement role of States securities regulators differs in
some ways from the SEC and the self-regulatory organizations (SRO's).
Because our local offices are often the first to receive complaints
from investors, State securities regulators serve as an early warning
system, working on the front lines, investigating potentially
fraudulent activity, and alerting the public to the latest scams. After
identifying a problem, many States can take immediate enforcement
action without the time-consuming need to obtain formal agency orders.
States also have a history of taking enforcement actions against the
very worst fraudsters, often those selling unlicensed products and
Ponzi and pyramid schemes of all types.
In addition to investigating cases and bringing enforcement
actions, States work with national regulators on marketwide solutions
when they are needed. Although States do not engage in rulemaking for
the national markets--that is rightly the purview of the SEC and the
SRO's--the State regulators are active participants in the SEC's
rulemaking process. That was the pattern followed with penny stock
fraud, microcap fraud, day trading, and the analyst cases discussed
below.\2\ We meet on a regular basis with SEC staff and provide written
comment to the Commission as it receives information from the States'
front lines during its deliberative rulemaking process. In the past 2
years, NASAA has submitted more than two dozen formal comment letters
to the SEC regarding rule proposals and concept releases. NASAA staff,
frequently joined by State regulatory personnel, also has held numerous
informal discussions with Commissioners and SEC staff on issues of
mutual interest, both in Washington, DC and the field.
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\2\ See State/Federal Dynamic Chart Attached.
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Wall Street Analyst Conflict of Interest Global Settlement
Since the early 1990's, long before the recent Research Analyst
Global Settlement, NASAA members were involved in a number of
coordinated multistate settlements with firms including Prudential
Securities, Salomon Brothers, D.H. Blair, and Stratton Oakmont, amongst
others.
Let me take just a moment to provide an update on the States'
component of the Wall Street analyst conflict-of-interest Global
Settlement. Christine Bruenn of Maine, then NASAA President, testified
last May before this Committee on the States' role in the investigation
and settlement with the Wall Street firms.
All 50 States, plus the District of Columbia and Puerto Rico,
agreed to settle with the 10 firms involved. Every jurisdiction, but
one, has completed the process by executing the settlement documents.
The Global Settlement was a model for State/Federal cooperation and the
process was completed in conjunction with the SEC, the New York Stock
Exchange, and the NASD. If you include the Merrill Lynch settlement,
which was reached by the States almost a year before the others, the
firms executed agreements with 52 State jurisdictions for a total of
520 settlements.
Those settlements achieved a number of very important objectives.
For example, in addition to penalties and disgorgement, a portion of
the payments required under the Global Settlement were earmarked for
investor education. Specifically, 7 of the firms agreed to pay a total
of $80 million for investor education with $27.5 million directed to
the States over 5 years for investor education purposes. That amount
comprises the ``Investor Education Fund'' that will be overseen by the
Investor Protection Trust (IPT), a charitable trust, classified by the
IRS as a public charity.
The settlements also resulted in much needed change in the way the
firms conduct their business. The independent research component is
scheduled to be implemented in July and will provide investors at the
10 firms with research procured by independent consultants. The
consultants are also charged with providing a track record of research
success or failure that can be evaluated over time.
Finally, a rigorous separation between research and banking was
effected by this settlement for the 10 firms involved, and by NASD and
NYSE rules for the rest of the industry. Over the last several years,
NASAA members have been active participants in the rulemaking and
legislative process in the area of analysts' conflicts of interest. The
States worked closely with the SEC and the SRO's, both to leverage
limited investigative resources and to formulate new, marketwide rules
that were needed to fix this problem. In addition, we commented on the
NASD/NYSE's proposed rules relating to research analysts, making
suggestions that we felt could make the rule stronger in some areas.
Many of our original proposals were incorporated in the final rule.
Also, NASAA was strongly supportive of Title V in S. 2673, which became
the Sarbanes-Oxley Act of 2002.
States' Investigations into Mutual Fund Industry Abuses
I commend this Committee for its thorough and deliberative
examination of trading abuses in the mutual fund industry. State
securities regulators, the SEC, NASD, and mutual-fund firms themselves
have launched inquiries into mutual fund trading practices. To date,
more than a dozen mutual funds are under investigation and several
mutual fund employees have either pleaded guilty, been charged, or
settled with State regulators. I will not dwell on this subject because
this Committee has already conducted comprehensive hearings
demonstrating that some in the mutual fund industry were putting their
own interests ahead of America's 95 million mutual fund shareholders. I
can assure you that the States will continue to actively pursue
inquiries into mutual fund improprieties and are committed to
aggressively addressing mutual fund complaints raised by investors in
our jurisdictions.
State Securities Enforcement Activity
These high profile national cases arise periodically, but they
should not obscure the more routine caseload representing the bulk of
the States' enforcement work. As always, State securities regulators
continue to vigorously pursue sales practice abuses and a variety of
scams and frauds against unsuspecting investors. State securities
regulators have a long history of protecting investors at the local
level day in and day out. We often initiate investigations as a result
of complaints from investors in your States who feel they have been
wronged by a broker-dealer, securities professional, or those claiming
to be a securities specialist. Each NASAA member has one or more
offices within their State, with contact information readily available
on the web. Many investors understandably feel that the logical place
to start with a grievance is their local State securities regulator.
