[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
FEDERAL AND STATE ENFORCEMENT
OF FINANCIAL CONSUMER AND
INVESTOR PROTECTION LAWS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
MARCH 20, 2009
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-18
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
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Page
Hearing held on:
March 20, 2009............................................... 1
Appendix:
March 20, 2009............................................... 59
WITNESSES
Friday, March 20, 2009
Dugan, Hon. John C., Comptroller, Office of the Comptroller of
the Currency................................................... 8
Duke, Hon. Elizabeth A., Governor, Board of Governors of the
Federal Reserve System......................................... 6
Galvin, Hon. William Francis, Secretary of the Commonwealth of
Massachusetts.................................................. 37
Glavin, Rita M., Acting Assistant Attorney General, Criminal
Division, U.S. Department of Justice........................... 16
Gruenberg, Hon. Martin J., Vice Chairman, Federal Deposit
Insurance Corporation.......................................... 12
Madigan, Hon. Lisa, Attorney General, State of Illinois.......... 39
Pistole, John, Deputy Director, Federal Bureau of Investigation.. 17
Polakoff, Scott M., Acting Director, Office of Thrift Supervision 14
Raskin, Sarah Bloom, Commissioner, Maryland Office of Financial
Regulation..................................................... 41
Ropp, James B., Commissioner, Delaware Division of Securities.... 43
Sharick, Merle D., Jr., Mortgage Asset Research Institute (MARI). 46
Walter, Hon. Elisse B., Commissioner, U.S. Securities and
Exchange Commission............................................ 10
APPENDIX
Prepared statements:
Cummings, Hon. Elijah E...................................... 60
Dugan, Hon. John C........................................... 62
Duke, Hon. Elizabeth A....................................... 81
Galvin, Hon. William Francis................................. 94
Glavin, Rita................................................. 102
Gruenberg, Hon. Martin J..................................... 114
Madigan, Hon. Lisa........................................... 133
Pistole, John................................................ 144
Polakoff, Scott M............................................ 152
Raskin, Sarah Bloom.......................................... 172
Ropp, James B................................................ 203
Sharick, Merle D., Jr........................................ 218
Walter, Hon. Elisse B........................................ 223
Additional Material Submitted for the Record
Dugan, Hon. John C.:
Written responses to questions submitted by Representative
Posey...................................................... 255
Duke, Hon. Elizabeth A.:
Written response to question posed during the hearing by
Representative Foster...................................... 261
Written response to question posed during the hearing by
Representative Gohmert..................................... 262
Written responses to questions submitted by Representative
Grayson.................................................... 263
Written responses to questions submitted by Representative
Posey...................................................... 265
Glavin, Rita M.:
Written responses to questions submitted by Representative
Grayson.................................................... 269
Written responses to questions submitted by Representative
Posey...................................................... 271
Gruenberg, Hon. Martin J.:
Written responses to questions submitted by Representative
Foster..................................................... 275
Written responses to questions submitted by Representative
Gohmert.................................................... 277
Written responses to questions submitted by Representative
Posey...................................................... 278
Pistole, John:
Written responses to questions submitted by Representative
Grayson.................................................... 282
Written responses to questions submitted by Representative
Posey...................................................... 285
Polakoff, Scott M.:
Written responses to questions submitted by Representative
Grayson.................................................... 290
Written responses to questions submitted by Representative
Posey...................................................... 293
Ropp, James B.:
Written response to question posed during the hearing by
Representative Gohmert..................................... 299
Written response to question posed during the hearing by
Representative Scott....................................... 300
Walter, Hon. Elisse B.:
Written responses to questions submitted by Representative
Foster..................................................... 301
Written responses to questions submitted by Representative
Gohmert.................................................... 303
Written responses to questions submitted by Representative
Grayson.................................................... 305
Written responses to questions submitted by Representative
Posey...................................................... 310
Written response to question posed during the hearing by
Representative Scott....................................... 314
FEDERAL AND STATE ENFORCEMENT
OF FINANCIAL CONSUMER AND
INVESTOR PROTECTION LAWS
----------
Friday, March 20, 2009
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:07 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Waters, Moore of
Kansas, Green, Foster, Carson, Driehaus, Maffei; Campbell,
Posey, and Lee.
Also present: Representatives Cummings, Scott of Virginia,
and Gohmert.
The Chairman. The hearing will come to order. I apologize
for the delay. This has been a somewhat busier week than usual.
And let me begin by saying when I asked that this hearing be on
Friday--I didn't ask, I decided--I was told there would be
votes. And I understand, obviously, there are members who left
town. I will confess that coming and seeing a manageable number
of members rather than 72, which is our quota, does give me
some encouragement, because I think we may be able to not be
here all day.
But I do want to explain that it is an important hearing. I
am not trying to slight it, obviously, by having it on a day
when there were no votes. We were told there were going to be
votes. And we do have a very busy schedule, which we are trying
to accommodate.
I also want to express my appreciation to my colleagues on
the Judiciary Committee, because we have before us officials
who are under the jurisdiction of the Judiciary Committee. One
of the things I have worked very hard on with my colleagues is
to avoid jurisdictional disputes. We have tried to be
cooperative. I have spoken to Mr. Conyers. I know he has spoken
to his Republican counterpart. And we have with us the
gentleman from Virginia, Mr. Scott, and the gentleman from
Texas, Mr. Gohmert, the chairman and ranking member of the
subcommittee of the Judiciary Committee. So to that extent,
this is a joint hearing.
We are joined by our colleague, Mr. Cummings of Maryland--
who also has had a great interest in this--from the Oversight
and Reform Committee. So it is a joint effort to that extent.
And it is important, because one of the questions we are going
to be asking of the assembled panel is whether going forward,
there is any legislative authority that you would like
enhanced. We, if that was the case, in the Financial Services
Committee would have jurisdiction over some of that, but the
Judiciary Committee would have jurisdiction over other parts of
it. Anything that is criminal, of course, goes to the Judiciary
Committee, plus staffing or other requirements for
recommendations from the people in the Justice Department. And
given the rules about personnel and salaries that have come up,
the Government Reform Committee has jurisdiction. Because one
of the things we have been asked in the past is, in some cases,
frankly, to make some special rules so some of these agencies
could acquire the degree of expertise they would need in
dealing with this. So that explains it all procedurally.
I am very grateful to the witnesses. It is a panel that is
fully representative of the capacity of the Federal Government
to enforce the various laws, both civil and criminal, that try
to keep our financial system honest in the literal sense.
You can start my 5 minutes now. I started it. I used up 10
seconds.
There are two reasons for this hearing, candidly. One is
the substance of the subject. We do want to know what, if
anything, we, the Congress, the relevant committees taking the
lead, can do to enhance your ability to protect the public,
which is what you do. And there are agencies that have dual
functions. You have general functions for keeping the market
going, but every one of you has some law enforcement activity
as well, both civil and criminal. And so it is important for us
to know what, going forward, we can do to help you.
And I want to make this very clear now. I know there is OMB
and all those other people. I am asking you on behalf of the
Financial Services Committee, and I believe the Judiciary
Committee, we are directing you to volunteer to us--not to
volunteer, but to respond if you need more resources. This is
not a case of you being accused of coming here behind OMB's
back. We insist on knowing what your honest assessment is of
your resource needs, because we cannot have a situation where
the public is being told that we don't have enough people to do
this.
We have had efforts before on a bipartisan basis out of
this committee; we have talked to Judiciary to try to get more
resources, for instance, to the Justice Department to deal with
mortgage fraud. And mortgage fraud is obviously one of the
issues that we are talking about.
The second part of that, and mortgage fraud gets me into
it, is there is in America today a justifiable level of anger
at the fact that the great majority of Americans are suffering
economically because of the mistakes of a relatively small
number of people and of a system that was inadequate to the
task. Some of those problems, as I say, resulted from an
inadequate system. We cannot prosecute people for breaking
rules when the rules didn't exist. And part of what we have to
do is to think about what rules we need to have going forward.
And you should feel free to tell us about those as well.
But it is also likely that there are people who violated
the rules, and if we are to sustain the capacity to govern
effectively, if we are to provide the resources that are needed
to deal with the current situation, we have to satisfy the
American public that everything is being done that can be done
legitimately to hold accountable the people who caused this
problem. And so it is important for people to know that to the
extent there were crimes committed, and there certainly were
crimes committed as we hear, that there will be prosecutions if
these are possible to achieve. And we will have a second panel
of State attorneys general whom we understand have a large part
of the criminal jurisdiction. There are also civil recoveries
that can be made. There are debarments that can be issued.
A great deal collectively can be done to protect the
public, and it is important to do that, because if we don't
convince the American public that this is being done
effectively, their response will be, I believe, one that will
shut down some of these efforts. That might be paradoxical, but
it will be there.
And then, of course, we do want to make sure that going
forward, we are better able to protect our financial system
from the kind of action and inaction that brought us where we
are today.
So this hearing is very important. Just to summarize, we
want you to tell us--no agency represented here today should go
out of this room and be able to say, the problem is they didn't
give us enough resources, or we need this change in the law,
unless you have told us that and given us a chance to respond.
I will give you one example. We had a hearing with the FHA
in January, still under the previous Administration, about
their role in reducing and issuing mortgages of the sort that
wouldn't lead to the subprime crisis. What evolved in that
hearing is they did not have sufficient power to debar past bad
actors. We elicited that in testimony--my colleagues from
California Ms. Waters and Ms. Speier. We elicited that
testimony. In the bill that the House passed a couple of weeks
ago, we gave the FHA that authority. That is an example of the
kinds of things we are looking to do.
And let me say the last thing is we are not asking for
names. We are not the prosecutors. This is not an appropriate
forum in which individuals should be attacked. We are
interested in your plans for going forward and what you intend
to do going backward. That is, what do you intend to do to
prosecute and recover funds where we can? What do you need to
make sure you do the best possible job going forward? This is
not a hearing in which, as I said, we want you to name names.
That would not be an appropriate legislative function.
And with that, let me call on the gentleman from Texas, Mr.
Gohmert, for an opening statement.
Mr. Gohmert. Thank you, Mr. Chairman. I appreciate being
included in this hearing. In several former lives ago, I was
hired as outside counsel to clean up some banking messes and
illnesses, and so I have a real interest in this. Those who
would seek to commit mortgage fraud often prey on the elderly
and other members of society who are most vulnerable. And
obviously, they shouldn't be allowed to defraud the American
public. Honest Americans must have the confidence to know they
can enter into a financial deal and the person on the other
side won't be able to cheat them without consequences.
Unfortunately, reporting of mortgage fraud on the
Suspicious Activity Reports filed with the Treasury's Financial
Crimes Enforcement Network shot up by 36 percent from 2007 to
2008, with 63,173 reported last year.
The problem of mortgage fraud is getting worse. Federal and
State entities that police these activities obviously must have
the resources and tools to deal with them.
One of the things that may surprise some folks here that
has brought together the ACLU, the Heritage Foundation, and,
maybe more surprisingly, Mr. Bobby Scott and me all on the same
side is that we have often been overcriminalizing way too many
activities, and so one of the things some of us have wanted to
start taking a look at is if there are ways to stop or slow a
bad activity by other means. If there is not criminal intent,
if there is not mens rea, then would a civil fine or some kind
of dollar penalty address the issue?
You look at mortgage companies who intended to put people
in mortgages so it didn't matter if they put people in homes
they couldn't afford, it didn't matter if people put down
fraudulent information in order to get a mortgage because they
intended to turn around and immediately sell those, package
them into a neat little security package and sell them without
recourse. Maybe if there was recourse civilly, you would
address this issue and you wouldn't see fraud skyrocketing,
because the people would have a real incentive, like
Countrywide would have a real incentive, to make sure that
people did not put down fraudulent information, they didn't get
in homes they couldn't afford because they didn't want people
coming back to them for the costs of this thing.
But I am glad to hear the FBI has increased the number of
special agents specifically devoted to mortgage fraud
nationally by half over the last year from 120 to 186. And I am
looking forward to hearing from the witnesses and learning
about how this all affects them and their suggestions. But my
time as a lawyer, as a prosecutor, judge, chief justice, and
Congressman has taught me that crises such as the scourge of
mortgage fraud can lead to overreaction in the form of new
criminal laws that potentially cover people who had no guilty
intent. For example, in this area, they were greedy, but they
didn't intend to commit a crime.
But one of our problems is this overreaction; let us
criminalize some conduct, let us put people in prison. We have
heard some terrible anecdotal evidence of some Federal agencies
who couldn't wait to get their own SWAT team with the red
lights and the ability to slam people to the ground and
handcuff them in public, because there apparently is a pent-up
desire to do that among some people. And wow, you can do it and
get paid for it at the same time. So we have to be careful
about spreading that ability to do that among people who should
not have that.
But perhaps we could hear thoughts on whether to outlaw
combining mortgages into securities. I know I have friends who
think I shouldn't talk like that, but when you lump mortgages
into a security, and you don't examine the value of each
mortgage and whether the payments have been made on time or the
property underlying the mortgage is keeping its value, then you
are going to end up needing to buy some insurance, or we will
call it a credit swap, and that way we don't have to hold money
in reserve in the event the insurable event ever occurs.
So there are a number of things we need to look at. If
greed is the problem, but there is no criminal intent, let us
address it with a proportional monetary cost to the wrongdoer
and pop them right where they hurt the worst, in the
pocketbook. And if there is criminal intent, then let us go
after them. I may be one of the few people in this room who has
watched his hand sign an order to have somebody taken and the
death penalty administered. I am serious about crime, but I do
want to make sure there is criminal intent; otherwise, if it is
just greed, let us hit them in the pocketbook where they really
hurt.
Thank you, Mr. Chairman.
The Chairman. At this, if I could take a second to express
agreement with him. That is why I did stress both civil and
criminal. And that is why we have people here from both the
civil and criminal jurisdictions. And it is why we are working
with Judiciary, because we don't want this to be narrowly done.
The gentleman is absolutely right, and I think he speaks for a
great majority of both committees.
Mr. Gohmert. And that is why I do appreciate this hearing
and being included. Thank you, Mr. Chairman.
The Chairman. The gentleman from Virginia, who is chairman
of the subcommittee on the Judiciary Committee.
Mr. Scott of Virginia. Thank you, Mr. Chairman, for
inviting the Judiciary Committee to participate in this hearing
on Federal and State enforcement of financial, consumer, and
investor protection laws. As a member of the House Judiciary
Committee and the Chair of the subcommittee overseeing crime
issues, we are exploring ways to hold accountable unscrupulous
mortgage brokers and Wall Street executives who are an integral
part of the problem. With the Department of Justice and FBI
witnesses, I hope this hearing will give more insight into what
is being done and what needs to be done, particularly what is
needed in the way of resources to investigate those suspected
of serious criminal activity which contributed to the crisis,
and what needs to be done to make sure they are prosecuted to
the full extent of the law.
The Financial Services Committee has been relentless in
investigating and uncovering the causes of the financial and
mortgage crisis. As banks and private mortgage companies
relaxed their standards for loans, approving riskier mortgages
with less scrutiny, they created an environment that invited
fraud. In the last 3 years alone, the number of criminal
mortgage fraud investigations opened by the FBI has more than
doubled. The FBI has testified before the Senate that it
currently has 1,800 mortgage fraud investigations that are
open, but only 240 agents specifically assigned to those cases.
It is my view that to fully protect law-abiding taxpayers
from criminal conduct, it is essential that appropriate
resources be dedicated to meet the challenges of investigating
mortgage and financial fraud. I am not persuaded that more laws
are needed, but what is needed is more resources to enforce
existing laws.
Many in this industry knew that they were dealing with
worthless paper. They had even names for the paper. They had
mortgages like ninja loans, no income, no job. When these are
passed off as triple A assets, someone has committed common law
fraud.
I believe that Federal mail and wire fraud criminal
statutes should be sufficient to address the problem. Those
penalties for those violations are substantial. Mail and wire
fraud violations carry a maximum penalty of 20 years, and any
mail or wire fraud that affects a financial institution
increases that maximum sentence to 30 years.
It is just not mail and wire fraud that is at the disposal
of Federal prosecutors. The FBI itself has identified nine
applicable Federal criminal statutes for which this fraud--for
which those committing the fraud may be charged. In addition to
the Federal criminal law, these crimes can also be aggressively
prosecuted by State and local law enforcement officials under
aggressive and very punitive State criminal law provisions as
well. So it seems that we may have enough in the way of
criminal code provisions, but what we need is to make sure that
we have adequate resources to State and Federal authorities to
battle fraud. And we need to ensure that the Federal
authorities are also coordinating their activities with local
and State officials.
So, Mr. Chairman, what we need to do is find out what
resources law enforcement officials need to prosecute the
fraud, whether it is consumer I.D. theft, contracting fraud in
Iraq, or even mortgage fraud before us today. I was happy to
see that the 2009 Omnibus Appropriations Act provided $10
million to the FBI to dedicate additional agents to the
mortgage fraud investigations. I am also supportive of other
bills that provide more resources in this area.
In conclusion, Mr. Chairman, I support more resources for
the Department of Justice to assist the FBI and the States in
enforcing fraud laws to recover the billions of dollars that
have been lost. We also need to make sure that we have in place
the prosecution and investigations to prevent these same
schemes from happening in the future. Today's hearing is an
opportunity to fully discuss these issues, and I look forward
to hearing from the witnesses. And I thank you again, Mr.
Chairman, for your relentless action to make sure that the
public is actually protected.
Thank you, and I yield back.
The Chairman. I thank the gentleman.
The gentleman from California, Mr. Campbell, will be giving
an opening statement from the Financial Services Committee. He
had a conflict, which is an unavoidable fate of all of us. He
is on his way. I would assume it will be all right with the
members if we proceed with the testimony, and if Mr. Campbell
has a statement when he arrives, he will give it. And given the
large number of witnesses, I cannot tell you how nice it is to
have the witnesses outnumber the members, because we will get
some real conversation going.
We will now begin with our first witness, the Honorable
Elizabeth Duke, who is a Governor of the Board of Governors of
the Federal Reserve system, and then go down the list. Governor
Duke?
