[Senate Hearing 109-696]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-696
 
    HEDGE FUNDS AND INDEPENDENT ANALYSTS: HOW INDEPENDENT ARE THEIR 
                             RELATIONSHIPS?

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

                                HEARING

                               before the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 28, 2006

                               __________

                          Serial No. J-109-93

                               __________

         Printed for the use of the Committee on the Judiciary



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                       COMMITTEE ON THE JUDICIARY

                 ARLEN SPECTER, Pennsylvania, Chairman
ORRIN G. HATCH, Utah                 PATRICK J. LEAHY, Vermont
CHARLES E. GRASSLEY, Iowa            EDWARD M. KENNEDY, Massachusetts
JON KYL, Arizona                     JOSEPH R. BIDEN, Jr., Delaware
MIKE DeWINE, Ohio                    HERBERT KOHL, Wisconsin
JEFF SESSIONS, Alabama               DIANNE FEINSTEIN, California
LINDSEY O. GRAHAM, South Carolina    RUSSELL D. FEINGOLD, Wisconsin
JOHN CORNYN, Texas                   CHARLES E. SCHUMER, New York
SAM BROWNBACK, Kansas                RICHARD J. DURBIN, Illinois
TOM COBURN, Oklahoma
           Michael O'Neill, Chief Counsel and Staff Director
      Bruce A. Cohen, Democratic Chief Counsel and Staff Director


                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa, 
  prepared statement.............................................   143
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah......     2
Schumer, Hon. Charles E., a U.S. Senator from the State of New 
  York...........................................................     4
Specter, Hon. Arlen, a U.S. Senator from the State of 
  Pennsylvania...................................................     1

                               WITNESSES

Aguirre, Gary J., former Investigator, Securities and Exchange 
  Commission, Washington, D.C....................................    16
Anifantis, Demetrios, former Client Relationship Manager, 
  Camelback Research Alliance, Inc., Scottsdale, Arizona.........    27
Blickenstaff, Kim, Founder, Chairman and Chief Executive Officer, 
  Biosite, Incorporated, San Diego, California...................    22
Blumenthal, Richard, Attorney General, State of Connecticut, 
  Hartford, Connecticut..........................................     8
Boersma, Jonathan A., Director, Standards of Practice, CFA Centre 
  for Financial Market Integrity, Charlottesville, Virginia......    31
Friedrich, Matthew, Principal Deputy Assistant Attorney General 
  and Chief of Staff, Criminal Division, Department of Justice, 
  Washington, D.C................................................     6
Kasowitz, Marc E., Senior Partner, Kasowitz, Benson, Torres & 
  Friedman LLP, on behalf of the Alliance for Investment 
  Transparency, New York, New York...............................    19
Lamont, Owen A., Professor of Finance, Yale School of Management, 
  New Haven, Connecticut.........................................    25
McLaughlin, Joseph, Partner, Sidley Austin LLP, on behalf of the 
  Managed Funds Association, New York, New York..................    20
Schilit, Howard, CPA, Founder and Non-Executive Chair, Center for 
  Financial Research and Analysis (CFRA, LLC), Rockville, 
  Maryland.......................................................    29

                         QUESTIONS AND ANSWERS

Responses of Gary Aguirre to questions submitted by Senator 
  Specter........................................................    48
Responses of Demetrios Anifantis to questions submitted by 
  Senator Specter................................................    55
Responses of Kim Blickenstaff to questions submitted by Senator 
  Specter........................................................    61
Responses of Richard Blumenthal to questions submitted by Senator 
  Specter........................................................    62
Responses of Jonathan Boersma to questions submitted by Senator 
  Specter........................................................    65
Responses of Matthew Friedrich to questions submitted by Senator 
  Specter........................................................    66
Responses of Marc Kasowitz to questions submitted by Senator 
  Specter........................................................    87
Responses of Owen Lamont to questions submitted by Senator 
  Specter........................................................    90
Responses of Joseph McLaughlin to questions submitted by Senator 
  Specter........................................................    91
Responses of Howard Schilit to questions submitted by Senator 
  Specter........................................................    96

                       SUBMISSIONS FOR THE RECORD

Aguirre, Gary J., former Investigator, Securities and Exchange 
  Commission, Washington, D.C., statement........................    97
Anifantis, Demetrios, former Client Relationship Manager, 
  Camelback Research Alliance, Inc., Scottsdale, Arizona, 
  statement......................................................   112
Bettis, Carr, Founder, President and Chief Executive Ofiicer, and 
  Donn Vickrey, Founder and Editor-in-Chief, Gradient Analytics, 
  Inc., statement................................................   121
Blickenstaff, Kim, Founder, Chairman and Chief Executive Officer, 
  Biosite, Incorporated, San Diego, California, statement........   123
Blumenthal, Richard, Attorney General, State of Connecticut, 
  Hartford, Connecticut, statement...............................   126
Boersma, Jonathan A., Director, Standards of Practice, CFA Centre 
  for Financial Market Integrity, Charlottesville, Virginia, 
  statement......................................................   131
Friedrich, Matthew, Principal Deputy Assistant Attorney General 
  and Chief of Staff, Criminal Division, Department of Justice, 
  Washington, D.C., statement....................................   136
Green, Stanton, Chairman, Investorside Research Association, 
  statement......................................................   144
Kasowitz, Marc E., Senior Partner, Kasowitz, Benson, Torres & 
  Friedman LLP, on behalf of the Alliance for Investment 
  Transparency, New York, New York, statement....................   151
Lamont, Owen A., Professor of Finance, Yale School of Management, 
  New Haven, Connecticut, statement..............................   160
Manning, Greg, Escala Group, Inc. New York, New York, statement..   171
McLaughlin, Joseph, Partner, Sidley Austin LLP, on behalf of the 
  Managed Funds Association, New York, New York, statement.......   191
Pollock, Alex J., Resident Fellow, American Enterprise Institute, 
  statement......................................................   205
Schilit, Howard, CPA, Founder and Non-Executive Chair, Center for 
  Financial Research and Analysis (CFRA, LLC), Rockville, 
  Maryland, statement............................................   210
Smith, Rich, Chief Executive Officer, Taser International, 
  Scottsdale, Arizona, letter....................................   214


    HEDGE FUNDS AND INDEPENDENT ANALYSTS: HOW INDEPENDENT ARE THEIR 
                             RELATIONSHIPS?

                              ----------                              


                        WEDNESDAY, JUNE 28, 2006

                                       U.S. Senate,
                                Committee on the Judiciary,
                                                   Washington, D.C.
    The Committee met, pursuant to notice, at 9:32 a.m., in 
room SD-226, Dirksen Senate Office Building, Hon. Arlen 
Specter, Chairman of the Committee, presiding.
    Present: Senators Specter, Hatch, and Schumer.

 OPENING STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM 
                   THE STATE OF PENNSYLVANIA

    Chairman Specter. Ladies and gentlemen, the Judiciary 
Committee will now proceed with this hearing to inquire into 
the adequacy of the Federal criminal statutes to deal with the 
potential issues for fraud on the investments of hedge funds in 
collaboration with so-called independent analysts. This is a 
subject of enormous importance to the United States economy, 
with hedge funds now having $1.2 trillion in assets and having 
stock transactions which involve some 30 percent of what goes 
on in the trading market.
    There have been some high-profile civil cases which have 
been brought with allegations, among other things, that hedge 
funds are collaborating with the so-called independent analysts 
to rig the information to make it appear that some companies 
are weaker than they really are, with short-selling and the 
potential for very, very substantial profits.
    The Judiciary Committee has been intimately involved in the 
regulatory process to the extent that it involves criminal 
prosecutions in the legislation captioned ``Sarbanes-Oxley,'' 
so much so that Senator Leahy, when he was Chairman of this 
Committee, and Representative Sensenbrenner, the Chairman of 
the House Committee, were conferees. The Banking Committees 
obviously have primary jurisdiction on the regulation of hedge 
funds. It is squarely within their purview. The issue of the 
adequacy of the criminal laws are a matter for the Judiciary 
Committee, and that is why we are making this inquiry today.
    Our focus will be on the adequacy of the provision of 
Sarbanes-Oxley, which was reported out of this Committee since 
it dealt with a criminal law, making it a violation for anyone 
who knowingly executes a scheme or an artifice to defraud any 
person in connection with any security or to obtain by means of 
false or fraudulent pretenses any money in connection with the 
purchase or sale of any security.
    We have a representative of the Department of Justice and 
we have the Attorney General of the State of Connecticut to 
give us their thinking on this subject.
    We are dealing with a subject matter which has enormous 
potential to have a very, very major impact on the markets. The 
case involving the Long-Term Capital Management Company was one 
which illustrates the potential problems. In 1998, when LTCM 
was on the verge of collapse, the New York Fed stepped in and 
undertook what we call a ``facilitation,'' a rescue package of 
some $3.6 billion in cash contributed by 13 private financial 
institutions. You have a situation where this company, LTCM, 
with $3 to $4 billion in assets, was able to leverage some $80 
to $100 billion, and if there had been a fire sale of their 
assets, it would have had an enormous impact on the market, and 
the Fed stepped in.
    Well, that is fine if the Fed can find 13 companies to step 
in to stabilize the market. But it raises some very, very 
important questions, especially in the context where the 
District of Columbia Circuit Court has held that the SEC does 
not have jurisdiction for some of the rulemaking. That is a 
matter, obviously, for the Banking Committee to take up. But 
the backdrop here of the applicability of the criminal laws is 
very, very important.
    Since this hearing was scheduled, the subject matter has 
attained substantial additional notoriety with the termination 
of a senior SEC lawyer, who will testify here today. We have 
had the decision by the Court of Appeals for the District of 
Columbia, and we have quite a heavy focus on these hedge funds. 
They had been attracting investors who were very, very wealthy, 
in the range of $400,000, and now we are finding people in the 
$10,000 to $20,000 category. So it is a matter of great 
concern, and it is very important that there be adequate 
investigation and oversight by the Department of Justice and 
oversight on the Department of Justice by this Committee if we 
need any new laws.
    My red light just went on, so I will yield to my 
distinguished colleague, the former Chairman of the Judiciary 
Committee, Senator Hatch.

STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM THE STATE 
                            OF UTAH

    Senator Hatch. Well, thank you, Mr. Chairman. I want to 
thank you for holding this hearing today. I know there has been 
some discussion about our Committee's jurisdiction here, and I 
want you to know that, in my opinion, our jurisdiction is 
clear. We have oversight responsibilities for the Department of 
Justice. Ultimately, the Senators on this Committee are the 
ones responsible for writing and amending our Nation's criminal 
law.
    In 2002, the President created a Corporate Fraud Task 
Force. It is chaired by the Deputy Attorney General and 
includes U.S. Attorneys, the heads of DOJ's Criminal and Tax 
Divisions, and representatives from the law enforcement 
community and government agencies, including the SEC. That task 
force is responsible for investigating corporate fraud, and we 
are responsible for determining whether DOJ is doing its job 
and whether we have provided them with the tools to do their 
job.
    Unfortunately, because of my schedule this morning--we have 
markups in both the HELP and Finance Committees, and one of my 
bills is being marked up this morning. Of course, I am a member 
of both of those as well, and I will not be able to attend all 
of this hearing, as much as I would like. But if I leave early, 
I do not want anybody to mistake that I am doing that for a 
lack of commitment to investigating this issue. I think that it 
is critical that we do so.
    I am pleased that Mr. Friedrich is here to testify today 
about the structure of the Corporate Fraud Task Force and its 
past successes. I think that the many successful prosecutions 
that he details are testament to the priority that the 
President and the attorneys at DOJ have given these cases. 
Market confidence and ultimately the health of our economy 
depends on them. There is no denying those successes.
    Now, I know that he cannot speak to ongoing investigations, 
but in reading your testimony, it seemed to me that there was a 
general reluctance to discuss, even in a general way, the 
Department's capability to investigate and prosecute what we 
are here today to discuss: the relationship between hedge funds 
and so-called independent analysts.
    We all know that hedge funds are a powerful force in our 
financial markets. It is critical that the power and influence 
that hedge funds have attained be exercised responsible, and we 
need to be sure that our laws that we give to the law 
enforcement authorities are effective and adequate to ensure 
that the substantial power of hedge funds is not abused. This 
is of particular concern because hedge funds are so lightly 
regulated and operate largely in secrecy.
    I am not necessarily calling for new regulations here. In 
fact, I have real questions about whether we should. But we 
need to monitor this field and make that our markets have the 
integrity that our investors need to continue investing and 
maintain our vibrant economy.
    DOJ has an important role to play here. Mr. Friedrich, as 
you explain in your testimony, the Corporate Fraud Task Force 
maps out a strategy and identifies best practice. I have a 
number of questions. Do you have the tools that you need? How 
often do you meet? Are you incorporating U.S. Attorneys only 
from major financial centers or also from nontraditional 
locations? After all, we are going to hear today about an 
alleged fraud that began not in New York but in Arizona. And I 
know that in my State of Utah, the issue of hedge funds and 
corporate fraud has become such an issue that the State 
legislature went into a special session to address the issue. 
And as you know, DOJ and SEC work closely in these cases, but 
sometimes, as I read the testimony today, I get the impression 
that if somebody asked both agencies who was ultimately 
responsible for initiating these investigations, they might 
just point fingers at each other.
    Now, I want to be clear about what we are not trying to get 
at through this hearing. This is not a hearing about naked 
shorting. It is most certainly not a hearing to drag anyone's 
name through the mud. And this is not a hearing that challenges 
hedge funds as a whole or the practice of naked shorting in 
general.
    As our friends in the press have continually reminded us 
since the hearing was called, there is nothing wrong with 
short-selling. We do not need to be reminded again. The market 
trend is upward, and it is good to have some pessimists around 
who keep prices honest and help to maintain market balance. We 
also know that shorters were well ahead of anyone in 
discovering that there were problems at Enron. And nobody is 
attacking this activity in general.
    As Mr. Kasowitz has noted, though he does represent a 
number of clients who alleged harm through market manipulation 
and short-selling, he does represent hedge funds in a variety 
of matters. These are legitimate investment vehicles, and I do 
not doubt that, for the most part, they are acting on the up 
and up. Yet hedge funds are the Wild West of our financial 
markets. There are 11,500 hedge funds. They are highly 
profitable to their managers and largely unregulated, more than 
all the stocks listed on the Stock Exchange, as I view it. They 
may be a small piece of the market, but they are growing. And 
because of their volume of trading and the commissions that 
they represent, they are an increasingly powerful member of the 
financial community.
    Well, there is a lot more I have to say, but my time is up. 
Let me just put the record of my statement in the record, Mr. 
Chairman.
    Chairman Specter. Without objection, Senator Hatch's full 
statement will be made a part of the record.
    Senator Schumer. Mr. Chairman?
    Chairman Specter. Who is seeking recognition?
    Senator Schumer. I am, Mr. Chairman.
    Chairman Specter. Well, in that event, I will ask you if 
you would care to make an opening statement.
    Senator Schumer. I would indeed, Mr. Chairman.
    Chairman Specter. Proceed.

 STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR FROM THE 
                       STATE OF NEW YORK

    Senator Schumer. I thank you, Mr. Chairman. Good morning, 
Mr. Chairman and members of the Committee. As the only member 
of this Committee also on the Banking Committee, I would like 
to bring a different perspective to today's hearings.
    First of all, Mr. Chairman, as you said, I support the 
jurisdiction of this Committee to hold hearings on legal issues 
raised by any industry, including the investment industry. But 
the very title of this hearing--''Hedge Funds and Independent 
Analysts: How Independent Are Their Relationships?''--raises a 
yellow flag of caution.
    From the written testimony submitted by many of the 
witnesses, it is clear that this hearing will focus on a broad 
range of regulatory issues facing the hedge fund industry. For 
starters, what are hedge funds? Just last week, the U.S. Court 
of Appeals negated the SEC's hedge fund registration rules 
because the agency's definition of a hedge fund was not 
adequately supported.
    Experts continue to disagree over what it is or is not, 
what a hedge fund is or what a hedge fund is not. Should hedge 
funds be regulated?--an issue we have discussed at great length 
in the Banking Committee. And a separate issue, does short-
selling benefit markets?
    The bottom line, in my judgment, Mr. Chairman, as one who 
sits on both Committees, is that many of these issues are best 
addressed in the Banking Committee. The Banking Committee has 
exclusive jurisdiction, as they have asserted in a letter sent 
to the Committee yesterday afternoon. I am going to read the 
letter and ask unanimous consent it be added to the record.
    Chairman Specter. Without objection, the letter will be 
made a part of the record.
    Senator Schumer. Thank you. This is a letter--short--from 
Chairman Shelby and Ranking Member Sarbanes.
    ``Dear Senators Specter and Leahy: We understand that the 
Judiciary Committee will hold a hearing tomorrow on hedge fund 
advisers and independent equity research analysts. While we 
appreciate your interest in these important participants in the 
capital markets, we are writing today to note that the 
operation and regulation of both hedge funds and stock analysts 
fall within the exclusive jurisdiction of the Banking 
Committee. Furthermore, our jurisdiction over these areas is 
well established and clearly delineated by Senate rules. This 
Committee''--the Banking Committee--''has held numerous 
oversight hearings in the past year on both hedge funds and 
Wall Street analysts, and we intend to continue this active 
oversight for the remainder of the 109th Congress and beyond.''
    Not only do the Banking Committees--and the letter is now 
in the record. Not only does the Banking Committee have 
exclusive jurisdiction, but it also has the critical expertise 
needed to examine these very complicated financial market 
issues. I worry that today's hearing will not afford us the 
benefit of the views and expertise of many of the critical 
Federal agencies charged with overseeing and enforcing our 
Nation's security laws. I understand that Mr. Blumenthal, my 
friend and a man I have great respect for, will be making 
claims that there should be additional regulation of hedge 
funds. Those arguments should absolutely be heard, but they 
should be heard before the Banking Committee, which has 
exclusive and relevant jurisdiction. And we should hear the 
views of the relevant regulators and the people in the industry 
who might disagree with those views so we could come to a fair 
and adequate conclusion.
    Though the Department of Justice undoubtedly plays an 
important role in securities enforcement, without the expert 
views of the SEC as principal regulator or other members of the 
President's Working Group on Financial Markets--Treasury, 
Federal Reserve, CFTC--this Committee is not likely to get a 
full and complete picture, complete view of the way in which 
participants in the capital markets operate legally and 
ethically.
    Thank you, Mr. Chairman.
    Chairman Specter. Thank you very much, Senator Schumer.
    We turn now to our first witness, Matthew Friedrich, 
Principal Deputy Assistant Attorney General and Chief of Staff 
of the Criminal Division of the Department of Justice; 
previously had been an Assistant United States Attorney in the 
Eastern District of Virginia; served as a member of the Enron 
Task Force and co-counsel in the first two criminal cases tried 
as part of the Enron investigation; a graduate from the 
University of Virginia, the University of Texas School of Law; 
clerked for District Judge Royal Ferguson in the Western 
District of Texas.
    Thank you for coming back to testify before this Committee, 
Mr. Friedrich, and we look forward to your views.

  STATEMENT OF MATTHEW FRIEDRICH, PRINCIPAL DEPUTY ASSISTANT 
    ATTORNEY GENERAL AND CHIEF OF STAFF, CRIMINAL DIVISION, 
            DEPARTMENT OF JUSTICE, WASHINGTON, D.C.

    Mr. Friedrich. Thank you. Good morning, Mr. Chairman and 
members of the Committee. On behalf of the Department of 
Justice, I want to thank you for inviting me here today to 
testify about the Department's ongoing efforts to combat 
corporate and investor fraud. The Justice Department 
appreciates the Committee's concerns, and I look forward to 
discussing this issue with you today.
    Prosecuting corporate and investor fraud is more than just 
enforcing the rules. It is about protecting the reliability, 
integrity, and transparency of American markets. Investing, 
after all, is a measure of trust. Investors generally will not 
put their money into companies or markets that they do not 
trust. Thus, in the global competition for investor dollars, 
market integrity is essential to the strength of our economy. 
It is a competitive edge that can bring with it new investment, 
new capital, and new jobs.
    Conversely, and as we were all reminded during the 
corporate scandals of 2001 and 2002, instances of corporate 
fraud put us at a disadvantage in that competition because, 
simply put, fraud is bad for business. Lack of investor 
confidence leads to weak markets and job loss. I am sure that 
concerns like these were paramount in the minds of members of 
this Committee in passing the landmark Sarbanes-Oxley 
legislation in 2002. You gave those of us in the front lines of 
prosecution new tools to use in our efforts against corporate 
fraud.
    We have utilized the tools which you have given us, and we 
are grateful to you for them. For example, since the inception 
of Sarbanes-Oxley, more than 53 defendants have been charged 
with securities fraud under Section 1348 of the Act. 
Additionally, through fiscal year 2005, we have issued five 
indictments involving violations of the certification 
provisions of Section 1350.
    I would note that the importance of the certification 
provision of Sarbanes-Oxley, however, is not measured solely by 
indictments. Section 1350 has had an enormous deterrent effect 
on corporate fraud, which ultimately is one of the primary 
purposes of this powerful law.
    As you know, and as Senator Hatch referred to earlier, the 
focal point of the Department's efforts in this arena is the 
President's Corporate Fraud Task Force. The task force is 
chaired by the Deputy Attorney General and includes members 
from the U.S. Attorney community, the head of the Criminal 
Division, and a broad array of Federal law enforcement and 
regulatory agencies, including the FBI and the SEC.
    From its inception in 2002 through this past December, the 
task force has obtained over 1,000 corporate fraud convictions. 
As to corporate officers, the task force has convicted 92 
corporate presidents, 82 CEOs, 40 chief financial officers, and 
17 corporate counsel or attorneys. In the Enron investigation 
alone, 34 individuals were charged, and 25 convictions to date 
have been obtained. Two of those recent convictions came last 
month. On May 25th, a Houston jury found Enron's top two 
executives, Kenneth Lay and Jeffrey Skilling, guilty of 
committing one of the largest financial crimes in history.
    As you know, in December of 2001, Enron, which was then one 
of the ten largest companies in the United States, collapsed 
into bankruptcy. Thousands of employees lost their jobs, 
investors and retirees lost billions of dollars in savings, and 
the investing public began to seriously question the integrity 
of our financial markets. During the 4-month trial earlier this 
year, the Department presented 22 witnesses, including many 
former top Enron executives who pled guilty to Enron-related 
crimes. These executives testified that at an Enron run by Lay 
and Skilling, the company's image and stock price were valued 
above anything else at any cost. The defense presented over 25 
witnesses of their own, which included weeks of testimony from 
both Lay and Skilling.
    The jury ultimately found that Lay and Skilling 
orchestrated a conspiracy to inflate profits artificially, to 
hide millions of dollars in losses, and misrepresent the true 
nature of the company's finances through misleading statements, 
omissions, half-truths, and lies.
    As one newspaper reported on the eve of trial, ``The 
implications of the outcome of this case are sure to be felt 
far beyond the courtroom. Most people in the white-collar world 
would agree that Enron is the Granddaddy of all frauds in the 
last two decades. How this comes out is a test of the limits of 
what the corporate community will tolerate in business 
practices.''
    The verdict also had a closer and more personal impact on 
the victims, some of whose reactions were carried by the press.
    ``Justice has been served,'' said Roger Boyce, who worked 
in Enron's plant building business. ``I'm satisfied with the 
verdict, but I'm happy for all of us employees and retirees 
that a just verdict has been reached.'' And, Mr. Chairman, for 
our prosecutors and agents who labored in bringing that trial, 
I am sure that there is no more fitting reward than comments 
like that from a victim.
    In summary, I can tell you that our work in combating 
corporate fraud is both continuing and vigorous. We are working 
with our law enforcement colleagues at State, local, Federal, 
and international levels. We are partnering with the SEC and 
the FBI, and we are doing many of those things using the 
impressive arsenal of new laws contained within Sarbanes-Oxley. 
Our corporate citizens are stepping up to the plate to follow 
the new rules created by Congress.
    Mr. Chairman, on behalf of the Department of Justice, I 
would like to again thank you for having the opportunity to 
testify today, and I will be happy to answer any questions 
which you may have.
    [The prepared statement of Mr. Friedrich appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Mr. Friedrich.
    We turn now to the distinguished Attorney General of the 
State of Connecticut, Richard Blumenthal. Previously he had 
been in the Connecticut State Senate and the State House of 
Representatives and the United States Attorney for Connecticut. 
He served as a law clerk to Supreme Court Justice Blackmun, was 
an assistant to former Senator Abraham Ribicoff and an aid to 
then-Presidential Assistant Daniel Patrick Moynihan; Phi Beta 
Kappa graduate from Harvard University and from the Yale Law 
School, where he was an editor of the Yale Law Journal, a 
prestigious position. Thank you for again joining us, Attorney 
General Blumenthal, and the floor is yours.