The States have compiled an impressive record in bringing
enforcement cases, including criminal prosecutions. The chart before
you, and attached to this testimony, illustrates State enforcement
statistics for the reporting period 2002 to 2003 with over 70 percent
of the 52 jurisdictions responding. The States filed a total of 2,964
administrative, civil, and criminal enforcement actions; assessed
$822,315,470 of monetary fines or penalties; collected $660,109,508 in
restitution, rescission, and disgorgement and sentenced criminals to
over 717 years of incarceration. NASAA sent out a recent survey to
obtain this latest data, and I would be pleased to follow-up with the
Committee in a few weeks with more complete information.
Because we are grassroots regulators, we often serve as an early
warning system of emerging corporate frauds and investment scams before
they are detected at the Federal level. Other frauds, generally
relating to companies not traded on any exchange, never reach the
Federal level and are handled by State regulators. The Alabama
Securities Commission's Enforcement Division opened an investigation on
Francis Clark Sr., CEO and President of U.S. Fabtec LLC, located in
Alabama. U.S. Fabtec, LLC was to be a joint venture with Mitsubishi
Aluminum Fabtec Holding, Inc., a subsidiary of Mitsubishi International
Corporation. Complaints alleged that Clark spent corporate funds on
personal items such as country club dues and his hobby of stock car
racing. Mr. Clark solicited seven domestic investors for $1,407,676 and
two Japanese companies to invest $1,287,553 for a total of $2,695,229.
It was determined that Clark thereafter continued to solicit additional
investments and embezzled money from the company. In 2003, Mr. Clark
was sentenced to 12 years and to pay restitution of $1,603,117.04 for
two counts of Securities Fraud and two counts of Theft of Property I.
For the past several years, NASAA has released its list of top 10
investment scams, schemes, and scandals to alert investors to
increasingly complex and confusing investment frauds. I will briefly
describe several of these scams and provide a State enforcement case
example for each.
Unregistered/Unlicensed
One problem area inundating State regulators is unlicensed
securities sellers pitching securities that are unregistered. Scam
artists use high commissions to entice some insurance agents,
investment advisers, and even accountants and lawyers into selling
investments they may know little about, such as bogus limited
partnerships or promissory notes, offering high returns with little or
no risk.
Unlicensed/Unregistered Case Example
The State of New Jersey is proceeding with efforts to obtain
restitution for at least 195 investors who may have lost up to $15
million in a real estate investment scam run by a Michael Casey in
Upper Saddle River. The suit filed in December 2003 alleges fraud and
the sale of unregistered securities through a complex set of real
estate based investments. New Jersey alleges that the monies raised
were illegally co-mingled, mismanaged, and/or diverted to pay Casey's
personal expenses and for other purposes unrelated to what investors
were promised.
Casey allegedly used his tax preparation business and a series of
investment workshops under the name Midas Financial Planning Services
Group to recruit investors. These workshops, held as recently as August
2003, involved numerous oral and written misrepresentations to
potential investors. Casey allegedly continued to conduct the workshops
in violation of a consent order he entered into with the Bureau of
Securities on April 7, 2003 that barred him from ``issuing, selling,
offering to sell, purchasing or offering to purchase, promoting,
negotiating, advertising or distributing from or within New Jersey any
securities or investment advisory advice concerning securities.''
Unlicensed/Unregistered Case Example
In Delaware, an insurance agent, who had been the subject of a
prior Delaware Cease and Desist Order prohibiting him from selling
unregistered securities, once again began selling unregistered
securities in violation of the existing order. Subsequent to the filing
of the Order, the Delaware Securities Division received a
complaint from a senior citizen who had invested $35,000 after
responding to an anonymous advertisement in a senior citizen newspaper.
The seller of the unregistered fraudulent offshore securities
(certificate of deposit issued by the First International Bank of
Grenada and Wellington Preferred Stock) was the same insurance agent
who had been ordered to stop selling unregistered securities. This
$35,000 investment represented the victim's entire life savings. She
received the $35,000 by the sale of her marital home which she sold
before moving in with her son after her retirement. The victim was a
retired State employee who was forced to return to the work force as a
result of the crime.
Through the use of a search warrant, Delaware seized the offender's
computer and business records and was able to find 14, primarily
elderly, victims who had invested in these fraudulent offshore
investments sold by the insurance agent. He was convicted in Delaware
Superior Court of 29 felonies and received a term of incarceration of 7
years. While the Court ordered over $600,000 in restitution, the
offender has not repaid any of his victims.
Unlicensed/Unregistered Case Example
In Alabama, an individual without use of ads, commercials, or
flyers was able to get 30,000 participations in an advance fee loan
investment by use of the Internet within a period of less than 100
days. The Alabama Commission issued 18,682 checks to reimburse
investors at 70 percent of their investment. The Commission, moving
quickly, was able to freeze bank accounts before the funds could be
transferred overseas.