STATEMENT OF THE HONORABLE ELIZABETH A. DUKE, GOVERNOR, BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Ms. Duke. Thank you, Mr. Chairman.
Chairman Frank, and members of the committee, I want to
thank you for the opportunity to discuss the Federal Reserve
Board's ongoing efforts to address and prevent mortgage-related
fraud and abusive lending practices in the institutions we
supervise.
While the expansion of the subprime mortgage market over
the past decade increased consumers' access to credit, too many
homeowners and communities are suffering today because of lax
underwriting standards and other unfair and deceptive practices
that resulted in unsustainable loans. The Federal Reserve is
committed to improving consumer protections and ensuring
responsible lending practices through each of the roles we
play, as supervisor for safety and soundness, as supervisor for
consumer compliance, and as rule writer.
Let me first address the steps that the Federal Reserve is
taking to combat mortgage fraud. In recent years, there has
been a significant increase in suspected mortgage fraud and
other mortgage-related criminal activity. Federal Reserve staff
regularly review Suspicious Activity Reports filed by the
financial institutions we supervise. In appropriate
circumstances, and particularly when bank insiders may be
involved, we initiate investigations, make criminal referrals,
coordinate with law enforcement and other regulatory agencies,
and pursue enforcement actions against individuals, including
seeking prohibition orders and, in appropriate cases, civil
money penalties and restitution. We are currently pursuing
numerous investigations involving insiders related to possible
mortgage-related fraud, both commercial and residential.
More generally, the Federal Reserve's enforcement efforts
begin with the examination of its supervised institutions. In
the Federal Reserve's regular safety and soundness examinations
of State member banks and bank holding companies, we evaluate
their risk management systems, financial condition, and
compliance with laws and regulations.
In assessing a bank's risk management systems, examiners
evaluate the adequacy of the bank's practices to identify,
manage, and control the credit risk arising from the bank's
mortgage lending activity. Examiners look at the bank's
underwriting standards, credit administration practices,
quality control processes over both its own originations and
third-party originations, and appraisal and collateral
valuation practices. Institutions with weaknesses are expected
to take corrective actions that include improving their
underwriting practices in the future. In those instances where
the bank is not willing to address the problem, we have and use
a full range of powerful enforcement tools to compel corrective
action.
The Federal Reserve conducts regular examinations of State
member banks to evaluate compliance with consumer protection
laws. Each examination includes an evaluation of the bank's
fair lending compliance program. Our objective is to identify
compliance risk at banks before they harm consumers, and to
ensure that banks have appropriate controls in place to manage
those risks.
When examiners identify banks with weak and ineffective
compliance programs, they document the weaknesses in the
examination report and take appropriate supervisory action. In
addition, when examiners identify patterns or practices of
lending discrimination, the Federal Reserve makes referrals to
the Department of Justice as required by the Equal Credit
Opportunity Act. Furthermore, Federal Reserve consumer
compliance examiners routinely participate in the review and
assessment of the adequacy of large bank holding company
compliance risk management programs.
In addition to our supervisory activities, in 2008 the
Federal Reserve Board finalized sweeping new rules for home
mortgage loans to better protect consumers and facilitate
responsible residential mortgage lending. The rules, which
amended Regulation Z, prohibit unfair, abusive, or deceptive
home mortgage lending practices.
Importantly, the rules apply to all mortgage lenders, not
just to the depository institutions supervised by the Federal
banking and thrift regulators. The rules apply to a newly
defined category of higher-priced mortgage loans secured by a
consumer's principal dwelling. The higher-priced thresholds
would cover all, or virtually all, of the subprime market. For
these loans, the rules will prohibit a lender from making a
loan without regard to the borrower's ability to repay the loan
from income and assets other than the home's value. In
addition, lenders are prohibited from making stated income
loans, and are required in each case to verify the income and
assets that they rely upon to determine the borrower's
repayment ability.
Again, I want to thank you for the opportunity to discuss
what the Federal Reserve does to address and prevent mortgage-
related fraud and abusive lending practices in the institutions
we supervise. I would be happy to answer any questions. Thank
you, Mr. Chairman.
[The prepared statement of Governor Duke can be found on
page 81 of the appendix.]
The Chairman. Next, the Comptroller of the Currency, John
Dugan.
STATEMENT OF THE HONORABLE JOHN C. DUGAN, COMPTROLLER, OFFICE
OF THE COMPTROLLER OF THE CURRENCY
Mr. Dugan. Thank you, Mr. Chairman, and members of the
committee. I welcome this opportunity to appear before you
today to discuss the OCC's enforcement authority and how we
have exercised that authority.
Recent unprecedented losses at financial firms, the
mortgage crisis, and shocking examples of both fraud and excess
have prompted your questions about the adequacy and use of
enforcement powers by Federal and State authorities. The OCC
vigorously applies laws and regulations to national banks
through both supervisory activities and enforcement actions to
protect the safety and soundness of national banks and their
customers.
The OCC and the other Federal banking agencies have a broad
range of supervisory and enforcement tools that are used to
supervise banks and protect consumers, investigate and halt
fraudulent activities, and remove and prohibit those
responsible from ever working in the banking industry again.
Unlike the Department of Justice and the FBI, however, the
Federal banking agencies are not criminal law enforcement
agencies, and we do not have the authority to investigate and
prosecute crimes of fraud. Rather, the Federal banking agencies
refer suspected criminal fraudulent acts to the Department of
Justice for prosecution.
My written statement today covers the OCC's activities and
perspectives on enforcement in four areas. The first is our
approach to enforcement. National banks are subject to
comprehensive, ongoing supervision that, when it works best,
enables examiners to identify problems early and obtain early
corrective action before enforcement action is necessary. Once
problems or weaknesses are identified, we expect bank
management and the board of directors to correct them promptly.
And because of the tremendous leverage that bank supervisors
have over banks, management normally takes great pains to do
so.
That is not always true, however, and in other cases, the
seriousness of the problem requires an enforcement response. In
those circumstances, we have a range of enforcement tools at
our disposal, from informal enforcement actions such as a
commitment letter or memorandum of understanding, to formal
enforcement actions such as a formal agreement, cease and
desist order, or removal and prohibition order.
We use all of these tools, depending on the circumstances,
to vigorously implement our safety and soundness and consumer
protection mandates, as the chart in my written statement
summarizes. These include actions taken to address a wide range
of issues, including capital adequacy, unfair and deceptive
practices, managerial competence, mortgage fraud, and many
others.
The second part of my testimony describes how we have
employed enforcement actions in problem bank situations to
protect consumers and eliminate fraud. Problem banks warrant
special supervisory attention, and our actions here are
designed to remedy various unsafe and unsound practice and
compliance violations. The various corrective measures
incorporated into our enforcement actions have included
requiring the bank to raise capital, restrict borrowings,
eliminate certain activities and even entire business lines,
adopt appropriate underwriting standards and policies to govern
lending activities, limit the transfer of assets, and eliminate
payments of bonuses or dividends.
The third part of my statement describes how we coordinate
with State and Federal regulatory agencies and law enforcement
agencies. As an example, when the OCC issues a remedial
enforcement action against a national bank, the Federal Reserve
Board will often take a complementary action with respect to
the bank's holding company.
We also coordinate extensively with other regulatory
agencies and with law enforcement authorities. The OCC has
entered into similar information-sharing agreements with most
State banking agencies and all 50 State insurance departments,
and recently with the Federal Trade Commission, and we
regularly share information with the SEC. When we suspect
criminal conduct, we make referrals to the Department of
Justice.
Finally, my statement concludes with a description of the
measures we have taken to address mortgage lending practices.
Abusive lending practices by mortgage lenders and brokers and
the current foreclosure crisis understandably have raised
questions about the role and effectiveness of bank regulators
in anticipating and preventing mortgage lending abuses. This
area represents a good example of how we apply our approach to
supervision and enforcement. It is important to be clear about
who did what.
The OCC extensively regulates the mortgage business of
national banks and their subsidiaries, and as a result of the
standards applied by the OCC, national banks originated less
than 15 percent of all subprime loan mortgages. In contrast,
the vast bulk of such loans were originated by nondepository
institution mortgage lenders and brokers that were not subject
to our regulation. It is these lenders and brokers that have
been widely recognized as the overwhelming source of abusive
subprime mortgages resulting in waves of foreclosures.
The OCC has been aggressive in combating abusive lending
practices and in preventing national banks from engaging in
such activities. We were the first Federal banking agency to
issue antipredatory lending regulations, and in recent years we
have issued, with the other agencies, a number of supervisory
issuances covering payday loans, title loans, unfair and
deceptive practices, risks associated with subprime mortgage
practices, and other related issues. Although many of these
statements were issued as guidance, compliance is not optional
for national banks. We require it.
We describe a number of enforcement actions that we have
taken in our testimony, including several that I won't go into
the details of here because the details were reported there.
And thank you very much. I will be happy to answer
questions.
[The prepared statement of Comptroller Dugan can be found
on page 62 of the appendix.]
The Chairman. Next, we have Commissioner Elisse Walter, a
relatively new Commissioner, of the Securities and Exchange
Commission. Commissioner Walter?
STATEMENT OF THE HONORABLE ELISSE B. WALTER, COMMISSIONER, U.S.
SECURITIES AND EXCHANGE COMMISSION
Ms. Walter. Thank you, Mr. Chairman, and good morning to
you, the members of the committee, and the members of the
Judiciary Committee. I am one of the five Commissioners of the
Securities and Exchange Commission, and I am testifying here
today on behalf of the Commission as a whole. I very much
appreciate the opportunity to discuss our enforcement program
and, more specifically, our efforts to address violations of
the law arising out of the current financial crisis. We are
fully committed to pursuing wrongdoers and returning as much
money as possible to injured investors.
The Commission's enforcement program is in a critical
transition period. Since joining the Commission in January, our
new Chairman, Mary Schapiro, has been taking important steps to
bolster our enforcement efforts and restore investor confidence
to our markets. Among other things, she has hired a new
Director of Enforcement, Robert Khuzami, an accomplished former
Federal prosecutor who is scheduled to join the agency at the
end of this month. And she has begun streamlining our
enforcement processes.
Today, as detailed in my written statement, I would like to
talk about the SEC's law enforcement authority and the steps we
are taking to address the current crisis. As you know, the SEC
is a capital markets regulator and a law enforcement agency. We
are charged with civil enforcement of the Federal securities
laws, and our Enforcement Division is authorized to investigate
any potential violation of these laws. We have the authority to
take action against any form of fraud in connection with the
purchase or sale of securities.
Our Enforcement Division, which numbers about 1,100,
initiates investigations based on information from many
sources, including referrals from within the Commission itself
and from other regulators, investor complaints, and tips. In
Fiscal Year 2008, the Division received more than 700,000
complaints, tips, and referrals.
The enforcement staff coordinates its work with other law
enforcement bodies across the country and around the globe in
order to leverage enforcement resources effectively. In our
actions, we seek a variety of remedies, including disgorgement
of ill-gotten gains, permanent injunctive relief against
violations of the law, remedial undertakings, civil penalties,
revocation of registration, and bars to prevent a wrongdoer
from serving as an officer or director of a public company or
from associating with any broker-dealer or investment adviser.
Whenever possible, the Commission seeks to return monies to
harmed investors under the Fair Funds provisions of the
Sarbanes-Oxley Act. Under the authority granted to us by
Congress in that legislation in 2002, we have authorized
approximately 220 Fair Funds, with an estimated total value of
more than $9.3 billion that has been or will be distributed to
investors.
To halt an ongoing fraud or to prevent misuse of investor
funds, we have the ability to seek emergency relief in court,
including temporary restraining orders, preliminary
injunctions, asset freezes, and the appointment of a receiver
to conduct operations during the case or to marshal any
remaining assets for the benefit of injured investors. During
this fiscal year thus far, we have already obtained 20
temporary restraining orders to halt ongoing frauds.
I would like to take a minute to give you a few examples of
our recent work to address the current crisis. Our Enforcement
Division has already filed nine cases involving subprime
issues, and has many more under active investigation. And
through the collective efforts of SEC enforcement, State
regulators, and FINRA, the self-regulatory organization for
broker-dealers, over the past year, tens of thousands of
auction-rate securities investors have received or will soon
receive over $67 billion of liquidity. These cases involve the
largest monetary settlements in the history of our agency.
Also, we are investigating the possible manipulation of the
securities of six large financial issuers involved in the
recent market turbulence, with particular focus on claims that
credit default swaps were being used to manipulate equity
prices.
We have also brought many cases involving hedge funds. As
you know, hedge funds and their advisers are not required to
register with us, but we still have authority to pursue fraud
cases against them. The SEC has dozens of active investigations
involving individuals associated with hedge funds.
Over the past 2 years, the Commission has filed enforcement
cases against the perpetrators of more than 75 Ponzi schemes,
including 12 such cases since December 2008. For example, we
recently filed an emergency action against Robert Allen
Stanford and others, alleging a massive Ponzi scheme. At our
request, the court issued a temporary restraining order,
appointed a receiver, and ordered an asset freeze.
Also this week, we filed a complaint alleging fraud by the
accountant who purportedly audited the firm run by Bernard
Madoff. A criminal fraud case was brought at the same time.
The SEC is committed to finding ways to improve, to act
more quickly and efficiently. Within days after her appointment
as SEC Chairman, Mary Schapiro repealed the pilot project under
which enforcement staff were required to seek preauthorization
from the five-member Commission before negotiating civil money
penalties against public issuers. In addition, she streamlined
the process for obtaining formal orders, and now they can be
authorized by a single Commissioner. We are also working with
the Center for Enterprise Modernization, a federally funded
research and development center, to establish a centralized
process that will more effectively identify leads for potential
enforcement as well as areas of high risk for compliance.
But these steps are just the start. We are carefully
examining our processes from top to bottom. However, while our
job has grown substantially, our resources have not kept pace.
Our staffing levels have actually declined in the recent past,
and our technology must be improved.
As the sole agency charged with protecting investors, the
SEC is committed to restoring the confidence needed for our
marketplace to thrive. Thank you again for the opportunity to
testify, and I look forward to answering any questions you
have.
[The prepared statement of Commissioner Walter can be found
on page 223 of the appendix.]
The Chairman. Next, Martin Gruenberg, who is the Vice Chair
of the Federal Deposit Insurance Corporation.
STATEMENT OF THE HONORABLE MARTIN J. GRUENBERG, VICE CHAIRMAN,
FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Gruenberg. Thank you, Mr. Chairman, and members of the
committee. I appreciate the opportunity to testify on behalf of
the FDIC regarding enforcement of consumer and investor
protection laws.
Earlier this month, in a speech before the National
Association of Attorneys General, FDIC Chairman Bair stated
that many of the current problems in the economy were caused by
a widespread failure to protect consumers. She noted that it is
essential that those whose actions contributed to the current
crisis and who are engaging in practices harmful to consumers
be held accountable, and that we take steps to prohibit these
practices from occurring again.
The FDIC has a strong commitment to the vigorous and
effective enforcement of consumer protection laws and other
statutes under its jurisdiction. The FDIC brings a unique
perspective to this issue because of the variety of functions
it performs, including deposit insurer, bank supervisor, and
receiver for failed insured depository institutions.
Immediately following the closing of every failed
institution, FDIC investigators and attorneys begin an
investigation. The purpose is to determine whether the failed
institution's directors, officers, and professionals such as
accountants, appraisers, and brokers were responsible for its
losses, and if so, to hold them accountable.
Recent failures of insured institutions, 3 in 2007, 25 in
2008, and 17 thus far this year, have resulted in a substantial
increase in our investigations and professional liability
workload. Since the beginning of 2007 through today,
investigations of mortgage fraud claims have increased from 0
to 4,375. Investigations of professional liability claims other
than mortgage fraud have increased from 34 to 427. And mortgage
fraud lawsuits have increased from 0 to 113.
As receiver of a failed institution, the FDIC has the
authority to terminate contracts upon an insured institutions's
failure. The FDIC routinely terminates compensation and other
contracts with senior management whose services are no longer
required.
In addition to the development and support of civil claims
brought by the FDIC with regard to failed institutions, our
investigators also identify signs of possible criminal activity
in a failed institution. These findings support the Department
of Justice's subsequent prosecution of the wrongdoers. The FDIC
also coordinates with other Federal, State, and international
agencies to detect and deter bank fraud.
The FDIC, in addition, pursues enforcement actions against
open insured depository institutions, their directors and
officers, employees, and other institution affiliate parties
where warranted, including third parties and independent
contractors such as accountants, attorneys, and appraisers,
under its Federal Deposit Insurance Act authority.
When FDIC examiners find other violations of law, breaches
of fiduciary duty, unsafe and unsound practices or
mismanagement in banks' consumer protection responsibilities,
the FDIC requires corrective action. During 2007 and 2008, the
FDIC issued 142 cease and desist orders and 102 removal and/or
prohibition orders banning individuals from banking. These
enforcement actions were based on a variety of harm or risks
caused to an insured institution, and included theft and
embezzlement by employees of the bank, poor lending policies or
procedures, and fraudulent actions on the part of a lending
officer.
Removing from office and prohibiting from banking those who
commit financial crimes is a primary goal of FDIC enforcement
actions. The employees found to have committed financial crimes
are removed from positions of trust, and are often required to
make restitution and pay a financial penalty to remedy these
transgressions.
The FDIC's Office of Inspector General brings another level
of enforcement. The OIG conducts investigations of fraud and
other criminal activity in or affecting FDIC-regulated open
financial institutions, all closed institutions in
receiverships, and other FDIC-related programs and operations.
Currently, the OIG has about 170 active investigations
involving open and closed institutions. The work focuses on
various types of fraud, including mortgage securities and
crimes such as embezzlement and money laundering.
Investigations of financial institution fraud currently
constitute about 88 percent of the OIG's investigative
caseload. Over the last 2 years, it has closed about 100
investigations, with the crimes occurring almost exclusively in
open institutions. These investigations have resulted in over
230 indictments, 170 convictions, and over $530 million in
fines, restitution, and monetary recoveries.