  STATEMENT OF RICHARD BLUMENTHAL, ATTORNEY GENERAL, STATE OF 
               CONNECTICUT, HARTFORD, CONNECTICUT

    Mr. Blumenthal. Thank you very much, Mr. Chairman, and to 
you, Senator Hatch, and to Senator Schumer, for being here 
today and for your leadership in having us address this 
critically important topic. I speak today as a former 
prosecutor, as United States Attorney, former Federal 
prosecutor, and I want to congratulate and thank the Department 
of Justice for the prosecutions that have just been discussed 
by my co-panelist and for its initiative and intense and 
successful action in that area.
    Let me address the precise question that has been raised by 
this Committee. I strongly urge and believe that penalties 
should be strengthened for the kind of manipulation that has 
been alleged involving hedge funds, in effect, shorting and 
distorting, using supposedly independent analysts that are 
really independent in name only. Right now the penalties, in my 
view, are inadequate. They are inadequate in a monetary sense, 
certainly, and in my testimony, I have recommended that there 
be a civil penalty of treble damages imposed for this kind of 
manipulation and deceptive practice as well.
    I believe that the susceptibility of the markets is 
particularly acute where hedge funds are involved and 
supposedly independent analysts because hedge funds can engage 
in short-selling, unlike other institutions, they operate in 
secret, and the supposedly independent analysts may be beholden 
to them as a result of very substantial fees that they receive 
in connection with the supposed custom reports that are meant 
to be unbiased but may not be. And I want to stress, borrowing 
a phrase from Senator Hatch, that there is nothing wrong with 
short-selling. It can be a very constructive and positive 
technique in the market. There is nothing wrong with hedge 
funds. By and large, they are operated honestly and 
effectively, and Connecticut is home to many of them.
    But there is a need for stronger scrutiny and oversight, 
and the Goldstein decision, which I think brings us to a 
turning point, a really critical juncture in this area, really 
makes absolutely certain the need for some kind of 
Congressional action. And it should be to establish a new 
framework of regulation that encompasses hedge funds, which 
previously had been unregulated. The Goldstein decision turns 
on a very narrow and technical point--namely, the definition of 
``client''--that could be easily clarified by the Congress or 
perhaps by the SEC. But the point is that States will fill the 
void that the court of appeals has created. Right now hedge 
funds are in a regulatory void without any disclosure or 
accountability. The absence of transparency and Federal 
inaction or inertia will invite State action. And under our 
State statutes in Connecticut, which track the Federal 
statutes, we could easily amend our laws, as could other 
States.
    Federal action and regulation is vastly preferable because 
the Federal Government can bring to bear the expertise as well 
as authority and uniformity that is so important in this area 
to assure credibility and trust in the markets. But States must 
consider their own regulatory standards, perhaps modeled on the 
SEC rules, achieving the same goals of disclosure and 
accountability. And if Federal agencies abandon the field, as 
they have done at other points in history, in other areas of 
regulation, then States will join forces, as we have done in 
joint legal action, to act separately or together to 
proactively protect our consumers.
    Let me conclude simply by saying that the recommendations 
that I have included are simply an opening shot or a beginning 
shot in this debate that post-Goldstein I think will be very 
much in the fore. And whether it is in this Committee, which I 
believe has clear authority over the criminal areas that are 
involved, or in the Banking Committee, I hope that the States 
are given a role in this debate.
    Thank you.
    [The prepared statement of Mr. Blumenthal appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Attorney General 
Blumenthal.
    Senator Grassley could not be here this morning. He is 
Chairman of the Finance Committee and is otherwise engaged. But 
he asked that this statement be put into the record.
    Senator Grassley says, ``Chairman Specter, I am pleased 
that you are holding this oversight hearing on hedge funds and 
independent analysts. I share the Chairman's concern regarding 
corporate fraud and integrity in the marketplace. The 
allegations we are hearing today remind me of the Enron debacle 
where positive accounting information was fabricated and 
disseminated about the company to increase the value of its 
stock. This Committee held hearings on Enron's fraudulent 
partnership and accounting practices, and we passed legislation 
included in Sarbanes-Oxley that strengthened the criminal 
prosecutions of persons who defrauded investors in publicly 
traded securities. The Sarbanes-Oxley law also included a 
provision that I offered''--Senator Grassley--``with Senator 
Leahy providing whistleblower protection to individuals who 
raised concerns about fraudulent activity.''
    ``All in all, I felt the Sarbanes-Oxley law had done much 
to assist Federal regulators to prosecute illegal activity and 
to keep our financial markets on the up and up. But maybe we 
did not go far enough. The wholesale fabrication of information 
and collaboration with market players to pull down the price of 
stock sounds suspect to me. In my mind, this kind of market 
manipulation seriously distorts the integrity of the financial 
marketplace, and everyone--that is, everyone except the bad 
actors--loses.''
    ``So what is independent analysis? Is research ever 
independent? Is there enough scrutiny of this kind of activity, 
or do we need more disclosures and safeguards in the trade? I 
want to make sure that the Department of Justice and SEC are 
being aggressive in their investigations of alleged wrongdoing. 
I want to make sure that they are doing everything in their 
power to protect investors and the public from fraudulent 
activity and manipulation of the marketplace. I want to find 
out whether the Department of Justice has a need for more tools 
or resources to get the job done. The stakes are high because 
so many are impacted by fraudulent market information--pension 
plans, small investors, seniors, ordinary workers, and their 
families. So we need to support our enforcement agencies in 
their efforts to clean up the market and make sure that we have 
enough tough laws in place, not just to punish but to deter 
these bad actors.''
    Mr. Friedrich, starting with you on the 5-minute round of 
questions, we are not looking at the regulatory approach. That 
is for others, and regulations obviously are very important. 
But there is nothing like a criminal prosecution. Criminal 
prosecutions may have a questionable effect on violent criminal 
conduct or barroom killings or a variety of street crimes where 
motivations are hard to understand. But when you deal with the 
corporate community, when you deal with white-collar crime, 
criminal sanction is very, very effective, much more effective 
in a regulatory scheme which may or may not be imposed. When it 
is imposed, not a whole lot happens except filing of a report 
or perhaps a civil proceeding or perhaps a fine within the 
regulatory scheme. But a jail sentence means a lot, especially 
to thoughtful white-collar criminals.
    You went over a litany of corporate fraud convictions that 
you have had. How about on hedge funds? Have there been any 
convictions by the Department of Justice on hedge funds or the 
so-called independent analysts going to the allegations which 
are current now about collusion and market manipulation?
    Mr. Friedrich. Senator, I am not aware of any closed cases 
that deal--or publicly reported cases that deal with that 
specific issue as between hedge funds and analysts. The 
Department has done some prosecutions in the area of hedge 
funds. Two I can think of offhand. In September 2005, the 
Southern District of New York had a couple pleas--
    Chairman Specter. You have done some prosecutions on hedge 
funds?
    Mr. Friedrich. Yes.
    Chairman Specter. Have there been jail sentences?
    Mr. Friedrich. My understanding is that as to the one 
closed case, there was a jail sentence.
    Chairman Specter. Well, would you please provide that 
information to us? On a hearing dealing with Department of 
Justice enforcement of criminal actions against hedge funds, I 
would have thought that would have been at the top of your 
agenda to tell us what you have done.
    Mr. Friedrich. Senator, the case that I was referring to 
involved the prosecution of two executives, I believe it was 
Bayou Capital Management in the Southern District of New York. 
If you would give me a moment, I can give you some more detail 
on that.
    Chairman Specter. Well, provide it in writing. There is a 
limited amount of time, and I want to turn to Attorney General 
Blumenthal. But give us the detail, if you will, please, as to 
what prosecutions have been brought in this field. And I do not 
want to ask you in open session about investigations, but we 
have oversight authority on pending matters. Would you please 
provide us on a confidential basis what the Department of 
Justice is doing on current investigations?
    Mr. Friedrich. I can provide you information as to the 
cases that are publicly reported as to closed cases. I am not 
aware that I am free to provide, even in a confidential format, 
information about pending cases.
    Chairman Specter. Well, take a look at the testimony in the 
confirmation of Deputy Attorney General McNulty and our 
discussion about our authority to get into pending cases and 
give me a response on that.
    Mr. Friedrich. Yes, sir.
    Chairman Specter. Attorney General Blumenthal, you say you 
would like to see some treble damage cases. I would be 
interested in your evaluation of the efficacy of treble damages 
against wealthy companies or wealthy individuals contrasted 
with a tough jail sentence behind bars?
    Mr. Blumenthal. Well, clearly, Senator, I agree with you 
wholeheartedly that incarceration has a much stronger impact, 
both in terms of deterrence and also a message to the public, 
than does any fine or monetary penalty. The case that involved 
the Bayou group, in fact, I think illustrates that idea because 
the two individuals there, Samuel Israel and Daniel Marino, 
might not have engaged in the massive fraud that caused the 
criminal prosecution by the Department of Justice. Excellent 
work done by the FBI and the Department of Justice. But the 
kinds of sentences in these cases, Bayou and--
    Chairman Specter. What were the sentences?
    Mr. Blumenthal. Well, I don't know that they have been 
sentenced yet. The prosecutions themselves, as Mr. Friedrich 
said, resulted in guilty pleas in December of 2005. Bayou is a 
Connecticut case, and I think that certainly the kinds of 
deterrent effect that you have discussed have much greater 
weight if there are criminal penalties. And that is true 
generally in the white-collar crime area, in my view.
    Chairman Specter. Well, my red light is on so I would yield 
now to Senator Hatch.
    Senator Hatch. Well, thank you, Mr. Chairman.
    Mr. Friedrich, as you know, the Sarbanes-Oxley Act defined 
a new Federal crime--securities fraud. It was designed to get 
past a patchwork set of laws under which securities fraud has 
previously been prosecuted. Now, that section codified at 18 
U.S.C. Section 1348 gave the Department of Justice a strong and 
important tool for combating illegal securities fraud, 
something that they did not have before.
    Now, what steps has the Department of Justice taken to 
ensure that hedge funds and corrupt securities analysts do not 
commit securities fraud in violation of Section 1348?
    Mr. Friedrich. I would say generally, Senator, obviously 
this is an area that we are aware of. There have been 
prosecutions, as I mentioned before, against principals of 
hedge funds. As to the use of that new statute, that is a 
statute that we train on in our securities fraud training at 
the National Advocacy Center. It is a tool that has been used, 
and I think it is a tool--as I mentioned, there have been 53 
indictments under that statute to date. I think it is a tool 
that will be used with increasing frequency in the area of 
hedge fund fraud or other types of securities fraud.
    Senator Hatch. Thank you.
    Mr. Blumenthal, in your testimony, you recommend 
specifically new regulation of hedge funds, and I agree with my 
colleague from New York, Senator Schumer, that such civil 
regulations would be the exclusive jurisdiction of the Banking 
Committee.
    Now, I did watch you on ``60 Minutes'' on that program a 
few weeks ago where you were addressing the relationship 
between independent analysts and various hedge funds. As I 
recall, you indicated that criminal investigation and 
prosecution of these is very, very difficult. Now, in your 
testimony, you just suggested that we need new tools for 
criminal enforcement, and that is within the jurisdiction of 
this Committee.
    So I have basically two questions for you, Mr. Blumenthal, 
and basically, that is, what new tools would you like us to 
come up with for criminal enforcement? And what tools would you 
like to see us investigate and come to a conclusion on with 
regard to all of these matters?
    Mr. Blumenthal. I think the new tools, Senator--and I am 
happy to respond, although obviously Federal jurisdiction is 
not within my purview. New tools should include stronger 
penalties, but also stronger protections for whistleblowers, 
stronger penalties against retaliation for individuals who are 
doing their job honestly and forthrightly and who may be 
victims of retaliation, either as whistleblowers or as public 
officials, as staff members of any of the agencies involved, 
whether criminal or civil, and perhaps some consideration of 
criminal penalties for that kind of retaliation. Obviously, 
obstruction of justice is one possibility, but there should be 
consideration of protection for whistleblowers and deterrence 
against retaliation.
    But, also, as you are obviously very well aware, Senator, 
resources are key in this area. And when I mentioned before 
that these cases are very complex and challenging, they are 
also very resource intensive. And my hope is that the resources 
for the criminal justice prosecutions will be provided by 
Congress so that both the Department of Justice and the SEC can 
exercise their criminal jurisdiction to investigate and 
prosecute.
    Senator Hatch. You mentioned in your testimony that the 
number and financial power of hedge funds, now reportedly more 
than 13,000 hedge funds--I had 11,500; it goes up all the 
time--with assets exceeding $24 trillion, I believe you said, 
provide fertile opportunity for potential fraud based on false 
or deliberately misleading stock analysts' reports. And I have 
to say that this is a matter of great concern to me, and you 
mentioned at least a couple of cases in here where there have 
been real allegations of collusion between hedge funds and 
analysts that may be corrupt or may be cooperating or may be 
conspiring to do wrong here.
    My time is up, but I just want to thank both of you for the 
work that you do do, and we are concerned about this. I believe 
that the vast majority of hedge funds are honest people and 
doing a good job, but there are literally, literally thousands 
of them, and I am really concerned about if there is widespread 
collusion and conspiracies to knock down the price of shares in 
various corporations, that could really discombobulate our 
whole market.
    I think my time is up, Mr. Chairman.
    Chairman Specter. Thank you very much, Senator Hatch.
    Mr. Friedrich, to what extent does the Department of 
Justice monitor the civil suits which have been brought? For 
example, Biovail, a pharmaceutical company, has alleged in a 
suit brought in New Jersey State courts, alleging that several 
hedge funds, an independent stock research firm, and a research 
analyst had participated in market manipulation to harm 
Biovail's stock. The lawsuit further contained allegations that 
similar executions were orchestrated on other companies, 
Calgene and Biowaste Technology, Incorporated.
    Are such lawsuits of assistance to the Department of 
Justice to followup to make a determination as to whether those 
allegations are true or whether they would support a criminal 
prosecution?
    Mr. Friedrich. I think the best way to answer that 
question, Senator, good criminal chiefs in every district make 
a practice of reading the newspapers and looking for lawsuits 
of the type that you describe. I think the best way to put it 
would be that is an indication that further questions may need 
to be asked. That is something that can tip us off that there 
may be some irregularity.
    Chairman Specter. Well, are you following up on Biovail's 
contentions?
    Mr. Friedrich. Unfortunately, Senator, I cannot comment as 
to any pending matter that the Justice Department might have. I 
can comment as to closed matters, and if I may just add to what 
Senator Hatch asked a moment ago, as to Section 1341, I can 
tell you that there was a Section 1341 complaint that was filed 
recently in the Northern District of Georgia as against the 
operators of a hedge fund.
    Chairman Specter. And what is the status of that matter?
    Mr. Friedrich. There has been a public complaint filed, and 
there has not been any other public actions so far as that case 
itself.
    Chairman Specter. Attorney General Blumenthal, have you 
initiated any criminal prosecutions in the State of Connecticut 
against hedge funds?
    Mr. Blumenthal. We have not, Senator, and they have been, 
as Mr. Friedrich has indicated, rare at the Federal level as 
well. But I think it is an emerging area of interest, and I 
know that State criminal as well as civil authorities are 
monitoring and following closely those actions involving 
Biovail and Overstock.com because they reflect on the need for 
greater disclosure. If there were disclosure, for example, of 
the relationships between the hedge funds and supposedly 
independent analysts, it would have a very positive effect in 
preventing perhaps the kind of collusion or manipulation that 
is alleged. Again, these claims are only allegations at this 
point. So we are following them to determine whether there is 
evidence and whether, in fact, they will ever go to trial.
    Chairman Specter. Attorney General Blumenthal, do you know 
if there are any actions brought by other State Attorneys 
General? The New York Attorney General, Mr. Spitzer, has been 
very active in the market area. Do you know if his office or 
any other Attorneys General have initiated either criminal or 
civil lawsuits in this area?
    Mr. Blumenthal. There have been none, Senator, so far as I 
am aware. But I know that there are very strong interests on 
the part of States like Connecticut, New York, and others in 
this potential area of manipulation or fraud, and certainly 
there is no reluctance to use existing State criminal 
authority, as we have done before.
    Chairman Specter. I was interested in a speech which Fed 
Chairman Ben Bernanke made recently where he says, ``The 
primary mechanism for regulating excessive leverage and other 
aspects of risk-taking in a market economy, referring to hedge 
funds as the discipline provided by creditors, counterparties, 
and investors. And Chairman Bernanke is against regulation but 
looks for the market to handle it itself.
    Now you have the circuit court decision limiting what the 
SEC can do, and in an area where there is so much opportunity 
for manipulation and such enormous profits reported that two 
individuals last year made in a hedge fund market $1 billion, 
listen, free economy, earn what you can. But where there is 
such enormous public impact, we ought to be looking at tough 
enforcement matters, especially with the void which we have at 
the moment with the most recently court ruling until the 
Banking Committee has an opportunity to provide the answers and 
the Federal legislation comes up and whatever is done with the 
SEC, which needs to be done.
    So I would urge you, Mr. Friedrich, to take a close look at 
this area and tell us if the existing laws are adequate or if 
you need tougher sanctions, if you agree with Mr. Blumenthal 
that there ought to be some civil treble damage penalties. My 
inclination would be against it. I would not want to give you 
that option. I would rather have you use the criminal statutes 
if you have crimes, if you have allegations of crimes, and 
especially serious ones.
    Senator Hatch, before we move on to panel two, would you 
care to ask anything further?
    Senator Hatch. Well, if I could. I did not particularly 
want to make this hearing one about naked shorting, but I might 
have a question for both of you on that.
    Let me just ask you this: How does your group work? How 
many meetings do you have with your particular regulatory 
group, the CFTF? Who do you invite as U.S. Attorneys? Are they 
all from the financial districts of the country, or are they 
from across the country? And where do you go with that? How 
often do you meet?
    Mr. Friedrich. It is a mix of representatives. There are 
representatives--the Deputy Attorney General chairs it. There 
are people from the Deputy's office who basically administer 
the task force on a more hands-on basis. There are a range of 
U.S. attorneys. Some are from the major districts. Some are 
from smaller districts. There is representation by the FBI, the 
SEC, the CFTC, and other relevant Federal agencies. Really, 
there is a lot of, I would say, sort of strategic direction, 
making sure people have the right resources, exchanging ideas 
about best practices, and items of that nature. In terms of--
    Senator Hatch. How often do you meet?
    Mr. Friedrich. I believe since Deputy Attorney General 
McNulty has been in, I believe there has been one meeting. I am 
not sure of the frequency of the meetings before he got here.
    Senator Hatch. OK.
    Mr. Friedrich. And I know they are planning another.
    Senator Hatch. Is this issue on your agenda? How do issues 
get on the agenda?
    Mr. Friedrich. I think really that is driven by what 
people--sort of items of current interest, either things that 
the regulators or the law enforcement folks or the Bureau want 
to put on the table, new trends that they are seeing. We are 
constantly looking for new trends and making sure that the 
resources that we have are arrayed in a logical way with 
respect to those trends. New types of corporate fraud, 
exchanging best practices, exchanging ideas about new court 
rulings--that type of thing.
    Senator Hatch. Maybe either or both of you could answer 
this question: As I understand it, with regard to naked short--
well, shorting in general, naked shorting in particular, within 
3 days after the date of sale, you have to register that with 
the--what is it called? The Depository Trust and Clearing 
Corporation? It is the DTCC, I believe. But it is my 
understanding that, at least last time I heard about it, there 
were about $6 billion per day in failure to deliver stock under 
the naked shorting situation.
    Are you both familiar with that? That to me is startling, 
and I have also heard from various sources that sometimes some 
of these companies will register the stock over in, say, 
Europe, like Germany, so that they do not have to meet that 
requisite of reporting to the DTCC.
    Mr. Blumenthal. Clearly, this is an area--this area is one 
that ought to be a focus for the Securities and Exchange 
Commission, and I hope it will be. It is largely beyond the 
purview of State authority, but it opens new opportunities and 
very fertile ground for manipulation and fraud and is tied, 
again, to hedge fund activities and illustrates the need for 
the deterrent effect of strong criminal penalties and stronger 
enforcement. There is no question that the penalties themselves 
will be dead letter unless they are enforced, like any criminal 
statute.
    Senator Hatch. Are both of you aware that that is going on?
    Mr. Friedrich. I am aware that that is a practice which is 
occurring, and I agree with you in terms of your statement of 
what the legal requirements are in that area. I know that the 
SEC as well as both major exchanges have taken public positions 
in terms of naked shorting, what it means and what it does not 
mean.
    Senator Hatch. Well, how can we allow $6 billion a day not 
to be reported? I mean, that is a lot of money, especially over 
a year, to not be reported and accounted for. And as we all 
know, naked shorting is where there is not enough stock to 
cover the short.
    Mr. Blumenthal. And it poses a danger to the markets, the 
health of the markets and their integrity.
    Senator Hatch. That is my point. It could really kill the 
marketplace if this is widespread. Now, I do not believe it is, 
but there may be some instances where it will. If it is $6 
billion a day, which is what I have been told, then there have 
got to be a lot of instances where this is being violated, and 
it ought to be stopped. Do you both agree with that?
    Mr. Friedrich. Respectfully, that is an area where I would 
really have to defer to the SEC in terms of answering a 
question like that.
    Senator Hatch. Do you agree?
    Mr. Blumenthal. I agree, but I would probably also have to 
defer to the SEC.
    Senator Hatch. You would defer also. I will defer it to the 
SEC, too, and I am suggesting that they better get on the ball 
and start checking on this type of stuff.
    Thank you both. I really appreciate it.
    Chairman Specter. Thank you very much, Senator Hatch, and 
thank you, Mr. Friedrich and Attorney General Blumenthal. We 
very much appreciate your coming in.
    We will now turn to our second panel: Mr. Aguirre, Mr. 
Kasowitz, Mr. McLaughlin, Mr. Blickenstaff, Mr. Lamont, Mr. 
Anifantis, Mr. Schilit, and Mr. Boersma.
    Our first witness is Mr. Gary Aguirre, formerly senior 
counsel with the Division of Enforcement at the Securities and 
Exchange Commission; nearly 40 years of litigation experience, 
including the areas of construction disputes, environmental 
regulations, securities litigation, and criminal defense; has 
published a number of scholarly legal articles, including one 
on the litigation arising out of the Enron debacle and the 
application of Section 10(b) of the Securities Act related to 
fraud; bachelor's degree in politics and a law degree from the 
University of California, Master of Fine Arts from UCLA.
    Mr. Aguirre, we very much appreciate your joining us here 
today. We have a copy of a lengthy letter which you have sent 
to the Chairman and Ranking Member of the Banking Subcommittee 
on Securities and Investment, which will be made a part of the 
record, and we look forward to your testimony.