Prime Bank
Prime bank schemes are a perennial favorite of con artists who
promise investors access to secret, high-yield investments made through
trades among the world's top or ``prime'' banks. Promoters falsely
claim the investment is guaranteed or secured by some kind of
collateral insurance or bank guarantee. The investors ultimately find
out that the prime banks simply do not exist. Negative publicity
attached to these schemes has caused some promoters in recent cases to
avoid explicitly referring to prime banks. Now it is common to avoid
the term altogether and underplay the role of banks by referring to
these schemes as ``risk free guaranteed high yield instruments.''
Prime Bank Case Example
The Arizona Corporation Commission shut down a prime bank scheme
and ordered 6 companies and their representatives to pay over $4.5
million in restitution and penalties for State securities violations.
The State has already recovered $3 million for investors. This case is
unusual because it is rare that large amounts of money are recovered
for investors in prime bank cases. The perpetrators told investors
their money would be safely held in bank certificates of deposit while
funds were traded in foreign banks. The duo also promised returns
greater than 500 percent. They continually sent newsletters to
investors trumpeting their million-dollar returns, but all the claims
were false. The case involved 102 investors from Arizona and other
States as well as from Germany and Japan. Most of the money was
funneled through a bank in Arizona to a bank in Texas and ultimately to
the Turks and Caicos Islands.
Variable Annuities
Sales of variable annuities have increased dramatically over the
past decade. As sales have risen, so too have complaints from
investors. State securities regulators are concerned that investors are
not being told about high surrender charges and the steep sales
commissions agents often earn when they move investors into variable
annuities. Often pitched to seniors through investment seminars, these
products are unsuitable for many retirees. Some investors also are
misled with claims of guaranteed returns when variable annuity returns
actually are vulnerable to the volatility of the stock market. The
benefits of variable annuities--tax-deferral, death benefits among
others--come with strings attached and additional costs. High
commissions often are the driving force for sales of variable
annuities.
Variable annuities are considered to be securities under Federal
law. Some States consider variable annuities to be insurance products
and others consider them to be both insurance and securities. NASAA is
encouraging changes in State laws that would allow State insurance
regulators to continue to oversee the insurance companies that sell
variable annuities while authorizing State securities regulators to
investigate complaints about variable annuities and to take action
against the companies and individuals who sell them. State securities
regulators look only at the sales practices of those selling variable
annuities as opposed to the licensing and registration of the product.
Variable Annuities Case Example
The Alabama Securities Commission and Mississippi Secretary of
State recently announced a joint enforcement action against AmSouth
Investment Services, a subsidiary of AmSouth Bank, which had acquired a
broker-dealer in a bank merger with First American of Nashville,
Tennessee. In this joint investigation involving two State regulators,
and information sharing with the SEC and the NASD, we found a number of
cases of poor oversight and, in one case, serious violations by an
AmSouth Investment Services representative. Most of the problems that
we found related to variable annuities and their unsuitability for most
investors. The case began after a routine examination by State
investigators discovered improper activity.
Under the agreement, AmSouth Investment Services paid a $25,000
fine, reimbursed the States $75,000 in investigative costs, contributed
$125,000 for investor education programs in Mississippi and Alabama,
and set up an uncapped fund to handle claims for those who wish to
surrender these policies if unsuitable. The broker-dealer must also pay
for an independent review of all internal policies and procedures
designed to detect and prevent securities law violations, and improve
access to compliance and supervisory rules at every branch office
including obtaining a new, state of the art computer compliance system.
On a negative note, there has been a major push by certain
insurance industry associations to remove variable annuities from State
securities review, even though variable annuities are securities under
Federal law. These efforts have been successful in preventing or
eliminating securities review in several States, hindering progress in
the uniform treatment of what are essentially stock funds with an
insurance element.
Viaticals
Risky viatical settlement contracts are products that have been on
our radar screen and subject to State securities enforcement actions
for the past several years. The viatical industry began around 1990 as
a way to help the terminally ill, most notably AIDS patients. In a
typical transaction, the person holding a life insurance policy sells
it to a third party ``broker'' in return for a portion of the death
benefit. The broker then sells shares of the policy to investors, who
collect a share of the death benefit from the broker when the original
policyholder dies.
A viatical settlement transaction is a hybrid transaction that
implicates both insurance and securities law. The securities law
component of a viatical settlement transaction arises when a viatical
settlement provider solicits investors to raise money to fund the
payout to the insured. Although in some jurisdictions State insurance
authorities have sole authority over viatical settlement transactions,
in the States where securities and insurance regulators share
oversight, securities regulators uniformly have stated that viatical
settlement transactions constitute securities under State securities
law and have vigorously pursued enforcement actions.