The FDIC expects the enforcement challenges in both the
closed bank and open bank context to increase for the
foreseeable future. In order to handle the substantially
increased workload in the closed bank area, we are increasing
our enforcement staff as well as retaining outside counsel. We
have also added to both our civil and criminal investigations
staff. In the open bank area, the FDIC has added 87 full-time
compliance examiners in 2007 and 2008, and has authorized the
hiring of 79 more. Since 2007, we have increased our legal
staff responsible for open bank enforcement by 29 attorneys.
The FDIC's core mission is to maintain public confidence in
the banking system. Critical to the achievement of that mission
is to hold accountable those who do not comply with applicable
laws and regulations. The FDIC looks forward to continuing to
work closely with the committee to achieve that goal.
Thank you, Mr. Chairman.
[The prepared statement of Vice Chairman Gruenberg can be
found on page 114 of the appendix.]
The Chairman. Next, the Acting Director of the Office of
Thrift Supervision, Mr. Scott Polakoff, to whom this committee
gave, I think, 2 days off this week. So welcome back, Mr.
Polakoff.
STATEMENT OF SCOTT M. POLAKOFF, ACTING DIRECTOR, OFFICE OF
THRIFT SUPERVISION
Mr. Polakoff. Thank you, sir.
Good morning, Chairman Frank, and members of the committee.
Thank you for the opportunity to testify on the enforcement
authority that the OTS exercises over regulated institutions
and their affiliates, and in particular OTS enforcement of
consumer protection laws.
The OTS has broad powers to protect customers of federally
regulated thrifts, their affiliates, and thrift holding
companies. These powers include specific authority regarding
truth in lending and unfair or deceptive practices. As you
know, the OTS used that authority over unfair practices to
initiate a process resulting in a final interagency rule in
January of 2009 banning unfair credit card practices.
We exercise our enforcement authority when our examiners
find problems during their examinations of thrifts as well as
when we receive consumer complaints and referrals from other
agencies.
Throughout 2008 and into 2009, we have seen a steady
increase in OTS enforcement actions. Formal actions, such as
cease and desist orders and monetary penalties, increased by 45
percent from 2007 to 2008, and the pace is accelerating further
this year.
I would like to highlight two particularly notable cases.
The first one occurred in June of 2007 and involved a Federal
savings bank and two affiliates that were charging excessive
fees to mortgage customers and failing to adequately evaluate
their creditworthiness. We required these institutions to
immediately stop these practices, establish a fund of $128
million to reimburse consumers, and commit an additional $15
million to support financial literacy and credit counseling.
The second case, in June of 2008, involved a Federal
savings bank and its subsidiaries that were charging
inappropriate and, in some cases, very large broker and lender
fees to mortgage customers. The enforcement action required the
bank to reform its practices and establish a $5 million fund to
reimburse consumers. Since 2007, I believe that OTS is the only
Federal banking agency to require institutions to make
restitution to bank customers for abusive lending practices,
enabling the customers to stay in their homes.
On criminal matters, the OTS makes referrals to the
Department of Justice and U.S. Attorneys' offices. The number
of these referrals is increasing, particularly in the fair
lending area. Five recent cases involve steering customers to
more expensive mortgages based upon their race or national
origin.
I would also like to point out that the OTS has been
increasing its enforcement resources for several years. Since
2006, the agency has increased the number of attorneys in its
Enforcement Division by 67 percent. The agency has also been
expanding the size of its staff devoted to fair lending issues.
As we discuss actions that will better protect consumers, I
think it is important to point out that gaps in laws and
regulations over mortgage lending leave some sectors of the
financial market underregulated, and therefore may leave
consumers unprotected. These sectors include mortgage brokers
and mortgage companies.
We urge Congress to establish a level playing field in
mortgage lending, with the same rules and oversights for all
players. Consumers do not understand, nor should they need to
understand, distinction between types of lenders offering to
provide them with a mortgage. They deserve the same service,
care, and protection from any lender.
Finally, I would like to offer two suggestions for
legislative changes that would improve consumer protection.
Number one, expand and enhance the temporary cease and desist
authority to make it easier to apply in consumer protection
cases. Number two, improve the jurisdiction of Federal banking
regulators over third parties such as mortgage brokers,
appraisers, and consultants to whom depository institutions
outsource key parts of their business.
Thank you again, Mr. Chairman.
[The prepared statement of Acting Director Polakoff can be
found on page 152 of the appendix.]
The Chairman. Thank you, Mr. Polakoff. Those last two
points are very much what we were hoping to hear.
And next, with the cooperation of the Judiciary Committee,
which has the primary jurisdiction over the Department of
Justice, Ms. Rita Glavin, who is the Acting Assistant Attorney
General of the Criminal Division.
STATEMENT OF RITA M. GLAVIN, ACTING ASSISTANT ATTORNEY GENERAL,
CRIMINAL DIVISION, U.S. DEPARTMENT OF JUSTICE
Ms. Glavin. Good morning, Mr. Chairman, and members of the
committee, and members of the House Judiciary Committee. Thank
you for your invitation to speak today.
The Nation's current economic crisis has had devastating
effects on the mortgage markets, credit markets, the banking
system, and all of our Nation's citizens. And although not all
of our current economic ills are the result of criminal
activity, the financial crisis has laid bare criminal activity
such as Ponzi schemes that may have otherwise gone undetected
for years.
The Department of Justice is committed to redoubling our
efforts to uncover abuses involving financial fraud schemes,
mortgage lending and securitization frauds, foreclosure rescue
scams, government program fraud, bankruptcy schemes, and
securities and commodities fraud. And we are committed to
adopting a proactive approach for better detecting and
deterring such fraud in the future. Put simply, where there is
evidence of criminal wrongdoing, including criminal activity
that may have contributed to the current economic crisis or any
attempt to criminally profit from this crisis, the Department
will prosecute those wrongdoers. We will work tirelessly to
recover assets and criminally derived proceeds and strive to
make whole victims of such schemes.
Historically the Department has had tremendous success in
identifying, investigating, and prosecuting massive financial
fraud schemes. Last year, for example, the Department secured
the convictions of five former executives, including the owner
and president of National Century Financial Enterprises, one of
the largest health care finance companies in the United States
until its bankruptcy in 2002, on charges stemming from an
investment fraud scheme resulting in $2.3 billion in investor
losses. Similarly, last year the Department obtained the
conviction of a former AIG executive and several Gen Re
executives who engaged in corporate fraud by executing two
false reinsurance transactions to conceal a $59 million
decrease in the loss reserves of AIG.
From the Department's prosecution of executives of Enron to
WorldCom to Adelphia to Revco, the prosecution of mortgage
fraudsters and architects of Ponzi schemes across the country,
the Department has considerable institutional experience which
it can and will draw upon in fighting crimes that relate to the
current crisis. Indeed, in recent weeks the Department has made
clear that its commitment to prosecuting financial crimes will
not abate.
The Department secured a guilty plea from Bernard Madoff
for securities fraud and mail fraud violations. The Department
filed a criminal complaint against the chief investment officer
of Stanford Financial, alleging that she obstructed a
Securities and Exchange Commission investigation into the
activities of Stanford Financial. And these are just two
examples of the Department's ongoing vigorous enforcement
efforts.
The Department has approached the current financial problem
with three primary goals. The first is coordination. The
Department has sought to aid in coordination among law
enforcement agencies. The sharing of information and ideas is
essential to identifying and prosecuting financial fraud in the
mortgage fraud problem. Accordingly, the Department has
encouraged and led by example a comprehensive information-
sharing effort within the Department and amongst our partner
agencies.
Second, investigation and prosecution. The Department has
focused on the investigation and prosecution of financial fraud
and mortgage fraud for many years. When criminals go to jail,
we deter similar conduct by others. The Department over the
last several years aggressively prosecuted mortgage fraud
cases, and we have yielded nationwide sweeps, resulting in
hundreds of convictions, and sending criminals to jail when
appropriate.
Third, in addition to deterring, detecting, and prosecuting
crimes, the Department is committed in its responsibilities to
help the victims of financial fraud and mortgage fraud schemes,
and, to the extent possible, attempt to make them whole. To
this end, prosecutors and law enforcement partners work to
locate and recover assets from the criminals and provide
restitution to the victims.
Unquestionably, the crisis now demands an aggressive and
comprehensive approach, and we are going to do that, doing it
the way we have always been doing it, through vigorous
investigations and prosecutions of those people who defraud
their customers, the American taxpayer, and may otherwise have
unlawfully placed billions of dollars of private and public
money at risk. We are committed to the effort. We are going to
look at allegations of fraud closely, follow the facts where
they may lead, and bring our resources to bear to prosecute
those who have committed crimes. Thank you for the opportunity
to address the committee, and I would be happy to answer any
questions.
[The prepared statement of Acting Assistant Attorney
General Glavin can be found on page 102 of the appendix.]
The Chairman. Thank you.
Our next speaker is John Pistole, who is the Deputy
Director of the FBI.
STATEMENT OF JOHN PISTOLE, DEPUTY DIRECTOR, FEDERAL BUREAU OF
INVESTIGATION
Mr. Pistole. Thank you, Chairman Frank and, from the
Judiciary Committee, Chairman Scott, and other members of the
committee.
Today, I would like to give just a very brief overview of
what we in the FBI are doing in facing the challenges that we
have, and I will describe some of the current efforts to combat
the fraud that has been described previously.
To state the obvious, we have experienced a significant
increase in mortgage-fraud-related cases since 2005, when we
had approximately 720 investigations. Today, the FBI has more
than 2,000 active mortgage fraud investigations and an
additional 566 corporate fraud investigations, a trend which we
expect to continue. Our work in mortgage-fraud-related crimes
generally appears in two distinct areas: fraud for profit; and
fraud for housing.
Our primary focus is in the fraud-for-profit area, which
refers to those individuals who falsely inflate the value of
property or issue loans related to fictitious properties. These
schemes rely on industry insiders, those appraisers,
accountants, mortgage brokers, and other professionals--who
override lender controls designed to prevent this crime from
happening.
The second area, fraud for housing, occurs when an
individual borrower, often with the assistance of a real estate
professional, acquires a house in which to live under false
pretenses.
The current financial crisis has also produced an
additional consequence--the exposure of pervasive fraud schemes
that have been thriving in the global financial system. These
schemes are not new but are coming to light, as has been
described, as a result of market deterioration. For example,
numerous Ponzi schemes, such as Madoff and other investment
frauds, have been uncovered which we are actively pursuing in
the following ways:
We have shifted resources and now have over 250 agents and
approximately 50 financial analysts and other intelligence
analysts assigned to mortgage fraud and related investigations.
We also have another 100-plus agents working corporate fraud
matters. We also augment our efforts with approximately 250
State and local law enforcement officers assigned to 18
mortgage fraud task forces and 47 working groups. We also
established at our FBI headquarters a national mortgage fraud
team to coordinate and to prioritize the FBI efforts across the
country and to provide tools to identify the most egregious
fraud perpetrators and to work even more effectively with our
counterparts in law enforcement, and regulatory and industry
leaders.
Even before the creation of this national initiative, we
were seeing results from our increased focus in this area. For
example, last June, we completed the initial phases of what we
called ``Operation Malicious Mortgage,'' involving the arrest
of more than 400 offenders nationwide believed to be
responsible for more than $1 billion in estimated losses. This
initiative has focused on three types of mortgage fraud:
lending, of course; mortgage rescue schemes; and mortgage-
related bankruptcy schemes. Our work on that initiative and
others continues.
In closing, it is clear to us in the FBI and to our law
enforcement partners that more must be done to protect our
country and our economy from those who try to enrich themselves
through illegal financial transactions. We are committed to
doing so, and we appreciate the committee's support. Thank you.
[The prepared statement of Deputy Director Pistole can be
found on page 144 of the appendix.]
The Chairman. Let me begin with Mr. Polakoff.
On page 17, Roman numeral V, as to closing the regulatory
gaps, you talk about establishing a level playing field. You
talk about unregulated or underregulated people in the mortgage
market.
The Federal Reserve has proposed some rules, as you know.
Actually, under the better-late-than-never category, the
Federal Reserve is invoking authority that this Congress gave
it in 1994. It was not used. Mr. Bernanke, to his credit,
decided to use it.
Is that the kind of thing you are talking about? What
specific language would you be looking for?
Mr. Polakoff. Mr. Chairman, what I am talking about is
boots-on-the-ground examiners.
The difference is, you take your respective State; Steve
Antonakes does a great job with examining mortgage brokers and
mortgage companies in your State. Not all States have such a
robust program. Sometimes it is because they do not have a
sufficient budget, and there are other reasons, so the rules
need to be consistent across-the-board, but the boots on the
ground actually examine--
The Chairman. Do you think we need uniform Federal mortgage
regulations for the nonbanks? I assume we are talking about
nonbanks.
Mr. Polakoff. Yes, sir, but it is the two parts. It is the
uniform regulation, and then it is the prudential supervision
of such.
The Chairman. In those cases where you think the States may
not have enough, would you authorize Federal regulators to step
in? How would we deal with that?
Mr. Polakoff. Yes, sir. We are suggesting that the State
charter remain as it currently is for these mortgage brokers or
mortgage companies, and there would be a joint examination
program with a Federal partner and a State partner.
The Chairman. That is an interesting approach.
Triggered by the State's request or would you have the
right to go in with or without a request?
Mr. Polakoff. Just like State-chartered banks now, we would
suggest it would be an alternating program.
The Chairman. I am not sure I know what that means.
Mr. Polakoff. I am sorry. So right now, for a State-
chartered bank, typically the State examiners go in one year to
conduct the examination. Then, the FDIC or the Federal Reserve
goes in the other year to conduct the examination.
The Chairman. And you would do the same with the OTS?
Mr. Polakoff. Our recommendation is there should be a
Federal agency. We would love to take that responsibility. It
would be up to you, sir, and Congress.
The Chairman. All right. Then I also appreciate your very
specific request about cease and desist power and the third
parties, and we will be taking those seriously.
Mr. Pistole, if that is not the correct pronunciation, I
apologize.
Mr. Pistole. It is correct, Mr. Chairman.
The Chairman. On the other hand, I do not pronounce
anything that well.
Mr. Pistole. ``Pistole'' is correct.
The Chairman. Obviously, the complaint, accusation,
explanation has been that, since September 11, 2001,
understandably, you have become the first line of defense for
American safety in ways that we had not anticipated. We are all
grateful for that.
The argument has been made that it has led to a diminution
of activity elsewhere. For instance, mortgage fraud lacks the
sense of physical threat. So I have a two-part question: Has
enforcement in that area suffered because of other priorities?
If so, do we need to do something to overcome it? I guess that
is the general sense and not a criticism of the FBI, because I
think people would say, if we had to choose between being blown
up and being defrauded, defrauded would win. Can we avoid that
choice in some ways, and is that a legitimate explanation of
what has happened in the past?
Mr. Pistole. Thank you, Mr. Chairman.
After 9/11, obviously, we moved a number of our traditional
criminal investigative resources to national security,
particularly counterterrorism. Most of those resources were in
our drug enforcement areas, recognizing the Department,
obviously, the DEA, had that primary responsibility and that
the FBI did not, frankly, need to be in the drug enforcement
business.
There were some lower level, white-collar crimes such as
bank teller fraud and things like that, and we did get out of
that business, so we did have that, but we did continue in the
significant corporate fraud investigations and other financial
frauds, as appropriate, depending on the U.S. Attorney's
Office's prosecutive guidelines and all that.
So, as I mentioned, we have more than doubled our resources
toward the mortgage fraud/corporate fraud investigations in the
last 2 years, trying to address those allegations that have
been coming in and also trying to be proactive. I would note
that we have several ongoing undercover operations, for
example, in the corporate fraud and financial fraud areas where
we are being proactive about seeking out perpetrators of frauds
on a wide-scale basis, not just sitting back, waiting for
referrals to come in.
The Chairman. Thank you.
The gentleman from California, who has graciously waived
his opening statement, will have his 5 minutes.
Mr. Campbell. I do not know how gracious I was by being
tardy, but I will accept that.
The Chairman. I would just say to the gentleman, as
chairman of the committee, I never mind members' absences.
Mr. Campbell. Should I take that personally, Mr. Chairman?
Anyway, thank you all for being here.
My question is going to be very broad and is to all of you.
I could go specifically and all that, but in front of us today,
we have representatives of the Federal Reserve, the Comptroller
of the Currency, the SEC, the FDIC, the Office of Thrift
Supervision, the Department of Justice, and the FBI. So we have
seven separate agencies all testifying in reasonable detail
about the investigative things you are doing relative to the
financial services area and issue.
My first overall question is: Do any of you believe that
there are duplicative areas where two out of the seven of you
or three out of the seven of you have an overlapping
jurisdiction or responsibility that results in and that has a
lack of coordination? Or, alternatively, are there areas where
there is a gap in the current jurisdiction, and so none of the
seven of you believe that it is actually your primary
responsibility to investigate? Do not all speak at once.
Mr. Polakoff. Congressman, I would offer only one example,
and it is not a gap. It is possibly an overlap, but I do not
think it is bad.
The example I would offer, sir, is if, in a financial
institution, there is an individual who may have his or her
activities warrant an investigation on our part to possibly
remove that individual from a bank, quite possibly, the FBI or
Justice will be looking at that same individual and will ask us
to stand down while it completes its investigation. That is not
bad. That is an overlap, and we will work together through
that. That is the only example I can think of off the top of my
head, sir.
Mr. Campbell. Yes. Commissioner Walter?
Ms. Walter. Thank you.
In the securities arena, there are gaps in the SEC's
authority with respect to certain types of instruments or
entities.
For example, a few years ago, we attempted to regulate
hedge funds and those rules were struck down by the courts so
that, today, we do not regulate hedge funds. As I noted in my
oral statement, we do have antifraud authority, but what we do
not have is the access to information about who all of them are
unless they voluntarily register, what the principals are, the
nature of their activities. Similarly, we specifically have no
authority with respect to the credit default swap market.