 STATEMENT OF GARY J. AGUIRRE, FORMER INVESTIGATOR, SECURITIES 
           AND EXCHANGE COMMISSION, WASHINGTON, D.C.

    Mr. Aguirre. Thank you, Mr. Chairman. I deeply appreciate 
the opportunity to offer some views on this critical issue.
    I would like to say preliminarily that I have forwarded 
your letter inviting me to testify today to the Securities and 
Exchange Commission, and yesterday I was informed by the 
Securities and Exchange Commission in a letter that it is their 
view that existing regulations prohibiting the disclosure of 
nonpublic information applies to my testimony today. So since 
there are various penalties that are applicable to disclosure 
of nonpublic information, I redrafted my testimony yesterday 
and submitted it so that it was intended to only disclose 
matters that have already been made public. Among those 
sanctions are criminal sanctions.
    I would like to offer this perspective: I believe that--
    Chairman Specter. Well, Mr. Aguirre, just a comment. I take 
issue with what the SEC has said to you. This is an oversight 
hearing on Federal criminal statutes, and there is a 
constitutional responsibility in this Committee, and we need to 
know the facts. And it may be that we will take some of your 
testimony in closed session, but I would have thought that had 
the SEC had some concern about the invitation, they would have 
communicated it to this Committee, to the Chairman. And this is 
the first that I have heard about it. I have just been handed a 
letter on the subject.
    Mr. Aguirre. I had actually suggested--my counsel suggested 
to them that if they did have some objections to my testimony, 
that they pass it along to this Committee. It is also my view 
that my testimony before this Committee is protected by the 
Lloyd-LaFollette Act. But given the contention of the SEC, I 
had prepared written testimony that I submitted that merely 
included what was public. I will do the best I can to answer 
your questions. I will do the best I can.
    Chairman Specter. Well, that is all you can do, but I think 
it is particularly problemsome when the information which you 
have heretofore disclosed and has been in the public domain 
raises questions about the propriety of what the SEC has done. 
This is not a matter of some comment about some third party. 
This is a matter about the propriety of what the SEC is doing.
    Mr. Aguirre. I agree with you 100 percent, Senator. 
Chairman Specter. We will start your time at 5 minutes so we 
can give you the substantive on substance without talking about 
these collateral matters, not to take it out of your time.
    Thank you, Chairman.
    I think that it helps to begin any analysis of the hedge 
fund potential for abuse on the financial markets by discussing 
three classes of those types of abuses:
    First is the long-term capital risk, and I am really not 
going to discuss that. It is more the subject, I think, of 
someone familiar with several different agencies.
    The second class of hedge fund abuse is hedge fund fraud on 
their own investors, and that class of fraud has been the 
subject of most of the cases that have been brought by the SEC 
and the Department of Justice. It has been the subject of cases 
for approximately 10 years. It is probably the SEC's strongest 
suit. And I am not sure to what extent it is going to require 
any form of regulation.
    The third area is the type of fraud that injures ever other 
market participant. The type of fraud we are talking about 
today or the potential type of fraud we are talking about today 
is one class of that. But there are multiple sub-classes of 
this type of fraud, for example, insider trading, different 
forms of market manipulation, the recent use of market timing 
and late trading by hedge funds to effectively siphon funds 
from the accounts of small investors. These are all classes of 
this type of fraud.
    Now, this fraud derives from the amount of trading that 
hedge funds do. We know that at this point that trading amounts 
to something in the area of 30 percent or more of the New York 
Stock Exchange and a larger percentage of the trading in other 
forms of securities. That can only be expected to significantly 
increase as we move from $1.3 trillion in hedge funds to $6 
trillion in hedge funds over the next 9 years.
    I believe the impact and the cause of that is the 
significant funds that are generated in fees and commissions to 
the various brokerage firms and investment banks that deal with 
hedge funds.
    If we look at the extent of scrutiny of hedge funds in this 
area, this third class of fraud, over the last 25 years, we 
will find that there was effectively no scrutiny until 2004. 
And I am not quoting my own research. I am quoting comments in 
recent SEC publications.
    In 2004, the SEC did not discover any of this class of 
fraud; rather, it was discovered by a State Attorney General--
Mr. Spitzer. That class of fraud, hedge fund abuse of mutual 
funds, was costing small investors somewhere in the vicinity of 
several billion a year over several years.
    Now, there has been over the last year a second class of 
fraud discovered, this second class impacting the market 
participants in general, and that is the PIPE cases. I discuss 
those to some extent in my written testimony.
    Now, aside from those two classes of fraud, you will have 
to search long and hard to find any enforcement by the 
Securities and Exchange Commission of any other class of hedge 
fund abuse against other market participants. I am talking 
about insider trading. I am talking about market manipulation. 
I am talking about the class of fraud that we are talking about 
today. The case that I handled, which I believe was perhaps one 
of the largest, if not the largest, or the broadest 
investigation of a hedge fund involved both market manipulation 
and insider trading. What I found there is that most of these 
referrals from the New York Stock Exchange and SROs had been 
coming into the SEC for years and had not been acted upon.
    It appears that my time has run out, Senator.
    [The prepared statement of Mr. Aguirre appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Mr. Aguirre. We will 
come back to you and give you an opportunity to amplify your 
statement during the question-and-answer session.
    Mr. Aguirre. Thank you.
    Chairman Specter. Our next witness is Mr. Marc Kasowitz, 
senior partner of Kasowitz, Benson, Torres & Friedman, 
representing large multinational corporations. ``American 
Lawyer'' has included Mr. Kasowitz on its list of the top 45 
lawyers under 45. That is kind of precarious category to be in, 
Mr. Kasowitz, subject to leaving it involuntarily.
    Mr. Kasowitz. That was 9 years ago when I was 45.
    [Laughter.]
    Chairman Specter. You are not one of the top 54 under 55, 
are you?
    Mr. Kasowitz. Well, but today is my birthday, Mr. Chairman.
    Chairman Specter. Well, happy birthday. Cum laude from 
Yale, law degree from Cornell, editor of the Cornell Law 
Review. He is testifying today on behalf of the Alliance for 
Investment Transparency.
    Thank you very much for coming in today, Mr. Kasowitz, and 
we look forward to your testimony.

   STATEMENT OF MARC E. KASOWITZ, SENIOR PARTNER, KASOWITZ, 
 BENSON, TORRES & FRIEDMAN LLP, ON BEHALF OF THE ALLIANCE FOR 
          INVESTMENT TRANSPARENCY, NEW YORK, NEW YORK

    Mr. Kasowitz. Thank you for inviting me, Mr. Chairman.
    Our firm has developed a considerable expertise and 
experience in the subject that the Committee is addressing 
today. We represent a number of clients who have been severely 
harmed by the market manipulation activities of certain 
extremely powerful hedge funds and certain supposedly 
independent securities analysts. Those clients have joined 
together to form the Alliance for Investment Transparency, on 
whose behalf I appear today.
    Our law firm has filed a lawsuit on behalf of one of our 
clients against some of those hedge funds and analysts, and we 
are currently investigating and analyzing claims on behalf of 
other clients. But I want to make clear at the outset that this 
is in no way a vendetta against hedge funds in any way. In 
fact, our firm represents many hedge funds in a variety of 
matters. The concerns I am addressing today have nothing to do 
with all those hedge funds which engage in perfectly legal and 
legitimate investment activities, and they have nothing to do 
with truly independent securities analysts.
    However, what our clients and other companies have 
experienced is truly shocking. These companies have been 
targets of a pattern of egregious collusion between certain 
influential hedge funds and certain supposedly independent 
analysts, including analysts at major Wall Street firms whose 
research, in effect, was bought and paid for by the hedge funds 
as part of illegal market manipulation schemes, typically 
involving short-selling.
    We are not talking about short-sellers who are making an 
honest bet that a company's stock is about to fall. We are 
talking about short-sellers who manipulate the market to cause 
a drop in a company's stock price by engaging in schemes to 
disseminate false and distorted research and other 
disinformation.
    The schemes those hedge funds engage in are strikingly 
simple but frighteningly destructive. They often target high-
tech, biotech, and pharmaceutical companies. Here is one of the 
ways in which those schemes work.
    The short-selling hedge fund selects a target company. The 
hedge fund then colludes with a so-called independent stock 
analyst to prepare a false and negative research report on the 
target. The analyst firm agrees not to release the research 
report to the public until the hedge fund accumulates a 
substantial short position in the target company's stock. Once 
the hedge fund has accumulated that substantial short position, 
the report is disseminated widely, causing the intended decline 
in the target stock price.
    The report that is disseminated--and this is also very 
important--contains no disclosure that the analyst was paid to 
prepare the report, no disclosure that the hedge fund 
participate in the preparation of the report, and no disclosure 
that the hedge fund had a substantial short position in the 
target stock. Once the false and negative research report has 
had its intended effect, the hedge fund then closes its 
position and makes an enormous profit, and it makes that profit 
at the expense of the proper functioning of the markets, at the 
expense of innocent investors, and at the expense of the target 
company and its employees.
    There are a number of other ways that hedge funds and 
analysts illegally manipulate the market as well. They engage 
in organized campaigns to drive down stock prices by spreading 
rumors and falsehoods in the financial press, on Internet chat 
boards, in investor conference calls, at analyst presentations, 
and at industry conferences. There are orchestrated campaigns 
to communicate egregiously false information directly to a 
target company's board of directors, larger shareholders, 
principal banks, and outside auditors.
    We are aware of instances in which the perpetrators of such 
campaigns have sought to instigate regulatory investigations 
based on disinformation in order to cause more adverse 
publicity about the targeted companies. The effects of these 
campaigns have been devastating to the companies, their 
employees, and everyday investors.
    You heard Mr. Aguirre talk about Pequot, at least in his 
correspondence to this Committee. Those allegations, if proven, 
are outrageous and illegal. The same is true here. The conduct 
that I have described today is egregious and illegal.
    Underlying both of these situations is the fact that this 
industry has grown so large, so powerful, and with so little 
transparency that the potential for gross fraud and abuse is 
stunning. In fact, based on the testimony of witnesses before 
this very Committee today, no one even knows within $1 trillion 
how large the hedge fund industry actually is. One witness 
estimates $2.4 trillion; another estimates $1.5 trillion; 
another says it is $1.2 trillion. The fact that we do not even 
know how big the industry is within a trillion dollars--which 
is real money, even in Washington, D.C.--proves the incredible 
lack of transparency.
    There is a pervasive pattern of illegal conduct. Civil 
remedies exist to address it on an individual basis. But it is 
critical that law enforcement utilize all of the tools at its 
disposal to assure that that conduct is uncovered, punished, 
and deterred.
    Thank you.
    [The prepared statement of Mr. Kasowitz appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Mr. Kasowitz. We now 
turn to Mr. Joseph McLaughlin, a partner at Sidley Austin, a 
practice focusing on securities regulation and enforcement; had 
been a member of the New York Stock Exchange Legal Advisory 
Committee to the Board of Governors; currently a member of the 
Subcommittee on Market Structure; a law degree from Columbia 
and a bachelor's degree also from Columbia. He is testifying 
today on behalf of the Managed Funds Association.
    Thank you for coming in, Mr. McLaughlin, and the floor is 
yours.

STATEMENT OF JOSEPH MCLAUGHLIN, PARTNER, SIDLEY AUSTIN LLP, ON 
  BEHALF OF THE MANAGED FUNDS ASSOCIATION, NEW YORK, NEW YORK

    Mr. McLaughlin. Thank you, Mr. Chairman. Good morning. The 
Managed Funds Association is a global membership organization 
based in the United States. It serves the needs of the 
professionals who specialize in the alternative investment 
industry. It has over 1,000 members who include professionals 
in hedge funds, funds of hedge funds, and managed futures 
funds. Its members manage a substantial portion of the 
estimated $1.2 trillion or more invested in these vehicles.
    On behalf of its members, MFA has worked with committees of 
the House and the Senate on hedge fund matters and with the 
President's Working Group on Financial Markets and that group's 
constituent departments and agencies.
    As members of this Committee are aware, hedge funds are 
more easily defined in relation to what they are not. They are 
essentially investment companies that are not publicly offered. 
The hedge fund universe is characterized by a wide variety of 
strategies with different risk characteristics and different 
return expectations.
    To the extent that hedge funds engage in short-selling as 
part of their investment strategy, they tend to dampen what may 
be irrationally positive market perceptions. They contribute to 
liquidity and price formation. To the extent that they target 
companies whose financial positions or whose accounting may be 
suspect, short-sellers try to identify the bad actors in our 
marketplace.
    As for short-selling, as I am sure you are aware, Mr. 
Chairman, the SEC was given by Congress plenary authority to 
regulate short-selling. It has done so. It recently adopted 
Regulation SHO to deal with the market operational problems 
that short-selling can create and to deal with the potential 
manipulative effects of short-selling.
    Mr. Chairman, whether investment managers are investing on 
the short side or the long side, they have a fiduciary duty to 
their investors to consider all reasonably available 
information that might bear upon the advisability of their 
decisions. And where available information leads some investors 
to take significant short positions in a public company's 
common stock, it sometimes occurs that the public company will 
allege that the short seller has been assisted by third parties 
and is seeking to profit from the short position.
    For example, companies frequently allege that investors 
established a short position in a company stock while feeding 
reports to the financial press, analysts, or other third 
parties that criticize the company's accounting or financial 
conduct. These allegations are not new. In my experience, they 
have been around since the 1960's when I started practicing 
law. They may well go back much more into the distant past. 
This does not involve just hedge funds, but other investors as 
well. The fact is these allegations on the part of public 
companies have seldom been substantiated.
    As discussed previously, short-sellers often turn out to be 
right in their conclusions about public companies. MFA believes 
it would be a serious policy mistake to inhibit short-sellers 
from continuing to perform the essential contrarian function I 
have described and that would raise serious constitutional 
issues to attempt to chill short-sellers' communications with 
third parties.
    Mr. Chairman, if an investor knows its allegations about a 
company are untrue, then existing law and SEC rules provide 
ample means for dealing with this conduct. As we have seen from 
the pump-and-dump schemes, which essentially involve the 
reverse situation from what we have here, the SEC has ample and 
enforcement authority under Rule 10(b)(5) and other provisions 
of the securities laws.
    Of course, unlike the pump-and-dump schemes, it is 
sometimes difficult to identify the source of negative 
information, except by requiring the recipient of the 
information to reveal his or her sources, a step that 
enforcement authorities are often understandably reluctant to 
take.
    At the same time, Mr. Chairman, persons who receive adverse 
information have their own responsibility to treat it with a 
degree of healthy skepticism. We believe the financial press 
has been increasingly diligent over the past few years in 
identifying possible sources of bias of persons whom they quote 
as having positive or negative views on a stock.
    In this connection, independent analysts are not subject to 
rules of the New York Stock Exchange or the NASD aimed at 
revealing conflicts of interest and otherwise enhancing the 
integrity of an analyst's research. The views expressed or 
reported by independent analysts are still part of the relevant 
mosaic, however, and users of independent research must make 
allowances for the fact that independent research is not 
subject to the same internal and external scrutiny and 
standards as research produced by securities firms.
    Mr. Chairman and Senator Hatch, MFA unequivocally condemns 
the intentional spreading of false or misleading information. 
At the same time, there will be many cases where the facts in 
the law are not clear, and MFA believes that the remedy in such 
cases should be not to chill speech but, rather, to encourage 
more speech. And we urge that the Congress and the regulators 
follow this principle in their further deliberations.
    Thank you.
    [The prepared statement of Mr. McLaughlin appears as a 
submission for the record.]
    Chairman Specter. Thank you, Mr. McLaughlin.
    Our next witness is Mr. Kim Blickenstaff, co-founder, 
Chairman, and Chief Executive Officer of Biosite, Incorporated; 
25 years' experience in health care financing, market 
management, sales and strategic planning; previously held 
various financial operations and marketing positions with 
Baxter Health Care, National Health Laboratories, and High-Tech 
Incorporated; a master's degree in business administration from 
University of Chicago, and a bachelor's degree from Loyola, a 
certified public accountant.
    We welcome you here, Mr. Blickenstaff, and look forward to 
your testimony.