Viaticals Case Examples
In February 2002, NASAA issued a press release \3\ about viatical
settlements, citing deceptive marketing practices, numerous instances
of fraud, and warning investors not to be misled by claims that
viaticals offer safe, guaranteed returns like
certificates of deposit. The release cites a Vermont investigation into
practices at Mutual Benefits Corporation (MBC). The Vermont Securities
Division currently has a civil lawsuit pending in Superior Court
alleging that MBC violated the Vermont Securities Act by: (1) selling
unregistered securities; (2) employing unregistered sales reps (mostly
insurance agents); (3) misrepresenting to investors the risks involved
in the purchase of viatical settlements; (4) misrepresenting the life
expectancies of viators; and (5) violating the suitability provisions
of Vermont law. The lawsuit seeks a civil penalty and restitution of
approximately $2 million. The Superior Court denied MBC's motion to
dismiss several months ago and the case is currently scheduled for
trial during the first week of December.
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\3\ NASAA press release dated February 26, 2002; ``Risky 'death
futures' draw warning from State regulators, Congressional scrutiny.''
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Just last month, State and Federal regulators stepped in to shut
down and revoke the license of Mutual Benefits Corporation, for
securities and insurance law violations, fraud and misrepresentation.
Florida's Office of Statewide Prosecution has charged the company with
racketeering and 15 counts of investor fraud, saying the company lured
tens of thousands of investors into an elaborate Ponzi scheme that
raised more than $1 billion.
Affinity Fraud
Con artists know that its only human nature to trust people who are
like yourself. That is why scammers often use their victim's religious
or ethnic identity to gain their trust and then steal their
lifesavings. Unfamiliar with the financial markets, too many people do
not know how to thoroughly research an investment and its salesperson.
So, many fall prey to affinity group fraud in which a con artist is, or
seems to be, a member of the same ethnic, religious, career, or
community-based group.
Affinity Fraud Case Example
The Alabama Securities Commission initiated an investigation into
an affinity fraud case that resulted in six defendants being sentenced
to jail by a judge for the Nineteenth Judicial Circuit. The charges
surrounded financial activities including nonexistent bonds, money
laundering, and securities fraud involving the proposed expansion of
the former Daystar Assembly of God church located in Prattville,
Alabama. It is estimated that the congregation lost about $3,000,000.
As a result of this scam, the congregation lost their church building
because funds were not available to meet mortgage payments. This case
clearly shows the power of cooperation and communication among the
local police department, county, and State legal authorities to work
together and take strong actions against white collar crime and people
who steal from members of their own community. The principal
perpetrator received a 31-year prison sentence.
International Efforts
My colleague, Ralph Lambiase, has already summarized most of the
States' international outreach efforts. In addition, I recently
represented NASAA at the United Nations Commission on International
Trade and Law's Colloquium on International Commercial Fraud. The
Colloquium was convened to address various aspects of the problem of
commercial fraud from the point of view of private law and to permit an
exchange of views from various interested parties, including those
working in national governments, intergovernmental organizations, and
relevant private organizations with a particular interest and expertise
in combating commercial fraud, what we generally call ``investment
fraud.'' The idea was to begin an exchange of views with the
international criminal law and regulatory sectors that combat
commercial fraud and to identify matters that could be coordinated or
harmonized. I was invited to present issues related to securities fraud
including the difficulties we experience in conducting investigations,
document production, and bringing civil and criminal prosecutions due
to ``red tape'' across international borders. I believe we will see
greater efforts made to share information and expedite investigations
with a view to freezing and preserving assets for investors.
Coordination
As we move forward, NASAA will enhance its existing cooperative
relationships and launch new projects to coordinate enforcement
activities. Even with the funding increase Congress allocated for the
SEC, the Commission cannot go it alone. That is why there must be
cooperation and division of labor among State, industry, and Federal
regulators.
In September 2003, the NASAA President and SEC Chairman announced a
joint initiative to address issues of coordination and cooperation
between Federal and State securities enforcement authorities. Since
December 2003, a working group consisting of six representatives of the
Commission staff and six representatives of NASAA has been meeting on a
regular basis to study ways to improve Federal and State cooperation. I
am a member of this working group and assure you that the discussions
have been thorough, constructive, and educational.
Another entity that NASAA works closely with is the Securities and
Commodities Fraud Working Group, which is an informal association of
law enforcement departments and regulatory agencies at the Federal,
State, and international levels. Organized under the auspices of the
Justice Department in 1988, the Group seeks to
enhance criminal and civil enforcement of securities and commodities
laws through tri-annual meetings and other information sharing
activities. For example, the Group maintains a ``Directory and Resource
Guide'' containing contact information for a broad range of law
enforcement and regulatory agencies.
State securities regulators routinely work and cooperate with other
agencies such as the Department of Justice, the National White Collar
Crime Center, the U.S. Postal Service, the Department of Homeland
Security, the Regional Organized Crime Information Center, and others.
In December 2001, the NASAA/NAIC Enforcement Coordination Subgroup
was formed. Comprised of delegates from each association, its mission
is to improve enforcement coordination between insurance and securities
regulators at the State level. A key focus of the group is the
persistent problem of insurance agents engaged in the unlawful sale of
various securities investments. Last month, the group hosted its first
joint training seminar for the benefit of regulators from both
disciplines.