So there are a number of areas in which there are
regulatory gaps that should be filled so that the appropriate
regulatory agencies--in this case, we think the SEC--have full
information about what is going on and can proceed vigorously.
Mr. Campbell. Thank you.
Ms. Glavin?
Ms. Glavin. What I was going to mention from the
Department's perspective is that we work with each of these
agencies. One of the best, most recent examples is we are
working now with the SEC on the Stanford financial
investigation. They work at it from the civil side. We work at
it from the criminal side.
One of the ways that we try to check on overlap and on
coordinating our efforts is that we have within the Criminal
Division a Bank Fraud Enforcement Working Group where we meet
on almost a monthly basis, with a number of the agencies that
are represented here, to talk about what they are doing
regulatory-wise, and we do some information sharing and
coordination. There are a number around the country, and it is
not limited to just the agencies here, but there are task
forces and working groups around the country that are
specifically formed with the aim to try and coordinate our
efforts, do deconfliction where it is appropriate, and do
coordination where it is appropriate as well so that the
taxpayer gets the most bang for his law enforcement regulatory
buck.
Mr. Campbell. Okay. Do any of the rest of you wish to
comment?
Yes, Comptroller?
Mr. Dugan. I would just highlight and amplify what Director
Polakoff said earlier about having a common mortgage standard
that goes across all providers so there are no gaps in what the
rules are and, secondly, to have comparable kinds of
supervision and enforcement to make sure those rules are
enforced comparably. I think that was a big issue that led to
where we are now with respect to the mortgage crisis, and I
think the kind of legislation the committee passed last year
with some amendment, I think, is quite appropriate.
Mr. Campbell. Thank you.
Governor Duke, did I see you?
Ms. Duke. I would really echo what Comptroller Dugan said,
and would point out that this was the focus of the HOEPA
regulations that the Federal Reserve issued last year, which
was to cover all lenders.
Also, we had a pilot program to go in with both Federal and
State examiners into the subsidiaries of holding companies that
we supervise and look at the mortgage operations for consumer
compliance as well as consumer protection. I think using the
authorities that we already have in new ways is also going to
be important in addition to any new authorities we might get.
Mr. Campbell. Thank you very much.
My time has expired.
Ms. Waters. [presiding] Thank you very much. I will
recognize myself for 5 minutes.
In my work on the foreclosure crisis, I have noticed an
explosion of fake Web sites that try to confuse homeowners into
believing that they are official government sites.
On Wednesday, I contacted the Federal Trade Commission and
the Federal Communications Commission to alert them about such
a fraudulent Web site that was purporting to offer loan
modifications through the Making Home Affordable Program. Of
course, within hours of my letter, the Web site was taken down.
However, I am really concerned about those Web sites and
the national ads. For example, there is one called the Federal
Loan Modification Company that is getting more and more
aggressive. There is no oversight for a business that springs
up, purporting to do loan modifications with names that sound
like government names.
What can be done? Who is doing something about that or who
is at least looking at it?
Mr. Pistole. We in the FBI, ma'am, look at any fraud that
would be perpetrated by one of those businesses, primarily
through our Internet Fraud Complaint Center, which receives
thousands of complaints from people around the country, such as
you have seen on the Web sites, so we look at it from the fraud
perspective and whatever type of fraud it is, but we are not in
the prevention business, if you will, of preventing those sites
from going up. Obviously, we do not do that, but we have a
number of those types of investigations ongoing right now.
Ms. Waters. Let me just ask you: The Federal Loan
Modification Company is advertising that, for $3,500, when you
talk to them, and I have called them, they will take care of
modifying your loan. They almost guarantee it. They assure you
that they can do that, and they collect $3,500 from you, but
they say, ``We tried, and the loan servicer just would not
cooperate.''
What is that? Is that fraud?
Mr. Pistole. I do not know the specifics about that one,
but typically, that is an advanced fee scheme where somebody is
required to pay a fee for a service that is not rendered, and
it is oftentimes used by people around the world. The Nigerian
fraud schemes are prevalent. In fact, my name and Director
Mueller's name have been used in saying the FBI has endorsed
this, so it is okay to provide that information. So I will get
calls from friends and family saying, ``Is this accurate?'' It
is, obviously, not.
Ms. Waters. Do we need to regulate this whole servicer
industry? It has become very important. We have servicers who
are independent and some who are working for our own government
agencies. Everybody has to have them, whether it is Fannie or
Freddie, etc. They all have servicers that they are contracting
with, but I do not know who the servicers are. I do not know
where they get their training. There is no licensing required,
and anybody can be a servicer. Do we need some new public
policy to deal with servicers?
Mr. Pistole. I would suggest that we would work with the
Department and the committee to explore that further.
Ms. Waters. All right. I have another little question I
want to ask, but it may not seem so big or important.
Yesterday, I heard information about overdrafts that really
bothered me. I understand that there are debit cards that
students may use, that parents get for them. They buy a cup of
coffee or something at Starbucks, and they can use that card
even if they do not have enough money on it, and then they
follow up with a $35 charge on a $4 item.
What is that considered? Let the marketplace work as it
may? Should there be any consumer protection in that at all?
Mr. Pistole. I would defer to my colleagues on that one.
Ms. Duke. Yes, ma'am.
The Federal Reserve has regulations out for comment right
now that would govern overdrafts and particularly those that
are with electronic means, debit card overdrafts, and those
regulations are out for comment. I am not sure exactly how far
we are through the comment period, but it would address exactly
that.
Ms. Waters. But it is something you are taking a look at?
Ms. Duke. Yes, ma'am.
Ms. Waters. Finally, let me just say to all of you:
Obviously, Countrywide emerged as the poster nonbank for
what was wrong with predatory lending and the subprime market.
How did they stay in business so long and get so far as a
nonbank with the kind of exotic products that they were putting
on the market with untrained brokers on the street? Who was
looking at that? What could have been done with what
Countrywide was doing? Anybody? Somebody?
Mr. Polakoff. Congresswoman, from an OTS perspective, I can
only speak from early 2007 when Countrywide converted to a
thrift. As you very astutely point out, a good portion of the
predatory lending business or subprime business was conducted
outside of the insured financial institution, so we would have
looked at that. Looking back and looking at all of those
activities, it would have been under the responsibility of the
State banking or the State entity to look at that particular
mortgage company.
Ms. Waters. Yes.
Mr. Dugan. Before it became a thrift, Countrywide had a
national bank, and it also had a holding company that engaged
in its mortgage activities. A relatively small proportion was
conducted in the bank. We did not allow the subprime to be put
in the bank, and so the mortgages that were actually booked in
the bank were not the issue, but it eventually left our charter
and became a Federal thrift.
Ms. Waters. I have to go to our next member now, but--
Mr. Gohmert. Madam Chairwoman, if there are others who want
to respond, I would love to hear from them.
Ms. Waters. Oh, I am sorry. Are there any others who would
like to respond? Yes, just one second. Okay. We do not have
anyone else who would like to respond.
Lastly, the so-called ``exotic products'' that keep
springing up and all of the products that were on the market,
whether they were Alt A or adjustable rates options, etc., am I
to understand that any product that can be thought of by
somebody--a mathematician or somebody assisting banks in ways
to make more money--can go on the market without your stopping
them? Does anybody have the ability to stop an exotic product
that, obviously, is going to defraud our consumers?
Mr. Polakoff. I will take the first stab at it.
What all of the banking regulators have the ability to stop
is a predatory product, an unsafe and unsound product. So the
important test for us, Congresswoman, is whether the borrower
has the capacity to repay, whether that is properly assessed.
Equally as important is whether the borrowers have the ability
to understand the product that they are committing to.
The Chairman. The gentleman from Texas.
Mr. Gohmert. Thank you, Mr. Chairman. I am pleased you came
back just to hear me. Thank you.
I am curious. We have had the credit default swaps brought
up a number of times. What do you think would have been the
most effective way to regulate or to control these things that
really threaten to bring down our financial system? Obviously,
it is a threat. Should they have been regulated by some type of
insurance standards or do one of you all have the ability and
the wherewithal to actually regulate them effectively? What do
we need to do? I am throwing that open to anybody.
Ms. Walter. Let me start.
I believe that, like many other innovative financial
products, it is very important that there not be a lack of
transparency. That is the first critical step.
Mr. Gohmert. Do you think there might have been some?
Ms. Walter. Oh, only a little, perhaps, but when you have a
product like this spring up and grow by leaps and bounds and
become huge and become systemically important before anyone has
any information about it, I think that is the first place to
start. We can all attack the issues to a certain extent from
the institutions we regulate. For example, we regulate broker-
dealers and investment advisers, but unless there is
transparency within the marketplace itself--
Mr. Gohmert. I agree with the transparency, but I am asking
specifically: Who really should have the ultimate authority now
that we know how untransparent they were? Who should have the
ultimate authority to regulate them? Who would have the
wherewithal to do it most effectively?
Ms. Walter. I think it would be a combination of different
regulators. We, on the one hand--
Mr. Gohmert. That is pretty specific. Could you be just a
little more specific?
Ms. Walter. Of course. I will go on from there.
I think that the SEC has a role to play in terms of looking
at the market forces that go on in terms of how these
instruments are traded. You are right. They are, essentially,
an insurance product, so there may be a role for insurance
regulators to play.
There, obviously, is a role for my colleagues up here at
the table to play because a lot of these instruments are held
by institutions they regulate. I do think, in the first place,
you need a market regulator who can look at the forces that are
operating and at the trading that is going on in the market as
a whole.
Mr. Gohmert. And you are talking specifically about which
market regulator?
Ms. Walter. I am talking about the market actually in
trading and the transactions that are going on in the credit
default swap market.
Mr. Gohmert. No. What entity? When you say it requires a
market--
Ms. Walter. I believe that the SEC is the right regulator
to do that.
Mr. Gohmert. All right. That is what I was trying to get
to. All right.
Anybody else?
Governor Duke?
Ms. Duke. The Federal Reserve has believed for some time
that these should be traded on a central exchange, and we have
just approved a central exchange for counterparties for that.
The Federal Reserve Bank in New York has been working on this
for a number of years, and there is now one up and running. I
think that will also improve the trading of the credit default
swaps.
Mr. Gohmert. Do you think that these things that you have
both mentioned would be enough to control what has become,
basically, criminal because of the effect on our economy?
Civilly, would that be sufficient to regulate this group
without imposing new criminal laws?
Ms. Walter. I believe that the criminal laws that are out
there are sufficient to cover it.
One of the things that will happen with the centralized
counterparties--and there are two others that are going to be
up and running soon, we think, and have been approved--is that
you will get more regularized pricing information, which will
provide the public with some indicators that are better than
the ones that are out there. But if you put them in a system,
for example, where you call them ``securities,'' securities
fraud will apply. The mail fraud, as well, will apply. So I
believe that the criminal statutes are sufficient, but I would
defer to the criminal authorities to my left.
Mr. Gohmert. Let me ask a quick question regarding the FBI.
My time is running out.
Mr. Pistole, I appreciate your being here.
From my experience and from what I have seen, white-collar
crime requires more experience, more expertise, more training.
I know that since Director Mueller has been in charge, he has
this 5-year up-or-out policy that has forced out thousands and
thousands of years of experience.
Are you still forcing out all of our best experienced
agents in charge out in the field or have you backed off of
that policy a little bit?
Mr. Pistole. We have modified that policy.
Mr. Gohmert. Because I have not heard that from the field
yet.
Mr. Pistole. We have modified that for our field
supervisors from 5 years to 7 years, and have even given them
an option to go up over 8 years if they do some time back at
headquarters. Yes, we have modified that.
Mr. Gohmert. Okay. I see my time has expired.
Thank you.
The Chairman. Let me now turn to the Chair of the Judiciary
subcommittee, who is our partner, Mr. Scott--or Mr. Moore
first. Let us go to Mr. Scott first to recognize the joint
jurisdiction.
Mr. Scott of Virginia. Thank you, Mr. Chairman.
I want to follow up on the last question a little bit, to
Ms. Glavin and Mr. Pistole.
If everybody knew that they had these so-called ninja
loans--no income, no jobs, no assets--and they were passed off
as AAA assets secured by real estate when, in fact, no one had
done any due diligence to ascertain the reasonable value of the
collateral or whether or not the borrower had any capacity to
pay for the loan after the readjustment from a teaser rate; if
everybody knew all of that was going on and an investor bought
the package based on a AAA rating, is there any problem with
the criminal law, fraud, wire fraud, and other things to go
after that kind of activity? Do we need any new criminal laws?
Ms. Glavin. There is a bill that just came out of the
Senate Judiciary Committee which the Justice Department
supports. It is the Fraud Enforcement and Recovery Act of 2009,
sponsored by Senators Leahy and Grassley.
A couple of the key provisions of that Act, which would add
tools to a prosecutor's arsenal beyond traditional mail fraud
and wire fraud, are that it would amend the definition of
``financial institution'' in title 18 to include private
mortgage lending businesses. So if you make a false statement
to a private mortgage lending business, which did a lot of
these subprime loans, we can prosecute you under some different
statutes, not just the mail and wire fraud statutes. That would
be helpful, and it would expand the menu of options that
prosecutors can use. Also, I think it could help us make
cleaner presentations to grand juries and to juries.
Mr. Scott of Virginia. Is that a jurisdictional issue that
you do not have to prove mail and that you can just prove a
financial institution?
Ms. Glavin. With mail and wire fraud, you do have to find
the mails and the wires. On the amendments to that particular
statute, I think there has to be some type of a Federal nexus,
which, I think, you would probably be able to find in a lot of
the private mortgage lending companies. If there is an
interstate--
The Chairman. If the gentleman would yield, only very few
of them operate intrastate.
Ms. Glavin. Yes.
The Chairman. I do not know of any company that does its
business only intrastate.
Ms. Glavin. So I do not think there would be difficulty in
a lot of cases if prosecutors wanted to use statutes beyond
1341 and 1343 to prosecute fraud on the mortgage lending
businesses.
In addition, one of the things that particular proposed
statute does is, the major fraud statute, which I believe is
1031, would also explicitly cover fraud in connection with TARP
funds and fraud in connection with the stimulus package. That
is not to say that we do not have other tools with which we can
prosecute such fraud, but it gives us a broader menu of
options, which the Department supports.
Mr. Scott of Virginia. In your comments, you mentioned
restitution involving the Iraq contracting. At a previous
hearing in the last Congress, we heard that the Department was
hesitant to get involved in False Claims Act cases involving
Iraqi fraud. In fact, it had many of the cases sealed, which
put whistleblowers out on a limb, where they could not get
evidence to prove what they were saying.
Is that policy of being reluctant to go after false claims
cases in Iraq and sealing those cases going to change?
Ms. Glavin. Congressman Scott, I come from the criminal
side of the Department. I think you are referring to the False
Claims Act, which is enforced by the civil side of the
Department. I am not aware--and I am happy to get back to you
on this--of a slowdown, and I think you are talking about the
sealing of cases, the qui tam cases, and I think there are time
limits for when it can be sealed.
Mr. Scott of Virginia. If you could get back to me on the
details.
Ms. Glavin. Yes, I would be happy to do that.
Mr. Scott of Virginia. Finally, I guess, for you and Mr.
Pistole, how many accountants would you need to effectively go
after these cases without transferring people from Homeland
Security's terrorist cases?
Mr. Pistole. Look, Congressman, to give you some context,
we have a little over 250 agents currently working on these
types of investigations along with about 50 financial analysts,
forensic accountants, and intelligence analysts. To go back to
the S&L crisis, we had about 1,000 agents. Obviously, the scope
of what we are dealing with now just hugely dwarfs the S&L
crisis, so we are--
Mr. Scott of Virginia. Has the Department submitted a
potential budget so we know, if we wanted to deal with it, we
could deal with it?
Mr. Pistole. In the 2009 budget, we received an additional
58 positions, which we are getting on board, and are applying
to that. Also, we are going through the 10 process right now.
Mr. Scott of Virginia. Mr. Chairman, I think he said 59.
The order of magnitude he was suggesting was that 1,000 would
not be enough. So, obviously, we have a lot of work to do.
The Chairman. Thank you. It does sound like that is a piece
of legislation where our two committees would be able to
cooperate, but it does sound to me like something we would want
to move on.
The gentleman from Florida.
Mr. Posey. Thank you very much, Mr. Chairman.
I have a lot more questions than we have time to have
answered here today. I wish I could have about an hour with
each of you individually.
The Chairman. Of course, we do have the option of getting
the follow-up answers in writing.
Mr. Posey. Thank you, Mr. Chairman. I was going to ask for
your permission to do that. Thank you, Mr. Chairman.
The first thing I would appreciate from all of you, if you
can see your way clear, would be a one-page summary, not a book
but a one-page summary and without corroborating your theories
with each other, of what you think the root cause of this
financial crisis is, not just the word ``greed.''
If your life depended on solving this puzzle, how would you
do it, and what do all indicators point to? If you think that
Congress is somehow culpable, I would expect you to say that in
all honesty and forthrightness for which you all have a
reputation. Stealing is still stealing even if the government
is doing the caper, unfortunately.
Also, since time will not allow an answer to these, I just
will request that you respond to us in writing.
First, to Governor Duke, the number of employees that you
have and the number of prosecutions and convictions to date
that you have had.
To Mr. Dugan, if and when you find criminal conduct, you
said you would refer it to an agency. I want to know how often
you have ever found criminal conduct and who you have referred
it to.
Commissioner Walter, I notice in your testimony, you have
1,100 attorneys in your organization. It looks like an attorney
handles a case every other year. It does not say anything about
convictions. I am interested in knowing how many convictions
they have ever had, if any.
I want to know, after the Madoff fiasco and when Mr.
Markopolos took that thick dossier to your organization almost
a decade ago and tried to get them to investigate Bernard
Madoff and you refused to do it--your agency, not you--I wonder
what discipline was taken for the employees who disregarded the
best interests of the citizens of this country and allowed that
to be perpetrated and allowed $75 billion to disappear from the
face of the Earth? There are quite a few people in my
constituency who think crime would not pay if the SEC were in
charge of it.