  STATEMENT OF KIM BLICKENSTAFF, FOUNDER, CHAIRMAN, AND CHIEF 
EXECUTIVE OFFICER, BIOSITE, INCORPORATED, SAN DIEGO, CALIFORNIA

    Mr. Blickenstaff. Thank you, Chairman Specter and Senator 
Hatch. I really appreciate you inviting me to this Committee. 
Obviously, my name is Kim Blickenstaff. I am a founder and 
Chairman and CEO of Biosite, Incorporated, and I think the only 
CEO on the panel today, so I think some of my perspective may 
be interesting.
    Just briefly, Biosite is a San Diego-based medical 
diagnostics company. We do utilize biotechnology techniques 
within our company to develop rapid diagnostic tests to improve 
the diagnosis of time-critical diseases. I should note that the 
company actually went public on the Nasdaq back in 1997.
    My testimony today is going to relate to a period in 2002 
in which Biosite experienced a rise in its stock price 
accompanied by highly negative independent research coverage 
that contained inaccuracies and speculation, so I will show you 
a lot of details in my comments. Also, I should note that 
during this same period the company's short position increased 
six-fold. In many cases, the distributions of these independent 
reports seemed to be timed to offset positive business 
developments that the company was reporting on a number of 
fronts. Due in large part to our experience during this period, 
we believe that the unregulated activities of independent 
research firms and their possible links to hedge funds merits 
further investigation by your Committee.
    Just to provide context, I will share some specific 
situations that influenced my perspective.
    In the spring of 2002, Biosite's business had upward 
momentum following reports of several financial and scientific 
developments. The stock had increased from $13 a share in 
January of that year to approximately $19 in February, and by 
May it had reached $36 a share on the Nasdaq. Much of the 
enthusiasm was fueled by the investment community and their 
believe that the market for a new test that we had introduced, 
our Triage BNP Test, which was the first test for congestive 
heart failure in the marketplace, could be a very substantial 
market opportunity. And I believe the rapid rise of our share 
price over that period of time and the opportunity to 
speculate--or negative speculation about the entry of potential 
competitors into the rapidly growing marketplace set the stage 
for what we experienced next with the independent research 
community.
    Just to give you background, in the 10 months from February 
to December 2002, the number of shares controlled by short-
sellers increased from 690,000 shares to 7.1 million shares, 
which represented nearly 50 percent of our outstanding stock, 
and we have the unfortunate distinction of being the most 
highly shorted stock on any of the exchanges here in the United 
States.
    During this same period, Sterling Financial Investment 
Group, which is a Florida-based research firm, issued at least 
seven negative research reports on Biosite, each carrying a 
``sell'' or ``sell short'' recommendation and an $11 target 
price in contrast to our $36 market price. Contrary to standard 
industry practices, no author was listed on the reports, and we 
believe these reports contain numerous inaccurate or false and 
misleading statements, which ultimately lent volatility to the 
stock's performance, thereby harming many of our long-term, 
fundamentally based investors.
    Just to give you an example, in a number of reports issued 
in the summer and fall of 2002, Sterling predicted the failure 
of our BNP test due to the expected entry of a competitive test 
into the marketplace. In several of these reports, Sterling 
included outright inaccuracies regarding the competitive 
advantages that supposedly favored the competitive test. The 
reports also included inaccuracies and misstatements about our 
own test performance, which were also construed to be an 
advantage for our competitors.
    On September 11, 2002, the same day that Biosite announced 
positive news, a column was written by Sally Yanchus which 
appeared on a website called RealMoneyPro.com. The column, 
which was critical of Biosite, was posted to Yahoo's Biosite 
message board, so it got onto the Internet.
    Ms. Yanchus previously participated on our quarterly 
conference calls under the affiliation Nightingale and Farber, 
and we were subsequently able to link Ms. Yanchus to Sterling 
Research through an NASD Disciplinary Panel Decision, dated 
April 15, 2005, which refers to her admission of knowingly 
including inaccuracies in reports on another health care 
company while working on behalf of Sterling Financial. And I 
should note that this all happened during the same timeframe 
that she was involved in these postings on Biosite.
    So, on November 18, 2002, members of my management team, 
including myself, met with the analyst from Sterling Research 
at the American Heart Association meeting. During our 
discussion the Sterling analyst told us her research at the 
conference--she was doing specific research on our products--
had elicited positive feedback on our BNP test. She also 
acknowledged that certain reports that they had previous 
released did contain inaccuracies, but indicated that what her 
research director wanted written was not necessarily in line 
with her own views from her own research. She further 
maintained that she felt our company would continue to do very 
well in the marketplace and expressed surprise as to why her 
managers felt the stock continued to be a good short target. 
When we asked her why she was writing negative material about 
the company, she said that her role was research and that the 
reports were, in fact, written by someone else who was at 
liberty to revise her research. She also said she was 
considering leaving Sterling because of the way they were 
operating and her discomfort about these operational processes 
on the research writing.
    So during this entire period, I should note our BNP test 
was, in fact, gaining market momentum. Sales grew from $3.4 
million in 2001 to $38 million in 2002, despite the 
competition. Despite all the progress being made by Biosite, 
our investors continued to see their investments compromised by 
the volatility in our stock that was created by the 
dissemination of these reports through various methodologies.
    Finally, I should note that in the fall of 2002, we 
attempted to independently investigate the activities of the 
short-sellers and their links to Sterling. Unfortunately, the 
lack of visibility into these trades made it impossible for our 
investigators to definitively produce a link between Sterling's 
activities--
    Chairman Specter. Mr. Blickenstaff, how much longer would 
you need?
    Mr. Blickenstaff. Just 2 seconds. It failed to produce a 
link between Sterling's activities and the resulting increase 
in our short position. Nevertheless, we believe the parallels 
between the magnitude and the timing of Sterling's research 
activity and Biosite's short position increase was more than a 
mere coincidence.
    I will conclude and go to questions when you have them at 
the end of the presentations.
    [The prepared statement of Mr. Blickenstaff appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Mr. Blickenstaff.
    Our next witness is Professor Owen Lamont, Professor of 
Finance and Senior Associate Dean for Faculty Affairs at the 
Yale School of Management; previously had been an associate 
economist and research associate to the Boston company Economic 
Advisers; also served as assistant professor of economics at 
Princeton University and assistant professor of Finance at the 
University of Chicago Graduate School of Business; a bachelor's 
degree with honors from Oberlin and a Ph.D. in Economics from 
MIT.
    We welcome you here, Professor Lamont, and the floor is 
yours.

STATEMENT OF OWEN A. LAMONT, PROFESSOR OF FINANCE, YALE SCHOOL 
             OF MANAGEMENT, NEW HAVEN, CONNECTICUT

    Mr. Lamont. Thank you very much, Mr. Chairman. I am honored 
to have this opportunity to testify today.
    As an economist, I am concerned with prices, the need to 
get the prices right. When the prices are wrong, investors are 
hurt and resources are wasted. In order to get prices right, we 
need to have all information, both the positive information and 
the negative information, get into the market. Just like in the 
world of politics, free speech is essential in the world of 
finance.
    Unfortunately, U.S. financial markets have a substantial 
optimistic bias built in. The good news is accepted, but the 
dissemination and discovery of bad news is suppressed. This 
bias happened for two reasons. One is it can be difficult 
technically to short-sell, and short-selling is today primarily 
done by hedge funds and is an important channel for negative 
information to get into the market. A second component of this 
bias is retaliation through legal means and other means against 
any public criticism of the company, whether it be from 
journalists or short-sellers or analysts.
    What happens when negative information is suppressed? 
Stocks can become overpriced, and we have already mentioned an 
example of that today, which is Enron. To prevent future Enrons 
from occurring, we need to make sure that pessimistic voices 
are heard in the market.
    Our current financial system is not set up to encourage 
short-selling. We have many institutions set up to encourage 
people to go long, but few institutions set up to encourage 
people to go short. And there are technical issues with short-
selling relating to our system of lending equities. Our system 
is just not designed to facilitate short-selling of equities, 
and for some stocks it can be just difficult or impossible to 
short them.
    In the case of analysts, part of the optimistic bias of our 
system comes from sell-side analysts--not independent analysts, 
but sell-side analysts from investment banks. These analysts 
have an incentive to curry favor with the issuing firms in 
hopes of gaining future underwriting business, and there is 
substantial evidence that these analysts have in the past been 
corrupt and intentionally issued overoptimistic forecasts.
    The antidote to this problem is independent analysts 
unaffiliated with any investment bank, and that antidote was 
mandated in the 2003 settlement between investment banks and 
securities firms and the Government.
    In the case of Enron, for example, independent analysts 
were substantially less optimistic than the analysts from 
investment banks. So independent analysts can help detect 
problems. Unfortunately, independent analysts also have an 
incentive to be overoptimistic because if they issue negative 
reports, they may be sued or otherwise harassed by the 
companies that they cover. And these lawsuits are a particular 
threat to independent analysts because they are typically small 
companies that lack the resources to withstand lawsuits.
    So I think there is a variety of evidence from academic 
studies that when you cannot short-sell, stocks can get 
overpriced. One example I have studied is battles between 
short-sellers and firms. These are cases in which firms sue 
short-sellers or otherwise take actions to prevent short-
sellers from shorting their stock. And consistent with the idea 
that when it is hard to short a stock it gets overpriced, firms 
that are fighting with short-sellers tend to have their stock 
price decline a great deal in subsequent years, suggesting that 
it was overpriced to begin with, either because of excessively 
optimistic investor expectations, because of a problem at the 
company, or just plain fraud on the part of management.
    A notable feature of the data that I studied is that many 
of the firms that fight with short-sellers are subsequently 
revealed to be fraudulent, and a variety of other evidence 
suggests that short-sellers are good at detecting and 
publicizing fraud, not just overpricing but fraud on the part 
of firms. I think the SEC and the other regulators cannot be 
our only line of defense against corporate fraud. We also need 
a vibrant short-selling community.
    In the case of Enron, I think that illustrated many of the 
benefits of short-selling. Executives from Enron in their 
recent trial in Houston claimed short-sellers had caused the 
demise of the company, Enron. I think that claim is nonsense. 
The jury did not buy that story, and neither should you.
    So my opinion is that we need to make the system less 
lopsided and more hospitable to short selling. We might also 
want to consider ways of protecting independent analysts from 
lawsuits from companies. We do not want these analysts to be 
cheerleaders. We want them to be able to express their honest 
opinions.
    Congress and the SEC are going to continue to hear 
complaints from companies about short-sellers. An example that 
I think is useful about who tends to be right in these 
situations comes from hearings in 1989 when the House Committee 
on Government Operations had hearings about the alleged evils 
of short-selling, featuring testimony from supposedly 
victimized firms. Officials from three firms testified at these 
hearings. Subsequent to this testimony, the presidents of two 
out of these three firms were charged with fraud by the SEC. So 
when you hear companies complain, keep in mind that short-
sellers are often the good guys.
    Thanks very much for this opportunity to testify. I would 
be happy to answer your questions.
    [The prepared statement of Mr. Lamont appears as a 
submission for the record.]
    Chairman Specter. Thank you, Professor Lamont.
    Our next witness is Mr. Demetrios Anifantis, manager of 
Small Business Relationships at J.P. Morgan Chase, formerly 
client relation manager with Camelback Research Alliance; 
previously held positions with Thompson Financial, Chase 
Manhattan, and Skyy Spirits; bachelor's degree in economics 
from the University of San Francisco and a master's in 
economics from Fordham.
    We welcome you, Mr. Anifantis, and the floor is yours.

 STATEMENT OF DEMETRIOS ANIFANTIS, FORMER CLIENT RELATIONSHIP 
MANAGER, CAMELBACK RESEARCH ALLIANCE, INC., SCOTTSDALE, ARIZONA

    Mr. Anifantis. Thank you so much, Mr. Chairman, Senator 
Hatch. I am pleased to be called to testify before this 
Committee this morning.
    As you mentioned, I did work for Camelback as a client 
relationship manager performing services for Camelback 
subscribers for approximately 1 year. I was in the trenches, so 
I am basically speaking from experience today on exactly what 
took place at one of these independent research firms. I do 
work for J.P. Morgan Chase right now as a small business 
banker.
    During my tenure at Camelback, I became well acquainted 
with Camelback's business model and its management team and 
staff. It was a relatively small operation while I was there.
    Camelback touted itself as supplying ``independent 
research'' for a fee to subscribers. It was in the business of 
publishing reports on public companies, and it also sold some 
software to subscribers that would rank public companies 
according to their financial performance and prospects. 
Basically this was a firm that touted itself on forensic 
accounting analysis, taking tax returns and financial 
statements and analyzing those tax returns and financial 
statements.
    I worked most closely with Donn Vickrey, who was one of 
Camelback's two principals. Vickrey and the other principal, 
James Carr Bettis, were the individuals who founded Camelback 
and had control of Camelback's operations.
    Vickrey was directly in charge of this independent analyst 
group, and Carr was more of a head figure of the company. 
Vickrey's key function was to oversee the research and writing 
that went into the reports covering publicly traded companies.
    Another manager, Jeff Mindlin, had the primary 
responsibility of engineering as well as managing the financial 
models that ranked each company.
    There were approximately 18 to 20 analysts during my tenure 
at Camelback; at any given time, approximately 10. These 
analysts had responsibility to research and write reports on 
publicly traded companies. The analysts were all recent 
graduates of universities with 4-year degrees in business-
related disciplines, yet management instructed employees to 
share with clients that the analyst team was comprised of CFAs 
and/or CPAs with advanced degrees, even though it appeared to 
me that none but Camelback's top management had such 
designations. All these individuals who were analysts at 
Camelback were graduates, recent graduates, recent undergrad 
graduates, with no certifications at all.
    Camelback advertised analytical reporting services on 
companies whose securities were publicly traded on various 
exchanges, the three major exchanges here in the United States.
    At the time I worked for Camelback, Camelback's client base 
consisted almost exclusively of large hedge funds and a couple 
mutual funds. My responsibilities included working with the 
clients to see that their requests were being met with a view 
toward keeping them satisfied so they would retain their 
subscription to Camelback's publications.
    The price for Camelback's subscription varied, but commonly 
there was an annual base subscription of approximately $25,000 
to $30,000 per year. For this fee, the client would receive 
access to all of Camelback's published reports and access to 
all historic reports on publicly traded companies. So all the 
reports that were written during Camelback's tenure were 
available to any client, even new customers or new clients.
    Camelback published these reports on several websites that 
clients did have access to.
    Camelback's promotional material and its actual sales 
practices included selling a yearly ``Base Subscription'' 
service to its research reports. Included in this package that 
I just referred to, between $25,00 and $30,000 a year, also 
came two custom reports, and these were reports that any of the 
customers could come and request from Camelback on a specific 
company.
    Typically, Camelback's subscribers would call Camelback and 
request these reports. That was usually who they called. They 
usually called me, either through myself or Vickrey. All report 
requests would be drafted by an analyst and turned over to 
Vickrey for final approval.
    These reports were represented to be qualitative analysis 
and were essentially more subjective in their coverage than 
quantitative, which was the models I was referring to earlier. 
In Camelback's qualitative reports, the company covered would 
receive an alpha score from ``A'' to ``F,'' ``A'' being a 
strong company, ``F'' being a very weak firm.
    Frequently, the subscribing client of Camelback requesting 
the custom report would actually supply Camelback with 
information on the companies that were the subject of the 
requested report, with instructions to consider and include 
such information in the report. Usually, the client would 
instruct Vickrey and other Camelback personnel involved in the 
intake of the request and the research and writing of the 
report to generate either a positive or negative report on the 
company that was the subject of the request.
    When a request came in to me, one of the three questions--
or two of the three questions that I would always ask of each 
client that was requesting a report was: Do you currently hold 
a position in the stock? And if you do hold a position, is it 
long or short? And this as information that Donn Vickrey wanted 
prior to beginning the research of any one of these companies.
    Just to wrap up here, since I am running out of time, I 
really truly believe that Camelback is built on deception, 
corruption, and a complete non-independent model. Independence 
to me means that all opinions and interpretations are not 
influenced by any third party or outside source. Camelback also 
held reports for specific clients, as mentioned by Mr. 
Kasowitz, where a customer would request that a report not be 
disseminated to the general paying subscriber base due to the 
fact that that requesting client, the client who requested the 
report, could gain some form of position in that stock. As the 
panel knows, it is oftentimes difficult to build a sizable 
short position--
    Chairman Specter. Mr. Anifantis, how much longer will you 
require?
    Mr. Anifantis. Just a minute, Mr. Specter.
    The other thing in regard to the deception, Camelback 
mentioned to all of its employees and professed that it did not 
run money or did not operate any hedge funds or did not co-
manage any funds, which they did.
    They would offer joint attacks with media personnel. Within 
days, even hours of releasing a report, a journalist individual 
would publish a report that was negative on the same firm.
    To wrap up, I believe that this type of thing I saw at 
Camelback is more common in the industry than regulators 
believe. The independent analysts feel it is virtually 
unregulated and lacks meaningful disclosure. I hope my 
testimony here today results in change in this area, both in 
enforcement and regulation, that will benefit America's public 
companies and their shareholders.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Anifantis appears as a 
submission for the record.]
    Chairman Specter. Thank you, Mr. Anifantis. Has Camelback 
changed its name?
    Mr. Anifantis. Yes, it has. It is now Gradient Analytics.
    Chairman Specter. Thank you.
    We now turn to Mr. Howard Schilit, founder and Chairman of 
Center for Financial Research and Analysis; previously an 
accounting professor at American University; author of the book 
``Financial Shenanigans: How to Detect Accounting Gimmicks & 
Fraud in Financial Reports;'' a Ph.D. and MBA in accounting and 
finance from the University of Maryland, master's in accounting 
from Binghampton, and bachelor's degree from Queens.
    Thank you very much for coming in today, Mr. Schilit, and 
we look forward to your testimony.