Conclusion
Mr. Chairman and Members of the Committee, State securities
regulators are dedicated to pursuing those firms and individuals who
have violated the securities laws. We will fight to ensure that State
securities regulators maintain the authority to regulate at the local
level and bring enforcement actions with appropriate remedies against
those firms that violate securities laws in their jurisdictions.
The NASAA membership wishes to work with the Committee to provide
you with any additional information or assistance you may need. Thank
you again for inviting me to speak on behalf of the States to discuss
our efforts to protect the investing public. I am happy to answer any
questions you may have.
PREPARED STATEMENT OF CHARLES LEVEN
Vice President, Board Goverance and
Chair, Board of Directors, AARP
June 2, 2004
Good morning Chairman Shelby, Ranking Member Sarbanes, and Members
of the Committee on Banking, Housing, and Urban Affairs. My name is
Charles Leven. I am AARP Vice President for Board Governance and Chair
of our Board of Directors. I appreciate this opportunity to testify on
a matter of keen interest to us--investor protection. My testimony
today focuses on the role that State securities regulation and
regulators, and the North American Securities Administrators
Association (NASAA), play in securing essential marketplace conditions
of fair play and practice.
Your letter of invitation asked for AARP's perspective on the role
played by State securities regulators in restoring public trust and
providing effective oversight of investment markets. More specifically,
you asked for our views on the:
Enforcement actions State securities regulators have taken,
Coordination efforts they have made with Federal regulators,
and
Investor education programs they have undertaken.
The rapid growth in investment activity over the past decade has
severely taxed the resources of Federal and State securities
commissions. According to NASAA there are at least 20,000 investment
advisor firms in the United States. Approximately 8,000 of these are
larger firms that register with the U.S. Securities and Exchange
Commission (SEC) because they have more than $25 million in assets
under management or are active in at least 30 States. The remaining
smaller firms are registered with the States. NASAA also estimates that
150,000 to 175,000 individuals hold State licenses to act as investment
advisor representatives.
According to the 2001 Federal Reserve's Survey of Consumer
Finances, the percentage of households that own stocks, either directly
or indirectly (through mutual funds, retirement accounts and other
managed assets), increased from 32 percent in 1989 to 52 percent in
2001. The shift to defined contribution plans places significant
responsibilities on individuals to make appropriate investment choices
so that they will have adequate income when they reach retirement. It
also heightens their risk if losses are incurred due to bad advice,
abusive practices, or fraud.
In recent years, stock markets have weathered a sluggish economy,
the steep market declines exacerbated by the September 11 terrorist
attacks, trade deficits, and reports of numerous scandals--ranging from
illegal corporate accounting practices to insider trading. These shocks
to the securities marketplace have resulted in serious consequences for
ordinary saver-investors. Suffice it to say, a lifetime's worth of
saving is not a renewable resource for older Americans.\1\ A recent
2004 survey of investors by AARP confirms a reduced confidence in
financial services professionals, continuing concerns about the
fairness of stock market conditions and practices, and the desire for
stronger regulation of the securities industry.\2\ This is the legacy
from a still recovering marketplace.
---------------------------------------------------------------------------
\1\ See: ``Impact of Stock Market Decline on 50-70 Year Old
Investors,'' an AARP survey report published, December, 2002 (available
at: http://research.aarp.org).
\2\ See: ``Investor Perceptions and Preferences Toward Selected
Stock Market Conditions and Practices: An AARP Survey of Stock Owners
Ages 50 and Older,'' published March 2004 (available at: http://
research.aarp.org).
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Others can speak more authoritatively about the evolution of the
Federal-State relationship over time--including the periodic tensions
that have surfaced between State and Federal regulators. We can
understand how some differences might surface with Federal regulators--
and among States--when a timely response to an emerging market problem
is needed. Nevertheless, we are reminded by recent market history just
how vital the State securities commissions are in our dual system of
market regulation and investor protection. The sensitivities and
concern associated with ``prior consultation'' will no doubt
periodically resurface.
For us, however, the goal of providing American investors with
market conditions of fair play and practice is advanced by promoting
harmonization wherever possible within our concurrent Federal-State
system of securities regulation. Clearly State securities regulatory
commissions and NASAA must and are playing an essential role. We
believe State regulatory authority must be maintained as an integral
component of our concurrent system, and refreshed as evolving market
circumstances warrant.
State regulation of securities is based on statutes that serve
three primary functions. These are the:
Registration of certain securities;
Registration of broker-dealers and their agents and more
recently of investment advisers and investment adviser
representatives; and
Enforcement of fraud and other remedies.
The State securities regulators are responsible for the licensing
of firms and investment professionals, the registration of some
securities offerings, branch office sale practice audits, investor
education, and most importantly, the enforcement of State securities
laws. Securities regulatory commissions are located in all 50 States,
the District of Columbia, and Puerto Rico.
Enforcement
One of the principle virtues of our concurrent system of securities
regulation is State securities commission authority to investigate and
bring enforcement actions with respect to fraud or deceit or unlawful
conduct in connection with securities transactions. State securities
administrators are frequently the first point of contact when an
investor has a securities transaction-related complaint. State
regulators often work very closely with criminal prosecutors at the
Federal, State, and local levels to punish those who violate our
securities laws.