Just to put it in a local perspective, if you have a local
police force and your street cops write one ticket every other
year, you probably have more than you need or they are not
doing enough.
Mr. Gruenberg, yours does not say how many employees you
have or how many prosecutions or convictions you have had, just
that you have had 4,375 mortgage fraud claims filed, and they
are expected to result in 900 additional civil mortgage fraud
lawsuits over the next 3 years. I would like your estimate,
your prognosis on what you think the success rate will be, what
justice you think will come to the American public, what amount
of money you think we will be able to recover from the bad
people involved in that.
Mr. Polakoff, there is a list attached of the total numbers
of OTS formal enforcement actions. It is a very, very modest
number. It looks like it is probably under 200. I wonder how
many employees it takes to get this many enforcement actions,
but more importantly, I would like to know how many of them
were criminally prosecuted successfully, and how many you
expect to see successfully prosecuted. Thank you.
Ms. Glavin, your agency has 62,000 suspicious activity
reports. I would be interested in knowing or of having a
breakdown of how those were handled and how they were referred.
That was between just the years of 2007 and 2008. I wonder if
your agency needs an invitation to invite the companies who
received TARP money to be investigated under the RICO, the
racketeering statutes, and if you would need Congress to ask
you to do that or if somebody from the Treasury or someone else
could ask for that. I think the public would just like a good
cleansing of the possibility that there is racketeering
involved.
Ken Lay went to prison for fleecing investors. We have
people in some of these companies who have fleeced every member
of the American public and future generations as well, and I
think the public deserves to know there was no racketeering
involved if, in fact, there was not any.
I would pose that same question, basically, to the FBI. I
would like a short summary of the prognosis you have for the
team you established in 2008. Unfortunately, I think we were a
day late and a dollar short in getting in front of this crime
wave. We got behind it, and we have a lot of cleanup to do, but
I would like your thoughts as to a prognosis of what you
forecast statistically, if necessary, to be the consequences
and the results of the new fraud team that you have put in
place there.
Again, I would wonder if you have done any investigations
on any of the companies that received TARP money or bailout
money and, if you have not, what it would take to have you take
a perfunctory view to see if there is evidence of racketeering
there. I think much of the public suspects that it is there,
and for better or for worse, I think we probably deserve to
know. Thank you.
Thank you very much for your indulgence.
The Chairman. Yes, we would like those answers, obviously,
in writing. They will be made a part of the record and will be
shared with all members of the committee.
The gentleman from Kansas, the chairman of the Oversight
Subcommittee.
Mr. Moore of Kansas. Thank you, Mr. Chairman.
Mr. Pistole, in your written testimony, you discuss the
rise in mortgage fraud investigations the FBI is conducting.
You say, ``The number of FBI mortgage fraud investigations
has risen from 881 in fiscal year 2006 to more than 2,000 in
fiscal year 2009. In addition, the FBI has more than 566 open
corporate fraud investigations, including 43 corporate fraud
and financial institution matters directly related to the
current financial crisis... The increasing mortgage, corporate
fraud and financial institution failure case inventory is
straining,'' and I repeat straining, ``the FBI's limited white
collar crime resources.''
Mr. Pistole, if you would, please, give us your best
estimate of how many more agents you need, that the FBI needs
now, to keep up with the growing number of fraud
investigations.
Mr. Pistole. Thank you, Congressman.
We are obviously doing a scrub of all of our investigative
resources internally, initially, to assess whether we can move
additional resources first from within our criminal
investigative division, from violations that are not as high-
priority as this, and that is where we have gleaned those
additional bodies, doubling from 2 years ago to where we are
now. We also look at the enhancement through the task forces,
which I also mentioned. I would have to get back with you in
terms of a precise number, but we obviously--
Mr. Moore of Kansas. I would appreciate that, sir.
Mr. Pistole. We will do that. We are also working with the
Department and with OMB to assess what we may be able to get in
the out-years, 2010 and beyond. In the meantime, we are moving
those resources as we can do that.
Mr. Moore of Kansas. That would be very helpful because I
think every member of this committee would want to make sure
that your Department, your agency, has sufficient personnel
resources to conduct the investigations necessary to stop what
is going on.
Mr. Pistole. Thank you, Congressman. I greatly appreciate
that.
Mr. Moore of Kansas. Thank you.
Ms. Glavin, I was a district attorney for 12 years in my
home district, and I certainly understand how important
personnel resources are, especially prosecutors, in trying to
stop some of what is going on here.
My question to you is basically the same as I just asked
the FBI agent: Do you have, do you think, adequate personnel
resources in terms of prosecutors right now, the Department of
Justice, to do what needs to be done to get this thing under
control?
Ms. Glavin. It just so happens the Attorney General made
some public comments about this a couple of days ago, and had
indicated that he had asked the President and OMB to take a
look at our budget numbers from 2010 to give additional
resources for what the Attorney General calls the ``traditional
side of the Department,'' which would be the non-national-
security side, so that we have the ability to hire new agents,
look at financial fraud matters, as well as hire additional
prosecutors to look into those matters.
Mr. Moore of Kansas. Thank you, Ms. Glavin.
I truly, truly believe that every member of this committee,
Republicans and Democrats, believes that we want to provide
sufficient resources to the agencies here to stop what is going
on when there are abuses and violations of criminal law, and I
thank you for that. If you can provide any more written
information about what you need, we would appreciate that as
well.
Thank you, Mr. Chairman. I yield back my time.
The Chairman. The gentleman from Texas.
Mr. Green. Thank you, Mr. Chairman.
I thank the witnesses for appearing today, and I also thank
my colleagues for the questions that I have heard. The
questions, themselves, have been beneficial to me.
Ms. Walter, ma'am, you indicated that the credit default
swaps were, and I am using my terminology now, under the radar
such that they had become quite pervasive before we had an
opportunity to discover the impact. Is this a fair rendition of
what you are saying, or would you prefer to say it another way?
Ms. Walter. Yes, Congressman, I think that is part of what
happened because, unlike with respect to instruments that trade
on an organized and regulated market, the information was not
available. Everyone knew they were growing and growing fast,
but we knew very little about the underlying aspects of them,
and because they were not standardized, the terms varied.
Mr. Green. I have a follow-up question quickly. My time is
limited. I am sorry.
Ms. Walter. That is okay.
Mr. Green. If this is true, is there some agency that these
products are required to be registered with? Is there some
clearinghouse, or is there some methodology by which we can
ascertain that such a product exists so that we can make some
determination as to the worth of it?
Ms. Walter. There has not been an agency with which these
types of instruments have to be registered. We do obtain
piecemeal information about them, various of us up here,
through institutions that we regulate.
As Governor Duke mentioned earlier, there is now one
central clearinghouse that is up and running, and that will
cause some further information to come forth. There are likely
to be at least two more, and that will cause some
standardization of the instruments as well, but we think
participation in a central clearinghouse should be mandatory,
and there should be an information flow to the regulators
across-the-board.
Mr. Green. Just for my edification, does everyone agree
with the commentary accorded, just presented? If you disagree,
would you kindly extend a hand into the air?
If such a clearinghouse is needed and if it should be
mandatory, should the penalty for failure to comply be civil or
criminal? Can you give me some indication as to how we would
enforce such a penalty, please?
Ms. Walter. If there were a requirement placed by statute,
depending on the statute in which it was placed, there would be
civil law enforcement authority. I, once again, will defer to
the criminal law enforcement authorities about how best to
address criminal sanctions for failure to follow the law.
Mr. Green. Are you of the opinion that they should be
criminal as well as civil, the penalties and sanctions?
Ms. Walter. Yes, I would certainly support that, of course,
with the appropriate state-of-mind requirements and the like
that are true in general with respect to criminal prosecution.
Mr. Green. Mr. Pistole?
Mr. Pistole. Yes, Congressman, I think we would have to
look at the details. If it is tantamount to a false statement,
then, obviously, there would be those criminal sanctions, but
absent that, in terms of a central clearinghouse, I think the
thing we would not want to happen is to slow down anything in
terms of the sense of urgency, and would want to focus on where
we are going. We have fairly robust reporting requirements now
to the individual components here, so my only concern would be
in going to a central clearinghouse that somehow slows
something down. If it acts as a deconfliction mechanism, that
has always been beneficial.
Mr. Green. My concern is that these products embrace so
many people and so many lives. Do we slow down at the end and
prosecute over some long period of time, or do we take the time
to make sure that they are products that will not harm us, is
the question?
Listen, do not answer that. I want to go to a closing
statement.
I do not favor invidious persecution. I do favor vigorous
prosecution. I think the public is not privy to prosecutions
that are taking place. I believe you when you say they are, but
my suspicion is most members of the public would say not enough
is being done. If it is as you say it is, we have to find a way
to get this message to the masses so that not only will they
know that the prosecutions are taking place but also such that
there will be a proper deterrent.
My time has expired. I yield back.
Ms. Waters. [presiding] Thank you very much.
Mr. Foster?
Mr. Foster. Governor Duke, my first question, do you think
that the detection of fraudulent mortgage originators would
have been quicker without teaser rates and so on that
temporarily hid a borrower's inability to repay?
Ms. Duke. I am not sure that I can understand the
characterization of the fraud as the inability to pay, because,
at the time, the ability to pay was not necessarily required by
regulation or by statute. It was only in the HOEPA regulations
that the requirement of identification and verification of the
income that would be used to pay became a requirement for
making a mortgage loan, if that is responsive to your question.
Mr. Foster. I was just wondering,if the only kind of
mortgage that was allowed to be originated was one that had a
constant level of payment, just this sort of fraudulent--
Ms. Duke. The regulations, actually, address not only
fixed-rate mortgages but also variable-rate mortgages, and
require that they be underwritten to the fully indexed rate so
that they be underwritten to the rate that they would
automatically go to after the teaser time expired.
Mr. Foster. Okay. Is there anyone else who would like to
make a comment on that?
Mr. Gruenberg. Congressman, I would just say that the
teaser rate was one of the means by which those who engaged in
predatory practices drew in borrowers who did not fully
understand the terms of the mortgage, such as when it would
adjust upwards. So, in a sense, it was part and parcel of the
problem. The guidance and the rules issued by the Fed under
HOEPA tried to address that by requiring lending based on the
borrower's ability to pay, which hopefully would address that
kind of a mortgage product.
Mr. Foster. Okay. Comptroller Dugan, I guess, this question
is for, how comprehensive is the list of banned individuals? Is
the list public? Is it nationwide? Does it span all financial
services industries?
Mr. Dugan. I am sorry, Congressman. Could you repeat that?
Mr. Foster. Oh, yes.
I was just wondering how comprehensive the list of banned
individuals is. Is it public? Is it nationwide? Does it span
all financial services industries?
Mr. Dugan. Yes, it is public. We publish it whenever we
issue such an order, and it is put on our Web site, and it is
distributed to all the law enforcement agencies as well, while
understood in the community.
Mr. Foster. Okay. Is it easy for consumers to sort of get
at it and be aware that--
Mr. Dugan. Yes. There is a central Web site. There are
links from all the agencies about who is banned and who is not.
Mr. Foster. Okay. Then the last question I have, I guess it
is to everyone, and it will probably require a written
response. I am trying to get my arms around what is the optimum
level of effort and money to put into enforcement. So what I
would like and if you could answer first is, what is your
budget associated with enforcement activities? What is a best
estimate of the losses in the area under your purview?
So, for example, for the SEC, that would be security fraud
and related activities. What would be the effect of an
increased avoidance of losses for a 10 percent and a factor of
2 increase in your budget? Do you understand my question?
I am trying to sort of prod the shape of the curve. From a
purely economic point of view, there is some best amount to
spend on enforcement activities. If we are underspending, then
giving you an additional dollar will result in more than one
dollar of losses avoided. If we are past that point, giving you
an additional dollar will result in less than a dollar of
avoided losses. I am just trying to get some feeling for where
we are on that curve for each of your activities.
Okay. I yield back.
Ms. Waters. Thank you very much.
Mr. Carson?
Mr. Carson. Thank you, Madam Chairwoman.
I appreciate, first of all, all of the witnesses joining us
today to discuss these very important issues.
My colleagues briefly touched on the recent growth of
mortgage foreclosure rescue schemes. I represent Indiana's
Seventh Congressional District, a district that has seen
dramatic rates of foreclosures in the past 2 years. I am
extremely invested in making sure my constituents are armed
with an effective knowledge base about these scams.
My first question goes to Mr. Pistole, a fellow Hoosier.
You said earlier, sir, that the FBI has open cases, and you
mentioned the problems with foreclosure rescue fraud in your
testimony. Will you please elaborate on the most common forms
of scams your agency and its regulatory partners have seen
lately and what specific kinds of actions the Bureau has taken
so far against these operations?
Mr. Pistole. Thank you, Congressman.
Yes. What I can talk about is from the Operation Malicious
Mortgage, which I mentioned, that is ongoing, but it is where
we have had over 400 people arrested. Part of that was focused
on the, obviously, upfront lending, all the false statements
and the fraud involved in those mortgage applications. We have
also seen areas of bankruptcy fraud associated with that, so
you are further downstream in terms of the fraud where people
who are caught up simply cannot pay, and then there may be even
unwitting people involved there, but then there is a bankruptcy
fraud committed.
Another aspect is, even in the reverse mortgage area, where
people, senior citizens, are able to get reverse mortgages,
there has been fraud that has been uncovered in that area. We
are looking at all of those to try to assess the systemic
nature of it and the numbers that would represent, again under
prosecutive guidelines for each U.S. Attorney's Office, what
makes sense in terms of trying to prioritize our limited
resources in a way that can have the maximum impact, for
example, on Indianapolis. So those are some of the areas that
we have focused on.
As one of the other members mentioned earlier, virtually
any scheme that could be conceived or devised has been, and we
believe we have uncovered, virtually, all of them. It is simply
a matter of applying those resources to the problems in the
various districts, and that is where we are right now.
Mr. Carson. Thank you, sir.
Secondly, Mr. Gruenberg and Mr. Dugan, would you please
comment on whether or not banks have been stepping up their
outreach to troubled borrowers, at least warning them of these
scams that are taking place?
Mr. Dugan. Speaking for the OCC, we have put information up
on our Web site about the scams.
And I also wanted to mention that the NeighborWorks
organization, which a number of us sit on the board of and it
is funded by Congress in part, also has an initiative that is
specifically related to this particular issue, which we
support.
Mr. Gruenberg. Congressman, I should mention that pursuant
to a directive from the Congress, the FDIC recently conducted a
large nationwide survey of banks' outreach efforts,
particularly with respect to consumers who lack access to
mainstream banking institutions. I think it is fair to say that
our survey indicated that, in terms of outreach efforts to
inform people in the community about the services that
mainstream financial institutions offer, there has been an
increasing effort by insured depository institutions to do
that.
Mr. Carson. Thank you, Madam Chairwoman. I yield back the
balance of my time.
Ms. Waters. Thank you very much. Mr. Gohmert had a request.
Mr. Gohmert. Yes. Thank you, Madam Chairwoman.
I have two questions that I would like to ask for written
answers to, if I could, to be submitted within the next 2
weeks.
Ms. Waters. Yes.
Mr. Gohmert. If that would be appropriate.
One, this is to everybody. We have a pretty amazing panel
here, when you look at everybody's title; and it is this
question: What would you recommend we do legislatively to keep
at least some financial risk with those who put people in
mortgages and with those who package and sell them as
securities?
If your answer is, do away with mortgage-backed securities,
fine. But I am not looking for a treatise on what all is
involved or who could--the question is very specifically: What
do you personally recommend? Because if you don't have
suggestions on something that has nearly brought down the
financial system, then we are in bigger trouble than I thought.
The other question is to the FBI; and that is, what is the
status of providing the States access to criminal history
information through the Nationwide Mortgage Licensing System
and Registry as required by the SAFE Act. Specifically, since
States are going to need that information this summer, has that
or when will that access be granted? Two, what is the status of
setting up the distribution mechanism between the Department of
Justice and the appropriate State agency? And, three, who
within the FBI is responsible for granting this access? And,
last, can the FBI provide this committee and the Judiciary
Committee with periodic progress reports on the status of this
issue?
That will take care of it.
Ms. Waters. Thank you.
Mr. Posey, I think you had an additional question you
wanted to ask.
Mr. Posey. Thank you very much, Madam Chairwoman.
This would be for Ms. Glavin and Mr. Pistole, written
responses, too, just in the interest of time. I appreciate your
patience, Madam Chairwoman.
To what extent are the RICO laws useful to convict those
committing white collar crimes? I understand that the DOJ
prosecutor did not use the RICO approach very often. How often
is it used and why is it not used more often? Are the RICO
statutes sufficiently broad to capture the kinds of activities
white collar criminals engage in? What are the limitations of a
RICO approach in deterring and prosecuting financial white
collar crimes? How do prosecutors determine criminal intent
apart from recklessness or general incompetence? And then,
finally, how best could Members of Congress strengthen criminal
statutes to discourage some executives from running off with
big bonuses while running their companies into the ground?
That is the bottom line that we are looking for. I thank
you all for your attention and your courtesy and for appearing
here today.
The Chairman. Did the gentleman from Virginia want to ask
some questions?
Mr. Scott of Virginia. Yes, if I could, Mr. Chairman. If I
could very briefly pose a couple of questions to be answered
for the record.
Ms. Walter indicated some of the exotic instruments that
are being used. One of the problems we have had is the
deviation from insurance standards, what are essentially
insurance products. If you could comment on the need for assets
to back what are essentially insurance products and the
deviation from the need for an insurable interest before you
can buy what is essentially an insurance product.
And for Ms. Glavin, whether or not there are any changes
that we need and restitution laws to make sure that we can get
our assets recovered and whether conspiracy laws are sufficient
to--and, also, Mr. Pistole, if you could answer this--whether
conspiracy laws are sufficient to get those who may also be
involved, like the accountants and others that may be involved.
And then, finally, to Mr. Polakoff, you indicated cease and
desist orders. Could you give us an idea of what you are using
these cease and desist orders for? Because my initial reaction
is that some of these could possibly be referrals for criminal
activity, rather than to stop breaking the law. If you could
give us an idea of what you are using those for?