  STATEMENT OF HOWARD SCHILIT, CPA, FOUNDER AND NON-EXECUTIVE 
CHAIR, CENTER FOR FINANCIAL RESEARCH AND ANALYSIS (CFRA, LLC), 
                      ROCKVILLE, MARYLAND

    Mr. Schilit. Thank you, Senator Specter and other esteemed 
members on the Committee. I am grateful to have this 
opportunity to participate in this important hearing.
    The perspective that I would like to share based upon the 
background first as a professor and author about topics on 
ethics and a founder of an independent research firm is about 
the independent research industry itself. I was one of the 
pioneers in the industry back in 1994 and observing the 
behavior of research firms and our clients, and I will have a 
series of recommendations on how to improve the behavior and 
eliminate some conflicts.
    I would first like to mention briefly one or two things 
about the investment management profession, and then I will 
move on to the research side.
    Investment managers can be segmented into two groups; those 
that own stocks on the long side only, and those that can short 
stocks. And it is important to recognize good or bad behavior 
can and does occur in both of those groups. I think in terms of 
the focus of this Committee, look more broadly, not just at a 
subset of investment managers, the hedge fund community, but 
more broadly at the behavior of investment managers in general.
    Moving to what is referred to as the independent research 
profession or organizations, perhaps as many as 500 investment 
research organizations are now selling a wide variety of 
products and services to investment managers. While most are 
still one- or two-person ``mom-and-pop'' operations, some have 
grown to generate tens of millions of dollars in revenue.
    Some research firms have well-thought-out conflict-of-
interest policies while others may demonstrate little or no 
scruples.
    I believe the most important result of this Committee's 
work would be to move the investment research profession to 
establish policies and procedures to eliminate both real and 
perceived conflicts of interest.
    I have half a dozen specific recommendations that perhaps 
you would like to consider.
    For firms selling a prescription product, all subscribers 
should receive the product at the same time and in the same 
form. No subscribers should be given advance copies, nor should 
they ever be tipped off of an upcoming report.
    Second, research firms should refrain from using nonpublic 
information to trade in their own accounts, particularly in 
advance of disseminating a report to subscribers.
    Third, research firms that make recommendations for stock 
purchase or sale should not be permitted to also manage an 
investment fund. While this may sound self-evident, today some 
research firms are also investment firms, either long-only or 
hedge funds.
    Four, fees received from investment management clients 
should never contain a percentage of profits earned from the 
research. Becoming a partner with a client would immediately 
strain the objectivity and independence of the research 
analyst.
    Five, research firms that also provide investment banking 
services should be prohibited from ever using the label 
``independent.''
    Six, company-sponsored research creates a special conflict-
of-interest problem and should generally render the research 
firm as ``not independent.''
    And, finally, just as an oversight board exists for 
auditors, the Public Company Accounting Oversight Board, and 
many other professionals, such a board is needed to review 
policies, procedures, and practices of independent research 
firms.
    While this list is far from complete, I think it may be a 
good starting point.
    A few words about the relationship between the independent 
research firm and the investment managers.
    Today, pressure can be brought to bear on research firms by 
investment managers, such as hedge fund professionals, to write 
or not write on certain companies, and perhaps even to provide 
nonpublic information to a high-paying client. My experience in 
running a large research center for over a decade is that by 
establishing transparent and verifiable rules for both clients 
and employees, rarely will clients push the research firm to 
act unethically. It is critical that at the beginning of a 
relationship with a client, he or she knows the rules of the 
game and also knows that they will always be enforced. That 
means occasionally firing a client who is unwilling to play by 
the ethical rules established by the research firm.
    A few concluding thoughts. While there may be only isolated 
cases of bad behavior by investment managers or research 
providers, the need exists for a careful review of the 
practices of each group and how they interact. For sure, from 
time to time investment managers will act badly and try to 
pressure research providers to act unethically, to the 
detriment of clients and investors in general. This problem is 
not too different than the one we all face as parents, as our 
usually wonderful children sometimes act badly and try to 
pressure us to do things we later regret doing. The absence of 
rules or failure to enforce them not only emboldens children to 
misbehave, but also investment managers.
    I hope these thoughts and recommendations were helpful. I 
look forward to answering any questions.
    [The prepared statement of Mr. Schilit appears as a 
submission for the record.]
    Chairman Specter. Thank you, Mr. Schilit.
    Our final witness today is Mr. Jonathan Boersma, Director 
of Standards of Practice, Centre for Financial Market 
Integrity, CFA Institute; responsible for managing and 
directing the development of the institute's Code of Ethics and 
Standards of Professional Conduct; previously worked in the 
investment management industry; bachelor's degree in economics 
from the University of Wisconsin.
    We appreciate your coming in, Mr. Boersma, and the floor is 
yours.

   STATEMENT OF JONATHAN A. BOERSMA, DIRECTOR, STANDARDS OF 
     PRACTICE, CFA CENTRE FOR FINANCIAL MARKET INTEGRITY, 
                   CHARLOTTESVILLE, VIRGINIA