The New York State criminal case against research analysts,
initiated in early 2003, is a useful illustration of the significant
role that State securities regulators can play in enforcement.
Precisely because the States also had investigatory and enforcement
powers, one State was able to take the initiative in what became a $1.4
billion settlement with 10 leading broker-dealer firms. Ultimately
NASAA, the State of New York and the Federal regulators worked
cooperatively on the Global Research Analyst Settlement.
Later in 2003, the securities regulators in Massachusetts began
what would become a series of investigations by other State and Federal
regulators into the Nation's $7.6 trillion mutual fund industry.
Clearly, these examples serve to validate the rationale for maintaining
a well-balanced and concurrent securities regulatory system.
From our perspective, the most serious ongoing State enforcement
issue is inadequate enforcement budgets--a challenge not unknown to
Federal regulators. We support increased State budgets to combat the
significant increases in fraud being found in many States. We believe
that Congressional and judicial oversight can mitigate disagreements
that periodically emerge.
Coordination
State regulators have been active in coordinating reviews of
filings, developing a uniform registration statement for offerings that
are exempt at the Federal level, and in crafting policy statements on a
number of review issues that strengthen uniformity of review in the
States. There are over 60 of these NASAA statements of policy which
have been adopted at the State law level as State rules or guidelines.
These statements of policy provide flexibility in the rapidly changing
securities marketplace, and can provide a basis for Federal-State
cooperation and coordination.
Two additional examples of the cooperative role that NASAA has
played with Federal regulators involve working with:
NASD to computerize and maintain the licensing and
disciplinary histories on more than 650,000 securities
professionals (broker-dealers) and 5,200 securities firms (referred
to as CRD for Central Registration Depository); and more recently
with the
SEC to develop a licensing, registration, and enforcement
database for investment advisors. This database, the Investment
Adviser Registration Depository (referred to as IARD), provides
employment and disciplinary histories on more than 11,000
investment adviser firms and 173,000 individual investment
advisers.
In 2002, a new version of the Uniform Securities Act was adopted by
the National Conference of Commissioners on Uniform State Laws. The
Uniform Securities Act has been the model for nearly 40 States'
securities laws including a reciprocal provision to the Securities Act
of 1933 that provides that the securities administrators ``shall, in
its discretion, take into consideration in carrying out the public
interest . . . maximizing uniformity in Federal and State regulatory
standards.''
As a practical matter, the SEC's annual conference on Federal
securities regulation, to which State securities regulators are
invited, provides a forum for addressing a range of mutual concerns.
And NASAA has been a frequent and influential commenter on SEC rule and
form proposals, and State regulators are often called to testify before
Congress on matters pertaining to securities regulation.
Education
AARP recognizes State securities regulators and NASAA for their
impressive efforts to enhance the capacity of individual investors and
their agencies to detect, report, and eliminate abusive and fraudulent
behavior. This effort at capacity-building is based on better investor
education and through improved agency staff training. Investor
education is the ordinary investor's first and sometimes their ultimate
line of defense against exploitive securities sales practices. Our
dynamic stock market makes upgrading investment skills a necessity.
Last year, complementing its existing Investor Education Section,
NASAA initiated a major education campaign aimed at older investors by
launching an online ``Senior Investor Resource Center.'' NASAA also
offers training to its members on an average of one seminar a month. It
also offers K through 12 teacher training academies.
Conclusion
While a range of statutory conventions and informal policy
discussion venues are available for harmonizing Federal-State
regulatory enforcement, stimulating coordination, and upgrading
investor education and investment skills, this does not mean that every
difference of view can or should be summarily resolved. By the same
token, our dual system of securities regulation provides a great deal
of flexibility for each State to address local concerns. There may be
modest costs associated with the concurrent system of regulation, as
well as redundant regulatory efforts including multiple fees for
securities issuers and professionals. But we believe that there are
demonstrated benefits to the dual system, and to the role and value of
State securities regulators. State securities regulatory authority
helps fill what would otherwise be important enforcement gaps.
I appreciate this opportunity to testify on behalf of AARP on the
important role that State securities commissions play in efforts to
secure marketplace conditions of fair play and practice. We look
forward to working with Members of this Committee in pursuit of these
shared goals. I would be happy to answer any questions you may have.
RESPONSE TO A WRITTEN QUESTION OF SENATOR MILLER
FROM RALPH A. LAMBIASE
Q.1. I asked Chairman Donaldson in a hearing on the ``State of
the Securities Industry'' what kind of working relationship he
had with the State securities administrators and the State
attorneys general on resolving the various enforcement issues
that have arisen, and whether he thought there were any changes
that might be needed to be made in the SEC's relationship with
the States.
Let me quote Chairman Donaldson's response to me. He said
That is an excellent question. It is one that we are very
concerned about. Let me say this, that we need and encourage
all the help we can get from local regulators in the securities
industry at the local level where they can uncover and
investigate things that go beneath our screen, so that if there
is malfeasance or fraud or whatever at a local level, we
welcome the local administrators, securities administrators,
and so forth.