Thank you, Mr. Chairman.
The Chairman. I thank the panel. It has been useful. And I
must say I thought the questions asked by my colleague, Mr.
Posey from Florida, were useful ones. We will look forward to
those answers.
Mr. Polakoff, you gave us some specific legislative
suggestions; Ms. Glavin did as well. All of those will go to
the Judiciary Committee. I promise you we will take all of them
very seriously, because we clearly, collectively have to do a
much better job than we have done as we go forward.
The next panel is now before us.
The panel will be seated. You can all be polite to each
other outside, please. I will ask the staff to close the doors,
and we will begin.
One of the points noted was the multiplicity of
jurisdictions, and we wanted to make clear that a very
important set of jurisdictions exist here at the State level.
Let me make a preliminary statement here. One action that
happened under the Bush Administration, although it was done by
a Clinton Administration holdover appointee, the Comptroller of
the Currency, was what I believe to be an excessive preemption
by the Comptroller of the Currency of the ability of States to
enforce laws against nationally chartered banks; and I believe
that left us with a vacuum because the Federal authorities did
not have the power to promulgate a code to fill the vacuum.
That was a resistance of the Federal Reserve. We have
improved that some. But there is clearly a role for the States.
And I will say it is not entirely irrelevant that on the
panel before us today at least two are elected. Mr. Ropp, are
you elected or appointed?
Mr. Ropp. My boss is elected.
The Chairman. We do have two directly elected officials.
Your boss, the Governor or the--
Mr. Ropp. The Attorney General of the State of Delaware.
The Chairman. The Attorney General.
I will say this: Consumer protection, particularly when you
have individual cases, for a variety of reasons does not have
the same aura that making grand policy does; and I have found
that, in the absence of a direct electoral spur, consumer
protection sometimes lags. Those of us who are in an elected
office here in the Congress are often asked by individuals in
our districts to do this, and we pursue it.
At the State level, unlike the Federal level, much of the
administration of consumer protection law is in the hands of
directly elected officials: the Secretary of the Commonwealth
of Massachusetts, the Attorney General of Illinois, the
Attorney General of Delaware; and I think there is a great deal
to be gained there.
So there are reasons for involving the State in consumer
protection both in terms of federalism, but, also, I believe
that having elected officials be charged with some of the
responsibility for consumer protection helps us overcome the
institutional lag that exist.
And your people say, these consumer things, they can be
annoying. When people vote for you, they become a lot less
annoying. So that is, I think, a mechanism that we want to take
a shot of.
With that, I will begin with my former colleague in the
Massachusetts Legislature, who has done a very good job of
administering securities law. In Massachusetts, the Secretary
of the Commonwealth is the Securities Administrator, William
Galvin.
STATEMENT OF THE HONORABLE WILLIAM FRANCIS GALVIN, SECRETARY OF
THE COMMONWEALTH OF MASSACHUSETTS
Mr. Galvin. Thank you, Mr. Chairman.
Chairman Frank and members of the committee, I am pleased
to have this opportunity to testify on the crucial role of
State securities regulators in financial regulation and
investor protection.
As Secretary of the Commonwealth, I am the Chief Securities
Regulator for Massachusetts. The Securities Division regulates
to protect investors and promote confidence in securities
markets. In the United States, securities regulations are
regulated by the Securities and Exchange Commission and by
States' securities agencies and by a system of complementary
regulation. State regulators serve an important backstop to
other regulators if they are not acting to protect investors.
Massachusetts, along with other States, has been at the
forefront to bring enforcement actions to protect investors.
These include actions against brokerages using bogus stock
analyst reports to entice customers to buy low-value stocks and
debt securities, cases against mutual fund companies that
illegally facilitated market timing trades, actions against the
abusive sales of variable annuities, actions against the use of
spurious senior credentials to sell inappropriate investments
to older investors, actions against unsuitable sales and
fraudulent practice in the sales of auction rate securities to
retail and municipal investors, and investigations and actions
against pyramid schemes including the Madoff scheme and their
feeder funds and several hedge fund cases.
The Massachusetts Securities Division has acted promptly
and decisively to protect the interest of investors,
particularly retail investors. Massachusetts and other States
have negotiated substantial refunds for investors and imposed
significant fines against violators. Massachusetts was the lead
State in 3 auction rate securities cases that ended with
settlements that returned $33.9 billion to investors. The
States' combined efforts in these cases will bring back $61.3
billion to date to investors across the country.
The State enforcement powers, however, go beyond monetary
sanctions. The Securities Division has revoked the licenses of
serious violators in order to drive them out of the securities
business. Massachusetts has often required financial firms to
admit wrongdoing.
The current crisis in financial services has once again
exposed a failure of aggressive enforcement, particularly at
the Federal level. For too long, a culture of compromise and
accommodation has overwhelmed enforcement efforts. Too often,
the guilty neither admit nor deny any wrongdoing and routinely
promise not to cheat again until they come up with a more
clever way to do again what they just said they would not do
again. I ask this committee and the Congress to give the States
the tools we need to maintain and enhance our ability to
regulate effectively and protect investors.
The National Securities Markets Improvement Act of 1996,
NSMIA, removes State regulatory authority over mutual funds,
most private offerings of securities and over large investment
advisors. Since the adoption of NSMIA, jurisdiction over
investment advisors has been split between the Federal
Government and States. I ask that Congress restore the States'
powers to act against federally registered investment advisors,
particularly for dishonest and unethical business practices.
The States Securities Act permits the States to impose a
range of remedial sanctions against violators, including that
violators make rescission to investors--that is repayment to
investors--for violation of laws. These sanctions give the
States the ability to recover money for defrauded investors.
The rescission remedy is particularly important because it
helps make the investors whole.
Unfortunately, several recent court decisions have held the
Federal Arbitration Act preempts the States' ability to order
rescissions for security violations. These cases hold the
rescission remedies preempted because arbitration is the sole
mechanism for investors to recover their losses. We strongly
dispute these decisions which ignore the remedial and deterrent
purposes of State-ordered rescission. We urge Congress to amend
the Federal Arbitration Act to clarify that it does not preempt
the States from ordering securities law violators to make
rescission to their victims.
Another area--under current law, broker-dealer firms deal
with their customers without fiduciary obligations. In contrast
to brokers, investment advisors work solely for their customers
and acknowledge a fiduciary duty of them.
Brokerages like to have the issue both ways. Among other
practices, they frequently give their salespeople the title
``financial advisor.'' This term blurs the nature of the firm's
relationship with its customer by making the broker appear to
be an investment advisor. However, when a dispute arises
between the customer and the broker, the broker will strongly
assert that it does not work for the customer but instead has
only an arm's-length relationship with the customer.
The Securities Division has seen examples of brokers
dealing unfairly and improperly with customers, and we have
witnessed customers who have recovered little or nothing for
their losses through the pro-industry arbitration system and
due to the fact that brokers are not considered fiduciaries.
This system should be changed. I urge the committee and the
Congress to require that brokerages be in a fiduciary
relationship with their customers, at least with respect to
individual retail customers.
There are, finally, several problems on the horizon that I
would like to bring your attention. Many hedge funds are
liquidating because their investment strategies did not work
and because the advisors anticipate they will not receive an
incentive share of funds profit for the years to come--the
investors, that is, will not receive profit for years to come.
We can expect many of the people who ran and advised the
last generation of hedge funds to set up new funds and start
again. Unless regulation of hedge funds is significantly
improved, we can expect to see a replay of past problems which
can and have caused great damage to our economy, including wild
speculations and essential commodities. I ask the committee and
the Congress to take steps to make hedge funds more transparent
and their activities more visible.
Lastly, American households now rely on mutual funds to
help fund retirement costs. Because so many retail investors
have their savings in mutual funds, I urge the committee and
the Congress to give mutual funds appropriate scrutiny.
No topic or type of investment should be off the table as
Congress enacts regulatory reform and improvements to investor
protection. Congress has an urgent need to restore confidence
in the financial markets. Effective regulation or enforcement
are desperately needed.
Thank you for this opportunity to testify on these
important issues, and I will welcome your questions.
[The prepared statement of Mr. Galvin can be found on page
94 of the appendix.]
The Chairman. Next, Attorney General Lisa Madigan, State of
Illinois.
STATEMENT OF THE HONORABLE LISA MADIGAN, ATTORNEY GENERAL,
STATE OF ILLINOIS
Ms. Madigan. Mr. Chairman and members of the committee,
thank you for inviting me to testify today.
My testimony is divided into two parts: first, I am going
to summarize the major enforcement actions that have been
brought by my office and other State Attorneys General against
lenders and other participants involved in the collapse of the
mortgage market; and second, I will identify some of the key
impediments to effective enforcement of consumer protection
laws at the State level.
Because State Attorneys General are on the front line of
consumer fraud, we hear about problems as they are happening.
And let's debunk the myth that the predatory practices in the
mortgage lending industry just started a year or two ago. In
fact, we have been pursuing predatory mortgage lending
practices for over 10 years. In that time, State Attorneys
General have often targeted very large mortgage lenders for
investigation, because our aim is to bring cases that will have
an impact on the lending practices of the industry as a whole.
In 1998, Illinois, Massachusetts, and Minnesota brought
civil consumer fraud suits against First Alliance Mortgage
Company, a California-based lender. FAMCO's business and
lending practices will, unfortunately, sound very familiar to
you. FAMCO sold high-cost home loans to subprime and prime
borrowers. Most of its loans were re-fi's, with borrowers
typically placed into a 2/28 ARM, one of the same products that
is causing so much trouble in the current market.
Another foreshadowing of today's crisis, FAMCO bundled and
sold its loans on Wall Street to Lehman Brothers. As a result
of being sold unnecessarily high-cost home loans, FAMCO
borrowers paid the price in the form of higher monthly payments
and lost equity. In a settlement of the lawsuit in 2002, the
States recovered well in excess of $50 million in restitution
for consumers' losses; and FAMCO was ultimately forced out of
business and into bankruptcy.
In the years since FAMCO, the States have brought a
succession of enforcement actions against some of the biggest
names in mortgage lending. These actions include a multistate
investigation of the subprime mortgage giant Household
Financial, which culminated in a $484 million settlement in
2002.
Following the Household settlement, the States launched a
probe of Ameriquest, the largest subprime lender in the Nation
at the time. The Ameriquest investigation was resolved in 2006
when the lender entered into a $325 million settlement
agreement with the States.
All of these enforcement actions targeted the kinds of
fraudulent, unfair, and deceptive practices that eventually led
to the collapse of the mortgage market.
By the fall of 2007, as the subprime mortgage market was
starting to crumble, my office opened an investigation into the
lending practices of Countrywide Home Loans. At the time,
Countrywide was the largest prime and subprime mortgage lender
in the Nation. My investigation, which was conducted in
conjunction with the California Attorney General's Office,
revealed that Countrywide had engaged in a wide range of
deceptive lending and marketing practices in relentless pursuit
of greater market share and profits.
As a result of our investigation, I filed a lawsuit against
Countrywide in June of last year; and in October, I and several
other State Attorneys General announced a settlement with
Countrywide's new owner, Bank of America. That settlement
established a mandatory loan modification program that covers
approximately 400,000 borrowers nationwide. The program is
estimated to provide $8.7 billion worth of loan modifications
to borrowers and give them a fighting chance to stay in their
homes. A mandatory loan modification program which requires the
lender to reviewer its most toxic products and modify its loans
is at the heart of the Countrywide settlement.
In my view, saving homes and stabilizing communities must
be the primary goal of any enforcement action against predatory
mortgage lenders. Unlike previous settlements with major
lenders, the Countrywide agreement could not prevent the
company from engaging in deceptive lending practices in the
future. This is because once we subpoenaed Countrywide, the
company moved all its lending business to its federally-
chartered subsidiary which State Attorneys General are arguably
prevented from investigating due to OCC regulations. In other
words, the lenders, supported by the OCC, argue that the States
are preempted.
We devote a tremendous amount of resources to investigating
and prosecuting the many other State-licensed participants
involved in the mortgage meltdown, including brokers, title
companies, and appraisers.
Congresswoman Waters, to address your concern about
mortgage rescue fraud, I want you to know that the State of
Illinois has brought 22 lawsuits against mortgage rescue fraud
companies; and we have outlawed up-front fees being paid for
these services. Our prosecutions of these wrongdoers are both
civil and criminal and remain a vital part of our enforcement
efforts.
While the States have been aggressively pursuing
enforcement actions against major lenders and other industry
participants, for years our efforts have been impeded by a
number of obstacles. State enforcement actions have been
hamstrung by the dual forces of preemption of State authority
and lack of oversight on the Federal level.
In the run-up to the crisis, many federally-chartered
lenders were engaging in the same predatory practices as State-
licensed lenders. The States, however, could not pursue these
Federal lenders, even though we would have liked to. When a
report showed that several lenders in the Chicago area had
possibly violated fair lending laws, I could send subpoenas
only to the State-licensed lenders implicated in the study. Two
of those State lenders have since moved to Federal charters to
avoid our investigation.
Preemption is a clear impediment to our investigations of
fair lending and consumer protection violations by Federal
banks. To give you an appreciation of the preemption battle,
there is currently a case before the United States Supreme
Court where a coalition of national banks is challenging the
authority of State Attorneys General to investigate violations
of State fair lending laws; and we all know the reason that
national banks have fought so hard to block States from
enforcing State laws against them.
Over the years, efforts to preempt State consumer
protection powers have left a large gap in regulatory
authority. So far, the Federal agencies have been unwilling to
fill this gap, and the national banks are counting on their
regulators to remain similarly resistant in the future.
As home loans grew increasingly complex and risky, Federal
regulators could have and should have taken steps to ensure
that lenders evaluated borrowers' ability to repay their
mortgage loans. Unfortunately, Federal regulators chose not to
exercise their authority to enact uniform marketwide
underwriting standards until the mortgage market showed the
first signs of the meltdown. By then, it was too little and too
late.
To conclude, I would say that the best thing you can do to
prevent further preemption is to give us the authority that we
need to go after federally-chartered banks as well.
Thank you for this opportunity to testify, and I would be
happy to answer any questions you may have.
[The prepared statement of Ms. Madigan can be found on page
133 of the appendix.]
The Chairman. Next, Commissioner Sarah Bloom Raskin of the
Maryland Office of Financial Regulation--you should know that
Congressman Cummings is a great supporter of yours. He was here
earlier and was called away but is clearly very pleased that
you are here.
STATEMENT OF SARAH BLOOM RASKIN, COMMISSIONER, MARYLAND OFFICE
OF FINANCIAL REGULATION
Ms. Bloom Raskin. Thank you for that.
Chairman Frank and distinguished members of the committee,
my name is Sarah Bloom Raskin, and I am the Commissioner of
Maryland's Office of Financial Regulation. Thank you for
inviting me to talk about my efforts and those of my
counterparts in other States to address the crisis of mortgage
fraud.
The downturn in our economy has ripped the veneer off of a
lot of predatory transactions that the good times kept hidden
from view. And what we are seeing today in the States is ugly
indeed. Let there be no doubt: We have a mortgage industry in
America; and we have a mortgage fraud industry in America. In
my office, people come in every day with heartbreaking stories
of bank accounts depleted, life savings wiped out, homes lost,
families bankrupted, and American dreams turned to living
nightmares with eviction notices and foreclosure sales.
In our Federal system, State officials play the leading
part in regulating mortgage activity which brings together a
buyer, a mortgage company, a house, and a neighborhood. State
Commissioners license and regulate over 77,000 mortgage
companies, another 50,000 branches, and over 400,000 loan
officers. This makes sense, because we are in proximity to the
transactions and to our citizens. Like neighborhood cops who
know their beats, we can detect both positive and negative
trends right as they emerge, and we have the flexibility at
ground level to respond.
But, as you know, the financial underpinnings of the
mortgage industry are national, if not international, in scope
and scale. Capitalization, securitization, wholesale funding,
servicing, and other integral functions are consolidated and
national in character. As State regulators, our reach into
these functions is minimal. Oversight in these fields is either
federalized or, as we have too frequently seen, nonexistent.
As State bank supervisors, we can meaningfully address only
the end point of the problem, the final rip-off of the mortgage
purchaser; and that is usually after the fact. But we are
without power to regulate the essential structural incentives
in the national banking industry or the basic content of
industry practices and transactions.
Now, don't get me wrong. State authorities have been
effectively pursuing unfair and deceptive mortgage practices.
Through several landmark settlements, State regulators have
recently returned nearly $1 billion to consumers who had been
ripped off by their mortgage companies.
In 2002, a settlement forced Household Financial to pay
consumers $484 million in restitution. A settlement with
Ameriquest Mortgage Company 4 years later produced $295 million
in restitution, and home buyers got back $60 million in a
settlement with First Alliance Mortgage Company.
My office responds to some 2,500 consumer complaints per
year. We conduct over 1,000 mortgage exams. Nationwide, States
took almost 6,000 enforcement actions against mortgage lenders
and brokers.
Furthermore, we have worked with our State legislatures to
enhance consumer protections to address rank abuses ungoverned
by Federal law. In Maryland, we have expanded legal protections
for homeowners in delinquency and foreclosure to thwart the
financial scam artists who inevitably descend on financial
victims like vultures on highway roadkill.
But one key point I want to make is that Congress should
eliminate the preemption of consumer protections enacted by the
States. I urge Congress to promptly implement a recommendation
made by the Congressional Oversight Panel in its special report
on regulatory reform to eliminate Federal preemption of the
application of State consumer protection laws to national
banks.
The magic of federalism is that if one level of government
falls asleep at the wheel or has too much to drink at the
party, another can drive everybody home safely. But when you
preempt our best laws, you take away the keys to the car and
our license to drive.
Today, we all share the same goals of stabilizing
homeownership, stopping foreclosures, ending the mortgage crime
wave, and getting our communities moving again. Such ability to
expand upon a basic Federal standard is essential to the
development of effective responses to new mortgage abuses as
they emerge.