    Mr. Boersma. Thank you, Mr. Chairman, and thank you for the 
opportunity to speak with you today.
    For more than 40 years, CFA Institute has administered the 
Chartered Financial Analyst, or CFA, examination and awarded 
the CFA charter, a designation I share with nearly 70,000 
investment professionals worldwide.
    The hallmark of membership in CFA Institute is adherence to 
our Code of Ethics and Standards of Professional Conduct. Each 
of our members, as well as more than 100,000 candidates in the 
CFA program, must abide by and annually attest to their 
adherence to our Code and Standards. Among other things, our 
Code and Standards require our members to maintain their 
independence and objectivity, prohibit them from engaging in 
market manipulation, require that they perform their research 
with diligence and rigor, and require that they disclose any 
conflicts of interest.
    The term ``independent research'' can have different 
meanings. It is not simply the product of a firm lacking an 
investment banking department. Research can be influenced 
internally, through investment banking, or externally, by the 
company the analyst is covering or by an investor. Client-
sponsored or even issuer-paid research, whereby a company with 
little or no research coverage hires a firm to write a report 
on their company, is certainly not independent.
    The key question is whether this research is objective. 
Research that is by its very nature dependent can still be 
objective. Our Code and Standards mandate all research must be 
conducted with integrity, thorough analysis, and care. There 
must be a reasonable and adequate basis to support and 
substantiate recommendations. This applies to positive and 
negative ratings. Analysts must not rely on hearsay or rumors, 
but must conduct careful investigations and rigorously test 
their hypotheses.
    Conflicts of interest are often present and must be managed 
appropriately--all with the mandate that investors' interests 
must come first. In order to maintain trust and confidence in 
our capital markets, it is critical that such conflicts are 
minimized to ensure that investors' interests are protected. 
Thorough disclosure is key here. This means, for example, 
letting investors know whether the research report has been 
funded by a third party.
    Another conflict that has been raised is whether analysts 
should be allowed to own, or short, shares in the companies 
that they cover. While some argue that analysts should be 
prohibited from taking such positions, others maintain that 
analysts should be required to because it aligns their 
interests with those of their clients. Our view is that this is 
indeed a conflict of interest and, like any other conflict, 
needs to be managed carefully--through black-out periods, pre-
approval of trades, or other means. Further, this conflict must 
be disclosed in order to help investors fully evaluate 
analysts' recommendations.
    Last year, CFA institute issues the Asset Manager Code of 
Professional Conduct. This voluntary code is to be used by 
asset managers, and hedge funds in particular, as a template 
for developing procedures that protect investors and promote 
ethical behavior. We believe that asset managers have a 
responsibility to act with integrity and, relevant to our 
discussion here today, refrain from market manipulation. Under 
the code, asset managers must not knowingly spread false rumors 
or attempt to influence analysts to rate or recommend a 
security in a way that benefits the asset manager or their 
clients.
    Asset managers are not prohibited from hiring outside 
research firms to supplement or validate their own research. 
Such research may be positive or negative, and asset managers 
should be free to take investment actions as a result of their 
own negative views or as otherwise confirmed by an outside 
research provider.
    Finally, let me say a word about corporate issuers, because 
they also have a role to play here. In December 2004, CFA 
Institute and the National Investor Relations Institute issued 
joint best practice guidelines dealing with the relationship 
between analysts and corporate issuers. These guidelines, which 
have been endorsed by the New York Stock Exchange and Nasdaq, 
outline the duties and responsibilities of analysts and 
corporate issuers with the goal of reducing retaliation and 
improving the integrity of research.
    As I stated at the beginning, all analysts have a 
responsibility to act with integrity and to publish only 
honest, thorough research. Market manipulation of any kind must 
be dealt with appropriately. Yet analysts must be free to state 
their opinions and be protected from pressures or threats from 
the companies when they do so. Not every stock is a ``buy,'' 
and analysts must have the freedom to say so. Corporate issuers 
must refrain from trying to influence analysts because that is 
market manipulation as well.
    In closing, I would like to thank you, Senator Specter, for 
the opportunity to speak with you, and we offer our assistance 
as you examine these issues further.
    [The prepared statement of Mr. Boersma appears as a 
submission for the record.]
    Chairman Specter. Thank you very much, Mr. Boersma.
    For the record, I want it noted that a number of key 
prospective witnesses declined to participate or cooperate with 
the Committee. We had sought representatives from SAC Capital, 
from Rockner Partners, and from Camelback Alliance. And we had 
sought the testimony of Mr. James Chanice. It was the thought 
of the Committee that they all had important testimony to add. 
We have compulsory process, as you know, if necessary, and we 
may call upon those people in the absence of coming in today to 
respond for the record. So let the record show that those 
matters are under consideration by the Committee.
    Beginning with Mr. Aguirre, to what extent did your work 
with the SEC involve referrals to the Department of Justice on 
any matters which might have had criminal overtones, such as 
those we are discussing today with hedge funds and so-called 
independent analysts?
    Mr. Aguirre. No, it did not. It did not involve independent 
analysts. We did--
    Chairman Specter. How about hedge funds?
    Mr. Aguirre. Well, yes. The case that I was investigating 
when I was discharged was referred to the U.S. Attorney's 
Office in New York, and I met with the U.S. Attorney and the 
FBI on the case in June--
    Chairman Specter. Well, that matter is under active 
investigation by the U.S. Attorney and the FBI?
    Mr. Aguirre. I understand that it is not. But that 
information has been--I picked that up from the media, which I 
understand was passed along to them by the SEC.
    Chairman Specter. I did not follow that. You say it is not 
under active investigation, but you had consulted with the U.S. 
Attorney and the FBI?
    Mr. Aguirre. I did, in June of 2005.
    Chairman Specter. And what happened after that?
    Mr. Aguirre. Well, in June of 2005, we basically presented 
the facts of the G.E.-Heller investigation to the U.S. 
Attorney.
    Chairman Specter. And what were those basic facts?
    Mr. Aguirre. That the CEO of Pequot had appeared to obtain 
a tip from the CEO of an investment bank.
    Chairman Specter. And would you define what a ``skip'' 
means?
    Mr. Aguirre. Pardon?
    Chairman Specter. Would you define what a ``skip'' means?
    Mr. Aguirre. I said ``tip,'' sir.
    Chairman Specter. Tip, oh. Well, I know what a tip means.
    Mr. Aguirre. Yes.
    Chairman Specter. Go ahead.
    Mr. Aguirre. We provided that information to the U.S. 
Attorney and the FBI.
    Chairman Specter. I know what a tip means, but you mean a 
tip which would be relevant to some inside information?
    Mr. Aguirre. Yes, regarding the pending acquisition. I had 
done a good deal of the background research through millions of 
e-mails, searching through calendars, credit card receipts, 
telephone records, and had basically come up with one 
significant lead as the possible tipper. We provided that 
information--after meeting with my supervisors and getting 
their approval, I provided that information to the U.S. 
Attorney and the FBI.
    Nine days later, I believe that investigation was 
essentially stopped when the investment banker--there was a 
newspaper article in the Wall Street Journal on June 23, 2005. 
That newspaper article announced that Morgan Stanley was 
considering rehiring Mr. Mack. And until that point, June 23rd, 
this investigation had the solid approval of my supervisors. I 
had received accolades for it. I was told by my assistant 
director that he had given me a personal award, said that he 
was not sure he had ever given this award to anyone else. It 
was the highest one of his personal awards. And 9 days later, 
the investigation was stopped.
    Chairman Specter. Do you know why the investigation was 
stopped?
    Mr. Aguirre. Well, I can tell you my conclusion from all of 
the evidence. I received a phone call from Morgan Stanley on 
June 23rd, from the head of their compliance. He had this 
question: Are you going to proceed against Mr. Mack? Because if 
you proceed against Mr. Mack, we are going to have problems in 
having him step in as CEO. We do not want him to step in as CEO 
if there is going to be a securities case brought against him 
by the SEC. Until that point, this case was, as I said, 
supported by everyone.
    Over the next 7 days, I saw the investigation come to a 
grinding halt. Essentially I was left out of meetings. High-
powered attorneys contacted my supervisors. I was present when 
my assistant director spoke with the person who had called me 
from Morgan Stanley.
    Chairman Specter. You were present during that 
conversation?
    Mr. Aguirre. The assistant director, after I informed him 
of the question from Morgan Stanley, called the compliance 
attorney from Morgan Stanley to corroborate what he had told 
me.
    Chairman Specter. Well, are you talking about a 
conversation which you overheard?
    Mr. Aguirre. Yes, I am. He was on speakerphone.
    Chairman Specter. And who were the participants in the 
conversation?
    Mr. Aguirre. Mark Kreitman, Assistant Director Mark 
Kreitman; Eric Darnell, who was the head of compliance at 
Morgan Stanley. Also in the room were Robert Hanson, my branch 
chief.
    Chairman Specter. Those were all the people present?
    Mr. Aguirre. Yes.
    Chairman Specter. And what was said?
    Mr. Aguirre. Assistant Director Kreitman asked Mr. Darnell 
to confirm his question that he had addressed to me, which was, 
essentially, Are you guys going to go on Mr. Mack? Because we 
have got a problem if you do, and we want simply want to know 
if you are serious about proceeding against him.
    At the end of the phone conversation, Mr. Kreitman said, 
``I think we have got to let them know that we probably will.'' 
And then he said, ``But, first, I am going to call Associate 
Director Paul Berger and let him know.''
    So Mr. Kreitman called Associate Director Paul Berger, and 
the conversation went something like this--
    Chairman Specter. Were you a party--you overheard the 
conversation?
    Mr. Aguirre. It was on speakerphone.
    Chairman Specter. Go ahead.
    Mr. Aguirre. Mr. Kreitman said to Mr. Berger, ``Paul, this 
case is coming along pretty well now. We got this phone call 
from Morgan Stanley, and I think they want to know whether we 
are serious about it. I think we are going to go on this, and I 
think we ought to say something now.''
    Mr. Kreitman was cutoff in mid-sentence by Mr. Berger, and 
it was rather sharp. Mr. Berger said, ``I don't think we are, 
and we shouldn't say anything.''
    Now, the problem was that Mr. Berger knew very, very little 
about the investigation that I had conducted.
    Chairman Specter. How do you know he knew very little about 
the investigation?
    Mr. Aguirre. Well, the information that I passed along--
customarily, when Mr. Berger was apprised, I would be asked to 
prepare something. Mr. Berger had not participated in any 
meetings. Most of the conversations I had were verbal. And I 
think he said something during the phone conversation that 
implied that he was not that familiar with the facts of the 
case. And the facts that I am talking about had been developed 
in the last, oh, 3 or 4 weeks.
    After the conversation with Mr. Berger, there was an abrupt 
reversal by my supervisors in their support for this 
investigation. I wrote two extensive e-mails to Mr. Kreitman 
outlining for him the facts suggesting that Pequot had acted on 
insider information and the facts at that point that suggested 
that Mr. Mack was the most likely--I shouldn't say ``most 
likely.'' At that point I gave several possibilities, and I put 
Mr. Mack at the top of the possibilities.
    Chairman Specter. Top possibility for what?
    Mr. Aguirre. Being the tipper.
    Now, Mr. Kreitman would not discuss the case with me. He 
was angry. He refused my request that we take Mr. Mack's 
testimony.
    Chairman Specter. You say he was angry. That is conclusory. 
What evidentiary base do you have to say that?
    Mr. Aguirre. I had provided him with two e-mails and two 
spread sheets. The tone of his voice. He threw one of the 
spread sheets at me physically. He was unwilling to discuss the 
case.
    I walked out of his office. I sent him an e-mail confirming 
what had just happened. Now, that was--
    Chairman Specter. You sent an e-mail contemporaneously with 
the event?
    Mr. Aguirre. Yes.
    Chairman Specter. Could you provide that to this Committee, 
please?
    Mr. Aguirre. I will, sir.
    Chairman Specter. Thank you.
    Mr. Aguirre. That e-mail essentially stated that what he 
was doing in stopping the issuance of the subpoenas was 
frustrating the investigation. I did not receive a response 
from that for almost 4 weeks, and I did not--in fact, I 
provided him with two e-mails, two spread sheets supporting 
what I saw as the next logical step in the investigation.
    Chairman Specter. Could you provide this Committee with 
those spread sheets?
    Mr. Aguirre. I will, sir.
    Chairman Specter. Thank you.
    Mr. Aguirre. Now, there was no response to any of these e-
mails--the nine-page e-mail, the six-page e-mail, the spread 
sheets, or the e-mail confirming his refusal to allow these 
subpoenas to be issued.
    Now, before this, I probably issued something between 90 
and 100 subpoenas in the case. On one occasion, I sent an e-
mail recommending that we take 27 different--we use 27 
subpoenas for 27 different witnesses. And it was unquestioned. 
Most of the discussions would be fairly brief. In this case, 
there were no discussions.
    On approximately June 23rd, my branch chief--now, this is 
just about the same time that the newspaper article came out. 
When I brought up the possibility of issuing a subpoena with 
him, he told me that Mr. Mack--that this would be very 
difficult, Mr. Mack had very powerful political connections. He 
would not authorize it and I would have to speak with Mr. 
Kreitman.
    In July, I sent an e-mail to Associate Director Berger 
informing him that my branch chief had told me that it would be 
very difficult to take Mr. Mack's testimony because of his 
political connections.
    Chairman Specter. Will you supply us a copy of that e-mail 
as well?
    Mr. Aguirre. I will.
    Chairman Specter. Thank you.
    Mr. Aguirre. Mr. Berger did not respond. I had a similar 
conversation with him shortly before I sent him the e-mail. 
When I did not get a response from Mr. Berger, I sent an e-mail 
to the Director of Enforcement, and I told her that--I reminded 
her that she had been present at a going-away party for a 
senior SEC official who had worked with me on the case. He was 
probably the most experienced person at the SEC in conducting 
investigations of insider trading. He taught insider trading to 
new enforcement staff. He taught insider trading to foreign 
officials.
    At his going-away party, he had told Director Thomsen that 
the most important case that he had worked on in his 30 years 
with the SEC was the case that I was heading. He told her that 
in my presence.
    In the e-mail I sent to Director Thomsen on August 4th, I 
informed her that--or reminded her of the statement that this 
senior staff person had made, and told her that the case was 
not moving in circles and could I speak with her about it. I 
did receive an e-mail and she did say, ``Well, bring in the 
team.''
    The next day, August 5th, in an e-mail and a face-to-face 
discussion, my branch chief advised me that they were going to 
reconsider my request, that they would vet my facts and then 
make a decision. He suggested that we would do this after we 
were both back from vacation. He was going on vacation the next 
day. As soon as he got back, I would be on vacation. So that 
meant the facts would be vetted in September.
    I notified the Director of Enforcement that it would not be 
necessary to meet with her because the matter had--the facts 
had changed. They were going to reconsider this issue.
    I went on vacation, and on approximately August 30th I 
received a phone call to call the office. I called the office 
and spoke with Associate Director Mark Kreitman, Branch Chief 
Hanson, and they told me that I was being discharged.
    Chairman Specter. Anything to report after that? Before you 
do, I have asked you specifically for a number of e-mails, but 
I did not interrupt you on some of the others. But please 
provide all the e-mails you have referenced, or any others 
which are relevant.
    Mr. Aguirre. I have provided a sworn statement--
    Chairman Specter. Will you provide those e-mails?
    Mr. Aguirre.--and 46 exhibits to the Finance and to the 
Banking Committee and to the Office of Special Counsel. Are you 
asking for those e-mails, Mr. Chairman?
    Chairman Specter. With the Banking Committee of the Senate?
    Mr. Aguirre. Yes.
    Chairman Specter. Oh, no, that is fine. They are in the 
jurisdiction of the Senate. You need not provide anything which 
would be duplicate. We can access those.
    Anything further to say on this subject, Mr. Aguirre?
    Mr. Aguirre. Well, all of my evaluations through the moment 
that I was discharged were positive. My pay raise went into 
effect 11 days before I was fired. After I was fired--I think I 
have said enough.
    Chairman Specter. Well, I have gone considerably over the 
5-minute limit here because I did not want to interrupt your 
testimony on this matter. And we will work with the Banking 
Committee, and all the documents which you have provided them 
we will have access to. And we may discuss this with you 
further.
    We are running late so I will not pursue the matter now, 
but we will review the documents, as I say, and doubtless have 
questions for you at the staff level beyond today.
    Mr. Aguirre. Sure.
    Chairman Specter. Thank you.
    Mr. Aguirre. Thank you.
    Chairman Specter. Senator Hatch?
    Senator Hatch. Well, this has been an interesting hearing, 
and I think it is an important hearing because if some of the 
allegations are true--and I presume you are all testifying 
truthfully, and your statements are pretty dramatic--then we 
have got some work to do up here on Capitol Hill.
    Mr. Anifantis--am I pronouncing that right?
    Mr. Anifantis. Yes.
    Senator Hatch. When did Camelback change its name?
    Mr. Anifantis. Camelback changed its name I believe in--it 
was shortly before I was actually let go, I believe October.
    Senator Hatch. Was it before or after the ``60 Minutes''--
    Mr. Anifantis. Much before that.
    Senator Hatch. Before that.
    Mr. Anifantis. Yes, about a year and a half before that.
    Senator Hatch. And they changed the name to Gradient 
Analytics?
    Mr. Anifantis. That is correct.
    Senator Hatch. OK. Mr. Kasowitz, a few years back, we saw 
successful prosecutions in what are called pump-and-dump cases, 
as I understand it. In my view, what you are describing, it 
seems to me, in your testimony is a slam-and dam case, if the 
allegations are true. To me, talking down a good stock in order 
to benefit a hedge fund's short position is just as damaging to 
the markets as almost anything you could do if the talking-down 
is false.
    Now, if this activity is widespread, it certainly has the 
potential to destroy investor confidence. I would like you to 
flesh out for us what the full ramifications of these alleged 
assaults on your clients really were.
    Mr. Kasowitz. Well, the ramifications are that there is 
damage at almost every level. There certainly is damage for the 
process of orderly markets because in the circumstances that I 
have described that our clients have experienced, clearly the 
hedge fund that is engaged in an improper manipulation, 
according to the way I have described it, is gaining a 
significant benefit not only in knowing about and being able to 
analyze a particular company and its operations, but, in fact, 
in damaging the company, damaging the value of its stock 
through the dissemination of false information, which the hedge 
fund controls. It writes the false information. It controls 
when that false information is disseminated. It controls the 
dissemination of that false information through an analyst firm 
that is supposed to be independent but, in fact, is not. And 
then it reaps great benefits from it. The shareholders of the 
company that is attacked in that way are damaged dramatically 
because the value of their equity holdings are substantially 
diminished. The employees of that company and the management of 
the company are damaged dramatically because the company, being 
under such attack, then faces business problems. The kinds of 
problems that it faces are problems with business partners, 
problems with its own banks and lending institutions who either 
terminate or redo the financing vehicles and the like.
    It is just problems up and down the spectrum, both on a 
macro level with respect to the market and on a micro level 
with respect to this particular company and its investors.
    Senator Hatch. Mr. Anifantis, how did Camelback make its 
money? I mean, did they have people subscribe to their 
analytical monthly letters or weekly letters, whatever it is? 
How did they make their money?
    Mr. Anifantis. Senator Hatch, thanks for the question. 
Camelback predominantly made their money through the 
qualitative service, which is the research service, which is 
the analyst reports. They were priced, as mentioned, between 
$25,000 and $30,000. Also, there were--
    Senator Hatch. They would pay $25,000 or $35,000 for the 
report or for all of the reports that they did?
    Mr. Anifantis. For an annual subscription to all of the 
pieces that would be published by the firm during that year, by 
Camelback during that calendar year, or during that contract 
year.
    The other way they made money, there were a couple 
customers that did only have packages that were based on custom 
reports. For example, a customer would sign up to the service 
to receive six custom reports, and six custom reports only.
    There was another set of customers that used what they 
sold, which was a quantitative model. It was basically a 
mathematically driven model which spat out scores based on 
accounting statistics.
    Senator Hatch. Was this a subscriber list or did you have 
salespeople go out and get these customers or how--
    Mr. Anifantis. The customers were predominantly acquired 
via outgoing calls by a staff of sales folks.
    Senator Hatch. OK. Mr. Blickenstaff--Mr. Chairman, I am a 