At another level, and that is the level of the structure of
the markets themselves, we believe and I believe very strongly
that we cannot have 50 different structural solutions, we
cannot have 50 different ways, perspectives as they are put
out, and trading rules and so forth, I believe that that has to
be done by the Federal administrators.
Having said that, we need to and we have cooperated with
local securities regulators, andjust 2 weeks ago in connection
with the chairwoman of the National Regulators Trade
Association, we agreed to enter into a joint arrangement with
them to see if we could not improve the communication between
what they are doing and improve the cooperation between what
they are doing. I think that will go a long way.
I will say it again and in frank answer to what you said,
there are areas where a local authority can step in too late to
an investigation that is already under way and in so doing
interrupt a carefully put-together investigation by a Federal
functionary, and this is where I think we get into trouble,
where there is considerable work that has been done, cases
being built, and someone comes in from left field and does not
really add anything and in fact might create an environment
where the accused will get off because of a technicality.
I would like to ask each of you basically the same
question.
What kind of working relationship does each of you have
with the SEC on resolving the various enforcement issues that
have arisen, and whether you thought there were any changes
that might be needed to be made in the SEC's relationship with
the States? And do you have any other comments on Chairman
Donaldson's response to me?
A.1. In September 2003, the NASAA President, Christine Bruenn,
and Securities and Exchange Commission (SEC) Chairman Bill
Donaldson announced a joint initiative to address issues of
coordination and cooperation between Federal and State
securities enforcement authorities. Since November 2003, a
working group consisting of six representatives of the
Commission and six representatives of NASAA has been meeting on
a regular basis to study ways to improve Federal and State
cooperation.
I believe the relationship between State securities
regulators and the SEC is already more open and cooperative
than it was when Chairman Donaldson appeared before the Banking
Committee on September 30, 2003. We are working on various ways
to exchange information on cases, and make a determination as
to when and how to work together on cases. Developing trust
between the States and the SEC is a key component of this
effort. As I said in my testimony, there is complete trust and
cooperation among State regulators. We share information, we
share resources, and we work jointly. We have a trust and
respect for each other that allows us to work as effectively as
we do. I would like to see that model extended to the State and
Federal working relationship.
Last fall, I stated that my foremost goal as President of
NASAA is to work with the SEC and the SRO's to use our
resources collectively to protect investors. This process has
to be a two-way street with information flowing back and forth
between our organizations, and I continue to work toward
reaching that goal.
Since Chairman Donaldson's September 2003 testimony, the
NASAA leadership has met several times with the Chairman and we
have had open, frank discussions on a variety of subjects. He
and his staff have been most receptive to our thoughts and
concerns. I agree with him that the SEC is the lead regulator
when it comes to establishing national rules for the securities
marketplace. Over the last several years, NASAA members have
been active commenters in the rulemaking and legislative
process. The States worked closely with the SEC and the SRO's
both to leverage limited resources and to formulate new,
marketwide rules on a variety of issues.
Also, NASAA invited Chairman Donaldson's Managing Executive
for Policy and Staff to a number of our meetings and gave him
the opportunity to address our membership on key topics of
interest to both organizations. In addition, the NASAA Section
Chairs meet regularly with corresponding SEC Division staff to
discuss issues of common interest.
RESPONSE TO A WRITTEN QUESTION OF SENATOR MILLER
FROM JOSEPH P. BORG
Q.1. I asked Chairman Donaldson in a hearing on the ``State of
the Securities Industry'' what kind of working relationship he
had with the State securities administrators and the State
attorneys general on resolving the various enforcement issues
that have arisen, and whether he thought there were any changes
that might be needed to be made in the SEC's relationship with
the States.
Let me quote Chairman Donaldson's response to me. He said
That is an excellent question. It is one that we are very
concerned about. Let me say this, that we need and encourage
all the help we can get from local regulators in the securities
industry at the local level where they can uncover and
investigate things that go beneath our screen, so that if there
is malfeasance or fraud or whatever at a local level, we
welcome the local administrators, securities administrators,
and so forth.
At another level, and that is the level of the structure of
the markets themselves, we believe and I believe very strongly
that we cannot have 50 different structural solutions, we
cannot have 50 different ways, perspectives as they are put
out, and trading rules and so forth, I believe that that has to
be done by the Federal administrators.
Having said that, we need to and we have cooperated with
local securities regulators, andjust 2 weeks ago in connection
with the chairwoman of the National Regulators Trade
Association, we agreed to enter into a joint arrangement with
them to see if we could not improve the communication between
what they are doing and improve the cooperation between what
they are doing. I think that will go a long way.
I will say it again and in frank answer to what you said,
there are areas where a local authority can step in too late to
an investigation that is already under way and in so doing
interrupt a carefully put-together investigation by a Federal
functionary, and this is where I think we get into trouble,
where there is considerable work that has been done, cases
being built, and someone comes in from left field and does not
really add anything and in fact might create an environment
where the accused will get off because of a technicality.
I would like to ask each of you basically the same
question.