Today, as you have heard, we have seen another mortgage
storm brewing in the area of loss mitigation consulting.
Historically, we confronted fraudulent transactions where title
was conveyed as part of a scheme to strip homeowners of their
equity. Today, there is no equity left to strip, so the rip-
offs have become fee-based with so-called consultants charging
high up-front fees to vulnerable consumers to help them get a
loan modification.
Up-front fees are restricted in Maryland, and our office
has recovered more than $80,000 for consumers to date. We have
worked through the State Foreclosure Prevention Working Group
to raise the issue with the Administration and to warn those
overseeing the President's housing program of the potential for
these practices to cause further financial instability.
On behalf of the 50 State banking supervisors, I want to
thank you for the opportunity to testify and restate our
commitment to working with you to reform and revitalize our
mortgage industry. We view close collaboration as the best way
to come out of this crisis and Federal preemption of our laws
as an impediment to swift recovery. And I look forward to
answering any questions you may have.
[The prepared statement of Ms. Raskin can be found on page
172 of the appendix.]
The Chairman. Thank you.
And next, Mr. Ropp.
STATEMENT OF JAMES B. ROPP, COMMISSIONER, DELAWARE DIVISION OF
SECURITIES
Mr. Ropp. Chairman Frank and members of the committee, I am
Jim Ropp, Delaware Securities Commissioner and Chair of the
Enforcement Section of the North American Securities
Administrators Association.
The Chairman. Could you pull the microphone a little closer
to you, please?
Mr. Ropp. I am sorry. I didn't turn it on, sir.
The Chairman. That is the alternative.
Mr. Ropp. I appreciate this opportunity to focus on the
role of State securities regulators in the current economic
crisis.
Since the Securities Division is part of the Delaware AG's
office, we have statutory jurisdiction over administrative,
civil, and criminal actions to address securities fraud. And we
do not have to refer our cases to an independent prosecutorial
agency. This allows us more freedom to pursue offenders
criminally, and we do not shy away from bringing criminal
cases.
Delaware was recently the first to indict a Ponzi scheme
operator who was offering investments in fraudulent real estate
deals. In another case, Delaware indicted a broker who had
defrauded a senior citizen out of more than $200,000. The
broker diverted funds from the client's account into a
fictitious account. Shortly thereafter, the broker withdrew the
money and left the country. Warrants are still outstanding and
we are attempting to secure his extradition to the United
States.
In short, criminal prosecutions are an important tool for
effective enforcement of Federal and State securities laws.
Delaware obtains cases in a number of ways. The primary
source of securities cases comes from investor complaints about
fraud and misconduct. We obtain cases from branch office
examinations, referral from local law enforcement agencies,
referral from other States, NASAA, the SEC, and FINRA.
Mr. Chairman, as you noted during last year's ARS hearings,
in a number of States it has been the State securities
officials and law enforcement officials who have taken the
lead. High-profile national cases receive great public
attention, but they should not obscure the more routine and
much larger caseload representing the bulk of the State's
enforcement work. Those are the cases which affect everyday
citizens and their local communities across the country.
During the past 3 months, the States have been very active.
Washington, working with the FBI and the IRS, broke up a $50
million oil and gas investment Ponzi scheme. Hawaii, with the
assistance of the SEC and the CFTC, shuttered a suspected Ponzi
scheme targeting a deaf community in Hawaii, parts of the
mainland, and in Japan.
An investigation by Texas resulted in a 6-year prison
sentence for a Ponzi scheme operator who stole at least $2.6
million from investors. Arizona stopped a religious community
fraud and ordered more than $11 million returned to investors.
Since January, the Alabama Securities Commission has
announced the conviction of nine individuals convicted of
securities fraud. These convictions encompass cases of fraud
and abuse ranging from classic Ponzi schemes to violations of
Reg D Rule 506. All convictions and charges were felonies.
Currently, Alabama has 27 defendants awaiting trial for
securities fraud in 19 separate cases.
During our most recent 3-year reporting period, State
securities regulators have conducted more than 8,300
enforcement actions, which resulted in $178 million in monetary
fines and penalties and more than $1.8 billion ordered returned
to investors.
We are responsible for the sending of fraudsters away for a
total of more than 2,700 years in prison over the last 3 years,
and yet, over a number of years, there has been a concerted
industry effort against State regulation which calls for the
preemption of both State regulation and enforcement.
For example, NSMIA did preempt much of the State's
regulatory authority for securities trade on national markets,
and although it left State antifraud enforcement largely
intact, it limited States' abilities to address fraud in its
earliest stages before massive losses had been inflicted on
investors.
A prime example in this area is the private offerings under
Rule 506 of Regulation D. These offerings enjoy an exemption
from registration under Federal securities laws, so they
receive virtually no regulatory scrutiny. As a result, since
the passing of NSMIA, we have observed a steady and significant
rise in the number of offerings made pursuant to Rule 506 that
are later discovered to be fraudulent.
Although Congress has referred the State's authority to
take enforcement actions for fraud in the offer and sale of all
covered securities, including Rule 506 offerings, the power is
no substitute for the State's ability to scrutinize offerings
for signs of potential abuse and to ensure that the disclosure
is adequate before harm is done to investors.
The time has come for Congress to reinstate State
regulatory oversight over all Rule 506 D offerings. There are a
number of legislative proposals pending now to significantly
increase funding for Federal law enforcement agencies. NASAA
supports these efforts, but urges Congress to consider
establishing Federal grant programs to assist State agencies,
including securities divisions, involved in the prevention,
investigation and prosecution of certain financial crimes.
State securities regulators have learned how to do more
with less. However, there is little doubt that additional
resources during this economic downturn would help prosecute
these cases, which have resulted in vulnerable investors
looking to recover their losses. State securities regulators
welcome the opportunity to work with our regulatory partners at
the SEC and the SROs to collectively use our resources to
protect investors.
To facilitate communication and coordination, on all
financial service issues, NASAA believes the President's
working group should be expanded to include representatives
from the State agencies that regulate banking insurance and
securities. Another improvement would be more consistent
cooperation between States and their regional counterparts at
the SEC.
In conclusion, State securities regulators are dedicated to
pursuing those firms and individuals who have violated
securities law. We want to ensure that we not only maintain but
enhance our authority to regulate at the local level and bring
enforcement actions with appropriate remedies against those
firms that violate securities laws in their jurisdictions. With
additional resources and support from Congress, State
securities regulators will continue to provide an indispensable
layer of protection to Main Street investors.
Thank you.
The Chairman. Thank you, Mr. Ropp.
[The prepared statement of Mr. Ropp can be found on page
203 of the appendix.]
The Chairman. And finally, Mr. Merle Sharick from the
Mortgage Asset Research Institute.
Mr. Sharick?
STATEMENT OF MERLE D. SHARICK, Jr., MORTGAGE ASSET RESEARCH
INSTITUTE (MARI)
Mr. Sharick. Good afternoon, Chairman Frank, and
distinguished members of the committee. My name is Merle
Sharick, and I am with MARI, the Mortgage Asset Research
Institute, a LexisNexis service. I commend the chairman and the
members of the committee for holding this hearing and for your
dedication to protecting consumers and promoting the principles
of responsible lending.
For over 18 years, MARI has managed and maintained the only
cooperative contributory database existing today in the
mortgage industry specifically established to keep track of
mortgage professionals and companies. This database, known as
MIDEX, the Mortgage Industry Data Exchange, includes public
financial sanction information from over 200 government
regulators and nonpublic incident reports provided by
subscribers when fraud or misrepresentation is confirmed in a
loan transaction.
MARI became a key part of LexisNexis in 2008. Our current
focus is driving and supporting the installation of a loan
fraud prevention database for loan origination pipelines for
all lenders to share and compare loans and process to prevent
fraud early in the mortgage process.
This month, MARI released its 11th periodic mortgage fraud
case report to the Mortgage Bankers Association, of which all
committee members have a copy. This report found that reported
cases of mortgage fraud in the United States are at an all-time
high and increased by 26 percent from 2007 to 2008.
Additionally, the report found that for the first time, Rhode
Island ranked first in the country for mortgage fraud with more
than 3 times the expected amount of reported mortgage fraud for
its origination volume. Florida ranked first in 2000 and 2007
and 2006, but dropped to second place for 2008 instances and is
followed by Illinois, Georgia, Maryland, New York, Michigan,
California, Missouri, and Colorado.
The top fraud incident type in 2008, representing 61
percent of all reported frauds, was application fraud. For the
5th year in a row, it topped the list. Second were frauds
related to tax returns and financial statements, which jumped
60 percent from 17 percent of reported frauds in 2007 to 28
percent of reported frauds in 2008. Additional documented fraud
types included in order of their volume frauds related to
appraisals of valuations, verifications of deposit,
verifications of employment, escrow or closing costs and credit
reports.
In 2008, Rhode Island made its first official appearance on
MARI's top 10 list. But since last year's case report, reports
of material misrepresentation have bolstered the State's
ranking to number 5 in our current snapshot of loans originated
in 2007.
The significant drops in reported incidences in Nevada,
Utah, California, and Michigan are most likely the result of
the lack of investors for subprime and alternative lending
products and tightened underwriting guidelines on conforming
products and that the flurry of delinquent and foreclosed loans
does not allow servicers significant time to investigate
default causes. Future reports that we will issue will indicate
whether this is just a 2008 phenomenon or not.
Some observations about fraud types: Many of the percentage
figures shown in our report are similar to those MARI has
reported for several years. Notable differences in the 2008
data include the percentage of reports of tax return and
financial statement misrepresentation nationwide is higher in
2008 than in previous years. The same is true for verification
of employment misrepresentation. Credit report fraud has
decreased and incidences reported for both 2007 and 2008.
Appraisal fraud is higher at the time of this report in
past years. Typically, appraisal fraud numbers grow as more
issues are uncovered.
There are many mortgage schemes out there, and I won't
elaborate on all of them, but I do want to comment on some
emerging fraud trends that have been reported by our
subscribers. These emerging fraud trends are further draining
lender, law enforcement, and consumer resources in the
industry's most challenging times ever.
Our subscribers reported an increase in traditional
mortgage misrepresentation of income inflation and bank
statement fraud. Our subscribers reported an increase in
foreclosure prevention schemes. Our subscribers also reported
an increase in elderly and immigrant identity fraud and a
significant increase in builder bailout fraud.
We must use technology more wisely, and we must pay
attention to details to return confidence and integrity to the
mortgage loan to attract the capital from a variety of sources
that the industry will need in a recovery. Combating mortgage
fraud is critically important to restoring integrity in the
mortgage loan transaction and attracting the necessary capital
to meet the needs of prospective homeowners in the industry. It
is also critical to rebuilding consumer trust in the industry's
professionals when the real estate market segment begins to
improve. We believe that the mid- to longer-term systemic
return of the real estate market segment must be anchored by
improved fraud prevention and lending practices already being
pursued by lenders.
Mr. Chairman, we look forward to working with the mortgage
industry, this committee, the States, the Federal financial
regulatory agencies, and other stakeholders to combat mortgage
fraud, protect consumers and promote the principles of
responsible lending.
I very much appreciate the time.
[The prepared statement of Mr. Sharick can be found on page
218 of the appendix.]
The Chairman. Thank you, Mr. Sharick.
Should that show any difference in terms of their
originations between the banks and the mortgage companies, to
the extent to which they are regulated at the Federal or State
level? Has that been in any way--is there any distinction?
Mr. Sharick. I think we will see that in future reports
particularly. But the change that has happened in the mortgage
industry over the last couple of years, the banks and
government-regulated financial institutions are the main
survivors.
The Chairman. And they have done a less bad job?
Mr. Sharick. They have, I think, more controls in place.
The Chairman. So that they have been less contributory.
The other question is, for those outside of that--and you
say they are survivors, but would you recommend--you said,
tighten the underwriting guidelines.
We still have some entities which operate outside of these
kinds of regulations. Would you recommend some kind of
statutory or other establishment of better guidelines?
Mr. Sharick. I am not sure. What I would recommend is more
due diligence, tightening underwriting guidelines.
The Chairman. Due diligence by whom?
Mr. Sharick. By everybody who is involved as far as the
lender and the lending transaction.
The Chairman. You would recommend that to the lender. But
if we have lenders that aren't doing it, would you mandate it?
Mr. Sharick. I think that is something that could be looked
at. We would be happy to talk with you about that some more.
The Chairman. Thank you.
Let me turn back to the question of preemption, which is an
important one. Attorney General Madigan, I think you were
referring to the case of Andrew Cuomo as the lead against the
central clearinghouse. I am pleased to reference here the
amicus brief signed by myself, the chairman of the Judiciary
Committee, Mr. Conyers, and several other senior members of
this committee on the side of the attorneys general.
Ms. Madigan. We appreciate it.
The Chairman. There is no question. But I often learn from
my former colleague, Mr. Galvin. In the area of bank
preemption, we don't need to change the statute. What happened
was, the Comptroller of the Currency, a Clinton appointee who
stayed over until the Bush Administration, Mr. Hawke, issued, I
think, an excessive degree of preemption. It was challenged in
court; and what the Supreme Court said basically was, this is a
matter that is very much within the discretion of the
administrator.
It was an extreme case of matters of discretion. What it
means was that--and it was a very extreme preemption. What it
says is that virtually no State laws can apply to banks--no
State law specifically related to a lot of banks; and even
where a State law or general application applies to banks, they
have to get the national bank people to administer it. Fair
lending, for example, would not hear the case the attorney
general and I were referring to. It is not an effort to
regulate sort of core banking decisions; it is a fair lending
issue.
The Comptroller of the Currency can undo what the
Comptroller of the Currency did. I was asked, I will say, by
members of this Administration, what my view was on the
reappointment of the current Comptroller. I have found him to
be responsible in a number of ways, for instance, in his
refutation and the argument that the Community Reinvestment Act
has been the cause of serious problems. And he was not the one
who did the preemption and he has been somewhat flexible in his
approach to it.
But I have asked--and I am in the process of asking all
three of the agencies, organizations represented here--the
State attorneys general, the State bank supervisors and the
State securities administrators--to create a working group; and
we will meet under our guidance with the Comptroller of the
Currency to un-preempt in the banking area. But my colleague
tells me that, apparently, in the securities area that has to
be statutory.
So we will do that as well, and we will have a--actually,
it will be the attorneys general and the State bank supervisors
in kind of a working group to dial back the preemption there.
But we will be asking the securities administrator, Mr. Ropp,
and Mr. Galvin to give us the statutory changes.
I think there is no question that this could work well. And
it would be my hope to have some hearings essentially on this,
maybe one in each of the two relevant subcommittees and a full
committee hearing. It is a very important subject, and I would
hope by the end of this year or early next year we could have
gotten an agreement to undo some of the excessive preemption by
the Comptroller and get back into--and change some of the
statutory matters that have to be done.
So I appreciate this, and I do not think--certainly in the
mortgage area, we didn't suffer from overenforcement. And I
think we are able to do this in a way--and it is a legitimate
complaint by a potential enforcement target, one of them being
hit in a contradictory way. I think we could work out among
ourselves ways to avoid that, so you could have a primary guide
or you could have some degree of coordination. But that is very
high on our list.
The gentleman from Texas.
Mr. Gohmert. Thank you, Mr. Chairman, and thank y'all for
being here today. I am sorry; I try to avoid saying y'all when
I am up here, and I let one out. I know Jeff Foxworthy is
right; when people hear a southern accent, they deduct 50 IQ
points from how smart they think you are.
But thank you. We appreciate you being here.
Mr. Ropp, you indicated the SEC has been criticized for
inaction toward securities fraud. Do you think that is a result
of a lack of commitment on the SEC's part, a lack of resources
or a need, heaven help us, for larger Federal regulatory
situation or a restructuring?
Mr. Ropp. I think it is a combination of things. I think
you have hit on most of them.
I think part of it probably is resources. I understand
their budget has not been raised for a number of years until
recently. I think that they focus on big cases and cases that
will bring them a lot of publicity. And unlike the States,
where we try to handle as much as comes along from the Main
Street investors, they rarely look at this one-person case,
two-person case, or the ones where there is a $25,000 loss or
$30,000 loss, which are real cases and real losses to these
people.
I think, because of the size and their resources, they do
look at the larger cases and don't necessarily look at some of
the smaller cases.
Mr. Gohmert. Thank you.
And I am a big proponent of States' rights. I hate to see
more and more States' rights usurped when I think the 10th
amendment means what it says, those powers are not specifically
enumerated, but are reserved for the States and the people.
But in that regard, you have been here. You have heard the
testimony of the other panel as they have talked about the
credit default swaps flying under the radar for way too long,
getting too big too fast. We are finding the inadequacies of
the Federal system in not picking that up sooner, before it got
us in some significant trouble.
What was it, do you think, that kept the States from
picking up on this, this growing, burgeoning fiasco? What kept
you guys from being able to pick up on it?
We know the Fed had problems. How about yourselves?
Mr. Galvin. If I may, I think part of this relates to the
preemptions that have been put into the law over the last
couple of decades.
Mr. Gohmert. As I understand it, some of the problem with
the credit default swaps was, we didn't have control over it.
We didn't jump in and take over, and that is why--
Mr. Galvin. It is a definitional issue. Part of the problem
here is, you had entities creating new instruments that were
unheard of before, new types of risks.
I don't think--I don't presume to speak for anybody else on
this panel, but I personally do not--I am not arguing for the
absence of a Federal regulator. There has to be a national
market regulator and that has to be Federal.
I think the issue really is, how do the two sides--this
isn't a competition between the States and the Federal
regulators; this is about making sure the States have the
ability to protect their citizens.
I do think there needs to be a national regulator. I know
you are going to revisit the whole issue of the structure, and
I think some of the gaps we have seen are now exposed. The
reality is, I think--the biggest lesson I think we can all take
from what has happened most recently is, these industries, they
aren't just some other business. This is a business that
affects every other business and all of us--indeed, you might
say even beyond the confines of the country.