little bit over. Could I have a few more questions?
    Chairman Specter. Go ahead.
    Senator Hatch. Mr. Blickenstaff, you described Sterling's 
approach to you and how it really affected your company 
detrimentally. How did they charge for their services? Do you 
have any idea?
    Mr. Blickenstaff. No. In fact, I was just looking at the 
disclosure. There is a fine print at the bottom of this 
research report. The one thing they did disclose is that they 
had no shares of Biosite's stock, so nobody owned our shares. 
It also said they never had a banking relationship, so we never 
paid them. And then it went on to say that we were not paying 
them for this research. I mean, of course we would not pay them 
for this kind of negative research. So who actually paid for 
the research is not disclosed in this sort of letterhead, and I 
think that is one key thing. If you could tell who actually was 
financing this, what firms were involved, that would be a big 
step toward saying this is paid advertisement.
    Senator Hatch. It would seem to me that ethically, Mr. 
Boersma, that there should be a disclosure of who is financing 
the research and whether or not there is a connection between 
the financing and the actual outcome of the research.
    Mr. Blickenstaff. I would agree. On the sell side, sell-
side analysts have to disclose whether there is a banking 
relationship with the firm, and obviously, you know, all the 
sell-siders that were covering us had not done underwriting, so 
there was not a banking relationship.
    Senator Hatch. You felt, though, even though your product 
was proving to be very beneficial and that you had gone up 
from, what $13 million to $38 million in just a short period of 
time, that here were all these negative reports that kept 
stultifying your stock.
    Mr. Blickenstaff. Absolutely. In fact, to give you a good 
example of the kind of research report, we actually had--in the 
third quarter of 2002, we beat expectations on our guidance on 
the ramp of BNP, and yet the headline is we beat expectation, 
but all the BNP risk remained of competition and--so it seems 
to turn good news into bad news, and all the reports then turn 
bad news into even worse news. So there is--
    Senator Hatch. We in the Congress fully understand that.
    [Laughter.]
    Mr. Blickenstaff. Believe me, I know what a negative 
campaign is all about. I have lived through it.
    Senator Hatch. I think we understand it maybe even better 
than you do.
    Mr. Blickenstaff. I think you might.
    Senator Hatch. Mr. McLaughlin, you are a very important 
person and I have a lot of respect for you, and I am sure you 
have heard this story before. Hedge funds get access and they 
get information because the number of trades they order in a 
given day is so lucrative, or at least they want it to be 
lucrative. What do you make of this assessment? Just how much 
power do these funds have over the marketplace? If there are 
11,500 of them, or more, what kind of power is that in the 
marketplace? I am not finding fault with the hedge fund 
business because I know there are a lot of honest, decent hedge 
funds out there, but it is a tremendous amount of power, isn't 
it? And I have heard that up to 30 percent of the marketplace 
happens to be short-selling, which I believe is essential to 
keep the marketplace honest. But what about that?
    Mr. McLaughlin. Well, Senator Hatch, I cannot confirm 
whether 30 percent of the volume on a given day is short or 
not. I am sure there is someone who can do that.
    Senator Hatch. Sure.
    Mr. McLaughlin. Any large customer or group of large 
customers tend to have some influence with the firms that 
execute their orders. It would be suicide, however, for a 
broker-dealer firm, because of the importance of the order flow 
from one or a group of hedge funds, to jeopardize its standing 
with its customers, clients, and with the enforcement agencies 
to step over the line and provide information, for example, 
where there was a duty of trust and confidence not to provide 
that information.
    Senator Hatch. I agree that is true with regard to broker-
dealers. What about analytical firms?
    Mr. McLaughlin. Well, independent firms, as I stated 
earlier, may not be subject to the same considerations, the 
same controls as firms that are members of the NASD or the New 
York Stock Exchange. I notice that the firm that Mr. 
Blickenstaff is referring to here is a member of the NASD and, 
therefore, of course, is subject to that organization's rules 
about having a reasonable basis for research and disclosing 
sources of bias. So when a report like this is published, it 
would be subject to that full range of controls and safeguards 
designed to promote the integrity of research.
    At the same time, there are many other firms providing 
information that would be relevant to investment decisions. And 
I hasten to add, as I stated earlier, it is very hard to draw 
the line here between independent analysts who are not subject 
to the same safeguards, sell-side analysts who are, and then 
you have the financial press, bloggers, and other people who 
publish information as well. And to deal with this problem, to 
the extent it is a problem, you have to consider what you might 
be doing that would have the effect of chilling communication, 
legitimate debate about companies and their prospects.
    Senator Hatch. Well, let me ask you this: I have no doubt 
that most of these funds, these hedge funds, are operating 
within the law. But would you agree--at least I assume that 
hedge funds are equally subject to the anti-fraud provisions of 
the Federal law.
    Mr. McLaughlin. Of course.
    Senator Hatch. And I assume that hedge funds worry that the 
accusations that we have been hearing today could spoil the 
industry's reputation if they are true. So I wonder if you 
could provide us with some examples of self-regulatory steps 
that the hedge fund industry has taken to make sure that we do 
not have fraud or insider trading through short-selling like 
some have described here today.
    Mr. McLaughlin. Well, each hedge fund is required by--each 
investment adviser, at least registered investment adviser, is 
required by law to have procedures in place to prevent 
violations of law arising from that type of activity. In 
addition, the MFA, on whose behalf I am appearing here today, 
recently published a set of best practices in this area. To the 
extent that hedge funds on the trading side and analysts on the 
analyst side are members of organizations--and, of course, the 
CFA Institute does in its area just what the MFA does in its, 
to try to raise the standards of conducts of its members. 
Neither organization has the ability to require people to 
become members or to follow these best practices.
    Senator Hatch. Can research that is paid for by a hedge 
fund with a large short or long position in a particular stock 
be later published as ``independent'' research without some 
kind of disclosure?
    Mr. McLaughlin. Under the 1933 Act--and this has been true 
since 1933--if research is paid for by a company, it must be 
disclosed. If research is paid for by a client, in my view it 
ought to be disclosed, but it would depend on the reliance of a 
particular analyst's customers and the marketplace's reliance 
on that analyst whether there would be a fraud violation if it 
were not disclosed.
    Senator Hatch. What is your estimation of how well the 
industry is complying across the board with reporting on 
especially naked shorts to the Depository Trust and Clearance 
Corporation? The DTCC, I guess it is.
    Mr. McLaughlin. The hedge fund industry?
    Senator Hatch. Yes, let's limit it to that.
    Mr. McLaughlin. Again, I have no statistics on that 
subject, but I would like to point out that the SEC did adopt 
Regulation SHO just 2 years ago.
    Senator Hatch. They have regulations, but they are not 
enforced. Wouldn't you agree?
    Mr. McLaughlin. I think the SEC understood when it adopted 
SHO that it is impossible to prevent every short sale from 
taking place without a borrow.
    Senator Hatch. Well, it is my understanding that the SEC 
responded to the problem of naked short-selling by enacting 
SHO, and that was enacted in, if I recall, January 2005. And 
that was to limit--SHO was enacted to limit market distortion 
caused by naked short-selling. But I think you would have to 
admit it falls pretty short of the goals that they set.
    Mr. McLaughlin. I don't know whether I am in a position to 
admit that, but I think the SEC is certainly concerned about 
trying to further reduce the extent of naked short-selling.
    Senator Hatch. I would think so. First, the Regulation SHO 
grandfathers in all failures to deliver that occurred prior to 
January 3, 2005, exempting a large portion of liabilities that 
will never be delivered. And, second, while Regulation SHO 
requires that the SEC publish a list of companies that have 
been targets of predatory short-selling, those for which 
brokerage firms have failed to deliver a large number of 
stocks, this seems only to have served as an identification 
list for further targeting of those firms. And, you know, I 
think that Regulation SHO also has failed to require either the 
disclosure or the aggregate failures to deliver in the 
marketplace or a number of failures to deliver of a particular 
company's stock. And, finally, despite the apparent widespread 
continuation of naked short-selling in the marketplace, there 
are no serious regulatory or criminal consequences for brokers 
repeatedly failing to deliver. Are you aware of all that?
    Mr. McLaughlin. Yes, I am, Senator Hatch. I go back on the 
regulation of short-selling for a good many years. I do not 
mean here to defend the practice of naked short-selling--
    Senator Hatch. I have not interpreted you as defending it. 
I think your testimony has been very straightforward and good.
    Are you aware that some of these companies actually go and 
register over in, say, Germany?
    Mr. McLaughlin. I have to say, Senator Hatch, that remark 
confused me when you said that earlier. I really--
    Senator Hatch. That is what my understanding is. I may be 
wrong on that. I would be happy to be corrected.
    Mr. McLaughlin. I certainly have clients that are going to 
public abroad these days instead of in the United States.
    Senator Hatch. My understanding is they do that in order to 
avoid having to report within the 3 days required here. Now, I 
may be wrong on that, but I would sure like to--would you mind 
looking at that and helping us understand--
    Mr. McLaughlin. I would like to look at that. I am very 
curious about it. I have not heard about that happening.
    Senator Hatch. If that is so, then that is a very serious 
charge that I know has been made to me personally and to others 
here on the Committee.
    Mr. Chairman, I have taken too much time, I understand, and 
I certainly appreciate your forbearance and your kindness in 
allowing me to do so.
    This has been a very important hearing. We acknowledge that 
the Banking Committee has the vast majority of control and 
jurisdiction here, but we do have the Justice Department 
jurisdiction, and that is pretty significant. And some of the 
things that I have heard here today really have alarmed me, 
especially from you, Mr. Aguirre. I have to say that I am very 
concerned, because if we do not get to the bottom of some of 
these things and make sure that things are straight, honest, 
and decent, we could have some really, really serious 
difficulties in our society.
    So I just want to thank you all for being willing to come 
in and testify and to help us to understand this better, and 
hopefully we can get through it and figure out what needs to be 
done. We appreciate your suggestions as well.
    Chairman Specter. Well, thank you, Senator Hatch, for the 
work you did while you were Chairman of the Committee and for 
your suggestion on holding this hearing today. It is past noon, 
and we have run way over time, but I want to ask just a few 
more questions.
    Mr. Kasowitz, you have outlined in some pretty strong 
language factual matters suggesting criminal conduct. have you 
relayed those to the Department of Justice?
    Mr. Kasowitz. That was directed to me, Mr. Chairman?
    Chairman Specter. Yes. Mr. Kasowitz.
    Mr. Kasowitz. We have included certain of the matters that 
I have discussed today within a civil lawsuit brought under a 
State RICO statute in New Jersey. That complaint is a matter of 
public record. Our focus has been with respect to that, and we 
certainly are here in cooperation with the Committee and stand 
prepared to cooperate with all regulators.
    Chairman Specter. Well, the allegations in your lawsuit are 
allegations of fraud?
    Mr. Kasowitz. That is right.
    Chairman Specter. Wouldn't they fit within the statute 
which I cited earlier, knowingly executes a scheme or artifice 
to defraud a person in connection with any security, et cetera?
    Mr. Kasowitz. Section 1348?
    Chairman Specter. Yes.
    Mr. Kasowitz. I believe they would.
    Chairman Specter. Well, why don't you report it to the U.S. 
Department of Justice?
    Mr. Kasowitz. Well, we certainly--
    Chairman Specter. Let me make a suggestion to you, instead 
of asking you why you have not, make a suggestion to you that 
you do. They have investigative resources, but not unlimited. 
You have factual materials. Tell them about that.
    I would also like you to take a look at the statute and 
give the Committee your judgment as to whether it ought to be 
expanded, whether the penalties are sufficient, what you think 
of Attorney General Blumental's testimony about civil penalties 
as well.
    And, Mr. Blickenstaff, you have testified about an employee 
of a so-called independent analytical firm telling you that the 
information published was false and erroneous, but she had no 
power or recourse but to let it stand. Correct?
    Mr. Blickenstaff. That is correct.
    Chairman Specter. Did you consider reporting that to the 
Department of Justice?
    Mr. Blickenstaff. Well, given the fact that we could not 
actually tie the hedge funds to these activities by the 
research firms, we came to the conclusion that it was a very 
small matter that, you know, probably was not reportable to a 
higher level.
    Chairman Specter. Well, it was a matter which seriously 
prejudiced your firm. Didn't it?
    Mr. Blickenstaff. Yes, it did, sure.
    Chairman Specter. It sounds to me like it comes within the 
context of the statute as scheme or artifice to defraud in 
connection with the sale of a security.
    You are a citizen. You are a businessman. You do not have 
the resources to conduct a criminal investigation.
    Mr. Blickenstaff. That was part of the problem. I think we 
spent several hundred thousand dollars trying to investigate 
this whole matter, and that was the only piece of this that 
really we could point to that we felt was, you know, 
borderline. But--
    Chairman Specter. Well, that is why we have a Department of 
Justice. I used to be a district attorney. People brought me 
information of this sort. If it sounded to me like a violation 
of law, we had detectives to go out and investigate.
    Mr. Blickenstaff. Well, at the time there was not a lot of 
focus on this whole hedge fund activity and these research 
firms that we are talking about today, and, you know, we were 
advised by Kroll & Associates that there just was not a 
groundswell in any of the major Justice Departments or the SEC 
that really would, you know, look at this matter. So we just 
sort of--
    Chairman Specter. Well, maybe we are creating a 
groundswell.
    Mr. Blickenstaff. We would be willing to cooperate.
    Chairman Specter. How long ago did this conversation occur?
    Mr. Blickenstaff. That conversation was in 2002. I think we 
do still know where that person is located.
    Chairman Specter. Well, I think you probably have a 5-year 
statute of limitations here, so consider making an official 
report on it and let the Committee know if you do, and we will 
pursue it and followup. OK?
    Mr. Blickenstaff. We will do that. Chairman Specter. 
Professor Lamont, you talk about
    investment bankers who like to secure favoritism with their 
customers and may exaggerate their report about their 
customers' stock. Does that come within the kind of language 
here, knowingly executes a scheme or artifice to defraud with 
the sale of a security, do you think?
    Mr. Lamont. I could not--
    Chairman Specter. I know you are a professor of economics.
    Mr. Lamont. Yes.
    Chairman Specter. How does that sound to you?
    Mr. Lamont. I could not give you any legal advice. I can 
tell you that in 2003 the SEC and other regulators had a 
settlement with the underwriters and the securities firms, a 
$1.5 billion settlement, so there must have been some legal 
basis for that settlement.
    Chairman Specter. Well, I am always suspect on civil 
settlements which are designed to go halfway. They are usually 
accompanied by a statement that there is no admission of 
liability or responsibility, disclaimers of every sort, but it 
has the effect of terminating a matter. And that does not 
really utilize the real power of criminal prosecution on white-
collar crime, which I described earlier.
    Mr. Schilit and Mr. Boersma, you have testified about and 
we have heard other testimony about the lack of professionalism 
among so-called independent analysts and lack of training. Mr. 
Anifantis went into some detail on that. Where you have a real 
estate broker, there are State laws which require the real 
estate brokers to take tests and to maintain certain standards, 
and a real estate broker deals with very small sums--relatively 
small sums of money for limited clients. Is this a matter which 
ought to be the subject of State laws? If you practice law 
without a license in Pennsylvania, you are subject to a 
criminal prosecution. What of that, Mr. Schilit? How about some 
sanctions which would be analogous to those considerations?
    Mr. Schilit. Well, the recommendation I was making is you 
have an industry, the investment and research industry, which 
has grown dramatically, and there are not standards. So if you 
wanted to leave your position in the Senate and form a research 
company, there are no prohibitions for you to do that and label 
yourself as an independent research company.
    Chairman Specter. Well, I could not become a real estate 
broker.
    Mr. Schilit. Correct. And so, you know--
    Chairman Specter. Maybe it is more--
    Mr. Schilit. Well, the recommendation--
    Chairman Specter. Maybe I can do more harm as a real estate 
broker than as a research analyst. I doubt it.
    Mr. Schilit. But I think the spirit of what you are 
suggesting I certainly would agree with, that there has to be 
standards before you enter that field.
    Chairman Specter. Mr. Boersma, what do you think about 
that? I am trying to get a few more opinions here and draw this 
hearing to a close?
    Mr. Boersma. There is an examination for--
    Chairman Specter. We are about to interfere with tomorrow's 
hearing.
    Mr. Schilit. There is an examination for those that work in 
a broker-dealer setting, but there is not any certification 
required for independent analysts, and we certainly think the 
CFA program and designation is a mark of good standing for 
analysts. But they are not required to do that.
    Chairman Specter. Well, after listening to the testimony 
today and after reviewing a lot of documents in this field, it 
is my judgment that we are dealing with a matter of enormous 
importance, $1.2 trillion, maybe more, as Mr. Kasowitz says, 
maybe double, and it is on its way to a lot more than that. And 
although it is only 5 percent of the market from the statistics 
I have seen, it has 30 percent of the transactions. And you had 
the case in 1998 where the company with assets of $3 to $4 
billion leveraged it to $80 to $100 billion. And had they 
collapsed, it would have had enormous repercussions. And you 
have potential for $1 billion a year, which is fine if it is 
done legally, but with only limiting it, as the Chairman of the 
Fed says, to pressures within the industry, it has enormous 
potential for abuse. And regulation is fine. That is up to the 
SEC and up to the Congress generally and the Banking Committee. 
But the Department of Justice and State prosecutors have a very 
important role to play here. And prosecutions for white-collar 
crime and jail sentences have a tremendous deterrent effect. 
And this Committee intends to push the Department of Justice to 
do that.
    If you have information, Mr. Kasowitz, Mr. Blickenstaff, 
others, pass it on.
    Senator Hatch. Mr. Chairman, can I just ask one more 
question?
    Chairman Specter. Are you serious?
    [Laughter.]
    Senator Hatch. Yes, I am serious.
    Chairman Specter. I know you are serious, but I mean about 
one more question.
    Senator Hatch. It might be more than one. But I will try 
and keep it to one. I just want to ask Mr. Kasowitz, I 
mentioned to Mr. McLaughlin--and this is something I understand 
is done, but I may be wrong on it. I would just like to know.
    These folks on these naked shorts are supposed to file with 
the Depository Trust and Clearing Corporation within 3 days. 
SHO was to try and make sure that they do that. But it is my 
understanding that some of these companies, to avoid doing 
that, go and register a stock in a foreign country. I will use 
Germany as an illustration. And then they can avoid it for 
months on end. Where there is not any stock to go get, which is 
the definition of ``naked shorting.''
    Are you aware of that?
    Mr. Kasowitz. The case that we have filed for our client, 
Biovail, does not involve that situation. I have heard reports 
similar to the ones that you have read about, Senator.
    Senator Hatch. Well, I would appreciate--Mr. Aguirre, have 
you heard about this?
    Mr. Aguirre. No, I have not.
    Senator Hatch. OK. Well, I would appreciate any information 
anybody on this panel, or otherwise, can give us on that, 
because if that is true, that I think may be very well 
constitute fraud. It may not, but it may very well constitute 
fraud that we are concerned about here under this particular 
statutory section, in order to evade reporting because they 
know that they are naked shorting and they cannot cover the 
stock.
    These are matters that I think are very important. Mr. 
Schilit, do you have any awareness of that?
    Mr. Schilit. I do not.
    Senator Hatch. Anybody else have any awareness of that?
    [No response.]
    Senator Hatch. OK. Well, then, I just wanted to ask that, 
and I would appreciate, Mr. McLaughlin, Mr. Kasowitz, if you 
can help us to understand that process. And if we are wrong, I 
would like to know. I would just like to know what is right 
here. I don't have any axes to grind here. I would just like to 
do what is right, and I am real concerned, as you can see the 
Chairman is, about some of the things we have heard here today 
and that we have been studying. We do not want to hurt anybody. 
We just want to make sure that our markets are not ruined 
because of the fraud.
    Chairman Specter. Thank you, Senator Hatch and thank you 
all.
    [Whereupon, at 12:15 p.m., the Committee was adjourned.]
    [Questions and answers and submissions for the record 
follow.]
    [Additional material is being retained in the Committee 
files.]

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