What kind of working relationship does each of you have
with the SEC on resolving the various enforcement issues that
have arisen, and whether you thought there were any changes
that might be needed to be made in the SEC's relationship with
the States? And do you have any other comments on Chairman
Donaldson's response to me?
A.1. I agree with Mr. Lambiase's comments and want to elaborate
on the cooperative enforcement efforts between State securities
regulators and the SEC. Even with the funding increase Congress
allocated for it, the SEC cannot go it alone. The scope of the
fraud and the other violations occurring in the financial
marketplace today is unfortunately just too large for one
regulator to handle. That is why there must be cooperation
among State, Federal, and industry regulators. And NASAA is
committed to that principle. As we move forward, NASAA will
enhance its cooperative relationships and launch new projects
to coordinate enforcement activities.
The advantages of having State as well as Federal
enforcement of the securities laws are many. As noted above,
the dual system simply brings more needed resources to bear. In
addition, States have historically played an important role
``an indispensable early warning system for fraud.'' Because of
their proximity to local investors, State regulators often are
the first to detect an emerging scam or pattern of violations.
Also, in some cases, States may have jurisdiction over an
investment or an activity while the SEC does not--and vice
versa. Further, some violations are more local in nature and
therefore more appropriately handled by the States. In
addition, some State securities regulators can bring criminal
prosecutions, which is especially important where the case is
not sufficiently national in scope or even in national cases
where agent
activity is of such a local nature not to warrant involvement
by the U.S. Attorney's office. For many reasons, therefore,
investors benefit from having a dual system of State and
Federal enforcement.
The benefits of this dual system are often seen when the
States and the SEC work together in the same case. In my own
State of Alabama, we have had an effective working relationship
with our SEC Regional Office in Atlanta and the District Office
in Miami, Florida. As an example, in April 2004, after
extensive discussion and investigation by the SEC and Alabama
Securities Commission (ASC), the ASC issued its Cease & Desist
Orders against Heymen International and other parties for their
involvement in a Ponzi scheme. The SEC simultaneously filed
their injunctive action in the U.S. District Court, with both
the SEC and Alabama Securities Commission lawyers appearing in
court. The joint SEC/ASC press release acknowledged the
investigative and cooperative efforts of the SEC, the State of
Alabama Securities Commission, the FBI, and the IRS.
Cooperative efforts such as these go back many years, including
one ofthe first of the ``cooking the books'' accounting
scandals within Comptronix, a publicly held company, in
Guntersville, AL. That case was prosecuted in 1996 and resulted
in felony convictions for corporate officers.
The working relationships between any State and any
regional office of the SEC, or other regulators, is determined
by a number of factors, including the type of case, the
personal relationships that have been developed over time
between respective offices, and the relative interest in the
case by Federal and State regulators. At certain times the
focus of Federal regulators may be on areas other than a
particular securities fraud, while at the State level there may
be occasions where State securities regulators are inundated
with other matters and therefore resources are stretched to the
limit precluding extensive efforts in a specific case.
As others have observed, however, enforcement of the law
should be distinguished from writing the rules. In Mr.
Donaldson's response in September 2003, he stated that there
cannot be ``50 different structural solutions . . . cannot have
50 different ways . . . trading rules.'' And he is correct.
State enforcement efforts target a specific fraud or rule
violation that affects the bedrock of our economy--the
investor. Enforcement actions and conduct remedies specifically
target a particular set of circumstances where the law has
already been transeressed. These responses to misconduct cannot
be confused with the formulation of new rules and regulations
that govern the national markets generally.
State regulators do work with national regulators on
market-wide solutions when they are required, but they do not
impose solutions. This is the pattern followed with penny stock
fraud, microcap fraud, day trading, and other areas all of
which were first ``uncovered'' by State securities regulators.
The States investigate and bring enforcement actions. They do
not engage in rulemaking for the national markets. The States
comment regularly on proposed market rules and meet with
various divisions of the SEC to share their experiences in the
``laboratories'' of the States and to discuss the implications
of new rules and procedures. The final result of these
discussions and commentaries is that the States have input into
the SEC's determinations of what will finally emerge as rules
for the national markets.
Finally, Chairman Donaldson mentioned concern that a local
authority could ``interrupt a carefully put together
investigation by a Federal functionary.'' This, of course,
works both ways, and in the instance referred to by the
Chairman in his testimony, the participant in the Federal
investigation was not a State securities regulator.
Nevertheless, State and Federal regulators alike should be
mindful ofthese concerns and should certainly try to assist,
rather than hamper, each other. This is a main focus in our
current NASAA/SEC meetings. It should be also be noted that
Chairman Donaldson's September 2003 testimony on this point
occurred prior to the joint initiative meetings between the SEC
and State regulators, and since that time there has been
extensive dialog and the lines of communication between the SEC
and State regulators have opened up considerably.
These communications continue as SEC and NASAA
representatives meet on a monthly basis. As I stated in my
testimony, these meetings are productive, giving both
regulators enhanced insight into each other's operations,
needs, and concerns. The future of cooperation between the SEC
and State securities regulators continues to be effective, and
with additional refinements now in process, should become more
efficient to the benefit of all investors.