So when we are talking about some sort of a regulatory
process, there has to be a national market regulator. There has
to be an entity that can step in and deal with the definitional
issues that you were touching upon in your question. But at the
same time, there has been this conscious effort to peel back
the rights of the States to protect their citizens. And in most
instances, those State laws are more aggressive than the
Federal laws.
Mr. Gohmert. Okay. I was trying to be specific on the
credit swap because if we can figure out exactly how we let
this get--or fall between the cracks so nobody picks it up,
then maybe we can avoid it. Because, let's face it, people on
Wall Street, people who came up with these ideas--Countrywide
pushed sometimes--they are smart people and they look for these
loopholes. And with credit swaps, heck, it basically sounds
like insurance. But if you don't call it insurance, you don't
have to put money in reserve to reserve against the insurable
event. And then we have a big problem.
So I am just looking for suggestions you might have on how
we keep it from falling between the cracks of the States and
the Federal Government.
Attorney General Madigan, I know you want the Federal
Government to run it all, but maybe you could elaborate.
Ms. Madigan. Obviously, one of the problems--and I don't
think we have specifically addressed it with this group--is, it
comes down to resources. I went through this Countrywide
investigation and lawsuit--six lawyers, and I have one of the
largest consumer protection bureaus in the country in an
attorney general's office.
So, obviously, resources was an issue. Last year alone, we
got over 33,000 consumer fraud complaints; we got 8,000 calls
from people who are struggling to pay their mortgages, who are
already in foreclosure. So we are attempting at the local level
to keep people in their homes and to do all we can to hold the
people involved in the mortgages.
Mr. Gohmert. My time is running out. I really appreciate
what you are doing. I am just looking for a way to figure out
how we keep another credit default swap from overwhelming.
I know my time is running out, Mr. Chairman.
If I could ask to submit in writing any suggestions you
might have as to how we can do it more effectively--I don't
need a term paper, just your own personal opinion of what we
can do to avoid this in the future.
Thank you, Mr. Chairman.
The Chairman. I am going to ask unanimous consent to just
take--the gentleman asked a very important question. I think
there is this distinction, because the problem with credit
default swaps was not that individuals were being swindled as
much as the cumulative impact was great. And that is not
something a State can do. The problem was that you had
accumulation of these that went beyond the capacity of the
system to handle them.
So I think there is a very important role for the States in
protecting investors from being mistreated. But when we are
talking about a systemic impact, that is inherently, I think, a
Federal thing. And that isn't always the case, but I think that
was the problem.
The problem with all insurance risk securities was that
people were not getting paid back. They weren't a systemic
risk. The problem with credit default swaps is that they became
a risk beyond any individual or any company nationally.
Mr. Gohmert. If I could just explain my question, though.
People at the State level often pick up on these quicker, and
even though it is a national problem, we should be the ones to
do something about it. There ought to be a way that they can
alert the Feds more quickly.
The Chairman. I appreciate the gentleman. If the gentleman
would yield, again, part of the problem though is--the problems
that went beyond any one State or the transactions in any one
State. One of the things we need to say, to be able to
accumulate these things, to keep track of all of them.
But there certainly needs to be--it is a cooperative
relationship and the States can, and have in some cases. I
believe the problem with auction rate securities, for example,
first came from the States alerting us.
The gentlewoman from California.
Ms. Waters. Thank you very much, Mr. Chairman, and I am
very appreciative for this hearing.
I am very appreciative for this panel. I was about to
regret that I had taken my Friday to come because the first
panel was obviously brain dead or something, except for maybe
the FDIC and the AG's office, I was beginning to feel a little
bit hopeless that we could get any real help in dealing with
these problems.
I think, Mr. Chairman, one of our real challenges is, how
do we have a clearinghouse on products without interfering in
``let the marketplace work?'' It seems to me as you gather in
the kind of interaction that you have described, that is one
thing that perhaps you can take a look at.
I know there are people who would think that, oh, you can't
have a clearinghouse where mere human beings would perhaps
interfere with products that were thought up by mathematicians
and others in the back room. But I think it is very important
that we find a way to look at these products before they hit
the market, so that we can at least do some kind of assessment
about what harm they may be causing to the citizens of this
country.
I want to especially thank this panel and, of course,
Attorney General Lisa Madigan and also Commissioner Bloom
Raskin. You have, I think, really inspired me and given me a
lot of hope that we certainly can do more.
Just the information that you gave us today about up-front
fees, I think can be executed also at the Federal level--and in
just talking with my chairman, as we whisper back and forth, he
seems to have liked that idea also.
And, of course, the preemption issue that he is talking
about, engaging the States and the Feds, I think is something
that can lead us to avoiding the kind of problems that we have
experienced in this meltdown and in this crisis.
I want to thank you for the work that you did on Ameriquest
and Household Finance. Household Finance had been around for
years, ripping off minority communities. I can remember as a
young woman with a family having been interactive with
Household Finance. So I want to thank you for all of that.
And I am just hopeful that you won't be in the position of
continuing to chase these bad actors all the way up to the Fed
door and then have the Fed door slammed in your face. And I
hope you come up with some real help to us in how you can take
your knowledge and your experience and all that information and
somehow work with the Feds to continue the chase until you get
them.
And that is it. Thank you very much.
The Chairman. The gentleman from Virginia.
Mr. Scott of Virginia. Thank you, Mr. Chairman. I wanted to
follow up on what you and the gentleman from Texas were talking
about on credit default swaps, because they are essentially
insurance products without the insurance regulation.
There are a couple of--and in terms of the marketplace
working, if you don't have to back these insurance products
with assets, you get to collect the assets, the premiums every
year, and when the house burns down, you don't have any money.
That is a very profitable business when--when the house burns
down, you either declare bankruptcy or get bailed out.
Ms. Waters. Yes.
Mr. Scott of Virginia. But in the meantime, it is a very
profitable business.
One of the things that the insurance requires is, one, it
has to be backed by assets. And it can't get out of control
because you have a finite amount of assets to back up your
insurance assets guarantee.
The other thing is, you have to have, if it is insurance,
an insurable interest. Because if you don't have an insurable
interest, then you are just betting on outcomes and everybody
gets to play, and nobody is really--so if something bad happens
or good happens, people are just kind of betting on the side.
Can the panelists say something about the need for anything
that looks like insurance to actually have assets backing it up
and whether or not the principle of having an insurable
interest is still a good thing?
Mr. Galvin. I don't have insurance jurisdiction. But I
served in the legislature for a long time, and I was on the
Insurance Committee in a leadership role.
I think one of the things we have seen is--and this does
touch upon the earlier discussion we were having about
preemption--there is an ongoing discussion about where
insurance should be regulated, where appropriately it should be
regulated. Wholly, the market has become national and
international, but some of the principles have been lost. Those
two principles you are talking--speaking about, assets and a
particular insurable interest, are fundamental to anyone who
has studied insurance or knows anything about the concept that
there has to be some interest in why you are getting this
insurance policy.
I think what has happened in the migration from insurance
to credit default swaps is those principles have been lost. I
certainly think that the problem--and I tried to touch upon
this in my remarks--is the problem with trying to regulate
credit default swaps, as we now know them, it is almost like a
bacteria. It is going to change into something else; by the
time we have a vaccine to deal with the current outbreak, we
will have something new.
So I think that it does argue--and I know there has been
some discussion of this--of having some sort of a national
regulator deal with some of these more exotic products. I think
you may well have to look at that, and you may have to look at
the concept that the lady from California mentioned about some
sort of a clearinghouse of products or an identification of
products, a definition of terms.
Frankly, the credit default swaps issue touches quite close
to home to me, coming from Massachusetts. One of the major
problems we are having in our finances right now is one of our
larger public entities, the Massachusetts Turnpike Authority,
got into some very bad credit default swaps at this point, and
they are having difficulty living up to the terms of them to
the extent they had to vote the State's credit behind it.
It is a real problem. But I don't think simply trying to
identify what happened before is going to solve the problem
going forward.
I am not arguing for an insurance--national insurance
regulator exemption of the States or preemption of the States.
I am saying, I think you have to start identifying these
products where they really exist, in anticipation there will be
new products that will take their place.
Mr. Scott of Virginia. You can kind of call them different
things and tweak them here or there. But if you are ultimately
liable, if something occurs and there is insurance, you have to
have assets around it. And that will cure any getting out of
control because you only have limited assets. And then the
insurable interest will limit the number of people who can get
into the thing.
Let me ask all of the witnesses to talk about the
cooperation with the Feds. We talked about eliminating the
preemption, but in law enforcement, there has to be some
cooperation so you can effectively use all of your resources.
How has the Federal Government helped or hindered your
ability to go after the bad actors?
Ms. Madigan. I can address that. And I know some others
have as well.
Most, if not all of us, are involved in essentially
mortgage fraud task forces. I think there are 18 of them,
regional ones, and I know there are about 47 that are smaller
in nature. And so we work mainly on criminal matters
cooperatively with the Feds.
But in terms of the Countrywides, the Ameriquests, rarely
were we working with the Feds. We were working with the other
States, we were working with the other State bank regulators as
well.
Ms. Bloom Raskin. I would only add, in Maryland, for
example, we have teamed up with our U.S. attorney and with a
variety of State regulatory agencies in the area of mortgage
fraud to create a Maryland mortgage task force; and we find
these mechanisms to have great potential because they provide
for a sharing of information, a real two-way street in terms of
what we are all seeing.
And we all bring different things to the table in terms of
the levels of enforcement, the number of feet we have on the
ground, and these turned out to be critical mechanisms for
spotting trends very early.
Mr. Ropp. From my standpoint, I work with the Federal
Legislation Subcommittee with NASAA, and almost every Federal
act that we look at has some preemption language in it,
preempting State action in certain areas; and I am not sure it
is always thought through what the impact of this is going to
be.
Secretary Galvin and I both spoke about the situation with
Reg D 506 offerings, private placements where States have
effectively been taken off the case except for where we know
there is fraud. So we can't look at them to see if there are
dishonest, unethical practices or bad actors or people who have
prior records, which we used to be able to do. And frankly, now
we get notice filings which we just sort of look at quickly and
file away because we really have no authority anymore because
of preemption under NSMIA to look at these things. These are
some of the concepts; and Secretary Galvin has also mentioned
them in his remarks, where the Federal Government has preempted
the States from being able to do what we think is our job of
protecting investors.
The Chairman. The gentleman from Illinois.
Mr. Scott of Virginia. Mr. Chairman? If we could, if the
witnesses, in writing, could respond, we have had ways where we
could hinder. If you could make recommendations how we can
actually effectively help these investigations, we would
appreciate those.
Thank you, Mr. Chairman.
The Chairman. The gentleman from Illinois.
Mr. Foster. Secretary Galvin, you had mentioned market
timing trade frauds. What fraction of market timing trade
frauds do you think are actually detected? And do you view this
as basically a State or a national problem?
Mr. Galvin. The market timing issue--which Massachusetts
brought, I think, the first case in the Putnam Investment
case--was clearly a national trend in the mutual fund industry.
One of the amazing things about that case was that as we
got deeper into it, we had company after company saying, oh,
well, we did it too. And when we tried to go back at them and
say, well, why? Well, everyone was doing it. So it kind of
argued against the policing, the self-policing of the industry.
I mentioned in my oral testimony the necessity of looking
at mutual funds. I think mutual funds again are an area of
financial services that morphed over time. Initially, they
started out as fairly small, pooled assets--people thoughtfully
investing your money, safety in numbers--and they got into
something very different.
I think the common thread that runs through both the market
timing scandal and many of the other issues that we have dealt
with is the idea that you have two different types of
investors. Special people are taken care of. Market timing was
all about you took care of the special customers, you let them
trade at a higher rate, you let them get out and make a quick
profit, while the average person that was relying on mutual
funds for their financial security, they were stuck.
So I think that these issues, as they emerge, while they
are different in the particular, are similar in the fact that
they really get back to the idea that there are two sets of
customers--special treatment for special customers. And what we
at the State level, I think, are more likely to find is, when
that is occurring, we are able to move more nimbly sometimes.
That is not to argue with the Federal people. We work with
the SEC, we worked with them on auction rate securities. We
have to work together. This is not a case where, as I said, we
are competing.
Mr. Foster. Thank you. I have to move on to a few other
issues, but I think this is a ball we have to keep our eye on.
Attorney General Madigan, you mentioned that several
institutions had changed to a Federal charter to basically
avoid subpoenas. Is that effect instantaneous, or can you look
back to the years when they were--in fact, were State-
chartered?
Ms. Madigan. We have to decide whether or not we are going
to essentially fight a preemption battle with these entities
when things of that nature occur. So when we look at potential
targets and we know there are bad actors out there, the first
thing we have to do is determine, are we going to fight that
battle or are we going to go after the other bad actors? And
there are plenty of them.
And so, on a going-forward basis, I think what I mentioned
in terms of Countrywide, part of that settlement and previous
settlements with Ameriquest and others, we put in injunctive
measures--so no prepayment penalties; certain notifications
have to be made if you are going to change the terms.
We couldn't do that in Countrywide because on a going-
forward basis we wouldn't be able to. Arguably, once they have
moved, we will have to engage in a preemption battle even for
past conduct.
Mr. Foster. Okay. And did the large settlements against
FAMCO and Countrywide and others that you mentioned, did those
result in anyone being added to the black list of banned
individuals that are not allowed to participate in financial--
Ms. Madigan. I don't know the answer to that question. We
can find out.
Mr. Foster. Okay. That is a very interesting one.
And does anyone on the panel have any reservations about
Attorney General Madigan's assessment of the value of freezing
and rolling back the Federal preemption? Is there any downside
to that you can see?
Ms. Madigan. Not on this panel.
Mr. Foster. Okay.
Mr. Sharick, how does tax return fraud typically work? And
are there technological fixes that might make this harder to
accomplish?
Mr. Sharick. Tax return fraud is accomplished by altering
documents in some way, altering the information. There are a
number of solutions now that allow certain vendors to go
directly to the IRS and to the Social Security Administration
to verify information. But the great percentage of fraud that
you see in the mortgage industry has to somewhere center itself
around altered documentation.
Mr. Foster. Okay.
And I guess my last question is the same one I posed to the
previous panel as to the cost-effective amount of resources to
put into enforcement.
And so, if you could, each of you, I guess the first four
members of the panel, provide an estimate of your total budget
for enforcement activities, the total value of losses averted--
just an estimate, do the math--and how many additional losses
might be avoided by a 10 percent increase and a factor-of-two
increase in your enforcement efforts?
Mr. Galvin. I am not sure I am good at math questions, but
I will tell you that my division, the Securities Division, is
relatively small.
My total operating budget for all my divisions is about $40
million. The Securities Division probably is about $3 million
of that. We do recoup some fines for our use. Most of it goes
to our general fund.
In terms of what we have saved, I did cite in my testimony
literally millions of dollars. Just in the last year, we
returned over $10 million to Massachusetts investors. But in
some of the larger cases where we cooperated with our
colleagues in other States, the States led the effort, for
instance, on auction rate securities; and as I noted in my
testimony, over $61 billion has been freed up by that.
So I think in terms of bang for your buck, you are getting
a very good bang for your buck at the State level.
Mr. Foster. I would just like to see that quantified across
the range of enforcement activities so we can think sensibly
about where to put the increase in enforcement activities.
Ms. Madigan. As I mentioned, our legal team who dealt with
Countrywide--six lawyers. I don't have financial investigators
in the office, so we end up hiring experts. Total, statewide, I
probably have 28 lawyers who do consumer fraud work.
There is an endless number of bad actors in the mortgage
meltdown that we could go after--literally hundreds, if not
thousands of brokers. In terms of just the volume of consumer
fraud complaints around mortgage fraud that we received last
year, 2,400.
And so we could always use more resources. With more
resources, we would have the ability to prevent, as well as
recoup, potentially, some of those losses and keep people in
their homes, which is what our priority is right now out of the
attorney general's office in Illinois.
Mr. Foster. So, for example, doubling your budget would
double the amount--you are still in a situation where doubling
your budget would double the amount of bad actors and losses
you would avoid?
Ms. Madigan. Potentially. And we would love it if you could
help us do that.
Mr. Foster. I yield back.
The Chairman. I do want to add--yes, Mr. Ropp, go quickly.
Mr. Ropp. I just wanted to say, our budget, I would love to
have Secretary Galvin's $3 million budget. I have $800,000 in
Delaware. And we had two investors in the auction rate
securities who had $1,250,000 returned to them just in those
two complaints based upon the leadership work done by the
States and Secretary Galvin's office and Texas and Missouri and
other States. So there can be a huge bang for the buck.
And in another case, we had one fraud actor who ripped off
11 Delawarians for $400,000, which would have been half of my
budget.
Now, we didn't get all the money back, but certainly the
cases we do on a very inexpensive basis do a lot of good for
the citizens of the States.
The Chairman. I am just going to--Mr. Ropp, you did say
that you could use some help with the funding. I would say
this.
I do believe that the States should be given more power,
but I don't think I could support sending the money with it. I
don't think you are going to see the Federal Government
subsidizing the State enforcement. And I think you can point
out the amount you could recover; and at some point, we are all
going to have to explain to the American people who in the
absence of a sufficient level of taxation, they cannot expect
the government activity that they need to protect themselves.
So I do think, at some point we yield to that.
The only other thing I just want to underline, and
Commissioner Bloom Raskin talked about--I think it was
Commissioner Bloom Raskin--the $25,000 fraud, the case of an
individual who would look to some of the Federal people, like a
fairly small case.
And the answer is, I think that is precisely why elected
officials need to be in the mix, because the anger of
individual constituents and the fear that one of them will go
to the newspaper and look terribly sympathetic and unaided is a
powerful goad to an elected official intervening.
As you percolate up to the appointed officials here in
Washington, that gets attenuated. So as I said, there is a good
political science reason why you want to connect State
officials, because you don't want the electoral process so--I
don't want the consumer complaint process as insulated from
electoral politics as it is here.
The hearing is concluded. We appreciate this, and we will
be pursuing many of these issues.
[Whereupon, at 1:10 p.m., the committee was adjourned.]
A P P E N D I X
March 20, 2009
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